Significant changes to any variables on which the 12% loss factor is based, over an extended period of time, would likely result in an increase or decrease in the Company’s loss factor with a corresponding increase or decrease in the amount of the Company’s loss and loss adjustment expense provision. For example, as external and internal statistical data are applied to the various sectors of the Company’s insured portfolio, a shift in business written toward sectors with high default rates would likely increase the loss factor, while a shift toward sectors with low default rates would likely decrease the loss factor. Additionally, increases in statistical default rates relative to the Company’s insured portfolio and in the Company’s actual loss experience or decreases in statistical recovery rates
Total case basis activity transferred from the Company’s unallocated loss reserve was $75 million in 2006, $189 million in 2005 and $127 million in 2004. During 2006, case basis activity primarily consisted of insured obligations within the CDO, equipment lease pools and home equity loan sectors, MBIA’s guaranteed tax lien portfolio and insured obligations issued by Allegheny Health, Education and Research Foundation (“AHERF”). Case basis activity related to AHERF was partially the result of a reduction in expected litigation recoveries from the AHERF bankruptcy estate. Partially offsetting this activity were reversals of previously established case basis reserves relating to the aircraft enhanced equipment trust certificates (“EETCs”) and manufactured housing sectors. During 2005, case basis activity primarily consisted of loss reserves for insured obligations within the EETCs, CDO and manufactured housing sectors and within MBIA’s guaranteed tax lien portfolios. Case basis activity during 2004 primarily consisted of loss reserves for insured obligations issued by Fort Worth Osteopathic Hospital, MBIA’s guaranteed tax lien portfolios, AHERF, an older vintage CDO and a manufactured housing exposure.
In October 2006, MBIA exercised a call right with respect to MBIA-insured notes issued by a 2000 vintage static multi-sector CDO in order to reduce future interest costs under its guarantee. Under the terms of the trust agreement, MBIA had the right to call the notes at par as a result of the occurrence of an event of default. In connection with its call of the notes, in October 2006 the Company made a claim payment of $177 million representing the insured outstanding principal, the proceeds of which were used by the trustee to repay the insured notes. The payment, net of estimated salvage, was applied against MBIA’s previously established case basis reserve for this transaction.
Corporate expenses were $19 million, $98 million and $18 million for the years ended December 31, 2006, 2005 and 2004, respectively. The significant increase in 2005 was principally due to a $75 million accrual of estimated penalties and disgorgement related to the settlement of regulatory investigations of the Company, as well as additional legal and consulting costs associated with these investigations.
MBIA’s tax policy is to optimize after-tax income by maintaining the appropriate mix of taxable and tax-exempt investments. In general, the effective tax rate fluctuates from time to time as the Company manages its investment portfolio on an after-tax total return basis. The effective tax rate, including tax related to discontinued operations, was 28.3%, 29.9% and 28.4% for the years ended December 31, 2006, 2005 and 2004, respectively. The increase in 2005 was primarily due to the accrual of regulatory penalties, which are not deductible for purposes of calculating the Company’s Federal income taxes.
The Company has significant liquidity supporting its businesses. At December 31, 2006, cash, cash equivalents and short-term investments totaled $3.2 billion. If, for any reason, significant cash flow reductions occur in any of its businesses, MBIA has alternatives for
Management believes that the Company’s reserves are adequate to cover the ultimate net cost of claims. However, because the reserves are based on management’s judgment and estimates, there can be no assurance that the ultimate liability will not exceed such estimates. See “Note 22: Loss and Loss Adjustment Expense Reserves” for additional information regarding the Company’s loss and LAE reserves.
In December 2004, the FASB issued SFAS 123(R). SFAS 123(R) is a revision of SFAS 123 and supersedes APB 25, “Accounting for Stock Issued to Employees.” SFAS 123(R) requires the Company to expense the fair value of employee stock options and other forms of stock-based compensation. In addition, SFAS 123(R) classifies share-based payment awards as either liability awards, which are remeasured at fair value at each balance sheet date, or equity awards, which are measured at fair value on the grant date and not subsequently remeasured. These requirements were effective for the Company as of January 1, 2006. The Company adopted the fair value provisions of SFAS 123 effective January 1, 2002 and the adoption of SFAS 123(R) for equity awards did not have a material effect on the Company’s financial position or results of operations. As the Company has previously remeasured liability awards and expensed related costs, the adoption of SFAS 123(R) did not have a material effect on the Company’s financial position or results of operations.
The Company has entered into derivative transactions that it views as an extension of its core financial guarantee business but which do not qualify for the financial guarantee scope exception under SFAS 133 and, therefore, must be stated at fair value. The insurance operations, which represent the majority of the Company’s notional derivative exposure, have insured derivatives primarily consisting of structured pools of credit default swaps that the Company intends to hold for the entire term of the contract. The insurance operations have also provided guarantees on the value of certain structured closed-end funds, which meet the definition of a derivative under SFAS 133. The Company reduces risks embedded in its insured portfolio through the use of reinsurance and by entering into derivative transactions. This includes cessions of insured derivatives under reinsurance agreements and capital markets transactions in which the Company economically hedges a portion of the credit and market risk associated with its insured credit derivative portfolio. Such arrangements are also accounted for as derivatives under SFAS 133 and recorded in the Company’s financial statements at fair value. Premiums received on insured derivatives are recorded as part of premiums earned. Additionally, changes in fair values of derivative transactions within MBIA’s insurance operations are recorded in current earnings.
At December 31, 2006, the Company reported an accumulated unrealized gain of $0.9 million (net of tax) in other comprehensive income related to the fair value of the cash flow hedges compared to a $6.0 million accumulated unrealized gain (net of tax) at December 31, 2005. The change resulted from a $5.4 million after-tax unrealized gain in the fair value of the cash flow hedges and the transfer of $0.3 million of after-tax net expense to earnings as a result of scheduled interest payments and receipts on the cash flow hedges. At December 31, 2006, the maximum term of derivative instruments that hedge forecasted transactions was approximately 12 years.
The use of market data requires management to make assumptions on how the fair value of derivative instruments is affected by current market conditions. Therefore, results can significantly differ between models and due to changes in management assumptions. The Company maintains an ongoing review of its valuation models and has instituted procedures for the approval and control of data inputs. In the years ended December 31, 2006, 2005 and 2004, there were no significant changes to the valuation process.
Prior to the third quarter of 2006, the Company’s municipal services segment included the operations of MBIA MuniServices Company and its wholly owned subsidiaries and Capital Asset. Beginning in the third quarter of 2006, the Company reported MBIA MuniServices Company and certain of its wholly owned subsidiaries (“MuniServices”) as a discontinued operation and no longer reported the municipal services operations as a separate reportable segment. In the fourth quarter of 2006, the Company completed the sale of the operations of both MuniServices and Capital Asset. The results of the municipal services operations have been excluded from MBIA’s segment reporting and, in accordance with SFAS 144, are reported as discontinued operations for all periods presented herein. See “Note 15: Discontinued Operations” for additional information related to the Company’s discontinued operations.
IMC also provides agreements obligating it to purchase designated securities in a bond reserve fund at par value upon the occurrence of certain contractually agreed-upon events. The opportunities and risks in these agreements are analogous to those of investment agreements. The total par value of securities subject to these agreements was $19.1 million at December 31, 2006.
Under private placement offerings, Triple-A issues commercial paper with maturities of up to 270 days. Outstanding commercial paper obligations, net of unamortized discount, at December 31, 2006 were $746 million and at December 31, 2005 were $860 million. As of December 31, 2006, commercial paper outstanding had original issue maturities ranging from January 2, 2007 to February 5, 2007, interest rates ranging from 5.33% to 5.41% and a weighted-average interest rate of 5.36%. As of December 31, 2005, commercial paper outstanding had original issue maturities ranging from January 3, 2006 to March 22, 2006, interest rates ranging from 4.21% to 4.52% and a weighted-average interest rate of 4.35%. Triple-A enters into 364-day or shorter term credit facilities with multiple independent third-party credit support providers as a source of liquidity in the event of a commercial paper market disruption.
The net insurance in force by type of bond is presented in the following table:
The insurance operations have entered into certain guarantees of derivative contracts, included in the preceding tables, which do not qualify for the financial guarantee scope exception under SFAS 133. MBIA Corp. generally guarantees the timely payment of principal and interest related to these derivatives upon the occurrence of a credit event with respect to a referenced obligation. The maximum amount of future payments that MBIA Corp. may be required to make under these guarantees, should a full credit event occur, is $100.1 billion. This amount is net of $21.0 billion of insured derivatives ceded under reinsurance agreements and capital market transactions in which MBIA Corp. economically hedges a portion of the credit and market risk associated with its insured derivatives. MBIA Corp.’s guarantees of derivative contracts have a legal maximum maturity range of 1-90 years. A small number of guaranteed credit derivative contracts have long maturities to satisfy regulatory requirements imposed on MBIA’s counterparties. However, the expected maturities of such contracts are much shorter due to amortizations and prepayments in the underlying collateral pools. In accordance with SFAS 133, the fair values of these guarantees at December 31, 2006 are recorded on the balance sheet as assets and liabilities, representing gross gains and losses, of $29.5 million and $26.0 million, respectively. These derivative contracts are discussed further in “Note 6: Derivative Instruments.”
The following table presents the total number of restricted share awards granted during the last three years. The proxy officers represent the six most highly compensated officers in 2006, the five most highly compensated officers in 2005 and the seven most highly compensated officers in 2004, as disclosed in the Company’s proxy statement.
LONG-TERM DEBT-The fair value is estimated based on quoted market prices for the same or similar securities.