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Loss and Loss Adjustment Expense Reserves | 9 Months Ended
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Sep. 30, 2014
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Loss and Loss Adjustment Expense Reserves | Note 5: Loss and Loss Adjustment Expense Reserves Loss and Loss Adj ustment Expense Process U.S. Public Finance U.S. public finance insur ed transactions consist of municipal bonds, including tax-exempt and taxable indebtedness of U.S. political subdivisions, as well as utility districts, airports, health care institutions, higher educational facilities, student loan issuers, housing authorities and other similar agencies and obligations issued by private entities that finance projects that serve a substantial public purpose. The Company estimates future losses by using probability-weighted scenarios that are customized to each insured transaction. Future loss estimates consider debt service due fo r each insured transaction, which includes par outstanding and interest due. As of September 30, 2014 and December 31, 2013, the Company established loss and loss adjustment expense (“LAE”) reserves totaling $62 million and $87 million, respectively, and insurance loss recoverable of $11 million and $13 million, respectively, related to U.S. public finance issues. For the nine months ended September 30, 2014, losses and LAE incurred was a benefit of $5 million, primar ily related to decreases in reserves for certain general obligation bonds, partially offset by losses related to Puerto Rico exposures. Certain local governments remain under financial and budgetary stress and a few have filed for protection under the Uni ted States Bankruptcy Code, or have entered into state statutory proceedings established to assist municipalities in managing through periods of severe fiscal stress. This could lead to an increase in defaults by such entities on the payment of their oblig ations and losses or impairments on a greater number of the Company’s insured transactions. The Company monitor s and analyze s these situations closely, however, the overall extent and duration of such events are uncertain and the filing for protection unde r the United States Bankruptcy Code or entering state statutory proceedings does not result in a default or indicate that an ultimate loss will occur. As of September 30, 2014 and December 31, 2013, the Company had $105.5 billion and $124.9 bil lion, respectively, of gross par outstanding on general obligations, of which $152 million and $161 million, respectively, were reflected on the Company’s “Classified List.” Capital appreciation bonds are reported at the par amount at the time of issuance of the insurance policy. Structured Finance and International As of September 30, 2014, the majority of the structured finance and international insurance segment’s case basis reserves and insurance loss recoveries recorded in accordance with GAAP were related to insured second and first-lien RMBS transactions. These reserves and recoveries do not include estimates for policies insuring credit derivatives or losses a nd recoveries on financial guarantee VIEs that are eliminated in consolidation. 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 influen ced 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 su ch contracts at a loss, the cumulative unrealized losses recorded from 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 ins ured derivatives, insured derivatives have similar terms, conditions, risks, and economic profiles to financial guarantee insurance policies, and therefore, are evaluated by the Com pany for loss (referred to as credit impairment herein) and LAE periodicall y in a manner similar to the 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 re coveries. MBIA Corp.’s, exclusive of MBIA UK, Insur ance Corporation’s expected future claim payments for insured derivatives were discounted using a rate of 5.09%, the same rate it used to calculate its statutory loss reserves as of September 30, 2014. MBIA UK used a rate of 2.50% to discount its expected future claim payments and statutory loss reserves. These credit impairments, calculated in accordance with statutory accounting principles (“U.S. STAT”) differ from the fair values recorded in the Company’s consolidated fi nancial statements. The Company considers 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: Fair Value of Financial Instruments” included herein for additional information about the Company’s insured credit derivative contracts. RMBS Case Basis Reserves and Recoveries (Financial Guarantees) The Company’s RMBS reserves and recoveries relate to financial guarantee insuranc e policies. The Company calculated RMBS case basis reserves as of September 30, 2014 for both second and first-lien RMBS transactions using a process called the “Roll Rate Methodology.” The Roll Rate Methodology is a multi-step process using a database o f loan level information, a proprietary internal cash flow model, and a commercially available model to estimate potential losses and recoveries 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 fut ure. Second-lien RMBS Reserves The Company’s second-lien RMBS case basis reserves as of September 30, 2014 relate to RMBS backed by home e quity lines of credit (“HELOC”) and closed-end second mortgages (“CES”). The Roll Rates for 30-59 day delinquent loa ns 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 and Real Estate Owned (“REO”) is 95%. The Roll Rates are applied to the amounts in the respective delinquency buckets based on delinquencies as of August 31, 2014 to estimate future losses from loans that are delinquent as of the current reporting period. Roll Rates for loans that are current as of August 31, 2014 (“Current Roll to Loss”) are also calculated on a transaction-specific basis. A proportion of loans reported current as of August 31, 2014 is assumed to become delinquent every month, at a Current Roll to Loss rate that persists a t current level s for a time and subsequently starts to decline. A key assumption in the model is the period of time in which the Company projects current levels of Current Roll to Loss to persist. The three different scenarios, base, stress and additional stress, differ in the period of time, for which the current levels of Current Roll to Loss rates persist. Loss reserves are calculated by using a weighted average of these three scenarios, with the majority of the probability assigned to the stress and add itional stress scenarios where the current levels of Current Roll to Loss rates persist for six or eighteen months before reverting to historic levels. I n the base case scenario, 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 August 31, 2014. For example, i f the amoun t of current loans which become 30-59 days delinquent were 10%, and recent performance were to suggest that 30% of those loans will be charged-off, the Current Roll to Loss for the transaction is 3%. In the base case, the Current Roll to Loss will then 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 September 2014 to February 201 5). After that six-month period in the base case scenario, the Company further reduces the l oss to 0% by late 2015 with the expectation that the performing seasoned loans will eventually result in loan performance reverting to low er levels of default consistent with history. I n the stress and additional stress case scenarios, the Current Roll to Loss trends persist for six months and eighteen months, respectively, before reverting to historic trends. In addition, the Company considers borrow er draw rates, voluntary prepayment rates and pool mortgage insurance, that primarily affect the excess spread generated by current loans, which offsets losses and results in reimbursements to the Company. The Company uses the twelve-month average voluntar y prepayment rates and the six-month average loss severities to model its loss reserves. For HELOCs, the current three-month average draw rate is generally used to project future draws on the line. P rojected cash flows are also based on an assumed constant basis spread between floating rate assets and floating rate insured debt obligations (the difference between P rime and London Interbank Offered Rate (“LIBOR”) interest rates, minus any applicable fees). For all transactions, cash flow models consider allo cations and other structural aspects, including managed amortization periods, rapid amortization periods and claims against MBIA Corp.’s insurance policy consistent with such policy’s terms and conditions. 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 probability-weighted estimates of how transactions will p erform over time. As of September 30, 2014 and December 31, 2013, the Company established loss and LAE reserves totaling $112 million and $126 million, respectively, related to second-lien RMBS issues after the elimination of $19 million and $43 million, respectively, as a result of consolidating VIEs. For the nine months ended September 30, 2014, the Company incurred $88 million of losses and LAE recorded in earnings related to second-lie n RMBS issues after the elimination of a $25 million expense as a result of consolidating VIEs. The Company monitors portfolio performance on a monthly basis against projected performance, reviewing delinquencies, Roll Rates, and prepayment rates (including voluntary and involuntary). However, loan 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 inc rease or decrease the case basis reserves accordingly. If actual performance were to remain at the current levels for six additional month s compared to the pro bability-weighted outcome currently used by the Company, t he addition to the case basis reserves would be approximately $50 million. Second-lien RMBS Recoveries The Company primarily records two types of recoveries related to insured second-lien RMBS exposures: “put-back” claims related to those mortgage loans whose inclusion in insured securitizations failed to comply with representations and warranties (“ineligible loans”) and excess spread that is generated from performing loans in the insured transactions. Excess Spread As of September 30, 2014 and December 31, 2013, the Company recorded estimated recoveries of $535 million and $681 million, respectively, for the reimbursement of past and future expected claims through excess spread in insured second-lien RMBS transactions after the elimination of $141 million and $190 million, respectively, as a result of consolidating VIEs. As of September 30, 2014, $529 million and $6 million were included in “Insurance loss recoverable” and “Loss and loss adjustment expense reserves” on the Comp any’s consolidated balance sheets, respectively, after the elimination of $141 million in “Insurance loss recoverable”, as a result of consolidating VIEs. As of December 31, 2013, $647 million and $34 million were included in “Insurance loss recoverable” and “Loss and loss adjustment expense reserves” on the Company’s consolidated balance sheets, respectively, after the elimination of $183 million and $7 million, respectively, as a result of consolidating VIEs. Excess spread is generated by performing l oans within insured second-lien RMBS securitizations and is the difference between interest inflows on mortgage loan collateral and interest outflows on insured beneficial interests. The amount of excess spread depends on the future loss trends (which incl ude future delinquency trends, average time to charge-off delinquent loans, and the availability of pool mortgage insurance), the future spread between Prime and LIBOR interest rates; and borrower refinancing behavior which results in voluntary prepayments. Minor deviations in loss trends and voluntary prepayments may substantially impact the amounts collected from excess spread. Voluntary prepayment rates generally increased for the nine months ended September 30, 2014. The use of these average voluntary pr epayment rates in the loss projections resulted in a reduction in estimated recoveries. Ineligible Mortgage Loans To date, MBIA has settled the majority of the Company’s put-back claims, with its claims against only Credit Suisse remaining as outstanding. The settlement amounts have been consistent with the put-back recoveries previously included in the Company’s financial statements. Refer to “Note 13: Commitments and Contingencies” for a dditional information about the litigation against Credit Suisse. The contract claim rema ining with Credit Suisse is related to the inclusion of ineligible mortgage loans in the 2007-2 Home Equity Mortgage Trust (“HEMT”) securitization. Credit Suisse has challenged the Company’s assessment of the ineligibility of individual mortgage loans and the dispute is the subject of litigation for which there is no assurance that the Company will prevail. As of September 30, 2014 and December 31, 2013, the Company recorded estimated recoveries of $365 m illion and $359 million, respecti vely, related to second-lien RMBS put-back claims on ineligible mortgage loans, reflected in “Loan repurchase commitments” presented under the heading “Assets of consolidated variable interest entities” on the Company’s consolidated balance sheets. The Company believes that it will prevail in enforcing its contractual put-back rights against Credit Suisse. Based on the Company’s assessment of the strength of these claims, the Company believes it is entitled to collect the full amount of its incurred loss es, which totaled $432 million through September 30, 2014. The Company is entitled to collect interest on amounts paid. However, u ncertainty remains with respect to the ultimate outcome of the litigation with Credit Suisse, which is contemplated in the s cenario based-modeling the Company uses. The Credit Suisse recovery scenarios are based on the amount of incurred losses measured against certain probabilities of ultimate resolution of the dispute with Credit Suisse over the inclusion of ineligible mortga ge loans in the HEMT securitization. Most of the probability weight is assigned to partial recovery scenarios and a re discounted using the current risk-free discount rates associated with the underlying transaction’s cash flows. The Company frequent ly rev iews the approach and assumptions it applies to calculate put-back recoveries. 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, 2013, for the Company’s assessment of the remaining unsettled recoveries related to insured Credit Suisse second-lien RMBS. First-lien RMBS Reserves The Company’s first-lien RMBS case basis reserves as of September 30, 2014, which prim arily 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, 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. The C urrent Roll to Loss rates stay at the August 31, 2014 level for one month before declining to 25% of this level over a 24-month period. The Company estimates future losses by using three different probability-weighted scenarios: base; stress; and additional stress. The thre e scenarios differ in the Roll Rates to loss of 90+ day delinquent loans. In the base scenario, the Company uses deal-specific Roll Rates obtained from historic loan level Roll Rate data for 90+ day delinquent loans. In the stress scenario, the Company ass umes a 90% Roll Rate for all 90+ day delinquent loans. In the additional stress scenario, the Roll Rates for each deal are an average of the deal-specific Roll Rate used in the base scenario and the 90% rate. The Roll Rates are applied to the amounts in ea ch deal’s respective 90+ delinquency bucket based on delinquencies as of August 31, 2014 in order to estimate future losses from loans that are delinquent as of September 30, 2014. 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 start the projection for trends in loss severities at loan liquidation. The loss severities are reduced over time to account for reduction in the amount of foreclosure inventory, anticipated future increases in home prices, principal amortization of the loan and government foreclosure moratoriums. As of September 30, 2014, the Company established loss and LAE reserves totaling $242 million related to first-lien RMBS issues. As of December 31, 2013, the Company e stablished loss and LAE reserves totaling $241 million related to first-lien RMBS issues after the elimination of $2 million as a result of consolidating VIEs. For the nine months ended September 30, 2014, the Company incurred $39 million of losses and LAE recorded in earnings related to first-lien RMBS issues after the elimination of a $1 million benefit as a result of consolidating VIEs. ABS CDOs (Financial Guarantees and Insured Der ivatives) 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, ABS CDOs, corporate CDOs and collateralized lo an obligations). These transactions were insured as either financial guarantee insurance policies or credit derivatives with the majority currently insured in the form of financial guarantees. Since the fourth quarter of 2007, MBIA’s insured par exposure w ithin the ABS CDO portfolio has been substantially reduced through a combination of terminations and commutations. Accordingly, as of September 30, 2014, the insured par exposure of the ABS CDO financial guarantee insurance policies and credit derivative s portfolio has declined by approximately 97% of the insured amount as of December 31, 2007. The primary factor in estimating reserves on insured ABS CDO policies written as financial guarantee insurance policies 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 u ses up to a total of five probability-weighted scenarios in order to estimate its reserves or impairments for ABS CDOs. The Company’s payment obligations after a default are timely interest and ultimate principa l. As of September 30, 2014 and December 31, 2013, the Company established loss and LAE reserves totaling $72 million and $115 million, respectively, related to ABS CDO financial guarantee insurance policies after the elimination of $243 million and $226 million, respectively, as a result of consolidating VIEs. For the nine months ended September 30, 2014, the Company had a benefit of $14 million of losses and LAE recorded in earnings related to ABS CDO financial guarantee insurance policies after the elimination of a $17 million expense as a result of consolidating VIEs. In the event of further deteriorating performance of the collateral referenced or held in ABS CDO transactions, the amo unt of losses estimated by the Company could increase substant ially. Credit Impairments Related to Structured CMBS Pools, CRE CDOs and CRE Loan Pools (Financial Guarantees and Insured Derivatives) MBIA’s insured CRE transactions comprise structured CMBS pools, CRE CDOs and CRE loan pools. The majority of this portfolio is a ccounted for as insured credit derivatives and carried at fair value in the Company’s consolidated financial statements. Refer to “Note 8: Derivative Instruments” for a further discussion of the Comp any’s use of derivatives and their impact on the Company’s consolidated financial statements. Since the Company’s insured credit derivatives have similar terms, conditions, risks, and economic profiles to its financial guarantee insurance policies, the Com pany evaluates them for impairment in the same way that it estimates loss and LAE for its financial guarantee policies. 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. The Company consider s several factors when developing the range of potential outcomes in the CRE market and their impact on MBIA. The following approaches require substantial judgments about the future performance of each transaction: Each transaction is evaluated for its commutation potentia l, which is customized by counterparty and considers historical commutation prices, the level of dialogue with the counterparty and the credit quality and payment profile of the underlying exposure. A range of loss scenarios is considered under different d efault and severity rates for each transaction’s distressed loan amounts. Additionally, certain loans may be reviewed individually so performance and loss severity can be more accurately determined. The loss severities projected by these approaches vary wi dely. 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. For the nine months ended September 30, 2014, additional credit impairments and LA E for insured derivatives on structured CMBS pools, CRE CDOs and CRE loan pools were estimated to be $97 million as a result of additional delinquencies and loan level liquidations, as well as MBIA’s continued assessment of various commut ation possibilities. Since 2013, the Company has been paying claims on a CMBS pool transaction that had experienced deterioration such that all remaining deductible was eliminated. Loss and LAE Activity Financial Guarantee Insurance Losses (Non-Derivative and Non-Consolidated VIEs) The Company’s financial guarantee insurance losses and LAE for the nine months ended September 30, 2014 are presented in the following table:
|  |  | Nine Months Ended September 30, 2014 |
|  |  |  | Second-lien |  | First-lien |  |  |  |  |
| In millions |  | RMBS |  | RMBS |  | Other(1) |  | Total |
| Losses and LAE related to expected payments |  | $ | 13 |  | $ | 43 |  | $ | (112) |  | $ | (56) |
| Recoveries of expected payments |  |  | 75 |  |  | (4) |  |  | 67 |  |  | 138 |
| Gross losses incurred |  |  | 88 |  |  | 39 |  |  | (45) |  |  | 82 |
| Reinsurance |  |  | - |  |  | - |  |  | - |  |  | - |
| Losses and LAE expense (benefit) |  | $ | 88 |  | $ | 39 |  | $ | (45) |  | $ | 82 |
| ________________ |
| (1) - Includes ABS CDOs, CMBS, U.S. public finance and other issues. |
The losses and LAE expense in the preceding table primarily related to decrease s in recoveries of expected payments as a result of lower projected collections from excess spread within insured second-lien RMBS securitizations and increase s in losses and LAE related to expected paymen t s on previously established insured first-lien RMBS reserves. Partially offsetting these expenses was a benefit related to a decrease in reserves on an international road transact ion. T h e f ol l owin g t abl e p r o v ide s in f o rm a t i o n a bou t t h e f i nan c ia l gu a r a n t e e s an d r el a t e d c la i m li a bili t y i n c lude d i n ea ch of M B I A’s s u rv e i llan ce c a t ego r ie s a s o f September 30, 2014
|  |  |  |  | Surveillance Categories
|  |  |  |  | Caution |  | Caution |  | Caution |  |  |  |  |  |
|  |  |  |  | List |  | List |  | List |  | Classified |  |  |
$ in millions |  | Low |  | Medium |  | High |  | List |  | Total
Number of policies |  |  | 46 |  |  | 102 |  |  | 6 |  |  | 185 |  |  | 339
Number of issues(1) |  |  | 21 |  |  | 10 |  |  | 5 |  |  | 120 |  |  | 156
Remaining weighted average contract |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
| period (in years) |  |  | 8.7 |  |  | 11.4 |  |  | 10.0 |  |  | 8.5 |  |  | 9.0
Gross insured contractual payments |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
| outstanding:(2) |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
|  | Principal |  | $ | 2,648 |  | $ | 1,735 |  | $ | 162 |  | $ | 7,879 |  | $ | 12,424
|  | Interest |  |  | 2,137 |  |  | 957 |  |  | 87 |  |  | 4,089 |  |  | 7,270
|  |  | Total |  | $ | 4,785 |  | $ | 2,692 |  | $ | 249 |  | $ | 11,968 |  | $ | 19,694
Gross Claim Liability |  | $ | - |  | $ | - |  | $ | - |  | $ | 841 |  | $ | 841
Less: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
| Gross Potential Recoveries |  |  | - |  |  | - |  |  | - |  |  | 798 |  |  | 798
| Discount, net(3) |  |  | - |  |  | - |  |  | - |  |  | 120 |  |  | 120
Net claim liability (recoverable) |  | $ | - |  | $ | - |  | $ | - |  | $ | (77) |  | $ | (77)
Unearned premium revenue |  | $ | 86 |  | $ | 34 |  | $ | 5 |  | $ | 88 |  | $ | 213
__________ |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
(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.
(3) - Represents discount related to Gross Claim Liability and Gross Potential Recoveries.
T h e f ol l owin g t abl e p r o v ide s in f o rm a t i o n a bou t t h e f i nan c ia l gu a r a n t e e s an d r el a t e d c la i m li a bili t y i n c lude d i n ea ch of M B I A’s s u rv e i llan ce c a t ego r ie s a s o f December 31, 2013:
|  |  |  |  | Surveillance Categories
|  |  |  |  | Caution |  | Caution |  | Caution |  |  |  |  |  |
|  |  |  |  | List |  | List |  | List |  | Classified |  |  |
$ in millions |  | Low |  | Medium |  | High |  | List |  | Total
Number of policies |  |  | 83 |  |  | 19 |  |  | 5 |  |  | 192 |  |  | 299
Number of issues(1) |  |  | 26 |  |  | 14 |  |  | 4 |  |  | 136 |  |  | 180
Remaining weighted average contract |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
| period (in years) |  |  | 11.0 |  |  | 4.9 |  |  | 11.5 |  |  | 9.5 |  |  | 9.7
Gross insured contractual payments |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
| outstanding:(2) |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
|  | Principal |  | $ | 5,290 |  | $ | 1,073 |  | $ | 40 |  | $ | 7,861 |  | $ | 14,264
|  | Interest |  |  | 3,829 |  |  | 253 |  |  | 24 |  |  | 4,526 |  |  | 8,632
|  |  | Total |  | $ | 9,119 |  | $ | 1,326 |  | $ | 64 |  | $ | 12,387 |  | $ | 22,896
Gross Claim Liability |  | $ | - |  | $ | - |  | $ | - |  | $ | 1,235 |  | $ | 1,235
Less: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
| Gross Potential Recoveries |  |  | - |  |  | - |  |  | - |  |  | 1,085 |  |  | 1,085
| Discount, net(3) |  |  | - |  |  | - |  |  | - |  |  | 205 |  |  | 205
Net claim liability (recoverable) |  | $ | - |  | $ | - |  | $ | - |  | $ | (55) |  | $ | (55)
Unearned premium revenue |  | $ | 112 |  | $ | 19 |  | $ | - |  | $ | 96 |  | $ | 227
__________
(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.
(3) - Represents discount related to Gross Claim Liability and Gross Potential Recoveries.
The gross claim liability in the preceding tables represents the Company’s estimate of undiscounted probability-weighted future claim payments. A s of September 30, 2014 and December 31, 2013, the gross claim liability primarily related to insured first and second-lien RMBS issues, ABS CDOs and an international road transaction. 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. As of September 30, 2014 and December 31, 2013, the gross potential recoveries principally relate d to insured second-lien RMBS and U.S. publi c finance issues. The Company’s recoveries have been, and remain 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 guaran tee insurance policies. 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, it 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. The gross claim liability and gross potential recoveries reflect the elimination of claim liabilities and potential re coveries 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 September 30, 2014 and December 31, 2013 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 paym ents and recoveries reported in the preceding tables.
|  |  |  | As of |  | As of |
| In millions |  | September 30, 2014 |  | December 31, 2013 |
| Loss reserves (claim liability) |  | $ | 449 |  | $ | 580 |
| LAE reserves |  |  | 68 |  |  | 61 |
|  | Loss and LAE reserves |  | $ | 517 |  | $ | 641 |
| Insurance claim loss recoverable |  | $ | (568) |  | $ | (694) |
| LAE insurance loss recoverable |  |  | (7) |  |  | - |
|  | Insurance loss recoverable |  | $ | (575) |  | $ | (694) |
| Reinsurance recoverable on unpaid losses |  | $ | 6 |  | $ | 7 |
| Reinsurance recoverable on unpaid LAE reserves |  |  | 1 |  |  | 1 |
|  | Reinsurance recoverable on paid and unpaid losses |  | $ | 7 |  | $ | 8 |
As of September 30, 2014, loss and LAE reserves include $612 m illion of reserves for expected future payments offset by expected recoveries of such future payments of $95 million. As of December 31, 2013, loss and LAE reserves included $847 m illion of reserves for expected future payments offset by expected recoveries of such future payments of $206 million. As of September 30, 2014 and December 31, 2013, the insurance loss recoverable primarily relate d to expected future recoveries on second-lien RMBS transactions resulting from excess spread generated by performing loans in such transactions. The decrease in i ns u rance loss recoverable w as primarily due to decreases in projected collections from excess spread within insured second-lien RMBS securitizations. The following table presents the amounts of the Compan y’s second-lien RMBS exposure, gross undiscounted claim liability and potential recoveries related to non-consolidated VIEs and consolidated VIEs, included in the Company’s “Classified List,” as of September 30, 2014:
Second-lien RMBS Exposure |  |  |  | Outstanding |  | Gross Undiscounted
|  |  |  |  | Gross |  | Gross |  | Claim |  | Potential
$ in billions |  | Issues |  | Principal |  | Interest |  | Liability |  | Recoveries
Non-consolidated VIEs |  | 24 |  | $ | 3.1 |  | $ | 1.0 |  | $ | 0.1 |  | $ | 0.6
Consolidated VIEs |  | 11 |  | $ | 1.5 |  | $ | 0.5 |  | $ | - |  | $ | 0.5
The following table presents changes in the Company’s loss and LAE reserves for the nine months ended September 30, 2014. Changes in the loss and LAE reserves attributable to the accretion of the claim liability discount, changes in discount rates, changes in amount and timing 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 September 30, 2014, the weighted average risk-free rate used to discount the Company’s loss reserves (claim liability) was 2.01%. 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 Nine Months Ended September 30, 2014 |  |  |
Gross Loss |  | Loss |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  | Gross Loss
and LAE |  | Payments |  | Accretion |  |  |  |  |  |  |  | Changes in |  |  |  |  |  |  |  | and LAE
Reserves as of |  | for Cases |  | of Claim |  | Changes in |  |  |  | Unearned |  | Changes in |  |  |  | Reserves as of
December 31, |  | with |  | Liability |  | Discount |  | Changes in |  | Premium |  | LAE |  |  |  | September 30,
2013 |  | Reserves |  | Discount |  | Rates |  | Assumptions |  | Revenue |  | Reserves |  | Other(1) |  | 2014
$ | 641 |  | $ | (131) |  | $ | 11 |  | $ | 42 |  | $ | (48) |  | $ | 17 |  | $ | 7 |  | $ | (22) |  | $ | 517
____________
(1) - Primarily changes in amount and timing of payments.
The decrease in the Company’s gross loss and LAE reserves reflected in the preceding table was primarily related to loss payments and changes in assumptions on an international road transaction, partially offset by increases in reserves due to changes in discount rates on ABS CDOs and insured first and second-lien RMBS issues outstanding as of December 31, 2013. C u rr en t pe r io d ch a nge s i n th e C o m pan y’s est i mat e o f p o tent i a l r e c o v e r i e s ma y be r e c o r de d a s a n in s u r an c e l oss r e c ove r a bl e as s et, net t e d a g ain s t th e g r os s l o s s an d L A E r e se r v e l i abi l i t y, or bo t h. The following table s present ch anges in the Company’s insurance loss recoverable and changes in recoveries on unpaid losses reported within the Company’s claim liability for the nine months ended September 30, 2014. Changes in insurance loss recoverable attributable to the accretion of the discount on the recoverable, changes in discount rates, changes in amount and timing of estimated collections, changes in assumptions and changes in LAE recoveries are recorded in “Losses and loss adjustment” expenses in the Company’s consolidated stat ements of operations.
|  |  |  |  |  | Changes in Insurance Loss Recoverable and Recoveries on Unpaid Losses |  |  |
|  |  |  |  |  | for the Nine Months Ended September 30, 2014 |  |  |
|  |  |  |  | Collections |  |  |  |  |  |  |  |  |  |  |
|  |  | As of |  | for Cases |  | Accretion |  | Changes in |  |  |  |  | Changes in |  |  |  | As of
|  |  | December 31, |  | with |  | of |  | Discount |  | Changes in |  | LAE |  |  |  | September 30,
In millions |  | 2013 |  | Recoveries |  | Recoveries |  | Rates |  | Assumptions |  | Recoveries |  | Other(1) |  | 2014
Insurance loss |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
| recoverable |  | $ | 694 |  | $ | (84) |  | $ | 10 |  | $ | 10 |  | $ | (63) |  | $ | 7 |  | $ | 1 |  | $ | 575
Recoveries on unpaid |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
| losses |  |  | 206 |  |  | - |  |  | 3 |  |  | 12 |  |  | (128) |  |  | 2 |  |  | - |  |  | 95
Total |  | $ | 900 |  | $ | (84) |  | $ | 13 |  | $ | 22 |  | $ | (191) |  | $ | 9 |  | $ | 1 |  | $ | 670
____________
(1) Primarily changes in amount and timing of collections.
Th e decrease in the C ompan y’s i n s uran ce l o ss re c overabl e and recoveries on unpaid losses durin g 2014 was pr i mar ily du e to changes in assumptions of projected future voluntary prepayment rates on second-lien RMBS and collections a ss o ci ate d with i ss ue s out s tandin g a s o f December 31, 2013. Re m ed i a t i o n a c t io n s m a y i n v o l v e, a m on g o t he r t hi n g s, wai v e rs o r r en e go t i a t i on s o f f i nan c ia l c o v ena n t s o r t r igge rs, wai v e rs o f c on t r a c t u a l p r o v i s ion s, t h e g r an t in g o f c on s en t s, t r a n s f e r o f s e rv i c ing, c o n s i de r a t io n o f r e s t r u c t u r in g p l an s, a cc ele r a t io n, s e c u r i t y o r c o l la t e r a l en f o r c e m e n t, a c t io n s i n ban kr up t cy o r r e c ei v e rs hip, li t iga t io n an d s i m ila r a c t ion s. T he t y p e s o f r e m e d ia l a c t i on s p u r s u e d a r e b a s e d o n t h e in s u r e d obl i ga t ion’s r i sk t y p e a n d t h e na t u re an d s c o p e o f t h e e v e n t gi v i n g r i s e t o t h e r e m edia t ion. A s pa rt o f a n y s u ch r e m edia l a c t ion s, MB I A s e e ks t o i m p r o ve i t s s e c u r i t y p o s i t i o n an d t o ob t ai n c on c e ss ion s f r o m t h e i ss ue r o f t h e in s u r e d obl i ga t ion. F r o m t i me t o t i m e, t h e i ss ue r o f a n M B I A-in s u r e d obl i ga t i on m a y, wi t h t h e c on s en t o f M B I A, r e s t r u c t u re t h e in s u r e d ob l iga t io n b y e x t en d in g t h e t e r m, in cr ea s in g o r de cr ea s in g t h e p a r a m oun t o r de cr ea s i n g t h e r ela t e d in t e r e st r a t e, wi t h M B I A in s u r i n g t h e r e s t r u c t u r e d obl i ga t i on. Co s t s a ss o c ia t e d wi t h r e m ed i a t i n g in s u r e d obl i ga t ion s a s s i gne d t o t h e Co m pan y’s “C a u t i o n Li s t—Low,” “C a u t i o n L i s t—M ediu m,” “Cau t io n L i s t—High” an d “Cla ss i f ie d Li s t” a re r e c o r de d a s L A E. L AE i s p r i m a r i l y r e c o r de d a s pa rt o f t he Co m pan y’s p r o v i s io n f o r i t s lo ss r e s e rv e s an d in c lud e d i n “L o s s e s an d lo ss adju s t m e n t” expenses o n t h e Co m pa n y’s c on s ol i da t ed s t a t e m en t s o f ope r a t ion s. T h e f o l lowi n g t abl e p r e s en t s t h e gross e x pen s e s r el a t e d t o r e m ed i al a c t ion s f o r in s u r e d ob l iga t ion s.
|  |  | Nine Months Ended September 30, |
| In millions |  | 2014 |  | 2013 |
| Loss adjustment expense incurred, gross |  | $ | 37 |  | $ | 31 |

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- Definition The entire disclosure for liabilities related to future policy benefits and unpaid claims and claim adjustments. + References Reference 1: http://www.xbrl.org/2003/role/presentationRef -Publisher SEC -Name Regulation S-X (SX) -Number 210 -Section 03 -Paragraph 13 -Article 7 Reference 2: 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 3: 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 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 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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