GAAP AGO-03-31-2013-10Q
Table of Contents

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
____________________________________________________________________________
FORM 10-Q
ý
 
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended March 31, 2013
Or
o
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition Period from              to               
Commission File No. 001-32141 
ASSURED GUARANTY LTD.
(Exact name of registrant as specified in its charter) 
Bermuda
 
98-0429991
(State or other jurisdiction
 
(I.R.S. employer
of incorporation)
 
identification no.)
 
30 Woodbourne Avenue
Hamilton HM 08
Bermuda
(Address of principal executive offices)
(441) 279-5700
(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 o
 
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 o
 
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.
Large accelerated filer x
 
Accelerated filer o
 
 
 
Non-accelerated filer o
 
Smaller reporting company o
(Do not check if a 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 o No x
The number of registrant’s Common Shares ($0.01 par value) outstanding as of May 1, 2013 was 189,776,540 (includes 88,549 unvested restricted shares).
 

Table of Contents


ASSURED GUARANTY LTD.

INDEX TO FORM 10-Q
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

Table of Contents

PART I.
FINANCIAL INFORMATION
 
ITEM 1.
FINANCIAL STATEMENTS

Assured Guaranty Ltd.

Consolidated Balance Sheets (unaudited)
 
(dollars in millions except per share and share amounts)
 
 
As of
March 31, 2013
 
As of
December 31, 2012
Assets
 

 
 

Investment portfolio:
 

 
 

Fixed maturity securities, available-for-sale, at fair value (amortized cost of $9,363 and $9,346)
$
9,985

 
$
10,056

Short term investments, at fair value
729

 
817

Other invested assets
148

 
212

Total investment portfolio
10,862

 
11,085

Cash
125

 
138

Premiums receivable, net of ceding commissions payable
956

 
1,005

Ceded unearned premium reserve
535

 
561

Deferred acquisition costs
116

 
116

Reinsurance recoverable on unpaid losses
56

 
58

Salvage and subrogation recoverable
543

 
456

Credit derivative assets
125

 
141

Deferred tax asset, net
872

 
721

Financial guaranty variable interest entities’ assets, at fair value
2,813

 
2,688

Other assets
296

 
273

Total assets
$
17,299

 
$
17,242

Liabilities and shareholders’ equity
 

 
 

Unearned premium reserve
$
4,982

 
$
5,207

Loss and loss adjustment expense reserve
532

 
601

Reinsurance balances payable, net
193

 
219

Long-term debt
832

 
836

Credit derivative liabilities
2,518

 
1,934

Financial guaranty variable interest entities’ liabilities with recourse, at fair value
2,071

 
2,090

Financial guaranty variable interest entities’ liabilities without recourse, at fair value
1,107

 
1,051

Other liabilities
340

 
310

Total liabilities
12,575

 
12,248

Commitments and contingencies (See Note 14)

 

Common stock ($0.01 par value, 500,000,000 shares authorized; 192,337,826 and 194,003,297 shares issued and outstanding)
2

 
2

Additional paid-in capital
2,685

 
2,724

Retained earnings
1,586

 
1,749

Accumulated other comprehensive income, net of tax of $169 and $198
447

 
515

Deferred equity compensation (320,193 and 320,193 shares)
4

 
4

Total shareholders’ equity
4,724

 
4,994

Total liabilities and shareholders’ equity
$
17,299

 
$
17,242

 
The accompanying notes are an integral part of these consolidated financial statements.


3
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Assured Guaranty Ltd.

Consolidated Statements of Operations (unaudited)
 
(dollars in millions except per share amounts)
 
 
Three Months Ended March 31,
 
2013
 
2012
Revenues
 
 
 
Net earned premiums
$
248

 
$
194

Net investment income
94

 
98

Net realized investment gains (losses):
 
 
 
Other-than-temporary impairment losses
(1
)
 
(28
)
Less: portion of other-than-temporary impairment loss recognized in other comprehensive income
4

 
(23
)
Other net realized investment gains (losses)
33

 
6

Net realized investment gains (losses)
28

 
1

Net change in fair value of credit derivatives:
 
 
 
Realized gains (losses) and other settlements
18

 
(57
)
Net unrealized gains (losses)
(610
)
 
(634
)
Net change in fair value of credit derivatives
(592
)
 
(691
)
Fair value gains (losses) on committed capital securities
(10
)
 
(14
)
Fair value gains (losses) on financial guaranty variable interest entities
70

 
(41
)
Other income
(14
)
 
91

Total revenues
(176
)
 
(362
)
Expenses


 


Loss and loss adjustment expenses
(48
)
 
242

Amortization of deferred acquisition costs
3

 
5

Interest expense
21

 
25

Other operating expenses
60

 
62

Total expenses
36

 
334

Income (loss) before income taxes
(212
)
 
(696
)
Provision (benefit) for income taxes
 

 
 

Current
55

 
29

Deferred
(123
)
 
(242
)
Total provision (benefit) for income taxes
(68
)
 
(213
)
Net income (loss)
$
(144
)
 
$
(483
)
 
 
 
 
Earnings per share:
 
 
 
Basic
$
(0.74
)
 
$
(2.65
)
Diluted
$
(0.74
)
 
$
(2.65
)
Dividends per share
$
0.10

 
$
0.09

 
The accompanying notes are an integral part of these consolidated financial statements.
 

4
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Assured Guaranty Ltd.

Consolidated Statements of Comprehensive Income (unaudited)
 
(in millions)
 
 
Three Months Ended March 31,
 
2013
 
2012
Net income (loss)
$
(144
)
 
$
(483
)
Unrealized holding gains (losses) arising during the period on:
 
 
 
Investments with no other-than-temporary impairment, net of tax provision (benefit) of $(19) and $19
(50
)
 
42

Investments with other-than-temporary impairment, net of tax provision (benefit) of $(8) and $(7)
(16
)
 
(14
)
Unrealized holding gains (losses) arising during the period, net of tax
(66
)
 
28

Less: reclassification adjustment for gains (losses) included in net income (loss), net of tax provision (benefit) of $(2) and $(1)
(3
)
 
(1
)
Change in net unrealized gains on investments
(63
)
 
29

Other, net of tax provision
(5
)
 
2

Other comprehensive income (loss)
$
(68
)
 
$
31

Comprehensive income (loss)
$
(212
)
 
$
(452
)
 
The accompanying notes are an integral part of these consolidated financial statements.
 

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Assured Guaranty Ltd.

Consolidated Statements of Shareholders’ Equity (unaudited)
 
For the Three Months Ended March 31, 2013
 
(dollars in millions, except share data)

 
Common Stock
 
Additional
Paid-in
Capital
 
Retained Earnings
 
Accumulated
Other
Comprehensive Income
 
Deferred
Equity Compensation
 
Total
Shareholders’ Equity
 
Shares
 
Amount
 
 
 
 
 
Balance at December 31, 2012
194,003,297

 
$
2

 
$
2,724

 
$
1,749

 
$
515

 
$
4

 
$
4,994

Net loss
—

 
—

 
—

 
(144
)
 
—

 
—

 
(144
)
Dividends ($0.10 per share)
—

 
—

 
—

 
(19
)
 
—

 
—

 
(19
)
Common stock repurchases
(1,914,566
)
 
0

 
(39
)
 
—

 
—

 
—

 
(39
)
Share-based compensation and other
249,095

 
0

 
0

 
—

 
—

 
—

 
0

Other comprehensive loss
—

 
—

 
—

 
—

 
(68
)
 
—

 
(68
)
Balance at March 31, 2013
192,337,826

 
$
2

 
$
2,685

 
$
1,586

 
$
447

 
$
4

 
$
4,724

 
The accompanying notes are an integral part of these consolidated financial statements.


6
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Assured Guaranty Ltd.

Consolidated Statements of Cash Flows (unaudited)
 
(in millions)
 
 
Three Months Ended March 31,
 
2013
 
2012
Net cash flows provided by (used in) operating activities
$
(14
)
 
$
75

Investing activities
 

 
 

Fixed maturity securities:
 

 
 

Purchases
(510
)
 
(383
)
Sales
183

 
189

Maturities
283

 
253

Net sales (purchases) of short-term investments
88

 
(143
)
Net proceeds from paydowns on financial guaranty variable interest entities’ assets
138

 
138

Other
55

 
53

Net cash flows provided by (used in) investing activities
237

 
107

Financing activities
 

 
 

Dividends paid
(19
)
 
(16
)
Repurchases of common stock
(39
)
 
—

Share activity under option and incentive plans
(2
)
 
(3
)
Net paydowns of financial guaranty variable interest entities’ liabilities
(167
)
 
(193
)
Repayment of long-term debt
(6
)
 
(5
)
Net cash flows provided by (used in) financing activities
(233
)
 
(217
)
Effect of exchange rate changes
(3
)
 
2

Increase (decrease) in cash
(13
)
 
(33
)
Cash at beginning of period
138

 
215

Cash at end of period
$
125

 
$
182

Supplemental cash flow information
 

 
 

Cash paid (received) during the period for:
 

 
 

Income taxes
$
32

 
$
2

Interest
$
9

 
$
12

The accompanying notes are an integral part of these consolidated financial statements.

7
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Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (unaudited)
 
March 31, 2013

1.
Business and Basis of Presentation
 
Business
 
Assured Guaranty Ltd. (“AGL” and, together with its subsidiaries, “Assured Guaranty” or the “Company”) is a Bermuda-based holding company that provides, through its operating subsidiaries, credit protection products to the United States (“U.S.”) and international public finance (including infrastructure) and structured finance markets. The Company applies its credit underwriting judgment, risk management skills and capital markets experience to offer insurance that protects holders of debt instruments and other monetary obligations from defaults in scheduled payments, including scheduled interest and principal payments. The Company markets its credit protection products directly to issuers and underwriters of public finance and structured finance securities as well as to investors in such obligations. The Company guarantees obligations issued in many countries, although its principal focus is on the U.S., as well as Europe and Australia.

Financial guaranty insurance policies provide an unconditional and irrevocable guaranty that protects the holder of a financial obligation against non-payment of principal and interest ("Debt Service") when due. Upon an obligor’s default on scheduled principal or interest payments due on the obligation, the Company is required under the financial guaranty policy to pay the principal or interest shortfall. The Company has issued financial guaranty insurance policies on public finance obligations and structured finance obligations. Public finance obligations insured by the Company consist primarily of general obligation bonds supported by the taxing powers of U.S. state or municipal governmental authorities, as well as tax-supported bonds, revenue bonds and other obligations supported by covenants from state or municipal governmental authorities or other municipal obligors to impose and collect fees and charges for public services or specific infrastructure projects. The Company also includes within public finance obligations those obligations backed by the cash flow from leases or other revenues from projects serving substantial public purposes, including utilities, toll roads, health care facilities and government office buildings. Structured finance obligations insured by the Company are generally issued by special purpose entities and backed by pools of assets such as residential or commercial mortgage loans, consumer or trade receivables, securities or other assets having an ascertainable cash flow or market value. The Company also includes within structured finance obligations other specialized financial obligations.
 
In the past, the Company had sold credit protection by issuing policies that guaranteed payment obligations under credit derivatives. Financial guaranty contracts accounted for as credit derivatives are generally structured such that the circumstances giving rise to the Company’s obligation to make loss payments are similar to those for financial guaranty insurance contracts and only occurs upon one or more defined credit events such as failure to pay or bankruptcy, in each case, as defined within the transaction documents, with respect to one or more third party referenced securities or loans. Financial guaranty contracts accounted for as credit derivatives are primarily comprised of credit default swaps (“CDS”). The Company’s credit derivative transactions are governed by International Swaps and Derivative Association, Inc. (“ISDA”) documentation.
 
The Company has not entered into any new CDS in order to sell credit protection since the beginning of 2009, when regulatory guidelines were issued that limited the terms under which such protection could be sold. The capital and margin requirements applicable under the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) also contributed to the decision of the Company not to enter into such new CDS in the foreseeable future. The Company actively pursues opportunities to terminate existing CDS, which have the effect of reducing future fair value volatility in income and/or reducing rating agency capital charges.

Basis of Presentation
 
The unaudited interim consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”) and, in the opinion of management, reflect all adjustments that are of a normal recurring nature, necessary for a fair statement of the financial condition, results of operations and cash flows of the Company and its consolidated financial guaranty variable interest entities (“FG VIEs”) for the periods presented. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of 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. These unaudited interim consolidated financial statements are as of March 31, 2013 and cover the three-

8
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month period ended March 31, 2013 ("First Quarter 2013") and the three-month period ended March 31, 2012 ("First Quarter 2012"). Certain financial information that is normally included in annual financial statements prepared in accordance with GAAP, but is not required for interim reporting purposes, has been condensed or omitted.The year-end balance sheet data was derived from audited financial statements.
 
The unaudited interim consolidated financial statements include the accounts of AGL and its direct and indirect subsidiaries (collectively, the “Subsidiaries”) and its consolidated FG VIEs. Intercompany accounts and transactions between and among all consolidated entities have been eliminated. Certain prior year balances have been reclassified to conform to the current year’s presentation.
 
These unaudited interim consolidated financial statements should be read in conjunction with the consolidated financial statements included in AGL’s Annual Report on Form 10-K for the year ended December 31, 2012, filed with the U.S. Securities and Exchange Commission (the “SEC”).

The Company's principal insurance company subsidiaries are:

•
Assured Guaranty Municipal Corp. ("AGM"), domiciled in New York;
•
Assured Guaranty Corp. ("AGC"), domiciled in Maryland; and
•
Assured Guaranty Re Ltd. (“AG Re”), domiciled in Bermuda.
    
The Company also has the following other insurance company subsidiaries:

•
Assured Guaranty (Europe) Ltd. and one other insurance subsidiary, organized in the United Kingdom;
•
Municipal Assurance Corp., domiciled in New York, that has not yet commenced insurance operations; and
•
a U.S. and a Bermuda insurance subsidiary that participate in a pooling agreement with AGM.

The Company’s organizational structure includes various holdings companies, two of which — Assured Guaranty US Holdings Inc. (“AGUS”) and Assured Guaranty Municipal Holdings Inc. (“AGMH”) — have public debt outstanding. See Note 15, Long Term Debt and Credit Facilities.


2.
Business Changes and Accounting Developments
 
Summarized below are updates of the most significant recent events that have had, or may have in the future, a material effect on the financial position, results of operations or business prospects of the Company.
 
Rating Actions
 
When a rating agency assigns a public rating to a financial obligation guaranteed by one of AGL’s insurance company subsidiaries, it generally awards that obligation the same rating it has assigned to the financial strength of the AGL subsidiary that provides the guaranty. Investors in products insured by AGL’s insurance company subsidiaries frequently rely on ratings published by nationally recognized statistical rating organizations (“NRSROs”) because such ratings influence the trading value of securities and form the basis for many institutions’ investment guidelines as well as individuals’ bond purchase decisions. Therefore, the Company manages its business with the goal of achieving high financial strength ratings. If the financial strength ratings of the Company’s insurance subsidiaries were reduced below current levels, the Company expects it could have adverse effects on its future business opportunities as well as the premiums it could charge for its insurance policies and consequently, a further downgrade could harm the Company’s new business production and results of operations in a material respect. However, the models used by NRSROs differ, presenting conflicting goals that may make it inefficient or impractical to reach the highest rating level. The models are not fully transparent, contain subjective data (such as assumptions about future market demand for the Company’s products) and change frequently. Ratings reflect only the views of the respective NRSROs and are subject to continuous review and revision or withdrawal at any time.
    
In the last several years, Standard and Poor’s Ratings Services (“S&P”) and Moody’s Investors Service, Inc. (“Moody’s”) have downgraded the financial strength ratings of all the Company’s insurance subsidiaries that they rate. On January 17, 2013, Moody’s downgraded the Insurance Financial Strength ("IFS") rating of AGM to A2 from Aa3, the IFS rating of AGC to A3 from Aa3, and the IFS rating of AG Re to Baa1 from A1. In the same rating action, Moody's also downgraded the senior unsecured debt ratings of AGUS and AGMH to Baa2 from A3. While the outlook for the ratings from S&P and Moody's is stable, there can be no assurance that S&P and Moody's will not take further action on the Company’s ratings. For a discussion of the effect of rating actions on the Company, see the following:

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•
Note 5, Expected Loss to be Paid
•
Note 8, Financial Guaranty Contracts Accounted for as Credit Derivatives
•
Note 13, Reinsurance and Other Monoline Exposures
•
Note 15, Long Term Debt and Credit Facilities (regarding the impact on the Company's insured leveraged lease transactions)
    
Accounting Changes

In 2013, the Company expanded Note 17, Other Comprehensive Income, upon adoption of new guidance on other comprehensive income disclosures.

Significant Transactions

•
In First Quarter 2013, under the current authorization, the Company repurchased 1.9 million common shares for $39 million at an average price of $20.46 per share. On May 8, 2013, the Company's board of directors authorized an additional $115 million of repurchases of the Company’s common shares, bringing the total authorization in 2013 to $315 million, of which the Company had repurchased a total of 5.6 million shares for approximately $115 million at an average price of $20.29 per share through May 6, 2013.

•
On May 6, 2013, the Company entered into an agreement with UBS Real Estate Securities Inc. and affiliates ("UBS") and a third party resolving the Company’s claims and liabilities related to specified residential mortgage-backed securities ("RMBS") transactions that were issued, underwritten or sponsored by UBS and insured by AGM or AGC under financial guaranty insurance policies. See Note 5, Expected Loss to be Paid.


3.
Outstanding Exposure
 
The Company’s financial guaranty contracts are written in either insurance or credit derivative form, but collectively are considered financial guaranty contracts. The Company seeks to limit its exposure to losses by underwriting obligations that are investment grade at inception, diversifying its insured portfolio and maintaining rigorous subordination or collateralization requirements on structured finance obligations. The Company also has utilized reinsurance by ceding business to third-party reinsurers. The Company provides financial guaranties with respect to debt obligations of special purpose entities, including VIEs. Some of these VIEs are consolidated as described in Note 9, Consolidation of Variable Interest Entities. The outstanding par and Debt Service amounts presented below include outstanding exposures on VIEs whether or not they are consolidated.
 
Debt Service Outstanding

 
Gross Debt Service
Outstanding
 
Net Debt Service
Outstanding
 
March 31,
2013
 
December 31,
2012
 
March 31,
2013
 
December 31,
2012
 
(in millions)
Public finance
$
696,771

 
$
722,562

 
$
654,113

 
$
677,369

Structured finance
104,976

 
112,388

 
97,628

 
104,811

Total financial guaranty
$
801,747

 
$
834,950

 
$
751,741

 
$
782,180

 

In addition to the amounts shown in the table above, the Company’s net mortgage guaranty insurance in force was approximately $149 million as of March 31, 2013. The net mortgage guaranty insurance in force is assumed excess of loss business written between 2004 and 2006 and comprises $135 million covering loans originated in Ireland and $14 million covering loans originated in the United Kingdom ("U.K.").

Unless otherwise noted, ratings disclosed herein on Assured Guaranty’s insured portfolio reflect Assured Guaranty’s internal ratings. Assured Guaranty’s ratings scale is similar to that used by the NRSROs; however, the ratings in these financial statements may not be the same as those assigned by any such rating agency. For example, the super senior category, which is not generally used by rating agencies, is used by Assured Guaranty in instances where Assured Guaranty’s AAA-rated exposure on its internal rating scale (which does not take into account Assured Guaranty’s financial guaranty) has additional credit

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enhancement due to either (1) the existence of another security rated AAA that is subordinated to Assured Guaranty’s exposure or (2) Assured Guaranty’s exposure benefiting from a different form of credit enhancement that would pay any claims first in the event that any of the exposures incurs a loss, and such credit enhancement, in management’s opinion, causes Assured Guaranty’s attachment point to be materially above the AAA attachment point.

 Financial Guaranty Portfolio by Internal Rating
As of March 31, 2013 

 
 
Public Finance
U.S.
 
Public Finance
Non-U.S.
 
Structured Finance
U.S
 
Structured Finance
Non-U.S
 
Total
Rating
Category
 
Net Par
Outstanding
 
%
 
Net Par
Outstanding
 
%
 
Net Par
Outstanding
 
%
 
Net Par
Outstanding
 
%
 
Net Par
Outstanding
 
%
 
 
(dollars in millions)
Super senior
 
$
—

 
—
%
 
$
1,071

 
3.1
%
 
$
13,259

 
18.9
%
 
$
4,522

 
25.1
%
 
$
18,852

 
3.8
%
AAA
 
4,053

 
1.1

 
580

 
1.7

 
26,628

 
37.9

 
7,504

 
41.7

 
38,765

 
7.7

AA
 
120,812

 
31.9

 
661

 
1.9

 
10,041

 
14.2

 
687

 
3.8

 
132,201

 
26.3

A
 
206,112

 
54.5

 
9,158

 
26.1

 
3,149

 
4.5

 
958

 
5.3

 
219,377

 
43.7

BBB
 
42,890

 
11.3

 
21,590

 
61.5

 
3,351

 
4.8

 
2,437

 
13.5

 
70,268

 
14.0

Below-investment-grade (“BIG”)
 
4,589

 
1.2

 
2,007

 
5.7

 
13,852

 
19.7

 
1,906

 
10.6

 
22,354

 
4.5

Total net par outstanding
 
$
378,456

 
100.0
%
 
$
35,067

 
100.0
%
 
$
70,280

 
100.0
%
 
$
18,014

 
100.0
%
 
$
501,817

 
100.0
%
 
Financial Guaranty Portfolio by Internal Rating
As of December 31, 2012 

 
 
Public Finance
U.S.
 
Public Finance
Non-U.S.
 
Structured Finance
U.S
 
Structured Finance
Non-U.S
 
Total
Rating
Category
 
Net Par
Outstanding
 
%
 
Net Par
Outstanding
 
%
 
Net Par
Outstanding
 
%
 
Net Par
Outstanding
 
%
 
Net Par
Outstanding
 
%
 
 
(dollars in millions)
Super senior
 
$
—

 
—
%
 
$
1,130

 
3.0
%
 
$
13,572

 
18.2
%
 
$
4,874

 
24.7
%
 
$
19,576

 
3.8
%
AAA
 
4,502

 
1.2

 
576

 
1.5

 
28,615

 
38.3

 
8,295

 
42.1

 
41,988

 
8.1

AA
 
124,525

 
32.1

 
875

 
2.3

 
9,589

 
12.8

 
722

 
3.7

 
135,711

 
26.1

A
 
210,124

 
54.1

 
9,781

 
26.1

 
4,670

 
6.2

 
1,409

 
7.2

 
225,984

 
43.4

BBB
 
44,213

 
11.4

 
22,885

 
61.0

 
3,717

 
5.0

 
2,427

 
12.3

 
73,242

 
14.1

BIG
 
4,603

 
1.2

 
2,293

 
6.1

 
14,532

 
19.5

 
1,964

 
10.0

 
23,392

 
4.5

Total net par outstanding
 
$
387,967

 
100.0
%
 
$
37,540

 
100.0
%
 
$
74,695

 
100.0
%
 
$
19,691

 
100.0
%
 
$
519,893

 
100.0
%
 
The Company classifies those portions of risks benefiting from reimbursement obligations collateralized, or expected to be collateralized, by eligible assets held in trust in acceptable reimbursement structures as the higher of 'AA' or their current internal rating.
 
Securities purchased for loss mitigation purposes, which are generally rated BIG, represented $1,119 million and $1,133 million of gross par outstanding as of March 31, 2013 and December 31, 2012, respectively. In addition, under the terms of certain credit derivative contracts, the Company has been delivered the obligations referenced in such contracts and recorded them in invested assets in the consolidated balance sheets. Such amounts totaled $219 million and $220 million in gross par outstanding as of March 31, 2013 and December 31, 2012, respectively.

In addition to amounts shown in the tables above, the Company had outstanding commitments to provide guaranties of $1.8 billion for structured finance and $0.7 billion for public finance obligations at March 31, 2013. The structured finance commitments include the unfunded component of pooled corporate and other transactions. Public finance commitments typically relate to primary and secondary public finance debt issuances. The expiration dates for the public finance commitments range between April 15, 2013 and February 25, 2017, with $0.6 billion expiring prior to December 31, 2013. The commitments are contingent on the satisfaction of all conditions set forth in them and may expire unused or be canceled at the counterparty’s request. Therefore, the total commitment amount does not necessarily reflect actual future guaranteed amounts.
 

11
Table of Contents

Economic Exposure to the Selected European Countries

Several European countries continue to experience significant economic, fiscal and/or political strains such that the likelihood of default on obligations with a nexus to those countries may be higher than the Company anticipated when such factors did not exist. The European countries where it believes heightened uncertainties exist are: Greece, Hungary, Ireland, Italy, Portugal and Spain (the “Selected European Countries”). The Company is closely monitoring its exposures in Selected European Countries where it believes heightened uncertainties exist. Published reports have identified countries that may be experiencing reduced demand for their sovereign debt in the current environment. The Company selected these European countries based on these reports and its view that their credit fundamentals are deteriorating. The Company’s economic exposure to the Selected European Countries (based on par for financial guaranty contracts and notional amount for financial guaranty contracts accounted for as derivatives) is shown in the following table net of ceded reinsurance.
 
Net Economic Exposure to Selected European Countries(1)
March 31, 2013

 
Greece
 
Hungary (2)
 
Ireland
 
Italy
 
Portugal
 
Spain (2)
 
Total
 
(in millions)
Sovereign and sub-sovereign exposure:
 

 
 

 
 

 
 

 
 

 
 

 
 

Public finance
$
—

 
$
—

 
$
—

 
$
978

 
$
105

 
$
258

 
$
1,341

Infrastructure finance
—

 
408

 
23

 
83

 
96

 
164

 
774

Sub-total
—

 
408

 
23

 
1,061

 
201

 
422

 
2,115

Non-sovereign exposure:
 

 
 

 
 

 
 

 
 

 
 

 
 

Regulated utilities
—

 
—

 
—

 
215

 
—

 
8

 
223

RMBS
—

 
205

 
135

 
476

 
—

 
—

 
816

Commercial receivables
—

 
2

 
13

 
61

 
14

 
2

 
92

Pooled corporate
22

 
—

 
177

 
226

 
15

 
498

 
938

Sub-total
22

 
207

 
325

 
978

 
29

 
508

 
2,069

Total
$
22

 
$
615

 
$
348

 
$
2,039

 
$
230

 
$
930

 
$
4,184

Total BIG
$
—

 
$
576

 
$
7

 
$
2

 
$
121

 
$
406

 
$
1,112

 ____________________
(1)                             While the Company’s exposures are shown in U.S. dollars, the obligations the Company insures are in various currencies, including U.S. dollars, Euros and British pounds sterling. Included in the table above is $135 million of reinsurance assumed on a 2004 - 2006 pool of Irish residential mortgages that is part of the Company’s remaining legacy mortgage reinsurance business. One of the residential mortgage-backed securities included in the table above includes residential mortgages in both Italy and Germany, and only the portion of the transaction equal to the portion of the original mortgage pool in Italian mortgages is shown in the table.

 (2)
See Note 5, Expected Loss to be Paid.
 
When the Company directly insures an obligation, it assigns the obligation to a geographic location or locations based on its view of the geographic location of the risk. For direct exposure this can be a relatively straight-forward determination as, for example, a debt issue supported by availability payments for a toll road in a particular country. The Company may also assign portions of a risk to more than one geographic location. The Company may also have direct exposures to the Selected European Countries in business assumed from unaffiliated monoline insurance companies. In the case of assumed business for direct exposures, the Company depends upon geographic information provided by the primary insurer.

The Company has included in the exposure tables above its indirect economic exposure to the Selected European Countries through exposure it provides on (a) pooled corporate and (b) commercial receivables transactions. The Company considers economic exposure to a selected European Country to be indirect when the exposure relates to only a small portion of an insured transaction that otherwise is not related to a Selected European Country. In most instances, the trustees and/or servicers for such transactions provide reports that identify the domicile of the underlying obligors in the pool, although occasionally such information is not available to the Company. The Company has reviewed transactions through which it believes it may have indirect exposure to the Selected European Countries that is material to the transaction and included in the

12
Table of Contents

tables above the proportion of the insured par equal to the proportion of obligors so identified as being domiciled in a Selected European Country. The Company may also have indirect exposures to Selected European Countries in business assumed from unaffiliated monoline insurance companies. However, in the case of assumed business for indirect exposures, unaffiliated primary insurers generally do not provide such information to the Company.

The Company no longer guarantees any sovereign bonds of the Selected European Countries. The exposure shown in the “Public Finance Category” is from transactions backed by receivable payments from sub-sovereigns in Italy, Spain and Portugal. Sub-sovereign debt is debt issued by a governmental entity or government backed entity, or supported by such an entity, that is other than direct sovereign debt of the ultimate governing body of the country.

The Company understands that Moody's recently had undertaken a review of redenomination risk in selected countries in the Eurozone, including some of the Selected European Countries. No redenomination from the Euro to another currency has yet occurred and it may never occur. Therefore, it is not possible to be certain at this point how a redenomination of an issuer’s obligations might be implemented in the future and, in particular, whether any redenomination would extend to the Company's obligations under a related financial guarantee.

Surveillance Categories
 
The Company segregates its insured portfolio into investment grade and BIG surveillance categories to facilitate the appropriate allocation of resources to monitoring and loss mitigation efforts and to aid in establishing the appropriate cycle for periodic review for each exposure. BIG exposures include all exposures with internal credit ratings below BBB-. The Company’s internal credit ratings are based on internal assessments of the likelihood of default and loss severity in the event of default. Internal credit ratings are expressed on a ratings scale similar to that used by the rating agencies and are generally reflective of an approach similar to that employed by the rating agencies.
 
The Company monitors its investment grade credits to determine whether any new credits need to be internally downgraded to BIG. The Company refreshes its internal credit ratings on individual credits in quarterly, semi-annual or annual cycles based on the Company’s view of the credit’s quality, loss potential, volatility and sector. Ratings on credits in sectors identified as under the most stress or with the most potential volatility are reviewed every quarter. The Company’s insured credit ratings on assumed credits are based on the Company’s reviews of low-rated credits or credits in volatile sectors, unless such information is not available, in which case, the ceding company’s credit rating of the transactions are used. The Company models most assumed RMBS credits with par above $1 million, as well as certain RMBS credits below that amount.
 
Credits identified as BIG are subjected to further review to determine the probability of a loss (see Note 5, Expected Loss to be Paid). Surveillance personnel then assign each BIG transaction to the appropriate BIG surveillance category based upon whether a lifetime loss is expected and whether a claim has been paid. The Company expects “lifetime losses” on a transaction when the Company believes there is at least a 50% chance that, on a present value basis, it will pay more claims over the life of that transaction than it ultimately will have reimbursed. For surveillance purposes, the Company calculates present value using a constant discount rate of 5%. (A risk-free rate is used for recording of reserves for financial statement purposes.)
 
More extensive monitoring and intervention is employed for all BIG surveillance categories, with internal credit ratings reviewed quarterly. The three BIG categories are:
 
•
BIG Category 1: Below-investment-grade transactions showing sufficient deterioration to make lifetime losses possible, but for which none are currently expected. Transactions on which claims have been paid but are expected to be fully reimbursed (other than investment grade transactions on which only liquidity claims have been paid) are in this category.
 
•
BIG Category 2: Below-investment-grade transactions for which lifetime losses are expected but for which no claims (other than liquidity claims which is a claim that the Company expects to be reimbursed within one year) have yet been paid.
 
•
BIG Category 3: Below-investment-grade transactions for which lifetime losses are expected and on which claims (other than liquidity claims) have been paid. Transactions remain in this category when claims have been paid and only a recoverable remains.
 

13
Table of Contents

Financial Guaranty Exposures
(Insurance and Credit Derivative Form)
As of March 31, 2013

 
BIG Net Par Outstanding
 
Net Par
 
BIG Net Par as
a % of Total Net Par
 
BIG 1
 
BIG 2
 
BIG 3
 
Total BIG
 
Outstanding
 
Outstanding
 
 
 
 
 
(in millions)
 
 
 
 
 
 
First lien U.S. RMBS:
 

 
 

 
 

 
 

 
 

 
 

Prime first lien
$
27

 
$
422

 
$
10

 
$
459

 
$
619

 
0.1
%
Alt-A first lien
98

 
1,937

 
1,430

 
3,465

 
4,439

 
0.7

Option ARM
65

 
339

 
362

 
766

 
1,387

 
0.2

Subprime
162

 
1,219

 
1,006

 
2,387

 
7,130

 
0.5

Second lien U.S. RMBS:
 

 
 

 
 

 
 

 
 

 
 

Closed end second lien
—

 
61

 
279

 
340

 
452

 
0.1

Home equity lines of credit (“HELOCs”)
72

 
12

 
2,526

 
2,610

 
3,059

 
0.5

Total U.S. RMBS
424

 
3,990

 
5,613

 
10,027

 
17,086

 
2.1

Trust preferred securities (“TruPS”)
1,873

 
—

 
941

 
2,814

 
5,496

 
0.5

Other structured finance
1,240

 
379

 
1,298

 
2,917

 
65,712

 
0.6

U.S. public finance
3,359

 
520

 
710

 
4,589

 
378,456

 
0.9

Non-U.S. public finance
983

 
1,024

 
—

 
2,007

 
35,067

 
0.4

Total
$
7,879

 
$
5,913

 
$
8,562

 
$
22,354

 
$
501,817

 
4.5
%

 Financial Guaranty Exposures
(Insurance and Credit Derivative Form)
As of December 31, 2012

 
BIG Net Par Outstanding
 
Net Par
 
BIG Net Par as
a % of Total Net Par
 
BIG 1
 
BIG 2
 
BIG 3
 
Total BIG
 
Outstanding
 
Outstanding
 
 
 
 
 
(in millions)
 
 
 
 
 
 
First lien U.S. RMBS:
 

 
 

 
 

 
 

 
 

 
 

Prime first lien
$
28

 
$
436

 
$
11

 
$
475

 
$
641

 
0.1
%
Alt-A first lien
109

 
1,987

 
1,479

 
3,575

 
4,589

 
0.7

Option ARM
61

 
392

 
643

 
1,096

 
1,550

 
0.2

Subprime (including net interest margin securities)
152

 
1,161

 
1,024

 
2,337

 
7,330

 
0.4

Second lien U.S. RMBS:
 

 
 

 
 

 
 

 
 

 
 

Closed end second lien
—

 
247

 
157

 
404

 
521

 
0.1

HELOCs
91

 
—

 
2,627

 
2,718

 
3,196

 
0.5

Total U.S. RMBS
441

 
4,223

 
5,941

 
10,605

 
17,827

 
2.0

TruPS
1,920

 
—

 
952

 
2,872

 
5,693

 
0.6

Other structured finance
1,310

 
384

 
1,325

 
3,019

 
70,866

 
0.6

U.S. public finance
3,290

 
500

 
813

 
4,603

 
387,967

 
0.9

Non-U.S. public finance
2,293

 
—

 
—

 
2,293

 
37,540

 
0.4

Total
$
9,254

 
$
5,107

 
$
9,031

 
$
23,392

 
$
519,893

 
4.5
%


14
Table of Contents

 
Below-Investment-Grade Credits
By Category
As of March 31, 2013

 
 
Net Par Outstanding
 
Number of Risks(2)
Description
 
Financial
Guaranty
Insurance(1)
 
Credit
Derivative
 
Total
 
Financial
Guaranty
Insurance(1)
 
Credit
Derivative
 
Total
 
 
(dollars in millions)
BIG:
 
 

 
 

 
 

 
 

 
 

 
 

Category 1
 
$
6,148

 
$
1,731

 
$
7,879

 
143

 
30

 
173

Category 2
 
3,289

 
2,624

 
5,913

 
82

 
26

 
108

Category 3
 
6,611

 
1,951

 
8,562

 
147

 
29

 
176

Total BIG
 
$
16,048

 
$
6,306

 
$
22,354

 
372

 
85

 
457


 Below-Investment-Grade Credits
By Category
As of December 31, 2012

 
 
Net Par Outstanding
 
Number of Risks(2)
Description
 
Financial
Guaranty
Insurance(1)
 
Credit
Derivative
 
Total
 
Financial
Guaranty
Insurance(1)
 
Credit
Derivative
 
Total
 
 
(dollars in millions)
BIG:
 
 

 
 

 
 

 
 

 
 

 
 

Category 1
 
$
7,049

 
$
2,205

 
$
9,254

 
153

 
30

 
183

Category 2
 
2,606

 
2,501

 
5,107

 
76

 
27

 
103

Category 3
 
7,028

 
2,003

 
9,031

 
142

 
32

 
174

Total BIG
 
$
16,683

 
$
6,709

 
$
23,392

 
371

 
89

 
460

_____________________
(1)    Includes net par outstanding for FG VIEs.
 
(2)
A risk represents the aggregate of the financial guaranty policies that share the same revenue source for purposes of making Debt Service payments.
 

4.
Financial Guaranty Insurance Premiums

The portfolio of outstanding exposures discussed in Note 3, Outstanding Exposure, includes financial guaranty contracts that meet the definition of insurance contracts as well as those that meet the definition of a derivative under GAAP. Amounts presented in this note relate only to financial guaranty insurance contracts. See Note 8, Financial Guaranty Contracts Accounted for as Credit Derivatives, for a discussion of credit derivative revenues.


15
Table of Contents

Net Earned Premiums
 
 
First Quarter
 
2013
 
2012
 
(in millions)
Scheduled net earned premiums
$
128

 
$
152

Acceleration of premium earnings
113

 
37

Accretion of discount on net premiums receivable
7

 
5

  Total financial guaranty insurance
248

 
194

Other
0

 
0

  Total net earned premiums(1)
$
248

 
$
194

 ___________________
(1)
Excludes $18 million and $17 million for First Quarter 2013 and 2012, respectively, related to consolidated FG VIEs.

Components of Unearned Premium Reserve
 
 
As of March 31, 2013
 
As of December 31, 2012
 
Gross
 
Ceded
 
Net(1)
 
Gross
 
Ceded
 
Net(1)
 
(in millions)
Deferred premium revenue:
 
 
 
 
 
 
 
 
 
 
 
   Financial guaranty
$
5,090

 
$
558

 
$
4,532

 
$
5,349

 
$
586

 
$
4,763

   Other
7

 
—

 
7

 
7

 
—

 
7

Total deferred premium revenue
$
5,097

 
$
558

 
$
4,539

 
$
5,356

 
$
586

 
$
4,770

Contra-paid
(115
)
 
(23
)
 
(92
)
 
(149
)
 
(25
)
 
(124
)
Total
$
4,982

 
$
535

 
$
4,447

 
$
5,207

 
$
561

 
$
4,646

 ____________________
(1)
Excludes $244 million and $262 million of deferred premium revenue, and $72 million and $98 million of contra-paid related to FG VIEs as of March 31, 2013 and December 31, 2012, respectively.

 
Net Deferred Premium Revenue Roll Forward

 
First Quarter
 
2013
 
2012
 
(in millions)
Balance beginning of period
$
4,770

 
$
5,327

Premium written, net
14

 
13

Net premium earned, excluding accretion
(241
)
 
(189
)
Commutations and changes in expected premiums
1

 
130

Foreign exchange translation
(4
)
 
3

Consolidation of FG VIEs
(1
)
 
(5
)
Balance, end of period
$
4,539

 
$
5,279


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Table of Contents

Gross Premium Receivable, Net of Ceding Commissions Roll Forward
 
 
First Quarter
 
2013
 
2012
 
(in millions)
Balance beginning of period
$
1,005

 
$
1,003

Premium written, net of ceding commissions
17

 
56

Premium payments received, net of ceding commissions
(53
)
 
(86
)
Adjustments:
 
 
 
Changes in the expected term of financial guaranty insurance contracts
1

 
33

Accretion of discount, net of ceding commissions
9

 
6

Foreign exchange translation
(23
)
 
12

Consolidation of FG VIEs
0

 
(5
)
Balance, end of period (1)
$
956

 
$
1,019

____________________
(1)
Excludes $28 million and $33 million as of March 31, 2013 and March 31, 2012, respectively, related to consolidated FG VIEs.
 
Gains or losses due to foreign exchange rate changes relate to installment premium receivables denominated in currencies other than the U.S. dollar. Approximately 46%, and 47% of installment premiums at March 31, 2013 and December 31, 2012, respectively, are denominated in currencies other than the U.S. dollar, primarily Euro and British Pound Sterling.
 
The timing and cumulative amount of actual collections may differ from expected collections in the tables below due to factors such as foreign exchange rate fluctuations, counterparty collectability issues, accelerations, commutations and changes in expected lives.
 
Expected Collections of Gross Premiums Receivable,
Net of Ceding Commissions (Undiscounted)

 
March 31, 2013
 
(in millions)
2013 (April 1 – June 30)
$
53

2013 (July 1 – September 30)
26

2013 (October 1 – December 31)
29

2014
105

2015
93

2016
87

2017
80

2018-2022
315

2023-2027
197

2028-2032
135

After 2032
154

Total(1)
$
1,274

 ____________________
(1)
Excludes expected cash collections on FG VIEs of $35 million.

17
Table of Contents

Scheduled Net Earned Premiums
Financial Guaranty Insurance Contracts
 
 
As of March 31, 2013
 
(in millions)
2013 (April 1 - June 30)
$
121

2013 (July 1 - September 30)
118

2013 (October 1–December 31)
112

Subtotal 2013
351

2014
422

2015
371

2016
338

2017
303

2018 - 2022
1,164

2023 - 2027
732

2028 - 2032
437

After 2032
414

Total present value basis(1)
4,532

Discount
250

Total future value
$
4,782

 ____________________
(1)
Excludes scheduled net earned premiums on consolidated FG VIEs of $244 million.

Selected Information for Policies Paid in Installments

 
As of
March 31, 2013
 
As of
December 31, 2012
 
(dollars in millions)
Premiums receivable, net of ceding commission payable
$
956

 
$
1,005

Gross deferred premium revenue
1,788

 
1,908

Weighted-average risk-free rate used to discount premiums
3.6
%
 
3.5
%
Weighted-average period of premiums receivable (in years)
9.5

 
9.6



5.
Expected Loss to be Paid
 
The following provides a summarized description of the three accounting models required under GAAP for each type of contract, with references to additional information provided throughout this report. The three models are insurance, derivative and VIE consolidation. This note provides information regarding expected claim payments to be made under all insured contracts regardless of form of execution.

Accounting Models:

Insurance Accounting

For contracts accounted for as financial guaranty insurance, loss and loss adjustment expenses ("LAE") reserve is recorded only to the extent and for the amount that expected losses to be paid exceed unearned premium reserve. As a result, the Company has expected losses that have not yet been expensed but will be expensed in future periods. Such amounts will be expensed in future periods as deferred premium revenue amortizes into income. Expected loss to be paid is important from a liquidity perspective in that it represents the present value of amounts that the Company expects to pay or recover in future periods. Expected loss to be expensed is important because it presents the Company's projection of incurred losses that will be recognized in future periods as deferred premium revenue amortizes into income. See Note 6, Financial Guaranty Insurance Losses.


18
Table of Contents

Derivative Accounting, at Fair Value

For contracts that do not meet the financial guaranty scope exception in the derivative accounting guidance (primarily due to the fact that the insured is not required to be exposed to the insured risk throughout the life of the contract), the Company records such credit derivative contracts at fair value on the consolidated balance sheet with changes in fair value recorded in the consolidated statement of operations. Expected loss to be paid is an important measure used by management to analyze the net economic loss on credit derivatives. The fair value recorded on the balance sheet represents an exit price in a hypothetical market. The fair value is determined using significant Level 3 inputs in an internally developed model while the expected loss to be paid (which represents the present value of expected cash outflows) uses methodologies and assumptions consistent with financial guaranty insurance expected losses to be paid. See Note 7, Fair Value Measurement and Note 8, Financial Guaranty Contracts Accounted for as Credit Derivatives.

VIE Consolidation, at Fair Value

For financial guaranty insurance contracts issued on the debt of variable interest entities over which the Company is deemed to be the primary beneficiary due to its control rights, as defined in accounting literature, the Company consolidates the FG VIE. The Company's expected loss to be paid is a component of the fair value of the FG VIEs liabilities. The Company carries the assets and liabilities of the FG VIEs at fair value under the fair value option election. Management assesses the losses on the insured debt of the consolidated FG VIEs in the same manner as other financial guaranty insurance and credit derivative contracts. Expected loss to be paid for FG VIEs pursuant to AGC's and AGM's financial guaranty insurance policies is calculated in a manner consistent with the Company's other financial guaranty insurance contracts.
     
Expected Loss to be Paid

The expected loss to be paid is equal to the present value of expected future cash outflows for claim and LAE payments, net of inflows for expected salvage and subrogation (i.e. excess spread on the underlying collateral, and estimated and contractual recoveries for breaches of representations and warranties), using current risk-free rates. When the Company becomes entitled to the cash flow from the underlying collateral of an insured credit under salvage and subrogation rights as a result of a claim payment or estimated future claim payment, it reduces the expected loss to be paid on the contract. Net expected loss to be paid is defined as expected loss to be paid, net of amounts ceded to reinsurers.

The current risk-free rate is based on the remaining period of the contract used in the premium revenue recognition calculation (i.e., the contractual or expected period, as applicable). The Company updates the discount rate each quarter and records the effect of such changes in economic loss development. Expected cash outflows and inflows are probability weighted cash flows that reflect the likelihood of all possible outcomes. The Company estimates the expected cash outflows and inflows using management's assumptions about the likelihood of all possible outcomes based on all information available to it. Those assumptions consider the relevant facts and circumstances and are consistent with the information tracked and monitored through the Company's risk-management activities.

Economic Loss Development

Economic loss development represents the change in expected loss to be paid attributable to all factors other than loss and LAE payments. It includes the effects of changes in assumptions based on observed market trends, changes in discount rates, accretion of discount and the economic effects of loss mitigation efforts.

Loss Mitigation

Expected loss to be paid and economic loss development include the effects of loss mitigation strategies and other contractual rights to mitigate losses such as: recoveries for breaches of representations and warranties, and purchases of insured debt obligations. Additionally, in certain cases, issuers of insured obligations elected, or the Company and an issuer mutually agreed as part of a negotiation, to deliver the underlying collateral or insured obligation to the Company. In circumstances where the Company has acquired its own insured obligations that have expected losses as part of loss mitigation strategy, expected loss to be paid is reduced by the proportionate share of the insured obligation that was purchased. The difference between the purchase price of the obligation and the fair value excluding the value of the Company's insurance, is treated as a paid loss. Assets that are purchased or put to the Company are recorded in the investment portfolio, at fair value, excluding the value of the Company's insurance or credit derivative contract. See Note 10, Investments and Cash and Note 7, Fair Value Measurement.


19
Table of Contents

Loss Estimation Process
 
The Company’s loss reserve committees estimate expected loss to be paid for all contracts. Surveillance personnel present analyses related to potential losses to the Company’s loss reserve committees for consideration in estimating the expected loss to be paid. Such analyses include the consideration of various scenarios with potential probabilities assigned to them. Depending upon the nature of the risk, the Company’s view of the potential size of any loss and the information available to the Company, those analyses may be based upon individually developed cash flow models, internal credit rating assessments and sector-driven loss severity assumptions, or judgmental assessments. In the case of its assumed business, the Company may conduct its own analyses as just described or, depending on the Company’s view of the potential size of any loss and the information available to the Company, the Company may use loss estimates provided by ceding insurers. The Company’s loss reserve committees review and refresh the estimate of expected loss to be paid each quarter. The Company’s estimate of ultimate loss on a policy is subject to significant uncertainty over the life of the insured transaction due to the potential for significant variability in credit performance as a result of economic, fiscal and financial market variability over the long duration of most contracts. The determination of expected loss to be paid is an inherently subjective process involving numerous estimates, assumptions and judgments by management.
 
The following table presents a roll forward of the present value of net expected loss to be paid for all contracts, whether accounted for as insurance, credit derivatives or FG VIEs, by sector before and after the benefit for contractual and expected breaches of representations and warranties ("R&W"). The Company used weighted average risk-free rates for U.S. dollar denominated obligations, which ranged from 0.0% to 3.72% as of March 31, 2013 and 0.0% to 3.28% as of December 31, 2012.

Net Expected Loss to be Paid
Before Recoveries for Breaches of R&W
Roll Forward by Sector
First Quarter 2013

 
Net Expected
Loss to be
Paid as of
December 31, 2012(2)
 
Economic Loss
Development
 
(Paid)
Recovered
Losses(1)
 
Net Expected
Loss to be
Paid as of
March 31, 2013(2)
 
(in millions)
U.S. RMBS:
 

 
 

 
 

 
 

First lien:
 

 
 

 
 

 
 

Prime first lien
$
10

 
$
6

 
$
(1
)
 
$
15

Alt-A first lien
693

 
1

 
(19
)
 
675

Option ARM
460

 
15

 
(112
)
 
363

Subprime
351

 
29

 
(4
)
 
376

Total first lien
1,514

 
51

 
(136
)
 
1,429

Second lien:
 

 
 

 
 

 
 

Closed-end second lien
99

 
(8
)
 
(4
)
 
87

HELOCs
39

 
14

 
(14
)
 
39

Total second lien
138

 
6

 
(18
)
 
126

Total U.S. RMBS
1,652

 
57

 
(154
)
 
1,555

TruPS
27

 
(3
)
 
(1
)
 
23

Other structured finance
312

 
(2
)
 
(3
)
 
307

U.S. public finance
7

 
7

 
(23
)
 
(9
)
Non-U.S public finance
52

 
10

 
—

 
62

Other
(3
)
 
(10
)
 
—

 
(13
)
Total
$
2,047

 
$
59

 
$
(181
)
 
$
1,925


20
Table of Contents

Net Expected Loss to be Paid
Before Recoveries for Breaches of R&W
Roll Forward by Sector
First Quarter 2012

 
Net Expected
Loss to be
Paid as of
December 31, 2011
 
Economic Loss
Development
 
(Paid)
Recovered
Losses(1)
 
Expected
Loss to be
Paid as of
March 31, 2012
 
(in millions)
U.S. RMBS:
 

 
 

 
 

 
 

First lien:
 

 
 

 
 

 
 

Prime first lien
$
5

 
$
1

 
$
—

 
$
6

Alt-A first lien
702

 
25

 
(26
)
 
701

Option ARM
935

 
26

 
(107
)
 
854

Subprime
342

 
11

 
(9
)
 
344

Total first lien
1,984

 
63

 
(142
)
 
1,905

Second lien:
 

 
 

 
 

 
 

Closed-end second lien
138

 
(5
)
 
(12
)
 
121

HELOCs
159

 
10

 
(71
)
 
98

Total second lien
297

 
5

 
(83
)
 
219

Total U.S. RMBS
2,281

 
68

 
(225
)
 
2,124

TruPS
64

 
(4
)
 
(2
)
 
58

Other structured finance
342

 
(22
)
 
(24
)
 
296

U.S. public finance
16

 
23

 
(6
)
 
33

Non-U.S public finance
51

 
198

 
54

 
303

Other
2

 
—

 
—

 
2

Total
$
2,756

 
$
263

 
$
(203
)
 
$
2,816

____________________
(1)
Net of ceded paid losses, whether or not such amounts have been settled with reinsurers. Ceded paid losses are typically settled 45 days after the end of the reporting period. Such amounts are recorded in reinsurance recoverable on paid losses included in other assets.

(2)
Includes expected LAE to be paid for mitigating claim liabilities of $31 million as of March 31, 2013 and $39 million as of December 31, 2012. The Company paid $13 million and $9 million in LAE for First Quarter 2013 and 2012, respectively.



21
Table of Contents

Net Expected Recoveries from
Breaches of R&W Rollforward
First Quarter 2013
 
 
Future Net
R&W Benefit as of
December 31, 2012
 
R&W Development
and Accretion of
Discount
During First Quarter 2013
 
R&W Recovered
During First Quarter 2013(1)
 
Future Net
R&W Benefit as of
March 31, 2013(2)
 
(in millions)
U.S. RMBS:
 
 
 
 
 
 
 
First lien:
 
 
 
 
 
 
 
Prime first lien
$
4

 
$
—

 
$
—

 
$
4

Alt-A first lien
378

 
(8
)
 
(8
)
 
362

Option ARM
591

 
153

 
(54
)
 
690

Subprime
109

 
4

 
—

 
113

Total first lien
1,082

 
149

 
(62
)
 
1,169

Second lien:
 
 
 
 
 
 
 
Closed end second lien
138

 
(9
)
 
(21
)
 
108

HELOC
150

 
17

 
(6
)
 
161

Total second lien
288

 
8

 
(27
)
 
269

Total
$
1,370

 
$
157

 
$
(89
)
 
$
1,438

 
Net Expected Recoveries from
Breaches of R&W Rollforward
First Quarter 2012
 
Future Net
R&W Benefit as of
December 31, 2011
 
R&W Development
and Accretion of
Discount
During First Quarter 2012
 
R&W Recovered
During First Quarter 2012(1)
 
Future Net
R&W Benefit as of
March 31, 2012 (2)
 
(in millions)
U.S. RMBS:
 
 
 
 
 
 
 
First lien:
 
 
 
 
 
 
 
Prime first lien
$
3

 
$
1

 
$
—

 
$
4

Alt-A first lien
407

 
27

 
(1
)
 
433

Option ARM
725

 
28

 
(18
)
 
735

Subprime
101

 
(5
)
 
—

 
96

Total first lien
1,236

 
51

 
(19
)
 
1,268

Second lien:
 
 
 
 
 
 
 
Closed end second lien
224

 
(2
)
 
—

 
222

HELOC
190

 
2

 
(51
)
 
141

Total second lien
414

 
—

 
(51
)
 
363

Total
$
1,650

 
$
51

 
$
(70
)
 
$
1,631

____________________
(1)