4 LOSSES AND LOSS EXPENSE RESERVE

As discussed in Note 2, a loss reserve is recorded on the balance sheet on a policy-by-policy basis for the excess of: (a) the present value of expected net cash flows to be paid under an insurance contract, i.e. the expected loss, over (b) the UPR for that contract. Below is the loss reserve roll-forward, net of subrogation recoverable and reinsurance for the years ended December 31, 2011 and 2010:


	2011			2010
Loss reserves at December 31, net of subrogation recoverable and reinsurance	$	4,424,450		$	3,777,321
Impact of adopting the new consolidation accounting guidance for VIEs		—			(503,887	)

Beginning balance of net loss reserves, net of subrogation recoverable and reinsurance		4,424,450			3,273,434
Changes in the loss reserves due to:
Current year:
Establishment of new loss reserves, gross of subrogation and net of reinsurance		503,697			721,792
Claim payments, net of subrogation and reinsurance		(2,442	)		14,034
Establishment of subrogation recoveries, net of reinsurance		(9,761	)		(153,342	)

Total current year		491,494			582,484
Prior year:
Change in previously established loss reserves, gross of subrogation and net of reinsurance		1,683,831			367,969
Change in previously established subrogation recoveries, net of reinsurance		(324,151	)		(216,501	)
Claim payments, net of subrogation recoverable and reinsurance		(179,440	)		(259,569	)

Total prior year		1,180,240			(108,101	)
Changes in loss reserves		1,671,734			474,383
Net deconsolidation of certain VIEs		134,596			676,633

Ending loss reserves, net of subrogation recoverable and reinsurance	$	6,230,780		$	4,424,450

The adverse development relating to prior years is primarily due to the continued deterioration of collateral supporting structured finance policies, including RMBS and student loan exposures which results in greater expected ultimate losses, partially offset by higher expected subrogation recoveries related to representation and warranty breaches on insured RMBS securitizations.

The net change in loss reserves of $1,671,734 and $474,383 for the years ended December 31, 2011 and 2010, respectively, are included in loss and loss expenses in the Consolidated Statement of Operations. Loss expense reserves are also established for significant surveillance and mitigation expenses associated with adversely classified credits. Total net loss expense reserves were $86,171 and $93,900 at December 31, 2011 and December 31, 2010, respectively. Total loss expense of $26,384 and $186,420 for the years ended December 31, 2011 and 2010, respectively, are included in loss and loss expenses in the Consolidated Statement of Operations. During the years ended December 31, 2011 and 2010, reinsurance recoveries of losses included in loss and loss expenses in the Consolidated Statement of Operations were $42,508 and $73,926, respectively.

The tables below summarize information related to policies currently included in Ambac's loss reserves at December 31, 2011 and 2010:

Surveillance Categories (at December 31, 2011)


	I/SL			IA			II			III			IV			V			Total
Number of policies		27			10			38			125			129			1			330
Remaining weighted-average contract period (in years)		18			10			17			19			9			6			13
Gross insured contractual payments outstanding:
Principal	$	2,222,493		$	354,713		$	2,060,102		$	13,342,814		$	13,092,057		$	47		$	31,072,226
Interest		1,069,538			100,448			1,088,036			8,117,496			3,587,812			29			13,963,359

Total	$	3,292,031		$	455,161		$	3,148,138		$	21,460,310		$	16,679,869		$	76		$	45,035,585

Gross undiscounted claim liability	$	48,573		$	10,667		$	52,355		$	4,766,815		$	7,632,709		$	75		$	12,511,194
Discount, gross claim liability		(4,208	)		(2,316	)		(3,800	)		(1,440,704	)		(828,061	)		(20	)		(2,279,109	)

Gross claim liability before all subrogation and before reinsurance	$	44,365		$	8,351		$	48,555		$	3,326,111		$	6,804,648		$	55		$	10,232,085

Less:
Gross RMBS subrogation⁽¹⁾		—			—			—			(461,725	)		(2,316,920	)		—			(2,778,645	)
Discount, RMBS subrogation		—			—			—			12,278			46,101			—			58,379

Discounted RMBS subrogation, before reinsurance		—			—			—			(449,447	)		(2,270,819	)		—			(2,720,266	)

Less:
Gross other subrogation⁽²⁾		—			(256	)		—			(52,871	)		(667,744	)		—			(720,871	)
Discount, other subrogation		—			77			—			6,550			45,912			—			52,539

Discounted other subrogation, before reinsurance		—			(179	)		—			(46,321	)		(621,832	)		—			(668,332	)

Gross claim liability, net of all subrogation and discounts, before reinsurance		44,365			8,172			48,555			2,830,343			3,911,997			55			6,843,487

Less: Unearned premium reserves		(25,264	)		(5,126	)		(22,111	)		(335,332	)		(158,687	)		—			(546,520	)
Plus: Loss adjustment expenses reserves		—			—			—			—			87,294			—			87,294

Claim liability reported on Balance Sheet, before reinsurance⁽³⁾		19,101			3,046			26,444			2,495,011			3,840,604			55			6,384,261

Reinsurance recoverable reported on Balance Sheet		1,117			9			5,714			139,499			13,563			—			159,902

(1)	RMBS subrogation represents Ambac's estimate of subrogation recoveries from RMBS transaction sponsors for representations and warranty breaches. Please see "RMBS Representation and Warranty Subrogation Recoveries" in Note 2 for a detailed discussion.

(2)	Other subrogation represents subrogation other than subrogation as defined in (1) above.

(3)	Claim liability reported is included in the Consolidated Balance Sheets as follows:


Loss and loss expense reserve (net of potential remediation subrogation of $1,890,797)	$	7,044,070
Subrogation recoverable (includes gross potential remediation of $829,469)		(659,810	)

	$	6,384,260

Loss reserves ceded to reinsurers at December 31, 2011 and 2010 were $153,480 and $128,993, respectively. Amounts were included in reinsurance recoverable on the Consolidated Balance Sheet.

Surveillance Categories (at December 31, 2010)


	I/SL			IA			II			III			IV			V			Total
Number of policies		24			4			34			118			127			1			308
Remaining weighted-average contract period (in years)		5			9			17			19			9			10			14
Gross insured contractual payments outstanding:
Principal	$	1,831,525		$	198,460		$	2,620,973		$	17,723,814		$	13,766,322		$	47		$	36,141,141
Interest		392,486			58,317			1,983,875			10,609,295			3,327,242			27			16,371,242

Total	$	2,224,011		$	256,777		$	4,604,848		$	28,333,109		$	17,093,564		$	74		$	52,512,383

Gross undiscounted claim liability	$	19,664		$	9,952		$	62,469		$	4,195,891		$	7,197,833		$	75		$	11,485,884
Discount, gross claim liability		(925	)		(4,700	)		13,974			(1,517,671	)		(1,234,704	)		(20	)		(2,744,046	)

Gross claim liability before all subrogation and before reinsurance	$	18,739		$	5,252		$	76,443		$	2,678,220		$	5,963,129		$	55		$	8,741,838

Less:
Gross RMBS subrogation⁽¹⁾		—			—			—			—			(2,514,477	)		—			(2,514,477	)
Discount, RMBS subrogation		—			—			—			—			97,371			—			97,371

Discounted RMBS subrogation, before reinsurance		—			—			—			—			(2,417,106	)		—			(2,417,106	)

Less:
Gross other subrogation⁽²⁾		—			—			(11	)		(629,022	)		(1,033,055	)		—			(1,662,088	)
Discount, other subrogation		—			—			—			207,811			89,166			—			296,977

Discounted other subrogation, before reinsurance		—			—			(11	)		(421,211	)		(943,889	)		—			(1,365,111	)

Gross claim liability, net of all subrogation, before reinsurance		18,739			5,252			76,432			2,257,009			2,602,134			55			4,959,621

Less: Unearned premium reserves		(9,095	)		(3,959	)		(49,782	)		(289,408	)		(149,235	)		—			(501,479	)
Plus: Loss adjustment expenses reserves		—			—			—			9,762			85,495			—			95,257

Claim liability reported on Balance Sheet, before reinsurance⁽³⁾		9,644			1,293			26,650			1,977,363			2,538,394			55			4,553,399

Reinsurance recoverable reported on Balance Sheet		542			8			1,588			107,920			26,928			—			136,986

(1)	RMBS subrogation represents Ambac's estimate of subrogation recoveries from RMBS transaction sponsors for representations and warranty breaches. Please see "RMBS Representation and Warranty Subrogation Recoveries in Note 2 for detailed discussion.

(2)	Other subrogation represents subrogation other than subrogation as defined in (1) above.

(3)	Claim liability reported is included in the Consolidated Balance Sheets as follows:


Loss and loss expense reserve (net of potential remediation subrogation of $714,679)	$	5,288,655
Subrogation recoverable (includes gross potential remediation of $1,702,427)		(714,270	)
Other assets (within)		(20,986	)

	$	4,553,399

As discussed in Note 2, Ambac records estimated subrogation recoveries for breaches of representations and warranties by sponsors of certain RMBS transactions utilizing an Adverse and Random Sample approach. Ambac has updated its estimated subrogation recoveries to $2,720,266 ($2,692,414 net of reinsurance) at December 31, 2011 from $2,417,106 ($2,391,335, net of reinsurance) at December 31, 2010. The balance of subrogation recoveries and the related claim liabilities, by estimation approach, at December 31, 2011 and December 31, 2010, are as follows:


	December 31, 2011
Approach	Count			Gross claim liability before subrogation recoveries		Subrogation recoveries⁽¹⁾			Gross claim liability after subrogation recoveries
Adverse samples		30	⁽²⁾	$	2,637,479	$	(1,457,472	)	$	1,180,006
Random samples		16	⁽²⁾		1,140,102		(1,262,794	)		(122,691	)

Totals		46		$	3,777,581	$	(2,720,266	)	$	1,057,315


	December 31, 2010
Approach	Count			Gross claim liability before subrogation recoveries		Subrogation recoveries⁽¹⁾			Gross claim liability after subrogation recoveries
Adverse samples		15	⁽²⁾	$	1,644,488	$	(719,448	)	$	925,040
Random samples		12	⁽ ² ⁾		1,010,704		(1,697,658	)		(686,954	)

Totals		27		$	2,655,192	$	(2,417,106	)	$	238,086

(1)

The amount of recorded subrogation recoveries related to each securitization is limited to ever-to-date paid losses plus the present value of projected future paid losses for each policy. To the extent significant losses have been paid but not yet recovered, the recorded amount of subrogation recoveries may exceed the expected future claims for a given policy. The net cash inflow for these policies is recorded as a "Subrogation recoverable" asset. For those transactions where the subrogation recovery is less than expected future claims, the net cash outflow for these policies is recorded as a "Loss and loss expense reserve" liability. Of the $2,720,266 of subrogation recoveries recorded at December 31, 2011, $829,469 was included in "Subrogation recoverable" and $1,890,797 was included in "Loss and loss expense reserves." Of the $2,417,106 of subrogation recoveries recorded at December 31, 2010, $1,702,427 was included in "Subrogation recoverable" and $714,679 was included in "Loss and loss expense reserves."

(2)

As discussed in Note 2, the sponsor's repurchase obligation may differ depending on the terms of the particular transaction and the status of the specific loan, such as whether it is performing or has been liquidated or charged off. The estimated subrogation recovery for these transactions is based primarily on loan level data provided through trustee reports received in the normal course of our surveillance activities or provided by the sponsor. While this data may not include all the components of the sponsor's contractual repurchase obligation we believe it is the best information available to estimate the subrogation recovery.

Below is the rollforward of RMBS subrogation, by estimation approach, for the year ended December 31, 2011:


	Random sample			# of transactions		Adverse transactions			# of deals
Rollforward:
Discounted RMBS subrogation (gross of reinsurance) at January 1, 2011	$	1,697,658			12	$	719,448			15

Changes recognized in 2011:
Additional transactions reviewed		100,586			4		402,750			15
Additional adverse sample loans reviewed		—			n/a		4,382			n/a
Adverse loans repurchased by the sponsor		—			n/a		(11,882	)		n/a
All other changes⁽¹⁾		(535,450	)		n/a		342,774			n/a

Discounted RMBS subrogation (gross of reinsurance) at December 31, 2011	$	1,262,794			16	$	1,457,472			30

(1)	This amount primarily represents differences due to refinements made to our random sample and adverse sample approaches as described more fully in the Loss Reserves section of Note 2—Significant Accounting Policies.