10-Q


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 September 30, 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
Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.    Yes  x    No  ¨
As of November 6, 2015, 45,020,521 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
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
Item 3.
 
Item 4.
 
 
 
 
 
PART II.
OTHER INFORMATION
 
 
Item 1.
 
Item 1A.
 
Item 2.
 
Item 3.
 
 
Item 4.
 
Item 5.
 
Item 6.
 
 
 
 
 
 


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
 
September 30,
 
December 31,
(Dollars in thousands, except share data)
2015
 
2014
 
(Unaudited)
 
 
Assets:
 
 
 
Investments:
 
 
 
Fixed income securities, at fair value (amortized cost: 2015—$4,869,500 and 2014—$4,514,878)
$
4,956,876

 
$
4,725,686

Fixed income securities pledged as collateral, at fair value (amortized cost: 2015—$64,556 and 2014—$64,378)
64,972

 
64,267

Short-term investments, at fair value (amortized cost: 2015—$364,784 and 2014—$360,069)
364,780

 
360,065

Other investments (includes 2015—$290,723 and 2014—$336,013 at fair value)
314,934

 
357,016

Total investments
5,701,562

 
5,507,034

Cash and cash equivalents
27,099

 
73,903

Receivable for securities
9,749

 
23,660

Investment income due and accrued
25,113

 
25,015

Premium receivables
895,446

 
1,000,607

Reinsurance recoverable on paid and unpaid losses
68,319

 
99,838

Deferred ceded premium
105,673

 
123,276

Subrogation recoverable
982,202

 
953,274

Loans
5,499

 
5,714

Derivative assets
91,088

 
109,017

Current taxes
985

 

Insurance intangible asset
1,279,448

 
1,410,920

Goodwill

 
514,511

Other assets
199,294

 
186,985

Variable interest entity assets:
 
 
 
Fixed income securities, at fair value
2,679,895

 
2,743,050

Restricted cash
5,895

 
7,708

Investment income due and accrued
3,940

 
1,284

Loans, at fair value
12,183,061

 
12,371,177

Other assets
2,651

 
2,891

Total assets
$
24,266,919

 
$
25,159,864

See accompanying Notes to Unaudited Consolidated Financial Statements
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
 
September 30,
 
December 31,
(Dollars in thousands, except share data)
2015
 
2014
 
(Unaudited)
 
 
Liabilities and Stockholders’ Equity:
 
 
 
Liabilities:
 
 
 
Unearned premiums
$
1,428,230

 
$
1,673,785

Loss and loss expense reserves
4,237,515

 
4,752,007

Ceded premiums payable
57,651

 
60,436

Obligations under investment agreements
100,358

 
160,079

Deferred taxes
1,957

 
2,079

Current taxes

 
5,701

Long-term debt
1,123,003

 
971,116

Accrued interest payable
334,999

 
304,139

Derivative liabilities
375,835

 
406,944

Other liabilities
59,809

 
63,396

Payable for securities purchased
87,697

 
762

Variable interest entity liabilities:
 
 
 
Accrued interest payable
5,855

 
3,268

Long-term debt, at fair value
12,791,012

 
12,882,076

Derivative liabilities
2,033,795

 
2,200,163

Other liabilities
166

 
178

Total liabilities
22,637,882

 
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: 45,036,587 and 45,005,932
450

 
450

Additional paid-in capital
189,981

 
189,138

Accumulated other comprehensive income
72,887

 
220,283

Accumulated earnings
1,091,946

 
989,290

Treasury stock, shares at cost: 16,066 and 2,459
(256
)
 
(56
)
Total Ambac Financial Group, Inc. stockholders’ equity
1,355,008

 
1,399,105

Noncontrolling interest
274,029

 
274,630

Total stockholders’ equity
1,629,037

 
1,673,735

Total liabilities and stockholders’ equity
$
24,266,919

 
$
25,159,864

See accompanying Notes to Unaudited Consolidated Financial Statements

1

Table of Contents

AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Total Comprehensive Income (Loss) (Unaudited)
 
Three Months Ended September 30,
 
 
Nine Months Ended September 30,
(Dollars in thousands, except share data)
2015
 
2014
 
 
2015
 
2014
Revenues:
 
 
 
 
 
 
 
 
Net premiums earned
$
71,535

 
$
64,831

 
 
$
198,132

 
212,391

Net investment income:
 
 
 
 
 
 
 
 
Securities available-for-sale and short-term
65,619

 
82,881

 
 
191,229

 
228,570

Other investments
(1,424
)
 
700

 
 
10,702

 
5,905

Total net investment income
64,195

 
83,581

 
 
201,931

 
234,475

Other-than-temporary impairment losses:
 
 
 
 
 
 
 
 
Total other-than-temporary impairment losses
(31,743
)
 
(4,715
)
 
 
(43,495
)
 
(19,737
)
Portion of other-than-temporary impairment recognized in other comprehensive income
22,593

 
(296
)
 
 
30,206

 
(4,420
)
Net other-than-temporary impairment losses recognized in earnings
(9,150
)
 
(5,011
)
 
 
(13,289
)
 
(24,157
)
Net realized investment gains (losses)
2,106

 
10,045

 
 
50,854

 
29,401

Change in fair value of credit derivatives:
 
 
 
 
 
 
 
 
Realized gains and other settlements
1,693

 
596

 
 
2,519

 
2,088

Unrealized gains (losses)
35,259

 
6,820

 
 
42,227

 
11,491

Net change in fair value of credit derivatives
36,952

 
7,416

 
 
44,746

 
13,579

Derivative products
(65,083
)
 
(15,685
)
 
 
(51,858
)
 
(117,511
)
Net realized gains (losses) on extinguishment of debt
1,420

 

 
 
81

 

Other income (expense)
7,150

 
1,046

 
 
5,206

 
8,206

Income (loss) on variable interest entities
(21,435
)
 
9,116

 
 
38,130

 
(34,574
)
Total revenues
87,690

 
155,339

 
 
473,933

 
321,810

Expenses:
 
 
 
 
 
 
 
 
Losses and loss expense (benefit)
(133,213
)
 
(28,698
)
 
 
(431,642
)
 
6,608

Insurance intangible amortization
39,680

 
41,908

 
 
115,200

 
109,878

Underwriting and operating expenses
25,006

 
25,513

 
 
75,402

 
75,332

Interest expense
29,899

 
31,841

 
 
85,980

 
96,122

Goodwill impairment
514,511

 

 
 
514,511

 

Total expenses (benefit)
475,883

 
70,564

 
 
359,451

 
287,940

Pre-tax income (loss) before reorganization items
(388,193
)
 
84,775

 
 
114,482

 
33,870

Reorganization items

 
2

 
 

 
211

Pre-tax income (loss)
(388,193
)
 
84,773

 
 
114,482

 
33,659

Provision for income taxes
2,838

 
2,344

 
 
8,464

 
3,414

Net income (loss)
(391,031
)
 
82,429

 
 
106,018

 
30,245

Less: net (gain) loss attributable to noncontrolling interest
(44
)
 
(21
)
 
 
(401
)
 
(242
)
Net income (loss) attributable to common shareholders
$
(390,987
)
 
$
82,450

 
 
$
106,419

 
$
30,487

Other comprehensive income (loss), after tax:
 
 
 
 
 
 
 
 
Net income (loss)
$
(391,031
)
 
$
82,429

 
 
$
106,018

 
$
30,245

Unrealized gains (losses) on securities, net of deferred income taxes of $0
8,382

 
(17,225
)
 
 
(122,905
)
 
256,660

Gains (losses) on foreign currency translation, net of deferred income taxes of $0
(30,909
)
 
(38,429
)
 
 
(24,224
)
 
(17,001
)
Changes to postretirement benefit, net of tax of $0
(220
)
 
(204
)
 
 
(467
)
 
(612
)
Total other comprehensive income (loss), net of tax
(22,747
)
 
(55,858
)
 
 
(147,596
)
 
239,047

Total comprehensive income (loss)
(413,778
)
 
26,571

 
 
(41,578
)
 
269,292

Less: comprehensive (loss) gain attributable to the noncontrolling interest:
 
 
 
 
 
 
 
 
Net (gain) loss
(44
)
 
(21
)
 
 
(401
)
 
(242
)
Currency translation adjustments
(272
)
 
(395
)
 
 
(200
)
 
(157
)
Total comprehensive income (loss) attributable to Ambac Financial Group, Inc.
$
(413,462
)
 
$
26,987

 
 
$
(40,977
)
 
$
269,691

Net income (loss) per share attributable to Ambac Financial Group, Inc. common shareholders
 
 
 
 
 
 
 
 
Basic
$
(8.66
)
 
$
1.83

 
 
$
2.36

 
$
0.68

Diluted
$
(8.66
)
 
$
1.77

 
 
$
2.30

 
$
0.65

See accompanying Notes to Unaudited Consolidated Financial Statements

2

Table of Contents

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 (loss)
(41,578
)
 
106,419

 
(147,396
)
 

 

 

 

 
(601
)
Stock-based compensation
2,150

 

 

 

 

 
2,150

 

 

Cost of shares (acquired) issued under equity plan
(256
)
 
(56
)
 

 

 

 

 
(200
)
 

Cost of warrants acquired
(5,017
)
 
(3,707
)
 

 

 

 
(1,310
)
 

 

Warrants exercised
3

 

 

 

 

 
3

 

 

Balance at September 30, 2015
$
1,629,037

 
$
1,091,946

 
$
72,887

 
$

 
$
450

 
$
189,981

 
$
(256
)
 
$
274,029

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at January 1, 2014
978,423

 
505,219

 
11,661

 

 
450

 
185,673

 
(19
)
 
275,439

Total comprehensive income (loss)
269,292

 
30,487

 
239,204

 

 

 

 

 
(399
)
Stock-based compensation
2,960

 

 

 

 

 
2,960

 

 

Warrants exercised
15

 

 

 

 

 
15

 

 

Balance at September 30, 2014
$
1,250,690

 
$
535,706

 
$
250,865

 
$

 
$
450

 
$
188,648

 
$
(19
)
 
$
275,040

See accompanying Notes to Unaudited Consolidated Financial Statements

3

Table of Contents

AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows (Unaudited)
 
 
Nine Months Ended September 30,
(Dollars in thousands)
 
2015
 
2014
Cash flows from operating activities:
 
 
 
 
Net income (loss) attributable to common shareholders
 
$
106,419

 
$
30,487

Noncontrolling interest in subsidiaries’ earnings
 
(401
)
 
(242
)
Net income (loss)
 
106,018

 
30,245

Adjustments to reconcile net income to net cash used in operating activities:
 
 
 
 
Depreciation and amortization
 
2,136

 
2,223

Impairment of goodwill
 
514,511

 

Amortization of bond premium and discount
 
(99,534
)
 
(50,432
)
Reorganization items
 

 
211

Share-based compensation
 
2,150

 
2,960

Deferred income taxes
 
(122
)
 
(23
)
Current income taxes
 
(6,686
)
 
47

Unearned premiums, net
 
(227,952
)
 
(284,355
)
Losses and loss expenses, net
 
(422,892
)
 
59,741

Ceded premiums payable
 
(2,785
)
 
(9,858
)
Investment income due and accrued
 
(98
)
 
4,845

Premium receivables
 
105,161

 
186,389

Accrued interest payable
 
30,860

 
81,956

Amortization of insurance intangible assets
 
115,200

 
109,878

Net mark-to-market (gains) losses
 
(42,227
)
 
(11,491
)
Net realized investment gains
 
(50,854
)
 
(29,401
)
Other-than-temporary impairment charges
 
13,289

 
24,157

Net realized (gains) losses on extinguishment of debt
 
(81
)
 

Variable interest entity activities
 
(38,130
)
 
34,574

Other, net
 
82,944

 
106,703

Net cash provided by operating activities
 
80,908

 
258,369

Cash flows from investing activities:
 
 
 
 
Proceeds from sales of bonds
 
797,660

 
1,727,142

Proceeds from matured bonds
 
695,879

 
896,936

Purchases of bonds
 
(1,696,858
)
 
(2,547,727
)
Proceeds from sales of other invested assets
 
147,336

 
40,173

Purchases of other invested assets
 
(101,913
)
 
(54,768
)
Change in short-term investments
 
(4,715
)
 
(279,781
)
Loans, net
 
215

 
112

Change in swap collateral receivable
 
(17,032
)
 
(105,354
)
Other, net
 
(2,480
)
 
6,553

Net cash (used in) investing activities
 
(181,908
)
 
(316,714
)
Cash flows from financing activities:
 
 
 
 
Proceeds from the sale of Junior Surplus Notes of the Segregated Account
 

 
224,262

Proceeds received from a secured borrowing
 
144,189

 

Paydowns of a secured borrowing
 
(7,355
)
 

Payments for investment agreement draws
 
(63,872
)
 
(199,970
)
Payments for extinguishment of long-term debt
 
(13,752
)
 

Proceeds from warrant exercises
 
3

 
15

Cost of warrants acquired
 
(5,017
)
 

Net cash provided by financing activities
 
54,196

 
24,307

Net cash flow
 
(46,804
)
 
(34,038
)
Cash and cash equivalents at beginning of period
 
73,903

 
77,370

Cash and cash equivalents end of period
 
$
27,099

 
$
43,332

 
 
 
 
 
Supplemental disclosure of cash flow information:
 
 
 
 
Cash paid during the period for:
 
 
 
 
Income taxes
 
$
15,176

 
$
3,246

Interest on secured borrowing
 
449

 

Interest on investment agreements
 
261

 
459

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

 
272

See accompanying Notes to Unaudited Consolidated Financial Statements

4

Table of Contents

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.
In October 2015, Ambac Assurance introduced a new program to invest in residential real estate owned (REO) properties from Ambac Assurance insured transactions.  A main component of the value creation will be the result of making repairs to the REO properties in order to bring them up to neighborhood standards.  Upon completion of necessary repairs, the properties will either be immediately re-sold or re-sold at a future date after being rented for a period of time.  We are working with third-party vendors for necessary expertise and infrastructure related to this initiative. This program will be rolled out gradually in order to validate our internal investment thesis. 
Ambac Assurance is considering the possibility of entering into transactions whereby it would monetize certain assets and/or restructure or exchange certain outstanding debt and insurance obligations with the objective of ending the Segregated Account Rehabilitation Proceedings (as defined below). In furtherance of such transactions, Ambac Assurance has discussed with OCI (as defined below), and has from time to time discussed with several counterparty creditors, a potential exchange pursuant to which outstanding surplus notes (other than junior surplus notes) and Deferred Amounts (as defined below), including accrued interest, would be exchanged for new securities and/or cash. As of the date of this filing, Ambac Assurance has not reached any agreement on the terms of a potential exchange, and we cannot provide assurance that any such transaction will be entered into by Ambac Assurance in the future, or if it is, as to the timing, terms or conditions of any such transaction. Any such transaction would remain subject to the prior approval of the board of Ambac Assurance, OCI and potentially the Rehabilitation Court (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.

5


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. 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 three and nine months ended September 30, 2015 and the year ended 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.
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 September 30, 2015 for policies allocated to the Segregated Account was $16,595,339. Policy obligations not allocated to the Segregated Account remain in the General Account of Ambac Assurance, 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 September 30, 2015, Ambac Assurance’s surplus as regards to policyholders of $350,559 exceeded the Minimum Surplus Amount. In the event that Ambac Assurance does not maintain surplus in excess of the Minimum Surplus Amount, 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 above) 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 financial 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 intercompany balances and transactions have been eliminated. The results of operations for the three and nine months ended September 30, 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.

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Goodwill:
At the Fresh Start Reporting Date, we revalued our assets and liabilities to current estimated fair value. The excess reorganization value which could not be attributed to the fair value of specific identified tangible and intangible assets ("fair value of net assets") was recorded as goodwill. Pursuant to the Intangibles - Goodwill and Other Topic of the ASC, goodwill is not amortized but is subject to annual impairment testing. We test goodwill for impairment as of October 1st of each year. Goodwill is also tested more frequently if indicators of impairment exist for each reporting unit. The Company has an option to first assess qualitative factors, in their totality, to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform a goodwill impairment test. If the Company determines that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, then the Company is required to perform the goodwill impairment test. Alternatively, we may bypass this qualitative assessment and perform step one of the goodwill impairment test described below.
Goodwill impairment is determined using a two-step approach. In step one of the goodwill impairment test, the fair value of a reporting unit is compared with its carrying amount, including goodwill. If the fair value is in excess of the carrying amount, including goodwill, the reporting unit’s goodwill is considered not to be impaired. If the carrying amount, including goodwill, of a reporting unit exceeds its fair value, the second step of the goodwill impairment test is performed to measure the amount of impairment loss, if any. In step two of the goodwill impairment test, the implied fair value of a reporting unit’s goodwill is compared with the carrying amount of that goodwill. The implied fair value of goodwill is determined in the same manner as the amount of goodwill recognized in a business combination and is defined as the excess of the fair value of a reporting unit over the fair value of the net assets of a reporting unit. If the carrying amount of goodwill exceeds its implied fair value, an impairment loss is recognized for the excess. If the carrying amount of goodwill is less than its implied fair value, no goodwill impairment is recognized.
Goodwill impairment testing is performed at the reporting unit level. We have identified two reporting units of Ambac: (1) Financial Guarantee, which provides financial guarantees (including credit derivatives) for public finance, structured finance and other obligations; and (2) Financial Services, which provides investment agreements, funding conduits, and interest rate swaps, principally to clients of the financial guarantee business. These reporting units are also the sole operating segments which make up the Financial Guarantee and Financial Services reportable segments, respectively, as further described in Note 19. Segment Information 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. We have assigned assets and liabilities to each reporting unit based on specific identification. In evaluating which reporting units should be assigned goodwill, we considered the sources of Ambac’s estimated enterprise value at the Fresh Start Reporting Date, as further described in Note 3. Fresh Start Financial Statement Reporting 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. Based on that analysis, we have assigned all goodwill recorded at the Fresh Start Reporting Date to the Financial Guarantee reporting unit.
During the September 30, 2015 reporting period, Ambac determined sufficient indicators of potential impairment existed to perform an interim goodwill impairment evaluation for the Financial Guarantee reporting unit. These indicators included the recent trading values of Ambac stock and changes in Ambac credit spreads. In conducting the goodwill impairment analysis as of September 30, 2015, we performed step one of the goodwill impairment test for the Financial Guarantee reporting unit. We estimated the fair value of the Financial Guarantee reporting unit using a market approach, which is derived using: i) Ambac’s common stock and warrant market capitalization, ii) fair value estimates of Ambac Assurance preferred shares (reported as noncontrolling interests on Ambac's balance sheet) and iii) an estimated control premium. Step one of the impairment test indicated the Financial Guarantee reporting unit's carrying value exceeded its fair value.
Accordingly, the Company performed step two of the impairment test as of September 30, 2015, which indicated the implied fair value of goodwill was zero. This was the result of substantial decreases in the Financial Guarantee reporting unit's fair value and substantial increases in the fair value of its net assets. The fair value of the Financial Guarantee reporting unit decreased significantly due to a material decrease in Ambac's market capitalization components (described above). The Financial Guarantee reporting unit's fair value of net assets increased significantly primarily as a result of a decrease in the estimated fair value of financial guarantee liabilities and, to a lesser extent, a decrease in the fair value of long-term debt. The fair value decrease in financial guarantee liabilities, which is a Level 3 estimate, was primarily driven by wider Ambac credit spreads and positive loss and loss expense reserves development. Please refer to Note 7. Fair Value Measurements for further discussion on the fair value model for financial guarantee liabilities. The fair value decrease in long-term debt was driven by lower market pricing on surplus notes and junior surplus notes.
As a result, the Company recorded a full non-cash, non-tax deductible goodwill impairment charge of $514,511 million at September 30, 2015.
The following is a summary of activity in goodwill for the Financial Guarantee reporting unit:
 
Nine Months Ended September 30, 2015
 
Year Ended
December 31, 2014
Beginning balance
$
514,511

 
$
514,511

Impairment loss
(514,511
)
 

Ending balance
$

 
$
514,511

Reclassifications
Certain reclassifications have been made to prior years' amounts to conform to the current year's presentation.

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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 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 has not determined whether it will adopt ASU 2015-03 prior to 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.
In May 2015, the FASB issued ASC 2015-09, Financial Services - Insurance (Topic 944) - Disclosures about Short-Duration Contracts. The primary objective of this ASU is to improve disclosures for insurance entities which issue short-duration contracts. The ASU made significant amendments to the Short-Duration Contract disclosure section and limited amendments affecting the General disclosure section of Topic 944. Ambac, as a provider of financial guarantee contracts, is subject to the General sections but not the Short-Duration Contract sections of Topic 944. The limited amendments made to the General disclosure section are not expected to have a material impact on Ambac's financial statement disclosures. The ASU is effective for annual periods beginning after December 15, 2015, and interim periods within annual periods beginning after December 15, 2016. Ambac will adopt ASU 2015-09 on December 31, 2016.
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 certain special purpose entities 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.
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

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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 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, 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. Assets and liabilities of VIEs that are consolidated as a result of Ambac's variable interest arising from financial guarantees written by Ambac's subsidiaries are reported within Variable interest entity assets or Variable interest entity liabilities on the Consolidated Balance Sheets. Results from such VIEs are reported within Income (loss) on variable interest entities in the Consolidated Statements of Total Comprehensive Income.
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 September 30, 2015 and December 31, 2014 the fair value of these entities are $9,322 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 September 30, 2015. Total principal amount of debt outstanding was $457,960 and $457,960 at September 30, 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 September 30, 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 September 30, 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.
In July 2015, Ambac Assurance entered into a secured borrowing transaction whereby it sold 17 Ambac insured residential mortgage-backed securities (the "Securities") and all rights associated therewith as of May 31, 2015, to a Delaware statutory trust (the "Trust") in exchange for an equity certificate in the Trust, all financial guarantee claim payments associated with the Securities and cash of $146,000 (prior to expenses associated with the transaction). The Securities had par and fair value of $386,129 and $403,106 as of September 30, 2015, respectively. Although the Securities were legally sold to the Trust, the Securities will remain in Invested assets on the Consolidated Balance Sheets. Refer to Note 8. Investments for further discussion of the restrictions on the invested assets. At the same time, a second Delaware statutory trust (the "Issuer"), issued $146,000 of debt securities and used the proceeds, together with an equity certificate of the Issuer, to purchase from the Trust a certificate entitling the Issuer to, and secured by, all principal and interest payments (other than financial guarantee claim payments) on the Securities. Interest on the debt securities is payable monthly at an annual rate of one month LIBOR + 2.8%. Both the Trust and the Issuer are consolidated VIEs because Ambac Assurance was involved in their design and holds a significant amount of the beneficial interests issued by the VIEs or guaranteed the assets held by the VIEs. VIE debt outstanding to third parties under this secured borrowing transaction had a carrying value of $137,049 as of September 30, 2015 and is reported in Long-Term Debt on the Consolidated Balance Sheets.
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 (when applicable), 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 (when applicable), 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).

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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. Furthermore, with respect to the consolidation or deconsolidation of VIEs related to financial guarantee insurance policies, there typically is no consideration paid or received by Ambac, and consequently has no impact on the above described gain or loss calculation. 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 for any of the periods presented.
As of September 30, 2015 consolidated VIE assets and liabilities relating to 15 consolidated entities were $14,875,442 and $14,830,828, 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 general creditors, other than those specific policy holders which own the VIE debt obligations, 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’s interests 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.
The table below provides the fair value of fixed income securities, by asset-type, held by consolidated VIEs as of September 30, 2015 and December 31, 2014
 
September 30,
2015
 
December 31,
2014
Investments:
 
 
 
Corporate obligations
$
2,679,895

 
$
2,743,050

Total variable interest entity assets: fixed income securities
$
2,679,895

 
$
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 September 30, 2015 and December 31, 2014:
 
Estimated fair value
 
Unpaid principal balance
September 30, 2015
 
 
 
Loans
$
12,183,061

 
$
9,446,235

Long-term debt
12,791,012

 
11,366,061

December 31, 2014
 
 
 
Loans
12,371,177

 
10,236,695

Long-term debt
$
12,882,076

 
$
11,925,499

For the three months ended September 30, 2015, Ambac deconsolidated one VIE as a result of the termination of the associated financial guarantee policy. There was a gain of $572 reported in Income (loss) on variable interest entities on the Consolidated Statements of Total Comprehensive Income (Loss). For the nine months ended September 30, 2015, Ambac deconsolidated two VIE's; one as a result of the termination of the associated financial guarantee policy and one as a result of the associated financial guarantee exposure matured. There was a gain of $572 reported in Income (loss) on variable interest entities on the Consolidated Statements of Total Comprehensive Income (Loss).
Variable Interests in Non-Consolidated VIEs
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

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with associated results from operations included within Net investment income: Other investments on the Consolidated Statements of Total Comprehensive Income (Loss).
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 September 30, 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)
September 30, 2015:
 
 
 
 
 
 
 
Global structured finance:
 
 
 
 
 
 
 
Collateralized debt obligations
$
1,041,843

 
$
271

 
$
3,716

 
$
(139,859
)
Mortgage-backed—residential
17,722,719

 
1,034,921

 
2,740,222

 

Other consumer asset-backed
4,321,282

 
51,802

 
648,958

 
(349
)
Other commercial asset-backed
2,597,067

 
115,751

 
105,826

 

Other
3,308,329

 
82,160

 
484,964

 
16,006

Total global structured finance
28,991,240

 
1,284,905

 
3,983,686

 
(124,202
)
Global public finance
30,463,734

 
427,717

 
483,506

 
(21,421
)
Total
$
59,454,974

 
$
1,712,622

 
$
4,467,192

 
$
(145,623
)
 
 
 
 
 
 
 
 
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.
(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.

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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 September 30, 2015
 
 
 
 
 
 
 
Beginning Balance
$
79,406

 
$
9,784

 
$
6,172

 
$
95,362

Other comprehensive income before reclassifications
1,342

 

 
(30,637
)
 
(29,295
)
Amounts reclassified from accumulated other comprehensive income
7,040

 
(220
)
 

 
6,820

Net current period other comprehensive income (loss)
8,382

 
(220
)
 
(30,637
)
 
(22,475
)
Balance at September 30, 2015
$
87,788

 
$
9,564

 
$
(24,465
)
 
$
72,887

 
 
 
 
 
 
 
 
Three Months Ended September 30, 2014
 
 
 
 
 
 
 
Beginning Balance
$
231,975

 
$
10,439

 
$
63,914

 
$
306,328

Other comprehensive income before reclassifications
(12,222
)
 

 
(38,034
)
 
(50,256
)
Amounts reclassified from accumulated other comprehensive income
(5,003
)
 
(204
)
 

 
(5,207
)
Net current period other comprehensive income (loss)
(17,225
)
 
(204
)
 
(38,034
)
 
(55,463
)
Balance at September 30, 2014
$
214,750

 
$
10,235

 
$
25,880

 
$
250,865

(1)    All amounts are net of tax and noncontrolling interest. Amounts in parentheses indicate debits.
 
Unrealized Gains
(Losses) on
Available- for
Sale Securities
(1)
 
Amortization of
Postretirement
Benefit
(1)
 
Gain (Loss) on
Foreign Currency
Translation
(1)
 
Total
Nine Months Ended September 30, 2015:
 
 
 
 
 
 
 
Beginning Balance
$
210,693

 
$
10,031

 
$
(441
)
 
$
220,283

Other comprehensive income before reclassifications
(85,313
)
 

 
(24,024
)
 
(109,337
)
Amounts reclassified from accumulated other comprehensive income
(37,592
)
 
(467
)
 

 
(38,059
)
Net current period other comprehensive income (loss)
(122,905
)
 
(467
)
 
(24,024
)
 
(147,396
)
Balance at September 30, 2015
$
87,788

 
$
9,564

 
$
(24,465
)
 
$
72,887

 
 
 
 
 
 
 
 
Nine Months Ended September 30, 2014:
 
 
 
 
 
 
 
Beginning Balance
$
(41,910
)
 
$
10,847

 
$
42,724

 
$
11,661

Other comprehensive income before reclassifications
261,879

 

 
(16,844
)
 
245,035

Amounts reclassified from accumulated other comprehensive income
(5,219
)
 
(612
)
 

 
(5,831
)
Net current period other comprehensive income (loss)
256,660

 
(612
)
 
(16,844
)
 
239,204

Balance at September 30, 2014
$
214,750

 
$
10,235

 
$
25,880

 
$
250,865

(1)    All amounts are net of tax and noncontrolling interest. Amounts in parentheses indicate debits.

12

Table of Contents

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 September 30,
 
Consolidated Statement of
Comprehensive Income Components
 
2015
 
2014
 
Total Comprehensive Income
Unrealized Gains (Losses) on Available-for-Sale Securities
 
 
 
 
 
 
 
 
$
7,040

 
$
(5,003
)
 
Net realized investment (losses) gains
 
 

 

 
Tax (expense) benefit
 
 
$
7,040

 
$
(5,003
)
 
Net of tax and noncontrolling interest (3)
Amortization of Postretirement Benefit
 
 
 
 
 
 
Prior service cost
 
$
(167
)
 
$
(166
)
 
Underwriting and operating expenses (2)
Actuarial gains (losses)
 
(53
)
 
(38
)
 
Underwriting and operating expenses (2)
 
 
(220
)
 
(204
)
 
Total before tax
 
 

 

 
Tax (expense) benefit
 
 
$
(220
)
 
$
(204
)
 
Net of tax and noncontrolling interest (3)
Total reclassifications for the period
 
$
6,820

 
$
(5,207
)
 
Net of tax and noncontrolling interest (3)
(1)
Amounts in parentheses indicate debits to the Consolidated Statement of Total 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.
 
 
Amount Reclassified from Accumulated
Other Comprehensive Income
(1)
 
Affected Line Item in the
Details about Accumulated Other
 
Nine Months Ended September 30,
 
Consolidated Statement of
Comprehensive Income Components
 
2015
 
2014
 
Total Comprehensive Income
Unrealized Gains (Losses) on Available-for-Sale Securities
 
 
 
 
 
 
 
 
$
(37,592
)
 
$
(5,219
)
 
Net realized investment gains
 
 

 

 
Tax (expense) benefit
 
 
$
(37,592
)
 
$
(5,219
)
 
Net of tax and noncontrolling interest (3)
Amortization of Postretirement Benefit
 
 
 
 
 
 
Prior service cost
 
$
(500
)
 
$
(498
)
 
Underwriting and operating expenses (2)
Actuarial gains (losses)
 
33

 
(114
)
 
Underwriting and operating expenses (2)
 
 
(467
)
 
(612
)
 
Total before tax
 
 

 

 
Tax (expense) benefit
 
 
$
(467
)
 
$
(612
)
 
Net of tax and noncontrolling interest (3)
Total reclassifications for the period
 
$
(38,059
)
 
$
(5,831
)
 
Net of tax and noncontrolling interest (3)
(1)
Amounts in parentheses indicate debits to the Consolidated Statement of Total 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 (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 nine months ended September 30, 2015 and 2014, 740 and 949 warrants were exercised, respectively, resulting in an issuance of 236 and 949 shares of common stock, respectively.
On June 30, 2015, the Board of Directors of Ambac authorized the establishment of a warrant repurchase program that permits the repurchase of up to $10,000 of warrants. As of September 30, 2015, Ambac had repurchased 577,500 warrants totaling $5,017, leaving 4,461,637 warrants outstanding with an exercise price of $16.67 per share and expiration of April 30, 2023

13

Table of Contents

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 vested and unvested options, unvested 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 September 30,
 
 
Nine Months Ended September 30,
 
2015
 
2014
 
 
2015
 
2014
Basic weighted average shares outstanding
45,174,521

 
45,115,882

 
 
45,173,671

 
45,083,831

Effect of potential dilutive shares:
 
 
 
 
 
 
 
 
Warrants

 
1,469,203

 
 
1,154,313

 
1,892,211

Stock options

 
8,220

 
 
7,083

 
10,569

Restricted stock units

 
31,384

 
 
14,418

 
40,473

Performance stock units

 

 
 
2,729

 

Diluted weighted average shares outstanding
45,174,521

 
46,624,689

 
 
46,352,214

 
47,027,084

For the three months ended September 30, 2015, Ambac incurred net losses and accordingly excluded all potentially dilutive securities from the determination of diluted loss per share as their impact was antidilutive. Antidilutive securities for the three months ended September 30, 2015 included stock options and warrants to purchase 176,668 and 4,461,637 shares of common stock, respectively, where the exercise price was greater than the average market price, 78,460 restricted stock units and 96,349 performance stock units at their target amounts. Antidilutive securities for the nine months ended September 30, 2015 included stock options to purchase 110,000 shares of common stock where the exercise price was greater than the average market price.
6. FINANCIAL GUARNTEE 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 September 30, 2015 and December 31, 2014, was 2.7% and 2.7%, respectively, and the weighted average period of future premiums used to estimate the premium receivable at September 30, 2015 and December 31, 2014, was 9.7 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 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 September 30, 2015 and December 31, 2014, approximately 28% and 32% of the premium receivables related to transactions with non-investment grade internal ratings, comprised mainly of non-investment grade RMBS, lease securitizations and student loan transactions, which comprised 7%, 6%, and 5%, of the total premium receivables at September 30, 2015 and 7%, 6%, and 8% of the total premium receivables at December 31, 2014, respectively. At September 30, 2015 and December 31, 2014, $15,802 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 September 30, 2015.

14

Table of Contents

Below is the gross premium receivable roll-forward (direct and assumed contracts) for the affected periods:
 
 
Nine Months Ended September 30,
 
 
2015
 
2014
Beginning premium receivable
 
$
1,000,607

 
$
1,453,021

Premium receipts
 
(70,940
)
 
(100,646
)
Adjustments for changes in expected and contractual cash flows
 
(39,613
)
 
(93,795
)
Accretion of premium receivable discount
 
18,795

 
29,644

Changes to uncollectable premiums
 
1,978

 
(801
)
Other adjustments (including foreign exchange)
 
(15,381
)
 
(20,791
)
Ending premium receivable
 
$
895,446

 
$
1,266,632

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 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 and nine months ended September 30, 2015 was $28,369 and $64,862, and for the three and nine months ended September 30, 2014 was $9,192 and $42,296, 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. 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 (a refunding) or a specified call date (a pre-refunding). 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. For policies with refunding securities, premium revenue recognition is not impacted as the escrowed maturity date is the same as the previous legal maturity date. For policies with pre-refunding securities, the maturity date of the pre-refunded security has been shortened from its previous legal maturity. Although premium revenue recognition has not been accelerated in the period of the pre-refunding, it results in an increase in the rate at which the policy's remaining UPR is to be recognized.
The effect of reinsurance on premiums written and earned for the respective periods was as follows:
 
Three Months Ended September 30, 2015
 
 
Three Months Ended September 30, 2014
 
Written
 
Earned
 
 
Written
 
Earned
Direct
$
(8,710
)
 
$
77,982

 
 
$
(13,700
)
 
$
68,685

Assumed

 
22

 
 

 
23

Ceded
(105
)
 
6,469

 
 
(2,805
)
 
3,877

Net premiums
$
(8,605
)
 
$
71,535

 
 
$
(10,895
)
 
$
64,831

 
Nine Months Ended September 30, 2015
 
 
Nine Months Ended September 30, 2014
 
Written
 
Earned
 
 
Written
 
Earned
Direct
$
(18,840
)
 
$
214,787

 
 
$
(64,952
)
 
$
222,894

Assumed

 
66

 
 

 
114

Ceded
(882
)
 
16,721

 
 
(7,316
)
 
10,617

Net premiums
$
(17,958
)
 
$
198,132

 
 
$
(57,636
)
 
$
212,391


15

Table of Contents

The table below summarizes the future gross undiscounted premiums to be collected and future premiums earned, net of reinsurance at September 30, 2015:
 
Future premiums
to be collected
(1)
 
Future
premiums to
be earned net of
reinsurance
(1)
Three months ended:
 
 
 
December 31, 2015
$
21,054

 
$
36,341

Twelve months ended:
 
 
 
December 31, 2016
82,229

 
125,182

December 31, 2017
76,613

 
105,390

December 31, 2018
71,514

 
94,004

December 31, 2019
67,678

 
87,387

Five years ended:
 
 
 
December 31, 2024
298,847

 
359,221

December 31, 2029
248,187

 
255,225

December 31, 2034
174,358

 
160,285

December 31, 2039
63,810

 
65,206

December 31, 2044
23,749

 
22,408

December 31, 2049
9,518

 
9,722

December 31, 2054
1,244

 
2,183

December 31, 2059
5

 
3

Total
$
1,138,806

 
$
1,322,557

(1)
Future premiums to be collected is undiscounted which are used to derive 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 further 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. 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:
The loss and loss expense reserve (“loss reserve”) policy for financial guarantee insurance 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. Losses and loss expenses are based upon estimates of the ultimate aggregate losses inherent in the non-derivative financial guarantee portfolio as of the reporting date. A loss reserve is recorded on the balance sheet on a policy-by-policy basis. Loss reserve components of an insurance policy include unpaid claims and the present value ("PV") of expected net cash flows required to be paid under an insurance contract, further described below:
Unpaid claims represent the sum of (i) claims presented and not yet paid for policies allocated to the Segregated Account, including Deferred Amounts and (ii) accrued interest on Deferred Amounts as required by the amended Segregated Account Rehabilitation Plan that became effective on June 12, 2014. Refer to Note 1. Background and Business Description in the Notes to Consolidated Financial Statements included in Ambac's Annual Report on Form 10-K for further discussion of the amended Segregated Account Rehabilitation Plan. Unpaid claims are measured based on the cost of settling the claims, which is principal plus accrued interest.
The PV of expected net cash flows represents the PV of expected cash outflows less the PV of expected cash inflows. The PV of expected net cash flows are impacted by: (i) expected future claims to be paid under an insurance contract, including the impact of potential settlement outcomes upon future installment premiums, (ii) expected recoveries from contractual breaches of RMBS representations and warranties by transaction sponsors, (iii) excess spread within the underlying transaction's cash flow structure, and (iv) other subrogation recoveries. Expected receipts from third parties within the underlying transaction's cash flow structure relating to contractual breaches in non-RMBS securitizations may also reduce expected future claims. Ambac’s approach to resolving disputes involving contractual breaches by transaction sponsors or other third parties has included negotiations and/or pursuing litigation. Ambac does not include potential recoveries from litigation attributed solely to fraudulent inducement claims in our estimate of subrogation recoveries, since any remedies under such claims would be non-contractual.
Net cash outflow policies represent contracts where the sum of unpaid claims plus the PV of expected cash outflows are greater than the PV of expected cash inflows. For such policies, a “Loss and loss expense reserves” liability is recorded for the sum of: (i) unpaid claims plus (ii) the excess of the PV of expected net cash outflows over the unearned premium reserve. Net cash inflow policies represent contracts where losses have been paid, but not yet recovered, such that the PV of expected cash inflows are greater than the sum of unpaid claims plus the PV of expected

16

Table of Contents

cash outflows. For such policies, a “Subrogation recoverable” asset is recorded for the difference between (i) the PV of expected net cash inflows and (ii) unpaid claims.
The approaches used to estimate expected future claims and expected future recoveries considers the likelihood of all possible outcomes. The evaluation process for determining expected losses is subject to certain estimates and judgments based on our assumptions regarding the probability of default by the issuer of the insured security, probability of settlement outcomes (which may include commutation settlements, refinancing and/or other settlement outcomes) and expected severity of credits for each insurance contract. Ambac’s loss reserves are based on management’s on-going review of the financial guarantee credit portfolio. Below are the components of the Loss and loss expense reserves liability and the Subrogation recoverable asset at September 30, 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
September 30, 2015:
 
 
 
 
 
 
 
 
 
 
 
Loss and loss expense reserves
$
2,193,214

 
$
324,125

 
$
3,137,857

 
$
(1,238,561
)
 
$
(179,120
)
 
$
4,237,515

Subrogation recoverable
785,993

 
125,225

 
148,147

 
(2,041,567
)
 

 
(982,202
)
Totals
$
2,979,207

 
$
449,350

 
$
3,286,004

 
$
(3,280,128
)
 
$
(179,120
)
 
$
3,255,313

 
 
 
 
 
 
 
 
 
 
 
 
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

Below is the loss and loss expense reserve roll-forward, net of subrogation recoverable and reinsurance, for the affected periods:
 
Nine Months Ended September 30,
 
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
1,404

 
236

Claim and loss expense (payments) recoveries, net of subrogation and reinsurance

 
(4
)
Total current year
1,404

 
232

Prior years:
 
 
 
Change in previously established loss and loss expense reserves, gross of RMBS subrogation and net of reinsurance
(414,642
)
 
(934
)
Claim and loss expense (payments) recoveries, net of subrogation and reinsurance
(61,740
)
 
67,736

(Increase) decrease in previously established RMBS subrogation recoveries, net of reinsurance
(31,744
)
 
(6,315
)
Total prior years
(508,126
)
 
60,487

Net change in net loss and loss expense reserves
(506,722
)
 
60,719

Ending net loss and loss expense reserves
3,191,656

 
5,408,596

Add reinsurance on loss and loss expense reserves (1)
63,657

 
105,641

Ending gross loss and loss expense reserves
$
3,255,313

 
$
5,514,237

(1)
Reinsurance recoverable reported on the Balance Sheet also includes reinsurance recoverables (payables) of previously presented loss and loss expenses of $4,662 and $(130) as of September 30, 2015 and 2014, respectively.
The positive development in loss and loss expense reserves established in prior years for the nine months ended September 30, 2015 was primarily due to the impact of commutations in the student loan portfolio and reduced future claims for both the Ambac UK and RMBS portfolios partially offset by negative development in certain public finance transactions and interest accrued on Deferred Amounts. The negative development in loss and loss expense reserves established in prior years for the nine months ended September 30, 2014 was primarily due to the addition of accrued interest on Deferred Amounts pursuant to the amended Segregated Account Rehabilitation Plan offset by improved performance in all sectors, including RMBS, international municipal and other structured finance.
The net change in net loss and loss expense reserves are included in losses and loss expenses in the Consolidated Statements of Total Comprehensive Income. Reinsurance recoveries of losses included in losses and loss expenses in the Consolidated Statements of Total Comprehensive Income

17

Table of Contents

were an expense of $6,907 and $30,727 for the three and nine months ended September 30, 2015 compared to an expense of $3,885 and $16,045 for the three and nine months ended September 30, 2014, respectively.
The tables below summarize information related to policies currently included in Ambac’s loss and loss expense reserves or subrogation recoverable at September 30, 2015 and December 31, 2014. Gross 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 September 30, 2015 and December 31, 2014 was 2.3% and 2.3%, respectively.
Surveillance Categories as of September 30, 2015
 
I/SL
 
IA
 
II
 
III
 
IV
 
V
 
Total
Number of policies
44

 
17

 
30

 
65

 
164

 
3

 
323

Remaining weighted-average contract period (in years)
7

 
17

 
14

 
19

 
14

 
6

 
16

Gross insured contractual payments outstanding:
 
 
 
 
 
 
 
 
 
 
 
 
 
Principal
$
2,099,540

 
$
305,681

 
$
1,338,428

 
$
3,913,273

 
$
8,897,699

 
$
54,590

 
$
16,609,211

Interest
730,755

 
138,831

 
356,410

 
2,940,877

 
1,827,031

 
18,157

 
6,012,061

Total
$
2,830,295

 
$
444,512

 
$
1,694,838

 
$
6,854,150

 
$
10,724,730

 
$
72,747

 
$
22,621,272

Gross undiscounted claim liability (1)
$
15,820

 
$
6,036

 
$
46,817

 
$
1,639,016

 
$
6,076,327

 
$
72,747

 
$
7,856,763

Discount, gross claim liability
(786
)
 
(596
)
 
(12,179
)
 
(524,462
)
 
(697,119
)
 
(6,146
)
 
(1,241,288
)
Gross claim liability before all subrogation and before reinsurance
$
15,034

 
$
5,440

 
$
34,638

 
$
1,114,554