Ambac Assurance UK Limited

Transcription

1 Directors' Report and Financial Statements Registered no:

2 Directors' Report and Financial Statements Pages Directors and advisers 1-2 Directors report 3-7 Independent auditor s report to the members of Ambac Assurance UK Limited 8 Technical account - general business 9 Non - technical account - general business 10 Statement of total recognised gains and losses 10 Reconciliation of movements in shareholder s funds 10 Balance sheet 11 Notes to the financial statements 12-26

3 Directors and advisers Executive Directors Diana Adams Ian Dixon (resigned 28 May 2010) Robert Donovan (resigned 13 August 2010) Robert Eisman (appointed 13 August 2010) Andrew Kuyk (resigned 13 August 2010) Peter Poillon (resigned 13 August 2010) John Tifft (appointed 28 May 2010) Non-executive directors Ken Davies Anthony Lowe Jonathan Scott - Chairman of the Board Secretary John Tifft (resigned 28 May 2010) Miguel Sánchez (appointed 28 May 2010) Registered Office 2nd Floor, 21 Great Winchester Street London EC2N 2JA Registered Auditor KPMG Audit Plc 15 Canada Square London E14 5GL Bankers Barclays Bank plc Level 11, 1 Churchill Place London E14 5HP Citibank NA 336 Strand London WC2R 1HB 1

4 Directors and advisers - continued Solicitors Clifford Chance LLP Ten Upper Bank Street London E14 5JJ Financial Advisors PricewaterhouseCoopers LLP Plumtree Court London EC4A 4HT 2

5 Directors' report The directors present their report and the audited financial statements for the year to 31 December Principal activity Ambac Assurance UK Limited (the Company ) is incorporated under the laws of England and Wales and is in the non-life financial guarantee insurance business. The Company is a wholly owned subsidiary of Ambac Assurance Corporation ( AAC ), a financial guarantee insurance company resident in Wisconsin, United States of America. The ultimate holding company is Ambac Financial Group, Inc., ( AFG ). AFG s common stock trades in the overthe-counter market under ticker symbol ABKFQ. The Company is regulated and supervised in the United Kingdom by the Financial Services Authority (the FSA ). In 2009, the FSA curtailed the Company s licence to undertake new business, and limited its licence to undertaking only run off related activity. Accordingly, the Company is authorised to run off its financial guarantee insurance portfolio in the United Kingdom, and is authorised to do the same in the European Economic Area through a passporting arrangement, which eliminates the necessity of additional licensing or authorisation in those other European jurisdictions. The Company maintains a branch office in Milan, Italy. The Company s principal business activity is portfolio risk management of its existing long term book of financial guarantee business. Financial guarantee insurance written by the Company provides an unconditional and irrevocable guarantee that protects the creditor under a debt obligation s scheduled terms. The Company makes payments if the issuer or obligor responsible for making payments fails to do so. In the event the Company does pay any insurance claims, it is generally subrogated to the rights of the claiming policyholders and may be able to claim back from the issuer any payments made under the guarantee through debt restructuring, exercising any security rights or otherwise. Business review The Company s portfolio comprises 131 financial guarantee obligations with a gross par outstanding of 18 billion as of 31 December The portfolio comprises financial guarantees for essential infrastructure, whole business securitisations, utility obligations, and other asset classes, principally in Europe, which were written by the Company prior to December The portfolio is contractually scheduled to run off over a period of approximately 35 years, although certain transactions can be prepaid and/or unwound under certain circumstances. With the exception of transactions for which provision has been made in the financial statements, the portfolio continues to perform satisfactorily. The Company s portfolio of financial guarantee business is monitored by its portfolio risk management team, based in London, with further support from other specialised teams within AFG and its affiliates (the Ambac Group ) as required. Activity in the year has included ongoing monitoring and remediation activity relating to the Company s portfolio. The Company continues to collect instalment premiums from its portfolio of transactions and also generates fees from processing requests for consents, waivers and amendments to existing transactions. Until March 2010, the Company was party to a reinsurance agreement (the Reinsurance Agreement ) and a net worth maintenance agreement (the Net Worth Maintenance Agreement ) with AAC. Under the Reinsurance Agreement AAC provided quota share reinsurance representing 90% of all credit and financial guarantee loss exposure. Further, the Company s net retention of all loss exposure was reinsured on an excess of loss basis above an attachment point of 500,000. Under the Net Worth Maintenance Agreement, AAC was required to cause the Company to maintain free assets of at least 10,500,000 above any regulatory requirement. The Company s claims under the Reinsurance Agreements were, under applicable US law, subordinated to the claims of AAC policy holders. On 28 September 2010, the Company entered into a Commutation and Release Agreement with AAC and the Special Deputy Commissioner of the Office of the Commissioner of Insurance in Wisconsin ( OCI ), pursuant to which the Reinsurance Agreement and the Net Worth Maintenance Agreement were commuted in exchange for certain mutual releases, including any right of AAC to reinsurance premiums from the Company. The effective date of the termination was 22 March AAC paid a nominal termination amount of one U.S. dollar to the Company in connection with the commutation. 3

6 Directors' report - continued Following the termination of the Reinsurance Agreement, the Company is deficient in terms of compliance with applicable regulatory capital requirements. The FSA is aware of the same, and dialogue between the Company s management and the FSA remains ongoing with respect to options for addressing the shortcoming, although such options remain few. On 8 November 2010, AFG filed a voluntary petition for relief under Chapter 11 of the United States Bankruptcy Code ( Bankruptcy Code ) in the United States Bankruptcy Court for the Southern District of New York ( Bankruptcy Court ). Until it emerges from the bankruptcy proceeding, AFG will continue to operate in the ordinary course of business as debtor-in-possession under the jurisdiction of the Bankruptcy Court and in accordance with the applicable provisions of the Bankruptcy Code and the orders of the Bankruptcy Court. It is the view of the directors that this event will have no material impact on the Company. Going Concern At 31 December 2010 the Company had a deficit in shareholders funds of million (31 December 2009: deficit of million). Notwithstanding the deficit in shareholders funds, the directors remain satisfied that the Company has adequate resources to meet its obligations as they fall due and that the Company remains a going concern for the reasons discussed below. The Company and its directors have taken detailed legal, accounting and specialist insolvency advice ongoing since ceasing to write new business, which has informed their view that it remains a going concern. Additionally, the Company has undertaken, and continues to undertake, close consultation with the FSA with regard to its situation. The Company continues to be entitled to receive instalment premium income in respect of its guaranteed obligations and, following the termination of the Reinsurance Agreement, is no longer paying reinsurance premiums to AAC. Accordingly, it is retaining these cash flows for the benefit of its policy holders. These future premium cash flows are supported by contractual make-wholes on certain transactions, which would be payable to the Company in the event that a transaction was prepaid before its scheduled maturity date, thereby ensuring a baseline of premium income. Following the termination of the Reinsurance Agreement, the Company is now exposed to 100% of potential claims in the existing portfolio; however, these claims are expected to be met by the Company s own claims paying resources. The Company has current claims paying resources at 31 December 2010 as follows: 31 December December s 000s Shareholder s funds (225,740) (252,143) Provision for unearned premiums 451, ,797 Policyholders reserves 226, ,654 Present value of expected future instalment premiums 123, ,495 Claims paying resources 349, ,149 Claims paying resources are calculated as the sum of: shareholder s funds (or deficit); the provision for unearned premium; and the present value of expected future instalment premiums (being the present value of instalment premiums the Company would receive over and above minimum contracted premiums if the guaranteed obligations amortised in line with expectations). In making their assessment of the adequacy of the Company s claims paying resources, the directors have considered the Company s detailed cash flow projections under stressed scenarios, including increased claims payments, reduced premium and/or investment income scenarios, and other changes to assumptions and estimates. The directors are satisfied that the Company has adequate resources to meet the day-to-day operational needs of the business for the foreseeable future and that the Company s claims paying resources are sufficient to satisfy projected claims as they fall due. 4

7 Directors' report - continued Principal risks and uncertainties The key risks to which the Company is exposed are: insurance risk; credit risk on its portfolio of financial guarantee business and through its exposure to other counterparties; market risk; liquidity risk; and operational risk. These are discussed further below. Insurance risk The principal risk is that losses on the portfolio are not adequately covered by the Company s claims paying resources, as discussed above under Going Concern. Credit risk The Company is exposed to credit risk on its portfolio of financial guarantee business, which is the risk that the credit of an individual issuer or issuers might deteriorate, and that losses within the portfolio might exceed management s expectations. The Company undertakes ongoing surveillance of the performance of individual transactions within its portfolio, and of the portfolio as a whole, including stress testing and downside scenario modelling. The Company also has credit risk on issuers of assets in its investment portfolio. This is mitigated by the Company s investment policy, which is to invest in highly rated securities, and to undertake ongoing monitoring of the credit rating of the issuers of those securities. Market risk Market risk is the risk that the performance of the Company s investment portfolio declines as a result of adverse movements in interest rates or foreign exchange rates. Additionally the Company has exposure to interest and foreign exchange rate movements in respect of the insured portfolio, particularly those transactions that have loss reserves. The Company is currently undertaking a review of its investment policy in consultation with its investment manager to ensure that the tenor, yield and currency of its investment portfolio remain appropriate in light of its potential future liabilities. Liquidity risk Liquidity risk is the risk that the Company has insufficient liquid assets to meet claims as they fall due. The Company s insured obligations generally require the payment of principal and interest by the Company when due, and are not generally subject to acceleration (except that the Company may have the right to accelerate insured obligations if they default). Further, the transactions within the Company s financial guarantee portfolio include transaction-level mitigants such as cash reserves and other credit enhancements which enable the Company to manage liquidity within each individual transaction that it has guaranteed. Accordingly, the Company s exposure to liquidity risk in respect of claims in the short term is limited. Operational risk In the course of 2010 the Company has started to localise certain operational activities which were previously outsourced to AAC. These include cash management, and the appointment in late 2010 of a London-based investment manager. The impact of these changes is to place a higher degree of reliance on key London-based staff, requiring the Company to ensure appropriate risk management procedures, particularly with regards to segregation of responsibilities, fraud risk policies and transition management. The Company outsources certain operational functions to AAC under various services agreements. These agreements largely remain in place notwithstanding the termination of the Reinsurance Agreement, and AAC continues to perform its obligations thereunder. The Company continues to monitor its operating requirements and risk management structure to ensure that they continue to meet its requirements. Key performance indicators The Company considers the following to be the key financial performance indicators for measuring the business performance in run-off. Earned premiums For the year ended 31 December 2010, premiums earned (net of reinsurance) were 61.8 million (year ended 31 December 2009: 10.9 million). The year on year increase is due primarily to the termination of the Reinsurance Agreement in March 2010, since which event the Company has no longer been obliged to pay reinsurance 5

8 Directors' report continued premiums to AAC. Gross premiums earned were 75.9 million (year ended 31 December 2009: million). The year on year reduction is primarily due to exceptional accelerations in Gross premiums earned are comprised of 57.2 million normal earned premiums and 18.7 million accelerations (2009: 65.2 million normal earned premiums and 49.9 million accelerations). Claims incurred The net claims incurred figure in the technical profit and loss account represents claims incurred, net of reinsurance up to the date of termination of the Reinsurance Agreement. For the year ended 31 December 2010, the Company s net claims expense was 47.4 million (year ended 31 December 2009: 8.9 million). The adverse variance arose primarily because following the termination of the Reinsurance Agreement the Company is responsible for 100% of claims. The movement in the year arose as a result of adverse movements in exchange rates and the discount rate applied in calculating the present value of claims (see Note 17). Results and dividends The results for the year are set out in the profit and loss account on pages 9 and 10. The directors do not recommend the payment of a dividend. For the avoidance of doubt, any dividend recommended by the directors would require the non-objection of the FSA prior to payment. Directors and directors' interests The directors who held office during the year are shown on page 1. Changes to the board during the year are discussed below. On 28 May 2010 Mr. Dixon resigned as a director and Mr. Tifft was appointed to the Board. On the same date, Mr. Tifft resigned as Company Secretary, and Mr. Sánchez was appointed Company Secretary. On 13 August 2010 Messrs. Donovan, Kuyk and Poillon resigned as directors and Mr. Eisman was appointed to the Board. On the same date Mrs. Adams resigned as Chairman and Mr. Scott was appointed Chairman. Pursuant to a resolution adopted by the Board of the Company on 21 October 2009, a committee of the Board was established, comprised of all directors who are not also employees of AAC (i.e. Mr. Tifft and the non-executive directors), to consider any matters with respect to which members of the Board who are also employees of AAC might have a conflict of interest. Auditors The Company has, by elective resolution, dispensed with the need to appoint auditors annually and therefore KPMG Audit Plc continue to hold office. Statement as to disclosure of information to auditors Each person who is a director at the date of approval of this report confirms that: i) so far as the director is aware, there is no relevant audit information of which the Company s auditors are unaware; and ii) each director has taken all the steps that he ought to have taken as a director to make himself aware of any relevant audit information and to establish that the Company s auditors are aware of that information. Statement of directors responsibilities in respect of the Directors Report and the financial statements The directors are responsible for preparing the Directors' Report and the financial statements in accordance with applicable law and regulations. Company law requires the directors to prepare financial statements for each financial year. Under that law they have elected to prepare the financial statements in accordance with UK Accounting Standards and applicable law (UK Generally Accepted Accounting Practice). 6

9 Directors' report continued Under company law the directors must not approve the financial statements unless they are satisfied that they give a true and fair view of the state of affairs of the Company and of the profit or loss of the Company for that period. In preparing these financial statements, the directors are required to: select suitable accounting policies and then apply them consistently; make judgments and estimates that are reasonable and prudent; state whether applicable UK Accounting Standards have been followed, subject to any material departures disclosed and explained in the financial statements; and prepare the financial statements on the going concern basis unless it is inappropriate to presume that the Company will continue in business. The directors are responsible for keeping adequate accounting records that are sufficient to show and explain the Company's transactions and disclose with reasonable accuracy at any time the financial position of the Company and enable them to ensure that the financial statements comply with the Companies Act They have general responsibility for taking such steps as are reasonably open to them to safeguard the assets of the company and to prevent and detect fraud and other irregularities. By order of the Board M Sánchez Secretary Registered no:

10 INDEPENDENT AUDITOR S REPORT TO THE MEMBERS OF AMBAC ASSURANCE UK LIMITED We have audited the financial statements of Ambac Assurance UK Limited set out on pages 9 to 26. The financial reporting framework that has been applied in their preparation is applicable law and UK Accounting Standards (UK Generally Accepted Accounting Practice). This report is made solely to the company's members, as a body, in accordance with Chapter 3 of Part 16 of the Companies Act Our audit work has been undertaken so that we might state to the company's members those matters we are required to state to them in an auditors' report and for no other purpose. To the fullest extent permitted by law, we do not accept or assume responsibility to anyone other than the company and the company's members, as a body, for our audit work, for this report, or for the opinions we have formed. Respective responsibilities of directors and auditors As explained more fully in the Directors' Responsibilities Statement set out on pages 6 and 7, the directors are responsible for the preparation of the financial statements and for being satisfied that they give a true and fair view. Our responsibility is to audit, and express an opinion on, the financial statements in accordance with applicable law and International Standards on Auditing (UK and Ireland). Those standards require us to comply with the Auditing Practices Board's (APB's) Ethical Standards for Auditors. Scope of the audit of the financial statements A description of the scope of an audit of financial statements is provided on the APB's web-site at Opinion on financial statements In our opinion the financial statements: give a true and fair view of the state of the company's affairs as at 31 December 2010 and of its profit for the year then ended; have been properly prepared in accordance with UK Generally Accepted Accounting Practice; and have been prepared in accordance with the requirements of the Companies Act Opinion on other matter prescribed by the Companies Act 2006 In our opinion the information given in the Directors' Report for the financial year for which the financial statements are prepared is consistent with the financial statements. Matters on which we are required to report by exception We have nothing to report in respect of the following matters where the Companies Act 2006 requires us to report to you if, in our opinion: adequate accounting records have not been kept, or returns adequate for our audit have not been received from branches not visited by us; or the financial statements are not in agreement with the accounting records and returns; or certain disclosures of directors' remuneration specified by law are not made; or we have not received all the information and explanations we require for our audit G R Simpson (Senior Statutory Auditor) for and on behalf of KPMG Audit Plc, Statutory Auditor Chartered Accountants 15 Canada Square London E14 5GL Date: 23 rd March

11 Profit and loss account Technical account - general business Earned premiums, net of reinsurance Restated Note 1 Notes '000 '000 '000 '000 Gross premiums written 3 28,863 94,462 Outward reinsurance premiums (9,086) (85,591) ,777 8,871 Change in the gross provision for unearned premiums 17 47,036 20,636 Change in the provision for unearned premiums, reinsurers share 17 (5,062) (18,581) ,974 2, ,751 10,926 Other technical income, net of reinsurance 2,568 2,840 Claims incurred, net of reinsurance Claims paid Gross amount (108) (60,240) Reinsurers share 49 48, Net claims paid (59) (12,207) Change in the provision for claims Gross amount 17 (64,064) 552,053 Reinsurers share 17 16,742 (548,765) Change in the net provision for claims (47,322) 3, Claims incurred, net of reinsurance (47,381) (8,919) Net operating expenses 5 (9,250) (8,743) Gain/(loss) against reinsurance debtor 23 15,740 (309,396) Balance on the technical account for general business 23,428 (313,292) ====== ====== 9

12 Profit and loss account Non - technical account - general business Restated Note 1 Notes Balance on the general business technical account 23,428 (313,292) Investment income 6 3,325 3,510 Investment expenses and charges 7 (90) (81) Other income and charges Profit/(loss) on ordinary activities before tax 8 27,088 (309,571) Tax on profit/(loss) on ordinary activities 11 (1,059) (194) Profit/(loss) on ordinary activities after tax 26,029 (309,765) Profit/(loss) for the financial year 26,029 (309,765) ====== ===== There is no material difference between the result as disclosed in the profit and loss account and the result on an unmodified historical cost basis and therefore a separate note of historical cost profits and losses has not been included. All amounts are derived from continuing operations. Statement of total recognised gains and losses Retained profit/(loss) after tax for the year Currency translation differences, net of related tax Total profits/(losses) recognised in the year Reconciliation of movements in shareholder s funds '000 '000 26,029 6 (309,765) (224) ,035 (309,989) ======= ======= '000 '000 Total recognised profit/(loss) in the year 26,035 (309,989) Credit in relation to share based payments Balance at beginning of the year (252,143) 57, Balance at end of year (225,740) ======= (252,143) ======= 10

13 Balance sheet at 31 December 2010 Assets Notes '000 '000 Investments Other financial investments ,274 83,721 Debtors Debtors arising out of direct insurance operations 358, ,177 Other debtors 13 4,297 4,017 Other assets Tangible assets Cash at bank and in hand 3,226 4,888 Prepayments and accrued income Deferred acquisition costs 17 9,372 10, Total assets 506, ,773 ======= ======= Liabilities Capital and reserves Called up share capital 16 36,000 36,000 Profit and loss account Capital reserve (266,933) 5,193 (292,968) 4, Shareholder s funds - equity interests (225,740) (252,143) Technical provisions Provision for unearned premiums Claims outstanding , , , ,042 Creditors Creditors arising out of reinsurance operations - 6,426 Other creditors including taxation and social security 15 2,936 2,574 Accruals and deferred income 18 1,144 22, Total liabilities 506, ,773 ======= ======= The financial statements on pages 9 to 11 were approved and authorised for issue by the board of directors on 23 rd March 2011 and were signed on its behalf by: John Tifft - Chief Executive Officer Registered no:

14 Notes to the financial statements 1 Basis of preparation The financial statements have been prepared under the provisions of The Large and Medium-sized Companies and Groups (Accounts and Reports) Regulations 2008 ("SI2008/410") relating to insurance companies, and in accordance with the Statement of Recommended Practice on Accounting for Insurance Business issued by the Association of British Insurers ("the ABI SORP") dated December 2005 (as amended in December 2006.) The financial statements have been prepared in accordance with applicable accounting standards and under the historical cost accounting rules. The following accounting policies have been applied consistently in dealing with items which are considered material to the financial statements. Going Concern Basis of Accounts The financial statements are prepared on a going concern basis notwithstanding the deficit in shareholder s funds for the following reasons. The Company continues to be entitled to receive instalment premium income in respect of its guaranteed obligations and, following the termination of the Reinsurance Agreement (see Note 23), is no longer paying reinsurance premiums to AAC. Accordingly, it is retaining these cash flows for the benefit of its policy holders. These future premium cash flows are supported by contractual make-wholes on certain transactions, which would be payable to the Company in the event that a transaction was prepaid before its scheduled maturity date, thereby ensuring a base-line of premium income. The Company s insured obligations are generally to pay principal and interest when due, and are not generally subject to acceleration (except that the Company may have the right to accelerate insured obligations if they default). Accordingly, the Company s exposure to liquidity risk in respect of material claims in the short term is limited. Following the termination of the Reinsurance Agreement, the Company is now exposed to 100% of potential claims in the existing portfolio; however, these claims are expected to be met by the Company s own claims paying resources. In making their assessment of the adequacy of the Company s claims paying resources, the directors have considered the Company s cash flow projections under stressed scenarios, including increased claims payments, reduced premium and/or investment income scenarios, and other changes to assumptions and estimates. The directors are satisfied that the Company has adequate resources to meet the day-to-day operational needs of the business for the foreseeable future and that the Company s claims paying resources are sufficient to satisfy projected claims as they fall due. Reclassifications Certain reclassifications have been made to prior period s amounts to conform to the current period s presentation. 12

15 Notes to the financial statements - continued 2 Accounting policies Basis of accounting for underwriting activities All business is accounted for on an annual basis. Premium income and unearned premiums The policy for premium recognition is dependent on the timing of the collection of premiums. Where the premium on a policy is received up front, the premium is recognised as written at the date of inception, and earned in the technical account on a basis proportionate to the remaining scheduled periodic maturity of principal and payment of interest to the original total principal and interest insured. When an issue insured by the Company has been refunded or called, the remaining unrecognised premium is recognised at that time. Unearned premiums for premiums received upfront represent the portion of premiums written that relate to unexpired terms of policies in force at the balance sheet date. When the premium on a policy is received in instalments, the premium recognition is dependent on whether the Company is contractually entitled to future premiums. For those contracts with guaranteed premium amounts, the contractually entitled amount is recognised as written at the inception of the policy. When an issue insured by the Company has been refunded or called, the remaining unrecognised premium is recognised at that time. Differences between settlement proceeds on refunded or called issues and unrecognised premium are taken to profit and loss. For those contracts where there is no contractual entitlement to future premiums, future instalment premiums are considered sufficiently uncertain such that recognition of future premiums as written at inception is not considered appropriate. Instalment premiums written are earned in the technical account over each instalment period. Unearned premiums for instalment premiums represent the portion of premiums written that relate to a future period. Outward reinsurance premiums were accounted for the same as the premiums for the related insurance business. The Company no longer has any reinsurance arrangements in place. Structuring and commitment fee revenue Structuring fee revenue represents consideration received from clients in return for the Company s involvement in structuring or restructuring certain insured transactions. These non-refundable fees are collected up-front and are earned over the estimated life of the insured transaction. Structuring fee revenue is reported as other technical income in the technical account. In connection with its financial guarantee business, the Company issued certain commitments to provide guarantees relating to potential future debt issuances. Commitment fees were generally collected on an instalment basis and were earned in the technical account over each instalment period. The Company currently has no outstanding commitments. Other fees These fees represent consideration received from clients in respect of consents, waivers, amendments and surveillance relating to the Company s portfolio of inforce business and are reported as other technical income in the technical account. Amendment, waiver and consent fees are earned in the period in which they are received and surveillance fees are earned in the period to which they relate. 13

16 Notes to the financial statements - continued 2 Accounting policies - continued Acquisition costs Certain costs incurred in prior years that primarily related to the production of new business were deferred in those respective years. These costs generally included compensation costs, premium taxes and certain other costs, net of reinsurance ceding commissions. These deferred acquisition costs and deferred ceding commissions are charged or credited to the accounting periods in which the related premiums are earned. Deferred acquisition costs on the balance sheet represent the proportion of acquisition costs that corresponds to the proportion of premiums written which are unearned at the balance sheet date. Given that no new business was underwritten during 2009 and 2010, the Company has not deferred acquisition costs during these periods. During 2010, the reinsurance contract with AAC was terminated, and all unamortised deferred ceding commissions were taken into income at that time. Additionally, as the Company had no other current reinsurers, the Company has not received any ceding commission income that would require deferral at 31 December Share based payments Compensation expense is recognised over the relevant service period based on the fair value of stock options and restricted stock units ( RSUs ) granted for the years 2003 to AFG did not issue stock options or RSUs to the Company s employees in 2009 or Stock option and RSU expenses are allocated to each of AFG s subsidiaries based on the actual number of stock options and RSUs granted to each subsidiary s employees. No unearned compensation is included in Shareholder s funds for such stock options and restricted stock units granted. Rather, such stock options and restricted stock units are included in Shareholder s funds when services required from employees are rendered and expensed. Pension costs Pension contributions are charged to the profit and loss account and represent the contributions payable to a money purchase pension scheme in respect of the financial year. Claims A loss provision is established for insured obligations when, in the judgment of management, a monetary default in the timely payment of debt service is imminent. A loss provision is established in an amount that is sufficient to cover the present value of the anticipated debt service payments over the expected period of default and estimated expenses associated with settling the claim less estimated recoveries under salvage and subrogation rights. Loss provisions for insured obligations denominated in foreign currencies are converted to sterling at the prevailing spot rate as of the balance sheet date, with foreign currency movements included as a component of the provision for claims. Where there was an expectation of a claim on policies yet to be issued where the Company had issued a commitment, a loss provision was established in line with other insured obligations. In certain transactions, the insured may be contractually required to reimburse the Company for lost investment income that resulted from claim payments. The loss provision is based upon estimates and judgments by management. As such, there can be no assurance that the actual losses in our financial guarantee insurance portfolio will not exceed its loss reserves. The rate utilised to discount claims and estimated recoveries under subrogation rights is equal to the lower of the rate of return on invested assets for either: i.) the current year or ii.) the period covering the current year plus the four previous years. 14

17 Notes to the financial statements - continued 2 Accounting policies continued Investment income Investment income is accounted for on an accrual basis. Interest is accrued up to the balance sheet date. Realised gains or losses represent, for investments included in the balance sheet at amortised cost, the difference between net sales proceeds and amortised cost, and for investments included in the balance sheet at current value, the difference between net sale proceeds and purchase price. All investment income, including realised gains and losses on investments, is reported in the non-technical account. Fixed income securities are shown at amortised cost. The difference between the purchase price of such securities and the amount repayable at maturity is charged or credited to the profit and loss account over the period to maturity using the interest method. Foreign currencies Transactions in foreign currencies are translated to sterling at the rate ruling at the date the transaction is made. Monetary assets and liabilities expressed in foreign currencies are translated to sterling at rates of exchange ruling at the end of the financial year. Differences arising on exchange are reflected in the nontechnical account. The profit and loss accounts of the Italy branch are translated to sterling using average rates of exchange. Assets and liabilities of the branch are translated to sterling at year-end rates of exchange. The impact of these foreign currency translations is recorded as a component of Shareholder s Funds within the statement of total recognised gains and losses. Taxation Provision is made for all taxation expected to be payable on taxable profits of the year. Except where otherwise required by accounting standards, full provision without discounting is made for all timing differences that have arisen but not reversed at the balance sheet date. Deferred tax is recognised without discounting, in respect of all timing differences between the treatment of certain items for taxation and accounting purposes which have arisen but not reversed by the balance sheet date, except as otherwise required by FRS 19. Tangible assets Expenditure on leasehold improvements, fixtures, fittings and office equipment is capitalised and depreciated over the estimated useful economic lives of the assets on a straight line basis. The periods used are as follows: Leasehold improvements - Remaining life of the lease Fixtures, fittings and office equipment - 5 years Computer equipment - 3 years 3 Segmental information The Company only wrote one class of business, that being non-life financial loss insurance, therefore the directors regard any segmental analysis as inappropriate at the present time. 4 Reinsurance balance The reinsurance balance of those items in the technical account that relate to outwards reinsurance transactions is income of 18,831,000 (2009: expense of 911,500,000). 15

18 Notes to the financial statements - continued 5 Net operating expenses Change in gross deferred acquisition costs 928 1,019 Administrative expenses 8,770 10, Gross operating expenses 9,698 11,543 Reinsurance commissions (909) (5,935) Change in deferred reinsurance commission 461 3, Net operating expenses 9,250 8,743 ==== ==== 6 Investment income - non-technical account Restated Note Income from other financial investments 2,929 3,353 Net realised and unrealised gains Investment income 3,325 3,510 ==== ==== Investment income includes 2,923,000 (2009: 3,349,000) of income from listed investments. 7 Investment expenses Investment management expenses == == 8 Profit on ordinary activities before tax Profit /(loss) on ordinary activities before tax is stated after charging Auditors' remuneration Audit Tax related services 91 - Other services - audit of regulatory returns Depreciation

19 Notes to the financial statements - continued 9 Remuneration of directors '000 '000 Directors' emoluments 1, Company contributions to money purchase schemes The emoluments of the highest paid director were 464,000 (2009: 550,000), which includes 179,000 compensation for loss of office during the year. This director is a member of a money purchase pension scheme, under which the accrued pension benefits as of 28 May 2010 (the date of the director s last day of employment with the Company) was 292,000 ( 259,000 as of 31 December 2009). As of 31 December 2010, the Company did not have any advances outstanding or amounts guaranteed on behalf of any of the directors. Retirement benefits are accruing to the following number of directors under: Number of directors At At December December Money purchase schemes 1 2 During 2010 and 2009, no directors exercised share options in the ultimate parent company. 10 Staff numbers and costs The average number of persons employed by the Company (including directors) during the year was as follows: Number of employees Portfolio management Administration 3 3 The aggregate payroll costs in respect of these persons were as follows: Wages and salaries 3,655 4,248 Social security costs Other pension costs

20 Notes to the financial statements - continued 11 Taxation Analysis of UK charge in year: Current tax: UK corporation tax at 28.0% Adjustment in respect of prior periods Total UK corporation tax (28) Foreign tax expense Adjustment in respect of prior periods Total foreign tax expense Total current tax expense Deferred tax Origination/reversal of timing differences Total deferred tax expense Tax expense on profit/(loss) on ordinary activities 1,160 (101) , ,059 ===== ===== 1,059 ===== 151 (69) ===== ===== 194 ===== Factors affecting tax charge for period: The tax assessed for the years ended 31 December 2010 and 2009 differ from the standard rates of corporation tax in the UK of 28.0%. The differences are explained below: 000 % 000 % Profit/(loss) on ordinary activities before tax 27,088 (309,571) Tax Charge at 28.0% 7, % (86,680) 28.0% Effects of: - Expenses disallowed for tax purposes % 86,652 (28.0%) - Excess of depreciation over capital allowances % Utilisation of trading losses (7,850) (29.0%) Adjustment in respect of prior periods (UK) - Differences in effective tax rates on % 23 - overseas earnings - Difference in overseas taxation basis % 128 (0.1%) - Adjustment in respect of prior periods (101) (0.3%) (69) - (overseas) Current tax expense 1, % 151 (0.1%) ===== ======= ==== ===== A potential deferred tax asset of 78,663,000 has not been recognised because, whilst future profit streams are expected, given the recent changes to the Company s business model, it is not considered prudent to recognise a deferred tax asset at this time. 18

21 Notes to the financial statements - continued 12 Other financial investments Original Cost Market Value Carrying Value Listed fixed income securities 73,139 68,332 75,942 71,165 72,526 67,982 Units in unit trusts 57,412 15,754 57,748 15,739 57,748 15, ,551 84, ,690 86, ,274 83,721 ===== ===== ===== ===== ===== ===== The fixed interest securities are carried at amortised cost, net of foreign currency translation gains or losses. The net excess of the amortised cost over the amount receivable on maturity at 31 December 2010 was 1,039,000 (2009: 1,232,000). 13 Other debtors Estimated recoveries under subrogation rights 1,955 1,856 Accrued interest Current corporate tax Other miscellaneous assets Due from affiliate ,297 4,017 ==== ==== 14 Tangible assets Leasehold Improvements Fixtures, fittings and office equipment Total Cost: At beginning of year 1, ,358 Additions At 31 December , ,567 ==== === === Depreciation: At beginning of year ,703 Charge for the year At 31 December , ,304 === === === Net book value: At beginning of year At 31 December === === === 19

22 Notes to the financial statements - continued 15 Other creditors The net book value of other creditors is made up as follows: Accrued expenditure 1,859 2,567 Current tax liability 1,070 - Deferred tax liability ,936 2,574 ==== ==== 16 Called up share capital Ordinary shares of 1 each: Authorised: 60,000,000 shares (2009: 60,000,000) 60,000 60,000 ===== ===== Allotted and called up and fully paid: 36,000,000 shares (2009: 36,000,000) 36,000 36,000 ===== ===== 20

23 Notes to the financial statements - continued 17. Technical provisions and deferred acquisition costs Provision for unearned premiums Gross amount At beginning of year 498, ,526 Movement in the provision (47,036) (20,636) Exchange movements 9 (93) At the end of period 451, ,797 Reinsurance amount At beginning of year - 467,706 Movement in the provision (5,062) (18,581) Exchange movements - (84) Movement in the provision against reinsurance debtor 5,062 (449,041) At the end of period - - Provision for claims, net of estimated recoveries under subrogation rights Gross amount At beginning of year 210,186 - Movement in the provision for claims 64, ,042 Movement in the estimated recoveries under subrogation rights (99) (1,856) At the end of period 274, ,186 Reinsurance amount At beginning of year - - Movement in the provision for claims 16, ,202 Estimated payments of ceded subrogation rights (134) (1,670) Movement in the provision against reinsurance debtor (16,742) (207,532) At the end of period - - Net technical provisions At end of year 726, ,983 At beginning of year 708,983 51,820 Net technical provisions at end of year 726, ,983 Deferred acquisition costs - gross (9,372) (10,315) - reinsurance commissions - (9,372) 19,457 9,142 Net insurance funds 716, ,125 21

24 Notes to the financial statements - continued 17. Technical provisions and deferred acquisition costs continued The Company discounts estimated future claims and recoveries under subrogation rights at a rate of 3.15% (2009: 3.99%), which approximates the weighted average return on the Company s invested assets for the current year ended 31 December Due to the long term nature of the claims payment schedule, future investment returns on the assets maintained to cover the provisions for claims may not reflect the historical returns used to discount the provision. The following table summarises the estimated change in the provision for claims assuming an immediate shift in the Company s investment yields only at specified levels at 31 December 2010: (in 000 s) Estimated provision for claims less estimated recoveries and subrogation Impact of changes in provision 100 basis point rise 216,726 (57,524) 50 basis point rise 243,699 (30,551) Base case 274, basis point decline 308,877 34, basis point decline 348,154 73,904 Provisions for claims may also change as the loss cash flows will be affected by external factors, such as, changes to the credit profile of the insured, changes in interest rates and foreign currency exchange rates on the guaranteed debt obligations. 31 December December 2009 ( 000) Undiscounted Discounted Undiscounted Discounted Provision for claims Gross amount Provision for claims 590, , , ,042 Estimated recoveries under subrogation rights (2,662) (1,955) (2,614) (1,856) At end of period 587, , , ,186 Reinsurance amount Provision for claims , ,202 Estimated payments of ceded subrogation rights - - (2,353) (1,670) Provision against reinsurance debtor - - (567,969) (207,532) At end of period Net amount Provision for claims 590, ,205 6,255 2,840 Estimated recoveries under subrogation rights (2,662) (1,955) (261) (186) Provision against reinsurance debtor , ,532 At end of period 587, , , ,186 22

25 Notes to the financial statements - continued 17. Technical provisions and deferred acquisition costs continued As discussed in Note 23 below, at 31 December 2009, provision was made against reinsurance balances of 309,396,000, represented by the reinsurance share of claims provisions, unearned premium provision and related creditors arising out of reinsurance operations. At 31 December 2010, the provision against reinsurance debtor, in addition to the reinsurance amounts on the provision for unearned premiums and for claims was 0 due to the Commutation and Release Agreement entered on 28 September 2010 with AAC and the Special Deputy Commissioner of OCI, pursuant to which the Reinsurance Agreement and the Net Worth Maintenance Agreement were commuted. 18 Accruals and deferred income The net book value of the accruals and deferred income is made up as follows: Deferred reinsurance commissions - 19,457 Deferred structuring fees 1,144 2, , ,077 ===== ====== As discussed in Note 23 below, the Reinsurance Agreement was terminated during Accordingly, all previously deferred ceding commissions were recognised upon the termination of the Reinsurance Agreement. 19. Statement of movement on reserves Profit and loss account Balance at 1 January (292,968) 17, Retained gain/(loss) for the year 26,029 (309,765) Exchange movements 6 (224) Balance at 31 December (266,933) (292,968) ======= ======= Capital reserve account Balance at 1 January 4,825 4,312 Capital contribution share based payments Balance at 31 December 5,193 4,825 ===== ===== 23

26 Notes to the financial statements - continued 20. Share based payments The AFG 1997 Equity Plan (the Equity Plan ) provides for the granting of stock options, appreciation rights, restricted stock units, performance units and other awards that are valued or determined by reference to the stock Common Stock of AFG. AFG generally expects to deliver shares to employees under this plan from its treasury stock. Stock options There were no new stock options awarded during 2010 and A summary of option activity for 2010 and 2009 is as follows: Weighted Weighted Average Average Exercise Exercise Shares Price Shares Price Outstanding at Beginning of year 183,551 $ ,717 $57.07 Granted - $ - - $ - Exercised - $ - - $ - Expired or cancelled 63,041 $ ,166 $56.61 Outstanding at End of year 120,510 $ ,551 $57.12 Exercisable 59,245 $ ,802 $52.64 Options Outstanding: Number Average Weighted Range of Outstanding at Remaining Average Exercise Prices 31 December 2010 Contractual Life Exercise Price $ $ , years $11.13 $ $ , years $76.10 $ $ , years $87.27 Gross stock option expense, prior to the effect of deferrals, was 109,109 (2009: 217,942). Restricted Stock Units RSUs may be granted to all eligible employees based upon the performance of AFG, the performance of the employee s department and the performance of the employee. Given the performance of AFG in 2010 and 2009 there were no new RSU s granted in either year. Gross RSU expense, prior to the effect of deferrals, was 259,717 (2009: 295,278). 24