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Net Premiums Earned

9 Months Ended

Sep. 30, 2011

Net Premiums Earned [Abstract]

Net Premiums Earned

(5) Net Premiums Earned

Gross premiums are received either upfront (typical of public finance obligations) or in installments (typical of structured finance obligations). For premiums received upfront, an unearned premium revenue ("UPR") liability is established, which is initially recorded as the cash amount received. For installment premium transactions, a premium receivable asset and offsetting UPR liability is initially established in an amount equal to: (i) the present value of future contractual premiums due (the "contractual" method) or, (ii) if the underlying insured obligation is a homogenous pool of assets which are contractually prepayable, the present value of premiums to be collected over the expected life of the transaction (the "expected" method). An appropriate risk-free rate corresponding to the weighted average life of each policy and exposure currency is used to discount the future premiums contractually due or expected to be collected. For example, U.S. dollar exposures are discounted using U.S. Treasury rates while exposures denominated in a foreign currency are discounted using the appropriate risk-free rate for the respective currency. The weighted average risk-free rate at September 30, 2011, and December 31, 2010, was 2.8% and 3.1%, respectively, and the weighted average period of future premiums used to estimate the premium receivable at September 30, 2011, and December 31, 2010, was 11.0 years and 10.4 years, respectively. Insured obligations consisting of homogeneous pools for which Ambac uses expected future premiums to estimate the premium receivable and UPR include residential mortgage-backed securities and consumer auto loans. As prepayment assumptions change for homogenous pool transactions, or if there is an actual prepayment for a "contractual" method installment transaction, the related premium receivable and UPR are adjusted in equal and offsetting amounts with no immediate effect on earnings using new premium cash flows and the then current risk free rate.

Generally, the priority for the payment of financial guarantee premiums to Ambac, as required by the bond indentures of the insured obligations, is very senior in the waterfall. Additionally, in connection with the allocation of certain liabilities to the Segregated Account, trustees are required under the Rehabilitation Plan to continue to pay installment premiums, notwithstanding the claims moratorium. As such, Ambac has not historically written off any meaningful amount of uncollectible premiums. In evaluating the credit quality of the premiums receivable, management evaluates the internal ratings of the transactions underlying the premiums receivable. As of September 30, 2011 and December 31, 2010, approximately 41% and 29% of the premiums receivable related to transactions with non-investment grade internal ratings, comprised mainly of non-investment grade MBS and student loan transactions, which comprised 11% and 13%, and 9% and 11% of the total premiums receivable at September 30, 2011 and December 31, 2010, respectively. Past due premiums on policies insuring non-investment grade obligations amounted to less than $200 at September 30, 2011.

For both upfront and installment premium policies, premium revenues are earned over the life of the financial guarantee contract in proportion to the insured principal amount outstanding at each reporting date (referred to as the level-yield method). For installment paying policies, the premium receivable discount, equating to the difference between the undiscounted future installment premiums and the present value of future installment premiums, is accreted as premiums earned in proportion to the premium receivable balance at each reporting date. Because the premium receivable discount and UPR are being accreted into income using different rates, the total premiums earned as a percentage of insured principal is higher in the earlier years and lower in the later years for an installment premium transaction as compared to an upfront premium transaction.

Below is the premium receivable roll-forward for the periods ended September 30, 2011 and December 31, 2010:


		September 30, 2011				December 31, 2010
Premium receivable at December 31, 2009						$	3,718,158
Impact of adoption of ASU 2009-17⁽¹⁾							(670,997	)

Premium receivable at January 1, 2011 and 2010		$	2,422,596				3,047,161
Premium payments received			(149,099	)			(266,028	)
Adjustments for changes in expected life of homogeneous pools or contractual cash flows			(173,455	)			(577,626	)
Accretion of premium receivable discount			48,999				84,567
(Consolidation)/Deconsolidation of certain VIEs⁽¹⁾			(44,001	)			173,511
Other adjustments (including foreign exchange)			(1,847	)			(38,989	)

Premium receivable at September 30, 2011 and December 31, 2010		$	2,103,193			$	2,422,596

(1)	Refer to Note 4 to the Unaudited Consolidated Financial Statements for discussion of the consolidation standard.

Similar to gross premiums, premiums ceded to reinsurers are paid either upfront or in installments. For premiums paid upfront, a deferred ceded premium asset is established which is initially recorded as the cash amount paid. For installment premiums, a ceded installment premiums payable liability and offsetting deferred ceded premium asset are initially established in an amount equal to: i) the present value of future contractual premiums due or, ii) if the underlying insured obligation is a homogenous pool of assets which are contractually prepayable, the present value of premiums to be paid over the life of the transaction. An appropriate risk-free rate corresponding to the weighted average life of each policy and exposure currency is used to discount the future premiums contractually due or expected to be collected. Premiums ceded to reinsurers reduce the amount of premiums earned by Ambac from its financial guarantee insurance policies. For both up-front and installment premiums, ceded premiums written are primarily recognized in earnings in proportion to and at the same time as the related gross premium revenue is recognized. For premiums paid to reinsurers on an installment basis, Ambac records the present value of future ceding commissions as an offset to ceded premiums payable, using the same assumptions noted above for installment premiums. The ceding commission revenue associated with the ceding premiums payable is deferred (as an offset to deferred acquisition cost) and recognized in income in proportion to ceded premiums.

The table below summarizes the future gross undiscounted premiums expected to be collected, and future expected premiums earned, net of reinsurance at September 30, 2011:


		Future premiums expected to be collected⁽¹⁾				Future premiums expected to be earned, net of reinsurance⁽¹⁾
Three months ended:
December 31, 2011			44,937				69,988

Twelve months ended:
December 31, 2012			164,236				259,984
December 31, 2013			156,143				235,341
December 31, 2014			158,817				218,941
December 31, 2015			153,879				206,987

Five years ended:
December 31, 2020			692,299				875,880
December 31, 2025			569,883				633,593
December 31, 2030			444,769				432,482
December 31, 2035			286,813				239,096
December 31, 2040			99,031				83,717
December 31, 2045			29,452				26,076
December 31, 2050			7,360				7,977
December 31, 2055			603				1,288

Total		$	2,808,222			$	3,291,350

(1)

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

When a bond issue insured by Ambac Assurance has been retired, including those retirements due to refunding or calls, any remaining UPR is recognized at that time to the extent the financial guarantee contract is legally extinguished. For installment premium paying transactions, we offset the recognition of any remaining UPR by the reduction of the related premium receivable to zero (as it will not be collected as a result of the retirement), which may cause negative accelerated premium revenue. Accelerated premium revenue for retired obligations for the three and nine months ended September 30, 2011, was $18,835 and $30,096, respectively. Accelerated premium revenue for retired obligations for the three and nine months ended September 30, 2010 was $30,004 and $96,450, respectively. Certain obligations insured by Ambac have been legally defeased whereby government securities are purchased by the issuer with the proceeds of a new bond issuance, or less frequently with other funds of the issuer, and held in escrow (a pre-refunding). The principal and interest received from the escrowed securities are then used to retire the Ambac-insured obligations at a future date either to their maturity date or a specified call date. Ambac has evaluated the provisions in certain financial guarantee insurance policies issued on legally defeased obligations and determined those policies have not been legally extinguished and, therefore, premium revenue recognition has not been accelerated.

The table below shows premiums written on a gross and net basis for the three and nine month periods ended September 30, 2011, and 2010:


		Three Months Ended September 30,								Nine Months Ended September 30,
		2011				2010				2011				2010
Revenues:
Financial Guarantee:
Gross premiums written		$	242,573			$	53,200			($	125,712	)		($	137,935	)
Ceded premiums written			(2,047	)			45,583				18,742				62,521

Net premiums written⁽¹⁾		$	240,526			$	98,783			($	106,970	)		($	75,414	)

(1)

Premiums written represent the change in the present value of future installment premiums. Such changes will not have an immediate impact on earned premium but will be earned over the life of the transaction using the level yield method discussed above. Factors that generate written premium are prepayments of the insured obligation, premium rate changes for policies that have ratings-based premium structures, discount rate changes and early termination of an insured obligation.