AMBAC FINANCIAL GROUP INC

The following discussion should be read along with the financial statements included in this Annual Report on Form 10-K, as well as Part II, "Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations" in this Annual Report on Form 10-K for the year ended December 31, 2022, which provides additional information on comparisons of years 2022 and 2021.

Net income attributable to common stockholders for the year ended December 31, 2023, was $4 compared to a net income attributable to common stockholders of $522 for the year ended December 31, 2022. The net income variance was primarily driven by: (i) a lower loss and loss adjustment expenses benefit, (ii) a litigation recovery in 2022, (iii) 2022 gains on derivative contracts, and (iv) 2022 net gains on extinguishment of debt, partially offset by higher returns from the investment portfolio and lower interest expense.

A summary of our financial results is shown below:

Ambac's results for the year ended December 31, 2023 compared to the year ended December 31, 2022 were impacted by the following:

•During 2023, Ambac completed LFG risk reduction transactions primarily through a quota share reinsurance cession, consisting primarily of military housing risk. This reinsurance cession had an adverse impact on net premiums earned of approximately $2.

•As of December 6, 2022, all AAC-insured Puerto Rico obligations were restructured under PROMESA via court-approved plans of adjustment or qualifying modifications. As a result of these restructurings, Ambac's 2022 consolidated financial results included a net benefit of $180 in losses and gains of $37 on the consolidation of newly established variable interest entities; partially offset by net losses of $23 from sales and changes to the fair value of securities received by AAC in the restructurings and losses of $17 on the VIEs after initial consolidation.

•On October 6, 2022, AAC entered into a Settlement Agreement and Release with Bank of America Corporation and certain affiliates thereof (the "BOA Parties") whereby the parties settled all RMBS litigation brought by AAC against the BOA Parties and AAC received $1,840 (the "BOA Settlement Payment"). On December 29, 2022, AAC entered into a Settlement Agreement and Release with Nomura Credit & Capital, Inc. ("Nomura") whereby the parties settled all RMBS litigation brought by AAC against Nomura and AAC received $140 on January 3, 2023. AAC used the proceeds from these settlements (net of reinsurance) plus approximately $6 of cash on hand to fully redeem all debt obligations secured by the net proceeds of litigations brought by AAC against RMBS sponsors. The settlements with the BOA Parties and Nomura brought to closure all of AAC's legacy litigation against RMBS sponsors. See Note 1. Background and Business Description in Part II, Item 8 in this Annual Report on Form 10-K for further information. During 2022, AAC recorded a gain of $123 million in loss and loss adjustment expenses and litigation recoveries of $126, offset by net realized losses on extinguishment of debt of $53 related to the above-mentioned settlement agreements. Interest expense was significantly reduced in 2023 as a result of these settlements.

The following paragraphs describe the consolidated results of operations of Ambac and its subsidiaries for 2023 and 2022.

Gross Premiums Written. Gross premiums written increased $161 for the year ended December 31, 2023, compared to the same periods in the prior year, as shown by segment below.

Legacy Financial Guarantee Insurance gross premiums written relate to changes in expected and contractual premium cash flows for existing financial guarantees in force.

Specialty P&C growth is primarily driven by the number of active programs and their size as of December 31, 2023, we have twenty-three programs with nineteen MGA/Us.

Net Premiums Written. Net premiums written increased $22 for the year ended December 31, 2023 compared to the year ended December 31, 2022, as shown by segment below:

Legacy Financial Guarantee Insurance net premiums written relate to changes in expected and contractual premium cash flows for existing financial guarantees in force, and reinsurance cessions in 2023 and 2021.

Specialty P&C growth is primarily driven by the number of active programs and their size as of December 31, 2023, in addition to the impact of two assumed reinsurance transactions executed during 2023.

Net Premiums Earned. Net premiums earned for the year ended December 31, 2023 increased by $22 or 38% as compared to net premiums earned for the year ended December 31, 2022, as shown below.

The reduction in the Legacy Financial Guarantee Insurance segment was primarily due to de-risking activities, including the 2023 reinsurance transaction, the 2022 Puerto Rico restructurings, and run-off of the insured portfolio. The increase in Specialty Property and Casualty Insurance net premiums earned was driven by the growth in net premiums written.

Commission Income and Commission Expense. Commission income was $51 compared to $31, for the years ended December 31, 2023 and 2022. Commissions include both base and profit sharing commissions from Cirrata Group companies in the Insurance Distribution segment. The increase was driven by organic growth in premiums placed as well as the acquisition of All Trans and Capacity Marine in November of 2022 and Riverton in August of 2023. Commission expense will largely track changes in gross commission.

For the year ended December 31, 2023 commission expense was $29 compared to $18 for the year ended December 31, 2022, representing approximately 57% of commission income in both periods.

Program Fees. Program fee revenues were $8 compared $3 for the years December 31, 2023 and 2022, respectively. Program fee revenues represent the recognition of ceding commissions in excess of direct acquisition costs received from reinsurers and minimum fees received from MGA/Us until related programs reach certain levels of premium ceded. Program fees are charged as a percentage of premiums ceded to reinsurers as a component of total ceding commissions.

Net Investment Income. Net investment income primarily consists of interest and net discount accretion on fixed maturity securities classified as available-for-sale, interest and changes in fair value of fixed maturity securities classified as trading, and net gains (losses) on pooled investment funds which include changes in fair value of the funds' net assets. Fixed maturity securities include investments in Ambac-insured securities that are made opportunistically based on their risk/reward and asset-liability management characteristics. Investments in pooled investment funds and certain other investments are either classified as trading securities with changes in fair value recognized in earnings or are reported under the equity method. These funds and other investments are reported in Other investments on the Consolidated Balance Sheets. For further information about investment funds held, refer to Note 4. Investments to the Consolidated Financial Statements, included in Part II, Item 8 in this Annual Report on Form 10-K. Net investment income for the periods presented were driven by the Legacy Financial Guarantee Insurance segment; other segments' results were not significant.

Net investment income from Ambac-insured securities, available-for-sale securities other than Ambac-insured and Other investments is summarized in the table below:

Net investment income increased $123 for the year ended December 31, 2023, compared to 2022.

•Income from Other investments and trading securities increased $97 in 2023, compared to the prior year. Pooled fund investments produced a gain of $40, an increase of $66 from 2022, driven by improved performance in all fund categories even with a lower allocation to funds overall. The largest increases were in hedge funds, equities and high-yield and leverage loan funds. Investments in pooled funds may be volatile, but are generally expected to produce higher returns than traditional fixed maturity investments. Gains on securities received in the Puerto Rico restructurings, which are classified as trading, were $7 in 2023, compared to a loss of $23 in 2022.

•Net investment income from available-for-sales securities other than Ambac-insured securities increased $27 in 2023, compared to the prior year, due to higher portfolio yields.

•Investment income from Ambac-insured securities was flat compared to 2022. Higher average holdings of Ambac-insured RMBS and student loans in 2023 offset the impact of the 2022 settlements of Puerto Rico bonds and the redemption of Sitka Senior Secured Notes (as defined in Note 12. Long-Term Debt to the Consolidated Financial Statements included in Part II, Item 8 in the Annual Report on Form 10-K) held in the portfolio in 2022.

Net Investment Gains (Losses), including Impairments. The following table provides a breakdown of net investment gains, for the periods presented:

Net investment gains (losses) during the year ended December 31, 2023, included impairments of Ambac-insured student loan securities that management intends to sell. Net investment gains during the year ended December 31, 2022, included a recovery of $9 from a class-action settlement relating to certain RMBS securities previously held in the investment portfolio, $4 from the distribution of residual assets of a legacy financial guarantee student loan restructuring vehicle and $5

from the mandatory redemption of Sitka Senior Secured Notes over their amortized cost value. Other net realized gains on securities sold or called in 2023 and 2022 are primarily from sales in connection with routine portfolio management. Refer to Note 2. Basis of Presentation and Significant Accounting Policies to the Consolidated Financial Statements located in Part II, Item 8 in this Annual Report on Form 10-K for a description of the Company's policies related to investment impairments.

Net Gains (Losses) on Derivative Contracts. Net gains (losses) on derivative contracts are primarily from the Company's interest rate derivatives portfolio. Into the second quarter of 2023, the interest rate derivatives portfolio was positioned to benefit from rising rates as a partial economic hedge against interest rate exposure in the financial guarantee insurance and investment portfolios. This economic hedge was substantially reduced since September 30, 2022, and was fully removed during the second quarter of 2023. Net gains (losses) on interest rate derivatives reflect mark-to-market gains (losses) in the portfolio caused by increases (declines) in forward interest rates during the periods, the carrying cost of the portfolio, and the impact of counterparty credit adjustments as discussed below. Results from other non-VIE derivatives were not significant to the periods presented.

Net losses on interest rate derivatives for the year ended December 31, 2023, were $1, compared to a net gains of $128 for the year ended December 31, 2022. Results for the year ended December 31, 2023, reflect the impacts of interest rate shifts in the early part of 2023 and counterparty credit adjustments as noted below. The net gains in 2022 were driven primarily by the significant rate increase during the year.

Counterparty credit adjustments are generally applicable for uncollateralized derivative assets that may not be offset by derivative liabilities under a master netting agreement. In periods when credit spreads are stable, counterparty credit adjustments will generally have a proportionate offsetting impact to gains or losses on derivative assets, relative to fully collateralized assets. In addition to the impact of interest rates on the underlying derivative asset values, the changes in counterparty credit adjustments are driven by movement of credit spreads. Generally, narrowing (widening) of credit spreads will increase (decrease) derivative gains relative to a period of stable credit spreads. Inclusion of counterparty credit adjustments in the valuation of interest rate derivatives resulted in gains (losses) within Net gains (losses) on derivative contracts of $2 and $8 for the years ended December 31, 2023 and 2022, respectively. The lower counterparty credit adjustments for both periods reflected lower underlying asset values with the further impact of credit spread narrowing in 2023 and widening in 2022.

Net Realized Gains on Extinguishment of Debt. Net realized gains on extinguishment of debt was $0 for year ended December 31, 2023. Net realized gains on extinguishment of debt was $81 for the year ended December 31, 2022. Gains were recognized due to repurchases of surplus notes below their carrying values, partially offset with losses recognized on the redemption of the Sitka AAC Note (as defined in Note 12. Long-term Debt to the Consolidated Financial Statements included in Part II, Item 8 in this Annual Report on Form 10-K) above its carrying value. AAC repurchased $266 million current par of surplus notes from third party holders in 2022. Subject to prevailing market conditions, our liquidity, internal and regulatory guidelines and approvals, contractual restrictions and OCI’s Run-off Capital Framework, Ambac may continue to opportunistically reduce, redeem, repurchase or otherwise retire its outstanding surplus notes, including through open market repurchases, tender offers, repayments, redemptions or otherwise, and may consider opportunities to exchange securities issued by it from time to time for other securities issued by AFG or AAC.

Income (Loss) on Variable Interest Entities. Included within Income (loss) on variable interest entities are income statement amounts relating to LFG-VIEs consolidated under the Consolidation Topic of the ASC as a result of Ambac's variable interest arising from financial guarantees written by Ambac's subsidiaries, including gains or losses attributable to consolidating or deconsolidating LFG-VIEs during the periods reported. Generally, the Company’s consolidated VIEs are entities for which Ambac has provided financial guarantees on all of or a portion of its assets or liabilities. In consolidation, most assets and liabilities of the LFG-VIEs are initially reported at fair value, except for customer contract assets and liabilities which are accounted for under the Revenue from Contracts with Customers Topic of the ASC. The related insurance assets and liabilities are eliminated in consolidation. The amount of LFG-VIE net assets (liabilities) that remain in consolidation incorporate the net positive (negative) future cash flows from (to) the VIEs which are attributable to Ambac’s insurance subsidiaries in the form of financial guarantee insurance premiums, fees and losses. Generally, LFG-VIEs in a net liability position are expected to have some portion of their obligations funded by Ambac’s insurance subsidiaries through insurance claim payments. Differences between the net carrying value of the insurance accounts under the Financial Services—Insurance Topic of the ASC and the carrying value of the consolidated LFG-VIEs' net assets or liabilities are recorded through income at the time of consolidation. Additionally, terminations or other changes to Ambac's financial guarantee insurance policies that impact projected cash flows between a consolidated LFG-VIE and Ambac could result in gains or losses, even if such policy changes do not result in deconsolidation of the LFG-VIE.

Income (loss) on variable interest entities was $3 and $21 for the years ended December 31, 2023 and 2022, respectively. Results for the year ended December 31, 2023, were driven primarily by the $4 gain upon consolidation of a VIE for which Ambac UK guarantees the senior debt. Results for the year ended December 31, 2022. related primarily to three VIE trusts created in connection with the Puerto Rico restructurings in 2022. The 2022 gain included the initial $37 million gain upon consolidation, losses of $9 from changes to fair value of these VIEs' assets, and losses of $7 from these VIEs' interest and other costs. Refer to Note 11. Variable Interest Entities to the Consolidated Financial Statements included in this Annual Report on Form 10-K for further information on the accounting for VIEs.

Litigation Recoveries. For the year ended December 31, 2022, in connection with the settlement agreement with Bank of America Corporation and certain affiliates, the BOA Settlement Payment included recoveries from litigations for alleged breaches of contractual obligations and fraud by the BOA Parties. Management allocated the BOA Settlement Payment to each of the litigations based on previously developed valuations of each individual litigation. The portion of the BOA Settlement Payment allocated to fraud litigation recoveries has been recorded as a litigation recovery in the Statement of Comprehensive Income (Loss).

Losses and Loss Adjustment Expenses (Benefit). Losses and loss adjustment expenses increased $364 for the year ended December 31, 2023, compared to the prior year. Below provides the breakout of loss and loss expenses by segment:

The large variance within legacy financial guarantee was driven by activities in the RMBS portfolio in 2023 and 2022, including the impact of the Settlement Agreements with Bank of America Corporation and certain affiliates thereof and the settlement agreement with Nomura during 2022. Refer to discussion of each segment's results below for further details.

General and Administrative Expenses ("G&A"). The following table provides a summary of G&A expenses for the periods presented:

G&A expenses for the year ended December 31, 2023 are $156, an increase of $15 from G&A expenses for the year ended December 31, 2022. The increase was primarily due to the following:

•Higher compensation costs primarily due to a net increase in staffing from additions in the Specialty Property and Casualty Insurance and Insurance Distribution segments and the impact of performance factor adjustments on incentive compensation expense, partially offset by reductions in staffing in the Legacy Financial Guarantee Insurance segment.

•Higher non-compensation costs primarily related to increased Legacy Financial Guarantee Insurance segment defensive litigation expenses and costs associated with growth of the Specialty Property and Casualty Insurance and Insurance Distribution businesses.

Intangible Amortization. Insurance intangible amortization was $25 and $44 for the years ended December 31, 2023 and 2022, respectively. The decrease was driven primarily by the timing of de-risking transactions (including Puerto Rico in 2022) and the reduced size of the financial guarantee insured portfolio. Insurance intangible amortization will decline after policies mature or they are de-risked Other intangible amortization was $3 and $3 for the years ended December 31, 2023 and 2022 relating to acquisitions within the Insurance Distribution segment.

Interest Expense. All interest expense relates to the Legacy Financial Guarantee Insurance segment and includes accrued interest on the LSNI Ambac Note (fully redeemed in 2021), Sitka AAC Note (fully redeemed during the fourth quarter of 2022), Tier 2 Notes (fully redeemed during the first quarter of 2023), surplus notes and other debt obligations. Additionally, interest expense includes discount accretion when the debt instrument carrying value is at a discount to par. The following table provides details by type of obligation for the periods presented:

(1)Includes interest on Junior Surplus Notes that were acquired and retired in 2021.

The decrease in interest expense for the year ended December 31, 2023, compared to the year ended December 31, 2022, reflects the impact of the 2022 redemption of secured notes and purchases of surplus notes as described further under "Debt Redemptions and Extinguishments" in Note 12. Long-term Debt to the Consolidated Financial Statements included in Part II, Item 8 in this Annual Report on Form 10-K.

Surplus note principal and interest payments require the approval of OCI. In May 2023, OCI declined the request of AAC to pay the principal amount of the surplus notes, plus all accrued and unpaid interest thereon, on the then next scheduled payment date of June 7, 2023. As a result, the scheduled payment date for interest, and the scheduled maturity date for payment of principal of the surplus notes was extended until OCI grants approval to make the payment. Interest will accrue, compounded on each anniversary of the original scheduled payment date or scheduled maturity date, on any unpaid principal or interest through the actual date of payment, at 5.1% per annum. Holders of surplus notes will have no rights to enforce the payment of the principal of, or interest on, surplus notes in the absence of OCI approval to pay such amount. The interest on the outstanding surplus notes were accrued for and AAC is accruing interest on the interest amounts following each scheduled payment date. Total accrued and unpaid interest for surplus notes outstanding to third parties was $475 at December 31, 2023. As required by the terms of surplus notes, AAC will continue to seek OCI’s approval to make payments of principal and interest on its surplus notes. OCI’s approval may be granted or denied in OCI’s sole discretion. Since the issuance of the surplus notes in 2010, OCI has declined to approve regular payments of interest on surplus notes, although the OCI has permitted two exceptional payments. Ambac can provide no assurance as to when or if surplus note principal and interest payments will be made.

Provision for Income Taxes. The provision for income taxes for the year ended December 31, 2023 and 2022, was a expense of $7 and $2, respectively. Income taxes for the year ended December 31, 2023 and 2022, includes provisions for income tax due in respect of Ambac UK of $8 and $3, respectively.

At December 31, 2023, the Company had approximately $3,400 of U.S. Federal net ordinary operating loss carryforwards, including approximately $1,640 at AFG and $1,760 at AAC.

Results of Operations by Segment

(1)Represents the share of Ambac stockholders equity for each subsidiary within the Legacy Financial Guarantee Insurance segment, including intercompany eliminations.

The Legacy Financial Guarantee Insurance segment is in active runoff. This will generally result in lower premium earned, investment income, operating expenses and intangible amortization. The variability in the financial results are primarily driven by changes in loss and loss adjustment expenses resulting from, amongst other items, litigation settlements, credit developments and de-risking transactions. Key variances not discussed above in the Consolidated Results section are as follows:

Net premiums earned. Net premiums earned decreased $16 for the year ended December 31, 2023, compared to the same period in the prior year. Net premiums earned were impacted by the organic and active runoff of the financial guarantee insured portfolio resulting in a reduction to current and future normal net premiums earned and the following:

•Changes to the allowance for credit losses on the premium receivable asset. The positive impact on net premiums earned related to credit losses amounted to $1 and $4 for the years ended December 31, 2023 and 2022, respectively.

•Accelerated financial guarantee premiums earned as a result of calls and other accelerations on insured obligations, largely due to active de-risking of the insured portfolio, were $0 and $8 for the years ended December 31, 2023 and 2022, respectively.

Losses and Loss Adjustment Expenses (Benefit). The following provides details for losses and loss expenses (benefit) incurred for the periods presented:

(1) Includes loss expenses incurred of $4 and $29 for the year ended years ended December 31, 2023 and 2022, respectively.

Loss and loss expenses (benefit) for 2023, was largely driven by RMBS recoveries and favorable development related to student loans, partially offset by the negative impact of discount rates on the RMBS portfolio. Changes in RMBS recoveries impacting loss and loss expenses can be volatile and therefore each period's results are not indicative of potential future results.

Losses and loss expenses (benefit) for 2022, were driven by favorable RMBS development due to the impact of the settlement agreements with the BOA Parties and Nomura of $123, the positive impact of discount rates, and favorable loss development in domestic public finance (primarily due to the Puerto Rico restructurings of $180).

G&A Expenses. The increase in Legacy Financial Guarantee Insurance segment operating expenses during the year ended December 31, 2023, as compared to the year ended December 31, 2022, is driven primarily by additional costs related to defensive litigation, partially offset by the impact of headcount and other cost reductions in the segment.

(1)Represents Ambac stockholders equity in the Specialty Property and Casualty Insurance segment, including intercompany eliminations.

The Specialty Property and Casualty Insurance segment has grown significantly since underwriting its first program in May 2021. Twenty-three programs were authorized to issue policies as of December 31, 2023. The growth in both the number and size of these programs has contributed to the increase in gross and net premiums written, net premiums earned, net loss and loss adjustment expenses incurred and amortization of deferred acquisition costs.

Losses and Loss Adjustment Expenses (Benefit). Loss and loss expenses incurred increased for the year ended December 31, 2023, relative to the year ended December 31, 2022, primarily due to the growth and diversification of the business. Everspan's loss ratio (including ULAE) was 70.7% and 65.4% for the years ended December 31, 2023 and 2022, respectively, inclusive of prior years development of 0.3% and 0.2%, respectively. The shift in the loss ratio was driven by commercial auto loss experience in the current accident year and diversification, primarily due to the addition of personal auto and workers compensation programs through assumed reinsurance. Everspan's loss ratio may shift as the inforce book of business grows and diversifies. The increase in the Loss and LAE ratio for the year ended December 31, 2023, compared to December 31, 2022, was partially offset by a benefit to acquisition costs as a result of sliding scale commission arrangements with program partners. Such benefit reduced the Specialty Property and Casualty Insurance segments expense ratio by 3.2% and 1.3% for the years ended December 31, 2023 and 2022, respectively. Certain Everspan programs were structured to include sliding scale commission arrangements within a loss ratio range. These sliding scale arrangements mitigate net income volatility.

Loss and loss adjustment expenses incurred may be adversely impacted by increasing economic and social inflation, particularly within the commercial auto business. The impact of inflation on ultimate loss reserves is difficult to estimate, particularly in light of recent disruptions to the judicial system, supply chain and labor markets. In addition, going forward, we may not be able to offset the impact of inflation on our loss costs with sufficient price increases. The estimation of loss reserves may also be more difficult during extreme events, such as a pandemic, or during the persistence of volatile or uncertain economic conditions, due to, amongst other reasons, unexpected changes in behavior of judicial decisions, claimants and policyholders, including fraudulent reporting of exposures and/or losses. Due to the inherent uncertainty underlying loss reserve estimates, the final resolution of the estimated liability for loss and loss adjustment expenses will likely be higher or lower than the related loss reserves at the reporting date. In addition, our estimate of losses and loss expenses may change. These additional liabilities or increases in estimates, or a range of either, could vary significantly from period to period.

G&A Expenses. General and administrative costs increased for the year ended December 31, 2023, relative to the year ended December 31, 2022, primarily resulting from the growth in Everspan's staffing and operations. The impact of growing operations was muted by costs incurred in 2022 in connection with the acquisition of additional shell insurance companies.

(1) The Consolidated Statements of Comprehensive Income includes this in General and Administrative Expenses.

(2) Represents the share of Ambac stockholders equity for each subsidiary within the Insurance Distribution segment, including intercompany eliminations.

Ambac's Insurance Distribution segment, Cirrata Group "Cirrata", currently includes Xchange Benefits, a P&C MGA specializing in accident and health products; All Trans, an MGA specializing in commercial automobile insurance for specific "for-hire" auto classes; Capacity Marine, a wholesale and retail brokerage and reinsurance intermediary specializing in marine and international risk; and Riverton Insurance Agency, an insurance services business specializing in professional liability lines and consisting of a MGA and a retail agency. The Insurance Distribution business is typically compensated for its services primarily by commissions paid by insurance carriers for underwriting, structuring and/or administering polices and, in some cases, the managing of claims under an agency agreement. Commission revenues are usually based on a percentage of the premiums placed. Cirrata is also eligible to receive profit sharing contingent commissions on certain of its programs based on the underwriting results of the policies it places with the carrier, which may cause some variability in revenue and earnings.

Cirrata business placed premiums for its carriers of approximately $231 for the year ended December 31, 2023, up $95 or 70% as compared to the year ended December 31, 2022. The growth was primarily driven by (i) premiums placed by All Trans and Capacity Marine since their acquisition in November 2022; (ii) premiums placed by Riverton since its acquisition in August 2023 and (iii) organic growth at Xchange of approximately 10%.

Insurance Distribution businesses may experience seasonal impacts on their revenues and operations. For example, Employer Stop Loss business underwritten by Xchange has seasonality in January and July, which results in revenue and earnings concentrations in the first and third quarters each calendar year. Seasonal impacts on the Insurance Distribution segment, and therefore Ambac's results, may increase or decrease over time depending on the relative growth of certain classes of business as well as acquisitions.

G&A Expenses. General and Administrative expenses for the year ended December 31, 2023, increased as compared to the year ended December 31, 2022, as a result of the addition of the operating expenses of All Trans, Capacity Marine and Riverton, which were acquired in November 2022, November 2022, and August 2023, respectively.