---

---

---

ITEM 1.	FINANCIAL STATEMENTS

---

---

---

---

---

---

---

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, 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, including 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 June 30, 2020 and cover the three-month period ended June 30, 2020 (Second Quarter 2020), the three-month period ended June 30, 2019 (Second Quarter 2019), the six-month period ended June 30, 2020 (Six Months 2020) and the six-month period ended June 30, 2019 (Six Months 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).

---

AGL'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, 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 Six Months 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.

---

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 Second Quarter 2020 and Six Months 2020, the Company recorded an additional $3 million and $14 million, respectively, in credit loss expense (including $1 million and $2 million, respectively, of accretion). Changes in the impairment model associated with PCD securities are to be applied prospectively. The Company did not purchase any PCD securities during Six Months 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 beginning in the first quarter of 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,

---

•	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 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.

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 11, 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 the Insurance segment invests. See Note 11, 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.

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

	Second Quarter 2020
	Insurance				Asset Management				Corporate				Other				Total
	(in millions)
Third-party revenues	$	244			$	12			$	—			$	38			$	294
Intersegment revenues	2				1				—				(3		)		—
Total revenues	246				13				—				35				294
Total expenses	90				24				32				4				150
Income (loss) before income taxes and equity in net earnings of investees	156				(11		)		(32		)		31				144
Equity in net earnings of investees	26				—				—				(26		)		—
Adjusted operating income (loss) before income taxes	182				(11		)		(32		)		5				144
Provision (benefit) for income taxes	28				(2		)		(6		)		—				20
Noncontrolling interests	—				—				—				5				5
Adjusted operating income (loss)	$	154			$	(9	)		$	(26	)		$	—			$	119
Supplemental income statement information
Net investment income	$	82			$	—			$	—			$	(4	)		$	78
Interest expense	—				—				23				(2		)		21
Non-cash compensation and operating expenses (1)	9				6				—				—				15

	Second Quarter 2019
	Insurance				Asset Management				Corporate				Other				Total
	(in millions)
Third-party revenues	$	241			$	—			$	1			$	21			$	263
Intersegment revenues	—				—				—				—				—
Total revenues	241				—				1				21				263
Total expenses	40				—				31				14				85
Income (loss) before income taxes and equity in net earnings of investees	201				—				(30		)		7				178
Equity in net earnings of investees	1				—				—				—				1
Adjusted operating income (loss) before income taxes	202				—				(30		)		7				179
Provision (benefit) for income taxes	41				—				(4		)		1				38
Noncontrolling interests	—				—				—				—				—
Adjusted operating income (loss)	$	161			$	—			$	(26	)		$	6			$	141
Supplemental income statement information
Net investment income	$	110			$	—			$	1			$	(1	)		$	110
Interest expense	—				—				22				—				22
Non-cash compensation and operating expenses (1)	9				—				2				—				11

---

	Six Months Ended June 30, 2020
	Insurance				Asset Management				Corporate				Other				Total
	(in millions)
Third-party revenues	$	437			$	28			$	(4	)		$	23			$	484
Intersegment revenues	5				2				—				(7		)		—
Total revenues	442				30				(4		)		16				484
Total expenses	174				52				67				3				296
Income (loss) before income taxes and equity in net earnings of investees	268				(22		)		(71		)		13				188
Equity in net earnings of investees	17				—				(5		)		(16		)		(4		)
Adjusted operating income (loss) before income taxes	285				(22		)		(76		)		(3		)		184
Provision (benefit) for income taxes	46				(4		)		(11		)		(1		)		30
Noncontrolling interests	—				—				—				2				2
Adjusted operating income (loss)	$	239			$	(18	)		$	(65	)		$	(4	)		$	152
Supplemental income statement information
Net investment income	$	165			$	—			$	1			$	(8	)		$	158
Interest expense	—				—				48				(5		)		43
Non-cash compensation and operating expenses (1)	18				9				3				—				30

	Six Months Ended June 30, 2019
	Insurance				Asset Management				Corporate				Other				Total
	(in millions)
Third-party revenues	$	474			$	—			$	1			$	22			$	497
Intersegment revenues	1				—				—				(1		)		—
Total revenues	475				—				1				21				497
Total expenses	147				—				62				14				223
Income (loss) before income taxes and equity in net earnings of investees	328				—				(61		)		7				274
Equity in net earnings of investees	2				—				1				—				3
Adjusted operating income (loss) before income taxes	330				—				(60		)		7				277
Provision (benefit) for income taxes	58				—				(9		)		1				50
Noncontrolling interests	—				—				—				—				—
Adjusted operating income (loss)	$	272			$	—			$	(51	)		$	6			$	227
Supplemental income statement information
Net investment income	$	209			$	—			$	2			$	(3	)		$	208
Interest expense	—				—				46				(1		)		45
Non-cash compensation and operating expenses (1)	20				—				3				—				23

_____________________

(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 June 30,								Six Months Ended June 30,
	2020				2019				2020				2019
	(in millions)
Net income (loss) attributable to AGL	$	183			$	142			$	128			$	196
Less pre-tax adjustments:
Realized gains (losses) on investments	4				8				(1		)		(4		)
Non-credit impairment unrealized fair value gains (losses) on credit derivatives	97				(12		)		9				(40		)
Fair value gains (losses) on CCS	(25		)		19				23				10
Foreign exchange gains (losses) on remeasurement of premiums receivable and loss and LAE reserves	2				(12		)		(55		)		(3		)
Total pre-tax adjustments	78				3				(24		)		(37		)
Less tax effect on pre-tax adjustments	(14		)		(2		)		—				6
Adjusted operating income (loss)	$	119			$	141			$	152			$	227

Revenue by Country of Domicile

	Three Months Ended June 30,								Six Months Ended June 30,
	2020				2019				2020				2019
	(in millions)
U.S.	$	243			$	212			$	393			$	394
Bermuda	38				46				72				90
U.K. and other	13				5				19				13
Total	$	294			$	263			$	484			$	497

---

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 June 30,								Six Months Ended June 30,
	2020				2019				2020				2019
	(in millions)
Revenues
Total consolidated revenues	$	372			$	266			$	468			$	461
Less: Realized gains (losses) on investments	4				8				(1		)		(4		)
Less: Non-credit impairment unrealized fair value gains (losses) on credit derivatives	97				(12		)		9				(40		)
Less: Fair value gains (losses) on CCS	(25		)		19				23				10
Less: Foreign exchange gains (losses) on remeasurement of premiums receivable and loss and LAE reserves	2				(12		)		(55		)		(3		)
Plus: Credit derivative impairment (recoveries) (1)	—				—				(8		)		(1		)
Total segment revenues	$	294			$	263			$	484			$	497
Expenses
Total consolidated expenses	$	150			$	85			$	304			$	224
Plus: Credit derivative impairment (recoveries) (1)	—				—				(8		)		(1		)
Total segment expenses	$	150			$	85			$	296			$	223

_____________________

(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.

3.	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.

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 11, Variable Interest Entities. Unless otherwise specified, the outstanding par and principal and interest (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 June 30, 2020 and December 31, 2019 was $5.8 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 June 30, 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 4, 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.

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 COVID-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. While the COVID-19 pandemic has been impacting the global economy and the Company for quite some time now, its ultimate size, depth, course and duration remain unknown, and the governmental and private responses to the pandemic continue to evolve. Consequently, and due to the nature of the Company's business, all of the direct and indirect consequences of COVID-19 on the Company are not yet fully known to the Company, and still 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 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 June 30, 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 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, 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 June 30, 2020				As of December 31, 2019				As of June 30, 2020				As of December 31, 2019
	(in millions)
Public finance	$	352,266			$	363,497			$	351,835			$	362,361
Structured finance	11,196				12,279				10,694				11,769
Total financial guaranty	$	363,462			$	375,776			$	362,529			$	374,130

Financial Guaranty Portfolio

by Internal Rating

As of June 30, 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		$	368			0.2	%		$	2,459			5.0	%		$	1,118			12.7	%		$	166			23.7	%		$	4,111			1.8	%
AA		17,800				10.3			4,916				10.0			3,885				44.0			34				4.9			26,635				11.4
A		92,807				53.6			10,314				20.9			1,002				11.3			172				24.5			104,295				45.0
BBB		56,448				32.6			30,741				62.3			1,065				12.1			288				41.1			88,542				38.2
BIG		5,720				3.3			863				1.8			1,752				19.9			41				5.8			8,376				3.6
Total net par outstanding		$	173,143			100.0	%		$	49,293			100.0	%		$	8,822			100.0	%		$	701			100.0	%		$	231,959			100.0	%

---

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 $119 million of gross par for public finance and $593 million of gross par of structured finance as of June 30, 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 June 30, 2020

	BIG Net Par Outstanding																Net Par
	BIG 1				BIG 2				BIG 3				Total BIG				Outstanding
									(in millions)
Public finance:
U.S. public finance	$	1,440			$	430			$	3,850			$	5,720			$	173,143
Non-U.S. public finance	817				—				46				863				49,293
Public finance	2,257				430				3,896				6,583				222,436
Structured finance:
U.S. RMBS	202				29				1,323				1,554				3,281
Other structured finance	97				56				86				239				6,242
Structured finance	299				85				1,409				1,793				9,523
Total	$	2,556			$	515			$	5,305			$	8,376			$	231,959

---

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
Other structured finance	69				62				88				219				6,515
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 June 30, 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		$	2,482			$	74			$	2,556			112			7			119
Category 2		511				4				515				19			1			20
Category 3		5,258				47				5,305				128			6			134
Total BIG		$	8,251			$	125			$	8,376			259			14			273

---

 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 $4.4 billion net par as of June 30, 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.

---

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 June 30, 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 27, 2020, the Oversight Board certified a revised fiscal plan for the Commonwealth. The revised certified Commonwealth fiscal plan contemplates a reduction in financial resources available for debt service as a result of efforts to contain, and the impact on the economy from, the COVID-19 pandemic. That revised fiscal plan also contemplates a postponement of reforms for the Commonwealth. The Company continues to disagree with the Oversight Board'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.

---

General Obligation Bonds		Assured Guaranty Net Par Outstanding as of June 30, 2020				Assured Guaranty Total Net Principal Claims Paid as of June 30, 2020				Assured Guaranty Total Net Interest Claims Paid as of June 30, 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 June 30, 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 June 30, 2020				Assured Guaranty Total Net Principal Claims Paid as of June 30, 2020				Assured Guaranty Total Net Interest Claims Paid as of June 30, 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 June 30, 2020, the Company had $842 million insured net par outstanding of PRHTA (transportation revenue) bonds and $515 million insured net par outstanding of PRHTA (highway 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 highway 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

---

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 26, 2020, 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 five-year forecast period

PRCCDA. As of June 30, 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 June 30, 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 June 30, 2020, the Company had $825 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 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 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.

On June 29, 2020, the Oversight Board certified a revised fiscal plan for PREPA. The revised certified PREPA fiscal plan projects no capacity to pay debt service over the five-year forecast period without incurring rate increases.

PRASA. As of June 30, 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. 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.

On June 29, 2020, the Oversight Board certified a revised fiscal plan for PRASA. The revised certified PRASA fiscal plan projects the ability to pay debt service over the five-year forecast period with the implementation of certain measures and draws from the current expense fund.

---

MFA. As of June 30, 2020, the Company had $271 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.

U of PR. As of June 30, 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. 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

---

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 filed a status report on May 15, 2020 regarding PREPA's financial condition and its request for approval of the PREPA RSA settlement, in which it requested that it be permitted to file an updated report by July 31, 2020, and that all proceedings related to the approval of the PREPA RSA settlement continue to be adjourned. On May 22, 2020, the Title III Court issued an order to that effect. The Oversight Board filed an updated status report on July 31, 2020, in which it requested that it be permitted to file another update by September 25, 2020.

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 has requested that it be allowed to file an updated status report by September 11, 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 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 June 1, 2020, the Supreme Court issued its opinion, reversing the First Circuit and holding that the selection process prescribed under PROMESA for Oversight Board members does not violate the Appointments Clause.

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 June 30, 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 June 30, 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.

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. The Oversight Board filed a status report on May 15, 2020, regarding PREPA's financial condition and its request for approval of the PREPA RSA settlement, in which it requested that it be permitted to file an updated report by July 31, 2020, that all proceedings related to the approval of the PREPA RSA settlement continue to be adjourned, and that the hearing in this adversary proceeding currently scheduled for June 3, 2020 be adjourned. On May 22, 2020, the Title III court issued an order to that effect.

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 of Puerto Rico, 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. The Oversight Board filed a status report on May 15, 2020 regarding PREPA’s financial condition and its request for approval of the PREPA RSA settlement, in which it requested that it be permitted to file an updated report by July 31, 2020, that all proceedings related to the approval of the PREPA RSA settlement continue to be adjourned, and that the hearing in this adversary proceeding currently scheduled for June 3, 2020 be adjourned. On May 22, 2020, the Title III Court issued an order to that effect.

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 occurred on June 4, 2020. On July 2, 2020, Judge Swain denied the motion to the extent it sought stay relief or adequate protection with respect to liens or other property interests in PRHTA Revenues that have not been deposited in the related bond resolution funds.  The movants intend to appeal this denial and the underlying determinations to the First Circuit.

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. Motions for partial summary judgment were filed on April 28, 2020, with a hearing scheduled for September 23, 2020.

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. This matter is stayed pending further order of the court.

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 occurred on June 4, 2020. On July 2, 2020, Judge Swain denied the motion to the extent it sought stay relief or adequate protection with respect to PRIFA Revenues that have not been deposited in the related sinking fund.  The movants intend to appeal this denial and the underlying determinations to the First Circuit either as a certified interlocutory appeal or following the issuance of a final order resolving additional issues that were not considered in the preliminary hearing.

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. Motions for partial summary judgment were filed on April 28, 2020, with a hearing currently scheduled for September 23, 2020.

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 occurred on June 4, 2020. On July 2, 2020, Judge Swain held that a proposed enforcement action by movants in another court would be subject to the automatic stay, that the movants have a colorable claim to a security interest in funds deposited in the “Transfer Account” and have shown a reasonable likelihood that a certain account held by Scotiabank is the Transfer Account, but denied the motion to the extent it sought stay relief or adequate protection with respect to PRCCDA Revenues that have not been deposited in the Transfer Account.  The movants intend to appeal the portion of the opinion constituting a denial and the underlying determinations related to the denial to the First Circuit either as a certified interlocutory appeal or following the issuance of a final order resolving additional issues that were not considered in the preliminary hearing.

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. Motions for partial summary judgment were filed on April 28, 2020, with a hearing currently scheduled for September 23, 2020.

---

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 June 30, 2020				As of December 31, 2019				As of June 30, 2020				As of December 31, 2019
	(in millions)
Exposure to Puerto Rico	$	4,458			$	4,458			$	6,843			$	6,956

Puerto Rico

Net Par Outstanding

	As of June 30, 2020 (1)				As of December 31, 2019
	(in millions)
Commonwealth Constitutionally Guaranteed
Commonwealth of Puerto Rico - General Obligation Bonds (2)	$	1,253			$	1,253
PBA (2)	140				140
Public Corporations - Certain Revenues Potentially Subject to Clawback
PRHTA (Transportation revenue) (2)	842				811
PRHTA (Highway revenue) (2)	515				454
PRCCDA	152				152
PRIFA	16				16
Other Public Corporations
PREPA (2)	825				822
PRASA	373				373
MFA	271				248
U of PR	1				1
Total net exposure to Puerto Rico	$	4,388			$	4,270

____________________

(1)	In Second Quarter 2020, the Company reassumed $118 million in net par of Puerto Rico exposures from its largest remaining legacy financial guaranty reinsurer.

(2)	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.

---

Amortization Schedule of Puerto Rico Net Par Outstanding

and Net Debt Service Outstanding

As of June 30, 2020

	Scheduled Net Par Amortization				Scheduled Net Debt Service Amortization
	(in millions)
2020 (July 1 - September 30)	$	291			$	399
2020 (October 1 - December 31)	—				3
Subtotal 2020	291				402
2021	153				360
2022	176				375
2023	206				397
2024	222				403
2025-2029	1,173				1,895
2030-2034	1,053				1,527
2035-2039	764				942
2040-2044	104				179
2045-2047	246				272
Total	$	4,388			$	6,752

Exposure to the U.S. Virgin Islands

 

As of June 30, 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.

 

In 2017, 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. More recently, the COVID-19 pandemic and evolving governmental and private responses to the pandemic have been impacting the USVI economy, especially the tourism sector. 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 June 30, 2020, $30 million of aircraft residual value insurance exposure was rated BIG.

---

Specialty Insurance and Reinsurance

Exposure

		Gross Exposure								Net Exposure
		As of June 30, 2020				As of December 31, 2019				As of June 30, 2020				As of December 31, 2019
		(in millions)
Life insurance transactions (1)		$	1,063			$	1,046			$	915			$	898
Aircraft residual value insurance policies		391				398				236				243
Total		$	1,454			$	1,444			$	1,151			$	1,141

____________________

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

4.	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 the expected loss on the portion of loss mitigation bonds owned), and 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)). All cash flows are discounted 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.

    

---

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 1.47% with a weighted average of 0.57% as of June 30, 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 June 30, 2020 and December 31, 2019, respectively.

Net Expected Loss to be Paid

Roll Forward

	Second Quarter								Six Months
	2020				2019				2020				2019
	(in millions)
Net expected loss to be paid, beginning of period	$	660			$	963			$	737			$	1,183
Economic loss development (benefit) due to:
Accretion of discount	2				6				6				14
Changes in discount rates	1				(1		)		32				(5		)
Changes in timing and assumptions	31				(42		)		(7		)		(48		)
Total economic loss development (benefit)	34				(37		)		31				(39		)
Net (paid) recovered losses	41				34				(33		)		(184		)
Net expected loss to be paid, end of period	$	735			$	960			$	735			$	960

Net Expected Loss to be Paid

Roll Forward by Sector

	Second Quarter 2020
	Net Expected Loss to be Paid/(Recovered) as of March 31, 2020				Economic Loss Development/ (Benefit)				(Paid)/ Recovered Losses (1)				Net Expected Loss to be Paid/(Recovered) as of June 30, 2020
	(in millions)
Public finance:
U.S. public finance	$	493			$	30			$	20			$	543
Non-U.S. public finance	26				2				1				29
Public finance	519				32				21				572
Structured finance:
U.S. RMBS	104				1				23				128
Other structured finance	37				1				(3		)		35
Structured finance	141				2				20				163
Total	$	660			$	34			$	41			$	735

---

	Second Quarter 2019
	Net Expected Loss to be Paid (Recovered) as of March 31, 2019				Economic Loss Development / (Benefit)				(Paid) Recovered Losses (1)				Net Expected Loss to be Paid (Recovered) as of June 30, 2019
	(in millions)
Public finance:
U.S. public finance	$	666			$	92			$	(9	)		$	749
Non-U.S. public finance	31				(8		)		—				23
Public finance	697				84				(9		)		772
Structured finance:
U.S. RMBS	237				(118		)		43				162
Other structured finance	29				(3		)		—				26
Structured finance	266				(121		)		43				188
Total	$	963			$	(37	)		$	34			$	960

	Six Months 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 June 30, 2020
	(in millions)
Public finance:
U.S. public finance	$	531			$	86			$	(74	)		$	543
Non-U.S. public finance	23				5				1				29
Public finance	554				91				(73		)		572
Structured finance:
U.S. RMBS	146				(62		)		44				128
Other structured finance	37				2				(4		)		35
Structured finance	183				(60		)		40				163
Total	$	737			$	31			$	(33	)		$	735

---

	Six Months 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 June 30, 2019
	(in millions)
Public finance:
U.S. public finance	$	832			$	154			$	(237	)		$	749
Non-U.S. public finance	32				(9		)		—				23
Public finance	864				145				(237		)		772
Structured finance:
U.S. RMBS	293				(183		)		52				162
Other structured finance	26				(1		)		1				26
Structured finance	319				(184		)		53				188
Total	$	1,183			$	(39	)		$	(184	)		$	960

____________________

(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 Six Months 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 $6 million and $9 million for Second Quarter 2020 and 2019, respectively, and $9 million and $16 million for Six Months 2020 and 2019, respectively, and (2) expected LAE to be paid of $24 million as of June 30, 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								Second Quarter								Six Months
	June 30, 2020				December 31, 2019				2020				2019				2020				2019
	(in millions)
Insurance	$	684			$	683			$	32			$	(22	)		$	31			$	(12	)
FG VIEs (See Note 11)	65				58				1				(14		)		7				(24		)
Credit derivatives (See Note 9)	(14		)		(4		)		1				(1		)		(7		)		(3		)
Total	$	735			$	737			$	34			$	(37	)		$	31			$	(39	)

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 $4.4 billion net par as of June 30, 2020, all of which was BIG. For additional information regarding the Company's Puerto Rico exposure, see "Exposure to Puerto Rico" in Note 3, 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 June 30, 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, which will likely be impacted by COVID-19. 

---

The Company projects its total net expected loss across its troubled U.S. public finance exposures as of June 30, 2020, including those mentioned above, to be $543 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 June 30, 2020 that credit was $917 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 (which may include shifting probability weightings of its scenarios) based on public information as well as nonpublic information obtained through its surveillance and loss mitigation activities. Such information includes management's view of the potential impact of COVID-19 on its distressed U.S. public finance exposures. 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 $30 million during Second Quarter 2020 and $86 million during Six Months 2020, and 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 3, 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 $29 million as of June 30, 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 $2 million during Second Quarter 2020, which was primarily attributable to the impact of negative European interest rates on an interest rate swap in an Italian transaction. The economic loss development of $5 million during Six Months 2020 was due primarily to the impact of negative European interest rates and 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 June 30, 2020, the Company had a net R&W payable of $95 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.

---

Net Economic Loss Development (Benefit)

U.S. RMBS

	Second Quarter								Six Months
	2020				2019				2020				2019
	(in millions)
First lien U.S. RMBS	$	4			$	(19	)		$	(55	)		$	(50	)
Second lien U.S. RMBS	(3		)		(99		)		(7		)		(133		)

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.

---

First Lien Liquidation Rates

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

Towards the end of the first quarter of 2020, lenders began offering mortgage borrowers the option to forbear interest and principal payments of their loans due to the COVID -19 pandemic, and to repay such amounts at a later date. This resulted in an increase in early-stage delinquencies in RMBS transactions during the Second Quarter 2020. The Company's expected loss estimate assumes that a portion of early-stage delinquencies are due to COVID-19 related forbearances, and applies a liquidation rate of 20% to such loans. This is the same liquidation rate assumption used when estimating expected losses for current loans modified or delinquent within the last 12 months, as the Company believes this is the category that most resembles the population of new forbearance delinquencies.

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 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 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 June 30, 2020							As of March 31, 2020									As of December 31, 2019
	Range					Weighted Average		Range						Weighted Average			Range					Weighted Average
Alt-A First Lien
Plateau CDR	1.6	%	-	9.4%		5.2%		0.0	%	-	8.3	%		4.0	%		0.3	%	-	8.4%		4.1%
Final CDR	0.1	%	-	0.5%		0.3%		0.0	%	-	0.4	%		0.2	%		0.0	%	-	0.4%		0.2%
Initial loss severity:
2005 and prior	60%							60%									60%
2006	70%							70%									70%
2007+	70%							70%									70%
Option ARM
Plateau CDR	2.4	%	-	10.4%		5.6%		1.7	%	-	7.7	%		5.0	%		1.8	%	-	8.4%		5.4%
Final CDR	0.1	%	-	0.5%		0.3%		0.1	%	-	0.4	%		0.3	%		0.1	%	-	0.4%		0.3%
Initial loss severity:
2005 and prior	60%							60%									60%
2006	60%							60%									60%
2007+	70%							70%									70%
Subprime
Plateau CDR	1.3	%	-	19.1%		5.5%		1.9	%	-	17.8	%		5.4	%		1.6	%	-	18.1%		5.6%
Final CDR	0.1	%	-	1.0%		0.3%		0.1	%	-	0.9	%		0.3	%		0.1	%	-	0.9%		0.3%
Initial loss severity:
2005 and prior	75%							75%									75%
2006	75%							75%									75%
2007+	75%							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 stressed CPR and the speed of recovery of loss severity rates. The Company probability weighted a total of five scenarios as of June 30, 2020 and December 31, 2019.

    

Total expected loss to be paid on all first lien U.S. RMBS was $122 million and $166 million as of June 30, 2020 and December 31, 2019, respectively. The $4 million economic loss development in Second Quarter 2020 for first lien U.S. RMBS transactions was primarily attributable to COVID-19 related forbearances, partially offset by higher excess spread in certain transactions and changes in liquidation rates. The $55 million economic benefit in Six Months 2020 for first lien U.S. RMBS was primarily attributable to higher excess spread on certain transactions, partially offset by changes in discount rates and COVID-19 related forbearances. Certain transactions benefit from excess spread when they are supported by large portions of fixed rate assets (either originally fixed or modified to be fixed) but have insured floating rate debt linked to LIBOR, which decreased in Second Quarter 2020 and Six Months 2020, and so increased excess spread. The Company used a similar approach to establish its pessimistic and optimistic scenarios as of June 30, 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 de minimis in Second Quarter 2020 and $25 million in Six Months 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 $47 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. As in the case of first lien transactions, second lien transactions have seen an increase in early-stage delinquency because of COVID-19 related forbearances. The Company applies a 20% liquidation rate to such forborn loans same as first lien RMBS transactions.

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 June 30, 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 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 loss to be paid on all second lien U.S. RMBS was $6 million as of June 30, 2020 and total expected recovery was $20 million as of December 31, 2019. The $3 million economic benefit in Second Quarter 2020 and $7 million economic benefit in Six Months 2020 were primarily attributable to higher excess spread and improved performance in certain transactions and higher actual recoveries received for previously charged-off loans, partially offset by COVID-19 related forbearances and, in the case of Six Months 2020, changes in discount rates.

---

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 June 30, 2020							As of March 31, 2020							As of December 31, 2019
	Range					Weighted Average		Range					Weighted Average		Range					Weighted Average
Plateau CDR	6.3	%	-	29.8%		13.0%		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%		2.5	%	-	3.2%		2.5%
Liquidation rates:
Delinquent/Modified in the Previous 12 Months	20%							20%							20%
30 – 59 Days Delinquent	30							30							30
60 – 89 Days Delinquent	40							45							45
90+ Days Delinquent	60							65							65
Bankruptcy	55							55							55
Foreclosure	55							60							55
Real Estate Owned	100							100							100
Loss severity (1)	98%							98%							98%
Projected future recoveries on previously charged-off loans	20%							20%							20%

___________________

(1)    Loss severities on future defaults.

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 $8 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 $9 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 June 30, 2020 was $35 million and is primarily attributable to $76 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 June 30, 2020, the Company's BIG net par in these transactions was $40 million. The economic loss development across all other structured finance transactions during Second Quarter 2020 and Six Months 2020 was $1 million and $2 million, respectively.

---

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 or reduce 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 3, Outstanding Insurance Exposure, for a discussion of the Company's exposure to Puerto Rico and related recovery litigation being pursued by the Company.

5.	Contracts Accounted for as Insurance

Premiums

The portfolio of outstanding exposures discussed in Note 3, Outstanding Insurance Exposure, and Note 4, 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 9, Contracts Accounted for as Credit Derivatives for amounts that relate to CDS and Note 11, Variable Interest Entities for amounts that are accounted for as consolidated FG VIEs.

Net Earned Premiums

 

	Second Quarter								Six Months
	2020				2019				2020				2019
	(in millions)
Financial guaranty:
Scheduled net earned premiums	$	83			$	85			$	165			$	172
Accelerations from refundings and terminations	32				20				47				46
Accretion of discount on net premiums receivable	5				5				10				9
Financial guaranty insurance net earned premiums	120				110				222				227
Specialty net earned premiums	1				2				2				3
Net earned premiums (1)	$	121			$	112			$	224			$	230

 ___________________

(1)	Excludes $1 million and $11 million for Second Quarter 2020 and 2019, respectively, and $2 million and $14 million for Six Months 2020 and 2019, respectively, related to consolidated FG VIEs.

---

Gross Premium Receivable,

Net of Commissions on Assumed Business

Roll Forward 

	Six Months
	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	220				98
Gross premiums received, net of commissions	(156		)		(127		)
Adjustments:
Changes in the expected term	(9		)		(10		)
Accretion of discount, net of commissions on assumed business	9				4
Foreign exchange gain (loss) on remeasurement	(55		)		(3		)
Financial guaranty insurance premium receivable (1)	1,293				865
Specialty insurance premium receivable	1				1
June 30,	$	1,294			$	866

____________________

(1)	Excludes $6 million and $8 million as of June 30, 2020 and June 30, 2019, respectively, related to consolidated FG VIEs.

Approximately 79% and 78% of installment premiums at June 30, 2020 and December 31, 2019, respectively, 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.

Expected Collections of

Financial Guaranty Insurance Gross Premiums Receivable,

Net of Commissions on Assumed Business

(Undiscounted)

	As of June 30, 2020
	(in millions)
2020 (July 1 - September 30)	$	86
2020 (October 1 - December 31)	14
2021	92
2022	106
2023	94
2024	86
2025-2029	342
2030-2034	238
2035-2039	151
After 2039	340
Total (1)	$	1,549

 ____________________

(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 June 30, 2020
	(in millions)
2020 (July 1 - September 30)	$	84
2020 (October 1 - December 31)	82
Subtotal 2020	166
2021	306
2022	281
2023	259
2024	238
2025-2029	930
2030-2034	653
2035-2039	386
After 2039	518
Net deferred premium revenue (1)	3,737
Future accretion	256
Total future net earned premiums	$	3,993

 ____________________

(1)	Excludes net earned premiums on consolidated FG VIEs of $45 million.

Selected Information for Financial Guaranty Insurance

Policies with Premiums Paid in Installments

	As of June 30, 2020				As of December 31, 2019
	(dollars in millions)
Premiums receivable, net of commission payable	$	1,293			$	1,284
Gross deferred premium revenue	1,679				1,637
Weighted-average risk-free rate used to discount premiums	1.6		%		1.7		%
Weighted-average period of premiums receivable (in years)	12.7				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 1.47% with a weighted average of 0.57% as of June 30, 2020 and 0.00% to 2.45% with a weighted average of 1.94% as of December 31, 2019.

---

Net Reserve (Salvage) 

	As of June 30, 2020				As of December 31, 2019
	(in millions)
Public finance:
U.S. public finance	$	341			$	328
Non-U.S. public finance	5				5
Public finance	346				333
Structured finance:
U.S. RMBS (1)	(84		)		(78		)
Other structured finance	41				40
Structured finance	(43		)		(38		)
Total	$	303			$	295

____________________

(1)	Excludes net reserves of $37 million and $33 million as of June 30, 2020 and December 31, 2019, respectively, related to consolidated FG VIEs.

Components of Net Reserves (Salvage)

 

	As of June 30, 2020				As of December 31, 2019
	(in millions)
Loss and LAE reserve	$	1,076			$	1,050
Reinsurance recoverable on unpaid losses (1)	(9		)		(38		)
Loss and LAE reserve, net	1,067				1,012
Salvage and subrogation recoverable	(795		)		(747		)
Salvage and subrogation reinsurance payable (2)	31				30
Salvage and subrogation recoverable, net	(764		)		(717		)
Net reserves (salvage)	$	303			$	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.

The table below provides a reconciliation of net expected loss to be paid for financial guaranty insurance contracts to net expected loss to be expensed. Expected loss to be paid for financial guaranty insurance contracts 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 June 30, 2020
	(in millions)
Net expected loss to be paid - financial guaranty insurance	$	682
Contra-paid, net	39
Salvage and subrogation recoverable, net, and other recoverable	764
Loss and LAE reserve - financial guaranty insurance contracts, net of reinsurance	(1,065		)
Net expected loss to be expensed (present value) (1)	$	420

____________________

(1)    Excludes $32 million as of June 30, 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 June 30, 2020
	(in millions)
2020 (July 1 - September 30)	$	9
2020 (October 1 - December 31)	9
Subtotal 2020	18
2021	36
2022	37
2023	34
2024	33
2025-2029	131
2030-2034	89
2035-2039	33
After 2039	9
Net expected loss to be expensed	420
Future accretion	56
Total expected future loss and LAE	$	476

 

---

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)
	Second Quarter								Six Months
	2020				2019				2020				2019
	(in millions)
Public finance:
U.S. public finance	$	33			$	94			$	92			$	164
Non-U.S. public finance	—				(8		)		—				(8		)
Public finance	33				86				92				156
Structured finance:
U.S. RMBS (1)	4				(88		)		(38		)		(115		)
Other structured finance	—				1				3				4
Structured finance	4				(87		)		(35		)		(111		)
Loss and LAE	$	37			$	(1	)		$	57			$	45

____________________

(1)	Excludes a loss of $2 million and a benefit of $14 million for Second Quarter 2020 and 2019, respectively, and a loss of $8 million and a benefit of $15 million for Six Months 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 June 30, 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)	112				(1		)		19				—				128				(4		)		259				—				259
Remaining weighted-average period (in years)	7.3				4.7				17.3				—				9.3				6.1				9.2				—				9.2
Outstanding exposure:
Par	$	2,493			$	(11	)		$	511			$	—			$	5,326			$	(68	)		$	8,251			$	—			$	8,251
Interest	944				(3		)		436				—				2,291				(18		)		3,650				—				3,650
Total (2)	$	3,437			$	(14	)		$	947			$	—			$	7,617			$	(86	)		$	11,901			$	—			$	11,901
Expected cash outflows (inflows)	$	155			$	(1	)		$	73			$	—			$	4,057			$	(54	)		$	4,230			$	(262	)		$	3,968
Potential recoveries (3)	(604		)		21				(3		)		—				(2,887		)		55				(3,418		)		188				(3,230		)
Subtotal	(449		)		20				70				—				1,170				1				812				(74		)		738
Discount	18				—				(10		)		—				(72		)		(1		)		(65		)		9				(56		)
Present value of expected cash flows	$	(431	)		$	20			$	60			$	—			$	1,098			$	—			$	747			$	(65	)		$	682
Deferred premium revenue	$	134			$	—			$	23			$	—			$	453			$	(3	)		$	607			$	(45	)		$	562
Reserves (salvage)	$	(465	)		$	20			$	41			$	—			$	740			$	2			$	338			$	(37	)		$	301

 

---

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.

6.	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.

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 June 30, 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 $248 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.

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 June 30, 2020, an estimated $1.3 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 June 30, 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.

---

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

	Second Quarter								Six Months
	2020				2019				2020				2019
Premiums Written:
Direct	$	148			$	50			$	212			$	89
Assumed	1				1				1				1
Ceded (1)	2				(2		)		2				13
Net	$	151			$	49			$	215			$	103
Premiums Earned:
Direct	$	113			$	99			$	207			$	204
Assumed	10				15				20				30
Ceded	(2		)		(2		)		(3		)		(4		)
Net	$	121			$	112			$	224			$	230
Loss and LAE:
Direct	$	38			$	—			$	46			$	54
Assumed	(1		)		1				11				2
Ceded	—				(2		)		—				(11		)
Net	$	37			$	(1	)		$	57			$	45

____________________

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

Ceded Reinsurance (1)

	As of June 30, 2020				As of December 31, 2019
	(in millions)
Ceded premium payable, net of commissions	$	17			$	20
Ceded expected loss to be recovered (paid)	(20		)		11
Financial guaranty ceded par outstanding (2)	886				1,349
Specialty ceded exposure (see Note 3)	303				303

____________________

(1)

The total collateral posted by all non-affiliated reinsurers required to post, or that had agreed to post, collateral as of June 30, 2020 and December 31, 2019 was approximately $18 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 BIG rated reinsurers, $79 million and $224 million is rated BIG as of June 30, 2020 and December 31, 2019, respectively.

---

Commutations

In Second Quarter 2020, the Company reassumed a previously ceded portfolio of insured business from its largest remaining legacy third party financial guaranty reinsurer, which includes $118 million in net par of Puerto Rico exposures.

Commutations of Ceded Reinsurance Contracts

	Second Quarter								Six Months
	2020				2019				2020				2019
	(in millions)
Increase in net unearned premium reserve	$	5			$	15			$	5			$	15
Increase in net par outstanding	336				1,069				336				1,069
Commutation gains (losses)	38				1				38				1

7.	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 Six Months 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 Six Months 2020. There was a transfer of a fixed-maturity security from Level 2 into Level 3 during Second Quarter 2019 and Six Months 2019. There were no other transfers into or from Level 3 during the period presented.

 

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 June 30, 2020, the Company used models to price 159 securities, including securities that were purchased or obtained for loss mitigation or other risk management purposes, with a Level 3 fair value of $1,094 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 gains (losses) on committed capital securities in the condensed consolidated statements 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.

 

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 contracts 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 June 30, 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. 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 0.23% to 0.89% at June 30, 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 June 30, 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.

 

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 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 typically 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 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 several Assured Investment Management investment vehicles listed below (collectively, the consolidated investment vehicles). All consolidated investment vehicles are accounted for at fair value. See Note 11, Variable Interest Entities.

The Assured Investment Management funds that are consolidated (consolidated Assured Investment Management funds) are:

•	AHP Capital Solutions, LP (AHP),

•	AIM Asset Backed Income Fund (US) L.P. (ABIF),

•	BlueMountain CLO Warehouse Fund (US) L.P. (CLO Warehouse Fund), and

•	AIM Municipal Bond Fund L.P. (AMBF).

The CLO Warehouse Fund invested in the following entities managed by Assured Investment Management, and which are also consolidated:

•	BlueMountain CLO XXVI Ltd. (CLO XXVI),

•	BlueMountain CLO XXIX Ltd. (CLO XXIX), and

•	BlueMountain CLO Warehouse Ltd. (CLOWH).

CLO XXVI and CLO XXIX, which are CLOs managed by Assured Investment Management (collectively, the consolidated CLOs), are collateralized financing entities (CFE) under Accounting Standards Codification (ASC) 810, Consolidation, and have elected to measure assets and liabilities using the fair value of their respective assets, which are more observable. The financial assets of consolidated CLOs are all Level 2 assets, and therefore more observable than the fair value of the financial liabilities of consolidated CLOs, which are all Level 3 liabilities. As a result, the financial assets of consolidated CLOs are measured at fair value and the financial liabilities of consolidated CLOs 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). CLOWH is not a CFE. The assets and liabilities of CLOWH are recorded at fair value under the fair value option.

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, municipal bonds, short-term and other investments. Assets supporting consolidated CLOs and certain assets of the consolidated funds are Level 2. Short-term investments are classified as Level 1. The remainder of the invested assets of consolidated funds are Level 3. Liabilities include various tranches of CLO debt, which are classified as Level 3 and securities sold short, which are classified as Level 2 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.

---

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 June 30, 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	$	4,113			$	—			$	4,016			$	97
U.S. government and agencies	174				—				174				—
Corporate securities	2,389				—				2,360				29
Mortgage-backed securities:
RMBS	635				—				381				254
Commercial mortgage-backed securities (CMBS)	411				—				411				—
Asset-backed securities	768				—				54				714
Non-U.S. government securities	140				—				140				—
Total fixed-maturity securities	8,630				—				7,536				1,094
Short-term investments	821				754				67				—
Other invested assets (1)	15				9				—				6
FG VIEs’ assets, at fair value	318				—				—				318
Assets of consolidated investment vehicles:
Fund investments
Debt securities	63				—				3				60
Equity securities and warrants	54				—				1				53
Structured products	43				—				37				6
Obligations of state and political subdivisions	39				—				39				—
CLO investments
Debt securities	850				—				850				—
Short-term investments	403				403				—				—
Total assets of consolidated investment vehicles	1,452				403				930				119
Other assets	160				41				42				77
Total assets carried at fair value	$	11,396			$	1,207			$	8,575			$	1,614
Liabilities:
Credit derivative liabilities	$	163			$	—			$	—			$	163
FG VIEs’ liabilities with recourse, at fair value	332				—				—				332
FG VIEs’ liabilities without recourse, at fair value	20				—				—				20
Liabilities of consolidated investment vehicles:
CLO obligations of CFE	806				—				—				806
Securities sold short	30				—				30				—
Total liabilities of consolidated investment vehicles	836				—				30				806
Total liabilities carried at fair value	$	1,351			$	—			$	30			$	1,321

 

---

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:
Fund investments
Debt securities	47				—				—				47
Equity securities and warrants	17				—				—				17
CLO investments
Debt securities	494				—				494				—
Total 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
CLO obligations of CFE	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.

---

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 Second Quarter 2020, Second Quarter 2019, Six Months 2020 and Six Months 2019.

Rollforward of Level 3 Assets

At Fair Value on a Recurring Basis

Second Quarter 2020

	Fixed-Maturity Securities																									Assets of Consolidated Investment Vehicles
	Obligations of State and Political Subdivisions					Corporate Securities					RMBS					Asset- Backed Securities					FG VIEs’ Assets at Fair Value					Debt Securities					Equity Securities and Warrants					Structured Products					Other (7)
	(in millions)
Fair value as of March 31, 2020	$	86				$	26				$	253				$	596				$	368				$	52				$	32				$	12				$	103
Total pretax realized and unrealized gains/(losses) recorded in:
Net income (loss)	1			(1	)	1			(1	)	2			(1	)	7			(1	)	(50		)	(2	)	3			(4	)	7			(4	)	3			(4	)	(25		)	(3	)
Other comprehensive income (loss)	10					2					12					17					—					—					—					—					—
Purchases	—					—					—					118					—					5					17					5					—
Sales	—					—					—					(21		)			—					—					(3		)			(14		)			—
Settlements	—					—					(13		)			(3		)			(18		)			—					—					—					—
VIE consolidations	—					—					—					—					18					—					—					—					—
Fair value as of June 30, 2020	$	97				$	29				$	254				$	714				$	318				$	60				$	53				$	6				$	78
Change in unrealized gains/(losses) included in earnings related to financial instruments held as of June 30, 2020																					$	25		(2	)	$	3		(4	)	$	7		(4	)	$	1		(4	)	$	(25	)	(3	)
Change in unrealized gains/(losses) included in OCI related to financial instruments held as of June 30, 2020	$	10				$	2				$	11				$	16																								$	—

---

Rollforward of Level 3 Liabilities

At Fair Value on a Recurring Basis

Second 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 March 31, 2020	$	(262	)			$	(312	)			$	(82	)			$	(426	)
Total pretax realized and unrealized gains/(losses) recorded in:
Net income (loss)	100			(6	)	(12		)	(2	)	63			(2	)	(18		)	(4	)
Other comprehensive income (loss)	—					(7		)			—					—
Issuances	—					—					—					(362		)
Settlements	1					15					2					—
VIE consolidations	—					(16		)			(3		)			—
Fair value as of June 30, 2020	$	(161	)			$	(332	)			$	(20	)			$	(806	)
Change in unrealized gains/(losses) included in earnings related to financial instruments held as of June 30, 2020	$	100		(6	)	$	(11	)	(2	)	$	(11	)	(2	)	$	(18	)	(4	)
Change in unrealized gains/(losses) included in OCI related to financial instruments held as of June 30, 2020						$	(7	)

Rollforward of Level 3 Assets and Liabilities

At Fair Value on a Recurring Basis

Second 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 March 31, 2019	$	104				$	48				$	318				$	958				$	560				$	68				$	(228	)			$	(505	)			$	(104	)
Total pretax realized and unrealized gains/(losses) recorded in:
Net income (loss)	1			(1	)	1			(1	)	5			(1	)	30			(1	)	47			(2	)	19			(3	)	(8		)	(6	)	(20		)	(2	)	(3		)	(2	)
Other comprehensive income (loss)	—					(1		)			15					(85		)			—					—					—					5					—
Purchases	—					—					—					8					—					—					—					—					—
Settlements	—					—					(13		)			(238		)			(75		)			—					20					69					1
FG VIE deconsolidation	—					—					—					—					(6		)			—					—					5					1
Transfers into Level 3	—					—					—					1					—					—					—					—					—
Fair value as of June 30, 2019	$	105				$	48				$	325				$	674				$	526				$	87				$	(216	)			$	(446	)			$	(105	)
Change in unrealized gains/(losses) included in earnings related to financial instruments held as of June 30, 2019																					$	52		(2	)	$	19		(3	)	$	(7	)	(6	)	$	(20	)	(2	)	$	(12	)	(2	)
Change in unrealized gains/(losses) included in OCI related to financial instruments held at June 30, 2019	$	—				$	(1	)			$	15				$	8									$	—									$	5

---

Rollforward of Level 3 Assets

At Fair Value on a Recurring Basis

Six Months 2020

	Fixed-Maturity Securities																									Assets of Consolidated Investment Vehicles
	Obligations of State and Political Subdivisions					Corporate Securities					RMBS					Asset- Backed Securities					FG VIEs’ Assets at Fair Value					Debt Securities					Equity Securities and Warrants					Structured Products					Other (7)
	(in millions)
Fair value as of December 31, 2019	$	107				$	41				$	308				$	658				$	442				$	47				$	17				$	—				$	55
Total pretax realized and unrealized gains/(losses) recorded in:
Net income (loss)	2			(1	)	(6		)	(1	)	5			(1	)	14			(1	)	(87		)	(2	)	8			(4	)	3			(4	)	3			(4	)	23			(3	)
Other comprehensive income (loss)	(11		)			(6		)			(35		)			(42		)			—					—					—					—					—
Purchases	—					—					—					118					—					5					50					17					—
Sales	—					—					—					(23		)			—					—					(17		)			(14		)			—
Settlements	(1		)			—					(24		)			(10		)			(55		)			—					—					—					—
VIE consolidations	—					—					—					—					18					—					—					—					—
Transfers out of Level 3	—					—					—					(1		)			—					—					—					—					—
Fair value as of June 30, 2020	$	97				$	29				$	254				$	714				$	318				$	60				$	53				$	6				$	78
Change in unrealized gains/(losses) included in earnings related to financial instruments held as of June 30, 2020																					$	(11	)	(2	)	$	8		(4	)	$	3		(4	)	$	1		(4	)	$	23		(3	)
Change in unrealized gains/(losses) included in OCI related to financial instruments held as of June 30, 2020	$	(11	)			$	(6	)			$	(34	)			$	(41	)																							$	—

---

Rollforward of Level 3 Liabilities

At Fair Value on a Recurring Basis

Six Months 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)	23			(6	)	4			(2	)	74			(2	)	37			(4	)
Other comprehensive income (loss)	—					6					—					—
Issuances	—					—					—					(362		)
Settlements	1					41					11					—
VIE consolidations	—					(16		)			(3		)			—
Fair value as of June 30, 2020	$	(161	)			$	(332	)			$	(20	)			$	(806	)
Change in unrealized gains/(losses) included in earnings related to financial instruments held as of June 30, 2020	$	27		(6	)	$	4		(2	)	$	(1	)	(2	)	$	37		(4	)
Change in unrealized gains/(losses) included in OCI related to financial instruments held as of June 30, 2020						$	6

---

Rollforward of Level 3 Assets and Liabilities

At Fair Value on a Recurring Basis

Six Months 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)	2			(1	)	(10		)	(1	)	11			(1	)	44			(1	)	64			(2	)	10			(3	)	(30		)	(6	)	(31		)	(2	)	(7		)	(2	)
Other comprehensive income (loss)	5					2					20					(94		)			—					—					—					5					—
Purchases	—					—					11					18					—					—					—					—					—
Settlements	(1		)			—					(26		)			(242		)			(101		)			—					21					92					3
FG VIE deconsolidation	—					—					—					—					(6		)			—					—					5					1
Transfers into Level 3	—					—					—					1					—					—					—					—					—
Fair value as of June 30, 2019	$	105				$	48				$	325				$	674				$	526				$	87				$	(216	)			$	(446	)			$	(105	)
Change in unrealized gains/(losses) included in earnings related to financial instruments held as of June 30, 2019																					$	72		(2	)	$	10		(3	)	$	(28	)	(6	)	$	(31	)	(2	)	$	(15	)	(2	)
Change in unrealized gains/(losses) included in OCI related to financial instruments held at June 30. 2019	$	5				$	2				$	20				$	11									$	—									$	5

 ____________________

(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.

---

Level 3 Fair Value Disclosures

 

Quantitative Information About Level 3 Fair Value Inputs

At June 30, 2020

Financial Instrument Description		Fair Value at June 30, 2020 (in millions)				Significant Unobservable Inputs		Range					Weighted Average (5)
Assets (2):
Fixed-maturity securities (1):
Obligations of state and political subdivisions		$	97			Yield		5.3	%	-	35.3%		10.9%
Corporate securities		29				Yield		45.3%
RMBS		254				CPR		2.7	%	-	15.0%		6.5%
						CDR		1.5	%	-	7.5%		5.4%
						Loss severity		45.0	%	-	125.0%		83.4%
						Yield		4.5	%	-	7.2%		5.5%
Asset-backed securities:
Life insurance transactions		335				Yield		5.5%
CLOs /Trust preferred securities (TruPS)		342				Yield		1.5	%	-	4.2%		2.4%
Others		37				Yield		13.3%
FG VIEs’ assets, at fair value (1)		318				CPR		0.4	%	-	18.8%		8.6%
						CDR		1.2	%	-	26.5%		5.3%
						Loss severity		45.0	%	-	100.0%		79.7%
						Yield		2.9	%	-	8.7%		5.9%
Assets of consolidated investment vehicles (3):
Debt securities		60				Discount rate		14.9	%	-	23.4%		18.5%
						Market multiple - enterprise/revenue value		0.66x
						Market multiple - enterprise/EBITDA (4)		10.0x
Equity securities and warrants		53				Discount rate		14.9	%	-	26.9%		25.6%
						Market multiple - enterprise/revenue value		0.66x
						Market multiple - enterprise/EBITDA		8.1x		-	10.0x
						Yield		10.1%
Structured products		6				Yield		4.8	%	-	11.6%		7.4%
Other assets (1)		75				Implied Yield		4.0	%	-	4.8%		4.4%
						Term (years)		10 years

---

Financial Instrument Description (1)		Fair Value at June 30, 2020 (in millions)				Significant Unobservable Inputs		Range					Weighted Average (5)
Liabilities:
Credit derivative liabilities, net		$	(161	)		Year 1 loss estimates		0.0	%	-	83.0%		2.1%
						Hedge cost (in basis points (bps))		21.0		-	119.0		44.0
						Bank profit (in bps)		44.0		-	289.0		107.0
						Internal floor (in bps)		9.0		-	30.0		9.0
						Internal credit rating		AAA		-	CCC		AA-
FG VIEs’ liabilities, at fair value		(352		)		CPR		0.4	%	-	18.8%		8.6%
						CDR		1.2	%	-	26.5%		5.3%
						Loss severity		45.0	%	-	100.0%		79.7%
						Yield		1.9	%	-	8.3%		4.6%
Liabilities of consolidated investment vehicles:
CLO obligations of CFE (6)		(806		)		Yield		2.6	%	-	13.4%		3.0%

___________________

(1)	Discounted cash flow is used as the primary valuation technique.

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

(3)	The primary inputs to the valuation are data on comparable companies, including market multiples, yields/discount rates, financial projections, and recent market transaction prices where available.

(4)	Earnings before interest, taxes, depreciation, and amortization.

(5)	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.

(6)	See CFE fair value methodology described above for consolidated CLOs.

---

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):
Debt securities		47				Discount rate		16.0	%	-	28.0%		21.5%
						Market multiple - enterprise/revenue value		0.5x
						Market multiple - enterprise/EBITDA		9.5x
Equity securities and warrants		17				Discount rate		16.0	%	-	28.0%		20.8%
						Market multiple - enterprise/revenue value		0.5x
						Market multiple - enterprise/EBITDA		9.5x
						Yield		12.5%
Other assets (1)		52				Implied Yield		5.1	%	-	5.8%		5.5%
						Term (years)		10 years

---

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 of CFE		(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 a 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.

 

Due From/To Brokers and Counterparties

Due from/to brokers and counterparties primarily consists of cash, margin deposits, and cash collateral with the clearing brokers and various counterparties and the net amounts receivable/payable for securities transactions that had not settled at the balance sheet date. Due from/to brokers and counterparties represent balances on a net-by counterparty basis on the consolidated balance sheet where a contractual right of offset exists under an enforceable netting arrangement. The cash at brokers is partially related to collateral for securities sold short and derivative contracts; its use is therefore restricted until the

---

securities are purchased or the derivative contracts are closed. The fair value of these items is approximated by carrying value and such items are considered Level 1. 

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 June 30, 2020								As of December 31, 2019
	Carrying Amount				Estimated Fair Value				Carrying Amount				Estimated Fair Value
	(in millions)
Assets (liabilities):
Other invested assets	$	—			$	2			$	1			$	2
Other assets (1)	84				84				97				97
Financial guaranty insurance contracts (2)	(2,724		)		(4,568		)		(2,714		)		(4,013		)
Long-term debt	(1,222		)		(1,517		)		(1,235		)		(1,573		)
Other liabilities (1)	(36		)		(36		)		(14		)		(14		)
Assets (liabilities) of consolidated investment vehicles:
Due from brokers and counterparties	41				41				—				—
Due to brokers and counterparties	(400		)		(400		)		—				—

____________________

(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.

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 credit impairment of financial assets.

Investment Portfolio

As of June 30, 2020, the majority of the investment portfolio is managed by six outside managers. 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 Investors Service, Inc. (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 (i) securities acquired for loss mitigation purposes or other risk management purposes, (ii) securities managed under Investment Management Agreements (IMAs) with BlueMountain, and (iii) other alternative investments, including both equity and debt securities, that the Company believes present an attractive investment opportunity. Alternative investments include assets invested in Assured Investment Management funds, which are accounted for as consolidated investment vehicles and therefore not included in this note.

    

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).

---

The insurance subsidiaries currently intend to invest $500 million in Assured Investment Management funds. As of June 30, 2020, the Insurance segment had committed capital to the four consolidated Assured Investment Management funds, of which $354 million has been drawn by the respective Assured Investment Management funds, and which had a fair value of $367 million as of June 30, 2020. The remaining outstanding commitment to the Assured Investment Management funds was $112 million as of June 30, 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 June 30, 2020 and December 31, 2019. See Note 11, Variable Interest Entities.

In Second Quarter 2020, AGM, AGC and MAC entered into IMAs with BlueMountain to manage a portfolio of municipal obligations and a portfolio of CLOs. As of June 30, 2020, they have together allocated $250 million to municipal obligation strategies and $100 million to CLO strategies, with authorization to allocate an additional $200 million to CLOs strategies.

The Company has agreed to purchase up to $100 million of limited partnership interests in a fund that invests in the equity of private equity managers of which $84 million of the commitment was not funded as of June 30, 2020. The Company has also invested in a limited liability company that owns fuel cells with a fair value of $61 million as of June 30, 2020.

Investment Portfolio

Carrying Value

	As of June 30, 2020				As of December 31, 2019
	(in millions)
Fixed-maturity securities (1):
Externally managed	$	7,503			$	7,978
Internally managed:
Assured Investment Management	354				—
Loss mitigation and other securities	773				876
Short-term investments	821				1,268
Other invested assets
Equity method investments	107				111
Other	15				7
Total	$	9,573			$	10,240

____________________

(1)	7.7% and 8.6% of fixed-maturity securities are rated BIG as of June 30, 2020 and December 31, 2019, respectively.

Accrued investment income, which is recorded in other assets, was $75 million and $79 million as of June 30, 2020 and December 31, 2019, respectively. In Six Months 2020, the Company did not write off any accrued investment income.

---

Fixed-Maturity Securities and Short-Term Investments

by Security Type 

As of June 30, 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	%		$	3,789			$	(11	)		$	336			$	(1	)		$	4,113			$	(1	)		AA-
U.S. government and agencies		2			160				—				14				—				174				—				AA+
Corporate securities		26			2,327				(38		)		138				(38		)		2,389				(18		)		A
Mortgage-backed securities (4):		0
RMBS		7			649				(20		)		37				(31		)		635				(29		)		A-
CMBS		4			384				—				27				—				411				—				AAA
Asset-backed securities		8			780				(6		)		12				(18		)		768				(4		)		BBB-
Non-U.S. government securities		2			148				—				1				(9		)		140				—				AA
Total fixed-maturity securities		91			8,237				(75		)		565				(97		)		8,630				(52		)		A+
Short-term investments		9			821				—				1				(1		)		821				—				AAA
Total		100	%		$	9,058			$	(75	)		$	566			$	(98	)		$	9,451			$	(52	)		A+

---

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 39% of mortgage backed securities as of June 30, 2020 and 42% as of December 31, 2019 based on fair value.

---

Fixed-Maturity Securities

Gross Unrealized Loss by Length of Time

For Which an Allowance for Credit Loss was Not Recorded

As of June 30, 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	$	35			$	(1	)		$	—			$	—			$	35			$	(1	)
Corporate securities	341				(8		)		61				(12		)		402				(20		)
Mortgage-backed securities:
RMBS	30				(2		)		1				—				31				(2		)
CMBS	—				—				1				—				1				—
Asset-backed securities	468				(10		)		118				(3		)		586				(13		)
Non-U.S. government securities	74				(1		)		40				(8		)		114				(9		)
Total	$	948			$	(22	)		$	221			$	(23	)		$	1,169			$	(45	)
Number of securities (1)					196								65								244

 

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 for which an allowance for credit loss was not recorded, 25 securities had unrealized losses in excess of 10% of their carrying value as of June 30, 2020. The total unrealized loss for these securities was $18 million as of June 30, 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 recorded as of June 30, 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 June 30, 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 June 30, 2020

 

	Amortized Cost				Estimated Fair Value
	(in millions)
Due within one year	$	338			$	335
Due after one year through five years	1,577				1,631
Due after five years through 10 years	1,994				2,078
Due after 10 years	3,295				3,540
Mortgage-backed securities:
RMBS	649				635
CMBS	384				411
Total	$	8,237			$	8,630

 

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 $290 million and $280 million, as of June 30, 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 $1,422 million and $1,502 million, based on fair value as of June 30, 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 (excluding investments accounted for under the equity method, which are recorded in equity in earnings of investees in the condensed consolidated statements of operations). 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

 

	Second Quarter								Six Months
	2020				2019				2020				2019
	(in millions)
Interest income:
Externally managed	$	62			$	69			$	124			$	141
Internally managed	18				43				38				71
Interest income	80				112				162				212
Investment expenses	(2		)		(2		)		(4		)		(4		)
Net investment income	$	78			$	110			$	158			$	208

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)

 

	Second Quarter								Six Months
	2020				2019				2020				2019
	(in millions)
Gross realized gains on available-for-sale securities	$	16			$	13			$	23			$	19
Gross realized losses on available-for-sale securities	(8		)		(1		)		(9		)		(3		)
Credit impairments (1)	(4		)		(4		)		(15		)		(20		)
Net realized investment gains (losses) (2)	$	4			$	8			$	(1	)		$	(4	)

____________________

(1)

Credit impairment in Second Quarter 2020 and Six Months 2020 was 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 losses in Six Months 2020. Credit impairment in Second Quarter 2019 was primarily attributable to foreign exchange losses while Six Months 2019 was primarily attributable to loss mitigation securities and foreign exchange losses.

(2)	Includes foreign currency losses of $2 million for Second Quarter 2020, $3 million for Second Quarter 2019 and $5 million for Six Months 2019, and foreign currency gains of $1 million for Six Months 2020.

The proceeds from sales of fixed-maturity securities classified as available-for-sale were $404 million in Second Quarter 2020, $443 million in Second Quarter 2019, $490 million in Six Months 2020 and $914 million in Six Months 2019.

---

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

for Fixed-Maturity Securities

	Second Quarter								Six Months
	2020				2019				2020				2019
	(in millions)
Balance, beginning of period	$	73			$	197			$	—			$	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	—				—				1				—
Reductions for securities sold and other settlements	(1		)		(6		)		(1		)		(6		)
Additions (reductions) for credit losses on securities for which credit impairments were previously recognized	3				—				13				12
Balance, end of period	$	75			$	191			$	75			$	191

9.	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.

 

---

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 June 30, 2020 and December 31, 2019, respectively.

 

Credit Derivatives (1)

 

		As of June 30, 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		$	2,195			$	(66	)		$	1,942			$	(83	)
Non-U.S. public finance		2,327				(29		)		2,676				(39		)
U.S. structured finance		1,119				(61		)		1,206				(58		)
Non-U.S. structured finance		124				(5		)		132				(5		)
Total		$	5,765			$	(161	)		$	5,956			$	(185	)

____________________

(1)    Expected recoveries were $14 million as of June 30, 2020 and $4 million as of December 31, 2019.

Distribution of Credit Derivative Net Par Outstanding by Internal Rating

 

		As of June 30, 2020							As of December 31, 2019
Ratings		Net Par Outstanding				% of Total			Net Par Outstanding				% of Total
		(dollars in millions)
AAA		$	1,594			27.6	%		$	1,730			29.0	%
AA		1,728				30.0			1,695				28.5
A		848				14.7			1,110				18.6
BBB		1,470				25.5			1,292				21.7
BIG (1)		125				2.2			129				2.2
Credit derivative net par outstanding		$	5,765			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)

 

	Second Quarter								Six Months
	2020				2019				2020				2019
	(in millions)
Realized gains on credit derivatives	$	1			$	1			$	3			$	4
Net credit derivative losses (paid and payable) recovered and recoverable and other settlements	(1		)		(21		)		(3		)		(25		)
Realized gains (losses) and other settlements	—				(20		)		—				(21		)
Net unrealized gains (losses)	100				12				23				(9		)
Net change in fair value of credit derivatives	$	100			$	(8	)		$	23			$	(30	)

     Realized losses and other settlements for Second Quarter 2019 and Six Months 2019 were primarily due to a final

maturity paydown of a U.S. structured finance transaction, for which there was an offsetting unrealized gain.

---

During Second Quarter 2020, unrealized gains were generated primarily as a result of price improvements of the underlying collateral.  These gains were partially offset by losses due to the decreased cost to buy protection on AGC, as the market cost of AGC's credit protection decreased 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, decreased, the implied spreads that the Company (or another comparable entity) would expect to receive on these transactions increased.

During Six Months 2020, unrealized gains were generated primarily as a result of the increased cost to buy protection on AGC, as the market cost of AGC's credit protection increased during the period. These gains were partially offset by the wider spreads of the underlying collateral and lower discount rates.

During Second Quarter 2019, unrealized gains were generated primarily as a result of a final maturity paydown of a CDS contract and price improvements. These items were partially offset by wider implied net spreads driven by the decreased market cost to buy protection in AGC’s name during the period.

During Six Months 2019, unrealized losses were generated primarily as a result of wider implied net spreads driven by the decreased market cost to buy protection in AGC’s name during the period. These losses were partially offset by the price improvements.

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 June 30, 2020			As of March 31, 2020			As of December 31, 2019			As of June 30, 2019			As of March 31, 2019			As of December 31, 2018
Five-year CDS spread	159			224			41			56			74			110
One-year CDS spread	32			64			9			13			20			22

Fair Value of Credit Derivative Assets (Liabilities)

and Effect of AGC

Credit Spread

	As of June 30, 2020				As of December 31, 2019
	(in millions)
Fair value of credit derivatives before effect of AGC credit spread	$	(388	)		$	(261	)
Plus: Effect of AGC credit spread	227				76
Net fair value of credit derivatives	$	(161	)		$	(185	)

The fair value of CDS contracts at June 30, 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 $148 million in CDS net par insured by the Company requires the Company to post collateral, subject to a $148 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 June 30, 2020, AGC did not need to post collateral to satisfy these requirements.

---

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

Asset Management Fees

	Second Quarter 2020				Six Months 2020
	(in millions)
Management fees:
CLOs (1)	$	3			$	7
Opportunity funds	2				4
Wind-down funds	6				15
Total management fees	11				26
Reimbursable fund expenses	9				17
Total asset management fees (2)	$	20			$	43

_____________________

(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 $7 million for Second Quarter 2020 and $17 million for Six Months 2020.

(2)

There were no performance fees for Second Quarter 2020 and Six Months 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.

11.	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 4, Expected Loss to be Paid.

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 both June 30, 2020 and December 31, 2019, the Company consolidated 27 FG VIEs. During Six Months 2020 there were two FG VIEs that matured and two FG VIEs that were consolidated. During Six Months 2019, two FG VIEs were deconsolidated. There were no other consolidations or deconsolidations for the periods presented.

The change in the ISCR of the FG VIEs’ assets held as of June 30, 2020 that was recorded in the condensed consolidated statements of operations for Second Quarter 2020 and Six Months 2020 were losses of $13 million and $16 million, respectively. The change in the ISCR of the FG VIEs’ assets were gains of $29 million and $35 million for Second Quarter 2019 and Six Months 2019, respectively. 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 June 30, 2020				As of December 31, 2019
	(in millions)
Excess of unpaid principal over fair value of:
FG VIEs’ assets	$	312			$	279
FG VIEs’ liabilities with recourse	30				21
FG VIEs’ liabilities without recourse	38				19
Unpaid principal balance for FG VIEs’ assets that were 90 days or more past due	49				52
Unpaid principal for FG VIEs’ liabilities with recourse (1)	362				388

____________________

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

---

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 June 30, 2020								As of December 31, 2019
	Assets				Liabilities				Assets				Liabilities
	(in millions)
With recourse:
U.S. RMBS first lien	$	228			$	261			$	270			$	297
U.S. RMBS second lien	59				59				70				70
Other	11				12				—				—
Total with recourse	298				332				340				367
Without recourse	20				20				102				102
Total	$	318			$	352			$	442			$	469

Consolidated Investment Vehicles

Through a jointly owned subsidiary, AGM, AGC and MAC, the U.S. insurance subsidiaries, intend to invest $500 million in Assured Investment Management funds. As of June 30, 2020 and December 31, 2019, $354 million and $79 million, respectively, was invested in Assured Investment Management funds. As of June 30, 2020 and December 31, 2019, the fair value of such investments in the Insurance segment was $367 million and $77 million, respectively. CLO Warehouse Fund invested in the subordinated notes of certain CLOs managed by Assured Investment Management, and which are also consolidated.

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 a jointly owned subsidiary of its U.S. insurance subsidiaries).

Each of the consolidated Assured Investment Management funds are investment companies for accounting purposes and therefore account for their underlying investments at fair value. The consolidated CLOs are CFEs. Under the practical expedient for CFEs, the Company elected to measure the consolidated CLOs’ assets and liabilities using the fair value of their 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.

    

Upon consolidation of an Assured Investment Management fund, the Company records noncontrolling interest (NCI) for the portion of each fund owned by employees and any third party investors. Redeemable employee-owned NCI is classified outside of shareholders’ equity, within temporary equity, and non-redeemable employee-owned NCI is presented within shareholders' equity in the consolidated balance sheets. During the first quarter of 2020 and Second Quarter 2020, redemption features for certain employee-owned interests were amended resulting in reclassifications from redeemable NCI to non-redeemable NCI.

The assets and liabilities of the Company's consolidated investment vehicles 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 investment vehicles and FG VIEs has a significant 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 through a jointly owned subsidiary of the U.S. insurance subsidiaries. The ownership interests of the Company's consolidated funds, to which the Company has no economic rights, are reflected as either redeemable or nonredeemable NCI in the

---

condensed 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 June 30, 2020				As of December 31, 2019
	(in millions)
Assets (1):
Fund assets:
Cash and cash equivalents	$	174			$	2
Fund investments, at fair value (2)
Debt securities	63				47
Equity securities and warrants	54				17
Structured products	43				—
Obligations of state and political subdivisions	39				—
Due from brokers and counterparties	29				—
CLO assets:
Cash	1				12
CLO investments, at fair value
Debt securities (3)	850				494
Short-term investments	403				—
Other assets	13				—
Total assets	$	1,669			$	572
Liabilities:
CLO obligations of CFE, at fair value (4)	806				481
Securities sold short, at fair value	30				—
Due to brokers and counterparties	400				—
Other liabilities	—				1
Total liabilities	$	1,236			$	482

____________________

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

(2)	Includes investment in affiliates of $53 million and $9 million as of June 30, 2020 and December 31, 2019, respectively.

(3)	Includes $846 million in corporate loans of CFEs as of June 30, 2020 and $494 million as of December 31, 2019.

(4)	The weighted average maturity and weighted average interest rate of CLO obligations were 5.9 years and 2.7%, respectively, for June 30, 2020 and 12.8 years and 3.8%, respectively, for December 31, 2019. CLO obligations will mature at various dates ranging from 2031 to 2032.

As of June 30, 2020, the consolidated investment vehicles had a commitment to invest $12 million.

---

Redeemable Noncontrolling Interests in Consolidated Investment Vehicles

	Second Quarter 2020				Six Months 2020
	(in millions)
Beginning balance	$	8			$	7
Reallocation of ownership interests	(8		)		(10		)
Contributions to investment vehicles	20				25
Net loss	—				(2		)
June 30,	$	20			$	20

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.

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 consolidated CLOs 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 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.

---

Effect of Consolidating FG VIEs and Consolidated Investment Vehicles

on the Condensed Consolidated Balance Sheets

Increase (Decrease)

	As of June 30, 2020				As of December 31, 2019
	(in millions)
Assets
Investment portfolio:
Fixed maturity securities and short-term investments	$	(35	)		$	(39	)
Equity method investments (1)	(367		)		(77		)
Total investments	(402		)		(116		)
Premiums receivable, net of commissions payable	(6		)		(7		)
Salvage and subrogation recoverable	(9		)		(8		)
FG VIEs’ assets, at fair value	318				442
Assets of consolidated investment vehicles (1)	1,669				572
Other assets	(1		)		—
Total assets	$	1,569			$	883
Liabilities and shareholders’ equity
Unearned premium reserve	$	(41	)		$	(39	)
Loss and LAE reserve	(46		)		(41		)
FG VIEs’ liabilities with recourse, at fair value	332				367
FG VIEs’ liabilities without recourse, at fair value	20				102
Liabilities of consolidated investment vehicles (1)	1,236				482
Other liabilities	1				—
Total liabilities	1,502				871
Redeemable noncontrolling interests in consolidated investment vehicles (1)	20				7
Retained earnings	30				34
Accumulated other comprehensive income	(28		)		(35		)
Total shareholders’ equity attributable to Assured Guaranty Ltd.	2				(1		)
Nonredeemable noncontrolling interests (1)	45				6
Total shareholders’ equity	47				5
Total liabilities, redeemable noncontrolling interests and shareholders’ equity	$	1,569			$	883

 ____________________

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

---

Effect of Consolidating FG VIEs and Consolidated Investment Vehicles

on the Condensed Consolidated Statements of Operations

Increase (Decrease)

	Second Quarter								Six Months
	2020				2019				2020				2019
	(in millions)
Net earned premiums	$	(1	)		$	(11	)		$	(2	)		$	(14	)
Net investment income	(2		)		(1		)		(3		)		(2		)
Asset management fees	(1		)		—				(2		)		—
Fair value gains (losses) on FG VIEs	1				33				(8		)		38
Fair value gains (losses) on consolidated investment vehicles	31				—				19				—
Loss and LAE	2				(14		)		8				(15		)
Other operating expense	1				—				1				—
Equity in net earnings of investees	(26		)		—				(16		)		—
Effect on income before tax	5				7				(3		)		7
Less: Tax provision (benefit)	—				1				(1		)		1
Effect on net income (loss)	5				6				(2		)		6
Effect on redeemable noncontrolling interests	5				—				2				—
Effect on net income (loss) attributable to AGL	$	—			$	6			$	(4	)		$	6

The fair value gains on consolidated investment vehicles for Second Quarter 2020 and Six Months 2020 were attributable to price appreciation on underlying assets.

For Second Quarter 2020, the fair value gains on FG VIEs were $1 million, primarily due to price appreciation due to observed tightening in market credit spreads for the underlying collateral, offset in part by the loss on consolidation of a new structured deal. The fair value losses on FG VIEs were $8 million for Six Months 2020, primarily due to price depreciation due to the observed widening in the market spreads for the underlying collateral. For Second Quarter 2019 and Six Months 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 $95 million and liabilities of $13 million as of June 30, 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 3, Outstanding Insurance Exposure, the Company monitors all policies in the insured portfolio. Of the approximately 18 thousand policies monitored as of June 30, 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 June 30, 2020 and December 31, 2019, the Company identified 88 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 27 FG VIEs as of both June 30, 2020 and December 31, 2019. 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 3, 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-

---

12.	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 June 30, 2020				As of December 31, 2019
	(in millions)
Deferred tax assets (liabilities)	$	(45	)		$	(17	)
Current tax assets (liabilities)	48				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 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

 

	Second Quarter								Six Months
	2020				2019				2020				2019
	(in millions)
Expected tax provision (benefit)	$	42			$	38			$	31			$	47
Tax-exempt interest	(4		)		(5		)		(8		)		(10		)
Foreign taxes	(1		)		4				7				5
Taxes on reinsurance	(1		)		3				(1		)		4
Other	(2		)		—				1				(2		)
Total provision (benefit) for income taxes	$	34			$	40			$	30			$	44
Effective tax rate	15.4		%		21.9		%		18.5		%		18.4		%

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

	Second Quarter								Six Months
	2020				2019				2020				2019
	(in millions)
U.S.	$	198			$	190			$	172			$	225
Bermuda	22				—				15				16
U.K. and other	2				(8		)		(27		)		(1		)
Total	$	222			$	182			$	160			$	240

---

Revenue by Tax Jurisdiction

	Second Quarter								Six Months
	2020				2019				2020				2019
	(in millions)
U.S.	$	313			$	227			$	406			$	376
Bermuda	45				40				59				73
U.K. and other	14				(1		)		3				12
Total	$	372			$	266			$	468			$	461

 

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

Audits

As of June 30, 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. In July 2020, the IRS issued a Revenue Agent Report which did not identify any material adjustments. 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 $0.3 million for Six Months 2020 and $1 million for the full year 2019. As of both June 30, 2020 and December 31, 2019, the Company has accrued $2 million of interest.

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 3, 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 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.

---

14.	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

Second 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, March 31, 2020	$	252			$	(66	)		$	(17	)		$	(38	)		$	7			$	138
Other comprehensive income (loss) before reclassifications	184				19				(6		)		—				—				197
Less: Amounts reclassified from AOCI to:
Net realized investment gains (losses)	12				(8		)		—				—				—				4
Fair value gains (losses) on FG VIEs	—				—				(1		)		—				—				(1		)
Total before tax	12				(8		)		(1		)		—				—				3
Tax (provision) benefit	(3		)		2				—				—				—				(1		)
Total amount reclassified from AOCI, net of tax	9				(6		)		(1		)		—				—				2
Net current period other comprehensive income (loss)	175				25				(5		)		—				—				195
Balance, June 30, 2020	$	427			$	(41	)		$	(22	)		$	(38	)		$	7			$	333

---

Changes in Accumulated Other Comprehensive Income by Component

Second 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, March 31, 2019	$	222			$	99			$	(31	)		$	(37	)		$	8			$	261
Other comprehensive income (loss) before reclassifications	90				(40		)		(2		)		(1		)		—				47
Less: Amounts reclassified from AOCI to:
Net realized investment gains (losses)	11				(3		)		—				—				—				8
Net investment income	2				14				—				—				—				16
Fair value gains (losses) on FG VIEs	—				—				(8		)		—				—				(8		)
Total before tax	13				11				(8		)		—				—				16
Tax (provision) benefit	(2		)		(3		)		2				—				—				(3		)
Total amount reclassified from AOCI, net of tax	11				8				(6		)		—				—				13
Net current period other comprehensive income (loss)	79				(48		)		4				(1		)		—				34
Balance, June 30, 2019	$	301			$	51			$	(27	)		$	(38	)		$	8			$	295

Changes in Accumulated Other Comprehensive Income by Component

Six Months 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	28				(42		)		3				—				—				(11		)
Less: Amounts reclassified from AOCI to:
Net realized investment gains (losses)	18				(19		)		—				—				—				(1		)
Fair value gains (losses) on FG VIEs	—				—				(3		)		—				—				(3		)
Total before tax	18				(19		)		(3		)		—				—				(4		)
Tax (provision) benefit	(3		)		4				1				—				—				2
Total amount reclassified from AOCI, net of tax	15				(15		)		(2		)		—				—				(2		)
Net current period other comprehensive income (loss)	13				(27		)		5				—				—				(9		)
Balance, June 30, 2020	$	427			$	(41	)		$	(22	)		$	(38	)		$	7			$	333

---

Changes in Accumulated Other Comprehensive Income by Component

Six Months 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	255				(47		)		(4		)		(1		)		—				203
Less: Amounts reclassified from AOCI to:
Net realized investment gains (losses)	14				(18		)		—				—				—				(4		)
Net investment income	2				14				—				—				—				16
Fair value gains (losses) on FG VIEs	—				—				(10		)		—				—				(10		)
Total before tax	16				(4		)		(10		)		—				—				2
Tax (provision) benefit	(3		)		—				2				—				—				(1		)
Total amount reclassified from AOCI, net of tax	13				(4		)		(8		)		—				—				1
Net current period other comprehensive income (loss)	242				(43		)		4				(1		)		—				202
Balance, June 30, 2019	$	301			$	51			$	(27	)		$	(38	)		$	8			$	295

Share Repurchases

On February 26, 2020, the Board of Directors (the Board) authorized the repurchase of another $250 million of common shares. As of August 6, 2020, the Company was authorized to purchase $149 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 - June 30)		5,956,422			164				27.49
2020 (July 1- August 6)		800,052			19				23.17
Total 2020		10,385,884			$	299			$	28.74

---

 

Computation of Earnings Per Share 

	Second Quarter								Six Months
	2020				2019				2020				2019
	(in millions, except per share amounts)
Basic Earnings Per Share (EPS):
Net income (loss) attributable to AGL	$	183			$	142			$	128			$	196
Less: Distributed and undistributed income (loss) available to nonvested shareholders	—				—				—				—
Distributed and undistributed income (loss) available to common shareholders of AGL and subsidiaries, basic	$	183			$	142			$	128			$	196
Basic shares	86.5				101.2				89.5				102.1
Basic EPS	$	2.11			$	1.40			$	1.43			$	1.92
Diluted EPS:
Distributed and undistributed income (loss) available to common shareholders of AGL and subsidiaries, basic	$	183			$	142			$	128			$	196
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	$	183			$	142			$	128			$	196
Basic shares	86.5				101.2				89.5				102.1
Dilutive securities:
Options and restricted stock awards	0.5				0.7				0.7				0.9
Diluted shares	87.0				101.9				90.2				103.0
Diluted EPS	$	2.10			$	1.39			$	1.42			$	1.90
Potentially dilutive securities excluded from computation of EPS because of antidilutive effect	0.6				0.1				1.2				—

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

•	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;

•	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.

---

---

---

---

---

---

(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.

---

•	fair value gains on credit derivatives in Second Quarter 2020 compared with losses in Second Quarter 2019,

•	commutation gains in Second Quarter 2020,

•	fair value gains in the consolidated Assured Investment Management funds (the consolidated investment vehicles), and

•	foreign exchange gains on remeasurement in Second Quarter 2020 compared with losses in Second Quarter 2019.

---

•	higher foreign exchange losses on remeasurement in Six Months 2020,

•	lower net investment income,

•	fair value losses on FG VIE in Six Months 2020 compared with gains in Six Months 2019, and

•	pretax loss in the Asset Management segment.

•	Insurance

•	Asset Management and Alternative Investments

•	Capital Management

---

•	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.

---

(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.

---

---

(1)	Represents the estimated accretive effect of cumulative repurchases since the beginning of 2013.

---

(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).

---

---

---

---

(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.”

---

---

---

(1)	Primarily related to cash.

---

---

(1)	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 of $917 million as of June 30, 2020 and $819 million as of December 31, 2019.

---

---

•	Loss and LAE in Second Quarter 2020 and Six Months 2020 was mainly driven by loss expense on certain Puerto Rico transactions. For Six Months 2020, these losses were partially offset by a benefit in first lien U.S. RMBS transactions.

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

---

(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.

---

•

the amount of aggregate collateral balance and principal cash of Assured Investment Management'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 secondary 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, and

•	the net asset value of all funds and accounts other than CLOs, plus any unfunded commitments.

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

•	“Intercompany assets under management” or “Intercompany AUM” refers to the assets Assured Investment Management 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 Assured Investment Management 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 Assured Investment Management does not collect fees or has elected to waive or rebate fees to investors. Assured Investment Management reserves the right to waive some or all fees for certain investors, including investors affiliated with Assured Investment Management and/or the Company. Further, to the extent that the Company's wind-down and/or opportunity funds are invested in Assured Investment Management 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 Assured Investment Management.

---

(1)	Includes AUM of the insurance company subsidiaries (intercompany AUM) of $256 million in opportunity funds, $221 million in the CLOs and $351 million in liquid strategies.

---

---

---

---

---

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

---

---

---

---

---

(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, and other GAAP adjustments.

---

•

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.

---

---

•	Constitutionally Guaranteed.

•	Public Corporations – Certain Revenues Potentially Subject to Clawback.

•	Other Public Corporations.

---

(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.

---

---

---

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

---

(1)	As of June 30, 2020 and December 31, 2019, weighted average duration of U.S. Holding Companies' fixed-maturity securities (excluding AGUS' investment in AGMH's debt) was 1.9 years and 4.4 years, respectively.

(2)	Represents receivable and payables with non-guarantor subsidiaries.

---

(1)	See Item 1, Financial Statements, Note 14, Shareholders' Equity, for additional information about share repurchases and authorizations.

(2)	See Long-Term Obligations below for interest paid by subsidiary.

---

(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 Six Months 2020 and $1 million in Six Months 2019. There was no loss on extinguishment of debt in Second Quarter 2020 and Second Quarter 2019.

---

---

•	operating expenses,

•	claims on the insured portfolio,

•	dividends or other distributions to AGL, AGUS and/or AGMH, as applicable,

•	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.

---

(1)	Includes $0.3 million and $11 million recovered for consolidated FG VIEs for Second Quarter 2020 and 2019, respectively, and de minimis amount paid and $12 million recovered for Six Months 2020 and Six Months 2019, respectively.

---

•	The maximum amount available during 2020 for AGM to distribute as dividends without regulatory approval is estimated to be approximately $193 million, of which approximately $87 million is estimated to be available for distribution in the third quarter of 2020.

•	The maximum amount available during 2020 for AGC to distribute as ordinary dividends is approximately $166 million, of which approximately $15 million is available for distribution in the third 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 $19 million, none of which is available for distribution in the third 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 June 30, 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 $226 million as of June 30, 2020, and (ii) the amount of statutory surplus, which as of June 30, 2020 was $311 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 June 30, 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 $399 million as of June 30, 2020, and (ii) the amount of statutory surplus, which as of June 30, 2020 was $286 million.

---

(1)	MAC Holdings distributed substantially all amounts to AGM and AGC, in proportion to their ownership percentages.

---

(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.

---

(1)	In 2020, the Company established allowance for credit looses which was $75 million as of June 30, 2020.

(2)	U.S. government-agency obligations were approximately 39% of mortgage backed securities as of June 30, 2020 and 42% as of December 31, 2019, based on fair value.

---

(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.

---

(1)	Includes primarily loss mitigation and other risk management assets. See Item I, Financial Statements, Note 8, Investments and Cash, for additional information.

---

•	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

ITEM 4.	CONTROLS AND PROCEDURES

---

PART II.	OTHER INFORMATION

ITEM 1.	LEGAL PROCEEDINGS

ITEM 1A.	RISK FACTORS

ITEM 2.	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

(1)

After giving effect to repurchases since the beginning of 2013 through August 6, 2020, the Company has repurchased a total of 116.1 million common shares for approximately $3,515 million, excluding commissions, at an average price of $30.27 per share. The Board of Directors authorized, on February 26, 2020, an additional $250 million of share repurchases. As of August 6, 2020, the remaining authorization the Company was authorized to purchase was $149 million of its common shares, on a settlement basis.

(2)	Excludes commissions.

---

ITEM 6.	EXHIBITS

*	Management contract or compensatory plan

---