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Loss And Loss Adjustment Expense Reserves | 3 Months Ended
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Mar. 31, 2012
Loss And Loss Adjustment Expense Reserves [Abstract] |
Loss And Loss Adjustment Expense Reserves | Note 5: Loss and Loss Adjustment Expense Reserves Loss and Loss Adjustment Expense Process As of March 31, 2012, the majority of the Company's case basis reserves and insurance loss recoveries recorded in accordance with GAAP were related to insured first-lien and second-lien RMBS transactions. These reserves and recoveries do not include estimates for policies insuring credit derivatives. Policies insuring credit derivative contracts are accounted for as derivatives and carried at fair value under GAAP. The fair values of insured derivative contracts are influenced by a variety of market and transaction-specific factors that may be unrelated to potential future claim payments under the Company's insurance policies. In the absence of credit impairments on insured derivative contracts or the early termination of such contracts at a loss, the cumulative unrealized losses recorded from fair valuing these contracts should reverse before or at the maturity of the contracts. Notwithstanding the difference in accounting under GAAP for financial guarantee policies and the Company's insured derivatives, insured derivatives have similar terms, conditions, risks, and economic profiles to financial guarantee insurance policies, and, therefore, are evaluated by the Company for loss (referred to as credit impairment herein) and LAE periodically in the same way that loss and LAE reserves are estimated for financial guarantee insurance policies. Credit impairments represent actual payments and collections plus the present value of estimated expected future claim payments, net of recoveries. MBIA Insurance Corporation's expected future claim payments were discounted using a rate of 5.59%, the same rate it used to calculate its statutory loss reserves as of March 31, 2012. These credit impairments, calculated in accordance with U.S. STAT, differ from the fair values recorded in the Company's consolidated financial statements. The Company regards its credit impairment estimates as critical information for investors as it provides information about loss payments the Company expects to make on insured derivative contracts. As a result, the following loss and LAE process discussion includes information about loss and LAE activity recorded in accordance with GAAP for financial guarantee insurance policies and credit impairments estimated in accordance with U.S. STAT for insured derivative contracts. Refer to "Note 6: Loss and Loss Adjustment Expense Reserves" in the Notes to Consolidated Financial Statements included in the Company's Annual Report on Form 10-K for the year ended December 31, 2011 for information about the Company's monitoring of outstanding insured obligations and for additional information about its loss reserving process. Refer to "Note 6: Fair Value of Financial Instruments" included herein for additional information about the Company's insured credit derivative contracts. RMBS Case Basis Reserves and Recoveries The Company's RMBS reserves and recoveries relate to financial guarantee insurance policies. The Company calculated RMBS case basis reserves as of March 31, 2012 for both first-lien and second-lien RMBS transactions using a process called the "Roll Rate Methodology." The Roll Rate Methodology is a multi-step process using a database of loan level information, a proprietary internal cash flow model, and a commercially available model to estimate expected ultimate cumulative losses on insured bonds. "Roll Rate" is defined as the probability that current loans become delinquent and that loans in the delinquent pipeline are charged-off or liquidated. Generally, Roll Rates are calculated for the previous three months and averaged. The loss reserve estimates are based on a probability-weighted average of three scenarios of loan losses (base case, stress case, and an additional stress case). In calculating ultimate cumulative losses for RMBS, the Company estimates the amount of loans that are expected to be charged-off (deemed uncollectible by servicers of the transactions) or liquidated in the future. The Company assumes that such charged-off loans have zero recovery values. First-lien RMBS Reserves The Company's first-lien RMBS case basis reserves as of March 31, 2012, which primarily relate to RMBS backed by alternative A-paper and subprime mortgage loans were determined using the Roll Rate Methodology. The Company assumes that the Roll Rate for loans in foreclosure, Real Estate Owned ("REO") and bankruptcy are 90%, 90% and 75%, respectively. Roll Rates for current, 30-59 day delinquent loans, 60-89 day delinquent loans and 90+ day delinquent loans are calculated on a transaction-specific basis. Roll Rates for loans that are current as of February 29, 2012 ("Current Roll to Loss") stay at the February 29, 2012 level for two months before declining to 25% of this level over a 24-month period. Additionally, the Company runs scenarios where the 90+ day roll rate to loss is set at 90%. The Roll Rates are applied to the amounts in the respective delinquency buckets based on delinquencies as of February 29, 2012 to estimate future losses from loans that are delinquent as of the current reporting period. In calculating ultimate cumulative losses for first-lien RMBS, the Company estimates the amount of loans that are expected to be liquidated through foreclosure or short sale. The time to liquidation for a defaulted loan is specific to the loan's delinquency bucket with the latest three-month average loss severities generally used to calculate losses at loan liquidation. The loss severities are reduced over time to account for reduction in the amount of foreclosure inventory, future increases in home prices, and principal amortization of the loan. Second-lien RMBS Reserves The Company's second-lien RMBS case basis reserves as of March 31, 2012 relate to RMBS backed by home equity lines of credit ("HELOCs") and closed-end second mortgages ("CES"). The Roll Rates for 30-59 day delinquent loans and 60-89 day delinquent loans are calculated on a transaction-specific basis. The Company assumes that the Roll Rate for 90+ day delinquent loans, excluding foreclosures, REO and bankruptcies, is 95%. The Roll Rates are applied to the amounts in the respective delinquency buckets based on delinquencies as of February 29, 2012 to estimate future losses from loans that are delinquent as of the current reporting period. Current Roll to Loss is calculated on a transaction-specific basis. A proportion of loans reported current as of February 29, 2012 is assumed to become delinquent every month, at a Current Roll to Loss rate that persists at a high level for a time and subsequently starts to decline. A key assumption in the model is the period of time in which the Company projects high levels of Current Roll to Loss to persist. In the Company's base case, the Company assumes that the Current Roll to Loss begins to decline immediately and continues to decline over the next six months to 25% of their levels as of February 29, 2012. In the stress case, the period of elevated delinquency and loss is extended by six months. In the additional stress case, the Company assumes that the current trends in losses will remain through mid-2013, after which time they will revert to the base case. For example, in the base case, as of February 29, 2012, if the amount of current loans which become 30-59 days delinquent is 10%, and recent performance suggests that 30% of those loans will be charged-off, the Current Roll to Loss for the transaction is 3%. In the base case, it is then assumed that the Current Roll to Loss will reduce linearly to 25% of its original value over the next six months (i.e., 3% will linearly reduce to 0.75% over the six months from March 2012 to August 2012). After that six-month period, the Company further reduces the Current Roll to Loss to 0% by early 2014 with the expectation that the performing seasoned loans will eventually result in loan performance reverting to historically low levels of default. In the model, the Company assumes that all current loans that become delinquent are charged-off. In addition, in the Company's loss reserve models for transactions secured by HELOCs, the Company considers borrower draw and prepayment rates and factors that could affect the excess spread generated by current loans which offsets losses and reduces payments. For HELOCs, the current three-month average draw rate is generally used to project future draws on the line. For HELOCs and transactions secured by fixed-rate CES, the three-month average conditional prepayment rate is generally used to start the projection for trends in voluntary principal prepayments. Projected cash flows are also based on an assumed constant basis spread between floating rate assets and floating rate insured debt obligations (the difference between Prime and London Interbank Offered Rate ("LIBOR") interest rates, minus any applicable fees). For all transactions, cash flow models consider allocations and other structural aspects of the transactions, including managed amortization periods, rapid amortization periods and claims against MBIA Corp.'s insurance policy consistent with such policy's terms and conditions. In developing multiple loss scenarios, stress is applied by elongating the Current Roll to Loss rate for various periods, simulating a slower improvement in the transaction performance. The estimated net claims from the procedure above are then discounted using a risk-free rate to a net present value reflecting MBIA's general obligation to pay claims over time and not on an accelerated basis. The above assumptions represent MBIA's best estimates of how transactions will perform over time. The Company monitors portfolio performance on a monthly basis against projected performance, reviewing delinquencies, Roll Rates, and prepayment rates (including voluntary and involuntary). However, given the large percentage of mortgage loans that were not underwritten by the sellers/servicers in accordance with applicable underwriting guidelines, performance remains difficult to predict and losses may exceed expectations. In the event of a material deviation in actual performance from projected performance, the Company would increase or decrease the case basis reserves accordingly. If actual performance were to remain at the peak levels the Company is modeling for six months longer than in the probability-weighted outcome, the addition to the case basis reserves before considering potential recoveries would be approximately $160 million. Second-lien RMBS Recoveries As of March 31, 2012, the Company recorded estimated recoveries of $3.2 billion, gross of income taxes, related to second-lien RMBS put-back claims on ineligible loans, consisting of $2.1 billion included in "Insurance loss recoverable" and $1.1 billion included in "Loan repurchase commitments" presented under the heading "Assets of consolidated variable interest entities" on the Company's consolidated balance sheets. As of March 31, 2012 and December 31, 2011, the Company's estimated recoveries after income taxes calculated at the federal statutory rate of 35%, were $2.1 billion and $2.0 billion, respectively, which was 111% and 119% of the consolidated total shareholders' equity of MBIA, excluding preferred stock of subsidiaries and noncontrolling interests. These estimated recoveries relate to the Company's put-back claims of ineligible loans, which have been disputed by the loan sellers/servicers and are currently subject to litigation initiated by the Company to pursue recovery. While the Company believes that it will prevail in enforcing its contractual rights, there is uncertainty with respect to the ultimate outcome. Furthermore, there is a risk that sellers/servicers or other responsible parties might not be able to satisfy their put-back obligations. Such risks are contemplated in the scenarios the Company utilizes to calculate recoveries. Beginning in 2008, the Company utilized loan level forensic review consultants to re-underwrite/review mortgage loan files underlying certain first-lien and second-lien RMBS transactions insured by MBIA. The consultants graded the individual mortgages that were sampled into an industry standard three level grading scale, defined as (i) Level 1—loans complied with specific underwriting guidelines, (ii) Level 2—loans contained some deviation from underwriting guidelines but also contained sufficient compensating factors and (iii) Level 3—loans contained material deviation from the underwriting guidelines without any compensating factors. MBIA's forensic review consultants utilized the same underwriting guidelines that the originators were to have used to qualify borrowers when originally underwriting the loans and determined that more than 80% of the loans reviewed were considered to be ineligible mortgage loans. The Company has developed estimates of breach rates primarily based upon loans with credit breaches or credit and compliance breaches because the Company believes that loans with these types of breaches are not judgmental and cannot be cured. Breach rates were determined by dividing the number of loans that contained credit and/or credit and compliance breaches by the total number of loans reviewed for a particular transaction. Legal decisions have led the Company to conclude that the practice of reviewing individual loans for the purpose of assessing put-back recoveries is no longer necessary. The Company determined in the context of the favorable decision on its motion in limine addressing the use of sampling to establish breach-of-contract claims in the Countrywide litigation (MBIA Insurance Corp. v. Countrywide Home Loans, Inc., et al, Index No. 602825/08 (N.Y. Sup. Ct.)) that a sufficient number of loans in each securitization have already been reviewed to demonstrate widespread breaches of the contractual provisions of the agreements with the sponsors. Furthermore, MBIA has received subsequent opinions which have confirmed that the Company is not limited to a loan-by-loan put-back remedy and can seek a pool-wide remedy based on sampling and extrapolation, as well as decisions in MBIA's favor related to causation and rescissory damages. The above-referenced developments have led the Company to utilize probability-weighted scenarios primarily based on the percentage of incurred losses the Company would collect as opposed to recoveries based primarily on loan file reviews. The Company's recovery estimates incorporate five scenarios that include full recovery of its incurred losses and limited/reduced recoveries due to litigation delays and risks and/or potential financial distress of the sellers/servicers. Probabilities were assigned across these scenarios, with most of the probability weight on partial recovery scenarios. However, based on the Company's assessment of the strength of its contract claims, the Company believes it is entitled to collect the full amount of its incurred losses on these transactions, which totaled $4.8 billion through March 31, 2012. The Company has not recognized potential recoveries related to sellers/servicers that MBIA has determined did not have sufficient capital and resources to honor their obligations. The Company's expected recoveries may be discounted in the future based on a review of the creditworthiness of the sellers/servicers. In particular, the Company believes it is now more likely that GMAC Mortgage, LLC and Residential Funding Company, LLC will file for bankruptcy in light of their reported financial condition and public comments made by Ally Financial Inc. In the event of a bankruptcy filing by GMAC Mortgage, LLC and Residential Funding Company, LLC, the Company will re-assess the value of its expected recoveries against GMAC Mortgage, LLC and Residential Funding Company, LLC and may have to substantially reduce the value of such recoveries depending on the Company's assessment of its likely recovery in the bankruptcy proceeding based on the information available in connection with the bankruptcy. At this time the Company cannot reasonably estimate the amount of the change, if any, in the value of the recoveries, which will depend on whether there is a bankruptcy filing and on other facts and circumstances that are unknown at this time. The Company assesses the financial abilities of the sellers/servicers using external credit ratings and other factors. The impact of such factors on cash flows related to expected recoveries is incorporated into the Company's probability-weighted scenarios. The indicative scenarios and related probabilities assigned to each scenario based on the Company's judgment about their relative likelihoods of being realized are used to develop a distribution of possible outcomes. The sum of the probabilities assigned to all scenarios is 100%. Expected cash inflows from recoveries are discounted using the current risk-free rate associated with the underlying transaction, which ranged from 1.0% to 2.2%, depending upon the transaction's expected average life. The Company's potential recoveries are typically based on either salvage rights, the rights conferred to MBIA through the transactional documents (inclusive of the insurance agreement), or subrogation rights embedded within financial guarantee insurance policies. The second-lien RMBS transactions with respect to which MBIA has estimated put-back recoveries provide the Company with such rights. Expected salvage and subrogation recoveries, as well as recoveries from other remediation efforts, reduce the Company's claim liability. Once a claim payment has been made, the claim liability has been satisfied and MBIA's right to recovery is no longer considered an offset to future expected claim payments, but is recorded as a salvage asset. The amount of recoveries recorded by the Company is limited to paid claims plus the present value of projected future claim payments. As claim payments are made, the recorded amount of potential recoveries may exceed the remaining amount of the claim liability for a given policy. To date, sellers/servicers have not substituted loans which MBIA has put-back, and the amount of loans repurchased has been insignificant. The unsatisfactory resolution of these put-backs led MBIA to initiate litigation against five of the sellers/servicers to enforce their obligations. The Company has alleged several causes of action in its complaints, including breach of contract, fraudulent inducement and indemnification. MBIA's aggregate $3.2 billion of estimated potential recoveries do not include damages from causes of action other than breach of contract. Irrespective of amounts recorded in its financial statements, MBIA is seeking to recover the full amount of its incurred losses and other damages on these transactions. MBIA has not collected any material amounts of cash related to these recoveries. Additional information on the status of these litigations can be found in the "Recovery Litigation" discussion within "Note 13: Commitments and Contingencies." MBIA has received five decisions with regard to the respective defendants' motions to dismiss the Company's claims. In each instance, the respective court denied the motion, allowing MBIA to proceed on, at minimum, its fraud and breach-of-contract claims. In December 2011, MBIA reached an agreement with one of the five sellers/servicers with whom it had initiated litigation and that litigation has been dismissed. The Company's assessment of the recovery outlook for insured second-lien RMBS issues is principally based on the following factors:
| 1. | the strength of the Company's existing contract claims related to ineligible loan substitution/repurchase obligations;
| 2. | the settlement for $1.1 billion of Assured Guaranty's put-back related claims with Bank of America in April 2011;
| 3. | the improvement in the financial strength of the sellers/servicers due to mergers and acquisitions and/or government assistance, which should facilitate their ability to comply with required loan repurchase/substitution obligations. The Company is not aware of any provisions that explicitly preclude or limit the successors' obligations to honor the obligations of the original sponsor. The Company's assessment of any credit risk associated with these sponsors (or their successors) is reflected in the Company's probability-weighted potential recovery scenarios;
| 4. | evidence of loan repurchase/substitution compliance by sellers/servicers for put-back requests made by other harmed parties with respect to ineligible loans; this factor is further enhanced by (i) Bank of America's disclosure that it has resolved $8.0 billion of repurchase requests in the fourth quarter of 2010; (ii) the Fannie Mae settlements with Ally Bank announced on December 23, 2010 and with Bank of America (which also involved Freddie Mac) announced on December 31, 2010, and (iii) the Company's settlement agreements entered into on July 16, 2010 and December 13, 2011 respectively, between MBIA Corp. and sponsors of certain MBIA Corp.-insured mortgage loan securitizations in which the Company received consideration in exchange for a release relating to its representation and warranty claims against the sponsor. These settlements resolved all of MBIA's representation and warranty claims against the sponsors on mutually beneficial terms and in aggregate were slightly more than the recoveries previously recorded by the Company related to these exposures;
| 5. | the favorable outcome for MBIA on defendants' motions to dismiss in the litigations discussed above, where the respective courts allowed MBIA's contract and fraud claims against the defendants to proceed;
| 6. | the favorable outcome in the Countrywide litigation on MBIA's motion to present evidence of liability and damages through the introduction of statistically valid random samples of loans rather than on a loan-by-loan basis;
| 7. | the favorable outcome in the Countrywide litigation denying Bank of America's motion to dismiss MBIA's claims for successor liability as well as a decision from the New York Supreme Court Appellate Division, First Department, which lifted the stay on discovery related to successor liability claims at Bank of America;
| 8. | the favorable outcome in the Countrywide litigation on MBIA's motion regarding causation and MBIA's right to rescissory damages;
| 9. | the unanimous ruling from the New York Supreme Court Appellate Division, First Department, in the Countrywide litigation allowing MBIA to pursue its fraud claims; and
| 10. | loan repurchase reserves and/or settlements which have been publicly disclosed by certain sellers/servicers to cover such obligations.
The Company continues to consider all relevant facts and circumstances, including the factors described above, in developing its assumptions on expected cash inflows, probability of potential recoveries (including the outcome of litigation) and recovery period. The estimated amount and likelihood of potential recoveries are expected to be revised and supplemented to the extent there are developments in the pending litigation, new litigation is initiated and/or changes to the financial condition of sellers/servicers occur. While the Company believes it will be successful in realizing recoveries from contractual and other claims, the ultimate amounts recovered may be materially different from those recorded by the Company given the inherent uncertainty of the manner of resolving the claims (e.g., litigation) and the assumptions used in the required estimation process for accounting purposes which are based, in part, on judgments and other information that are not easily corroborated by historical data or other relevant benchmarks. All of the Company's policies insuring second-lien RMBS for which litigation has been initiated against sellers/servicers are in the form of financial guarantee insurance contracts. The Company has not recorded a gain contingency with respect to pending litigation. ABS CDOs (Financial Guarantees and Insured Derivatives) MBIA's insured ABS CDOs are transactions that include a variety of collateral ranging from corporate bonds to structured finance assets (which includes but are not limited to RMBS related collateral, CDOs of ABS, corporate CDOs and collateralized loan obligations). These transactions were insured as either financial guarantee insurance policies or credit derivatives with the majority insured in the form of credit derivatives. Since the fourth quarter of 2007, MBIA's insured par exposure within the ABS CDO portfolio has been substantially reduced through a combination of terminations and commutations. Accordingly, as of March 31, 2012, the insured par exposure of the ABS CDO financial guarantee insurance policies and credit derivatives portfolio has declined by approximately 84% of the insured amount as of December 31, 2007. The Company's ABS CDOs originally benefited from two sources of credit enhancement. First, the subordination in the underlying securities collateralizing the transaction must be fully eroded and second, the subordination below the insured tranche in the CDO transaction must be fully eroded before the insured tranche is subject to a claim. The Company's payment obligations after a default vary by transaction and by insurance type. The primary factor in estimating reserves on insured ABS CDO policies written as financial guarantees and in estimating impairments on insured ABS CDO credit derivatives is the losses associated with the underlying collateral in the transactions. MBIA's approach to establishing reserves or impairments in this portfolio employs a methodology which is similar to other structured finance asset classes insured by MBIA. The Company uses a total of five probability-weighted scenarios in order to estimate its reserves or impairments for ABS CDOs. As of March 31, 2012, the Company had loss and LAE reserves totaling $168 million related to ABS CDO financial guarantee insurance policies. For the three months ended March 31, 2012, the Company had a benefit of $2 million of losses and LAE recorded in earnings related to ABS CDO financial guarantee insurance policies after the elimination of a $16 million benefit as a result of consolidating VIEs. In addition, as of March 31, 2012, the Company estimated insured ABS CDO credit derivative impairments and LAE reserves, net of reinsurance and recoveries, totaling $432 million. For the three months ended March 31, 2012, the change in estimated impairments and LAE related to insured ABS CDO credit derivatives were a benefit of $12 million, which was primarily due to agreed upon commutations of credit derivative exposures at less than previously estimated impairments. In the event of further deteriorating performance of the collateral referenced or held in ABS CDO transactions, the amount of losses estimated by the Company could increase materially. Credit Impairments Related to Structured CMBS Pools, CRE CDOs and CRE Loan Pools (Accounted for as Derivatives) Most of the structured CMBS pools, CRE CDOs and CRE loan pools insured by MBIA are accounted for as insured credit derivatives and are carried at fair value in the Company's consolidated financial statements. The following discussion provides information about the Company's process for estimating credit impairments on these contracts using its statutory loss reserve methodology, determined as the present value of the probability-weighted potential future losses, net of estimated recoveries, across multiple scenarios, plus actual payments and collections. For the three months ended March 31, 2012, additional credit impairments and LAE on structured CMBS pools, CRE CDOs and CRE loan pools were estimated to be $295 million as a result of additional delinquencies and loan level liquidations, as well as continued refinements of MBIA's assessment of various commutation possibilities. The cumulative credit impairments and LAE on structured CMBS pools, CRE CDOs and CRE loan pools were estimated to be $3.1 billion through March 31, 2012. Although the pace of increases in the delinquency rate has slowed and many loans are being modified, liquidations have taken place. Some loans were liquidated with minimal losses of 1% to 2%, others experienced near complete losses, and in some cases severities exceeded 100%. These liquidations have led to losses in the CMBS market, and in many cases, have resulted in reductions of enhancement to the individual CMBS bonds referenced by the insured structured CMBS pools. In certain insured transactions, these losses have resulted in deductible erosion. Bond level enhancement and pool level deductibles are structural features intended to mitigate losses to the Company. However, some of the transactions reference similar rated subordinate tranches of CMBS bonds. When there are broad-based declines in property performance, this leverage can result in rapid deterioration in pool performance. In the CRE CDO portfolio, transaction specific structures require managers to report reduced enhancement according to certain guidelines which often include downgrades even when the bond is still performing. As a result, as well as additional collateral defaults, reported enhancement has been reduced significantly in some CRE CDOs. Moreover, many of the CRE CDO positions are amortizing more quickly than originally expected as most or all interest that would have been allocated to more junior classes within the CDO have been diverted and redirected to pay down the senior most classes insured by MBIA. The Company has developed multiple scenarios to consider the range of potential outcomes in the CRE market and their impact on MBIA. The approaches require substantial judgments about the future performance of the underlying loans, and include the following:
| • |  | The first approach considers the range of commutation agreements achieved and agreed to since 2010, which included 65 structured CMBS pools, CRE CDOs and CRE loan pool policies totaling $32.9 billion of gross insured exposure. The Company considers the range of commutations achieved over the past several years with multiple counterparties. This approach results in an estimated price to commute the remaining policies with price estimates, based on this experience. It is customized by counterparty and is dependent on the level of dialogue with the counterparty and the credit quality and payment profile of the underlying exposure.
| • |  | The second approach considers current delinquency rates and uses current and projected net operating income ("NOI") and capitalization rates ("Cap Rates") to project losses under two scenarios. Loans are stratified by size with larger loans being valued utilizing lower Cap Rates than for smaller loans. These scenarios also assume that Cap Rates and NOIs remain flat for the near term and then begin to improve gradually. Additionally, in these scenarios, any loan with a balance greater than $75 million with a debt service coverage ratio ("DSCR") less than 1.0x or that was reported as being in any stage of delinquency, was reviewed individually so that performance and loss severity could be more accurately determined. Specific loan level assumptions for this large loan subset were then incorporated into these scenarios, as well as specific assumptions regarding certain smaller loans when there appeared to be a material change in the asset's financial or delinquency performance over the preceding six months. These scenarios project different levels of additional defaults with respect to loans that are current. This approach relies heavily on year-end financial statements at the property level. In modeling these scenarios, the Company has received financial statements for year-end 2011 for 31% of the properties in the pools and statements from year-end 2010 on another 53% of the properties in the pool.
| • |  | The third approach stratifies loans into debt service coverage buckets and projects defaults by using probabilities implied by a third-party default study for each bucket and relies on year-end financial statements at the property level. The implied defaults are converted into losses using a loss severity assumption. As the Company continues to see more current market performance statistics regarding modifications and liquidations in this cycle, the Company will continue to de-emphasize this more actuarial-based approach and focus more on those scenarios which best reflect current market observations.
| • |  | The fourth approach stratifies loans into buckets based on delinquency status (including a "current" bucket) and utilizes recent Roll Rates actually experienced within each of the commercial mortgage-backed index ("CMBX") series in order to formulate an assumption to predict future delinquencies. Ultimately, this generates losses over a projected time horizon based on the assumption that loss severities will begin to decline from the high levels seen in 2010 and 2011. The Company further examines those loans referenced in the CMBX indices which were categorized as 90+ days delinquent or in the process of foreclosure and determined the monthly ratio of such loans which were cured versus those which were liquidated or still delinquent over the past 37 months. The Company then applies the most recent rolling six-month average of this cure ratio to all loans in the 90+ day delinquent bucket or in the foreclosure process (and those projected to roll into late stage delinquency from the current and lesser stage levels of delinquency) and assumes all other loans are liquidated. The Company assumes all loans in the REO category liquidate over the next twelve months.
| • |  | The fifth approach is based on a proprietary model developed by reviewing performance data on over 80,000 securitized CRE loans originated between 1992 and 2011. The time period covered during the performance review includes the years 2006 through 2011. The Company believes that these five years represent an appropriate time period in which to conduct a performance review because they encompass a period of extreme stress in the economy and the CRE market.
Based on a review of the data, the Company found property type and DSCR to be the most significant determinants of a loan's default probability. Other credit characteristics were less influential. As a result, the Company developed a model in which the loans were divided into 168 representative cohorts based on their DSCR and property type. For each of these cohorts, the Company calculated the average annual probability of default, and then ran Monte Carlo simulations to estimate the timing of defaults. In addition, the model incorporated the following logic:
| • |  | NOI and Cap Rates were assumed to remain at current levels for loans in the Company's classified portfolio, resulting in no modifications or extensions under the model other than as described in the next bullet point, to reflect the possibility that the U.S. economy and CRE market could experience no growth for the foreseeable future.
| • |  |
Any valuation estimates obtained by special servicers since a loan's origination as well as the Company's individual loan level analysis (which may incorporate additional assumptions regarding modifications and/or extensions in a few select cases) were incorporated as described in the second approach.
The loss severities projected by these scenarios vary widely, from moderate to substantial losses. Actual losses will be a function of the proportion of loans in the pools that are foreclosed and liquidated and the loss severities associated with those liquidations. If the deductibles in the Company's insured transactions and underlying referenced CMBS transactions are fully eroded, additional property level losses upon foreclosures and liquidations could result in substantial losses for MBIA. Since foreclosures and liquidations have only begun to take place during this economic cycle, particularly for larger properties, ultimate loss rates remain uncertain. Whether CMBS collateral is included in a structured pool or in a CRE CDO, the Company believes the modeling related to the underlying bond should be the same. The Company assigns a wide range of probabilities to these scenarios, with lower severity scenarios being weighted more heavily than higher severity scenarios. This reflects the view that liquidations will continue to be mitigated by loan extensions and modifications, and that property values and NOIs have bottomed for many sectors and markets in the U.S. The weightings are customized to each counterparty. If macroeconomic stress were to increase or the U.S. goes into a recession, higher delinquencies, liquidations and/or higher severities of loss upon liquidation may result and the Company may incur substantial additional losses. Relatively little liquidation has taken place to date, so the range of possible outcomes is wider than those for the Company's exposures to ABS CDOs and second-lien RMBS. Loss and LAE Activity Financial Guarantee Insurance Losses (Non-Derivative) The Company's financial guarantee insurance losses and LAE for the three months ended March 31, 2012 are presented in the following table:
Losses and LAE |
|  | Three Months Ended March 31, 2012 |
In millions |  | Second-lien RMBS |  |  | Other |  |  | Total |
Losses and LAE related to actual and expected payments |  | $ | 129 |  |  | $ | 18 |  |  | $ | 147 |
Recoveries of actual and expected payments |  |  | (48) |  |  |  | (2) |  |  |  | (50) |
Gross losses incurred |  |  | 81 |  |  |  | 16 |  |  |  | 97 |
Reinsurance |  |  | 0 |  |  |  | 0 |  |  |  | 0 |
Losses and LAE |  | $ | 81 |  |  | $ | 16 |  |  | $ | 97 |
The second-lien RMBS losses and LAE related to actual and expected payments included in the preceding table comprise net increases of previously established reserves. The second-lien RMBS recoveries of actual and expected payments comprise $49 million in recoveries resulting from ineligible mortgage loans included in insured exposures that are subject to contractual obligations by sellers/servicers to repurchase or replace such mortgages, offset by a $1 million reduction in excess spread. Current period changes in the Company's estimate of potential recoveries may impact the amount recorded as an insurance loss recoverable asset, the amount of expected recoveries on unpaid losses netted against the gross loss and LAE reserve liability, or both. Total paid losses and LAE, net of reinsurance and collections, for the three months ended March 31, 2012 was $156 million, including $128 million related to insured second-lien RMBS transactions. For the three months ended March 31, 2012, the increase in insurance loss recoverable related to paid losses totaled $91 million, and primarily related to insured second-lien RMBS transactions. The following table provides information about the financial guarantees and related claim liability included in each of MBIA's surveillance categories as of March 31, 2012:
|  | Surveillance Categories |
$ in millions |  | Caution List Low |  |  | Caution List Medium |  |  | Caution List High |  |  | Classified List |  |  | Total |
Number of policies |  |  | 54 |  |  |  | 33 |  |  |  | 13 |  |  |  | 204 |  |  |  | 304 |
Number of issues(1) |  |  | 31 |  |  |  | 20 |  |  |  | 12 |  |  |  | 132 |  |  |  | 195 |
Remaining weighted average contract period (in years) |  |  | 8.6 |  |  |  | 4.4 |  |  |  | 6.6 |  |  |  | 9.5 |  |  |  | 8.6 |
Gross insured contractual payments outstanding(2): |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Principal |  | $ | 3,929 |  |  | $ | 2,005 |  |  | $ | 524 |  |  | $ | 10,281 |  |  | $ | 16,739 |
Interest |  |  | 2,752 |  |  |  | 452 |  |  |  | 148 |  |  |  | 5,762 |  |  |  | 9,114 |
Total |  | $ | 6,681 |  |  | $ | 2,457 |  |  | $ | 672 |  |  | $ | 16,043 |  |  | $ | 25,853 |
Gross claim liability |  | $ | - |  |  | $ | - |  |  | $ | - |  |  | $ | 1,782 |  |  | $ | 1,782 |
Less: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Gross potential recoveries |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 3,882 |  |  |  | 3,882 |
Discount, net |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 184 |  |  |  | 184 |
Net claim liability (recoverable) |  | $ | - |  |  | $ | - |  |  | $ | - |  |  | $ | (2,284) |  |  | $ | (2,284) |
Unearned premium revenue |  | $ | 149 |  |  | $ | 21 |  |  | $ | 4 |  |  | $ | 129 |  |  | $ | 303 |
(1) - An "issue" represents the aggregate of financial guarantee policies that share the same revenue source for purposes of making debt service payments. (2) - Represents contractual principal and interest payments due by the issuer of the obligations insured by MBIA. |
The following table provides information about the financial guarantees and related claim liability included in each of MBIA's surveillance categories as of December 31, 2011:
|  | Surveillance Categories |
$ in millions |  | Caution List Low |  |  | Caution List Medium |  |  | Caution List High |  |  | Classified List |  |  | Total |
Number of policies |  |  | 54 |  |  |  | 28 |  |  |  | 14 |  |  |  | 200 |  |  |  | 296 |
Number of issues(1) |  |  | 32 |  |  |  | 18 |  |  |  | 11 |  |  |  | 130 |  |  |  | 191 |
Remaining weighted average contract period (in years) |  |  | 8.2 |  |  |  | 5.6 |  |  |  | 6.0 |  |  |  | 9.6 |  |  |  | 8.8 |
Gross insured contractual payments outstanding(2): |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Principal |  | $ | 4,310 |  |  | $ | 1,213 |  |  | $ | 561 |  |  | $ | 10,420 |  |  | $ | 16,504 |
Interest |  |  | 2,653 |  |  |  | 351 |  |  |  | 144 |  |  |  | 5,836 |  |  |  | 8,984 |
Total |  | $ | 6,963 |  |  | $ | 1,564 |  |  | $ | 705 |  |  | $ | 16,256 |  |  | $ | 25,488 |
Gross claim liability |  | $ | - |  |  | $ | - |  |  | $ | - |  |  | $ | 1,812 |  |  | $ | 1,812 |
Less: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Gross potential recoveries |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 3,813 |  |  |  | 3,813 |
Discount, net |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 177 |  |  |  | 177 |
Net claim liability (recoverable) |  | $ | - |  |  | $ | - |  |  | $ | - |  |  | $ | (2,178) |  |  | $ | (2,178) |
Unearned premium revenue |  | $ | 155 |  |  | $ | 16 |  |  | $ | 3 |  |  | $ | 134 |  |  | $ | 308 |
(1) - An "issue" represents the aggregate of financial guarantee policies that share the same revenue source for purposes of making debt service payments. (2) - Represents contractual principal and interest payments due by the issuer of the obligations insured by MBIA. |
The gross claim liability as of March 31, 2012 and December 31, 2011 in the preceding tables represents the Company's estimate of undiscounted probability-weighted future claim payments, which principally relate to insured first-lien and second-lien RMBS transactions and U.S. public finance transactions. The gross potential recoveries represent the Company's estimate of undiscounted probability-weighted recoveries of actual claim payments and recoveries of estimated future claim payments, and principally relate to insured second-lien RMBS transactions. Both amounts reflect the elimination of claim liabilities and potential recoveries related to VIEs consolidated by the Company. The following table presents the components of the Company's loss and LAE reserves and insurance loss recoverable as reported on the Company's consolidated balance sheets as of March 31, 2012 and December 31, 2011 for insured obligations within MBIA's "Classified List." The loss reserves (claim liability) and insurance claim loss recoverable included in the following table represent the present value of the probability-weighted future claim payments and recoveries reported in the preceding tables.
In millions |  | As of March 31, 2012 |  |  | As of December 31, 2011 |
Loss reserves (claim liability) |  | $ | 755 |  |  | $ | 781 |
LAE reserves |  |  | 112 |  |  |  | 55 |
Loss and LAE reserves |  | $ | 867 |  |  | $ | 836 |
Insurance claim loss recoverable |  | $ | (3,116) |  |  | $ | (3,032) |
LAE insurance loss recoverable |  |  | (21) |  |  |  | (14) |
Insurance loss recoverable |  | $ | (3,137) |  |  | $ | (3,046) |
Reinsurance recoverable on unpaid losses |  | $ | 14 |  |  | $ | 15 |
Reinsurance recoverable on LAE reserves |  |  | 0 |  |  |  | 0 |
Reinsurance recoverable on paid losses |  |  | 1 |  |  |  | 1 |
Reinsurance recoverable on paid and unpaid losses |  | $ | 15 |  |  | $ | 16 |
As of March 31, 2012, loss and LAE reserves include $1.4 billion of reserves for expected future payments offset by expected recoveries of such future payments of $518 million. As of December 31, 2011, loss and LAE reserves included $1.4 billion of reserves for expected future payments offset by expected recoveries of such future payments of $562 million. As of March 31, 2012 and December 31, 2011, the insurance loss recoverable primarily related to estimated recoveries of payments made by the Company resulting from ineligible mortgage loans in certain insured second-lien residential mortgage loan securitizations that are subject to a contractual obligation by the sellers/servicers to repurchase or replace the ineligible mortgage loans and expected future recoveries on second-lien RMBS transactions resulting from expected excess spread generated by performing loans in such transactions. The Company expects to be reimbursed for the majority of its potential recoveries related to ineligible mortgage loans by the second quarter of 2013. The following table presents the Company's second-lien RMBS exposure, gross undiscounted claim liability and potential recoveries, before the elimination of amounts related to consolidated VIEs, as of March 31, 2012. All loan files reviewed with potential recoveries are included within the "Classified List."
Second-lien RMBS Exposure |  |  |  |  | Outstanding |  |  | Gross Undiscounted |
$ in billions |  | Issues |  |  | Gross Principal |  |  | Gross Interest |  |  | Claim Liability |  |  | Potential Recoveries |
Insured issues designated as "Classified List" |  |  | 34 |  |  | $ | 7.2 |  |  | $ | 2.7 |  |  | $ | 0.6 |  |  | $ | 4.7 |
Loan files reviewed with potential recoveries |  |  | 26 |  |  | $ | 6.7 |  |  | $ | 2.6 |  |  | $ | 0.5 |  |  | $ | 4.6 |
The Company has performed loan file reviews on 29 of the 34 issues and recorded potential recoveries on 26 of those 29 issues, primarily related to four issuers (Countrywide, RFC, GMAC and Credit Suisse). The gross potential recoveries include estimated recoveries based on the Company's incurred loss to date. In addition, the Company has received consideration on two transactions, including one Alt-A transaction, which has been excluded from the loan files reviewed with potential recoveries in the preceding table. The following table presents changes in the Company's loss and LAE reserves for the three months ended March 31, 2012. Changes in the loss and LAE reserves attributable to the accretion of the claim liability discount, changes in discount rates, changes in the timing and amounts of estimated payments and recoveries, changes in assumptions and changes in LAE reserves are recorded in "Losses and loss adjustment" expenses in the Company's consolidated statements of operations. As of March 31, 2012, the weighted average risk-free rate used to discount the Company's loss reserves (claim liability) was 1.73%. LAE reserves are expected to be settled within a one year period and are not discounted.
In millions |  |  | Changes in Loss and LAE Reserves for the Three Months Ended March 31, 2012 |  |  | Gross Loss and LAE Reserves as of March 31, 2012 |
Gross Loss and LAE Reserves as of December 31, 2011 |  |  | Loss Payments for Cases with Reserves |  |  | Accretion of Claim Liability Discount |  |  | Changes in Discount Rates |  |  | Changes in Timing of Payments |  |  | Changes in Amount of Net Payments |  |  | Changes in Assumptions |  |  | Changes in Unearned Premium Revenue |  |  | Changes in LAE Reserves |  |
$ | 836 |  |  | $ | (114) |  |  | $ | 3 |  |  | $ | (22) |  |  | $ | 34 |  |  | $ | (1) |  |  | $ | 78 |  |  | $ | (4) |  |  | $ | 57 |  |  | $ | 867 |
The increase in the Company's gross loss and LAE reserves reflected in the preceding table was primarily due to changes in assumptions and changes in LAE reserves on insured second-lien RMBS issues outstanding as of December 31, 2011. Offsetting these increases were decreases in reserves related to loss payments. The following table presents changes in the Company's insurance loss recoverable and changes in recoveries on unpaid losses reported within the Company's claim liability for the three months ended March 31, 2012. Changes in insurance loss recoverable attributable to the accretion of the discount on the recoverable, changes in discount rates, changes in the timing and amounts of estimated collections, changes in assumptions and changes in LAE recoveries are recorded in "Losses and loss adjustment" expenses in the Company's consolidated statements of operations.
|  |  |  |  | Changes in Insurance Loss Recoverable and Recoveries on Unpaid Losses for the Three Months Ended March 31, 2012 |  |  |  |
In millions |  | Gross Reserve as of December 31, 2011 |  |  | Collections for Cases with Recoveries |  |  | Accretion of Recoveries |  |  | Changes in Discount Rates |  |  | Changes in Timing of Collections |  |  | Changes in Amount of Collections |  |  | Changes in Assumptions |  |  | Changes in LAE Recoveries |  |  | Gross Reserve as of March 31, 2012 |
Insurance loss recoverable |  | $ | 3,046 |  |  | $ | (2) |  |  | $ | 9 |  |  | $ | (12) |  |  | $ | - |  |  | $ | (63) |  |  | $ | 152 |  |  | $ | 7 |  |  | $ | 3,137 |
Recoveries on unpaid losses |  |  | 562 |  |  |  | - |  |  |  | 2 |  |  |  | (15) |  |  |  | - |  |  |  | - |  |  |  | (30) |  |  |  | (1) |  |  |  | 518 |
Total |  | $ | 3,608 |  |  | $ | (2) |  |  | $ | 11 |  |  | $ | (27) |  |  | $ | - |  |  | $ | (63) |  |  | $ | 122 |  |  | $ | 6 |  |  | $ | 3,655 |
The Company's insurance loss recoverable increased during 2012 primarily due to changes in assumptions associated with issues outstanding as of December 31, 2011, which related to increases in excess spread and ineligible mortgage loans included in insured second-lien residential mortgage securitization exposures that are subject to contractual obligations by sellers/servicers to repurchase or replace such mortgages, partially offset by changes in the amount of collections. Recoveries on unpaid losses decreased primarily due to changes in assumptions as a result of a reduction of excess spread related to first-lien and second-lien RMBS transactions and changes in discount rates. The following table presents the Company's total estimated recoveries from ineligible mortgage loans included in certain insured second-lien mortgage loan securitizations as of March 31, 2012. The total estimated recoveries from ineligible loans of $3.2 billion include $2.1 billion recorded as "Insurance loss recoverable" and $1.1 billion recorded as "Loan repurchase commitments" presented under the heading "Assets of consolidated variable interest entities" on the Company's consolidated balance sheets.
In millions |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Total Estimated Recoveries from Ineligible Loans as of December 31, 2011 |  |  | Accretion of Future Collections |  |  | Changes in Discount Rates |  |  | Recoveries (Collections) |  |  | Changes in Amount of Collections |  |  | Changes in Assumptions |  |  | Total Estimated Recoveries from Ineligible Loans as of March 31, 2012 |
$ | 3,119 |  |  | $ | 11 |  |  | $ | (6) |  |  | $ | - |  |  | $ | - |  |  | $ | 44 |  |  | $ | 3,168 |
The Company's total estimated recoveries from ineligible loans in the preceding table increased primarily as a result of the probability-weighted scenarios as described within the preceding "Second-lien RMBS Recoveries" section. Remediation actions may involve, among other things, waivers or renegotiations of financial covenants or triggers, waivers of contractual provisions, the granting of consents, transfer of servicing, consideration of restructuring plans, acceleration, security or collateral enforcement, actions in bankruptcy or receivership, litigation and similar actions. The types of remedial actions pursued are based on the insured obligation's risk type and the nature and scope of the event giving rise to the remediation. As part of any such remedial actions, MBIA seeks to improve its security position and to obtain concessions from the issuer of the insured obligation. From time to time, the issuer of an MBIA-insured obligation may, with the consent of MBIA, restructure the insured obligation by extending the term, increasing or decreasing the par amount or decreasing the related interest rate, with MBIA insuring the restructured obligation. Costs associated with remediating insured obligations assigned to the Company's "Caution List—Low," "Caution List—Medium," "Caution List—High" and "Classified List" are recorded as LAE. LAE is primarily recorded as part of the Company's provision for its loss reserves and included in "Losses and loss adjustment" on the Company's consolidated statements of operations. The following table presents the expenses (gross and net of reinsurance) related to remedial actions for insured obligations:
|  | Three Months Ended March 31, |
In millions |  | 2012 |  |  | 2011 |
Loss adjustment expense incurred, gross |  | $ | 75 |  |  | $ | 15 |
Loss adjustment expense incurred, net |  | $ | 75 |  |  | $ | 15 |

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- Definition Disclosure of accounting policy for the various components of the reserve for future policy benefits and guaranteed minimum benefits, and for claims and claims adjustment expenses; the significant assumptions for estimating claims losses; causes of significant variances from prior periods (such as catastrophes, asbestos and environmental claims reserve losses); and reconciliations of beginning to ending reserve balances. + References Reference 1: http://www.xbrl.org/2003/role/presentationRef -Publisher FASB -Name Accounting Standards Codification -Topic 944 -SubTopic 40 -Section 50 -Paragraph 3 -URI http://asc.fasb.org/extlink&oid=6482485&loc=d3e14764-158437 Reference 2: http://www.xbrl.org/2003/role/presentationRef -Publisher FASB -Name Accounting Standards Codification -Topic 944 -SubTopic 40 -Section 50 -Paragraph 6 -URI http://asc.fasb.org/extlink&oid=6482852&loc=d3e14931-158439 Reference 3: http://www.xbrl.org/2003/role/presentationRef -Publisher SEC -Name Regulation S-X (SX) -Number 210 -Article 7 -Section 03 -Paragraph 13 Reference 4: http://www.xbrl.org/2003/role/presentationRef -Publisher FASB -Name Accounting Standards Codification -Topic 944 -SubTopic 40 -Section 50 -Paragraph 1 -URI http://asc.fasb.org/extlink&oid=6482485&loc=d3e14754-158437 Reference 5: http://www.xbrl.org/2003/role/presentationRef -Publisher FASB -Name Statement of Financial Accounting Standard (FAS) -Number 60 -Paragraph 60 -LegacyDoc This reference is SUPERSEDED by the Accounting Standards Codification effective for interim and annual periods ending after September 15, 2009. This reference is included to help users transition from the previous accounting hierarchy and will be removed from future versions of this taxonomy. Reference 6: http://www.xbrl.org/2003/role/presentationRef -Publisher AICPA -Name Statement of Position (SOP) -Number 94-5 -Paragraph 11 -LegacyDoc This reference is SUPERSEDED by the Accounting Standards Codification effective for interim and annual periods ending after September 15, 2009. This reference is included to help users transition from the previous accounting hierarchy and will be removed from future versions of this taxonomy. Reference 7: http://www.xbrl.org/2003/role/presentationRef -Publisher FASB -Name Accounting Standards Codification -Topic 944 -SubTopic 210 -Section S99 -Paragraph 1 -Subparagraph (SX 210.7-03.13(a)(1),(b)) -URI http://asc.fasb.org/extlink&oid=6879938&loc=d3e572229-122910 + Details
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