Ambac Financial Group, Inc. is a holding company whose subsidiaries provide financial guarantees and financial services to clients in both the public and private sectors around the world. Our diluted earnings per share was $6.87 for 2005, a 5% increase compared with 2004. During 2005,
Critical accounting estimates are defined as those that require management to make significant judgments and could potentially result in materially different results under different assumptions and conditions. Management has identified the accounting for loss and loss expenses and the valuation of financial instruments as critical accounting estimates. This discussion should be read in conjunction with the consolidated financial statements and notes thereon included elsewhere in this report. Management has discussed each of these critical accounting and estimates with the Audit and Risk Assessment Committee of the Board of Directors.
Political, economic or other unforeseen events could have an adverse impact on default probabilities. However, despite such unforeseen events, our experience has shown, it is not reasonably likely that there would be a change in the probability of default estimates such that a material change in our loss reserve estimate would occur. Our experience has shown that credit deterioration and related changes in default probabilities are a gradual process that typically occurs over a long period of time. Historically, claim payments on financial guarantee contracts have been infrequent but subject to potential high severity. Severity represents the amount of loss that would be incurred on a defaulted obligation due to the difference in the amount of net par guaranteed and the value of the related collateral and other subrogation rights. Loss severity estimates are based upon available information such as rating agency recovery rates or surveillance data such as collateral appraisals. However, severity data used are estimates that are subject to change with political, economic and other market conditions or as new information becomes available. Severity of loss is a primary assumption used to estimate losses and an increase or decrease of the severity would provide a range of reasonably possible future outcomes that would differ from our current loss estimate, which could be material.
Ambac’s exposure to derivative instruments is created through interest rate, currency, total return and credit default swaps. These contracts are accounted for at fair value under SFAS 133 “Accounting for Derivative Instruments and Certain Hedging Activities,” as amended (“SFAS 133”). Fair value is determined based upon market quotes from independent sources, when available. When independent quotes are not available, fair value is determined using valuation models. These valuation models require market-driven inputs, including contractual terms; credit spreads on underlying referenced obligations, yield curves and tax-exempt interest ratios. The net fair value of derivative contracts was $167 million at December 31, 2005. Ambac uses both vendor-developed and proprietary models, based on the complexity of transactions. The selection of a model to value a derivative depends on the contractual terms of, and specific risks inherent in, the instrument as well as the availability of pricing information in the market. For derivatives that trade in liquid markets, such as interest rate and currency swaps, we utilize vendor-developed models. For derivatives that trade in less liquid markets, such as credit derivatives on synthetic collateralized debt obligations and total return swaps, a proprietary model is used because such instruments tend to be more complex and pricing information is less available in the market. These models and the related assumptions are continuously re-evaluated by management and enhanced, as appropriate, based on improvements in modeling techniques.
Public Finance bond obligations par value written was $53.8 billion, $44.6 billion and $43.0 billion for 2005, 2004 and 2003, respectively. Ambac’s market share for 2005, based upon par insured, remained relatively flat at 23% compared to 2004 and up nearly 2% over 2003 at approximately 21%. Insured market penetration was 57% in 2005, the highest in the past 10 years, up from 55% and 50% in 2004 and 2003, respectively.
When an issue insured by Ambac Assurance has been refunded or called, any remaining unearned premium (net of refunding credits, if any) is earned at that time. The level of refundings or calls vary, depending upon a number of conditions, primarily the relationship between current interest rates and interest rates on outstanding debt. The current relatively low long-term interest rate environment continues to prompt the high levels of refundings. As long-term interest rates rise in the future, refundings should decline. Earnings on refundings relate to transactions where the premium was paid up-front at the inception of the policy. Accelerated earnings also include the difference between negotiated return premiums and the associated unearned premium on reinsurance cancellations. Net premiums earned included accelerated earnings of $141.5 million and $81.9 million during 2005 and 2004, respectively.
Net premiums earned and other credit enhancement fees during 2004 increased 14% from $667.3 million in 2003. This increase was primarily the result of increased normal net premiums earned from
At December 31, 2005, expected future claim payments on credits that have already defaulted, net of estimated recoveries totaled $81.0 million. Related future payments are $73.6 million, $2.2 million, $0.5 million, $0.6 million and $1.6 million for 2006, 2007, 2008, 2009, and 2010, respectively.
Ambac Capital Services enters into total return swaps and Ambac Credit Products enters into credit derivative contracts. All of our total return swaps and a portion of our credit derivatives have collateral support agreements. In addition, a downgrade of our financial strength rating below specified levels would allow credit derivative counterparties to terminate certain agreements, resulting in a possible payment of a settlement amount or we would have to pledge collateral for the benefit of the counterparty. At December 31, 2005, Ambac has not pledged collateral under any of its credit derivative or total return swap contracts.
Ambac Assurance pledged cash and fixed income securities to foreign insurers of $13,556, $15,086 and $13,584 at December 31, 2005, 2004 and 2003, respectively, related to business assumed from those insurers.
Ambac provides postretirement health care and life insurance benefits to certain eligible retired employees and eligible dependents. All plans are contributory. None of the plans are currently funded. Postretirement benefits expense was $571, $207 and $171 in 2005, 2004 and 2003, respectively. The unfunded accumulated postretirement benefit obligation was $4,980 and the related accrued postretirement liability was $4,125 as of December 31, 2005. The assumed health care cost trend rates
The fair value of total plan assets at December 31, 2005 and 2004 by asset category were as follows:
amount that will be available during 2006 for payment of dividends by Ambac Assurance is approximately $333,000. Ambac Assurance paid cash dividends of $353,400, $103,600 and $89,600 on its common stock in 2005, 2004 and 2003, respectively. The 2005 amounts required regulatory approval since it exceeded the statutorily prescribed threshold.