Table of Contents

 

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

x

QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934

 

For the Quarterly Period Ended March 31, 2009

 

OR

 

o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

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 of incorporation)

 

(I.R.S. employer identification no.)

 

30 Woodbourne Avenue

Hamilton HM 08

Bermuda

(address of principal executive office)

 

(441) 299-9375

(Registrants 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    o    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, 2009 was 90,990,867.

 

 

 



Table of Contents

 

ASSURED GUARANTY LTD.

 

INDEX TO FORM 10-Q

 

 

 

 

Page

PART I. FINANCIAL INFORMATION

 

 

Item 1.

Financial Statements:

 

 

 

Consolidated Balance Sheets (unaudited) as of March 31, 2009 and December 31, 2008

 

3

 

Consolidated Statements of Operations and Comprehensive Income (unaudited) for the Three Months Ended March 31, 2009 and 2008

 

4

 

Consolidated Statements of Shareholders’ Equity (unaudited) for the Three Months Ended March 31, 2009

 

5

 

Consolidated Statements of Cash Flows (unaudited) for the Three Months Ended March 31, 2009 and 2008

 

6

 

Notes to Consolidated Financial Statements (unaudited)

 

7

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

57

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

 

108

Item 4.

Controls and Procedures

 

110

 

 

 

 

PART II. OTHER INFORMATION

 

 

Item 1.

Legal Proceedings

 

111

Item 1A.

Risk Factors

 

112

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

112

Item 4.

Submission of Matters to a Vote of Security Holders

 

112

Item 5.

Other Information

 

114

Item 6.

Exhibits

 

114

 

2



Table of Contents

 

PART I — FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

Assured Guaranty Ltd.
Consolidated Balance Sheets
(in thousands of U.S. dollars except per share and share amounts)

(Unaudited)

 

 

 

March 31,

 

December 31,

 

 

 

2009

 

2008

 

 

 

 

 

 

 

Assets

 

 

 

 

 

Fixed maturity securities, at fair value (amortized cost: $3,172,426 in 2009 and $3,162,308 in 2008)

 

$

3,176,178

 

$

3,154,137

 

Short-term investments, at cost which approximates fair value

 

616,834

 

477,197

 

 

 

 

 

 

 

Total investments

 

3,793,012

 

3,631,334

 

Cash and cash equivalents

 

19,328

 

12,305

 

Accrued investment income

 

34,310

 

32,846

 

Deferred acquisition costs

 

382,525

 

288,616

 

Prepaid reinsurance premiums

 

23,655

 

18,856

 

Reinsurance recoverable on ceded losses

 

7,763

 

6,528

 

Premiums receivable

 

748,414

 

15,743

 

Goodwill

 

85,417

 

85,417

 

Credit derivative assets

 

149,798

 

146,959

 

Deferred tax asset

 

117,560

 

129,118

 

Current income taxes receivable

 

 

21,427

 

Salvage recoverable

 

120,515

 

80,207

 

Committed capital securities, at fair value

 

70,728

 

51,062

 

Other assets

 

35,303

 

35,289

 

 

 

 

 

 

 

Total assets

 

$

5,588,328

 

$

4,555,707

 

 

 

 

 

 

 

Liabilities and shareholders’ equity

 

 

 

 

 

Liabilities

 

 

 

 

 

Unearned premium reserves

 

$

2,153,312

 

$

1,233,714

 

Reserves for losses and loss adjustment expenses

 

222,555

 

196,798

 

Profit commissions payable

 

7,751

 

8,584

 

Reinsurance balances payable

 

22,673

 

17,957

 

Current income taxes payable

 

4,578

 

 

Funds held by Company under reinsurance contracts

 

30,962

 

30,683

 

Credit derivative liabilities

 

706,768

 

733,766

 

Senior Notes

 

197,452

 

197,443

 

Series A Enhanced Junior Subordinated Debentures

 

149,774

 

149,767

 

Other liabilities

 

66,910

 

60,773

 

 

 

 

 

 

 

Total liabilities

 

3,562,735

 

2,629,485

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

Shareholders’ equity

 

 

 

 

 

Common stock ($0.01 par value, 500,000,000 shares authorized; 90,122,385 and 90,955,703 shares issued and outstanding in 2009 and 2008)

 

901

 

910

 

Additional paid-in capital

 

1,284,093

 

1,284,370

 

Retained earnings

 

738,831

 

638,055

 

Accumulated other comprehensive income

 

1,768

 

2,887

 

 

 

 

 

 

 

Total shareholders’ equity

 

2,025,593

 

1,926,222

 

 

 

 

 

 

 

Total liabilities and shareholders’ equity

 

$

5,588,328

 

$

4,555,707

 

 

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

 

3



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Assured Guaranty Ltd.
Consolidated Statements of Operations and Comprehensive Income
(in thousands of U.S. dollars except per share amounts)

(Unaudited)

 

 

 

Three Months Ended
March 31,

 

 

 

2009

 

2008

 

 

 

 

 

 

 

Revenues

 

 

 

 

 

 

 

 

 

 

 

Net earned premiums

 

$

148,446

 

$

46,833

 

Net investment income

 

43,601

 

36,574

 

Net realized investment (losses) gains

 

(17,110

)

627

 

Change in fair value of credit derivatives

 

 

 

 

 

Realized gains and other settlements on credit derivatives

 

20,579

 

27,617

 

Unrealized gains (losses) on credit derivatives

 

26,982

 

(259,621

)

Net change in fair value of credit derivatives

 

47,561

 

(232,004

)

Other income

 

20,568

 

8,536

 

 

 

 

 

 

 

Total revenues

 

243,066

 

(139,434

)

 

 

 

 

 

 

Expenses

 

 

 

 

 

Loss and loss adjustment expenses

 

79,754

 

55,138

 

Profit commission expense

 

255

 

1,180

 

Acquisition costs

 

23,421

 

11,883

 

Other operating expenses

 

32,318

 

28,638

 

Interest expense

 

5,821

 

5,821

 

Other expense

 

1,400

 

735

 

 

 

 

 

 

 

Total expenses

 

142,969

 

103,395

 

 

 

 

 

 

 

Income (loss) before provision (benefit) for income taxes

 

100,097

 

(242,829

)

Provision (benefit) for income taxes

 

 

 

 

 

Current

 

11,575

 

10,113

 

Deferred

 

3,033

 

(83,733

)

 

 

 

 

 

 

Total provision (benefit) for income taxes

 

14,608

 

(73,620

)

 

 

 

 

 

 

Net income (loss)

 

85,489

 

(169,209

)

Other comprehensive loss, net of taxes

 

 

 

 

 

Unrealized holding losses on fixed maturity securities arising during the period

 

(9,702

)

(4,897

)

Reclassification adjustment for realized losses (gains) included in net income (loss)

 

17,075

 

(394

)

 

 

 

 

 

 

Change in net unrealized gains on fixed maturity securities

 

7,373

 

(5,291

)

Change in cumulative translation adjustment

 

(8,387

)

357

 

Change in cash flow hedge

 

(105

)

(105

)

Other comprehensive loss, net of taxes

 

(1,119

)

(5,039

)

 

 

 

 

 

 

Comprehensive income (loss)

 

$

84,370

 

$

(174,248

)

 

 

 

 

 

 

Earnings per share(1):

 

 

 

 

 

Basic

 

$

0.94

 

$

(2.09

)

Diluted

 

$

0.93

 

$

(2.09

)

 

 

 

 

 

 

Dividends per share

 

$

0.045

 

$

0.045

 

 


(1) Effective January 1, 2009, the Company adopted FSP EITF  03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities.” See Note 12 for more information.

 

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

 

4



Table of Contents

 

Assured Guaranty Ltd.
Consolidated Statements of Shareholders’ Equity
For the Three Months Ended March 31, 2009
(in thousands of U.S. dollars except per share amounts)

(Unaudited)

 

 

 

Common
Stock

 

Additional
Paid-in
Capital

 

Retained
Earnings

 

Accumulated
Other
Comprehensive
Income

 

Total
Shareholders’
Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, December 31, 2008

 

$

910

 

$

1,284,370

 

$

638,055

 

$

2,887

 

$

1,926,222

 

Cumulative effect of accounting change - Adoption of FAS 163 effective January 1, 2009

 

 

 

19,443

 

 

19,443

 

Net income

 

 

 

85,489

 

 

85,489

 

Dividends ($0.045 per share)

 

 

 

(4,122

)

 

(4,122

)

Dividends on restricted stock units

 

 

34

 

(34

)

 

 

Common stock repurchases

 

(10

)

(3,666

)

 

 

(3,676

)

Shares cancelled to pay withholding taxes

 

(1

)

(941

)

 

 

(942

)

Share-based compensation and other

 

2

 

4,296

 

 

 

4,298

 

Change in cash flow hedge, net of tax of $(56)

 

 

 

 

(105

)

(105

)

Change in cumulative translation adjustment

 

 

 

 

(8,387

)

(8,387

)

Unrealized gain on fixed maturity securities, net of tax of $4,550

 

 

 

 

7,373

 

7,373

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, March 31, 2009

 

$

901

 

$

1,284,093

 

$

738,831

 

$

1,768

 

$

2,025,593

 

 

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

 

5



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Assured Guaranty Ltd.
Consolidated Statements of Cash Flows
(in thousands of U.S. dollars)

(Unaudited)

 

 

 

Three Months Ended
March 31,

 

 

 

2009

 

2008

 

 

 

 

 

 

 

Operating activities

 

 

 

 

 

Net income (loss)

 

$

85,489

 

$

(169,209

)

Adjustments to reconcile net income to net cash flows provided by operating activities:

 

 

 

 

 

Non-cash interest and operating expenses

 

4,795

 

7,612

 

Net amortization of (discount) premium on fixed maturity securities

 

(1,819

)

1,178

 

Accretion of discount on premium receivable

 

(5,287

)

 

Provision (benefit) for deferred income taxes

 

3,033

 

(83,733

)

Net realized investment losses (gains)

 

17,110

 

(627

)

Unrealized (gains) losses on credit derivatives

 

(26,982

)

259,621

 

Fair value gain on committed capital securities

 

(19,666

)

(8,512

)

Change in deferred acquisition costs

 

7,927

 

(13,376

)

Change in accrued investment income

 

(1,464

)

(2,383

)

Change in premiums receivable

 

(5,946

)

3,912

 

Change in prepaid reinsurance premiums

 

1,826

 

(4,003

)

Change in unearned premium reserves

 

91,945

 

126,989

 

Change in reserves for losses and loss adjustment expenses, net

 

13,870

 

32,108

 

Change in profit commissions payable

 

(833

)

(10,963

)

Change in funds held by Company under reinsurance contracts

 

279

 

3,599

 

Change in current income taxes receivable

 

26,005

 

9,670

 

Other changes in credit derivative assets and liabilities, net

 

(2,856

)

4,372

 

Other

 

(20,409

)

(7,210

)

 

 

 

 

 

 

Net cash flows provided by operating activities

 

167,017

 

149,045

 

 

 

 

 

 

 

Investing activities

 

 

 

 

 

Fixed maturity securities:

 

 

 

 

 

Purchases

 

(289,219

)

(326,204

)

Sales

 

274,260

 

118,392

 

Maturities

 

3,500

 

3,250

 

(Purchases) sales of short-term investments, net

 

(139,622

)

62,142

 

 

 

 

 

 

 

Net cash flows used in investing activities

 

(151,081

)

(142,420

)

 

 

 

 

 

 

Financing activities

 

 

 

 

 

Dividends paid

 

(4,122

)

(3,647

)

Repurchases of common stock

 

(3,676

)

 

Share activity under option and incentive plans

 

(942

)

(2,262

)

Equity offering costs

 

 

(429

)

 

 

 

 

 

 

Net cash flows used in financing activities

 

(8,740

)

(6,338

)

Effect of exchange rate changes

 

(173

)

43

 

 

 

 

 

 

 

Increase in cash and cash equivalents

 

7,023

 

330

 

Cash and cash equivalents at beginning of period

 

12,305

 

8,048

 

 

 

 

 

 

 

Cash and cash equivalents at end of period

 

$

19,328

 

$

8,378

 

 

 

 

 

 

 

Supplementary cash flow information

 

 

 

 

 

Cash (received)/paid during the period for:

 

 

 

 

 

Income taxes

 

$

(14,514

)

$

500

 

Interest

 

$

 

$

 

 

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

 

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Table of Contents

 

Assured Guaranty Ltd.
Notes to Consolidated Financial Statements

March 31, 2009

(Unaudited)

 

1. Business and Organization

 

Assured Guaranty Ltd. (the “Company”) is a Bermuda-based holding company which provides, through its operating subsidiaries, credit enhancement products to the public finance, structured finance and mortgage markets. Credit enhancement products are financial guarantees or other types of support, including credit derivatives, that improve the credit of underlying debt obligations. The Company issues policies in both financial guaranty and credit derivative form. Assured Guaranty Ltd. applies its credit expertise, risk management skills and capital markets experience to develop insurance, reinsurance and derivative products that meet the credit enhancement needs of its customers. Under a reinsurance agreement, the reinsurer, in consideration of a premium paid to it, agrees to indemnify another insurer, called the ceding company, for part or all of the liability of the ceding company under one or more insurance policies that the ceding company has issued. A derivative is a financial instrument whose characteristics and value depend upon the characteristics and value of an underlying security. Assured Guaranty Ltd. markets its products directly to and through financial institutions, serving the U.S. and international markets. Assured Guaranty Ltd.’s financial results include four principal business segments: financial guaranty direct, financial guaranty reinsurance, mortgage guaranty and other. These segments are further discussed in Note 14.

 

Financial guaranty insurance provides an unconditional and irrevocable guaranty that protects the holder of a financial obligation against non-payment of principal and interest when due. Financial guaranty insurance may be issued to the holders of the insured obligations at the time of issuance of those obligations, or may be issued in the secondary market to holders of public bonds and structured securities. A loss event occurs upon existing or anticipated credit deterioration, while a payment under a policy occurs when the insured obligation defaults. This requires the Company to pay the required principal and interest when due in accordance with the underlying contract. The principal types of obligations covered by the Company’s financial guaranty direct and financial guaranty assumed reinsurance businesses are structured finance obligations and public finance obligations. Because both businesses involve similar risks, the Company analyzes and monitors its financial guaranty direct portfolio and financial guaranty assumed reinsurance portfolio on a unified process and procedure basis.

 

Mortgage guaranty insurance is a specialized class of credit insurance that provides protection to mortgage lending institutions against the default of borrowers on mortgage loans that, at the time of the advance, had a loan to value in excess of a specified ratio. Reinsurance in the mortgage guaranty insurance industry is used to increase the insurance capacity of the ceding company, to assist the ceding company in meeting applicable regulatory and rating agency requirements, to augment the financial strength of the ceding company, and to manage the ceding company’s risk profile. The Company provides mortgage guaranty protection on an excess of loss basis.

 

The Company has participated in several lines of business that are reflected in its historical financial statements but that the Company exited in connection with its 2004 initial public offering (“IPO”). The results from these lines of business make up the Company’s Other segment discussed in Note 14.

 

The Company’s subsidiaries have been assigned the following insurance financial strength ratings as of the date of this filing. These ratings are subject to continuous review.

 

 

 

Moody’s

 

S&P

 

Fitch

Assured Guaranty Corp.

 

Aa2(Excellent)

 

AAA(Extremely Strong)

 

AA(Very Strong)

Assured Guaranty Re Ltd.

 

Aa3(Excellent)

 

AA(Very Strong)

 

AA-(Very Strong)

Assured Guaranty Re Overseas Ltd.

 

Aa3(Excellent)

 

AA(Very Strong)

 

AA-(Very Strong)

Assured Guaranty Mortgage Insurance Company

 

Aa3(Excellent)

 

AA(Very Strong)

 

AA-(Very Strong)

Assured Guaranty (UK) Ltd

 

Aa2(Excellent)

 

AAA(Extremely Strong)

 

AA(Very Strong)

 

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On May 4, 2009, Fitch Ratings Inc. (“Fitch”) downgraded the debt and insurer financial strength ratings of Assured Guaranty Ltd. and its subsidiaries. Fitch’s insurer financial strength ratings for Assured Guaranty Corp. and Assured Guaranty (UK) Ltd., the Company’s principal financial guaranty direct subsidiaries, are now AA (rating watch evolving), down from AAA (stable) while the insurer financial strength ratings for Assured Guaranty Re Ltd. (“AG Re”), the Company’s principal financial guaranty reinsurance company, are rated AA- (rating watch evolving), down from AA (stable). Fitch’s ratings on Assured Guaranty Ltd.’s $200 million of 7.0% senior notes due 2034 are now A, down from A+ and their ratings on Assured Guaranty Ltd’s $150 million series A enhanced junior subordinated debentures are now rated A-, down from A.

 

Acquisition of Financial Security Assurance Holdings Ltd.

 

On November 14, 2008, Assured Guaranty Ltd. announced that it had entered into a definitive agreement (“the Purchase Agreement”) with Dexia Holdings, Inc. (“Dexia”) to purchase Financial Security Assurance Holdings Ltd. (“FSAH”) and, indirectly, all of its subsidiaries, including the financial guaranty insurance company, Financial Security Assurance, Inc. The definitive agreement provides that the Company will be indemnified against exposure to FSAH’s Financial Products segment, which includes its guaranteed investment contract business. Pursuant to the Purchase Agreement, the Company agreed to buy 33,296,733 issued and outstanding shares of common stock of FSAH, representing as of the date thereof approximately 99.8524% of the issued and outstanding shares of common stock of FSAH. The remaining shares of FSAH are currently held by current or former directors of FSAH. Assured expects that it will acquire the remaining shares of FSAH common stock concurrent with the closing of the acquisition of shares of FSAH common stock from Dexia or shortly thereafter at the same price paid to Dexia. The Company has received all required shareholder and regulatory approvals and expects to close the FSAH acquisition in the second quarter 2009 upon the completion of various closing conditions and if the rating agencies complete their transaction reviews, including their evaluation of the separation of FSA’s Financial Products segment, which the Company is not acquiring.

 

The purchase price is $722 million (based upon the closing price of the Company’s common shares on the NYSE on November 13, 2008 of $8.10), consisting of $361 million in cash and up to 44,567,901 of the Company’s common shares. If, prior to the closing date under the stock purchase agreement, the Company issues new common shares (other than pursuant to an employee benefit plan) or other securities that are convertible into or exchangeable for or otherwise linked to the Company’s common shares at a purchase price per share of less than $8.10, the Company has agreed to issue to Dexia on the closing date an additional number of the Company’s common shares with an aggregate value as of the closing date (measured based on the average of the volume weighted average price per share for each day in the 20 NYSE trading day period ending three business days prior to the closing date) representing the amount of dilution as a result of such issuance. The amount of dilution is defined to mean (x) the number of the Company’s common shares issued (or that upon conversion or exchange would be issuable) as a result of the dilutive issuance, multiplied by (y) the positive difference if any between $8.10 and the purchase (or reference, implied, conversion, exchange or comparable) price per share received by the Company in the dilutive issuance, multiplied by (z) the percentage of the issued and outstanding share capital of the Company represented by the Company common shares to be received by Dexia under the stock purchase agreement (without taking into account any additional Assured Guaranty Ltd.’s common shares issued or issuable as a result of the anti-dilution provision).

 

Under the Purchase Agreement, the Company may elect to pay $8.10 per share in cash in lieu of up to 22,283,951 of the Company’s common shares that it would otherwise deliver as part of the purchase price.

 

The Company expects to finance the cash portion of the acquisition with the proceeds of a public equity offering. The Company has received a backstop commitment (“the WLR Backstop Commitment”) from the WLR Funds, a related party, to fund the cash portion of the purchase price with the purchase of newly issued common shares. The Company entered into the WLR Backstop Commitment on November 13, 2008 with the WLR Funds. The WLR Backstop Commitment amended the Investment Agreement between the Company and the WLR Funds and provided to the Company the option to cause the WLR Funds to purchase from Assured Guaranty Ltd. or Assured Guaranty US Holdings Inc. a number of the Company’s common shares equal to the quotient of (i) the aggregate dollar amount not to exceed $361 million specified by the Company divided by (ii) the volume weighted average price of the Company’s common share on the NYSE for the 20 NYSE trading days ending with the last NYSE trading day immediately preceding the date of the closing under the stock purchase agreement, with a floor of $6.00 and a cap of $8.50.

 

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The WLR Funds have no obligation to purchase these common shares pursuant to the WLR Backstop Commitment until the closing under the stock purchase agreement occurs. The Company may use the proceeds from the sale of the Company’s common shares pursuant to the WLR Backstop Commitment solely to pay a portion of the purchase price under the stock purchase agreement. The WLR Funds’ obligations under the WLR Backstop Commitment have been secured by letters of credit issued for the benefit of the Company by Bank of America, N.A. and RBS Citizens Bank, N.A., each in the amount of $180.5 million.

 

The Company has paid the WLR Funds a nonrefundable commitment fee of $10,830,000 in connection with the option granted by the WLR Backstop Commitment and has agreed to pay the WLR Funds’ expenses in connection with the transactions contemplated thereby. The Company reimbursed the WLR Funds for the $4.1 million cost of obtaining the letters of credit referred to above.

 

2. Significant Accounting Policies

 

Basis of Presentation

 

The unaudited interim consolidated financial statements, which include the accounts of the Company, 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, which are of a normal recurring nature, necessary for a fair statement of the Company’s financial condition, results of operations and cash flows 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 cover the three-month period ended March 31, 2009 (“First Quarter 2009”) and the three-month period ended March 31, 2008 (“First Quarter 2008”). Operating results for the three-month period ended March 31, 2009 are not necessarily indicative of the results that may be expected for a full year. Certain prior year items have been reclassified to conform to the current year presentation. These unaudited interim consolidated financial statements should be read in conjunction with the Company’s consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2008, filed with the Securities and Exchange Commission. All intercompany accounts and transactions have been eliminated.

 

Certain of the Company’s subsidiaries are subject to U.S. and U.K. income tax. The provision for income taxes is calculated in accordance with Statement of Financial Accounting Standards (“FAS”) FAS No. 109, “Accounting for Income Taxes”. The Company’s provision for income taxes for interim financial periods is not based on an estimated annual effective rate due to the variability in changes in fair value of its credit derivatives, which prevents the Company from projecting a reliable estimated annual effective tax rate and pre-tax income for the full year of 2009. A discrete calculation of the provision is calculated for each interim period.

 

The volatility and disruption in the global financial markets have reached unprecedented levels. The availability and cost of credit has been materially affected. These factors, combined with depressed home prices and increasing foreclosures, falling equity market values, rising unemployment, declining business and consumer confidence and the risk of increased inflation, have precipitated an economic slowdown and fears of a severe recession. The conditions may adversely affect the Company’s future profitability, financial position, investment portfolio, cash flow, statutory capital, financial strength ratings and stock price. Additionally, future legislative, regulatory or judicial changes in the jurisdictions regulating the Company may adversely affect its ability to pursue its current mix of business, materially impacting its financial results.

 

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Adoption of FAS 163

 

In May 2008, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“FAS”) No. 163, “Accounting for Financial Guarantee Insurance Contracts” (“FAS 163”). FAS 163 requires that an insurance enterprise recognize a claim liability prior to an event of default (insured event) when there is evidence that credit deterioration has occurred in an insured financial obligation. FAS 163 also clarifies the methodology to be used for financial guaranty premium revenue recognition and claim liability measurement, as well as requiring expanded disclosures about the insurance enterprise’s risk management activities. The provisions of FAS 163 related to premium revenue recognition and claim liability measurement are effective for financial statements issued for fiscal years beginning after December 15, 2008, and all interim periods within those fiscal years. Earlier application of these provisions was not permitted. The expanded risk management activity disclosure provisions of FAS 163 were effective for the third quarter of 2008 and are included in Note 7 of these unaudited interim consolidated financial statements. FAS 163 will be applied to all existing and future financial guaranty insurance contracts written by the Company.

 

FAS 163 mandates the accounting changes prescribed by the statement be recognized by the Company as a cumulative effect adjustment to retained earnings as of January 1, 2009. The impact of adopting FAS 163 on the Company’s balance sheet was as follows:

 

(dollar in thousands)

 

December 31,
2008
As reported

 

Transition
Adjustment

 

January 1,
2009
Per FAS 163

 

 

 

 

 

 

 

 

 

ASSETS:

 

 

 

 

 

 

 

Deferred acquisition costs

 

$

288,616

 

$

101,836

 

$

390,452

 

Prepaid reinsurance premiums

 

18,856

 

6,625

 

25,481

 

Reinsurance recoverable on ceded losses

 

6,528

 

(1,184

)

5,344

 

Premiums receivable

 

15,743

 

721,438

 

737,181

 

Deferred tax asset

 

129,118

 

(7,743

)

121,375

 

Salvage recoverable

 

80,207

 

6,917

 

87,124

 

Total assets

 

4,555,707

 

827,889

 

5,383,596

 

 

 

 

 

 

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY:

 

 

 

 

 

 

 

Unearned premium reserves

 

$

1,233,714

 

$

827,653

 

$

2,061,367

 

Reserves for losses and loss adjustment expenses

 

196,798

 

(25,379

)

171,419

 

Reinsurance balances payable

 

17,957

 

6,172

 

24,129

 

Total liabilities

 

2,629,485

 

808,446

 

3,437,931

 

Retained earnings

 

638,055

 

19,443

 

657,498

 

Total shareholders’ equity

 

1,926,222

 

19,443

 

1,945,665

 

Total liabilities and shareholders’ equity

 

4,555,707

 

827,889

 

5,383,596

 

 

A summary of the effects of FAS 163 on the balance sheet amounts above is as follows:

 

·                  Deferred acquisition costs increased to reflect commissions on future installment premiums related to assumed reinsurance policies.

·                  Premium receivable increased to reflect the recording of the net present value of future installment premiums discounted at a risk-free rate. Reinsurance balances payable increased correspondingly for those amounts ceded to reinsurers.

·                  Unearned premium reserves increased to reflect the recording of the net present value of future installment premiums discounted at a risk-free rate and the change in the premium earnings methodology to the effective yield method prescribed by FAS 163. Prepaid reinsurance premiums increased correspondingly for those amounts ceded to reinsurers.

·                  Reserves for losses and loss adjustment expenses decreased to reflect the release of the Company’s portfolio reserves on fundamentally sound credits. This was partially offset by an increase in case reserves, which are now calculated based on probability weighted cash flows discounted at a risk free rate instead of based on a single case best estimate reserve discounted based on the after-tax investment yield of the Company’s investment portfolio (6%). Reinsurance recoverable on ceded losses decreased correspondingly. Salvage recoverable increased to reflect the change in discount

 

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rates.

·                  Deferred tax asset decreased to reflect the deferred tax effect of the above items.

·                  Retained earnings as of January 1, 2009 increased to reflect the net effect of the above adjustments.

 

Premium Revenue Recognition

 

Premiums are received either upfront or in installments.

 

Upon Adoption of FAS 163

 

The Company recognizes a liability for the unearned premium revenue at the inception of a financial guarantee contract equal to the present value of the premiums due or expected to be collected over the period of the contract. If the premium is a single premium received at the inception of the financial guarantee contract, the Company measures the unearned premium revenue as the amount received. The period of the contract is the expected period of risk that generally equates to the contract period. However, in some instances, the expected period of risk is significantly shorter than the full contract period due to expected prepayments. In those instances where the financial guarantee contract insures a homogeneous pool of assets that are contractually prepayable and where those prepayments are probable and the timing and amount of prepayments can be reasonably estimated the Company uses the expected period of risk to recognize premium revenues. The Company adjusts prepayment assumptions when those assumptions change and recognizes a prospective change in premium revenues as a result. The adjustment to the unearned premium revenue is equal the adjustment to the premium receivable with no effect on earnings at the time of the adjustment.

 

The Company recognizes the premium from a financial guarantee insurance contract as revenue over the period of the contract in proportion to the amount of insurance protection provided. As premium revenue is recognized, a corresponding decrease in the unearned premium revenue occurs. The amount of insurance protection provided is a function of the insured principal amount outstanding. Therefore, the proportionate share of premium revenue to be recognized in a given reporting period is a constant rate calculated based on the relationship between the insured principal amount outstanding in a given reporting period compared with the sum of each of the insured principal amounts outstanding for all periods. When the issuer of an insured financial obligation retires the insured financial obligation before its maturity and replaces it with a new financial obligation, referred to as a refunding, the financial guarantee insurance contract on the retired financial obligation is extinguished. The Company immediately recognizes any nonrefundable unearned premium revenue related to that contract as premium revenue and any associated acquisition costs previously deferred as an expense.

 

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The following table provides information for financial guaranty insurance contracts where premiums are received on an installment basis as of and for the three months ended March 31, 2009 (dollars in thousands):

 

Premiums receivable, net of ceding commissions (end of period)(1)

 

$

737,925

 

Unearned premium reserves (end of period)(2)

 

$

957,804

 

Accretion of discount on premium receivable

 

$

5,287

 

Weighted-average risk-free rate to discount premiums

 

2.7

%

Weighted-average period of premiums receivable (in years)

 

10.4

 

 


(1)                      Includes $96.5 million of ceding commissions due on future installment premium receivable.

(2)                      Includes unearned premium related to the upfront portion of premiums received on bi-furcated deals.

 

The premiums receivable expected to be collected are:

 

(dollar in thousands)

 

 

 

2009 (April 1 – June 30)

 

$

27,976

 

2009 (July 1 – September 30)

 

16,119

 

2009 (October 1 – December 31)

 

17,245

 

2010 (January 1 – March 31)

 

17,409

 

2010 (April 1 – December 31)

 

41,949

 

2011

 

49,497

 

2012

 

47,449

 

2013

 

40,688

 

2014 - 2018

 

161,884

 

2019 - 2023

 

116,868

 

2024 - 2028

 

91,444

 

2029 – 2033

 

71,454

 

2034 – 2038

 

31,790

 

2039 – 2043

 

12,297

 

2044 – 2048

 

3,870

 

2049 – 2053

 

446

 

2053 - 2056

 

29

 

Total premiums receivable, net of ceding commissions

 

$

748,414

 

 

The following table provides a reconciliation of the beginning and ending balances of premium receivable:

 

(dollar in thousands)

 

 

 

Balance as of January 1, 2009

 

$

737,181

 

Add: premiums written - net

 

234,796

 

 Add: accretion of premium receivable discount

 

5,287

 

Less: premium payments received

 

228,850

 

Balance as of March 31, 2009

 

$

748,414

 

 

The accretion of premium receivable discount is included in earned premium in the Company’s statement of operations. The above amounts are presented net of applicable ceding commissions.

 

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The future expected premium revenue that the Company expects to recognize are:

 

(dollar in thousands)

 

 

 

2009 (April 1 – June 30)

 

$

42,034

 

2009 (July 1 – September 30)

 

46,771

 

2009 (October 1 – December 31)

 

45,668

 

2010 (January 1 – March 31)

 

42,529

 

2010 (April 1 – December 31)

 

125,647

 

2011

 

154,946

 

2012

 

141,417

 

2013

 

127,868

 

2014 - 2018

 

512,825

 

2019 - 2023

 

358,559

 

2024 - 2028

 

251,200

 

After 2028

 

303,848

 

 

 

 

 

Total future expected premium revenue

 

$

2,153,312

 

 

In the Company’s reinsurance businesses, the Company estimates the ultimate written and earned premiums to be received from a ceding company at the end of each quarter and the end of each year because some of the Company’s ceding companies report premium data anywhere from 30 to 90 days after the end of the relevant period. Written premiums reported in the Company’s statement of operations are based upon reports received from ceding companies supplemented by the Company’s own estimates of premium for which ceding company reports have not yet been received. Differences between such estimates and actual amounts are recorded in the period in which the actual amounts are determined.

 

Prior to Adoption of FAS 163

 

Upfront premiums were earned in proportion to the expiration of the amount at risk. Each installment premium was earned ratably over its installment period, generally one year or less. Premium earnings under both the upfront and installment revenue recognition methods were based upon and were in proportion to the principal amount guaranteed and therefore resulted in higher premium earnings during periods where guaranteed principal was higher. For insured bonds for which the par value outstanding was declining during the insurance period, upfront premium earnings were greater in the earlier periods thus matching revenue recognition with the underlying risk. The premiums were allocated in accordance with the principal amortization schedule of the related bond issue and were earned ratably over the amortization period. When an insured issue was retired early, was called by the issuer, or was in substance paid in advance through a refunding accomplished by placing U.S. Government securities in escrow, the remaining unearned premium reserves were earned at that time. Unearned premium reserves represented the portion of premiums written that were applicable to the unexpired amount at risk of insured bonds.

 

Deferred Acquisition Costs

 

Acquisition costs incurred, other than those associated with financial guarantees written in credit derivative form, that vary with and are directly related to the production of new business are deferred in proportion to written premium and amortized in relation to earned premiums. These costs include direct and indirect expenses such as ceding commissions, brokerage expenses and the cost of underwriting and marketing personnel. Management uses its judgment in determining what types of costs should be deferred, as well as what percentage of these costs should be deferred. The Company annually conducts a study to determine which operating costs vary with, and are directly related to, the acquisition of new business and qualify for deferral. Ceding commissions received on premiums the Company cedes to other reinsurers reduce acquisition costs. Anticipated losses, loss adjustment expenses and the remaining costs of servicing the insured or reinsured business are considered in determining the recoverability of acquisition costs. Acquisition costs associated with credit derivative products are expensed as incurred. When an insured issue is retired early, as discussed above in the Premium Revenue Recognition section, the remaining related deferred acquisition cost is expensed at that time. Ceding commissions, calculated at their contractually defined

 

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rate, associated with future installment premiums on assumed and ceded reinsurance business were recorded in deferred acquisition costs upon the adoption of FAS 163 with a corresponding offset to premium receivable.

 

Reserves for Losses and Loss Adjustment Expenses

 

The Company’s financial guarantees written in credit derivative form have substantially the same terms and conditions as its financial guaranty contracts written in insurance form. Under GAAP, however, the former are subject to derivative accounting rules and the latter are subject to insurance accounting rules.

 

Financial Guaranty Contracts Upon Adoption of FAS 163

 

The Company recognizes a reserve for losses and loss adjustment expenses on a financial guarantee insurance contract when the Company expects that a claim loss will exceed the unearned premium revenue for that contract based on the present value of expected net cash outflows to be paid under the insurance contract. The unearned premium revenue represents the insurance enterprise’s stand-ready obligation under a financial guarantee insurance contract at initial recognition. Subsequently, if the likelihood of a default (insured event) increases so that the present value of the expected net cash outflows expected to be paid under the insurance contract exceeds the unearned premium revenue, the Company recognizes a reserve for losses and loss adjustment expenses in addition to the unearned premium revenue.

 

A reserve for losses is equal to the present value of expected net cash outflows to be paid under the insurance contract discounted using a current risk-free rate. That current risk-free rate is based on the remaining period (contract or expected, as applicable) of the insurance contract. Expected net cash outflows (cash outflows, net of potential recoveries, expected to be paid to the holder of the insured financial obligation, excluding reinsurance) are probability-weighted cash flows that reflect the likelihood of all possible outcomes. The Company estimates the expected net cash outflows using the internal assumptions about the likelihood of all possible outcomes based on all information available. Those assumptions consider all relevant facts and circumstances and are consistent with the information tracked and monitored through the Company’s risk-management activities.

 

The Company updates the discount rate each reporting period and revises expected net cash outflows when increases (or decreases) in the likelihood of a default (insured event) and potential recoveries occur. The discount amount is accreted on the reserve for losses and loss adjustment expenses through earnings in incurred loss and loss adjustment expenses (recoveries). Revisions to a reserve for loss and loss adjustment expenses in periods after initial recognition are recognized as incurred loss and loss adjustment expenses (recoveries) in the period of the change.

 

Financial Guaranty Contracts Prior to Adoption of FAS 163

 

Reserves for losses for non-derivative transactions in the Company’s financial guaranty direct and financial guaranty assumed reinsurance included case reserves and portfolio reserves. Case reserves were established when there was significant credit deterioration on specific insured obligations and the obligations were in default or default was probable, not necessarily upon non-payment of principal or interest by an insured. Case reserves represented the present value of expected future loss payments and loss adjustment expenses, net of estimated recoveries, but before considering ceded reinsurance. This reserving method was different from case reserves established by traditional property and casualty insurance companies, which establish case reserves upon notification of a claim and establish incurred but not reported reserves for the difference between actuarially estimated ultimate losses and recorded case reserves. Financial guaranty insurance and assumed reinsurance case reserves and related salvage and subrogation, if any, were discounted at the taxable equivalent yield on the Company’s investment portfolio, which was approximately 6%, during 2008.

 

The Company recorded portfolio reserves in its financial guaranty direct and financial guaranty assumed reinsurance business. Portfolio reserves were established with respect to the portion of the Company’s business for which case reserves were not established.

 

Portfolio reserves were not established based on a specific event, rather they are calculated by aggregating the portfolio reserve calculated for each individual transaction. Individual transaction reserves were calculated on a

 

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quarterly basis by multiplying the par in-force by the product of the ultimate loss and earning factors without regard to discounting. The ultimate loss factor was defined as the frequency of loss multiplied by the severity of loss, where the frequency was defined as the probability of default for each individual issue. The earning factor was inception to date earned premium divided by the estimated ultimate written premium for each transaction. The probability of default was estimated from rating agency data and was based on the transaction’s credit rating, industry sector and time until maturity. The severity was defined as the complement of recovery/salvage rates gathered by the rating agencies of defaulting issues and was based on the industry sector.

 

Portfolio reserves were recorded gross of reinsurance. The Company did not cede any amounts under these reinsurance contracts, as the Company’s recorded portfolio reserves did not exceed the Company’s contractual retentions, required by said contracts.

 

The Company recorded an incurred loss that was reflected in the statement of operations upon the establishment of portfolio reserves. When the Company initially recorded a case reserve, the Company reclassified the corresponding portfolio reserve already recorded for that credit within the balance sheet. The difference between the initially recorded case reserve and the reclassified portfolio reserve was recorded as a charge in the Company’s statement of operations. Any subsequent change in portfolio reserves or the initial case reserves were recorded quarterly as a charge or credit in the Company’s statement of operations in the period such estimates changed.

 

Mortgage Guaranty and Other Lines of Business

 

Mortgage guaranty and other lines of business are not in the scope of FAS 163. Reserves for losses and loss adjustment expenses in the Company’s mortgage guaranty line of business include case reserves and portfolio reserves. Case reserves are established when there is significant credit deterioration on specific insured obligations and the obligations are in default or default is probable, not necessarily upon non-payment of principal or interest by an insured. Case reserves represent the present value of expected future loss payments and loss adjustment expenses (“LAE”), net of estimated recoveries, but before considering ceded reinsurance. This reserving method is different from case reserves established by traditional property and casualty insurance companies, which establish case reserves upon notification of a claim and establish incurred but not reported (“IBNR”) reserves for the difference between actuarially estimated ultimate losses and recorded case reserves.

 

The Company also records portfolio reserves for mortgage guaranty line of business in a manner consistent with its financial guaranty business prior to the adoption of FAS 163. While other mortgage guaranty insurance companies do not record portfolio reserves, rather just case and IBNR reserves, the Company records portfolio reserves because the Company writes business on an excess of loss basis, while other industry participants write quota share or first layer loss business. The Company manages and underwrites this business in the same manner as its financial guaranty insurance and reinsurance business because they have similar characteristics as insured obligations of mortgage backed securities.

 

The Company also records IBNR reserves for its other line of business. IBNR is an estimate of losses for which the insured event has occurred but the claim has not yet been reported to the Company. In establishing IBNR, the Company uses traditional actuarial methods to estimate the reporting lag of such claims based on historical experience, claim reviews and information reported by ceding companies. The Company records IBNR for trade credit reinsurance within its other segment, which is 100% reinsured. The other segment represents lines of business that the Company exited or sold as part of the Company’s IPO.

 

Due to the inherent uncertainties of estimating loss and LAE reserves, actual experience may differ from the estimates reflected in the Company’s consolidated financial statements, and the differences may be material.

 

Reinsurance

 

In the ordinary course of business, the Company’s insurance subsidiaries assume and retrocede business with other insurance and reinsurance companies. These agreements provide greater diversification of business and may minimize the net potential loss from large risks. Retrocessional contracts do not relieve the Company of its

 

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obligation to the reinsured. Reinsurance recoverable on ceded losses includes balances due from reinsurance companies for paid and unpaid losses and LAE that will be recovered from reinsurers, based on contracts in force, and is presented net of any provision for estimated uncollectible reinsurance. Any change in the provision for uncollectible reinsurance is included in loss and loss adjustment expenses. Prepaid reinsurance premiums represent the portion of premiums ceded to reinsurers relating to the unexpired terms of the reinsurance contracts in force.

 

Certain of the Company’s assumed and ceded reinsurance contracts are funds held arrangements. In a funds held arrangement, the ceding company retains the premiums instead of paying them to the reinsurer and losses are offset against these funds in an experience account. Because the reinsurer is not in receipt of the funds, the reinsurer earns interest on the experience account balance at a predetermined credited rate of interest. The Company generally earns interest at fixed rates of between 4% and 6% on its assumed funds held arrangements and generally pays interest at fixed rates of between 4% and 6% on its ceded funds held arrangements. The interest earned or credited on funds held arrangements is included in net investment income. In addition, interest on funds held arrangements will continue to be earned or credited until the experience account is fully depleted, which can extend many years beyond the expiration of the coverage period.

 

Salvage Recoverable

 

When the Company becomes entitled to the underlying collateral (generally a future stream of cash flows or pool assets) of an insured credit under salvage and subrogation rights as a result of a claim payment or estimates recoveries from disputed claim payments on contractual grounds, it reduces the corresponding loss reserve for a particular financial guaranty insurance policy for the estimated salvage and subrogation, in accordance with FAS No. 60, “Accounting and Reporting by Insurance Enterprises”. If the expected salvage and subrogation exceeds the estimated loss reserve for a policy, such amounts are recorded as a salvage recoverable asset in the Company’s balance sheets.

 

3. Recent Accounting Pronouncements

 

In December 2007, the FASB issued FAS No. 141 (revised), “Business Combinations” (“FAS 141R”). FAS 141R establishes principles and requirements for how the acquirer of a business recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree. FAS 141R also provides guidance for recognizing and measuring the goodwill acquired in the business combination and determines what information to disclose to enable users of the financial statement to evaluate the nature and financial effects of the business combination. FAS 141R is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim statements within those fiscal years. Early adoption is not permitted. Since FAS 141R applies prospectively to business combinations whose acquisition date is subsequent to the statement’s adoption. The Company is applying the provisions of FAS 141R to account for its pending acquisition of FSAH. As of March 31, 2009, the Company had paid $4.6 million related to the Company’s pending acquisition of FSAH that the Company expensed in the first quarter 2009 in operating expenses.

 

In October 2008, the FASB issued FASB Staff Position (“FSP”) No. FAS 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active” (“FSP 157-3”). FSP 157-3 clarified the application of FAS 157, “Fair Value Measurements” (“FAS 157”), in a market that is not active. FSP 157-3 was effective when issued. It did not have an impact on the Company’s current results of operations or financial position.

 

The FASB adopted FSP FAS 133-1 and FIN 45-4, “Disclosures About Credit Derivatives and Certain Guarantees” (“FSAP 133-1”) and FAS 161, “Disclosures about Derivative Instruments and Hedging Activities” (“FAS 161”) to address concerns that current derivative disclosure requirements did not adequately address the potential adverse effects that these instruments can have on the financial performance and operations of an entity. Companies will be required to provide enhanced disclosures about their derivative activities to enable users to better understand: (1) how and why a company uses derivatives, (2) how it accounts for derivatives and related hedged items, and (3) how derivatives affect its financial statements. These should include the terms of the derivatives, collateral posting requirements and triggers, and other significant provisions that could be detrimental to earnings or liquidity. Management believes that the Company’s current derivatives disclosures are in compliance with the requirements of FSP 133-1 and FAS 161.

 

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In April 2009, the FASB issued FSP FAS No. 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly” (“FSP 157-4”). FSP 157-4 amends FAS 157 to provide additional guidance on estimating fair value when the volume and level of activity for an asset or liability have significantly decreased in relation to normal market activity for the asset or liability. FSP 157-4 also provides additional guidance on circumstances that may indicate that a transaction is not orderly. FSP 157-4 supersedes FSP 157-3. FSP 157-4 amends FAS 157 to require additional disclosures about fair value measurements in annual and interim reporting periods. FSP 157-4 is effective for interim and annual reporting periods ending after June 15, 2009. Early adoption is permitted, but only for periods ending after March 15, 2009. FSP 157-4 must be applied prospectively and does not require disclosures for earlier periods presented for comparative purposes at initial adoption. The Company will adopt FSP 157-4 in its Form 10-Q for the period ended June 30, 2009. The Company is currently evaluating the impact, if any, FSP 157-4 will have on its financial statements.

 

In April 2009, the FASB issued FSP No. FAS 107-1 and APB 28-1, “Interim Disclosures about Fair Value of Financial Instruments” (“FSP 107-1”). FSP 107-1 extends the disclosure requirements of FAS No. 107, “Disclosures about Fair Value of Financial Instruments,” to interim financial statements of publicly traded companies. FSP 107-1 is effective for interim reporting periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. FSP 107-1 does not require disclosures for earlier periods presented for comparative purposes at initial adoption. In periods after initial adoption, FSP 107-1 requires comparative disclosures only for periods ending after initial adoption. The Company will adopt FSP 107-1 in its Form 10-Q for the period ended June 30, 2009. The Company is currently evaluating the impact, if any, FSP 107-1 will have on its financial statements disclosures.

 

In April 2009, the FASB issued FSP No. FAS 115-2 and FAS 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments” (“FSP 115-2”). FSP 115-2 provides new guidance on the recognition and presentation of an other than temporary impairment (“OTTI”) for debt securities classified as available-for-sale and held-to-maturity and provides some new disclosure requirements for both debt and equity securities. FSP 115-2 mandates new disclosure requirements affect both debt and equity securities and extend the disclosure requirements (both new and existing) to interim periods. FSP 115-2 is effective for interim and annual periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. FSP 115-2 is to be applied to existing and new investments held by an entity as of the beginning of the period in which it is adopted. The Company will adopt FSP 115-2 in its Form 10-Q for the period ended June 30, 2009. The Company is currently evaluating the impact, if any, FSP 115-2 will have on its financial statements.

 

4. Credit Derivatives

 

Financial guarantees written in credit derivative form issued by the Company, principally in the form of insured credit default swap (“CDS”) contracts, have been deemed to meet the definition of a derivative under FAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“FAS 133”), FAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities” (“FAS 149”) and FAS No. 155, “Accounting for Certain Hybrid Financial Instruments” (“FAS 155”). FAS 133 and FAS 149 require that an entity recognize all derivatives as either assets or liabilities in the consolidated balance sheets and measure those instruments at fair value. If certain conditions are met, a derivative may be specifically designated as a fair value, cash flow or foreign currency hedge. FAS 155 requires companies to recognize freestanding or embedded derivatives relating to beneficial interests in securitized financial instruments. This recognition was not required prior to January 1, 2007. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative and the resulting designation.

 

Realized gains and other settlements on credit derivatives include credit derivative premiums received and receivable for credit protection the Company has sold under its insured CDS contracts as well as any contractual claim losses paid and payable related to insured credit events under these contracts, ceding commissions (expense) income and realized gains or losses related to their early termination. The Company almost always holds credit derivative contracts to maturity. However, in certain circumstances such as for the downgrade of AGC or AGRe, the CDS counterparty may decide to terminate a credit derivative contract prior to maturity.

 

The following table disaggregates realized gains and other settlements on credit derivatives into its component

 

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parts for the periods ended March 31, 2009 and 2008 (dollars in thousands):

 

 

 

Three Months Ended
March 31,

 

 

 

2009

 

2008

 

 

 

 

 

 

 

Realized gains and other settlements on credit derivatives

 

 

 

 

 

Net credit derivative premiums received and receivable

 

$

29,515

 

$

27,822

 

Net credit derivative losses (paid and payable) recovered and recoverable

 

(9,058

)

14

 

Ceding commissions received/receivable (paid/payable), net

 

122

 

(219

)

 

 

 

 

 

 

Total realized gains and other settlements on credit derivatives

 

$

20,579

 

$

27,617

 

 

Unrealized gains (losses) on credit derivatives represent the adjustments for changes in fair value that are recorded in each reporting period, under FAS 133. Changes in unrealized gains and losses on credit derivatives are reflected in the consolidated statements of operations and comprehensive income in unrealized gains (losses) on credit derivatives. Cumulative unrealized losses, determined on a contract by contract basis, are reflected as either net assets or net liabilities in the Company’s balance sheets. Unrealized gains and losses resulting from changes in the fair value of credit derivatives occur because of changes in interest rates, credit spreads, the credit ratings of the referenced entities and the issuing Company’s own credit rating and other market factors. The unrealized gains and losses on credit derivatives will reduce to zero as the exposure approaches its maturity date, unless there is a payment default on the exposure or early termination. Changes in the fair value of the Company’s credit derivative contracts do not generally reflect actual claims or credit losses, and have no impact on the Company’s claims paying resources, rating agency capital or regulatory capital positions.

 

The Company determines fair value of its credit derivative contracts primarily through modeling that uses various inputs such as credit spreads, based on observable market indices and on recent pricing for similar contracts, and expected contractual life to derive an estimate of the value of our contracts in our principal market (see Note 5). Credit spreads capture the impact of recovery rates and performance of underlying assets, among other factors, on these contracts. The Company’s pricing model takes into account not only how credit spreads on risks that it assumes affects pricing, but how the Company’s own credit spread affects the pricing of its deals. If credit spreads of the underlying obligations change, the fair value of the related credit derivative changes. Market liquidity could also impact valuations of the underlying obligations.

 

The impact of changes in credit spreads will vary based upon the volume, tenor, interest rates, and other market conditions at the time these fair values are determined. In addition, since each transaction has unique collateral and structure terms, the underlying change in fair value of each transaction may vary considerably. The fair value of credit derivative contracts also reflects the change in the Company’s own credit cost based on the price to purchase credit protection on AGC. During First Quarter 2009, the Company incurred net pre-tax unrealized gains on credit derivative contracts of $27.0 million. Of this amount, $2,291.5 million was due to the widening of AGC’s own credit spread from 1,775 basis points at December 31, 2008 to 3,847 basis points at March 31, 2009. As of March 31, 2009 the net credit liability includes a reduction in the liability of $6,439.1 million associated with the widening of AGC’s credit spread to 3,847 basis points. Management believes that the widening of AGC’s credit spread is due to the correlation between AGC’s risk profile and that experienced currently by the broader financial markets and increased demand for credit protection against AGC as the result of its direct segment financial guarantee volume as well as the overall lack of liquidity in the CDS market. Offsetting the gain attributable to the significant increase in AGC’s credit spread were declines in fixed income security market prices primarily attributable to widening spreads in certain markets as a result of the continued deterioration in credit markets and some credit rating downgrades, rather than from delinquencies or defaults on securities guaranteed by the Company. The higher credit spreads in the fixed income security market are due to the recent lack of liquidity in the high yield collateralized debt obligation and collateralized loan obligation markets as well as continuing market concerns over the most recent vintages of subprime residential mortgage backed securities and commercial mortgage backed securities.

 

During First Quarter 2008, the Company incurred net mark-to-market losses on credit derivative contracts of $(259.6) million, pre-tax, related to high yield and investment grade corporate collateralized loan obligations (“CLOs”), as well as residential and commercial mortgage backed securities exposures. The unrealized loss on credit derivatives

 

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resulted largely from the decline in fixed income security market prices resulting from higher credit spreads, due to the lack of liquidity in the High Yield CDO and CLO market as well as market concerns over continued recent vintages of subprime residential mortgage backed securities, rather than from credit rating downgrades, delinquencies or defaults on securities guaranteed by the Company.

 

The total notional amount of credit derivative exposure outstanding as of March 31, 2009 and December 31, 2008 and included in the Company’s financial guaranty exposure was $73.3 billion and $75.1 billion, respectively.

 

The components of the Company’s unrealized gain (loss) on credit derivatives for the three months ended March 31, 2009 is:

 

 

 

As of March 31, 2009

 

First Quarter 2009

 

Asset Type

 

Net Par
Outstanding
(in billions)

 

Weighted
Average Credit
Rating
(1)

 

Unrealized Gain
(Loss)
(in millions)

 

Corporate collateralized loan obligations

 

$

26.0

 

AAA

 

$

(78.9

)

Market value CDOs of corporate obligations

 

3.4

 

AAA

 

(7.0

)

Trust preferred securities

 

6.0

 

A-

 

75.3

 

Total pooled corporate obligations

 

35.4

 

AA+

 

(10.5

)

Commercial mortgage-backed securities

 

5.8

 

AAA

 

(31.2

)

Residential mortgage-backed securities

 

19.6

 

AA-

 

(89.8

)

Other

 

9.3

 

AA-

 

142.3

 

Total

 

70.0

 

AA

 

10.8

 

Reinsurance exposures written in CDS form

 

3.3

 

AA+

 

16.2

 

Grand Total

 

$

73.3

 

AA

 

$

27.0

 

 


(1)          Based on the Company’s internal rating, which is on a comparable scale to that of the nationally recognized rating agencies.

 

Corporate collateralized loan obligations, market value CDO’s, and trust preferred securities, which comprise the Company’s pooled corporate exposures, include all U.S. structured finance pooled corporate obligations and international pooled corporate obligations. Commercial mortgage backed securities are comprised of commercial U.S. structured finance and commercial international mortgage backed securities. Residential mortgage backed securities are comprised of prime and subprime U.S. mortgage backed and home equity securities, international residential mortgage backed and international home equity securities. Other includes all other U.S. and international asset classes, such as commercial receivables, and international infrastructure and pooled infrastructure securities.

 

The Company’s exposure to pooled corporate obligations is highly diversified in terms of obligors and industries. Most pooled corporate transactions are structured to limit exposure to any given obligor and industry. The majority of the Company’s pooled corporate exposure in the direct segment consists of collateralized loan obligations (“CLOs”). Most of these direct CLOs have an average obligor size of less than 1% and typically restrict the maximum exposure to any one industry to approximately 10%. The Company’s exposure also benefits from embedded credit enhancement in the transactions which allows a transaction to sustain a certain level of losses in the underlying collateral, further insulating the Company from industry specific concentrations of credit risk on these deals.

 

The Company’s $9.3 billion exposure to Other CDS contracts is also highly diversified. It includes $3.7 billion of exposure to four pooled infrastructure transactions comprised of diversified pools of international infrastructure project transactions and loans to regulated utilities. These pools were all structured with underlying credit enhancement sufficient for the Company to attach at super senior AAA levels. The remaining $5.6 billion of exposure in Other CDS contracts is comprised of numerous deals typically structured with significant underlying credit enhancement and spread across various asset classes, such as commercial receivables, infrastructure, regulated utilities and consumer receivables. Substantially all of this $9.3 billion of exposure is rated investment grade and the weighted average credit rating is AA-.

 

The unrealized gain of $142.3 million on Other CDS contracts for the three months ended March 31, 2009 is primarily attributable to the aforementioned change in AGC’s credit spread. This increased hedge cost caused the

 

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implied spreads of several UK public finance infrastructure transactions and a film securitization transaction to narrow during the quarter as on offset.

 

With considerable volatility continuing in the market, unrealized gains (losses) on credit derivatives may fluctuate significantly in future periods.

 

The Company’s exposure to the mortgage industry is discussed in Note 7.

 

The following table presents additional details about the Company’s unrealized loss on pooled corporate obligation credit derivatives, which includes collateralized loan obligations, market value CDOs and trust preferred securities, by asset type as of March 31, 2009:

 

Asset Type

 

Original
Subordination
(2)

 

Current
Subordination
(2)

 

Net Par
Outstanding
(in billions)

 

Weighted
Average
Credit
Rating
(1)

 

First Quarter
2009
Unrealized
Gain (Loss)
(in millions)

 

High yield corporate obligations

 

35.9

%

29.6

%

$

22.8

 

AAA

 

$

(77.4

)

Trust preferred

 

46.7

%

41.7

%

6.0

 

A-

 

75.3

 

Market value CDOs of corporate obligations

 

38.4

%

27.3

%

3.4

 

AAA

 

(7.0

)

Investment grade corporate obligations

 

28.7

%

29.9

%

2.3

 

AAA

 

1.6

 

Commercial real estate

 

49.1

%

47.9

%

0.8

 

AAA

 

(2.2

)

CDO of CDOs (corporate obligations)

 

1.7

%

5.4

%

0.1

 

AAA

 

(0.9

)

Total

 

37.7

%

31.8

%

$

35.4

 

AA+

 

$

(10.5

)

 


(1)          Based on the Company’s internal rating, which is on a comparable scale to that of the nationally recognized rating agencies.

(2)          Represents the sum of subordinate tranches and over-collateralization and does not include any benefit from excess interest collections that may be used to absorb losses

 

The following table presents additional details about the Company’s unrealized loss on credit derivatives associated with commercial mortgage-backed securities by vintage as of March 31, 2009:

 

Vintage

 

Original
Subordination
(2)

 

Current
Subordination
(2)

 

Net Par
Outstanding
(in billions)

 

Weighted
Average
Credit
Rating
(1)

 

First Quarter
2009
Unrealized
Gain (Loss)
(in millions)

 

2004 and Prior

 

19.8

%

21.5

%

$

0.3

 

AAA

 

$

(0.6

)

2005

 

27.8

%

28.9

%

3.4

 

AAA

 

(19.7

)

2006

 

27.7

%

28.5

%

1.8

 

AAA

 

(9.6

)

2007

 

35.8

%

35.9

%

0.2

 

AAA

 

(1.4

)

2008

 

 

 

 

 

 

2009

 

 

 

 

 

 

Total

 

27.7

%

28.7

%

$

5.8

 

AAA

 

$

(31.2

)

 

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The following tables present additional details about the Company’s unrealized loss on credit derivatives associated with residential mortgage-backed securities by vintage and asset type as of March 31, 2009:

 

Vintage

 

Original
Subordination
(2)

 

Current
Subordination
(2)

 

Net Par
Outstanding
(in billions)

 

Weighted
Average
Credit
Rating
(1)

 

First Quarter
2009
Unrealized
Gain (Loss)
(in millions)

 

2004 and Prior

 

5.2

%

13.0

%

$

0.4

 

A

 

$

4.6

 

2005

 

24.5

%

51.6

%

4.8

 

AA

 

1.3

 

2006

 

16.6

%

23.5

%

5.7

 

AA

 

1.2

 

2007

 

16.5

%

18.7

%

8.7

 

A

 

(96.9

)

2008

 

 

 

 

 

 

2009

 

 

 

 

 

 

Total

 

18.2

%

28.1

%

$

19.6

 

AA-

 

$

(89.8

)

 

Asset Type

 

Original
Subordination
(2)

 

Current
Subordination
(2)

 

Net Par
Outstanding
(in billions)

 

Weighted
Average
Credit
Rating
(1)

 

First Quarter
2009
Unrealized
Gain (Loss)
(in millions)

 

Alt-A loans

 

20.3

%

23.1

%

$

6.3

 

A-

 

$

(44.1

)

Prime first lien

 

10.3

%

12.6

%

7.8

 

AA+

 

(48.7

)

Subprime lien

 

26.9

%

55.0

%

5.6

 

AA-

 

3.0

 

Total

 

18.2

%

28.1

%

$

19.6

 

AA-

 

$

(89.8

)

 

In general, the Company structures credit derivative transactions such that the circumstances giving rise to our obligation to make payments is similar to that for financial guaranty policies and generally occurs as losses are realized on the underlying reference obligation. Nonetheless, credit derivative transactions are governed by International Swaps and Derivatives Association, Inc. (“ISDA”) documentation and operate differently from financial guaranty insurance policies. For example, our control rights with respect to a reference obligation under a credit derivative may be more limited than when the Company issues a financial guaranty insurance policy on a direct primary basis. In addition, while the Company’s exposure under credit derivatives, like the Company’s exposure under financial guaranty insurance policies, is generally for as long as the reference obligation remains outstanding, unlike financial guaranty insurance policies, a credit derivative may be terminated due to the occurrence of an event of default set forth in the ISDA documentation or other specific termination events. In some older credit derivative transactions, one such specified termination event is the failure of AGC to maintain specified financial strength ratings ranging from A or A2 to BBB- or Baa3. If a credit derivative is terminated the Company could be required to make a mark-to-market payment as determined under the ISDA documentation.  For example, if AGC’s ratings were downgraded to A- or A3, the CDS counterparties could terminate CDS covering $847.8 million par insured.  If AGC’s ratings are downgraded to levels between BBB+ or Baa1 and BB+ or Ba1, the CDS counterparties could terminate the CDS covering $10.9 billion par insured.  Given current market conditions, the Company does not believe that it can accurately estimate the payments it would be required to make if AGC or AGRe were downgraded and the CDS counterparties terminated the CDS.  These payments could have a material adverse effect on the Company’s liquidity and financial condition.  During May 2009 the Company entered into an agreement with a CDS counterparty, which had the right to terminate four CDS contracts if AGC was downgraded below AA- or Aa3.  Under the agreement, the CDS counterparty’s right to terminate the CDS contracts based on AGC’s ratings was eliminated.  In return, the Company agreed to post up to $250 million in collateral to secure its payment obligations under the CDS contracts covering $5.9 billion of par insured.  The collateral posting would increase to up to $300 million if AGC were downgraded to below AA- or A2.  The posting of this collateral has no impact on the Company’s net income or shareholders’ equity under U.S. GAAP nor does it impact AGC’s statutory surplus or net income.

 

Under a limited number of credit derivative contracts, the Company is required to post eligible securities as collateral, generally cash or U.S. government or agency securities. The need to post collateral under these transactions is generally based on mark-to-market valuation in excess of contractual thresholds. The particular thresholds decline if the Company’s ratings decline. As of March 31, 2009 the Company had pre-IPO transactions with approximately $1.8 billion of par subject to collateral posting due to changes in market value. Of this amount, as of March 31, 2009, the Company posted collateral totaling approximately $177.9 million (including $156.2 million for AGC) based on the unrealized mark-to-market loss position for transactions with two of its counterparties. Any amounts required to be posted as collateral in the future will depend on changes in the market values of these transactions. Additionally, in the event AGC were downgraded below A-, contractual thresholds would be eliminated and the amount of par that could be subject to collateral posting requirements would be $2.3 billion. Based on market values as of March 31, 2009, the Company estimates that such a downgrade would have resulted in AGC posting an additional $113.7 million of collateral. The actual amounts posted would be based on market conditions at the time of the posting and would be based on the CDS contract’s ISDA documentation.  The actual amounts that would be required to be posted could be materially larger than the Company’s estimate. As described above, in May 2009 AGC posted an additional $250 million of collateral.

 

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As of March 31, 2009 and December 31, 2008, the Company considered the impact of its own credit risk, in combination with credit spreads on risk that it assumes through CDS contracts, in determining the fair value of its credit derivatives. The Company determines its own credit risk based on quoted CDS prices traded on the Company at each balance sheet date. The quoted price of CDS contracts traded on AGC at March 31, 2009 and December 31, 2008 was 3,847 basis points and 1,775 basis points, respectively. Historically, the price of CDS traded on AGC moves directionally the same as general market spreads. Generally, a widening of the CDS prices traded on AGC has an effect of offsetting unrealized losses that result from widening general market credit spreads, while a narrowing of the CDS prices traded on AGC has an effect of offsetting unrealized gains that result from narrowing general market credit spreads. An overall narrowing of spreads generally results in an unrealized gain on credit derivatives for the Company and an overall widening of spreads generally results in an unrealized loss for the Company. At March 31, 2009, the values of our CDS contracts before and after considering implications of our credit spreads were $(6,959.5) million and $(520.4) million, respectively. At December 31, 2008, the values of our CDS contracts before and after considering implications of our credit spreads were $(4,686.8) million and $(539.2) million, respectively. As noted above, our own credit spread widened from 180 basis points at December 31, 2007 to 1,775 basis points at December 31, 2008.

 

The following table summarizes the estimated change in fair values on the net balance of the Company’s credit derivative positions assuming immediate parallel shifts in credit spreads on AGC and on the risks that it assumes at March 31, 2009:

 

(Dollars in millions)

 

Credit Spreads(1)

 

Estimated Net
Fair Value (Pre-Tax)

 

Estimated Pre-Tax
Change in Gain / (Loss)

 

 

 

 

 

 

 

March 31, 2009:

 

 

 

 

 

 

 

 

 

 

 

100%

widening in spreads

 

$

(1,603.8

)

$

(1,083.4

)

50%

widening in spreads

 

(1,075.6

)

(555.2

)

25%

widening in spreads

 

(792.5

)

(272.1

)

10%

widening in spreads

 

(632.7

)

(112.3

)

Base Scenario

 

(520.4

)

 

10%

narrowing in spreads

 

(457.2

)

63.2

 

25%

narrowing in spreads

 

(366.0

)

154.4

 

50%

narrowing in spreads

 

(233.0

)

287.4

 

 


(1)                                  Includes the effects of spreads on both the underlying asset classes and the Company’s own credit spread.

 

The Company had no derivatives designated as hedges during 2009 and 2008.

 

5. Fair Value of Financial Instruments

 

Background

 

Effective January 1, 2008, the Company adopted FAS No. 157, “Fair Value Measurements” (“FAS 157”). FAS 157 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. FAS 157 applies to other accounting pronouncements that require or permit fair value measurements, but does not require any new fair value measurements.

 

FAS 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants on the measurement date. The price shall represent that available in the principal market for the asset or liability. If there is no principal market, then the price is based on the market that maximizes the value received for an asset or minimizes the amount paid for a liability (i.e. the most advantageous market).

 

FAS 157 specifies a fair value hierarchy based on whether the inputs to valuation techniques used to measure fair value are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect Company estimates of market assumptions. In accordance with FAS 157, the fair value hierarchy prioritizes model inputs into three broad levels as follows:

 

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·                  Level 1—Quoted prices for identical instruments in active markets.

·                  Level 2—Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and observable inputs other than quoted prices, such as interest rates or yield curves and other inputs derived from or corroborated by observable market inputs.

·                  Level 3—Model derived valuations in which one or more significant inputs or significant value drivers are unobservable. This hierarchy requires the use of observable market data when available.

 

An asset or liability’s categorization within the fair value hierarchy is based on the lowest level of significant input to its valuation.

 

Effect on the Company’s financial statements

 

FAS 157 applies to both amounts recorded in the Company’s financial statements and to disclosures. Amounts recorded at fair value in the Company’s financial statements on a recurring basis are fixed maturity securities available for sale, short-term investments, credit derivative assets and liabilities relating to the Company’s CDS contracts and CCS Securities. The fair value of these items as of March 31, 2009 is summarized in the following table.

 

 

 

 

 

Fair Value Measurements Using

 

(Dollars in millions)

 

Fair Value

 

Quoted Prices in
Active Markets
for Identical
Assets
(Level 1)

 

Significant Other Observable
Inputs
(Level 2)

 

Significant
Unobservable
Inputs
(Level 3)

 

Assets

 

 

 

 

 

 

 

 

 

Fixed maturity securities

 

$

3,176.2

 

$

 

$

3,176.2

 

$

 

Short-term investments

 

616.8

 

67.3

 

549.5

 

 

Credit derivative assets

 

149.8

 

 

 

149.8

 

CCS Securities

 

70.7

 

 

70.7

 

 

Total assets

 

$

4,013.5

 

$

67.3

 

$

3,796.4

 

$

149.8

 

Liabilities

 

 

 

 

 

 

 

 

 

Credit derivative liabilities

 

$

706.8

 

$

 

$

 

$

706.8

 

Total liabilities

 

$

706.8

 

$

 

$

 

$

706.8

 

 

The fair value of these items as of December 31, 2008 is summarized in the following table.

 

 

 

Fair Value Measurements Using

 

(Dollars in millions)

 

Fair Value

 

Quoted Prices in
Active Markets for
Identical Assets
(Level 1)

 

Significant Other
Observable Inputs
(Level 2)

 

Significant
Unobservable
Inputs
(Level 3)

 

Assets

 

 

 

 

 

 

 

 

 

Fixed maturity securities

 

$

3,154.1

 

$

 

$

3,154.1

 

$

 

Short-term investments

 

477.2

 

47.8

 

429.4

 

 

Credit derivative assets

 

147.0

 

 

 

147.0

 

CCS Securities

 

51.1

 

 

51.1

 

 

Total assets

 

$

3,829.4

 

$

47.8

 

$

3,634.6

 

$

147.0

 

Liabilities

 

 

 

 

 

 

 

 

 

Credit derivative liabilities

 

$

733.8

 

$

 

$

 

$

733.8

 

Total liabilities

 

$

733.8

 

$

 

$

 

$

733.8

 

 

Fixed Maturity Securities and Short-term Investments

 

The fair value of fixed maturity securities and short-term investments is determined using one of three different pricing services: pricing vendors, index providers or broker-dealer quotations. Pricing services for each sector of the market are determined based upon the provider’s expertise.

 

Typical inputs used by these three pricing methods include, but are not limited to, reported trades, benchmark yields, issuer spreads, bids, offers, and/or estimated cash flows and prepayments speeds. Based on the typical trading volumes and the lack of quoted market prices for fixed maturities, third party pricing services will normally derive the security prices through recent reported trades for identical or similar securities making adjustments through the reporting date based upon available market observable information as outlined above. If there are no recent reported trades, the third party pricing services and brokers may use matrix or model processes to develop a security price where future cash flow expectations are developed based upon collateral performance and discounted at an estimated market rate. Included in the pricing of asset backed securities are estimates of the rate of future prepayments of principal over the remaining life of the securities. Such estimates are derived based on the characteristics of the underlying structure and prepayment speeds previously experienced at the interest rate levels projected for the underlying collateral. The Company does not make any internal adjustments to prices provided by its third party pricing service.

 

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Table of Contents

 

The Company has analyzed the third party pricing services’ valuation methodologies and related inputs, and has also evaluated the various types of securities in its investment portfolio to determine an appropriate FAS 157 fair value hierarchy level based upon trading activity and observability of market inputs. Based on this evaluation, each price was classified as Level 1, 2 or 3. Prices provided by third party pricing services with market observable inputs are classified as Level 2. Prices on the money fund portion of short-term investments are classified as Level 1. No investments were classified as Level 3 as of or for the three months ended March 31, 2009.

 

Committed Capital Securities (“CCS Securities”)

 

The fair value of CCS Securities represents the present value of remaining expected put option premium payments under the CCS Securities agreements and the value of such estimated payments based upon the quoted price for such premium payments as of March 31, 2009 (see Note 10). The $70.7 million fair value asset for CCS Securities is included in the consolidated balance sheet. Changes in fair value of this asset are included in other income in the consolidated statement of operations and comprehensive income. The significant market inputs used are observable, therefore, the Company classified this fair value measurement as Level 2.

 

Level 3 Valuation Techniques

 

Financial instruments are considered Level 3 when their values are determined using pricing models, discounted cash flow methodologies or similar techniques and at least one significant model assumption or input is unobservable. Level 3 financial instruments also include those for which the determination of fair value requires significant management judgment or estimation. A brief description of the valuation techniques used for Level 3 assets and liabilities is provided below.

 

Credit Derivatives

 

The Company’s credit derivatives consist of insured CDS contracts (see Note 4). As discussed in Note 4, the Company does not typically exit its credit derivative contracts, and there are no quoted prices for its instruments or for similar instruments. Observable inputs other than quoted market prices exist, however, these inputs reflect contracts that do not contain terms and conditions similar to the credit derivative contracts issued by the Company. Therefore, the valuation of credit derivative contracts requires the use of models that contain significant, unobservable inputs. Thus, we believe the credit derivative valuations are in Level 3 in the fair value hierarchy discussed above.

 

The fair value of the Company’s credit derivative contracts represents the difference between the present value of remaining expected premiums the Company receives for the credit protection and the estimated present value of premiums that a comparable financial guarantor would hypothetically charge the Company for the same protection at the balance sheet date. The fair value of the Company’s credit derivatives depends on a number of factors including notional amount of the contract, expected term, credit spreads, changes in interest rates, the credit ratings of referenced entities, the Company’s own credit risk and remaining contractual cash flows. Contractual cash flows, which are included in the “Realized gains and other settlements on credit derivatives” fair value component of credit derivatives, are the most readily observable variables of the fair value of credit derivative contracts since they are based on contractual terms. These variables include (i) net premiums received and receivable on written credit derivative contracts, (ii) net premiums paid and payable on purchased contracts, (iii) losses paid and payable to credit derivative contract counterparties and (iv) losses recovered and recoverable on purchased contracts. The remaining key variables described above impact “Unrealized gains (losses) on credit derivatives”.

 

Market conditions at March 31, 2009 were such that market prices of the Company’s CDS contracts were not generally available. Where market prices were not available, the Company used a combination of observable market data and valuation models, using various market indices, credit spreads, the Company’s own credit risk, and estimated contractual payments to estimate the “Unrealized gains (losses) on credit derivatives” portion of the fair value of its credit derivatives. These models are primarily developed internally based on market conventions for similar transactions.

 

Management considers the non-standard terms of its credit derivative contracts in determining the fair value of these contracts. These terms differ from credit derivatives sold by companies outside the financial guaranty industry. The non-standard terms include the absence of collateral support agreements or immediate settlement provisions, relatively high attachment points and the fact that the Company does not exit derivatives it sells for

 

24



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credit protection purposes, except under specific circumstances such as exiting a line of business. Because of these terms and conditions, the fair value of the Company’s credit derivatives may not reflect the same prices observed in an actively traded market of credit derivatives that do not contain terms and conditions similar to those observed in the financial guaranty market. These models and the related assumptions are continuously reevaluated by management and enhanced, as appropriate, based upon improvements in modeling techniques and availability of more timely market information.

 

Valuation models include the use of management estimates and current market information. Management is also required to make assumptions on how the fair value of credit derivative instruments is affected by current market conditions. Management considers factors such as current prices charged for similar agreements, performance of underlying assets, life of the instrument, and the extent of credit derivative exposure the Company ceded under reinsurance agreements, and the nature and extent of activity in the financial guaranty credit derivative marketplace. The assumptions that management uses to determine its fair value may change in the future due to market conditions. Due to the inherent uncertainties of the assumptions used in the valuation models to determine the fair value of these credit derivative products, actual experience may differ from the estimates reflected in the Company’s consolidated financial statements and the differences may be material.

 

Listed below are various inputs and assumptions that are key to the establishment of our fair value for CDS contracts.

 

Assumptions

 

The key assumptions of our internally developed model include:

 

·                  Gross spread is the difference between the yield of a security paid by an issuer on an insured versus uninsured basis or, in the case of a CDS transaction, the difference between the yield and an index such as LIBOR. Such pricing is well established by historical financial guarantee fees relative to capital market spreads as observed and executed in competitive markets, including in financial guarantee reinsurance and secondary market transactions.

·                  Gross spread on a financial guarantee written in CDS form is allocated among 1) profit the originator, usually an investment bank, realizes for putting the deal together and funding the transaction, 2) premiums paid to us for our credit protection provided and 3) the cost of CDS protection purchased on us by the originator to hedge their counterparty credit risk exposure to the Company. The premium the Company receives is referred to as the net spread. The Company’s own credit risk is factored into the determination of net spread based on the impact of changes in the quoted market price for credit protection bought on the Company, as reflected by quoted market prices on CDS sold on Assured Guaranty Corp. The cost to acquire CDS protection sold on AGC affects the amount of spread on CDS deals that the Company captures and, hence, their fair value. As the cost to acquire CDS protection sold on AGC increases the amount of premium we capture on a deal generally decreases. As the cost to acquire CDS protection sold on AGC decreases the amount of premium we capture on a deal generally increases. In our model, the premium we capture is not permitted to go below the minimum rate that we would currently charge to assume similar risks. This has the effect of mitigating the amount of unrealized gains that are recognized on certain CDS contracts.

·                  The Company determines the fair value of its CDS contracts by applying the net spread for the remaining duration of each contract to the notional value of its CDS contracts.

·                  Actual transactions are used to validate the model results and to explain the correlation between various market indices and indicative CDS market prices.

 

Inputs

 

The specific model inputs are listed below, including how we derive inputs for market credit spreads on the underlying transaction collateral.

 

·                  Gross spread—This is an input into the Company’s fair value model that is used to ultimately determine the net spread a comparable financial guarantor would charge the Company to transfer risk at the reporting date. The Company’s estimate of fair value represents the difference between the estimated present value of premiums that a comparable financial guarantor would accept to assume the risk from the Company on the current reporting date, on terms identical to the original contracts written by the Company and at the contractual premium for each individual credit derivative contract.

 

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This is an observable input that the Company obtains for deals it has closed or bid on in the market place.

·                  Credit spreads on risks assumed—These are obtained from market data sources published by third parties (e.g. dealer spread tables for the collateral similar to assets within our transactions) as well as collateral-specific spreads provided by trustees or obtained from market sources. If observable market credit spreads are not available or reliable for the underlying reference obligations, then market indices are used that most closely resembles the underlying reference obligations, considering asset class, credit quality rating and maturity of the underlying reference obligations. As discussed previously, these indices are adjusted to reflect the non-standard terms of the Company’s CDS contracts. As of March 31, 2009, the Company obtained approximately 20% of its credit spread data, based on notional par outstanding, from sources published by third parties, while 80% was obtained from market sources or similar market indices. Market sources determine credit spreads by reviewing new issuance pricing for specific asset classes and receiving price quotes from their trading desks for the specific asset in question. Management validates these quotes by cross-referencing quotes received from one market source against quotes received from another market source to ensure reasonableness. In addition, we compare the relative change in price quotes received from one quarter to another, with the relative change experienced by published market indices for a specific asset class. Collateral specific spreads obtained from third-party, independent market sources are un-published spread quotes from market participants and or market traders whom are not trustees. Management obtains this information as the result of direct communication with these sources as part of the valuation process.

·                  Credit spreads on the Company’s name—The Company obtains the quoted price of CDS contracts traded on AGC from market data sources published by third parties.

 

The following is an example of how changes in gross spreads, the Company’s own credit spread and the cost to buy protection on the Company affect the amount of premium the Company can demand for its credit protection. Scenario 1 represents the market conditions in effect on the transaction date and Scenario 2 represents market conditions at a subsequent reporting date.

 

 

 

Scenario 1

 

Scenario 2

 

 

 

bps

 

% of Total

 

bps

 

% of Total

 

Original Gross Spread / Cash Bond Price (in Bps)

 

185

 

 

 

500

 

 

 

Bank Profit (in Bps)

 

115

 

62

%

50

 

10

%

Hedge Cost (in Bps)

 

30

 

16

%

440

 

88

%

AGC Premium Received Per Annum (in Bps)

 

40

 

22

%

10

 

2

%

 

In Scenario 1, the gross spread is 185bps. The bank or deal originator captures 115bps of the original gross spread and hedges 10% of its exposure to AGC, when the CDS spread on AGC was 300bps (300bps × 10% = 30bps). Under this scenario AGC received premium of 40bps, or 22% of the gross spread.

 

In Scenario 2, the gross spread is 500bps. The bank or deal originator captures 50bps of the original gross spread and hedges 25% of its exposure to AGC, when the CDS spread on AGC was 1,760bps (1,760bps × 25% = 440bps). Under this scenario AGC would receive premium of 10bps, or 2% of the gross spread.

 

In this example, the contractual cash flows (the AGC premium above) exceed the amount a market participant would require AGC to pay in today’s market to accept its obligations under the credit default swap contract, thus resulting in an asset. This credit derivative asset is equal to the difference in premium rate discounted at a risk adjusted rate over the weighted average remaining life of the contract. The expected future cash flows for the Company’s credit derivatives were discounted at rates ranging from 1.0% to 23.0% over LIBOR at March 31, 2009, with over 95% of the transactions ranging from 1.0% to 6.0% over LIBOR.

 

The Company corroborates the assumptions in its fair value model, including the amount of exposure to the Company hedged by its counterparties, with independent third parties each reporting period. Recent increases in the CDS spread on AGC have resulted in the bank or deal originator hedging a greater portion of its exposure to AGC. This has the effect of reducing the amount of contractual cash flows AGC can capture for selling our protection.

 

The amount of premium a financial guaranty insurance market participant can demand is inversely related to the cost of credit protection on the insurance company as measured by market credit spreads. This is because the buyers of credit protection typically hedge a portion of their risk to the financial guarantor, due to the fact that

 

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contractual terms of financial guaranty insurance contracts typically do not require the posting of collateral by the guarantor. The widening of a financial guarantor’s own credit spread increases the cost to buy credit protection on the guarantor, thereby, reducing the amount of premium the guarantor can capture out of the gross spread on the deal. The extent of the hedge depends on the types of instruments insured and the current market conditions.

 

A credit derivative asset under FAS 157 is the result of contractual cash flows on in-force deals in excess of what a hypothetical financial guarantor could receive if it sold protection on the same risk as of the current reporting date. If the Company were able to freely exchange these contracts (i.e., assuming its contracts did not contain proscriptions on transfer and there was a viable exchange market), it would be able to realize an asset representing the difference between the higher contractual premiums to which it’s entitled and the current market premiums for a similar contract.

 

To clarify, management does not believe there is an established market where financial guaranty insured credit derivatives are actively traded. The terms of the protection under an insured financial guaranty credit derivative do not, except for certain rare circumstances, allow the Company to exit its contracts. Management has determined that the exit market for the Company’s credit derivatives is a hypothetical one based on its entry market. Management has tracked the historical pricing of the Company’s deals to establish historical price points in the hypothetical market that are used in the fair value calculation.

 

The following spread hierarchy is utilized in determining which source of spread to use, with the rule being to use CDS spreads where available. If not available, the Company either interpolates or extrapolates CDS spreads based on similar transactions or market indices.

 

1.               Actual collateral specific credit spreads (if up-to-date and reliable market-based spreads are available, they are used).

2.               Credit spreads are interpolated based upon market indices or deals priced or closed during a specific quarter within a specific asset class and specific rating.

3.               Credit spreads provided by the counterparty of the credit default swap.

4.               Credit spreads are extrapolated based upon transactions of similar asset classes, similar ratings, and similar time to maturity.

 

Over time the data inputs can change as new sources become available or existing sources are discontinued or are no longer considered to be the most appropriate. It is the Company’s objective to move to higher levels on the hierarchy whenever possible, but it is sometimes necessary to move to lower priority inputs because of discontinued data sources or assessments that the higher priority inputs are no longer considered to be representative of market spreads for a given type of collateral. This can happen, for example, if transaction volume changes such that a previously used spread index is no longer viewed as being reflective of current market levels.

 

As of March 31, 2009, the Company obtained approximately 8% of its credit spread information, based on notional par outstanding, from actual collateral specific credit spreads, while 80% was based on market indices and 12% was based on spreads provided by the CDS counterparty. The Company interpolates a curve based on the historical relationship between premium the Company receives when a financial guarantee written in CDS form closes to the daily closing price of the market index related to the specific asset class and rating of the deal. This curve indicates expected credit spreads at each indicative level on the related market index. For specific transactions where no price quotes are available and credit spreads need to be extrapolated, an alternative transaction for which the Company has received a spread quote from one of the first three sources within the Company’s spread hierarchy is chosen. This alternative transaction will be within the same asset class, have similar underlying assets, similar credit ratings, and similar time to maturity. The Company then calculates the percentage of relative spread change quarter over quarter for the alternative transaction. This percentage change is then applied to the historical credit spread of the transaction for which no price quote was received in order to calculate the transactions current spread. Counterparties determine credit spreads by reviewing new issuance pricing for specific asset classes and receiving price quotes from their trading desks for the specific asset in question. These quotes are validated by cross-referencing quotes received from one market source with those quotes received from another market source to ensure reasonableness. In addition, management compares the relative change experienced on published market indices for a specific asset class for reasonableness and accuracy.

 

The Company’s credit derivative valuation model, like any financial model, has certain strengths and weaknesses

 

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The primary strengths of the Company’s CDS modeling techniques are:

 

·                  The model takes account of transaction structure and the key drivers of market value. The transaction structure includes par insured, weighted average life, level of subordination and composition of collateral.

·                  The model maximizes the use of market-driven inputs whenever they are available. The key inputs to the model are market-based spreads for the collateral, and the credit rating of referenced entities. These are viewed by us to be the key parameters that affect fair value of the transaction.

·                  The Company is able to use actual transactions to validate its model results and to explain the correlation between various market indices and indicative CDS market prices.

·                  The model is a well-documented, consistent approach to valuing positions that minimizes subjectivity. The Company has developed a hierarchy for market-based spread inputs that helps mitigate the degree of subjectivity during periods of high illiquidity.

 

The primary weaknesses of the Company’s CDS modeling techniques are:

 

·                  There is no exit market or actual exit transactions. Thus our exit market is a hypothetical one based on our entry market.

·                  There is a very limited market in which to verify the fair values developed by the Company’s model.

·                  At March 31, 2009, the markets for the inputs to the model were highly illiquid, which impacts their reliability. However, the Company employs various procedures to corroborate the reasonableness of quotes received and calculated by our internal valuation model, including comparing to other quotes received on similarly structured transactions, observed spreads on structured products with comparable underlying assets and, on a selective basis when possible, through second independent quotes on the same reference obligation.

·                  Due to the non-standard terms under which the Company enters into derivative contracts, the fair value of its credit derivatives may not reflect the same prices observed in an actively traded market of credit derivatives that do not contain terms and conditions similar to those observed in the financial guaranty market.

 

As discussed above, the Company does not trade or exit its credit derivative contracts in the normal course of business. As such, the ability to test modeled results is limited by the absence of actual exit transactions. However, management does compare modeled results to actual data that is available. Management first attempts to compare modeled values to premiums on deals the Company received on new deals written within the reporting period. If no new transactions were written for a particular asset type in the period or if the number of transactions is not reflective of a representative sample, management compares modeled results to premium bids offered by the Company to provide credit protection on new transactions within the reporting period, the premium the Company has received on historical transactions to provide credit protection in net tight and wide credit environments and/or the premium on transactions closed by other financial guaranty insurance companies during the reporting period.

 

The net par outstanding of the Company’s credit derivative contracts was $73.3 billion and $75.1 billion at March 31, 2009 and December 31, 2008, respectively. The estimated remaining average life of these contracts at March 31, 2009 was 7.9 years.

 

As required by FAS 157, financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. As of March 31, 2009, these contracts are classified as Level 3 in the FAS 157 hierarchy since there is reliance on at least one unobservable input deemed significant to the valuation model, most significantly the Company’s estimate of the value of the non-standard terms and conditions of its credit derivative contracts and of the Company’s current credit standing.

 

The table below presents a reconciliation of the Company’s credit derivatives whose fair value included significant unobservable inputs (Level 3) during the three months ended March 31, 2009 and 2008.

 

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Fair Value Measurements Using
Significant Unobservable Inputs
(Level 3)

 

 

 

First Quarter 2009

 

First Quarter 2008

 

(Dollars in millions)

 

Credit Derivative
Liability (Asset), net

 

Credit Derivative
Liability (Asset), net

 

 

 

 

 

 

 

Beginning Balance

 

$

586,807

 

$

617,644

 

Total gains or losses realized and unrealized

 

 

 

 

 

Unrealized (gains) losses on credit derivatives

 

(26,982

)

259,621

 

Realized gains and other settlements on credit derivatives

 

(20,579

)

(27,617

)

Current period net effect of purchases, settlements and other activity included in unrealized portion of beginning balance

 

17,724

 

31,989

 

Transfers in and/or out of Level 3

 

 

 

 

 

 

 

 

 

Ending Balance

 

$

556,970

 

$

881,637

 

 

 

 

 

 

 

Gains and losses (realized and unrealized) included in earnings for the period are reported as follows:

 

 

 

 

 

Total realized and unrealized (gains) losses included in earnings for the period

 

$

(47,561

)

$

232,004

 

 

 

 

 

 

 

Change in unrealized (gains) losses on credit derivatives still held at the reporting date

 

$

(27,182

)

$

262,462

 

 

6. Investments

 

The following table summarizes the Company’s aggregate investment portfolio as of March 31, 2009:

 

 

 

Amortized
Cost

 

Gross
Unrealized
Gains

 

Gross
Unrealized
Losses

 

Estimated
Fair Value

 

 

 

(in thousands of U.S. dollars)

 

Fixed maturity securities

 

 

 

 

 

 

 

 

 

U.S. government and agencies

 

$

426,058

 

$

36,575

 

$

(23

)

$

462,610

 

Obligations of state and political subdivisions

 

1,245,811

 

34,310

 

(32,102

)

1,248,019

 

Corporate securities

 

278,772

 

3,984

 

(20,522

)

262,234

 

Mortgage-backed securities

 

1,089,288

 

28,968

 

(50,109

)

1,068,147

 

Asset-backed securities

 

70,880

 

249

 

(2,006

)

69,123

 

Foreign government securities

 

61,617

 

4,428

 

 

66,045

 

Preferred stock

 

 

 

 

 

Total fixed maturity securities

 

3,172,426

 

108,514

 

(104,762

)

3,176,178

 

Short-term investments

 

616,834

 

 

 

616,834

 

Total investments

 

$

3,789,260

 

$

108,514

 

$

(104,762

)

$

3,793,012

 

 

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The following table summarizes the Company’s aggregate investment portfolio as of December 31, 2008:

 

 

 

Amortized
Cost

 

Gross
Unrealized
Gains

 

Gross
Unrealized
Losses

 

Estimated
Fair Value

 

 

 

(in thousands of U.S. dollars)

 

Fixed maturity securities

 

 

 

 

 

 

 

 

 

U.S. government and agencies

 

$

426,592

 

$

49,370

 

$

(36

)

$

475,926

 

Obligations of state and political subdivisions

 

1,235,942

 

33,196

 

(51,427

)

1,217,711

 

Corporate securities

 

274,237

 

5,793

 

(11,793

)

268,237

 

Mortgage-backed securities

 

1,081,879

 

21,772

 

(51,817

)

1,051,834

 

Asset-backed securities

 

80,710

 

 

(7,144

)

73,566

 

Foreign government securities

 

50,323

 

4,173

 

 

54,496

 

Preferred stock

 

12,625

 

 

(258

)

12,367

 

Total fixed maturity securities

 

3,162,308

 

114,304

 

(122,475

)

3,154,137

 

Short-term investments

 

477,197

 

 

 

477,197

 

Total investments

 

$

3,639,505

 

$

114,304

 

$

(122,475

)

$

3,631,334

 

 

Approximately 28% and 29% of the Company’s total investment portfolio as of March 31, 2009 and December 31, 2008, respectively, was composed of mortgage backed securities, including collateralized mortgage obligations and commercial mortgage backed securities. As of March 31, 2009 and December 31, 2008, respectively, approximately 70% and 69% of the Company’s total mortgage backed securities were government agency obligations. As of both March 31, 2009 and December 31, 2008, the weighted average credit quality of the Company’s entire investment portfolio was AA+. The Company’s portfolio is comprised primarily of high-quality, liquid instruments. The Company continues to receive sufficient information to value its investments and has not had to modify its approach due to the current market conditions.

 

Under agreements with its cedants and in accordance with statutory requirements, the Company maintains fixed maturity securities in trust accounts of $1,269.2 million and $1,233.4 million as of March 31, 2009 and December 31, 2008, respectively, for the benefit of reinsured companies and for the protection of policyholders, generally in states in which the Company or its subsidiaries, as applicable, are not licensed or accredited.

 

Under certain derivative contracts, the Company is required to post eligible securities as collateral, generally cash or U.S. government or agency securities. The need to post collateral under these transactions is generally based on mark-to-market valuation in excess of contractual thresholds. The fair market value of the Company’s pledged securities totaled $177.9 million and $157.7 million as of March 31, 2009 and December 31, 2008, respectively.

 

The Company has a formal review process for all securities in its investment portfolio, including a review for impairment losses. Factors considered when assessing impairment include:

 

·                  a decline in the market value of a security by 20% or more below amortized cost for a continuous period of at least six months;

·                  a decline in the market value of a security for a continuous period of 12 months;

·                  recent credit downgrades of the applicable security or the issuer by rating agencies;

·                  the financial condition of the applicable issuer;

·                  whether loss of investment principal is anticipated;

·                  whether scheduled interest payments are past due; and

·                  whether the Company has the ability and intent to hold the security for a sufficient period of time to allow for anticipated recoveries in fair value.

 

If the Company believes a decline in the value of a particular investment is temporary, the decline is recorded as an unrealized loss on the balance sheet in “accumulated other comprehensive income” in shareholders’ equity. If the Company believes the decline is “other than temporary,” the Company will write down the carrying value of the investment and record a realized loss in its consolidated statements of operations and comprehensive income. In periods subsequent to the recognition of an other-than-temporary impairment, the impaired security is accounted for as if it had been purchased on the measurement date of the impairment. Accordingly, the discount (or reduced premium) based on the new cost basis is accreted into net investment income in future periods based upon

 

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the amount and timing of expected future cash flows of the security, if the recoverable value of the investment based upon those cash flows is greater than the carrying value of the investment after the impairment.

 

The Company’s assessment of a decline in value includes management’s current assessment of the factors noted above. The Company also seeks advice from its outside investment managers. If that assessment changes in the future, the Company may ultimately record a loss after having originally concluded that the decline in value was temporary.

 

As part of its other than temporary impairment review process, management considers the nature of the investment, the cause for the impairment (interest or credit related), the severity (both as a percentage of book value and absolute dollars) and duration of the impairment, the severity of the impairment regardless of duration, and any other available evidence, such as discussions with investment advisors, volatility of the securities fair value and recent news reports when performing its assessment.

 

As of March 31, 2009, the Company’s gross unrealized loss position stood at $104.8 million compared to $122.5 million at December 31, 2008. The $17.7 million decrease in gross unrealized losses was primarily attributable to municipal securities, $19.3 million, mortgage and asset backed securities, $6.9 million, and partially offset by an increase in gross unrealized losses in corporate securities, $8.8 million. The decrease in gross unrealized losses during the three months ended March 31, 2009 was related to the recovery of liquidity in the financial markets.

 

As of March 31, 2009, the Company had 85 securities in an unrealized loss position for greater than 12 months, representing a gross unrealized loss of $55.8 million. Of these securities, 28 securities had unrealized losses greater than 10% of book value. The total unrealized loss for these securities as of March 31, 2009 was $39.0 million. This unrealized loss is primarily attributable to the market illiquidity and volatility in the U.S. economy mentioned above and not specific to individual issuer credit. Except as noted below, the Company has recognized no other than temporary impairment losses and has the ability and intent to hold these securities until a recovery in value.

 

The Company recognized $18.5 million of other than temporary impairment losses substantially related to mortgage backed and corporate securities for the three months ended March 31, 2009 primarily due to the fact that it does not have the intent to hold these securities until there is a recovery in their value. The Company continues to monitor the value of these investments. Future events may result in further impairment of the Company’s investments. The Company had no write downs of investments for other than temporary impairment losses for the three months ended March 31, 2008.

 

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The following table summarizes the unrealized losses in our investment portfolio by type of security and the length of time such securities have been in a continuous unrealized loss position as of the dates indicated:

 

 

 

As of March 31, 2009

 

As of December 31, 2008

 

Length of Time in Continuous Unrealized Loss Position

 

Estimated
Fair
Value

 

Gross
Unrealized
Losses

 

Estimated
Fair
Value

 

Gross
Unrealized
Losses

 

 

 

($ in millions)

 

Municipal securities

 

 

 

 

 

 

 

 

 

0-6 months

 

$

148.1

 

$

(2.6

)

$

168.8

 

$

(5.8

)

7-12 months

 

174.8

 

(5.8

)

310.6

 

(22.9

)

Greater than 12 months

 

295.8

 

(23.7

)

137.9

 

(22.7

)

 

 

 

 

 

 

 

 

 

 

 

 

618.7

 

(32.1

)

617.3

 

(51.4

)

Corporate securities

 

 

 

 

 

 

 

 

 

0-6 months

 

66.9

 

(7.6

)

23.7

 

(1.7

)

7-12 months

 

71.8

 

(9.0

)

81.9

 

(8.5

)

Greater than 12 months

 

20.1

 

(4.0

)

14.2

 

(1.6

)