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ASSURED GUARANTY LTD - Quarter Report: 2020 March (Form 10-Q)


 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
____________________________________________________________________________
FORM 10-Q
☒
 
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended March 31 2020,
Or
For the transition Period from              to       
☐
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
      
Commission File No. 001-32141 

ASSURED GUARANTY LTD.
(Exact name of registrant as specified in its charter) 
Bermuda
 
98-0429991
(State or other jurisdiction
 
(I.R.S. employer
of incorporation)
 
identification no.)
 
30 Woodbourne Avenue
Hamilton HM 08, Bermuda
(Address of principal executive offices)
(441) 279-5700
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class:
Trading Symbol(s)
Name of exchange on which registered
Common Shares
$0.01 par value per share
AGO
New York Stock Exchange
Assured Guaranty Municipal Holdings Inc. 6-7/8% $100,000,000 Quarterly Interest Bonds due 2101 (and the related guarantee of Registrant)
AGO PRB
New York Stock Exchange
Assured Guaranty Municipal Holdings Inc. 6.25% $230,000,000 Quarterly Interest Bonds due 2102 (and the related guarantee of Registrant)
AGO PRE
New York Stock Exchange
Assured Guaranty Municipal Holdings Inc. 5.60% $100,000,000 Quarterly Interest Bonds due 2103 (and the related guarantee of Registrant)
AGO PRF
New York Stock Exchange
Assured Guaranty US Holdings Inc. 5.000% $500,000,000 Senior Notes due 2024 (and the related guarantee of Registrant)
AGO 24
New York Stock Exchange
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).   Yes ☒ No ☐


Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See definition of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer
☒
 
Accelerated filer
☐
  Non-accelerated filer
☐
 
Smaller reporting company
☐
 
 
 
Emerging growth company
☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No  ☒

The number of registrant’s Common Shares ($0.01 par value) outstanding as of May 5, 2020 was 86,916,590 (includes 40,455 unvested restricted shares).
 


ASSURED GUARANTY LTD.
INDEX TO FORM 10-Q
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


PART I.    FINANCIAL INFORMATION
 
ITEM 1.
FINANCIAL STATEMENTS

Assured Guaranty Ltd.
Condensed Consolidated Balance Sheets (unaudited) 
(dollars in millions except per share and share amounts) 
 
As of
March 31, 2020
 
As of
December 31, 2019
Assets
 

 
 

Investment portfolio:
 

 
 

Fixed-maturity securities, available-for-sale, at fair value (amortized cost of $8,410 and $8,371, allowance for credit loss of $73 at March 31, 2020)
$
8,568

 
$
8,854

Short-term investments at fair value
933

 
1,268

Other invested assets (includes $12 and $6 measured at fair value)
121

 
118

Total investment portfolio
9,622

 
10,240

Cash
139

 
169

Premiums receivable, net of commissions payable
1,233

 
1,286

Deferred acquisition costs
113

 
111

Salvage and subrogation recoverable
820

 
747

Financial guaranty variable interest entities’ assets, at fair value
368

 
442

Assets of consolidated investment vehicles (includes $557 and $558 measured at fair value)
645

 
572

Goodwill and other intangible assets
212

 
216

Other assets (includes $177 and $135 measured at fair value)
593

 
543

Total assets
$
13,745

 
$
14,326

Liabilities and shareholders’ equity
 

 
 

Unearned premium reserve
$
3,706

 
$
3,736

Loss and loss adjustment expense reserve
1,050

 
1,050

Long-term debt
1,221

 
1,235

Credit derivative liabilities, at fair value
265

 
191

Financial guaranty variable interest entities’ liabilities with recourse, at fair value
312

 
367

Financial guaranty variable interest entities’ liabilities without recourse, at fair value
82

 
102

Liabilities of consolidated investment vehicles (includes $426 and $481 measured at fair value)
431

 
482

Other liabilities
405

 
511

Total liabilities
7,472

 
7,674

 
 
 
 
Commitments and contingencies (see Note 14)

 

Redeemable noncontrolling interests in consolidated investment vehicles
8

 
7

 
 
 
 
Common stock ($0.01 par value, 500,000,000 shares authorized; 89,983,322 and 93,274,987 shares issued and outstanding)
1

 
1

Retained earnings
6,100

 
6,295

Accumulated other comprehensive income, net of tax of $34 and $71
138

 
342

Deferred equity compensation
1

 
1

Total shareholders’ equity attributable to Assured Guaranty Ltd.
6,240

 
6,639

Nonredeemable noncontrolling interests
25

 
6

Total shareholders’ equity
6,265

 
6,645

Total liabilities, redeemable noncontrolling interests and shareholders’ equity
$
13,745

 
$
14,326


The accompanying notes are an integral part of these condensed consolidated financial statements.

1

Assured Guaranty Ltd.

Condensed Consolidated Statements of Operations (unaudited)
 
(dollars in millions except per share amounts)
 
Three Months Ended March 31,
 
2020
 
2019
Revenues
 
 
 
Net earned premiums
$
103

 
$
118

Net investment income
80

 
98

Asset management fees
23

 
—

Net realized investment gains (losses)
(5
)
 
(12
)
Net change in fair value of credit derivatives
(77
)
 
(22
)
Fair value gains (losses) on committed capital securities
48

 
(9
)
Fair value gains (losses) on financial guaranty variable interest entities
(9
)
 
5

Fair value gains (losses) on consolidated investment vehicles
(12
)
 
—

Foreign exchange gains (losses) on remeasurement
(62
)
 
11

Other income (loss)
7

 
6

Total revenues
96

 
195

Expenses
 
 
 
Loss and loss adjustment expenses
20

 
46

Interest expense
22

 
23

Amortization of deferred acquisition costs
3

 
6

Employee compensation and benefit expenses
64

 
41

Other operating expenses
45

 
23

Total expenses
154

 
139

Income (loss) before income taxes and equity in net earnings of investees
(58
)
 
56

Equity in net earnings of investees
(4
)
 
2

Income (loss) before income taxes
(62
)
 
58

Provision (benefit) for income taxes
(4
)
 
4

Net income (loss)
(58
)
 
54

Less: Noncontrolling interests
(3
)
 
—

Net income (loss) attributable to Assured Guaranty Ltd.
$
(55
)
 
$
54

 
 
 
 
Earnings per share:
 
 
 
Basic
$
(0.59
)
 
$
0.52

Diluted
$
(0.59
)
 
$
0.52

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

2

Assured Guaranty Ltd.

Condensed Consolidated Statements of Comprehensive Income (unaudited)
 
(in millions)
 
 
Three Months Ended March 31,
 
2020
 
2019
Net income (loss)
$
(58
)
 
$
54

Change in net unrealized gains (losses) on:
 
 
 
Investments with no credit impairment recognized in the statement of operations, net of tax provision (benefit) of $(27) and $25
(162
)
 
163

Investments with credit impairment recognized in the statement of operations, net of tax provision (benefit) of $(13) and $0
(52
)
 
5

Change in net unrealized gains (losses) on investments
(214
)
 
168

Change in net unrealized gains (losses) on financial guaranty variable interest entities' liabilities with recourse, net of tax
10

 
—

Other, net of tax provision (benefit) of $0 and $0
—

 
—

Other comprehensive income (loss)
(204
)
 
168

Comprehensive income (loss)
(262
)
 
222

Less: Comprehensive income (loss) attributable to noncontrolling interest
(3
)
 
—

Comprehensive income (loss) attributable to Assured Guaranty Ltd.
$
(259
)
 
$
222

 
The accompanying notes are an integral part of these condensed consolidated financial statements.

3


 Assured Guaranty Ltd.

Condensed Consolidated Statements of Shareholders’ Equity (unaudited) (continued)

(dollars in millions, except share data)

For the Three Months Ended March 31, 2020
 
 
Common Shares Outstanding
 
 
Common 
Stock
Par Value
 
Retained Earnings
 
Accumulated
Other
Comprehensive Income
 
Deferred
Equity Compensation
 
Total Shareholders’ Equity Attributable to Assured Guaranty Ltd.
 
Nonredeemable Noncontrolling Interests
 
Total
Shareholders’ Equity
Balance at
December 31, 2019
93,274,987

 
 
$
1

 
$
6,295

 
$
342

 
$
1

 
$
6,639

 
$
6

 
$
6,645

Net loss
—

 
 
—

 
(55
)
 
—

 
—

 
(55
)
 
(1
)
 
(56
)
Dividends ($0.20 per share)
—

 
 
—

 
(19
)
 
—

 
—

 
(19
)
 
—

 
(19
)
Share-based compensation
337,745

 
 
—

 
(5
)
 
—

 
—

 
(5
)
 
—

 
(5
)
Common stock repurchases
(3,629,410
)
 
 
—

 
(116
)
 
—

 
—

 
(116
)
 
—

 
(116
)
Other comprehensive loss
—

 
 
—

 
—

 
(204
)
 
—

 
(204
)
 
—

 
(204
)
Contributions and reallocation of ownership interests
—

 
 
—

 
—

 
—

 
—

 
—

 
20

 
20

Balance at
March 31, 2020
89,983,322

 
 
$
1

 
$
6,100

 
$
138

 
$
1

 
$
6,240

 
$
25

 
$
6,265



For the Three Months Ended March 31, 2019
 
 
Common Shares Outstanding
 
 
Common 
Stock
Par Value
 
Additional
Paid-in
Capital
 
Retained Earnings
 
Accumulated
Other
Comprehensive Income
 
Deferred
Equity Compensation
 
Total Shareholders’ Equity Attributable to Assured Guaranty Ltd.
 
Nonredeemable noncontrolling Interests
 
Total
Shareholders’ Equity
Balance at
December 31, 2018
103,672,592

 
 
$
1

 
$
86

 
$
6,374

 
$
93

 
$
1

 
$
6,555

 
$
—

 
$
6,555

Net income
—

 
 
—

 
—

 
54

 
—

 
—

 
54

 
—

 
54

Dividends ($0.18 per share)
—

 
 
—

 
—

 
(19
)
 
—

 
—

 
(19
)
 
—

 
(19
)
Share-based compensation
506,422

 
 
—

 
(10
)
 
—

 
—

 
—

 
(10
)
 
—

 
(10
)
Common stock repurchases
(1,908,605
)
 
 
—

 
(76
)
 
(3
)
 
—

 
—

 
(79
)
 
—

 
(79
)
Other comprehensive income
—

 
 
—

 
—

 
—

 
168

 
—

 
168

 
—

 
168

Balance at
March 31, 2019
102,270,409

 
 
$
1

 
$
—

 
$
6,406

 
$
261

 
$
1

 
$
6,669

 
$
—

 
$
6,669




The accompanying notes are an integral part of these condensed consolidated financial statements.

4

Assured Guaranty Ltd.

Condensed Consolidated Statements of Cash Flows (unaudited)

 (in millions)
 
 
Three Months Ended March 31,
 
2020
 
2019
Net cash flows provided by (used in) operating activities
$
(164
)
 
$
(332
)
Investing activities
 

 
 

Fixed-maturity securities:
 

 
 

Purchases
(278
)
 
(196
)
Sales
86

 
471

Maturities and paydowns
217

 
177

Short-term investments with maturities of over three months:
 
 
 
Purchases
(56
)
 
(107
)
Sales
4

 
2

Maturities and paydowns
12

 
67

Net sales (purchases) of short-term investments with original maturities of less than three months
375

 
25

Net proceeds from paydowns on financial guaranty variable interest entities’ assets
37

 
26

Proceeds from sales of other invested assets
1

 
27

Other
(9
)
 
—

Net cash flows provided by (used in) investing activities
389

 
492

Financing activities
 

 
 

Dividends paid
(20
)

(20
)
Repurchases of common stock
(116
)

(80
)
Net paydowns of financial guaranty variable interest entities’ liabilities
(35
)
 
(25
)
Paydown of long-term debt
(21
)
 
(3
)
Other
(11
)
 
(14
)
Contributions from noncontrolling interests to investment vehicles
23

 
—

Net cash flows provided by (used in) financing activities
(180
)
 
(142
)
Effect of foreign exchange rate changes
(7
)
 
1

Increase (decrease) in cash and restricted cash
38

 
19

Cash and restricted cash at beginning of period
$
183

 
104

Cash and restricted cash at end of period
$
221

 
$
123


(continued on next page)

The accompanying notes are an integral part of these condensed consolidated financial statements.


5

Assured Guaranty Ltd.

Condensed Consolidated Statements of Cash Flows (unaudited) - (Continued)

 (in millions)

 
Three Months Ended March 31,
 
2020
 
2019
Supplemental cash flow information
 
 
 
Cash paid (received) during the period for:
 
 
 
Interest on long-term debt
9

 
9

 
 
 
 
Supplemental disclosure of non-cash investing activities:
 
 
 
Purchases of fixed-maturity investments
$
—

 
$
(139
)
 
 
 
 
 
 
 
 
 
As of March 31, 2020
 
As of March 31, 2019
Reconciliation of cash and restricted cash to the condensed consolidated balance sheets:
 
 
 
Cash
$
139

 
$
123

Cash of consolidated investment vehicles (see Note 12)
82

 
—

Cash and restricted cash at the end of period
$
221

 
$
123



The accompanying notes are an integral part of these condensed consolidated financial statements.


6

Assured Guaranty Ltd.

Notes to Condensed Consolidated Financial Statements (unaudited)
 
March 31, 2020


1.
Business and Basis of Presentation
 
Business
 
Assured Guaranty Ltd. (AGL and, together with its subsidiaries, Assured Guaranty or the Company) is a Bermuda-based holding company that provides, through its operating subsidiaries, credit protection products to the United States (U.S.) and international public finance (including infrastructure) and structured finance markets, as well as asset management services.

Through its insurance subsidiaries, the Company applies its credit underwriting judgment, risk management skills and capital markets experience primarily to offer financial guaranty insurance that protects holders of debt instruments and other monetary obligations from defaults in scheduled payments. If an obligor defaults on a scheduled payment due on an obligation, including a scheduled principal or interest payment (debt service), the Company is required under its unconditional and irrevocable financial guaranty to pay the amount of the shortfall to the holder of the obligation. The Company markets its financial guaranty insurance directly to issuers and underwriters of public finance and structured finance securities as well as to investors in such obligations. The Company guarantees obligations issued principally in the U.S. and the United Kingdom (U.K.), and also guarantees obligations issued in other countries and regions, including Western Europe, Canada and Australia. The Company also provides specialty insurance and reinsurance on transactions with risk profiles similar to those of its structured finance exposures written in financial guaranty form.

On October 1, 2019, Assured Guaranty US Holdings Inc. (AGUS), a wholly-owned subsidiary of AGL, completed the acquisition (the BlueMountain Acquisition) of all of the outstanding equity interests in BlueMountain Capital Management, LLC (BlueMountain) and its associated entities. In connection with the BlueMountain Acquisition the Company established its Assured Investment Management platform, through which it provides investment management services across various asset classes including collateralized loan obligations (CLOs) and long-duration opportunity funds that build on its corporate credit, asset-backed finance and healthcare structured capital experience as well as certain funds now subject to orderly wind-down.

Basis of Presentation
 
The unaudited interim condensed consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (GAAP). In management's opinion, all material adjustments necessary for a fair statement of the financial condition, results of operations and cash flows of the Company and its consolidated variable interest entities (VIEs) are reflected in the periods presented and are of a normal, recurring nature. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. These unaudited interim condensed consolidated financial statements are as of March 31, 2020 and cover the three-month period ended March 31, 2020 (First Quarter 2020) and the three-month period ended March 31, 2019 (First Quarter 2019). Certain financial information that is normally included in annual financial statements prepared in accordance with GAAP, but is not required for interim reporting purposes, has been condensed or omitted. The year-end condensed consolidated balance sheet data was derived from audited financial statements, but does not include all disclosures required by GAAP. Certain prior year balances have been reclassified to conform to the current year's presentation.

The unaudited interim condensed consolidated financial statements include the accounts of AGL, its direct and indirect subsidiaries and its consolidated VIEs. Intercompany accounts and transactions between and among all consolidated entities have been eliminated.
 
These unaudited interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements included in AGL’s Annual Report on Form 10-K for the year ended December 31, 2019, filed with the U.S. Securities and Exchange Commission (SEC).


7

The Company's principal insurance subsidiaries are:

•
Assured Guaranty Municipal Corp. (AGM), domiciled in New York;
•
Municipal Assurance Corp. (MAC), domiciled in New York;
•
Assured Guaranty Corp. (AGC), domiciled in Maryland;
•
Assured Guaranty (Europe) plc (AGE UK), organized in the U.K.;
•
Assured Guaranty (Europe) SA (AGE SA), organized in France;
•
Assured Guaranty Re Ltd. (AG Re), domiciled in Bermuda; and
•
Assured Guaranty Re Overseas Ltd. (AGRO), domiciled in Bermuda.

The Company's principal asset management subsidiaries are BlueMountain Capital Management, LLC, BlueMountain CLO Management, LLC, and BlueMountain GP Holdings, LLC.

The Company’s organizational structure includes various holding companies, two of which - AGUS and Assured Guaranty Municipal Holdings Inc. (AGMH) - have public debt outstanding.

Adopted Accounting Standards

Credit Losses on Financial Instruments

On January 1, 2020, the Company adopted Accounting Standards Update (ASU) 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.  The following summarizes the effect of adoption on the relevant balances.

Financial Assets Carried at Amortized Cost
This ASU provides a new current expected credit loss model (CECL) to account for credit losses on certain financial assets carried at amortized cost such as reinsurance recoverables, premiums receivable, asset management and performance fees receivables, as well as off-balance sheet exposures such as loan commitments. The new model requires an entity to estimate lifetime credit losses related to these assets, based on relevant historical information, adjusted for current conditions and reasonable and supportable forecasts that could affect the collectability of the reported amount. The Company determined that this ASU had no effect on these balances on the date of adoption or for First Quarter 2020.

Financial Assets Carried at Fair Value, not Through Net Income
The most significant effect of the adoption of this ASU is in respect of the available-for-sale investment portfolio, for which targeted amendments were made to the impairment model. Under the new guidance, credit losses are recognized as an allowance for credit loss rather than a direct write-down of the amortized cost basis of the investment (e.g. other-than-temporary impairment, or OTTI, under the previous impairment model). The allowance for credit loss is limited to the excess of amortized cost over fair value, and may be reduced, with a corresponding reversal of credit loss expense, in the event that the expected cash flows of the instrument improves. The Company has elected to classify credit loss expense (including accretion and changes in the allowance for credit loss) as a component of realized gain (loss) on investments.
When amounts are deemed uncollectible, the Company writes-off such amounts. Write-offs are deducted from the allowance for credit loss and the amortized cost basis is written down. Amounts that have been written off may not be reversed through the allowance for credit loss, and any subsequent recovery of such amounts is only recognized in income when received.
The assessment of whether a credit loss exists is performed each quarter and includes numerous factors including the extent to which fair value is less than amortized cost, and any adverse conditions specifically related to the security, industry, and/or geographic area, including changes in the financial condition of the issuer, or underlying loan obligors, as well as general economic and political factors. Additional factors considered, as applicable, include remaining payment terms of the security, prepayment speeds, expected defaults and the value of any embedded credit enhancements. Unlike the previous OTTI model, management may not consider the length of time an instrument has been impaired or the effect of changes in foreign exchange rates in its assessment of credit loss. If, based on an assessment of these and other relevant factors, the Company determines that a credit loss may exist, it then performs a discounted cash flow analysis to determine its best estimate of such allowance for credit loss.
This ASU also eliminates the existing guidance for purchased credit impaired (PCI) securities (such as the Company's loss mitigation securities) and introduced a new model for purchased financial assets with credit deterioration (PCD securities).

8

PCD securities are defined in the new guidance as financial assets that, as of the date of acquisition, have experienced a more-than-insignificant deterioration in credit quality since origination, as determined by an acquirer’s assessment. The ASU requires the recognition of an initial allowance for credit loss on the date of acquisition of PCD securities. Under the new guidance, the amortized cost of PCD securities on the date of acquisition is equal to the purchase price plus the allowance for credit loss, but no credit loss expense is recognized in the statement of operations on the date of acquisition. After the date of acquisition, PCD securities follow the guidance described above for the periodic assessment of credit losses in the available-for-sale investment portfolio.
For securities the Company intends to sell and securities for which it is more-likely-than-not that the Company will be required to sell the security before recovery of its amortized cost, the Company writes off any existing allowance for credit loss, and writes down the amortized cost basis of the instrument to fair value with an offset to realized gain (loss) in the statement of operations.
For all securities that were originally purchased with credit deterioration, whether or not an allowance was established on January 1, 2020, accrued interest is not separately presented, but rather is a component of the amortized cost of the instrument. For all other available-for-sale securities, a separate amount for accrued interest is reported in other assets. The Company has elected to not measure credit losses on its accrued interest receivable and instead write off accrued interest at the earliest to occur of (i) the date it is deemed uncollectible or (ii) when it is six months past due. All write offs of accrued interest are recorded as a reduction to interest income in the statement of operations.

The changes to the impairment model for available-for-sale securities were applied using a modified retrospective approach, and resulted in no effect to shareholders’ equity in total or by component. On the date of adoption, there was no change to the carrying value of the available-for-sale investment portfolio, other than a gross-up of amortized cost and the recording of an offsetting allowance for credit losses for securities to which the Company applied the PCD accounting model. On January 1, 2020, the Company applied the PCD accounting model to PCI securities that were not in an unrealized gain position as of December 31, 2019. The fair value of these PCI securities was $248 million and their amortized cost was $266 million as of December 31, 2019. The Company determined the allowance for credit loss for such PCD securities was $62 million on January 1, 2020. The recording of the allowance for these PCD securities on January 1, 2020 had no effect on the condensed consolidated statement of operations or any component of shareholders’ equity. In First Quarter 2020, the Company recorded an additional $11 million in credit loss expense (including $1 million of accretion). Changes in the impairment model associated with PCD securities are to be applied prospectively. The Company did not purchase any PCD securities in First Quarter 2020.

See Part II, Item 8, Financial Statements and Supplementary Data, Note 10, Investments and Cash, of the Company's 2019 Annual Report on Form 10-K for a complete discussion of the accounting policy for evaluating investments for OTTI prior to January 1, 2020.

Registered Debt Offerings that Include Credit Enhancements from an Affiliate

In March 2020, the SEC adopted amendments to the financial disclosure requirements related to certain debt securities, including registered debt securities issued by a wholly-owned, operating subsidiary that are fully and unconditionally guaranteed by the parent company. Prior to the amendments, a parent guarantor was required to provide condensed consolidating financial information for so long as the guaranteed securities were outstanding. The requirements amend financial disclosures to allow summarized financial information, which may be presented on a combined basis, reducing the number of periods presented and permitting the disclosures to be provided outside the notes to the financial statements. The Company elected to apply the amended requirements for First Quarter 2020, and is no longer providing condensed consolidating financial information that resulted from the registered debt obligations of its subsidiaries that were disclosed in Part II, Item 8, Financial Statements and Supplementary Data, Note 25, Subsidiary Information, of the Company's 2019 Annual Report on Form 10-K.

Future Application of Accounting Standards

Targeted Improvements to the Accounting for Long-Duration Contracts

In August 2018, the Financial Accounting Standards Board (FASB) issued ASU 2018-12, Financial Services - Insurance (Topic 944): Targeted Improvements to the Accounting for Long-Duration Contracts.  The amendments in this ASU:

•
improve the timeliness of recognizing changes in the liability for future policy benefits and modify the rate used to discount future cash flows,

9

•
simplify and improve the accounting for certain market-based options or guarantees associated with deposit (or account balance) contracts,
•
simplify the amortization of deferred acquisition costs, and
•
improve the effectiveness of the required disclosures.

This ASU does not affect the Company’s financial guaranty insurance contracts, but may affect its accounting for certain specialty (non-financial guaranty) contracts. In October 2019, the FASB affirmed its decision to defer the effective date of the ASU to January 1, 2022. The Company does not plan to adopt this ASU until January 1, 2022, and does not expect this ASU to have a material effect on its condensed consolidated financial statements.

Simplification of the Accounting for Income Taxes

In December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes. The amendments in this ASU simplify the accounting for income taxes by removing certain exceptions and clarifying certain requirements regarding franchise taxes, goodwill, consolidated tax expenses and annual effective tax rate calculations. The ASU is effective for interim and annual periods beginning after December 15, 2020, with early adoption permitted. The Company is currently assessing the impact of this ASU on its consolidated financial statements.

Reference Rate Reform
    
In March 2020, the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting. This ASU provides optional guidance for a limited period of time to ease the potential burden in accounting for (or recognizing the effects of) contract modifications caused by reference rate reform. The new guidance provides optional expedients and exceptions for applying U.S. GAAP to contracts, hedging relationships, and other transactions affected by reference rate reform if certain criteria are met. The amendments apply only to contracts that reference the London Interbank Offered Rate (LIBOR) or another reference rate that is expected to be discontinued due to reference rate reform. This guidance is effective immediately, and the Company may elect to apply the amendments prospectively through December 31, 2022. The Company is evaluating the effect that this ASU will have on its consolidated financial statements.

2.    Ratings
 
The financial strength ratings (or similar ratings) for AGL’s insurance subsidiaries, along with the date of the most recent rating action (or confirmation) by the rating agency, are shown in the table below. Ratings are subject to continuous rating agency review and revision or withdrawal at any time. In addition, the Company periodically assesses the value of each rating assigned to each of its companies, and as a result of such assessment may request that a rating agency add or drop a rating from certain of its companies.

 
S&P Global Ratings, a division of Standard & Poor’s Financial Services LLC
 
Kroll Bond Rating
Agency
 
Moody’s Investors Service, Inc.
 
A.M. Best Company,
Inc.
AGM
AA (stable) (11/7/19)
 
AA+ (stable) (12/19/19)
 
A2 (stable) (8/13/19)
 
—
AGC
AA (stable) (11/7/19)
 
AA (stable) (11/22/19)
 
(1)
 
—
MAC
AA (stable) (11/7/19)
 
AA+ (stable) (3/4/20)
 
—
 
—
AG Re
AA (stable) (11/7/19)
 
—
 
—
 
—
AGRO
AA (stable) (11/7/19)
 
—
 
—
 
A+ (stable) (7/12/19)
AGE UK
AA (stable) (11/7/19)
 
AA+ (stable) (12/19/19)
 
A2 (stable) (8/13/19)
 
—
AGE SA
AA (stable) (1/29/20)
 
AA+ (stable) (1/21/20)
 
—
 
—
____________________
(1)
AGC requested that Moody’s Investors Service, Inc. (Moody’s) withdraw its financial strength ratings of AGC in January 2017, but Moody's denied that request. Moody’s continues to rate AGC A3 (stable).

There can be no assurance that any of the rating agencies will not take negative action on the financial strength ratings (or similar ratings) of AGL's insurance subsidiaries in the future or cease to rate one or more of AGL's insurance subsidiaries, either voluntarily or at the request of that subsidiary.

10

For a discussion of the effects of rating actions on the Company, see Note 6, Contracts Accounted for as Insurance, and Note 7, Reinsurance.

3.    Segment Information

The Company reports its results of operations consistent with the manner in which the Company's chief operating decision maker (CODM) reviews the business to assess performance and allocate resources. Prior to the acquisition of BlueMountain on October 1, 2019, the Company's operating subsidiaries were all insurance companies, and results of operations were viewed by the CODM as one segment. Beginning in the fourth quarter of 2019, with the acquisition of BlueMountain and expansion into the asset management business, the Company established the Assured Investment Management platform and now operates in two distinct segments, Insurance and Asset Management. The following describes the components of each segment, along with the Corporate division and Other categories. The Insurance and Asset Management segments are presented without giving effect to the consolidation of the financial guaranty (FG) VIEs and investment vehicles. See Note 12, Variable Interest Entities.

The Insurance segment primarily consists of the Company's domestic and foreign insurance subsidiaries and their wholly-owned subsidiaries that provide credit protection products to the U.S. and international public finance (including infrastructure) and structured finance markets. The Insurance segment also includes the income (loss) from its proportionate equity investments in funds managed in the Assured Investment Management platform (Assured Investment Management funds).
    
The Asset Management segment consists of the Company's Assured Investment Management platform subsidiaries, which provide asset management services to outside investors as well as to the Company's Insurance segment. The Asset Management segment presents reimbursable fund expenses netted in other operating expenses, whereas on the condensed consolidated statement of operations such reimbursable expenses are shown gross, as components of asset management fees and other operating expenses.

The Corporate division consists primarily of interest expense on the debt of AGUS and AGMH, as well as other operating expenses attributed to holding company activities, including administrative services performed by operating subsidiaries for the holding companies.

Other items consist of intersegment eliminations, reclassification of asset management reimbursable expenses, and consolidation adjustments, including the effect of consolidating FG VIEs and certain Assured Investment Management investment vehicles in which Insurance segment invests. See Note 12, Variable Interest Entities.
    
The Company does not report assets by reportable segment as the CODM does not use assets to assess performance and allocate resources and only reviews assets at a consolidated level.

Total adjusted operating income includes the effect of consolidating both FG VIEs and investment vehicles; however, the effect of consolidating such entities, including the related eliminations, is included in the "other" column in the tables below, which represents the CODM's view, consistent with the management approach guidance for presentation of segment metrics.


11

The Company analyzes the operating performance of each segment using "adjusted operating income." Results for each segment include specifically identifiable expenses as well as allocations of expenses between legal entities based on time studies and other cost allocation methodologies based on headcount or other metrics. Adjusted operating income is defined as net income (loss) attributable to AGL, as reported under GAAP, adjusted for the following:
 
1)
Elimination of realized gains (losses) on the Company’s investments, except for gains and losses on securities classified as trading.

2)
Elimination of non-credit-impairment unrealized fair value gains (losses) on credit derivatives that are recognized in net income, which is the amount of unrealized fair value gains (losses) in excess of the present value of the expected estimated economic credit losses, and non-economic payments.
 
3)
Elimination of fair value gains (losses) on the Company’s committed capital securities (CCS) that are recognized in net income.

4)
Elimination of foreign exchange gains (losses) on remeasurement of net premium receivables and loss and loss adjustment expense (LAE) reserves that are recognized in net income.

5)
Elimination of the tax effects related to the above adjustments, which are determined by applying the statutory tax rate in each of the jurisdictions that generate these adjustments.

The following tables present the Company's operations by operating segment. The information for the prior year has been conformed to the new segment presentation.

Segment Information

 
Three Months Ended March 31, 2020
 
Insurance
 
Asset Management
 
Corporate
 
Other
 
Total
 
(in millions)
Third-party revenues
$
193

 
$
16

 
$
(4
)
 
$
(15
)
 
$
190

Intersegment revenues
3

 
1

 
—

 
(4
)
 
—

Total revenues
196

 
17

 
(4
)
 
(19
)
 
190

Total expenses
84

 
28

 
35

 
(1
)
 
146

Income (loss) before income taxes and equity in net earnings of investees
112

 
(11
)
 
(39
)
 
(18
)
 
44

Equity in net earnings of investees
(9
)
 
—

 
(5
)
 
10

 
(4
)
Adjusted operating income (loss) before income taxes
103

 
(11
)
 
(44
)
 
(8
)
 
40

Provision (benefit) for income taxes
18

 
(2
)
 
(5
)
 
(1
)
 
10

Noncontrolling interests
—

 
—

 
—

 
(3
)
 
(3
)
Adjusted operating income (loss)
$
85

 
$
(9
)
 
$
(39
)
 
$
(4
)
 
$
33

 
 
 
 
 
 
 
 
 
 
Supplemental income statement information
 
 
 
 
 
 
 
 
 
Net investment income
$
83

 
$
—

 
$
1

 
$
(4
)
 
$
80

Interest expense
—

 
—

 
25

 
(3
)
 
22

Non-cash compensation and operating expenses (1)
9

 
3

 
3

 
—

 
15




12

 
Three Months Ended March 31, 2019
 
Insurance
 
Asset Management
 
Corporate
 
Other
 
Total
 
(in millions)
Third-party revenues
$
233

 
$
—

 
$
—

 
$
1

 
$
234

Intersegment revenues
1

 
—

 
—

 
(1
)
 
—

Total revenues
234

 
—

 
—

 
—

 
234

Total expenses
107

 
—

 
31

 
—

 
138

Income (loss) before income taxes and equity in net earnings of investees
127

 
—

 
(31
)
 
—

 
96

Equity in net earnings of investees
1

 
—

 
1

 
—

 
2

Adjusted operating income (loss) before income taxes
128

 
—

 
(30
)
 
—

 
98

Provision (benefit) for income taxes
17

 
—

 
(5
)
 
—

 
12

Noncontrolling interests
—

 
—

 
—

 
—

 
—

Adjusted operating income (loss)
$
111

 
$
—

 
$
(25
)
 
$
—

 
$
86

 
 
 
 
 
 
 
 
 
 
Supplemental income statement information
 
 
 
 
 
 
 
 
 
Net investment income
$
99

 
$
—

 
$
1

 
$
(2
)
 
$
98

Interest expense
—

 
—

 
24

 
(1
)
 
23

Non-cash compensation and operating expenses (1)
11

 
—

 
1

 
—

 
12

_____________________
(1)
Consists of amortization of deferred acquisition costs and intangible assets, depreciation and share-based compensation.

Reconciliation of Net Income (Loss) Attributable to AGL
to Adjusted Operating Income (Loss)

 
Three Months Ended March 31,
 
2020
 
2019
 
(in millions)
Net income (loss) attributable to AGL
$
(55
)
 
$
54

Less pre-tax adjustments:
 
 
 
Realized gains (losses) on investments
(5
)
 
(12
)
Non-credit impairment unrealized fair value gains (losses) on credit derivatives
(88
)
 
(28
)
Fair value gains (losses) on CCS
48

 
(9
)
Foreign exchange gains (losses) on remeasurement of premiums receivable and loss and LAE reserves
(57
)
 
9

Total pre-tax adjustments
(102
)
 
(40
)
Less tax effect on pre-tax adjustments
14

 
8

Adjusted operating income (loss)
$
33

 
$
86














13

Revenue by Country of Domicile

 
Three Months Ended March 31,
 
2020
 
2019
 
(in millions)
U.S.
$
150

 
$
182

Bermuda
34

 
44

U.K. and other
6

 
8

Total
$
190

 
$
234



The following table reconciles the Company's total consolidated revenues and expenses to segment revenues and expenses:

Reconciliation of Segment Revenues and Expenses

 
Three Months Ended March 31,
 
2020
 
2019
 
(in millions)
Revenues
 
 
 
Total consolidated revenues
$
96

 
$
195

Less: Realized gains (losses) on investments
(5
)
 
(12
)
Less: Non-credit impairment unrealized fair value gains (losses) on credit derivatives
(88
)
 
(28
)
Less: Fair value gains (losses) on CCS
48

 
(9
)
Less: Foreign exchange gains (losses) on remeasurement of premiums receivable and loss and LAE reserves
(57
)
 
9

Plus: Credit derivative impairment (recoveries) (1)
(8
)
 
(1
)
Total segment revenues
$
190

 
$
234

 
 
 
 
Expenses
 
 
 
Total consolidated expenses
$
154

 
$
139

Plus: Credit derivative impairment (recoveries) (1)
(8
)
 
(1
)
Total segment expenses
$
146

 
$
138

_____________________
(1)
Credit derivative impairment (recoveries) are included in "Net change in fair value of credit derivatives" in the Company's condensed consolidated statements of operations.

4.
Outstanding Insurance Exposure
 
The Company primarily sells credit protection contracts in financial guaranty insurance form. Until 2009, the Company also sold credit protection by issuing policies that guaranteed payment obligations under credit derivatives, primarily credit default swaps (CDS). The Company's contracts accounted for as credit derivatives are generally structured such that the circumstances giving rise to the Company’s obligation to make loss payments are similar to those for its financial guaranty insurance contracts. The Company has not entered into any new CDS in order to sell credit protection in the U.S. since the beginning of 2009, when regulatory guidelines were issued that limited the terms under which such protection could be sold. The capital and margin requirements applicable under the Dodd-Frank Wall Street Reform and Consumer Protection Act also contributed to the Company not entering into such new CDS in the U.S. since 2009. The Company has, however, acquired or reinsured portfolios both before and after 2009 that include financial guaranty contracts in credit derivative form.

The Company also writes specialty insurance that is consistent with its risk profile and benefits from its underwriting experience.


14

The Company seeks to limit its exposure to losses by underwriting obligations that it views as investment grade at inception, although on occasion it may underwrite new issuances that it views as below-investment-grade (BIG), typically as part of its loss mitigation strategy for existing troubled exposures. The Company also seeks to acquire portfolios of insurance from financial guarantors that are no longer writing new business by acquiring such companies, providing reinsurance on a portfolio of insurance or reassuming a portfolio of reinsurance it had previously ceded; in such instances, it evaluates the risk characteristics of the target portfolio, which may include some BIG exposures, as a whole in the context of the proposed transaction. The Company diversifies its insured portfolio across asset classes and, in the structured finance portfolio, typically requires subordination or collateral to protect it from loss. Reinsurance may be used in order to reduce net exposure to certain insured transactions.

     Public finance obligations insured by the Company primarily consist of general obligation bonds supported by the taxing powers of U.S. state or municipal governmental authorities, as well as tax-supported bonds, revenue bonds and other obligations supported by covenants from state or municipal governmental authorities or other municipal obligors to impose and collect fees and charges for public services or specific infrastructure projects. The Company also includes within public finance obligations those obligations backed by the cash flow from leases or other revenues from projects serving substantial public purposes, including utilities, toll roads, healthcare facilities and government office buildings. The Company also includes within public finance similar obligations issued by territorial and non-U.S. sovereign and sub-sovereign issuers and governmental authorities.

Structured finance obligations insured by the Company are generally issued by special purpose entities, including VIEs, and backed by pools of assets having an ascertainable cash flow or market value or other specialized financial obligations. Some of these VIEs are consolidated as described in Note 12, Variable Interest Entities. Unless otherwise specified, the outstanding par and debt service amounts presented in this note include outstanding exposures on VIEs whether or not they are consolidated. The Company also provides specialty insurance and reinsurance on transactions without special purpose entities but with risk profiles similar to those of its structured finance exposures written in financial guaranty form.

Second-to-pay insured par outstanding represents transactions the Company has insured that are already insured by another financial guaranty insurer and where the Company's obligation to pay under its insurance of such transactions arises only if both the obligor on the underlying insured obligation and the primary financial guaranty insurer default. The Company underwrites such transactions based on the underlying insured obligation without regard to the primary financial guaranty insurer and internally rates the transaction the higher of the rating of the underlying obligation and the rating of the primary financial guarantor. The second-to-pay insured par outstanding as of March 31, 2020 and December 31, 2019 was $6.2 billion and $6.6 billion, respectively. The par on second-to-pay exposure where the ratings of the primary financial guaranty insurer and underlying insured transaction are BIG was $100 million and $105 million as of March 31, 2020 and December 31, 2019, respectively.

Surveillance Categories
 
The Company segregates its insured portfolio into investment grade and BIG surveillance categories to facilitate the appropriate allocation of resources to monitoring and loss mitigation efforts and to aid in establishing the appropriate cycle for periodic review for each exposure. BIG exposures include all exposures with internal credit ratings below BBB-. The Company’s internal credit ratings are based on internal assessments of the likelihood of default and loss severity in the event of default. Internal credit ratings are expressed on a ratings scale similar to that used by the rating agencies and are generally reflective of an approach similar to that employed by the rating agencies, except that the Company's internal credit ratings focus on future performance rather than lifetime performance.
 
The Company monitors its insured portfolio and refreshes its internal credit ratings on individual exposures in quarterly, semi-annual or annual cycles based on the Company’s view of the exposure’s credit quality, loss potential, volatility and sector. Ratings on exposures in sectors identified as under the most stress or with the most potential volatility are reviewed every quarter, although the Company may also review a rating in response to developments impacting the credit when a ratings review is not scheduled. For assumed exposures, the Company may use the ceding company’s credit ratings of transactions where it is impractical for it to assign its own rating.
 
Exposures identified as BIG are subjected to further review to determine the probability of a loss. See Note 5, Expected Loss to be Paid, for additional information. Surveillance personnel then assign each BIG transaction to the appropriate BIG surveillance category based upon whether a future loss is expected and whether a claim has been paid. The Company uses a tax-equivalent yield to calculate the present value of projected payments and recoveries and determine whether a future loss is expected in order to assign the appropriate BIG surveillance category to a transaction. For financial statement measurement purposes, the Company uses risk-free rates, which are determined each quarter, to calculate the expected loss.

15

More extensive monitoring and intervention is employed for all BIG surveillance categories, with internal credit ratings reviewed quarterly. For purposes of determining the appropriate surveillance category, the Company expects “future losses” on a transaction when the Company believes there is at least a 50% chance that, on a present value basis, it will in the future pay claims on that transaction that will not be fully reimbursed. The three BIG categories are:
 
•
BIG Category 1: Below-investment-grade transactions showing sufficient deterioration to make future losses possible, but for which none are currently expected.
 
•
BIG Category 2: Below-investment-grade transactions for which future losses are expected but for which no claims (other than liquidity claims, which are claims that the Company expects to be reimbursed within one year) have yet been paid.
 
•
BIG Category 3: Below-investment-grade transactions for which future losses are expected and on which claims (other than liquidity claims) have been paid.

Unless otherwise noted, ratings disclosed herein on the Company's insured portfolio reflect its internal ratings. The Company classifies those portions of risks benefiting from reimbursement obligations collateralized by eligible assets held in trust in acceptable reimbursement structures as the higher of 'AA' or their current internal rating.

Impact of COVD-19 Pandemic
A novel coronavirus emerged in Wuhan, China in late 2019 and began to spread beyond China in early 2020. The virus is highly infectious and causes a coronavirus disease, COVID-19, that can be fatal. COVID-19 has been declared a pandemic by the World Health Organization, and its emergence and reactions to it, including various shelter-in-place guidelines and related restrictions, are having a profound effect on the global economy and financial markets. Because of the size and depth of the COVID-19 pandemic and its unknown course and duration, and evolving governmental and private responses to the pandemic, all of the direct and indirect consequences of COVID-19 are not yet known and may not emerge for some time. The Surveillance department is closely monitoring the insured portfolio, with emphasis on state and local governments and entities that were already experiencing significant budget deficits and pension funding and revenue shortfalls, as well as obligations supported by revenue streams most impacted by shelter-in-place guidelines and related restrictions or an economic downturn.

Financial Guaranty Exposure

The Company measures its financial guaranty exposure in terms of (a) gross and net par outstanding and (b) gross and net debt service.

The Company typically guarantees the payment of principal and interest when due. Since most of these payments are due in the future, the Company generally uses gross and net par outstanding as a proxy for its financial guaranty exposure. Gross par outstanding generally represents the principal amount of the insured obligation at a point in time. Net par outstanding equals gross par outstanding net of any third-party reinsurance. The Company includes in its par outstanding calculation the impact of any consumer price index inflator to the reporting date as well as, in the case of accreting (zero-coupon) obligations, accretion to the reporting date.

The Company purchases securities that it has insured, and for which it has expected losses to be paid, in order to
mitigate the economic effect of insured losses (loss mitigation securities). The Company excludes amounts attributable to loss mitigation securities from par and debt service outstanding, which amounts are included in the investment portfolio, because the Company manages such securities as investments and not insurance exposure. As of both March 31, 2020 and December 31, 2019, the Company excluded $1.4 billion, of net par attributable to loss mitigation securities.

Gross debt service outstanding represents the sum of all estimated future principal and interest payments on the obligations insured, on an undiscounted basis. Net debt service outstanding equals gross debt service outstanding net of any third-party reinsurance. Future debt service payments include the impact of any consumer price index inflator after the reporting date, as well as, in the case of accreting (zero-coupon) obligations, accretion after the reporting date.

The Company calculates its debt service outstanding as follows:

•
for insured obligations that are not supported by homogeneous pools of assets (which category includes most of the Company's public finance transactions), as the total estimated contractual future principal and interest due through maturity, regardless of whether the obligations may be called and regardless of whether, in the case of obligations

16

where principal payments are due when an underlying asset makes a principal payment, the Company believes the obligations will be repaid prior to contractual maturity; and

•
for insured obligations that are supported by homogeneous pools of assets that are contractually permitted to prepay principal (which category includes, for example, residential mortgage-backed securities (RMBS) and CLOs), as the total estimated expected future principal and interest due on insured obligations through their respective expected terms, which includes the Company's expectations as to whether the obligations may be called and, in the case of obligations where principal payments are due when an underlying asset makes a principal payment, when the Company expects principal payments to be made prior to contractual maturity.

The calculation of debt service requires the use of estimates, which the Company updates periodically, including estimates for the expected remaining term of insured obligations supported by homogeneous pools of assets, updated interest rates for floating and variable rate insured obligations, behavior of consumer price indices for obligations with consumer price index inflators, foreign exchange rates and other assumptions based on the characteristics of each insured obligation. The anticipated sunset of LIBOR at the end of 2021 has introduced another variable into the Company's calculation of future debt service. Debt service is a measure of the estimated maximum potential exposure to insured obligations before considering the Company’s various legal rights to the underlying collateral and other remedies available to it under its financial guaranty contract.

Actual debt service may differ from estimated debt service due to refundings, terminations, negotiated restructurings, prepayments, changes in interest rates on variable rate insured obligations, consumer price index behavior differing from that projected, changes in foreign exchange rates on non-U.S. dollar denominated insured obligations and other factors.

Financial Guaranty Portfolio
Debt Service Outstanding
 
 
Gross Debt Service
Outstanding
 
Net Debt Service
Outstanding
 
As of March 31, 2020
 
As of December 31, 2019
 
As of March 31, 2020
 
As of December 31, 2019
 
(in millions)
Public finance
$
353,984

 
$
363,497

 
$
353,031

 
$
362,361

Structured finance
11,372

 
12,279

 
10,862

 
11,769

Total financial guaranty
$
365,356

 
$
375,776

 
$
363,893

 
$
374,130




Financial Guaranty Portfolio
by Internal Rating
As of March 31, 2020

 
 
Public Finance
U.S.
 
Public Finance
Non-U.S.
 
Structured Finance
U.S
 
Structured Finance
Non-U.S
 
Total
Rating
Category
 
Net Par
Outstanding
 
%
 
Net Par
Outstanding
 
%
 
Net Par
Outstanding
 
%
 
Net Par
Outstanding
 
%
 
Net Par
Outstanding
 
%
 
 
(dollars in millions)
AAA
 
$
375

 
0.2
%
 
$
2,453

 
5.1
%
 
$
1,182

 
13.4
%
 
$
176

 
24.4
%
 
$
4,186

 
1.8
%
AA
 
19,037

 
11.0

 
4,921

 
10.1

 
3,753

 
42.7

 
35

 
4.8

 
27,746

 
12.0

A
 
92,788

 
53.7

 
14,621

 
30.1

 
1,031

 
11.7

 
172

 
23.8

 
108,612

 
47.0

BBB
 
54,965

 
31.8

 
25,743

 
53.0

 
1,110

 
12.6

 
298

 
41.3

 
82,116

 
35.6

BIG
 
5,630

 
3.3

 
837

 
1.7

 
1,730

 
19.6

 
41

 
5.7

 
8,238

 
3.6

Total net par outstanding
 
$
172,795

 
100.0
%

$
48,575


100.0
%

$
8,806


100.0
%

$
722


100.0
%

$
230,898


100.0
%




17

Financial Guaranty Portfolio
by Internal Rating
As of December 31, 2019 

 
 
Public Finance
U.S.
 
Public Finance
Non-U.S.
 
Structured Finance
U.S
 
Structured Finance
Non-U.S
 
Total
Rating
Category
 
Net Par
Outstanding
 
%
 
Net Par
Outstanding
 
%
 
Net Par
Outstanding
 
%
 
Net Par
Outstanding
 
%
 
Net Par
Outstanding
 
%
 
 
(dollars in millions)
AAA
 
$
381

 
0.2
%
 
$
2,541

 
5.0
%
 
$
1,258

 
13.5
%
 
$
181

 
23.8
%
 
$
4,361

 
1.8
%
AA
 
19,847

 
11.3

 
5,142

 
10.0

 
4,010

 
43.1

 
38

 
5.0

 
29,037

 
12.3

A
 
94,488

 
53.9

 
15,627

 
30.4

 
1,030

 
11.1

 
184

 
24.2

 
111,329

 
47.0

BBB
 
55,000

 
31.3

 
27,051

 
52.8

 
1,206

 
13.0

 
317

 
41.6

 
83,574

 
35.3

BIG
 
5,771

 
3.3

 
898

 
1.8

 
1,796

 
19.3

 
41

 
5.4

 
8,506

 
3.6

Total net par outstanding
 
$
175,487

 
100.0
%
 
$
51,259

 
100.0
%
 
$
9,300

 
100.0
%
 
$
761

 
100.0
%
 
$
236,807

 
100.0
%


    
In addition to amounts shown in the table above, the Company had outstanding commitments to provide guaranties of $444 million of gross par for public finance and $593 million of gross par of structured finance as of March 31, 2020. These commitments are contingent on the satisfaction of all conditions set forth in them and may expire unused or be canceled at the counterparty’s request. Therefore, the total commitment amount does not necessarily reflect actual future guaranteed amounts.

Financial Guaranty Portfolio
Components of BIG Net Par Outstanding
As of March 31, 2020

 
BIG Net Par Outstanding
 
Net Par
 
BIG 1
 
BIG 2
 
BIG 3
 
Total BIG
 
Outstanding
 
 
 
 
 
(in millions)
 
 
 
 
Public finance:
 
 
 
 
 
 
 
 
 
U.S. public finance
$
1,441

 
$
430

 
$
3,759

 
$
5,630

 
$
172,795

Non-U.S. public finance
793

 
—

 
44

 
837

 
48,575

Public finance
2,234

 
430

 
3,803

 
6,467

 
221,370

Structured finance:
 
 
 
 
 
 
 
 
 
U.S. RMBS
190

 
64

 
1,326

 
1,580

 
3,393

Life insurance transactions
—

 
—

 
40

 
40

 
1,788

Other structured finance
45

 
59

 
47

 
151

 
4,347

Structured finance
235

 
123

 
1,413

 
1,771

 
9,528

Total
$
2,469

 
$
553

 
$
5,216

 
$
8,238

 
$
230,898





18

Financial Guaranty Portfolio
Components of BIG Net Par Outstanding
As of December 31, 2019

 
BIG Net Par Outstanding
 
Net Par
 
BIG 1
 
BIG 2
 
BIG 3
 
Total BIG
 
Outstanding
 
 
 
 
 
(in millions)
 
 
 
 
Public finance:
 
 
 
 
 
 
 
 
 
U.S. public finance
$
1,582

 
$
430

 
$
3,759

 
$
5,771

 
$
175,487

Non-U.S. public finance
854

 
—

 
44

 
898

 
51,259

Public finance
2,436

 
430

 
3,803

 
6,669

 
226,746

Structured finance:
 
 
 
 
 
 
 
 
 
U.S. RMBS
162

 
74

 
1,382

 
1,618

 
3,546

Life insurance transactions
—

 
—

 
40

 
40

 
1,771

Other structured finance
69

 
62

 
48

 
179

 
4,744

Structured finance
231

 
136

 
1,470

 
1,837

 
10,061

Total
$
2,667

 
$
566

 
$
5,273

 
$
8,506

 
$
236,807




Financial Guaranty Portfolio
BIG Net Par Outstanding
and Number of Risks
As of March 31, 2020

 
 
Net Par Outstanding
 
Number of Risks (2)
Description
 
Financial
Guaranty
Insurance (1)
 
Credit
Derivative
 
Total
 
Financial
Guaranty
Insurance (1)
 
Credit
Derivative
 
Total
 
 
(dollars in millions)
BIG:
 
 

 
 

 
 

 
 

 
 

 
 

Category 1
 
$
2,380

 
$
89

 
$
2,469

 
109

 
7

 
116

Category 2
 
549

 
4

 
553

 
22

 
1

 
23

Category 3
 
5,183

 
33

 
5,216

 
128

 
6

 
134

Total BIG
 
$
8,112

 
$
126

 
$
8,238

 
259

 
14

 
273




19

 Financial Guaranty Portfolio
BIG Net Par Outstanding
and Number of Risks
As of December 31, 2019

 
 
Net Par Outstanding
 
Number of Risks (2)
Description
 
Financial
Guaranty
Insurance (1)
 
Credit
Derivative
 
Total
 
Financial
Guaranty
Insurance (1)
 
Credit
Derivative
 
Total
 
 
(dollars in millions)
BIG:
 
 

 
 

 
 

 
 

 
 

 
 

Category 1
 
$
2,600

 
$
67

 
$
2,667

 
121

 
6

 
127

Category 2
 
561

 
5

 
566

 
24

 
1

 
25

Category 3
 
5,216

 
57

 
5,273

 
131

 
7

 
138

Total BIG
 
$
8,377

 
$
129

 
$
8,506

 
276

 
14

 
290

_____________________
(1)    Includes VIEs.
 
(2)
A risk represents the aggregate of the financial guaranty policies that share the same revenue source for purposes of making debt service payments.   


Exposure to Puerto Rico
    
The Company had insured exposure to general obligation bonds of the Commonwealth of Puerto Rico (Puerto Rico or the Commonwealth) and various obligations of its related authorities and public corporations aggregating $4.3 billion net par as of March 31, 2020, all of which was rated BIG. Beginning on January 1, 2016, a number of Puerto Rico exposures have defaulted on bond payments, and the Company has now paid claims on all of its Puerto Rico exposures except for Puerto Rico Aqueduct and Sewer Authority (PRASA), Municipal Finance Agency (MFA) and University of Puerto Rico (U of PR).

On November 30, 2015 and December 8, 2015, the then governor of Puerto Rico issued executive orders (Clawback Orders) directing the Puerto Rico Department of Treasury and the Puerto Rico Tourism Company to "claw back" certain taxes pledged to secure the payment of bonds issued by the Puerto Rico Highways and Transportation Authority (PRHTA), Puerto Rico Infrastructure Financing Authority (PRIFA), and Puerto Rico Convention Center District Authority (PRCCDA). The Puerto Rico exposures insured by the Company subject to clawback are shown in the table “Puerto Rico Net Par Outstanding.”

On June 30, 2016, the Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA) was signed into law. PROMESA established a seven-member financial oversight board (Oversight Board) with authority to require that balanced budgets and fiscal plans be adopted and implemented by Puerto Rico. Title III of PROMESA provides for a process analogous to a voluntary bankruptcy process under chapter 9 of the United States Bankruptcy Code (Bankruptcy Code).

The Company believes that a number of the actions taken by the Commonwealth, the Oversight Board and others with respect to obligations the Company insures are illegal or unconstitutional or both, and has taken legal action, and may take additional legal action in the future, to enforce its rights with respect to these matters. In addition, the Commonwealth, the Oversight Board and others have taken legal action naming the Company as a party. See “Puerto Rico Litigation” below.

The Company also participates in mediation and negotiations relating to its Puerto Rico exposure. The COVID-19 pandemic and evolving governmental and private responses to the pandemic are impacting both Puerto Rico itself and the process of resolving the payment defaults of the Commonwealth and some of its related authorities and public corporations, including delaying related litigation, the various Title III proceedings, and other legal proceedings.

The final form and timing of responses to Puerto Rico’s financial distress, the devastation of Hurricane Maria and the COVID-19 pandemic and evolving governmental and private responses to the pandemic, eventually taken by the federal government or implemented under the auspices of PROMESA and the Oversight Board or otherwise, and the final impact on the Company, after resolution of legal challenges, of any such responses on obligations insured by the Company, are uncertain. The impact of developments relating to Puerto Rico during any quarter or year could be material to the Company's results of operations in that particular quarter or year.

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The Company groups its Puerto Rico exposure into three categories:

•
Constitutionally Guaranteed. The Company includes in this category public debt benefiting from Article VI of the Constitution of the Commonwealth, which expressly provides that interest and principal payments on the public debt are to be paid before other disbursements are made.

•
Public Corporations – Certain Revenues Potentially Subject to Clawback. The Company includes in this category the debt of public corporations for which applicable law permits the Commonwealth to claw back, subject to certain conditions and for the payment of public debt, at least a portion of the revenues supporting the bonds the Company insures. As a constitutional condition to clawback, available Commonwealth revenues for any fiscal year must be insufficient to pay Commonwealth debt service before the payment of any appropriations for that year. The Company believes that this condition has not been satisfied to date, and accordingly that the Commonwealth has not to date been entitled to claw back revenues supporting debt insured by the Company.

•
Other Public Corporations. The Company includes in this category the debt of public corporations that are supported by revenues it does not believe are subject to clawback.

Constitutionally Guaranteed

General Obligation. As of March 31, 2020, the Company had $1,253 million insured net par outstanding of the general obligations of Puerto Rico, which are supported by the good faith, credit and taxing power of the Commonwealth. Despite the requirements of Article VI of its Constitution, the Commonwealth defaulted on the debt service payment due on July 1, 2016, and the Company has been making claim payments on these bonds since that date. The Oversight Board has filed a petition under Title III of PROMESA with respect to the Commonwealth.

On May 9, 2019, the Oversight Board certified a revised fiscal plan for the Commonwealth. The revised certified Commonwealth fiscal plan indicates an expected primary budget surplus, if fiscal plan reforms are enacted, of $13.7 billion that would be available for debt service over the six-year forecast period ending 2024. The Company believes the available surplus set forth in the Oversight Board's revised certified fiscal plan (which assumes certain fiscal reforms are implemented by the Commonwealth) should be sufficient to cover contractual debt service of Commonwealth general obligation issuances and of authorities and public corporations directly implicated by the Commonwealth’s general fund during the forecast period. However, the revised certified Commonwealth fiscal plan indicates a net cumulative primary budget deficit through 2049, and there can be no assurance that the fiscal reforms will be enacted or, if they are, that the forecasted primary budget surplus will occur or, if it does, that such funds will be used to cover contractual debt service.

On May 4, 2020, the Commonwealth submitted to the Oversight Board for certification a further revised fiscal plan. The new draft plan contemplates a reduction in near term financial resources available for debt service as a result of efforts to contain the COVID-19 crisis, and a postponement of many of the Oversight Board’s previously announced reforms for the Commonwealth. The Oversight Board has in the past required changes to fiscal plans submitted by the Commonwealth before certifying them. The Company continues to disagree with the Commonwealth’s view of available resources.

On February 9, 2020, the Oversight Board announced it had entered into an amended general obligation Plan Support Agreement (Amended GO PSA) with certain general obligation (GO) and Puerto Rico Public Buildings Authority (PBA) bondholders representing approximately $8 billion of the aggregate amount of general obligation and PBA bond claims. The Amended GO PSA purports to provide a framework to address approximately $35 billion of Commonwealth debt (including PBA debt) and unsecured claims. The Company is not a party to that agreement and does not support it. 
 
The Amended GO PSA provides for different recoveries based on the bonds’ vintage issuance date, with GO and PBA bonds issued before 2011(Vintage) receiving higher recoveries than GO and PBA bonds issued in 2011 and thereafter (except that, for purposes of the Amended GO PSA, Series 2011A GO bonds would be treated as Vintage bonds). The recoveries for the GO bonds, by vintage issuance date, are set forth in the table included below. The differentiated recovery scheme provided under the Amended GO PSA is purportedly based on the Oversight Board’s attempt to invalidate the non-Vintage GO and PBA bonds (see “Puerto Rico Litigation” below). Under the Amended GO PSA, GO and PBA bondholders generally would receive newly issued Commonwealth GO bonds, Puerto Rico Sales Tax Financing Corporation (COFINA) junior lien bonds and cash equal to the amounts set out below, expressed as a percent of their outstanding pre-petition claims (which excludes post-petition accrued interest), based on the vintage issuance date of the bonds they hold.  In all cases, holders of GO/PBA bonds supporting the Amended GO PSA are also entitled to certain fees.


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General Obligation Bonds
 
Assured Guaranty Net Par Outstanding as of March 31, 2020
 
Assured Guaranty Total Net Principal Claims Paid as of March 31, 2020
 
Assured Guaranty Total Net Interest Claims Paid as of March 31, 2020
 
Base Recovery as a % of Pre-Petition Claims
 
 
(in millions)
 
(percent)
Vintage GO
 
$
669

 
$
383

 
$
165

 
74.9
%
2011 GO (Series D, E and PIB)
 
5

 
6

 
1

 
73.8

2011 GO (Series C)
 
210

 
—

 
48

 
70.4

2012 GO
 
369

 
—

 
72

 
69.9

2014 GO
 
—

 
—

 
—

 
65.4


On February 28, 2020, the Oversight Board filed with the Title III court an Amended Joint Plan of Adjustment of the Commonwealth (Amended POA) to restructure approximately $35 billion of debt (including the GO bonds) and other claims against the government of Puerto Rico and certain entities and $50 billion in pension obligations. The Amended POA includes the terms of the settlement relating to the GO bonds embodied in the Amended GO PSA. The Company believes the Amended POA, as currently constituted, does not comply with the laws and constitution of Puerto Rico and the provisions of PROMESA and does not satisfy the statutory requirements for confirmation of a plan of adjustment under Title III of PROMESA.

PBA. As of March 31, 2020, the Company had $140 million insured net par outstanding of PBA bonds, which are supported by a pledge of the rents due under leases of government facilities to departments, agencies, instrumentalities and municipalities of the Commonwealth, and that benefit from a Commonwealth guaranty supported by a pledge of the Commonwealth’s good faith, credit and taxing power. Despite the requirements of Article VI of its Constitution, the PBA defaulted on most of the debt service payment due on July 1, 2016, and the Company has been making claim payments on these bonds since then. On September 27, 2019, the Oversight Board filed a petition under Title III of PROMESA with respect to the PBA to allow the restructuring of the PBA claims through the Amended POA.

            Under the Amended GO PSA (which does not include the Company as a party and which the Company does not support), PBA bondholders generally would receive newly issued Commonwealth GO bonds, COFINA junior lien bonds and cash equal to the amounts set out below, expressed as a percent of their outstanding pre-petition claims (which excludes post-petition accrued interest), based on the vintage issuance date of the bonds they hold. In all cases, holders of PBA bonds supporting the Amended GO PSA are also entitled to certain fees.
    
PBA Bonds
 
Assured Guaranty Net Par Outstanding as of March 31, 2020
 
Assured Guaranty Total Net Principal Claims Paid as of March 31, 2020
 
Assured Guaranty Total Net Interest Claims Paid as of March 31, 2020
 
Base Recovery as a % of Pre-Petition Claims
 
 
(in millions)
 
(percent)
Vintage PBA
 
$
140

 
$
32

 
$
27

 
77.6
%
2011 PBA
 
—

 
—

 
—

 
76.8

2012 PBA
 
—

 
—

 
—

 
72.2


As noted above, on February 28, 2020, the Oversight Board filed with the Title III court an Amended POA to restructure approximately $35 billion of debt (including the PBA bonds) and other claims against the government of Puerto Rico and certain entities and $50 billion in pension obligations. The Amended POA includes the terms of the settlement relating to the PBA bonds embodied in the Amended GO PSA. The Company believes the Amended POA, as currently constituted, does not comply with the laws and constitution of Puerto Rico and the provisions of PROMESA and does not satisfy the statutory requirements for confirmation of a plan of adjustment under Title III of PROMESA.

Public Corporations - Certain Revenues Potentially Subject to Clawback

PRHTA. As of March 31, 2020, the Company had $811 million insured net par outstanding of PRHTA (transportation revenue) bonds and $454 million insured net par outstanding of PRHTA (highways revenue) bonds. The transportation revenue bonds are secured by a subordinate gross lien on gasoline and gas oil and diesel oil taxes, motor vehicle license fees and certain tolls, plus a first lien on up to $120 million annually of taxes on crude oil, unfinished oil and derivative products. The highways revenue bonds are secured by a gross lien on gasoline and gas oil and diesel oil taxes, motor vehicle license fees and certain tolls. The non-toll revenues consisting of excise taxes and fees collected by the Commonwealth on behalf of PRHTA and its bondholders that are statutorily allocated to PRHTA and its bondholders are potentially subject to clawback. Despite the

22

presence of funds in relevant debt service reserve accounts that the Company believes should have been employed to fund debt service, PRHTA defaulted on the full July 1, 2017 insured debt service payment, and the Company has been making claim payments on these bonds since that date. The Oversight Board has filed a petition under Title III of PROMESA with respect to PRHTA.

On June 5, 2019, the Oversight Board certified a revised fiscal plan for PRHTA. The revised certified PRHTA fiscal plan projects very limited capacity to pay debt service over the six-year forecast period.

PRCCDA. As of March 31, 2020, the Company had $152 million insured net par outstanding of PRCCDA bonds, which are secured by certain hotel tax revenues. These revenues are sensitive to the level of economic activity in the area and are potentially subject to clawback. There were sufficient funds in the PRCCDA bond accounts to make only partial payments on the July 1, 2017 PRCCDA bond payments guaranteed by the Company, and the Company has been making claim payments on these bonds since that date.

PRIFA. As of March 31, 2020, the Company had $16 million insured net par outstanding of PRIFA bonds, which are secured primarily by the return to PRIFA and its bondholders of a portion of federal excise taxes paid on rum. These revenues are potentially subject to the clawback. The Company has been making claim payments on the PRIFA bonds since January 2016.

Other Public Corporations

Puerto Rico Electric Power Authority (PREPA). As of March 31, 2020, the Company had $822 million insured net par outstanding of PREPA obligations, which are secured by a lien on the revenues of the electric system. The Company has been making claim payments on these bonds since July 1, 2017. On July 2, 2017, the Oversight Board commenced proceedings for PREPA under Title III of PROMESA. On June 27, 2019, the Oversight Board certified a revised fiscal plan for PREPA.

On May 3, 2019, AGM and AGC entered into a restructuring support agreement with PREPA (PREPA RSA) and other stakeholders, including a group of uninsured PREPA bondholders, the Commonwealth of Puerto Rico, and the Oversight Board, that is intended to, among other things, provide a framework for the consensual resolution of the treatment of the Company’s insured PREPA revenue bonds in PREPA's recovery plan. Upon consummation of the restructuring transaction, PREPA’s revenue bonds will be exchanged into new securitization bonds issued by a special purpose corporation and secured by a segregated transition charge assessed on electricity bills. The revised fiscal plan of PREPA certified by the Oversight Board on June 27, 2019 reflects the relevant terms of the PREPA RSA.

The closing of the restructuring transaction is subject to a number of conditions, including approval by the Title III Court of the PREPA RSA and settlement described therein, a minimum of 67% support of voting bondholders for a plan of adjustment that includes this proposed treatment of PREPA revenue bonds and confirmation of such plan by the Title III court, and execution of acceptable documentation and legal opinions. Under the PREPA RSA, the Company has the option to guarantee its allocated share of the securitization exchange bonds, which may then be offered and sold in the capital markets. The Company believes that the additive value created by attaching its guarantee to the securitization exchange bonds would materially improve its overall recovery under the transaction, as well as generate new insurance premiums; and therefore that its economic results could differ from those reflected in the PREPA RSA.

PRASA. As of March 31, 2020, the Company had $373 million of insured net par outstanding of PRASA bonds, which are secured by a lien on the gross revenues of the water and sewer system. On June 29, 2019, the Oversight Board certified a revised fiscal plan for PRASA. In July 2019, PRASA entered into a restructuring transaction with the federal government and the Oversight Board to restructure its subordinated loans from federal agencies that had been under forbearance for over three years (the PRASA Agreement). The PRASA Agreement extends the maturity of the loans for up to 40 years and provides for low interest rates and no interest accrual for the first ten years on a portion of the loans, but also places the subordinated loans on a parity with the PRASA bonds the Company guarantees.  The Company was not asked to consent to the PRASA Agreement. The PRASA Agreement reduces the amount of annual debt service owed by PRASA for its current debt. The PRASA bond accounts contained sufficient funds to make the PRASA bond payments due through the date of this filing that were guaranteed by the Company, and those payments were made in full.

MFA. As of March 31, 2020, the Company had $248 million net par outstanding of bonds issued by MFA secured by a lien on local property tax revenues. The MFA bond accounts contained sufficient funds to make the MFA bond payments due through the date of this filing that were guaranteed by the Company, and those payments were made in full.


23

U of PR. As of March 31, 2020, the Company had $1 million insured net par outstanding of U of PR bonds, which are general obligations of the university and are secured by a subordinate lien on the proceeds, profits and other income of the university, subject to a senior pledge and lien for the benefit of outstanding university system revenue bonds. As of the date of this filing, all debt service payments on U of PR bonds insured by the Company have been made.

Resolved Commonwealth Credit

COFINA. On February 12, 2019, pursuant to a plan of adjustment approved by the PROMESA Title III Court on February 4, 2019 (COFINA Plan of Adjustment), the Company paid off in full its its $273 million net par outstanding of insured COFINA bonds, plus accrued and unpaid interest. Pursuant to the COFINA Plan of Adjustment, the Company received $152 million in initial par of closed lien senior bonds of COFINA validated by the PROMESA Title III Court (COFINA Exchange Senior Bonds), along with cash. The total recovery (cash and COFINA Exchange Senior Bonds) represented 60% of the Company’s official Title III claim, which related to amounts owed as of the date COFINA entered Title III proceedings. The fair value of the COFINA Exchange Senior Bonds, excluding accrued interest, was $139 million at February 12, 2019, and was recorded as salvage received. During the third quarter of 2019 the Company sold all of its COFINA Exchange Senior Bonds.

Puerto Rico Litigation
 
The Company believes that a number of the actions taken by the Commonwealth, the Oversight Board and others with respect to obligations it insures are illegal or unconstitutional or both, and has taken legal action, and may take additional legal action in the future, to enforce its rights with respect to these matters. In addition, the Commonwealth, the Oversight Board and others have taken legal action naming the Company as party.

Currently, there are numerous legal actions relating to the default by the Commonwealth and certain of its entities on debt service payments, and related matters, and the Company is a party to a number of them. On July 24, 2019, Judge Laura Taylor Swain of the United States District Court for the District of Puerto Rico (Federal District Court for Puerto Rico) held an omnibus hearing on litigation matters relating to the Commonwealth. At that hearing, she imposed a stay through November 30, 2019, on a series of adversary proceedings and contested matters amongst the stakeholders and imposed mandatory mediation on all parties through that date. On October 28, 2019, Judge Swain extended the stay until December 31, 2019, and has since stayed the proceedings pending the Court's determination on the Commonwealth's plan of adjustment. Among the goals of the mediation is to reach an agreed-upon schedule for addressing the resolution of numerous issues, including, among others: (a) issues related to the validity, secured status and priority regarding bonds issued by the Commonwealth and certain of its entities; (b) the validity and impact of the Clawback Orders and other diversion of collateral securing certain bonds; (c) classification of claims; (d) constitutional issues; and (e) identification of essential services. A number of the legal actions in which the Company is involved remain subject to stay orders.

On January 7, 2016, AGM, AGC and Ambac Assurance Corporation commenced an action for declaratory judgment and injunctive relief in the Federal District Court for Puerto Rico to invalidate the executive orders issued on November 30, 2015 and December 8, 2015 by the then governor of Puerto Rico directing that the Secretary of the Treasury of the Commonwealth of Puerto Rico and the Puerto Rico Tourism Company claw back certain taxes and revenues pledged to secure the payment of bonds issued by the PRHTA, the PRCCDA and PRIFA. The Commonwealth defendants filed a motion to dismiss the action for lack of subject matter jurisdiction, which the court denied on October 4, 2016. On October 14, 2016, the Commonwealth defendants filed a notice of PROMESA automatic stay. While the PROMESA automatic stay expired on May 1, 2017, on May 17, 2017, the court stayed the action under Title III of PROMESA.

On June 3, 2017, AGC and AGM filed an adversary complaint in the Federal District Court for Puerto Rico seeking (i) a judgment declaring that the application of pledged special revenues to the payment of the PRHTA bonds is not subject to the PROMESA Title III automatic stay and that the Commonwealth has violated the special revenue protections provided to the PRHTA bonds under the Bankruptcy Code; (ii) an injunction enjoining the Commonwealth from taking or causing to be taken any action that would further violate the special revenue protections provided to the PRHTA bonds under the Bankruptcy Code; and (iii) an injunction ordering the Commonwealth to remit the pledged special revenues securing the PRHTA bonds in accordance with the terms of the special revenue provisions set forth in the Bankruptcy Code. On January 30, 2018, the court rendered an opinion dismissing the complaint and holding, among other things, that (x) even though the special revenue provisions of the Bankruptcy Code protect a lien on pledged special revenues, those provisions do not mandate the turnover of pledged special revenues to the payment of bonds and (y) actions to enforce liens on pledged special revenues remain stayed. A hearing on AGM and AGC’s appeal of the trial court’s decision to the United States Court of Appeals for the First Circuit (First Circuit) was held on November 5, 2018. On March 26, 2019, the First Circuit issued its opinion affirming the trial court’s decision and held that Sections 928(a) and 922(d) of the Bankruptcy Code permit, but do not require, continued payments

24

during the pendency of the Title III proceedings. The First Circuit agreed with the trial court that (i) Section 928(a) of the Bankruptcy Code does not mandate the turnover of special revenues or require continuity of payments to the PRHTA bonds during the pendency of the Title III proceedings, and (ii) Section 922(d) of the Bankruptcy Code is not an exception to the automatic stay that would compel PRHTA, or third parties holding special revenues, to apply special revenues to outstanding obligations. On April 9, 2019, AGM, AGC and other petitioners filed a petition with the First Circuit seeking a rehearing by the full court; the petition was denied by the First Circuit on July 31, 2019. On September 20, 2019, AGC, AGM and other petitioners filed a petition for review by the U.S. Supreme Court of the First Circuit's holding, which was denied on January 13, 2020.

On June 26, 2017, AGM and AGC filed a complaint in the Federal District Court for Puerto Rico seeking (i) a declaratory judgment that the PREPA restructuring support agreement executed in December 2015 (2015 PREPA RSA) is a “Preexisting Voluntary Agreement” under Section 104 of PROMESA and the Oversight Board’s failure to certify the 2015 PREPA RSA is an unlawful application of Section 601 of PROMESA; (ii) an injunction enjoining the Oversight Board from unlawfully applying Section 601 of PROMESA and ordering it to certify the 2015 PREPA RSA; and (iii) a writ of mandamus requiring the Oversight Board to comply with its duties under PROMESA and certify the 2015 PREPA RSA. On July 21, 2017, in light of its PREPA Title III petition on July 2, 2017, the Oversight Board filed a notice of stay under PROMESA.

On July 18, 2017, AGM and AGC filed in the Federal District Court for Puerto Rico a motion for relief from the automatic stay in the PREPA Title III bankruptcy proceeding and a form of complaint seeking the appointment of a receiver for PREPA. The court denied the motion on September 14, 2017, but on August 8, 2018, the First Circuit vacated and remanded the court's decision. On October 3, 2018, AGM and AGC, together with other bond insurers, filed a motion with the court to lift the automatic stay to commence an action against PREPA for the appointment of a receiver. Under the PREPA RSA, AGM and AGC have agreed to withdraw from the lift stay motion upon the Title III Court’s approval of the settlement of claims embodied in the PREPA RSA. The Oversight Board is required to file a status report by May 15, 2020 regarding PREPA's financial condition and its request for approval of the PREPA RSA settlement.

On May 23, 2018, AGM and AGC filed an adversary complaint in the Federal District Court for Puerto Rico seeking a judgment declaring that (i) the Oversight Board lacked authority to develop or approve the new fiscal plan for Puerto Rico which it certified on April 19, 2018 (Revised Fiscal Plan); (ii) the Revised Fiscal Plan and the Fiscal Plan Compliance Law (Compliance Law) enacted by the Commonwealth to implement the original Commonwealth Fiscal Plan violate various sections of PROMESA; (iii) the Revised Fiscal Plan, the Compliance Law and various moratorium laws and executive orders enacted by the Commonwealth to prevent the payment of debt service (a) are unconstitutional and void because they violate the Contracts, Takings and Due Process Clauses of the U.S. Constitution and (b) are preempted by various sections of PROMESA; and (iv) no Title III plan of adjustment based on the Revised Fiscal Plan can be confirmed under PROMESA. On August 13, 2018, the court-appointed magistrate judge granted the Commonwealth's and the Oversight Board's motion to stay this adversary proceeding pending a decision by the First Circuit in an appeal by Ambac Assurance Corporation of an unrelated adversary proceeding decision, which the First Circuit rendered on June 24, 2019. On July 24, 2019, Judge Swain announced a court-imposed stay of a series of adversary proceedings and contested matters through November 30, 2019, with a mandatory mediation element. Judge Swain extended the stay until December 31, 2019, and further extended the stay until March 11, 2020. Pursuant to the request of AGM, AGC and the defendants, Judge Swain ordered on September 6, 2019 that the claims in this complaint be addressed in the Commonwealth plan confirmation process and be subject to her July 24, 2019 stay and mandatory mediation order and be addressed in the Commonwealth plan confirmation process. Judge Swain postponed certain deadlines and hearings, including those related to the plan of adjustment, indefinitely as a result of the COVID-19 pandemic. The Oversight Board is required to file an updated status report by July 15, 2020 regarding the effects of the pandemic on the Commonwealth, including a proposal for the plan of adjustment and disclosure statement process.
   
On July 23, 2018, AGC and AGM filed an adversary complaint in the Federal District Court for Puerto Rico seeking a judgment (i) declaring the members of the Oversight Board are officers of the U.S. whose appointments were unlawful under the Appointments Clause of the U.S. Constitution; (ii) declaring void from the beginning the unlawful actions taken by the Oversight Board to date, including (x) development of the Commonwealth's Fiscal Plan, (y) development of PRHTA's Fiscal Plan, and (z) filing of the Title III cases on behalf of the Commonwealth and PRHTA; and (iii) enjoining the Oversight Board from taking any further action until the Oversight Board members have been lawfully appointed in conformity with the Appointments Clause of the U.S. Constitution. The Title III court dismissed a similar lawsuit filed by another party in the Commonwealth’s Title III case in July 2018. On August 3, 2018, a stipulated judgment was entered against AGM and AGC at their request based upon the court's July decision in the other Appointments Clause lawsuit and, on the same date, AGM and AGC appealed the stipulated judgment to the First Circuit. On August 15, 2018, the court consolidated, for purposes of briefing and oral argument, AGM and AGC's appeal with the other Appointments Clause lawsuit. The First Circuit consolidated AGM and AGC's appeal with a third Appointments Clause lawsuit on September 7, 2018 and held a hearing on December 3, 2018. On February 15, 2019, the First Circuit issued its ruling on the appeal and held that members of the Oversight Board were not

25

appointed in compliance with the Appointments Clause of the U.S. Constitution but declined to dismiss the Title III petitions citing the (i) de facto officer doctrine and (ii) negative consequences to the many innocent third parties who relied on the Oversight Board’s actions to date, as well as the further delay which would result from a dismissal of the Title III petitions. The case was remanded back to the Federal District Court for Puerto Rico for the appellants’ requested declaratory relief that the appointment of the board members of the Oversight Board is unconstitutional. The First Circuit delayed the effectiveness of its ruling for 90 days so as to allow the President and the Senate to validate the currently defective appointments or reconstitute the Oversight Board in accordance with the Appointments Clause. On April 23, 2019, the Oversight Board filed a petition for review by the U.S. Supreme Court of the First Circuit's holding that its members were not appointed in compliance with the Appointments Clause and on the following day filed a motion in the First Circuit to further stay the effectiveness of the First Circuit’s February 15, 2019 ruling pending final disposition by the U.S. Supreme Court. On May 24, 2019, AGC and AGM filed a petition for a review by the U.S. Supreme Court of the First Circuit’s holding that the de facto officer doctrine allows courts to deny meaningful relief to successful challengers suffering ongoing injury at the hands of unconstitutionally appointed officers. On July 2, 2019, the First Circuit granted the Oversight Board’s motion to stay the effectiveness of the First Circuit’s February 15, 2019 ruling pending final disposition by the U.S. Supreme Court. On October 15, 2019, the U.S. Supreme Court heard oral arguments on the First Circuit's ruling.

On December 21, 2018, the Oversight Board and the Official Committee of Unsecured Creditors of all Title III Debtors (other than COFINA) filed an adversary complaint in the Federal District Court for Puerto Rico seeking a judgment declaring that (i) the leases to public occupants entered into by the PBA are not “true leases” for purposes of Section 365(d)(3) of the Bankruptcy Code and therefore the Commonwealth has no obligation to make payments to the PBA under the leases or Section 365(d)(3) of the Bankruptcy Code, (ii) the PBA is not entitled to a priority administrative expense claim under the leases pursuant to Sections 503(b)(1) and 507(a)(2) of the Bankruptcy Code, and (iii) any such claims filed or asserted against the Commonwealth are disallowed. On January 28, 2019, the PBA filed an answer to the complaint. On March 12, 2019, the Federal District Court for Puerto Rico granted, with certain limitations, AGM’s and AGC’s motion to intervene. On March 21, 2019, AGM and AGC, together with certain other intervenors, filed a motion for judgment on the pleadings. On July 24, 2019, Judge Swain announced a court-imposed stay of a series of adversary proceedings and contested matters, which include this proceeding, through November 30, 2019, with a mandatory mediation element. Judge Swain extended the stay until December 31, 2019, and has since stayed these proceedings pending the Court's determination on the Commonwealth's plan of adjustment.

On January 14, 2019, the Oversight Board and the Official Committee of Unsecured Creditors filed an omnibus
objection in the Title III Court to claims filed by holders of approximately $6 billion of Commonwealth general obligation
bonds issued in 2012 and 2014, asserting among other things that such bonds were issued in violation of the Puerto Rico
constitutional debt service limit, such bonds are null and void, and the holders have no equitable remedy against the
Commonwealth. Pursuant to procedures established by Judge Swain, on April 10, 2019, AGM filed a notice of participation in
these proceedings. As of March 31, 2020, $369 million of the Company’s insured net par outstanding of the general
obligation bonds of Puerto Rico were issued on or after March 2012. On May 21, 2019, the Official Committee of Unsecured
Creditors filed a claim objection to certain Commonwealth general obligation bonds issued in 2011, approximately $215 million of which are insured by the Company as of March 31, 2020, on substantially the same bases as the January 14, 2019 filing, and which the plaintiffs propose to be subject to the proceedings relating to the 2012 and 2014 bonds. On July 24, 2019, Judge Swain announced a court-imposed stay of a series of adversary proceedings and contested matters, which include this proceeding, through November 30, 2019, with a mandatory mediation element. Judge Swain extended the stay until December 31, 2019, but did not further extend the stay with respect to this matter. On January 8, 2020, certain Commonwealth general obligation bondholders (self-styled as the Lawful Constitutional Debt Coalition) filed a claim objection to the 2012 and 2014 bonds, asserting among other things that those bonds were issued in violation of the Puerto Rico constitutional debt limit and are not entitled to first priority status under the Puerto Rico Constitution. Judge Swain stayed these proceedings pending the Court’s determination on the Commonwealth’s plan of adjustment.

On May 2, 2019, the Oversight Board and the Official Committee of Unsecured Creditors filed an adversary complaint in the Federal District Court for Puerto Rico against various Commonwealth general obligation bondholders and bond insurers, including AGC and AGM, that had asserted in their proofs of claim that their bonds are secured. The complaint seeks a judgment declaring that defendants do not hold consensual or statutory liens and are unsecured claimholders to the extent they hold allowed claims. The complaint also asserts that even if Commonwealth law granted statutory liens, such liens are avoidable under Section 545 of the Bankruptcy Code. On July 24, 2019, Judge Swain announced a court-imposed stay of a series of adversary proceedings and contested matters, which include this proceeding, through November 30, 2019, with a mandatory mediation element. Judge Swain has since stayed these proceedings pending the Court's determination on the Commonwealth's plan of adjustment.


26

On May 20, 2019, the Oversight Board and the Official Committee of Unsecured Creditors filed an adversary complaint in the Federal District Court for Puerto Rico against the fiscal agent and holders and/or insurers, including AGC and AGM, that have asserted their PRHTA bond claims are entitled to secured status in PRHTA’s Title III case. Plaintiffs are seeking to avoid the PRHTA bondholders’ liens and contend that (i) the scope of any lien only applies to revenues that have been both received by PRHTA and deposited in certain accounts held by the fiscal agent and does not include PRHTA’s right to receive such revenues; (ii) any lien on revenues was not perfected because the fiscal agent does not have “control” of all accounts holding such revenues; (iii) any lien on the excise tax revenues is no longer enforceable because any rights PRHTA had to receive such revenues are preempted by PROMESA; and (iv) even if PRHTA held perfected liens on PRHTA’s revenues and the right to receive such revenues, such liens were terminated by Section 552(a) of the Bankruptcy Code as of the petition date. On July 24, 2019, Judge Swain announced a court-imposed stay of a series of adversary proceedings and contested matters, which include this proceeding, through November 30, 2019, with a mandatory mediation element. Judge Swain extended the stay through December 31, 2019, and extended the stay again pending further order of the court on the understanding that these issues will be resolved in other proceedings.

On September 30, 2019, certain parties that either had advanced funds to PREPA for the purchase of fuel or had succeeded to such claims (Fuel Line Lenders) filed an amended adversary complaint in the Federal District Court for Puerto Rico against the Oversight Board, PREPA, the Puerto Rico Fiscal Agency and Financial Advisory Authority ("AAFAF"), U.S. Bank National Association, as trustee for PREPA bondholders, and various PREPA bondholders and bond insurers, including AGC and AGM. The complaint seeks, among other things, declarations that the advances made by the Fuel Line Lenders are Current Expenses as defined in the trust agreement pursuant to which the PREPA bonds were issued and there is no valid lien securing the PREPA bonds unless and until the Fuel Line Lenders are paid in full, as well as orders subordinating the PREPA bondholders’ lien and claim to the Fuel Line Lenders’ claims and declaring the PREPA RSA null and void. A hearing on a motion to dismiss is scheduled for June 2020.

On October 30, 2019, the retirement system for PREPA employees (SREAEE) filed an amended adversary complaint in the Federal District Court for Puerto Rico against the Oversight Board, PREPA, AAFAF, the Commonwealth, the Governor, and U.S. Bank National Association, as trustee for  PREPA bondholders. The complaint seeks, among other things, declarations that amounts owed to SREAEE are Current Expenses as defined in the trust agreement pursuant to which the PREPA bonds were issued, that there is no valid lien securing the PREPA bonds other than on amounts in the sinking funds and that SREAEE is a third-party beneficiary of certain trust agreement provisions, as well as orders subordinating the PREPA bondholders’ lien and claim to the SREAEE claims. On November 7, 2019, the court granted a motion to intervene by AGC and AGM. A hearing on the defendants’ motion to dismiss is scheduled for June 2020.

On January 16, 2020, AGM and AGC along with certain other monoline insurers filed in Federal District Court for Puerto Rico a motion (amending and superseding a motion filed by AGM and AGC on August 23, 2019) for relief from the automatic stay imposed pursuant to Title III of PROMESA to permit movants to enforce in another forum the application of the revenues securing the PRHTA Bonds (the PRHTA Revenues) or, in the alternative, for adequate protection for their property interests in PRHTA Revenues. A preliminary hearing on the motion is currently scheduled for June 4, 2020.

On January 16, 2020, the Financial Oversight and Management Board brought an adversary proceeding in the Federal District Court for Puerto Rico against AGM, AGC and other insurers of PRHTA Bonds, objecting to the bond insurers claims in the Commonwealth Title III proceedings and seeking to disallow such claims, among other reasons, as being duplicative of the master claims filed by the trustee, for lack of standing and for any assertions of secured status or property interests with respect to PRHTA Revenues.

On January 16, 2020, the Financial Oversight and Management Board, on behalf of the PRHTA, brought an adversary proceeding in the Federal District Court for Puerto Rico against AGM, AGC and other insurers of PRHTA Bonds, objecting to the bond insurers claims in the PRHTA Title III proceedings and seeking to disallow such claims, among other reasons, as being duplicative of the master claims filed by the trustee and for any assertions of secured status or property interests with respect to PRHTA Revenues.

On January 16, 2020, AGM and AGC along with certain other monoline insurers and the trustee for the PRIFA Rum Tax Bonds filed in Federal District Court for Puerto Rico a motion concerning application of the automatic stay to the revenues securing the PRIFA Bonds (the PRIFA Revenues), seeking an order lifting the automatic stay so that movants can enforce rights respecting the PRIFA Revenues in another forum or, in the alternative, that the Commonwealth must provide adequate protection for movants’ lien on the PRIFA Revenues. A preliminary hearing on the motion is scheduled for June 4, 2020.


27

On January 16, 2020, the Financial Oversight and Management Board brought an adversary proceeding in the Federal District Court for Puerto Rico against AGC and other insurers of PRIFA Bonds, objecting to the bond insurers claims and seeking to disallow such claims, among other reasons, as being duplicative of the master claims filed by the trustee, for lack of standing and for any assertions of secured status or ownership interests with respect to PRIFA Revenues.

On January 16, 2020, AGM and AGC along with certain other monoline insurers and the trustee for the PRCCDA Bonds filed in Federal District Court for Puerto Rico a motion concerning application of the automatic stay to the revenues securing the PRCCDA Bonds (the PRCCDA Revenues), seeking an order that an action to enforce rights respecting the PRCCDA Revenues in another forum is not subject to the automatic stay associated with the Commonwealth’s Title III proceeding or, in the alternative, if the court finds that the stay is applicable, lifting the automatic stay so that movants can enforce such rights in another forum or, in the further alternative, if the court finds the automatic stay applicable and does not lift it, that the Commonwealth must provide adequate protection for movants’ lien on the PRCCDA Revenues. A preliminary hearing on the motion is scheduled for June 4, 2020.

On January 16, 2020, the Financial Oversight and Management Board brought an adversary proceeding in the Federal District Court for Puerto Rico against AGC and other insurers of PRCCDA Bonds, objecting to the bond insurers claims and seeking to disallow such claims, among other reasons, as being duplicative of the master claims filed by the trustee and for any assertions of secured status or property interests with respect to PRCCDA Revenues.

Puerto Rico Par and Debt Service Schedules

All Puerto Rico exposures are internally rated BIG. The following tables show the Company’s insured exposure to general obligation bonds of Puerto Rico and various obligations of its related authorities and public corporations.

Puerto Rico
Gross Par and Gross Debt Service Outstanding

 
Gross Par Outstanding
 
Gross Debt Service Outstanding
 
As of March 31, 2020
 
As of December 31, 2019
 
As of March 31, 2020
 
As of December 31, 2019
 
(in millions)
Exposure to Puerto Rico
$
4,458

 
$
4,458

 
$
6,845

 
$
6,956




28

Puerto Rico
Net Par Outstanding

 
As of
March 31, 2020
 
As of
December 31, 2019
 
(in millions)
Commonwealth Constitutionally Guaranteed
 
 
 
Commonwealth of Puerto Rico - General Obligation Bonds (1)
$
1,253

 
$
1,253

PBA (1)
140

 
140

Public Corporations - Certain Revenues Potentially Subject to Clawback
 
 
 
PRHTA (Transportation revenue) (1)
811

 
811

PRHTA (Highways revenue) (1)
454

 
454

PRCCDA
152

 
152

PRIFA
16

 
16

Other Public Corporations
 
 
 
PREPA (1)
822

 
822

PRASA
373

 
373

MFA
248

 
248

U of PR
1

 
1

Total net exposure to Puerto Rico
$
4,270

 
$
4,270

____________________
(1)
As of the date of this filing, the Oversight Board has certified a filing under Title III of PROMESA for these exposures.

The following table shows the scheduled amortization of the insured general obligation bonds of Puerto Rico and various obligations of its related authorities and public corporations. The Company guarantees payments of interest and principal when those amounts are scheduled to be paid and cannot be required to pay on an accelerated basis. In the event that obligors default on their obligations, the Company would only be required to pay the shortfall between the principal and interest due in any given period and the amount paid by the obligors.


29

Amortization Schedule of Puerto Rico Net Par Outstanding
and Net Debt Service Outstanding
As of March 31, 2020

 
Scheduled Net Par Amortization
 
Scheduled Net Debt Service Amortization
 
(in millions)
2020 (April 1 - June 30)
$
—

 
$
3

2020 (July 1 - September 30)
286

 
392

2020 (October 1 - December 31)
—

 
3

Subtotal 2020
286

 
398

2021
149

 
351

2022
139

 
332

2023
205

 
392

2024
222

 
398

2025-2029
1,158

 
1,862

2030-2034
1,021

 
1,484

2035-2039
740

 
917

2040-2044
104

 
179

2045-2047
246

 
272

Total
$
4,270

 
$
6,585




Exposure to the U.S. Virgin Islands
 
As of March 31, 2020, the Company had $485 million insured net par outstanding to the U.S. Virgin Islands and its related authorities (USVI), of which it rated $219 million BIG. The $266 million USVI net par the Company rated investment grade primarily consisted of bonds secured by a lien on matching fund revenues related to excise taxes on products produced in the USVI and exported to the U.S., primarily rum. The $219 million BIG USVI net par consisted of (a) Public Finance Authority bonds secured by a gross receipts tax and the general obligation, full faith and credit pledge of the USVI and (b) bonds of the Virgin Islands Water and Power Authority secured by a net revenue pledge of the electric system.
 
Hurricane Irma caused significant damage in St. John and St. Thomas, while Hurricane Maria made landfall on St. Croix as a Category 4 hurricane on the Saffir-Simpson scale, causing loss of life and substantial damage to St. Croix’s businesses and infrastructure, including the power grid. The USVI is benefiting from the federal response to the 2017 hurricanes and has made its debt service payments to date.

Specialty Insurance and Reinsurance Exposure

The Company also provides specialty insurance and reinsurance on transactions with risk profiles similar to those of its structured finance exposures written in financial guaranty form. All specialty insurance and reinsurance exposures shown in the table below were rated investment grade internally as of December 31, 2019. As of March 31, 2020, $30 million of aircraft residual value insurance exposure was rated BIG.


30

Specialty Insurance and Reinsurance
Exposure

 
 
Gross Exposure
 
Net Exposure
 
 
As of
March 31, 2020
 
As of December 31, 2019
 
As of
March 31, 2020
 
As of December 31, 2019
 
 
(in millions)
Life insurance transactions (1)
 
$
1,091

 
$
1,046

 
$
940

 
$
898

Aircraft residual value insurance policies
 
393

 
398

 
238

 
243

Total
 
$
1,484

 
$
1,444

 
$
1,178

 
$
1,141

____________________
(1)
The life insurance transactions net exposure is projected to increase to approximately $1.0 billion by September 30, 2026.

5.
Expected Loss to be Paid
 
This note provides information regarding expected claim payments to be made under all contracts in the insured portfolio, regardless of the accounting model (insurance, derivative or VIE). The expected loss to be paid is equal to the present value of expected future cash outflows for claim and LAE payments, net of inflows for expected salvage and subrogation (and other recoveries including future payments by obligors pursuant to restructuring agreements, settlements or litigation judgments, excess spread on underlying collateral, and other estimated recoveries, including those from restructuring bonds and for breaches of representations and warranties (R&W)), using current risk-free rates.

Loss Estimation Process

The Company’s loss reserve committees estimate expected loss to be paid for all contracts by reviewing analyses that consider various scenarios with corresponding probabilities assigned to them. Depending upon the nature of the risk, the Company’s view of the potential size of any loss and the information available to the Company, that analysis may be based upon individually developed cash flow models, internal credit rating assessments, sector-driven loss severity assumptions and/or judgmental assessments. In the case of its assumed business, the Company may conduct its own analysis as just described or, depending on the Company’s view of the potential size of any loss and the information available to the Company, the Company may use loss estimates provided by ceding insurers. The Company monitors the performance of its transactions with expected losses and each quarter the Company’s loss reserve committees review and refresh their loss projection assumptions, scenarios and the probabilities they assign to those scenarios based on actual developments during the quarter and their view of future performance.
 
The financial guaranties issued by the Company insure the credit performance of the guaranteed obligations over an extended period of time, in some cases over 30 years, and in most circumstances the Company has no right to cancel such financial guaranties. As a result, the Company's estimate of ultimate loss on a policy is subject to significant uncertainty over the life of the insured transaction. Credit performance can be adversely affected by economic, fiscal and financial market variability over the life of most contracts.

The Company does not use traditional actuarial approaches to determine its estimates of expected losses. The determination of expected loss to be paid is an inherently subjective process involving numerous estimates, assumptions and judgments by management, using both internal and external data sources with regard to frequency, severity of loss, economic projections, governmental actions, negotiations and other factors that affect credit performance. These estimates, assumptions and judgments, and the factors on which they are based, may change materially over a reporting period, and as a result the Company’s loss estimates may change materially over that same period.

In some instances, the terms of the Company's policy give it the option to pay principal losses that have been recognized in the transaction but which it is not yet required to pay, thereby reducing the amount of guaranteed interest due in the future. The Company has sometimes exercised this option, which uses cash but reduces projected future losses.
    

31

The following tables present a roll forward of net expected loss to be paid for all contracts. The Company used risk-free rates for U.S. dollar denominated obligations that ranged from 0.00% to 1.39% with a weighted average of 0.64% as of March 31, 2020 and 0.00% to 2.45% with a weighted average of 1.94% as of December 31, 2019. Expected losses to be paid for transactions denominated in currencies other than the U.S. dollar represented approximately 3.9% and 3.2% of the total as of March 31, 2020 and December 31, 2019, respectively.

Net Expected Loss to be Paid
Roll Forward

 
First Quarter
 
2020
 
2019
 
(in millions)
Net expected loss to be paid, beginning of period
$
737

 
$
1,183

Economic loss development (benefit) due to:
 
 
 
Accretion of discount
4

 
8

Changes in discount rates
31

 
(4
)
Changes in timing and assumptions
(38
)
 
(6
)
Total economic loss development (benefit)
(3
)
 
(2
)
Net (paid) recovered losses
(74
)
 
(218
)
Net expected loss to be paid, end of period
$
660

 
$
963




Net Expected Loss to be Paid
Roll Forward by Sector
 
First Quarter 2020
 
Net Expected
Loss to be Paid/(Recovered) as of
December 31, 2019
 
Economic Loss
Development/ (Benefit)
 
(Paid)/
Recovered
Losses (1)
 
Net Expected
Loss to be Paid/(Recovered) as of
March 31, 2020
 
(in millions)
Public finance:
 
 
 
 
 
 
 
U.S. public finance
$
531

 
$
56

 
$
(94
)
 
$
493

Non-U.S. public finance
23

 
3

 
—

 
26

Public finance
554

 
59

 
(94
)
 
519

Structured finance:
 
 
 
 
 
 
 
U.S. RMBS
146

 
(63
)
 
21

 
104

Other structured finance
37

 
1

 
(1
)
 
37

Structured finance
183

 
(62
)
 
20

 
141

Total
$
737

 
$
(3
)
 
$
(74
)
 
$
660


32

 
First Quarter 2019
 
Net Expected
Loss to be
Paid/(Recovered) as of
December 31, 2018
 
Economic Loss
Development/ (Benefit)
 
(Paid)/
Recovered
Losses (1)
 
Net Expected
Loss to be
Paid/(Recovered) as of
March 31, 2019
 
(in millions)
Public finance:
 
 
 
 
 
 
 
U.S. public finance
$
832

 
$
62

 
$
(228
)
 
$
666

Non-U.S. public finance
32

 
(1
)
 
—

 
31

Public finance
864

 
61

 
(228
)
 
697

Structured finance:
 

 
 

 
 

 
 
U.S. RMBS
293

 
(65
)
 
9

 
237

Other structured finance
26

 
2

 
1

 
29

Structured finance
319

 
(63
)
 
10

 
266

Total
$
1,183

 
$
(2
)
 
$
(218
)
 
$
963

____________________
(1)
Net of ceded paid losses, whether or not such amounts have been settled with reinsurers. Ceded paid losses are typically settled 45 days after the end of the reporting period. Such amounts are recorded as reinsurance recoverable on paid losses in other assets. The amounts for First Quarter 2019 are net of the COFINA Exchange Senior Bonds and cash that were received pursuant to the COFINA Plan of Adjustment.

The tables above include (1) LAE paid of $3 million and $7 million for First Quarter 2020 and 2019, respectively, and (2) expected LAE to be paid of $30 million as of March 31, 2020 and $33 million as of December 31, 2019.


Net Expected Loss to be Paid (Recovered) and
Net Economic Loss Development (Benefit)
By Accounting Model

 
Net Expected Loss to be Paid/(Recovered)
 
Net Economic Loss Development/ (Benefit)
 
As of
March 31, 2020
 
As of
December 31, 2019
 
First Quarter 2020
 
First Quarter 2019
 
(in millions)
Insurance
$
609

 
$
683

 
$
(1
)
 
$
10

FG VIEs (See Note 12)
64

 
58

 
6

 
(10
)
Credit derivatives (See Note 10)
(13
)
 
(4
)
 
(8
)
 
(2
)
Total
$
660

 
$
737

 
$
(3
)
 
$
(2
)

Selected U.S. Public Finance Transactions
 
The Company insured general obligation bonds of the Commonwealth of Puerto Rico and various obligations of its related authorities and public corporations aggregating $4.3 billion net par as of March 31, 2020, all of which was BIG. For additional information regarding the Company's Puerto Rico exposure, see "Exposure to Puerto Rico" in Note 4, Outstanding Insurance Exposure.
    
On February 25, 2015, a plan of adjustment resolving the bankruptcy filing of the City of Stockton, California (the City) under chapter 9 of the Bankruptcy Code became effective. As of March 31, 2020, the Company’s net par subject to the plan consisted of $107 million of pension obligation bonds. As part of the plan of adjustment, the City will repay claims paid on the pension obligation bonds from certain fixed payments and certain variable payments contingent on the City’s revenue growth. 


33

The Company projects its total net expected loss across its troubled U.S. public finance exposures as of March 31, 2020, including those mentioned above, to be $493 million, compared with a net expected loss of $531 million as of December 31, 2019. The total net expected loss for troubled U.S. public finance exposures is net of a credit for estimated future recoveries of claims already paid. At March 31, 2020 that credit was $911 million compared with $819 million at December 31, 2019. The Company’s net expected losses incorporate management’s probability weighted estimates of possible scenarios. Each quarter, the Company may revise its scenarios, update assumptions and/or shift probability weightings of its scenarios based on public information as well as nonpublic information obtained through its surveillance and loss mitigation activities. Management assesses the possible implications of such information on each insured obligation, considering the unique characteristics of each transaction.

The economic loss development for U.S. public finance transactions was $56 million during First Quarter 2020, which was primarily attributable to Puerto Rico exposures. The loss development attributable to the Company’s Puerto Rico exposures reflects adjustments the Company made to the assumptions it uses in its scenarios based on the public information summarized under "Exposure to Puerto Rico" in Note 4, Outstanding Insurance Exposure as well as nonpublic information related to its loss mitigation activities during the period.

Selected Non - U.S. Public Finance Transactions
    
Expected loss to be paid for non-U.S. public finance transactions was $26 million as of March 31, 2020, compared with $23 million as of December 31, 2019, primarily consisting of: (i) an obligation backed by the availability and toll revenues of a major arterial road into a city in the U.K., which has been underperforming due to higher costs compared with expectations at underwriting, (ii) transactions with sub-sovereign exposure to various Spanish and Portuguese issuers where a Spanish and Portuguese sovereign default may cause the sub-sovereigns also to default, and (iii) an obligation backed by payments from a region in Italy, and for which the Company has been paying claims because of the impact of negative Euro Interbank Offered Rate (Euribor) on the transaction.

The economic loss development for non-U.S. public finance transactions, including those mentioned above, was approximately $3 million during First Quarter 2020 and primarily attributable to a weaker outlook of the performance of the U.K. road mentioned above.

U.S. RMBS Loss Projections
 
The Company projects losses on its insured U.S. RMBS on a transaction-by-transaction basis by projecting the performance of the underlying pool of mortgages over time and then applying the structural features (i.e., payment priorities and tranching) of the RMBS and any expected R&W recoveries/payables to the projected performance of the collateral over time. The resulting projected claim payments or reimbursements are then discounted using risk-free rates.

As of March 31, 2020, the Company had a net R&W payable of $106 million to R&W counterparties, compared with a net R&W payable of $53 million as of December 31, 2019. The Company’s agreements with providers of R&W generally provide for reimbursement to the Company as claim payments are made and, to the extent the Company later receives reimbursements of such claims from excess spread or other sources, for the Company to provide reimbursement to the R&W providers. When the Company projects receiving more reimbursements in the future than it projects to pay in claims on transactions covered by R&W settlement agreements, the Company will have a net R&W payable.

The Company's RMBS loss projection methodology assumes that the housing and mortgage markets will improve. Each period the Company makes a judgment as to whether to change the assumptions it uses to make RMBS loss projections based on its observation during the period of the performance of its insured transactions (including early-stage delinquencies, late-stage delinquencies and loss severity) as well as the residential property market and economy in general, and, to the extent it observes changes, it makes a judgment as to whether those changes are normal fluctuations or part of a trend. The assumptions that the Company uses to project RMBS losses are shown in the sections below.


34

Net Economic Loss Development (Benefit)
U.S. RMBS

 
First Quarter
 
2020
 
2019
 
(in millions)
First lien U.S. RMBS
$
(59
)
 
$
(31
)
Second lien U.S. RMBS
(4
)
 
(34
)


U.S. First Lien RMBS Loss Projections: Alt-A First Lien, Option ARM, Subprime and Prime

     The majority of projected losses in first lien RMBS transactions are expected to come from non-performing mortgage loans (those that are or in the past twelve months have been two or more payments behind, have been modified, are in foreclosure, or have been foreclosed upon). Changes in the amount of non-performing loans from the amount projected in the previous period are one of the primary drivers of loss projections in this portfolio. In order to determine the number of defaults resulting from these delinquent and foreclosed loans, the Company applies a liquidation rate assumption to loans in each of various non-performing categories. The Company arrived at its liquidation rates based on data purchased from a third party provider and assumptions about how delays in the foreclosure process and loan modifications may ultimately affect the rate at which loans are liquidated. Each quarter the Company reviews the most recent twelve months of this data and (if necessary) adjusts its liquidation rates based on its observations. The following table shows liquidation assumptions for various non-performing categories.


35

First Lien Liquidation Rates

 
As of March 31, 2020
 
As of December 31, 2019
Delinquent/Modified in the Previous 12 Months
 
 
 
Alt-A and Prime
20%
 
20%
Option ARM
20
 
20
Subprime
20
 
20
30 – 59 Days Delinquent
 
 
 
Alt-A and Prime
30
 
30
Option ARM
30
 
35
Subprime
35
 
35
60 – 89 Days Delinquent
 
 
 
Alt-A and Prime
40
 
40
Option ARM
45
 
45
Subprime
45
 
45
90+ Days Delinquent
 
 
 
Alt-A and Prime
55
 
55
Option ARM
55
 
55
Subprime
50
 
50
Bankruptcy
 
 
 
Alt-A and Prime
45
 
45
Option ARM
50
 
50
Subprime
40
 
40
Foreclosure
 
 
 
Alt-A and Prime
65
 
65
Option ARM
65
 
65
Subprime
55
 
60
Real Estate Owned
 
 
 
All
100
 
100


    
While the Company uses liquidation rates as described above to project defaults of non-performing loans (including current loans modified or delinquent within the last 12 months), it projects defaults on presently current loans by applying a conditional default rate (CDR) trend. The start of that CDR trend is based on the defaults the Company projects will emerge from currently nonperforming, recently nonperforming and modified loans. The total amount of expected defaults from the non-performing loans is translated into a constant CDR (i.e., the CDR plateau), which, if applied for each of the next 36 months, would be sufficient to produce approximately the amount of defaults that were calculated to emerge from the various delinquency categories. The CDR thus calculated individually on the delinquent collateral pool for each RMBS is then used as the starting point for the CDR curve used to project defaults of the presently performing loans.
 
In the most heavily weighted scenario (the base case), after the initial 36-month CDR plateau period, each transaction’s CDR is projected to improve over 12 months to an intermediate CDR (calculated as 20% of its CDR plateau); that intermediate CDR is held constant and then steps to a final CDR of 5% of the CDR plateau. In the base case, the Company assumes the final CDR will be reached 3.25 years after the initial 36-month CDR plateau period. Under the Company’s methodology, defaults projected to occur in the first 36 months represent defaults that can be attributed to loans that were modified or delinquent in the last 12 months or that are currently delinquent or in foreclosure, while the defaults projected to occur using the projected CDR trend after the first 36-month period represent defaults attributable to borrowers that are currently performing or are projected to reperform.

     Another important driver of loss projections is loss severity, which is the amount of loss the transaction incurs on a loan after the application of net proceeds from the disposal of the underlying property. Loss severities experienced in first lien

36

transactions had reached historically high levels, and the Company is assuming in the base case that the still elevated levels generally will continue for another 18 months. The Company determines its initial loss severity based on actual recent experience. Each quarter the Company reviews available data and (if necessary) adjusts its severities based on its observations. The Company then assumes that loss severities begin returning to levels consistent with underwriting assumptions beginning after the initial 18-month period, declining to 40% in the base case over 2.5 years.
 
The following table shows the range as well as the average, weighted by outstanding net insured par, for key assumptions used in the calculation of expected loss to be paid for individual transactions for vintage 2004 - 2008 first lien U.S. RMBS.

Key Assumptions in Base Case Expected Loss Estimates
First Lien RMBS
 
 
As of
March 31, 2020
 
As of
December 31, 2019
 
Range
 
Weighted Average
 
Range
 
Weighted Average
Alt-A First Lien
 
 
 
 
 
 
 
 
 
 
 
Plateau CDR
0.0
%
-
8.3%
 
4.0%
 
0.3
%
-
8.4%
 
4.1%
Final CDR
0.0
%
-
0.4%
 
0.2%
 
0.0
%
-
0.4%
 
0.2%
Initial loss severity:
 
 
 
 
 
2005 and prior
60%
 
 
 
60%
 
 
2006
70%
 
 
 
70%
 
 
2007+
70%
 
 
 
70%
 
 
Option ARM
 
 
 
 
 
 
 
Plateau CDR
1.7
%
-
7.7%
 
5.0%
 
1.8
%
-
8.4%
 
5.4%
Final CDR
0.1
%
-
0.4%
 
0.3%
 
0.1
%
-
0.4%
 
0.3%
Initial loss severity:
 
 
 
 
 
2005 and prior
60%
 
 
 
60%
 
 
2006
60%
 
 
 
60%
 
 
2007+
70%
 
 
 
70%
 
 
Subprime
 
 
 
 
 
 
 
 
 
 
 
Plateau CDR
1.9
%
-
17.8%
 
5.4%
 
1.6
%
-
18.1%
 
5.6%
Final CDR
0.1
%
-
0.9%
 
0.3%
 
0.1
%
-
0.9%
 
0.3%
Initial loss severity:
 
 
 
 
 
2005 and prior
75%
 
 
 
75%
 
 
2006
75%
 
 
 
75%
 
 
2007+
75%
 
 
 
75%
 
 


 
The rate at which the principal amount of loans is voluntarily prepaid may impact both the amount of losses projected (since that amount is a function of the CDR, the loss severity and the loan balance over time) as well as the amount of excess spread (the amount by which the interest paid by the borrowers on the underlying loan exceeds the amount of interest owed on the insured obligations). The assumption for the voluntary conditional prepayment rate (CPR) follows a similar pattern to that of the CDR. The current level of voluntary prepayments is assumed to continue for the plateau period before gradually increasing over 12 months to the final CPR, which is assumed to be 15% in the base case. For transactions where the initial CPR is higher than the final CPR, the initial CPR is held constant and the final CPR is not used. These CPR assumptions are the same as those the Company used for December 31, 2019.
 
In estimating expected losses, the Company modeled and probability weighted sensitivities for first lien transactions by varying its assumptions of how fast a recovery is expected to occur. One of the variables used to model sensitivities was how quickly the CDR returned to its modeled equilibrium, which was defined as 5% of the initial CDR. The Company also

37

stressed CPR and the speed of recovery of loss severity rates. The Company probability weighted a total of five scenarios as of March 31, 2020 and December 31, 2019.
    
Total expected loss to be paid on all first lien U.S. RMBS was $110 million and $166 million as of March 31, 2020 and December 31, 2019, respectively. The $59 million economic benefit in First Quarter 2020 for first lien U.S. RMBS was primarily attributable to higher excess spread on certain transactions supported by large portions of fixed rate assets (either originally fixed or modified to be fixed) and with insured floating rate debt linked to LIBOR, which decreased in First Quarter 2020. The Company used a similar approach to establish its pessimistic and optimistic scenarios as of March 31, 2020 as it used as of December 31, 2019, increasing and decreasing the periods of stress from those used in the base case. LIBOR may be discontinued, and it is not yet clear how this will impact the calculation of the various interest rates in this portfolio referencing LIBOR. The economic development attributable to changes in discount rates was a loss of $25 million in First Quarter 2020.

In the Company's most stressful scenario where loss severities were assumed to rise and then recover over nine years and the initial ramp-down of the CDR was assumed to occur over 15 months, expected loss to be paid would increase from current projections by approximately $46 million for all first lien U.S. RMBS transactions.

In the Company's least stressful scenario where the CDR plateau was six months shorter (30 months, effectively assuming that liquidation rates would improve) and the CDR recovery was more pronounced (including an initial ramp-down of the CDR over nine months), expected loss to be paid would decrease from current projections by approximately $49 million for all first lien U.S. RMBS transactions.

U.S. Second Lien RMBS Loss Projections
 
Second lien RMBS transactions include both home equity lines of credit (HELOC) and closed end second lien mortgages. The Company believes the primary variable affecting its expected losses in second lien RMBS transactions is the amount and timing of future losses or recoveries in the collateral pool supporting the transactions. Expected losses are also a function of the structure of the transaction, the CPR of the collateral, the interest rate environment and assumptions about loss severity.
 
In second lien transactions, the projection of near-term defaults from currently delinquent loans is relatively straightforward because loans in second lien transactions are generally “charged off” (treated as defaulted) by the securitization’s servicer once the loan is 180 days past due. The Company estimates the amount of loans that will default over the next six months by calculating current representative liquidation rates. Similar to first liens, the Company then calculates a CDR for six months, which is the period over which the currently delinquent collateral is expected to be liquidated. That CDR is then used as the basis for the plateau CDR period that follows the embedded plateau losses.
    
For the base case scenario, the CDR (the plateau CDR) was held constant for six months. Once the plateau period has ended, the CDR is assumed to gradually trend down in uniform increments to its final long-term steady state CDR. (The long-term steady state CDR is calculated as the constant CDR that would have yielded the amount of losses originally expected at underwriting.) In the base case scenario, the time over which the CDR trends down to its final CDR is 28 months. Therefore, the total stress period for second lien transactions is 34 months, representing six months of delinquent loan liquidations, followed by 28 months of decrease to the steady state CDR, the same as of December 31, 2019.

HELOC loans generally permit the borrower to pay only interest for an initial period (often ten years) and, after that period, require the borrower to make both the monthly interest payment and a monthly principal payment. This causes the borrower's total monthly payment to increase, sometimes substantially, at the end of the initial interest-only period. In the prior periods, as the HELOC loans underlying the Company's insured HELOC transactions reached their principal amortization period, the Company incorporated an assumption that a percentage of loans reaching their principal amortization periods would default around the time of the payment increase.

The HELOC loans underlying the Company's insured HELOC transactions are now past their original interest-only reset date, although a significant number of HELOC loans were modified to extend the original interest-only period for another five years. As a result, the Company does not apply a CDR increase when such loans reach their principal amortization period. In addition, based on the average performance history, the Company applies a CDR floor of 2.5% for the future steady state CDR on all its HELOC transactions.

When a second lien loan defaults, there is generally a low recovery. The Company assumed, as of March 31, 2020 and December 31, 2019, that it will generally recover 2% of future defaulting collateral at the time of charge-off, with additional amounts of post charge-off recoveries projected to come in over time. A second lien on the borrower’s home may be retained in

38

the Company's second lien transactions after the loan is charged off and the loss applied to the transaction, particularly in cases where the holder of the first lien has not foreclosed. If the second lien is retained and the value of the home increases, the servicer may be able to use the second lien to increase recoveries, either by arranging for the borrower to resume payments or by realizing value upon the sale of the underlying real estate. The Company evaluates its assumptions periodically based on actual recoveries of charged-off loans observed from period to period. In instances where the Company is able to obtain information on the lien status of charged-off loans, it assumes there will be a certain level of future recoveries of the balance of the charged-off loans where the second lien is still intact. The Company projects future recoveries on these charged-off loans at the rate shown in the table below. Such recoveries are assumed to be received evenly over the next five years. Increasing the recovery rate to 30% would result in an economic benefit of $55 million, while decreasing the recovery rate to 10% would result in an economic loss of $55 million. 
 
The rate at which the principal amount of loans is prepaid may impact both the amount of losses projected as well as the amount of excess spread. In the base case, an average CPR (based on experience of the past year) is assumed to continue until the end of the plateau before gradually increasing to the final CPR over the same period the CDR decreases. The final CPR is assumed to be 15% for second lien transactions (in the base case), which is lower than the historical average but reflects the Company’s continued uncertainty about the projected performance of the borrowers in these transactions. For transactions where the initial CPR is higher than the final CPR, the initial CPR is held constant and the final CPR is not used. This pattern is consistent with how the Company modeled the CPR as of December 31, 2019. To the extent that prepayments differ from projected levels it could materially change the Company’s projected excess spread and losses.
 
In estimating expected losses, the Company modeled and probability weighted five scenarios, each with a different CDR curve applicable to the period preceding the return to the long-term steady state CDR. The Company believes that the level of the elevated CDR and the length of time it will persist and the ultimate prepayment rate are the primary drivers behind the amount of losses the collateral will likely suffer.

The Company continues to evaluate the assumptions affecting its modeling results. The Company believes the most important driver of its projected second lien RMBS losses is the performance of its HELOC transactions. Total expected recovery on all second lien U.S. RMBS was $6 million as of March 31, 2020 and $20 million as of December 31, 2019. The economic benefit for second lien U.S. RMBS was $4 million in First Quarter 2020, primarily attributable to higher actual recoveries for previously charged-off loans and improved performance.

The following table shows the range as well as the average, weighted by net par outstanding, for key assumptions used in the calculation of expected loss to be paid for individual transactions for vintage 2004 - 2008 HELOCs.

Key Assumptions in Base Case Expected Loss Estimates
HELOCs

 
As of
March 31, 2020
 
As of
December 31, 2019
 
Range
 
Weighted Average
 
Range
 
Weighted Average
Plateau CDR
4.1
%
-
23.3%
 
9.6%
 
5.9
%
-
24.6%
 
9.5%
Final CDR trended down to
2.5
%
-
3.2%
 
2.5%
 
2.5
%
-
3.2%
 
2.5%
Liquidation rates:
 
 
 
 
 
 
 
 
 
 
 
Delinquent/Modified in the Previous 12 Months
20%
 
 
 
20%
 
 
30 – 59 Days Delinquent
30
 
 
 
30
 
 
60 – 89 Days Delinquent
45
 
 
 
45
 
 
90+ Days Delinquent
65
 
 
 
65
 
 
Bankruptcy
55
 
 
 
55
 
 
Foreclosure
55
 
 
 
55
 
 
Real Estate Owned
100
 
 
 
100
 
 
Loss severity (1)
98%
 
 
 
98%
 
 
Projected future recoveries on previously charged-off loans
20%
 
 
 
20%
 
 

___________________
(1)    Loss severities on future defaults.


39

The Company’s base case assumed a six-month CDR plateau and a 28 month ramp-down (for a total stress period of 34 months). The Company also modeled a scenario with a longer period of elevated defaults and another with a shorter period of elevated defaults. In the Company's most stressful scenario, increasing the CDR plateau to eight months and increasing the ramp-down by three months to 31 months (for a total stress period of 39 months) would increase the expected loss by approximately $6 million for HELOC transactions. On the other hand, in the Company's least stressful scenario, reducing the CDR plateau to four months and decreasing the length of the CDR ramp-down to 25 months (for a total stress period of 29 months), and lowering the ultimate prepayment rate to 10% would decrease the expected loss by approximately $6 million for HELOC transactions.

Other Structured Finance
 
The Company projected that its total net expected loss across its troubled other structured finance exposures as of March 31, 2020 was $37 million and is primarily attributable to $80 million in BIG net par of student loan securitizations issued by private issuers that are classified as structured finance. In general, the projected losses of these transactions are due to: (i) the poor credit performance of private student loan collateral and high loss severities, or (ii) high interest rates on auction rate securities with respect to which the auctions have failed.

The Company also had exposure to troubled life insurance transactions. As of March 31, 2020, the Company's BIG net par in these transactions was $40 million.

The economic loss development during First Quarter 2020 was $1 million.

Recovery Litigation

In the ordinary course of their respective businesses, certain of AGL's subsidiaries are involved in litigation with third parties to recover insurance losses paid in prior periods or prevent losses in the future. The impact, if any, of these and other proceedings on the amount of recoveries the Company receives and losses it pays in the future is uncertain, and the impact of any one or more of these proceedings during any quarter or year could be material to the Company's results of operations in that particular quarter or year.

    The Company has asserted claims in a number of legal proceedings in connection with its exposure to Puerto Rico. See Note 4, Outstanding Insurance Exposure, for a discussion of the Company's exposure to Puerto Rico and related recovery litigation being pursued by the Company.

6.
Contracts Accounted for as Insurance

Premiums

The portfolio of outstanding exposures discussed in Note 4, Outstanding Insurance Exposure, and Note 5, Expected Loss to be Paid, includes contracts that are accounted for as insurance contracts, derivatives, and consolidated FG VIEs. Amounts presented in this note relate only to contracts accounted for as insurance. See Note 10, Contracts Accounted for as Credit Derivatives for amounts that relate to CDS and Note 12, Variable Interest Entities for amounts that are accounted for as consolidated FG VIEs.


40

Net Earned Premiums
 
 
First Quarter
 
2020
 
2019
 
(in millions)
Financial guaranty:
 
 
 
Scheduled net earned premiums
$
82

 
$
87

Accelerations from refundings and terminations
15

 
26

Accretion of discount on net premiums receivable
5

 
4

Financial guaranty insurance net earned premiums
102

 
117

Specialty net earned premiums
1

 
1

  Net earned premiums (1)
$
103

 
$
118

 ___________________
(1)
Excludes $1 million and $3 million for First Quarter 2020 and 2019, respectively, related to consolidated FG VIEs.

Gross Premium Receivable,
Net of Commissions on Assumed Business
Roll Forward 

 
First Quarter
 
2020
 
2019
 
(in millions)
Beginning of year
$
1,286

 
$
904

Less: Specialty insurance premium receivable
2

 
1

Financial guaranty insurance premiums receivable
1,284

 
903

Gross written premiums on new business, net of commissions
67

 
41

Gross premiums received, net of commissions
(60
)
 
(54
)
Adjustments:
 
 
 
Changes in the expected term
(4
)
 
(4
)
Accretion of discount, net of commissions on assumed business
3

 
1

Foreign exchange gain (loss) on remeasurement
(58
)
 
9

Financial guaranty insurance premium receivable (1)
1,232

 
896

Specialty insurance premium receivable
1

 
1

March 31,
$
1,233


$
897

____________________
(1)
Excludes $7 million and $8 million as of March 31, 2020 and March 31, 2019, respectively, related to consolidated FG VIEs.

Approximately 78% of installment premiums at both March 31, 2020 and December 31, 2019 are denominated in currencies other than the U.S. dollar, primarily the pound sterling and euro.
 
The timing and cumulative amount of actual collections may differ from those of expected collections in the table below due to factors such as foreign exchange rate fluctuations, counterparty collectability issues, accelerations, commutations, changes in expected lives and new business.


41

Expected Collections of
Financial Guaranty Insurance Gross Premiums Receivable,
Net of Commissions on Assumed Business
(Undiscounted)

 
As of
March 31, 2020
 
(in millions)
2020 (April 1 - June 30)
$
50

2020 (July 1 - September 30)
36

2020 (October 1 - December 31)
18

2021
90

2022
92

2023
80

2024
78

2025-2029
337

2030-2034
235

2035-2039
149

After 2039
338

Total (1)
$
1,503

 ____________________
(1)
Excludes expected cash collections on consolidated FG VIEs of $8 million.

The timing and cumulative amount of actual net earned premiums may differ from those of expected net earned premiums in the table below due to factors such as accelerations, commutations, changes in expected lives and new business.

Scheduled Financial Guaranty Insurance Net Earned Premiums

 
As of
March 31, 2020
 
(in millions)
2020 (April 1 - June 30)
$
80

2020 (July 1 - September 30)
78

2020 (October 1 - December 31)
76

Subtotal 2020
234

2021
287

2022
265

2023
246

2024
229

2025-2029
914

2030-2034
641

2035-2039
376

After 2039
507

Net deferred premium revenue (1)
3,699

Future accretion
262

Total future net earned premiums
$
3,961

 ____________________
(1)
Excludes net earned premiums on consolidated FG VIEs of $46 million.


42

Selected Information for Financial Guaranty Insurance
Policies with Premiums Paid in Installments
 
As of
March 31, 2020
 
As of
December 31, 2019
 
(dollars in millions)
Premiums receivable, net of commission payable
$
1,232

 
$
1,284

Gross deferred premium revenue
1,635

 
1,637

Weighted-average risk-free rate used to discount premiums
1.7
%
 
1.7
%
Weighted-average period of premiums receivable (in years)
13.2

 
13.3



Financial Guaranty Insurance Losses

The following table provides information on net reserve (salvage), which includes loss and LAE reserves and salvage and subrogation recoverable, both net of reinsurance. To discount loss reserves, the Company used risk-free rates for U.S. dollar denominated financial guaranty insurance obligations that ranged from 0.00% to 1.39% with a weighted average of 0.64% as of March 31, 2020 and 0.00% to 2.45% with a weighted average of 1.94% as of December 31, 2019.

Net Reserve (Salvage) 

 
As of
March 31, 2020
 
As of
December 31, 2019
 
(in millions)
Public finance:
 
 
 
U.S. public finance
$
291

 
$
328

Non-U.S. public finance
5

 
5

Public finance
296

 
333

Structured finance:
 
 
 
U.S. RMBS (1)
(110
)
 
(78
)
Other structured finance
40

 
40

Structured finance
(70
)
 
(38
)
Total
$
226

 
$
295

____________________
(1)
Excludes net reserves of $35 million and $33 million as of March 31, 2020 and December 31, 2019, respectively, related to consolidated FG VIEs.
Components of Net Reserves (Salvage)
 
 
As of
March 31, 2020
 
As of
December 31, 2019
 
(in millions)
Loss and LAE reserve
$
1,050

 
$
1,050

Reinsurance recoverable on unpaid losses (1)
(35
)
 
(38
)
Loss and LAE reserve, net
1,015

 
1,012

Salvage and subrogation recoverable
(820
)
 
(747
)
Salvage and subrogation reinsurance payable (2)
31

 
30

Salvage and subrogation recoverable, net, and other recoverable
(789
)
 
(717
)
Net reserves (salvage)
$
226

 
$
295

____________________
(1)
Recorded as a component of other assets in the condensed consolidated balance sheets.

(2)
Recorded as a component of other liabilities in the condensed consolidated balance sheets.


43

The table below provides a reconciliation of net expected loss to be paid to net expected loss to be expensed. Expected loss to be paid differs from expected loss to be expensed due to: (i) the contra-paid which represents the claim payments made and recoveries received that have not yet been recognized in the statement of operations, (ii) salvage and subrogation recoverable for transactions that are in a net recovery position where the Company has not yet received recoveries on claims previously paid (and therefore recognized in income but not yet received), and (iii) loss reserves that have already been established (and therefore expensed but not yet paid).

Reconciliation of Net Expected Loss to be Paid and
Net Expected Loss to be Expensed
Financial Guaranty Insurance Contracts

 
As of
March 31, 2020
 
(in millions)
Net expected loss to be paid - financial guaranty insurance
$
607

Contra-paid, net
44

Salvage and subrogation recoverable, net, and other recoverable
789

Loss and LAE reserve - financial guaranty insurance contracts, net of reinsurance
(1,013
)
Net expected loss to be expensed (present value) (1)
$
427

____________________
(1)    Excludes $33 million as of March 31, 2020, related to consolidated FG VIEs.

The following table provides a schedule of the expected timing of net expected losses to be expensed. The amount and timing of actual loss and LAE may differ from the estimates shown below due to factors such as accelerations, commutations, changes in expected lives and updates to loss estimates. This table excludes amounts related to FG VIEs, which are eliminated in consolidation.
 
Net Expected Loss to be Expensed
Financial Guaranty Insurance Contracts 

 
As of
March 31, 2020
 
(in millions)
2020 (April 1 - June 30)
$
9

2020 (July 1 - September 30)
9

2020 (October 1 - December 31)
9

Subtotal 2020
27

2021
35

2022
35

2023
33

2024
32

2025-2029
134

2030-2034
90

2035-2039
32

After 2039
9

Net expected loss to be expensed
427

Future accretion
59

Total expected future loss and LAE
$
486

 


44

The following table presents the loss and LAE recorded in the condensed consolidated statements of operations by sector for insurance contracts. Amounts presented are net of reinsurance.

Loss and LAE
Reported on the
Condensed Consolidated Statements of Operations
  
 
Loss (Benefit)
 
First Quarter
 
2020
 
2019
 
(in millions)
Public finance:
 
 
 
U.S. public finance
$
59

 
$
70

Non-U.S. public finance
—

 
—

Public finance
59

 
70

Structured finance:
 
 
 
U.S. RMBS (1)
(42
)
 
(27
)
Other structured finance
3

 
3

Structured finance
(39
)
 
(24
)
Loss and LAE
$
20

 
$
46


____________________
(1)
Excludes a loss of $6 million and a benefit of $1 million for First Quarter 2020 and 2019 respectively, related to consolidated FG VIEs.

The following tables provide information on financial guaranty insurance contracts categorized as BIG.
 
Financial Guaranty Insurance
BIG Transaction Loss Summary
As of March 31, 2020
 
 
BIG  Categories
 
BIG 1
 
BIG 2
 
BIG 3
 
Total
BIG, Net
 
Effect of
Consolidating
FG VIEs
 
Total
 
Gross
 
Ceded
 
Gross
 
Ceded
 
Gross
 
Ceded
 
 
 
 
(dollars in millions)
Number of risks (1)
109

 
(6
)
 
22

 
—

 
128

 
(7
)
 
259

 
—

 
259

Remaining weighted-average period (in years)
7.7

 
5.0

 
16.9

 
—

 
9.5

 
8.0

 
9.5

 
—

 
9.5

Outstanding exposure:
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Par
$
2,433

 
$
(53
)
 
$
549

 
$
—

 
$
5,353

 
$
(170
)
 
$
8,112

 
$
—

 
$
8,112

Interest
980

 
(15
)
 
459

 
—

 
2,351

 
(64
)
 
3,711

 
—

 
3,711

Total (2)
$
3,413

 
$
(68
)
 
$
1,008

 
$
—

 
$
7,704

 
$
(234
)
 
$
11,823

 
$
—

 
$
11,823

Expected cash outflows (inflows)
$
163

 
$
(3
)
 
$
77

 
$
—

 
$
3,984

 
$
(128
)
 
$
4,093

 
$
(260
)
 
$
3,833

Potential recoveries (3)
(629
)
 
21

 
(5
)
 
—

 
(2,846
)
 
105

 
(3,354
)
 
187

 
(3,167
)
Subtotal
(466
)
 
18

 
72

 
—

 
1,138

 
(23
)
 
739

 
(73
)
 
666

Discount
21

 
—

 
(12
)
 
—

 
(76
)
 
(1
)
 
(68
)
 
9

 
(59
)
Present value of expected cash flows
$
(445
)
 
$
18

 
$
60

 
$
—

 
$
1,062

 
$
(24
)
 
$
671

 
$
(64
)
 
$
607

Deferred premium revenue
$
144

 
$
(1
)
 
$
25

 
$
—

 
$
466

 
$
(4
)
 
$
630

 
$
(46
)
 
$
584

Reserves (salvage)
$
(480
)
 
$
18

 
$
42

 
$
—

 
$
701

 
$
(22
)
 
$
259

 
$
(35
)
 
$
224

 

45

Financial Guaranty Insurance
BIG Transaction Loss Summary
As of December 31, 2019
 
 
BIG Categories
 
BIG 1
 
BIG 2
 
BIG 3
 
Total
BIG, Net
 
Effect of
Consolidating
FG VIEs
 
Total
 
Gross
 
Ceded
 
Gross
 
Ceded
 
Gross
 
Ceded
 
 
(dollars in millions)
Number of risks (1)
121

 
(6
)
 
24

 
—

 
131

 
(7
)
 
276

 
—

 
276

Remaining weighted-average period (in years)
8.0

 
5.2

 
17.0

 
—

 
9.7

 
8.3

 
9.7

 
—

 
9.7

Outstanding exposure:
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Par
$
2,654

 
$
(54
)
 
$
561

 
$
—

 
$
5,386

 
$
(170
)
 
$
8,377

 
$
—

 
$
8,377

Interest
1,149

 
(15
)
 
481

 
—

 
2,507

 
(73
)
 
4,049

 
—

 
4,049

Total (2)
$
3,803

 
$
(69
)
 
$
1,042

 
$
—

 
$
7,893

 
$
(243
)
 
$
12,426

 
$
—

 
$
12,426

Expected cash outflows (inflows)
$
135

 
$
(3
)
 
$
84

 
$
—

 
$
4,185

 
$
(132
)
 
$
4,269

 
$
(264
)
 
$
4,005

Potential recoveries (3)
(598
)
 
21

 
(10
)
 
—

 
(2,926
)
 
107

 
(3,406
)
 
189

 
(3,217
)
Subtotal
(463
)
 
18

 
74

 
—

 
1,259

 
(25
)
 
863

 
(75
)
 
788

Discount
54

 
(1
)
 
(21
)
 
—

 
(151
)
 
(3
)
 
(122
)
 
17

 
(105
)
Present value of expected cash flows
$
(409
)
 
$
17

 
$
53

 
$
—

 
$
1,108

 
$
(28
)
 
$
741

 
$
(58
)
 
$
683

Deferred premium revenue
$
142

 
$
(1
)
 
$
34

 
$
—

 
$
480

 
$
(4
)
 
$
651

 
$
(48
)
 
$
603

Reserves (salvage)
$
(441
)
 
$
17

 
$
35

 
$
—

 
$
742

 
$
(25
)
 
$
328

 
$
(33
)
 
$
295

____________________
(1)
A risk represents the aggregate of the financial guaranty policies that share the same revenue source for purposes of making debt service payments. The ceded number of risks represents the number of risks for which the Company ceded a portion of its exposure.

(2)
Includes amounts related to FG VIEs.

(3)
Represents expected inflows for future payments by obligors pursuant to restructuring agreements, settlements or litigation judgments, excess spread on any underlying collateral and other estimated recoveries. Potential recoveries also include recoveries on certain investment grade credits, related mainly to exposures that were previously BIG and for which claims have been paid in the past.


Ratings Impact on Financial Guaranty Business
 
A downgrade of one of AGL’s insurance subsidiaries may result in increased claims under financial guaranties issued by the Company if counterparties exercise contractual rights triggered by the downgrade against insured obligors, and the insured obligors are unable to pay. See Part II, Item 8, Financial Statements and Supplementary Data, Note 7, Contracts Accounted for as Insurance, of the Company’s Annual Report on Form 10-K for the year ended December 31, 2019.

7.
Reinsurance
 
The Company assumes exposure (Assumed Business) from third party insurers, primarily other monoline financial guaranty companies that currently are in runoff and no longer actively writing new business (Legacy Monoline Insurers), and may cede portions of exposure it has insured (Ceded Business) in exchange for premiums, net of any ceding commissions. The Company, if required, secures its reinsurance obligations to these Legacy Monoline Insurers, typically by depositing in trust assets with a market value equal to its assumed liabilities calculated on a U.S. statutory basis.

Substantially all of the Company’s Assumed Business and Ceded Business relates to financial guaranty business, except for a modest amount that relates to AGRO's specialty business. The Company historically entered into, and with respect to new business originated by AGRO continues to enter into, ceded reinsurance contracts in order to obtain greater business diversification and reduce the net potential loss from large risks.


46

Financial Guaranty Business
 
The Company’s facultative and treaty assumed agreements with the Legacy Monoline Insurers are generally subject to termination at the option of the ceding company:

•
if the Company fails to meet certain financial and regulatory criteria;

•
if the Company fails to maintain a specified minimum financial strength rating; or

•
upon certain changes of control of the Company.
 
Upon termination due to one of the above events, the Company typically would be required to return to the ceding company unearned premiums (net of ceding commissions) and loss reserves, calculated on a U.S. statutory basis, attributable to the Assumed Business (plus in certain cases, an additional required amount), after which the Company would be released from liability with respect to such business.

As of March 31, 2020, if each third party company ceding business to any of the Company's insurance subsidiaries had a right to recapture such business, and chose to exercise such right, the aggregate amounts that AG Re and AGC could be required to pay to all such companies would be approximately $41 million and $254 million, respectively.

The Company has ceded financial guaranty business to non-affiliated companies to limit its exposure to risk. The Company remains primarily liable for all risks it directly underwrites and is required to pay all gross claims. It then seeks reimbursement from the reinsurer for its proportionate share of claims. The Company may be exposed to risk for this exposure if it were required to pay the gross claims and not be able to collect ceded claims from an assuming company experiencing financial distress. The Company’s ceded contracts generally allow the Company to recapture ceded financial guaranty business after certain triggering events, such as reinsurer downgrades.

In April 2020, the Company reassumed $336 million in par from its largest remaining legacy third party financial guaranty reinsurer. This represents 27% of the Company's ceded financial guaranty par outstanding as of March 31, 2020.

Specialty Business

The Company, through AGRO, assumes specialty business from third party insurers (Assumed Specialty Business). It also cedes and retrocedes some of its specialty business to third party reinsurers. A downgrade of AGRO’s financial strength rating by S&P Global Ratings, a division of Standard & Poor's Financial Services LLC (S&P) below "A" would require AGRO to post, as of March 31, 2020, an estimated $0.1 million of collateral in respect of certain of its Assumed Specialty Business. A further downgrade of AGRO’s S&P rating below A- would give the company ceding such business the right to recapture the business for AGRO’s collateral amount, and, if also accompanied by a downgrade of AGRO's financial strength rating by A.M. Best Company, Inc. below A-, would also require AGRO to post, as of March 31, 2020, an estimated $13 million of collateral in respect of a different portion of AGRO’s Assumed Specialty Business. AGRO’s ceded/retroceded contracts generally have equivalent provisions requiring the assuming reinsurer to post collateral and/or allowing AGRO to recapture the ceded/retroceded business upon certain triggering events, such as reinsurer rating downgrades.


47

Effect of Reinsurance

The following table presents the components of premiums and losses reported in the condensed consolidated statements of operations and the contribution of the Company's Assumed and Ceded Businesses (both financial guaranty and specialty).

Effect of Reinsurance on Statement of Operations

 
First Quarter
 
2020
 
2019
 
 
Premiums Written:
 
 
 
Direct
$
64

 
$
39

Assumed
—

 
—

Ceded (1)
—

 
15

Net
$
64

 
$
54

Premiums Earned:
 
 
 
Direct
$
94

 
$
105

Assumed
10

 
15

Ceded
(1
)
 
(2
)
Net
$
103

 
$
118

Loss and LAE:
 
 
 
Direct
$
8

 
$
54

Assumed
12

 
1

Ceded
—

 
(9
)
Net
$
20

 
$
46

____________________
(1)
Positive ceded premiums written were due to terminations and changes in expected debt service schedules.

Ceded Reinsurance (1)

 
As of
March 31, 2020
 
As of
December 31, 2019
 
(in millions)
Ceded premium payable, net of commissions
$
19

 
$
20

Ceded expected loss to be recovered (paid)
7

 
11

Financial guaranty ceded par outstanding (2)
1,255

 
1,349

Specialty ceded exposure (see Note 4)
306

 
303

____________________
(1)
The total collateral posted by all non-affiliated reinsurers required to post, or that had agreed to post, collateral as of March 31, 2020 and December 31, 2019 was approximately $67 million and $68 million, respectively. Such collateral is posted (i) in the case of certain reinsurers not authorized or "accredited" in the U.S., in order for the Company to receive credit for the liabilities ceded to such reinsurers in statutory financial statements, and (ii) in the case of certain reinsurers authorized in the U.S., on terms negotiated with the Company.

(2)
Of the total par ceded to unrated or BIG rated reinsurers, $223 million and $224 million is rated BIG as of March 31, 2020 and December 31, 2019, respectively.


48

8.
Fair Value Measurement
 
The Company carries a significant portion of its assets and liabilities at fair value. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (i.e., exit price). The price represents the price available in the principal market for the asset or liability. If there is no principal market, then the price is based on a hypothetical market that maximizes the value received for an asset or minimizes the amount paid for a liability (i.e., the most advantageous market).
 
Fair value is based on quoted market prices, where available. If listed prices or quotes are not available, fair value is based on either internally developed models that primarily use, as inputs, market-based or independently sourced market parameters, including but not limited to yield curves, interest rates and debt prices or with the assistance of an independent third party using a discounted cash flow approach and the third party’s proprietary pricing models. In addition to market information, models also incorporate transaction details, such as maturity of the instrument and contractual features designed to reduce the Company’s credit exposure, such as collateral rights as applicable.

Valuation adjustments may be made to ensure that financial instruments are recorded at fair value. These adjustments include amounts to reflect counterparty credit quality, the Company’s creditworthiness and constraints on liquidity. As markets and products develop and the pricing for certain products becomes more or less transparent, the Company may refine its methodologies and assumptions. During First Quarter 2020, no changes were made to the Company’s valuation models that had, or are expected to have, a material impact on the Company’s condensed consolidated balance sheets or statements of operations and comprehensive income.
 
The Company’s methods for calculating fair value produce a fair value that may not be indicative of net realizable value or reflective of future fair values. The use of different methodologies or assumptions to determine fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.
 
The categorization within the fair value hierarchy is determined based on whether the inputs to valuation techniques used to measure fair value are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect Company estimates of market assumptions. The fair value hierarchy prioritizes model inputs into three broad levels as follows, with Level 1 being the highest and Level 3 the lowest. An asset's or liability’s categorization is based on the lowest level of significant input to its valuation.

Level 1—Quoted prices for identical instruments in active markets. The Company generally defines an active market as a market in which trading occurs at significant volumes. Active markets generally are more liquid and have a lower bid-ask spread than an inactive market.
 
Level 2—Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and observable inputs other than quoted prices, such as interest rates or yield curves and other inputs derived from or corroborated by observable market inputs.
 
Level 3—Model derived valuations in which one or more significant inputs or significant value drivers are unobservable. Financial instruments are considered Level 3 when their values are determined using pricing models, discounted cash flow methodologies or similar techniques and at least one significant model assumption or input is unobservable. Level 3 financial instruments also include those for which the determination of fair value requires significant management judgment or estimation.
 
There was a transfer of a fixed-maturity security from Level 3 into Level 2 during First Quarter 2020. There were no other transfers into or from Level 3 during the period presented.
 

49

Carried at Fair Value
 
Fixed-Maturity Securities and Short-Term Investments
 
The fair value of fixed-maturity securities in the investment portfolio is generally based on prices received from third-party pricing services or alternative pricing sources with reasonable levels of price transparency. The pricing services prepare estimates of fair value using their pricing models, which take into account: benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, reference data, industry and economic events, and sector groupings. Additional valuation factors that can be taken into account are nominal spreads and liquidity adjustments. The pricing services evaluate each asset class based on relevant market and credit information, perceived market movements, and sector news.

Benchmark yields have in many cases taken priority over reported trades for securities that trade less frequently or those that are distressed trades, and therefore may not be indicative of the market. The extent of the use of each input is dependent on the asset class and the market conditions. The valuation of fixed-maturity investments is more subjective when markets are less liquid due to the lack of market based inputs.
    
Short-term investments that are traded in active markets are classified within Level 1 in the fair value hierarchy as their value is based on quoted market prices. Securities such as discount notes are classified within Level 2 because these securities are typically not actively traded due to their approaching maturity and, as such, their cost approximates fair value.
 
As of March 31, 2020, the Company used models to price 129 securities, including securities that were purchased or obtained for loss mitigation or other risk management purposes, with a Level 3 fair value of $961 million. Most Level 3 securities were priced with the assistance of an independent third party. The pricing is based on a discounted cash flow approach using the third party’s proprietary pricing models. The models use inputs such as projected prepayment speeds; severity assumptions; recovery lag assumptions; estimated default rates (determined on the basis of an analysis of collateral attributes, historical collateral performance, borrower profiles and other features relevant to the evaluation of collateral credit quality); home price appreciation/depreciation rates based on macroeconomic forecasts and recent trading activity. The yield used to discount the projected cash flows is determined by reviewing various attributes of the security including collateral type, weighted average life, sensitivity to losses, vintage, and convexity, in conjunction with market data on comparable securities. Significant changes to any of these inputs could have materially changed the expected timing of cash flows within these securities which is a significant factor in determining the fair value of the securities.
 
Other Assets
 
Committed Capital Securities

Each of AGC and AGM have entered into put agreements with four separate custodial trusts allowing each of AGC and AGM, respectively, to issue an aggregate of $200 million of non-cumulative redeemable perpetual preferred securities to the trusts in exchange for cash. Each custodial trust was created for the primary purpose of issuing $50 million face amount of CCS, investing the proceeds in high-quality assets and entering into put options with AGC or AGM, as applicable.

The fair value of CCS, which is recorded in other assets on the condensed consolidated balance sheets, represents the difference between the present value of remaining expected put option premium payments under AGC's CCS and AGM’s Committed Preferred Trust Securities (the AGM CPS) agreements, and the estimated present value that the Company would hypothetically have to pay currently for a comparable security. The change in fair value of the AGC CCS and AGM CPS are recorded in fair value of gains (losses) on committed capital securities in the condensed consolidated statement of operations. The estimated current cost of the Company’s CCS is based on several factors, including AGC and AGM CDS spreads, LIBOR curve projections, the Company's publicly traded debt and the term the securities are estimated to remain outstanding. The AGC CCS and AGM CPS are classified as Level 3 in the fair value hierarchy.

Supplemental Executive Retirement Plans

The Company classifies the fair value measurement included in the Company's various supplemental executive retirement plans as either Level 1 or Level 2. The fair value of these assets is valued based on the observable published daily values of the underlying mutual fund included in the plans (Level 1) or based upon the net asset value (NAV) of the funds if a published daily value is not available (Level 2). The NAVs are based on observable information. Change in fair value of these assets is recorded in other operating expenses in the condensed consolidated statement of operations.
 

50

Contracts Accounted for as Credit Derivatives
 
The Company’s credit derivatives primarily consist of insured CDS contracts, and also include interest rate swaps that qualify as derivatives under GAAP, which require fair value measurement with changes recorded in the statement of operations. The Company did not enter into CDS with the intent to trade these contracts and the Company may not unilaterally terminate a CDS contract absent an event of default or termination event that entitles the Company to terminate such contracts; however, the Company has mutually agreed with various counterparties to terminate certain CDS transactions. In transactions where the counterparty does not have the right to terminate, such transactions are generally terminated for an amount that approximates the present value of future premiums or for a negotiated amount, rather than at fair value.
 
The terms of the Company’s CDS contracts differ from more standardized credit derivative contracts sold by companies outside the financial guaranty industry. The non-standard terms generally include the absence of collateral support agreements or immediate settlement provisions. In addition, the Company employs relatively high attachment points and does not exit derivatives it sells, except under specific circumstances such as mutual agreements with counterparties. Management considers the non-standard terms of the Company's credit derivative contracts in determining the fair value of these contracts.
 
Due to the lack of quoted prices and other observable inputs for its instruments or for similar instruments, the Company determines the fair value of its credit derivative contracts primarily through internally developed, proprietary models that use both observable and unobservable market data inputs. There is no established market where financial guaranty insured credit derivatives are actively traded; therefore, management has determined that the exit market for the Company’s credit derivatives is a hypothetical one based on its entry market. These contracts are classified as Level 3 in the fair value hierarchy as there are multiple unobservable inputs deemed significant to the valuation model, most importantly the Company’s estimate of the value of the non-standard terms and conditions of its credit derivative contracts and how the Company’s own credit spread affects the pricing of its transactions.

The fair value of the Company’s credit derivative contracts represents the difference between the present value of remaining premiums the Company expects to receive and the estimated present value of premiums that a financial guarantor of comparable credit-worthiness would hypothetically charge at the reporting date for the same protection. The fair value of the Company’s credit derivatives depends on a number of factors, including notional amount of the contract, expected term, credit spreads, changes in interest rates, the credit ratings of referenced entities, the Company’s own credit risk and remaining contractual cash flows. The expected remaining contractual premium cash flows are the most readily observable inputs since they are based on the CDS contractual terms. Credit spreads capture the effect of recovery rates and performance of underlying assets of these contracts, among other factors. Consistent with previous years, market conditions at March 31, 2020 were such that market prices of the Company’s CDS contracts were not available.

Assumptions and Inputs

The various inputs and assumptions that are key to the establishment of the Company’s fair value for CDS contracts are as follows: the gross spread, the allocation of gross spread among the bank profit, net spread and hedge cost, and the weighted average life which is based on debt service schedules. The Company obtains gross spreads on its outstanding contracts from market data sources published by third parties (e.g., dealer spread tables for the collateral similar to assets within the Company’s transactions), as well as collateral-specific spreads provided or obtained from market sources. The bank profit represents the profit the originator, usually an investment bank, realizes for structuring and funding the transaction; the net spread represents the premiums paid to the Company for the Company’s credit protection provided; and the hedge cost represents the cost of CDS protection purchased by the originator to hedge its counterparty credit risk exposure to the Company.

With respect to CDS transactions for which there is an expected claim payment within the next twelve months, the allocation of gross spread reflects a higher allocation to the cost of credit rather than the bank profit component. It is assumed that a bank would be willing to accept a lower profit on distressed transactions in order to remove these transactions from its financial statements.

Market sources determine credit spreads by reviewing new issuance pricing for specific asset classes and receiving price quotes from their trading desks for the specific asset in question. Management validates these quotes by cross-referencing quotes received from one market source against quotes received from another market source to ensure reasonableness. In addition, the Company compares the relative change in price quotes received from one quarter to another, with the relative change experienced by published market indices for a specific asset class. Collateral specific spreads obtained from third-party, independent market sources are un-published spread quotes from market participants or market traders who are not trustees.

51

Management obtains this information as the result of direct communication with these sources as part of the valuation process. The following spread hierarchy is utilized in determining which source of gross spread to use.

•
Actual collateral specific credit spreads (if up-to-date and reliable market-based spreads are available).

•
Transactions priced or closed during a specific quarter within a specific asset class and specific rating.

•
Credit spreads interpolated based upon market indices adjusted to reflect the non-standard terms of the Company's CDS contracts.

•
Credit spreads extrapolated based upon transactions of similar asset classes, similar ratings, and similar time to maturity.
 
The rates used to discount future expected premium cash flows ranged from 0.46% to 1.47% at March 31, 2020 and 1.69% to 2.08% at December 31, 2019.

The premium the Company receives is referred to as the “net spread.” The Company’s pricing model takes into account not only how credit spreads on risks that it assumes affect pricing, but also how the Company’s own credit spread affects the pricing of its transactions. The Company’s own credit risk is factored into the determination of net spread based on the impact of changes in the quoted market price for credit protection bought on the Company, as reflected by quoted market prices on CDS referencing AGC. The Company obtains the quoted price of CDS contracts traded on AGC from market data sources published by third parties. The cost to acquire CDS protection referencing AGC affects the amount of spread on CDS transactions that the Company retains and, hence, their fair value. As the cost to acquire CDS protection referencing AGC increases, the amount of premium the Company retains on a transaction generally decreases. Due to the relatively low volume and characteristics of CDS contracts remaining in AGM's portfolio, changes in AGM's credit spreads do not significantly affect the fair value of these CDS contracts.

In the Company’s valuation model, the premium the Company captures is not permitted to go below the minimum rate that the Company would currently charge to assume similar risks. This assumption can have the effect of mitigating the amount of unrealized gains that are recognized on certain CDS contracts. Given market conditions and the Company’s own credit spreads, de minimis amounts, based on fair value, of the Company's CDS contracts were fair valued using this minimum premium as of March 31, 2020 and December 31, 2019. The percentage of transactions that price using the minimum premiums fluctuates due to changes in AGC's credit spreads. In general, when AGC's credit spreads narrow, the cost to hedge AGC's name declines and more transactions price above previously established floor levels. Meanwhile, when AGC's credit spreads widen, the cost to hedge AGC's name increases causing more transactions to price at established floor levels. The Company corroborates the assumptions in its fair value model, including the portion of exposure to AGC hedged by its counterparties, with independent third parties periodically. The implied credit risk of AGC, indicated by the trading level of AGC’s own credit spread, is a significant factor in the amount of exposure to AGC that a bank or transaction hedges. When AGC's credit spreads widen, the hedging cost of a bank or originator increases. Higher hedging costs reduce the amount of contractual cash flows AGC can capture as premium for selling its protection, while lower hedging costs increase the amount of contractual cash flows AGC can capture.

The amount of premium a financial guaranty insurance market participant can demand is inversely related to the cost of credit protection on the insurance company as measured by market credit spreads assuming all other assumptions remain constant. This is because the buyers of credit protection typically hedge a portion of their risk to the financial guarantor, due to the fact that the contractual terms of the Company's contracts typically do not require the posting of collateral by the guarantor. The extent of the hedge depends on the types of instruments insured and the current market conditions.
 
A credit derivative liability on protection sold is the result of contractual cash inflows on in-force transactions that are less than what a hypothetical financial guarantor could receive if it sold protection on the same risk as of the reporting date. If the Company were able to freely exchange these contracts (i.e., assuming its contracts did not contain proscriptions on transfer and there was a viable exchange market), it would realize a loss representing the difference between the lower contractual premiums to which it is entitled and the current market premiums for a similar contract. The Company determines the fair value of its CDS contracts by applying the difference between the current net spread and the contractual net spread for the remaining duration of each contract to the notional value of its CDS contracts and taking the present value of such amounts discounted at the LIBOR corresponding to the weighted average remaining life of the contract.
 

52

Strengths and Weaknesses of Model
 
The Company’s credit derivative valuation model, like any financial model, has certain strengths and weaknesses.
 
The primary strengths of the Company’s CDS modeling techniques are:
 
•
The model takes into account the transaction structure and the key drivers of market value.

•
The model maximizes the use of market-driven inputs whenever they are available.

•
The model is a consistent approach to valuing positions.
 
The primary weaknesses of the Company’s CDS modeling techniques are:
 
•
There is no exit market or any actual exit transactions; therefore, the Company’s exit market is a hypothetical one based on the Company’s entry market.

•
There is a very limited market in which to validate the reasonableness of the fair values developed by the Company’s model.

•
The markets for the inputs to the model are highly illiquid, which impacts their reliability.

•
Due to the non-standard terms under which the Company enters into derivative contracts, the fair value of its credit derivatives may not reflect the same prices observed in an actively traded market of credit derivatives that do not contain terms and conditions similar to those observed in the financial guaranty market.

Fair Value Option on FG VIEs’ Assets and Liabilities

The Company elected the fair value option for all the FG VIEs’ assets and liabilities and classifies them as Level 3 in the fair value hierarchy. The prices are generally determined with the assistance of an independent third party, based on a discounted cash flow approach. The net change in the fair value of consolidated FG VIEs’ assets and liabilities is recorded in "fair value gains (losses) on FG VIEs" in the condensed consolidated statements of operations, except for change in fair value of FG VIEs’ liabilities with recourse caused by changes in instrument-specific credit risk (ISCR) which is separately presented in other comprehensive income (OCI). Interest income and interest expense are derived from the trustee reports and also included in "fair value gains (losses) on FG VIEs." The FG VIEs issued securities collateralized by first lien and second lien RMBS as well as loans and receivables.

The fair value of the Company’s FG VIEs’ assets is generally sensitive to changes in estimated prepayment speeds; estimated default rates (determined on the basis of an analysis of collateral attributes such as: historical collateral performance, borrower profiles and other features relevant to the evaluation of collateral credit quality); yields implied by market prices for similar securities; and house price depreciation/appreciation rates based on macroeconomic forecasts. Significant changes to some of these inputs could have materially changed the market value of the FG VIEs’ assets and the implied collateral losses within the transaction. In general, the fair value of the FG VIEs’ assets is most sensitive to changes in the projected collateral losses, where an increase in collateral losses typically could lead to a decrease in the fair value of FG VIEs’ assets, while a decrease in collateral losses typically leads to an increase in the fair value of FG VIEs’ assets.

The third party utilizes an internal model to determine an appropriate yield at which to discount the cash flows of the security, by factoring in collateral types, weighted-average lives, and other structural attributes specific to the security being priced. The expected yield is further calibrated by utilizing algorithms designed to aggregate market color, received by the independent third party, on comparable bonds.

The models used to price the FG VIEs’ liabilities generally apply the same inputs used in determining fair value of FG VIEs’ assets. For those liabilities insured by the Company, the benefit of the Company's insurance policy guaranteeing the timely payment of principal and interest is also taken into account.

Significant changes to any of the inputs described above could have materially changed the timing of expected losses within the insured transaction which is a significant factor in determining the implied benefit of the Company’s insurance policy guaranteeing the timely payment of principal and interest for the insured tranches of debt issued by the FG VIEs. In general, extending the timing of expected loss payments by the Company into the future typically could lead to a decrease in

53

the value of the Company’s insurance and a decrease in the fair value of the Company’s FG VIEs’ liabilities with recourse, while a shortening of the timing of expected loss payments by the Company typically could lead to an increase in the value of the Company’s insurance and an increase in the fair value of the Company’s FG VIEs’ liabilities with recourse.

Assets and Liabilities of Consolidated Investment Vehicles

Due to the fact that BlueMountain manages and the insurance companies have an investment in certain Assured Investment Management funds, the Company consolidated one Assured Investment Management managed CLO and three Assured Investment Management funds (collectively, the consolidated investment vehicles). The consolidated Assured Investment Management funds are: AHP Capital Solutions, LP (AHP), AIM Asset Backed Income Fund (US) L.P. (ABIF) and a BlueMountain CLO Warehouse Fund (US) L.P. (CLO Warehouse Fund). CLO Warehouse Fund invested in BlueMountain CLO XXVI Ltd. (CLO XXVI). All four consolidated investment vehicles are accounted for at fair value. See Note 12, Variable Interest Entities.

CLO XXVI is a collateralized financing entity (CFE) under Accounting Standards Codification (ASC) 810, Consolidation, and has elected to measure assets and liabilities using the fair value of its assets, which are more observable. The financial assets of CLO XXVI are all Level 2 assets, and therefore more observable than the fair value of the financial liabilities of CLO XXVI, which are all Level 3 liabilities. As a result, the financial assets of CLO XXVI are measured at fair value and the financial liabilities of CLO XXVI are measured as: (1) the sum of the fair value of the financial assets, and the carrying value of any nonfinancial assets held temporarily, less (2) the sum of the fair value of any beneficial interests retained by the Company (other than those that represent compensation for services), and the Company’s carrying value of any beneficial interests that represent compensation for services. The resulting amount is allocated to the individual financial liabilities (other than the beneficial interests retained by the Company).

Investments of consolidated investment vehicles which are not listed or quoted on an exchange, but are traded over-the-counter, or are listed on an exchange which have no reported sales, are valued at their fair value as determined by the Company, after giving consideration to third party data generally at the average between the offer and bid prices. These fair values are generally based on dealer quotes, indications of value or pricing models that consider the time value of money, the current market, contractual prices and potential volatilities of the underlying financial instruments. Inputs are used in applying the various valuation techniques and broadly refer to the current assumptions that market participants use to make valuation decisions, including assumptions about risk. Inputs may include dealer price quotations, yield curves, credit curves, forward/CDS/index spreads, prepayments rates, strike and expiry dates, volatility statistics and other factors.

Assets in consolidated Assured Investment Management funds that are carried at fair value primarily consist of corporate loans, CLOs, asset backed securities and other investments. Assets supporting CLO XXVI and certain assets of the consolidated funds are Level 2. The remainder of the invested assets of consolidated funds are Level 3. Liabilities include various tranches of CLO debt and are classified as Level 3 in the fair value hierarchy. Significant changes to any of the inputs described above could have a material effect on the fair value of the consolidated assets and liabilities.


54

Amounts recorded at fair value in the Company’s financial statements are presented in the tables below.
 
Fair Value Hierarchy of Financial Instruments Carried at Fair Value
As of March 31, 2020
 
 
 
 
Fair Value Hierarchy
 
Fair Value
 
Level 1
 
Level 2
 
Level 3
 
(in millions)
Assets:
 

 
 

 
 

 
 

Investment portfolio, available-for-sale:
 

 
 

 
 

 
 

Fixed-maturity securities
 

 
 

 
 

 
 

Obligations of state and political subdivisions
$
4,204

 
$
—

 
$
4,118

 
$
86

U.S. government and agencies
175

 
—

 
175

 
—

Corporate securities
2,233

 
—

 
2,207

 
26

Mortgage-backed securities:
 

 
 
 
 
 
 
RMBS
717

 
—

 
464

 
253

Commercial mortgage-backed securities (CMBS)
414

 
—

 
414

 
—

Asset-backed securities
653

 
—

 
57

 
596

Non-U.S. government securities
172

 
—

 
172

 
—

Total fixed-maturity securities
8,568


—

 
7,607

 
961

Short-term investments
933

 
865

 
68

 
—

Other invested assets (1)
12

 
6

 
—

 
6

FG VIEs’ assets, at fair value
368

 
—

 
—

 
368

Assets of consolidated investment vehicles
557

 
—

 
461

 
96

Other assets
177

 
36

 
38

 
103

Total assets carried at fair value
$
10,615

 
$
907

 
$
8,174

 
$
1,534

Liabilities:
 

 
 
 
 
 
 
Credit derivative liabilities
$
265

 
$
—

 
$
—

 
$
265

FG VIEs’ liabilities with recourse, at fair value
312

 
—

 
—

 
312

FG VIEs’ liabilities without recourse, at fair value
82

 
—

 
—

 
82

Liabilities of consolidated investment vehicles
426

 
—

 
—

 
426

Total liabilities carried at fair value
$
1,085

 
$
—

 
$
—

 
$
1,085

 

55

Fair Value Hierarchy of Financial Instruments Carried at Fair Value
As of December 31, 2019
 
 
 
 
Fair Value Hierarchy
 
Fair Value
 
Level 1
 
Level 2
 
Level 3
 
(in millions)
Assets:
 

 
 

 
 

 
 

Investment portfolio, available-for-sale:
 

 
 

 
 

 
 

Fixed-maturity securities
 

 
 

 
 

 
 

Obligations of state and political subdivisions
$
4,340

 
$
—

 
$
4,233

 
$
107

U.S. government and agencies
147

 
—

 
147

 
—

Corporate securities
2,221

 
—

 
2,180

 
41

Mortgage-backed securities:
 

 
 

 
 

 
 

RMBS
775

 
—

 
467

 
308

CMBS
419

 
—

 
419

 
—

Asset-backed securities
720

 
—

 
62

 
658

Non-U.S. government securities
232

 
—

 
232

 
—

Total fixed-maturity securities
8,854

 
—

 
7,740

 
1,114

Short-term investments
1,268

 
1,061

 
207

 
—

Other invested assets (1)
6

 
—

 
—

 
6

FG VIEs’ assets, at fair value
442

 
—

 
—

 
442

Assets of consolidated investment vehicles
558

 
—

 
494

 
64

Other assets
135

 
32

 
45

 
58

Total assets carried at fair value
$
11,263

 
$
1,093

 
$
8,486

 
$
1,684

Liabilities:
 

 
 

 
 

 
 

Credit derivative liabilities
$
191

 
$
—

 
$
—

 
$
191

FG VIEs’ liabilities with recourse, at fair value
367

 
—

 
—

 
367

FG VIEs’ liabilities without recourse, at fair value
102

 
—

 
—

 
102

Liabilities of consolidated investment vehicles
481

 
—

 
—

 
481

Total liabilities carried at fair value
$
1,141

 
$
—

 
$
—

 
$
1,141

____________________
(1)
Includes Level 3 mortgage loans that are recorded at fair value on a non-recurring basis.








56

Changes in Level 3 Fair Value Measurements
 
The tables below present a roll forward of the Company’s Level 3 financial instruments carried at fair value on a recurring basis during First Quarter 2020 and 2019.

Rollforward of Level 3 Assets
At Fair Value on a Recurring Basis
First Quarter 2020
 
Fixed-Maturity Securities
 
 
 
 
 
 
 
 
Obligations
of State and
Political
Subdivisions
 
Corporate Securities
 
RMBS
 
Asset-
Backed
Securities
 
FG VIEs’
Assets at
Fair
Value
 
Assets of Consolidated Investment Vehicles
 
Other
(7)
 
 
(in millions)
Fair value as of
December 31, 2019
$
107

 
$
41

 
$
308

 
$
658

 
$
442

 
$
64

 
$
55

 
Total pretax realized and unrealized gains/(losses) recorded in:
 
 
 
 
 
 
 
 

 
 
 
 
 
 

Net income (loss)
1

(1
)
(7
)
(1
)
3

(1
)
7

(1
)
(37
)
(2
)
1

(4
)
48

(3
)
Other comprehensive income (loss)
(21
)
 
(8
)
 
(47
)
 
(59
)
 

—

 
—

 
—

 

Purchases
—

 
—

 
—

 
—

 

—

 
45

 
—

 

Sales
—

 
—

 
—

 
(2
)
 
—

 
—

 
—

 
Settlements
(1
)
 
—

 
(11
)
 
(7
)
 
(37
)
 
(14
)
 
—

 

Transfers out of Level 3
—

 
—

 
—

 
(1
)
 
—

 
—

 
—

 
Fair value as of
March 31, 2020
$
86

 
$
26

 
$
253

 
$
596

 
$
368

 
$
96

 
$
103

 
Change in unrealized gains/(losses) included in earnings related to financial instruments held as of March 31, 2020
 
 
 
 
 
 
 
 
$
(35
)
(2
)
$
1

(4
)
$
48

(3
)
Change in unrealized
gains/(losses) included in OCI related to financial instruments held as of March 31, 2020
$
(21
)
 
$
(8
)
 
$
(46
)
 
$
(58
)
 
 
 
 
 
 
 

57

Rollforward of Level 3 Liabilities
At Fair Value on a Recurring Basis
First Quarter 2020
 
 
 
FG VIEs’ Liabilities, at Fair Value
 
 
 
 
Credit
Derivative
Asset
(Liability),
net (5)
 
With
Recourse
 
Without
Recourse
 
Liabilities of Consolidated Investment Vehicles
 
 
(in millions)
Fair value as of December 31, 2019
$
(185
)
 
$
(367
)
 
$
(102
)
 
$
(481
)
 
Total pretax realized and unrealized gains/(losses) recorded in:
 
 

 
 

 
 

 
 
Net income (loss)
(77
)
(6
)
16

(2
)
11

(2
)
55

(4
)
Other comprehensive income (loss)
—

 

13

 

—

 

—

 
Settlements
—

 

26

 

9

 

—

 
Fair value as of March 31, 2020
$
(262
)
 
$
(312
)
 
$
(82
)
 
$
(426
)
 
Change in unrealized gains/(losses) included in earnings related to financial instruments held as of March 31, 2020
$
(73
)
(6
)
$
15

(2
)
$
11

(2
)
$
55

(4
)
Change in unrealized gains/(losses) included in OCI related to financial instruments held as of March 31, 2020
 
 
$
13

 
 
 
 
 


































58

Rollforward of Level 3 Assets and Liabilities
At Fair Value on a Recurring Basis
First Quarter 2019
 
Fixed-Maturity Securities
 
 
 
 
 
 
 
FG VIEs’ Liabilities, at Fair Value
 
 
Obligations
of State and
Political
Subdivisions
 
Corporate Securities
 
RMBS
 
Asset-
Backed
Securities
 
FG VIEs’
Assets at
Fair
Value
 
Other
(7)
 
Credit
Derivative
Asset
(Liability),
net (5)
 

With
Recourse
 

Without
Recourse
 
 
(in millions)
Fair value as of
December 31, 2018
$
99

 
$
56

 
$
309

 
$
947

 
$
569

 
$
77

 
$
(207
)
 
$
(517
)
 
$
(102
)
 
Total pretax realized and unrealized gains/(losses) recorded in:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

Net income (loss)
1

(1
)
(11
)
(1
)
6

(1
)
14

(1
)
17

(2
)
(9
)
(3
)
(22
)
(6
)
(11
)
(2
)
(4
)
(2
)
Other comprehensive income (loss)
5

 
3

 
5

 
(9
)
 
—

 
—

 

—

 

—

 

—

 

Purchases
—

 
—

 
11

 
10

 
—

 
—

 

—

 

—

 

—

 

Settlements
(1
)
 
—

 
(13
)
 
(4
)
 
(26
)
 
—

 

1

 

23

 

2

 

Fair value as of
March 31, 2019
$
104

 
$
48

 
$
318

 
$
958

 
$
560

 
$
68

 
$
(228
)
 
$
(505
)
 
$
(104
)
 
Change in unrealized gains/(losses) included in earnings related to financial instruments held as of March 31, 2019
 
 
 
 
 
 
 
 
$
20

(2
)
$
(9
)
(3
)
$
(21
)
(6
)
$
(11
)
(2
)
$
(3
)
(2
)
Change in unrealized gains/(losses) included in OCI related to financial instruments held at March 31. 2019
$
5

 
$
3

 
$
5

 
$
(8
)
 
 
 
$
—

 
 
 
$
—

 
 
 
 ____________________
(1)
Included in net realized investment gains (losses) and net investment income.

(2)
Included in fair value gains (losses) on FG VIEs.

(3)
Recorded in fair value gains (losses) on CCS, net investment income and other income.

(4)
Recorded in fair value gains (losses) on consolidated investment vehicles.

(5)
Represents the net position of credit derivatives. Credit derivative assets (recorded in other assets) and credit derivative liabilities (presented as a separate line item) are shown as either assets or liabilities in the condensed consolidated balance sheet based on net exposure by transaction.

(6)
Reported in net change in fair value of credit derivatives.

(7)
Includes CCS and other invested assets.









59

Level 3 Fair Value Disclosures
 
Quantitative Information About Level 3 Fair Value Inputs
At March 31, 2020

Financial Instrument Description
 
Fair Value at
March 31, 2020
(in millions)
 
Significant Unobservable Inputs
 
Range
 
Weighted Average (4)
Assets (2):
 
 

 
 
 
 
 
 
Fixed-maturity securities (1):
 
 

 
 
 
 
 
 
 
 
Obligations of state and political subdivisions
 
$
86

 
Yield
 
5.3
%
-
41.4%
 
16.9%
 
 
 
 
 
 
 
 
 
 
 
Corporate securities
 
26

 
Yield
 
51.7%
 
 
 
 
 
 
 
 
 
 
 
 
 
RMBS
 
253

 
CPR
 
3.3
%
-
15.0%
 
6.4%
 
 
CDR
 
1.5
%
-
7.5%
 
4.9%
 
 
Loss severity
 
40.0
%
-
125.0%
 
79.0%
 
 
Yield
 
5.7
%
-
8.1%
 
6.9%
Asset-backed securities:
 
 
 
 
 
 
 
 
 
 
Life insurance transactions
 
321

 
Yield
 
6.5%
 
 
 
 
 
 
 
 
 
 
 
 
 
CLOs /Trust preferred securities (TruPS)
 
240

 
Yield
 
2.4
%
-
4.4%
 
3.0%
 
 
 
 
 
 
 
 
 
 
 
Others
 
35

 
Yield
 
20.7%
 
 
 
 
 
 
 
 
 
 
 
 
 
FG VIEs’ assets, at fair value (1)
 
368

 
CPR
 
0.1
%
-
18.7%
 
8.4%
 
 
CDR
 
1.2
%
-
24.9%
 
4.9%
 
 
Loss severity
 
40.0
%
-
100.0%
 
74.3%
 
 
Yield
 
5.1
%
-
10.8%
 
7.2%
 
 
 
 
 
 
 
 
 
 
 
Assets of consolidated investment vehicles (3)
 
96

 
Discount rate
 
15.3
%
-
27.6%
 
21.8%
 
 
 
Market multiple - enterprise/revenue value
 
0.6x

-
8.6x
 
 
 
 
 
Yield
 
6.9
%
-
21.2%
 
12.7%
 
 
 
 
 
 
 
 
 
 
 
Other assets (1)
 
100

 
Implied Yield
 
5.5
%
-
6.3%
 
5.9%
 
 
Term (years)
 
10 years
 
 

60

Financial Instrument Description (1)
 
Fair Value at
March 31, 2020
(in millions)
 
Significant Unobservable Inputs
 
Range
 
Weighted Average (4)
Liabilities:
 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Credit derivative liabilities, net
 
$
(262
)
 
Year 1 loss estimates
 
0.0
%
-
85.0%
 
2.3%
 
 
Hedge cost (in basis points (bps))
 
35.0
-
168.0
 
67.0
 
 
Bank profit (in bps)
 
0.0
-
369.0
 
104.0
 
 
Internal floor (in bps)
 
9.0

-
30.0
 
14.0
 
 
Internal credit rating
 
AAA

-
CCC
 
AA-
 
 
 
 
 
 
 
 
 
 
 
FG VIEs’ liabilities, at fair value
 
(394
)
 
CPR
 
0.1
%
-
18.7%
 
8.4%
 
 
CDR
 
1.2
%
-
24.9%
 
4.9%
 
 
Loss severity
 
40.0
%
-
100.0%
 
74.3%
 
 
Yield
 
4.2
%
-
10.8%
 
5.6%
 
 
 
 
 
 
 
 
 
 
 
Liabilities of consolidated investment vehicles:
 
 
 
 
 
 
 
 
 
 
CLO obligations (5)
 
(426
)
 
Yield
 
3.8%
 
 
 
 
 
 
Discount rate
 
29.0%
 
 
___________________
(1)
Discounted cash flow is used as the primary valuation technique.

(2)
Excludes several investments recorded in other invested assets with fair value of $6 million.

(3)
The primary inputs to the valuation are recent market transaction prices, supported by market multiples and yields/discount rates.

(4)
Weighted average is calculated as a percentage of current par outstanding for all categories except for assets of consolidated investment vehicles, where it is calculated as a percentage of fair value.

(5)
See CFE fair value methodology described above for CLO XXVI.

61

Quantitative Information About Level 3 Fair Value Inputs
At December 31, 2019

Financial Instrument Description
 
Fair Value at
December 31, 2019
(in millions)
 
Significant Unobservable Inputs
 
Range
 
Weighted Average as a Percentage of Current Par Outstanding
Assets (2):
 
 

 
 
 
 
 
 
 
 
Fixed-maturity securities (1):
 
 

 
 
 
 
 
 
 
 
Obligations of state and political subdivisions
 
$
107

 
Yield
 
4.5
%
-
31.1%
 
8.5%
 
 
 
 
 
 
 
 
 
 
 
Corporate securities
 
41

 
Yield
 
35.9%
 
 
 
 
 
 
 
 
 
 
 
 
 
RMBS
 
308

 
CPR
 
2.0
%
-
15.0%
 
6.3%
 
 
CDR
 
1.5
%
-
7.0%
 
4.9%
 
 
Loss severity
 
40.0
%
-
125.0%
 
78.8%
 
 
Yield
 
3.7
%
-
6.1%
 
4.8%
Asset-backed securities:
 
 
 
 
 
 
 
 
 
 
Life insurance transactions
 
350

 
Yield
 
5.8%
 
 
 
 
 
 
 
 
 
 
 
 
 
CLOs/TruPS
 
256

 
Yield
 
2.5
%
-
4.1%
 
2.9%
 
 
 
 
 
 
 
 
 
 
 
Others
 
52

 
Yield
 
2.3
%
-
9.4%
 
9.3%
 
 
 
 
 
 
 
 
 
 
 
FG VIEs’ assets, at fair value (1)
 
442

 
CPR
 
0.1
%
-
18.6%
 
8.6%
 
 
CDR
 
1.2
%
-
24.7%
 
4.9%
 
 
Loss severity
 
40.0
%
-
100.0%
 
76.1%
 
 
Yield
 
3.0
%
-
8.4%
 
5.2%
 
 
 
 
 
 
 
 
 
 
 
Assets of consolidated investment vehicles (3)
 
64

 
Discount rate
 
16.0
%
-
28.0%
 
21.0%
 
 
Market multiple - enterprise/revenue value
 
0.5x

-
6.7x
 
 
 
 
Yield
 
12.5%
 
 
 
 
 
 
 
 
 
 
 
 
 
Other assets (1)
 
52

 
Implied Yield
 
5.1
%
-
5.8%
 
5.5%
 
 
 
 
Term (years)
 
10 years
 
 


62

Financial Instrument Description (1)
 
Fair Value at
December 31, 2019
(in millions)
 
Significant Unobservable Inputs
 
Range
 
Weighted Average as a Percentage of Current Par Outstanding
Liabilities:
 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Credit derivative liabilities, net
 
$
(185
)
 
Year 1 loss estimates
 
0.0
%
-
46.0%
 
1.3%
 
 
Hedge cost (in bps)
 
5.0
-
31.0
 
11.0
 
 
Bank profit (in bps)
 
51.0
-
212.0
 
76.0
 
 
Internal floor (in bps)
 
30.0
 
 
 
 
Internal credit rating
 
AAA

-
CCC
 
AA-
 
 
 
 
 
 
 
 
 
 
 
FG VIEs’ liabilities, at fair value
 
(469
)
 
CPR
 
0.1
%
-
18.6%
 
8.6%
 
 
CDR
 
1.2
%
-
24.7%
 
4.9%
 
 
Loss severity
 
40.0
%
-
100.0%
 
76.1%
 
 
Yield
 
2.7
%
-
8.4%
 
4.2%
 
 
 
 
 
 
 
 
 
 
 
Liabilities of consolidated investment vehicles:
 
 
 
 
 
 
 
 
 
 
CLO obligations
 
(481
)
 
Yield
 
10.0%
 
 
____________________
(1)
Discounted cash flow is used as the primary valuation technique.

(2)
Excludes several investments recorded in other invested assets with fair value of $6 million.

(3)
The primary inputs to the valuation are recent market transaction prices, supported by market multiples and yields/discount rates.

Not Carried at Fair Value

Financial Guaranty Insurance Contracts

Fair value is based on management’s estimate of what a similarly rated financial guaranty insurance company would demand to acquire the Company’s in-force book of financial guaranty insurance business. It is based on a variety of factors that may include pricing assumptions management has observed for portfolio transfers, commutations, and acquisitions that have occurred in the financial guaranty market, as well as prices observed in the credit derivative market with an adjustment for illiquidity so that the terms would be similar to a financial guaranty insurance contract, and also includes adjustments for stressed losses, ceding commissions and return on capital. The Company classified the fair value of financial guaranty insurance contracts as Level 3.
 
Long-Term Debt
 
Long-term debt issued by AGUS and AGMH is valued by broker-dealers using third party independent pricing sources and standard market conventions and classified as Level 2 in the fair value hierarchy. The market conventions utilize market quotations, market transactions for the Company’s comparable instruments, and to a lesser extent, similar instruments in the broader insurance industry. The fair value of notes payable was determined by calculating the present value of the expected cash flows, and was classified as Level 3 in the fair value hierarchy.
 

63

The carrying amount and estimated fair value of the Company’s financial instruments not carried at fair value are presented in the following table.

Fair Value of Financial Instruments Not Carried at Fair Value
 
 
As of
March 31, 2020
 
As of
December 31, 2019
 
Carrying
Amount
 
Estimated
Fair Value
 
Carrying
Amount
 
Estimated
Fair Value
 
(in millions)
Assets (liabilities):
 

 
 

 
 

 
 

Other invested assets
$
1

 
$
2

 
$
1

 
$
2

Other assets (1)
93

 
93

 
97

 
97

Financial guaranty insurance contracts (2)
(2,668
)
 
(4,306
)
 
(2,714
)
 
(4,013
)
Long-term debt
(1,221
)
 
(1,510
)
 
(1,235
)
 
(1,573
)
Other liabilities (1)
(18
)
 
(18
)
 
(14
)
 
(14
)
____________________
(1)
The Company's other assets and other liabilities consist predominantly of: accrued interest, management fees receivables, receivables for securities sold and payables for securities purchased, for which the carrying value approximates fair value, and a promissory note receivable.

(2)
Carrying amount includes the assets and liabilities related to financial guaranty insurance contract premiums, losses, and salvage and subrogation and other recoverables net of reinsurance. 

9.    Investments and Cash

Accounting Policy

Refer to Note 1, Business and Basis of Presentation for a description of new accounting guidance adopted as of January 1, 2020 related to the credit impairment of financial assets.

Investment Portfolio

As of March 31, 2020, the majority of the investment portfolio is managed by six outside managers (including Wasmer, Schroeder & Company LLC, in which the Company has a minority interest). The Company has established detailed guidelines regarding credit quality, exposure to a particular sector and exposure to a particular obligor within a sector. The externally managed portfolio must maintain a minimum average rating of A+ by S&P or A1 by Moody's.

The investment portfolio tables shown below include assets managed both externally and internally. The internally managed portfolio primarily consists of the Company's investments in securities for (i) loss mitigation purposes, (ii) other risk management purposes and (iii) other alternative investments that the Company believes present an attractive investment opportunity.
    
One of the Company's strategies for mitigating losses has been to purchase loss mitigation securities at discounted prices. The Company also holds other invested assets that were obtained or purchased as part of negotiated settlements with insured counterparties or under the terms of the financial guaranties (other risk management assets).

Alternative investments include investing in both equity and debt securities, and include investments in Assured Investment Management funds, additional amounts in other accounts managed in the Assured Investment Management platform, and alternative investments not managed in the Assured Investment Management platform. The insurance subsidiaries currently intend to invest $500 million in Assured Investment Management funds. As of March 31, 2020, the Insurance segment had committed capital to the three consolidated Assured Investment Management funds, of which $192 million has been drawn by the respective Assured Investment Management funds, and which had a fair value of $179 million as of March 31, 2020. The remaining outstanding commitment to the Assured Investment Management funds was $78 million as of March 31, 2020. The undrawn portion is reflected in short-term investments in the table below. All of the Assured Investment Management funds in which the insurance subsidiaries invest were consolidated as of March 31, 2020 and December 31, 2019. See Note 12, Variable Interest Entities. The Company has agreed to purchase up to $100 million of limited partnership interests in a fund that

64

invests in the equity of private equity managers of which $86 million of the commitment was not funded as of March 31, 2020. The Company has also invested in a limited liability company that owns fuel cells.

Investment Portfolio
Carrying Value

 
As of
March 31, 2020
 
As of
December 31, 2019
 
(in millions)
Fixed-maturity securities (1):
 
 
 
Externally managed
$
7,826

 
$
7,978

Internally managed
742

 
876

Short-term investments
933

 
1,268

Other invested assets
 
 
 
Equity method investments
108

 
111

Other
13

 
7

Total
$
9,622

 
$
10,240

____________________
(1)
7.6% and 8.6% of fixed-maturity securities are rated BIG as of March 31, 2020 and December 31, 2019, respectively.

Accrued investment income, which is recorded in other assets, was $83 million and $79 million as of March 31, 2020 and December 31, 2019, respectively. In First Quarter 2020, the Company did not write off any accrued investment income.

Fixed-Maturity Securities and Short-Term Investments
by Security Type 
As of March 31, 2020

Security Type
 
Percent
of
Total (1)
 
Amortized
Cost
 
Allowance for Credit Losses
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair
Value
 
AOCI (2)
Pre-tax Gain
(Loss) on
Securities
with
Credit Loss
 
Weighted
Average
Credit
Rating (3)
 
 
(dollars in millions)
Fixed-maturity securities:
 
 

 
 

 
 
 
 

 
 

 
 

 
 

 
 
Obligations of state and political subdivisions
 
42
%
 
$
3,952

 
$
(11
)
 
$
269

 
$
(6
)
 
$
4,204

 
$
(2
)
 
AA-
U.S. government and agencies
 
2

 
160

 
—

 
15

 
—

 
175

 
—

 
AA+
Corporate securities
 
25

 
2,292

 
(39
)
 
58

 
(78
)
 
2,233

 
(36
)
 
A
Mortgage-backed securities (4):
 
0

 
 
 
 
 
 
 
 

 
—

 
 

 
 
RMBS
 
8

 
737

 
(16
)
 
39

 
(43
)
 
717

 
(39
)
 
A
CMBS
 
4

 
399

 
—

 
15

 
—

 
414

 
—

 
AAA
Asset-backed securities
 
7

 
687

 
(7
)
 
9

 
(36
)
 
653

 
(6
)
 
BBB-
Non-U.S. government securities
 
2

 
183

 
—

 
1

 
(12
)
 
172

 
—

 
AA
Total fixed-maturity securities
 
90

 
8,410

 
(73
)
 
406

 
(175
)
 
8,568

 
(83
)
 
A+
Short-term investments
 
10

 
933

 
—

 
1

 
(1
)
 
933

 
—

 
AAA
Total
 
100
%
 
$
9,343

 
$
(73
)
 
$
407

 
$
(176
)
 
$
9,501

 
$
(83
)
 
AA-

65

Fixed-Maturity Securities and Short-Term Investments
by Security Type 
As of December 31, 2019 

Security Type
 
Percent
of
Total (1)
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair
Value
 
AOCI
Pre-tax
Gain
(Loss) on
Securities
with
OTTI
 
Weighted
Average
Credit
Rating (3)
 
 
(dollars in millions)
Fixed-maturity securities:
 
 

 
 

 
 

 
 

 
 

 
 

 
 
Obligations of state and political subdivisions
 
42
%
 
$
4,036

 
$
305

 
$
(1
)
 
$
4,340

 
$
40

 
AA-
U.S. government and agencies
 
1

 
137

 
10

 
—

 
147

 
—

 
AA+
Corporate securities
 
23

 
2,137

 
103

 
(19
)
 
2,221

 
(8
)
 
A
Mortgage-backed securities (4):
 
 

 
 

 
 

 
 

 
 

 
 

 
 
RMBS
 
8

 
745

 
37

 
(7
)
 
775

 
8

 
A-
CMBS
 
4

 
402

 
17

 
—

 
419

 
—

 
AAA
Asset-backed securities
 
7

 
684

 
38

 
(2
)
 
720

 
16

 
BB+
Non-U.S. government securities
 
2

 
230

 
7

 
(5
)
 
232

 
3

 
AA
Total fixed-maturity securities
 
87

 
8,371

 
517

 
(34
)
 
8,854

 
59

 
A+
Short-term investments
 
13

 
1,268

 
—

 
—

 
1,268

 
—

 
AAA
Total
 
100
%
 
$
9,639

 
$
517

 
$
(34
)
 
$
10,122

 
$
59

 
AA-
____________________
(1)
Based on amortized cost.
 
(2)
Accumulated OCI (AOCI).

(3)
Ratings represent the lower of the Moody’s and S&P classifications, except for bonds purchased for loss mitigation or risk management strategies, which use internal ratings classifications. The Company’s portfolio primarily consists of high-quality, liquid instruments.
 
(4)
U.S. government-agency obligations were approximately 44% of mortgage backed securities as of March 31, 2020 and 42% as of December 31, 2019 based on fair value.

The following tables summarize, for all fixed-maturity securities in an unrealized loss position, the aggregate fair value and gross unrealized loss by length of time the amounts have continuously been in an unrealized loss position.


66

Fixed-Maturity Securities
Gross Unrealized Loss by Length of Time
For Which an Allowance for Credit Loss was Not Recorded
As of March 31, 2020
 
 
Less than 12 months
 
12 months or more
 
Total
 
Fair
Value
 
Unrealized
Loss
 
Fair
Value
 
Unrealized
Loss
 
Fair
Value
 
Unrealized
Loss
 
(dollars in millions)
Obligations of state and political subdivisions
$
104

 
$
(4
)
 
$
—

 
$
—

 
$
104

 
$
(4
)
Corporate securities
679

 
(29
)
 
68

 
(13
)
 
747

 
(42
)
Mortgage-backed securities:
 
 
 
 
 
 
 

 
 
 
 
RMBS
42

 
(4
)
 
5

 
—

 
47

 
(4
)
CMBS
36

 
—

 
3

 
—

 
39

 
—

Asset-backed securities
434

 
(22
)
 
132

 
(8
)
 
566

 
(30
)
Non-U.S. government securities
95

 
(3
)
 
52

 
(9
)
 
147

 
(12
)
Total
$
1,390

 
$
(62
)
 
$
260

 
$
(30
)
 
$
1,650

 
$
(92
)
Number of securities (1)
 

 
376

 
 

 
79

 
 

 
430

 

Fixed-Maturity Securities
Gross Unrealized Loss by Length of Time
As of December 31, 2019

 
Less than 12 months
 
12 months or more
 
Total
 
Fair
Value
 
Unrealized
Loss
 
Fair
Value
 
Unrealized
Loss
 
Fair
Value
 
Unrealized
Loss
 
(dollars in millions)
Obligations of state and political subdivisions
$
45

 
$
(1
)
 
$
—

 
$
—

 
$
45

 
$
(1
)
U.S. government and agencies
5

 
—

 
5

 
—

 
10

 
—

Corporate securities
61

 
—

 
119

 
(19
)
 
180

 
(19
)
Mortgage-backed securities:
 

 
 

 
 

 
 

 
 
 
 
RMBS
10

 
—

 
75

 
(7
)
 
85

 
(7
)
CMBS
—

 
—

 
4

 
—

 
4

 
—

Asset-backed securities
24

 
—

 
183

 
(2
)
 
207

 
(2
)
Non-U.S. government securities
—

 
—

 
56

 
(5
)
 
56

 
(5
)
Total
$
145

 
$
(1
)
 
$
442

 
$
(33
)
 
$
587

 
$
(34
)
Number of securities
 

 
57

 
 

 
119

 
 

 
176

Number of securities with OTTI
 

 
1

 
 

 
7

 
 

 
8

___________________
(1)
The number of securities does not add across because lots consisting of the same securities have been purchased at different times and appear in both categories above (i.e., less than 12 months and 12 months or more). If a security appears in both categories, it is counted only once in the total column.

Of the securities in an unrealized loss position as of March 31, 2020, 57 securities had unrealized losses in excess of 10% of their carrying value. The total unrealized loss for these securities was $33 million as of March 31, 2020. The Company considered the credit quality, cash flows, interest rate movements, ability to hold a security to recovery and intent to sell a security in determining whether a security had a credit loss. The Company has determined that the unrealized losses

67

recorded as of March 31, 2020 were not related to credit quality. In addition, the Company currently does not intend to and is not required to sell investments in an unrealized loss position prior to expected recovery in value.

Of the securities in an unrealized loss position for 12 months or more as of December 31, 2019, 19 securities had unrealized losses greater than 10% of book value. The total unrealized loss for these securities was $25 million as of December 31, 2019. The Company considered the credit quality, cash flows, interest rate movements, ability to hold a security to recovery and intent to sell a security in determining whether a security had a credit loss. The Company determined that the unrealized losses recorded as of December 31, 2019 were not related to credit quality.
 
The amortized cost and estimated fair value of available-for-sale fixed maturity securities by contractual maturity as of March 31, 2020 are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
 
Distribution of Fixed-Maturity Securities
by Contractual Maturity
As of March 31, 2020
 
 
Amortized
Cost
 
Estimated
Fair Value
 
(in millions)
Due within one year
$
300

 
$
300

Due after one year through five years
1,691

 
1,694

Due after five years through 10 years
2,028

 
2,037

Due after 10 years
3,255

 
3,406

Mortgage-backed securities:
 

 
 

RMBS
737

 
717

CMBS
399

 
414

Total
$
8,410

 
$
8,568

 
Based on fair value, investments and restricted assets that are either held in trust for the benefit of third party ceding insurers in accordance with statutory requirements, placed on deposit to fulfill state licensing requirements, or otherwise pledged or restricted totaled $277 million and $280 million, as of March 31, 2020 and December 31, 2019, respectively. The investment portfolio also contains securities that are held in trust by certain AGL subsidiaries or otherwise restricted for the benefit of other AGL subsidiaries in accordance with statutory and regulatory requirements in the amount of $1,365 million and $1,502 million, based on fair value as of March 31, 2020 and December 31, 2019, respectively.

Net Investment Income

Net investment income is a function of the yield that the Company earns on invested assets and the size of the portfolio. Net investment income includes the income earned on fixed-maturity securities, short-term investments and other invested assets, other than investments accounted for under the equity method, which are recorded in equity in earnings of investees. The investment yield is a function of market interest rates at the time of investment as well as the type, credit quality and maturity of the invested assets.

68

Net Investment Income
 
 
First Quarter
 
2020
 
2019
 
(in millions)
Interest income:
 
 
 
Externally managed
$
62

 
$
72

Internally managed
20

 
28

Interest income
82

 
100

Investment expenses
(2
)
 
(2
)
Net investment income
$
80

 
$
98



Realized Investment Gains (Losses)

The table below presents the components of net realized investment gains (losses). Realized gains and losses on sales of investments are determined using the specific identification method.

Net Realized Investment Gains (Losses)
 
 
First Quarter
 
2020
 
2019
 
(in millions)
Gross realized gains on available-for-sale securities
$
7

 
$
6

Gross realized losses on available-for-sale securities
(1
)
 
(2
)
Credit impairments (1)
(11
)
 
(16
)
Net realized investment gains (losses) (2)
$
(5
)
 
$
(12
)

____________________
(1)
Credit impairment in First Quarter 2020 related primarily to an increase in the allowance for credit loss on loss mitigation securities. Shut-downs due to COVID-19 pandemic restrictions contributed to the increase in the allowance for credit loss in First Quarter 2020. Credit impairment in First Quarter 2019 was primarily attributable to OTTI on loss mitigation securities and foreign exchange losses.

(2)
Includes foreign currency gains of $3 million and $1 million for First Quarter 2020 and First Quarter 2019, respectively.


The proceeds from sales of fixed-maturity securities classified as available-for-sale were $86 million in First Quarter 2020 and $471 million in First Quarter 2019.


69

The following table presents the roll-forward of the credit losses on fixed-maturity securities for which the Company has recognized an allowance for credit losses in 2020 or an OTTI and for which unrealized loss was recognized in OCI for 2019.

Roll Forward of Credit Losses
in the Investment Portfolio

 
First Quarter
 
2020
 
2019
 
(in millions)
 
 
Balance, beginning of period
$
—

 
$
185

Effect of adoption of accounting guidance on credit losses on January 1, 2020
62

 
 
Additions for credit losses on securities for which credit impairments were not previously recognized
2

 
—

Additions (reductions) for credit losses on securities for which credit impairments were previously recognized
9

 
12

Balance, end of period
$
73

 
$
197




10.
Contracts Accounted for as Credit Derivatives
 
The Company has a portfolio of financial guaranty contracts that meet the definition of a derivative in accordance with GAAP (primarily CDS). The credit derivative portfolio also includes interest rate swaps.
 
Credit derivative transactions are governed by International Swaps and Derivatives Association, Inc. documentation and have certain characteristics that differ from financial guaranty insurance contracts. For example, the Company’s control rights with respect to a reference obligation under a credit derivative may be more limited than when the Company issues a financial guaranty insurance contract. In addition, there are more circumstances under which the Company may be obligated to make payments. Similar to a financial guaranty insurance contract, the Company would be obligated to pay if the obligor failed to make a scheduled payment of principal or interest in full. However, the Company may also be required to pay if the obligor becomes bankrupt or if the reference obligation were restructured if, after negotiation, those credit events are specified in the documentation for the credit derivative transactions. Furthermore, the Company may be required to make a payment due to an event that is unrelated to the performance of the obligation referenced in the credit derivative. If events of default or termination events specified in the credit derivative documentation were to occur, the non-defaulting or the non-affected party, which may be either the Company or the counterparty, depending upon the circumstances, may decide to terminate a credit derivative prior to maturity. In that case, the Company may be required to make a termination payment to its swap counterparty upon such termination. Absent such an event of default or termination event, the Company may not unilaterally terminate a CDS contract; however, the Company on occasion has mutually agreed with various counterparties to terminate certain CDS transactions.
 

70

Credit Derivative Net Par Outstanding by Sector
 
The components of the Company’s credit derivative net par outstanding are presented in the table below. The estimated remaining weighted average life of credit derivatives was 11.3 years and 11.5 years as of March 31, 2020 and December 31, 2019, respectively.
 
Credit Derivatives (1)
 
 
 
As of March 31, 2020
 
As of December 31, 2019
 
 
Net Par
Outstanding
 
Net Fair Value Asset (Liability)
 
Net Par
Outstanding
 
Net Fair Value Asset (Liability)
 
 
(in millions)
U.S. public finance
 
$
2,065

 
$
(112
)
 
$
1,942

 
$
(83
)
Non-U.S. public finance
 
2,461

 
(52
)
 
2,676

 
(39
)
U.S. structured finance
 
1,156

 
(89
)
 
1,206

 
(58
)
Non-U.S. structured finance
 
124

 
(9
)
 
132

 
(5
)
Total
 
$
5,806

 
$
(262
)
 
$
5,956

 
$
(185
)

____________________
(1)    Expected recoveries were $13 million as of March 31, 2020 and $4 million as of December 31, 2019.

Distribution of Credit Derivative Net Par Outstanding by Internal Rating
 
 
 
As of March 31, 2020
 
As of December 31, 2019
Ratings
 
Net Par
Outstanding
 
% of Total
 
Net Par
Outstanding
 
% of Total
 
 
(dollars in millions)
AAA
 
$
1,631

 
28.1
%
 
$
1,730

 
29.0
%
AA
 
1,702

 
29.3

 
1,695

 
28.5

A
 
1,127

 
19.4

 
1,110

 
18.6

BBB
 
1,220

 
21.0

 
1,292

 
21.7

BIG (1)
 
126

 
2.2

 
129

 
2.2

Credit derivative net par outstanding
 
$
5,806

 
100.0
%
 
$
5,956

 
100.0
%

____________________
(1)
All BIG credit derivatives are U.S. RMBS transactions.

Fair Value of Credit Derivatives
 
Net Change in Fair Value of Credit Derivative Gains (Losses)
 
 
First Quarter
 
2020
 
2019
 
(in millions)
Realized gains on credit derivatives
$
2

 
$
3

Net credit derivative losses (paid and payable) recovered and recoverable and other settlements
(2
)
 
(4
)
Realized gains (losses) and other settlements
—

 
(1
)
Net unrealized gains (losses)
(77
)
 
(21
)
Net change in fair value of credit derivatives
$
(77
)
 
$
(22
)


     During First Quarter 2020, non-credit impairment fair value losses were generated primarily as a result of wider spreads of the underlying collateral and lower discount rates. These were partially offset by gains due to the increased cost to buy protection on AGC, as the market cost of AGC's credit protection increased during the period. For those CDS transactions that were pricing at or above their floor levels, when the cost of purchasing CDS protection on AGC, which management refers

71

to as the CDS spread on AGC, increased, the implied spreads that the Company would expect to receive on these transactions decreased.

During First Quarter 2019, non-credit impairment fair value losses were driven by the decreased cost to buy protection in AGC’s name, as the market cost of AGC’s credit protection decreased during the period.

The impact of changes in credit spreads will vary based upon the volume, tenor, interest rates, and other market conditions at the time these fair values are determined. In addition, since each transaction has unique collateral and structural terms, the underlying change in fair value of each transaction may vary considerably. The fair value of credit derivative contracts also reflects the change in the Company’s own credit cost based on the price to purchase credit protection on AGC. The Company determines its own credit risk based on quoted CDS prices traded on the Company at each balance sheet date.
 
CDS Spread on AGC (in bps)
 
 
As of
March 31, 2020
 
As of
December 31, 2019
 
As of
March 31, 2019
 
As of
December 31, 2018
Five-year CDS spread
224

 
41

 
74

 
110

One-year CDS spread
64

 
9

 
20

 
22


Fair Value of Credit Derivative Assets (Liabilities)
and Effect of AGC
Credit Spread

 
As of
March 31, 2020
 
As of
December 31, 2019
 
(in millions)
Fair value of credit derivatives before effect of AGC credit spread
$
(478
)
 
$
(261
)
Plus: Effect of AGC credit spread
216

 
76

Net fair value of credit derivatives
$
(262
)
 
$
(185
)


The fair value of CDS contracts at March 31, 2020, before considering the benefit applicable to AGC’s credit spreads, is a direct result of the relatively wide credit spreads of certain underlying credits generally due to the long tenor of these credits.
 
Collateral Posting for Certain Credit Derivative Contracts

The transaction documentation with one counterparty for $168 million in CDS net par insured by the Company requires the Company to post collateral, subject to a $168 million cap, to secure its obligation to make payments under such contracts. Eligible collateral is generally cash or U.S. government or agency securities; eligible collateral other than cash is valued at a discount to the face amount. As of March 31, 2020, AGC did not need to to post collateral to satisfy these requirements.


72

11.    Asset Management Fees

The following table presents the sources of asset management fees on a consolidated basis.

Asset Management Fees
 
First Quarter 2020
 
(in millions)
Management fees:
 
CLOs (1)
$
4

Opportunity funds
2

Wind-down funds
9

Total management fees
15

Reimbursable fund expenses
8

Total asset management fees (2)
$
23

_____________________
(1)
To the extent that the Company's wind-down and/or opportunity funds are invested in BlueMountain managed CLOs, BlueMountain may rebate any management fees and/or performance compensation earned from the CLOs to the extent such fees are attributable to the wind-down and opportunity funds’ holdings of CLOs also managed by BlueMountain. Gross management fees from CLOs, before rebates, were $10 million.

(2)
There were no performance fees for First Quarter 2020. Performance fees are recorded when the contractual performance criteria have been met and when it is probable that a significant reversal of revenues will not occur in future reporting periods. For opportunity funds, these conditions are met typically close to the end of the fund’s life. The Company's current opportunity funds were not near the end of their harvest period during the quarter, when they would typically earn performance fee.

The Company had management fees receivable, which are included in other assets on the condensed consolidated balance sheets, of $5 million as of March 31, 2020 and management and performance fees receivable of $9 million as of December 31, 2019. The Company had no unearned revenues as of March 31, 2020 and December 31, 2019.     

12.
Variable Interest Entities

Financial Guaranty Variable Interest Entities

The Company provides financial guaranties with respect to debt obligations of special purpose entities, including VIEs, but does not act as the servicer or collateral manager for any VIE obligations guaranteed by its insurance subsidiaries. The transaction structure generally provides certain financial protections to the Company. This financial protection can take several forms, the most common of which are overcollateralization, first loss protection (or subordination) and excess spread. In the case of overcollateralization (i.e., the principal amount of the securitized assets exceeds the principal amount of the structured finance obligations guaranteed by the Company), the structure allows defaults of the securitized assets before a default is experienced on the structured finance obligation guaranteed by the Company. In the case of first loss, the Company's financial guaranty insurance policy only covers a senior layer of losses experienced by multiple obligations issued by the VIEs. The first loss exposure with respect to the assets is either retained by the seller or sold off in the form of equity or mezzanine debt to other investors. In the case of excess spread, the financial assets contributed to VIEs generate interest income that are in excess of the interest payments on the debt issued by the VIE. Such excess spread is typically distributed through the transaction’s cash flow waterfall and may be used to create additional credit enhancement, applied to redeem debt issued by the VIE (thereby, creating additional overcollateralization), or distributed to equity or other investors in the transaction.

Assured Guaranty is not primarily liable for the debt obligations issued by the VIEs it insures and would only be required to make payments on those insured debt obligations in the event that the issuer of such debt obligations defaults on any principal or interest due and only for the amount of the shortfall. AGL’s and its subsidiaries’ creditors do not have any rights with regard to the collateral supporting the debt issued by the FG VIEs. Proceeds from sales, maturities, prepayments and interest from such underlying collateral may only be used to pay debt service on FG VIEs’ liabilities. Net fair value gains and losses on FG VIEs are expected to reverse to zero at maturity of the FG VIEs’ debt, except for net premiums received and net claims paid by Assured Guaranty under the financial guaranty insurance contract. The Company’s estimate of expected loss to be paid for FG VIEs is included in Note 5, Expected Loss to be Paid.

73

As part of the terms of its financial guaranty contracts, the Company, under its insurance contract, obtains certain protective rights with respect to the VIE that give the Company additional controls over a VIE. These protective rights are triggered by the occurrence of certain events, such as failure to be in compliance with a covenant due to poor deal performance or a deterioration in a servicer or collateral manager's financial condition. At deal inception, the Company typically is not deemed to control a VIE; however, once a trigger event occurs, the Company's control of the VIE typically increases. The Company continuously evaluates its power to direct the activities that most significantly impact the economic performance of VIEs that have debt obligations insured by the Company and, accordingly, where the Company is obligated to absorb VIE losses or receive benefits that could potentially be significant to the VIE. The Company is deemed to be the control party for certain VIEs under GAAP, typically when its protective rights give it the power to both terminate and replace the deal servicer, which are characteristics specific to the Company's financial guaranty contracts. If the protective rights that could make the Company the control party have not been triggered, then the VIE is not consolidated. If the Company is deemed no longer to have those protective rights, the VIE is deconsolidated.

The Company has elected the fair value option for assets and liabilities classified as FG VIEs' assets and liabilities because the carrying amount transition method was not practical.

As of March 31, 2020 and December 31, 2019, the Company consolidated 26 and 27 FG VIEs, respectively. During First Quarter 2020 there was one FG VIE that matured. There were no other consolidations or deconsolidations for the periods presented.

The change in the ISCR of the FG VIEs’ assets held as of March 31, 2020 that was recorded in the condensed consolidated statements of operations for First Quarter 2020 was a loss of $3 million. The change in the ISCR of the FG VIEs’ assets was a gain of $6 million for First Quarter 2019. To calculate ISCR, the change in the fair value of the FG VIEs’ assets is allocated between changes that are due to ISCR and changes due to other factors, including interest rates. The ISCR amount is determined by using expected cash flows at the original date of consolidation discounted at the effective yield less current expected cash flows discounted at that same original effective yield.

The inception to date change in fair value of the FG VIEs’ liabilities with recourse attributable to the ISCR is calculated by holding all current period assumptions constant for each security and isolating the effect of the change in the Company’s CDS spread from the most recent date of consolidation to the current period. In general, if the Company’s CDS spread tightens, more value will be assigned to the Company’s credit; however, if the Company’s CDS widens, less value is assigned to the Company’s credit.

 
As of
March 31, 2020
 
As of
December 31, 2019
 
(in millions)
Excess of unpaid principal over fair value of:
 
 
 
FG VIEs’ assets
$
316

 
$
279

FG VIEs’ liabilities with recourse
49

 
21

FG VIEs’ liabilities without recourse
30

 
19

Unpaid principal balance for FG VIEs’ assets that were 90 days or more past due
53

 
52

Unpaid principal for FG VIEs’ liabilities with recourse (1)
361

 
388

____________________
(1)
FG VIEs’ liabilities with recourse will mature at various dates ranging from 2020 to 2038.


74

The table below shows the carrying value of the consolidated FG VIEs’ assets and liabilities in the condensed consolidated financial statements, segregated by the types of assets that collateralize the respective debt obligations for FG VIEs’ liabilities with recourse.

Consolidated FG VIEs
By Type of Collateral

 
As of March 31, 2020
 
As of December 31, 2019
 
Assets
 
Liabilities
 
Assets
 
Liabilities
 
(in millions)
With recourse:
 

 
 

 
 

 
 

U.S. RMBS first lien
$
224

 
$
252

 
$
270

 
$
297

U.S. RMBS second lien
62

 
60

 
70

 
70

Total with recourse
286

 
312

 
340

 
367

Without recourse
82

 
82

 
102

 
102

Total
$
368

 
$
394

 
$
442

 
$
469



Consolidated Investment Vehicles

Through a jointly owned subsidiary, AGM, AGC and MAC, the U.S. insurance subsidiaries, initially intend to invest $500 million in Assured Investment Management funds. As of March 31, 2020 and December 31, 2019, $192 million and $79 million, respectively, was invested in three separate Assured Investment Management funds: AHP, ABIF and CLO Warehouse Fund. As of March 31, 2020 and December 31, 2019, the fair value of such investments was $179 million and $77 million, respectively. CLO Warehouse Fund invested in the subordinated notes of CLO XXVI.

AHP, ABIF, CLO Warehouse Fund and CLO XXVI (collectively, the consolidated investment vehicles) are VIEs. The Company consolidates these investment vehicles as it is deemed to be the primary beneficiary based on its power to direct the most significant activities of each VIE (through its Assured Investment Management platform asset management subsidiaries) and its level of economic interest in the entities (through its U.S. insurance subsidiaries).

AHP, ABIF and CLO Warehouse Fund are investment companies for accounting purposes and therefore account for their underlying investments at fair value. CLO XXVI is a CFE. Under the practical expedient for CFEs, the Company elected to measure CLO XXVI's assets and liabilities using the fair value of its assets, which are more observable. Changes in the fair value of assets and liabilities of consolidated investment vehicles are recorded in "fair value gains (losses) on consolidated investment vehicles" in the condensed consolidated statements of operations.
    
As a result of consolidating AHP, ABIF and CLO Warehouse Fund, the Company records noncontrolling interest for the portion of each fund owned by employees and any third party investors. As of March 31, 2020, redeemable employee-owned noncontrolling interest in CLO Warehouse Fund was classified outside of shareholders’ equity, within temporary equity, and non-redeemable employee-owned noncontrolling interest in AHP and ABIF is presented within shareholders' equity in the consolidated balance sheets. As of December 31, 2019, redeemable employee-owned noncontrolling interest, held in ABIF and CLO Warehouse Fund, was classified outside of shareholders' equity, within temporary equity. For AHP, nonredeemable noncontrolling interest is presented within shareholders' equity in the consolidated balance sheets. During First Quarter 2020, redemption features for employee-owned interests in ABIF were amended, resulting in a reclassification from redeemable NCI to non-redeemable noncontrolling interest.

The assets and liabilities of the Company's consolidated investment vehicles (which include consolidated funds: AHP, ABIF and CLO Warehouse Fund as well as CLO XXVI) are held within separate legal entities. The assets of the consolidated investment vehicles are not available to creditors of the Company, other than creditors of the applicable consolidated investment vehicles. In addition, creditors of the consolidated investment vehicles have no recourse against the assets of the Company, other than the assets of such applicable consolidated investment vehicles. 

Generally, the consolidation of the Company's consolidated investment vehicles and FG VIEs has a significant gross-up effect on the Company's assets, liabilities and cash flows. The consolidated investment vehicles have no net effect on the net income attributable to the Company, other than the economic interest the Company holds in consolidated funds in the Company's Insurance segment. The ownership interests of the Company's consolidated funds, to which the Company has no

75

economic rights, are reflected as either redeemable or nonredeemable noncontrolling interest in the consolidated funds in the Company's consolidated financial statements. Liquidity available at the Company's consolidated investment vehicles is typically not available for corporate liquidity needs, except to the extent of the Company's investment in the fund.

Assets and Liabilities
of Consolidated Investment Vehicles
 
 
As of
March 31, 2020
 
As of
December 31, 2019
 
(in millions)
Assets:
 
 
 
Cash and restricted cash (1)
$
82

 
$
14

Corporate loans of CFE, at fair value
433

 
494

Corporate loans, at fair value
53

 
47

Other assets (2)
77

 
17

Total assets
$
645

 
$
572

Liabilities:
 
 
 
CLO obligations of CFE, at fair value (3)
426

 
481

Other liabilities
5

 
1

Total liabilities
$
431

 
$
482

____________________
(1)
Cash held by consolidated investment vehicles are not available to fund the general liquidity needs of the Company.

(2)
Includes investment in affiliates of $7 million and $9 million as of March 31, 2020 and December 31, 2019, respectively.

(3)
The weighted average maturity and weighted average interest rate of CLO obligations were 6.3 years and 3.8%, respectively, for March 31, 2020 and 12.8 years and 3.8%, respectively, for December 31, 2019. CLO obligations will mature in 2032.

As of March 31, 2020, the consolidated investment vehicles had a commitment to invest $17 million.

Redeemable Noncontrolling Interests in Consolidated Investment Vehicles
 
First Quarter 2020
 
(in millions)
Beginning balance
$
7

Reallocation of ownership interests
(2
)
Contributions to investment vehicles
5

Net loss
(2
)
March 31,
$
8



Interest income and interest expense are included in "fair value gains (losses) on consolidated investment vehicles." Investment purchases and sales for all consolidated investment vehicles are classified as operating activities, debt issuances and repayments are classified in financing activities.

Effect of Consolidating FG VIEs and Consolidated Investment Vehicles

The effect on the statements of operations and financial condition of consolidating FG VIEs includes (i) changes in fair value gains (losses) on FG VIEs’ assets and liabilities, (ii) the elimination of premiums and losses related to the AGC and AGM FG VIEs’ liabilities with recourse and (iii) the elimination of investment balances related to the Company’s purchase of AGC and AGM insured FG VIEs’ debt. Upon consolidation of a FG VIE, the related insurance and, if applicable, the related investment balances are considered intercompany transactions and therefore eliminated. Such eliminations are included in the table below to present the full effect of consolidating FG VIEs.


76

The effect on the statements of operations and financial condition of consolidating Assured Investment Management investment vehicles includes (i) changes in fair value of consolidated investment vehicles assets and liabilities, (2) the elimination of the equity in earnings in investees related to the Insurance segment's investments in the consolidated Assured Investment Management funds, (3) the elimination of debt of the CLO XXVI against the assets of the consolidated CLO Warehouse Fund, (4) the recording of noncontrolling interest for the proportion of each consolidated Assured Investment Management fund that is not owned by any other subsidiary of the Company, and (5) the elimination of intercompany asset management fees.

The cash flows generated by the FG VIEs’ assets are classified as cash flows from investing activities. Paydowns of FG VIEs' liabilities are supported by the cash flows generated by FG VIEs’ assets, and for liabilities with recourse, possibly claim payments made by AGM or AGC under its financial guaranty insurance contracts. Paydowns of FG VIEs' liabilities both with and without recourse are classified as cash flows used in financing activities. Interest income, interest expense and other expenses of the FG VIEs’ assets and liabilities are classified as operating cash flows. Claim payments made by AGC and AGM under the financial guaranty contracts issued to the FG VIEs are eliminated upon consolidation and therefore such claim payments are treated as paydowns of FG VIEs’ liabilities and as a financing activity as opposed to an operating activity of AGM and AGC.

Cash flows of the consolidated investment vehicles attributable to such entities' investment purchases and dispositions, as well as operating expenses of the investment vehicles, are presented as cash flow from operating activities in the condensed consolidated statements of cash flows. Financing activities and capital cash flows to and from investors are presented as financing activities consistent with investment company guidelines.


77

Effect of Consolidating FG VIEs and Consolidated Investment Vehicles
on the Condensed Consolidated Balance Sheets
Increase (Decrease)

 
As of
March 31, 2020
 
As of
December 31, 2019
 
(in millions)
Assets
 
 
 
Investment portfolio:
 
 
 
Fixed maturity securities and short-term investments
$
(34
)
 
$
(39
)
Equity method investments (1)
(179
)
 
(77
)
Total investments
(213
)
 
(116
)
Premiums receivable, net of commissions payable
(7
)
 
(7
)
Salvage and subrogation recoverable
(9
)
 
(8
)
FG VIEs’ assets, at fair value
368

 
442

Assets of consolidated investment vehicles (1)
645

 
572

Other assets
(1
)
 
—

Total assets
$
783

 
$
883

Liabilities and shareholders’ equity
 
 
 
Unearned premium reserve
$
(41
)
 
$
(39
)
Loss and LAE reserve
(44
)
 
(41
)
Deferred tax liabilities
2

 
—

FG VIEs’ liabilities with recourse, at fair value
312

 
367

FG VIEs’ liabilities without recourse, at fair value
82

 
102

Liabilities of consolidated investment vehicles (1)
431

 
482

Total liabilities
742

 
871

 
 
 
 
Redeemable noncontrolling interests in consolidated investment vehicles (1)
8

 
7

 
 
 
 
Retained earnings
30

 
34

Accumulated other comprehensive income
(22
)
 
(35
)
Total shareholders’ equity attributable to Assured Guaranty Ltd.
8

 
(1
)
Nonredeemable noncontrolling interests (1)
25

 
6

Total shareholders’ equity
33

 
5

Total liabilities, redeemable noncontrolling interests and shareholders’ equity
$
783

 
$
883

 ____________________
(1)
These line items represent the components of the effect of consolidating Assured Investment Management investment vehicles.




78

Effect of Consolidating FG VIEs and Consolidated Investment Vehicles
on the Condensed Consolidated Statements of Operations
Increase (Decrease)
 
First Quarter
 
2020

2019
 
(in millions)
Net earned premiums
$
(1
)
 
$
(3
)
Net investment income
(1
)
 
(1
)
Asset management fees
(1
)
 
—

Fair value gains (losses) on FG VIEs
(9
)
 
5

Fair value gains (losses) on consolidated investment vehicles
(12
)
 
—

Loss and LAE
6

 
(1
)
Equity in net earnings of investees
10

 
—

Effect on income before tax
(8
)
 
—

Less: Tax provision (benefit)
(1
)
 
—

Effect on net income (loss)
(7
)
 
—

Effect on redeemable noncontrolling interests
(3
)
 
—

Effect on net income (loss) attributable to AGL
$
(4
)
 
$
—



Effect of Consolidating FG VIEs and Consolidated Investment Vehicles
on Condensed Consolidated Statements of Cash Flows
Inflows (Outflows)

 
First Quarter
 
2020
 
2019
 
(in millions)
Effect on cash flows from operating activities
$
(67
)
 
$
1

Effect on cash flows from investing activities
147

 
24

Effect on cash flows from financing activities
(12
)
 
(25
)
Total effect on cash flows
$
68

 
$
—



For First Quarter 2020, the fair value losses on FG VIEs were attributable to price depreciation due to the observed widening in the market spreads for the underlying collateral. The change in fair value of consolidated investment vehicles was a loss of $12 million for First Quarter 2020 attributable to price depreciation on underlying assets. For First Quarter 2019, the primary driver of the gain was price appreciation on the FG VIE assets resulting from improvement in the underlying collateral.

Other Consolidated VIEs

In certain instances where the Company consolidates a VIE that was established as part of a loss mitigation negotiated settlement that results in the termination of the original insured financial guaranty insurance or credit derivative contract, the Company classifies the assets and liabilities of those VIEs in the line items that most accurately reflect the nature of the items, as opposed to within the FG VIEs’ assets and FG VIEs’ liabilities. The largest of these VIEs had assets of $93 million and liabilities of $23 million as of March 31, 2020, and assets of $91 million and liabilities of $12 million as of December 31, 2019, primarily recorded in the investment portfolio and credit derivative liabilities on the condensed consolidated balance sheets.

Non-Consolidated VIEs
 
As described in Note 4, Outstanding Insurance Exposure, the Company monitors all policies in the insured portfolio. Of the approximately 18 thousand policies monitored as of March 31, 2020, approximately 16 thousand policies are not within the scope of ASC 810 because these financial guaranties relate to the debt obligations of governmental organizations or financing entities established by a governmental organization. The majority of the remaining policies involve transactions where the Company is not deemed to currently have control over the FG VIEs’ most significant activities. As of March 31,

79

2020 and December 31, 2019, the Company identified 87 and 90 policies, respectively, that contain provisions and experienced events that may trigger consolidation. Based on management’s assessment of these potential triggers or events, the Company consolidated 26 and 27 FG VIEs as of March 31, 2020 and December 31, 2019, respectively. The Company’s exposure provided through its financial guaranties with respect to debt obligations of FG VIEs is included within net par outstanding in Note 4, Outstanding Insurance Exposure.

The Company manages funds and CLOs that have been determined to be a VIE or voting interest entity, in which the Company concluded that it held no variable interests, through either equity interests held, debt interests held or decision-making fees received by the Assured Investment Management platform subsidiaries. As such, the Company does not consolidate these entities.
    
13.
Income Taxes

Overview
 
AGL and its Bermuda subsidiaries AG Re, AGRO, and Cedar Personnel Ltd. (Bermuda Subsidiaries), are not subject to any income, withholding or capital gains taxes under current Bermuda law. The Company has received an assurance from the Minister of Finance in Bermuda that, in the event of any taxes being imposed, AGL and its Bermuda Subsidiaries will be exempt from taxation in Bermuda until March 31, 2035. AGL's U.S. and U.K. subsidiaries are subject to income taxes imposed by U.S. and U.K. authorities, respectively, and file applicable tax returns. In addition, AGRO, a Bermuda domiciled company, has elected under Section 953(d) of the U.S. Internal Revenue Code (the Code) to be taxed as a U.S. domestic corporation.

In November 2013, AGL became tax resident in the U.K. although it remains a Bermuda-based company and its administrative and head office functions continue to be carried on in Bermuda.

AGUS files a consolidated federal income tax return with all of its U.S. subsidiaries. Assured Guaranty Overseas US Holdings Inc. and its subsidiaries AGRO and AG Intermediary Inc. file their own consolidated federal income tax return.

The CARES (Coronavirus Aid, Relief, and Economic Security) Act became law on March 27, 2020 and was updated on April 9, 2020. The CARES Act, among other tax changes, accelerates the ability of companies to receive refunds of alternative minimum tax (AMT) credits related to tax years beginning in 2018 and 2019. As a result, the Company has recognized a current tax asset of $12 million of AMT credits that had been recorded as a deferred tax asset as of December 31, 2019.

Tax Assets (Liabilities)
    
Deferred and Current Tax Assets (Liabilities) (1)

 
As of
March 31, 2020
 
As of
December 31, 2019
 
(in millions)
Deferred tax assets (liabilities)
$
14

 
$
(17
)
Current tax assets (liabilities)
58

 
47

____________________
(1)
Included in other assets or other liabilities on the condensed consolidated balance sheets.

Valuation Allowance
 
The Company has $13 million of foreign tax credits (FTC) carryovers from previous acquisitions and $23 million of FTC due to the 2017 Tax Cuts and Jobs Act for use against regular tax in future years. FTCs will begin to expire in 2020 and will fully expire by 2027. In analyzing the future realizability of FTCs, the Company notes limitations on future foreign source income due to overall foreign losses as negative evidence. After reviewing positive and negative evidence, the Company came to the conclusion that it is more likely than not that the FTC of $36 million will not be utilized, and therefore recorded a valuation allowance with respect to this tax attribute.

The Company came to the conclusion that it is more likely than not that the remaining deferred tax assets will be fully realized after weighing all positive and negative evidence available as required under GAAP. The positive evidence that was considered included the cumulative income the Company has earned over the last three years, and the significant unearned

80

premium income to be included in taxable income. The positive evidence outweighs any negative evidence that exists. As such, the Company believes that no valuation allowance is necessary in connection with the remaining deferred tax assets. The Company will continue to analyze the need for a valuation allowance on a quarterly basis.

Provision for Income Taxes

The Company's provision for income taxes for interim financial periods is not based on an estimated annual effective rate due, for example, to the variability in loss reserves, fair value of its credit derivatives and VIEs, and foreign exchange gains and losses which prevents the Company from projecting a reliable estimated annual effective tax rate and pretax income for the full year 2020. A discrete calculation of the provision is calculated for each interim period.

The effective tax rates reflect the proportion of income recognized by each of the Company’s operating subsidiaries, with U.S. subsidiaries taxed at the U.S. marginal corporate income tax rate of 21%, U.K. subsidiaries taxed at the U.K. marginal corporate tax rate of 19%, and no taxes for the Company’s Bermuda Subsidiaries unless subject to U.S. tax by election. The Company’s overall effective tax rate fluctuates based on the distribution of income across jurisdictions.
 
A reconciliation of the difference between the provision for income taxes and the expected tax provision at statutory rates in taxable jurisdictions is presented below.

Effective Tax Rate Reconciliation
 
 
First Quarter
 
2020
 
2019
 
(in millions)
Expected tax provision (benefit)
$
(11
)
 
$
9

Tax-exempt interest
(4
)
 
(5
)
State tax
1

 
1

Foreign taxes
8

 
1

Taxes on reinsurance
—

 
1

Deferred compensation
2

 
(2
)
Other
—

 
(1
)
Total provision (benefit) for income taxes
$
(4
)
 
$
4

Effective tax rate
7.1
%
 
7.8
%



The expected tax provision (benefit) is calculated as the sum of pretax income in each jurisdiction multiplied by the statutory tax rate of the jurisdiction by which it will be taxed. Where there is a pretax loss in one jurisdiction and pretax income in another, the total combined expected tax rate may be higher or lower than any of the individual statutory rates.

 The following tables present pretax income and revenue by jurisdiction.
 
Pretax Income (Loss) by Tax Jurisdiction

 
First Quarter
 
2020
 
2019
 
(in millions)
U.S.
$
(26
)
 
$
35

Bermuda
(7
)
 
16

U.K. and other
(29
)
 
7

Total
$
(62
)
 
$
58





81

Revenue by Tax Jurisdiction

 
First Quarter
 
2020
 
2019
 
(in millions)
U.S.
$
93

 
$
149

Bermuda
14

 
33

U.K. and other
(11
)
 
13

Total
$
96

 
$
195


 
Pretax income by jurisdiction may be disproportionate to revenue by jurisdiction to the extent that insurance losses incurred are disproportionate.

Audits

As of March 31, 2020, AGUS had open tax years with the U.S. Internal Revenue Service (IRS) for 2016 to present and is currently under audit for the 2016 tax year. Assured Guaranty Overseas US Holdings Inc. has open tax years of 2016 forward but is not currently under audit with the IRS. The Company's U.K. subsidiaries are not currently under examination and have open tax years of 2017 forward. CIFG Assurance North America Inc., which was acquired by AGC during 2016, is not currently under examination and has open tax years of 2016 to the date of acquisition.

Uncertain Tax Positions

The Company's policy is to recognize interest related to uncertain tax positions in income tax expense and has accrued $0.2 million for First Quarter 2020 and $1 million for the full year 2019. As of both March 31, 2020 and December 31, 2019, the Company has accrued $2 million of interest.

The total amount of reserves for unrecognized tax positions, including accrued interest, as of both March 31, 2020 and December 31, 2019 that would affect the effective tax rate, if recognized, was $17 million.

14.    Commitments and Contingencies

Lawsuits arise in the ordinary course of the Company’s business. It is the opinion of the Company’s management, based upon the information available, that the expected outcome of litigation against the Company, individually or in the aggregate, will not have a material adverse effect on the Company’s financial position or liquidity, although an adverse resolution of litigation against the Company in a fiscal quarter or year could have a material adverse effect on the Company’s results of operations in a particular quarter or year.

In addition, in the ordinary course of their respective businesses, certain of AGL's insurance subsidiaries are involved in litigation with third parties to recover losses paid in prior periods or prevent or reduce losses in the future. For example, the Company is involved in a number of legal actions in the Federal District Court for Puerto Rico to enforce or defend its rights with respect to the obligations it insures of Puerto Rico and various of its related authorities and public corporations. See "Exposure to Puerto Rico" section of Note 4, Outstanding Insurance Exposure, for a description of such actions. Also in the ordinary course of their respective business, certain of AGL's investment management subsidiaries are involved in litigation with third parties regarding fees, appraisals, or portfolio companies. The impact, if any, of these and other proceedings on the amount of recoveries the Company receives and losses it pays in the future is uncertain, and the impact of any one or more of these proceedings during any quarter or year could be material to the Company's results of operations in that particular quarter or year.

The Company also receives subpoenas duces tecum and interrogatories from regulators from time to time.

Litigation

On November 28, 2011, Lehman Brothers International (Europe) (in administration) (LBIE) sued AG Financial Products Inc. (AGFP), an affiliate of AGC which in the past had provided credit protection to counterparties under CDS. AGC acts as the credit support provider of AGFP under these CDS. LBIE’s complaint, which was filed in the Supreme Court of the State of New York, asserted a claim for breach of the implied covenant of good faith and fair dealing based on AGFP's

82

termination of nine credit derivative transactions between LBIE and AGFP and asserted claims for breach of contract and breach of the implied covenant of good faith and fair dealing based on AGFP's termination of 28 other credit derivative transactions between LBIE and AGFP and AGFP's calculation of the termination payment in connection with those 28 other credit derivative transactions. Following defaults by LBIE, AGFP properly terminated the transactions in question in compliance with the agreement between AGFP and LBIE, and calculated the termination payment properly. AGFP calculated that LBIE owes AGFP approximately $4 million for the claims which were dismissed and approximately $25 million in connection with the termination of the other credit derivative transactions, whereas LBIE asserted in the complaint that AGFP owes LBIE a termination payment of approximately $1.4 billion. AGFP filed a motion to dismiss the claims for breach of the implied covenant of good faith in LBIE's complaint, and on March 15, 2013, the court granted AGFP's motion to dismiss in respect of the count relating to the nine credit derivative transactions and narrowed LBIE's claim with respect to the 28 other credit derivative transactions. LBIE's administrators disclosed in an April 10, 2015 report to LBIE’s unsecured creditors that LBIE's valuation expert has calculated LBIE's claim for damages in aggregate for the 28 transactions to range between a minimum of approximately $200 million and a maximum of approximately $500 million, depending on what adjustment, if any, is made for AGFP's credit risk and excluding any applicable interest. AGFP filed a motion for summary judgment on the remaining causes of action asserted by LBIE and on AGFP's counterclaims, and on July 2, 2018, the court granted in part and denied in part AGFP’s motion. The court dismissed, in its entirety, LBIE’s remaining claim for breach of the implied covenant of good faith and fair dealing and also dismissed LBIE’s claim for breach of contract solely to the extent that it is based upon AGFP’s conduct in connection with the auction. With respect to LBIE’s claim for breach of contract, the court held that there are triable issues of fact regarding whether AGFP calculated its loss reasonably and in good faith. On October 1, 2018, AGFP filed an appeal with the Appellate Division of the Supreme Court of the State of New York, First Judicial Department, seeking reversal of the portions of the lower court's ruling denying AGFP’s motion for summary judgment with respect to LBIE’s sole remaining claim for breach of contract. On January 17, 2019, the Appellate Division affirmed the Supreme Court's decision, holding that the lower court correctly determined that there are triable issues of fact regarding whether AGFP calculated its loss reasonably and in good faith. The trial, originally scheduled for March 9, 2020, has been postponed due to the COVID-19 pandemic. A status conference is scheduled for May 11, 2020.


83

15.
Shareholders' Equity

Other Comprehensive Income
 
The following tables present the changes in each component of AOCI and the effect of reclassifications out of AOCI on the respective line items in net income.

Changes in Accumulated Other Comprehensive Income by Component
First Quarter 2020

 
Net Unrealized Gains (Losses) on Investments with no credit impairment
 
Net Unrealized gains (Losses) on Investments with credit impairment
 
Net Unrealized Gains (Losses) on FG VIEs’ Liabilities with Recourse due to ISCR
 
Cumulative
Translation
Adjustment
 
Cash Flow 
Hedge
 
Total 
AOCI
 
(in millions)
Balance, December 31, 2019
$
352

 
$
48

 
$
(27
)
 
$
(38
)
 
$
7

 
$
342

Effect of adoption of accounting guidance on credit losses
62

 
(62
)
 
—

 
—

 
—

 
—

Other comprehensive income (loss) before reclassifications
(156
)
 
(61
)
 
9

 
—

 
—

 
(208
)
Less: Amounts reclassified from AOCI to:
 
 
 
 
 
 
 
 
 
 
 
Net realized investment gains (losses)
6

 
(11
)
 
—

 
—

 
—

 
(5
)
Net investment income
—

 
—

 
—

 
—

 
—

 
—

Fair value gains (losses) on FG VIEs
—

 
—

 
(2
)
 
—

 
—

 
(2
)
Total before tax
6

 
(11
)
 
(2
)
 
—

 
—

 
(7
)
Tax (provision) benefit
—

 
2

 
1

 
—

 
—

 
3

Total amount reclassified from AOCI, net of tax
6

 
(9
)
 
(1
)
 
—

 
—

 
(4
)
Net current period other comprehensive income (loss)
(162
)
 
(52
)
 
10

 
—

 
—

 
(204
)
Balance, March 31, 2020
$
252

 
$
(66
)
 
$
(17
)
 
$
(38
)
 
$
7

 
$
138























84

Changes in Accumulated Other Comprehensive Income by Component
First Quarter 2019

 
Net Unrealized Gains (Losses) on Investments with no credit impairment
 
Net Unrealized gains (Losses) on Investments with credit impairment
 
Net Unrealized Gains (Losses) on FG VIEs’ Liabilities with Recourse due to ISCR
 
Cumulative
Translation
Adjustment
 
Cash Flow 
Hedge
 
Total 
AOCI
 
(in millions)
Balance, December 31, 2018
$
59

 
$
94

 
$
(31
)
 
$
(37
)
 
$
8

 
$
93

Other comprehensive income (loss) before reclassifications
165

 
(7
)
 
(2
)
 
—

 
—

 
156

Less: Amounts reclassified from AOCI to:
 
 
 
 
 
 
 
 
 
 
 
Net realized investment gains (losses)
3

 
(15
)
 
—

 
—

 
—

 
(12
)
Fair value gains (losses) on FG VIEs
—

 
—

 
(2
)
 
—

 
—

 
(2
)
Total before tax
3

 
(15
)
 
(2
)
 
—

 
—

 
(14
)
Tax (provision) benefit
(1
)
 
3

 
—

 
—

 
—

 
2

Total amount reclassified from AOCI, net of tax
2

 
(12
)
 
(2
)
 
—

 
—

 
(12
)
Net current period other comprehensive income (loss)
163

 
5

 
—

 
—

 
—

 
168

Balance, March 31, 2019
$
222


$
99


$
(31
)

$
(37
)

$
8


$
261



Share Repurchases

On February 26, 2020, the Board of Directors (the Board) authorized the repurchase of another $250 million of common shares. As of May 7, 2020, the Company was authorized to purchase $239 million of its common shares. The Company expects to repurchase shares from time to time in the open market or in privately negotiated transactions. The timing, form and amount of the share repurchases under the program are at the discretion of management and will depend on a variety of factors, including funds available at the parent company, other potential uses for such funds, market conditions, the Company's capital position, legal requirements and other factors, some of which factors may be impacted by the direct and indirect consequences of the course and duration of the COVID-19 pandemic and evolving governmental and private responses to the pandemic. The repurchase program may be modified, extended or terminated by the Board at any time. It does not have an expiration date.

Share Repurchases

Period
 
Number of Shares Repurchased
 
Total Payments
(in millions)
 
Average Price Paid Per Share
2019 (January 1 - March 31)
 
1,908,605

 
$
79

 
$
41.62

2019 (April 1 - June 30)
 
2,519,130

 
111

 
43.89

2019 (July 1 - September 30)
 
3,400,677

 
150

 
44.11

2019 (October 1 - December 31)
 
3,335,517

 
160

 
47.97

Total 2019
 
11,163,929

 
$
500

 
$
44.79

2020 (January 1 - March 31)
 
3,629,410

 
116

 
32.03

2020 (April 1 - May 7)
 
3,311,130

 
93

 
28.01

Total 2020
 
6,940,540

 
$
209

 
$
30.11



85

16.    Earnings Per Share
 
Computation of Earnings Per Share 

 
First Quarter
 
2020

2019
 
(in millions, except per share amounts)
Basic Earnings Per Share (EPS):
 
 
 
Net income (loss) attributable to AGL
$
(55
)
 
$
54

Less: Distributed and undistributed income (loss) available to nonvested shareholders
—

 
—

Distributed and undistributed income (loss) available to common shareholders of AGL and subsidiaries, basic
$
(55
)
 
$
54

Basic shares
92.6

 
103.0

Basic EPS
$
(0.59
)
 
$
0.52

 
 
 
 
Diluted EPS:
 
 
 
Distributed and undistributed income (loss) available to common shareholders of AGL and subsidiaries, basic
$
(55
)
 
$
54

Plus: Re-allocation of undistributed income (loss) available to nonvested shareholders of AGL and subsidiaries
—

 
—

Distributed and undistributed income (loss) available to common shareholders of AGL and subsidiaries, diluted
$
(55
)
 
$
54

 
 
 
 
Basic shares
92.6

 
103.0

Dilutive securities:
 
 
 
Options and restricted stock awards
—

 
1.0

Diluted shares
92.6

 
104.0

Diluted EPS
$
(0.59
)
 
$
0.52

Potentially dilutive securities excluded from computation of EPS because of antidilutive effect
1.7

 
—



ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward Looking Statements

This Form 10-Q contains information that includes or is based upon forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward looking statements give the expectations or forecasts of future events of Assured Guaranty Ltd. (AGL) and its subsidiaries (collectively with AGL, Assured Guaranty or the Company). These statements can be identified by the fact that they do not relate strictly to historical or current facts and relate to future operating or financial performance.
 
Any or all of Assured Guaranty’s forward looking statements herein are based on current expectations and the current economic environment and may turn out to be incorrect. Assured Guaranty’s actual results may vary materially. Among factors that could cause actual results to differ adversely are:

•
the development, course and duration of the COVID-19 pandemic and the governmental and private actions taken in response, and the global consequences of the pandemic and such actions, including their impact on the factors listed below;
•
changes in the world’s credit markets, segments thereof, interest rates, credit spreads or general economic conditions;
•
developments in the world’s financial and capital markets that adversely affect insured obligors’ repayment rates, Assured Guaranty’s insurance loss or recovery experience, investments of Assured Guaranty or assets it manages;

86

•
reduction in the amount of available insurance opportunities and/or in the demand for Assured Guaranty's insurance;
•
the loss of investors in Assured Guaranty's asset management strategies or the failure to attract new investors to Assured Guaranty's asset management business;
•
the possibility that budget or pension shortfalls or other factors will result in credit losses or impairments on obligations of state, territorial and local governments and their related authorities and public corporations that Assured Guaranty insures or reinsures;
•
insured losses in excess of those expected by Assured Guaranty or the failure of Assured Guaranty to realize loss recoveries that are assumed in its expected loss estimates for insurance exposures;
•
increased competition, including from new entrants into the financial guaranty industry;
•
poor performance of Assured Guaranty's asset management strategies compared to the performance of the asset management strategies of Assured Guaranty's competitors;
•
the possibility that investments made by Assured Guaranty for its investment portfolio, including alternative investments and investments it manages, do not result in the benefits anticipated or subject Assured Guaranty to reduced liquidity at a time it requires liquidity or to unanticipated consequences;
•
the impact of market volatility on the mark-to-market of Assured Guaranty’s assets and liabilities subject to mark-to-market, including certain of its investments, most of its contracts written in credit default swap (CDS) form, and variable interest entities (VIEs) as well as on the mark-to-market of assets Assured Guaranty manages;
•
rating agency action, including a ratings downgrade, a change in outlook, the placement of ratings on watch for downgrade, or a change in rating criteria, at any time, of AGL or any of its insurance subsidiaries, and/or of any securities AGL or any of its subsidiaries have issued, and/or of transactions that AGL’s insurance subsidiaries have insured;
•
the inability of Assured Guaranty to access external sources of capital on acceptable terms;
•
changes in applicable accounting policies or practices;
•
changes in applicable laws or regulations, including insurance, bankruptcy and tax laws, or other governmental actions;
•
the failure of Assured Guaranty to successfully integrate the business of BlueMountain Capital Management, LLC (BlueMountain) and its associated entities;

•
the possibility that acquisitions made by Assured Guaranty, including its acquisition of BlueMountain (BlueMountain Acquisition), do not result in the benefits anticipated or subject Assured Guaranty to unanticipated consequences;
•
difficulties with the execution of Assured Guaranty’s business strategy;
•
loss of key personnel;
•
the effects of mergers, acquisitions and divestitures;
•
natural or man-made catastrophes or pandemics;
•
other risk factors identified in AGL’s filings with the United States (U.S.) Securities and Exchange Commission (the SEC);
•
other risks and uncertainties that have not been identified at this time; and
•
management’s response to these factors.
The foregoing review of important factors should not be construed as exhaustive, and should be read in conjunction with the other cautionary statements that are included in this Form 10-Q, as well as the risk factors included in AGL's 2019

87

Annual Report on Form 10-K. The Company undertakes no obligation to update publicly or review any forward looking statement, whether as a result of new information, future developments or otherwise, except as required by law. Investors are advised, however, to consult any further disclosures the Company makes on related subjects in the Company’s reports filed with the SEC.
 
If one or more of these or other risks or uncertainties materialize, or if the Company’s underlying assumptions prove to be incorrect, actual results may vary materially from what the Company projected. Any forward looking statements in this Form 10-Q reflect the Company’s current views with respect to future events and are subject to these and other risks, uncertainties and assumptions relating to its operations, results of operations, growth strategy and liquidity.
 
For these statements, the Company claims the protection of the safe harbor for forward looking statements contained in Section 27A of the Securities Act of 1933, as amended (the Securities Act), and Section 21E of the Securities Exchange Act of 1934, as amended (the Exchange Act).

Available Information
 
The Company maintains an Internet web site at www.assuredguaranty.com. The Company makes available, free of charge, on its web site (under www.assuredguaranty.com/sec-filings) the Company's annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13 (a) or 15 (d) of the Exchange Act as soon as reasonably practicable after the Company files such material with, or furnishes it to, the SEC. The Company also makes available, free of charge, through its web site (under www.assuredguaranty.com/governance) links to the Company's Corporate Governance Guidelines, its Code of Conduct, AGL's Bye-Laws and the charters for its Board committees. In addition, the SEC maintains an Internet site (at www.sec.gov) that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC.

The Company routinely posts important information for investors on its web site (under www.assuredguaranty.com/company-statements and, more generally, under the Investor Information tab at www.assuredguaranty.com/investor-information and Businesses tab at www.assuredguaranty.com/businesses). The Company uses this web site as a means of disclosing material information and for complying with its disclosure obligations under SEC Regulation FD (Fair Disclosure). Accordingly, investors should monitor the Company Statements, Investor Information and Businesses portions of the Company's web site, in addition to following the Company's press releases, SEC filings, public conference calls, presentations and webcasts.

The information contained on, or that may be accessed through, the Company's web site is not incorporated by reference into, and is not a part of, this report.

Executive Summary
  
This executive summary of management’s discussion and analysis highlights selected information and may not contain all of the information that is important to readers of this Quarterly Report. For a more detailed description of events, trends and uncertainties, as well as the capital, liquidity, credit, operational and market risks and the critical accounting policies and estimates affecting the Company, this Quarterly Report should be read in its entirety and in addition to AGL's 2019 Annual Report on Form 10-K.

Overview

Beginning in the fourth quarter of 2019, after the acquisition of BlueMountain, the Company realigned its reporting structure to be consistent with how management now views the Company's different business lines. Management views the Company's businesses in two distinct segments: Insurance and Asset Management. The Company's Corporate division activities are presented separately. The Insurance and Asset Management businesses are conducted through separate legal entities, which is the basis on which the results of operations are presented and reviewed by the chief operating decision maker (CODM) to assess performance and allocate resources.

In the Insurance segment, the Company provides credit protection products to the U.S. and international public finance (including infrastructure) and structured finance markets. The Company applies its credit underwriting judgment, risk management skills and capital markets experience primarily to offer credit protection products to holders of debt instruments and other monetary obligations that protect them from defaults in scheduled payments. If an obligor defaults on a scheduled payment due on an obligation, including a scheduled debt service payment, the Company is required under its unconditional and irrevocable financial guaranty to pay the amount of the shortfall to the holder of the obligation. The Company markets its

88

credit protection products directly to issuers and underwriters of public finance and structured finance securities as well as to investors in such obligations. The Company guarantees obligations issued principally in the U.S. and the United Kingdom (U.K.), and also guarantees obligations issued in other countries and regions, including Western Europe, Canada and Australia. The Company also provides other forms of insurance that are consistent with its risk profile and benefit from its underwriting experience.

Premiums are earned over the contractual lives, or in the case of homogeneous pools of insured obligations, the remaining expected lives, of financial guaranty insurance contracts. The Company estimates remaining expected lives of its insured obligations and makes prospective adjustments for such changes in expected lives. Scheduled net earned premiums decrease each year unless replaced by a higher amount of new business, reassumptions of previously ceded business, or books of business acquired in a business combination.

In the Asset Management segment, the Company established the Assured Investment Management platform to provide investment advisory services, which include the management of collateralized loan obligations (CLOs) and opportunity funds, as well as certain legacy hedge and opportunity funds now subject to an orderly wind-down. As of March 31, 2020, the Assured Investment Management platform had $16.5 billion of assets under management (AUM) of which $12.6 billion is from CLOs, $1.0 billion is from opportunity funds and $2.9 billion is from wind-down funds. These amounts are inclusive of $257 million that is managed on behalf of the Company's insurance subsidiaries. AUM may be impacted by a wide range of factors, including the condition of the global economy and financial markets, the relative attractiveness of the investment strategies of the Assured Investment Management platform, and regulatory or other governmental policies or actions. For an explanation of how the Company defines and uses the AUM metric and why it provides useful information to investors, please see " -- Results of Operations by Segment -- Asset Management Segment."

Fees in respect of investment advisory services are the largest components of revenues for the Asset Management segment. Assured Investment Management asset managers are compensated for their investment advisory services generally through management fees which are based on AUM. In addition, with respect to CLOs and certain hedge and opportunity funds, Assured Investment Management asset managers may receive performance fees if certain thresholds are met.

The Corporate division consists primarily of interest expense on the debt of Assured Guaranty US Holdings Inc. (AGUS) and Assured Guaranty Municipal Holdings Inc. (AGMH), as well as other operating expenses attributed to holding company activities, including administrative services performed by operating subsidiaries for the holding companies.

The Company reviews its segment results before giving effect to the consolidation of VIEs. The effect of consolidating VIEs, as well as intersegment eliminations and certain reclassification are presented separately in the Company's reconciliations of segment results to GAAP and non-GAAP measures.

Economic Environment and Impact of COVID-19
    
A novel coronavirus emerged in Wuhan, China in late 2019 and began to spread beyond China in early 2020. The virus is highly infectious and causes a coronavirus disease, COVID-19, that can be fatal. COVID-19 has been declared a pandemic by the World Health Organization, and its emergence and reactions to it, including various shelter-in-place guidelines and related restrictions, are having a profound effect on the global economy and financial markets. Because of the size and depth of the COVID-19 pandemic and its unknown course and duration, and evolving governmental and private responses to the pandemic, all of the direct and indirect consequences of COVID-19 are not yet known and may not emerge for some time.

As a consequence of the onset of the COVID-19 pandemic, the positive economic momentum in the U.S. since the beginning of 2016 ended during the three-months ended March 31, 2020 (First Quarter 2020). Global economic activity significantly slowed as a number of U.S. states and nations issued shelter-in-place guidelines and related restrictions. U.S. gross domestic product (GDP) fell at a 4.8% annual rate in the first quarter of the year. In March, the U.S. economy lost 701,000 jobs, the largest loss of jobs since the 2007-2009 recession. The U.S. Department of Labor (DOL) estimated that by the end of March, 7.5 million people were filing for unemployment, an increase of 4.4 million filers from only one week prior. In its release, the DOL stated that this was “the highest level of seasonally adjusted insured unemployment in the history of the seasonally adjusted series. The previous high was 6,635,000 in May of 2009.” By late April, 30 million Americans had filed for unemployment insurance over a six-week period starting mid-March.

The U.S. Government and the Federal Reserve (the Fed) have been responding to the economic shocks brought on by the COVID-19 pandemic and reactions to the pandemic. At the beginning of First Quarter 2020, the target range for the federal funds rate was at 1.50% to 1.75%. On March 3, 2020, the Federal Open Market Committee (FOMC) cut the target range for the federal funds rate by a half of a percentage point to 1% to 1.25% and announced a $1.5 trillion injection into the bond market in

89

an effort to ensure sufficient liquidity. On March 15, 2020, the Fed again lowered the target range for the federal funds rate to 0% - 0.25%, lowering it by another full percentage point.

In addition to the rate cuts, the Fed:
•
Committed to purchase at least $700 billion more in bonds as part of its new quantitative easing measures, including purchasing mortgage-backed securities in an effort to stabilize home loans.
•
Expanded the scope of its Term Asset-Backed Securities Loan Facility (TALF) program to include triple-A rated tranches of both outstanding commercial mortgage-backed securities and newly issued CLOs.
•
Announced that it would be establishing a Municipal Liquidity Facility that would offer up to $500 billion in lending to states and municipalities. The Facility would purchase short-term notes (i.e., notes maturing no later than 36 months from issuance) of “Eligible Issuers”, defined as U.S. States, the District of Columbia, U.S. cities with a population greater than 250,000 people and U.S. counties with a population greater than 500,000 people.
•
Expanded the Primary and Secondary Market Corporate Credit Facilities and the Term Asset-Backed Securities Loan Facility intended to support as much as $850 billion in credit.
•
Established the Money Market Mutual Fund Liquidity Facility, or MMLF, to broaden its program of support for the flow of credit to households and businesses. As part of this, the Federal Reserve Bank of Boston will make loans available to eligible financial institutions secured by high-quality assets purchased by the financial institution from money market mutual funds.
•
Extended U.S. dollar swap lines to other key nations, including Japan, England, Europe, Canada and Switzerland, to ensure those countries have enough dollar reserves on hand, similar to moves the Fed had made in 2008.
•
Unveiled plans to provide $2.3 trillion in loans to support households and local businesses. Created the Paycheck Protection Program (PPP) Liquidity Facility designed to supply “liquidity to participating financial institutions through term financing backed by PPP loans to small businesses” and established the Main Street Lending Program to “ensure credit flows to small and midsize businesses with the purchase of up to $600 billion in loans.”

In late March 2020, the U.S. Congress passed a $2 trillion spending bill called the CARES (Coronavirus Aid, Relief, and Economic Security) Act to blunt the impact of an economic downturn set in motion by the global pandemic. The CARES Act followed the passage of two smaller pieces of legislation by the U.S. Congress focused on the response to the coronavirus (the Coronavirus Preparedness and Response Supplemental Appropriations Act and the Families First Coronavirus Response Act). In late April, Congress passed a nearly $500 billion coronavirus aid-related spending bill.

Volatility in both the fixed-income and equity markets increased dramatically in response to the increased uncertainty. The 20-year AAA Municipal Market Data (MMD) rate and the 30-year AAA MMD rate started First Quarter 2020 at 1.88%.and 2.09%, respectively. Both experienced first quarter lows on March 9 of 1.19% and 1.38%, respectively, and then less than two weeks later, on March 20 and March 23, both rates reached their first quarter highs of 3.18% and 3.37%, respectively. By the end of First Quarter 2020, the rates were very close to where they had started, finishing at 1.8% and 1.99%. See Key Business Strategies, Insurance section below for the impact of the low interest rate environment and relatively tight U.S. municipal credit spreads on the demand for bond insurance. The Dow Jones Industrial Average (DJIA) lost more than 23% of its value in First Quarter 2020, the S&P 500 fell 20%, and the Nasdaq Composite fell more than 14%.

The impact of the COVID-19 pandemic and governmental and private actions taken in response on home prices has yet to emerge. Nationally, home prices in January and February (the latest data available from S&P CoreLogic Case-Shiller) were up, rising 3.9% and 4.2%, respectively, compared to a rise of 3.7% in December. In March, pending home sales fell 20.8% according to the National Association of Realtors. See Item 1, Financial Statements, Note 5, Expected Loss to be Paid, for a discussion of the residential market assumptions used in determining expected losses for U.S. residential mortgage-backed securities (RMBS).

Direct and indirect consequences of COVID-19 are causing financial distress to many of the obligors and assets underlying obligations guaranteed by the Company, and may result in increases in claims and loss reserves. The Company believes that state and local governments and entities that were already experiencing significant budget deficits and pension funding and revenue shortfalls, as well as obligations supported by revenue streams most impacted by shelter-in-place guidelines and related restrictions or an economic downturn, are most at risk for increased claims. See Part II, Other Information, Item 1A, Risk Factors, “The Company’s business, liquidity, financial condition and stock price may be adversely affected by the development, course and duration of the COVID-19 pandemic and the governmental and private actions taken in response, and the global consequences of the pandemic and such actions.” While, because the size and depth of the

90

COVID-19 pandemic, its course and duration and the direct and indirect consequences of governmental and private responses are unknown, the Company cannot predict the ultimate size of the increases in claims and loss reserves that may result from the pandemic, the Company believes its financial guaranty business model is particularly well-suited to withstand global economic disruptions. If an insured obligor defaults, the Company is required to pay only any shortfall in interest and principal on scheduled payment dates; the Company’s policies forbid acceleration of its obligations without its consent. In addition, many of the obligations the Company insures benefit from debt service reserve funds or other funding sources from which interest and principal may be paid during limited periods of stress, providing the obligor with an opportunity to recover. While the Company believes its guaranty may support the market value of an insured obligation in comparison to a similar uninsured obligation, the Company’s ultimate loss on a defaulted insured obligation is not a function of that underlying obligation’s market price. Rather, the Company’s ultimate loss is the sum of all principal and interest payments it makes under its policy less the sum of all reimbursements, subrogation payments and other recoveries it receives from the obligor or any other sources in connection with the obligation. For contracts accounted for as insurance (which constitute 97% of its net par outstanding at March 31, 2020), its expected losses equal the discounted value of all insurance claims it projects paying less the discounted value of all recoveries it expects to receive, on a probability-weighted basis. See Part I, Financial Statements, Note 5, Expected Losses to be Paid.

The nature of the financial guaranty business model, which requires the Company to pay only any shortfall in interest and principal on scheduled payment dates, along with the Company’s liquidity practices, reduce the need of the Company to sell investment assets in periods of market distress. As of March 31, 2020, the Company had $933 million of short-term investments and $139 million of cash. In addition, the Company’s investment portfolio generates cash over time through interest and principal receipts.

While volatility and dislocation in the municipal finance market in the U.S. resulted in the Company issuing a reduced number of new insurance policies in late March and into April compared to the prior year, the Company has continued to write new insurance business in the secondary market during this period. The Company cannot predict what impact the COVID-19 pandemic and the governmental and private actions taken in response, and the global consequences of the pandemic and such actions, will have on the market for its insurance products. On one hand, increased defaults and an increased focus on the credit of public finance issuers and other obligors may increase the perceived value of the Company’s insurance products, and so increase demand. On the other hand, legislative responses, especially in the public finance sector, could reduce the need for the Company’s insurance products. In addition, rating downgrades or other indicators of reduced financial strength resulting from the COVID-19 pandemic and the governmental and private actions taken in response, and the global consequences of the pandemic and such actions, could reduce the demand for the Company’s insurance products. While a reduction in new insurance business written compared to previous years would be unwelcome since it would impact the Company's net income in future years, it would have a limited impact on the current year’s net income, since the Company earns the premium for a new policy over the term of the policy, often as long as twenty or thirty years. In 2019, for example, only approximately 3% of the premiums the Company earned in 2019 related to new financial guaranty policies it wrote in 2019.

The COVID-19 pandemic and the governmental and private actions taken in response, and the global consequences of the pandemic and such actions, may have an adverse impact on the amount of the Company’s AUM, which would reduce the amount of management fees earned by the Company. In addition, the Company’s asset management segment operates in highly competitive markets. The Company’s ability to raise third party funds and increase and retain AUM is directly related to the performance of the assets it manages as measured against market averages and the performance of the Company’s competitors, and if it performs worse during the COVID-19 pandemic than its competitors, that could impede its ability to raise funds, seek investors and hire and retain professionals, and may also lead to an impairment of goodwill. On the other hand, periods of market volatility may increase the attractiveness of investment managers such as those in the Company’s Assured Investment Management platform, and may provide the Company with opportunities to increase its AUM. In First Quarter 2020, the Company considered the impact of COVID-19 on the Company’s goodwill carrying value associated with the asset management segment, and determined no impairment had occurred. 

Over the past several years, the Company’s insured subsidiaries have sought and received permission from their respective regulators to make certain discretionary payments to their holding companies, which has increased the amount of cash available to such holding companies to make investments in the asset management business and, in the case of AGL, to repurchase its common shares. The COVID-19 pandemic and the governmental and private actions taken in response, and the global consequences of the pandemic and such actions, may impact the Company’s regulatory capital position and the willingness of the insurance subsidiaries’ regulators to permit discretionary payments to their holding companies, which may result in the Company investing less in the asset management business or making fewer repurchases of its common shares than it had planned. For more information, see Part I, Item 1A, Risk Factors, “Operational Risks - The Company’s holding companies’ ability to meet their obligations may be constrained,” of the Company’s Annual Report on Form 10-K for the year ended December 31, 2019.

91

The Company began operating remotely in accordance with its business continuity plan in March, 2020, instituting mandatory work-from-home policies beginning on March 16, 2020, in its U.S. offices, on March 17, 2020, in its U.K. offices, and on March 19, 2020, in its Bermuda office. The Company is providing the services and communications it normally would, and continues to close new insurance transactions and make insurance claim payments and, in its asset management business, make trades. However, the Company’s operations could be disrupted if key members of its senior management or a significant percentage of its workforce or the workforce of its vendors were unable to continue work because of illness, government directives, or otherwise. In addition, the Company’s shift to working from home has made it more dependent on internet and communications access and capabilities and has heightened its risk of cybersecurity attacks. For more information, see Part I, Item 1A, Risk Factors, “Operational Risks - The Company is dependent on its information technology and that of certain third parties, and a cyberattack, security breach or failure in such systems could adversely affect the Company’s business,” of the Company’s Annual Report on Form 10-K for the year ended December 31, 2019.

Financial Performance of Assured Guaranty

Results of operations for First Quarter 2020 include the results of BlueMountain, which was acquired on October 1, 2019.

Financial Results
 
First Quarter
 
2020
 
2019
 
(in millions)
GAAP Highlights
 
 
 
Net income (loss) attributable to AGL
$
(55
)
 
$
54

Net income (loss) attributable to AGL per diluted share
(0.59
)
 
0.52

Weighted average diluted shares
92.6

 
104.0

 
 
 
 
Adjusted operating income (loss) (1) (2)
 
 
 
Insurance
$
85


$
111

Asset Management
(9
)

—

Corporate
(39
)

(25
)
Other
(4
)

—

Adjusted operating income (loss)
33

 
86

Adjusted operating income per diluted share (2)
0.36

 
0.82

 
 
 
 
Insurance Segment
 
 
 
Gross written premiums (GWP)
$
64

 
$
39

Present value of new business production (PVP) (1)
51

 
42

Gross par written
3,033

 
2,707

Asset Management Segment
 
 
 
Wind-down funds net outflows
$
(875
)
 
$
—


92

 
As of March 31, 2020
 
As of December 31, 2019
 
Amount
 
Per Share
 
Amount
 
Per Share
 
(in millions, except per share amounts)
Shareholders' equity attributable to AGL
$
6,240

 
$
69.35

 
$
6,639

 
$
71.18

Adjusted operating shareholders' equity (1) (3)
6,051

 
67.25

 
6,246

 
66.96

Adjusted book value (1) (4)
8,820

 
98.02

 
9,047

 
96.99

Gain (loss) related to the effect of consolidating VIEs (VIE consolidation) included in adjusted operating shareholders' equity
12

 
0.14

 
7

 
0.07

Gain (loss) related to VIE consolidation included in adjusted book value
2

 
0.03

 
(4
)
 
(0.05
)
Common shares outstanding (5)
90.0

 
 
 
93.3

 
 
____________________
(1)
See “—Non-GAAP Financial Measures” for a definition of the financial measures that were not determined in accordance with accounting principles generally accepted in the United States of America (GAAP) and a reconciliation of the non-GAAP financial measure to the most directly comparable GAAP measure, if available. See “—Non-GAAP Financial Measures” for additional details.
(2)
"Adjusted operating income" was formerly known as "Non-GAAP operating income."
(3)
"Adjusted operating shareholders' equity" was formerly known as "Non-GAAP operating shareholders' equity."
(4)
"Adjusted book value" was formerly known as "Non-GAAP adjusted book value."
(5)
See "Key Business Strategies – Capital Management" below for information on common share repurchases.
    
Several primary drivers of volatility in net income or loss are not necessarily indicative of credit impairment or improvement, or ultimate economic gains or losses such as: changes in credit spreads of insured credit derivative obligations, changes in fair value of assets and liabilities of VIEs, and committed capital securities (CCS), changes in fair value of credit derivatives related to the Company's own credit spreads, and changes in risk-free rates used to discount expected losses.

Other factors that drive volatility in net income in the Insurance segment include: changes in expected losses and recoveries, the amount and timing of the refunding and/or termination of insured obligations, realized gains and losses on the investment portfolio (including credit impairment), changes in foreign exchange rates, the effects of large settlements, commutations, acquisitions, the effects of the Company's various loss mitigation strategies,and changes in the fair value of investments in Assured Investment Management funds. In the Asset Management segment, changes in the fair value of Assured Investment Management funds affect the amount of management and performance fees earned. Changes in laws and regulations, among other factors, may also have a significant effect on reported net income or loss in a given reporting period. 


93

Condensed Consolidated Results of Operations

Condensed Consolidated Results of Operations
 
 
Three Months Ended March 31,
 
2020
 
2019
 
(in millions)
Revenues:
 
 
 
Net earned premiums
$
103

 
$
118

Net investment income
80

 
98

Asset management fees
23

 
—

Net realized investment gains (losses)
(5
)
 
(12
)
Net change in fair value of credit derivatives
(77
)
 
(22
)
Fair value gains (losses) on CCS
48

 
(9
)
Fair value gains (losses) on financial guaranty VIEs
(9
)
 
5

Fair value gains (losses) on consolidated investment vehicles
(12
)
 
—

Foreign exchange gain (loss) on remeasurement
(62
)
 
11

Other income (loss)
7

 
6

Total revenues
96

 
195

Expenses:
 
 
 
Loss and loss adjustment expenses (LAE)
20

 
46

Interest expense
22

 
23

Amortization of deferred acquisition costs (DAC)
3

 
6

Employee compensation and benefit expenses
64

 
41

Other operating expenses
45

 
23

Total expenses
154

 
139

Income (loss) before provision for income taxes and equity in net earnings of investees
(58
)
 
56

Equity in net earnings of investees
(4
)
 
2

Income (loss) before income taxes
(62
)
 
58

Provision (benefit) for income taxes
(4
)
 
4

Net income (loss)
(58
)
 
54

Less: Noncontrolling interest
(3
)
 
—

Net income (loss) attributable to AGL
$
(55
)
 
$
54


First Quarter 2020 Compared with First Quarter 2019

Net income attributable to AGL for First Quarter 2020 was lower compared to the three-month period ended March 31, 2019 (First Quarter 2019) primarily due to:

•
foreign exchange losses on remeasurement in First Quarter 2020 compared with gains in First Quarter 2019,

•
higher fair value losses on credit derivatives in First Quarter 2020,

•
losses in the Asset Management segment and fair value losses in the Assured Investment Management funds, and

•
lower net investment income.

These decreases were offset in part by fair value gains on CCS in First Quarter 2020 compared with losses in First Quarter 2019, and lower loss and LAE in First Quarter 2020.


94

Shareholders' equity attributable to AGL decreased since December 31, 2019 primarily due to unrealized losses on available for sale investment securities, share repurchases, net loss and dividends. Adjusted operating shareholders' equity decreased in First Quarter 2020 as adjusted operating income was offset mainly by share repurchases and dividends. Adjusted book value decreased in First Quarter 2020 primarily due to share repurchases and dividends, partially offset by net premiums written.

Shareholders' equity attributable to AGL per share decreased in First Quarter 2020 to $69.35, and adjusted operating shareholders' equity per share and adjusted book value per share increased in First Quarter 2020 to $67.25 and $98.02, respectively. In First Quarter 2020, the Company repurchased an additional 3.6 million shares under the share repurchase program that began in 2013. See "Accretive Effect of Cumulative Repurchases" table below.
 
The Company’s effective tax rate reflects the proportion of income recognized by each of the Company’s operating subsidiaries, with U.S. subsidiaries generally taxed at the U.S. marginal corporate income tax rate of 21% in 2019, U.K. subsidiaries taxed at the U.K. marginal corporate tax rate of 19%, and no taxes for the Company’s Bermuda Subsidiaries, unless subject to U.S. tax by election or as a U.S. controlled foreign corporation. The effective tax rate was lower in 2019 due to the proportion of income in different tax jurisdictions.

Key Business Strategies
 
The Company continually evaluates its business strategies. For example, with the BlueMountain Acquisition the Company has increased its focus on asset management and alternative investments. Currently, the Company is pursuing the following key business strategies in three areas:

•
Insurance
•
Asset Management and Alternative Investments
•
Capital Management

Insurance

The Company seeks to grow the insurance business through new business production, acquisitions of legacy monolines and reinsurance transactions, and to continue to mitigate losses in its current insured portfolio.

Growth of the Insured Portfolio

The Company seeks to grow its insurance portfolio through new business production in each of its three markets: U.S. public finance, international infrastructure and global structured finance. The Company believes high-profile defaults by municipal obligors, such as Puerto Rico, Detroit, Michigan and Stockton, California have led to increased awareness of the value of bond insurance and stimulated demand for the product. The Company believes there will be continued demand for its insurance in this market because, for those exposures that the Company guarantees, it undertakes the tasks of credit selection, analysis, negotiation of terms, surveillance and, if necessary, loss mitigation. The Company believes that its insurance:

•
encourages retail investors, who typically have fewer resources than the Company for analyzing municipal bonds, to purchase such bonds;
•
enables institutional investors to operate more efficiently; and
•
allows smaller, less well-known issuers to gain market access on a more cost-effective basis.

On the other hand, the persistently low interest rate environment and relatively tight U.S. municipal credit spreads have dampened demand for bond insurance, and provisions in legislation known as the 2017 Tax Cuts and Jobs Act, such as the termination of the tax-exempt status of advance refunding bonds and the reduction in corporate tax rates, have resulted in a reduction of supply and made municipal obligations less attractive to certain institutional investors.

In certain segments of the global infrastructure and structured finance markets the Company believes its financial guaranty product is competitive with other financing options. For example, certain investors may receive advantageous capital requirement treatment with the addition of the Company’s guaranty. The Company considers its involvement in both international infrastructure and structured finance transactions to be beneficial because such transactions diversify both the Company's business opportunities and its risk profile beyond U.S. public finance. Quarterly business activity in the international infrastructure and structured finance sectors is influenced by typically long lead times and therefore may vary from quarter to quarter.


95

While volatility and dislocation in the municipal finance market in the U.S. resulted in the Company issuing a reduced number of new insurance policies in late March and into April compared to the prior year, the Company has continued to write new insurance business in the secondary market during this period. The Company cannot predict what impact the COVID-19 pandemic and the governmental and private actions taken in response, and the global consequences of the pandemic and such actions, will have on the market for its insurance products. On one hand, increased defaults and an increased focus on the credit of public finance issuers and other obligors may increase the perceived value of the Company’s insurance products, and so increase demand. On the other hand, legislative responses, especially in the public finance sector, could reduce the need for the Company’s insurance products. In addition, rating downgrades or other indicators of reduced financial strength resulting from the COVID-19 pandemic and the governmental and private actions taken in response, and the global consequences of the pandemic and such actions, could reduce the demand for the Company’s insurance products. While a reduction in new insurance business written compared to previous years would be unwelcome since it would impact the Company's net income in future years, it would have a limited impact on the current year’s net income, since the Company earns the premium for a new policy over the term of the policy, often as along as twenty or thirty years. In 2019, for example, only approximately 3% of the premiums the Company earned in 2019 related to new financial guaranty policies it wrote in 2019.

The Company also considers opportunities to acquire financial guaranty portfolios, whether by acquiring financial guarantors who are no longer actively writing new business or their insured portfolios. These transactions enable the Company to improve its future earnings and deploy excess capital.

In April 2020, the Company reassumed $336 million in par from its largest remaining legacy third party financial guaranty reinsurer. This represents 27% of the Company's ceded financial guaranty par outstanding as of March 31, 2020.

U.S. Municipal Market Data and Bond Insurance Penetration Rates (1)
Based on Sale Date
 
 
First Quarter 2020
 
First Quarter 2019
 
Year Ended December 31, 2019
 
(dollars in billions, except number of issues and percent)
Par:
 
 
 
 
 
New municipal bonds issued
$
87.8

 
$
75.6

 
$
406.6

Total insured
$
4.8

 
$
3.6

 
$
23.9

Insured by Assured Guaranty
$
2.3

 
$
2.0

 
$
14.0

Number of issues:
 
 
 
 
 
New municipal bonds issued
2,119

 
1,811

 
10,590

Total insured
360

 
290

 
1,724

Insured by Assured Guaranty
161

 
163

 
839

Bond insurance market penetration based on:
 
 
 
 
 
Par
5.5
%
 
4.8
%
 
5.9
%
Number of issues
17.0
%
 
16.0
%
 
16.3
%
Single A par sold
19.1
%
 
21.8
%
 
21.4
%
Single A transactions sold
52.6
%
 
53.4
%
 
54.9
%
$25 million and under par sold
20.4
%
 
17.7
%
 
18.1
%
$25 million and under transactions sold
20.8
%
 
19.8
%
 
19.7
%
____________________
(1)
Source: The amounts in the table are those reported by Thomson Reuters. The table excludes Corporate-CUSIP healthcare and project finance transactions insured by Assured Guaranty, which the company also considers to be public finance business.


96

Loss Mitigation
    
In an effort to avoid, reduce or recover losses and potential losses in its insurance portfolios, the Company employs a number of strategies.
    
In the public finance area, the Company believes its experience and the resources it is prepared to deploy, as well as its ability to provide bond insurance or other contributions as part of a solution, result in more favorable outcomes in distressed public finance situations than would be the case without its participation. This has been illustrated by the Company's role in the Detroit, Michigan; Stockton, California; and Jefferson County, Alabama financial crises. Currently, the Company is actively working to mitigate potential losses in connection with the obligations it insures of the Commonwealth of Puerto Rico and various obligations of its related authorities and public corporations and was an active participant in negotiating the Puerto Rico Electric Power Authority (PREPA) restructuring support agreement and the Puerto Rico Sales Tax Financing Corporation (COFINA) plan of adjustment. The Company will also, where appropriate, pursue litigation to enforce its rights, and it has initiated a number of legal actions to enforce its rights in Puerto Rico. For more information about developments in Puerto Rico and related recovery litigation being pursued by the Company, see Item 1, Financial Statements, Note 4, Outstanding Insurance Exposure and Insured Portfolio section below.

The Company is currently working with the servicers of some of the RMBS it insures to encourage the servicers to provide alternatives to distressed borrowers that will encourage them to continue making payments on their loans to help improve the performance of the related RMBS.

In some instances, the terms of the Company's policy give it the option to pay principal on an accelerated basis on an obligation on which it has paid a claim, thereby reducing the amount of guaranteed interest due in the future. The Company has at times exercised this option, which uses cash but reduces projected future losses. The Company may also facilitate the issuance of refunding bonds, by either providing insurance on the refunding bonds or purchasing refunding bonds, or both. Refunding bonds may provide the issuer with payment relief.

Asset Management
    
The BlueMountain Acquisition represents a significant increase in the Company's participation in the asset management industry. BlueMountain is a diversified asset manager that serves as investment advisor to CLOs and opportunity funds as well as certain legacy hedge and opportunity funds now subject to an orderly wind-down. BlueMountain manages structured finance, credit and special situation investments, with a track record dating back to 2003. BlueMountain underwrites assets and structures investments while leveraging a technology-enabled risk platform, which aims to maximize returns for its clients.

As of March 31, 2020, the Assured Investment Management platform is a top-twenty CLO manager by AUM, as published by CreditFlux, and is led by an experienced CLO and loan research team. BlueMountain and its affiliates have issued 37 CLOs since inception, in both the U.S. and European markets. The CLOs have broad investor distribution with access to a diversified set of global investors. The team has focused on building diversified portfolios with a focus on free cash flow generation and downside protection.
    
The Company intends to initially invest $500 million of capital in funds managed in the Assured Investment Management platform plus additional amounts in other accounts managed in the Assured Investment Management platform. The Company intends to use these capital investments to (a) launch new products (CLOs, and/or opportunity funds) on the Assured Investment Management platform and (b) enhance the returns of its own investment portfolio. As of March 31, 2020, the Company had invested approximately $192 million of the $500 million it intends to initially invest in Assured Investment Management funds. This capital was invested in three new investment vehicles, with each vehicle dedicated to a single strategy including CLOs, asset-backed finance and healthcare structured capital. These strategies are consistent with the investment strengths of the Assured Investment Management platform and its plans to continue to grow its structured finance strategies.
    
Over time, the Company seeks to broaden and further diversify its Asset Management segment leading to increased AUM and a fee-generating platform. The Company intends to leverage the Assured Investment Management infrastructure and platform to grow its Asset Management segment both organically and through strategic combinations.


97

Capital Management

In recent years, the Company has developed several strategies to manage capital within the Assured Guaranty group efficiently.
    
From 2013 through May 7, 2020, the Company has repurchased 112.7 million common shares for approximately $3,425 million, representing 58% of the total shares outstanding at the beginning of the repurchase program in 2013. On February 26, 2020, the Board of Directors (the Board) authorized an additional $250 million of share repurchases. As of May 7, 2020, the Company had remaining authorization to purchase $239 million of its common shares. Shares may be repurchased from time to time in the open market or in privately negotiated transactions. The timing, form and amount of the share repurchases under the program are at the discretion of management and will depend on a variety of factors, including funds available at the parent company, other potential uses for such funds, market conditions, the Company's capital position, legal requirements and other factors, some of which factors may be impacted by the direct and indirect consequences of the course and duration of the COVID-19 pandemic and evolving governmental and private responses to the pandemic. The repurchase program may be modified, extended or terminated by the Board at any time and it does not have an expiration date. See Item 1, Financial Statements, Note 15, Shareholders' Equity, for additional information about the Company's repurchases of its common shares.

Summary of Share Repurchases

 
Amount
 
Number of Shares
 
Average price
per share
 
(in millions, except per share data)
2013 - 2019
$
3,216

 
105.72

 
$
30.42

2020 (First Quarter)
116

 
3.63

 
32.03

2020 (through May 7, 2020)
93

 
3.31

 
28.01

Cumulative repurchases since the beginning of 2013
$
3,425

 
112.66

 
$
30.40


Accretive Effect of Cumulative Repurchases (1)

 
First Quarter 2020
 
As of
March 31, 2020
 
(per share)
Net income (loss) attributable to AGL
NA

 
 
Adjusted operating income
0.09

 
 
Shareholders' equity attributable to AGL
 
 
$
21.12

Adjusted operating shareholders' equity
 
 
20.03

Adjusted book value
 
 
36.86

_________________
(1)
Represents the estimated accretive effect of cumulative repurchases since the beginning of 2013. On a U.S. GAAP basis the Company had a net loss.

The Company considers the appropriate mix of debt and equity in its capital structure, and may repurchase some of its debt from time to time. For example, in First Quarter 2020, AGUS purchased $23 million of par of AGMH's outstanding Junior Subordinated Debentures, which resulted in a loss on extinguishment of debt of $5 million in First Quarter 2020. The Company may choose to make additional purchases of this or other Company debt in the future.

Other Events

Brexit

On June 23, 2016, a referendum was held in the U.K. in which a majority voted to exit the European Union (EU), known as “Brexit”. The U.K. government served notice to the European Council on March 29, 2017 of its desire to withdraw in accordance with Article 50 of the Treaty on European Union. As described in Part 1, Item 1, Business, Regulation of the Company's Annual Report on Form 10-K for the year ended December 31, 2019, the U.K. parliament has approved a

98

withdrawal agreement with the EU and the U.K. left the EU on January 31, 2020. There is a transition period under the terms of the withdrawal agreement which will end on December 31, 2020. Negotiations will be ongoing during the transition period between the U.K. and EU to determine the wider terms of the U.K.'s future relationship with the EU, including the terms of trade between the U.K. and the EU. If the U.K. and EU fail to agree the U.K.'s future relationship with the EU during the transition period ending on December 31, 2020, there will be considerable uncertainty as to the ongoing terms of the U.K’s relationship with the EU, including the terms of trade between the U.K. and the EU, and a likely negative impact on all parties.
    
LIBOR Sunset

In 2017, the U.K.’s Financial Conduct Authority announced that after 2021 it would no longer compel banks to submit the rates required to calculate London Interbank Offered Rate (LIBOR). This announcement indicates that the continuation of LIBOR on the current basis cannot and will not be guaranteed after 2021. Consequently, at this time, it is not possible to predict whether and to what extent banks will continue to provide submissions for the calculation of LIBOR. While regulators have suggested substitute rates, including the Secured Overnight Financing Rate, the impact of the discontinuance of LIBOR, if it occurs, will be contract-specific. The Company has exposure to LIBOR in three areas of its operations: (i) issuers of obligations the Company insures have obligations, assets and hedges that reference LIBOR, and some of the obligations the Company insures reference LIBOR, (ii) debt issued by the Company's wholly owned subsidiaries AGUS and AGMH currently pay, or will convert to, a floating interest rate tied to LIBOR, and (iii) CCS from which the Company benefits also pay interest tied to LIBOR. For more information, see Part II, Item 8, Financial Statements and Supplementary Data, Note 15, Long-Term Debt and Credit Facilities of the Company's Annual Report on Form 10-K for the year ended December 31, 2019.

The Company has reviewed its insured portfolio to identify insured transactions that it believes may be vulnerable to the transition from LIBOR. The review focused on insured issues that are scheduled or projected to have an outstanding principal balance as of December 31, 2021, the date of LIBOR’s scheduled sunset, and excluded, due to their immateriality, insured issues projected to have an outstanding principal balance of less than $1 million at December 31, 2021. The Company reviewed the language governing the setting of interest rates in the event of unavailability of LIBOR in the governing documents of all below-investment-grade (BIG) insured transactions (except those issues projected to have an outstanding principal balance of less than $1 million at December 31, 2021), which the Company believes are most likely to be vulnerable to issues relating to the setting of interest rates after the sunset of LIBOR. The Company has also reviewed relevant language in the documents relating to the debt issued by the Company and the CCS that benefit the Company. As a significant portion of these securities are likely to become fixed rate in December 2021, the initial benefit or harm of the sunset of LIBOR depends on the level of interest rates at such time. Also, whatever interest rate is set by the party responsible for calculating the interest rate may be challenged in the court by other parties in interest. The Company has initiated a dialogue with relevant trustees, calculation agents, auction agents, servicers and other parties responsible for implementing the rate change in these transactions. Most have not yet committed to a course of action.
    
Given the lack of clarity on decisions that parties responsible for calculating interest rates will make and the reaction of impacted parties as well as the unknown level of interest rates when the change occurs, the Company cannot at this time predict the impact of the discontinuance of LIBOR, if it occurs, on every obligor and obligation the Company enhances or on its own debt issuances. For more information, see the Risk Factor captioned “The Company may be adversely impacted by the transition from LIBOR as a reference rate” under Operational Risks in Part 1, Item 1A, Risk Factors of the Company's Annual Report on Form 10-K for the year ended December 31, 2019.

Income Taxes

The U.S. Internal Revenue Service and Department of the Treasury issued proposed regulations on July 10, 2019
relating to the tax treatment of passive foreign investment companies. The proposed regulations provide guidance on various passive foreign investment company rules, including changes resulting from the 2017 Tax Cuts and Jobs Act. Management is currently in the process of evaluating the impact to its shareholders and business operations.

Results of Operations

Business Segments

The Company reports its results of operations consistent with the manner in which the Company's CODM reviews the business to assess performance and allocate resources. Prior to the BlueMountain Acquisition on October 1, 2019, the Company's operating subsidiaries were all insurance companies, and results of operations were viewed by the CODM as one segment. Beginning in the fourth quarter of 2019, with the BlueMountain Acquisition and expansion into the asset management business, the Company now operates in two distinct segments, Insurance and Asset Management. The Company

99

calls its Asset Management segment its "Assured Investment Management" platform. The following describes the components of each segment, along with the Corporate division and Other categories. The Insurance and Asset Management segments are presented without giving effect to the consolidation of the financial guaranty (FG) VIEs and investment vehicles. See Item 1. Financial Statement, Note 12, Variable Interest Entities.

The Insurance segment primarily consists of the Company's domestic and foreign insurance subsidiaries and their wholly-owned subsidiaries that provide credit protection products to the U.S. and international public finance (including infrastructure) and structured finance markets. The Insurance segment also includes the income (loss) from its proportionate equity interest in Assured Investment Management funds.
    
The Asset Management segment consists of the Company's Assured Investment Management platform subsidiaries, which provide asset management services to outside investors as well as to the Company's Insurance segment. The Asset Management segment presents reimbursable fund expenses netted in other operating expenses, whereas on the condensed consolidated statement of operations such reimbursable expenses are shown gross, as components of asset management fees and other operating expenses.

The Corporate division consists primarily of interest expense on the debt of AGUS and AGMH, as well as other operating expenses attributed to holding company activities, including administrative services performed by operating subsidiaries for the holding companies.

Other items consist of intersegment eliminations, reclassification of asset management reimbursable expenses, and consolidation adjustments, including the effect of consolidating FG VIEs and certain Assured Investment Management investment vehicles in which Insurance segment invests.
        
The Company does not report assets by reportable segment as the CODM does not use assets to assess performance and allocate resources and only reviews assets at a consolidated level.

The Company analyzes the operating performance of each segment using "adjusted operating income." See “-- Non-GAAP Financial Measures -- Adjusted Operating Income” below for definition of "adjusted operating income" (formerly known as non-GAAP operating income) and Item 1, Financial Statements, Note 3, Segment Information. Results for each segment include specifically identifiable expenses as well as allocations of expenses among legal entities based on time studies and other cost allocation methodologies based on headcount or other metrics. Total adjusted operating income includes the effect of consolidating both FG VIEs and investment vehicles; however the effect of consolidating such entities, including the related eliminations, is included in the "other" column in the tables below, which represents the CODM's view, consistent with the management approach guidance for presentation of segment metrics.


100

The following table summarizes adjusted operating income from the Company's business segment operations and also provides a reconciliation of the segment measure to net income on a consolidated GAAP basis. See also Item 1, Financial Statements, Note 3, Segment Information.

 
First Quarter
 
2020
 
2019
 
(in millions)
Adjusted operating income (loss) by segment:
 
 
 
Insurance
$
85

 
$
111

Asset management
(9
)
 
—

Corporate
(39
)
 
(25
)
Other
(4
)
 
—

Adjusted operating income (loss)
$
33

 
$
86

Reconciling items from adjusted operating income to net income (loss) attributable to AGL:
 
 
 
Plus pre-tax adjustments:
 
 
 
Realized gains (losses) on investments
$
(5
)
 
$
(12
)
Non-credit impairment unrealized fair value gains (losses) on credit derivatives
(88
)
 
(28
)
Fair value gains (losses) on CCS
48

 
(9
)
Foreign exchange gains (losses) on remeasurement of premiums receivable and loss and LAE reserves
(57
)
 
9

Total pre-tax adjustments
(102
)
 
(40
)
Plus tax effect on pre-tax adjustments
14

 
8

Net income (loss) attributable to AGL
$
(55
)
 
$
54




101

Results of Operations by Segment

Insurance Segment Results

Insurance Results

 
First Quarter
 
2020
 
2019
 
(in millions)
Revenues
 
 
 
Net earned premiums and credit derivative revenues
$
107

 
$
126

Net investment income
83

 
99

Other income (loss)
6

 
9

Total revenues
196

 
234

Expenses
 
 
 
Loss expense
18

 
44

Amortization of DAC
3

 
6

Employee compensation and benefit expenses
41

 
37

Other operating expenses
22

 
20

Total expenses
84

 
107

Equity in net earnings of investees (1)
(9
)
 
1

Adjusted operating income (loss) before income taxes
103

 
128

Provision (benefit) for income taxes
18

 
17

Adjusted operating income (loss)
$
85


$
111

____________________
(1)
Includes interest income of $1 million related to CLO Warehouse Fund (US) L.P. (CLO Warehouse Fund) and AIM Asset Backed Income Fund (US) L.P. (ABIF) investments in debt securities in First Quarter 2020.


102

Insurance New Business Production

Gross Written Premiums and
New Business Production

 
First Quarter
 
2020
 
2019
 
(in millions)
GWP
 
 
 
Public Finance—U.S.
$
29

 
$
30

Public Finance—non-U.S.
34

 
2

Structured Finance—U.S.
1

 
6

Structured Finance—non-U.S.
—

 
1

Total GWP
$
64

 
$
39

PVP (1):
 
 
 
Public Finance—U.S.
$
29

 
$
32

Public Finance—non-U.S.
21

 
4

Structured Finance—U.S.
1

 
5

Structured Finance—non-U.S.
—

 
1

Total PVP
$
51

 
$
42

Gross Par Written (1):
 
 
 
Public Finance—U.S.
$
2,641

 
$
2,016

Public Finance—non-U.S.
377

 
176

Structured Finance—U.S.
15

 
494

Structured Finance—non-U.S.
—

 
21

Total gross par written
$
3,033

 
$
2,707

Average rating on new business written
BBB+
 
A
____________________
(1)
PVP and Gross Par Written in the table above are based on "close date," when the transaction settles. See “– Non-GAAP Financial Measures – PVP or Present Value of New Business Production.”

GWP relates to both financial guaranty insurance and specialty insurance and reinsurance contracts. Financial guaranty GWP includes amounts collected upfront on new business written, the present value of future premiums on new business written (discounted at risk-free rates), as well as the effects of changes in the estimated lives of transactions in the inforce book of business. Specialty insurance and reinsurance GWP is recorded as premiums are due. Credit derivatives are accounted for at fair value and therefore not included in GWP. The non-GAAP measure, PVP, on the other hand, includes upfront premiums and the present value of estimated future installments on new business at the time of issuance for all contracts whether in insurance or credit derivative form, discounted at a pre-tax book yield. See Non-GAAP Financial Measures below.

First Quarter 2020

The increases in GWP and PVP were attributable to non-U.S. public finance new business, including a guaranty of a solar bond transaction in Spain, written by the Company's new French subsidiary, Assured Guaranty (Europe) SA , as well as additional premiums upon the conversion of several existing transactions from CDS to financial guaranty insurance contracts. The Company has consistently written new non-U.S. public finance business every quarter since the end of 2015.
    
Business activity in the international infrastructure and structured finance sectors is influenced by typically long lead times and therefore may vary from period to period.

The volatility and dislocation in the municipal finance market in the U.S. caused by the COVID-19 pandemic resulted in the Company issuing a reduced number of new insurance policies in late March. However, First Quarter 2020 U.S. public

103

finance GWP was $29 million, only slightly lower compared with First Quarter 2019 GWP of $30 million. Similarly, PVP was $29 million in First Quarter 2020, compared with PVP of $32 million in First Quarter 2019.

    Net Earned Premiums and Credit Derivative Revenues

Premiums are earned over the contractual lives, or in the case of homogeneous pools of insured obligations, the remaining expected lives, of financial guaranty insurance contracts. The Company estimates remaining expected lives of its insured obligations and makes prospective adjustments for such changes in expected lives. Scheduled net earned premiums decrease each year unless replaced by a higher amount of new business, reassumptions of previously ceded business or books of business acquired in a business combination. See Item 1, Financial Statements, Note 6, Contracts Accounted for as Insurance, Financial Guaranty Insurance Premiums, for additional information. Credit derivative revenue represents realized gains on credit derivatives representing premiums received and receivable.

Net earned premiums due to accelerations are attributable to changes in the expected lives of insured obligations driven by (a) refundings of insured obligations or (b) terminations of insured obligations either through negotiated agreements or the exercise of the Company's contractual rights to make claim payments on an accelerated basis.
    
Refundings occur in the public finance market and had been at historically high levels in recent years primarily due to the low interest rate environment, which has allowed many municipalities and other public finance issuers to refinance their debt obligations at lower rates. The premiums associated with the insured obligations of municipalities and other public finance issuers are generally received upfront when the obligations are issued and insured. When such issuers pay down insured obligations prior to their originally scheduled maturities, the Company is no longer on risk for payment defaults, and therefore accelerates the recognition of the nonrefundable deferred premium revenue remaining. Provisions in the 2017 Tax Cuts and Jobs Act regarding the termination of the tax-exempt status of advance refunding bonds have resulted in fewer refundings.

Terminations are generally negotiated agreements with beneficiaries resulting in the extinguishment of the Company’s insurance obligation. Terminations are more common in the structured finance asset class, but may also occur in the public finance asset class. While each termination may have different terms, they all result in the expiration of the Company’s insurance risk, the acceleration of the recognition of the associated deferred premium revenue and the reduction of any remaining premiums receivable.


104

Net Earned Premiums and Credit Derivative Revenues
 
 
First Quarter
 
2020
 
2019
 
(in millions)
Financial guaranty insurance:
 
 
71

Public finance
 
 
 
Scheduled net earned premiums
$
70

 
$
71

Accelerations:
 
 
 
Refundings
15

 
27

Terminations
—

 
—

Total accelerations
15

 
27

Total public finance
85

 
98

Structured finance
 
 
 
Scheduled net earned premiums
18

 
23

Terminations
—

 
(1
)
Total structured finance
18

 
22

Specialty insurance and reinsurance
1

 
1

Total net earned premiums
$
104

 
$
121

Credit derivative revenues
3

 
5

Total net earned premiums and credit derivative revenue
$
107

 
$
126


Net earned premiums decreased in First Quarter 2020 compared with First Quarter 2019 primarily due to reduction in accelerations from refundings, as well as the scheduled decline in net par outstanding. At March 31, 2020, $3.8 billion of net deferred premium revenue remained to be earned over the life of the insurance contracts.

Credit derivative revenues have declined in First Quarter 2020 compared with First Quarter 2019 primarily due to the decline in the net par outstanding. The Company has not written new credit derivatives since 2009. Other than credit derivatives acquired in business combinations and reinsurance agreements, or as part of loss mitigation strategies, credit derivative exposure is expected to decline.

Net Investment Income and Equity in Net Earnings of Investees

Net investment income is a function of the yield earned and the size of the investment portfolio. The investment yield is a function of market interest rates at the time of investment as well as the type, credit quality and maturity of the invested assets. Net investment income in the Insurance segment represents income earned on the available for sale portfolio, short-term investments and other invested assets, other than equity method investments. Equity method investments in the Insurance segment include the insurance companies' investments in Assured Investment Management funds, as well as other direct investments. The income (loss) on such investments is presented as a separate line item, "equity in earnings of investees." The Company currently intends to invest up to $500 million in Assured Investment Management funds, and as of March 31, 2020 had invested $192 million.


105

Net Investment Income and Equity in Net Earnings of Investees

 
First Quarter
 
2020
 
2019
 
(in millions)
Income from fixed-maturity securities managed by third parties
$
62

 
$
73

Income from internally managed securities
20

 
27

Interest income from intercompany loans
3

 
1

Gross investment income
85

 
101

Investment expenses
(2
)
 
(2
)
Net investment income
$
83

 
$
99

 
 
 
 
Fair value gains (losses) on Assured Investment Management funds
$
(10
)
 
$
—

Other
1

 
1

Equity in net earnings of investees (1)
(9
)
 
1

____________________
(1)
Includes interest of $1 million related to CLO Warehouse Fund and ABIF investments in debt securities in First Quarter 2020.

Net investment income for First Quarter 2020 decreased compared to First Quarter 2019 primarily due to a decrease in the average asset balances in the investment portfolio. The overall pre-tax book yield was 3.41% as of March 31, 2020 and 3.88% as of March 31, 2019. Excluding the internally managed portfolio, pre-tax book yield was 3.14% as of March 31, 2020 and 3.26% as of March 31, 2019.

The fair value losses on Assured Investment Management funds in First Quarter 2020 were primarily attributable to price depreciation on the underlying assets of the CLO Warehouse Fund and ABIF funds due to volatility and dislocation in the market.

Other Income (Loss)
 
Other income (loss) consists of recurring items such as those listed in the table below as well as ancillary fees on financial guaranty policies for commitments and consents, and if applicable, other revenue items on financial guaranty insurance and reinsurance contracts such as loss mitigation recoveries and other non-recurring items.

Other Income (Loss)

 
First Quarter
 
2020
 
2019
 
(in millions)
Foreign exchange gain (loss) on remeasurement (1)
$
(5
)
 
$
1

Other
11

 
8

Total other income (loss)
$
6

 
$
9

 ____________________
(1)
Primarily related to cash.


106

Economic Loss Development
 
The insured portfolio includes policies accounted for under three separate accounting models depending on the characteristics of the contract and the Company’s control rights. For a discussion of assumptions and methodologies used in calculating the expected loss to be paid for all contracts and the accounting policies for measurement and recognition under GAAP for each type of contract, see the notes listed below in Part II. Item 8, Financial Statements and Supplementary Data, of the Company's 2019 Annual Report on Form 10-K:

•Note 6 for expected loss to be paid
•Note 7 for contracts accounted for as insurance
•Note 9 for fair value methodologies for credit derivatives and FG VIEs’ assets and liabilities
•Note 11 for contracts accounted for as credit derivatives
•Note 14 for FG VIEs

In order to efficiently evaluate and manage the economics of the entire insured portfolio, management compiles and analyzes expected loss information for all policies on a consistent basis. The discussion of losses that follows encompasses losses on all contracts in the insured portfolio regardless of accounting model, unless otherwise specified. Net expected loss to be paid primarily consists of the present value of future: expected claim and LAE payments, expected recoveries from issuers or excess spread, cessions to reinsurers, expected recoveries/payables for breaches of representations and warranties, and the effects of other loss mitigation strategies. Current risk-free rates are used to discount expected losses at the end of each reporting period and therefore changes in such rates from period to period affect the expected loss estimates reported. Assumptions used in the determination of the net expected loss to be paid such as delinquency, severity, and discount rates and expected time frames to recovery were consistent by sector regardless of the accounting model used. The primary drivers of economic loss development are discussed below. Changes in risk-free rates used to discount losses affect economic loss development, and loss and LAE; however, the effect of changes in discount rates are not indicative of actual credit impairment or improvement in the period.

Net Expected Loss to be Paid (Recovered) and
Net Economic Loss Development (Benefit)
By Accounting Model

 
Net Expected Loss to be Paid/ (Recovered)
 
Net Economic Loss Development/ (Benefit)
 
As of
 
First Quarter
 
March 31, 2020
 
December 31, 2019
 
2020
 
2019
 
(in millions)
Insurance
$
609

 
$
683

 
$
(1
)
 
$
10

FG VIEs
64

 
58

 
6

 
(10
)
Credit derivatives
(13
)
 
(4
)
 
(8
)
 
(2
)
Total
$
660

 
$
737

 
$
(3
)
 
$
(2
)
 
 
 
 
 
 
 
 
Net exposure rated BIG
$
8,268

 
$
8,506

 
 
 
 


107

Net Expected Loss to be Paid (Recovered) and
Net Economic Loss Development (Benefit)
By Sector

 
Net Expected Loss to be Paid/(Recovered)
 
Net Economic Loss Development/(Benefit)
 
As of
 
First Quarter
 
March 31, 2020
 
December 31, 2019
 
2020
 
2019
 
(in millions)
U.S. public finance
$
493

 
$
531

 
$
56

 
$
62

Non-U.S. public finance
26

 
23

 
3

 
(1
)
Structured finance
 
 
 
 
 
 
 
U.S. RMBS
104

 
146

 
(63
)
 
(65
)
Other structured finance
37

 
37

 
1

 
2

Structured finance
141

 
183

 
(62
)
 
(63
)
Total
$
660

 
$
737

 
$
(3
)
 
$
(2
)
 
 
 
 
 
 
 
 
Effect of changes in the risk-free rates included in economic loss development (benefit)
 
 
 
 
$
31

 
$
(4
)

Risk-Free Rates
 
Risk-Free Rates used in Expected Loss for U.S. Dollar Denominated Obligations
 
Range
 
Weighted Average
As of March 31, 2020
0.00
%
-
1.39%
 
0.64
%
As of December 31, 2019
0.00
%
-
2.45%
 
1.94
%
As of March 31, 2019
0.00
%
-
2.87%
 
2.46
%
As of December 31, 2018
0.00
%
-
3.06%
 
2.74
%

First Quarter 2020 Net Economic Loss Development

Public Finance: Public finance expected loss to be paid primarily related to U.S. exposures, which had BIG net par outstanding of $5.6 billion as of March 31, 2020 compared with $5.8 billion as of December 31, 2019. The Company projects that its total net expected loss across its troubled U.S. public finance exposures as of March 31, 2020 will be $493 million, compared with $531 million as of December 31, 2019. Economic loss development on U.S. exposures in First Quarter 2020 was $56 million, which was primarily attributable to Puerto Rico exposures. The economic loss development was approximately $3 million for non-U.S. exposures during First Quarter 2020 due to the weaker outlook of the performance of a troubled U.K. road.

U.S. RMBS: The net benefit attributable to U.S. RMBS was $63 million and was mainly related to higher excess spread on certain transactions supported by large portions of fixed rate assets (either originally fixed or modified to be fixed) and with insured floating rate debt linked to LIBOR, which decreased in First Quarter 2020. The economic development attributable to changes in discount rates was a loss of $32 million in First Quarter 2020.

See Item 1, Financial Statements, Note 5, Expected Loss to be Paid for additional information.
    
First Quarter 2019 Net Economic Loss Development

Public Finance: Public finance expected loss to be paid primarily related to U.S. exposures, which had BIG net par outstanding of $6.1 billion as of March 31, 2019 compared with $6.4 billion as of December 31, 2018. The Company projected that its total net expected loss across its troubled U.S. public finance exposures as of March 31, 2019 would be $666 million, compared with $832 million as of December 31, 2018. Economic loss development on U.S. exposures in First Quarter 2019 was $62 million, which was primarily attributable to Puerto Rico exposures.

108

U.S. RMBS: The net benefit attributable to U.S. RMBS was $65 million and was mainly related to improved performance in certain second lien transactions.

Insurance Segment Loss and LAE

The primary differences between net economic loss development and the amount reported as loss and LAE in the condensed consolidated statements of operations are that loss and LAE: (1) considers deferred premium revenue in the calculation of loss reserves and loss and LAE for financial guaranty insurance contracts, (2) eliminates loss and LAE related to consolidated FG VIEs, and (3) does not include estimated losses on credit derivatives.     

Loss and LAE reported in the Insurance segment adjusted operating income (i.e., adjusted loss and LAE) includes loss and LAE on financial guaranty insurance contracts (without giving effect to eliminations related to consolidation of FG VIEs), plus credit derivative losses.

For financial guaranty insurance contracts, each transaction’s expected loss to be expensed is compared with the deferred premium revenue of that transaction. When the expected loss to be expensed exceeds the deferred premium revenue, a loss is recognized in income for the amount of such excess. Therefore, the timing of loss recognition in income does not necessarily coincide with the timing of the actual credit impairment or improvement reported in net economic loss development. Transactions (particularly BIG transactions) acquired in a business combination or seasoned portfolios assumed from legacy financial guaranty insurers generally have the largest deferred premium revenue balances. Therefore the largest differences between net economic loss development and loss and LAE on financial guaranty insurance contracts generally relate to those policies.

The amount of loss and LAE recognized in the Insurance segment income, which includes all policies regardless of form, is a function of the amount of economic loss development discussed above and the deferred premium revenue amortization in a given period, on a contract-by-contract basis.

While expected loss to be paid is an important liquidity measure that provides the present value of amounts that the Company expects to pay or recover in future periods on all contracts, expected loss to be expensed is important because it presents the Company’s projection of net expected losses that will be recognized in future periods as deferred premium revenue amortizes into income for financial guaranty insurance policies.

The following table presents the Insurance segment loss and LAE, net of reinsurance.

Insurance Segment
Loss and LAE (Benefit)
 
First Quarter
 
2020
 
2019
 
(in millions)
U.S. public finance
$
59

 
$
70

Structured finance
 
 
 
U.S. RMBS
(44
)
 
(29
)
Other structured finance
3

 
3

Structured finance
(41
)
 
(26
)
Total loss and LAE (benefit)
$
18

 
$
44


The primary components of the Insurance segment loss and LAE expense were as follows:

•
Loss and LAE in First Quarter 2020 was mainly driven by higher losses on certain Puerto Rico exposures, partially offset by a benefit on first lien U.S. RMBS exposures.

•
Loss and LAE in First Quarter 2019 was mainly driven by higher losses on certain Puerto Rico exposures, partially offset by a benefit on U.S. RMBS exposures.



109

For additional information on the expected timing of net expected losses to be expensed see Item 1, Financial Statements, Note 6, Contracts Accounted for as Insurance, Financial Guaranty Insurance Losses.

Compensation, Benefits, Other Operating Expenses and Amortization of DAC

First Quarter 2020 compared with First Quarter 2019: Employee compensation and benefit expenses increased in First Quarter 2020 compared with First Quarter 2019 primarily due to higher severance and bonus expenses. Amortization of DAC was lower in First Quarter 2020 compared with First Quarter 2019 primarily due to a decrease in accelerations of net earned premiums due to refundings.

Asset Management Segment Results

Asset Management Results
 
First Quarter
 
2020
 
(in millions)
Revenues
 
Management fees:
 
CLOs
$
5

Opportunity funds
2

Wind-down funds
9

Total management fees (1)
16

Other income
1

Total revenues
17

Expenses
 
Amortization of intangible assets
3

Employee compensation and benefit expenses
18

Other operating expenses
7

Total expenses
28

Adjusted operating income (loss) before income taxes
(11
)
Provision (benefit) for income taxes
(2
)
Adjusted operating income (loss)
$
(9
)
_____________________
(1)
The Asset Management segment presents reimbursable fund expenses netted in other operating expenses, whereas on the condensed consolidated statement of operations such reimbursable expenses are shown gross, as components of asset management fees and other operating expenses.
    
Asset Management Fees

Management fees from CLOs are the net management fees that BlueMountain retains after rebating the portion of these fees that pertains to the CLO equity that is held directly by Assured Investment Management funds. Gross management fees from CLOs, before rebates to Assured Investment Management funds, were $10 million for the First Quarter 2020.
Management fees from opportunity funds for the quarter are mainly attributable to a previously established opportunity fund, along with two new opportunity funds that primarily represent $216 million in AUM of the Company's insurance subsidiaries.
There were no performance fees recognized in the First Quarter 2020. Funds that do not hit high water marks or return hurdles are not eligible to receive performance fees for the year. Performance fees are recorded when the contractual performance criteria have been met and when it is probable that a significant reversal of revenues will not occur in future reporting periods. For opportunity funds, these conditions are met typically close to the end of the fund’s life. The Company's current opportunity funds were not near the end of their harvest period during the quarter, when they would typically earn performance fee.

110

Expenses

Expenses primarily consist of employee compensation and benefits, and also include other operating expenses primarily consisting of depreciation and amortization related to the leases held by BlueMountain in New York and London. Amortization of finite-lived intangible assets, which mainly consist of BlueMountain's CLO and investment management contracts and its CLO distribution network, was $3 million during First Quarter 2020.
Assets Under Management

The Company uses AUM as a metric to measure progress in its Asset Management segment. The Company uses measures of its AUM in its decision making process and intends to use a measure of change in AUM in its calculation of certain components of management compensation. Investors also use AUM to evaluate companies that participate in the asset management business. AUM refers to the assets managed, advised or serviced by the Asset Management segment and equals the sum of the following:

•
the net asset value of the opportunity and wind-down funds plus any unfunded commitments; and

•
the amount of aggregate collateral balance and principal cash of BlueMountain's CLOs, including CLO equity that may be held by Assured Investment Management funds. This also includes CLO assets managed by BlueMountain Fuji Management, LLC (BM Fuji). BlueMountain is not the investment manager of BM Fuji CLOs, but rather has entered into a services agreement and a secondment agreement with BM Fuji pursuant to which BlueMountain provides certain services associated with the management of BM Fuji-advised CLOs and acts in the capacity of service provider.

The Company's calculation of AUM may differ from the calculation employed by other investment managers and, as a result, this measure may not be directly comparable to similar measures presented by other investment managers. The calculation also differs from the manner in which BlueMountain affiliates registered with the SEC report “Regulatory Assets Under Management” on Form ADV and Form PF in various ways.

The Company also uses several other measurements of AUM to understand and measure its AUM in more detail and for various purposes, including its relative position in the market and its income and income potential:

•
“Third-party assets under management” or “3rd Party AUM” refers to the assets BlueMountain manages or advises on behalf of third-party investors. This includes current and former employee investments in Assured Investment Management funds. For CLOs, this also includes CLO equity that may be held by Assured Investment Management funds funds.

•
“Intercompany assets under management” or “Intercompany AUM” refers to the assets BlueMountain manages or advises on behalf of the Company. This includes investments from affiliates of Assured Guaranty along with general partners' investments of BlueMountain (or its affiliates) into the funds.

•
“Funded assets under management” or “Funded AUM” refers to assets that have been deployed or invested into the funds or CLOs.

•
“Unfunded assets under management” or “Unfunded AUM” refers to unfunded capital commitments from closed-end funds and CLO warehouse fund.

•
“Fee earning assets under management” or “Fee Earning AUM” refers to assets where BlueMountain collects fees and has elected not to waive or rebate fees to investors.

•
“Non-fee earning assets under management” or “Non-Fee Earning AUM” refers to assets where BlueMountain does not collect fees or has elected to waive or rebate fees to investors. BlueMountain reserves the right to waive some or all fees for certain investors, including investors affiliated with BlueMountain and/or the Company. Further, to the extent that the Company's wind-down and/or opportunity funds are invested in BlueMountain managed CLOs, BlueMountain may rebate any management fees and/or performance compensation earned from the CLOs to the extent such fees are attributable to the wind-down and opportunity funds’ holdings of CLOs also managed by BlueMountain.


111

Assets Under Management

 
CLOs
 
Opportunity Funds
 
Wind-Down Funds
 
Total
 
(in millions)
Rollforward:
 
 
 
 
 
 
 
AUM, December 31, 2019
$
12,758

 
$
1,023

 
$
4,046

 
$
17,827

 
 
 
 
 
 
 
 
Inflows
—

 
88

 
—

 
88

Outflows:
 
 
 
 
 
 
 
Redemptions
—

 
—

 
—

 
—

Distributions
(67
)
 
(85
)
 
(875
)
 
(1,027
)
Total outflows
(67
)
 
(85
)
 
(875
)
 
(1,027
)
Net flows
(67
)
 
3

 
(875
)
 
(939
)
Change in fund value
(46
)
 
(57
)
 
(306
)
 
(409
)
AUM, March 31, 2020 (1)
$
12,645

 
$
969

 
$
2,865

 
$
16,479

 
 
 
 
 
 
 
 
As of March 31, 2020:
 
 
 
 
 
 
 
Funded AUM
$
12,634

 
$
849

 
$
2,843

 
$
16,326

Unfunded AUM
11

 
120

 
22

 
153

 
 
 
 
 
 
 
 
Fee Earning AUM
$
6,038

 
$
814

 
$
2,601

 
$
9,453

Non-Fee Earning AUM
6,607

 
155

 
264

 
7,026

 
 
 
 
 
 
 
 
As of December 31, 2019:
 
 
 
 
 
 
 
Funded AUM
$
12,721

 
$
796

 
$
3,980

 
$
17,497

Unfunded AUM
37

 
227

 
66

 
330

 
 
 
 
 
 
 
 
Fee Earning AUM
$
3,438

 
$
695

 
$
3,838

 
$
7,971

Non-Fee Earning AUM
9,320

 
328

 
208

 
9,856

_____________________
(1)
Includes AUM of the insurance company subsidiaries (intercompany AUM) of $216 million in opportunity funds and $41 million in the CLO Warehouse Fund.
    
CLO AUM includes CLO equity that is held by various Assured Investment Management funds of $259 million as of March 31, 2020, and $536 million as of December 31, 2019. This CLO equity corresponds to the majority of the non-fee earning CLO AUM, as BlueMountain typically rebates the CLO fees back to Assured Investment Management funds. Prior to the market dislocation caused by the COVID-19 pandemic in March, Assured Investment Management funds sold CLO equity, which contributed to the increase in fee earning AUM from $7,971 million as of December 31, 2019 to $9,453 million as of March 31, 2020.

Net outflows were $939 million, primarily driven by the return of capital in wind-down funds, which includes funds that are in their harvest period, partially offset by additional subscriptions into two opportunity funds focused on asset-backed finance and healthcare structured capital strategies. The new funds launched in the fourth quarter of 2019 and were primarily funded with capital from the Insurance segment.


112

Corporate Division Results

Corporate Results
 
First Quarter
 
2020
 
2019
 
(in millions)
Revenues
 
 
 
Net investment income
$
1

 
$
1

Loss on extinguishment of debt
(5
)
 
(1
)
Total revenues
(4
)
 
—

Expenses
 
 
 
Interest expense
25

 
24

Employee compensation and benefit expenses
5

 
4

Other operating expenses
5

 
3

Total expenses
35

 
31

Equity in net earnings of investees
(5
)
 
1

Adjusted operating income (loss) before income taxes
(44
)
 
(30
)
Provision (benefit) for income taxes
(5
)
 
(5
)
Adjusted operating income (loss)
$
(39
)

$
(25
)
    
The loss on extinguishment of debt, recorded in other income, is related to AGUS's purchase of a portion of the principal amount of AGMH's outstanding Junior Subordinated Debentures. The loss represents the difference between the amount paid to purchase AGMH's debt and the carrying value of the debt, which includes the unamortized fair value adjustments that were recorded upon the acquisition of AGMH in 2009.

Interest expense relates to debt issued by AGUS and AGMH. The increase in interest expense was due the $250 million debt from Assured Guaranty Municipal Corp. (AGM), Assured Guaranty Corp. (AGC) and Municipal Assurance Corp. (MAC) in October 2019 in connection with the BlueMountain acquisition, which was partially offset by a decrease in interest expense due to AGUS's purchase of $23 million in principal of AGMH's debt.

Compensation and benefits expenses allocated to the Corporate division are based on time studies and represent the costs incurred and time spent on holding company activities, capital management, corporate oversight and governance. Other expenses include Board of Director expenses, legal fees and other direct or allocated expenses.

Equity in net earnings of investees was a loss in First Quarter 2020 due to a write down of AGUS' investment in an investment firm that provides investment banking services in the global infrastructure sector.

Other
 
Other consists of intersegment eliminations, reclassifications of reimbursable fund expenses, and consolidation adjustments, including the effect of consolidating FG VIEs and certain Assured Investment Management investment vehicles in which the Insurance segment invests. The net effect on adjusted operating income (loss) of these items was a loss of $4 million in First Quarter 2020 and de minimis in First Quarter 2019. See Item 1, Financial Statements, Note 3, Segment Information.


113

VIE Consolidation Effect on
Net Income (Loss) Attributable to AGL

 
First Quarter
 
2020
 
2019
 
(in millions)
Effect of consolidating:
 
 
 
   FG VIEs
$
(4
)
 
$
—

 Investment vehicles
—

 
—

     VIE consolidation effect
$
(4
)
 
$
—


The types of VIEs the Company consolidates when it is deemed to be the primary beneficiary include (1) entities whose debt obligations the insurance subsidiaries insure, and (2) investment vehicles such as collateralized financing entities and investment funds managed by the Asset Management subsidiaries, in which the insurance company subsidiaries have a variable interest (consolidated investment vehicles). The Company eliminates the effects of intercompany transactions between consolidated VIEs and its insurance and asset management subsidiaries, as well as intercompany transactions between consolidated VIEs.

Generally, the consolidation of the Company's consolidated investment vehicles and FG VIEs has a significant gross-up effect on the Company's assets, liabilities and cash flows. The consolidation of the investment vehicles have no net effect on the net income attributable to the Company. The economic interest the Company holds in consolidated funds is presented in the Insurance segment. The ownership interests of the Company's consolidated funds, to which the Company has no economic rights, are reflected as either redeemable or nonredeemable noncontrolling interests in the consolidated funds in the Company's consolidated financial statements. See Item 1, Financial Statements, Note 12, Variable Interest Entities, for additional information.

Reconciliation to GAAP

Reconciliation of Net Income (Loss)
Attributable to AGL
To Adjusted Operating Income (Loss)

 
First Quarter
 
2020
 
2019
 
(in millions)
Net income (loss) attributable to AGL
$
(55
)
 
$
54

Less pre-tax adjustments:
 
 
 
Realized gains (losses) on investments
(5
)
 
(12
)
Non-credit impairment unrealized fair value gains (losses) on credit derivatives
(88
)
 
(28
)
Fair value gains (losses) on CCS
48

 
(9
)
Foreign exchange gains (losses) on remeasurement of premiums receivable and loss and LAE reserves
(57
)
 
9

Total pre-tax adjustments
(102
)
 
(40
)
Less tax effect on pre-tax adjustments
14

 
8

Adjusted operating income (loss)
$
33

 
$
86





114

Net Realized Investment Gains (Losses)

The table below presents the components of net realized investment gains (losses).

Net Realized Investment Gains (Losses)
 
 
First Quarter
 
2020
 
2019
 
(in millions)
Gross realized gains on available-for-sale securities
$
7

 
$
6

Gross realized losses on available-for-sale securities
(1
)
 
(2
)
Credit impairments
(11
)
 
(16
)
Net realized investment gains (losses)
$
(5
)
 
$
(12
)

    
Net realized losses in First Quarter 2020 related primarily to an increase in the allowance for credit loss on loss mitigation securities. Shut-downs due to COVID-19 pandemic restrictions contributed to the increase in the allowance for credit loss in First Quarter 2020. Credit impairment in First Quarter 2019 was primarily attributable to other-than-temporary impairment, or OTTI, on loss mitigation securities and foreign exchange losses.

Non-Credit Impairment Unrealized Fair Value Gains (Losses) on Credit Derivatives
  
Changes in the fair value of credit derivatives occur because of changes in the Company's own credit rating and credit spreads, collateral credit spreads, notional amounts, credit ratings of the referenced entities, expected terms, realized gains (losses) and other settlements, interest rates, and other market factors. The components of changes in fair value of credit derivatives related to credit derivative revenues and changes in expected losses are included in Insurance segment results. Non-economic changes in unrealized fair value gains and losses on credit derivatives are not included in the Insurance segment measure of adjusted operating income because it does not represent actual claims or expected losses and are expected to reverse to zero as the exposure approaches its maturity date. Changes in the fair value of the Company’s credit derivatives that do not reflect actual or expected claims or credit losses have no impact on the Company’s statutory claims-paying resources, rating agency capital or regulatory capital positions. Unrealized gains (losses) on credit derivatives may fluctuate significantly in future periods.

The impact of changes in credit spreads will vary based upon the volume, tenor, interest rates, and other market conditions at the time fair values are determined. In addition, since each transaction has unique collateral and structural terms, the underlying change in fair value of each transaction may vary considerably. The fair value of credit derivative contracts also reflects the change in the Company’s own credit cost based on the price to purchase credit protection on AGC. The Company determines its own credit risk based on quoted CDS prices traded on AGC at each balance sheet date. Generally, a widening of credit spreads of the underlying obligations results in unrealized losses and the tightening of credit spreads of the underlying obligations results in unrealized gains. A widening of the CDS prices traded on AGC has an effect of offsetting unrealized losses that result from widening general market credit spreads, while a narrowing of the CDS prices traded on AGC has an effect of offsetting unrealized gains that result from narrowing general market credit spreads. Due to the relatively low volume and characteristics of CDS contracts remaining in AGM's portfolio, changes in AGM's credit spreads do not significantly affect the fair value of these CDS contracts.

The valuation of the Company’s credit derivative contracts requires the use of models that contain significant, unobservable inputs, and are classified as Level 3 in the fair value hierarchy. The models used to determine fair value are primarily developed internally based on market conventions for similar transactions that the Company observed in the past. There has been very limited new issuance activity in this market over the past several years and as of March 31, 2020, market prices for the Company’s credit derivative contracts were generally not available. Inputs to the estimate of fair value include various market indices, credit spreads, the Company’s own credit spread, and estimated contractual payments. See Item 1, Financial Statements, Note 8, Fair Value Measurement, for additional information.


115

During First Quarter 2020, non-credit impairment fair value losses were generated primarily as a result of wider spreads of the underlying collateral and lower discount rates. These were partially offset by gains due to the increased cost to buy protection on AGC, as the market cost of AGC's credit protection increased during the period. For those CDS transactions that were pricing at or above their floor levels, when the cost of purchasing CDS protection on AGC, which management refers to as the CDS spread on AGC, increased, the implied spreads that the Company would expect to receive on these transactions decreased.

During First Quarter 2019, non-credit impairment fair value losses were driven by the decreased cost to buy protection in AGC’s name, as the market cost of AGC’s credit protection decreased during the period.
    
Sensitivity to Changes in Credit Spread
 
The following table summarizes the estimated change in fair values on the net balance of the Company’s credit derivative positions assuming an immediate shift in the net spreads assumed by the Company. The net spread is affected by the spread of the underlying collateral and the credit spreads on AGC.

Effect of Changes in Credit Spread

 
 
As of March 31, 2020
 
As of December 31, 2019
Credit Spreads (1)
 
Estimated Net
Fair Value
(Pre-Tax)
 
Estimated Change
in Gain/(Loss)
(Pre-Tax)
 
Estimated Net
Fair Value
(Pre-Tax)
 
Estimated Change
in Gain/(Loss)
(Pre-Tax)
 
 
(in millions)
Increase of 25 basis points (bps)
 
$
(378
)
 
$
(116
)
 
$
(315
)
 
$
(130
)
Base Scenario
 
(262
)
 
—

 
(185
)
 
—

Decrease of 25 bps
 
(164
)
 
98

 
(97
)
 
88

All transactions priced at floor
 
(65
)
 
197

 
(56
)
 
129

 ____________________
(1)
Includes the effects of changes in the net spreads assumed by the Company.

Fair Value Gains (Losses) on CCS

Fair value gains on CCS in First Quarter 2020 were primarily due to a widening in market spreads during the quarter. Fair value losses on CCS in First Quarter 2019 were primarily due to a tightening in market spreads during the quarter. Fair value of CCS is heavily affected by, and in part fluctuates with, changes in market interest rates, credit spreads and other market factors and are not expected to result in an economic gain or loss.

Foreign Exchange Gain (Loss) on Remeasurement

Foreign exchange gains and losses in both periods primarily relate to remeasurement of premiums receivable and are mainly due to changes in the exchange rate of the pound sterling relative to the U.S. dollar.

Non-GAAP Financial Measures
 
To reflect the key financial measures that management analyzes in evaluating the Company’s operations and progress towards long-term goals, the Company discloses both financial measures determined in accordance with GAAP and financial measures not determined in accordance with GAAP (non-GAAP financial measures).

Financial measures identified as non-GAAP should not be considered substitutes for GAAP financial measures. The primary limitation of non-GAAP financial measures is the potential lack of comparability to financial measures of other companies, whose definitions of non-GAAP financial measures may differ from those of the Company.

By disclosing non-GAAP financial measures, the Company gives investors, analysts and financial news reporters access to information that management and the Board of Directors review internally. The Company believes its presentation of non-GAAP financial measures provides information that is necessary for analysts to calculate their estimates of Assured Guaranty’s financial results in their research reports on Assured Guaranty and for investors, analysts and the financial news media to evaluate Assured Guaranty’s financial results.


116

The Company also provides the effect of VIE consolidation that is embedded in each non-GAAP financial measure, as applicable, which the Company believes may also be useful to investors, analysts and financial news media to evaluate Assured Guaranty’s financial results. GAAP requires the Company to consolidate certain FG VIEs and investment vehicles. The Company does not own the consolidated FG VIEs and its exposure is limited to its obligation under the financial guaranty insurance contract. The Insurance segment presents the economic effect of the financial guaranty contracts associated with the consolidated FG VIEs. The Company does own a substantial ownership interest in its consolidated investment vehicles, which is reflected in the Insurance segment.

Management and the Board of Directors use non-GAAP financial measures further adjusted to remove the effect of VIE consolidation (which the Company refers to as its core financial measures), as well as GAAP financial measures and other factors, to evaluate the Company’s results of operations, financial condition and progress towards long-term goals. The Company uses core financial measures in its decision making process and in its calculation of certain components of management compensation.
    
Management believes that many investors, analysts and financial news reporters use adjusted operating shareholders’ equity, further adjusted to remove the effect of VIE consolidation, as the principal financial measure for valuing AGL’s current share price or projected share price and also as the basis of their decision to recommend, buy or sell AGL’s common shares. Management also believes that many of the Company’s fixed income investors also use this measure to evaluate the Company’s capital adequacy.

Management believes that many investors, analysts and financial news reporters also use adjusted book value, further adjusted to remove the effect of VIE consolidation, to evaluate AGL’s share price and as the basis of their decision to recommend, buy or sell the AGL common shares. Adjusted operating income further adjusted for the effect of VIE consolidation enables investors and analysts to evaluate the Company’s financial results in comparison with the consensus analyst estimates distributed publicly by financial databases.

The core financial measures that the Company uses to help determine compensation are: (1) adjusted operating income, further adjusted to remove the effect of VIE consolidation, (2) adjusted operating shareholders' equity, further adjusted to remove the effect of VIE consolidation, (3) growth in adjusted book value per share, further adjusted to remove the effect of VIE consolidation, and (4) PVP.
 
In the first quarter of 2020, the Company changed the discount rate used in the calculation of PVP and net present value of estimated future net revenues, which is a component of adjusted book value. Beginning in 2020, the discount rate will be the approximate average pre-tax fixed book yield of fixed-maturity securities purchased in the prior calendar year, excluding loss mitigation bonds. In prior periods the discount rate was a constant 6% discount rate. The Company made these changes and recast prior periods to better reflect the then current interest rate environment. The reconciliation tables of GAAP to non-GAAP financial measures for PVP and ABV indicate the new discount rate for each relevant period. The following paragraphs define each non-GAAP financial measure disclosed by the Company and describe why it is useful. To the extent there is a directly comparable GAAP financial measure, a reconciliation of the non-GAAP financial measure and the most directly comparable GAAP financial measure is presented below.
 
Adjusted Operating Income

Management believes that adjusted operating income is a useful measure because it clarifies the understanding of the underwriting results of the Company. Adjusted operating income is defined as net income (loss) attributable to AGL, as reported under GAAP, adjusted for the following:
 
1) Elimination of realized gains (losses) on the Company’s investments, except for gains and losses on securities classified as trading. The timing of realized gains and losses, which depends largely on market credit cycles, can vary considerably across periods. The timing of sales is largely subject to the Company’s discretion and influenced by market opportunities, as well as the Company’s tax and capital profile.

2) Elimination of non-credit-impairment unrealized fair value gains (losses) on credit derivatives that are recognized in net income, which is the amount of unrealized fair value gains (losses) in excess of the present value of the expected estimated economic credit losses, and non-economic payments. Such fair value adjustments are heavily affected by, and in part fluctuate with, changes in market interest rates, the Company's credit spreads, and other market factors and are not expected to result in an economic gain or loss.
 

117

3) Elimination of fair value gains (losses) on the Company’s CCS that are recognized in net income. Such amounts are affected by changes in market interest rates, the Company's credit spreads, price indications on the Company's publicly traded debt, and other market factors and are not expected to result in an economic gain or loss.
 
4) Elimination of foreign exchange gains (losses) on remeasurement of net premium receivables and loss and LAE reserves that are recognized in net income. Long-dated receivables and loss and LAE reserves represent the present value of future contractual or expected cash flows. Therefore, the current period’s foreign exchange remeasurement gains (losses) are not necessarily indicative of the total foreign exchange gains (losses) that the Company will ultimately recognize.
 
5) Elimination of the tax effects related to the above adjustments, which are determined by applying the statutory tax rate in each of the jurisdictions that generate these adjustments.

Adjusted Operating Shareholders’ Equity and Adjusted Book Value
 
     Management believes that adjusted operating shareholders’ equity is a useful measure because it excludes the fair value adjustments on investments, credit derivatives and CCS that are not expected to result in economic gain or loss.

Adjusted operating shareholders’ equity is the basis of the calculation of adjusted book value (see below). Adjusted operating shareholders’ equity is defined as shareholders’ equity attributable to AGL, as reported under GAAP, adjusted for the following:
 
1) Elimination of non-credit-impairment unrealized fair value gains (losses) on credit derivatives, which is the amount of unrealized fair value gains (losses) in excess of the present value of the expected estimated economic credit losses, and non-economic payments. Such fair value adjustments are heavily affected by, and in part fluctuate with, changes in market interest rates, credit spreads and other market factors and are not expected to result in an economic gain or loss.
 
2) Elimination of fair value gains (losses) on the Company’s CCS. Such amounts are affected by changes in market interest rates, the Company's credit spreads, price indications on the Company's publicly traded debt, and other market factors and are not expected to result in an economic gain or loss.

3) Elimination of unrealized gains (losses) on the Company’s investments that are recorded as a component of accumulated other comprehensive income (AOCI) (excluding foreign exchange remeasurement). The AOCI component of the fair value adjustment on the investment portfolio is not deemed economic because the Company generally holds these investments to maturity and therefore should not recognize an economic gain or loss.

4) Elimination of the tax effects related to the above adjustments, which are determined by applying the statutory tax rate in each of the jurisdictions that generate these adjustments.

Management uses adjusted book value, further adjusted for VIE consolidation, to measure the intrinsic value of the Company, excluding franchise value. Growth in adjusted book value per share, further adjusted for VIE consolidation (core adjusted book value), is one of the key financial measures used in determining the amount of certain long-term compensation elements to management and employees and used by rating agencies and investors. Management believes that adjusted book value is a useful measure because it enables an evaluation of the Company’s in-force premiums and revenues net of expected losses. Adjusted book value is adjusted operating shareholders’ equity, as defined above, further adjusted for the following:
 
1) Elimination of deferred acquisition costs, net. These amounts represent net deferred expenses that have already been paid or accrued and will be expensed in future accounting periods.
 
2) Addition of the net present value of estimated net future revenue. See below.
 
3) Addition of the deferred premium revenue on financial guaranty contracts in excess of expected loss to be expensed, net of reinsurance. This amount represents the present value of the expected future net earned premiums, net of the present value of expected losses to be expensed, which are not reflected in GAAP equity.


118

4) Elimination of the tax effects related to the above adjustments, which are determined by applying the statutory tax rate in each of the jurisdictions that generate these adjustments.

The unearned premiums and revenues included in adjusted book value will be earned in future periods, but actual earnings may differ materially from the estimated amounts used in determining current adjusted book value due to changes in foreign exchange rates, prepayment speeds, terminations, credit defaults and other factors.

Reconciliation of Shareholders’ Equity Attributable to AGL
To Adjusted Book Value (1)
 
 
As of March 31, 2020
 
As of December 31, 2019
 
After-Tax
 
Per Share
 
After-Tax
 
Per Share
 
(dollars in millions, except per share amounts)
Shareholders’ equity attributable to AGL
$
6,240

 
$
69.35

 
$
6,639

 
$
71.18

Less pre-tax adjustments:
 
 
 
 
 
 
 
Non-credit impairment unrealized fair value gains (losses) on credit derivatives
(144
)
 
(1.60
)
 
(56
)
 
(0.60
)
Fair value gains (losses) on CCS
101

 
1.12

 
52

 
0.56

Unrealized gain (loss) on investment portfolio excluding foreign exchange effect
275

 
3.06

 
486

 
5.21

Less taxes
(43
)
 
(0.48
)
 
(89
)
 
(0.95
)
Adjusted operating shareholders’ equity
6,051

 
67.25

 
6,246

 
66.96

Pre-tax adjustments:
 
 
 
 
 

 
 

Less: Deferred acquisition costs
113

 
1.26

 
111

 
1.19

Plus: Net present value of estimated net future revenue
193

 
2.14

 
206

 
2.20

Plus: Net unearned premium reserve on financial guaranty contracts in excess of expected loss to be expensed
3,273

 
36.37

 
3,296

 
35.34

Plus taxes
(584
)
 
(6.48
)
 
(590
)
 
(6.32
)
Adjusted book value
$
8,820

 
$
98.02

 
9,047

 
96.99

 
 
 
 
 
 
 
 
Gain (loss) related to VIE consolidation included in adjusted operating shareholders' equity (net of tax provision of $4 and $2)
$
12

 
$
0.14

 
$
7

 
$
0.07

 
 
 
 
 
 
 
 
Gain (loss) related to VIE consolidation included in adjusted book value (net of tax provision (benefit) of $2 and $(1))
$
2

 
$
0.03

 
$
(4
)
 
$
(0.05
)
___________________
(1) The discount rate used for net present value of estimated net future revenues as of March 31, 2020 is 3%. The prior period has been recast to present the net present value of net future revenues discounted at 3% instead of 6%.

Net Present Value of Estimated Net Future Revenue
 
Management believes that this amount is a useful measure because it enables an evaluation of the value of the present value of estimated net future revenue for contracts other than financial guaranty insurance contracts (such as specialty insurance and reinsurance contracts and credit derivatives). This amount represents the net present value of estimated future revenue from these contracts (other than credit derivatives with net expected losses), net of reinsurance, ceding commissions and premium taxes.

Future installment premiums are discounted at the approximate average pre-tax book yield of fixed maturity securities purchased during the prior calendar year, other than loss mitigation securities. The discount rate is recalculated annually and updated as necessary. Net present value of estimated future revenue for an obligation may change from period to period due to a change in the discount rate or due to a change in estimated net future revenue for the obligation, which may change due to changes in foreign exchange rates, prepayment speeds, terminations, credit defaults or other factors that affect par outstanding or the ultimate maturity of an obligation. There is no corresponding GAAP financial measure.

119

PVP or Present Value of New Business Production

Management believes that PVP is a useful measure because it enables the evaluation of the value of new business production for the Company by taking into account the value of estimated future installment premiums on all new contracts underwritten in a reporting period as well as additional installment premium on existing contracts (which may result from supplements or fees or from the issuer not calling an insured obligation the Company projected would be called), whether in insurance or credit derivative contract form, which management believes GAAP gross written premiums and changes in fair value of credit derivatives do not adequately measure. PVP in respect of contracts written in a specified period is defined as gross upfront and installment premiums received and the present value of gross estimated future installment premiums. 

Future installment premiums are discounted at the approximate average pre-tax book yield of fixed maturity securities purchased during the prior calendar year, other than loss mitigation securities. The discount rate is recalculated annually and updated as necessary. Under GAAP, financial guaranty installment premiums are discounted at a risk-free rate. Additionally, under GAAP, management records future installment premiums on financial guaranty insurance contracts covering non-homogeneous pools of assets based on the contractual term of the transaction, whereas for PVP purposes, management records an estimate of the future installment premiums the Company expects to receive, which may be based upon a shorter period of time than the contractual term of the transaction.

Actual installment premiums may differ from those estimated in the Company's PVP calculation due to factors including, but not limited to, changes in foreign exchange rates, prepayment speeds, terminations, credit defaults, or other factors that affect par outstanding or the ultimate maturity of an obligation. 

Reconciliation of GWP to PVP (1)

 
First Quarter 2020
 
First Quarter 2019
 
Public Finance
 
Structured Finance
 
 
 
Public Finance
 
Structured Finance
 
 
 
U.S.
 
Non - U.S.
 
U.S.
 
Non - U.S.
 
Total
 
U.S.
 
Non - U.S.
 
U.S.
 
Non - U.S.
 
Total
 
(in millions)
GWP
$
29

 
$
34

 
$
1

 
$
—

 
$
64

 
$
30

 
$
2

 
$
6

 
$
1

 
$
39

Less: Installment GWP and other GAAP adjustments (2)
—

 
34

 
1

 
—

 
35

 
(2
)
 
2

 
5

 
—

 
5

Upfront GWP
29

 
—

 
—

 
—

 
29

 
32

 
—

 
1

 
1

 
34

Plus: Installment premium PVP
—

 
21

 
1

 
—

 
22

 
—

 
4

 
4

 
—

 
8

PVP
$
29

 
$
21

 
$
1

 
$
—

 
$
51

 
$
32

 
$
4

 
$
5

 
$
1

 
$
42

___________________
(1)
The discount rate used for PVP as of March 31, 2020 is 3%. The prior period has been recast to present PVP discounted at 3% instead of 6%.

(2)
Includes present value of new business on installment policies discounted at the prescribed GAAP discount rates, GWP adjustments on existing installment policies due to changes in assumptions, any cancellations of assumed reinsurance contracts, and other GAAP adjustments.

Insured Portfolio
 
Financial Guaranty Exposure

The Company measures its financial guaranty exposure in terms of (a) gross and net par outstanding and (b) gross and net debt service, which includes scheduled principal and interest. The Company uses gross and net par outstanding and gross and net debt service to measure and understand the financial guaranty risk it guarantees in its Insurance segment and to understand its relative position in the fixed income markets.

The Company typically guarantees the payment of principal and interest when due. Since most of these payments are due in the future, the Company generally uses gross and net par outstanding as a proxy for its financial guaranty exposure. Gross par outstanding generally represents the principal amount of the insured obligation at a point in time. Net par outstanding equals gross par outstanding net of any third-party reinsurance. The Company includes in its par outstanding calculation the

120

impact of any consumer price index inflator to the reporting date as well as, in the case of accreting (zero-coupon) obligations, accretion to the reporting date.

The Company purchases securities that it has insured, and for which it has expected losses to be paid, in order to mitigate the economic effect of insured losses (loss mitigation securities). The Company excludes amounts attributable to loss mitigation securities from par and debt service outstanding, which amounts are included in the investment portfolio, because the Company manages such securities as investments and not insurance exposure. As of both March 31, 2020 and December 31, 2019, the Company excluded $1.4 billion, of net par attributable to loss mitigation securities. See Item 1, Financial Statements, Note 4, Outstanding Insurance Exposure, for additional information.
 
Gross debt service outstanding represents the sum of all estimated future principal and interest payments on the obligations insured, on an undiscounted basis. Net debt service outstanding equals gross debt service outstanding net of any third-party reinsurance. Future debt service payments include the impact of any consumer price index inflator after the reporting date, as well as, in the case of accreting (zero-coupon) obligations, accretion after the reporting date.

The Company calculates its debt service outstanding as follows:

•
for insured obligations that are not supported by homogeneous pools of assets (which category includes most of the Company's public finance transactions), as the total estimated contractual future principal and interest due through maturity, regardless of whether the obligations may be called and regardless of whether, in the case of obligations where principal payments are due when an underlying asset makes a principal payment, the Company believes the obligations will be repaid prior to contractual maturity; and

•
for insured obligations that are supported by homogeneous pools of assets that are contractually permitted to prepay principal (which category includes, for example, RMBS and CLOs), as the total estimated expected future principal and interest due on insured obligations through their respective expected terms, which includes the Company's expectations as to whether the obligations may be called and, in the case of obligations where principal payments are due when an underlying asset makes a principal payment, when the Company expects principal payments to be made prior to contractual maturity.

The calculation of debt service requires the use of estimates, which the Company updates periodically, including estimates for the expected remaining term of insured obligations supported by homogeneous pools of assets, updated interest rates for floating and variable rate insured obligations, behavior of consumer price indices for obligations with consumer price index inflators, foreign exchange rates and other assumptions based on the characteristics of each insured obligation. The anticipated sunset of LIBOR at the end of 2021 has introduced another variable into the Company's calculation of future debt service. See the Risk Factor captioned “The Company may be adversely impacted by the transition from LIBOR as a reference rate” under Operational Risks in Part 1, Item 1A, Risk Factors of the Company’s Annual Report on Form 10-K for the year ended December 31, 2019. Debt service is a measure of the estimated maximum potential exposure to insured obligations before considering the Company’s various legal rights to the underlying collateral and other remedies available to it under its financial guaranty contract.

Actual debt service may differ from estimated debt service due to refundings, terminations, negotiated restructurings, prepayments, changes in interest rates on variable rate insured obligations, consumer price index behavior differing from that projected, changes in foreign exchange rates on non-U.S. dollar denominated insured obligations and other factors.
   
The following table presents the insured financial guaranty portfolio by sector, net of cessions to reinsurers. It includes all financial guaranty contracts outstanding as of the dates presented, regardless of the form written (i.e., credit derivative form or traditional financial guaranty insurance form) or the applicable accounting model (i.e., insurance, derivative or VIE consolidation).

121

Financial Guaranty Portfolio
Net Par Outstanding and Average Internal Rating by Sector

 
 
As of March 31, 2020
 
As of December 31, 2019
Sector
 
Net Par
Outstanding
 
Avg.
Rating
 
Net Par
Outstanding
 
Avg.
Rating
 
 
(dollars in millions)
Public finance:
 
 
 
 
 
 

 
 
U.S.:
 
 
 
 
 
 

 
 
General obligation
 
$
72,340

 
A-
 
$
73,467

 
A-
Tax backed
 
35,715

 
A-
 
37,047

 
A-
Municipal utilities
 
25,926

 
A-
 
26,195

 
A-
Transportation
 
16,105

 
BBB+
 
16,209

 
BBB+
Healthcare
 
7,256

 
BBB+
 
7,148

 
A-
Higher education
 
5,977

 
A-
 
5,916

 
A-
Infrastructure finance
 
5,384

 
A-
 
5,429

 
A-
Housing revenue
 
1,363

 
BBB+
 
1,321

 
BBB+
Investor-owned utilities
 
654

 
A-
 
655

 
A-
Renewable energy
 
207

 
A-
 
210

 
A-
Other public finance—U.S.
 
1,868

 
A-
 
1,890

 
A-
Total public finance—U.S.
 
172,795

 
A-
 
175,487

 
A-
Non-U.S.:
 
 
 
 
 
 

 
 
Regulated utilities
 
17,825

 
BBB+
 
18,995

 
BBB+
Infrastructure finance
 
16,684

 
BBB
 
17,952

 
BBB
Sovereign and sub-sovereign
 
10,834

 
A+
 
11,341

 
A+
Renewable energy
 
1,905

 
A
 
1,555

 
A
Pooled infrastructure
 
1,327

 
AAA
 
1,416

 
AAA
Total public finance—non-U.S.
 
48,575

 
A-
 
51,259

 
A-
Total public finance
 
221,370

 
A-
 
226,746

 
A-
Structured finance:
 
 
 
 
 
 

 
 
U.S.:
 
 
 
 
 
 

 
 
RMBS
 
3,393

 
BBB-
 
3,546

 
BBB-
Life insurance transactions
 
1,794

 
AA-
 
1,776

 
AA-
Pooled corporate obligations
 
1,350

 
AA-
 
1,401

 
AA-
Consumer receivables
 
909

 
A-
 
962

 
A-
Financial products
 
806

 
AA-
 
1,019

 
AA-
Other structured finance—U.S.
 
554

 
BBB+
 
596

 
BBB+
Total structured finance—U.S.
 
8,806

 
A-
 
9,300

 
A-
Non-U.S.:
 
 
 
 
 
 

 
 
RMBS
 
401

 
A
 
427

 
A
Pooled corporate obligations
 
55

 
BB+
 
55

 
BB+
Other structured finance
 
266

 
A+
 
279

 
A+
Total structured finance—non-U.S.
 
722

 
A
 
761

 
A
Total structured finance
 
9,528

 
A-
 
10,061

 
A-
Total net par outstanding
 
$
230,898

 
A-
 
$
236,807

 
A-




122

The following table sets forth the Company’s net financial guaranty portfolio by internal rating.

Financial Guaranty
Portfolio by Internal Rating

 
 
As of March 31, 2020
 
As of December 31, 2019
Rating
Category
 
Net Par Outstanding
 
%
 
Net Par Outstanding
 
%
 
 
(dollars in millions)
AAA
 
$
4,186

 
1.8
%
 
$
4,361

 
1.8
%
AA
 
27,746

 
12.0

 
29,037

 
12.3

A
 
108,612

 
47.0

 
111,329

 
47.0

BBB
 
82,116

 
35.6

 
83,574

 
35.3

BIG
 
8,238

 
3.6

 
8,506

 
3.6

Total net par outstanding
 
$
230,898

 
100.0
%
 
$
236,807

 
100.0
%


Exposure to Puerto Rico
         
The Company had insured exposure to general obligation bonds of the Commonwealth of Puerto Rico (Puerto Rico or the Commonwealth) and various obligations of its related authorities and public corporations aggregating $4.3 billion net par as of March 31, 2020, all of which was rated BIG. Beginning on January 1, 2016, a number of Puerto Rico exposures have defaulted on bond payments, and the Company has now paid claims on all of its Puerto Rico exposures except for Puerto Rico Aqueduct and Sewer Authority (PRASA), Municipal Finance Agency (MFA) and University of Puerto Rico (U of PR).

The Company groups its Puerto Rico exposure into three categories:

•
Constitutionally Guaranteed.
•
Public Corporations – Certain Revenues Potentially Subject to Clawback.
•
Other Public Corporations.

Additional information about recent developments in Puerto Rico and the individual exposures insured by the Company may be found in Item 1, Financial Statements, Note 4, Outstanding Insurance Exposure.


123

Exposure to Puerto Rico
As of March 31, 2020

 
 
Net Par Outstanding
 
 
 
 
AGM
 
AGC
 
Assured Guaranty Re Ltd. (AG Re)
 
Eliminations (1)
 
Total
Net Par Outstanding
 
Gross
Par Outstanding
 
 
(in millions)
Commonwealth Constitutionally Guaranteed
 
 
 
 
 
 
 
 
 
 
 
 
Commonwealth of Puerto Rico - General Obligation Bonds (2)
 
$
611

 
$
268

 
$
375

 
$
(1
)
 
$
1,253

 
$
1,294

Puerto Rico Public Buildings Authority (PBA) (2)
 
7

 
140

 
—

 
(7
)
 
140

 
145

Public Corporations - Certain Revenues Potentially Subject to Clawback
 
 
 
 
 
 
 
 
 
 
 
 
Puerto Rico Highways and Transportation Authority (PRHTA) (Transportation revenue) (2)
 
223

 
480

 
187

 
(79
)
 
811

 
842

PRHTA (Highway revenue) (2)
 
345

 
74

 
35

 
—

 
454

 
515

Puerto Rico Convention Center District Authority (PRCCDA)
 
—

 
152

 
—

 
—

 
152

 
152

Puerto Rico Infrastructure Financing Authority (PRIFA)
 
—

 
15

 
1

 
—

 
16

 
16

Other Public Corporations
 
 
 
 
 
 
 
 
 
 
 
 
PREPA (2)
 
525

 
71

 
226

 
—

 
822

 
838

PRASA
 
—

 
284

 
89

 
—

 
373

 
373

MFA
 
153

 
33

 
62

 
—

 
248

 
282

U of PR
 
—

 
1

 
—

 
—

 
1

 
1

Total exposure to Puerto Rico
 
$
1,864

 
$
1,518

 
$
975

 
$
(87
)
 
$
4,270

 
$
4,458

 ___________________
(1)
Net par outstanding eliminations relate to second-to-pay policies under which an Assured Guaranty insurance subsidiary guarantees an obligation already insured by another Assured Guaranty insurance subsidiary.
 
(2)
As of the date of this filing, the seven-member financial oversight board established by the Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA) has certified a filing under Title III of PROMESA for these exposures.



124

The following tables show the scheduled amortization of the general obligation bonds of Puerto Rico and various obligations of its related authorities and public corporations insured by the Company. The Company guarantees payments of interest and principal when those amounts are scheduled to be paid and cannot be required to pay on an accelerated basis. In the event that obligors default on their obligations, the Company would only pay the shortfall between the principal and interest due in any given period and the amount paid by the obligors.     

Amortization Schedule
of Net Par Outstanding of Puerto Rico
As of March 31, 2020

 
Scheduled Net Par Amortization
 
2020 (2Q)
2020 (3Q)
2020 (4Q)
2021
2022
2023
2024
2025 - 2029
2030 - 2034
2035 - 2039
2040 - 2044
2045 - 2047
Total
 
(in millions)
Commonwealth Constitutionally Guaranteed
 
 
 
 
 
 
 
 
 
 
 
 
 
Commonwealth of Puerto Rico - General Obligation Bonds
$
—

$
141

$
—

$
15

$
37

$
14

$
73

$
289

$
419

$
265

$
—

$
—

$
1,253

PBA
—

5

—

13

—

7

—

58

38

19

—

—

140

Public Corporations - Certain Revenues Potentially Subject to Clawback
 
 
 
 
 
 
 
 
 
 
 
 


PRHTA (Transportation revenue)
—

25

—

18

28

33

4

163

166

292

82

—

811

PRHTA (Highway revenue)
—

22

—

35

6

32

33

55

177

94

—

—

454

PRCCDA
—

—

—

—

—

—

—

19

76

57

—

—

152

PRIFA
—

—

—

—

—

2

—

—

—

7

7

—

16

Other Public Corporations
 
 
 
 
 
 
 
 
 
 
 
 


PREPA
—

48

—

28

28

95

93

386

140

4

—

—

822

PRASA
—

—

—

—

—

—

1

109

—

2

15

246

373

MFA
—

45

—

40

40

22

18

79

4

—

—

—

248

U of PR
—

—

—

—

—

—

—

—

1

—

—

—

1

Total
$
—

$
286

$
—

$
149

$
139

$
205

$
222

$
1,158

$
1,021

$
740

$
104

$
246

$
4,270



125

Amortization Schedule
of Net Debt Service Outstanding of Puerto Rico
As of March 31, 2020

 
Scheduled Net Debt Service Outstanding
 
2020 (2Q)
2020 (3Q)
2020 (4Q)
2021
2022
2023
2024
2025 - 2029
2030 - 2034
2035 - 2039
2040 - 2044
2045 - 2047
Total
 
(in millions)
Commonwealth Constitutionally Guaranteed
 
 
 
 
 
 
 
 
 
 
 
 
 
Commonwealth of Puerto Rico - General Obligation Bonds
$
—

$
173

$
—

$
74

$
94

$
70

$
128

$
514

$
572

$
294

$
—

$
—

$
1,919

PBA
—

9

—

20

6

13

6

81

50

20

—

—

205

Public Corporations - Certain Revenues Potentially Subject to Clawback
 
 
 
 
 
 
 
 
 
 
 
 


PRHTA (Transportation revenue)
—

46

—

59

68

72

41

331

294

356

89

—

1,356

PRHTA (Highway revenue)
—

34

—

58

27

52

51

134

233

101

—

—

690

PRCCDA
—

3

—

7

7

7

7

52

103

61

—

—

247

PRIFA
—

—

—

1

1

3

1

4

3

10

8

—

31

Other Public Corporations
 
 
 
 
 
 
 
 
 
 
 
 


PREPA
3

65

3

63

62

128

121

467

155

5

—

—

1,072

PRASA
—

10

—

19

19

19

20

190

68

70

82

272

769

MFA
—

52

—

50

48

28

23

89

5

—

—

—

295

U of PR
—

—

—

—

—

—

—

—

1

—

—

—

1

Total
$
3

$
392

$
3

$
351

$
332

$
392

$
398

$
1,862

$
1,484

$
917

$
179

$
272

$
6,585



Financial Guaranty Exposure to U.S. RMBS
 
The table below provides information on certain risk characteristics of the Company’s U.S. RMBS exposures. U.S. RMBS exposures represent 1.5% of the total net par outstanding, and BIG U.S. RMBS represent 19.2% of total BIG net par outstanding. See Item 1, Financial Statements, Note 5, Expected Loss to be Paid, for a discussion of expected losses to be paid on U.S. RMBS exposures.
     
Distribution of U.S. RMBS by Year Insured and Type of Exposure as of March 31, 2020

Year
insured:
 
Prime
First Lien
 
Alt-A
First Lien
 
Option
ARMs
 
Subprime
First Lien
 
Second
Lien
 
Total Net Par
Outstanding
 
 
(in millions)
2004 and prior
 
$
21

 
$
18

 
$
1

 
$
539

 
$
44

 
$
623

2005
 
48

 
213

 
23

 
219

 
123

 
626

2006
 
36

 
41

 
10

 
263

 
206

 
556

2007
 
—

 
316

 
26

 
934

 
270

 
1,546

2008
 
—

 
—

 
—

 
42

 
—

 
42

Total exposures
 
$
105

 
$
588

 
$
60

 
$
1,997

 
$
643

 
$
3,393

 
 
 
 
 
 
 
 
 
 
 
 
 
Exposures rated BIG
 
$
57

 
$
329

 
$
32

 
$
995

 
$
167

 
$
1,580

    



126

Specialty Insurance and Reinsurance Exposure

The Company also provides specialty insurance and reinsurance on transactions with risk profiles similar to those of its structured finance exposures written in financial guaranty form. All specialty insurance and reinsurance exposures shown in the table below were rated investment grade internally as of December 31, 2019. As of March 31, 2020, $30 million of aircraft residual value insurance exposure was rated BIG.

Specialty Insurance and Reinsurance Exposure

 
Gross Exposure
 
Net Exposure
 
As of March 31, 2020
 
As of December 31, 2019
 
As of March 31, 2020
 
As of December 31, 2019
 
(in millions)
Life insurance transactions (1)
$
1,091

 
$
1,046

 
$
940

 
$
898

Aircraft residual value insurance policies
393

 
398

 
238

 
243

Total
$
1,484

 
$
1,444

 
$
1,178

 
$
1,141

____________________
(1)
The life insurance transactions net exposure is projected to increase to approximately $1.0 billion by September 30, 2026.


Reinsurer Exposures
 
The Company has exposure to reinsurers through reinsurance arrangements (both as a ceding company and as an assuming company). Most of the Company's exposure as a ceding company and as an assuming company relates to financial guaranty contracts written before 2009, although the Company has assumed or reassumed (from financial guarantors no longer writing new business) some of those exposures more recently. The Company continues to cede portions of certain specialty exposures to reinsurers to mitigate its risk. See Item 1, Financial Statements, Note 7, Reinsurance.

Liquidity and Capital Resources
 
Liquidity Requirements and Sources
 
AGL and its Holding Company Subsidiaries
 
The liquidity of AGL, AGUS and AGMH is largely dependent on dividends from their operating subsidiaries and their access to external financing. The operating liquidity requirements of AGL and the U.S. Holding Companies include the payment of operating expenses, interest on debt issued by AGUS and AGMH, and dividends on AGL's common shares. AGL and its holding company subsidiaries may also require liquidity to fund acquisitions of new businesses, to make capital investments in their operating subsidiaries, purchase the Company's outstanding debt, or in the case of AGL, to repurchase its common shares pursuant to its share repurchase authorization. In the ordinary course of business, the Company evaluates its liquidity needs and capital resources in light of holding company expenses and dividend policy, as well as rating agency considerations. The Company also subjects its cash flow projections and its assets to a stress test, maintaining a liquid asset balance of one time its stressed operating company net cash flows. Management believes that AGL will have sufficient liquidity to satisfy its needs over the next twelve months. See “—Distributions From Subsidiaries” below for a discussion of the dividend restrictions of its insurance subsidiaries.


127

AGL (Guarantor) fully and unconditionally guarantees all of the AGUS and AGMH (Issuers) debt. The following tables includes summarized financial information for AGL and the U.S. Holding Company subsidiaries, excluding their investments in subsidiaries. AGUS and AGMH are shown on a combined basis as "U.S. Holding Companies" in the tables below.

 
As of March 31, 2020
 
As of December 31, 2019
 
AGL
 
U.S. Holding Companies
 
AGL
 
U.S. Holding Companies
 
(in millions)
Investments and cash (1)
$
33

 
$
294

 
$
135

 
$
243

Receivables from affiliates (2)
25

 
—

 
29

 
—

Receivable from U.S. Holding Companies
70

 
—

 
40

 
—

Other assets
1

 
71

 
2

 
59

 
 
 
 
 
 
 
 
Long term debt
—

 
1,217

 
—

 
1,231

Loans payable to affiliate
—

 
290

 
—

 
290

Payable to affiliates (2)
15

 
6

 
9

 
5

Payable to AGL
—

 
70

 
—

 
40

Other liabilities
5

 
146

 
8

 
130

____________________
(1)
As of March 31, 2020 and December 31, 2019, weighted average duration of U.S. Holding Companies' fixed-maturity securities (excluding AGUS' investment in AGMH's debt) was 2.1 years and 4.4 years, respectively.

(2)
Represents receivable and payables with non-guarantor subsidiaries.

 
Three Months Ended March 31, 2020
 
AGL
 
U.S. Holding Companies
 
(in millions)
Revenues
$
—

 
$
(4
)
 
 
 
 
Interest expense
—

 
25

Other expenses
10

 
1

 
 
 
 
Income (loss) before provision for income taxes
(10
)
 
(30
)
Equity in net earnings of investees
—

 
(5
)
Net income (loss)
(10
)
 
(27
)


128

The following table presents significant holding company cash flow activities (other than investment income, expenses and taxes) related to distributions from subsidiaries and outflows for debt service, dividends and other capital management activities.
AGL and U.S. Holding Company Subsidiaries
Significant Cash Flow Items

 
AGL
 
U.S. Holding Companies
 
(in millions)
First Quarter 2020
 
 
 
Intercompany sources
$
40

 
$
157

Intercompany (uses)
—

 
(70
)
External sources (uses):
 
 
 
Dividends paid to AGL shareholders
(20
)
 
—

Repurchases of common shares (1)
(116
)
 
—

Interest paid (2)
—

 
(9
)
 
 
 
 
First Quarter 2019
 
 
 
Intercompany sources
$
100

 
$
116

Intercompany (uses)
—

 
(60
)
External sources (uses):
 
 
 
Dividends paid to AGL shareholders
(20
)
 
—

Repurchases of common shares (1)
(80
)
 
—

Interest paid (2)
—

 
(9
)
____________________
(1)
See Item 1, Financial Statements, Note 15, Shareholders' Equity, for additional information about share repurchases and authorizations.

(2)
See Long-Term Obligations below for interest paid by subsidiary.

Generally, dividends paid by a U.S. company to a Bermuda holding company are subject to a 30% withholding tax. After AGL became tax resident in the U.K., it became subject to the tax rules applicable to companies resident in the U.K., including the benefits afforded by the U.K.’s tax treaties. The income tax treaty between the U.K. and the U.S. reduces or eliminates the U.S. withholding tax on certain U.S. sourced investment income (to 5% or 0%), including dividends from U.S. subsidiaries to U.K. resident persons entitled to the benefits of the treaty.

For more information, see also Part II, Item 8. Financial Statements and Supplementary Data, Note 15, Long-Term Debt and Credit Facilities of the Company's Annual Report on Form 10-K for the year ended December 31, 2019.

129

Commitments and Contingencies- Long-Term Debt Obligations
 
The Company has outstanding long-term debt issued primarily by AGUS and AGMH. All of AGUS' and AGMH's debt is fully and unconditionally guaranteed by AGL; AGL's guarantee of the junior subordinated debentures is on a junior subordinated basis. The outstanding principal, and interest paid, on long-term debt were as follows:

Principal Outstanding
and Interest Paid on Long-Term Debt and Intercompany Loans

 
As of March 31, 2020
 
As of December 31, 2019
 
Principal
 
Carrying
Value
 
Principal
 
Carrying
Value
 
(in millions)
AGUS
$
850

 
$
845

 
$
850

 
$
844

Intercompany loans
290

 
290

 
290

 
290

Total AGUS
1,140

 
1,135

 
1,140

 
1,134

AGMH
730

 
477

 
730

 
476

AGM
4

 
4

 
4

 
4

AGMH's debt purchased by AGUS (1)
(154
)
 
(105
)
 
(131
)
 
(89
)
Elimination of intercompany loans
(290
)
 
(290
)
 
(290
)
 
(290
)
Total
$
1,430

 
$
1,221

 
$
1,453

 
$
1,235

 ____________________
(1)
Represents principal amount of Junior Subordinated Debentures issued by AGMH that has been purchased by AGUS. Loss on extinguishment of debt was $5 million in First Quarter 2020 and $1 million in First Quarter 2019.

Issued by AGUS:

7% Senior Notes.  On May 18, 2004, AGUS issued $200 million of 7% Senior Notes due 2034 for net proceeds of $197 million. Although the coupon on the Senior Notes is 7%, the effective rate is approximately 6.4%, taking into account the effect of a cash flow hedge. The notes are redeemable, in whole or in part, at their principal amount plus accrued and unpaid interest at the date of redemption or, if greater, the make-whole redemption price.
 
5% Senior Notes. On June 20, 2014, AGUS issued $500 million of 5% Senior Notes due 2024 for net proceeds of $495 million. The net proceeds from the sale of the notes were used for general corporate purposes, including the purchase of common shares of AGL. The notes are redeemable, in whole or in part, at their principal amount plus accrued and unpaid interest at the date of redemption or, if greater, the make-whole redemption price.

Series A Enhanced Junior Subordinated Debentures.  On December 20, 2006, AGUS issued $150 million of Debentures due 2066. The Debentures paid a fixed 6.4% rate of interest until December 15, 2016, and thereafter pay a floating rate of interest, reset quarterly, at a rate equal to three month LIBOR plus a margin equal to 2.38%. LIBOR may be discontinued. For more information, see the Risk Factor captioned "The Company may be adversely impacted by the transition from LIBOR as a reference rate" under Risks Related to the Financial, Credit and Financial Guaranty Markets in Part I, Item 1A, Risk Factors in AGL's Annual Report on Form 10-K for the year ended December 31, 2019. AGUS may elect at one or more times to defer payment of interest for one or more consecutive periods for up to ten years. Any unpaid interest bears interest at the then applicable rate. AGUS may not defer interest past the maturity date. The debentures are redeemable, in whole or in part, at their principal amount plus accrued and unpaid interest to the date of redemption.

Issued by AGMH:
 
6 7/8% QUIBS.  On December 19, 2001, AGMH issued $100 million face amount of 6 7/8% QUIBS due December 15, 2101, which are redeemable without premium or penalty in whole or in part at their principal amount plus accrued and unpaid interest up to but not including the date of redemption.
 
6.25% Notes.  On November 26, 2002, AGMH issued $230 million face amount of 6.25% Notes due November 1, 2102, which are redeemable without premium or penalty in whole or in part at their principal amount plus accrued and unpaid interest up to but not including the date of redemption. 

130

5.6% Notes.  On July 31, 2003, AGMH issued $100 million face amount of 5.6% Notes due July 15, 2103, which are redeemable without premium or penalty in whole or in part at their principal amount plus accrued and unpaid interest up to but not including the date of redemption.
 
Junior Subordinated Debentures.  On November 22, 2006, AGMH issued $300 million face amount of Junior Subordinated Debentures with a scheduled maturity date of December 15, 2036 and a final repayment date of December 15, 2066. The final repayment date of December 15, 2066 may be automatically extended up to four times in five-year increments provided certain conditions are met. The debentures are redeemable, in whole or in part, at any time prior to December 15, 2036 at their principal amount plus accrued and unpaid interest to the date of redemption or, if greater, the make-whole redemption price. Interest on the debentures will accrue from November 22, 2006 to December 15, 2036 at the annual rate of 6.4%. If any amount of the debentures remains outstanding after December 15, 2036, then the principal amount of the outstanding debentures will bear interest at a floating interest rate equal to one-month LIBOR plus 2.215% until repaid. LIBOR may be discontinued. For more information, see the Risk Factor captioned "The Company may be adversely impacted by the transition from LIBOR as a reference rate" under Risks Related to the Financial, Credit and Financial Guaranty Markets in Part I, Item 1A, Risk Factors in AGL's Annual Report on Form 10-K for the year ended December 31, 2019. AGMH may elect at one or more times to defer payment of interest on the debentures for one or more consecutive interest periods that do not exceed ten years. In connection with the completion of this offering, AGMH entered into a replacement capital covenant for the benefit of persons that buy, hold or sell a specified series of AGMH long-term indebtedness ranking senior to the debentures. Under the covenant, the debentures will not be repaid, redeemed, repurchased or defeased by AGMH or any of its subsidiaries on or before the date that is twenty years prior to the final repayment date, except to the extent that AGMH has received proceeds from the sale of replacement capital securities. The proceeds from this offering were used to pay a dividend to the shareholders of AGMH. In First Quarter 2020 and First Quarter 2019, AGUS purchased $23 million and $3 million, respectively, of principal of the debentures, which resulted in a loss on extinguishment of debt on a consolidated basis of $5 million in First Quarter 2020 and $1 million in First Quarter 2019. The Company may choose to make additional purchases of this or other Company debt in the future.

Intercompany Loans and Guarantees

On October 1, 2019 AGM, AGC and MAC made 10-year, 3.5% interest rate intercompany loans to AGUS totaling $250 million to fund the BlueMountain Acquisition and the related capital contributions. See the Company's 2019 Annual Report on Form 10-K, Part II. Item 8. Financial Statements and Supplementary Data, Note 2, Business Combinations and Assumption of Insured Portfolio, for additional information.

In addition, in 2012 AGUS borrowed $90 million from its affiliate AGRO to fund the acquisition of MAC. In 2018, the maturity date was extended to November 2023. As of March 31, 2020, $40 million remained outstanding.

From time to time, AGL and its subsidiaries have entered into intercompany loan facilities. For example, on October 25, 2013, AGL, as borrower, and AGUS, as lender, entered into a revolving credit facility pursuant to which AGL may, from time to time, borrow for general corporate purposes. Under the credit facility, AGUS committed to lend a principal amount not exceeding $225 million in the aggregate. The commitment under the revolving credit facility terminates on October 25, 2023 (the loan commitment termination date). The unpaid principal amount of each loan will bear semi-annual interest at a fixed rate equal to 100% of the then applicable interest rate as determined under Internal Revenue Code Section 1274(d). Accrued interest on all loans will be paid on the last day of each June and December and at maturity. AGL must repay the then unpaid principal amounts of the loans, if any, by the third anniversary of the loan commitment termination date. AGL has not drawn upon the credit facility.

Furthermore, AGL fully and unconditionally guarantees the payment of the principal of, and interest on, the $1,130 million aggregate principal amount of senior notes issued by AGUS and AGMH, and the $450 million aggregate principal amount of junior subordinated debentures issued by AGUS and AGMH, in each case, as described under "Commitments and Contingencies -- Long-Term Debt Obligations" above.

Insurance Subsidiaries

Liquidity of the insurance subsidiaries is primarily used to pay for:

•
operating expenses,
•
claims on the insured portfolio,
•
dividends or other distributions to AGL, AGUS and/or AGMH, as applicable,

131

•
posting of collateral in connection with reinsurance and credit derivative transactions, if necessary,
•
reinsurance premiums,
•
principal of and, where applicable, interest on surplus notes, and
•
capital investments in their own subsidiaries, where appropriate.

Management believes that the insurance subsidiaries’ liquidity needs for the next twelve months can be met from current cash, short-term investments and operating cash flow, including premium collections and coupon payments as well as scheduled maturities and paydowns from their respective investment portfolios. The Company targets a balance of its most liquid assets including cash and short-term securities, Treasuries, agency RMBS and pre-refunded municipal bonds equal to 1.5 times its projected operating company cash flow needs over the next four quarters. The Company intends to hold and has the ability to hold temporarily impaired debt securities until the date of anticipated recovery of amortized cost.
 
The insurance subsidiaries initially intend to invest $500 million in Assured Investment Management funds. As of March 31, 2020, the Insurance segment had invested $192 million in Assured Investment Management funds which are accounted for under the equity method, using net asset value as a practical expedient. On a consolidated basis, these investments are eliminated and the underlying funds and CLOs are consolidated. The insurance subsidiaries have committed an additional $78 million to the three Assured Investment Management funds that may be drawn in the future. See Item 1, Financial Statements, Note 12, Variable Interest Entities.

Beyond the next twelve months, the ability of the operating subsidiaries to declare and pay dividends may be influenced by a variety of factors, including market conditions, general economic conditions, and, in the case of the Company's insurance subsidiaries, insurance regulations and rating agency capital requirements.
 
Insurance policies issued provide, in general, that payments of principal, interest and other amounts insured may not be accelerated by the holder of the obligation. Amounts paid by the Company therefore are typically in accordance with the obligation’s original payment schedule, unless the Company accelerates such payment schedule, at its sole option.
 
 Payments made in settlement of the Company’s obligations arising from its insured portfolio may, and often do, vary significantly from year to year, depending primarily on the frequency and severity of payment defaults and whether the Company chooses to accelerate its payment obligations in order to mitigate future losses. Direct and indirect consequences of COVID-19 are causing financial distress to many of the obligors and assets underlying obligations guaranteed by the Company, and may result in increases in claims and loss reserves. The Company believes that state and local governments and entities that were already experiencing significant budget deficits and pension funding and revenue shortfalls, as well as obligations supported by revenue streams most impacted by shelter-in-place guidelines and relates restrictions or an economic downturn, are most at risk for increased claims. See Part II, Other Information, Item 1A, Risk Factors, “The Company’s business, liquidity, financial condition and stock price may be adversely affected by the development, course and duration of the COVID-19 pandemic and the governmental and private actions taken in response, and the global consequences of the pandemic and such actions.”

In addition, the Company has net par exposure to the general obligation bonds of Puerto Rico and various obligations of its related authorities and public corporations aggregating $4.3 billion, all of which is rated BIG. Beginning in 2016, the Commonwealth and certain related authorities and public corporations have defaulted on obligations to make payments on its debt. Information regarding the Company's exposure to the Commonwealth of Puerto Rico and its related authorities and public corporations is set forth in Item 1, Financial Statements, Note 4, Outstanding Insurance Exposure.


132

Claims (Paid) Recovered

 
First Quarter
 
2020
 
2019
 
 
Public finance
$
(94
)
 
$
(228
)
Structured finance:
 
 
 
U.S. RMBS
21

 
9

Other structured finance
(1
)
 
1

Structured finance
20

 
10

Claims (paid) recovered, net of reinsurance (1)
$
(74
)
 
$
(218
)
____________________
(1)
Includes $0.3 million paid and $1 million recovered for consolidated FG VIEs for First Quarter 2020 and 2019, respectively.

In connection with the acquisition of AGMH, AGM agreed to retain the risks relating to the debt and strip policy portions of the leveraged lease business. In a leveraged lease transaction, a tax-exempt entity (such as a transit agency) transfers tax benefits to a tax-paying entity by transferring ownership of a depreciable asset, such as subway cars. The tax-exempt entity then leases the asset back from its new owner.
 
If the lease is terminated early, the tax-exempt entity must make an early termination payment to the lessor. A portion of this early termination payment is funded from monies that were pre-funded and invested at the closing of the leveraged lease transaction (along with earnings on those invested funds). The tax-exempt entity is obligated to pay the remaining, unfunded portion of this early termination payment (known as the strip coverage) from its own sources. AGM issued financial guaranty insurance policies (known as strip policies) that guaranteed the payment of these unfunded strip coverage amounts to the lessor, in the event that a tax-exempt entity defaulted on its obligation to pay this portion of its early termination payment. Following such events, AGM can then seek reimbursement of its strip policy payments from the tax-exempt entity, and can also sell the transferred depreciable asset and reimburse itself from the sale proceeds.

Currently, all the leveraged lease transactions in which AGM acts as strip coverage provider are breaching a rating trigger related to AGM and are subject to early termination. However, early termination of a lease does not result in a draw on the AGM policy if the tax-exempt entity makes the required termination payment. If all the leases were to terminate early and the tax-exempt entities did not make the required early termination payments, then AGM would be exposed to possible liquidity claims on gross exposure of approximately $668 million as of March 31, 2020. To date, none of the leveraged lease transactions that involve AGM has experienced an early termination due to a lease default and a claim on the AGM policy. As of March 31, 2020, approximately $1.7 billion of cumulative strip par exposure had been terminated since 2008 on a consensual basis. The consensual terminations have resulted in no claims on AGM. 

The terms of the Company’s CDS contracts generally are modified from standard CDS contract forms approved by International Swaps and Derivatives Association, Inc. in order to provide for payments on a scheduled "pay-as-you-go" basis and to replicate the terms of a traditional financial guaranty insurance policy. However, the Company may also be required to pay if the obligor becomes bankrupt or if the reference obligation were restructured if, after negotiation, those credit events are specified in the documentation for the credit derivative transactions. Furthermore, the Company may be required to make a payment due to an event that is unrelated to the performance of the obligation referenced in the credit derivative. If events of default or termination events specified in the credit derivative documentation were to occur, the Company may be required to make a cash termination payment to its swap counterparty upon such termination. Any such payment would probably occur prior to the maturity of the reference obligation and be in an amount larger than the amount due for that period on a “pay-as-you-go” basis.

The transaction documentation with one counterparty for $168 million of the CDS insured by the Company requires the Company to post collateral, subject to a cap, to secure its obligation to make payments under such contracts. As of March 31, 2020, AGC did not have to post collateral to satisfy these requirements and the maximum posting requirement was $168 million.


133

Distributions From Insurance Subsidiaries

The Company anticipates that for the next twelve months, amounts paid by AGL’s direct and indirect insurance subsidiaries as dividends or other distributions will be a major source of its liquidity. The insurance subsidiaries’ ability to pay dividends depends upon their financial condition, results of operations, cash requirements, other potential uses for such funds, and compliance with rating agency requirements, and is also subject to restrictions contained in the insurance laws and related regulations of their states of domicile. For more information, see Part II, Item 8, Financial Statements and Supplementary Data, Note 18, Insurance Company Regulatory Requirements, of the Company's Annual Report on Form 10-K for the year ended December 31, 2019 for a complete discussion of the Company's dividend restrictions applicable to AGC, AGM, MAC, AG Re and AGRO.
    
Dividend restrictions by insurance subsidiary are as follows:

•
The maximum amount available during 2020 for AGM to distribute as dividends without regulatory approval is estimated to be approximately $212 million, none of which is estimated to be available for distribution in the second quarter of 2020.

•
The maximum amount available during 2020 for AGC to distribute as ordinary dividends is approximately $166 million, of which approximately $24 million is available for distribution in the second quarter of 2020.

•
The maximum amount available during 2020 for MAC to distribute to MAC Assurance Holdings Inc. (MAC Holdings) as dividends without regulatory approval is estimated to be approximately $20 million, of which approximately $20 million is available for distribution in the second quarter of 2020.

•
Based on the applicable law and regulations, in 2020 AG Re has the capacity to (i) make capital distributions in an aggregate amount up to $128 million without the prior approval of the Bermuda Monetary Authority (the Authority) and (ii) declare and pay dividends in an aggregate amount up to approximately $274 million as of March 31, 2020. Such dividend capacity is further limited by (i) the actual amount of AG Re’s unencumbered assets, which amount changes from time to time due in part to collateral posting requirements and which was approximately $261 million as of March 31, 2020, and (ii) the amount of statutory surplus, which as of March 31, 2020 was $233 million.

•
Based on the applicable law and regulations, in 2020 AGRO has the capacity to (i) make capital distributions in an aggregate amount up to $21 million without the prior approval of the Authority and (ii) declare and pay dividends in an aggregate amount up to approximately $103 million as of March 31, 2020. Such dividend capacity is further limited by (i) the actual amount of AGRO’s unencumbered assets, which amount changes from time to time due in part to collateral posting requirements and which was approximately $383 million as of March 31, 2020, and (ii) the amount of statutory surplus, which as of March 31, 2020 was $272 million.

Distributions from
Insurance Company Subsidiaries

 
First Quarter
 
2020
 
2019
 
(in millions)
Dividends paid by AGC to AGUS
$
85

 
$
42

Dividends paid by AGM to AGMH
72

 
74

Dividends paid by AG Re to AGL
—

 
40

Dividends paid by MAC to MAC Holdings (1)
—

 
5

____________________
(1)
MAC Holdings distributed the entire amounts to AGM and AGC, in proportion to their ownership percentages.


134

External Financing

From time to time, AGL and its subsidiaries have sought external debt or equity financing in order to meet their obligations. External sources of financing may or may not be available to the Company, and if available, the cost of such financing may not be acceptable to the Company.

Commitments and Contingencies-Committed Capital Securities

Each of AGC and AGM have entered into put agreements with four separate custodial trusts allowing each of AGC and AGM, respectively, to issue an aggregate of $200 million of non-cumulative redeemable perpetual preferred securities to the trusts in exchange for cash. Each custodial trust was created for the primary purpose of issuing $50 million face amount of CCS, investing the proceeds in high-quality assets and entering into put options with AGC or AGM, as applicable. The Company does not consider itself to be the primary beneficiary of the trusts and the trusts are not consolidated in Assured Guaranty's financial statements.

The trusts provide AGC and AGM access to new equity capital at their respective sole discretion through the exercise of the put options. Upon AGC's or AGM's exercise of its put option, the relevant trust will liquidate its portfolio of eligible assets and use the proceeds to purchase AGC or AGM preferred stock, as applicable. AGC or AGM may use the proceeds from its sale of preferred stock to the trusts for any purpose, including the payment of claims. The put agreements have no scheduled termination date or maturity. However, each put agreement will terminate if (subject to certain grace periods) specified events occur. Both AGC and AGM continue to have the ability to exercise their respective put options and cause the related trusts to purchase their preferred stock.

Prior to 2008 or 2007, the amounts paid on the CCS were established through an auction process. All of those auctions failed in 2008 or 2007, and the rates paid on the CCS increased to their respective maximums. The annualized rate on the AGC CCS is one-month LIBOR plus 250 bps, and the annualized rate on the AGM Committed Preferred Trust Securities is one-month LIBOR plus 200 bps. LIBOR may be discontinued. Fore more information, see the Risk Factor captioned "The Company may be adversely impacted by the transition from LIBOR as a reference rate" under Operational Risks in Part I, Item 1A, Risk Factors in AGL's Annual Report on Form 10-K for the year ended December 31, 2019.

Assured Investment Management Sources and Uses of Liquidity

The Asset Management segment's sources of liquidity are (1) net working capital, (2) cash from operations, including management and performance fees (which are unpredictable as to amount and timing), and (3) capital contributions from AGUS (in First Quarter 2020, $30 million had been contributed to supplement working capital). As of March 31, 2020, the Assured Investment Management platform subsidiaries had $29 million in cash.

Liquidity needs in the Asset Management segment primarily include (1) paying operating expenses including compensation, (2) paying dividends to AGUS, and (3) capital to support growth and expansion of the asset management business.


135

Condensed Consolidated Cash Flows
 
Condensed Consolidated Cash Flow Summary
 
 
First Quarter
 
2020
 
2019
 
(in millions)
Net cash flows provided by (used in) operating activities before effect of VIE consolidation
$
(97
)
 
$
(333
)
Effect of VIE consolidation (1)
(67
)
 
1

Net cash flows provided by (used in) operating activities
(164
)
 
(332
)
Net cash flows provided by (used in) investing activities before effect of VIE consolidation
242

 
468

Effect of VIE consolidation (1)
147

 
24

Net cash flows provided by (used in) investing activities
389

 
492

Dividends paid
(20
)
 
(20
)
Repurchases of common stock
(116
)
 
(80
)
Repurchase of debt
(21
)
 
(3
)
Net cash flows provided by (used in) financing activities before effect of VIE consolidation
(11
)
 
(14
)
Effect of VIE consolidation (1)
(12
)
 
(25
)
Net cash flows provided by (used in) financing activities (2)
(180
)
 
(142
)
Effect of exchange rate changes
(7
)
 
1

Cash and restricted cash at beginning of period
183

 
104

Total cash and restricted cash at the end of the period
$
221

 
$
123

____________________
(1)
VIE consolidation includes the effects of FG VIEs and consolidated investment vehicles.

(2)
Claims paid on consolidated FG VIEs are presented in the condensed consolidated cash flow statements as a component of paydowns on FG VIEs' liabilities in financing activities as opposed to operating activities.

Cash flows from operations, excluding the effect of consolidating VIEs, was an outflow of $97 million in First Quarter 2020 and an outflow of $333 million in First Quarter 2019. The decrease in cash outflows was primarily due a significant claim payment for Puerto Rico COFINA exposures in First Quarter 2019. In addition, first quarter 2020 included net cash outflows related to the Asset Management segment. Cash flows from operations attributable to the effect of consolidated VIEs was negative in First Quarter 2020 due to the inclusion of investing activities of consolidated investment vehicles.

Investing activities primarily consisted of net sales (purchases) of fixed-maturity and short-term investments, and paydowns on and sales of FG VIEs’ assets. The decrease in investing cash inflows was mainly attributable to sales of securities to fund share repurchases and, in First Quarter 2019, the COFINA claim payment.

Financing activities primarily consisted of share repurchases, dividends, debt extinguishment and paydowns of FG VIEs’ liabilities. It also included issuances of CLOs in consolidated investment vehicles.

From April 1, 2020 through May 7, 2020, the Company repurchased an additional 3.3 million of common shares. As of May 7, 2020, the Company was authorized to purchase $239 million of its common shares, including a $250 million authorization that was approved by the Board on February 26, 2020. For more information about the Company's share repurchases and authorizations, see Item 1, Financial Statements, Note 15, Shareholders' Equity.

Leases
 
AGL and its subsidiaries lease office space and certain other items. Future cash payments associated with contractual obligations pursuant to operating leases for office space have not materially changed since December 31, 2019. See Item 1, Financial Statements, Note 14, Commitments and Contingencies.


136

Investment Portfolio
 
The disruption in the financial markets related to COVID-19 has contributed to credit impairment losses on certain loss mitigation securities in the investment portfolio, which are recognized in the condensed consolidated statements of operations. The disruption in the financial markets caused by COVID-19 has also contributed to unrealized losses in the investment portfolio due to reduced market valuations. Losses in the Company’s investment portfolio impact its U.S GAAP financial statements. Credit impairment losses also impact its capital as measured by insurance regulators and rating agencies.

The Company’s principal objectives in managing its investment portfolio are to support the highest possible ratings for each operating company, to manage investment risk within the context of the underlying portfolio of insurance risk, to maintain sufficient liquidity to cover unexpected stress in the insurance portfolio, and to maximize after-tax net investment income.
 
The Company’s fixed-maturity securities and short-term investments had a duration of 4.0 years as of March 31, 2020 and 4.1 years as of December 31, 2019. Generally, the Company’s fixed-maturity securities are designated as available-for-sale. For more information about the Investment Portfolio and a detailed description of the Company’s valuation of investments see Item 1, Financial Statements, Note 9, Investments and Cash.

Fixed-Maturity Securities and Short-Term Investments
by Security Type 

 
As of March 31, 2020
 
As of December 31, 2019
 
Amortized
Cost (1)
 
Estimated
Fair Value
 
Amortized
Cost
 
Estimated
Fair Value
 
(in millions)
Fixed-maturity securities:
 

 
 

 
 

 
 

Obligations of state and political subdivisions
$
3,952

 
$
4,204

 
$
4,036

 
$
4,340

U.S. government and agencies
160

 
175

 
137

 
147

Corporate securities
2,292

 
2,233

 
2,137

 
2,221

Mortgage-backed securities (2):
 
 
 
 
 
 
 

RMBS
737

 
717

 
745

 
775

Commercial mortgage-backed securities (CMBS)
399

 
414

 
402

 
419

Asset-backed securities
687

 
653

 
684

 
720

Non-U.S. government securities
183

 
172

 
230

 
232

Total fixed-maturity securities
8,410

 
8,568

 
8,371

 
8,854

Short-term investments
933

 
933

 
1,268

 
1,268

Total fixed-maturity and short-term investments
$
9,343

 
$
9,501

 
$
9,639

 
$
10,122

 ____________________
(1)
In 2020, the Company established allowance for credit looses which was $73 million as of March 31, 2020.

(2)
U.S. government-agency obligations were approximately 44% of mortgage backed securities as of March 31, 2020 and 42% as of December 31, 2019, based on fair value.
 


137

The following tables summarize, for all fixed-maturity securities in an unrealized loss position as of March 31, 2020 and December 31, 2019, the aggregate fair value and gross unrealized loss by length of time the amounts have continuously been in an unrealized loss position.

Fixed-Maturity Securities
Gross Unrealized Loss by Length of Time 
For Which an Allowance for Credit Loss was Not Recorded
As of March 31, 2020

 
Less than 12 months
 
12 months or more
 
Total
 
Fair
Value
 
Unrealized
Loss
 
Fair
Value
 
Unrealized
Loss
 
Fair
Value
 
Unrealized
Loss
 
(dollars in millions)
Obligations of state and political subdivisions
$
104

 
$
(4
)
 
$
—

 
$
—

 
$
104

 
$
(4
)
Corporate securities
679

 
(29
)
 
68

 
(13
)
 
747

 
(42
)
Mortgage-backed securities:
 
 
 
 
 
 
 

 
 
 
 
RMBS
42

 
(4
)
 
5

 
—

 
47

 
(4
)
CMBS
36

 
—

 
3

 
—

 
39

 
—

Asset-backed securities
434

 
(22
)
 
132

 
(8
)
 
566

 
(30
)
Non-U.S. government securities
95

 
(3
)
 
52

 
(9
)
 
147

 
(12
)
Total
$
1,390

 
$
(62
)
 
$
260

 
$
(30
)
 
$
1,650

 
$
(92
)
Number of securities (1)
 

 
376

 
 

 
79

 
 

 
430

 

Fixed-Maturity Securities
Gross Unrealized Loss by Length of Time 
As of December 31, 2019

 
Less than 12 months
 
12 months or more
 
Total
 
Fair
Value
 
Unrealized
Loss
 
Fair
Value
 
Unrealized
Loss
 
Fair
Value
 
Unrealized
Loss
 
(dollars in millions)
Obligations of state and political subdivisions
$
45

 
$
(1
)
 
$
—

 
$
—

 
$
45

 
$
(1
)
U.S. government and agencies
5

 
—

 
5

 
—

 
10

 
—

Corporate securities
61

 
—

 
119

 
(19
)
 
180

 
(19
)
Mortgage-backed securities:
 

 
 

 
 

 
 

 


 


RMBS
10

 
—

 
75

 
(7
)
 
85

 
(7
)
CMBS
—

 
—

 
4

 
—

 
4

 
—

Asset-backed securities
24

 
—

 
183

 
(2
)
 
207

 
(2
)
Non-U.S. government securities
—

 
—

 
56

 
(5
)
 
56

 
(5
)
Total
$
145

 
$
(1
)
 
$
442

 
$
(33
)
 
$
587

 
$
(34
)
Number of securities
 

 
57

 
 

 
119

 
 

 
176

Number of securities with OTTI
 

 
1

 
 

 
7

 
 

 
8

___________________
(1)
The number of securities does not add across because lots consisting of the same securities have been purchased at different times and appear in both categories above (i.e., less than 12 months and 12 months or more). If a security appears in both categories, it is counted only once in the total column.
 
Of the securities in an unrealized loss position as of March 31, 2020, 57 securities had unrealized losses in excess of 10% of their carrying value.The total unrealized loss for these securities was $33 million as of March 31, 2020. The Company considered the credit quality, cash flows, interest rate movements, ability to hold a security to recovery and intent to sell a

138

security in determining whether a security had a credit loss. The Company has determined that the unrealized losses recorded as of March 31, 2020 were not related to credit quality. In addition, the Company currently does not intend to and is not required to sell investments in an unrealized loss position prior to expected recovery in value.

Of the securities in an unrealized loss position for 12 months or more as of December 31, 2019, 19 securities had unrealized losses greater than 10% of book value. The total unrealized loss for these securities was $25 million as of December 31, 2019. The Company considered the credit quality, cash flows, interest rate movements, ability to hold a security to recovery and intent to sell a security in determining whether a security had a credit loss. The Company has determined that the unrealized losses recorded as of December 31, 2019 were not related to credit quality.
 
Changes in interest rates affect the value of the Company’s fixed-maturity portfolio. As interest rates fall, the fair value of fixed-maturity securities generally increases and as interest rates rise, the fair value of fixed-maturity securities generally decreases. The Company’s portfolio of fixed-maturity securities primarily consists of high-quality, liquid instruments.
 
The amortized cost and estimated fair value of the Company’s available-for-sale fixed-maturity securities, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

Distribution of Fixed-Maturity Securities
by Contractual Maturity
As of March 31, 2020
 
 
Amortized
Cost
 
Estimated
Fair Value
 
(in millions)
Due within one year
$
300

 
$
300

Due after one year through five years
1,691

 
1,694

Due after five years through 10 years
2,028

 
2,037

Due after 10 years
3,255

 
3,406

Mortgage-backed securities:
 

 
 

RMBS
737

 
717

CMBS
399

 
414

Total
$
8,410

 
$
8,568

 

The following table summarizes the ratings distributions of the Company’s investment portfolio as of March 31, 2020 and December 31, 2019. Ratings reflect the lower of the Moody’s Investors Service, Inc. and S&P Global Ratings, a division of Standard & Poor's Financial Services LLC classifications, except for bonds purchased for loss mitigation or other risk management strategies, which use Assured Guaranty’s internal ratings classifications.
 

139

Distribution of
Fixed-Maturity Securities by Rating
 
Rating
 
As of
March 31, 2020
 
As of
December 31, 2019
AAA
 
16.1
%
 
16.2
%
AA
 
45.1

 
45.1

A
 
22.1

 
21.2

BBB
 
8.5

 
8.2

BIG (1)
 
7.6

 
8.6

Not rated
 
0.6

 
0.7

Total
 
100.0
%
 
100.0
%
____________________
(1)
Includes primarily loss mitigation and other risk management assets. See Item I, Financial Statements, Note 9, Investments and Cash, for additional information.
 
Based on fair value, investments and restricted assets that are either held in trust for the benefit of third party ceding insurers in accordance with statutory requirements, placed on deposit to fulfill state licensing requirements, or otherwise pledged or restricted totaled $277 million and $280 million as of March 31, 2020 and December 31, 2019, respectively. The investment portfolio also contains securities that are held in trust by certain AGL subsidiaries or otherwise restricted for the benefit of other AGL subsidiaries in accordance with statutory and regulatory requirements in the amount of $1,365 million and $1,502 million, based on fair value, as of March 31, 2020 and December 31, 2019, respectively.

Consolidated VIEs

The Company manages its liquidity needs by evaluating cash flows without the effect of consolidated VIEs; however, the Company's consolidated financial statements reflect the financial position of Assured Guaranty as well as Assured Guaranty's consolidated VIEs. The primary sources and uses of cash at Assured Guaranty's consolidated VIEs are as follows:

•
FG VIEs. The primary sources of cash in FG VIEs are the collection of principal and interest on the collateral supporting its insured debt obligations, and the primary uses of cash are the payment of principal and interest due on the insured obligations.

•
Investment Vehicles. The primary sources and uses of cash in the consolidated investment vehicles are raising capital from investors, using capital to make investments, generating cash flows from operations, distributing cash flow to investors and issuing debt to finance investments (CLOs).

ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

As of March 31, 2020, there were no material changes in the market risks that the Company is exposed to since December 31, 2019.

ITEM 4.
CONTROLS AND PROCEDURES

Assured Guaranty’s management, with the participation of AGL’s President and Chief Executive Officer and Chief Financial Officer, is responsible for establishing and maintaining disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) that are effective in recording, processing, summarizing and reporting, within the time periods specified in the Securities and Exchange Commission’s rules and forms, information required to be disclosed by AGL in the reports that it files or submits under the Exchange Act and ensuring that such information is accumulated and communicated to management, including the President and Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosures.
 
Management of the Company, with the participation of its Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the Company’s disclosure controls and procedures as of March 31, 2020. Based on their evaluation as of March 31, 2020 covered by this Form 10-Q, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were effective.

140

PART II.
OTHER INFORMATION

ITEM 1.
LEGAL PROCEEDINGS
 
The Company is subject to legal proceedings and claims, as described in the Company's Annual Report on Form 10-K for the year ended December 31, 2019 and in Part I, Item 1, Financial Statements, Note 14, Commitments and Contingencies – Legal Proceedings contained in this Form 10-Q. Material developments to such proceedings during the three months ended March 31, 2020, are described below and in the "Litigation" section of Note 14, Commitments and Contingencies, of the Financial Statements.

On November 28, 2011, Lehman Brothers International (Europe) (in administration) (LBIE) sued AG Financial Products Inc. (AGFP), an affiliate of AGC which in the past had provided credit protection to counterparties under CDS. AGC acts as the credit support provider of AGFP under these CDS. LBIE’s complaint, which was filed in the Supreme Court of the State of New York, asserted a claim for breach of the implied covenant of good faith and fair dealing based on AGFP's termination of nine credit derivative transactions between LBIE and AGFP and asserted claims for breach of contract and breach of the implied covenant of good faith and fair dealing based on AGFP's termination of 28 other credit derivative transactions between LBIE and AGFP and AGFP's calculation of the termination payment in connection with those 28 other credit derivative transactions. Following defaults by LBIE, AGFP properly terminated the transactions in question in compliance with the agreement between AGFP and LBIE, and calculated the termination payment properly. AGFP calculated that LBIE owes AGFP approximately $4 million for the claims which were dismissed and approximately $25 million in connection with the termination of the other credit derivative transactions, whereas LBIE asserted in the complaint that AGFP owes LBIE a termination payment of approximately $1.4 billion. AGFP filed a motion to dismiss the claims for breach of the implied covenant of good faith in LBIE's complaint, and on March 15, 2013, the court granted AGFP's motion to dismiss in respect of the count relating to the nine credit derivative transactions and narrowed LBIE's claim with respect to the 28 other credit derivative transactions. LBIE's administrators disclosed in an April 10, 2015 report to LBIE’s unsecured creditors that LBIE's valuation expert has calculated LBIE's claim for damages in aggregate for the 28 transactions to range between a minimum of approximately $200 million and a maximum of approximately $500 million, depending on what adjustment, if any, is made for AGFP's credit risk and excluding any applicable interest. AGFP filed a motion for summary judgment on the remaining causes of action asserted by LBIE and on AGFP's counterclaims, and on July 2, 2018, the court granted in part and denied in part AGFP’s motion. The court dismissed, in its entirety, LBIE’s remaining claim for breach of the implied covenant of good faith and fair dealing and also dismissed LBIE’s claim for breach of contract solely to the extent that it is based upon AGFP’s conduct in connection with the auction. With respect to LBIE’s claim for breach of contract, the court held that there are triable issues of fact regarding whether AGFP calculated its loss reasonably and in good faith. On October 1, 2018, AGFP filed an appeal with the Appellate Division of the Supreme Court of the State of New York, First Judicial Department, seeking reversal of the portions of the lower court's ruling denying AGFP’s motion for summary judgment with respect to LBIE’s sole remaining claim for breach of contract. On January 17, 2019, the Appellate Division affirmed the Supreme Court's decision, holding that the lower court correctly determined that there are triable issues of fact regarding whether AGFP calculated its loss reasonably and in good faith. The trial, originally scheduled for March 9, 2020, has been postponed due to the COVID-19 pandemic. A status conference is scheduled for May 11, 2020.

ITEM 1A.
RISK FACTORS

See the risk factors set forth in Part I, "Item 1A. Risk Factors" of the Company’s Annual Report on Form 10-K for the year ended December 31, 2019. Except as set forth below, there have been no material changes to the risk factors disclosed in such Annual Report on Form 10-K during the three months ended March 31, 2020.

The Company’s business, liquidity, financial condition, results of operations and stock price may be adversely affected by the development, course and duration of the COVID-19 pandemic and the governmental and private actions taken in response, and the global consequences of the pandemic and such actions.

A novel coronavirus emerged in Wuhan, China in late 2019 and began to spread beyond China in early 2020. The virus is highly infectious and causes a coronavirus disease, COVID-19, that can be fatal. COVID-19 has been declared a pandemic by the World Health Organization, and its emergence and reactions to it, including various shelter-in-place guidelines and related restrictions, are having a profound effect on the global economy and financial markets. Because of the size and depth of the COVID-19 pandemic and its unknown course and duration, and evolving governmental and private responses to the pandemic, all of the direct and indirect consequences of COVID-19 are not yet known and may not emerge for some time. Risks presented by the ongoing effects of COVID-19 include the following:


141

Insurance Claims. Direct and indirect consequences of COVID-19 are causing financial distress to many of the obligors and assets underlying obligations guaranteed by the Company, and may result in increases in claims and loss reserves. The Company believes that state and local governments and entities that were already experiencing significant budget deficits and pension funding and revenue shortfalls, as well as obligations supported by revenue streams most impacted by shelter-in-place guidelines and related restrictions or an economic downturn, are most at risk for increased claims. In addition to obligations already internally rated in the low investment grade or below-investment grade categories, the Company believes that its public finance sectors most at risk include (i) Mass Transit - Domestic; (ii) Toll Roads and Transportation - International; (iii) Hotel / Motel Occupancy Tax; (iv) Stadiums; (v) UK University Housing - International; (vi) Privatized Student Housing: Domestic; and (vii) Continuing Care Retirement Communities, and that its structured finance sector most at risk is Commercial Receivables. For more information, see the following risk factors described in Part I, Item 1A, Risk Factors, of the Company’s Annual Report on Form 10-K for the year ended December 31, 2019,

•
“Risks Related to Economic, Market and Political Conditions and National Phenomena,”

•
“Operational Risks - Significant claim payments may reduce the Company’s liquidity,” and “-The Company may require additional capital from time to time, including from soft capital and liquidity facilities, which may not be available or may be available only on unfavorable terms,” and “-The ability of AGL and its subsidiaries to meet their liquidity needs may be limited,” and

•
“Risks Related to Estimates, Assumptions and Valuations - Estimates of expected losses are subject to uncertainties and may not be adequate to cover potential paid claims.”

Recent or future legislative or regulatory action may be detrimental or beneficial to the Company’s claims experience and loss reserve levels. The Company believes the impact of the direct and indirect consequences on the individual obligations in the Company’s insurance portfolio of the COVID-19 pandemic and the governmental and private actions taken in response are likely to take some time to develop and that, as a result, its internal ratings and loss reserves are likely to be subject to increased volatility until the development, course and duration of the COVID-19 pandemic and the governmental and private actions taken in response, and the global consequences of the pandemic and such actions, are better known. For more information, see Part I, Item 1A, Risk Factors, “Estimates of expected losses are subject to uncertainties and may not be adequate to cover potential claims,” of the Company’s Annual Report on Form 10-K for the year ended December 31, 2019.

Investments. The disruption in the financial markets related to COVID-19 has contributed to credit impairment losses on certain loss mitigation securities in the investment portfolio, which are recognized in the Statement of Operations. The disruption in the financial markets caused by COVID-19 has also contributed to unrealized losses in the investment portfolio due to reduced market valuations. For more information, see Part I, Item 1A, Risk Factors, “Risks Related to Estimates, Assumptions and Valuations - The valuation of many of the Company’s assets and liabilities and AUM includes methodologies, estimates and assumptions that are subject to differing interpretations and could result in changes to valuations of the Company’s assets and liabilities that may material adversely affect the Company’s results of operations and financial condition,” of the Company’s Annual Report on Form 10-K for the year ended December 31, 2019. Losses in the Company’s investment portfolio impact its financial statements directly and credit impairment losses also impact its capital as measured by insurance regulators and rating agencies.

The Company is exposed to correlation risk across various assets the Company insures and in which it invests. The Company believes that the COVID 19 pandemic and the governmental and private actions taken in response, and the global consequences of the pandemic and such actions, expose a wide range of its insurance and investment portfolio to stress at the same time. For example, as of March 31, 2020, 75% of its net insured par outstanding is U.S. public finance, while 44% of its investment portfolio is invested in U.S. public finance. For more information, see Part I, Item 1A, Risk Factors, “Risks Related to Economic, Market and Political Conditions and National Phenomena - The Company may be subjected to significant risks from individual or correlated exposures,” of the Company’s Annual Report on Form 10-K for the year ended December 31, 2019.

Ability to Meet Capital Requirements. The COVID 19 pandemic and the governmental and private actions taken in response, and the global consequences of the pandemic and such actions, are likely to negatively impact the amount by which the Company’s capital at its insurance subsidiaries exceeds that required by its insurance regulators and the amount required to maintain its ratings as a result of increases in claims and loss reserves, deterioration in the credit quality of the insurance portfolio and deterioration in its investment portfolio. While the Company believes it currently has sufficient excess capital to withstand substantial deterioration in its insurance and investment portfolios, because the size and depth of the COVID-19 pandemic and its course and duration, and as well as evolving governmental and private responses to the pandemic, and all of

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the direct and indirect consequences of COVID-19, are not yet known and may not emerge for some time, the Company can provide no assurance that it will be able to maintain excess capital under all relevant measures and under all possible scenarios.

Insurance regulatory authorities impose capital requirements, including leverage ratios and surplus requirements, on the Company’s insurance subsidiaries. Deterioration in the regulatory capital position of the Company’s insurance subsidiaries, if it occurs, could limit their ability to pay dividends and make other payments to their holding companies, and may make it less likely that a regulator will permit discretionary payments by the Company’s insurance subsidiaries to their holding companies. Such dividends and permitted payments are currently expected to be the primary source of funds for the holding companies to meet ongoing cash requirements, including operating expenses, any future debt service payments and other expenses, and to pay dividends to their respective shareholders. Such cash is also used by AGL to repurchase its common shares. Accordingly, if the insurance subsidiaries cannot pay sufficient dividends or make other permitted payments at the times or in the amounts that are required, that would have an adverse effect on the ability of AGL, AGUS and AGMH to satisfy their ongoing cash requirements and on their ability to pay dividends to shareholders. For more information, see Part I, Item 1A, Risk Factors, “Operational Risks - The Company’s holding companies’ ability to meet their obligations may be constrained,” of the Company’s Annual Report on Form 10-K for the year ended December 31, 2019. In addition, an unmitigated increase in an insurance subsidiary’s leverage ratio beyond regulatory thresholds may limit the amount of new insurance that insurance subsidiary may write. For more information, see Part I, Item 1A, Risk Factors, “Operational Risks - An increase in the Company’s insurance subsidiaries’ leverage ratio may prevent them from writing new insurance,” of the Company’s Annual Report on Form 10-K for the year ended December 31, 2019.

The financial strength and financial enhancement ratings assigned to the Company’s insurance subsidiaries by each rating agency are based, in part, on that rating agency’s evaluation of the adequacy of the capital maintained by the rated insurance subsidiary. The rating agencies have evaluated the Company’s insurance subsidiaries under a variety of scenarios and assumptions, and have changed their methodologies and criteria from time to time. Factors influencing the rating agencies are beyond management's control and not always known to the Company. In the event of an actual or perceived deterioration in creditworthiness of large risks in the Company’s insurance portfolio, or a change in a rating agency's capital model or rating methodology, a rating agency may require the Company to increase the amount of capital it holds to maintain its financial strength ratings under the rating agencies' capital adequacy models. The insurance subsidiaries' financial strength ratings are an important competitive factor in the financial guaranty insurance and reinsurance markets. If the financial strength or financial enhancement ratings of one or more of the Company's insurance subsidiaries were reduced below current levels, the Company expects that would reduce the number of transactions that would benefit from the Company's insurance; consequently, a downgrade by rating agencies could harm the Company's new business production, results of operations and financial condition. For more information, see Part I, Item 1A, Risk Factors, “Strategic Risks - A downgrade of the financial strength or financial enhancement ratings of any of the Company’s insurance and reinsurance subsidiaries would adversely affect its business and prospects and, consequently, its results of operations and financial condition,” of the Company’s Annual Report on Form 10-K for the year ended December 31, 2019.

New Insurance Business Generation. While volatility and dislocation in the municipal finance market in the U.S. resulted in the Company issuing a reduced number of new insurance policies in late March and into April compared to the prior year, the Company has continued to write new insurance business in the secondary market during this period. The Company cannot predict what impact the COVID-19 pandemic and the governmental and private actions taken in response, and the global consequences of the pandemic and such actions, will have on the market for its insurance products. On one hand, increased defaults and an increased focus on the credit of public finance issuers and other obligors may increase the perceived value of the Company’s insurance products, and so increase demand. On the other hand, legislative responses, especially in the public finance sector, could reduce the need for the Company’s insurance products. In addition, rating downgrades or other indicators of reduced financial strength resulting from the COVID-19 pandemic and the governmental and private actions taken in response, and the global consequences of the pandemic and such actions, could reduce the demand for the Company’s insurance products.

Asset Management Business. The COVID-19 pandemic and the governmental and private actions taken in response, and the global consequences of the pandemic and such actions, may have an adverse impact on the amount of the Company’s AUM, which would reduce the amount of management fees earned by the Company. In addition, the Company’s Asset Management segment operates in highly competitive markets. The Company competes with many other firms in every aspect of the asset management industry, including raising funds, seeking investments, and hiring and retaining professionals. The Company’s ability to raise third party funds and increase and retain AUM is directly related to the performance of the assets it manages as measured against market averages and the performance of the Company’s competitors, and if it performs worse during the COVID-19 pandemic than its competitors, that could impede its ability to raise funds, seek investors and hire and retain professionals, and may also lead to an impairment of goodwill. On the other hand, periods of market volatility may

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increase the attractiveness of investment managers such as those in the Company’s Assured Investment Management platform, and may provide the Company with opportunities to increase its AUM.

The Company’s goodwill represents the excess of the acquisition price of BlueMountain over the fair value as determined on the date of acquisition.  The Company tests at least annually for indications of an impairment in fair value.  Certain events, including changes in the business environment may trigger a more frequent evaluation of goodwill impairment.  In First Quarter 2020, the Company considered the impact of COVID-19 on global financial markets, general macroeconomic factors, and industry conditions, as well as the financial performance of BlueMountain relative to its expectations, on the Company’s goodwill carrying value, and determined no impairment had occurred. However, because the size and depth of the COVID-19 pandemic and its course and duration, and evolving governmental and private responses to the pandemic, are unknown, the Company’s assessment may change and may, in the future, result in a goodwill impairment. The carrying value of goodwill as of March 31, 2020 is $117 million. Any future potential goodwill impairments may have a significant effect on the results of operations in a given period, but are not expected to have a material effect on the financial condition of the Company.

Operational Disruptions and Heightened Security Risks. The Company began operating remotely in accordance with its business continuity plan in March, 2020, instituting mandatory work-from-home policies on March 16, 2020, in its U.S. offices, on March 17, 2020, in its and U.K. offices and on March 19, 2020, in its Bermuda office. The Company is providing the services and communications it normally would, and continues to close new insurance transactions and make insurance claim payments and, in its asset management business, make trades. However, the Company’s operations could be disrupted if key members of its senior management or a significant percentage of its workforce or the workforce of its vendors were unable to continue work because of illness, government directives, or otherwise. In addition, the Company’s shift to working from home has made it more dependent on internet and communications access and capabilities and has heightened its risk of cybersecurity attacks. For more information, see Part I, Item 1A, Risk Factors, “Operational Risks - The Company is dependent on its information technology and that of certain third parties, and a cyberattack, security breach or failure in such systems could adversely affect the Company’s business,” of the Company’s Annual Report on Form 10-K for the year ended December 31, 2019.

Exacerbation of Other Risks. The Company believes that the direct and indirect consequences of the COVID-19 pandemic and the governmental and private actions taken in response, and the global consequences of the pandemic and such actions, are also likely to exacerbate many of the risks applicable to the Company in ways or to an extent not yet identified by the Company.

ITEM 2.
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
 
Issuer’s Purchases of Equity Securities
 
The following table reflects purchases of AGL common shares made by the Company during First Quarter 2020.
 
Period
 
Total
Number of
Shares
Purchased
 
Average
Price Paid
Per Share
 
Total Number of
Shares Purchased as
Part of Publicly
Announced Program (1)
 
Maximum Number
(or Approximate Dollar Value) of Shares that May Yet Be
Purchased
Under the Program (2)
January 1 - January 31
 
416,892

 
$
48.34

 
413,721

 
$
177,873,446

February 1 - February 29
 
678,457

 
$
46.33

 
430,008

 
$
407,873,472

March 1 - March 31
 
2,785,681

 
$
27.37

 
2,785,681

 
$
331,636,552

Total
 
3,881,030

 
$
32.93

 
3,629,410

 
 

____________________
(1)
After giving effect to repurchases since the beginning of 2013 through May 7, 2020, the Company has repurchased a total of 112.7 million common shares for approximately $3,425 million, excluding commissions, at an average price of $30.40 per share. The Board of Directors authorized, on February 26, 2020, an additional $250 million of share repurchases. As of May 7, 2020, the remaining authorization the Company was authorized to purchase was $239 million of its common shares, on a settlement basis.

(2)
Excludes commissions.


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ITEM 6.
EXHIBITS.
 
The following exhibits are filed with this report:
 
Exhibit
Number
 
Description of Document
10.1

 
10.2

 
10.3

 
10.4

 
10.5

 
10.6

 
31.1

 
31.2

 
32.1

 
32.2

 
101.1

 
The following financial information from Assured Guaranty Ltd.’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2020 formatted in inline XBRL: (i) Condensed Consolidated Balance Sheets at March 31, 2020 and December 31, 2019; (ii) Condensed Consolidated Statements of Operations for the Three Months ended March 31, 2020 and 2019; (iii) Condensed Consolidated Statements of Comprehensive Income for the Three Months ended March 31, 2020 and 2019; (iv) Condensed Consolidated Statements of Shareholders’ Equity for the Three Months ended March 31, 2020 and 2019; (v) Condensed Consolidated Statements of Cash Flows for the Three Months ended March 31, 2020 and 2019; and (vi) Notes to Condensed Consolidated Financial Statements.
104.1

 
The Cover Page Interactive DataFile from Assured Guaranty Ltd.’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2020 formatted, in inline XBRL (the cover page XBRL tags are embedded in the inline XBRL document and included in Exhibit 101).



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SIGNATURES
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
ASSURED GUARANTY LTD.
(Registrant)
 
 
Dated May 8, 2020
By:
/s/ ROBERT A. BAILENSON
 
 
 
 
 
Robert A. Bailenson
Chief Financial Officer (Principal Financial Officer and Duly Authorized Officer)



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