FOLEY & LARGNER LLP ‘osrernct sor COPY Sees Jane 12016 “oe HAND DELIVERED RECEIVED JUN ~1 2016 Honorable Richard ©. Niess Circuit Cour ge ae cow cucu court Dane County Courthouse 218 South Hamilton Street ‘Madison, Wisconsin $3703 Re: Inthe Matter ofthe Rehabilitation of Segregated Account of Ambac Assurance Corporation, Case No. 10 CV 1576 (Dane County Cireuit Cour) Dear Judge Niess: Enclosed for fling isthe 2016 Annual Report on the Rehabilitation ofthe Segregated ‘Account of Ambac Assurance Corporation. All partes-ininterest on the service list are in the ‘process of being served today with the report by emai and the report will prompily be posted on the Court-approved website Please note that this filing is informational and does not require court approval or the scheduling ofa hearing “Thank you for your attention to this matter. Sincerely, : . Testiey A. Simmpons Enclosure cc: Counsel of Record (with enclosure, via email) Simas Sirens Soren HasseCOPY STATE OF WISCONSIN eincurt couRT ANE COUNTY prancns. FILED tt ggg In the Matter ofthe Rehabilitation of: Dave coun cur cour Case No. 10. CV 1576 Segregated Account of Ambac Assurance Corporation 2016 ANNUAL REPORT ON THE REHABILITATION OF THE. SEGREGATED ACCOUNT OF AMBAC ASSURANCE CORPORATION ‘On March 24, 2010, the Cireuit Cour for Dane County, State of Wisconsin entered an order placing the Segregated Account of Ambac Assurance Corporation into chabilitation pursuant to the provisions ofthe Wisconsin Insurers Rehabilitation and Liquidation ‘Act. As part ofthe Decision and Final Order Confirming the Rehabilitator’s Pan of Rehabilitation (entered January 24,2011) (at page 60, § 8), the Court directed the Rehabilttor to file report each year by June I" “advising on the status ofthe rehabilitation” The Rehabilitator hereby submits the enclosed 2016 Annuel Report onthe Rehabilitation of the Segregated Account of Ambac Assurance Corporation toadvie the Court and all interested partes about certain developments inthe reat tion proceeding since the filing of the 2015 Annual Report on the Rehabilitation of the Segregated Acccunt of Ambac Assurance Corporation,Kevin G, Fitzgerald, SBN 1004777 ‘Morgan J.Tilleman, SBN 1086388. FOLEY & LARDNER LLP ‘TIT East Wisconsin Avenue Milwaukee, Wisconsin 53202 Telephone: (414) 271-2400 Facsimile: (414) 297-4900 Post Office Box 1497 Madison, Wisconsin $3701 Telephone: (608) 257-5035 Facsimile: (608) 258-4258, Counsel for he RehabiliatorANNUAL REPORT ON THE REHABILITATION OF THE SEGREGATED ACCOUNT ‘OF AMBAC ASSURANCE CORPORATION ‘The Commissioner of Insurance of the State of Wisconsin, as the Court-Appointed Rehabilitator of the Segregated Account ‘of Ambac Assurance Corporation June 1,2016DISCLAIMER ‘This Anmual Report on the Rehabilitation of the Segregated Account of Ambac Assurance Corporation (this “Annual Repo), prepared by the court-appointed Rehabilitato: of the Segregated Account, summarizes and describes developments in the Rehabilitation Proceeding since the 2015 Annual Report was submitted to the Rehabilitation Court. It does not contain an exhaustive discussion of the Rehabilitation Proceeding, which is discussed in further dewil in the relevant papers and pleadings Filed with the Rehabilitation Court. Those papers and pleafings are available for review on the website (the “Websie”),htp://www.ambacpolicyholders.con. ‘This Annual Report is not required to be prepared in accordance with federal or state securities laws or other applicable law. None of the Securities and Exchange Commission (“SEC”), any state securities commission, or any similar public, govemmental or regulatory authority has approved this Annual Report, ot has passed on the accuracy or adequacy of the sttements contained herein, Persons trading in or otherwise purchasing, selling or transfering securities of the Segregated Account should evaluate this Annual Report in light of the purpose for which it ‘was prepared, and should also consider other publicly available information, including the ‘materials on file with the SEU prepared by Ambac Financial Group, Inc [No registration statement under the Securities Act of 1933, as amended, or any other federal or state securities or “blue sky" laws has been filed with the SEC or any other agency by the Rehabilitator or the Segregated Account of Ambsc Assurance Corporation (the “Segregated ‘Account") with respect to any securities that may be issued by the Segregated Account Except as specifically and expressly stated herein, this Annual Report does not reflect any events that may o¢cur subsequent to the date hereof. Such events may have a material impect on the information contained in this Annual Report, The financial information provided herein or incorporated herein by reference was not prepared with a view toward compliance with ‘published guidelines of the SEC, the American Institute of Certified Public Accountants or ‘Accounting Principles Generally Accepted in the United States of America ("GAAP"), or in accordance with U.S. statulory accounting principles prescribed or permitted by the State of ‘Wisconsin Office of the Commissioner of Insurance. ‘This Annual Report may not be relied upon for any purpose other than to obtain in‘ormation about the status of the Rehabilitation Proceeding generally. Nothing contained herein will constitute an admission of any factor of any liability by any party with regard to any claim or Ttigation, including, but not limited 0, any proceeding involving the Rehabiliator, the Segregated Account or any other party or any proceeding wit respect to any legal effect of the rehabilitation ofthe Segregated Account None of Ambae Assurance Corporation, the Segregated Account or the Rehabilitator make any ‘warranty, express or implied, as to the accuracy or completeness ofthe information contained herein. In particular, events and forces beyond the control of the Rehebiltator may alter the ‘assumptions upon which the disclosures in this Annual Report are based, ‘This Anmual Report may contain statements that are, or may be deemed to be, forwanl-looking, statements within the meaning of the Private Securities Litigation Reform Act of 1995, Suchforward-looking statements include those regarding consummation of transactions in conjunction ‘with the Rehabilitation Proceeding. Although the Rehabilitator believes that any such forward- Tooking statements are reasonable, no assurance can be given that such expectations will prove to have been correct. Any such forward-looking statements involve known and unknown risks, uncertainties, and other factors that may cause the actual resuls, performance or achievements of the Segregated Account to be different from any future results performance and achievements ‘expressed or implied by these statements “The Rehabiltator’s Loss Projections (found in Section VI herein) are based ugon estimates and assumptions developed in good feth by the Rehabiltator based upon cerain materials provided by Ambae Assurance Corporation and other information that was determined to be relevant. ‘THE REHABILITATOR’S LOSS PROJECTIONS AND UNDERLYING ASSUMPTIONS DO NOT REFLECT THE VIEWS OF AMBAC ASSURANCE CORPORATICN OR AMBAC FINANCIAL GROUP, INC. OR ITS MANAGEMENT. The estimates and assumptions incorporated in the Rehabiliaior's Loss Projections may not be realized and are inherently subject to significant business, economic and competitive uncertainties and contingencies, many Of which are beyond the Rehabiltator's contol. No representations can be cr are made as to whether the actual results will be within the range set forth in the Rehabiitator's Loss Projections. Some assumptions will not materialize and events and circumstances occurring, subsequent to the date on which the Rebabilitator's Loss Projections were prepared may be Gifferent from those assumed or may be unanteipated, and therefore may affect financial results in a material and possibly adverse manner. Accordingly, due to the inherertly unpredictable nature of such projections, no representation can be or is being made with respect tothe accuracy Of the Rehabilitator’s Loss Projections, and the Rehabilitator's Loss Projection, therefore, may not be relied upon as a guarantee or other assurance of the actual results that will eur.‘TABLE OF CONTENTS DISCLAIMER. TABLE OF CONTENTS. 1. Introduction ‘Ambac Assurance Corporation... ‘Bank Settlement Agreement Allocation tothe Segregated Account of Liabilities to AFGI and the IRS ‘The Commissioner and Special Deputy Commissioner. Status of Rehabilitation Proceeding. Plan of Rehabilitation 1. Confirmation ofthe Plan of Rehabilitation. Interim Cash Payments on Permitted Poliey Claims Resolution of Tax Uncertainties . ‘Amendments othe Plan of Rehabilitation Guidelines Issued Pursuant to the Plan of Rehabilitation Interim Payment Percentage and Equalizing Deferred Payments B. Other Significant Aspects of the Rehabilitation Proceeding 1. Supplemental Payments eon 2, RMBS Remediation Claim Settlements. 3. The Secured Note and the Reinsurance Agreement 4. __ Improving Mortgage Loan Servicing, C. Significant Transactions since May 2015 1. IP Morgan RMBS Dispute Settlement 2. Commulation/Termination of Policies Insuring Bonds Backed by Student Loan Trusts... . env >e mpop> UL, Summary of Other Litigation Related to the Rehabilitation Proceeding... ‘A. Favorable Resolution of All Outstanding Appellate Litigation. 8B. _Lkigaion Stemming fom the Allocation othe Segregated Account of Liabilities tothe United States. FFI Ful Lid. Appeal Motions Heard Since May 2015 urn RMBS Representation and Warranty Litigation, IV, Financial Review . ‘General Account Assets... Investment Portfolio Holdings. Installment Premiums. Intercompeny Loans. Investment in Subsidiaries JPM Settlement. >E mye Establishment of the Segregated Account and Petition for Rehebilitaton..vil. 6. Miseellaneous B. Policy Liabilities ofthe General Account and the Segregated Account. 1. Summary of Liabilities 2. General Account Exposures 3. Segregated Account Exposures, ‘The Rehabilitator’s Financial Projections. ‘The Rehabilitator’s Loss Projections. A Overview. B. Certain Considerations... Description of Rehabilitator’s Financial Projections, Scenarios and Projected Recoveries. General Recovery of Deferred! Amounts, Surplus Notes and Junior Sulu ‘Notes under the Rebabiltator's Financial Projections. Scenario One. 7 Scenario Two. ‘Scenario Three Sunn . Scenario Four von Projected Recoveries and Distributable Value emmon p>1. INTRODUCTION A. Ambac Assurance Comorstion Ambac Assurance Corporation (“AAC”) is a Wisconsin-domiciled insurance company. It was incomporated under the laws of Wisconsin as CMI Credit Insurance, Ine. on February 25, 1970, sand is a wholly-owned subsidiary of Ambac Financial Group, Ine. (“AEGI"), 9 corpora headquartered in New York City B, Establishment ofthe Segregated Accou habiltation (On March 24, 2010, AAC established the Segregated Account of Ambac Assurance Comoration (ihe “Segregated Account”). Under Wisconsin insurance law, the Segregated Account is separate insurer ffom AAC for purposes of the Rehabilitation Proceeding (as described below), “The Commissioner of Insurance for the State of Wisconsin (the “Commissionet”) approved the establishment of the Segregated Account by letter dated March 24, 2010, AAC allocated the following to the Segregated Account: (i) certain polices insuring ot relating, to credit default swaps; (i) policies insuring residential mortgage-backed securities (“RMBS"), (Gi) certain student loan pol cies, some of which were allocated to the Segregated Aczount on ‘March 24, 2010 (or shorly thereafter), and some of which were allocated on October 8, 2010, after undergoing an assessment process; (iv) certain ether policies insuring obligations with substantial projected impairments or relating to transactions which have contractual “triggers” based upon AAC’s financial condition of the commencement of a rehabilitation preceeding, which triggers, if exercised, could have materially and adversely affected AAC's financial condition; (v) remediation claims, defenses, offsets, andlor eredits (except with respect 10 recoveries arising from remediation efforts or reimbursement ot collection right), if any, in respect of policies allocated to the Segregated Account; (vi) AC's disputed, contingent ibility, if any, under the long-term lease with One State Street, LLC, and its contingent liability, if an ‘under the Ambac Assurance UK Limited (‘Ambac UK") lease with British Land; ( limited liability interests in Ambac Credit Products, LLC (“ACP”), Ambac Conduit Funding, LLC, Aleutian Investments, LLC (now liquidated), and Juneau Investments, LLC (together, the “Allocated Subsidiaries”); (vil) all of AAC’s lisbilides as reinsurer’ under reinsurance agreements (except for reinsurance assumed from Everspan Financial Guarantee Corp); and (ix) effective Novernber 7, 2010, any liability to AFG relating to tax refunds and any Habilty to the Intemal Revenue Service ("IRS") relating to taxes. A list of the insurance policy Fabilties allocated tothe Segregated Account is available on the Website The Segregated Account is operated in accordance with the Plan of Operation for the Segregated Account ne it has heen amesded, and may he fether amended From time to ime in the fture (the “Plan of Operation”). Fursuant to the Plan of Operation, the libilties of the Segregated ‘Account are supported by a Secured Note issued by AAC to the Segregeled Account an March 24, 2010 (the “Secured Nate") and an Aggregate Excess of Loss Reinsurance Agreement between the Segregated Account and AAC dated as of March 24, 2010 (the “Reinsurance Agreement”). AAC issued the Secured Note to the Segregated Account in the initial aincipal ‘amount of 82 billion, due in 2050, Pursuant 1 the Secured Note, the Segregated Accoust had the ability to demand payment from AAC from time to time to pay claims and other liabilities. Oncethe Secured Note is exhausted, which occurred in May 2014, and is discussed further below in Section II.B3, the Segregated Account has the ability to demand payment from time to time under the Reinsurance Agreement fo pay claims and other liabilities. The Secured Note together with the Reinsurance Agreement have effectively rendered all ofthe claims-paying resources of ‘AAC’s General Account (the “General Account”) available to pay all claim liabilities of the Segregated Account (including any payments with respect 1o SA Surplus Notes (as defined below) and junior surplus notes), withthe exception that AC is not obligated to make payments fon the Secured Note or under the Reinsurance Agreement if its surplus as regards 10 policyholders is (or would be) less than $100 million, or such higher amount as the Wisconsin Office of the Commissioner of Insurance (“OCI”) permits pursuant to a prescribed accounting practice (the “Minimum Sumlus Amount). As long asthe surplus as regards to policyholders i ‘ot less than the Minimum Surplus Amount, payments by the General Account to the Segregated ‘Account under the Reinsurance Agreement are not capped. In connection with the Secured Note and the Reinsurance Agreement, the Segregated Account also has a perfected security interest inthe following receivables: installment premiums received by AAC in respect of policies allocated to the Segregated Account, reinsurance premiums received in respect of assumed reinsurance agreements with AAC, where AAC's liabilities thereunder have been allocated to the Segregated Account, recoveries under thied party reinsurance agreements in respect of policies allocated to the Segregated Account, recoveries arising from remediation efforts and reimbursement or collection rights with respect to policies allocated to the Segregated Account, and all identifiable products and proceeds ofthe foregoing. For those categories of assets which are material, estimates of the amounts, and to the extent predictable, the timing for collection, can be found in Section IV below. Notwithstanding the aforementioned security interest, all ofthe claims-paying resources of the General Account are available to pay permitted claims of the Segregated Account, subject 1o maintenance of the ‘Minimum Surplus Amount. During the Rehabilitation Proceeding of the Segregated Account (as described below), the Commissioner controls the management of the Segregated Account. AAC provides certain ‘management and administrative services to the Segregated Account and the Commissioner as Rebabilitator of the Segregated Account (the “Rehabilitator”) pursuant to a Management Services Agreement, including information technology services, credit exposure management, ‘weasury, accounting, tax, management information, risk management, loss management, internal audit services and business continuity services. Services are provided at cost, subject to mutual agreement of the Segregated Account and AAC. [AAC and the Segregated Account have also entered into a Cooperation Agreement, pursuant to which the parties have agreed to certain matters related to decision-making, information sharing, tax compliance and allocation of expenses (including an agreement by AAC to reimburse the Segregated Account for specified expenses tothe extent not reimbursed under the Secured Note, subject to the Minimum Surplus Amount). AAC has made certain covenants to the Segregated ‘Account, including an agreement to not enter into any transaction with, or use any asset or property of, any third party involving consideration or other proceeds of more than $5 millon (or such higher amount as is agreed with the Segregated Account) without the Segregated Account’s prior written consent (other than policy claim payments made in the ordinary course of business and investments in accordance with AAC’s investment policy), and providing the SegregatedAccount with an annual operating expense budget for AAC snd its subsidiaries, as well as (quarterly analyses of variances. On Maes 24, 2010 (ve “Petion Date), dhe Commissioner, then Sean Ditweg, pone the Wisconsin Circuit Court for Dane County (the “Rehabilitation Cour”) to place the Segregated ‘Account into rehabilitation pursuant to the provisions ofthe Wisconsin Insurers Rehabilitation and Liguidation Act. Subsequently on March 24, 2010, the Rehabilitation Coun entered the Onder for Rehabilitation, by which the Commissioner's petition was granted (he “Rehabilitation ‘Order. With entry ofthe order, the Segregated Account was placed into rehabilitation pursuant to Wis, Sat. § 645.32, andthe Rehabilitation Court was named th cout for all matter relating to the Segregated Account (he “Rehabilitation Proceeding”). The Rehabilitation Court appointed the Commissioner as Rehabilitator of the Segregned Account with fll powers and authority ‘granted pursuant co Wis, Sat. §§ 645.33 to 645.35 ad all ether applicable laws as are reasonable and necessary to full his dues and vespnsibiles. On the Petition Date the Rehabilitation Court also issued an injunction effective unt further order of the Rehabilitation Court enjoining certtin actions by Segregated Accouat policyholders and ober counterparts, including, witout limitation the asertion of damages or acceleration of losses based on esrly temination and the exereise of contol rights in transactions that, but for the occurence of the Rehabilitation Proceeding or the financial condition of AAC, the General ‘Account, the Allocated Subsidiaries or the Segregated Account, would have been exercised by ‘AAC, the Allocated Subsidiaries or the Segregated Account (lhe “Injunction Order”). Policy obligations not allocated tothe Segregated Account are not subject to and, therefore, not be directly impacted by, the Rehabilitation Proceeding. © lement Agreement In the fall of 2009, AC became aware that several large financial institutions that were parties to credit default swaps with ACP in respect of collateralized debt obligations backed primarily by RMBS (“ABS CDOs") and collateralized loan obligations (“CLOs”) and other collateralized debt obligations ("CDOs") were forming a group to negotiate with AAC regarding a global commutation of those exposures (the “Bank Group”). The obligations of ACP under these ABS ‘CDOs, CLOs and CDOs were guaranteed by AAC pursuant to financial guaranty policies. These policies represented the greatest concentration of projected losses to AC as well asthe largest potential source of collateral damage through the possibility of “mark-to-market damages. The Bank Group eventually consisted of fourteen financial institutions that, together wth their direct. affiliates, are among the largest financial institutions inthe world On June 7, 2010, AAC, AFGI, ACP and the Bank Group entered into a settlement agreement which effected the commutation of all of ACP's outstanding credit default swaps in respect of ABS CDUs with respect to the Bank Group, and all of AAC'S related Tinancial guaranty exposure (the “Bank Group Setlement"). In exchange for AAC and ACP commuting $16.5 billion of net par exposure, AAC transfered to the Bank Group, in the aggregate, $2.6 billion in cash and $2 billion of surplus notes newly issued by AAC (the "Bank Settlement Notes"). AAC also paid $96.5 million to the Bank Group to commute certain other obligations, including certain non-ABS CDO obligations, with par amounting to $1.4 billion, in full satisfaction, butpartial payment, of such obligations. Averaging the valuations of AAC’ independent appraiser, the Bank Group Settlement ultimately paid the Bank Group 43.3% of the present value of expected losses, with 24.5% in cash and 18.8% in Bank Settlement Notes, D. Allocation tothe Searepated Account of Libilties to AFOI and the IRS. On November 3, 2010, the Rehabiltator leamed that AFGT had received an “Information Document Request” from the IRS asking AFGI to describe its legal basis for claiming approximately $700 million of income tax refunds that were subsequently paid to AAC pursuant toa Tax Sharing Agreement between AFGI and AAC (the “Tax Refund Payments"). Out of concer thatthe IRS might have attempted to impose a levy on the proceeds of the Tax Refund Payments, an action which could have had severe consequences for AC and the Segregated ‘Account, the AAC board of directors voted, on November 7, 2010, to allocate tothe Segregated ‘Account: (i) any liabilities that AAC may have to APGI in regard to tax refunds including, but ‘ot limited to, any preference claim or fraudulent transfer claim pertaining to such subjects brought by, or on behalf of, AFGI in any bankruptcy proceeding involving AFGI; and (i) any liabilities thar AAC may have to the IRS in regard to certain taxes or tax refunds On November 8, 2010, the Rehabilitator filed # motion secking to supplement the Injunction Order entered on the Petition Date to ensure that, among other things: (i) any disputes regarding claims of AFOI or its bankruptey creditors of the IRS pertaining o the tax refund payments 0 ‘AAC will be litigated before the Rehabilitation Cour; (i) any remedies available for such liabilities would be implemented in accordance with the Plan (as described below); and (il) the federal govemment’s claims receive the appropriate priority under Wisconsin insurance laws. ‘The Rehabilitation Court granted the Rehabilitator’s motion by order dated November 8, 2010 (the “Supplemental Injunction’) (On April 30, 2013, the Rehabilitator, OCI, the Segregated Account, AFGI, AAC, the Official Committee of Unsecured Creditors of Ambac Financial Group, Inc. (ihe “Creditors Committee") and the IRS settled the lawsuit brought by AFG against the IRS seeking: () to enjoin the IRS from attempting to levy AFGI's assets in connection with the Tax Refund Payments, and (i) to determine the amount, if any, of AFGI’s tax Hablity (the “IRS Dispute”). The terms of this settlement (the “IRS Settlement”) included: () a payment to the IRS by the Segregated Account ‘of $100 million; (i) # payment to the IRS by AFGI of $1.9 million; and (ii) AFGI's ‘consolidated tax group, including AAC and the Segregated Account (the “Ambac Group"), relinquishing its claims to loss carry-forwards resulting from losses on credit default swap ‘contracts arising on or before December 3, 2010 to the extent that such carry-forwards exceed $3.4 billion. On April 30, 2013, AFGI and the IRS executed a closing agreement for the IRS Seitlement. AS a result, the IRS Settlement has been consummated and the IRS Dispute is resolved. 5 issioner and Special Deputy Commissi On January 3, 2011, Theodore K. Nickel replaced Sean Dilweg as Commissioner. Thereafer, ‘Mr. Nickel assumed all roles and duties as Rehabiltator. References in this Annual Report tothe ‘Commissioner or the Rehebilitator are to Mr. Dilweg or Mr. Nickel, as appropriate. On February 17, 2016, the Rehabilitator appointed Daniel J Schwartzer as Special Deputy Commissioner forthe Segregated Account, and Mr, Schwartz assumed all authority of the Special Deputy ‘Commissioner as set forth in the Rehabiltaion Order. On May 23, 2016, the Rehabilitation Court approved Mr. Schwartzer’s engagement 2s a consultant to serve as Special Deputy Commissioner. Mr. Schwartzer replaced former Special Deputy Commissioner Roger A. Peterson, who in tum replaced former Special Deputy Commissioner Kimberly A. Shaul References in this Annual Repor to the Special Deputy Commissioner are to Mr. Schwartzer, Mr Peterson of Ms, Shaul, as appropriate I _ STATUS OF REHABILITATION PROCEEDING A. Plan of Rehabilitation 1. Confirmation ofthe Plan of Rehabilitation (On October 8, 2010, the Rehebiltator filed the Plan of Rehabilitation (the “Plan”), together with 1 Diselosure Statement Accompanying Plan of Rehabilitation (the “Disclosure Statement") and ‘4 Motion for Confirmation ofthe Plan in the Rebebiltaion Court. The Plan sets forth the terms ‘and conditions for the settlement and payment of claims against the Segregated Account. The Plan provided for holders of permitted policy claims to receive 25% of their permitted elsims in ‘cash and 75% in surplus notes issued by the Segregated Account, and that delivery of such cash and surplus notes would constitute satisfaction in full of the Segregated Account’s obligations in respect of each claim. ‘An evidentiary heating regarding confirmation ofthe Plan took place inthe Rehabilitation Court ‘uring the week of November 15-19, 2010. All policyholders and other paties-in-interest were permitted to attend and were afforded an opportunity to be heard to call, examine and cross- examine witnesses, and 0 provide oral argument about confirmation on November 30, 2010. ‘More than 20 parties appeared, examined witnesses, fled writen objections to confirmation, and presented oral argument ‘The Rehabilitation Court confirmed the Plan by order dated January 24, 2011 (the “Confimmation Order”) finding, among other things, that: (j) the Rehebilitator’s disclosures regarding the Plan ‘were sufficient; (i) the Plan follows the priority scheme required by Wisconsin insurance lav; ‘the initial cash/nate spit for policy claims is reasonable and more favorable to policyholders than liquidation; (iv) the Plan's use of surplus notes is fir; and (y) the Plan is fair and equitable to policyholders. Since the entry of the Confirmation Order, the Rehabilitator has taken steps to address certain risks and uncertainties facing the rehabilitation, which include amendments to the Plan which ‘were confirmed on June 11, 2014, as discussed below in Section IL.A.4 (the “Amendments”, 2. Interim Cash Payments icy Claims (On June 4, 2012, the Rehabilitation Court approved the Rehabilitator's Motion for Approval to ‘Commence Making Interim Cash Payments on Permitted Policy Claims, Stating on September 20, 2012 but before the Effective Date the Rehabilitator made interim cash payments equal to 25% of the permitted amount of each policy claim, as approved for payment by the Rehabilitator (Interim Claim Payments”)3. Resolution of Tax Uncertainties ‘A number of potential tax issues arose from the Plan as originally confirmed, inclucing: () the potential deconsolidation of AAC from the AFGI consolidated tax group for US. federal income ‘ax purposes resulting from the treatment of the surplus notes as equity rather than debt, ji) he imposition of original issue discount treatment on holders of surplus notes, and (ii) AC's recognition of significant cancellation of indebtedness income with respect to the surplus notes fF of the time of their issuance, The Rehabilittor, AAC and APO hive tnken three major ‘actions to mitigate thee tax issues and to achieve certainty regarding the tax consequences of the Rehabilitation First, OCI and the Rehabilitator reached an agreement with AAC, AFG and The Official Committee of Unsecured Creditors of Ambac Financial Group, Ine. (he “AEGI Settlement”) which resolved all outstanding tax and expense-elated issues between AFGI and ‘AAC, and which, among other things, allocated certain net operating losses ("NOLS") generated by the AFGI consolidated tax group prior to September 30, 2011 to AAC and provided for AAC to compensate AFGI for the use of such NOLs above a defined threshold. The AFGI Setlement js described in detail in motion papers available on the Website and in the 2012 Annual Report, ‘Second, the Rebabilitator and AFGI sought a Private Letter Ruling (the “PLR") fiom the IRS to the effect that () the Rehabilitation, the Plan and the Amendments have not and will not result in a disafiliaion of AAC {com AFGI for federal tax purposes; (i) policies allocated to the Segregated Account will continue to be tested as insurance contracts for federal tex purposes; snd (i) the obligations to pay both Cash Payments and Deferred Amount, including accretion, (both as defined and discussed below) are taken into account in computing “losses incurred” for federal tax purposes. On March 12, 2014, the IRS issued a favorable PLR with respect to all three issues. Finally, the Rehabilitator fled the Amendments Motion with the Rehabilitation Court on April 21, 2014 seeking approval ofthe Amendments, as discussed in deal below. 4, Amendments tothe Plan of Rehabilitation With the receipt of @ favorable PLR from the IRS and the favorable outcome of the appellate proceedings discussed below in Section Ill, the Rehabilitator moved forward wih proposed ‘Amendments to the Plan, which were filed with the Rehabilitation Court on April 21, 2014, slong with a Motion to Amend the Plan of Rehabilitation (the “Amendments Motion”) and an affidavit of Roger A. Peterson in support of the Amendments Motion. The Amencments were supplemented by Filings with the Rehabilitation Court on May 20, 2014 and June $, 2014, The ‘Amendments modified the mechanism for handling claims under the Plan. Instead of a Combination of cash payments and surplus notes, as under the Plan as originally holders of permitted policy claims now receive cash payments (“Cash Payments” Segregated Account establishes on its books deferred amounts equal to the remaining balance of such elaims, reduced from time to time by recoveries and/or payments made by the Segregated ‘Account ("Deferred Amounts"), Payment of Deferred Amounts (each such payment a “Deferred Payment”) are made at such times asthe Rehebiltator deems appropriate, in his sole dseretion, besed on an analysis of estimated liabilities, available claims-paying resources, and other considerations relevant (0 equitable treatment of claims and the best interests of policyholders. With the exception of adjustments for certain under-collateralized transactions as desc below in footnote 1, Deferred Amounts curently accrete at an effective annual rate of 5.186. The Rehabilitator reserves the right to amend the Plan or take such other action ss he deems necessary or appropriate to adjust the rate of accretion on Deferred Amounts from time to timebased on such factors as he considers relevant. Additionally, the Segregated Account shall, if required in satisfaction of any junior claims, establish on its books junior deferred amounts accreting at 5.1% per year insléad of issuing junior surplus notes besring interest at 5.1% per year, ‘The Amendments require proportionate payments to be applied in redemption of certain surplus notes issued by the Segregated Account in commutation of Policy liabilies (the “SA Surplus Notes” which, together with the Bank Setlement Notes, ate the “Surplus Notes") as and when payments are made on Deferred Amounts, including the Equalizing Deferred Payment paid to policyholders on December 22, 2014 (described later in this Section). Pursuant to the Bank Group Settlement, AC is also required to make proportionate payments in redemption of the Bank Settlement Notes as and when the Segregated Account makes a payment in redemption of| the SA Surplus Notes. After a hearing on June 11, 2014, the Rebsbilitation Count approved the Amendments by an order dated June 11, 2014 (the “Amendments Order"), Pursuant to Section 5.02 of the Plan, the Plan, as amended by the Amendments, Became effective on June 12, 2014 (the “Effective Date”) 5. Guidelines Issued Pursuant to the Plan of Rehbiltation ‘As part of the commencement of the Interim Claim Payments, the Rehabilitstor promulgated the Rules Governing the Submission, Processing and Payment of Partial Payment of Policy Claims in Accordance withthe June 4, 2012 Interim Cash Payment Order and the Rules Governing the Submission, Processing and Partial Payment of Claims under Financial Guaranty Policy No, 17548BE in Accordance with June 4, 2012 Interim Cash Payment Order (collectively the “Interim Rules"). The Rehabiltator also issued a statement on September 6, 2012 clarifying that policyholders may not submit claims under th Interim Rules subject a reservation of rights. Concurrent with the development ofthe Amendments, the Rehabilitator developed the Payment Guidelines for Plan of Rehabilitation, as Amended (the “Plan Payment Guidelines") and the LVM Payment Guidelines for Plan’ of Rehabilitation, as Amended (the “LVM Payment Guidetines") and the Guidelines Governing Ceded Reinsurance Contacts Following the 2014 Amendments (the “Reinsuran "), along with proof of claim forms, claim schedules, and allocation schedules for both the Plan Peyment Guidelines and the LVM Payment Guidelines (collectively, the “Payment Guidelines"). The Payment Guidelines were based in part on the Interim Rules. On the Effective Date, the Payment Guidelines became effective and superseded and replaced the Interim Rules, and the Reinsurance Guidelines also became effective and superseded and replaced the Rules Governing Ceded Reinsurance Contracts Following June 4, 2012 Interim Cash Payment Order. 6, Interim Payment Percentage and Equalizing Deferred Payments ‘After the Effective Date, the Rehabilitator increased the portion of permitted policy claims to be paid in cash from 25% 10 45% (the “Interim Payment Percentage”) effective July 21, 2014 ‘Accordingly, on and after July 21, 2014, (i) holders of permitted policy claims receive Cash Payments equal to 45% of their claims, and (i) the Segregated Account records Deferred ‘Amounts on its books in favor of the respective holders in an amount equal 10 $5% of suchclaims, which accretes in accordance with the Payment Guidelines at an effective amnual rate of 51%! In order to maintain parity among all policyholders, including those whose permited policy claims were accepted and paid prior to July 21, 2014, a Deferred Payment (he “Equalizing Deferred Payment’) was made on December 22, 2014 to policyholders that received Interim Claim Payments (as defined in Section 1.8.2). The amount of the Equalizing Deferred Payment was 26.67% of such holder's Deferred Amounts, including the value of accretion, in each case, as at July 20, 2014, This Equalizing Deferred Payment constituted the amount recessary to provide policyholders who received Interim Claim Payments with @ total payment of 45% of their permitted policy claim amounts, the amount which is now paid as Cash Payments to policyholders with permitted policy claims under the Payment Guidelines. This resuted in equal {reatment of those policyholders whose permitted policy claims were processed under the Interim Rules prior to July 21, 2014 and policyholders whose policy claims are processed under the Plan and the Payment Guidelines ‘The Rehabiltator provided notice of the Equalizing Deferred Payment and the inerease in Interim Payment Percentage, as required by the Plan, on June 20, 2014, With the Rehabilitator’s permission, the proportionate Surplus Note redemption payments required by the Amendments and the Bank Group Settlement to be made in conjunction with any Deferred Payment were made on November 20, 2014, rather than on December 22, 2014 when the Equalizing Deferred Payment was made. This early payment date for Surplus Notes resulted in interest savings to AAC that benefit all policyholders, and facilitated the orderly processing and disbursement of all payments to policyholders, B. Other Significant Aspects ofthe Rehabilitation Proceedin 1 Supol ments In certain RMBS transactions, AAC is contractually entitled to be reimbursed from various cash flows in such transactions (“Reimbursements”), tothe extent that AAC has satisfied claims under the polices issued by it in connection therewith. This means that certain amounts in excess ofthe Segregated Account's claim payments to policyholders would not be reimbursed unless a supplemental payment is made in respect of the related policy claims. (On August 2, 2013, the Rehabilitation Court entered, upon the motion of the Rehailitatr, the (Order Granting Rehabilitator’s Motion for Approval to Make Supplemental Cash Payments as to Certtin Policy Claims For the Purpose of Maximizing Reimbursements for the Benefit of All Policyholders ((he “Supplemental Payments Order"). The Supplemental Payments Order authorized the Rehabilitalor to make payments in excess of the then-current Claim Payment percentage (“Supplemental Payments") for certain permitted policy claims for the purpose of ‘maximizing Reimbursements payable to AAC, By making Supplemental Payments and "There are cern limied situations involving under-colaeralzed obligations where Defereé Amour nay not crete stan fective anal rato 1a 5th pore dal in he Amendments,maximizing Reimbursements, AAC is effectively able to pay Permitted Policy Claims in a ‘manner that makes efficient use of its financial resources. The Supplemental Payments Order has been superseded by the Plan, as amended, and the Plan Payment Guidelines, which permit the Rehabiltator to make Supplemental Payments in order to maximize Reimbursements and to minimize Supplemental Payments in excess of available reimbursement amounts. Supplemental Payments made in 2015 exceeded $46 million. As of the ate ofthis report, all ofthe amounts paid as Supplemental Payments in 2015 have been retumed to AAC as Reimbursements 2. RMBS Remediation Claim Setlements Ina February 13, 2014 order (the “RMBS Setlement Proceeds Order”), the Rehabilitation Court approved the Rehabiltator’s Motion for Approval to Disburse Proceeds and Make Permitted Policy Claim Payments as He Deems Appropriate from Settlement of RMBS Remediation Claims, Including Those Proceeds Received, and to be Received, from a Settlement Memorialized in a Stipulated Order ofthe Bankruptcy Court Handling the Residential Capital LLC Cases. The RMBS Seulement Proceeds Order: (i) auhurized the Relabiliator w allvcate and distribute cash and other forms of consideralion generated by settlements of RMBS remediation claims (‘RMBS Remediation Clsims"), and (ji) approved the Rehabilitator's approach for disbursing certain settlement proceeds and making permitted policy elaim payments to specific policyholders inthe Rehabilitation Proceeding in accordance with the stipulated order (the “Stipulated Order") of the United States Bankruptey Court for the Southern District of New York in the matter of in re: Residential Capital, LEC, etal, Case No. 12-1220. The Stipulated Order reflects the setlement achieved by AAC and the Segregated Account with Residential Capital LLC and certain of its affiliates (collectively, “ResCap") with respect to certain RMBS Remediation Claims. 3, The Secured Note and the Reinsurance Agreement In May 2014, the Segregated Account drew down the last of the principal amount available under the Secured Note as a result of ongoing claims payments and expenses. The Segregeted ‘Account now makes periodic demands to AAC under the Reinsurance Agreement in arder to take claims and certain Surplus Note payments. The Secured Note and Reinsurance Agreement are discussed in greater depth in Section LB above. 4. Improving Mortgage Loan Servicing ‘Throughout the pendency of the Rehabilitation, the Rehabilitator and the Management Services Provider have pursued various efforts and strategies directed at maximizing claims-paying resources. Those efforts are consistent with the Rehabilitator’s overall effort to improve outcomes for insured policyholders through prompt, efficacious management and administrative strategies. Those efforts have included replacing mortgage loans services, either through voluntary agreements or through the exercise of control rights provided in the transactional documents governing the insured securities,C. Significant Transuctions since May 2015 1, JPMorgan RMBS Dispute Settlement In January 2016, AAC and the Segregated Account setled their RMBS-related disputes and litigation against JP Morgan Chase & Co. and certain of its afilintes (colletively “JP Morean"). Pursuant to the settlement, JP Morgan paid AC $995 million in cash in return for releases of all of AAC's claims against JP Morgan arising from certain RMBS transactions insured by AAC. 'As part of the settlement, AAC also agreed to withdraw its ebjections to IPMorgan’s global MBS settlement with RMBS trustees. 2. Commutation’Termination of Policies Insuring Bonds Backed by Student Loan Trusts Since May 2015, AC has executed 2 number of symthetic commutations with respect to a portion of the Segregated Account's exposure in connection with financial guarantee policies {guaranteeing the payment of principal and interest on bonds backed by student loans held in securitization trusts (collectively, the “Student Loan Bonds"), Additionally, certain other insurance policies guaranteeing student loan backed bonds were terminate. ‘As a resull of these synthetic commutations and policy terminations, approximately $1,167 rillion of principal exposure has been extinguished since May 2015. This includes policy terminations and synthetic commutations of approximately $768 million wth respect to National Collegiate Student Loan Trust and approximately $180 million with respect to South Carolina Student Loan Corp. These extinguished exposures represent approximately 39% of the Segregated Account's total aggregate student loan backed principal exposure as at June 1, 2015, IL, SUMMARY OF OTHER LITIGATION RELATED TO THE REHABILITATION PROCEEDING ‘A. Favorable Resolution of All Outstanding Aposilate Litigation By Order dated March 19, 2014, the Wisconsin Supreme Court denied the petitions for review filed by certain of the appellanis seeking review of the published decision of the Wisconsin Cour of Appeals entered on October 24, 2013. That decision by the Wisconsin Court of Appeals affirmed all of the orders entered by the Rehabilitation Court in favor ofthe Rehabilitator that were the subject of Appeal Nos, 2010AP1291, 2010AP2022, 2010AP283 and 201 1APS6I. The Rehabilitation Court's Confirmation Order was among the orders of the Rehabilitation Court that were affirmed by the Wisconsin Court of Appeals. See In the Matter of the Rehabilitation of: Segregated Account of Ambac Assurance Corporation, 2013 WI App 129, 351 Wis, 24539, 841 N.W.2d 482, review denied 2014 (the “Court of Appeals Desision"). Following the Wisconsin ‘Supreme Cout’s denial ofthe appellant's petitions for review, the Court of Appeals Decision is ‘now the controlling law ofthe ease inthe RehabilitationB, Ligation Stemming from the Allocation to the Searegated Account of Liabilities {othe United Sates ‘On December 8, 2010, after the confirmation hearings but before entry of the Confirmation Order, the United States removed the Rehabilitation Proceeding to the United States District Cour for the Western District of Wisconsin (the “District Coun”), with the stated intent of challenging the Supplemental Injunction. By order dated January 14, 2011, the District Court remanded the Rehabilitation Proceeding to the Rehabilitation Cour, concluding thatthe removal ‘was preempted by the McCarran-Ferguson Act, and that the District Court therefore lacked subject mater jurisdition aver the proceeding. On February 9, 2011, the United States filed a separate complaint and a motion for a preliminary injunetion in the District Court seeking, among other things, t@ enjoin enforcement of the Supplemental Injunction and Confirmation Order against the United Stats in ease captioned United States of America v. Wisconsin State Circuit Court for Dane Coury, Case No. 11-cv-099. The District Court dismissed that cuit for lack of subject matter jurisdiction on February 18, 2011 and the United States filed a notice of, appeal on February 22, 2011, The sppeals atthe Seventh Circuit were captioned as Appeal Nos. 11-1158 and 11-1419 (dhe “Appeals”, As a result of the closing of the IRS Settlement (as described in Section ID) on May 9, 2013 the United States filed an Unopposed Motion to Dismiss the Appeals. The District Court vacated all opinions and orders underlying the Appeals by Order dated July 15, 2013. ©. FELEund Lid. as On June 9, 2014, the Rehabilitator filed a motion with the Rehabilitation Court seeking an order confirming and declaring the correctness ofthe long-standing manne in which Deutsche Bank National Trust Company, acting solely as the trustee forthe two residemtial mortgage-backed securitization trusts described below, the trust administrator, Ambac and the Segregated ‘Account, have been calculating the reimbursements due Ambac and the Segregated Account for ‘payments on permitted claims respecting Financial Guaranty Insurance Policy Nos. ABIOL4BE and ABIO37BE. Six holders of uninsured certificates opposed the motion. The Rehebiltation Court granted the mation in its entirety on July 7, 2014. The sic holders of uninsured certificates appealed the Rehebilitation Court's decision in an appeal captioned: Ted Nickel and Office of the Commission of Insurance, etal. v. FFI Fund Lic, etal, Appeal No. 14 AP 2033. (On March 4,2016, the Wisconsin Court of Appeals affirmed the Rehabilitation Court's decision. ‘The Court of Appeals held that, among other things, “the legal principles and judicial policies underlying a rehabilitation proceeding weigh heavily against allowing individual certificate or policy holders 1 have standing to challenge orders by the rehabilitation court following adoption ‘of a rehabilitation plan.” D. Motions Heard Since Mav 2015 Motion to Show Cause and Motion 10 Quash Subpoena. On February 11, 2016, a group of investment funds calling themselves the “CarVal Holders” filed 2 motion in the Rehabilitation Court requesting that the Court issue an order to show cause why the Interim Payment Percentage should nat now be substantially increased and additional distributions promptly made{holders of obligations of the Segregated Account. In connection with that mation, the CarVal Holders issued a subpoena duces tecum to AAC seeking a variety of financial information. On March 2, 2016, the Rehebilitatr filed, and AAC joined, a motion to quash the CarVal Holders’ subpoena. On April 5, 2016, the Rehabilitation Court held a hearing on both motions and denied the CarVal Holders” motion to show cause and granted the Rehabiltator's motion to quash the subpoena. At that hearing, the Rehabilitation Court also ordered that interested partes may not take discovery in the Rehabilitation Proceeding without fist seeking leave to do so from the Rehabilitation Court E en Ww tion ‘AAC andlor the Segregated Account are curently plaintiffs in five lawsuits against parties involved in RMBS transactions insured by polices allocated to the Segregated Account. The cases generelly involve claims that the defendants breached contractual representations and warranties to AAC and/or thatthe defendants engaged in fraud. Those lawsuits areas follows: Ambac Assurance Corporation, eta. v. Countrywide Home Loans, Inc, eta, Index No. 10-CV- 651652 (N.Y. Sup. Cl). This case was filed in 2010. Diseavery is complete and the trial court has ruled on motions for suramary judgment. The trial court's decisions on summary judgment are curently on appeal. No tral date has been set. Ambac Assurance Corporation, etal v. Countrywide Home Loans, ine, eta, Case No. 14-CV- 3511 (Cir. Ct. Dane Co. Wis.). This ease was dismissed by the circuit court for lack of personal jurisdiction. AAC and the Segregated Account appealed that decision tothe Wisconsin Count of ‘Appeals, Appeal No. 2015 AP 1493. Briefing is complete on the appeal. AAC and the Segregated Account commenced litigation in New York (Index No. 15-CV-652321) alleging claims identical to the Wisconsin case and filed a motion to stay the New York aetion pending resolution ofthe Wisconsin appeal, which defendants have opposed, Ambac Assurance Corporation et al. v. Countrywide Home Loans, inc. etal. Index No. 14-CV- {653979 (NY. Sup. CL). This case was filed in 2014, Defendants” motion to dismiss is pending. ‘The case isin the discovery phase. Ambac Assurance Corporation, etal. v, First Franklin Financial Corp. et al. Index No. 12-CV. 651217 (N.Y. Sup. CL). This case was filed in 2012. Defendants’ motion to dismiss and strike are pending. The case i in the discovery phase. Ambac Assurance Corporation, eta. Nomura Credit & Capita, Inc, eta. Index No. 13-CV- 651359 (N.Y. Sup. CL). This case was filed in 2013, The cas isin the diseavery phase.IV. FINANCIAL REVIEW With the assistance of his financial advisors, the Rehabiltator provides the following update on the financial condition of the General Account and Segregated Account, A. General Account Assets Including the proceeds received in January 2016 from the JP Morgan RMBS Dispute Settlement (the “JEM Seilement"), total claims-paying resources are estimated at approximately $6.5 billion as of December 31, 2015, a 81.6 billion, or 33%, increase ftom estimated claims-paying resources of $4.9 billion as of December 31, 2014. The increase in claims-paying resources is attributable to (i) $1.0 billion in proceeds from the JPM Settlement, (i) a $0.3 billion increase in ‘the statutory earrying value of investment portfolio assets, and (ii) $0.4 billion in incremental value attributable 10 AAC's investment in subsidiaries (Which i largely attributable to the inclusion of Ambac Assurance UK Limited asa claims-paying resource). The primary components of elaims-paying resources as of December 31, 2015 are () $4.5 billion of investment portfolio assets at statutory carrying value, (i) $1.0 billion in proceeds from the JPM Settlement, (i) $0.6 billion associated with AC's investments in, and transactions with, subsidiaries, (iv) $0.3 billion in net present value of future installment premiums and (v) $0.1 billion of miscellaneous financial assets at statutory carrying value. The foregoing estimate of claims-paying resources includes cerain assumptions and judgments made by the Rehabilitstor regarding future evens that are described more fully below, 1. Investment Portfolio Holdings? ‘As of December 31, 2015, AAC held fixed income investment securities with a fair value of approximately $4.6 billion, statutory carrying value of approximately $4.5 billion and par value of approximately $4.7 billion. Certain information regarding AAC’s portfolio holdings is summarized below: * The cicsson of investment potolo holdings is based on infomation repoed by AAC aso the end of the foun quaner of 205 and therefore excludes the proceed that AAC ectved fam the JPM Setement nthe rst quate of 2016AAC Investment Portfolio by Asset Class as of December 31, 2015" ice Cen Cane Guns Stomnca e onpm ‘need Sin met Oe Cnr | (GE orm an Og: RMBS and corporate obligations account for 75% of portfolio holdings on both a fair value and carrying value basis, compared with 67% (fuir value) and 68% (carrying value), respectively, twelve months prior, Municipal obligations, which accounted for more than 20% of aggregate hholdings on both a fair value and carrying value basis two years prior (that i, as of December 2013), now account for 7% of AAC’s holdings on a fair value bass and 6% on a carrying value basis. ‘The statutory carrying value of AC's investment portfolio assets inereased by $0.3 billion, or 8%, during 2015, while the fair value of AC's investment portfolio assets increased by $55 nillion, or 1%, ftom year-end 2014. This relatively modest change in portfolio fair value was 7 Approximately 99% of AC's non-ageney RMS holdings, 5 measured by story caring value, ae |AACsinsuedinsruments,Aczodigly, he ye to matty and weghed-averge ie associated with AAC's not teeney RMBS holdings ae necesanly Inked 19 AC's assumptions epading the amount and timing of lan payments such holding il recive aner he Rehabtaon Plan 4 On luly 26, 2018, AAC borowed $146 milion by contrbuting RMIBS guarased by AAC with 2 stator eying value af $368 millon as of December 31,2018 ta third pay tas As of December 31, 2015, {he snor canyng vale ofthe Borowed funds elaing 1 the ats Was approximately 3133 lion resign ‘et laity of S193 milion. The contbuted RMBS remain reponed in AC's lnvesmentponlin. ARC's invesment portfolio war reduced as proceeds fom conibuled RMBS were ased ro pay te cette owned by third party investors in he amount of 15 milion during 2015. See Note 11 Yo AACS 2013 anal siaony Financia atement or erhe afermato othe 2018 watscton,due in part to AAC's concentration in corporate bonds and nonagency RMBS (predominantly ‘AAC-insured instruments), given the relatively weak performance of corporate fixed income in 2015 and the widening of AC credit spreads following Puerto Rico's announcement of its intent to restructure is obligations. AAs of December 31, 2015, investment portfolio holdings representing approximately 53% of aggregate portfolio carying value had an investment grade rating or may otherwise be considered investment-grade, versus 49% one year prior and 69% two years prior. Investments in ‘AACzinsuted securities account for approximately 94% of all non-investment grade holdings, compared with 87% one year earlier. ‘The market liquidity profile of AAC's investment portfolio as of December 31, 2015 is summarized as follows: AAC Investment Portfolio by Market Liquidity Classification as of December 31,2015 1, Highly Llauid: floes widely-held secwies with tight bid'ask speeds and transparent markets Asset ‘esses epesnts inthis catepry incl money market haldings,cetin munisipal bonds, and US. sarees Sd essen 2. Medium Llguit: Incorporates wiely-held secures with bcaderbidsk spreads in acivey-raded makes [Sst elses represented in thi exper ineide eran astettacked cures, residential morgage backed ‘Secures, corporate ebligains nd municipal bonds. 3. Lam Linu Incorporates closed secures with wide bids spends. Price changes ar primal rei Given. Asset cases represented in this etegry inclderesierl magagebacked Secures and compere ‘hligtion. Certain of thet secures may aenerte periodic principal dtibtns. 4. and: tncledes daressed andor comple secures i specialty asst classes such as CDOVCLOS, certie erporte ciation srstures Insurance, and consi muicpl Bonds a wel a secures insured by AAC including residential mongage-backed secures Cenain of thee secs may genera pede propa sribatons. Portfolio holdings classified as highly liquid or medium liquid represent 50% of total portfolio carrying valve as of December 31, 2015, versus 49% as of December 31, 2014 and 63% as of December 31, 2013,° Conversely, portfolio holdings classified as low liquid or illiquid represent 50% of aggregate carrying value as of December 31, 2015, compared to 51% as of December 31, 2014 and 37% as of December 31, 2013, The Weighted-average book yield for securities Classified as either highly liquid or medium liquid was 3.2% as of December 31, 2015, compared Te sabeguen eept of proceeds fom the JPM Seulement nthe Fst quarter of 2016 inceasad AAC's agaregatehoiingsof highly iui and medio uid ss,swith 3.3% twelve month prior. In comparison, the weighted-average book yield for securities classified as either low liquid or iliquid was 9.9%, compared with 9.6% as of December 31, 2014. AAC insted instruments accotint for 88% ofthe carrying value ofall securities elasified 2s low liquid or illiquid, compared with 8646 ewelve months earlier. 2. Installment Premium Many insurance policies issued by AAC provide for premiums tobe paid to AAC over the life of| ‘he corresponding exposure. Pursuant othe Plan of Operation, installment premiums related to Segregated Account policies are to be paid tothe General Account, but are available ‘or payment for the Reinsurance Agreement. ‘The value attributable to future installment premium receipts is subject to significant uncertainty. Events such as early contract termination, commutation, faster than expected principal amortization, prepayment of the underlying obligation, and payment default may cause actual installment premium receipts to be lower than projected amounts. In light of these factors, the Rehabilittor’s estimate of future installment premium receipts is less than the aggregate amount of installment premiums receivable if all existing policies remain in force until contractual maturity ‘After giving effect to such adjustments, the Rehabiltator’s estimate of the present value of future installment premiums (net of reinsurance) for General Account and Segregated Acccunt policies is $0.3 billion as of December 31, 2015 using a 5.1%6 discount rate, compared with $0.4 billion as of December 31, 2014. 3. Intercompany Loans [As of December 31, 2015, AAC had $540 million in loans receivable from i's allilites, representing a $60 million increase from the $880 million of intercompany loans oustanding as of December 31, 2014, Loans to affiliates comprised (i) $195 million in unsecured loans to ‘Ambac Cupital Funding, Inc. (“ACEI”) and (ji) $64 million in unsecured loans of securities and ‘$681 million in unsecured cash loans to Ambac Financial Services, LLC (“AFS"). The increase in intercompany loans over the past twelve months is attributable to APS, which has been equited to post addtional collateral due to adverse interest rate movements ‘A portion of the AFS obligation is comprised of $64 million of loans inthe form of marketable securities, In accordance with Statutory Accounting Practices (‘SAP"), the statutory carrying value ofthe loaned securities is included inthe investment portfolio totals summarized in Section IV.A.1 above; accordingly, $64 million is excluded from the intercompany loan component of claims-paying resources, and the net inter-company loan receivable, before impairments, is $876 tmillion, After impairments, the statutory value ofthe intercompany loans is $8 millon a) LIntercompany Loar ‘The guaranteed investment contract (“GIC") business operated through ACFI had approximately $100 milion in GIC outstanding as of December 31, 2015, compared to $161 million as of December 31, 2014. The lst remaining GIC matures in March 2017,AAC expects a $187 million impairment of the $195 million unsecured loan to ACF, implying residval value available to policyholders of just $8 million, This estimate is largely consistent with its prior-year impairment estimate of $178 million. This estimate is based upon various assumptions, including but not limited 10 assumptions regarding interest rates and portfolio performance, ») ABS Intercompany Loans ‘As of December 31, 2015, AFS maintsined swap positions with gross notional exposure of approximately $2.3 billion, compared to $24 billion as of December 31, 2014. These swap cbligations are primarily floating-for-fixed interest rate swaps with municipalities and financial institutions as counter-partes. ‘AAC has fully impaired the $681 million unsecured cash loan to AFS, indicating thatno residual ‘value will be available to policyholders from this intercompany loan. The rise in the balance of this loan since December 31, 2014 was largely the result of adverse interest rate movements. In sedition to the foregoing factors this impairment is based upon various assumptions. including but not limited to forward interest rates, the ability of counterparties to pay when due and early contract terminations, Accordingly, the ultimate impairment realized in respect of this obligation ‘may change, pechaps materially, to the extent future performance differs from such assumptions, For example, a sustained increase in the term structure of interest rates would reduce the estimated impairment ofthe AFS intercompany loan, while inereasing prospective policy claims in respect of floating rte insured exposures. In contrast, a sustained decline inthe tem structure of interest rates could lead to @ greater impairment estimate andior recognition of a further loss ‘on AAC’s guarantee of AFS" obligations, which would be mitigated by reduced polizy claims in respect of floating rete insured exposures. 4, Investment in Subsidiaries 8) —_Everspan Financial Guarantee Corp. ‘As of December 31, 2015, AC's investment in its indirect, wholly-owned subsidiary Everspan Financial Guarantee Corp. (*Everspan") is valued at $223 million, compared to $218 million as ‘of December 31, 2014, Everspan’s only insured obligation represents approximately $6 millon fof net par outstanding as of December 31, 2015. The exposure is healthcare-elated and aadversely-classtied, although no statutory los reserves have been established. The Rehabilitator believes that AAC's investment in Everspan will ultimately be available to AAC to find General ‘Account and Segregated Account obligations in accordance with te Plan, b) Ambac Assurance UK Limited ‘AAC’s investment in its wholly-owned subsidiary Ambac Assurance UK Limited (“AUK”) is a ror-admitted asset for statutory accounting purposes. AAC is eurently unable to repatriate funds from AUK due to local regulatory capital requirements. In addition, AUK’s license was amended {in 2010 to require regulatory approval of any transfer of value andlor assets from AUK to AAC. Accordingly, we do not anticipate that AAC will receive dividends from AUK until it has paid or fully remediated its policies with losses, which may not occur until 2036 (Which represents thecontractual end of AUK's most significant currently-identified policy with losses) or perhaps later (in the event that addtional policies with losses develop) We consider AUK to be the most volatile component of AC's claim-paying resources. As of December 31, 2015, AUK has approximately 51.0 billion in claims-paying resources, including 80. billion of investment portfolio assets and $0.4 billion in net present value of installment premiums. Such claims-paying resources support $17.8 billion in net par outstanding, of which 51,7 billion was adversely classified as of December 31, 2015. We estimate the present value of future losses associated with UK's policy obligations at $0.4 billion. Based upon our review of | AUK's investment portfolio, policy obligations, operating expenses, prospective tax liability, and other factors, we estimate the present value of AC's interest in AUK, employing the statutory discount rate of $.1%, at approximately $350 million, 5, JPMSettlement On January 26,2016, AAC announced tha it had setled its RMBS-related disputes and litigation against JP Morgan Chase & Co, and certain ofits afiliates (collectively, “JPM"), Pursuant tothe JPM Settlement, JPM paid AAC $995 million in cash ($993 million net of reinsurance) in return for releases of all of AC's claims against JPM arising from certain RMBS transactions insured by AAC. Although this setement was consummated afer December 31, 2015, we have included the proceeds received by AAC in the JPM Settlement in our estimate of claims-paying resources. 6. Miseellaneous Other claims-paying resources include (2) investment income due and acerued (i) cash and (ii) receivables for securities, none of which are incorporated in the investment portfolio totals summarized above. AAC had $74 million of such assets as of December 31, 2015, compared ‘with $64 million twelve months prior. AAC’s miscellaneous financial assets as of December 2015 comprise (i) $24 million of investment income due and accrued, (ji) 86 million in eash, and (Gi) $44 million in receivables for securities. B, Policy Liabilities ofthe General Account and the Segregated Account 1. Summary of Lisbiliies The Segregated Account is primarily exposed to RMBS and student Joan-related credit risk While the General Account is primarily exposed to the U.S. public finance sector on a direct basis, it retains exposure to Segregated Account policies under the terms of the Reinsurance ‘Agreement Further information on this subject is contained in AFGT's annual reports on Form 10-K and Form 10-K/A and quarterly reports on Form 10-Q. 2 General Account Exposures AAs of December 31, 2015, the General Account had approximately 4,600 policies in force, representing $76 billion in net par outstanding, compared to approximately 6,200 polices, representing $106 billion in net par outstanding, as of December 31, 2014. Included in the General Account net par outstanding as of December 31, 2015 and December 31, 2014 is $1 billion in seeond-to-pay insured exposures related to obligations where AUK isthe primaryinsurer, This net paris generally reported as AUK par in Ambac-related filings. The year-over year decline of 28%, or $30 billion, in General Account net par outstanding is a function of Scheduled terminations (such as maturity of a specific obligston), unscheduled terminations (uch as refinancing transactions), and de-risking initiatives US. public finance exposures represent 65 billion, or 85%, of aggregate net par outstanding in the General Account, as well as 95% of total General Account policies.® See below for a summary of policies and net par oustanding by exposure category General Account Policies and Net Par Outstanding as of December 31,2015 Dalai Mine i NevPa Ownsntng samen Pest ean _ Pots CLOrndooe CDOs “ om 1% os Tou +30 pos rou, a) Credit While the total amount of adversely classified General Acccunt exposures has declined, the percentage of those exposures that ae classified in the more severe categories has increased, due in large part to exposures associated with Puerto Rico. Approximately $6.6 billion, or 8.6%, of General Account exposure is adversely classified, compared t0 $8.6 billion, of 8.1%, of General ‘Account net par outstanding as of December 31, 2014. AAC’ insured Puerto Rico exposures ‘account for approximately 33% ofall General Account adversely classified NPO. Approximately 52.2 billion ofall adversely classified General Account exposures are curently classified in the more severe If (Doubtful with Clear Potential for Loss) and IV (Imminent Default or Defaulted) classifications, compared to $1.8 billion as of December 31, 2014. Additionally, $0.1 billion is classified in the most severe V (Fully Reserved) category as of December 31, 2015, compared with a de minimis amounts in the prior-year period. The amount of General Account net par classified as lass Il, IV or V credits represents the highest amount reported in prior iterations of this Report. A summary of adversely classified General Account net par outstanding is shown below. Net pr exposures within the US. public nance markt inlae capital appreciation bonds whch are reponed atthe par amt she ine of sean fhe trance poleb) Loss Reserves Statutory loss reserves, net of reinsurance, reflect AAC management's best estimate of the present value of future loss payments (net of projected subrogation recoveries) for policies that have already defaulted, discounted at the applicable statutory rate (currently 5.1%). As of December 31, 2015, total staruiory reserves associated with General Account policies were $437 million including loss expenses, compared to $445 milion in the prior-year period Pursuant to GAAP accounting requirements, AC develops estimates of gros claim liability” for all policies, regardless of whether claims have been presented. The aggregate gross claim liability, net of reinsurance, associated with all General Account policies was $989 million as of| December 31, 2015, versus $937 million as of December 31, 2014, As the calculation of gross claim liabilities under GAAP is different from that of statutory loss reserves in certain respect, readers should consult AFGI's annual reports on Form 10-K and Form 10-K/A and quarterly reports on Form 10-Q fora detailed description of GAAP loss calculations ©) Claim Payments during 2015 and since the Petition Date ‘AAC paid $21 million in claims resulting from General Account policies and received $2 million in recoveries during 2015, compared to paid claims of $46 million and recoveries of $15 million in 2014, AAC paid $189 million in aggregate General Account payments from the Petition Date ‘through December 31, 2015 and received $94 milion in recoveries. 3. Segregated Account Exposures 8) Overview Aggregate Segregated Account net par oustanding declined by $3.4 billion, or 18%, from $18.8 billion as of December 31, 2014 to $15.4 billion as of December 31, 2015. RMBS'and student loan exposures accounted for 89% of aggregate Segregated Account net par outstanding. See below for a summary of Segregated Account policies and net par outstanding "or pupae of hs Report, gross cla ability for General Account exposures defined as the present value of projected lees mins the preset value of projected suboguion ecveres. * Al elim payment information is presents ross of resized recoveries,‘Segregated Account Policies and Net Par Outstanding as of December 31, 2015 eta a Mone mm Ovtnding mown ____Pecenage Pecemage Diss rains 22 suse m8 Seen tae 8 233 we ra 5 ” ” m Fotos 0 sus su po b) Credit Profile Approximately $12.4 billion, or 81%, of aggregate Segregated Account net par outstanding is dversely classified, compared to $164 billion, or 87%, as of December 31, 2014 Approximately $9.5 billion or 62% of aggregate Segregated Account net par outstanding was allocated tothe more severe III and IV risk classifications, compared to $12.6 billion, oF 67%, as of December 31, 2014. A summary of adversely classified Segregated Account net par outstanding is presented below. [Net Par Outstanding Associated with Adversely Classified Segregated Account Policies a io ) LossRes AAs of December 31, 2015, total statutory loss and loss expense reserves, net of reinsurance, associated with defaulted Segregated Account policies amounted to approximately $1.4 billion, 2compared to $2.0 billion as of December 31, 2014. As mentioned above, statutory loss reserves reflect AAC management's best estimate of the present value of future loss payments, For Segregated Account exposures such loss reserves include defereed amounts. Specifically, statutory loss and loss expense reserves as of December 31, 2015, include $3.5 billion of unpaid permitted poliey claims, inclusive of deferred interest accrued, and are net of approximately 52.6 billion of projected remediation recoveries associated with alleged representation and warranty breaches ("R&W Recoveries”) related to certain RMBS transactions.” Excluding the R&W Recoveries associated with the JPM Settlement, aggregate statutory reserves for Segregated Account polices are $2.4 billion as of December 31, 2015. If all other R&W Recoveries are excluded from the reserve calculation, aggregate statutory reserves for Segregated Account policies are $4.1 billion as of December 31, 2015, compared to $4.3 billion as of December 31, 2014."° Statutory loss reserves associated with Segregated Account policies are maintained in the General Account for reporting purposes, in accordance with accounting principles prescribed or permitted by OCI and exclude the effect of the allocation of the policies to the Segregated ‘Account, The allocation ofthe liabilities to the Segregated Account is reflected on the balance sheet of the General Account, prepared in accordance with SAP as “Liabilities Allocated to the ‘Ambac Assurance Corporation Segregated Account.” See below for a summary of statutory reserves associated with Segregated Account policies by category, Statutory Reserves Associated with Segregated Account Policies us of December 31, 2015 As PeeSeartary Recovein Arce clung Al Dols ia Mine Finca State Wish JPM Seremene as. a8 an om USP Force 2 2 2 Senet Lee en = ) Lon Adbwonen Expo. se s se Tota. sist an si [As noted above, statutory reserves reflect prospective losses for defaulted policies. As part of GAAP accounting requirements, AAC develops estimates of gross claim liability” for all * Readers shoul consult AFGI's annual repos on Form 1O-K and Form 10-K/A and quately reports on om 10:0 for adtonldiclsie regarding RAW Recovers, Raw Recoveries asocaed with defeled RMBS polices and discounted atthe statutory scout ate wer $26 lion and 87} billon a of December 31, 2018 and December 31,201, respectively "For purposes of this Repo, goss lao lint fer Segregated Accoum exposures defined asthe prevent value of projected loner plus Delered Amount minus the present value of projected strogsionpolices, regardless of whether claims have been presented. The aggregate gross claim liability, net of reinsurance, associated with Segregated Account policies was approximately $2.0 billion as of December 31, 2015, compared to $2.8 billion as of December 31, 2014, Such estimates include RAW Recoveries (as estimated in accordance with GAAP) of $2.8 billion as of December 2015 (including $1.0 billion associated with the JPM Settlement) and $25 billion as of December 2014, respectively. Accordingly, excluding R&W Recoveries associated with the JPM Settlement, the aggregate gross claim liability associated with Segregated Account policies was approximately $3.0 billion as of December 31, 2015. If all other REW Recoveries are excluded from this calculation, aggregate gross claim liabilities associated with Segregated Account policies would be $4.8 billion as of December 31, 2015, In comparison, the aggregate gross claim liability associated with Segregated Account policies ‘excluding all R&W Recoveries was $5.3 billion as of December 31, 2014. AAs the calculution of yross claim lisbilies, including RAW Recoveries, under GAAP Is ifferent than that of statutory loss reserves in many respects, readers should consult AFGI's annual reports on Form 10-K and Form 10-K/A and quarterly reports on Form 10-Q for further descriptions of GAAP loss calculations 8) Claims Presented during 2014 and since the Petition Date Excluding commutation payments, aggregate claims of approximately $263 million (representing sn average of $22 million per month) against Segregated Account policies were presented during 2015, compared to $397 million (representing an average of $33 million per month) in 2014, Total claims presented declined by 34% on a year-over-year basis, From the Petition Date to December 31, 2015, aggregate claims of approximately $5.9 billion have been presented against Segregated Account policies, representing an average of $85 million pet month, Such claims are summarized by category as follows: Segregated Account Claims Presented Since Petition Date From Petition Date January 1, 2015 Dollas in Millions to December 3, 20M _to December 31, 20158 Tot I Lien RMBS sou $232 54173 2ed Lien RMBS 1683, % 1,709 Other SA Exposures 39 mn Tonal $5,693 $263 $5046 ©) Claims Paid during 2015 and since the Petition Date Exclusive of commutation payments AAC paid $240 million in Interim Payment Amounts in respect of Segregated Account policy claims during 2015. In comparison, AAC paid S14 billion in Interim Payment Amouns in respect of Segregated Account policy claims during 2014, consisting of $1.1 billion associated with the distibutions resulting from the increase in theInterim Payment Percentage CPP") from 25% 10 48% (and the corresponding Deferred Payments) and $0.3 bllion distributed inthe ordinary cours. From the Petition Date to December 31, 2015, AAC paid approximately $3.0 billion in Interim Payments in respect of Segregated Account policy claims. Such claim payments are summarized by category as follows: Segregated Account Claims Presented, Claims Paid (Int ‘Outstanding™*” Payments), and Claims Cumolatve Comlatve Acensed but Dollars in Millions Chime Presented Claims Paid __Unpaid Claime Ist Lien RMBS $4173 3227 $2046 2nd Lien RMBS 1709 97 912 (Other SA Exposures 6a 54 10 Total 55.946 $2,978, 32,968, In 2015, AAC received $308 million in reimbursements in connection with previously-paid claims, compared 10 $488 million in 2014. AAC has received $1.6 billion in such reimbursements since the Petition Date. \V. ‘THE REHABILITATOR’S FINANCIAL PROJECTIONS ‘The Rehabilitator and his financial advisors have developed detailed financial projections (the “Rehabiltator’s Financial Projections") to aid in the administration of the Rehabilitation. The Rehabilitator’s Financial Projections were intially developed prior to the Petition Date and have been periodically updated and revised since that time. These Projections serve as both (i) a decision-making too! for the Rehabilitator and his advisors and (i) a mechanism by which the Rehabilitator can apprise Holders of Policy Claims of potential recoveries available under certain financial and operating scenarios, ‘The Rehabiltator’s Financial Projections reflect the analysis and assessment ofthe Rehabiltator and his advisors in respect of a range of financial and operating factors that affect AAC’s performance and recoveries that may be available to Holders of Policy Claims. The Rehabilitaror's Financial Projections are derived from direct involvement in and/or on-going review of these critical factors, including the following: 1. Detailed reviews of adversely classified exposures; ® pirences betwee cumulative claims presemed and hims pad at th ner Payment Prcetage rie ‘re prinarilstbuableo the Suplementl Payment Progam, © peered bu unpaid lain ota exclude cerein. 22, Periodic sector reviews adéressing both performing and adversely classifed exposures; 3. Detailed analysis of commutation stategies and specific transactions; 4, Periodic reviews of investment portfli strategies, criteria and performance; 5. Detailed reviews of AAC’s RMBS litigation strategy and activity; and 66. Detailed analysis and review of the Mediation Agreement and the Private Letter Ruling, Which collectively affect AAC’s and the Segregated Account’s prospective tex liability ‘The Rehabilitator’s Financial Projections reflect the improvement that has occurred in AC's financial condition over the past twelve months. Claim-paying resources have grown by approximately $1.6 billion, or 33%, largely due to the JPM Settlement. Further, AAC continues to experience favorable trends with respect tothe amount and variability of potenti Segregated ‘Account losses, particularly due to the ongoing run off of RMBS losses. These positive trends are tempered by a variety of adverse factors, which are addressed further in the following VI. THE REHABILITATOR’S LOSS PROJECTIONS A. Qverview ‘A central element of the Rehabilitator’s Financial Projections are estimates of future losses eveloped by the Rehabilitator and his financial advisors for both the General Account and Segregated Account, using financial information provided by AAC, including information that may have been prepared for Statutory or GAAP financial statements or at the request of the Rehabilitator. Such loss estimates do not purport to reflect the views of AAC, AFI or their management. Two distinct sets of loss estimates, a “base case” and a “stress case,” have been developed, based on financial data for the period ending December 31, 2015, as adjusted for certain subsequent events. Present value calculations, including the loss estimates described herein, employ a 5.1% discount rate, These loss estimates are presented herein on a “gross” basis, meaning that these estimates do not reflect the effect of AAC's ovnership of AAC-insured securities, and thus are comparable to the estimate of claims-peying resources detailed above. Actual losses attributable to General Account and/or Segregated Account policies may exceed these base case and stress case loss estimates, perhaps materially, and such estimates do not represent a eap on prospective losses, In general, base and stress case loss projections are developed by aggregating AAC’ second- ‘worst and worst-case loss estimates, respectively, for each exposure for which a loss is projected, although this methodology has been adjusted in respect of certain policies where the Rehabilitator determined thatthe second-worst and worst-case loss estimates should be revised. In addition, certain adjustments have been made to exposure-evel loss estimates to reflect volving risk assessments and (ji) material events subsequent to December 31, 2015, Jding commutation transactions consummated with respect to certain student loanexposures). In light of such adjustments (as well as other factors), we do not believe that the estimates contained herein would differ materially if more recent data were incorporated, The base case losses for the General Account and the Segregated Account, before any R&W Recoveries, as of December 31, 2015 are estimated to be $1.3 billion and $4.6 billion, respectively. The base case Segregated Account loss estimate includes (i) $3.5 billion in gross acerued but unpaid claims (including accretion) (ji) $0.6 billion in projected RMBS losses, (i) 50.4 Billion in projected student loan losses, and (iv) $0.1 billion in losses associated with other Segregated Account exposures, ‘The stress ease losses for the General Account and the Segregated Account, before any RAW: Recoveries, as of December 31, 2015, are estimated to be $1.9 billion and $4.7 billion, respectively. The stress case Segregated Account loss estimate includes (i) $3.5 billion in gross accrued but unpaid claims (including accretion, (i) $0.7 billion in projected RMBS losses, (i) ‘$04 billion in projected student loan losses, and (iv) $0.1 billion in losses associated with other Segregated Account exposures. B, Certain Consideration Excluding AC's holdings of Surplus Notes, AAC had $1.2 billion of Surplus Notes outstanding (including scerued and unpaid interest) as of December 31, 2015." The Sunplus Notes are not Jncluded in the base case and stress case losses detailed above. Any payment on or redemption of| the Segregated Account Surplus Notes will, pursuant to the tems ofthe Bank Group Settlement, also require a proportionate payment or redemption of the Surplus Notes issued by AAC. Based tn the foregoing, AAC's Surplus Note obligations (including ace-ued but unpaid interest affect both the financial condition ofthe Segregated Account and prospective recoveries for Segregated ‘Account policy beneficiaries. Itis important to note that AC's financial condition remains subject to many uncertainties that ‘cannot be definitively incorporated in a projection model. For example, while the prospect of substantial losses associated with AC's $2.2 billion in net par outstanding issued by certain Puerto Rico entities represents the most immediate credit rsk facing AAC, the Rehablitator remains concemed about the possiblity of further adverse credit developments with respect to (other troubled public finance exposures and (ji) the military housing and equipment-leasing sectors as well as other segments of AAC’s insured book. In addition, losses associated with the Segregated Account’s remaining student loan exposures are correlated with interest rates, ‘meaning that losses may ultimately exceed the estimates contcined herein in the event of & prolonged upward shift in the erm structure of interest rates. As such, actual losses attributable {o General Account and/or Segregated Account policies may exceed the base case and stress case Joss estimates summarized above, perhaps materially. These estinates do not representa eap on. prospective losses. voles Junior Spas NotesVII, DESCRIPTION OF REHABILITATOR’S FINANCIAL PROJECTIONS, SCENARIOS AND PROJECTED RECOVERIES A. General Four iterations, or scenarios, of the Rehabiltator’s Financial Projections were prepared to demonstrate the sensitivity of Ambac’s financial performance, and thus resources available to pay Holders of Policy Claims, under various operating assumptions. In prior iterations of this, Report, these scenarios have generally been developed to highlight a range of outcomes in relation to two primary factors, ic. future oss development and R&W Recoveries. However, in this Report we have incorporated one other important factor in our scenarios, Le. the projected realization of AUK's residual value by AAC. Given the risks inherent in AAC's insured portfolio and other matters facing the company, the range of actual outcomes may differ from {hooe highlighted below materially ‘The Rehabilitator’s Financial Projections are not intended to project the timing of any () future adjustment of the Interim Payment Percentage (currently, 45% of Permitted Clsims) or (Gi) payments in respect ofthe Deferred Amounts (which are defined as the sum of Deferred Loss ‘Amounts and the associated Accretion Amounts) and/or Surplus Notes (and interest accrued thereon) existing under the Plan. Adjustments of the Interim Payment Percentage and associated payments in respect of Deferred Amounts and redemptions of Surplus Notes (and interest acerved thereon) will be determined in accordance with the Plan. B. Recovery of Deferrat 1s, Surplus Notes and Junior Surplus Notes under the Rehabilitator's Financial Projections Holders of Permitted Policy Claims wil receive a combination of Cash andthe right to Deferred ‘Amounts to satisfy their Policy Claims under the Plan. The ultimate recovery achieved in respect of the Deferred Amounts will vary based upon many factors, including, but not limited to (lifetime losses attributable to the Policies, (i) the amount and timing of R&W Recoveries received, (il) operating expenses, and (iv) investment portfolio performance. For purposes ofthis analysis, the Rehabilitator has assumed that () the Cash to Deferred Amount ratio remains unchanged at 45:55, (i) the Surplus Notes issued by the Segregated Account are ;parl passu with the Deferred Amouns allocated to the Segregated Account policyholders in the Rehabilitation proceeding, and (ji)such Deferred Amounts and Surplus Notes remain outstanding until all Policy obligations are extinguished in the year 2052 (the “Projection Period”). At that time, all residual claims-paying resources are assumed to be distributed to Deferred Amount and Surplus Note holders up to the then-outstanding amount of such obligations. Funbermore, to the extent that any claims-paying resources are available after distributions are rade in respect of Deferred Amounts and Surplus Notes, such funds wovld be available to the Junior Surplus Notes. Given the disparity in priority and size that exists between the Junior Surplus Notes on the one hand and the Deferred Amounts and the Surplus Notes on the othe, relatively small changes in assumptions and/or outcomes have a disproportionate effect on the potential recoveries, if any, that may be achieved in respect ofthe Junior Surplus Notes.Scenario One Scenario One contemplates (i) the Rehabilitator’s base case loss estimates for both the General fand Segregated Accounts, (i) realization of R&W Recoveries equal to the amounts stated in 'AAC’s Statutory financial statements as at December 31, 2015, and (il) realization of 100% of the estimated residual value associated with AUK, with dividends ftom AUK to AAC assumed to commence in 2036, Under Scenario One, holders of Surplus Notes and recipients of Deferred Amounts would receive payment in full of their then-outstanding claims (including interest ot sceretion, respectively) at the end of the Projection Period Under Seenario One, the Rehabilitator expects a 100% all-in recovery (including actual and prospective interim’ eash payments received in respect of such policy claims discounted at 5.1%). Holders of Junior ‘Surplus Notes would receive a 100% recovery oftheir then-outstarding claim as well D. Scenario Two Scenario Two contemplates (i) the Rehabilitatr’s base case loss zstimates for both the General land Segregated Accounts, (i) realization of R&W Recoveries equal to 75% of the amounts stated in AC's Statutory financial statements as at December 31, 2015, and (i) realization of 50% of the estimated residual value associated with AUK, with dividends from AUK to AAC assumed to commence in 2036. Under Scenario Two, holders of Surplus Notes and recipients of Deferred Amounts would reccive payment in full of their then-outstanding claims (including interest or accretion, respectively) at the end of the Projection Pesiod. Under Seenario Two, the Rehabilitatr expects @ 100% all-in recovery (including actual and prospective interim cash payments received in respect of such policy claims discounted at 5.1%). Holders of Junior Surplus Notes would receive a 17.4% recovery of their then-outstanding claim as wel. E, Scenario Three Scenario Three contemplates (i) the Rehabiltator’s stress case loss estimates for both the General and Segregated Accounts, (i) realization of RAW Recoveries equal to the amounts stated in AAC’s Statutory Financial statements as at December 3, 2015, and (ii) realization of 100% of the estimated residual value associated with AUK, with dividends ftom AUK to AAC assumed to commence in 2036, Under Scenario Three, holders of Surplus Notes and recipients of Deferred Amounts would receive approximately 97.8% of their then-outstanding claims (including interest or aecretion, respectively) atthe end of the Projection Period. Under Scenario ‘Three, the Rehabilitator expects a 98.8% all-in recovery (inc uding. actual and prospective interim cash payments received in respect of sueh policy clalms ¢iscounted at 5.199). Holders of ‘unior Surplus Notes would receive no recovery of their then-outsanding claim as wel, F, —Seenario Four Scenario Four contemplates (i) the Rehablitator’s stress case loss estimates for both the General and Segregated Accounts, (i) realization of RAW Recoveries equal to 75% of the amounts stated in AAC's statutory financial statements as at December 31, 2015, and (ii) realization of 50% of the estimated residual value associated with AUK, with dividends from AUK to AAC ‘assumed to commence in 2036, Under Scenario Four, holders of Surplus Notes and recipients of Deferred Amounts would receive approximately '84.4% of their then-outstanding claims(including interest or accretion, respectively) atthe end ofthe Projection Period, Under Scenario Four, the Rehabiltator expects a 91.4% all-in recovery (including actual and prospective interim cash payments received in respect of such policy claims discounted at $19). Holders of Junior Surplus Notes would receive no recovery of their then-outstanding claim, G. Projected Recoveries and Distributable Value It is important to note that the projected recoveries contemplated herein do not represent immediately distributable value, as the scenarios explicitly contemplate payment in full a the end of the Projection Period, which is December 31, 2082. The timing and amount of disteibutions to holders of Surplus Notes and recipients of Deferred Amounts, as managed by the Interim Payment Percentage, is largely a function of the nature of AC's assets and liabilities and the Rehubilitator’s assessment of future risks. On the asset side of the equation, xp to 30% of the aggregate value that may be available o satisfy Surplus Note and Deferred Amount claims has yet to be realized ~ and may not be realized for some time. Examples include the prospective proceeds from unresolved RMBS-related litigation, the value of future installmen: premiums, ‘nd the residual value associated with AAC’ interest in AUK. ‘The Rehabiltator expects AAC to experience substantial losses inthe future. As detailed above, ‘we believe the present value of future (i) Segregated Account losses range from SI. billion t0 $1.2 billion and (i) General Account losses range from $1.3 billion to $1.9 billion, Certain losses also may require material levels of funding in the near to medium term with recoveries realized ‘over the long-term, As a result, AC's near and medium term liquidity may be stained while long-term recoveries are subject to greater uncertainty and risk Although forecasted recoveries have increased since the Rehabilitatoy's last annual vepurt was issued, significant uncertainty and volatility remain with respect to future elaims ard realizable assets. As noted above, the Rehabilitator's stress case scenarios attempt to reflec: reasonable downside risks, but should not be construed to portray the worst possible outcomes, given the highly leveraged nature of AC's business, the long duration of the insured book, the increased volatility and uncertainty surrounding certain exposures (e.g. Puerto Rico), and the wide variety of credit characteristics embedded therein. Accordingly, such estimates do not represent a cap on ‘potential loses, but instead reflect the Rehabilitator's judgment ofthe relevant ange at this point intime