AMBC-2015.03.31-10Q


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
 
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended March 31, 2015
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
 
OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number: 1-10777
Ambac Financial Group, Inc.
(Exact name of Registrant as specified in its charter)
Delaware
 
13-3621676
(State of incorporation)
 
(I.R.S. employer identification no.)
 
 
 
One State Street Plaza, New York, New York
 
10004
(Address of principal executive offices)
 
(Zip code)
212-658-7470
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨
Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files).    Yes  x    No  ¨
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer”, “accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the Exchange Act): (Check one):
Large accelerated filer
x
Accelerated filer
¨
Non-accelerated filer
¨
Smaller reporting company
¨
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes  ¨    No  x
As of May 7, 2015, 45,003,680 shares of common stock, par value $0.01 per share, of the Registrant were outstanding.



AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
 
 
PAGE
 
 
 
 
PART I.
FINANCIAL INFORMATION
 
 
Item 1.
Unaudited Consolidated Financial Statements of Ambac Financial Group, Inc. and Subsidiaries
 
 
 
Consolidated Balance Sheet (Unaudited)
 
 
Consolidated Statements of Total Comprehensive Income (Unaudited)
 
 
Consolidated Statements of Stockholders' Equity (Unaudited)
 
 
Consolidated Statements of Cash Flows (Unaudited)
 
 
Notes to Unaudited Consolidated Financial Statements
 
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
 
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
 
Item 4.
Controls and Procedures
 
 
 
 
 
PART II.
OTHER INFORMATION
 
 
Item 1.
Legal Proceedings
 
Item 1A.
Risk Factors
 
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
 
Item 3.
Defaults Upon Senior Securities
 
 
Item 4.
Mine Safety Disclosures
 
Item 5.
Other Information
 
Item 6.
Exhibits
 
 
 
 
 
SIGNATURES
 


Table of Contents

PART I.    FINANCIAL INFORMATION
Item 1.     Financial Statements of Ambac Financial Group, Inc. and Subsidiaries
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
 
March 31,
 
December 31,
(Dollars in thousands, except share data)
2015
 
2014
 
(Unaudited)
 
 
Assets:
 
 
 
Investments:
 
 
 
Fixed income securities, at fair value (amortized cost: 2015—$4,672,886 and 2014—$4,514,878)
$
4,865,750

 
$
4,725,686

Fixed income securities pledged as collateral, at fair value (amortized cost: 2015—$64,432 and 2014—$64,378)
64,813

 
64,267

Short-term investments, at fair value (amortized cost: 2015—$220,980 and 2014—$360,069)
220,980

 
360,065

Other investments (includes 2015—$310,578 and 2014—$336,013 at fair value)
332,609

 
357,016

Total investments
5,484,152

 
5,507,034

Cash and cash equivalents
26,641

 
73,903

Receivable for securities
8,779

 
23,660

Investment income due and accrued
24,994

 
25,015

Premium receivables
951,999

 
1,000,607

Reinsurance recoverable on paid and unpaid losses
79,308

 
99,838

Deferred ceded premium
117,688

 
123,276

Subrogation recoverable
984,129

 
953,274

Loans
5,494

 
5,714

Derivative assets
113,622

 
109,017

Insurance intangible asset
1,347,295

 
1,410,920

Goodwill
514,511

 
514,511

Other assets
221,252

 
186,985

Variable interest entity assets:
 
 
 
Fixed income securities, at fair value
2,704,657

 
2,743,050

Restricted cash
6,219

 
7,708

Investment income due and accrued
3,783

 
1,284

Loans, at fair value
12,789,201

 
12,371,177

Other assets
2,886

 
2,891

Total assets
$
25,386,610

 
$
25,159,864

AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
 
March 31,
 
December 31,
(Dollars in thousands, except share data)
2015
 
2014
 
(Unaudited)
 
 
Liabilities and Stockholders’ Equity:
 
 
 
Liabilities:
 
 
 
Unearned premiums
$
1,583,615

 
$
1,673,785

Loss and loss expense reserves
4,475,991

 
4,752,007

Ceded premiums payable
59,268

 
60,436

Obligations under investment agreements
111,967

 
160,079

Deferred taxes
1,905

 
2,079

Current taxes
2,333

 
5,701

Long-term debt
979,001

 
971,116

Accrued interest payable
322,408

 
304,139

Derivative liabilities
447,356

 
406,944

Other liabilities
56,914

 
63,396

Payable for securities purchased
34,559

 
762

Variable interest entity liabilities:
 
 
 
Accrued interest payable
5,768

 
3,268

Long-term debt, at fair value
13,341,902

 
12,882,076

Derivative liabilities
2,125,713

 
2,200,163

Other liabilities
189

 
178

Total liabilities
23,548,889

 
23,486,129

Commitments and contingencies (see Note 11)
 
 
 
Stockholders’ equity:

 

Preferred stock, par value $0.01 per share; 20,000,000 shares authorized; issued and outstanding shares—none

 

Common stock, par value $0.01 per share; 130,000,000 shares authorized; issued and outstanding shares: 2015—45,006,057; 2014—45,005,932
450

 
450

Additional paid-in capital
189,533

 
189,138

Accumulated other comprehensive income
169,329

 
220,283

Accumulated earnings
1,204,001

 
989,290

Treasury stock, shares at cost: 2015—2,459; 2014—2,459
(56
)
 
(56
)
Total Ambac Financial Group, Inc. stockholders’ equity
1,563,257

 
1,399,105

Noncontrolling interest
274,464

 
274,630

Total stockholders’ equity
1,837,721

 
1,673,735

Total liabilities and stockholders’ equity
$
25,386,610

 
$
25,159,864

See accompanying Notes to Unaudited Consolidated Financial Statements

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Table of Contents

AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Total Comprehensive Income (Unaudited)
 
Three Months Ended March 31,
(Dollars in thousands, except share data)
2015
 
2014
Revenues:
 
 
 
Net premiums earned
$
65,718

 
$
82,547

Net investment income:
 
 
 
Securities available-for-sale and short-term
63,332

 
68,807

Other investments
9,651

 
1,994

Total net investment income
72,983

 
70,801

Other-than-temporary impairment losses:
 
 
 
Total other-than-temporary impairment losses
(10,361
)
 
(10,392
)
Portion of other-than-temporary impairment recognized in other comprehensive income
7,242

 

Net other-than-temporary impairment losses recognized in earnings
(3,119
)
 
(10,392
)
Net realized investment gains
54,101

 
16,289

Change in fair value of credit derivatives:
 
 
 
Realized gains and other settlements
419

 
775

Unrealized gains (losses)
(2,918
)
 
6,607

Net change in fair value of credit derivatives
(2,499
)
 
7,382

Derivative products
(37,774
)
 
(53,841
)
Net realized losses on extinguishment of debt
(93
)
 

Other income (expense)
(788
)
 
1,894

Income (loss) on variable interest entities
6,962

 
(5,542
)
Total revenues
155,491

 
109,138

Expenses:
 
 
 
Losses and loss (benefit)
(150,952
)
 
(140,011
)
Insurance intangible amortization
37,432

 
31,714

Underwriting and operating expenses
24,523

 
25,786

Interest expense
27,908

 
32,328

Total expenses (benefit)
(61,089
)
 
(50,183
)
Pre-tax income before reorganization items
216,580

 
159,321

Reorganization items

 
23

Pre-tax income
216,580

 
159,298

Provision for income taxes
1,709

 
3,249

Net income
214,871

 
156,049

Less: net (gain) loss attributable to noncontrolling interest
160

 
107

Net income attributable to common shareholders
$
214,711

 
$
155,942

Other comprehensive income (loss), after tax:
 
 
 
Net income
$
214,871

 
$
156,049

Unrealized gains (losses) on securities, net of deferred income taxes of $0
(17,448
)
 
88,722

Gains (losses) on foreign currency translation, net of deferred income taxes of $0
(33,805
)
 
4,284

Changes to postretirement benefit, net of tax of $0
(27
)
 
(204
)
Total other comprehensive income (loss), net of tax
(51,280
)
 
92,802

Total comprehensive income
163,591

 
248,851

Less: comprehensive (loss) gain attributable to the noncontrolling interest:
 
 
 
Net (gain) loss
160

 
107

Currency translation adjustments
(326
)
 
46

Total comprehensive income attributable to Ambac Financial Group, Inc.
$
163,757

 
$
248,698

Net income per share attributable to Ambac Financial Group, Inc. common shareholders:
 
 
 
Basic
$
4.75

 
$
3.46

Diluted
$
4.57

 
$
3.31

See accompanying Notes to Unaudited Consolidated Financial Statements

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AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Stockholders’ Equity (Unaudited)
 
 
 
Ambac Financial Group, Inc.
 
 
(Dollars in thousands)
Total
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Income
 
Preferred
Stock
 
Common
Stock
 
Additional Paid-in
Capital
 
Common
Stock Held
in Treasury,
at Cost
 
Noncontrolling
Interest
Balance at January 1, 2015
$
1,673,735

 
$
989,290

 
$
220,283

 
$

 
$
450

 
$
189,138

 
$
(56
)
 
$
274,630

Total comprehensive income
163,591

 
214,711

 
(50,954
)
 

 

 

 

 
(166
)
Stock-based compensation
393

 

 

 

 

 
393

 

 

Warrants exercised
2

 

 

 

 

 
2

 

 

Balance at March 31, 2015
$
1,837,721

 
$
1,204,001

 
$
169,329

 
$

 
$
450

 
$
189,533

 
$
(56
)
 
$
274,464

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at January 1, 2014
978,422

 
505,219

 
11,661

 

 
450

 
185,672

 
(19
)
 
275,439

Total comprehensive income
248,851

 
155,942

 
92,756

 

 

 

 

 
153

Stock-based compensation
1,537

 

 

 

 

 
1,537

 

 

Warrants exercised
1

 

 

 

 

 
1

 

 

Balance at March 31, 2014
$
1,228,811

 
$
661,161

 
$
104,417

 
$

 
$
450

 
$
187,210

 
$
(19
)
 
$
275,592

See accompanying Notes to Unaudited Consolidated Financial Statements

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AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows (Unaudited)
 
Three Months Ended March 31,
(Dollars in thousands)
2015
 
2014
Cash flows from operating activities:
 
 
 
Net income (loss) attributable to common shareholders
$
214,711

 
$
155,942

Noncontrolling interest in subsidiaries’ earnings
160

 
107

Net income (loss)
214,871

 
156,049

Adjustments to reconcile net income to net cash used in operating activities:
 
 
 
Depreciation and amortization
791

 
748

Amortization of bond premium and discount
(31,477
)
 
(27,940
)
Reorganization items

 
23

Share-based compensation
393

 
1,537

Deferred income taxes
(174
)
 
3

Current income taxes
(3,368
)
 
3,023

Unearned premiums, net
(84,582
)
 
(84,667
)
Losses and loss expenses, net
(197,332
)
 
(146,494
)
Ceded premiums payable
(1,168
)
 
(1,070
)
Investment income due and accrued
21

 
3,022

Premium receivables
48,608

 
34,907

Accrued interest payable
18,269

 
22,235

Amortization of insurance intangible assets
37,432

 
31,714

Net mark-to-market (gains) losses
2,918

 
(6,607
)
Net realized investment gains
(54,101
)
 
(16,289
)
Other-than-temporary impairment charges
3,119

 
10,392

Losses on extinguishment of debt
93

 

Variable interest entity activities
(6,962
)
 
5,542

Other, net
58,229

 
52,397

Net cash provided by operating activities
5,580

 
38,525

Cash flows from investing activities:
 
 
 
Proceeds from sales of bonds
487,462

 
276,555

Proceeds from matured bonds
299,715

 
230,290

Purchases of bonds
(919,361
)
 
(625,507
)
Proceeds from sales of other invested assets
36,543

 
36,894

Purchases of other invested assets
(10,176
)
 
(20,611
)
Change in short-term investments
139,085

 
56,016

Loans, net
220

 
(71
)
Change in swap collateral receivable
(37,239
)
 
(35,410
)
Other, net
779

 
(2,352
)
Net cash (used in) investing activities
(2,972
)
 
(84,196
)
Cash flows from financing activities:
 
 
 
Proceeds from warrant exercise
2

 
1

Payments for investment agreement draws
(49,872
)
 

Net cash provided by (used in) financing activities
(49,870
)
 
1

Net cash flow
(47,262
)
 
(45,670
)
Cash and cash equivalents at beginning of period
73,903

 
77,370

Cash and cash equivalents end of period
$
26,641

 
$
31,700

 
 
 
 
Supplemental disclosure of cash flow information:
 
 
 
Cash paid during the period for:
 
 
 
Income taxes
$
4,933

 
$

Interest on investment agreements
88

 
202

Cash payments related to reorganization items:
 
 
 
Professional fees paid for services rendered in connection with the Chapter 11 proceeding

 
81

See accompanying Notes to Unaudited Consolidated Financial Statements

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AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
1.    BACKGROUND AND BUSINESS DESCRIPTION
Ambac Financial Group, Inc. (“Ambac” or the “Company”), headquartered in New York City, is a financial services holding company incorporated in the state of Delaware on April 29, 1991.
Ambac has two reportable business segments: Financial Guarantee and Financial Services.
Ambac’s financial guarantee business segment is conducted through its primary operating subsidiary, Ambac Assurance Corporation (“Ambac Assurance”), and its wholly owned subsidiary, Ambac Assurance UK Limited (“Ambac UK”). Insurance policies issued by Ambac Assurance and Ambac UK generally guarantee payment when due of the principal and interest on the obligations guaranteed. Ambac Assurance also has another wholly-owned financial guarantee subsidiary, Everspan Financial Guarantee Corp. (“Everspan”), which has been in runoff since its acquisition in 1997. The deterioration of Ambac Assurance’s financial condition resulting from losses in its insured portfolio since 2007 has prevented Ambac Assurance from being able to write new business. An inability to write new business has and will continue to negatively impact Ambac’s future operations and financial results. Ambac Assurance’s ability to pay dividends and, as a result, Ambac’s liquidity, have been significantly restricted by the deterioration of Ambac Assurance’s financial condition, by the rehabilitation of the Segregated Account (as defined below) and by the terms of the Settlement Agreement, dated as of June 7, 2010 (the "Settlement Agreement"), by and among Ambac Assurance, Ambac Credit Products LLC (“ACP”), Ambac and certain counterparties to credit default swaps with ACP that were guaranteed by Ambac Assurance. Ambac Assurance is also restricted in its ability to pay dividends pursuant to regulatory restrictions, the terms of its Auction Market Preferred Shares, and the terms of agreements entered into with the Segregated Account. It is highly unlikely that Ambac Assurance will be able to make dividend payments to Ambac for the foreseeable future.
Ambac’s financial services business segment is conducted through subsidiaries of Ambac Assurance, which provide financial and investment products, including investment agreements, funding conduits and interest rate swaps, principally to the clients of its financial guarantee business. Ambac Assurance insured all of the obligations of its financial services subsidiaries. These businesses are in active runoff, which is being effectuated by transaction terminations, settlements, and scheduled amortization of contracts. The Financial Services business also maintains interest rate derivatives to mitigate exposure to floating rate insured obligations in the Financial Guarantee segment.
Ambac’s primary goal is to maximize shareholder value through executing the following key strategies:
Increasing the value of its investment in Ambac Assurance by actively managing its assets and liabilities with a focus on maximizing risk-adjusted investment portfolio returns and mitigating or remediating losses on poorly performing insured transactions through executing policy commutations, pursuing recoveries of losses through litigation and the exercise of contractual and legal rights, restructuring transactions, and other means; and
Selectively exploring opportunities to grow and diversify Ambac, which may include the development or acquisition of financial services businesses such as advisory, asset servicing, asset management and/or insurance.
As part of its asset/liability management strategy, Ambac Assurance is considering the possibility of entering into transactions whereby it would monetize certain assets and/or restructure or exchange its outstanding debt and insurance obligations with the objective of ending the Segregated Account Rehabilitation Proceedings (as defined below).
Although we are exploring new business opportunities for Ambac, no assurance can be given that we will be able to identify or execute the acquisition or development of any new business. In addition, there can be no assurance that we will be able to obtain the financial and other resources that may be required to finance the acquisition or development of any new business. Due to these factors, as well as uncertainties relating to the ability of Ambac Assurance to deliver value to Ambac, the value of our securities is speculative.
The execution of Ambac’s strategy to increase the value of its investment in Ambac Assurance is subject to the authority of the Rehabilitator (as defined below) to control the management of the Segregated Account (as defined below). In exercising such authority, the Rehabilitator will act for the benefit of policyholders, and will not take into account the interests of Ambac. Similarly, by operation of the contracts executed in connection with the establishment, and subsequent rehabilitation, of the Segregated Account, the Rehabilitator retains rights to oversee and approve certain actions taken by or in respect of Ambac Assurance. This oversight by the Rehabilitator could impair Ambac’s ability to execute certain of its strategies. Ambac Assurance's ability to commute policies or purchase certain investments may also be limited by available liquidity.
As a result of uncertainties associated with the aforementioned oversight by the Rehabilitator of the Segregated Account, management has concluded that there is substantial doubt about Ambac's ability to continue as a going concern. Ambac’s financial statements as of and for the and three and twelve months ending March 31, 2015 and December 31, 2014, respectively, are prepared assuming Ambac continues as a going concern and do not include any adjustment that might result from its inability to continue as a going concern.

5


In March 2010, Ambac Assurance established a Segregated Account pursuant to Wisc. Stat. §611.24 (2) (the “Segregated Account”) to segregate certain segments of Ambac Assurance’s liabilities, and the Office of the Commissioner of Insurance for the State of Wisconsin (“OCI” (which term shall be understood to refer to such office as regulator of Ambac Assurance and to refer to the Commissioner of Insurance for the State of Wisconsin as rehabilitator of the Segregated Account (the “Rehabilitator”), as the context requires)) commenced rehabilitation proceedings in the Dane County, Wisconsin Circuit Court (the “Rehabilitation Court”) with respect to the Segregated Account (the “Segregated Account Rehabilitation Proceedings”) in order to permit OCI to facilitate an orderly run-off and/or settlement of the liabilities allocated to the Segregated Account pursuant to the provisions of the Wisconsin Insurers Rehabilitation and Liquidation Act. On October 8, 2010, OCI filed a plan of rehabilitation for the Segregated Account (the “Segregated Account Rehabilitation Plan”) in the Rehabilitation Court. On June 11, 2014, the Rehabilitation Court approved amendments to the Segregated Account Rehabilitation Plan that had been proposed by the Rehabilitator, and the Segregated Account Rehabilitation Plan, as amended, became effective on June 12, 2014. Under the amended Segregated Account Rehabilitation Plan holders of permitted policy claims have received and will receive an initial interim cash payment for a portion of each policy claim (“Interim Payment”), together with the right to receive a deferred payment equal to the balance of the unpaid policy claim, as may be adjusted from time to time pursuant to the terms of the amended Segregated Account Rehabilitation Plan (“Deferred Amount”). Net par exposure as of March 31, 2015 for policies allocated to the Segregated Account was $18,052,539. Policy obligations not allocated to the Segregated Account remain in the General Account, and such policies in the General Account are not subject to and, therefore, will not be directly impacted by the Segregated Account Rehabilitation Plan.
To pay claims and other liabilities, the Segregated Account has the ability to demand payment from time to time under an aggregate excess of loss reinsurance agreement provided by Ambac Assurance (the “Reinsurance Agreement”). In addition, certain operating and administrative costs and expenses of the Segregated Account are reimbursable by Ambac Assurance pursuant to the Cooperation Agreement, dated as of March 24, 2010, by and between the Segregated Account and Ambac Assurance, as amended (the “Cooperation Agreement”). Ambac Assurance is not obligated to make payments under the Reinsurance Agreement or Cooperation Agreement if its surplus as regards to policyholders is less than $100,000 (the “Minimum Surplus Amount”). As long as the surplus as regards to policyholders is not less than the Minimum Surplus Amount, payments by Ambac Assurance to the Segregated Account under the Reinsurance Agreement and Cooperation Agreement are not capped. At March 31, 2015, Ambac Assurance’s surplus as regards to policyholders is at the Minimum Surplus Amount and therefore $26,169 of the Segregated Account’s insurance liabilities were not assumed by Ambac Assurance under the Reinsurance Agreement. In the event that Ambac Assurance does not generate future surplus in the amount of insurance liabilities not assumed under the Reinsurance Agreement, the Segregated Account would experience a shortfall in funds available to pay its liabilities. Any such shortfall would be a consideration for the Rehabilitator in the determination of whether any changes to the Segregated Account Rehabilitation Plan (as defined below) and/or the amount of partial policy claim payments are necessary or appropriate or whether to institute general rehabilitation proceedings against Ambac Assurance.
2.    BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES
The Company has disclosed its significant accounting policies in Note 2. Significant Accounting Policies in the Notes to Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014. The following significant accounting policies provide an update to those included in the Company’s Annual Report on Form 10-K.
Basis of Presentation
The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles ("GAAP") for interim financial reporting and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and disclosures required by GAAP for annual periods. These statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Annual Report on Form 10-K for the year ended December 31, 2014. The accompanying consolidated financial statements have not been audited by an independent registered public accounting firm in accordance with the standards of the Public Company Accounting Oversight Board (U.S.), but in the opinion of management such financial statements include all adjustments, consisting only of normal recurring adjustments, necessary for the fair statement of the Company’s consolidated financial position and results of operations. All material intercompany balances and transactions have been eliminated. The results of operations for the three months ended March 31, 2015 may not be indicative of the results that may be expected for the year ending December 31, 2015. The December 31, 2014 consolidated balance sheet was derived from audited financial statements.
The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. As additional information becomes available or actual amounts become determinable, the recorded estimates are revised and reflected in operating results.
Reclassifications
Certain reclassifications have been made to prior years' amounts to conform to the current year's presentation.
Recently Adopted and Recently Issued Accounting Standards
Adopted:
Effective January 1, 2015, Ambac adopted ASU 2014-08, Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360) - Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity. The objective of this ASU is to limit discontinued operations reporting to disposals of components of an entity that represent strategic shifts that have (or will have) a major effect on an entity's operations and financial results. Under previous U.S. GAAP, many disposals, some of which may be routine in nature and

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not a change in an entity's strategy, were reported in discontinued operations. The ASU also requires certain expanded disclosures for discontinued operations and disclosure of the pre-tax profit or loss of an individually significant component of an entity that does not qualify for discontinued operations reporting. The adoption of this ASU did not have a material effect on Ambac's financial statements.
Issued:
In April 2015, the FASB issued ASU 2015-03, Interest - Imputation of Interest (Subtopic 835-30). This ASU simplifies the presentation of debt issuance costs by requiring that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected by the amendments in this ASU. The ASU is effective for annual periods and interim periods within those annual periods beginning after December 15, 2015. Early adoption is also permitted for financial statements that have not been previously issued. Upon adoption, the ASU must be retrospectively applied to all prior periods presented. Ambac will adopt ASU 2015-02 on January 1, 2016. The adoption of this ASU is not expected to have a material impact on Ambac's financial statements.
In May 2015, the FASB issued ASU 2015-07, Fair Value Measurement (Topic 820) - Disclosures for Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent). Reporting entities are permitted to use net asset value ("NAV") as a practical expedient to measure the fair value of certain investments. Under current U.S. GAAP, investments that use the NAV practical expedient to measure fair value are categorized within the fair value hierarchy as level 2 or level 3 investments depending on their redemption attributes, which has led to diversity in practice. This ASU will remove the requirement to categorize within the fair value hierarchy all investments that use the NAV practical expedient for fair value measurement purposes. Furthermore, the ASU will remove the requirement to make certain disclosures for all investments that are eligible to be measured at fair value using the NAV practical expedient. The ASU is effective for fiscal years beginning after December 15, 2015 and interim periods with those fiscal years. The ASU must be applied retrospectively to all prior periods presented. Ambac will adopt ASU 2015-07 on January 1, 2016. The adoption of this ASU is not expected to have a material impact on Ambac's financial statements.
3.    SPECIAL PURPOSE ENTITIES, INCLUDING VARIABLE INTEREST ENTITIES ("VIEs")
Ambac, with its subsidiaries, has engaged in transactions with special purpose entities, including VIEs, in various capacities. Ambac most commonly provides financial guarantees, including credit derivative contracts, for various debt obligations issued by special purpose entities, including VIEs. Ambac has also sponsored special purpose entities that issued medium-term notes to fund the purchase of certain financial assets. Ambac is also an investor in collateralized debt obligations, mortgage-backed and other asset-backed securities issued by VIEs and its ownership interest is generally insignificant to the VIE and/or Ambac does not have rights that direct the activities that are most significant to such VIE. As further described in Note 1. Background and Business Description in the Notes to Consolidated Financial Statements included Part II, Item 8 in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014, on August 28, 2014, Ambac monetized its ownership of the junior surplus note issued to it by the Segregated Account by depositing the junior surplus note into a newly formed VIE trust in exchange for cash and an owner trust certificate, which represents Ambac's right to residual cash flows from the junior surplus note. Ambac does not consolidate the VIE. Ambac reports its interest in the VIE as an equity investment within Other investments on the Consolidated Balance Sheets with associated results from operations included within Net investment income: Other investments on the Consolidated Statements of Total Comprehensive Income (Loss).
Financial Guarantees:
Ambac’s subsidiaries provide financial guarantees in respect of assets held or debt obligations of special purpose entities, including VIEs. Ambac’s primary variable interest exists through this financial guarantee insurance or credit derivative contract. The transaction structures provide certain financial protection to Ambac. This financial protection can take several forms; however, the most common are over-collateralization, first loss and excess spread. In the case of over-collateralization (i.e., the principal amount of the securitized assets exceeds the principal amount of the debt obligations guaranteed), the structure allows the transaction to experience defaults among the securitized assets before a default is experienced on the debt obligations that have been guaranteed by Ambac’s subsidiaries. In the case of first loss, the financial guarantee insurance policy or credit derivative contract only covers a senior layer of losses on assets held or debt issued by special purpose entities, including VIEs. The first loss with respect to the assets is either retained by the asset seller or sold off in the form of equity or mezzanine debt to other investors. In the case of excess spread, the securitized assets contributed to special purpose entities, including VIEs, generate interest cash flows that are in excess of the interest payments on the related debt; such excess cash flow is applied to redeem debt, thus creating over-collateralization. Generally, upon deterioration in the performance of a transaction or upon an event of default as specified in the transaction legal documents, Ambac will obtain certain loss remediation rights. These rights may enable Ambac to direct the activities of the entity that most significantly impact the entity’s economic performance.
We determined that Ambac’s subsidiaries generally have the obligation to absorb a VIE's expected losses given that they have issued financial guarantees supporting the liabilities (and in certain cases assets). As further described below, we consolidated certain VIEs because: (i) we determined for certain transactions that experienced the aforementioned performance deterioration, that Ambac’s subsidiaries had the power, through voting rights or similar rights, to direct the activities of certain VIEs that most significantly impact the VIE’s economic performance because certain triggers had been breached in these transactions resulting in their ability to exercise certain loss remediation activities, or (ii) due to the passive nature of the VIEs’ activities, Ambac’s subsidiaries’ contingent loss remediation rights upon a breach of certain triggers in the future is considered to be the power to direct the activities that most significantly impact the VIEs’ economic performance. With respect to existing VIEs involving Ambac financial guarantees, Ambac is required to consolidate a VIE in the period that applicable triggers result in Ambac having control over the VIE’s most significant economic activities. A VIE is deconsolidated in the period that Ambac no longer has such control,

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which could occur in connection with insurance policies that are allocated to the Segregated Account, execution of remediation activities on the transaction or amortization of insured exposure, any of which may reduce the degree of Ambac’s control over a VIE.
Ambac Sponsored VIEs:
A subsidiary of Ambac transferred financial assets to two special purpose entities. The business purpose of these entities was to provide certain financial guarantee clients with funding for their debt obligations. These special purpose entities were established as separate legal entities, demonstrably distinct from Ambac and that Ambac, its affiliates or its agents could not unilaterally dissolve. The permitted activities of these entities were contractually limited to purchasing assets from Ambac, issuing MTNs to fund such purchase, executing derivative hedges and obtaining financial guarantee policies with respect to indebtedness incurred. Effective February 17, 2015, one of the special purpose entities was liquidated as it no longer had any outstanding liabilities. Ambac has not consolidated these entities because Ambac Assurance’s policies issued to these entities were allocated to the Segregated Account, thereby limiting Ambac’s control over the entities’ most significant economic activities. Ambac elected to account for its equity interest in these entities at fair value under the fair value option in accordance with the Financial Instruments Topic of the ASC. We believe that the fair value of the investments in these entities provides for greater transparency for recording profit or loss as compared to the equity method under the Investments – Equity Method and Joint Ventures Topic of the ASC. Refer to Note 7. Fair Value Measurements for further information on the valuation technique and inputs used to measure the fair value of Ambac’s equity interest in these entities. At March 31, 2015 and December 31, 2014 the fair value of these entities are $10,036 and $12,036, respectively, and is reported within Other assets on the Consolidated Balance Sheets.
Since their inception, there have been 15 individual transactions with these entities, of which 3 transactions remain outstanding as of March 31, 2015. Total principal amount of debt outstanding was $457,960 and $457,960 at March 31, 2015 and December 31, 2014, respectively. In each case, Ambac sold assets to these entities. The assets are composed of utility obligations with a weighted average rating of BBB at March 31, 2015 and weighted average life of 6.8 years. The purchase by these entities of financial assets was financed through the issuance of medium-term notes (“MTNs”), which are cross-collateralized by the purchased assets. The MTNs have the same expected weighted average life as the purchased assets. Derivative contracts (interest rate swaps) are used within the entities for economic hedging purposes only. Derivative positions were established at the time MTNs were issued to purchase financial assets. As of March 31, 2015 Ambac Assurance had financial guarantee insurance policies issued for all assets, MTNs and derivative contracts owned and outstanding by the entities.
Insurance premiums paid to Ambac Assurance by these entities are earned in a manner consistent with other insurance policies, over the risk period. Additionally, any losses incurred on such insurance policies are included in Ambac’s Consolidated Statements of Total Comprehensive Income (Loss). Under the terms of an Administrative Agency Agreement, Ambac provides certain administrative duties, primarily collecting amounts due on the obligations and making interest payments on the MTNs.
Consolidation of VIEs:
Upon initial consolidation of a VIE, we recognize a gain or loss in earnings for the difference between: (i) the fair value of the consideration paid, the fair value of any non-controlling interests and the reported amount of any previously held interests and (ii) the net amount, as measured on a fair value basis, of the assets and liabilities consolidated. Upon deconsolidation of a VIE, we recognize a gain or loss for the difference between: (i) the fair value of any consideration received, the fair value of any retained non-controlling investment in the VIE and the carrying amount of any non-controlling interest in the VIE and (ii) the carrying amount of the VIE’s assets and liabilities. Gains or losses from consolidation and deconsolidation that are reported in earnings are reported within Income (loss) on variable interest entities on the Consolidated Statements of Total Comprehensive Income (Loss).
The variable interest in a VIE generally involves one or more of the following: a financial guarantee policy issued to the VIE, a written credit derivative contract that references liabilities of the VIE or an investment in securities issued by the VIE. The impact of consolidating such VIEs on Ambac’s balance sheet is the elimination of transactions between the consolidated VIEs and Ambac’s operating subsidiaries and the inclusion of the VIE’s third party assets and liabilities. For a financial guarantee insurance policy issued to a consolidated VIE, Ambac does not reflect the financial guarantee insurance policy in accordance with the related insurance accounting rules under the Financial Services – Insurance Topic of the ASC. Consequently, upon consolidation, Ambac eliminates the insurance assets and liabilities associated with the policy from the Consolidated Balance Sheets. Such insurance assets and liabilities may include premium receivables, reinsurance recoverable, deferred ceded premium, subrogation recoverable, unearned premiums, loss and loss expense reserves, ceded premiums payable and insurance intangible assets. For investment securities owned by Ambac that are debt instruments issued by the VIE, the investment securities balance is eliminated upon consolidation. Ambac did not consolidate any VIEs solely as a result of purchases of the VIE’s debt instruments.
As of March 31, 2015 consolidated VIE assets and liabilities relating to 14 consolidated entities were $15,506,746 and $15,473,572, respectively. As of December 31, 2014, consolidated VIE assets and liabilities relating to 15 consolidated entities were $15,126,110 and $15,085,685, respectively. Ambac is not primarily liable for, and does not guarantee all of the debt obligations issued by the VIEs. Ambac would only be required to make payments on the VIE debt obligations in the event that the issuer of such debt obligations defaults on any principal or interest due and such obligation is guaranteed by Ambac. Additionally, Ambac’s creditors do not have rights with regard to the assets of the VIEs. Ambac evaluates the net income effects and earnings per share effects to determine attributions between Ambac and non-controlling interests as a result of consolidating a VIE. Ambac has determined that the net changes in fair value of most consolidated VIE assets and liabilities are attributable to Ambac due to Ambac’s interest through financial guarantee premium and loss payments with the VIE.
The financial reports of certain VIEs are prepared by outside trustees and are not available within the time constraints Ambac requires to ensure the financial accuracy of the operating results. As such, the financial results of certain VIEs are consolidated on a time lag that is no longer than 90 days.

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The table below provides the fair value of fixed income securities, by asset-type, held by consolidated VIEs as of March 31, 2015 and December 31, 2014
 
March 31,
2015
 
December 31,
2014
Investments:
 
 
 
Corporate obligations
$
2,704,657

 
$
2,743,050

Total variable interest entity assets: fixed income securities
$
2,704,657

 
$
2,743,050

The following table provides supplemental information about the loans held as assets and long-term debt associated with the VIEs for which the fair value option has been elected as of March 31, 2015 and December 31, 2014:
 
Estimated fair value
 
Unpaid principal balance
March 31, 2015
 
 
 
Loans
$
12,789,201

 
$
9,675,140

Long-term debt
13,341,902

 
11,299,861

December 31, 2014
 
 
 
Loans
12,371,177

 
10,236,695

Long-term debt
$
12,882,076

 
$
11,925,499

For the three months ended March 31, 2015, Ambac deconsolidated one VIE when the associated financial guarantee exposure matured. There was no gain or loss resulting from this deconsolidation.
Variable Interests in Non-Consolidated VIEs
The following table displays the carrying amount of the assets, liabilities and maximum exposure to loss of Ambac’s variable interests in non-consolidated VIEs resulting from financial guarantee and derivative contracts by major underlying asset classes, as of March 31, 2015 and December 31, 2014:
 
Carrying Value of Assets and Liabilities
 
Maximum
Exposure
To Loss
(1)
 
Insurance
Assets
(2)
 
Insurance
Liabilities
(3)
 
Net Derivative
Assets (Liabilities) 
(4)
March 31, 2015:
 
 
 
 
 
 
 
Global structured finance:
 
 
 
 
 
 
 
Collateralized debt obligations
$
1,297,393

 
$
303

 
$
3,889

 
$
(155,357
)
Mortgage-backed—residential
18,837,405

 
1,037,566

 
2,879,199

 

Other consumer asset-backed
4,460,126

 
55,219

 
671,303

 
(35,558
)
Other commercial asset-backed
2,943,920

 
129,218

 
124,124

 

Other
3,546,270

 
94,529

 
565,657

 
16,766

Total global structured finance
31,085,114

 
1,316,835

 
4,244,172

 
(174,149
)
Global public finance
30,674,652

 
438,852

 
513,664

 
(29,891
)
Total
$
61,759,766

 
$
1,755,687

 
$
4,757,836

 
$
(204,040
)
 
 
 
 
 
 
 
 
December 31, 2014:
 
 
 
 
 
 
 
Global structured finance:
 
 
 
 
 
 
 
Collateralized debt obligations
$
1,386,100

 
$
345

 
$
4,000

 
$
(145,565
)
Mortgage-backed—residential
19,464,549

 
1,011,888

 
2,924,987

 

Other consumer asset-backed
5,109,776

 
65,204

 
885,572

 
(36,877
)
Other commercial asset-backed
3,119,891

 
135,215

 
128,988

 

Other
3,801,382

 
97,345

 
599,915

 
18,176

Total global structured finance
32,881,698

 
1,309,997

 
4,543,462

 
(164,266
)
Global public finance
31,639,004

 
457,774

 
533,192

 
(22,135
)
Total
$
64,520,702

 
$
1,767,771

 
$
5,076,654

 
$
(186,401
)
(1)
Maximum exposure to loss represents the maximum future payments of principal and interest on insured obligations and derivative contracts plus Deferred Amounts and accrued and unpaid interest thereon. Ambac’s maximum exposure to loss does not include the benefit of any financial instruments (such as reinsurance or hedge contracts) that Ambac may utilize to mitigate the risks associated with these variable interests.

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(2)
Insurance assets represent the amount recorded in “Premium receivables” and “Subrogation recoverable” for financial guarantee contracts on Ambac’s Consolidated Balance Sheets.
(3)
Insurance liabilities represent the amount recorded in “Loss and loss expense reserves” and “Unearned premiums” for financial guarantee contracts on Ambac’s Consolidated Balance Sheets.
(4)
Net derivative assets (liabilities) represent the fair value recognized on credit derivative contracts and interest rate swaps on Ambac’s Consolidated Balance Sheets.
4.    COMPREHENSIVE INCOME
The following tables detail the changes in the balances of each component of accumulated other comprehensive income for the affected periods:
 
Unrealized Gains
(Losses) on
Available- for
Sale Securities
(1)
 
Amortization of
Postretirement
Benefit
(1)
 
Gain (Loss) on
Foreign Currency
Translation
(1)
 
Total
Three Months Ended March 31, 2015
 
 
 
 
 
 
 
Beginning Balance
$
210,693

 
$
10,031

 
$
(441
)
 
$
220,283

Other comprehensive income before reclassifications
33,554

 

 
(33,479
)
 
75

Amounts reclassified from accumulated other comprehensive income
(51,002
)
 
(27
)
 

 
(51,029
)
Net current period other comprehensive income (loss)
(17,448
)
 
(27
)
 
(33,479
)
 
(50,954
)
Balance at March 31, 2015
$
193,245

 
$
10,004

 
$
(33,920
)
 
$
169,329

 
 
 
 
 
 
 
 
Three Months Ended March 31, 2014
 
 
 
 
 
 
 
Beginning Balance
$
(41,910
)
 
$
10,847

 
$
42,724

 
$
11,661

Other comprehensive income before reclassifications
94,622

 

 
4,238

 
98,860

Amounts reclassified from accumulated other comprehensive income
(5,900
)
 
(204
)
 

 
(6,104
)
Net current period other comprehensive income (loss)
88,722

 
(204
)
 
4,238

 
92,756

Balance at March 31, 2014
$
46,812

 
$
10,643

 
$
46,962

 
$
104,417

(1)    All amounts are net of tax and noncontrolling interest. Amounts in parentheses indicate debits.
The following table details the significant amounts reclassified from each component of accumulated other comprehensive income for the affected periods:
 
 
Amount Reclassified from Accumulated
Other Comprehensive Income
(1)
 
Affected Line Item in the
Details about Accumulated Other
 
Three Months Ended March 31,
 
Consolidated Statement of
Comprehensive Income Components
 
2015
 
2014
 
Total Comprehensive Income
Unrealized Gains (Losses) on Available-for-Sale Securities
 
 
 
 
 
 
 
 
$
(51,002
)
 
$
(5,900
)
 
Net realized investment gains
 
 

 

 
Tax (expense) benefit
 
 
$
(51,002
)
 
$
(5,900
)
 
Net of tax and noncontrolling interest (3)
Amortization of Postretirement Benefit
 
 
 
 
 
 
Prior service cost
 
$
(166
)
 
$
(166
)
 
Underwriting and operating expenses (2)
Actuarial gains (losses)
 
139

 
(38
)
 
Underwriting and operating expenses (2)
 
 
(27
)
 
(204
)
 
Total before tax
 
 

 

 
Tax (expense) benefit
 
 
$
(27
)
 
$
(204
)
 
Net of tax and noncontrolling interest (3)
Total reclassifications for the period
 
$
(51,029
)
 
$
(6,104
)
 
Net of tax and noncontrolling interest (3)
(1)
Amounts in parentheses indicate debits to the Consolidated Statement of Comprehensive Income.
(2)
These accumulated other comprehensive income components are included in the computation of net periodic benefit cost.
(3)
Amount agrees with amount reported as reclassifications from AOCI in the disclosure about changes in AOCI balances.
5.     NET INCOME PER SHARE
Pursuant to the Second Modified Fifth Amended Plan of Reorganization of Ambac Financial Group, Inc. (the "Reorganization Plan"), 45,000,000 shares of new common stock at par value of $0.01 per share and 5,047,138 warrants were issued. Warrants entitle such holders to acquire up to 5,047,138 shares of new common stock at an exercise price of $16.67 per share at any time on or prior to April 30, 2023. For the three months

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ended March 31, 2015 and 2014, 125 and 51 warrants were exercised, respectively, resulting in an issuance of 125 and 51 shares of common stock, respectively. As of March 31, 2015, Ambac had 5,039,752 warrants outstanding.
Basic net income per share is computed by dividing net income attributable to common shareholders by the weighted-average number of common shares outstanding and vested restricted stock units. Diluted net income per share is computed by dividing net income attributable to common shareholders by the weighted-average number of common shares used for basic earnings per share plus all potential dilutive common shares outstanding during the period. All potential dilutive common shares outstanding consider common stock deliverable pursuant to warrants issued under the Reorganization Plan and unvested options, restricted stock units and performance stock units granted under employee and director compensation plans.
The following table provides a reconciliation of the common shares used for basic net income per share to the diluted shares used for diluted net income per share:
 
Three Months Ended March 31,
 
2015
 
2014
Weighted average number of common shares used for basic earnings per share
45,156,202

 
45,042,823

Effect of potential dilutive shares:
 
 
 
Warrants
1,751,798

 
1,998,028

Stock options
12,841

 
4,891

Restricted stock units
25,013

 

Performance stock units
3,145

 

Weighted average number of common shares and potential dilutive shares used for diluted earnings per share
46,948,999

 
47,045,742

Stock options to purchase 110,000 shares of common stock were outstanding but not included in the computation of diluted earnings per share because they were antidilutive under the treasury stock method for the three months ended March 31, 2015.
6.    FINANCIAL GUARANTEE INSURANCE CONTRACTS
Amounts presented in this Note relate only to Ambac’s non-derivative insurance business for insurance policies issued to beneficiaries, including VIEs, for which we do not consolidate the VIE.
Net Premiums Earned:
Gross premiums are received either upfront (typical of public finance obligations) or in installments (typical of structured finance obligations). For premiums received upfront, an unearned premium revenue (“UPR”) liability is established, which is initially recorded as the cash amount received. For installment premium transactions, a premium receivable asset and offsetting UPR liability is initially established in an amount equal to: (i) the present value of future contractual premiums due (the “contractual” method) or (ii) if the underlying insured obligation is a homogenous pool of assets which are contractually prepayable, the present value of premiums to be collected over the expected life of the transaction (the “expected” method). An appropriate risk-free rate corresponding to the weighted average life of each policy and currency is used to discount the future premiums contractually due or expected to be collected. For example, U.S. dollar exposures are discounted using U.S. Treasury rates while exposures denominated in a foreign currency are discounted using the appropriate risk-free rate for the respective currency. The weighted average risk-free rate at March 31, 2015 and December 31, 2014, was 2.5% and 2.7%, respectively, and the weighted average period of future premiums used to estimate the premium receivable at March 31, 2015 and December 31, 2014, was 9.6 years and 10.1 years, respectively.
Insured obligations consisting of homogeneous pools for which Ambac uses expected future premiums to estimate the premium receivable and UPR include residential mortgage-backed securities. As prepayment assumptions change for homogenous pool transactions, or if there is an actual prepayment for a “contractual” method installment transaction, the related premium receivable and UPR are adjusted in equal and offsetting amounts with no immediate effect on earnings using new premium cash flows and the then current risk-free rate.
Generally, the priority for the payment of financial guarantee premiums to Ambac, as required by the bond indentures of the insured obligations, is very senior in the waterfall. Additionally, in connection with the allocation of certain liabilities to the Segregated Account, trustees and other parties are required under the Segregated Account Rehabilitation Plan and related court orders to continue to pay installment premiums, notwithstanding the Segregated Account Rehabilitation Proceedings. In evaluating the credit quality of the premium receivables, management evaluates the transaction waterfall structures and the internal ratings of the transactions underlying the premium receivables. Uncollectable premiums are determined on a policy basis and utilize a combination of historical premium collection data in addition to cash flow analysis to determine if an impairment in the related policy's premium receivables exist. As of March 31, 2015 and December 31, 2014, approximately 32% and 32% of the premium receivables related to transactions with non-investment grade internal ratings, comprised mainly of non-investment grade RMBS and student loan transactions, which comprised 7% and 7%, of the total premium receivables at March 31, 2015 and 7% and 8%, of the total premium receivables at December 31, 2014, respectively. At March 31, 2015 and December 31, 2014, $17,082 and $17,780 respectively, of premium receivables were deemed uncollectable. Past due premiums on policies insuring non-investment grade obligations amounted to less than $500 at March 31, 2015.

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Below is the gross premium receivable roll-forward (direct and assumed contracts) for the affected periods:
 
Three Months Ended March 31,
 
2015
 
2014
Beginning premium receivable
$
1,000,607

 
$
1,453,021

Premium receipts
(27,453
)
 
(33,128
)
Adjustments for changes in expected and contractual cash flows
(5,918
)
 
(15,062
)
Accretion of premium receivable discount
6,282

 
10,370

Uncollectable premiums
698

 
(1,074
)
Other adjustments (including foreign exchange)
(22,217
)
 
3,987

Ending premium receivable
$
951,999

 
$
1,418,114

Similar to gross premiums, premiums ceded to reinsurers are paid either upfront or in installments. Premiums ceded to reinsurers reduce the amount of premiums earned by Ambac from its financial guarantee insurance policies.
When a bond issue insured by Ambac Assurance has been retired, including those retirements due to refundings or calls, any remaining UPR is recognized at that time to the extent the financial guarantee contract is legally extinguished, causing accelerated premium revenue. For installment premium paying transactions, the recognition of any remaining UPR is offset by the reduction of the related premium receivable to zero (as it will not be collected as a result of the retirement), which may cause negative accelerated premium revenue. Ambac’s accelerated premium revenue for retired obligations for the three months ended March 31, 2015 and 2014 was $22,852 and $25,114, respectively. Certain obligations insured by Ambac have been legally defeased whereby government securities are purchased by the issuer with the proceeds of a new bond issuance, or less frequently with other funds of the issuer, and held in escrow (a pre-refunding). The principal and interest received from the escrowed securities are then used to retire the Ambac-insured obligations at a future date either to their maturity date or a specified call date. Ambac has evaluated the provisions in certain financial guarantee insurance policies issued on legally defeased obligations and determined those insurance policies have not been legally extinguished and, therefore, premium revenue recognition has not been accelerated.
The effect of reinsurance on premiums written and earned was as follows:
 
Three months ended March 31, 2015
 
 
Three months ended March 31, 2014
 
Written
 
Earned
 
 
Written
 
Earned
Direct
$
1,062

 
$
71,649

 
 
$
(5,766
)
 
$
86,183

Assumed

 
22

 
 

 
68

Ceded
365

 
5,953

 
 
456

 
3,704

Net premiums
$
697

 
$
65,718

 
 
$
(6,222
)
 
$
82,547


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The table below summarizes the future gross undiscounted premiums to be collected and future premiums earned, net of reinsurance at March 31, 2015:
 
Future premiums
to be collected
(1)
 
Future
premiums to
be earned net of
reinsurance
(1)
Three months ended:
 
 
 
June 30, 2015
$
22,082

 
$
38,127

September 30, 2015
22,103

 
35,798

December 31, 2015
21,686

 
33,635

Twelve months ended:
 
 
 
December 31, 2016
83,054

 
123,206

December 31, 2017
76,968

 
110,175

December 31, 2018
72,261

 
101,113

December 31, 2019
68,564

 
94,047

Five years ended:
 
 
 
December 31, 2024
304,049

 
385,547

December 31, 2029
254,696

 
272,177

December 31, 2034
179,393

 
169,638

December 31, 2039
65,595

 
67,126

December 31, 2044
25,189

 
23,328

December 31, 2049
9,831

 
9,824

December 31, 2054
1,244

 
2,183

December 31, 2059
5

 
3

Total
$
1,206,720

 
$
1,465,927

(1)
Future premiums to be collected is undiscounted and relates to the discounted premium receivable asset recorded on Ambac's balance sheet. Future premiums to be earned, net of reinsurance relate to the unearned premium liability and deferred ceded premium asset 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 in Note 2. Basis of Presentation and Significant Accounting Principles in the Notes to Consolidated Financial Statements included in Ambac's Annual Report on Form 10-K for the year ended December 31, 2014. This results in a different premium receivable balance than if expected lives were considered. If installment paying policies are retired or prepay early, premiums reflected in the premium receivable asset and amounts reported in the above table for such policies may not be collected in the future. Future premiums to be earned also considers the use of contractual lives for many bond types which do not have homogeneous pools of underlying collateral, which results in higher unearned premium than if expected lives were considered. If those bonds types are retired early, premium earnings may be negative in the period of call or refinancing.
Loss and Loss Expense Reserves:
Below are the components of the Loss and loss expense reserves liability and the Subrogation recoverable asset at March 31, 2015 and December 31, 2014:
 
Unpaid Claims
 
Present Value of Expected
Net Cash Flows
 
 
 
 
Balance Sheet Line Item
Claims
 
Accrued
Interest
 
Claims and
Loss Expenses
 
Recoveries
 
Unearned
Premium
Revenue
 
Gross Loss and
Loss Expense
Reserves
March 31, 2015:
 
 
 
 
 
 
 
 
 
 
 
Loss and loss expense reserves
$
2,158,007

 
$
265,708

 
$
3,579,957

 
$
(1,268,916
)
 
$
(258,765
)
 
$
4,475,991

Subrogation recoverable
774,960

 
103,429

 
175,415

 
(2,037,933
)
 

 
(984,129
)
Totals
$
2,932,967

 
$
369,137

 
$
3,755,372

 
$
(3,306,849
)
 
$
(258,765
)
 
$
3,491,862

 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2014:
 
 
 
 
 
 
 
 
 
 
 
Loss and loss expense reserves
$
2,172,041

 
$
234,802

 
$
3,792,133

 
$
(1,205,621
)
 
$
(241,348
)
 
$
4,752,007

Subrogation recoverable
772,948

 
94,425

 
197,751

 
(2,018,398
)
 

 
(953,274
)
Totals
$
2,944,989

 
$
329,227

 
$
3,989,884

 
$
(3,224,019
)
 
$
(241,348
)
 
$
3,798,733


13

Table of Contents

Below is the loss and loss expense reserve roll-forward, net of subrogation recoverable and reinsurance, for the affected periods:
 
Three Months Ended March 31,
 
2015
 
2014
Beginning gross loss and loss expense reserves
$
3,798,733

 
$
5,470,234

Less reinsurance on loss and loss expense reserves
100,355

 
122,357

Beginning balance of net loss and loss expense reserves
$
3,698,378

 
$
5,347,877

Changes in the loss and loss expense reserves due to:
 
 
 
Current year:
 
 
 
Establishment of new loss and loss expense reserves, gross of RMBS subrogation and net of reinsurance
1

 
151

Total current year
1

 
151

Prior years:
 
 
 
Change in previously established loss and loss expense reserves, gross of RMBS subrogation and net of reinsurance
(132,639
)
 
(117,692
)
Claim and loss expense (payments) recoveries, net of subrogation and reinsurance
(104,202
)
 
(9,375
)
(Increase) decrease in previously established RMBS subrogation recoveries, net of reinsurance
(44,195
)
 
(18,331
)
Total prior years
(281,036
)
 
(145,398
)
Net change in net loss and loss expense reserves
(281,035
)
 
(145,247
)
Ending net loss and loss expense reserves
$
3,417,343

 
$
5,202,630

Add reinsurance on loss and loss expense reserves (1)
74,519

 
111,303

Ending gross loss and loss expense reserves
$
3,491,862

 
$
5,313,933

(1)
Reinsurance recoverable reported on the Balance Sheet also includes reinsurance recoverables of previously presented loss and loss expenses of $4,789 and $139 as of March 31, 2015 and 2014, respectively.
The positive development in loss and loss expense reserves established in prior years for the three months ended March 31, 2015 was primarily due to improved performance and lower interest rates in the RMBS portfolio and the impact of commutations and lower interest rates in the student loan portfolio. The positive development in loss and loss expense reserves established in prior years for the three months ended March 31, 2014 was primarily due to improved performance of the RMBS portfolio and higher commutation probabilities for student loan exposures.
The net change in net loss and loss expense reserves are included in losses and loss expenses in the Consolidated Statement of Total Comprehensive Income. Reinsurance recoveries of losses included in losses and loss expenses in the Consolidated Statements of Total Comprehensive Income (Loss) were an expense of $20,601 and $10,559 for the three months ended March 31, 2015 and 2014, respectively.

14

Table of Contents

The tables below summarize information related to policies currently included in Ambac’s loss and loss expense reserves or subrogation recoverable at March 31, 2015 and December 31, 2014. Net par exposures include capital appreciation bonds which are reported at the par amount at the time of issuance of the insurance policy. The weighted average risk-free rate used to discount loss reserves at March 31, 2015 and December 31, 2014 was 2.1% and 2.3%, respectively.
Surveillance Categories as of March 31, 2015
 
I/SL
 
IA
 
II
 
III
 
IV
 
V
 
Total
Number of policies
34

 
21

 
43

 
66

 
163

 
3

 
330

Remaining weighted-average contract period (in years)
7

 
16

 
17

 
21

 
13

 
6

 
15

Gross insured contractual payments outstanding:
 
 
 
 
 
 
 
 
 
 
 
 
 
Principal
$
910,033

 
$
399,516

 
$
4,186,210

 
$
3,550,121

 
$
9,376,691

 
$
59,712

 
$
18,482,283

Interest
339,721

 
159,138

 
8,484,779

 
2,286,780

 
1,928,647

 
19,651

 
13,218,716

Total
$
1,249,754

 
$
558,654

 
$
12,670,989

 
$
5,836,901

 
$
11,305,338

 
$
79,363

 
$
31,700,999

Gross undiscounted claim liability (1)
$
12,901

 
$
6,344

 
$
239,113

 
$
1,596,918

 
$
6,297,440

 
$
79,357

 
$
8,232,073

Discount, gross claim liability
(644
)
 
(605
)
 
(18,502
)
 
(521,225
)
 
(712,562
)
 
(6,592
)
 
(1,260,130
)
Gross claim liability before all subrogation and before reinsurance
$
12,257

 
$
5,739

 
$
220,611

 
$
1,075,693

 
$
5,584,878

 
$
72,765

 
$
6,971,943

Less:
 
 
 
 
 
 
 
 
 
 
 
 
 
Gross RMBS subrogation (2)

 

 

 

 
(2,579,450
)
 

 
(2,579,450
)
Discount, RMBS subrogation

 

 

 

 
11,097

 

 
11,097

Discounted RMBS subrogation, before reinsurance

 

 

 

 
(2,568,353
)
 

 
(2,568,353
)
Less:
 
 
 
 
 
 
 
 
 
 
 
 
 
Gross other subrogation (3)

 

 
(12,388
)
 
(142,548
)
 
(646,741
)
 
(13,356
)
 
(815,033
)
Discount, other subrogation

 

 
3,474

 
35,608

 
33,795

 
3,660

 
76,537

Discounted other subrogation, before reinsurance

 

 
(8,914
)
 
(106,940
)
 
(612,946
)
 
(9,696
)
 
(738,496
)
Gross claim liability, net of all subrogation and discounts, before reinsurance
$
12,257

 
$
5,739

 
$
211,697

 
$
968,753

 
$
2,403,579

 
$
63,069

 
$
3,665,094

Less: Unearned premium revenue
(8,812
)
 
(2,175
)
 
(107,836
)
 
(76,061
)
 
(63,368
)
 
(513
)
 
(258,765
)
Plus: Loss expense reserves

 
16

 
2,185

 
7,465

 
75,825

 
42

 
85,533

Gross loss and loss expense reserves
$
3,445

 
$
3,580

 
$
106,046

 
$
900,157

 
$
2,416,036

 
$
62,598

 
$
3,491,862

Reinsurance recoverable reported on Balance Sheet (4)
$
1

 
$
910

 
$
2,331

 
$
85,082

 
$
(9,016
)
 
$

 
$
79,308

 
(1)
Gross undiscounted claim liability includes unpaid claims, including accrued interest on Deferred Amounts, on policies allocated to the Segregated Account and Ambac's estimate of expected future claims.
(2)
RMBS subrogation represents Ambac’s probability-weighted estimate of subrogation recoveries from RMBS transaction sponsors for representation and warranty ("R&W") breaches.
(3)
Other subrogation primarily represents subrogation related to excess spread or other contractual cash flows on public finance and structured finance transactions, including RMBS.
(4)
Reinsurance recoverable reported on Balance Sheet includes reinsurance recoverables of $74,519 related to future loss and loss expenses and $4,789 related to previously presented loss and loss expenses.

15

Table of Contents

Surveillance Categories as of December 31, 2014
 
I/SL
 
IA
 
II
 
III
 
IV
 
V
 
Total
Number of policies
36

 
26

 
33

 
69

 
160

 
1

 
325

Remaining weighted-average contract period (in years)
8

 
12

 
15

 
21

 
12

 
6

 
16

Gross insured contractual payments outstanding:
 
 
 
 
 
 
 
 
 
 
 
 
 
Principal
$
1,026,513

 
$
519,291

 
$
3,091,744

 
$
3,792,559

 
$
9,892,760

 
$
47

 
$
18,322,914

Interest
418,746

 
212,296

 
1,878,770

 
2,765,537

 
1,979,627

 
19

 
7,254,995

Total
$
1,445,259

 
$
731,587

 
$
4,970,514

 
$
6,558,096

 
$
11,872,387

 
$
66

 
$
25,577,909

Gross undiscounted claim liability (1)
$
16,360

 
$
11,525

 
$
155,488

 
$
2,040,402

 
$
6,456,139

 
$
60

 
$
8,679,974

Discount, gross claim liability
(1,147
)
 
(937
)
 
(16,438
)
 
(716,812
)
 
(774,611
)
 
(3
)
 
(1,509,948
)
Gross claim liability before all subrogation and before reinsurance
$
15,213

 
$
10,588

 
$
139,050

 
$
1,323,590

 
$
5,681,528

 
$
57

 
$
7,170,026

Less:
 
 
 
 
 
 
 
 
 
 
 
 
 
Gross RMBS subrogation (2)

 

 

 

 
(2,541,219
)
 

 
(2,541,219
)
Discount, RMBS subrogation

 

 

 

 
17,679

 

 
17,679

Discounted RMBS subrogation, before reinsurance

 

 

 

 
(2,523,540
)
 

 
(2,523,540
)
Less:
 
 
 
 
 
 
 
 
 
 
 
 
 
Gross other subrogation (3)

 

 
(18,034
)
 
(127,143
)
 
(647,110
)
 

 
(792,287
)
Discount, other subrogation

 

 
6,069

 
36,779

 
48,960

 

 
91,808

Discounted other subrogation, before reinsurance

 

 
(11,965
)
 
(90,364
)
 
(598,150
)
 

 
(700,479
)
Gross claim liability, net of all subrogation and discounts, before reinsurance
$
15,213

 
$
10,588

 
$
127,085

 
$
1,233,226

 
$
2,559,838

 
$
57

 
$
3,946,007

Less: Unearned premium revenue
(10,945
)
 
(3,432
)
 
(73,749
)
 
(88,332
)
 
(64,890
)
 

 
(241,348
)
Plus: Loss expense reserves
3

 
1,303

 
1,968

 
6,470

 
84,330

 

 
94,074

Gross loss and loss expense reserves
$
4,271

 
$
8,459

 
$
55,304

 
$
1,151,364

 
$
2,579,278

 
$
57

 
$
3,798,733

Reinsurance recoverable reported on Balance Sheet (4)
$
73

 
$
890

 
$
1,355

 
$
110,957

 
$
(13,437
)
 
$

 
$
99,838

(1)
Gross undiscounted claim liability includes unpaid claims, including accrued interest on Deferred Amounts, on policies allocated to the Segregated Account and Ambac's estimate of expected future claims.
(2)
RMBS subrogation represents Ambac’s probability-weighted estimate of subrogation recoveries from RMBS transaction sponsors for representation and warranty ("R&W") breaches.
(3)
Other subrogation primarily represents subrogation related to excess spread or other contractual cash flows on public finance and structured finance transactions, including RMBS.
(4)
Reinsurance recoverable reported on Balance Sheet includes reinsurance recoverables of $100,355 related to future loss and loss expenses and $(517) related to previously presented loss and loss expenses.
Ambac records estimated subrogation recoveries for breaches of representations and warranties (R&W) by sponsors of certain RMBS transactions. Prior to the June 30, 2014 reporting period, Ambac utilized the Adverse and Random Sample approaches to estimate R&W subrogation recoveries for certain RMBS transactions. For a discussion of these subrogation recovery approaches, see Note 2. Basis Of Presentation And Significant Accounting Policies in the Notes to Consolidated Financial Statements included Part II, Item 8 in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014. Beginning with the June 30, 2014 reporting period, as a result of gaining further access to loan files, the Random Sample approach has been utilized for all transactions which were previously evaluated using the Adverse Sample approach.
Ambac has recorded RMBS subrogation recoveries of $2,568,353, ($2,540,710 net of reinsurance) and $2,523,540, ($2,496,515 net of reinsurance) at March 31, 2015 and December 31, 2014, respectively. The balance of RMBS subrogation recoveries and the related claim liabilities, by estimation approach, at March 31, 2015 and December 31, 2014, are as follows:
Approach
Gross loss
reserves before
subrogation
recoveries
(1)
 
Subrogation
recoveries
(2)(3)
 
Gross loss
reserves after
subrogation
recoveries
March 31, 2015:
 
 
 
 
 
Random samples (4)
$
1,899,087

 
$
(2,568,353
)
 
$
(669,266
)
 
 
 
 
 
 
December 31, 2014:
 
 
 
 
 
Random samples (4)
$
1,897,426

 
$
(2,523,540
)
 
$
(626,114
)

16

Table of Contents

(1)
Includes unpaid RMBS claims, including accrued interest on Deferred Amounts, on policies allocated to the Segregated Account.
(2)
The amount of recorded subrogation recoveries related to each securitization is limited to ever-to-date paid and unpaid losses plus the present value of expected cash flows for each policy. To the extent losses have been paid but not yet fully recovered, the recorded amount of RMBS subrogation recoveries may exceed the sum of the unpaid claims and the present value of expected cash flows 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 the sum of unpaid claims and the present value of expected cash flows, the net cash outflow for these policies is recorded as a “Loss and loss expense reserves” liability.
(3)
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.
(4)
From time to time R&W subrogation may include estimates of potential sponsor settlements that are currently in negotiation, but have not been subject to a sampling approach. However, such estimates are not material to Ambac’s financial results and therefore are included in the Random Sample section of this table.
Below is the rollforward of RMBS subrogation, by estimation approach, for the affected periods:
 
Random
sample
 
Adverse
sample
 
Total
Discounted RMBS subrogation (gross of reinsurance) at January 1, 2015
$
2,523,540

 
$

 
$
2,523,540

Changes recognized in 2015:
 
 
 
 
 
Changes in estimation approach

 

 

Impact of sponsor actions (1)

 

 

All other changes (2)
44,813

 

 
44,813

Discounted RMBS subrogation (gross of reinsurance) at March 31, 2015
$
2,568,353

 
$

 
$
2,568,353

 
 
 
 
 
 
Discounted RMBS subrogation (gross of reinsurance) at January 1, 2014
$
953,825

 
$
1,252,773

 
$
2,206,598

Changes recognized in 2014:
 
 
 
 
 
Changes in estimation approach

 

 

Impact of sponsor actions (1)

 

 

All other changes (2)
51,789

 
(34,092
)
 
17,697

Discounted RMBS subrogation (gross of reinsurance) at March 31, 2014
$
1,005,614

 
$
1,218,681

 
$
2,224,295

(1)
Sponsor actions include loan repurchases, direct payments to Ambac and other contributions.
(2)
All other changes which may impact RMBS subrogation recoveries include changes in actual or projected collateral performance, changes in the creditworthiness of a sponsor, and/or the projected timing of recoveries. All other changes may also include estimates of potential sponsor settlements that are currently in negotiation but have not been subject to a sampling approach. However, such estimates are not material to Ambac’s financial results and therefore are included in the Random Sample column of this table.
Insurance intangible asset:
The insurance intangible amortization expense is included in insurance intangible amortization on the Consolidated Statements of Total Comprehensive Income (Loss). For the three months ended March 31, 2015 and 2014, the insurance intangible amortization expense was $37,432 and $31,714, respectively. As of March 31, 2015 and December 31, 2014, the gross carrying value of the insurance intangible asset was $1,631,068 and $1,660,125, respectively. Accumulated amortization of the insurance intangible asset was $283,773 and $249,205, as of March 31, 2015 and December 31, 2014, respectively, resulting in a net insurance intangible asset of $1,347,295 and $1,410,920, respectively.
The estimated future amortization expense for the net insurance intangible asset is as follows:
 
 
2015
 
2016
 
2017
 
2018
 
2019
 
Thereafter
Amortization expense
 
$
90,801

 
$
107,443

 
$
97,726

 
$
90,095

 
$
83,380

 
$
877,850


17

Table of Contents

7.    FAIR VALUE MEASUREMENTS
The Fair Value Measurement Topic of the ASC establishes a framework for measuring fair value and disclosures about fair value measurements.
Fair Value Hierarchy:
The Fair Value Measurement Topic of the ASC specifies a fair value hierarchy based on whether the inputs to valuation techniques used to measure fair value are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect Company-based assumptions. The fair value hierarchy prioritizes model inputs into three broad levels as follows:
Ÿ Level 1
 
Quoted prices for identical instruments in active markets. Assets and liabilities classified as Level 1 include US Treasury securities, exchange traded futures contracts, variable rate demand obligations, money market funds and mutual funds.
 
 
Ÿ Level 2
 
Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets. Assets and liabilities classified as Level 2 generally include investments in fixed income securities representing municipal, asset-backed and corporate obligations, most financial services derivatives and most long-term debt of variable interest entities consolidated under the Consolidation Topic of the ASC. Also included are equity interests in pooled investment funds measured at fair value where the investment can be redeemed in the near term at a value based on the net asset value.