Reserves for losses and loss adjustment expenses for non-derivative transactions in our financial guaranty direct, financial guaranty assumed reinsurance and mortgage guaranty business include case reserves and portfolio reserves. See the “Valuation of Derivative Financial Instruments” of the Critical Accounting Estimates section for more information on our derivative transactions. Case reserves are established when there is significant credit deterioration on specific insured obligations and the obligations are in default or default is probable, not necessarily upon non-payment of principal or interest by an insured. Case reserves represent the present value of expected future loss payments and LAE, net of estimated recoveries, but before considering ceded reinsurance. This reserving method is different from case reserves established by traditional property and casualty insurance companies, which establish case reserves upon notification of a claim and establish incurred but not reported (“IBNR”) reserves for the difference between actuarially estimated ultimate losses and recorded case reserves. Financial guaranty insurance and assumed reinsurance case reserves and related salvage and subrogation, if any, are discounted at 6%, which is the approximate taxable equivalent yield on our investment portfolio in all periods presented. When the Company becomes entitled to the underlying collateral of an insured credit under salvage and subrogation rights as a result of a claim payment, it records salvage and subrogation as an asset, based on the expected level of recovery. Such amounts are included in the Company’s balance sheet within “Other assets.”
the run-off of transactions and changes in credit spreads, the 2005 loss of $3.5 million primarily relates to the run-off of transactions and a slight widening in investment grade corporate spreads over that period, and the 2004 gain of $52.5 million primarily relates to an approximate 15-20% tightening in credit spreads.
Net earned premiums for the years ended December 31, 2006, 2005 and 2004, were $89.7 million, $74.5 million and $88.8 million, respectively. The increase of $15.2 million in net earned premiums in 2006 compared with 2005 reflects our increased market penetration, which has generated additional net written premiums and in-force business, discussed above. These components contributed to the increased net earned premium. The decrease of $14.3 million in net earned premiums in 2005 compared with 2004 is due to $24.2 million of net earned premiums in 2004 related to the close out of a transaction in which we no longer participate, offset by new business.
Portfolio reserves for 2005 were reduced $7.0 million, attributable to changes in credit quality and from continued runoff from maturing CDO exposures, as well as management updating its loss reserving data, as part of our normal portfolio reserve process, to include the most current rating agency default studies. Primarily offsetting this portfolio reserve decrease was an addition of $4.5 million in case reserves for a specific mortgage transaction executed in 2002, consisting of sub-prime mortgages originated in 2000.
these premiums. The $8.8 million decrease in 2005 net earned premiums compared with 2004 was primarily caused by $5.3 million of reduced refundings in our public finance business. In addition, the FSA transaction reduced net earned premiums by $3.0 million, while the termination of one cedant relationship and decreased business from a second cedant, effective July 1, 2004, also contributed to the decline.
(2) Lease payments are subject to escalations in building operating costs and real estate taxes.
Any such incremental commitment increase is subject to certain conditions provided in the agreement and must be for at least $25.0 million.
As of December 31, 2006 and 2005, the put option had not been exercised.
Amounts presented prior to April 28, 2004, the IPO date, were prepared on an historical combined basis, since Assured Guaranty Ltd. and its subsidiaries were included in the results of ACE. However, since the entities are the same for all periods presented, the financial statements have been prepared and reported on a consolidated basis. This presentation has no impact on the Company’s results of operations or financial condition. Certain expenses reflected in the combined financial statements incurred prior to April 28, 2004 include allocations of corporate expenses incurred by ACE, related to general and administrative services provided to the Company, including tax consulting and preparation services, internal audit services and liquidity facility costs. These expenses were allocated based on estimates of the cost incurred by ACE to provide these services to the Company.
upon reports received by ceding companies supplemented by the Company’s own estimates of premium for which ceding company reports have not yet been received. Differences between such estimates and actual amounts are recorded in the period in which the actual amounts are determined.
If the Company believes a decline in the value of a particular investment is temporary, the decline is recorded as an unrealized loss on the balance sheet in accumulated other comprehensive income in shareholders’ equity. If the Company believes the decline is “other than temporary,” the Company will write down the carrying value of the investment and record a realized loss in its consolidated statements of operations and comprehensive income. The Company’s assessment of a decline in value includes management’s current assessment of the factors noted above. The Company also seeks advice from its outside investment managers. If the Company’s assessment changes in the future, the Company may ultimately record a loss after having originally concluded that the decline in value was temporary.
Certain of the Company’s subsidiaries are subject to U.S. income tax. In accordance with FAS No. 109, “Accounting for Income Taxes”, deferred income taxes are provided for with respect to the temporary differences between the financial statement carrying amounts and tax bases of assets and
Prior to the adoption of FAS 123R, the Company followed the guidance of APB 25 and did not record share-based compensation expense related to employee stock options in the statement of operations, since for all grants the exercise price was equal to the market value of the common stock on the grant date.
Beginning January 1, 2006, upon adoption of FAS 123R, the Company recorded share-based compensation for the cost of stock options, restricted stock and the Company sponsored employee stock purchase plan. Also, the Company began recording the cost associated with the accelerated vesting of retirement-eligible employees. As a result of adopting FAS 123R on January 1, 2006, the Company’s 2006 income before income taxes and net income are $4.9 million and $4.0 million lower, respectively, than if it had continued to account for share-based compensation under APB 25. Basic and diluted earnings per share for the year ended December 31, 2006 were both $0.05 lower, than if the Company had continued to account for share-based compensation under APB 25.
and $3.1 million ($2.8 million after tax), respectively. The amount of share-based compensation capitalized in 2006, 2005 and 2004 as DAC was $2.6 million, $1.1 million and $0.8 million, respectively.
The Incentive Plan authorizes the grant of incentive stock options, non-qualified stock options, stock appreciation rights, and full value awards that are based on the Company’s common shares. The grant of full value awards may be in return for a participant’s previously performed services, or in return for the participant surrendering other compensation that may be due, or may be contingent on the achievement of performance or other objectives during a specified period, or may be subject to a risk of forfeiture or other restrictions that will lapse upon the achievement of one or more goals relating to completion of service by the participant, or achievement of performance or other objectives. Awards under the Incentive Plan may accelerate and become vested upon a change in control of Assured Guaranty.
The Company recorded $9.5 million ($7.5 million after tax) in share-based compensation, related to restricted stock awards, during the year ended December 31, 2006.
(1) Balance related to ACE restricted stock awards prior to the IPO.
(1) Since the shares held as treasury stock were required to be settled by delivery of employer stock, those shares are included in the calculation of basic and diluted EPS in 2005 and 2004.
The following table provides underwriting gain (loss) by line of business for the other segment.