6. Losses and Loss Expense Reserve

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, over (b) the UPR for that contract. Below is the loss reserve roll-forward, net of subrogation recoverable and reinsurance for the three months ended March 31, 2012 and the year ended December 31, 2011:


	Three months Ended March 31, 2012			Year Ended December 31, 2011
Beginning balance of net loss reserves, net of subrogation recoverable and reinsurance		6,230,780			4,424,450
Changes in the loss reserves due to:
Current year:
Establishment of new loss reserves, gross of subrogation and net of reinsurance		29,610			503,697
Claim payments, net of subrogation and reinsurance		(2,968	)		(2,442	)
Establishment of subrogation recoveries, net of reinsurance		(1,786	)		(9,761	)

Total current year		24,856			491,494
Prior year:
Change in previously established loss reserves, gross of subrogation and net of reinsurance		(7,920	)		1,683,831
Change in previously established subrogation recoveries, net of reinsurance		(9,606	)		(324,151	)
Claim recoveries (payments), net of subrogation recoverable and reinsurance		10,422			(179,440	)

Total prior year		(7,104	)		1,180,240
Changes in loss reserves		17,752			1,671,734
Net deconsolidation of certain VIEs		—			134,596

Ending loss reserves, net of subrogation recoverable and reinsurance	$	6,248,532		$	6,230,780

The positive development in loss reserves established in prior years for the three months ended March 31, 2012 was driven by lower estimated losses in the first-lien RMBS and student loan portfolios, offset by lower expected subrogation recoveries and an increase in loss adjustment reserves for RMBS credits.

The adverse development in loss reserves established in prior years for the year ended December 31, 2011 was primarily due to the continued deterioration of collateral supporting structured finance policies, including RMBS and student loan exposures which resulted 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 $17,752 and $1,671,734 for the period and year ended March 31, 2012 and December 31, 2011, respectively, are included in loss and loss expenses in the Consolidated Statements of Total Comprehensive Income. Loss expense reserves are also established for significant surveillance and mitigation expenses associated with adversely classified credits. Total net loss expense reserves were $145,766 and $86,171 at March 31, 2012 and December 31, 2012, respectively. Total loss expense of $(2,320) and $919,647 for the three month periods ended March 31, 2012 and 2011, respectively, are included in loss and loss expenses in the Consolidated Statements of Total Comprehensive Income. During the three month periods ended March 31, 2012 and 2011, respectively, reinsurance recoveries of losses included in loss and loss expenses in the Consolidated Statements of Total Comprehensive Income were $12,518 and $7,691, respectively.

The tables below summarize information related to policies currently included in Ambac's loss reserves at March 31, 2012 and December 31, 2011:

Surveillance Categories (at March 31, 2012)


	I/SL			IA			II			III			IV			V			Total
Number of policies		25			7			38			125			139			1			335
Remaining weighted-average contract period (in years)		18			10			17			19			9			10			13
Gross insured contractual payments outstanding:
Principal		1,938,086			173,018			1,981,014			11,557,578			12,974,787			47			28,624,530
Interest		1,023,136			62,902			1,029,788			6,696,703			4,070,566			22			12,883,117

Total		2,961,222			235,920			3,010,802			18,254,281			17,045,353			69			41,507,647

Gross undiscounted claim liability		46,138			6,115			52,455			4,740,571			7,768,911			69			12,614,258
Discount, gross claim liability		(4,752	)		(1,044	)		(4,632	)		(1,613,139	)		(812,496	)		(16	)		(2,436,078	)

Gross claim liability before all subrogation and before reinsurance		41,386			5,071			47,823			3,127,432			6,956,415			53			10,178,180

Less:
Gross RMBS subrogation⁽¹⁾		—			—			—			(380,945	)		(2,337,818	)		—			(2,718,763	)
Discount, RMBS subrogation		—			—			—			7,998			55,353			—			63,351

Discounted RMBS subrogation, before reinsurance		—			—			—			(372,947	)		(2,282,465	)		—			(2,655,412	)

Less:
Gross other subrogation⁽²⁾		—			(222	)		(421	)		(105,730	)		(691,019	)		—			(797,392	)
Discount, other subrogation		—			80			119			11,061			37,278			—			48,538

Discounted other subrogation, before reinsurance		—			(142	)		(302	)		(94,669	)		(653,741	)		—			(748,854	)

Gross claim liability, net of all subrogation and discounts, before reinsurance		41,386			4,929			47,521			2,659,816			4,020,209			53			6,773,914

Less: Unearned premium reserves		(24,012	)		(2,914	)		(21,449	)		(302,892	)		(165,202	)		—			(516,469	)
Plus: Loss adjustment expenses reserves		—			—			—			—			147,497			—			147,497

Claim liability reported on Balance Sheet, before reinsurance⁽³⁾		17,374			2,015			26,072			2,356,924			4,002,504			53			6,404,942

Reinsurance recoverable reported on Balance Sheet		2,037			—			5,620			141,399			21,743			—			170,799

(1)	RMBS subrogation represents Ambac's estimate of subrogation recoveries from RMBS transaction sponsors for representations and warranty breaches.

(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 $1,966,891)	$	6,924,346
Subrogation recoverable (includes gross potential remediation of $688,521)		(519,404	)

	$	6,404,942

Loss reserves ceded to reinsurers at March 31, 2012 and December 31, 2011 were $156,410 and $153,480, respectively. Amounts were included in reinsurance recoverable on the Consolidated Balance Sheet.

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.

(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

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 $2,655,412 ($2,627,233 net of reinsurance) at March 31, 2012 from $2,720,266 ($2,692,414 net of reinsurance) at December 31, 2011. The balance of subrogation recoveries and the related claim liabilities, by estimation approach, at March 31, 2012 and December 31, 2011, are as follows:


	March 31, 2012
Approach	Count			Gross claim liability before subrogation recoveries		Subrogation recoveries⁽¹⁾			Gross claim liability after subrogation recoveries
Adverse samples		29	⁽²⁾	$	2,699,417	$	(1,493,416	)	$	1,206,001
Random samples		16	⁽²⁾		1,184,921		(1,161,996	)		22,925

Totals		45		$	3,884,338	$	(2,655,412	)	$	1,228,926


	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

(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 $2,655,412 of subrogation recoveries recorded at March 31, 2012, $688,521 was included in "Subrogation recoverable" and $1,966,891 was included in "Loss and loss expense reserves." 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."

(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 period December 31, 2011 through March 31, 2012:


	Random sample			Number of transactions		Adverse sample		Number of transactions			Total
Rollforward:
Discounted RMBS subrogation (gross of reinsurance) at December 31, 2011	$	1,262,794			16	$	1,457,472		30			2,720,266

Changes recognized in 2012:
Additional transactions reviewed		—			n/a		—		n/a			n/a
Additional adverse sample loans reviewed		—			n/a		—		n/a			n/a
Adverse loans repurchased by the sponsor		—			n/a		—		n/a			n/a
All other changes⁽¹⁾		(100,798	)		n/a		35,944		(1	)		(64,854	)

Discounted RMBS subrogation (gross of reinsurance) at March 31, 2012	$	1,161,996			16	$	1,493,416		29			2,655,412

(1)

Other changes which may impact subrogation recoveries include changes in actual or projected collateral performance and/or the projected timing of recoveries. For the three months ended March 31, 2012, one transaction was removed from the Adverse Sample subrogation population; however, the impacts on RMBS subrogation disclosed in the Adverse Sample column relate to multiple transactions.