The two AAA-rated ceding companies with which RAM had treaties in 2008 wrote minimal new business volume.
The liquidity risk present in most CDS contracts sold outside the financial guaranty industry, i.e., the risk that the CDS writer would be required to make cash payments, is not present in a CDS contract written by a financial guarantor. Terms are designed to replicate the payment provisions of financial guaranty contracts in that (a) losses, if any, are generally paid over time, and (b) the financial guarantor is not required to post collateral to secure its obligation under the CDS contract.
Year Ended December 31, 2008 Compared to December 31, 2007 and Year Ended December 31, 2007 Compared to December 31,
On July 25, 2008, RAM Re entered into a Commutation Agreement with Syncora Guaranty Re (formerly XL Financial Assurance Ltd.) (“XLFA”), whereby RAM Re transferred all business previously ceded to RAM Re by XLFA back to XLFA and each of RAM Re and XLFA released each other from claims under the reinsurance agreements. As consideration for the Commutation Agreement, RAM Re paid $94.4 million which comprised the repayment of $8.6 million of unearned premiums, net of ceding commission, $16.1 million towards estimated loss reserves on RMBS and $69.7 million towards unrealized losses on ABS CDOs.
Structured finance gross written premiums, excluding the premiums returned on commutations, were $22.8 million in 2008, a decrease of 10.2% from $25.4 million in 2007. Structured finance gross written premiums in 2007 increased by 2.4% from $24.8 million in 2006. Structured finance written premiums declined in 2008 over 2007, largely the result of the commutation of MBIA and XLFA during the year, which reduced the quarterly installment premiums written. Structured finance written premiums grew in 2007 over 2006 as a result of the new treaties along with increased cessions from our other primaries for 2007 over prior years.
Also included within realized gains and other settlements in 2008 were losses and loss expenses of $95.2 million compared to $Nil for the comparable 2007 and 2006 periods. The 2008 amount included $69.7 million relating to the XLFA credit derivative policies and $25.5 million relating to MBIA credit derivative policies which were commuted during the year. The total $95.2 million realized losses on commutation of credit derivatives policies is offset by a reduction in unrealized losses on credit derivative policies on commutations of $136.1 million and $95.9 million, relating to MBIA and XLFA, respectively. The overall net gain on commutations relating to credit derivative policies, included within the net change in fair value of credit derivatives was $136.8 million.
Other. The “Other” category may include other RMBS types such as international and prime. Also shown is the current subordination level below RAM Re and RAM Re’s current internal rating:
In compliance with the requirements of FAS 157, the Company adjusts the fair value of its insured credit derivatives to account for the Company’s own non-performance risk. There is no observable credit spread for RAM Re or RAM Holdings, and as such there is inherently a significant amount of judgment, subjectivity and uncertainty involved in the estimation of the adjustment for RAM’s non performance risk. Management has used inputs that reflect assumptions market participants may use in pricing RAM’s creditworthiness. In determining the Company’s own non-performance risk when measuring the fair value of a liability, the Company uses an implied market price for buying credit protection on RAM and a cash flow model, which models a typical CDS contract, to calculate a value price based on those spreads and cash flows. The Company identifies comparable entities with active CDS markets to estimate credit spreads for RAM. Such identification focuses on the nature of risk positions (primarily public finance and structured products) and of approximate capital adequacy as depicted by publicly available credit ratings agencies reports. Based on this information, as at December 31, 2008, the Company estimated its credit spread to be approximately 2254 basis points per annum. An approximation of a typical CDS contract is made based on a 5-year insured CDS contract, an assumption of a 10 year weighted average life, and an assumption for par, coupon, duration and the appropriate discount rate based on a 5-year swap rate. The Company believes that these data points may be considered by hypothetical market participants in determining RAM’s creditworthiness. The effect of applying this requirement of FAS 157 was a reduction in the Company’s derivative liability at December 31, 2008 of approximately $203.3 million.
In addition, the terms of RAM Re’s Class B preference shares restrict RAM Re’s ability to pay dividends on its common shares unless all accrued and unpaid dividends on the Class B preference shares for the then current dividend period have been declared and paid or a sum sufficient for payment thereof set apart. There is an exception however that permits RAM Re to declare dividends on its common shares in such amounts as are necessary for RAM Holdings (i) to service indebtedness for borrowed money as such payments become due (or to satisfy any of its guarantee obligations made in respect of indebtedness of RAM Re or RAM Holdings) or (ii) to pay its operating expenses.
The primary weaknesses of the Premium Method of valuing CDS are:
The model uses market inputs whenever they are available. The key inputs to the model for any transactions are market- based spreads for the underlying referenced collateral, assumed recovery rates specific to the type and rating of the referenced collateral, and the diversity score of the collateral pool. These are viewed as key parameters that affect the fair value of the transaction and, to the extent practicable; the inputs are market-based inputs.
The Company believes that the above data points are hypothetical with the spread movements used in the sensitivity analysis of 100, 500, and 1000 basis points supported by previous large spread changes that have occurred in the last year in our primaries’ spreads. Therefore, it is not unreasonable for RAM to use these spread movements in the sensitivity analysis. This calculation is based on estimates, involves a significant degree of management judgment and is sensitive to selected assumptions. Changes to assumptions used in this valuation could lead to materially different results.
Proceeds from maturities and sales of investments in fixed interest securities available for sale during 2008, 2007, and 2006 were $517,447,080, $128,096,094, and $118,996,819 respectively. Gross gains of $10,252,643, $6,007 and $nil in 2008, 2007, and 2006, respectively, and gross losses of $2,140,491, $10,227, and $1,002,055 in 2008, 2007, and 2006, respectively, were realized on those sales.
As of December 31, 2008 and 2007, the Company’s outstanding principal reinsured was $30.0 billion and $45.4 billion, respectively. If a primary financial guaranty insurance company pays a claim and has recourse through subrogation rights, the Company would benefit based on its proportionate share of risk.
As at December 31, 2008 and 2007, $Nil and $0.5 million, respectively, was owing to the counterparty of the Company’s retrocession agreement, representing written premiums ceded net of ceding commissions.
During 2007, the Company renewed its agreement to lease office space for the two years ending December 31, 2009. As of December 31, 2008, the future minimum commitment under the lease, for the year remaining, is $0.3 million. Rental expense for the aforementioned lease amounted to $0.3 million in all years presented.
In December 2003, two of our shareholders became investors in FGIC Corporation, an insurance holding company whose subsidiary FGIC was one of the four largest U.S. based primary financial guaranty insurance companies through December 2007. In the ordinary course of business, we have entered into treaty and facultative reinsurance agreements with FGIC. The treaty agreement was not renewed in 2008. In 2008, 2007 and 2006, financial guarantee gross premiums written plus premiums received on CDS policies ceded from FGIC accounted for 7%, 26% and 12% of total premiums received by the Company, respectively (prior to taking effect of premiums returned on commutations in 2008). In 2008, RAM Re paid $3.1 million to FGIC to settle disputes under certain reinsurance agreements. There were no amounts due from FGIC as of December 31, 2008 and 2007.
As at December 31, 2008 and 2007, authorized share capital was 90,000,000 common shares and 10,000,000 undesignated preference shares with a par value of $0.10 each. Shares issued and outstanding as at December 31, 2008 and 2007 were 27,251,595 and 27,238,976, respectively. During the years ended December 31, 2008 and 2007, 12,619 and 4,221, respectively, restricted stock units vested and were issued as share capital, increasing the common shares issued and outstanding.
Statutory financial statements prepared under the Act differ from financial statements prepared in accordance with US GAAP, principally due to the exclusion of non-admitted assets such as deferred policy acquisition costs, prepaid expenses and the fair value adjustment of derivative instruments in excess of credit impairments, a non-GAAP measure.