5.	FINANCIAL GUARANTEE INSURANCE CONTRACTS

Net Premiums Earned

The portfolio of financial guarantees discussed in Note 4, Financial Guarantees in Force, includes financial guarantee contracts that meet the definition of insurance contracts as well as those that meet the definition of derivative contracts. Amounts presented in this Note relates only to Ambac’s non-derivative insurance business for insurance policies issued to beneficiaries, including VIEs, for which we do not consolidate the VIE.

Below is the gross premium receivable roll-forward (direct and assumed contracts) for the periods ended December 31, 2012 and 2011:


	December 31, 2012			December 31, 2011
Premium receivable at January 1, 2012 and 2011	$	2,028,479		$	2,422,596
Premium payments received		(155,626	)		(190,823	)
Adjustments for changes in expected life of homogeneous pools and actual changes to contractual cash flows		(299,906	)		(240,547	)
Accretion of premium receivable discount		50,407			62,841
Consolidation of certain VIEs		—			(104,736	)
Deconsolidation of certain VIEs		—			87,978
Uncollectible premiums		(28,031	)		—
Other adjustments (including foreign exchange)		25,298			(8,830	)

Premium receivable at December 31, 2012 and 2011	$	1,620,621		$	2,028,479

The effect of reinsurance on premiums written and earned was as follows:


	2012						2011
	Written			Earned			Written			Earned
Direct	($	277,508	)	$	434,488		($	171,283	)	$	429,033
Assumed		—			155			(7,670	)		(345	)
Ceded		23,371			(20,039	)		20,835			(22,718	)

Net premiums	($	254,137	)	$	414,604		($	158,118	)	$	405,970

The table below summarizes the future gross undiscounted premiums expected to be collected, and future expected premiums earned, net of reinsurance at December 31, 2012:


	Future premiums expected to be collected ⁽¹⁾		Future expected premiums to be earned, net of reinsurance ⁽¹⁾
Three months ended:
March 31, 2013	$	35,559	$	58,837
June 30, 2013		34,183		56,236
September 30, 2013		32,926		53,603
December 31, 2013		32,241		51,675

Twelve months ended:
December 31, 2014		137,580		193,964
December 31, 2015		132,688		179,782
December 31, 2016		127,268		169,673
December 31, 2017		121,879		159,999

Five years ended:
December 31, 2022		540,832		670,854
December 31, 2027		424,888		478,565
December 31, 2032		300,682		306,473
December 31, 2037		155,521		156,287
December 31, 2042		51,660		44,426
December 31, 2047		15,266		15,142
December 31, 2052		3,642		4,695
December 31, 2057		92		297

Total	$	2,146,907	$	2,600,508

(1)

The future premiums expected to be collected and future premiums expected to be earned, net of reinsurance disclosed in the above table relate to the discounted premium receivable asset and unearned premium liability recorded on Ambac’s balance sheet. The use of contractual lives for many bond types which do not have homogeneous pools of underlying collateral is required in the calculation of the premium receivable as described above, which results in a higher premium receivable balance than if expected lives were considered. If installment paying policies are retired early as a result of rate step-ups or other early retirement provision incentives for the issuer, premiums reflected in the premium receivable asset and amounts reported in the above table for such policies may not be collected in the future.

Loss and Loss Expense Reserves:

A loss reserve is recorded on the balance sheet on a policy-by-policy basis for the excess of: (a) the present value of expected net cash flows required to be paid under an insurance contract, over (b) the UPR for that contract. Below is the loss reserve roll-forward, net of subrogation recoverable and reinsurance for the years ended December 31, 2012 and 2011:


	Year Ended December 31, 2012			Year Ended December 31, 2011
Beginning balance of loss and loss expense reserves, net of subrogation recoverable and reinsurance	$	6,230,780		$	4,424,450
Changes in the loss and loss expense reserves due to:
Current year:
Establishment of new loss and loss expense reserves, gross of subrogation and net of reinsurance		464,058			503,697
Paid claims and loss expenses, net of subrogation and reinsurance		(20,765	)		(2,442	)
Establishment of subrogation recoveries, net of reinsurance		—			(9,761	)

Total current year		443,293			491,494
Prior years:
Change in previously established loss and loss expense reserves, gross of subrogation and net of reinsurance		72,700			1,683,831
Paid claims and loss expenses, net of subrogation and reinsurance		(944,860	)		(179,440	)
Change in previously established subrogation recoveries, net of reinsurance		172,818			(324,151	)

Total prior years		(699,342	)		1,180,240
Net change in loss and loss expense reserves		(256,049	)		1,671,734
Net deconsolidation of VIEs		—			134,596

Ending loss and loss expense reserves, net of subrogation recoverable and reinsurance	$	5,974,731		$	6,230,780

The adverse development in loss reserves established in prior years for the year ended December 31, 2012 was primarily due to the continued deterioration of collateral supporting structured finance policies, including RMBS and student loan exposures which resulted in greater expected ultimate losses and lower expected subrogation recoveries related to representation and warranty breaches on insured RMBS securitizations.

The net change in loss reserves of ($256,049) and $1,671,734 for the years ended December 31, 2012 and 2011, respectively, are included in loss and loss expenses in the Consolidated Statement of Total Comprehensive Loss. Loss expense reserves are also established for surveillance, legal and other mitigation expenses associated with adversely classified credits. Total net loss expense reserves, included in the above table, were $136,790 and $86,171 at December 31, 2012 and December 31, 2011, respectively. Total loss expense of $83,226 and $26,384 for the years ended December 31, 2012 and 2011, respectively, are included in loss and loss expenses in the Consolidated Statement of Total Comprehensive Loss. During the years ended December 31, 2012 and 2011, reinsurance recoveries of losses included in loss and loss expenses in the Consolidated Statement of Total Comprehensive Loss were $6,996 and $42,508, respectively.

The tables below summarize information related to policies currently included in Ambac’s loss reserves or subrogation recoverable at December 31, 2012 and 2011:

Surveillance Categories (at December 31, 2012)


	I/SL			IA			II			III			IV			V			Total
Number of policies		14			12			28			114			147			1			316
Remaining weighted-average contract period (in years)		15			21			18			20			8			6			13
Gross insured contractual payments outstanding:
Principal	$	311,157		$	786,998		$	1,245,793		$	9,161,747		$	12,554,628		$	47		$	24,060,370
Interest		166,276			715,129			379,237			4,905,775			3,076,746			20			9,243,183

Total	$	477,433		$	1,502,127		$	1,625,030		$	14,067,522		$	15,631,374		$	67		$	33,303,553

Gross undiscounted claim liability	$	2,135		$	40,898		$	49,521		$	4,051,076		$	7,976,765		$	67		$	12,120,462
Discount, gross claim liability		(219	)		(3,532	)		(3,247	)		(1,342,910	)		(788,720	)		(3	)		(2,138,631	)

Gross claim liability before all subrogation and before reinsurance	$	1,916		$	37,366		$	46,274		$	2,708,166		$	7,188,045		$	64		$	9,981,831

Less:
Gross RMBS subrogation⁽¹⁾		—			—			—			(16,170	)		(2,544,993	)		—			(2,561,163	)
Discount, RMBS subrogation		—			—			—			312			37,626			—			37,938

Discounted RMBS subrogation, before reinsurance		—			—			—			(15,858	)		(2,507,367	)		—			(2,523,225	)

Less:
Gross other subrogation⁽²⁾		—						—			(141,012	)		(766,717	)		—			(907,729	)
Discount, other subrogation		—						—			21,238			15,711			—			36,949

Discounted other subrogation, before reinsurance		—						—			(119,774	)		(751,006	)		—			(870,780	)

Gross claim liability, net of all subrogation and discounts, before reinsurance		1,916			37,366			46,274			2,572,534			3,929,672			64			6,587,826

Less: Unearned premium reserves		(1,179	)		(21,626	)		(17,120	)		(450,247	)		(113,622	)		—			(603,794	)
Plus: Loss adjustment expenses reserves		—			—			—			—			138,108			—			138,108

Claim liability reported on Balance Sheet, before reinsurance⁽³⁾		737			15,740			29,154			2,122,287			3,954,158			64			6,122,140

	I/SL			IA			II			III			IV			V			Total
Reinsurance recoverable reported on Balance Sheet		—			1,078			7,085			128,333			22,590			—			159,086

(1)	RMBS subrogation represents Ambac’s estimate of subrogation recoveries from RMBS transaction sponsors for representations and warranty breaches. Please see “RMBS Representation and Warranty Subrogation Recoveries” in Note 2 for a detailed discussion.

(2)	Other subrogation represents subrogation, including subrogation from RMBS transactions, other than subrogation as defined in (1) above.

(3)	Claim liability reported on the Balance Sheet, before reinsurance is included in the Consolidated Balance Sheets as follows:


Loss and loss expense reserve (net of potential subrogation recoveries of $2,611,430)	$	6,619,486
Subrogation recoverable (includes gross potential recovery of $782,575)		(497,346	)

	$	6,122,140

Loss reserves ceded to reinsurers at December 31, 2012 and 2011 were $147,409 and $153,480, respectively. Amounts were included in reinsurance recoverable on the Consolidated Balance Sheets.

Surveillance Categories (at December 31, 2011)


	I/SL			IA			II			III			IV			V			Total
Number of policies		27			10			38			125			129			1			330
Remaining weighted-average contract period (in years)		15			20			18			20			8			6			13
Gross insured contractual payments outstanding:
Principal	$	2,222,493		$	354,713		$	2,060,102		$	13,342,814		$	13,092,057		$	47		$	31,072,226
Interest		1,069,538			100,448			1,088,036			8,117,496			3,587,812			29			13,963,359

Total	$	3,292,031		$	455,161		$	3,148,138		$	21,460,310		$	16,679,869		$	76		$	45,035,585

Gross undiscounted claim liability	$	48,573		$	10,667		$	52,355		$	4,766,815		$	7,632,709		$	75		$	12,511,194
Discount, gross claim liability		(4,208	)		(2,316	)		(3,800	)		(1,440,704	)		(828,061	)		(21	)		(2,279,110	)

Gross claim liability before all subrogation and before reinsurance	$	44,365		$	8,351		$	48,555		$	3,326,111		$	6,804,648		$	54		$	10,232,084

Less:
Gross RMBS subrogation⁽¹⁾		—			—			—			(461,725	)		(2,316,920	)		—			(2,778,645	)
Discount, RMBS subrogation		—			—			—			12,278			46,101			—			58,379

Discounted RMBS subrogation, before reinsurance		—			—			—			(449,447	)		(2,270,819	)		—			(2,720,266	)

Less:
Gross other subrogation⁽²⁾		—			(256	)		—			(52,871	)		(667,744	)		—			(720,871	)
Discount, other subrogation		—			77			—			6,550			45,912			—			52,539

Discounted other subrogation, before reinsurance		—			(179	)		—			(46,321	)		(621,832	)		—			(668,332	)

Gross claim liability, net of all subrogation and discounts, before reinsurance		44,365			8,172			48,555			2,830,343			3,911,997			54			6,843,486

Less: Unearned premium reserves		(25,264	)		(5,126	)		(22,111	)		(335,332	)		(158,687	)		—			(546,520	)
Plus: Loss adjustment expenses reserves		—			—			—			—			87,294			—			87,294

Claim liability reported on Balance Sheet, before reinsurance⁽³⁾		19,101			3,046			26,444			2,495,011			3,840,604			54			6,384,260

Reinsurance recoverable reported on Balance Sheet		1,117			9			5,714			139,499			13,563			—			159,902

(1)	RMBS subrogation represents Ambac’s estimate of subrogation recoveries from RMBS transaction sponsors for representations and warranty breaches. Please see “RMBS Representation and Warranty Subrogation Recoveries” in Note 2 for detailed discussion.

(2)	Other subrogation represents subrogation, including subrogation from RMBS transactions, other than subrogation as defined in (1) above.

(3)	Claim liability reported on the Balance Sheet, before reinsurance is included in the Consolidated Balance Sheets as follows:


Loss and loss expense reserve (net of potential subrogation recoveries of $2,559,129)	$	7,044,070
Subrogation recoverable (includes gross potential recovery of $829,469)		(659,810	)

	$	6,384,260

As discussed in Note 2, Ambac records estimated subrogation recoveries for breaches of representations and warranties by sponsors of certain RMBS transactions utilizing an Adverse and Random Sample approach. Ambac has updated its estimated RMBS subrogation recoveries to $2,523,225 ($2,497,233 net of reinsurance) at December 31, 2012 from $2,720,266 ($2,692,414, net of reinsurance) at December 31, 2011. The balance of RMBS subrogation recoveries and the related claim liabilities, by estimation approach, at December 31, 2012 and December 31, 2011, are as follows:


	December 31, 2012
Approach	Count		Gross loss reserve before subrogation recoveries		Subrogation recoveries⁽¹⁾⁽²⁾			Gross loss reserve after subrogation recoveries
Adverse samples		27	$	2,331,878	$	(1,442,817	)	$	889,061
Random samples		22		1,231,466		(1,080,408	)		151,058

Totals		49	$	3,563,344	$	(2,523,225	)	$	1,040,119


	December 31, 2011
Approach	Count		Gross loss reserve before subrogation recoveries		Subrogation recoveries ⁽¹⁾⁽²⁾			Gross loss reserve after subrogation recoveries
Adverse samples		30	$	2,637,479	$	(1,457,472	)	$	1,180,007
Random samples		16		1,140,102		(1,262,794	)		(122,692	)

Totals		46	$	3,777,581	$	(2,720,266	)	$	1,057,315

(1)

The amount of recorded subrogation recoveries related to each securitization is limited to ever-to-date paid losses plus the present value of projected future paid losses for each policy. To the extent significant losses have been paid but not yet recovered, the recorded amount of subrogation recoveries may exceed the expected future claims for a given policy. The net cash inflow for these policies is recorded as a “Subrogation recoverable” asset. For those transactions where the subrogation recovery is less than expected future claims, the net cash outflow for these policies is recorded as a “Loss and loss expense reserve” liability.

(2)

As discussed in Note 2, the sponsor’s repurchase obligation may differ depending on the terms of the particular transaction and the status of the specific loan, such as whether it is performing or has been liquidated or charged off. The estimated subrogation recovery for these transactions is based primarily on loan level data provided through trustee reports received in the normal course of our surveillance activities or provided by the sponsor. While this data may not include all the components of the sponsor’s contractual repurchase obligation we believe it is the best information available to estimate the subrogation recovery.

Below is the rollforward of RMBS subrogation, by estimation approach, for the year ended December 31, 2012:


	Random sample			Number of transactions		Adverse sample			Number of transactions			Total
Rollforward:
Discounted RMBS subrogation (gross of reinsurance) at January 1, 2012	$	1,262,794			16	$	1,457,472			30		$	2,720,266

Changes recognized in 2012: Additional transactions reviewed		54,467			6		(35,486	)		(1	)		18,981
Additional adverse sample loans reviewed		—			n/a		—			—			—
Adverse loans repurchased by the sponsor		—			n/a		35			—			35
All other changes ⁽¹⁾		(236,853	)		n/a		20,796			(2	)		(216,057	)

Discounted RMBS subrogation (gross of reinsurance) at December 31, 2012	$	1,080,408			22	$	1,442,817			27		$	2,523,225

(1)

Other changes which may impact subrogation recoveries include changes in actual or projected collateral performance and/or the projected timing of recoveries. For the year ended December 31, 2012, two transactions were removed from the Adverse Sample subrogation population; however, the impacts on RMBS subrogation disclosed in the Adverse Sample column relate to multiple transactions.

Assumed Reinsurance:

At December 31, 2012, assumed par outstanding was $235,471. On March 24, 2010, all assumed reinsurance agreements with third parties were allocated to the Segregated Account, which will not allow for cancellations without the approval of the Rehabilitator.

Ceded Reinsurance:

Ambac Assurance has reinsurance in place pursuant to treaty and facultative reinsurance agreements. The reinsurance of risk does not relieve Ambac Assurance of its original liability to its policyholders. In the event that any of Ambac Assurance’s reinsurers are unable to meet their obligations under reinsurance contracts, Ambac Assurance would, nonetheless, be liable to its policyholders for the full amount of its policy.

Ambac Assurance’s reinsurance assets, including deferred ceded premiums and reinsurance recoverables on losses amounted to $326,365 at December 31, 2012. Credit exposure existed at December 31, 2012 with respect to reinsurance recoverables to the extent that any reinsurer may not be able to reimburse Ambac Assurance under the terms of these reinsurance arrangements. At December 31, 2012, there were ceded reinsurance balances payable of $94,527 offsetting this credit exposure.

To minimize its exposure to significant losses from reinsurer insolvencies, Ambac Assurance (i) is contractually entitled to receive collateral from its reinsurance counterparties in certain reinsurance contracts; and (ii) has certain cancellation rights that can be exercised by Ambac Assurance in the event of rating agency downgrades of a reinsurer (among other events and circumstances). Ambac Assurance held letters of credit and collateral amounting to approximately $302,692 from its reinsurers at December 31, 2012. As of December 31, 2012, the aggregate amount of insured par ceded by Ambac Assurance to reinsurers under reinsurance agreements was $21,396,732 with the largest reinsurer accounting for $18,779,685 or 7.7% of gross par outstanding at December 31, 2012. The following table represents the percentage ceded to reinsurers and reinsurance recoverable at December 31, 2012 and its rating levels as of March 15, 2013:


	Moody’s						Net unsecured
				Percentage ceded par			reinsurance recoverable (in thousands)⁽¹⁾
Reinsurers	Rating		Outlook	Percentage ceded par			reinsurance recoverable (in thousands)⁽¹⁾
Assured Guaranty Re Ltd		Baa1	Stable		87.77	%	$	—
Sompo Japan Insurance Inc		A1	Stable		6.82	%		—
Assured Guaranty Corporation		A3	Stable		5.41	%		13,370

Total					100.00	%	$	13,370

(1)	Represents reinsurance recoverables on paid and unpaid losses and deferred ceded premiums, net of ceded premium payables due to reinsurers, letters of credit, and collateral posted for the benefit of Ambac Assurance.