OCTAVE SPECIALTY GROUP INC 10-K

ambc-20211231 Table of Contents UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K ☒ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Fiscal Year Ended December 31, 2021 ☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission File Number: 1-10777 AMBAC FINANCIAL GROUP, INC. (Exact name of Registrant as specified in its charter) Delaware 13-3621676 (State of incorporation) (I.R.S. employer identification no.) One World Trade Center New York NY 10007 (Address of principal executive offices) (Zip code) (212) 658-7470 (Registrant’s telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: Title of each class Trading Symbols Name of each exchange on which registered Common Stock, par value $0.01 per share AMBC New York Stock Exchange Warrants AMBC WS New York Stock Exchange Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☒ No ☐ Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes ☐ No ☒ Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐ Indicate by check mark whether the Registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐ Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See definition of “large accelerated filer”, “accelerated filer”, “smaller reporting company”and"emerging growth company" in Rule 12b-2 of the Exchange Act): (Check one): Large accelerated filer ☒ Accelerated filer ☐ Non-accelerated filer ☐ Smaller reporting company ☐ Emerging growth company ☐ If an emerging growth company, indicate by check mark if the Registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐ Indicate by check mark whether the registrant has filed a report on and attestation to its management's assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☒ Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒ The aggregate market value of voting stock held by non-affiliates of the Registrant as of the close of business on June 30, 2021 was $ 723,465,112 . As of February 22, 2022, there were 46,337,006 shares of Common Stock, par value $ 0.01 per share, were outstanding. Documents Incorporated By Reference Portions of the Registrant’s Proxy Statement related to its annual meeting of stockholders are incorporated by reference in this Form 10-K in response to Part III Items 10, 11, 12, 13, and 14. Table of Contents AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES TABLE OF CONTENTS Cautionary Statement Pursuant to the Private Securities Litigation Reform Act of 1995 1 Item Number Page Item Number Page PART I PART II (CONTINUED) 1 Business 2 Accounting Standards 54 Introduction 2 U.S. Insurance Statutory Basis Financial Results 54 Description of the Business 2 Ambac UK Financial Results Under UK Accounting Principles 56 Enterprise Risk Management 8 Non-GAAP Financial Measures 57 Available Information 9 7A Quantitative and Qualitative Disclosures about Market Risk 58 Insurance Regulatory Matters and Other Restrictions 9 8 Financial Statements and Supplementary Data 61 Investments and Investment Policy 11 9 Changes in and Disagreements With Accountants on Accounting and Financial Disclosure 139 Employees 11 9A Controls and Procedures 139 1A Risk Factors 12 9B Other Information 139 1B Unresolved Staff Comments 27 PART III 2 Properties 27 10 Directors, Executive Officers and Corporate Governance 139 3 Legal Proceedings 27 11 Executive Compensation 140 4 Mine Safety Disclosures 27 12 Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 140 PART II 13 Certain Relationships and Related Transactions, and Director Independence 141 5 Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities 27 14 Principal Accountant Fees and Services 141 6 Selected Financial Data 29 PART IV 7 Management’s Discussion and Analysis of Financial Condition and Results of Operations 29 15 Exhibits, Financial Statement Schedules 141 Executive Summary 29 Schedule I—Summary of Investments Other Than Investments in Related Parties 145 Critical Accounting Policies and Estimates 32 Schedule II—Condensed Financial Information of Registrant (Parent Company Only) 146 Financial Guarantees in Force 34 Schedule IV—Reinsurance 151 Results of Operations 42 Liquidity and Capital Resources 46 SIGNATURES 152 Balance Sheet 48 Table of Contents CAUTIONARY STATEMENT PURSUANT TO THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 In this Annual Report, we have included statements that may constitute “forward-looking statements” within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Words such as “estimate,” “project,” “plan,” “believe,” “anticipate,” “intend,” “planned,” “potential” and similar expressions, or future or conditional verbs such as “will,” “should,” “would,” “could,” and “may,” or the negative of those expressions or verbs, identify forward-looking statements. We caution readers that these statements are not guarantees of future performance. Forward-looking statements are not historical facts but instead represent only our beliefs regarding future events, which may by their nature be inherently uncertain and some of which may be outside our control. These statements may relate to plans and objectives with respect to the future, among other things which may change. We are alerting you to the possibility that our actual results may differ, possibly materially, from the expected objectives or anticipated results that may be suggested, expressed or implied by these forward-looking statements. Important factors that could cause our results to differ, possibly materially, from those indicated in the forward-looking statements include, among others, those discussed under “Risk Factors” in Part I, Item 1A of this Annual Report on Form 10-K. Any or all of management’s forward-looking statements here or in other publications may turn out to be incorrect and are based on management’s current belief or opinions. Ambac Financial Group’s (“AFG”) and its subsidiaries’ (collectively, “Ambac” or the “Company”) actual results may vary materially, and there are no guarantees about the performance of Ambac’s securities. Among events, risks, uncertainties or factors that could cause actual results to differ materially are: (1) the highly speculative nature of AFG’s common stock and volatility in the price of AFG’s common stock; (2) uncertainty concerning the Company’s ability to achieve value for holders of its securities, whether from Ambac Assurance Corporation (“AAC”) and its subsidiaries or from the specialty property and casualty program insurance business, the managing general agency/underwriting business, or related businesses; (3) the inability of AAC to realize the expected recoveries, including RMBS litigation recoveries, included in its financial statements, or changes in estimated RMBS litigation recoveries over time; (4) failure to recover claims paid on Puerto Rico exposures or realization of losses in amounts higher than expected; (5) inadequacy of reserves established for losses and loss expenses and possibility that changes in loss reserves may result in further volatility of earnings or financial results; (6) potential for rehabilitation proceedings or other regulatory intervention against AAC; (7) credit risk throughout Ambac’s business, including but not limited to credit risk related to insured residential mortgage-backed securities, student loan and other asset securitizations, public finance obligations (including risks associated with Chapter 9 and other restructuring proceedings), issuers of securities in our investment portfolios, and exposures to reinsurers; (8) our inability to effectively reduce insured financial guarantee exposures or achieve recoveries or investment objectives; (9) our inability to generate the significant amount of cash needed to service our debt and financial obligations, including through litigation recoveries or disposition of assets, and our inability to refinance our indebtedness; (10) Ambac’s substantial indebtedness could adversely affect its financial condition and operating flexibility; (11) Ambac may not be able to obtain financing or raise capital on acceptable terms or at all due to its substantial indebtedness and financial condition; (12) the impact of catastrophic public health, environmental or natural events, including events like the COVID-19 pandemic, on significant portions of our insured portfolio; (13) credit risks related to large single risks, risk concentrations and correlated risks; (14) risks associated with adverse selection as Ambac’s financial guarantee insurance portfolio runs off; (15) the risk that Ambac’s risk management policies and practices do not anticipate certain risks and/or the magnitude of potential for loss; (16) restrictive covenants in agreements and instruments that impair Ambac’s ability to pursue or achieve its business strategies; (17) adverse effects on operating results or the Company’s financial position resulting from measures taken to reduce financial guarantee risks in its insured portfolio; (18) disagreements or disputes with Ambac's insurance regulators; (19) loss of control rights in transactions for which we provide financial guarantee insurance; (20) adverse tax consequences or other costs resulting from the characterization of the AAC’s surplus notes or other obligations as equity; (21) risks attendant to the change in composition of securities in the Ambac’s investment portfolio; (22) adverse impacts from changes in prevailing interest rates; (23) events or circumstances that result in the impairment of our intangible assets and/or goodwill that was recorded in connection with Ambac’s acquisition of 80% of the membership interests of Xchange Benefits, LLC and Xchange Affinity Underwriting Agency, LLC; (24) risks associated with the expected discontinuance of the London Inter-Bank Offered Rate; (25) factors that may negatively influence the amount of installment premiums paid to Ambac; (26) risks relating to determinations of amounts of impairments taken on investments; (27) the risk of litigation and regulatory inquiries or investigations, and the risk of adverse outcomes in connection therewith; (28) actions of stakeholders whose interests are not aligned with broader interests of the Ambac's stockholders; (29) system security risks, data protection breaches and cyber attacks; (30) regulatory oversight of Ambac Assurance UK Limited (“Ambac UK”) and applicable regulatory restrictions may adversely affect our ability to realize value from Ambac UK or the amount of value we ultimately realize; (31) failures in services or products provided by third parties; (32) our inability to attract and retain qualified executives, senior managers and other employees, or the loss of such personnel; (33) fluctuations in foreign currency exchange rates; (34) failure to realize our business expansion plans or failure of such plans to create value; (35) greater competition for our specialty property & casualty program insurance business; (36) loss or lowering of the AM Best rating for our property and casualty insurance company subsidiaries; (37) disintermediation within the insurance industry or greater competition that negatively impacts our managing general agency/underwriting business; (38) changes in law or in the functioning of the healthcare market that impair the business model of our accident and health managing general underwriter; and (39) other risks and uncertainties that have not been identified at this time. | Ambac Financial Group, Inc. 1 2021 FORM 10-K | Table of Contents PART I Item 1. Business INTRODUCTION Ambac Financial Group, Inc. ("AFG"), headquartered in New York City, is a financial services holding company incorporated in the State of Delaware on April 29, 1991. References to “Ambac,” the “Company,” “we,” “our,” and “us” are to AFG and its subsidiaries, as the context requires. Ambac's business operations include: • Financial Guarantee ("FG") Insurance — Ambac Assurance Corporation ("AAC") and its wholly owned subsidiary, Ambac Assurance UK Limited (“Ambac UK”) are legacy financial guarantee insurance carriers, both of which have been in runoff since 2008 (the "Financial Guarantee Insurance companies"). • Specialty Property & Casualty Program Insurance ("SPCP") — Currently includes excess and surplus lines (“E&S” or “nonadmitted”) insurer Everspan Indemnity Insurance Company ("Everspan Indemnity") and admitted insurer Everspan Insurance Company, along with four other admitted insurance carrier subsidiaries (“Everspan”). Everspan insurance carriers that are currently part of the intercompany pooling agreement received an AM Best Financial Strength rating of 'A-' (Excellent) in February 2021 and launched its first insurance program in May 2021. • Managing General Agency / Underwriting ("MGA/U")— Currently includes Xchange Benefits, LLC and Xchange Affinity Underwriting Agency, LLC (collectively, “Xchange”) a property and casualty Managing General Underwriter of which AFG acquired 80% on December 31, 2020. Refer to Note 3. Business Combination to the Consolidated Financial Statements included in Part II, Item 8 of this Form 10-K for further information relating to this acquisition. AFG has $269 million in net assets (excluding its investment in subsidiaries) and net operating loss carry-forwards of $3,744 million ($2,148 million of which is allocated to AAC) at December 31, 2021. See Schedule II for more information on the holding company. While SPCP and MGA/U (together, the "Specialty P&C Program Insurance Platform") are distinct businesses, they are currently not significant enough to Ambac's operations to warrant segment presentation. Management evaluates its reportable segments at least annually and as facts and circumstances change. Corporate Strategy: The Company's primary goal is to maximize shareholder value through the execution of key strategies for both its (i) Specialty P&C Program Insurance Platform and (ii) Financial Guarantee Insurance companies. Specialty P&C Insurance Program Platform strategic priorities include: • Growing and diversifying Everspan's participatory fronting platform with existing and new program partners. • Building a leading federation of specialty MGA/U partners through additional acquisitions and de novo builds, supported by a centralized business services unit including core technology solutions. • Making opportunistic investments that are strategic to the overall Specialty P&C Program Insurance Platform. Financial Guarantee Insurance companies’ strategic priorities include: • Actively managing, de-risking and mitigating insured portfolio risk. • Pursuing loss recovery through active litigation and other means, particularly residential mortgage back security representation and warranty litigation. • Improving operating efficiency and optimizing our asset and liability profile. • Exploring, at the appropriate time, strategic options to further maximize value for AFG. DESCRIPTION OF THE BUSINESS Financial Guarantee Insurance Business: Financial guarantee insurance policies provide an unconditional and irrevocable guarantee which protects the holder of a debt obligation against non-payment when due of the principal and interest on the obligations guaranteed. Pursuant to such guarantees, AAC and Ambac UK make payments if the obligor responsible for making payments fails to do so when due. AAC and Ambac UK's financial condition began to deteriorate in 2007 as a result of which these companies have been unable to write new financial guaranty business since such time. Ambac's Financial Guarantee business strategy is to increase the residual value of AAC and Ambac UK with the ultimate goal of monetizing such value through (i) dividends and capital distributions while managing their active run-off; (ii) one or more reinsurance transactions or other de-risking transactions that will accelerate or enhance the ability of AAC and/or Ambac UK to pay dividends and make capital distributions; (iii) the sale of all or portions of AAC and Ambac UK, or (iv) other strategic transactions to accelerate or enhance the above-stated corporate strategy. We can provide no assurance that Ambac will achieve any of the aforementioned goals. AAC and Ambac UK have been working toward reducing risk within their insured portfolios, such as exposures to financially stressed municipal entities (including Puerto Rico) and asset-backed securities (including residential mortgage-backed securities ("RMBS") and student loan-backed securities). Opportunities for remediating losses on poorly performing insured transactions depend on a number of factors including market conditions, the structure of the underlying risk and associated policy, as well as counterparty specific factors. AAC's ability to remediate risk and commute policies may be limited by available liquidity. Additionally, AAC and Ambac UK are actively managing their regulatory frameworks and seeking to optimize capital allocation in a challenging environment that includes long | Ambac Financial Group, Inc. 2 2021 FORM 10-K | Table of Contents duration obligations. AAC is also actively prosecuting legal claims to recover losses in its FG portfolio. With regards to AAC, this strategy is subject to the restrictions set forth in the Settlement Agreement, dated as of June 7, 2010 (the "Settlement Agreement"), by and among AAC, Ambac Credit Products LLC ("ACP"), AFG and certain counterparties to credit default swaps with ACP that were guaranteed by AAC; the Stipulation and Order (as defined in Note 1. Background and Business Description to the Consolidated Financial Statements included in Part II, Item 8 of this Form 10-K); and in the indenture for the Tier 2 Notes (as defined in Note 12. Long-term Debt to the Consolidated Financial Statements included in Part II, Item 8 of this Form 10-K), each of which requires OCI (as defined below) and, under certain circumstances, holders of the debt instruments benefiting from such restrictions, to approve certain actions taken by or in respect of AAC. In exercising its approval rights, OCI will act for the benefit of policyholders, and will not take into account the interests of AFG. See Note 1. Background and Business Description to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K for further information. Financial guarantee revenues consist mostly of premiums earned from insurance contracts, net of reinsurance. Financial guarantee expenses consist of: (i) loss and commutation payments; (ii) loss adjustment expenses; (iii) interest expense on debt, (iv) operating expenses and (v) insurance intangible amortization. AAC’s ability to pay dividends to AFG has been significantly restricted by the deterioration of AAC’s financial condition and by regulatory, legal and contractual restrictions. It is highly unlikely that AAC will be able to make dividend payments to AFG for the foreseeable future, which constrains AFG's liquidity. Refer to "Dividend Restrictions, Including Contractual Restrictions" below and Note 8. Insurance Regulatory Restrictions to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K, for more information on dividend payment restrictions. Interest rate derivative transactions are executed through Ambac Financial Services (“AFS”), a wholly-owned subsidiary of AAC. The primary activity of AFS is to partially hedge interest rate risk in the financial guarantee insurance and investment portfolios. Accordingly, interest rate derivatives are positioned to benefit from rising rates. Under agreements governing interest rate derivative positions, AFS generally must post collateral or margin in excess of the market value of the swaps and futures contracts. A termination of AFS’s derivatives could result in losses. AFS has borrowed cash and securities from AAC to help support its collateral and margin posting requirements, previous termination payments and other cash needs. Credit risk associated with interest rate derivative positions primarily relates to the potential default of a counterparty. As AFS's interest rate derivatives generally consist of centrally cleared swaps, US treasury futures, the associated credit risk is mitigated through the use of industry standard collateral or margin requirements. For the small number of remaining legacy derivatives with financial guarantee customers that do not require collateral, credit risk is managed through the risk management processes described in the Risk Management Group section below. Ambac manages a variety of risks inherent in its businesses, including credit, market, liquidity, operational and legal. These risks are identified, measured, and monitored through a variety of control mechanisms, which are in place at different levels throughout the organization. See “Quantitative and Qualitative Disclosures About Market Risk” included in Part II, Item 7A in this Form 10-K for further information. Risk Management Ambac’s financial guarantee insurance policies and credit derivative contracts expose the Company to the direct credit risk of the assets and/or obligor supporting the guaranteed obligation. In addition, insured transactions expose Ambac to indirect risks that may increase our overall risk, such as credit risk separate from, but correlated with, our direct credit risk; market; model; economic; natural disaster; pandemic and mortality or other non-credit type risks. Please refer to Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Financial Guarantees in Force” section below for details on the financial guarantee insured portfolio. The Risk Management Group ("RMG") is primarily responsible for the development, implementation and oversight of loss mitigation strategies, surveillance and remediation of the insured financial guarantee portfolio (including through the pursuit of recoveries in respect of paid claims and commutations of policies). Our ability to execute certain risk management activities may be limited by the restrictions set forth in the Settlement Agreement, the Stipulation and Order and the indenture for the Tier 2 Notes. See Note 1. Background and Business Description to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K for further information. Ambac’s RMG has an organizational structure designed around four primary areas of focus: Surveillance, Risk Remediation, Credit Risk Management and Loss Reserving and Analytics. Surveillance The Surveillance group's focus is on the early identification of potential stress and/or credit deterioration and the related analysis of credit exposures in the insured portfolio. Additionally, Surveillance evaluates the impact of changes in the economic, regulatory or political environment on the insured portfolio. Analysts in this group perform periodic credit reviews of insured exposures according to a schedule based on the risk profile of the guaranteed obligations or as necessitated by specific credit events or other macro-economic variables. Risk-adjusted surveillance strategies have been developed for each bond type with review periods and scope of review based upon each bond type’s risk profile. The risk profile is assessed regularly in response to our own experience and judgments or external factors such as the economic environment and industry trends. The focus of a credit review is to assess performance, identify credit trends and recommend appropriate credit classifications, ratings and changes to a transaction or bond type’s review period and surveillance requirements. Please refer to Note 2. Basis of Presentation and Significant Accounting Policies to the Consolidated Financial Statements included in Part II, Item 8 in | Ambac Financial Group, Inc. 3 2021 FORM 10-K | Table of Contents this Form 10-K for further discussion of the various credit classifications utilized by Ambac. If a problem is detected, the Surveillance group will then work with the Risk Remediation group on a loss mitigation plan, as necessary. The insured portfolio contains exposures that are correlated and/or concentrated. RMG's surveillance activities include identifying these types of exposures and identifying the risks that would or could trigger credit deterioration across these related exposures. This is the case with student loans and RMBS, for example, which have several correlations including those associated with consumer lending, unemployment and home prices. In the future, Ambac’s portfolio may be subject to similar credit deterioration arising from concentrated and/or correlated risks. Examples of other such risks that could impact our portfolio, and that our surveillance is designed to monitor include the impact of potential municipal bankruptcy contagion, the impact of tax reform on state and municipal bond issuers, the impact of large scale domestic military cutbacks on our privatized military housing portfolio and event risk such as pandemics (e.g., COVID-19), natural disasters or other regional stresses. Most such risks cannot be predicted and may materialize unexpectedly or develop rapidly. Although our surveillance allows us to connect the event and stress to the related exposures and assign an adverse credit classification and estimate losses across the affected credits, when necessary, we may not have adequate resources or contractual rights and remedies to mitigate loss arising from such risks. Risk Remediation Risk Remediation's focus is on exposure reduction and loss mitigation related to the insured portfolio. In particular, this group focuses on reducing exposure to credits that have negative developing trends, the potential for future adverse development or are already adversely classified by, among other things, exercising rights and remedies, which may help to mitigate losses in the event of further deterioration or events of default, or, as available, working with an issuer to refinance, defease or otherwise retire debt. Loss mitigation focuses on the execution of commutation and related claims reduction or workout strategies for policies with potential future claims. For certain adversely classified, survey list and watch list credits, Risk Remediation will develop and implement a remediation or loss mitigation plan that could include actions such as working with the issuer, trustee, bond counsel, servicer and other interested parties in an attempt to remediate the problem and minimize AAC’s exposure to potential loss. Other actions could include working with bond holders and other economic stakeholders to negotiate, structure and execute solutions, such as commutations. In addition, reinsurance is used as a remediation tool to reduce exposure to certain targeted policies and large concentrations. Adversely classified, survey list and watch list credits are tracked closely as part of the risk remediation process and are discussed at regularly scheduled meetings with Credit Risk Management (see discussion following in “Credit Risk Management”). In some cases, the RMG will engage restructuring or workout experts, attorneys and/or other consultants with appropriate expertise in the targeted loss mitigation area to assist in examining the underlying contracts or collateral, providing industry specific advice and/or executing strategies. We have established cross-functional teams in key areas of focus, comprised of personnel both within the RMG and in other departments, as part of the risk remediation process. An example of such efforts includes the teams of professionals focused on the review and enforcement of contractual representations and warranties ("R&W") supporting RMBS policies. Members of these cross-functional teams will often work with external experts in the pursuit of risk reduction efforts. Credit Risk Management ("CRM") The CRM function manages the decision process for all material matters that affect credit exposures within the insured portfolio. CRM provides a forum for independent assessments, reviews and approvals and drives consistency and timeliness. The scope of credit matters under the purview of CRM includes material amendments, consents and waivers, evaluation of remediation or loss mitigation plans, credit review scheduling, credit classifications, rating designations, review of watch list or adversely classified credits, sector reviews and overall portfolio reviews. Formal plans or transactions that relate to risk remediation, loss mitigation or restructuring may also require AAC Risk Committee approval, as described below in the section entitled, "Enterprise Risk Management." Control Rights In structured transactions, including certain structured public finance transactions, AAC may be the control party as a result of insuring the transaction’s senior class or tranche of debt obligations. The control party may direct specified parties, usually the trustee, to take or not take certain actions following contractual defaults or trigger events. Control rights and the scope of direction and remedies vary considerably among our insured transactions. Because Ambac is party to and/or has certain rights in documents supporting transactions in the insured portfolio, Ambac frequently receives requests for amendments, consents and waivers (“ACWs”). CRM reviews, analyzes and processes all requests for ACWs. The decision to approve or reject ACWs is based upon certain credit factors, such as the issuer’s ability to repay the bonds and the bond’s security features and structure. As part of the CRM process, members of the RMG review, analyze and process all requests for ACWs. Similarly, in certain international structured finance, regulated utility, public-private partnerships and other international transactions, Ambac UK may be the control party. Because Ambac UK is party to and/or has certain rights in documents supporting Ambac UK-insured transactions, Ambac UK receives requests for ACWs. At Ambac UK, the Portfolio Risk Management team reviews, analyzes and processes ACWs with similar credit considerations as noted in the AAC process factored into the decision to approve or reject the ACW. As a part of the Segregated Account Rehabilitation Proceedings (as defined in Note 1. Background and Business Description to the Consolidated Financial Statements included in Part II, Item 8 of this Form 10-K), the Rehabilitation Court (as defined in Note 1. Background and Business Description to the Consolidated Financial Statements included in Part II, Item 8 of this Form 10-K) enjoined certain actions by other parties to preserve AAC’s control rights that could otherwise have lapsed or been | Ambac Financial Group, Inc. 4 2021 FORM 10-K | Table of Contents compromised. Pursuant to the Second Amended Plan of Rehabilitation (as defined in Note 1. Background and Business Description to the Consolidated Financial Statements included in Part II, Item 8 of this Form 10-K) and orders of the Rehabilitation Court, such protections continue after the conclusion of the Segregated Account Rehabilitation Proceedings. Watch List and Adversely Classified Credits Watch list and adversely classified credits are tracked closely by the appropriate RMG teams and discussed as part of the CRM process. Adversely classified credit meetings include members of RMG and other groups within the Company, as necessary. The review schedule for adversely classified credits is tailored to the remediation plan to track and prompt timely action and proper internal and external resourcing. A summary of developments regarding adversely classified credits and credit trends is also provided to AFG’s, AAC’s and Ambac UK's Board of Directors no less than quarterly. Ambac assigns internal credit ratings to individual exposures as part of the surveillance process. These internal credit ratings, which represent Ambac’s independent judgments, are based upon underlying credit parameters consistent with the exposure type. Loss Reserving and Analytics ("LRA") LRA manages the quarterly loss reserving process for insured portfolio credits with projected policy claims. It also supports the development, operation and/or maintenance of various analytical models used in the loss reserving process as well as in other risk management functions. LRA works with surveillance and risk remediation analysts responsible for a particular credit on the development, review and implementation of loss reserve scenarios and related analysis. Specialty Property & Casualty Program Insurance Everspan’s strategy is to develop a sustainable, long-term specialty property & casualty program insurance business with diverse classes of risks. Everspan sources business through program administrators and managing general agents (collectively “MGA”), reinsurers, brokers, producers and others. Everspan is developing long-term relationships with its distribution partners. Subject to Everspan's operational oversight, Everspan engages third parties to market and administer policies and handle claims within defined authorities on Everspan's behalf. Everspan's management team has significant years of experience in the program insurance business and has long-standing and broad relationships with MGAs, reinsurers, brokers, producers and third-party claims administrators. Everspan is comprised of Everspan Indemnity Insurance Company, an E&S carrier, which is eligible to write business in all U.S. states and territories and five admitted carriers. Everspan's admitted carriers include: • Everspan Insurance Company, which holds certificates of authority in fifty-one U.S. states and territories, of which forty-six grant full property and casualty authority. • Providence Washington Insurance Company (“PWIC”) and 21st Century Indemnity Insurance Company, 21st Century Pacific Insurance Company and 21st Century Auto Insurance Company of New Jersey (collectively, the "21st Century Companies"), which were acquired by Everspan Insurance Company on October 1, 2021 and January 1, 2022, respectively. • PWIC holds certificates of authority in forty-seven states and territories; and the vast majority of PWIC’s legacy liabilities have been transferred out of PWIC pursuant to an insurance business transfer, which was approved by the Oklahoma County District Court in October 2020. All remaining liabilities are fully ceded to reinsurers and are supported by an unlimited indemnity from the Seller, Enstar Holdings (US), which mitigates any residual risk to these reinsurers. • The 21st Century Companies were acquired from a national insurance group that has a Financial Strength Rating of “A” (Excellent) from AM Best. The 21st Century Companies collectively possess active certificates of authority in thirty-six states. All legacy liabilities remain with affiliates of the sellers through reinsurance and contractual indemnities. The 21st Century Companies will be re-named during 2022. Everspan is focused on generating strong underwriting results via its participatory risk retention business model. For the year ended December 31, 2021, Everspan issued insurance policies generating $13 million of gross written premium, of which Everspan retained approximately 20%. Everspan may retain up to 30% of risk on each program and will reinsure the remainder to reinsurers and other providers of risk capital. These reinsurers may be domestic and foreign (re)insurers and institutional risk investors (capacity providers) that want access to specific lines of U.S. property and casualty insurance business that they may not have the required licenses and filings to otherwise insure. Everspan purchases reinsurance to manage its net retention on individual risks and overall exposure to losses, while providing it with the ability to offer policies with sufficient limits to meet producer and policyholder needs. Generally, reinsurance contracts are specific to a program, are purchased on an annual basis and are subject to renegotiation at renewal. The key contractual provisions include, but are not limited to, those relating to ceding commissions, fronting fees, required reports to reinsurers, responsibility for taxes, arbitration in the event of a dispute and Everspan's termination rights when, among other triggers, a reinsurer defaults (such as by failing to collateralize its obligations when required) or its financial strength falls below an acceptable level. Everspan’s ceded reinsurance contracts do not legally discharge Everspan from its primary liability for the full amount of the policies, and Everspan will be required to pay the loss and bear collection risk if a reinsurer fails to meet its obligations under the reinsurance agreement. Everspan mitigates this credit risk by selecting well capitalized, highly rated, authorized capacity providers, or requiring that the capacity provider post collateral to secure the reinsured risks. See Note 7. Insurance Contracts to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K for further information on reinsurance recoverables, including the evaluation for credit impairments. | Ambac Financial Group, Inc. 5 2021 FORM 10-K | Table of Contents Competition: Everspan faces competition from program business market participants such as State National, Clear Blue Insurance Group, Accelerant Specialty, Benchmark Insurance Company, Falls Lake Insurance, Fortegra Insurance Group, Spinnaker Insurance Company and Accredited Surety and Casualty Company, Inc. Most of these entities have both admitted and E&S carriers. Competition may take the form of lower ceding fees, broader coverages, greater product flexibility, higher coverage limits, greater customer service or higher financial strength ratings by independent rating agencies. Few barriers exist to prevent insurers from entering target markets within the property and casualty industry. Market conditions and capital capacity influence the degree of competition at any point in time. During periods of excess underwriting capacity, as defined by the availability of capital, competition can result in lower pricing and less favorable policy terms and conditions for insurers. During periods of reduced underwriting capacity, pricing and policy terms and conditions are generally more favorable for insurers. Historically, the performance of the property and casualty insurance industries has tended to fluctuate in cyclical periods of price competition and excess underwriting capacity, followed by periods of high premium rates and shortages of underwriting capacity. At any given time, Everspan's portfolio of insurance products could experience varying combinations of these characteristics. This cyclical market pattern can be more pronounced in the specialty insurance and reinsurance markets in which Everspan competes than in the standard insurance market. For the last several years the property and casualty industry has been in a period of high premium rates with a shortage of underwriting capacity. While not anticipated to end in the short-term, this cyclical period will eventually end, perhaps unexpectedly. The end of this favorable cycle could have negative consequences for Everspan's growth and profitability prospects. Business Acquisition and Program Partner Selection: As noted above, most of Everspan’s programs are sourced either from MGAs or through other third parties, such as reinsurance brokers, that are seeking to provide customized insurance solutions that require a carrier with a high rating from AM Best. Everspan works with MGAs that leverage both data and technology to streamline or improve the underwriting process. For each new opportunity that Everspan chooses to evaluate, an initial evaluation of the MGA is conducted, including an assessment of its underwriting approach, philosophy, size, quality of management, past performance, future performance targets and, above all, compatibility with Everspan’s operating model, risk appetite, and existing book of business. Upon receipt of a new submission, Everspan promptly determines whether the program is within Everspan's appetite and Everspan has the ability to write the program; it then either declines or starts an initial diligence process. During the initial diligence process, underwriting, actuarial and program management resources review the submission. If approved by these resources, an underwriting memorandum is prepared and submitted to Everspan's Underwriting Risk Committee for initial approval. Everspan's Underwriting Risk Committee is chaired by Everspan’s Chief Underwriting Officer and consists of employees and consultants with expertise in underwriting, credit, and finance. If initial approval is received, Everspan then conducts comprehensive underwriting, claims, operational, compliance and financial diligence on the partner. As part of the diligence process, Everspan works closely with the potential MGA to design the program’s underwriting guidelines, ongoing reporting and auditing requirements. Everspan also typically requires the producing partner to retain underwriting risk or otherwise align incentives with the program’s underwriting performance. Additionally, as part of the diligence process for each program, Everspan will perform a review of the claims management function, typically performed by a third-party claims administrator or (“TPA”), which in some cases are managed by the MGA or producing partner. Diligence focuses on claims handling and litigation management, compliance, finance, governance, staff and vendor management, data and IT. After due diligence is completed and reinsurers are identified, each program is presented to the Underwriting Risk Committee for final approval. The Underwriting Risk Committee will consider recommendations made by the credit subcommittee as respects the solvency of the MGA and/or reinsurers. Ongoing monitoring: For active programs, Everspan authorizes MGAs to underwrite and bind coverages in accordance with approved underwriting guidelines and delegates authority to the TPA for claims adjustment and payment. Everspan closely monitors each MGA and TPA’s adherence to the agreed upon underwriting and claims guidelines. Everspan will conduct periodic reviews of loss experience, rate levels, reserves and the overall financial health of the MGA and TPA and hold monthly underwriting meetings with both the MGA and TPA. Underwriting and claims data is provided by the MGAs and TPAs monthly. Additionally, Everspan conducts underwriting, claims and accounting audits, generally on-site, for each program at least once a year. Although Everspan monitors its programs on an ongoing basis including performance of statutory required procedures, monitoring efforts may not be adequate, or these entities may exceed their underwriting or claims settlement authorities or otherwise breach obligations owed to Everspan. To the extent that these entities exceed their authorities or otherwise breach obligations owed to Everspan in the future, our results of operations or financial condition could be materially adversely affected. Everspan maintains the right to terminate relationships with its MGAs and TPAs. Reasons to terminate a relationship include an inability to produce targeted underwriting results, writing exposures outside of agreed upon risk tolerances, delinquency in meeting reporting requirements, a change of strategic direction, or failure to meet collateral or other commitments to Everspan. Ratings: Ratings are an important factor in assessing Everspan’s competitive position in the insurance industry. AM Best assigns Financial Strength Ratings (FSRs) to property and casualty insurance companies based on quantitative criteria such as profitability, leverage and liquidity, as well as qualitative assessments such as the spread of risk, the adequacy and soundness of ceded reinsurance, the quality and estimated market value of assets, the adequacy of loss reserves and surplus | Ambac Financial Group, Inc. 6 2021 FORM 10-K | Table of Contents and the competence, experience and integrity of management. AM Best's FSR scale ranges from 'A++' (superior) to 'D' (poor). These ratings are not a recommendation to buy, sell or hold any security, and they may be revised or withdrawn at any time by AM Best. Additionally, AM Best assigns a Best’s Financial Size Category (FSC) to letter-rated insurers, which is a convenient indicator of the company’s size. The FSC is represented by Roman numerals ranging from Class I (smallest) to Class XV (largest). The FSC is not part of the FSR. Everspan insurance carriers that were part of the intercompany pooling agreement during 2021 received an AM Best rating of 'A-' (Excellent) and Financial Size Category of Class VIII. We view this rating and financial size category as a competitive advantage in the marketplace. Under the intercompany pooling agreement, affiliated parties agree to and associate themselves, as the Everspan Pool, for the purpose of insuring and reinsuring all business written by or on behalf of each of them, with the intention that each party shall participate, jointly and severally, in the fortunes of the combined underwriting, reinsurance, retrocessions, and claim operations of the other party to the extent of their respective fixed percentage in the Everspan Pool. It is expected that the newly acquired admitted carriers will be participants to the Everspan Pool in 2022 or have a reinsurance agreement with an Everspan entity to share underwriting risk. A downgrade in the AM Best rating could adversely impact Everspan’s business volumes and competitive position because demand for certain of its products may be reduced, particularly because some customers require that Everspan maintain minimum ratings to enter, maintain or renew business with it. Managing General Agency / Underwriting Ambac’s MGA/U strategy is to build a diversified portfolio of MGA/U covering various P&C products. Ambac expects to grow the MGA/U business using several strategies, including (i) organic growth, (ii) additional acquisitions and/or partnerships, and (iii) hiring experienced underwriting teams to incubate our own MGA/U. Key criteria include a track record of profitability and a seasoned management team. Insurance underwritten through Ambac's MGA/Us may utilize Everspan as an insurance carrier, but will not necessarily be required to do so, depending on strategic and operational considerations. On December 31, 2020, Ambac acquired 80% of the membership interests of Xchange. Xchange's management team has significant longstanding relationships with carriers, agents, policyholders, affinity groups and reinsurers. Ambac has the option to purchase the remaining 20% after 2023 and Xchange's management has the option to sell their 20% to Ambac after 2025. Xchange was formed in 2010 and operates through specialty producers in accident and health sectors across the U.S. which are typically not targeted by large direct writers and to whom Xchange customized service. Below is a description of Xchange's largest products for which it is delegated underwriting authority by insurance carriers: Employer Stop Loss ("ESL") — provides protection for self-insured employers by serving as a reimbursement mechanism for catastrophic claims, both specific and in aggregate exceeding pre-determined levels. Limited Medical ("LM") — designed for those not covered by traditional Affordable Care Act medical programs and sold primarily through affinity groups, providing a variety of medically related benefits such as inpatient hospital stays, diagnostic services or physician visits. Short-term Medical ("STM") — sold primarily through affinity groups, providing non Affordable Care Act comprehensive medical coverage for short durations (i.e. less than one year). Xchange underwrote premiums for its carriers of approximately $118 million for the year ended December 31, 2021. Xchange is compensated for its services primarily by commissions paid by insurance carriers for underwriting, structuring and/or administering polices and, in the case of ESL, managing claims under an agency agreement. Commission revenues are usually based on a percentage of the premiums paid by the insured. Xchange is also eligible to receive profit sharing contingent commissions on certain programs (mostly LM and STM) based on the underwriting results of the policies it writes, which may cause some variability in revenue and earning recognition. Gross Commission revenues for 2021 were $26 million. Business written by Xchange is generally concentrated in January and July, which may result in revenue and earnings concentrations in the first and third quarters each calendar year. Xchange's core expenses include commissions it pays to its independent agents / producers and compensation for its management and staff, which currently total 21 individuals. Commission expenses are a variable cost as we pay a percentage of premiums written to the agents / producers. Xchange conducts business through approximately ten insurance carriers and dozens of agents and other distributors. Commission revenue and expense growth will be driven by Xchange’s expansion of its U.S. geographic distribution, diversification of its products and by adding new insurance carriers and their related distribution network. Competition: The MGA/U business is highly competitive, and firms actively compete with Xchange for customers and insurance carrier capacity. • The ESL market is increasing in size as large companies continue to transition from fully insured to self-funded. As the market size increases, capital is flowing into the market, but prices and margins remain stable. Blue Cross, UnitedHealth, CIGNA and Aetna are the largest writers. Competition also comes from large direct writers such as Tokio Marine, HCC and Sun Life as well as smaller carriers such as Gerber Life writing through other MGA/U firms. • For LM and STM, overall market conditions remain stable. The overall market is large as entrepreneurs and the unemployed seek options for individual insurance. Competition for Xchange's business comes from both direct carriers and other intermediaries and, depending on the product, may include Blue Cross, UnitedHealth, CIGNA, Aetna, Tokio Marine, Houston Casualty Company, Sun Life, United Health, Axis, Chubb, and National General. | Ambac Financial Group, Inc. 7 2021 FORM 10-K | Table of Contents ENTERPRISE RISK MANAGEMENT The Company's policies and procedures relating to risk assessment and risk management are overseen by its Board of Directors. The Board of Directors takes an enterprise-wide approach to risk management oversight that is designed to support the Company's business plans at a level of risk considered by the Board to be reasonable. A fundamental part of risk assessment and risk management is not only understanding the risks the Company faces and what steps management is taking to manage those risks, but also understanding what level of risk is appropriate for the Company. The Board of Directors periodically reviews the Company's business plan, factoring risk management into account. It also approves the Company's risk appetite statements, which articulate the Company's tolerance for certain risks and describes the general types of risk that the Company accepts, within certain parameters, or attempts to avoid. While the Board of Directors has the ultimate oversight responsibility for the risk management process, various committees of the Board also have responsibilities related to risk assessment and risk management, and management has responsibility for managing the risks to which the Company is exposed and reporting on such matters to the Board of Directors and applicable Board committees. • The Audit Committee oversees the management of risks associated with the integrity of Ambac’s financial statements and its compliance with legal and regulatory requirements. In addition, the Audit Committee discusses policies with respect to risk assessment and risk management, including major financial risk exposures and the steps management has taken to monitor and control such exposures. The Audit Committee reviews with management, internal auditors and independent auditors Ambac's critical accounting policies, Ambac's system of internal controls over financial reporting and the quality and appropriateness of disclosure and content in the financial statements and other external financial communications. • The Compensation Committee oversees the management of risk primarily associated with our ability to attract, motivate and retain quality talent (particularly executive talent) and with setting financial incentives that do not motivate undue risk-taking. • The Governance and Nominating Committee oversees the management of risk primarily associated with Ambac’s ability to attract and retain quality directors, Ambac’s corporate governance programs and practices and our compliance therewith, including integration of ESG and sustainability policies, practices and goals into the Company's business strategy and decision making. Additionally, the Governance and Nominating Committee oversees the processes for evaluation of the performance of the Board of Directors and its committees each year and considers risk management effectiveness as part of its evaluation. The Governance and Nominating Committee also performs oversight of the business ethics and compliance program, and reviews compliance with Ambac’s Code of Business Conduct. • The Strategy Committee oversees the management of risk and risk appetite primarily with respect to strategic plans and initiatives. The Board of Directors receives quarterly updates from Board committees and the Board provides guidance to individual committee activities, as appropriate. In order to assist the Board of Directors in overseeing Ambac’s risk management, Ambac uses enterprise risk management, a company-wide process that involves the Board of Directors, management and other personnel in an integrated effort to identify, assess and manage a broad range of risks (e.g., credit, financial, legal, liquidity, market, model, operational, regulatory, reputational and strategic), that may affect the Company’s ability to execute on its corporate strategy and fulfill its business objectives. The Enterprise Risk Committee (“ERC”), which is a management committee, is comprised of executive and senior level management responsible for assisting in the management of the Company’s risks on an individual and aggregate basis. The ERC produces the relevant risk management information for executive and senior management and the Board of Directors. Ambac management has established other management committees to assist in managing the risks throughout the enterprise. These committees will meet monthly or as needed on an ad hoc basis. • The AAC Risk Committee's objective is to establish an interdisciplinary team of professionals to provide oversight of the key risk remediation issues impacting AAC. The purview of the committee is to review and approve risk remediation activities for the financial guarantee insured portfolio. Additionally, the Risk Committee will provide oversight and review new risk remediation structures or approaches in connection with risk remediation plans or anticipated transactions. Members of the Risk Committee include the Chief Executive Officer, Head of Risk Management, Chief Financial Officer and senior managers from throughout risk, corporate services, operations, investment management, legal and finance. • The Asset Liability Management Committee's (“ALCO”) objective is to foster an enterprise wide culture and approach to liquidity management, asset management, asset valuation and hedging. Members of ALCO include the Chief Executive Officer, Chief Financial Officer, Head of Risk Management and senior managers from investment management and the Risk Management Group. • The Disclosure Committee's objective is to assist the CEO and CFO in their responsibilities to design, establish, maintain and evaluate the effectiveness of disclosure controls and procedures. Members of the Disclosure Committee include the CEO, CFO, Chief Accounting Officer, General Counsel, Chief Operating Officer, Head of Risk Management and senior managers from finance and legal. Everspan established an Underwriting Risk Committee in 2021 to provide oversight of the active underwriting operations of Everspan, develop underwriting parameters, and assist the Boards of the Everspan companies in overseeing the integrity and effectiveness of Everspan’s underwriting risk management | Ambac Financial Group, Inc. 8 2021 FORM 10-K | Table of Contents framework. Members of the committee include Ambac's Chief Executive Officer, key members of Everspan management and other senior managers or advisors of Ambac. Additionally, a Reinsurance & Program Administrator Credit Risk sub-committee was established at the direction of the Underwriting Risk Committee to assist with the management of credit risk emanating from ceded reinsurance and program administrators. Xchange established an Underwriting Committee in 2021 for the purpose of reviewing and approving any new business initiative or product line proposed to be undertaken by Xchange. Members of the Underwriting Committee include Ambac's Chief Executive Officer, Chief Financial Officer, key members of Xchange management and other senior managers or advisors of Ambac. AVAILABLE INFORMATION Our Internet address is www.ambac.com. We make available through the investor relations section of our web site, annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, and any amendments to those reports, filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as well as proxy statements, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the U.S. Securities and Exchange Commission. Our Investor Relations Department can be contacted at Ambac Financial Group, Inc., One World Trade Center, 41st Floor, New York, New York 10007, Attn: Investor Relations, telephone: 212-208-3222 email: ir@ambac.com. The reference to our website address does not constitute inclusion or incorporation by reference of the information contained on our website in this Form 10-K or other filings with the SEC and the information contained on our website is not part of this document. INSURANCE REGULATORY MATTERS AND OTHER RESTRICTIONS Regulatory Matters United States AAC is domiciled in the state of Wisconsin and is therefore subject to the insurance laws and regulations of the State of Wisconsin and regulated by the Wisconsin Office of the Commissioner of Insurance (“OCI”) as a domestic insurer. Everspan Indemnity and its wholly owned subsidiary, Everspan Insurance Company ("Everspan Insurance") are domiciled in the state of Arizona and are therefore subject to the insurance laws and regulations of the State of Arizona and regulated by the Arizona Department of Insurance and Financial Institutions as domestic insurers. The subsidiaries of Everspan Insurance are domiciled in various States and are therefore subject to the insurance laws and regulations of their respective domiciliary States and regulated by the insurance departments of those States as domestic insurers. AAC, Everspan Insurance and its subsidiaries are also subject to the insurance laws and regulations of the other jurisdictions in which they are licensed and operate as foreign insurers in such jurisdictions. See Note 8. Insurance Regulatory Restrictions to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K for further information on regulatory restrictions. Pursuant to the terms of the Settlement Agreement, the Stipulation and Order and the indenture for the Tier 2 Notes, AAC must seek prior approval by OCI of certain corporate actions. The Settlement Agreement, Stipulation and Order and indenture for the Tier 2 Notes include covenants which restrict the operations of AAC. The Settlement Agreement will remain in force until the surplus notes issued thereunder have been redeemed, repurchased or repaid in full. The Stipulation and Order will remain in force for so long as OCI determines it to be necessary. The indenture for the Tier 2 Notes will remain in force until the Tier 2 Notes have been redeemed, repurchased or repaid in full. Certain of the restrictions in the Settlement Agreement and indenture for the Tier 2 Notes may be waived with the approval of the OCI and/or the requisite percentage of holders of debt securities issued thereunder. Xchange Benefits is a property and casualty managing general underwriter, specializing in accident and health insurance. Xchange Affinity is also a managing general underwriter. Xchange Benefits and Xchange Affinity, like some other managing general underwriters and program administrators, may be subject to licensing requirements and regulation by insurance regulators in various states in which they conduct business. Cybersecurity and Privacy Regulation Ambac and its subsidiaries are subject to various U.S. Federal and state laws and regulations with respect to privacy, data protection and cybersecurity that require financial institutions, including insurance companies and agencies, to safeguard personal and other sensitive information, and may provide for notice of their practices relating to the collection, disclosure and processing of personal information, and any related security breaches. For example, the National Association of Insurance Commissioners (“NAIC”) adopted the NAIC Insurance Data Security Model Law (#668) (“NAIC Model Law”) that creates rules for insurers and other covered entities addressing data security and the investigation and notification of cybersecurity events involving unauthorized access to, or the misuse of, certain nonpublic information. This includes maintaining an information security program based on ongoing risk assessment, overseeing third-party service providers, investigating data breaches and notifying regulators of a cybersecurity event. Legislation based on the NAIC Model Law has been enacted in several states and may be enacted in other states. Certain of our subsidiaries, as insurance companies and agencies licensed in the State of New York, are also required to comply with the New York Department of Financial Services (“NYDFS”) cybersecurity regulation, which establishes requirements for covered financial services institutions to implement a cybersecurity program designed to protect the confidentiality, integrity and availability of information systems of regulated entities, and information stored on those systems. The regulation imposes a governance framework for cybersecurity program, risk based minimum standards for technology systems for data protection, monitoring and testing, third-party service provider reviews, security incident response and reporting to NYDFS of certain security incidents, annual certifications of regulatory compliance to NYDFS, and other requirements. The California Consumer Privacy Act, went into effect in January 2020, and provides additional privacy rights for California residents, and in November 2020, California further | Ambac Financial Group, Inc. 9 2021 FORM 10-K | Table of Contents expanded privacy rights for California residents by enacting the California Privacy Rights Act. In 2021 Virginia and Colorado enacted similar privacy laws. We anticipate federal and state regulators to continue to enact legislation related to privacy and cybersecurity. The federal Health Insurance Portability and Accountability Act of 1996 and its implementing regulations (“HIPAA”) impose minimum standards on covered entities, such as health insurers, for the privacy and security of protected health information (“PHI”). The Health Information Technology for Economic and Clinical Health Act, enacted in 2009 (“HITECH”) provides for the extension of certain privacy and security provisions of HIPAA to business associates of covered entities that handle electronic PHI. Xchange specializes in accident and health insurance and is a business associate of the health insurers carriers it partners with, making it subject to compliance with the provisions of HITECH and HIPAA applicable to business associates. United Kingdom The Prudential Regulatory Authority ("PRA") and Financial Conduct Authority ("FCA") (and their predecessor regulator the Financial Services Authority (“FSA”)) exercise significant oversight over Ambac UK. In 2009, the FSA limited Ambac UK’s license to undertaking only run-off related activity. As such, Ambac UK is authorized to run-off its insurance portfolio in the United Kingdom. See Note 8. Insurance Regulatory Restrictions to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K for further information on regulatory restrictions. AFG and certain of its subsidiaries are also subject to non-U.S. laws and regulations relating to the cybersecurity and privacy of the information of clients, employees or others. AFG’s UK subsidiary, Ambac UK, has conducted insurance business throughout Europe and is subject to the U.K.’s Data Protection Act 2018, and the E.U.’s General Data Protection Regulation (GDPR), but these laws should not have a significant impact on Ambac UK. The application, interpretation and enforcement of these non-U.S laws and regulations are often uncertain, and may have an impact on AFG and its subsidiaries businesses and operations. Regulation of Change in Control Under applicable insurance law, any acquisition of control of AFG, or any other direct or indirect acquisition of control of AAC or one or more members of the Everspan, requires the prior approval (or non-disapproval) of the domiciliary regulator of the acquired company (or, in the case of AFG, the domiciliary regulators of AAC and each member of the Everspan). “Control” is generally defined as the direct or indirect power to direct or cause the direction of the management and policies of a person. Any purchaser of 10% or more of the outstanding voting stock of a corporation is presumed to have acquired control of that corporation and its subsidiaries unless the applicable insurance regulator, upon application, determines otherwise. For purposes of this test, AFG believes that a holder of common stock having the right to cast 10% or more of the votes which may be cast by the holders of all shares of common stock of AFG would be presumably deemed to have control of AAC, Everspan Indemnity, Everspan Insurance and its subsidiaries within the meaning of applicable insurance laws and regulations, although insurance regulators may in their discretion deem control not to exist where, for example, control is disclaimed by a passive investor. The United Kingdom has similar requirements applicable in respect of AFG, as the ultimate holding company of Ambac UK. Dividend Restrictions, Including Contractual Restrictions Due to contractual and regulatory restrictions, AAC has been unable to pay ordinary dividends to AFG since 2008 and will be unable to pay ordinary dividends in 2022. AAC’s ability to pay dividends is further restricted by the Settlement Agreement, the Stipulation and Order, the indenture for the Tier 2 Notes and the terms of its Auction Market Preferred Shares ("AMPS"). See Note 8. Insurance Regulatory Restrictions to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K for further information on dividends. As a result of these restrictions, AAC is not expected to pay dividends to AFG for the foreseeable future. Pursuant to the Settlement Agreement and the indenture for the Tier 2 Notes, AAC may not make any “Restricted Payment” (which includes dividends from AAC to AFG) in excess of $5 million in the aggregate per annum, other than Restricted Payments from AAC to AFG in an amount up to $7.5 million per annum solely to pay operating expenses of AFG. Concurrent with making any such Restricted Payment, a pro rata amount of AAC's surplus notes would also need to be redeemed at par. Any such payment on surplus notes would require either payment or collateralization of a proportional amount of the Tier 2 Notes (or interest thereon) in accordance with the terms of the Tier 2 Note indenture. The Stipulation and Order requires OCI approval for the payment of any dividend or distribution on the common stock of AAC. Under the terms of AAC’s AMPS, dividends may not be paid on the common stock of AAC unless all accrued and unpaid dividends on the AMPS for the then current dividend period have been paid, provided that dividends on the common stock may be made at all times for the purpose of, and only in such amounts as are necessary for, enabling AFG (i) to service its indebtedness for borrowed money as such payments become due or (ii) to pay its operating expenses. If dividends are paid on the common stock as provided in the prior sentence, dividends on the AMPS become cumulative until the date that all accumulated and unpaid dividends have been paid on the AMPS. While the UK insurance regulatory laws impose no statutory restrictions on an insurer’s ability to declare a dividend, the PRA’s and FCA’s capital requirements in practice act as a restriction on the payment of dividends, where a firm has a lower level of regulatory capital than its regulatory capital requirement as is the case for Ambac UK. Further, the FSA amended Ambac UK’s license in 2010 such that the PRA must specifically approve any transfer of value and/or assets from Ambac UK to AAC or any other Ambac group company, other than in respect of certain disclosed contracts between the two parties (such as in respect of a management services agreement | Ambac Financial Group, Inc. 10 2021 FORM 10-K | Table of Contents between AAC and Ambac UK). As a result, Ambac UK is not expected to pay any dividends to AAC for the foreseeable future. Everspan Indemnity, Everspan Insurance and its subsidiaries are also subject to regulatory restrictions on their ability to pay dividends. Everspan Indemnity and Everspan Insurance do not have sufficient earned surplus at this time to pay ordinary dividends under the insurance laws and regulations of Arizona. Furthermore, certain subsidiaries of Everspan Insurance are restricted from paying dividends to Everspan Insurance until 2025 or later, unless otherwise approved by the domestic regulator of the relevant subsidiary, pursuant to the regulatory orders approving the acquisition of those subsidiaries. INVESTMENTS AND INVESTMENT POLICY As of December 31, 2021, the consolidated non-VIE investments of Ambac had an aggregate fair value of approximately $2,955 million. Investments are managed both internally by experienced investment managers and externally by investment management firms. All investments are made in accordance with the general objectives, policies, and guidelines for investments reviewed or overseen by the Board of Directors of the applicable subsidiary. These policies and guidelines include liquidity, credit quality, diversification and duration objectives and are periodically reviewed and revised as appropriate. Additionally, senior credit personnel monitor the portfolio on a continuous basis. As of December 31, 2021, the AAC and Everspan non-VIE investment portfolios had an aggregate fair value of approximately $2,123 million. The investment objective is to achieve the highest risk-adjusted after-tax return on a diversified investment portfolio consistent with the respective company's risk tolerance while employing active asset/liability management practices to satisfy all operating and strategic liquidity needs. In addition to internal investment policies and guidelines, the investment portfolio of each company is subject to limits on the types and quality of investments imposed by applicable insurance laws and regulations of the jurisdictions in which it is licensed. The Board of Directors of each respective subsidiary approves any changes to the investment policy. Within its guidelines, AAC opportunistically purchases and sells AAC and Ambac UK insured securities given their relative risk/reward characteristics. In certain instances, AAC may exceed its established credit rating or concentration limits with appropriate regulatory approval. Changes to AAC’s investment policies are subject to approval by OCI pursuant to covenants made by AAC in the Settlement Agreement, the Stipulation and Order and the indenture for the Tier 2 Notes. See Note 1. Background and Business Description and Note 12. Long-term Debt to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K for more information about the Settlement Agreement, the Stipulation and Order and the indenture for the Tier 2 Notes. Such requirements could adversely impact the performance of the investment portfolio. As of December 31, 2021, the non-VIE Ambac UK investment portfolio had an aggregate fair value of approximately $669 million. Ambac UK’s investment policy is designed with the primary objectives of ensuring a reasonable risk-adjusted return over the remaining runoff of the insured portfolio and that Ambac UK is able to meet its financial obligations as they fall due, in particular with respect to policy holder claims. Ambac UK’s investment portfolio is primarily diversified fixed maturity securities and pooled investment funds. The portfolio is subject to internal investment guidelines and may be subject to limits on types and quality of investments imposed by its regulator. The Board of Directors of Ambac UK approves any changes or exceptions to Ambac UK’s investment policy. As of December 31, 2021, the non-VIE AFG (parent company only, excluding investments in subsidiaries) investment portfolio had an aggregate fair value of approximately $254 million. The primary investment objective is to preserve capital for strategic uses while maximizing income. The investment portfolio is subject to internal investment guidelines. Such guidelines set forth minimum credit rating requirements and credit risk concentration limits. Included in the investment portfolio is AFG's investment in securities insured or issued by AAC, including surplus notes ($90 million fair value at December 31, 2021) that are eliminated in consolidation. The following table provide certain information concerning the consolidated investments of Ambac: 2021 2020 Investment Category ($ in millions) December 31, Carrying Value (2) Weighted Average Yield (1) Carrying Value (2) Weighted Average Yield (1) Municipal obligations $ 340 5.3 % $ 358 4.8 % Corporate securities 613 2.2 % 1,077 3.9 % Foreign obligations 87 0.5 % 98 0.2 % U.S. government obligations 60 1.0 % 121 1.6 % Residential mortgage-backed securities 252 7.3 % 302 6.6 % Asset-backed securities 393 5.0 % 377 5.7 % Total long-term fixed maturity investments 1,745 3.9 % 2,332 4.3 % Short-term investments 519 — % 617 0.1 % Other investments (3) 690 — % 595 — % Total $ 2,955 2.9 % $ 3,544 3.4 % (1) Yields are stated on a pre-tax basis, based on average amortized cost for both long and short term fixed-maturity investments. (2) Includes investments guaranteed by AAC and Ambac UK ("Ambac insured"). Refer to Note 4. Investments of the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K for further discussion of Ambac insured securities held in the investment portfolio. (3) Other investments include interests in pooled investment funds that are either classified as trading securities or are reported under the equity method and for 2020 Ambac's interests in an unconsolidated trust created in connection with its sale of junior surplus notes on August 28, 2014. EMPLOYEES As of December 31, 2021, Ambac had 122 employees in the United States and 10 employees in the United Kingdom. Our 2021 voluntary turnover rate was approximately 4.7%. Ambac considers its employee relations to be satisfactory. | Ambac Financial Group, Inc. 11 2021 FORM 10-K | Table of Contents Ambac’s focus has been on identifying and retaining key talent through individual development programs following skills assessments. Ambac’s succession planning has identified internal candidates that could fill executive management and senior management positions as the need arises. The Company has established a senior advisory team to work with, and advise, executive management on key initiatives, and has invested in both personal and professional growth programs to identify and prepare individuals for promotion within the Company. The Company continues to rely on compensation components (such as salary, long-term incentive plan awards, deferred cash awards and short-term incentive plan awards) to support employee retention and discourage excessive risk taking. The Company incorporates performance metrics as part of the annual short-term incentive bonus offering with increased bonus potential for exceptional results. We utilize third-party benchmark data to establish market-based compensation levels. We believe that our current compensation and incentive levels reflect high performance expectations as part of our merit pay philosophy. The targeted use of long-term equity incentive plan awards for key talent is an important element of Ambac’s long-term retention strategy. Item 1A. Risk Factors ($ in millions) Capitalized terms used but not defined in this section shall have the meanings ascribed thereto in Part I, Item 1 in this Form 10-K or in Note 1. Background and Business Description to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K unless otherwise indicated. Our risk factors are organized in the following sections Page Risks Related to AFG Common Shares 12 Risks Related to FG Insured Portfolio Losses 13 Risks Related to Capital, Liquidity and Markets 16 Risks Related to Financial and Credit Markets 20 Risks Related to the Company's Business 21 Risks Related to Taxation 26 Risks Related to Strategic Plan 26 Risks Related to AFG Common Shares Investments in AFG's common stock are highly speculative and the price per share of AFG's common stock may be subject to a high degree of volatility, including significant price declines. Ambac's legacy financial guarantee business is in run-off and faces significant risks and uncertainties described elsewhere in Part I, Item 1A. Risk Factors. In addition, Ambac's Specialty Property & Casualty Program Insurance and Managing General Agency / Underwriting businesses are new and relatively small and therefore are also subject to uncertainties described elsewhere in Part I, Item 1A. Risk Factors. Although AFG's common stock is listed on the New York Stock Exchange ("NYSE"), there can be no assurance as to the liquidity of the trading market or the price at which such shares can be sold. The price of the shares may decline substantially in response to a number of events or circumstances, including but not limited to: • adverse developments in our financial condition or results of operations; • actual or perceived adverse developments with regards to AAC's residential mortgage-backed securities ("RMBS") litigations; • changes in the actual or perceived risk within our FG insured portfolio, particularly with regards to concentrations of credit risk, such as in Puerto Rico; • changes to regulatory status; • changes in investors’ or analysts’ valuation measures for our stock; • market perceptions of our success, or lack thereof, in pursuing and implementing our Specialty Property & Casualty Program Insurance and Managing General Agency / Underwriting businesses and our new business strategy more generally; • the impact or perceived impact of any acquisition, disposition or other strategic transaction, including entry into a new line of business, on the value or long-term prospects of the Company; and • results and actions of other participants in our industries. In addition, the price of AFG's shares may be affected by the additional risks described below, including risks associated with AAC’s ability to deliver value to AFG. Investments in AFG's common stock should be considered highly speculative and may be subject to a high degree of volatility. AFG may not be able to realize value from AAC; risk remains that AAC could be subject to rehabilitation proceedings. The value of AFG's common stock is partially dependent upon realizing residual value and/or receiving dividends from AAC; the receipt of payments to be made by AAC pursuant to the intercompany expense sharing and cost allocation agreement (the "Cost Allocation Agreement"); the receipt of payments on investments made in surplus notes issued by AAC; and the receipt of payments on other investments. There can be no assurance that AFG will be able to realize residual value and/or receive dividends from AAC, which is in run-off. AFG's ability to realize residual value and/or receive dividends from AAC will depend upon, amongst other considerations, AAC's ability to satisfy all of its obligations that are senior to AFG's equity interests, including obligations to policyholders, holders of its indebtedness (including surplus notes, the Sitka AAC Note and the Tier 2 Notes) and holders of its preferred stock. AAC's ability to satisfy all of its obligations that are senior to AFG's equity depends on a number of considerations, including its ability to achieve recoveries, particularly from litigations concerning insured RMBS; mitigate losses from its insured portfolio, which is subject to significant risks and uncertainties, including as a result of varying potential perceptions of the value of AAC’s guarantees and securities; realize material value from its investment in Ambac UK; and repay its indebtedness in a timely manner such that accruing interest costs are manageable. Increased loss development in the FG insured portfolio or significant losses or other events resulting from litigation, | Ambac Financial Group, Inc. 12 2021 FORM 10-K | Table of Contents particularly the failure to achieve sufficient recoveries from existing litigations concerning insured RMBS, or the inability of AAC to pay its debts or other obligations may prompt OCI to determine that it is in the best interests of policyholders to initiate rehabilitation proceedings with respect to AAC or to issue supervisory orders that impose restrictions on AAC, either preemptively or in response to any such event or circumstance. If OCI were to decide to initiate rehabilitation proceedings with respect to AAC, adverse consequences may result, including, without limitation and absent enforceable protective injunctive relief, the assertion of damages by counterparties, the acceleration of losses based on early termination triggers, and the loss of control rights in insured transactions. Any such consequences may reduce or eliminate any residual value of AAC for AFG. For example, if AAC were to lose control rights, its ability to mitigate loss severities and realize remediation recoveries will be compromised, and actual ultimate losses in the insured portfolio could exceed current loss reserves. Additionally, the rehabilitator would assume control of all of AAC’s assets and management of AAC. In exercising control, the rehabilitator would act solely for the benefit of policyholders, which may result in material adverse consequences for our security holders. Similar risks would arise if Ambac UK were to become subject to a proceeding to protect the interests of its policyholders, in which case AAC's ability to realize value from Ambac UK (and consequently AFG's ability to realize value from AAC) would diminish. If OCI were to issue supervisory orders imposing restrictions on AAC, AAC's ability to satisfy its obligations to policyholders or creditors, or its ability to deliver value to AFG, may be significantly constrained. Due to the above considerations, as well as applicable legal and contractual restrictions described elsewhere herein, it is highly unlikely that AAC will be able to pay AFG any dividends for the foreseeable future. Furthermore, the payments to be made to AFG under the intercompany Cost Allocation Agreement are subject to, in certain instances, OCI approval, making the amount and timing of such payments uncertain. Risks Related to FG Insured Portfolio Losses Loss reserves for the FG business may not be adequate to cover potential losses, and changes in loss reserves may result in further volatility of net income and comprehensive income. Loss reserves are established when management has observed credit deterioration in its insured credits. Loss reserves established with respect to our non-derivative FG insurance policies issued to beneficiaries, including VIEs for which we do not consolidate the VIE, are based upon estimates and judgments by management, including estimates and judgments with respect to the probability of default; the severity of loss upon default; management’s ability to execute policy commutations, restructurings and other loss mitigation strategies; and estimated remediation recoveries for, among other things, breaches by RMBS issuers of representations and warranties. The objective of establishing loss reserve estimates is not to, and our loss reserves do not, reflect the worst possible outcomes. While our reserving scenarios reflect a wide range of possible outcomes (on a probability weighted basis), reflecting the significant uncertainty regarding future developments and outcomes, our loss reserves may change materially based on future developments. As a result of inherent uncertainties in the estimates and judgments made to determine loss reserves, there can be no assurance that either the actual losses in our financial guarantee insurance portfolio will not exceed such reserves or that our reserves will not materially change over time as circumstances, our assumptions, or our models change. Catastrophic public health or environmental events, like the COVID-19 pandemic or those associated with hurricanes, earthquakes, wildfires and droughts, that result in material disruption of economic activity, loss of human life or significant property damage, can have a materially negative impact on the financial performance of issuers of public finance, structured finance, investor owned utility, privatized military housing and other obligations insured by AAC. Such stresses could result in liquidity claims and/or permanent losses on obligations of those obligations. The COVID-19 pandemic caused economic and financial disruptions that adversely affected, and may continue to adversely affect, our business and results of operations. In particular, Ambac insures the obligations of a number of issuers that have been, or may in the future be, substantially affected by the prolonged economic effects of COVID-19, such as municipalities and securitizations, including those backed by consumer loans such as mortgages or student loans. As described more fully in Management's Discussion and Analysis of Financial Condition and Results of Operations, municipalities and their authorities, agencies and instrumentalities, especially those dependent on narrow revenue streams flowing from particular economic activities, such as the collection of hotel occupancy taxes, have suffered, and may to continue to suffer, from depressed revenues due to the lingering negative economic impact brought about by the COVID-19 pandemic in certain parts of the economy. Furthermore, securitizations dependent on cash flows from payments on mortgage loans have experienced, and may continue to experience, shortfalls in receipts due to borrower nonpayments. Notably, in response to the COVID-19 pandemic, the U.S. Federal government and State governments and their agencies adopted policies or guidelines to provide emergency relief to consumers, such as limiting debt collection efforts, encouraging or requiring extensions, modifications or forbearance with respect to certain loans and fees, and establishing foreclosure and eviction moratoriums. Most of these policies or guidelines have since expired, but as a result of the impact of delays in mortgage foreclosures and of potential forbearance-related mortgage loan modifications AAC may experience higher losses in its insured portfolio of RMBS securities. See Part II, Item 7 of this Form 10-K, Management's Discussion and Analysis of Financial Condition and Results of Operations, Executive Summary, Financial Guarantees in Force, Liquidity and Capital Resources and Balance Sheet for further detail. AAC also insures the obligations of a number of issuers that have been, or may in the future be, substantially affected by environmental or other public health events, including flooding, hurricanes, earthquakes, wildfires and drought. In addition, certain catastrophic environmental events, notably wildfires, can | Ambac Financial Group, Inc. 13 2021 FORM 10-K | Table of Contents result in significant potential liabilities for issuers such as investor-owned utilities, that increase bankruptcy risk and the potential default on obligations of the issuer insured by AAC. The ultimate impact of a catastrophic public health event like COVID-19 or a catastrophic environmental event on issuers and their obligations, and the economy in general, is by its very nature uncertain, and will be determined by a number of factors including, but not limited to, the depth and duration of a particular crisis; the extent to which affected consumers, businesses, municipal entities and other debtors or sources of revenues recover from depressed economic circumstances, and the timelines for such recoveries; the level and efficacy of government intervention or support for municipal entities, consumers, businesses and the financial markets via emergency relief measures; the availability of insurance; the availability of cost-effective financing; management of public health crisis remediation efforts; the effectiveness of other public or private crisis management efforts, mitigation measures or support; and certain socio-economic variables, such as unemployment levels. Consequently, if issuers affected by such catastrophic events do not have sufficient resources or financial flexibility, receive adequate measures of support or realize the appropriate level of economic recovery, their ultimate ability to service the debt insured by Ambac could be materially impaired and Ambac could suffer material permanent losses and therefore may have an adverse effect on our results of operations and financial condition. AAC insures obligations of the Commonwealth of Puerto Rico, including certain of its authorities and public corporations that are or were subject to Title III or Title VI proceedings under the Puerto Rico Oversight, Management and Stability Act ("PROMESA"). AAC has made, and will continue to be required to make significant amounts of policy payments over the next several years, which will lead to material permanent losses. The recoverability of these policy payments is subject to uncertainty as well as variability in terms of the value of portions of the plan consideration to be made available under the various PROMESA plans of adjustment and qualifying modifications for the obligations AAC insures. While we believe our reserves are adequate to cover losses on Puerto Rico insured bonds, there can be no assurance that AAC may not incur additional losses in the future. Such losses may have a material adverse effect on Ambac's results of operation and financial condition. AAC has exposure to the Commonwealth of Puerto Rico (the "Commonwealth"), including its authorities and public corporations. Each has its own credit risk profile attributable to, as applicable, discrete revenue sources, direct general obligation pledges and/or general obligation guarantees. AAC had approximately $1,054 of net par exposure to the Commonwealth and these instrumentalities as of December 31, 2021. Components of the overall Puerto Rico net par outstanding include capital appreciation bonds that are reported at the par amount at the time of issuance of the related insurance policy as opposed to the current accreted value of the bonds. The outstanding net insured amount including accretion on capital appreciation bonds is approximately $1,280 as of December 31, 2021. Total net insured lifetime debt service (net par and interest) to the Commonwealth of Puerto Rico and its instrumentalities was approximately $2,423 as of December 31, 2021. As of July 27, 2021, AAC had signed on to (i) the PRIFA Related Plan Support Agreement (“PRIFA PSA”), dated as of July 27, 2021, by and among the Federal Oversight and Management Board for Puerto Rico, as representative of the Commonwealth of Puerto Rico (the “Oversight Board”), AAC, Financial Guaranty Insurance Company (“FGIC”), and certain holders of bonds issued by PRIFA, (ii) the PRHTA/CCDA Related Plan Support Agreement (“PRHTA/CCDA PSA”), dated as of May 5, 2021, by and among the Oversight Board, as representative of the Commonwealth of Puerto Rico and Puerto Rico Highways and Transportation Authority (“PRHTA”), and certain creditors of the Commonwealth and PRHTA, and (iii) the Amended and Restated Plan Support Agreement ("Amended and Restated GO / PBA PSA"), dated as of July 12, 2021, by and among the Oversight Board, as representative of the Commonwealth of Puerto Rico, Puerto Rico Public Buildings Authority (“PBA”) and the Employee Retirement System of the Government of the Commonwealth of Puerto Rico, and certain other creditors of the Commonwealth and PBA. As of the October 18, 2021 voting deadline, AAC had voted to support the amended Commonwealth Plan of Adjustment and as of the November 3, 2021 voting deadline, AAC voted to support the Title VI Qualifying Modifications for both PRIFA and CCDA (the "PRIFA QM" and "CCDA QM", respectively). On January 18, 2022, Judge Laura Taylor Swain, U.S. District Court for the District of Puerto Rico, confirmed a modified version of the Eighth Amended Title III Joint Plan of Adjustment of the Commonwealth of Puerto Rico ("Eighth Amended POA"). On January 22, 2022, Judge Swain approved the PRIFA QM and the CCDA QM. While the Eighth Amended POA, the PRIFA QM, and CCDA QM are expected to become effective on or before March 15, 2022, they remain subject to appeal. On January 28, 2022, Federación de Maestros de Puerto Rico, Inc., Grupo Magisterial Educadores(as) por la Democracia, Unidad, Cambio, Militancia y Organización Sindical, Inc., and Unión Nacional de Educadores y Trabajadores de la Educación, Inc. (collectively, the"Teachers' Unions") filed a notice of appeal of the Court's order confirming the Eighth Amended POA. A number of credit unions (the "Credit Unions") filed their notice of appeal on the same day. On February 1, 2022, the Teachers' Union moved for a stay of the confirmation order while the appeal is pending. On February 3, 2022, Suiza Dairy Corp. filed its notice of appeal of the Court's order confirming the Eighth Amended POA. On February 4, 2022, Asociación Puertorriqueña de la Judicatura, Inc. ("APJ") filed a notice of appeal of the confirmation order, as well as a motion for a stay of the same pending appeal. The Credit Unions filed their motion for a stay pending appeal on February 4, 2022. Briefing in connection with the motions for a stay pending appeal was complete as of February 17, 2022. The Court has taken the motions on submission. Because the effective dates of the PRIFA QM and CCDA QM are conditioned on the occurrence of the effective date of the Eighth Amended POA, a stay pending the appeal of the Eighth Amended POA would delay the effective dates for each of the Eighth Amended POA, PRIFA QM, and CCDA QM. | Ambac Financial Group, Inc. 14 2021 FORM 10-K | Table of Contents The Plan of Adjustment for the PRHTA ("PRHTA POA") is expected to be filed prior to March 31, 2022, with a confirmation hearing expected to follow later in 2022. As a result of the developments described in this Risk Factor and elsewhere in this Annual Report on Form 10-K (see Part II, Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations - Financial Guarantees in Force, and Note 6. Financial Guarantees in Force to the Consolidated Financial Statements included in Part II, Item 8 in this Annual Report on Form 10-K), the Commonwealth and certain of its instrumentalities are continuing to default on debt service payments, including payments owed on bonds insured by AAC. AAC has made, and will continue to be required to make, significant amounts of policy payments over the next several years which will lead to material permanent losses. The recoverability of these policy payments is subject to uncertainty as well as variability as it relates, in particular, to the realizable value of the contingent value instrument ("CVI") portions of the plan consideration to be made available under the recently-confirmed Commonwealth Plan of Adjustment, PRIFA QM, and CCDA QM, and the proposed PRHTA POA. The outcome of the pending appeal of order confirming the Eighth Amended POA remains uncertain at this time and no assurances can be given that the PRHTA POA will be confirmed or that material changes will not be made to the PRHTA POA prior to confirmation. Additionally, it is possible that certain restructuring process solutions, together with associated legislation, budgetary, and/or public policy proposals could be adopted that significantly further impair our exposures or impact the value of the creditor consideration, including the new GO and PRHTA bonds and CVI, contemplated by the Commonwealth Plan of Adjustment, the CCDA QM, the PRIFA QM, and the PRHTA POA. Furthermore, it is also possible that economic or demographic outcomes may be as, or worse than, forecasted in the Commonwealth Fiscal Plan, which could result in performance-dependent sources of recovery like the CVI to produce no value or less value than expected based on current circumstances and assumptions. Given the potential variability of the CVI together with the aforementioned uncertainties and risks related to the consideration to be made available under various plans of adjustment and qualifying modifications as well as to the risk related to the confirmation of the PRHTA POA, there can be no assurance that AAC will not experience losses materially exceeding current reserves whereby AAC's financial condition would be materially adversely affected. While our reserving scenarios reflect a wide range of possible outcomes reflecting the significant uncertainty regarding future developments and outcomes, given our exposure to Puerto Rico and the economic, fiscal, legal and political uncertainties associated therewith, our loss reserves may ultimately prove to be insufficient to cover our losses, potentially by a material amount, and may be subject to material volatility. Changes to our loss reserves may have a material adverse impact on AAC’s results of operations and financial condition. AAC is subject to credit risk and other risks in its insured portfolio, including related to RMBS and securities backed by student loans, Public Finance obligations, and International obligations. We are also subject to risks associated with adverse selection as our insured portfolio runs off. Performance of our insured FG transactions, including (but not limited to) RMBS transactions and those involving securities backed by student loans, can be adversely affected by general economic conditions, such as recession, unemployment levels, underemployment, home prices that decline or do not increase in the patterns assumed in our models, increasing foreclosure rates and unavailability of consumer credit, mortgage product attributes, such as interest rate adjustments and balloon payment obligations, borrower and/or originator fraud or misrepresentations, mortgage and student loan servicer performance or underperformance and financial difficulty, such as risks related to whether the servicer may be required to delay the remittance of any cash collections held by it or received by it after the time it becomes subject to bankruptcy or insolvency proceedings. While further deterioration in the performance of consumer assets, including mortgage-related assets and student loans, may occur, the timing, extent and duration of any future deterioration of the credit markets is unknown, as is the impact on potential claim payments and ultimate losses on the securities within our insured FG portfolio. In addition, there can be no assurance that any governmental or private sector initiatives designed to address such credit deterioration in the markets will be successful or inure to the benefit of the transactions we insure. For example, any initiative which permits the discharge of student loan debt in bankruptcy may adversely affect our portfolio. Similarly, servicer settlements with governmental authorities regarding foreclosure or servicing irregularities are generally designed to protect borrowers and may increase losses on securities we insure. In particular, the student loan industry and, specifically, trusts with securities insured by AAC have been subject to heightened Consumer Finance Protection Bureau ("CFPB") scrutiny and enforcement action over servicing and collections practices and potential chain of title issues and, consequently, any settlements, orders or penalties resulting from CFPB actions, or any failure on the part of servicers or other parties asserting claims against delinquent borrowers to establish title to the loans, could lead to increased losses on securities we insure. In addition, there can be no assurance that AAC would be successful, or that it would not be delayed, in enforcing the subordination provisions, credit enhancements or other contractual provisions of RMBS or any other security that AAC insures. Some issuers in AAC's Public Finance insured portfolio are experiencing fiscal stress that could result in increased losses on those obligations or increased liquidity claims, including losses or claims resulting from payment defaults, Chapter 9 bankruptcy or other restructuring proceedings or loss of market access. Issuers of public finance obligations insured by AAC have reported, or may report, budget shortfalls, significantly underfunded pensions or other fiscal stresses that imperil their ability to pay debt service or will require them to significantly raise taxes and/or cut spending in order to satisfy their obligations. Furthermore, over time, the consequences of poor public policy decisions by state and local governments or increases in tax burdens can impact demographic trends, such as | Ambac Financial Group, Inc. 15 2021 FORM 10-K | Table of Contents out-migration from one state or municipality to another, that may negatively impact the creditworthiness of related issuers. Some issuers of obligations insured by AAC have declared payment moratoriums, defaulted or filed for bankruptcy or similar debt adjustment proceedings, raising concerns about their ultimate ability or willingness to service the debt insured by AAC and AAC's ability to recover claims paid in the future. If the issuers of the obligations in the public finance portfolio are unable to raise taxes, cut spending, or receive federal or state assistance, or if such issuers default or file for bankruptcy under Chapter 9 or for similar relief under other laws that allow for the adjustment of debts, AAC may experience liquidity claims and/or ultimate losses on those obligations, which could adversely affect the Company's business, financial condition and results of operations. Issuers in Chapter 9 or similar proceedings may obtain judicial rulings and orders that impair creditors' rights or their ability to collect on amounts owed. In certain cases, judicial decisions may be contrary to AAC's expectations or understanding of the law or its rights thereunder, which may lead to worse outcomes in Chapter 9 or similar proceedings than anticipated at the outset. As the runoff of the insured portfolio continues, the proportion of exposures we rate as below investment grade relative to the aggregate insured portfolio is likely to increase, leaving the portfolio increasingly concentrated in higher risk exposures. This risk may result in greater volatility or have adverse effects on the Company's results from operations and on our financial condition. We may not be able to effectively reduce FG insured exposures. Measures taken to reduce such risks may have an adverse effect on the Company's operating results or financial position. In pursuing the objective of improving our financial position, we are seeking to terminate, commute, reinsure or otherwise reduce FG insured exposures. De-risking transactions may not be feasible or economically viable. We cannot provide any assurance that any such transaction will be consummated in the future, or if it is, as to the timing, terms or conditions of any such transaction. Even if we consummate one or more of such transactions, doing so may ultimately prove to be unsuccessful in creating value for any or all of our stakeholders and may negatively impact our operating results or financial position. Our credit risk management policies and practices may not adequately identify significant risks. As described in Part I, Item 1, “Risk Management” in this Form 10-K, we have established risk management policies and practices which seek to mitigate our exposure to credit risk in our insured portfolio. Ongoing surveillance of credit risks in our insured portfolio is an important component of our risk management process. These policies and practices in the past have not insulated us from risks that were unforeseen and which had unanticipated loss severity, and such policies and practices may not do so in the future. There can be no assurance that these policies and practices will be adequate to avoid future losses. If we are not able to identify significant risks, we may not be able to timely mitigate such risks, thereby increasing the amount of losses to which we are exposed. An inability to identify significant risks could also result in the failure to establish loss reserves that are sufficient in relation to such risks. We use analytical models and tools to assist our projection of performance of our insured FG obligations and our investment portfolio but actual results could differ materially from the model and tool outputs and related analyses. We rely on internally and externally developed complex financial models, including default models related to RMBS and a waterfall tool provided by a nationally recognized vendor for RMBS and student loan exposures, to project performance of our insured FG obligations and similar securities in our investment portfolio. These models and tools assume various conditions, probability scenarios, facts and circumstances, and there can be no assurance that such models or tools accurately predict or measure the quantum of losses, loss reserves and timing of losses. Differences in the models and tools that we employ, uncertainties or flaws in these financial models and tools, or faulty assumptions inherent in these financial models and tools or those determined by management could lead to material changes in projected outcomes, and could include increased losses, loss reserves and/or credit impairments on the investment portfolio. Moreover, estimates of transaction performance depend in part on the interpretation of contracts and other bases of our legal rights. Such interpretations may prove to be incorrect or different interpretations may be employed by bond trustees and other transaction participants and, ultimately courts, which could lead to increased losses, loss reserves and/or investment impairments. Political developments may materially adversely affect our insured portfolio. Our insured exposures and our results of operations can be materially affected by political developments at the federal, state and/or local government levels. Government shutdowns, trade disputes, political turnover, judicial decisions, adverse changes in federal funding, or poor public policy decision making could disrupt the national and local economies where we have insured exposures. In addition, we are exposed to correlation risk as a result of the possibility that multiple credits may concurrently and/or consecutively experience losses or increased stress as a result of any such event or series of events. Risks Related to Capital, Liquidity and Markets Our inability to realize the expected recoveries included in our financial statements could adversely impact our liquidity, financial condition and results of operations and the value of our securities, including the Sitka Senior Secured Notes and Tier 2 Notes. AAC is pursuing claims in litigation with respect to certain RMBS transactions that it insured. These claims are based on, among other things, representations with respect to the characteristics of the securitized loans, the absence of borrower misrepresentations in the underlying loan pools or other misconduct in the origination process, the compliance of loans with the prevailing underwriting policies, and compliance of the RMBS transaction counterparties with policies and procedures related to loan origination and securitization. In such cases, where contract claims are being pursued, the sponsor of the transaction is obligated to repurchase, cure or substitute | Ambac Financial Group, Inc. 16 2021 FORM 10-K | Table of Contents collateral for any loan that breaches the representations and warranties, subject to the terms and conditions of the applicable contracts. However, generally the sponsors have not honored those obligations and have vigorously defended claims brought against them. As of December 31, 2021, we have estimated RMBS R&W subrogation recoveries of $1,704 (net of reinsurance) included in our financial statements. These estimated recoveries are based on the contractual claims brought in the aforementioned litigations and represent a probability-weighted estimate of amounts we expect to recover under various possible scenarios. The estimated recoveries we have recorded do not represent the best or the worst possible outcomes with respect to any particular transaction or group of transactions. There can be no assurance that AAC will be successful in prosecuting its claims in the RMBS litigations. The outcome of any litigation, including the RMBS litigations, is inherently unpredictable, including because of risks intrinsic in the adversarial nature of litigation. Motions made to the court, rulings and appeals - in the cases being prosecuted by AAC or in other relevant cases - could delay or otherwise impact any recovery by AAC. Moreover, rulings that may be adverse to AAC (in any of its RMBS litigations, as well as in other RMBS cases in which it is not a party, including an unrelated RMBS case with an appeal argued on February 8, 2022 at the New York Court of Appeals (decision pending) involving issues relevant to AAC’s breach of contract claims, which could affect one of the bases supporting the inclusion of all breaching loans in AAC's breach-of-contract cases) could adversely affect AAC’s ability to pursue its claims, or the amount or timing of any recovery, or negatively alter settlement dynamics with RMBS litigation defendants. Due to the foregoing factors, any litigation award or settlement may be for an amount less than the amount necessary (even when combined with other pledged collateral) to pay the Sitka Senior Secured Notes or the Tier 2 Notes, which could have a material adverse effect on our financial condition or results of operations. Such an award or settlement would also impair AAC’s ability to repay its outstanding surplus notes, on a timely basis or at all. In the event that AAC is unable to satisfy its obligations with respect to the Sitka Senior Secured Notes or the Tier 2 Notes, holders will have the right to foreclose on any available collateral and to sue AAC for failure to make required payments; however, there can be no assurance that the sale of collateral will produce proceeds in an amount sufficient to pay any or all amounts due on the Sitka Senior Secured Notes or the Tier 2 Notes, as the case may be, or that holders will be successful in any litigation seeking payments from AAC. Even if AAC were to recover the estimated RMBS R&W subrogation recoveries of $1,704 (net of reinsurance) included in our financial statements and pay off or cause to be paid off the Sitka Senior Secured Notes and the Tier 2 Notes, AAC may still be unable to deliver value to AFG, through dividends or otherwise. In such a scenario, AAC may not have sufficient capital and surplus, or may not be permitted by OCI, to pay off its surplus notes or a substantial portion of them, whether immediately following the resolution of the RMBS litigations or within a reasonable timeframe thereafter. If the surplus notes or a substantial portion of them were to remain outstanding for a significant period of time after the resolution of the RMBS litigations, AAC's obligation to pay interest on the surplus notes would continue to grow, which would diminish AAC's financial flexibility and reduce the likelihood that AAC will be able to pay dividends or otherwise bring value to AFG. Additionally, while AAC may pursue settlement negotiations, there can be no assurance that any settlement negotiations will materialize or that any settlement agreement can be reached on terms acceptable to AAC, or at all. Depending on the length of time required to resolve these litigations, either through settlement or at trial, AAC could incur greater litigation expenses than currently projected. If a case is brought to trial, AAC’s ultimate recovery would be subject to the additional risks inherent in any trial, including adverse findings or determinations by the trier of fact or the court, which could materially adversely impact the value of our securities, including the Sitka Senior Secured Notes and the Tier 2 Notes. Any litigation award is subject to risks of recovery, including that a defendant is unable to pay a judgment that AAC may obtain in litigation. In some instances, AAC also has claims against a parent or an acquirer of the counterparty. However, AAC may not be successful in enforcing its claims against any successor entity. The RMBS litigations could also be adversely affected if AAC does not have sufficient resources to actively prosecute its claims or becomes subject to rehabilitation, liquidation, conservation or dissolution, or otherwise impaired by actions of OCI. Our ability to realize the estimated RMBS R&W subrogation recoveries included in our financial statements and the timing of the recoveries, if any, is subject to significant uncertainty, including the risks described above and uncertainties inherent in the assumptions used in estimating such recoveries. The amount of these subrogation recoveries is significant and if we were unable to recover all such amounts, our stockholders’ equity as of December 31, 2021, would decrease from $1,098 to $(606). We expect to recover material amounts of claims payments through remediation measures, including the litigation described above, as well as through cash flows in the securitization structures of transactions that AAC insures. Realization of such expected recoveries is subject to various risks and uncertainties, including the rights and defenses of other parties with interests that conflict with AAC’s interests, the performance of the collateral and assets backing the obligations that AAC insures, and the performance of servicers involved in securitizations in which AAC participates as insurer. Additionally, our ability to realize recoveries in insured transactions may be impaired if the continuing orders of the Rehabilitation Court are not effective. Adverse developments with respect to any of the factors described above may cause our recoveries to fall below expectations, which could have a material adverse effect on our financial condition, including our capital and liquidity, and may result in adverse consequences such as impairing the ability of AAC to honor its financial obligations, particularly its outstanding debt and preferred stock obligations; the initiation of rehabilitation proceedings against AAC; eliminating or reducing the possibility of AAC delivering value to AFG, through | Ambac Financial Group, Inc. 17 2021 FORM 10-K | Table of Contents dividends or otherwise; diminished business prospects due to third party concerns about our ability to recover losses; and a significant drop in the value of securities issued or insured by AFG or AAC, including the Sitka Senior Secured Notes and the Tier 2 Notes. Ambac’s estimate of RMBS litigation recoveries is subject to significant uncertainty and changes to the estimate could adversely impact its liquidity, financial condition and results of operations. For Ambac’s RMBS cases for which it records an RMBS R&W subrogation recovery in its financial statements, Ambac has obtained loan files from the relevant original pool and has conducted loan file re-underwriting to derive a breach rate that is extrapolated to estimate the damages Ambac expects to recover. Ambac does not estimate an RMBS R&W subrogation recovery for litigations where its sole claim is for fraudulent inducement. Nor does Ambac include potential recoveries attributable to pre-judgment interest in the estimate of subrogation recoveries. The amount estimated for purposes of Ambac’s RMBS R&W subrogation recovery and the amount Ambac may ultimately receive is subject to significant uncertainty, as described in the immediately preceding risk factor. Ambac’s findings and assumptions regarding collateral performance and Ambac’s expectations with respect to the outcome of the RMBS litigations and related timing have a significant impact on Ambac’s estimated RMBS R&W subrogation recovery. If these findings, assumptions or estimates prove to be incorrect or otherwise do not support our claims, actual recoveries could differ materially from those estimated. Although Ambac believes that its methodology for estimating recoveries is appropriate, the methodologies Ambac uses to estimate expected collateral losses and specific transaction performance may not be similar to methodologies used by Ambac’s competitors, counterparties or other market participants. The determination of expected RMBS R&W subrogation recoveries is an inherently subjective and complex process involving numerous estimates and assumptions and judgments by management, using both internal and external data sources to derive a specific transaction's cash flows. Ambac reevaluates its estimated R&W recoveries on a quarterly basis in connection with the preparation of its financial statements. See “Critical Accounting Policies and Estimates” in Part II, Item 7, Note 2. Basis of Presentation and Significant Accounting Policies and Note 7. Insurance Contracts to the Consolidated Financial Statements included in Part II, Item 8 of this Form 10-K for the fiscal year ended December 31, 2021. As a result of any reevaluation, the estimated amount of Ambac’s R&W recovery may be adjusted downward due to, among other things, changes in law or developments in RMBS litigation cases that impact our estimated recoveries, changes in management's view of such estimated recoveries or timing of receipt thereof and/or changes in the loss reserves related to such recoveries, and any adjustment may be material. A reduction in estimated R&W recoveries may result in material changes in Ambac’s financial condition, including its capital and liquidity. Management makes no representation that the estimated R&W recoveries will not be reduced in the future, possibly materially, including in the near term. As a result of the foregoing factors, Ambac’s current estimates may not reflect Ambac’s ultimate recovery, and management makes no representation that the actual amounts recovered, if any, will not differ materially from those estimated. The failure of Ambac’s actual recoveries to meet or exceed its current estimates could result in a material adverse effect on Ambac’s financial condition, including its capital and liquidity. AAC's ability to generate the significant amount of cash needed to service its debt and financial obligations and its ability to refinance all or a portion of its indebtedness or obtain additional financing depends on many factors beyond our control. AAC is highly leveraged. AAC’s ability to make payments on and/or refinance its debt and to fund its operations will depend on its ability to generate substantial operating cash flow and on the performance of the FG insured portfolio. AAC’s cash flow generation will depend on receipt of premiums, investment returns, receipts from subsidiaries and expected litigation recoveries, offset by policyholder claims, commutation payments, reinsurance premiums, operating and loss adjustment expenses, and interest expense, which will be subject to prevailing economic conditions and to financial, business and other factors, many of which are beyond our control and many of which are event-driven. There is substantial risk that AAC may not have the financial resources necessary to pay its debts in full and on time due to risks associated with its cash flow, expected litigation recoveries and insured portfolio, as discussed elsewhere in these Risk Factors. As of December 31, 2021, AAC had approximately $1,508 of indebtedness outstanding (the Tier 2 Notes and the Sitka AAC Note) that are senior to its surplus notes. AAC had $853 principal balance of surplus notes outstanding as of December 31, 2021. The Tier 2 Notes and the Sitka AAC Note are secured by potential litigation recoveries (and in the case of the Sitka AAC Note, other assets), the receipt of which is highly uncertain. Failure to achieve litigation recoveries in an amount sufficient to repay the Tier 2 Notes and the Sitka AAC Note would materially weaken AAC’s ability to service its indebtedness. If AAC cannot pay its policyholders’ claims or service its debt, it will have to take actions such as selling assets, restructuring or refinancing its debt or seeking additional capital. Any of these remedies may not, if necessary, be effected on commercially reasonable terms, or at all. The value of assets to be sold, including collateral for the Sitka AAC Note and the Tier 2 Notes in the event of liquidation, will depend on market and economic conditions, the availability of buyers, the requirements and conditions of local law, including regulatory restrictions, and other factors that may result in AAC or a party enforcing rights against AAC to be unable to receive proceeds sufficient to discharge debts or other obligations. Furthermore, the ability of creditors or claimants to realize upon any assets, including collateral, may also be subject to bankruptcy and insolvency law limitations or similar limitations applicable in insurance company rehabilitation or liquidation proceedings. Because of these and other factors beyond our control, AAC may be unable to pay or discharge the principal, interest or other amounts on its indebtedness when due or ever, which may precipitate defaults, rehabilitation proceedings, increased supervision by OCI, enforcement actions by creditors, policyholders and/or other claimants, and other actions by or against AAC or AFG that may | Ambac Financial Group, Inc. 18 2021 FORM 10-K | Table of Contents further impair AAC's creditworthiness and value or the creditworthiness and value of AFG. AAC has substantial indebtedness, which could adversely affect our financial condition, operational flexibility and our ability to obtain financing in the future. AAC's substantial indebtedness could have significant consequences for our financial condition and operational flexibility. For example, it could: • increase our vulnerability to general adverse economic, competitive and industry conditions; • limit our ability to obtain additional financing in the future for working capital, capital expenditures, payment of policyholder claims, debt service requirements, acquisitions, general corporate purposes or other purposes on satisfactory terms or at all; • require AAC to dedicate a substantial portion of its cash flow from operations to the payment of indebtedness, thereby reducing the funds available for operations and to fund the execution of key strategies; • limit or restrict AFG from making strategic acquisitions or cause us to make non-strategic divestitures; • limit AAC's ability or increase the costs to refinance indebtedness or repay such indebtedness due to ongoing interest accretion; • limit our ability to attract and retain key employees; and • limit our ability to enter into hedging transactions by reducing the number of counterparties with whom we can enter into such transactions, as well as the volume of those transactions. Despite current indebtedness levels, we may incur additional debt. While restrictive covenants in certain of our contracts may limit the amount of additional indebtedness AAC may incur, we may obtain waivers of those restrictions and incur additional indebtedness in the future. In addition, if Ambac incurred indebtedness, its ability to make scheduled payments on, or refinance, any such indebtedness may depend on the ability of our subsidiaries to make distributions or pay dividends, which in turn will depend on their future operating performance and contractual, legal and regulatory restrictions on the payment of distributions or dividends to which they may be subject. There can be no assurance that any such dividends or distributions would be made. This could further exacerbate the risks associated with AAC's substantial leverage. Revenues and cash flow would be adversely impacted by a decline in realization of installment premiums. A significant percentage of our FG premium revenue is attributable to installment premiums. The amount of installment premiums we actually realize could be reduced in the future due to factors such as early termination of insurance contracts, accelerated prepayments of underlying obligations or insufficiency of cash flows (by the premium paying entity). Such reductions would result in lower revenues. The composition of the securities in our investment portfolio exposes us to greater risk than before we invested in alternative assets. Each of AAC and Ambac UK maintains a portion of its investment portfolio in below investment grade securities, equities and/or alternative assets, such as hedge funds, with the objective to increase risk-adjusted portfolio returns. Investments in below investment grade securities, equities and alternative assets could expose AAC and/or Ambac UK to greater earnings volatility, increased losses and decreased liquidity in the investment portfolio. We may have future capital needs and may not be able to obtain third-party financing or raise additional third-party capital on acceptable terms, or at all. An inability to obtain third-party debt financing or raise additional third-party capital, when required by us or when business conditions warrant, could have a material adverse effect on our business, financial condition and results of operations. Our financial condition, the risks described elsewhere in Part I, Item 1A of this Form 10-K for the fiscal year ended December 31, 2021, as well as other factors, may constrain our financing abilities. Our ability to secure third-party financing will depend upon our future operating performance, regulatory conditions, the availability of credit generally, economic conditions and financial, business and other factors, many of which are beyond our control. The market conditions and the macroeconomic conditions that affect our business could have a material adverse effect on our ability to secure third-party financing on favorable terms, if at all. If third-party financing is not available when needed, or is available on unfavorable terms, we may be unable to take advantage of business opportunities, respond to competitive pressures or effectively and efficiently manage our balance sheet, any of which could have a material adverse effect on our business, financial condition and results of operations. The determination of the amount of credit impairments taken on our investments is highly subjective and could materially impact our results of operations or financial position. The determination of the amount of credit impairments on our investments varies by investment type and is based upon our periodic evaluation and assessment of known and inherent risks associated with the respective asset class. Such evaluations and assessments are revised as conditions change and new information becomes available. Management updates its evaluations regularly and reflects changes in impairments as such evaluations are revised. There can be no assurance that management has accurately assessed the level of impairments taken in our financial statements. Furthermore, additional impairments may need to be taken in the future and historical trends may not be indicative of future impairments. We use financial models and tools to project impairments. Differences and flaws in these models and tools, and/or faulty assumptions inherent in these models and tools and those determined by management, could lead to increased impairments. | Ambac Financial Group, Inc. 19 2021 FORM 10-K | Table of Contents Risks Related to the Financial and Credit Markets Changes in prevailing interest rate levels and market conditions could adversely impact our business results and prospects. Increases in prevailing interest rate levels can adversely affect the value of our investment portfolio and, therefore, our financial strength. In the event that investments must be sold in order to pay claims, to pay debt obligations, to meet collateral posting requirements or to meet other liquidity needs, such investments would likely be sold at discounted prices. Additionally, increasing interest rates would have an adverse impact on AAC's insured portfolio. For example, increasing interest rates could result in higher claim payments in respect of defaulted obligations that bear floating rates of interest. Higher interest rates can also lead to increased credit stress on consumer asset-backed transactions (as the securitized assets supporting a portion of these exposures are floating rate consumer obligations), slower prepayment speeds and resulting “extension risk” relative to such consumer asset-backed transactions in our insured and investment portfolios, and decreased refinancing activity. Decreasing interest rates could result in early terminations of FG insurance policies in respect of which AAC and Ambac UK are paid on an installment basis and do not receive a termination premium, thus reducing premium earned for these transactions. Decreases in prevailing interest rates may also limit growth of, or reduce, investment income and may adversely impact interest rate swap values. Our investment portfolio may also be adversely affected by credit rating downgrades, ABS and RMBS prepayment speeds, foreign exchange movements, spread volatility, and credit losses. We are subject to credit risk throughout our FG businesses, including large single risks, risk concentrations, correlated risks and reinsurance counterparty credit risk. We are exposed to the risk that issuers of debt which AAC and Ambac UK have insured, issuers of debt which we hold in our investment portfolios, reinsurers and other contract counterparties of AAC and Ambac UK (including derivative counterparties) may default in their financial obligations, whether as the result of insolvency, lack of liquidity, operational failure, fraud or other reasons. These credit risks could cause increased losses and loss reserves, and/or estimates of credit impairments and mark-to-market losses, in amongst other places, our investment portfolios which materially adversely impact our results of operations and financial strength. Such credit risks may be in the form of large single risk exposures to particular issuers, reinsurers, counterparties or sectors; losses caused by catastrophic events (including public health crises, terrorist acts and natural disasters); losses in respect of different, but correlated, credit exposures; or other forms of credit risk. The amount of interest payable on the Sitka Senior Secured Notes is set once per quarter based on the three-month LIBOR rate (or an Alternative Reference Rate as applicable) on the applicable interest determination date, which rate may fluctuate substantially; increases in interest rates will increase the cost of servicing our debt reducing our profitability and our ability to service our debt. The Sitka Senior Secured Notes will bear interest at floating rates that could rise significantly, increasing AAC’s interest expense and reducing its cash flow and profitability. Each one percentage point increase in interest rates above the 75 basis point LIBOR (or Alternative Reference Rate as applicable) floor would result in a $12 increase in the annual cash interest payments due on the Sitka Senior Secured Notes. If AAC’s interest expense increases significantly, whether due to changes in LIBOR (or Alternative Reference Rate as applicable) or increased borrowing costs if it refinances its current indebtedness, AAC may not be able to make payments with respect to the Sitka Senior Secured Notes or its other indebtedness. Uncertainties regarding the expected discontinuance of the London Inter-Bank Offered Rate or any other interest rate benchmark could have adverse consequences. In 2017, the U.K. Financial Conduct Authority (“FCA”), which regulates the London Interbank Offered Rate ("LIBOR"), announced that it will no longer persuade or compel banks to submit rates for the calculation of LIBOR after 2021. On November 30, 2020, the ICE Benchmark Administration and the FCA announced that most tenors of USD LIBOR are expected to be published only through June 2023. However, Non-USD LIBOR, certain less common tenors of USD-LIBOR and certain other indices which are utilized as benchmarks ceased to be published at the end of 2021. In October 2021 noteholders of obligations insured by Ambac UK consented to the replacement of GBP LIBOR references with compounded SONIA plus a credit adjustment spread effective on the first interest payment date in 2022. AAC and Ambac UK therefore no longer insure any obligations linked to Non-USD LIBOR. AAC and/or Ambac UK insure securities, own assets, are party to certain derivative contracts and have issued debt and other obligations that reference USD LIBOR. In 2021, New York State passed legislation addressing the cessation of U.S. Dollar (“USD”) LIBOR and specified a recommended benchmark replacement based on the Secured Overnight Financing Rate (“SOFR”) for certain legacy transactions. Similar federal legislation is pending and has already been passed by the House of Representatives. The Alternative Rates Committee, the Federal Reserve Board and several industry associations and groups have expressed support for the New York law and are encouraging Federal legislation. While Ambac believes the New York LIBOR law and pending federal legislation are generally positive steps, there remains significant uncertainty about whether the federal legislation will be enacted and how such laws will be interpreted or challenged as well as about other aspects of the discontinuance of LIBOR, including the impact of the Federal legislation, if passed. | Ambac Financial Group, Inc. 20 2021 FORM 10-K | Table of Contents While regulators and market participants continue to promote the creation and functioning of post-LIBOR indices (SOFR in particular), the impact of the discontinuance and replacement of LIBOR is uncertain. It is not currently possible to know with certainty what rate or rates may become accepted alternatives to LIBOR, or what the effect of any such changes in views and alternatives may have on the financial markets for LIBOR-linked financial instruments for the periods preceding and following LIBOR's cessation. Differences in contractual provisions of certain legacy assets and liabilities and other factors may cause the consequences of the discontinuance of LIBOR to vary by instrument. While enacted and pending legislation is intended to address issues with respect to legacy LIBOR-linked assets and liabilities, it is unclear whether they will completely address the issues associated with legacy transactions. Nevertheless, the value of our assets, derivatives and liabilities; costs to operate our business; and the losses associated with our insured portfolio may be affected in a way that may ultimately materially adversely impact Ambac’s results of operations and financial condition. In addition, Ambac may experience adverse tax and accounting impacts, system and model disruption, and increased liquidity demands in connection with the transition away from LIBOR that may have adverse operational consequences resulting in further adverse impacts on Ambac’s results of operations and financial condition. Ambac continues to actively monitor developments surrounding the transition from LIBOR-based indices and evaluate the potential impact. In addition to reviewing several hundred transactions involving various LIBOR-based indices, Ambac has made, and is in the process of making, adjustments to its reporting and analytical infrastructures to facilitate the transition from LIBOR. Risks Related to the Company's Business Everspan may not be successful in executing its business plans or may experience greater than expected insurance underwriting losses and/or reinsurance counterparty losses, which could result in losses material to Everspan's capital position, a downgrade of its AM Best rating and a loss of its franchise value. Such events could have a material adverse impact on the value of AFG's shares. Everspan is in the nascent stage of the specialty insurance program business. Its business plans entails establishing programs with managing general agents ("MGAs") and managing general underwriters ("MGUs") over time. The success of these programs is dependent upon the quality of business sourced by the MGAs and MGUs, the quality of underwriting oversight of the MGAs and MGUs by Everspan, the quality and creditworthiness of reinsurance obtained with respect to the risks underwritten by Everspan, loss experience over time, premium levels, competition and other factors, some of which are outside Everspan's control. Should Everspan fail in executing its business plans or experience greater than expected losses due to shortcomings in the management of programs, Everspan's underwriting of risks, the performance of reinsurers or other factors, Everspan may suffer losses that are material to its capital position, a downgrade in its AM Best rating and/or a loss of its franchise value. Any such outcomes could have a material adverse impact on the value of AFG's shares. Failure of Everspan's Program Partners or Xchange to properly market, underwrite or administer policies could adversely affect us. The marketing, underwriting, claims administration and administration of policies in our Specialty Property & Casualty Program Insurance and Managing General Agency/Underwriting businesses have been contracted to Everspan's program partners and our owned MGU, Xchange. Any failure by them to properly handle these functions could result in liability to us. Even though Everspan's program partners may be required to compensate us for any such liability, there are risks that such compensation may be insufficient or entirely unavailable if, for example, the relevant program partner becomes insolvent or is otherwise unable to pay us. Any such failures could result in monetary losses, create regulatory issues or harm our reputation, which could materially and adversely affect our business, financial condition and results of operations. A downgrade in the AM Best financial strength ratings of our specialty program property and casualty insurance company subsidiaries may negatively affect our business. Our specialty program property and casualty insurance company subsidiaries are evaluated for overall financial strength by AM Best to receive financial strength ratings ("FSRs"), which are an important factor in establishing the competitive position of insurance companies. These FSRs reflect AM Best’s opinion of our specialty program property and casualty insurance company subsidiaries’ financial strength, operating performance, strategic position and ability to meet obligations to policyholders, and are not evaluations directed to investors. Our specialty program property and casualty insurance company subsidiaries’ FSRs are subject to periodic review, and the criteria used in the rating methodologies are subject to change. All of our insurance company subsidiaries of Everspan currently writing business are rated "A-" (Excellent). A downgrade in Everspan's FSR could lead to Everspan's program partners moving business to other insurance companies, which would adversely affect our business, financial condition and results of operations. If in our Specialty Program Property and Casualty Insurance business we are unable to accurately underwrite risks and charge competitive yet profitable rates to our clients and policyholders, our business, financial condition and results of operations may be adversely affected. In general, the premiums for our specialty program property and casualty insurance policies are established at the time a policy is issued and, therefore, before all of our underlying costs are known. Like other property and casualty insurance companies, Everspan relies on estimates and assumptions in setting its premium rates. Establishing adequate premium rates is necessary, together with investment income, to generate sufficient revenue to offset losses, loss adjustment expenses and other general and administrative expenses in order to earn a profit. If Everspan does not accurately assess the risks that it assumes, it may not charge adequate premiums to cover its | Ambac Financial Group, Inc. 21 2021 FORM 10-K | Table of Contents losses and expenses, which would adversely affect our results of operations and our profitability. Alternatively, Everspan could set its premiums too high, which could reduce its competitiveness and lead to lower policyholder retention, resulting in lower revenues. Pricing is a highly complex exercise involving the acquisition and analysis of historical loss data and the projection of future trends, loss costs and expenses, and inflation trends, among other factors, for each of Everspan's products in multiple risk tiers and many different markets. Everspan seeks to implement its pricing accurately in accordance with its assumptions. Everspan's ability to undertake these efforts successfully and, as a result, to accurately price its policies, is subject to a number of risks and uncertainties, including insufficient or unreliable data; incorrect or incomplete analysis of available data; uncertainties generally inherent in estimates and assumptions; failure to implement appropriate actuarial projections and ratings formulas or other pricing methodologies; regulatory constraints on rate increases; failure to accurately estimate investment yields and the duration of liabilities for losses and loss adjustment expenses; and unanticipated court decisions, legislation or regulatory action. If Everspan is unable to obtain reinsurance coverage at reasonable prices or on terms that adequately protect it, we may be required to bear increased risks or reduce the level of our underwriting commitments. Our specialty program property and casualty insurance company subsidiaries purchase reinsurance as part of our overall risk management strategy. While reinsurance does not discharge our insurance subsidiaries from their obligations to pay claims for losses insured under their insurance policies, it does make the reinsurer liable to them for the reinsured portion of the risk. As part of our strategy for our specialty program property and casualty business, we reinsure underwriting risk to third-party reinsurers. At the inception of a new program, Everspan acts as an issuing carrier and reinsures a majority of such risk to third parties. Everspan may be unable to maintain its current reinsurance arrangements or to obtain other reinsurance in adequate amounts and at favorable rates, particularly if reinsurers become unwilling or unable to support our specialty program property and casualty business in the future. Additionally, market conditions beyond our control may impact the availability and cost of reinsurance and could have an adverse effect on our business, financial condition and results of operations. A decline in the availability of reinsurance may increase the cost of reinsurance and materially and adversely affect our business prospects. Everspan may, at certain times, be forced to incur additional costs for reinsurance or may be unable to obtain sufficient reinsurance on acceptable terms. In the latter case, Everspan would have to accept an increase in exposure to risk, reduce the amount of business written by it or seek alternatives in line with Everspan's risk limits, all of which could adversely affect our business, financial condition and results of operations. Everspan is subject to reinsurance counterparty credit risk. Its reinsurers may not pay on losses in a timely fashion, or at all. Everspan purchases reinsurance to transfer part of the risk it has assumed to reinsurance companies in exchange for part of the premium Everspan receives in connection with the risk. Although reinsurance makes reinsurers liable to Everspan for the risk transferred or ceded to the reinsurer, it does not relieve Everspan of its liability to policyholders. Accordingly, Everspan is exposed to credit risk with respect to its reinsurers, especially to the extent reinsurance receivables are not sufficiently secured by collateral or do not benefit from other credit enhancements. Everspan also bears the risk that a reinsurer may be unwilling to pay amounts it has recorded as reinsurance recoverable for any reason, including that the terms of the reinsurance contract do not reflect the intent of the parties of the contract or there is a disagreement between the parties as to their intent; the terms of the contract cannot be legally enforced; the terms of the contract are interpreted by a court or arbitration panel differently than intended by Everspan; the reinsurance transaction performs differently than Everspan anticipated due to a flawed design of the reinsurance structure, terms or conditions; or changes in law and regulation, or in the interpretation of laws and regulations, affects a reinsurance transaction. The insolvency of one or more of Everspan's reinsurers, or their inability or unwillingness to make timely payments if and when required under the terms of reinsurance contracts, could adversely affect our business, financial condition and results of operations. Our ability to grow our Specialty Program Property and Casualty Insurance Business will depend in part on the addition of new Program Partners, and our inability to effectively onboard such new Program Partners could have an adverse effect on our business, financial condition and results of operations. Our ability to grow our specialty program property and casualty insurance business will depend in part on the addition of new program partners. If Everspan does not effectively onboard new program partners, including assisting such program partners to quickly resolve any post-onboarding matters and provide effective ongoing support, Everspan's ability to add new program partners and its relationships with its existing program partners could be adversely affected. Additionally, Everspan's reputation with potential new customers could be damaged if it fails to meet the requirements of its customers as a result of its failure to effectively onboard new program partners. Such reputational damage could make it more difficult for Everspan to attract new and retain existing program partners, which could have an adverse effect on our business, financial condition and results of operations. We compete with a large number of companies in the property and casualty insurance industry for underwriting premium. We compete with a large number of companies in the property and casualty insurance industry for underwriting premium. During periods of intense competition for premium, in particular, our specialty program property and casualty insurance and managing general agency / underwriting businesses may be challenged to maintain competitiveness with other companies that may seek to write policies without the same regard for risk and profitability targeted by our specialty program property and casualty insurance and managing general agency / underwriting businesses. During these times, it may be difficult for Everspan or our MGAs and MGUs to grow or | Ambac Financial Group, Inc. 22 2021 FORM 10-K | Table of Contents maintain premium volume without lowering underwriting standards, sacrificing income, or both. In addition, our specialty program property and casualty insurance and managing general agency / underwriting businesses face competition from a wide range of specialty insurance companies, underwriting agencies and intermediaries, as well as diversified financial services companies that are significantly larger than our specialty program property and casualty insurance and managing general agency/underwriting businesses are and that have significantly greater financial, marketing, management and other resources. Some of these competitors also have greater market recognition than we do. The greater resources or market presence that these competitors possess may enable them to avoid or defray particular costs, employ greater pricing flexibility, have a higher tolerance for risk or loss, or exploit other advantages that may make it more difficult for us to compete. We may incur increased costs in competing for underwriting revenues in this environment. If we are unable to compete effectively in the markets in which our specialty program property and casualty insurance and managing general agency/underwriting businesses operate or expand into, our underwriting revenues may decline, as well as overall business results. System security risks, data protection breaches and cyber-attacks could adversely affect our business and results of operations. We rely on our information technology systems for many enterprise-critical functions and a prolonged failure or interruption of these systems for any reason could cause significant disruption to our operations and have a material adverse effect on our business, financial condition and operating results. Our information technology and application systems may be vulnerable to threats from computer viruses, natural disasters, unauthorized access, cyber-attack and other similar disruptions. Computer hackers may be able to penetrate our network’s system security and misappropriate or compromise confidential information, create system disruptions or cause shutdowns. In addition to our own confidential information, we sometimes receive and are required to protect confidential information obtained from third parties and personally identifiable information of individuals. To the extent any disruption or security breach results in a loss or damage to our data, or inappropriate disclosure of our confidential information or that of others, or personally identifiable information of individuals, it could cause significant financial losses that are either not, or not fully, insured against, cause damage to our reputation, affect our relationships with third parties, lead to claims against us, result in regulatory action, or otherwise have a material adverse effect on our business or results of operations. In addition, we may be required to incur significant costs to mitigate the damage caused by any security breach, or to protect against future damage. Moreover, although we have incident response, disaster recovery and business continuity plans in place, we may not be able to adequately execute these plans in a timely fashion in the event of a disruption to our information technology and application systems. We may be adversely affected by failures in services or products provided by third parties. We outsource and may further outsource certain technology and business process functions, and rely upon third-party vendors for other essential services and information, such as the provision of data used in setting loss reserves. If we do not effectively develop, implement and monitor our vendor relationships, if third party providers do not perform as anticipated, if we experience technological or other problems with a transition, or if vendor relationships relevant to our business process functions are terminated, we may not realize expected productivity improvements or cost efficiencies and may experience operational difficulties, increased costs and a loss of business . A material failure by an external service or information provider or a material defect in the products, services or information provided thereby could adversely affect our financial condition and results of operations. Our outsourcing of certain technology and business process functions to third parties may expose us to increased risk related to data security, service disruptions or the effectiveness of our control system. These risks could increase as vendors increasingly offer cloud-based software services rather than software services which can be run within our data centers or as we choose to move additional functions to the cloud. Our inability to attract and retain qualified executives, senior managers and other employees or the loss of any of these personnel could negatively impact our business. Our ability to execute on our business strategies depends on the retention and recruitment of qualified executives and other professionals. We rely substantially upon the services of our current executive and senior management teams. In addition to these officers, we rely on key staff with insurance, underwriting, business development, credit, risk mitigation, structured finance, investment, accounting, finance, legal, technology and other technical and specialized skills. As a result of AAC’s financial situation, there is a higher risk that executive officers and other key staff will leave the Company and replacements may not be motivated to join the Company. The loss of the services of members of our executive or senior management teams or our inability to hire and retain other talented personnel could delay or prevent us from succeeding in executing our strategies, which could further negatively impact our business. We are subject to the risk of litigation and regulatory inquiries or investigations, and the outcome of proceedings we are or may become involved in could have a material adverse effect on our business, operations, financial position, profitability or cash flows. AAC is defending or otherwise involved in various lawsuits relating to its FG business. In addition, the Company from time to time receives various regulatory inquiries and requests for information, and its insurance company subsidiaries are subject to examination by regulatory authorities. Please see Note 19. Commitments and Contingencies to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K for information on these various proceedings. It is not possible to predict the extent to which whether additional suits involving AFG, AAC or one or more other subsidiaries will be filed or the extent to which additional | Ambac Financial Group, Inc. 23 2021 FORM 10-K | Table of Contents regulatory inquiries or requests for information will be made, and it is also not possible to predict the outcome of litigation, inquiries, requests for information or examination. It is possible that there could be unfavorable outcomes in these or other proceedings. Management is unable to make a meaningful estimate of the amount or range of loss that could result from unfavorable outcomes or of the expenses that will be incurred in connection with such lawsuits or regulatory matters. Under some circumstances, adverse results in any such proceedings and/or the incurring of significant litigation or other expenses could be material to our business, operations, financial position, profitability or cash flows. Our business could be negatively affected by actions of stakeholders whose interests may not be aligned with the broader interests of our stockholders. Ambac could be negatively affected as a result of actions by stakeholders whose interests may not be aligned with the broader interests of our stockholders, and responding to any such actions could be costly and time-consuming, disrupt operations and divert the attention of management and employees. Such activities could interfere with our ability to execute on our strategic plans. The Settlement Agreement, Stipulation and Order and Indenture for the Tier 2 Notes contain restrictive covenants that may impair AAC's ability to pursue its business strategies. Pursuant to the terms of the Settlement Agreement, Stipulation and Order and indenture for the Tier 2 Notes, AAC must seek prior approval by OCI of certain corporate actions. The Settlement Agreement, Stipulation and Order and indenture for the Tier 2 Notes also include covenants which restrict the operations of AAC which, (i) in the case of the Settlement Agreement, remain in force until the surplus notes that were issued pursuant to the Settlement Agreement have been redeemed, repurchased or repaid in full, (ii) in the case of the Stipulation and Order, remain in place until the OCI decides to relax such restrictions, and (iii) in the case of the indenture for the Tier 2 Notes, remain in force until the Tier 2 Notes have been redeemed, repurchased or repaid in full. Certain of these restrictions may be waived with the approval of holders of the applicable debt securities and/or OCI. If we are unable to obtain the required consents under the Settlement Agreement, the Stipulation and Order and/or the indenture for the Tier 2 Notes, AAC may not be able to execute its planned business strategies. OCI has certain enforcement rights with respect to the Settlement Agreement and Stipulation and Order. Disputes may arise over the interpretation of such agreements, the exercise or purported exercise of rights thereunder, or the performance of or failure or purported failure to perform obligations thereunder. Any such dispute could have material adverse effects on AAC, and the Company more broadly, whether through litigation, administrative proceedings, supervisory orders, failure to execute transactions sought by management, interference with corporate strategies, objectives or prerogatives, inefficient decision-making or execution, forced realignment of resources, increased costs, distractions to management, strained working relationships or otherwise. Such effects would also increase the risk that OCI would seek to initiate rehabilitation proceedings or issue supervisory orders against AAC. Actions of the PRA and FCA could reduce the value of Ambac UK realizable by AAC, which would adversely affect our securityholders. Ambac’s international business is operated by Ambac UK, which is regulated by the Prudential Regulation Authority (“PRA”) for prudential purposes and the Financial Conduct Authority (“FCA”) for conduct purposes. The terms of Ambac UK’s regulatory authority are now restricted and Ambac UK is in run-off. Among other things, Ambac UK may not write any new business, and, with respect to any entity within the Ambac group of affiliates, commute, vary or terminate any existing financial guaranty policy, transfer certain assets, or pay dividends, without the prior approval of the PRA and FCA. The PRA and FCA act generally in the interests of Ambac UK policyholders and will not take into account the interests of AAC or the securityholders of Ambac when considering whether to provide any such approval. Accordingly, determinations made by the PRA and FCA, in their capacity as Ambac UK’s regulators, could potentially result in adverse consequences for our securityholders and also reduce the value realizable by AAC for Ambac UK. Regulatory uncertainty in relation to Ambac UK’s capital position could adversely affect the value of Ambac UK and affect our securityholders. Under applicable regulatory capital rules (“Solvency II”) Ambac UK was deficient in terms of capital until September 30, 2021, but as at December 31, 2021 expects to meet the capital requirements under these rules. Ambac UK's regulators are aware of the deficiency which previously existed, and dialogue between Ambac UK and its regulators remains ongoing with respect to options for strengthening the capital position further whilst Ambac UK remains in run-off. Until Ambac UK has been able to strengthen its capital position, through the natural run-off of the insurance portfolio or otherwise, there remains a risk that market movements impacting its investments or adverse credit developments impacting loss reserving requirements within its insured portfolio could result in the capital position becoming deficient once again. The PRA supervisory statement SS7/15 “Supervision of firms in difficulty or run-off” notes that “there are many circumstances in which a run-off strategy is in the best interests of policyholders” and notes that the PRA will review such firms and that they “may be permitted to continue activities necessary to carry out existing contracts in a manner, and for so long as, the PRA considers necessary in order to afford an appropriate degree of protection to policyholders”. If Ambac UK were to return to a capital deficit position then its run-off would become subject to the PRA taking no action in relation to that capital deficit and related Solvency II requirements. Alternative courses of action open to the PRA could adversely impact the anticipated run-off trajectory of Ambac UK and impact its value. | Ambac Financial Group, Inc. 24 2021 FORM 10-K | Table of Contents Impairment of the intangible and goodwill assets, which resulted from the acquisition of Xchange, could adversely affect our results of operations. In connection with Ambac’s acquisition of 80% of the membership interests of Xchange, Ambac recorded the fair value of identifiable intangible assets (primarily related to distribution relationships) and goodwill. The intangible assets will be amortized over their remaining useful lives. The Company will test intangible assets for impairment if certain events occur or circumstances change indicating that the carrying amount of the intangible asset may not be recoverable. Goodwill will be tested for impairment annually or whenever events occur or circumstances change that may indicate impairment. Intangible asset and goodwill impairments are driven by a variety of factors, which could include, among other things, declining future cash flows of the acquired business as addressed in other risk factors related to the Managing General Underwriting Business. Any intangible asset or goodwill impairment could adversely affect the Company's operating results and financial condition. Xchange derives a significant portion of its commission revenues from a limited number of insurance companies, the loss of any of which could result in lower commissions or loss of business production. For the year ended December 31, 2021, a majority of Xchange’s total commissions was derived from insurance policies underwritten by a limited number of insurance companies. Should one or more of these insurance companies terminate its arrangements with Xchange or otherwise decrease the number of insurance policies underwritten for it, Xchange may lose significant commission revenues or lose significant business production while it seeks other insurance companies to underwrite the business. Xchange’s business, results of operation, financial condition and liquidity may be materially adversely affected by certain potential claims, regulatory actions or proceedings. Xchange is subject to various potential claims, regulatory actions and other proceedings, including those relating to alleged errors and omissions in connection with the placement or servicing of insurance and/or the provision of services in the ordinary course of business, of which we cannot, and likely will not be able to, predict the outcome with certainty. Because Xchange often assists customers with matters involving substantial amounts of money, including the placement of insurance and the handling of related claims that customers may assert, errors and omissions, claims against it may arise alleging potential liability for all or part of the amounts in question. Also, the failure of an insurer with whom Xchange places business could result in errors and omissions claims against it by its customers, which could adversely affect Ambac’s results of operations and financial condition. Claimants may seek large damage awards, and these claims may involve potentially significant legal costs and damages. In addition, regardless of monetary costs, these matters could have a material adverse effect on Xchange's reputation and cause harm to its carrier, customer or employee relationships, or divert personnel and management resources. Xchange’s current market share may decrease because of disintermediation within the insurance industry, including increased competition from insurance companies, technology companies and the financial services industry, as well as the shift away from traditional insurance markets. The MGU business is highly competitive and Xchange actively competes with numerous firms for customers and insurance companies, many of which have relationships with insurance companies or have a significant presence in niche insurance markets that may give them an advantage. Other competitive concerns may include pricing, the entrance of technology companies into the MGU business and the direct-to-consumer insurance carriers that don't utilize third party agents and brokers as production sources. Additionally, the insurance industry may experience consolidation, and Xchange therefore may experience increased competition from insurance companies and the financial services industry, as a growing number of larger financial institutions increasingly, and aggressively, offer a wider variety of financial services, including MGU services. While Xchange collaborates and competes in these segments on a fee-for-service basis, we cannot be certain that such alternative markets will provide the same level of insurance coverage or profitability as traditional insurance markets. Changes in law or in the functioning of the healthcare market could significantly impair Xchange’s business and therefore negatively impact Ambac’s financial condition and results of operation. Adoption of a single payer healthcare system or a public health insurance option would likely adversely impact the entire healthcare industry. While Xchange has historically demonstrated an ability to adjust its products to major changes in the healthcare industry, given its focus on Accident and Health products, Xchange would likely be adversely impacted by such a material change in the U.S. healthcare system particularly if private health insurance is eliminated, materially limited, or is rendered noncompetitive. Material adverse developments to Xchange's business would have a negative impact on Ambac's financial condition and results of operations which could be material. Xchange’s business and results of operation and financial condition may be adversely affected by conditions that result in reduced insurer capacity. Xchange’s results of operations depend on the continued capacity of insurance carriers to underwrite risk and provide coverage, which depends in turn on those insurance companies’ ability to procure reinsurance. Capacity among insurance carriers and reinsurers for Xchange's products may diminish because of Xchange's performance or due to factors outside Xchange's control. For example, capacity could be reduced by insurance companies failing or withdrawing from writing certain coverages that Xchange offers to its customers. To the extent that reinsurance becomes less widely available or significantly more expensive, Xchange may not be able to procure the amount or types of coverage that its customers desire and the coverage Xchange is able to procure for its customers may be more expensive or limited. | Ambac Financial Group, Inc. 25 2021 FORM 10-K | Table of Contents Variations in Xchange’s commissions that result from the timing of policy renewals and the net effect of new and lost business production may have unexpected effects on our results of operation. Xchange’s commission income can vary quarterly or annually due to the timing of policy renewals and the net effect of new and lost business production. Xchange does not control the factors that cause these variations. Specifically, customers’ demand for insurance products can influence the timing of renewals, new business and lost business (which includes policies that are not renewed), and cancellations. Quarterly and annual fluctuations in revenues based upon increases and decreases associated with the timing of new business, policy renewals and payments from insurance companies may adversely affect our financial condition, results of operations and cash flows. Profit-sharing contingent commissions are paid by insurance companies based upon the profitability of the business placed with such companies. In the past these commissions have accounted for a significant amount of Xchange’s total commissions and fees. Due to, among other things, the inherent uncertainty of loss in Xchange’s industry and changes in underwriting criteria by insurance companies, there will be a level of uncertainty related to the payment of profit-sharing contingent commissions. Risks Related to Taxation Certain surplus notes or other obligations of AAC may be characterized as equity of AAC and as a result, AAC may no longer be a member of the U.S. federal income tax consolidated group of which AFG is the common parent. It is possible that certain surplus notes or other obligations of AAC may be characterized as equity of AAC for U.S. federal income tax purposes. If such surplus notes or other obligations are characterized as equity of AAC that is taken into account for tax affiliation purposes and it is determined that such “equity” represented more than twenty percent of the total value of the stock of AAC, AAC may no longer be characterized as an includable corporation that is affiliated with AFG. As a result, AAC would no longer be characterized as a member of the U.S. federal income tax consolidated group of which AFG is the common parent (the “Ambac Consolidated Group”) and AAC would be required to file a separate consolidated tax return as the common parent of a new U.S. federal income tax consolidated group including AAC as the new common parent and AAC’s affiliated subsidiaries (the “AAC Consolidated Tax Group”). To the extent AAC is no longer a member of the Ambac Consolidated Group, AAC’s net operating loss carry-forwards ("NOLs") (and certain other available tax attributes of AAC and the other members of the AAC Consolidated Tax Group) may no longer be available for use by the AAC Consolidated Tax Group or any of the remaining members of the AAC Consolidated Tax Group to reduce the U.S. federal income tax liabilities of the AAC Consolidated Tax Group. AFG, AAC and their affiliates entered into a tax sharing agreement that would require AFG to make certain tax elections that could mitigate the loss of NOLs and other tax attributes resulting from a deconsolidation of AAC from the Ambac Consolidated Group. However, in the event of a deconsolidation, certain other benefits resulting from U.S. federal income tax consolidation may no longer be available to the Ambac Consolidated Group, including certain favorable rules relating to transactions occurring between members of the Ambac Consolidated Group and members of the AAC Consolidated Tax Group. A deconsolidation of AAC from the Ambac Consolidated Group could have a material adverse impact on our results of operations and financial condition. If surplus notes or other obligations are characterized as equity of AAC, the AAC NOLs (and certain other tax attributes or tax benefits of the Ambac Consolidated Group) may be subject to limitation under Section 382 of the Tax Code. It is possible that certain surplus notes or other obligations may be characterized as equity of AAC for U.S. federal income tax purposes. Such characterization could result in an “ownership change” of AAC for purposes of Section 382 of the Tax Code. If such an ownership change were to occur, the value and amount of the AAC NOLs would be substantially impaired, increasing the U.S. federal income tax liability of AAC and materially reducing the value of AAC’s stock owned by AFG and the potential for future dividend payments from AAC to AFG. Deductions with respect to interest accruing on certain surplus notes may be eliminated or deferred until payment. To the extent certain surplus notes are characterized as equity for U.S. federal income tax purposes, accrued interest will not be deductible by AAC. In addition, even if such surplus notes are characterized as debt for U.S. federal income tax purposes, the deduction of interest accruing on such surplus notes may be deferred until paid or eliminated in part depending upon (i) the terms of any deferral and payment provisions provided in such surplus notes, (ii) whether such surplus notes have “significant original issue discount,” and (iii) the yield to maturity of surplus notes. To the extent deductions with respect to interest are eliminated or deferred, the U.S. federal income tax of AAC or the members of the AAC Consolidated Tax Group as the case may be, could be increased reducing the amount of cash available to pay its obligations and, therefore, the value of AAC’s stock owned by AFG and the potential for future dividend payments from AAC to AFG. Risks Related to Strategic Plan Ambac is planning to further develop and expand the Specialty Property and Casualty Program Insurance business and the Managing General Agency/Underwriting business; however, such plans may not be realized, or if realized, may not create value and may negatively impact our financial results. The value of AFG's common stock depends in part upon the ability of Ambac to generate earnings apart from AAC. Ambac is planning to further develop and expand the Specialty Property and Casualty Program Insurance Business and the Managing General Agency/Underwriting business. Such plans may involve additional acquisitions of assets or existing businesses and the development of businesses through new or existing subsidiaries. | Ambac Financial Group, Inc. 26 2021 FORM 10-K | Table of Contents It is not possible at this time to fully predict the future prospects or other characteristics of such businesses. While we expect to conduct business, financial and legal due diligence in connection with the evaluation of any future business or acquisition opportunities, there can be no assurance our due diligence investigations will identify every matter that could have a material adverse effect on us. Efforts to pursue certain business opportunities may be unsuccessful or require significant financial or other resources, which could have a negative impact on our operating results and financial condition. To effect our growth strategy, we must be able to meet our capital needs, expand our systems and our internal controls effectively, allocate our human resources optimally, identify and hire qualified employees and effectively integrate any acquisitions we make in our effort to achieve growth. No assurances can be given that Ambac will successfully execute its plans for new business, generate any earnings or value from new businesses or be able to successfully integrate any such business into our current operating structure. The failure to manage our growth effectively could have a material adverse effect on our business, financial condition and results of operations. Moreover, Ambac’s ability to enter into new businesses may be constrained, given the financial condition of AAC, counterparty or rating agency concerns about AAC's ability to mitigate insured portfolio losses or recover losses in litigation, the difficulty of leveraging or monetizing Ambac’s other assets, and the uncertainty of Ambac's ability to raise capital. Due to these factors, as well as those relating to AAC as described in this Item 1A. Risk Factors, the value of our securities is speculative. Should changes in Ambac’s circumstances or financial condition or in the political, economic and/or legal environment occur, there can be no assurance that all or any part of our strategy and/or initiatives will not be abandoned or amended to take account of such changes. Any such adjustment or abandonment may have an material adverse effect on our securities. Item 1B. Unresolved Staff Comments — No matters require disclosure. Item 2. Properties The executive office of Ambac is located at One World Trade Center, New York, New York 10007, and consists of 46,927 square feet of office space, under a sublease agreement that expires in January 2030. Ambac continues to hold a lease at One State Street Plaza that expires in December 2029 (25,871 square feet). Ambac has sublet this space through its expiration date. During 2020 and 2021, Ambac temporarily leased additional office space in New Jersey related to its COVID response plan. The New Jersey lease expired in September 2021. Ambac UK maintains an office in London, England, which consists of 3,514 square feet of office space, under a lease agreement that expires in October 2025. Xchange maintains office space in (i) Armonk, NY which consists of 2,754 square feet under a lease agreement that expires in July 2028 and (ii) Indianapolis, IN which consists of 3,678 square feet under a lease agreement that expires in March 2024. Ambac maintains a disaster recovery site in Kingston, NY which consists of 12,374 square feet under a lease that expires in March 2024. During a disaster event, the site would allow employees in our New York offices an alternative office location. Item 3. Legal Proceedings Refer to Notes to the Consolidated Financial Statements—Note 19. Commitments and Contingencies included in Part II, Item 8 in this Form 10-K for a discussion on legal proceedings against Ambac. Item 4. Mine Safety Disclosures — Not applicable. PART II Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Market Information Since February 3, 2020, the Company 's common stock and warrants have been trading on the NYSE under the symbol “AMBC" and "AMBC WS", respectively. Prior to being listed on the NYSE, the Company's common stock and warrants were listed on NASDAQ under the symbols “AMBC” and "AMBCW," respectively. Holders On February 22, 2022, there were 20 stockholders of record of AFG’s common stock and 60 holders of record of AFG's warrants. Dividends The Company did not pay cash dividends on its common stock during 2021 and 2020. Information concerning restrictions on the payment of dividends from Ambac's insurance subsidiaries is set forth in Item 1 above under the caption “Dividend Restrictions, Including Contractual Restrictions" and in Note 8. Insurance Regulatory Restrictions to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K. Purchases of Equity Securities By the Issuer and Affiliated Purchasers The following table summarized Ambac's share purchases during the fourth quarter of 2021. When restricted stock unit awards issued by Ambac vest or settle, they become taxable compensation to employees. For certain awards, shares may be withheld to cover the employee's portion of withholding taxes. In the fourth quarter of 2021, Ambac purchased shares from employees that settled restricted stock units to meet employee tax withholdings. | Ambac Financial Group, Inc. 27 2021 FORM 10-K | Table of Contents October 2021 November 2021 December 2021 Fourth Quarter 2021 Total Shares Purchased (1) 8,057 1,342 — 9,399 Average Price Paid Per Share $ 14.38 16.49 — $ 14.68 Total Number of Shares Purchased as Part of Publicly Announced Plan — — — — Maximum Number of Shares That may Yet be Purchased Under the Plan — — — — (1) There were no other repurchase of equity securities made during the three months ended December 31, 2021. Ambac does not have a stock repurchase program. Warrants Each warrant represents the right to purchase one share of AFG common stock. The warrants are exercisable for cash at any time on or prior to April 30, 2023, at an exercise price of $16.67 per share. The warrants also have a cashless exercise provision. On June 30, 2015, the Board of Directors of AFG authorized the establishment of a warrant repurchase program that permits the repurchase of up to $10 million of warrants. On November 3, 2016, the Board of Directors of AFG authorized an additional $10 million to the warrant repurchase program. The remaining aggregate authorization at December 31, 2021, is $11.9 million. Ambac currently has 4,877,617 warrants outstanding. Stock Performance Graph The following graph compares the performance of an investment in our common stock from the close of business on December 30, 2016, through December 31, 2021, with the Russell 2000 Index and S&P Completion Index. The graph assumes $100 was invested on December 30, 2016, in our common stock at the closing price of $22.50 per share and at the closing price for the Russell 2000 Index and S&P Completion Index. It also assumes that dividends (if any) were reinvested on the date of payment without payment of any commissions. The performance shown in the graph represents past performance and should not be considered an indication of future performance. ` December 31, 2016 2017 2018 2019 2020 2021 Ambac Financial Group, Inc. $100 $71 $77 $96 $68 $71 Russell 2000 Index $100 $113 $100 $123 $147 $167 S&P Completion Index $100 $116 $104 $131 $171 $191 | Ambac Financial Group, Inc. 28 2021 FORM 10-K | Table of Contents Item 6. Selected Financial Data Reserved Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations The objectives of our Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) are to provide users of our consolidated financial statements with the following: • A narrative explanation from the perspective of management of our financial condition, results of operations, cash flows, liquidity and certain other factors that may affect future results; • Context to the consolidated financial statements; and • Information that allows assessment of the likelihood that past performance is indicative of future performance. The following discussion should be read in conjunction with our consolidated financial statements in Item 8 of this Report and the matters described under Item 1A. Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2021. Refer to Item 1. Business and Note 1. Background and Business Description for a description of our business and our key strategies to achieve our primary goal to maximize shareholder value. Organization of Information MD&A includes the following sections: Page Executive Summary 29 Critical Accounting Estimates 32 Financial Guarantees in Force 34 Results of Operations 42 Liquidity and Capital Resources 46 Balance Sheet 48 Accounting Standards 54 Ambac Assurance Statutory Basis Financial Results 54 Ambac UK Financial Results under UK Accounting Principles 56 Non-GAAP Financial Measu res 57 EXECUTIVE SUMMARY ($ in millions) AFG During 2021, AFG progressed the development of its specialty property and casualty program insurance business. Developments included the following: • AFG contributed $92 of additional capital to Everspan. • Everspan received an 'A-' Financial Strength Rating from AM Best in February 2021. • Everspan launched its specialty insurance program business in May 2021. • To support expansion of the admitted insurance component of its business, during 2021 Everspan entered into stock purchase agreements to acquire four insurance shell companies. Such acquisitions will enhance Everspan's capabilities to launch new admitted programs, develop innovative products and provide enhanced flexibility to foster strategic relationships with prospective program partners. On October 1, 2021, Everspan completed the acquisition of Providence Washington Insurance Company (“PWIC”) from a subsidiary of Enstar Group Limited. PWIC holds certificates of authority in forty-seven states and territories. PWIC's legacy liabilities were fully ceded to reinsurers and Everspan also benefits from an unlimited, uncapped indemnity from Enstar Holdings (US) to mitigate any residual risk to these reinsurers. On January 3, 2022, Everspan completed the acquisition of the 21st Century Companies (three carriers) from a national insurance group that has a Financial Strength Rating of “A” (Excellent) from AM Best. The 21st Century Companies collectively possess certificates of authority in thirty-nine states. All legacy liabilities remain with affiliates of the sellers through reinsurance and contractual indemnities. The 21st Century Companies will be re-named during 2022. • During 2021, AFG made minority investments in certain insurance related businesses, including insurtech platforms, that we believe will be synergistic to our specialty property & casualty program insurance or Managing General Agency/Underwriting businesses. • See below AAC and Subsidiaries for the various 2021 activities relating to the financial guarantee business In addition to its focus on Xchange, AFG is actively seeking to expand the MGA/U business though additional acquisitions and development of new MGA/U companies. Net Assets As of December 31, 2021, net assets of AFG, excluding its equity investments in subsidiaries, were $269. ($ in millions) Cash and short-term investments $ 125 Other investments (1) 130 Other net assets 14 Total $ 269 (1) Includes surplus notes (fair value of $90) issued by AAC that are eliminated in consolidation. AAC and Subsidiaries A key strategy for Ambac is to increase the value of its investment in AAC by actively managing its assets and liabilities. Asset management primarily entails maximizing the risk-adjusted return on non-VIE invested assets and managing liquidity to help ensure resources are available to meet operational and strategic cash needs. These strategic cash needs include activities associated with Ambac's liability management and loss mitigation programs. Asset Management Investment portfolios are subject to internal investment guidelines, as well as limits on types and quality of investments | Ambac Financial Group, Inc. 29 2021 FORM 10-K | Table of Contents imposed by insurance laws and regulations. The investment portfolios of AAC and Ambac UK hold fixed maturity securities and various pooled investment funds. Refer to Note 4. Investments to the Consolidated Financial Statements, included in Part II, Item 8 in this Form 10-K for further details of fixed maturity investments by asset category and pooled investment funds by investment type. At December 31, 2021, Ambac and its subsidiaries owned $609 of distressed Ambac-insured bonds, including significant concentrations of insured Puerto Rico and RMBS bonds. Subject to internal and regulatory guidelines, market conditions and other constraints, Ambac may continue to opportunistically purchase or sell Ambac-insured securities, surplus notes and/or other Ambac issued securities, and may consider opportunities to exchange securities issued by it from time to time for other securities issued by it. Liability and Insured Exposure Management AAC's Risk Management Group focuses on the implementation and execution of risk reduction, defeasance and loss recovery strategies. Analysts evaluate the estimated timing and severity of projected policy claims as well as the potential impact of loss mitigation or remediation strategies in order to target and prioritize policies, or portions thereof, for commutation, reinsurance, refinancing, restructuring or other risk reduction strategies. For targeted policies, analysts will engage with issuers, bondholders and other economic stakeholders to negotiate, structure and execute such strategies. During 2021, Ambac completed risk reduction transactions consisting of quota share reinsurance, refinancings, and commutations of $2,695, of which, quota share reinsurance represented $1,695. The following table provides a comparison of total, adversely classified ("ACC") and watch list credit net par outstanding in the insured portfolio at December 31, 2021 and 2020. Net par exposure within the U.S. public finance market includes capital appreciation bonds which are reported at the par amount at the time of issuance of the insurance policy as opposed to the current accreted value of the bonds. ($ in billions) December 31, 2021 2020 Variance Total $ 28,020 $ 33,888 $ (5,868) (17) % ACC $ 6,361 $ 8,458 $ (2,097) (25) % Watch List $ 3,824 $ 4,720 $ (896) (19) % The decrease in total, ACC and watch list credit net par outstanding resulted from active de-risking initiatives, as noted above, as well as scheduled maturities, amortizations, refundings and calls. We have been paying claims for several years on most of our exposure to Puerto Rico, which consists of several different issuing entities (all below investment grade). These issuing entities, which have been part of the PROMESA restructuring process that began in 2016, each have their own credit risk profile attributable to discrete revenue sources, direct general obligation pledges, and/or general obligation guarantees. On January 18, 2022, Judge Swain, U.S. District Court for the District of Puerto Rico, confirmed the modified Eighth Amended Plan of Adjustment for the Commonwealth of Puerto Rico ("Eighth Amended POA"). On January 20, 2022, Judge Swain approved the Qualifying Modifications for PRIFA and CCDA ("PRIFA QM" and "CCDA QM", respectively). Although the Eighth Amended POA, the PRIFA QM and CCDA QM remain subject to appeal (see Risk Factors— "Insured Portfolio Losses"), the Eighth Amended POA, PRIFA QM, and CCDA QM are expected to become effective on or before March 15, 2022. Consummation of the plan of adjustment and qualifying modifications will resolve the PROMESA restructuring process for the GO, PBA, PRIFA and CCDA issuing entities that have portions of their bonds insured by AAC. On the effective date of the Eighth Amended POA, PRIFA QM, and CCDA QM, and pursuant to bondholder elections, (i) all of the remaining outstanding AAC-insured GO and PBA bonds will be satisfied and eliminated via commutation or acceleration, and (ii) about 39% and 19% of the par of AAC's outstanding AAC-insured PRIFA and CCDA bonds, respectively, will be reduced via commutation, with the remainder of those bonds (belonging to bondholders who elected not to commute their AAC Insurance Policies) being deposited into trusts together with such policies and the bondholders' respective shares of distributed Eighth Amended POA, PRIFA QM, or CCDA QM consideration. Those bondholders participating in the trusts are expected to receive scheduled payments from the applicable trust, unless Ambac elects, in its sole discretion, to pay all or a portion of the outstanding par amounts of the AAC-insured bonds in such trust. AAC-insured bonds of PRHTA are subject to the PRHTA POA, a separate plan of adjustment that is expected to be filed prior to March 31, 2022, with a confirmation hearing to follow later in 2022. Refer to Part II, Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, Financial Guarantees in Force, in this Annual Report on Form 10-K for additional information regarding the different issuing entities that encompass Ambac's exposures to Puerto Rico. COVID-19 The COVID-19 pandemic had, and to a lesser degree, continues to have, an impact on general economic conditions; including, but not limited to, higher unemployment; volatility in the capital markets; closure or severe curtailment of the operations and, hence, revenues, of many businesses and public and private enterprises to which we are directly or indirectly exposed. COVID-19 and the public health responses by the US federal and state governments at the onset of the pandemic resulted in a shut down for several months of significant portions of the US economy, including areas that Ambac's insured obligors rely upon to generate the revenues and cash flows necessary to service debts we insure. In the U.S. and Europe, where most of Ambac's financial guaranty exposure is located, significant fiscal stimulus measures, monetary policy actions and other relief measures helped to moderate the negative economic impacts of COVID-19 and supported the economic recovery which began in the second half of 2020 and continues into 2022. As of December 31, 2021, there have been no defaults of Ambac-insured obligations as a result of the COVID-19 pandemic. | Ambac Financial Group, Inc. 30 2021 FORM 10-K | Table of Contents Despite the significant overall benefit of the above relief measures, which were designed to help mitigate the economic impact of the COVID-19 pandemic generally, certain of these measures may still adversely affect Ambac's insured portfolio. In particular, this includes the U.S. government's temporary relief measures that required mortgage loan servicers to offer relief to borrowers who suffer hardship as a result of COVID-19. These relief measures included moratoriums on foreclosures and evictions as well as the expansion of forbearance and subsequent repayment options. While these relief measures have largely since expired, the resulting delays in starting mortgage foreclosure processes and the impact of potential post-forbearance related mortgage loan modifications may have an adverse impact on our insured RMBS transactions. Consequently, we have anticipated that we will experience an increase in claim payments for certain of our insured RMBS obligations following the resumption of foreclosure activity and the implementation of post-forbearance mortgage loan modifications. However, since the onset of the COVID-19 pandemic, much of the potential increase in claim experience has been offset by the benefit to excess spread within the securitization structures as a result of the reduction in interest rates, which is expected to result in higher excess spread recoveries to Ambac. The impact from the COVID-19 pandemic on Ambac also includes the ability of our counterparties to pay their obligations when due, most notably AAC's reinsurers for their portion of future financial guaranty claim payments. Ambac has reinsured approximately 17.9% of its gross par outstanding to five reinsurance counterparties. Each of these reinsurance counterparties (i) is experienced in the business of reinsuring and/or writing financial guaranty insurance and (ii) have current ratings of A+ (by S&P) or better and have collateralization or replacement triggers upon downgrade within Ambac's reinsurance agreements. Ambac actively monitors each of these reinsurance entities and currently believes they have the ability to perform under their respective reinsurance policies, but this is subject to change. Given the economic uncertainties associated with the duration and effects of the COVID-19 pandemic, it is impossible to fully predict all of its consequences and, as a result, it is possible that our future operating results and financial condition may be materially adversely affected. Refer to "Financial Guarantees In Force," "Results of Operations" and "Balance Sheet Commentary" for further financial details on the current impact from COVID-19. With regard to Ambac's new business strategic objective, we continue to evaluate opportunities in a disciplined manner. Our evaluation process incorporates the perceived impact of COVID-19 on historical and prospective business results. Financial Statement Impact of Foreign Currency The impact of foreign currency as reported in Ambac's Consolidated Statement of Total Comprehensive Income (Loss) for the year ended December 31, 2021 included the following: ($ in millions) Net income (1) $ (7) Gain (losses) on foreign currency translation (net of tax) (8) Unrealized gains (losses) on non-functional currency available-for-sale securities (net of tax) 3 Impact on total comprehensive income (loss) $ (12) (1) A portion of Ambac UK's, and to a lesser extent AAC's, assets and liabilities are denominated in currencies other than its functional currency and accordingly, we recognized net foreign currency transaction gains/(losses) as a result of changes to foreign currency rates through our Consolidated Statement of Total Comprehensive Income (Loss). Refer to Note 2. Basis of Presentation and Significant Accounting Policies to the Consolidated Financial Statements included in Part II, Item 8 in this Annual Report in Form 10-K for further details on transaction gains and losses. Future changes to currency rates, may adversely affect our financial results. Refer to Part II, Item 7A "Quantitative and Qualitative Disclosures about Market Risk" for further information on the impact of future currency rate changes on Ambac's financial instruments. LIBOR Sunset In July 2017, the Financial Conduct Authority, the authority that regulates LIBOR, announced its intention to stop compelling banks to submit rates for the calculation of LIBOR after 2021. The Alternative Reference Rates Committee (‘ARRC’), a group of private-market participants convened by the Federal Reserve Board and the Federal Reserve Bank of New York to help ensure a successful transition from U.S. dollar LIBOR (‘USD-LIBOR’) to a more robust reference rate, proposed that the Secured Overnight Financing Rate (‘SOFR’) represents the best alternative to USD-LIBOR for use in derivatives and other financial contracts that are currently indexed to USD-LIBOR. ARRC has proposed a transition plan with specific steps and timelines designed to encourage the adoption of SOFR and guide the transition to SOFR from USD-LIBOR. The Financial Conduct Authority in the United Kingdom and other regulatory bodies have issued statements encouraging cessation of new transactions referencing USD LIBOR after December 31, 2021, while supporting extension of the publication of major USD-LIBOR tenors to mid-2023 to allow additional legacy contracts to mature on their existing terms. Organizations are currently working on industry-wide and company-specific transition plans related to derivatives and cash markets exposed to USD-LIBOR. After December 31, 2021, banks ceased publishing most GBP-LIBOR rates. In response, in October 2021, noteholders of obligations linked to GBP-LIBOR and insured by Ambac UK consented to the replacement of GBP-LIBOR references with compounded Sterling Overnight Index Average ("SONIA") plus a credit adjustment spread effective on the first interest payment date in 2022. Ambac therefore no longer insures any obligations linked to Non-USD LIBOR. As of December 31, 2021, the Company has exposure to LIBOR in the following areas: (i) the financial guarantee insured portfolio, (ii) the Sitka AAC Note (as defined in Note 1. Background and Business Description to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K) included in long-term debt, (iii) certain invested assets and interest rate derivatives. | Ambac Financial Group, Inc. 31 2021 FORM 10-K | Table of Contents Ambac has reviewed its financial guarantee portfolio to identify insured transactions that it believes may be impacted by the transition from LIBOR. The review focused on insured issues that were scheduled or projected to have an outstanding principal balance as of December 31, 2021. The Company reviewed the governing documents' provisions for the setting of interest rates in the event LIBOR is unavailable ("fallback language"). The Company has initiated a dialogue with relevant trustees, calculation agents, auction agents, servicers and other parties responsible for implementing the rate change in these transactions. Most have not yet committed to specific courses of action, but the passage of legislation in New York State and the expectation that similar federal legislation will be enacted should facilitate greater clarity for those transactions that do not have clear fallback language. The Sitka AAC Note is referenced to 3-month USD-LIBOR and has a final maturity of July 6, 2026. The Sitka AAC Note includes specific fallback language that addresses both the calculation of interest using a replacement reference rate to 3-month USD-LIBOR and the circumstances that would trigger use of the replacement rate. Ambac's investment and derivative portfolios have been evaluated to assess the risk of LIBOR unavailability based on the respective instruments' fallback language and parties responsible for implementing the alternative rates. Investments that are Ambac-insured securities are being addressed through efforts on the financial guarantee portfolio described above. For other investments, we are working with our investment managers to ensure LIBOR indexed positions in our portfolio contain unambiguous fallback language or will be governed by relevant legislation. Ambac's centrally cleared interest rate swaps are expected to follow LIBOR transition steps outlined by the International Swaps and Derivatives Association, Inc. ("ISDA"). Our non-cleared interest rate swaps are all governed by New York law and either have offsetting LIBOR exposure with a single counterparty that serves as calculation agent responsible for rate changes or have Ambac as the calculation agent. Given the uncertainty of the ultimate timing of the LIBOR sunset, as well as the lack of clarity on decisions that parties responsible for calculating interest rates will make and the reaction of impacted parties as well as the unknown level of interest rates when the change occurs, the Company cannot at this time predict the impact of the discontinuance of LIBOR, if it occurs, on every obligation the Company guarantees or on its other LIBOR indexed financial instruments. For more information, see the the risk factor " Uncertainties regarding the expected discontinuance of the London Inter-Bank Offered Rate or any other interest rate benchmark could have adverse consequences " found in Part I, Item 1A of this Form 10-K. CRITICAL ACCOUNTING POLICIES AND ESTIMATES Ambac's Consolidated Financial Statements have been prepared in accordance with GAAP. This section highlights accounting estimates management views as critical because they are most important to the portrayal of the Company's financial condition; and require management to make difficult and subjective judgments regarding matters that are inherently uncertain and subject to change. These estimates are evaluated on an on-going basis considering historical developments, political events, market conditions, industry trends and other information. There can be no assurance that actual results will conform to estimates and that reported results of operations will not be materially adversely affected by the need to make future accounting adjustments to reflect changes in these estimates from time to time. Management has identified the following critical accounting policies and estimates: (i) valuation of financial guarantee loss and loss expense reserves, (ii) valuation of certain financial instruments and (iii) valuation of deferred tax assets. Management has discussed each of these critical accounting policies and estimates with the Audit Committee, including the reasons why they are considered critical and how current and anticipated future events impact those determinations. Additional information about these policies can be found in Note 2. Basis of Presentation and Significant Accounting Policies to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K. Valuation of Financial Guarantee Losses and Loss Expense Reserves (including Subrogation Recoverables) The loss and loss expense reserves and subrogation recoverable assets (collectively defined as "loss reserves") discussed in this section relate only to Ambac’s non-derivative financial guarantee insurance policies issued to beneficiaries, including unconsolidated VIEs. A loss reserve is recorded on the balance sheet on a policy-by-policy basis at the present value ("PV") of expected net claim cash outflows or expected net recovery cash inflows, discounted at risk-free rates. The estimate for future net cash flows consider the likelihood of all possible outcomes that may occur from missed principal and/or interest payments on the insured obligation. This estimate also considers future recoveries related to breaches of contractual representations and warranties by RMBS transaction sponsors, remediation strategies, excess spread and other contractual or subrogation-related cash flows. Ambac’s approach to resolving disputes involving contractual breaches by transaction sponsors or other third parties has included negotiations and/or pursuing litigation. Ambac does not estimate recoveries for litigations where its sole claim is for fraudulent inducement, since any remedies under such claims would be non-contractual. Nor does Ambac include potential recoveries attributable to pre-judgment interest in the estimate of subrogation recoveries. The evaluation process for expected future net cash flows is subject to certain estimates and judgments regarding the probability of default by the issuer of the insured security, probability of negotiation or settlement outcomes (which may include commutation, litigation and other settlements, and/or a refinancing), probability of a restructuring outcome (which may include payment moratoriums, debt haircuts and/or subsequent recoveries) and the expected loss severity of credits for each insurance contract. As the probability of default for an individual credit increases and/or the severity of loss given a default increases, our loss reserve for that insured obligation will also increase. Political, | Ambac Financial Group, Inc. 32 2021 FORM 10-K | Table of Contents economic, credit or other unforeseen events could have an adverse impact on default probabilities and loss severities. The loss reserves for many transactions are derived from the issuer’s creditworthiness. For public finance issuers, loss reserves will consider not only creditworthiness but also political dynamics and economic status and prospects. The loss reserves for transactions which have no direct issuer support, such as most structured finance exposures, including RMBS and student loan exposures, are derived from the default activity and the estimated loss given default of the underlying collateral supporting the transactions. In addition, many transactions have a combination of issuer/entity and collateral support. Loss reserves reflect our assessment of the transaction’s overall structure, support and expected performance. Loss reserve volatility will be a direct result of the credit performance of our insured portfolio, including the number, size, bond types and quality of credits included in our loss reserves; our ability to execute workout strategies and commutations; economic and market conditions; and management's judgments with regards to the current performance and future developments within the insured portfolio. The number and severity of credits included in our loss reserves depend to a large extent on transaction specific attributes, but will generally increase during periods of economic stress and decline during periods of economic prosperity. Reinsurance contracts mitigate our loss reserves but since Ambac currently has minimal exposure ceded to reinsurers on credits with loss reserves, the existing reinsurance contracts are unlikely to have a significant effect on loss reserve volatility. Loss reserve volatility will also be materially impacted by changes in interest rates from period to period. The table below indicates the gross par outstanding and gross loss reserves (including loss expenses) related to policies in Ambac’s Financial Guarantee loss and loss expense reserves at December 31, 2021 and 2020: Gross Par Outstanding (1) (2) Gross Loss and Loss Expense Reserves (1) (3) (4) December 31, 2021 Structured Finance 2,371 (1,178) Domestic Public Finance 2,742 562 Other 1,189 17 Loss expenses — 45 Totals 6,302 (554) December 31, 2020 Structured Finance 2,945 (1,212) Domestic Public Finance 3,016 724 Other 1,612 23 Loss expenses — 68 Totals 7,573 (397) (1) Ceded par outstanding on policies with loss reserves and ceded loss and loss expense reserves are $784 and $24 respectively, at December 31, 2021, and $739 and $33, respectively at December 31, 2020. Ceded loss and loss expense reserves are included in Reinsurance recoverable on paid and unpaid losses. (2) Gross Par Outstanding includes capital appreciation bonds, which are reported at the par amount at the time of issuance of the insurance policy as opposed to the current accreted value of the bond. (3) Loss and Loss Expense reserves at December 31, 2021, of $(554) are included in the balance sheet in the following line items: Loss and loss expense reserves: $1,538 and Subrogation recoverable: (2,092). Loss and Loss Expense reserves at December 31, 2020, of $(397) are included in the balance sheet in the following line items: Loss and loss expense reserves: $1,759 and Subrogation recoverable: $2,156. (4) Ambac records as a component of its loss and loss expense reserves, estimated recoveries related to securitized loans in RMBS transactions that breached certain representations and warranties. Ambac has recorded gross estimated recoveries of $1,730 and $1,751 at December 31, 2021 and 2020, respectively. See Note 2. Basis of Presentation and Significant Accounting Policies to the Consolidated Financial Statements, included in Part II, Item 8 in this Form 10-K for a description of the cash flow and statistical methodologies used to develop loss reserves. The majority of our large loss reserves utilize the cash flow method of reserving. Various cash flow scenarios are developed to represent the range of possible outcomes and resultant future claim payments and timing. Scenarios and probabilities of each are adjusted regularly to reflect changes in status, outlook and our analysis and views. Significant judgment is used to develop the cash flow assumptions and related probabilities, and there can be no certainty that the scenarios or probabilities will not deviate materially from ultimate outcomes. • In some cases, such as RMBS and student loans, cash flow projections include the modeling of an issuer or transaction’s future revenues and expenses to determine the resources available to pay debt service on our insured obligations. Key assumptions impacting RMBS cash flow models include projected home price appreciation and interest rates A component of our RMBS loss reserve estimate includes subrogation recoveries related to securitized loans in such transactions that breached certain representations and warranties ("R&W"). Key assumptions impacting student loan cash flow models include projected loan defaults, recoveries and interest rates. • In other cases, such as many public finance exposures, we consider the issuer's overall ability and willingness to pay as it relates to the existing fiscal, economic, legal, restructuring and/or political framework relevant to a particular exposure or group of exposures. We then develop multiple scenarios where issuer debt service is paid, missed and/or haircut with claims paid then modeled for any recovery amount (and potential variability of the recovery amount) and timing. There is no certainty our assumptions as to scenarios or probabilities will not be subject to material changes as developments occur. • In estimating loss reserves, we also incorporate scenarios which represent the potential outcome of remediation strategies. Remediation scenarios may include (i) a potential refinancing of the transaction by the issuer; (ii) the issuer’s ability to redeem outstanding securities at a discount, thereby increasing the structure’s ability to absorb future losses; and (iii) our ability to terminate, restructure or commute the policy in whole or in part. The remediation scenarios and the related probabilities of occurrence vary by policy depending on ongoing and expected discussions and negotiations with issuers and/or investors. In addition to commutation negotiations that are underway with various counterparties in various forms, our reserve | Ambac Financial Group, Inc. 33 2021 FORM 10-K | Table of Contents estimates may also include scenarios which incorporate our ability and/or expectation to commute additional exposure with other counterparties. Valuation of Certain Financial Instruments The Fair Value Measurement Topic of the ASC requires financial instruments to be classified within a three-level fair value hierarchy. The fair value hierarchy, the financial instruments classified within each level, our valuation methods, inputs, assumptions and the review and validation procedures over quoted and modeled pricing are further detailed in Note 5. Fair Value Measurements to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K. The level of judgment in estimating fair value is largely dependent on the amount of observable market information available to fair value a financial instrument, which is also determinative of where the financial instrument is classified in the fair value hierarchy. Level 3 instruments are valued using models which use one or more significant inputs or value drivers that are unobservable and therefore require significant judgment. Level 3 financial instruments which are material include certain invested assets, uncollateralized interest rate swaps and investments and loan receivables of consolidated VIEs. Model-derived valuations of Level 3 financial instruments incorporate estimates of the effects of Ambac's own credit risk and/or counterparty credit risk, which can be complex and judgmental. Furthermore, Level 3 investments and loan receivables of consolidated VIEs incorporate estimates of Ambac's financial guarantee cash flows, including future premiums and losses. Such cash flow estimates require judgments regarding prepayments of VIE debt, loss probabilities and loss severities, all of which are inherently uncertain. All models and related assumptions are continuously re-evaluated by management and enhanced, as appropriate, based on improvements in information and modeling techniques. The re-evaluation process includes a quarterly meeting of senior Finance personnel to review and approve changes to models and key assumptions. As a result of the significant judgment for the above-described instruments, the actual trade value of the financial instrument in the market, or exit value of the financial instrument owned by Ambac, may be significantly different from its recorded fair value. Valuation of Deferred Tax Assets Our provision for taxes is based on our income, statutory tax rates and tax planning opportunities available to us in the jurisdictions in which we operate. Tax laws are complex and subject to different interpretations by the taxpayer and respective governmental taxing authorities. Significant judgment is required in determining our tax expense and in evaluating our tax positions. We review our tax positions quarterly and adjust the balances as new information becomes available. Deferred tax assets arise because of temporary differences between the financial reporting and tax bases of assets and liabilities, as well as from net operating loss ("NOL"). More specifically, deferred tax assets represent a future tax benefit that results from losses recorded under GAAP in a current period which are only deductible for tax purposes in future periods and NOL carry forwards. Valuation allowances are established to reduce deferred tax assets to an amount that “more likely than not” will be realized. On a quarterly basis, management identifies and considers all available evidence, both positive and negative, in making the determination with significant weight given to evidence that can be objectively verified. Positive evidence includes removal of the going concern independent auditor opinion in 2018, the Segregated Account's February 12, 2018 exit from rehabilitation, Everspan's receipt of an 'A-'' Financial Strength Rating from AM Best, the launch of a specialty program property and casualty insurance business, and AFG's acquisition of a majority interest in an MGA/U business. Negative evidence includes the potential for unrecognized future insurance tax losses; cumulative pre-tax losses in recent years; uncertainty regarding timing and magnitude of RMBS R&W litigation recoveries; and no new financial guarantee business. The level of deferred tax asset recognition is influenced by management’s assessment of future expected taxable income, which depends on the existence of sufficient taxable income within the carry forward periods available under the tax law. As a result of the above-described risks and uncertainties associated with future operating results, management believes it is more likely than not that the Company will not generate sufficient taxable income to recover the U.S. federal deferred tax asset and therefore has a full valuation allowance. To the extent such risks and uncertainties are resolved, Ambac may have the ability to establish a history of making reliable estimates of future income which could ultimately result in a reduction to the deferred tax asset valuation allowance. See Note 16. Income Taxes to the Consolidated Financial Statements, included in Part II, Item 8 in this Form 10-K for additional information on the Company's deferred income taxes. FINANCIAL GUARANTEES IN FORCE ($ in millions) Financial guarantee products were sold in three principal markets: U.S. public finance, U.S. structured finance and international finance. The following table provides a breakdown of guaranteed net par outstanding by market at December 31, 2021 and 2020. Net par exposures within the U.S. public finance market include capital appreciation bonds which are reported at the par amount at the time of issuance of the insurance policy as opposed to the current accreted value of the bonds. Guaranteed net par outstanding includes the exposures of policies insuring variable interest entities (“VIEs”) consolidated in accordance with the Consolidation Topic of the ASC . Guaranteed net par outstanding excludes the exposures of policies that insure bonds which have been refunded or pre-refunded and excludes exposure of the policies insuring the Sitka Senior Secured Notes and LSNI Secured Notes as defined in Note 1. Background and Business Description to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K. | Ambac Financial Group, Inc. 34 2021 FORM 10-K | Table of Contents December 31, 2021 2020 Public Finance (1) (2) $ 12,360 $ 15,497 Structured Finance 4,904 6,337 International Finance 10,756 12,054 Total net par outstanding $ 28,020 $ 33,888 (1) Includes $5,490 and $5,575 of Military Housing net par outstanding at December 31, 2021 and 2020, respectively. (2) Includes $1,054 and $1,070 of Puerto Rico net par outstanding at December 31, 2021 and 2020, respectively. Below we will discuss the significant exposures in our insured portfolio relating to each of the three markets. See Note 6. Financial Guarantees in Force to the Consolidated Financial Statements, included in Part II, Item 8 in this Form 10-K for exposures by bond type. U.S. Public Finance Insured Portfolio Ambac’s portfolio of U.S. public finance exposures is $12,360 in net par outstanding, representing 44% of Ambac’s net par outstanding as of December 31, 2021, and a 20% reduction from the amount outstanding at December 31, 2020. This reduction in exposure was due to additional reinsurance acquired, restructuring transactions, scheduled paydowns, and early terminations (calls, refundings and pre-refundings). While Ambac’s U.S. public finance portfolio consists predominantly of municipal bonds such as general obligation, revenue, and lease and tax-backed obligations of state and local government entities, the portfolio also includes several non-municipal types of bonds, such as financings for not-for-profit entities and transactions with public and private elements, which generally finance infrastructure, housing and other public interests. Municipal bonds are generally supported directly or indirectly by the issuer’s taxing authority or by public sector fees and assessments which may or may not be specifically pledged. Risk factors in these transactions derive from the municipal issuer, including its fiscal management, politics, and economic position, as well as its ability and willingness to continue to pay its debt service. Municipal bankruptcies and similar proceedings, while still relatively uncommon, have occurred, exposing Ambac to the risk of liquidity claims and ultimate losses if issuers cannot successfully adjust their liabilities without impairing creditors. Public/private transactions are generally structured to achieve their targeted public interest objective without direct support from the public sector. Some examples of this type of financing include affordable housing, private education, privatized military housing and student housing. Protections within these financings provided to Ambac usually include the strength of the financed asset’s essentiality and public purpose and may include financial covenants, collateral and control rights. Risk factors include financial underperformance, event risk and a shift in the asset’s mission or essentiality. One example of this type of financing is U.S. military housing. • Ambac insures approximately $5,490 net par of privatized military housing debt. The debt was issued to finance the construction and/or renovation of housing units for military personnel and their families on domestic U.S. military bases. Debt service is not directly paid or guaranteed by the U.S. Government. Rather, the bonds are serviced from the cash flow generated in most cases by rental payments deposited by the military directly into lockbox accounts as part of each service personnel’s Basic Allowance for Housing (BAH). In typically small percentages, rental payments can also come from civilians, including retired service personnel and US Department of Defense contractors living on a particular base. Collateral for these transactions includes the BAH payments as well as an interest in the ground lease. Risk factors affecting these transactions include ongoing base essentiality, military deployments, the U.S. government’s commitment to fund the BAH, marketability/attractiveness of the on-base housing units versus off-base housing, construction completion, environmental remediation, utility and other operating costs and housing management. Ambac's exposure to privatized military housing debt is a growing concentration given the long-dated maturity profile of the exposure relative to faster run-off of other parts of Ambac's insured portfolio. As of December 31, 2021, privatized military housing represented approximately 20% of net par outstanding. U.S. Structured Finance Portfolio Ambac’s portfolio of U.S. structured finance exposures is $4,904 in net par outstanding, representing 18% of Ambac’s net par outstanding as of December 31, 2021, and a 23% reduction from the amount outstanding at December 31, 2020. This reduction in exposure was primarily related to (i) residential mortgage-backed securities ("RMBS") policies, which continued to prepay as well as incur claims and (ii) quota share reinsurance of a structured insurance credit. Current insured exposures primarily include securitizations of mortgage loans, home equity loans and student loans, in each case where the majority of the underlying collateral risk is situated in the United States. At December 31, 2021, RMBS represented approximately 10% of net par outstanding. Structured finance securitization exposures generally entail three forms of risk: (i) asset risk, which relates to the amount and quality of the underlying assets; (ii) structural risk, which relates to the extent to which the transaction’s legal structure and credit support provide protection from loss; and (iii) servicer risk, which is the risk that poor performance at the servicer or manager level contributes to a decline in cash flow available to the transaction. AAC seeks to mitigate and manage these risks through its risk management practices. International Finance Insured Portfolio Ambac’s portfolio of international finance insured exposures is $10,756 in net par outstanding, representing 38% of Ambac’s net par outstanding as of December 31, 2021, and a 11% reduction from the amount outstanding at December 31, 2020. This reduction in exposure was primarily the result of scheduled maturities within investor-owned utilities, commutations and a strengthening of the US dollar versus the British pound and the Euro. Ambac’s international finance insured exposures include a wide array of obligations in the international markets, including infrastructure financings, utility obligations, whole business securitizations (e.g., securitizations of substantially all of the operating assets of a corporation) and sub-sovereign credits. At December 31, 2021, sub-sovereign and investor-owned and | Ambac Financial Group, Inc. 35 2021 FORM 10-K | Table of Contents public utilities represented approximately 18% and 12% of net par outstanding, respectively. Ambac has no insured exposure related to emerging markets. When underwriting transactions in the international markets, Ambac considered the specific risks related to the particular country and region that could impact the credit of the issuer. These risks include the legal and political environment, capital markets dynamics, foreign exchange issues and the degree of governmental support. Ambac continues to assess these risks through its ongoing risk management. Ambac UK, which is regulated in the United Kingdom (“UK”), had been AAC’s primary vehicle for directly issuing financial guarantee policies in the UK and the European Union with $10,292 net par outstanding at December 31, 2021. The portfolio of insured exposures underwritten by Ambac UK is financially supported exclusively by the assets of Ambac UK and no capital support arrangements are in place with any other Ambac affiliate. Ambac's international net par exposures are principally in the United Kingdom ($9,255); however, we also have exposures with credit risk based in various EU member states, including Austria, France, Germany and Italy ($1,284). Italy, with net par exposure of $718 in particular has experienced economic, fiscal and political strains since the 2008 global financial crisis such that the likelihood of default on an insured sub-sovereign obligation in that country is higher than when the policy was underwritten. Ambac does not guarantee any sovereign bonds of the above EU countries. Largest Insured Exposures: The table below shows Ambac’s ten largest exposures, by repayment source, as a percentage of total financial guarantee net par outstanding at December 31, 2021 (in millions): Risk Name Country-Bond Type Ambac Ratings (1) Ultimate Maturity Year Net Par Outstanding % of Total Net Par Outstanding IF AUK Capital Hospitals plc (2) UK-Infrastructure A- 2046 925 3.3 % IF AUK Anglian Water UK-Utility A- 2035 905 3.2 % IF AUK Mitchells & Butlers Finance plc-UK Pub Securitisation UK-Asset Securitizations BBB 2033 $ 892 3.2 % IF AUK Aspire Defence Finance plc UK-Infrastructure A- 2040 836 3.0 % IF AUK National Grid Gas UK-Utility BBB+ 2037 835 3.0 % IF AUK Posillipo Finance II S.r.l Italy-Sub-Sovereign BIG 2035 661 2.4 % PF AAC New Jersey Transportation Trust Fund Authority - Transportation System US-Lease and Tax-backed Revenue BBB- 2036 623 2.2 % IF AUK National Grid Electricity Transmission UK-Utility BBB+ 2036 557 2.0 % IF AUK RMPA Services plc UK-Infrastructure BBB+ 2038 550 2.0 % IF AUK Catalyst Healthcare (Manchester) Financing plc (2) UK-Infrastructure BBB- 2040 541 1.9 % Total $ 7,325 26.2 % PF = Public Finance, SF = Structured Finance, IF = International Finance AAC = Ambac Assurance, AUK = Ambac UK (1) Internal credit ratings are provided solely to indicate the underlying credit quality of guaranteed obligations based on the view of Ambac. In cases where Ambac has insured multiple tranches of an issue with varying internal ratings, or more than one obligation of an issuer with varying internal ratings, a weighted average rating is used. Ambac credit ratings are subject to revision at any time and do not constitute investment advice. BIG denotes credits deemed below investment grade. (2) A portion of this transaction is insured by an insurance policy issued by AAC. AAC has issued a policy for this transaction that will only pay in the event that Ambac UK does not pay under its insurance policies (“second to pay policy") Net par related to the top ten exposures reduced $394 from December 31, 2020. Exposures are impacted by changes in foreign exchange rates, certain indexation rates, scheduled and unscheduled paydowns and the purchase of quota share reinsurance. As a result of recent increases in inflation, such indexation exposures have increased at a faster pace than they have historically. The concentration of net par amongst the top ten (as a percentage of net par outstanding) increased slightly to 26.2% at December 31, 2021 from 22.9% at December 31, 2020. National Grid Gas had an Ambac rating downgrade since December 31, 2020, Excluding the top ten exposures, the remaining insured portfolio of financial guarantees has an average net par outstanding of $32 per single risk, with insured exposures ranging up to $455 and a median net par outstanding of $5. Given that Ambac has not written any new insurance policies since 2008, the risk exists that the insured portfolio becomes increasingly concentrated to large and/or below investment grade exposures. Puerto Rico We continue to experience stress in our exposure to Puerto Rico (the "Commonwealth") that consists of several different issuing entities (all below investment grade) with total net par exposure of $1,054 as of December 31, 2021. Each issuing entity has its own credit risk profile attributable to, as applicable, discrete revenue sources, direct general obligation pledges and/or general | Ambac Financial Group, Inc. 36 2021 FORM 10-K | Table of Contents obligation guarantees. Refer to Part I, Item 1 in this Annual Report on Form 10-K for additional information regarding the different issuing entities that encompass Ambac's exposures to Puerto Rico. Commonwealth Plan of Adjustment (Title III Case) On November 3, 2021, the Financial Oversight and Management Board for Puerto Rico ("Oversight Board"), as representative of the Commonwealth of Puerto Rico, the Puerto Rico Public Buildings Authority, and the Employees Retirement System of the Government of the Commonwealth of Puerto Rico, filed the Eighth Amended Title III Joint Plan of Adjustment of the Commonwealth of Puerto Rico, et al. ("Eighth Amended POA"). The Eighth Amended POA proposed to restructure approximately $33,000 of debt across various Commonwealth instrumentalities, including obligations insured by AAC, and approximately $50,000 in pension obligations. The Eighth Amended POA, among other things, incorporated the settlement reflected in the PRIFA Related Plan Support Agreement (“PRIFA PSA”) that was signed on July 27, 2021, by the Oversight Board, as representative of the Commonwealth of Puerto Rico, AAC, FGIC, and other holders of bonds issued by PRIFA. The Eighth Amended POA also incorporated the settlements reflected in the PRHTA/CCDA Related Plan Support Agreement (“PRHTA/CCDA PSA”) dated May 5, 2021, and the Amended and Restated Plan Support Agreement with the Oversight Board, as representative of the Commonwealth of Puerto Rico, PBA, and the Employee Retirement System of the Government of the Commonwealth of Puerto Rico ("Amended and Restated GO / PBA PSA") dated as of July 12, 2021. The plan consideration to be made available to creditors under these plan support agreements is described below. A hearing to confirm the Commonwealth’s plan of adjustment was held over several days between November 8, 2021. On January 10, 2022, Judge Laura Taylor Swain, U.S. District Court for the District of Puerto Rico, entered an order requesting certain changes to the Eighth Amended POA and related materials. None of the requested changes would substantively impact the contemplated recovery to Ambac and holders of AAC-insured bonds under the Eighth Amended POA. The Oversight Board filed a revised version of the plan and corresponding materials shortly thereafter. On January 18, 2022, Judge Swain confirmed the Eighth Amended POA. The Eighth Amended POA, together with the qualifying modifications for PRIFA and CCDA discussed below, are expected to have an effective date on before March 15, 2022. Certain parties have appealed from the order confirming the Eighth Amended POA and have sought a stay pending this appeal; if the stay is granted, the effective date may be delayed. The successful consummation of the Eighth Amended POA and qualifying modifications for PRIFA and CCDA on the effective date will represent a significant step towards resolution of AAC's remaining Puerto Rico exposure. PRIFA/CCDA Qualifying Modifications (Title VI Cases) The PRIFA PSA and PRHTA/CCDA PSA contain provisions requiring the parties thereto to support the terms of Title VI Qualifying Modifications for PRIFA and CCDA. On October 8, 2021, the Oversight Board commenced Title VI proceedings and filed applications for approval of the proposed PRIFA Qualifying Modification ("PRIFA QM") and CCDA Qualifying Modification ("CCDA QM"). The PRIFA QM and CCDA QM proposed to restructure about $1,900 and $384 of debt, respectively, including obligations insured by AAC. The hearing to consider approval of the PRIFA QM and the CCDA QM was held contemporaneously with the confirmation hearing in the Commonwealth’s Title III proceedings in November 2021. On January 20, 2022, Judge Swain approved the PRIFA QM and CCDA QM. The PRIFA QM and CCDA QM will share the same effective date as the Eighth Amended POA, which is expected to occur on or prior to March 15, 2022. As discussed above, this date may be delayed if a stay is granted pending the appeal of the Eighth Amended POA. PRHTA Plan of Adjustment (Title III Case) The Oversight Board, as Title III representative of the Puerto Rico Highways and Transportation Authority ("PRHTA"), is expected to file a Title III Plan of Adjustment for PRHTA ("PRHTA POA") prior to March 31, 2022. A confirmation hearing for the PRHTA POA is expected to follow later in 2022. Bondholder Elections: GO, PBA, PRIFA, and CCDA As outlined in the Election Notice for Ambac Bond Holders with Claims in Class 19 (the “GO Election Notice”) and the Election Notice for Ambac Bond Holders with Claims in Classes 4 and 26 (the “PBA Election Notice”), GO and PBA bondholders were each permitted to choose between two different treatment options for the satisfaction of their claims. The first option allows the bondholders to elect commutation of their insurance policies (the “Ambac Insurance Policies”). Under this option, bondholders will receive: 1) their respective shares of certain consideration available under the Commonwealth Plan, and 2) cash from Ambac. Ambac’s obligations to the bondholders under the Ambac Insurance Policies who elected this option will be deemed fully satisfied. Under the second option, bondholders who failed to elect commutation will receive payment, in cash, of the outstanding principal amount of the bondholders’ insured bonds plus the accrued and unpaid interest thereon as of the effective date (the “Ambac Acceleration Price.”), as adjusted for any payments already made by Ambac on account of the applicable Ambac Insurance Policies. Pursuant to this option, bondholders will receive the Ambac Acceleration Price in full and final discharge of Ambac’s obligations under the Ambac Insurance Policies. As outlined in the Election Notice for Holders of Ambac Insured PRIFA Bond Claims in Connection with Certain Capital Appreciation Bonds (the “PRIFA CABs Election Notice”), the Election Notice for Holders of Ambac Insured PRIFA Bond Claims in Connection with Certain Current Interest Bonds (the “PRIFA CIBs Election Notice”), and the Election Notice for Holders of Ambac Insured CCDA Bond Claims (the “CCDA Election Notice”), PRIFA and CCDA bondholders were each permitted to choose between two different treatment options for the satisfaction of their claims. The first option allows the bondholders to elect commutation of their Ambac Insurance Policies. Under the first option, bondholders will receive: 1) their respective shares of certain consideration available under | Ambac Financial Group, Inc. 37 2021 FORM 10-K | Table of Contents the Commonwealth Plan and the PRIFA QM, or CCDA QM, as applicable and 2) cash from Ambac. Bondholders who elected this option will receive this consideration in full and final discharge of Ambac’s obligations under the Ambac Insurance Policies. Under the second option, the bondholders’ respective shares of consideration available under the Commonwealth Plan and the PRIFA QM, or CCDA QM, as applicable, will be deposited into a trust. Those bondholders are expected to receive scheduled payments from this trust, unless Ambac elects, in its sole discretion, to pay all or a portion of the outstanding par amounts of the Ambac-insured bonds in such trust. The accelerated payments will satisfy Ambac's obligations under the applicable Ambac Insurance Policies. On the plan effective date, about 39% and 19% of the outstanding par of the Ambac-insured PRIFA and CCDA bonds, respectively, will be commuted with the remainder deposited into the trusts. Plan Support Agreements PRIFA PSA The PRIFA PSA reflects a July 14, 2021, agreement between the Oversight Board, AAC and FGIC to resolve claims related to bonds issued by PRIFA. Under the PRIFA PSA, PRIFA creditors will receive, on account of approximately $1,900 of allowed claims arising from PRIFA bonds, consideration in the form of (i) $193.5 cash and (ii) a contingent value instrument ("CVI") premised on outperformance of general fund rum tax collections relative to the certified 2021 Commonwealth Fiscal Plan's projections (the "Rum Tax CVI"). The Rum Tax CVI is subject to a lifetime nominal cap of about $1,300, and is also subject to various permitted rum tax waterfall deductions and caps on distributions, including the lesser of (a) 40% of cumulative outperformance (net of waterfall deductions), starting on July 1, 2021, less Rum Tax CVI payments made to PRIFA creditors in previous years, (b) 50% of annual rum tax outperformance (net of waterfall deductions), and (c) $30 annually. The Rum Tax CVI will be deposited into a master trust (the "CVI Master Trust") and into a sub trust (the "PRIFA CVI Sub Trust") within the CVI Master Trust for the benefit of PRIFA bondholders (the "PRIFA Trust"); the PRIFA CVI Sub Trust will also be funded with a share (approximately 27%) of the Clawback CVI, described below. The lifetime sum of the Rum Tax CVI and the Clawback CVI cannot exceed the $1,300 lifetime nominal cap (75% of allowed PRIFA claim) under the Eighth Amended POA. Further, under the PRIFA PSA, AAC and other creditors may also receive fees in connection with negotiating the PRIFA PSA and supporting the restructuring agreement reflected therein. The value of the PRIFA CVI Sub Trust is highly uncertain given the contingent, outperformance-driven structure of the CVIs coupled with the likely back-ended nature of most of the potential cash flows. Changes in our assumed values of the PRIFA CVI Sub Trust or the actual performance of the CVIs could cause an adverse change in our reserves which could be material. As a result, a decrease in our assumed values of the PRIFA CVI Sub Trust could have a material adverse impact on our results of operations and financial condition. PRHTA/CCDA PSA AAC signed a joinder to the PRHTA/CCDA PSA on July 15, 2021. The PRHTA/CCDA PSA, originally executed on May 5, 2021, provides for certain consideration for holders of bonds issued by certain Commonwealth instrumentalities, PRHTA, and CCDA on account of their claims against the Commonwealth arising from such bonds ("Clawback" claims). This consideration consists of a contingent value instrument tied to the outperformance of the Commonwealth's sales and use tax ("SUT") relative to the certified 2020 Commonwealth Fiscal Plan's projections (the "Clawback CVI"). For years one through 30, a portion of the Clawback CVI consideration reflects a 40% share of cumulative outperformance, starting July 1, 2021, subject to a combined 95% outperformance limit with the subsequently described amounts subject to a waterfall. The other portion of the Clawback CVI receives, on an annual basis, the lesser of (i) 50% of cumulative outperformance, less payments previously made, and (ii) 75% of annual outperformance, and is subject to a waterfall. The waterfall provides that, in years one through 22, (a) holders of general obligation ("GO") bonds will receive the first $100 of outperformance; (b) the Clawback creditors will receive the next $11.1; and (c) any amounts received thereafter will be split 90%/10% between GO creditors and Clawback creditors. In years 23 through 30, subject to the limits in (i) and (ii) above, 100% of the outperformance goes to the Clawback creditors. Overall, Clawback CVI recoveries are subject to a lifetime cap of 75% of allowed claim amounts under the Eighth Amended POA. PRHTA creditors will receive an approximately 69% share of the Clawback CVI, subject to a lifetime nominal cap of about $3,700, and subject to a PRHTA-specific waterfall: holders of PRHTA ’68 bonds will receive the first dollars of Clawback CVI, followed by holders of PRHTA ’98 bonds. CCDA bondholders will receive a 4% share of the Clawback CVI, subject to a lifetime nominal cap of about $217. The value of the Clawback CVI is highly uncertain, given the contingent, outperformance-driven structure of the instrument coupled with the likelihood that cash flows in later years (years 23 through 30) will significantly exceed those in earlier years. Changes in our assumed values of the Clawback CVI or in the actual performance of the Clawback CVI could cause an adverse change in our reserves which could be material. As a result, a significant decrease in our assumed values of the Clawback CVI could have a material adverse impact on our results of operations and financial condition. For example, a 1% change in the estimated value of the Clawback CVI plan consideration related to the AAC-insured PRIFA, CCDA and PRHTA bonds would have an impact of about $2 on reserves. Under the PRHTA/CCDA PSA, PRHTA bondholders will also receive new PRHTA bonds with a face amount of $1,245, maturities of up to 40 years and an average interest rate of 5.0%. Of the $1,245 in new bonds, approximately $646.4 will be allocated to holders of PRHTA '68 bonds and approximately $598.6 will be allocated to holders of PRHTA '98 bonds. PRHTA creditors will also share $389 of cash proceeds, including a $264 interim distribution, payable at the effective date of the Eighth Amended POA. In addition, certain restriction fees and consummation costs are payable at the effective date of the PRHTA POA. AAC will receive directly the pro rata share of the CW/PRHTA clawback recovery and interim PRHTA distributions allocable to its owned or insured PRHTA bonds. Of the $264 interim cash distribution, $184.8 would be allocated to holders of PRHTA ’68 bonds and $79.2 would be allocated to holders of PRHTA ’98 bonds. Claim recovery expectations for PRHTA creditors under the PRHTA/CCDA PSA are uncertain and subject to interpretation due to the aforementioned | Ambac Financial Group, Inc. 38 2021 FORM 10-K | Table of Contents uncertainty related to the value of and/or the actual performance of the Clawback CVI. Under the PRHTA/CCDA PSA, CCDA creditors will receive $112 of cash, inclusive of up to $15 related to restriction fees and consummation costs payable at the effective date of the Eighth Amended POA. Amended and Restated GO / PBA PSA On July 27, 2021, Ambac joined the July 12, 2021, Amended and Restated Plan Support Agreement with the Oversight Board, as representative of the Commonwealth of Puerto Rico, PBA, and the Employee Retirement System of the Government of the Commonwealth of Puerto Rico ("Amended and Restated GO / PBA PSA"). In general, this PSA follows the Second Amended GO/PBA PSA, originally signed on February 23, 2021. Under the Amended GO/PBA PSA, creditors will receive up to $7,024 of cash, of which up to $350 was contingent upon FY2021 revenue outperformance exceeding $350 on a dollar-for-dollar basis, $6,683 of new GO current interest bonds, $443 of new GO 5.375% capital appreciation bonds, $288 of new GO 5.00% capital appreciation bonds, and GO Bond CVI, subject to a lifetime cap of about $3,500. The GO Bond CVI is intended to provide creditors with additional returns tied to outperformance of the SUT against the certified 2020 Commonwealth Fiscal Plan's projections. The value of the GO Bond CVI is highly uncertain, given the contingent, outperformance-driven structure of the instrument Recovery derived from fixed consideration (i.e., excluding GO Bond CVI) is estimated to vary between approximately 67% and 77% (as of the petition date) for GO creditors, and between approximately 75% and 80% (as of the petition date) for PBA creditors. Under the Amended and Restated GO/PBA PSA, in exchange for executing the agreement and agreeing to its terms and conditions, creditors that were authorized to vote their claim will receive a PSA restriction fee of 1.32% of their claim amount at the effective date of the Eighth Amended POA. The Amended and Restated GO/PBA PSA was further amended to allow for additional time to consummate the Eighth Amended POA (i.e., relevant deadlines therein extended from January 31, 2022 to March 15, 2022). Plan of Adjustment and Qualifying Modification Considerations The Eighth Amended POA has been confirmed, and the PRIFA QM and the CCDA QM have been approved. All are expected to become effective on or before March 15, 2022. However, uncertainty remains as to (i) whether the effective date will be stayed pending the appeal of the order confirming Eighth Amended POA; (ii) the result of the pending First Circuit appeal of the order confirming the Eighth Amended POA; (iii) the value or perceived value of the consideration provided by or on behalf of the debtors under the Eighth Amended POA, PRIFA QM, and CCDA QM; (iv) the extent to which exposure management strategies, such as commutation and acceleration, will be executed; (v) the tax treatment of the consideration provided by or on behalf of the debtors under the Eighth Amended POA, PRIFA QM, and CCDA QM; (vi) whether and when the PRHTA POA will be confirmed; and (vii) other factors, including market conditions such as interest rate movements, credit spread changes on the new GO and CVI instruments, and liquidity for the new GO and CVI instruments. Ambac’s loss reserves may prove to be understated or overstated, possibly materially, due to favorable or unfavorable developments or results with respect to these factors. Refer to Management's Discussion and Analysis of Financial Condition and Results of Operations - Balance Sheet to the Unaudited Consolidated Financial Statements included in Part I, Item 2 in this Form 10-Q for the possible increase in loss reserves under stress or other adverse conditions. There can be no assurance that losses may not exceed such estimates. Ambac Title III Litigation Update AAC is party to a number of litigations related to its Puerto Rico exposures, and actively participates in the Commonwealth’s Title III proceedings before the United States District Court for the District of Puerto Rico. In connection with the July 27, 2021 PRIFA PSA, Ambac filed an urgent motion to stay various pending matters related to outstanding litigation in connection with the Commonwealth's Title III proceedings. On August 3, 2021, the Court entered an order staying the requested matters. While confirmation of the Eighth Amended POA and approval of the PRIFA QM and CCDA QM resolve many of the issues raised in the pending matters, the Court’s order confirming the Eighth Amended POA are now subject to appeal. AAC continues to actively participate in PRHTA’s Title III proceedings. Refer to Note 19. Commitments and Contingencies to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K for further information about Ambac's litigation relating to Puerto Rico. Summary Ambac has considered these developments and other factors in evaluating its Puerto Rico loss reserves. While management believes its reserves are adequate to cover losses in its Public Finance insured portfolio, there can be no assurance that Ambac may not incur additional losses in the future, particularly given the developing economic, political, and legal circumstances in Puerto Rico. Such additional losses may have a material adverse effect on Ambac’s results of operations and financial condition. Due to uncertainty regarding numerous factors, described above, that will ultimately determine the extent of Ambac's losses, it is also possible that favorable developments and results with respect to such factors may cause losses to be lower than current reserves, possibly materially. | Ambac Financial Group, Inc. 39 2021 FORM 10-K | Table of Contents The following table outlines Ambac's insured exposure to each Commonwealth of Puerto Rico issuer. ($ in millions) Range of Maturity Ambac Ratings (1) Net Par Outstanding Net Par and Interest Outstanding (2)(4) Ever-to-Date Net Claims Paid (3) PR Infrastructure Financing Authority (Special Tax Revenue) 2023-2044 BIG $ 403 $ 872 $ 202 PR Highways and Transportation Authority (1998 Resolution - Senior Lien Transportation Revenue) 2022-2042 BIG 394 620 164 PR Convention Center District Authority (Hotel Occupancy Tax) 2028-2031 BIG 86 123 72 PR Public Buildings Authority - Guaranteed by the Commonwealth of Puerto Rico 2022-2035 BIG 83 139 96 PR Sales Tax Financing Corporation - Senior Sales Tax Revenue (COFINA) 2047-2054 BIG 73 648 37 Commonwealth of Puerto Rico - General Obligation Bonds 2022-2023 BIG 11 12 56 PR Highways and Transportation Authority (1968 Resolution - Highway Revenue) 2022-2027 BIG 4 9 25 Total Net Exposure to The Commonwealth of Puerto Rico and Related Entities $ 1,054 $ 2,423 $ 652 (1) Internal credit ratings are provided solely to indicate the underlying credit quality of guaranteed obligations based on the view of Ambac. In cases where Ambac has insured multiple tranches of an issue with varying internal ratings, or more than one obligation of an issuer with varying internal ratings, a weighted average rating is used. Ambac credit ratings are subject to revision at any time and do not constitute investment advice. BIG denotes credits deemed below investment grade. . (2) Net Par and Interest Outstanding ("P&I") represent the total insured future debt service remaining over the lifetime of the bonds. P&I for capital appreciation bonds does not represent the accreted amount but rather the amount due at respective maturity dates. (3) In addition to ever-to-date net claims paid, Ambac made net claim payments of $23 in January 2022. (4) Net Par and Interest Outstanding excludes the effects of a 10% current interest rate on $60 net par of PR Public Buildings Authority ("PBA") bonds with a maturity date of July 1, 2035, resulting from the absence of a remarketing. Should a remarketing not occur before the maturity of the bonds, the Net Par and Interest Outstanding for PBA exposure would increase by $37. Additional Insured Portfolio Information Average Life of Insured Portfolio Ambac estimates that the average life of its guarantees on par in force at December 31, 2021 is approximately 10 years. The average life is determined by applying a weighted average calculation, using the remaining years to expected maturity of each guaranteed bond, and weighting them on the basis of the remaining net par guaranteed. Except for RMBS policies, no assumptions are made for non-contractual reductions, refundings or terminations of insured issues. RMBS policies incorporate assumptions on expected prepayments over the remaining life of the insured obligation. The following table depicts amortization of existing guaranteed net par outstanding: Net Par Outstanding Amortization (1) ($ in millions) Estimated Net Amortization 2022 $ 2,395 2023 1,584 2024 1,814 2025 1,468 2026 1,385 2022-2026 $ 8,646 2027-2031 6,131 2032-2036 6,817 2037-2041 3,544 After 2041 2,882 Total $ 28,020 (1) Depicts amortization of existing guaranteed portfolio, assuming no advance refundings, as of December 31, 2021. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay guaranteed obligations. | Ambac Financial Group, Inc. 40 2021 FORM 10-K | Table of Contents Exposure Currency The table below shows the distribution by currency of Ambac's existing guaranteed net par outstanding as of December 31, 2021: Currency ($ in millions) Net Par Amount Outstanding in Base Currency Net Par Amount Outstanding in U.S. Dollars Percentage of Net Par Amount Outstanding U.S. Dollars $ 17,497 $ 17,497 62 % British Pounds £ 6,690 9,054 32 % Euros € 1,113 1,267 5 % Australian Dollars A$ 279 202 1 % Total $ 28,020 100 % See Note 6. Financial Guarantees in Force to the Consolidated Financial Statements, included in Part II, Item 8 included in this Form 10-K, for geographic detail by location of risk as of December 31, 2021. Ratings Distribution The following charts provide a rating distribution of existing net par outstanding based upon internal Ambac credit ratings at December 31, 2021 and 2020 and a distribution of Ambac's below investment grade ("BIG") net par exposures at December 31, 2021 and 2020. BIG is defined as those exposures with an internal credit rating below BBB-: Note: AAA is less than 1% in both periods. (1) Internal credit ratings are provided solely to indicate the underlying credit quality of guaranteed obligations based on the view of Ambac. In cases where Ambac has insured multiple tranches of an issue with varying internal ratings, or more than one obligation of an issuer with varying internal ratings, a weighted average rating is used. Ambac credit ratings are subject to revision at any time and do not constitute investment advice. Summary of Below Investment Grade Exposure: Bond Type ($ in millions) Net Par Outstanding December 31, 2021 2020 Public Finance: Puerto Rico $ 1,054 $ 1,070 Military Housing 370 308 Other 317 1,057 Total Public Finance 1,741 2,435 Structured Finance: RMBS 2,170 2,800 Student loans 302 512 Total Structured Finance 2,472 3,312 International Finance: Sovereign/sub-sovereign 774 742 Transportation 389 760 Other 62 72 Total International Finance 1,225 1,574 Total $ 5,438 $ 7,321 The net decline in below investment grade exposures is primarily due to de-risking activities. Below investment grade exposures could increase as a relative proportion of the guarantee portfolio given that stressed borrowers generally have less ability to prepay or refinance their debt. Accordingly, due to these and other factors, it is not unreasonable to expect the proportion of below investment grade exposure in the guarantee portfolio to continue to increase in the future. Ceded Reinsurance AAC has reinsurance in place pursuant to surplus share treaties and facultative agreements. As a primary financial guarantor, AAC is required to honor its obligations to its policyholders whether or not its reinsurers perform their obligations under these reinsurance agreements. As of December 31, 2021, the aggregate amount of insured par ceded by AAC to reinsurers under reinsurance agreements was $6,102, with the largest reinsurer accounting for $2,695 or 7.9% of gross par outstanding at December 31, 2021. | Ambac Financial Group, Inc. 41 2021 FORM 10-K | Table of Contents The following table shows the distribution, by bond type, of AAC’s ceded guaranteed portfolio at December 31, 2021: Bond Type ($ in millions) Ceded Par Amount Outstanding December 31, 2021 2020 Public Finance: Lease and tax-backed revenue $ 1,618 $ 1,156 General obligation 1,458 1,327 Housing revenue 922 934 Transportation revenue 749 586 Other 612 509 Total Public Finance 5,359 4,512 Structured Finance: Structured insurance 313 115 Investor-owned utilities 222 224 Other 185 280 Total Structured Finance 720 619 Total Domestic 6,079 5,131 International Finance: Total International Finance 23 51 Total $ 6,102 $ 5,182 Percentage of Gross Par Ceded 18 % 13 % RESULTS OF OPERATIONS ($ in millions) The following discussion should be read along with the financial statements included in this Form 10-K, as well as Part II, "Item 7, Management's Discussion and Analysis's of Financial Condition and Results of Operations" of our Form 10-K for the year ended December 31, 2020, which provides additional information on comparisons of years 2020 and 2019. Net loss attributable to common stockholders for the year ended December 31, 2021, was $17 compared to a net loss attributable to common stockholders of $437 for the year ended December 31, 2020. The decrease in losses was primarily driven by: (i) lower loss and loss expenses, (ii) net gains on derivative contracts, (iii) a $33 net gain on extinguishment of debt in 2021, (iv) higher investment income and (v) lower interest expense, partially offset by higher operating and tax expenses. A summary of our financial results is shown below: ($ in millions) Year Ended December 31, 2021 2020 2019 Revenues: Net premiums earned $ 47 $ 54 $ 66 Net investment income 139 122 227 Net investment gains (losses), including impairments 7 22 81 Net gains (losses) on derivative contracts 22 (50) (50) Net realized gains (losses) on extinguishment of debt 33 — — Other income (expense) (1) 27 3 134 Income (loss) on variable interest entities 7 5 38 Expenses: Losses and loss expenses (benefit) (88) 225 13 Intangible amortization 55 57 295 Operating expenses 126 92 103 Interest expense 187 222 269 Provision (benefit) for income taxes 18 (3) 32 Net income (loss) (16) (437) (216) Net income (loss) attributable to common stockholders $ (17) $ (437) $ (216) (1) 2019 includes proceeds received in connection with an SEC action against Citigroup Global Markets Inc. in the amount of $142. Ambac's 2020 results of operations and financial position were adversely impacted by the COVID-19 pandemic's effect on the global economy and financial markets. Significant interest rate declines during the first quarter of 2020 contributed materially to a net increase in loss reserves and losses on interest rate derivative contracts for the year ended December 31, 2020. Financial market disruptions were reflected through lower valuations of certain fixed maturity securities (recorded through other comprehensive income) and the majority of other investments (recorded through net investment income). During the second half of 2020 and into 2021, valuations recovered (favorably impacting counterparty credit adjustments on derivative assets and valuations of investment securities). The scope, duration and magnitude of the direct and indirect effects of COVID-19 are evolving in ways that are difficult or impossible to anticipate. As a result, it is possible that Ambac's results of operations and financial condition may be further adversely affected by the evolving effects of the COVID-19 pandemic. For additional information on the risks posed by COVID-19, refer to “Part I, Item 1A-Risk Factors” in this Form 10-K. | Ambac Financial Group, Inc. 42 2021 FORM 10-K | Table of Contents The following paragraphs describe the consolidated results of operations of Ambac for 2021 and 2020. Net Premiums Earned. Net premiums earned for the year ended December 31, 2021, decreased by $7 or 13% as compared to net premiums earned for the year ended December 31, 2020. The decline was driven by reductions in FG premiums earned partially offset by $1 of specialty property and casualty net premiums earned. Net premiums earned for FG were impacted by the runoff of the financial guarantee insured portfolio, including through transaction terminations, calls and scheduled maturities, which reduce current and future net premiums earned and were also impacted by the following: • Changes to the allowance for credit losses on the premium receivable asset. The impact on net premiums earned related to credit losses amounted to $6 and $(5) for the for the years ended December 31, 2021 and 2020. • Accelerated financial guarantee premium earnings as a result of calls and other accelerations on insured obligations largely due to de-risking activity of $1 and $12 for the for the years ended December 31, 2021 and 2020. • New financial guarantee ceded reinsurance which reduces normal net premiums earned over the remaining period of the related ceded policies. • The strengthening or weakening of the U.S. dollar relative to the British Pound since Ambac's wholly-owned UK subsidiary, Ambac UK, operates in the United Kingdom and the British Pound is its functional currency. Net Investment Income. Net investment income primarily consists of interest and net discount accretion on fixed maturity securities classified as available-for-sale, and net gains (losses) on pooled investment funds which include changes in fair value of the funds' net assets. Fixed maturity securities include investments in Ambac-insured securities that are made opportunistically based on their risk/reward and asset-liability management characteristics. Investments in pooled investment funds and certain other investments are either classified as trading securities with changes in fair value recognized in earnings or are reported under the equity method. These funds and other investments are reported in Other investments on the Consolidated Balance Sheets. For further information about investment funds held, refer to Note 4. Investments to the Consolidated Financial Statements, included in this Annual Report on Form 10-K. Net investment income from Ambac-insured securities, available-for-sale and short-term securities other than Ambac-insured and Other investments is summarized in the table below: ($ in millions) Year Ended December 31, 2021 2020 2019 Securities available-for-sale: Ambac-insured (including LSNI and Sitka Senior Secured Notes) $ 45 $ 62 $ 121 Securities available-for-sale and short-term other than Ambac-insured 29 41 75 Other investments (includes trading securities) 66 19 32 Net investment income $ 139 $ 122 $ 227 Net investment income increased $18 for the year ended December 31, 2021, compared to 2020. As described further below, the variance was primarily driven by 2020 pricing volatility within fund investments resulting from the impact of the COVID-19 pandemic on financial markets and the impact of the LSNI Secured Note redemption in July 2021. • Investment income from Ambac-insured securities decreased $17 in 2021, compared to 2020, due to lower income on LSNI Secured Notes. As described in Note 1. Background and Business Description, to the Consolidated Financial Statements, included in this Annual Report on Form 10-K, on July 6, 2021, the LSNI Secured Notes were fully redeemed, including those held in Ambac's investment portfolio. Investment income from other Ambac-insured securities, primarily consisting of RMBS and Puerto Rico bonds, was flat compared to 2020. • Net investment income from available-for-sales securities other than Ambac-insured securities decreased $12 in 2021, compared to the prior year, reflecting a smaller asset base and lower average yields. Portfolio repositioning during 2021 and 2020, resulted in a higher allocation of pooled funds and Ambac-insured Puerto Rico bonds, while reinvestment in non-insured available-for-sale securities were generally at lower yields. Short term rates also remained low throughout 2021, adversely impacting investment income. Additionally, the use of cash for early debt redemptions and operating cash needs contributed to the smaller asset base. • Other investments income increased $47 in 2021, compared to the prior year. The increase resulted from overall positive performance in 2021 and additional investments, particularly in hedge and equity funds. Relatively low returns in 2020 were driven by adverse changes in fair values as a consequence of the initial economic and financial market impact of the COVID-19 pandemic in the first quarter, offset by a generally strong market recovery in subsequent quarters of 2020. | Ambac Financial Group, Inc. 43 2021 FORM 10-K | Table of Contents Net Investment Gains (Losses), including Impairments. The following table provides a breakdown of net investment gains, for the periods presented: ($ in millions) Year Ended December 31, 2021 2020 2019 Net realized gains on securities sold or called $ 11 $ 26 $ 59 Foreign exchange gains (losses) (5) (4) 22 Credit impairment — — — Intent / requirement to sell impairments — — — Total net investment gains, including impairments $ 7 $ 22 $ 81 Net investment gains on securities sold or called during the year ended December 31, 2021, included a gain of $4 realized on the sale of AFG's equity interest in the Corolla Trust in connection with the Corolla Exchange Transaction. Other net realized gains on securities sold or called in 2021 and 2020 are primarily from sales in connection with routine portfolio management. Impairments are reported through earnings if management intends to sell securities or it is more likely than not that the Company will be required to sell before recovery of amortized cost. Credit impairments are recorded in earnings only to the extent management does not intend to sell, and it is not more likely than not that the Company will be required to sell the securities, before recovery of their amortized cost. When credit impairments are recorded, any non-credit related impairment amounts on the securities are recorded in other comprehensive income. Net Gains (Losses) on Derivative Contracts. Net gains (losses) on derivative contracts includes result from the Company's interest rate derivatives portfolio and its runoff credit derivative portfolio. The interest rate derivatives portfolio is positioned to benefit from rising rates as a partial economic hedge against interest rate exposure in the financial guarantee and investment portfolios. Net gain (loss) on interest rate derivatives generally 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 credit derivatives were not significant to the periods presented. • Net gains on interest rate derivatives for the year ended December 31, 2021, were $22, compared to a net losses of $50 for the year ended December 31, 2020. The net gain for the year ended December 31, 2021, resulted from the impact of rising interest rates and gains related to counterparty credit adjustments partially offset by the carrying cost of maintaining the economic hedge position. The net loss for the year ended December 31, 2020, reflects significant declines in forward interest rates, triggered by the COVID-19 pandemic, and losses from the application of counterparty credit adjustments, described further below. • Counterparty credit adjustments are generally applicable for uncollateralized derivative assets that may not be offset by derivative liabilities under a master netting agreement. Inclusion of counterparty credit adjustments in the valuation of interest rate derivatives resulted in gains (losses) within Net gains (losses) on derivative contracts of $5 and $(6) for the years ended December 31, 2021 and 2020, respectively. The gain for the year ended December 31, 2021, resulted from the decrease in underlying net asset values as interest rates increased. The loss in 2020 was driven by wider credit spreads reflecting the credit rating downgrade of a derivative counterparty by Ambac during the first quarter, simultaneous with an increase in the underlying asset values as interest rates declined. Other Income (Expense). Other income (expense) includes commission revenues of Xchange, ceding fees from the specialty property and casualty business, various financial guarantee fees and foreign exchange gains / (losses) unrelated to investments or loss reserves. For the year ended December 31, 2021, other income includes Xchange revenues of $26. Xchange pays commissions to sub-producers which are included in operating expenses. Net Realized Gains on Extinguishment of Debt . Net realized gains on extinguishment of debt was $33 for the year ended December 31, 2021, resulting from the first quarter 2021 exchanges of junior surplus notes below their carrying values. Refer to Note 1. Background and Business Description to the Consolidated Financial Statements, included in this Annual Report on Form 10-K, for further discussion of the 2021 Surplus Notes Exchanges. Income (Loss) on Variable Interest Entities. Included within Income (loss) on variable interest entities are income statement amounts relating to 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 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, assets and liabilities of the VIEs are initially reported at fair value and the related insurance assets and liabilities are eliminated. However, the amount of VIE net assets (liabilities) that remain in consolidation generally result from the net positive (negative) projected 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. In the case of VIEs with net negative projected cash flows, the net liability is generally to be 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 VIE’s 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 VIE and Ambac could result in gains or losses, even if such policy changes do not result in deconsolidation of the VIE. Income (loss) on variable interest entities was $7 and $5 for the years ended December 31, 2021 and 2020, respectively. Results for the year ended December 31, 2021, were driven by the | Ambac Financial Group, Inc. 44 2021 FORM 10-K | Table of Contents higher valuation of net assets on VIEs, together with realized gains of $2 on sales of assets from the COFINA Trust. Results for the year ended December 31, 2020, were due to realized gains of $8 on sales of assets from the COFINA Trust partially offset by the lower valuation of net assets on a VIE impacted by COVID-19. 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. Losses and Loss Expenses (Benefit). Losses and loss expenses include the financial guarantee and specialty property and casualty businesses. Ambac records as a component of its loss reserve estimate subrogation recoveries related to securitized loans in RMBS transactions with respect to which AAC is pursuing claims for breaches of representations and warranties. Ambac does not include potential recoveries attributed solely to fraudulent inducement claims in our litigations in our estimate of subrogation recoveries. Nor does Ambac include potential recoveries attributable to pre-judgment interest in the estimate of subrogation recoveries. Generally, the sponsor of an RMBS transaction provided representations and warranties with respect to the securitized loans, including representations with respect to the loan characteristics, the absence of borrower misrepresentations in the underlying loan pools or other misconduct in the origination process and attesting to the compliance of loans with the applicable underwriting guidelines. Ambac has recorded R&W subrogation recoveries, net of reinsurance, of $1,704 and $1,725 at December 31, 2021 and 2020, respectively. The decrease in these recoveries was primarily driven by lower projected losses. Refer to Note 2. Basis of Presentation and Significant Accounting Policies to the Consolidated Financial Statements included in Part II, Item 8 in this Annual Report on Form 10-K for more information regarding the estimation process for R&W subrogation recoveries. The following table provides details, by bond type, for losses and loss expenses (benefit) incurred for the periods presented: ($ in millions) Year Ended December 31, 2021 2020 2019 Structured Finance (1) $ (20) $ (52) $ (111) Domestic Public Finance (73) 256 250 Other (2) 4 21 (127) Totals (3) $ (88) $ 225 $ 13 (1) The loss and loss expense (benefit) associated with changes in estimated representation and warranties for the year ended December 31, 2021, 2020 and 2019 was $20, ($23) and $42, respectively. (2) Includes specialty property and casualty loss and loss expenses incurred of less than $1 for the year ended December 31, 2021. (3) Includes loss expenses incurred of $55, $103 and $78 for the year ended December 31, 2021, 2020 and 2019, respectively. Losses and loss expenses for 2021 were largely driven by favorable loss development in domestic public finance, primarily related to Puerto Rico, and structured finance, primarily related to improved credit in RMBS , partially offset by the negative impact of discount rates , and loss expenses incurred. Losses and loss expenses for 2020 were driven by higher projected losses in domestic public finance, largely Puerto Rico; partially offset by improved Structured Finance losses as a result of the positive impact of lower interest rates on excess spread, reduced by lower discount rates and expected losses from COVID-19 related delinquencies. Intangible Amortization. Insurance intangible amortization was $52 and $57 for the years ended December 31, 2021 and 2020, respectively. The decrease in amortization for the year ended December 31, 2021, compared to 2020, is primarily due to run-off of the insured portfolio and de-risking activity. Other intangible amortization for the year ended December 31, 2021 was $3. Operating Expenses. Operating expenses consist of gross operating expenses plus reinsurance commissions. The following table provides a summary of operating expenses for the periods presented: ($ in millions) Year Ended December 31, 2021 2020 2019 Compensation $ 62 $ 51 $ 58 Non-compensation 64 41 44 Gross operating expenses 126 92 103 Reinsurance commissions, net — — — Total operating expenses $ 126 $ 92 $ 103 Gross operating expenses for the year ended December 31, 2021 are $126, an increase of $34 from gross operating expenses for the year ended December 31, 2020. The increase was primarily due to the following: • Higher compensation costs primarily due to: (i) hiring in connection with the launch of Everspan offset by continued right sizing of staff levels, (ii) inclusion of Xchange costs of $4 and (iii) the impact of performance factors on incentive compensation. • Higher non-compensation costs primarily due to: (i) inclusion of Xchange costs of $16, mainly from producer commissions of $15, (ii) launch of Everspan, and (iii) increased legal fees. Legal and consulting services provided for the benefit of OCI were flat at $2 during the years ended December 31, 2021 and 2020. Interest Expense. Interest expense includes accrued interest on the LSNI Ambac Note (as defined in Note 1. Background and Business Description to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K), Sitka AAC Note, Tier 2 Notes, Surplus Notes and other debt obligations. Additionally, interest expense includes discount accretion when the debt instrument carrying value is at a discount to par. The following table provides details by type of obligation for the periods presented: | Ambac Financial Group, Inc. 45 2021 FORM 10-K | Table of Contents ($ in millions) Year Ended December 31, 2021 2020 2019 Surplus Notes (1) $ 77 $ 85 $ 99 LSNI Ambac Note 50 107 143 Sitka AAC Note 32 — — Tier 2 Notes 27 28 26 Other 1 1 — Total interest expense $ 187 $ 222 $ 269 (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, 2021, compared to the year ended December 31, 2020, reflects the impacts of the Secured Note Refinancing and 2021 Surplus Note Exchanges, described further in Note 1. Background and Business Description to the Consolidated Financial Statements, included in this Annual Report on Form 10-K. These transactions resulted in lower debt outstanding and a lower coupon interest rate on the Sitka AAC Note relative to the LSNI Ambac Note. Interest expense for 2021 also declined as a result of the Tier 2 Note fully accreting through interest expense by December 31, 2020. These benefits were partially offset by the effects of interest compounding on surplus notes and the Tier 2 Notes. Surplus Note principal and interest payments require the approval of OCI. In May 2021, OCI declined the request of AAC to pay the principal amount of the Surplus Notes, plus all accrued and unpaid interest thereon, on the scheduled payment date of June 7, 2021. As a result, the scheduled payment date for interest, and the scheduled maturity date for payment of principal of the Surplus Notes, was extended and shall continue to be 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 were $576 at December 31, 2021. 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 Surplus Note principal and interest payments will be made, if ever. If OCI does not approve regular payments on Surplus Notes within the next several years, the total amount due for Surplus Notes may exceed AAC's financial resources and holders of Surplus Notes may not ever be paid in full. Provision for Income Taxes. The provision for income taxes for the year ended December 31, 2021 and 2020, was a expense of $18 and a benefit of $3, respectively. Income taxes for the year ended December 31, 2021 and 2020, includes provisions for income tax due in respect of Ambac UK of $16 and $(3), respectively. At December 31, 2021, the Company had approximately $3,744 of U.S. Federal net ordinary operating loss carryforwards, including approximately $1,596 at AFG and $2,148 at AAC. LIQUIDITY AND CAPITAL RESOURCES ($ in millions) Liquidity is a measure of a company’s ability to generate sufficient cash to meet the cash requirements of its business operations and to satisfy general corporate obligations. Holding Company Liquidity AFG is organized as a legal entity separate and distinct from its operating subsidiaries. AFG is a holding company with no outstanding debt. AFG’s liquidity is primarily dependent on its net assets, excluding its equity investments in subsidiaries, totaling $269 as of December 31, 2021, of which $142 is considered highly liquid, and secondarily on distributions and expense sharing payments from its subsidiaries. AFG's investments include securities directly and indirectly issued and/or insured by AAC, some of which are eliminated in consolidation. Securities issued or insured by AAC and certain other of AFG's investments are generally less liquid than investment grade and highly traded investments. • During 2021, AFG received distributions from Xchange of $6. • Under an inter-company cost allocation agreement, AFG is reimbursed by AAC for a portion of certain operating costs and expenses and, if approved by OCI, entitled to an additional payment of up to $4 per year to cover expenses not otherwise reimbursed. The $4 reimbursement for 2020 expenses was approved (by OCI) and paid (by AAC) in April 2021. It is highly unlikely that AAC will be able to make dividend payments to AFG for the foreseeable future or that Everspan will be able to make dividend payments to AFG for several years, and therefore cash and investments, payments under the intercompany cost allocation agreement and distributions from Xchange will be AFG’s principal sources of liquidity in the near term. Refer to Part I, Item 1, “Insurance Regulatory Matters — Dividend Restrictions, Including Contractual Restrictions” in this Annual Report on Form 10-K, and Note 8. Insurance Regulatory Restrictions to the Consolidated Financial Statements included in Part II, Item 8, in this Annual Report on Form 10-K, for more information on dividend payment restrictions. The principal uses of liquidity are the payment of operating expenses, including costs to explore opportunities to grow and diversify Ambac; the making of strategic investments, which may include illiquid investments; and capital investments to acquire, grow and/or capitalize new and/or existing businesses. AFG may also provide short-term financial support, primarily in the form of loans, to its operating subsidiaries to support their operating requirements. Contingencies could cause material liquidity strains. • AFG supported the development of the Specialty P&C business, and its acquisitions, by contributing capital to | Ambac Financial Group, Inc. 46 2021 FORM 10-K | Table of Contents Everspan Indemnity of approximately $92 and $6 in 2021 and the first quarter of 2022, respectively. In the opinion of the Company’s management the net assets of AFG are sufficient to meet AFG’s current liquidity requirements. However, events or circumstances could arise that may cause AFG to seek additional capital. Operating Companies' Liquidity Insurance: The liquidity requirements of the Company’s insurance subsidiaries are met primarily by funds generated from premiums; recoveries on claim payments, including RMBS representation and warranty subrogation recoveries (AAC only); reinsurance recoveries; fees; investment income and maturities and sales of investments. • Our ability to realize RMBS representation and warranty subrogation recoveries is subject to significant uncertainty, including risks inherent in litigation, such as adverse rulings or decisions in our cases or in litigations to which AAC is not a party that set precedents or resolve questions of law that impact our own claims; collectability of such amounts from counterparties (and/or their respective parents and affiliates); timing of receipt of any such recoveries, including uncertainty due to delays in court proceedings; intervention by the OCI, which could impede our ability to take actions required to realize such recoveries; and uncertainty inherent in the assumptions used in estimating the amount of such recoveries. The amount of these subrogation recoveries is significant and if AAC is unable to recover any amounts or recovers materially less than estimated recoveries, its future available liquidity to pay claims, debt service and meet other obligations would be materially adversely impacted. See Part I, Item 1A. Risk Factors in this Annual Report on Form 10-K for more information about risks relating to RMBS R&W subrogation recoveries. • See Note 7. Insurance Contracts to the Consolidated Financial Statements included in Part II, Item 8, in this Annual Report on Form 10-K for a summary of future gross financial guarantee premiums to be collected by AAC and Ambac UK. Termination of financial guarantee policies on an accelerated basis may adversely impact AAC’s liquidity. Cash provided from these sources is used primarily for claim payments and commutations, loss expenses and acquisition costs, debt service on outstanding debt (AAC only), operating expenses, reinsurance payments and purchases of securities and other investments that may not be immediately converted into cash. • Although AAC has not yet experienced incremental claim payments as a result of the impact of COVID-19, such claims may occur in the future as issuers, particularly those with revenues that have been interrupted by the effects of the pandemic, may not have sufficient resources to pay debt service on insured debt. Refer to "Executive Summary" in this Management's Discussion and Analysis for further discussion of the potential impact of the COVID-19 pandemic. See below within this Management Discussion and Analysis in the section titled "Balance Sheet" for the expected future financial guarantee claim payments, gross of expected recoveries. • Interest and principal payments on surplus notes are subject to the approval of OCI, which has full discretion over payments regardless of the liquidity position of AAC. Any such payment on surplus notes would require either payment or collateralization of a portion of the Tier 2 Notes under the terms of the Tier 2 Note indenture. As discussed more fully in "Results of Operations" above in this Management's Discussion and Analysis, OCI declined AAC's request to pay the principal amount of the surplus notes, plus all accrued and unpaid interest thereon, on June 7, 2021. See Note 12. Long-term Debt to the Consolidated Financial Statements, included in Part II, Item 8 in this Form 10-K for further discussion of the payment terms and conditions of the Tier 2 Notes as well as the aggregate annual maturities of all debt outstanding. In addition to principal amounts of $2,334 as of December 31, 2021 with various maturities as described in Note 12. Long-term Debt to the Consolidated Financial Statements, included in Part II, Item 8 in this Form 10-K, AAC's future interest obligations include $62 annually on the Sitka AAC Note through maturity on July 6, 2026, $605 of accrued and unpaid interest that would be payable on surplus notes if approved by OCI on the next scheduled payment date of June 7, 2022, and Tier 2 Note interest that may be paid-in-kind until maturity on February 12, 2055 at which time $5,060 would be due. • Ambac is the lessee in operating leases for corporate offices, a data center and various equipment. See Note 18. Leases to the Consolidated Financial Statements included in Part II, Item 8, in this Annual Report on Form 10-K, for a scheduled future undiscounted lease payments, gross of sublease receipts. • AAC lends its wholly-owned subsidiary, Ambac Financial Services ("AFS") cash to support its operations. AFS uses interest rate derivatives (primarily interest rate swaps and US Treasury futures) as a partial economic hedge against the effects of rising interest rates elsewhere in the Company, including on AAC’s financial guarantee exposures. AFS's derivatives also include interest rate swaps previously provided to asset-backed issuers and other entities in connection with their financings. AAC loans cash and securities to AFS as needed to fund payments under these derivative contracts, collateral posting requirements and operating expenses. Intercompany loans are governed by an established lending agreement with defined borrowing limits that has received non-disapproval from OCI. Insurance subsidiaries manage their liquidity risk by maintaining comprehensive analyses of projected cash flows and maintaining specified levels of cash and short-term investments at all times. It is the opinion of the Company’s management that the insurance subsidiaries’ near term liquidity needs will be adequately met from the sources described above. Managing General Agent / Underwriting (MGA/U): The liquidity requirements of the MGA/U subsidiary are met primarily by funds generated from commission receipts (both | Ambac Financial Group, Inc. 47 2021 FORM 10-K | Table of Contents base and profit commissions) from insurance carriers. Base commissions are generally received monthly, whereas profit commissions are received only if the business underwritten is profitable. Cash provided from these sources is used primarily for commissions paid to sub-producers, distributions to its members (including AFG) and operating expenses. Consolidated Cash Flow Statement Discussion The following table summarizes the net cash flows for the periods presented. ($ in million) Year Ended December 31, 2021 2020 2019 Cash provided by (used in): Operating activities $ (131) $ (175) $ (311) Investing activities 776 432 1,000 Financing activities (657) (303) (691) Effect of foreign exchange on cash and cash equivalents — — — Net cash flow $ (12) $ (46) $ (2) Operating activities The following represents the significant cash operating activities during the years ended December 31, 2021 and 2020: • Debt service on the LSNI Ambac Note was $51 and $107 for the years ended December 31, 2021 and 2020, respectively. • Debt service on the Sitka AAC Note was $30 for the year ended December 31, 2021. • Cash provided from financial guarantee premiums were $35 and $47 for the years ended December 31, 2021 and 2020. Cash provided from specialty property and casualty premiums were $8 for the year ended December 31, 2021. • Payments related to (i) operating expenses were $83 and $76 for the years ended December 31, 2021 and 2020, respectively, ( ii) reinsurance premiums were $26 and $2 for the years ended December 31, 2021 and 2020, respectively, and (iii) interest rate derivatives were $(1) and $20 for the years ended December 31, 2021 and 2020, respectively. • Interest, dividends and other distributed income from the investment portfolio was $80 and $104 for the years ended December 31, 2021 and 2020, respectively. • Net loss and loss expenses paid, including commutation payments are detailed below: ($ in million) Year Ended December 31, 2021 2020 2019 Net losses paid $ 103 $ 159 $ 416 Net subrogation received (121) (118) (168) Net loss expenses paid 77 108 70 Net cash flow $ 59 $ 149 $ 318 Future operating cash flows will primarily be impacted by interest payments on outstanding debt, claim and expense payments, subrogation recoveries, investment income receipts and premium collections. Investing Activities Cash provided for investing activities in both 2021 and 2020 were to (i) provide liquidity for operating activities; (ii) diversify the investment portfolio from fixed maturity to other assets (total fair value of pooled investments of $683 at December 31, 2021) and (iii) support strategic initiatives, including AFG's purchase 80% of Xchange for $74 in 2020, net of cash acquired. Financing Activities Financing activities for the year ended December 31, 2021, include paydowns of the LSNI Ambac Note of $1,641, paydowns/maturities of VIE debt obligations of $170, partially offset by the proceeds from the Sitka AAC Note issuance of 1,163. Financing activities for the year ended December 31, 2020, include paydowns of the LSNI Ambac Note of $121 and paydowns of VIE debt obligations of $178. Collateral AFS hedges a portion of the interest rate risk in the financial guarantee and investment portfolio, along with legacy customer interest rate swaps with standardized derivative contracts, including financial futures contracts, which contain collateral or margin requirements. Under these hedge agreements, AFS is required to post collateral or margin to its counterparties and futures commission merchants to cover unrealized losses. In addition, AFS is required to post collateral or margin in excess of the amounts needed to cover unrealized losses. All AFS derivative contracts containing ratings-based downgrade triggers that could result in collateral or margin posting or a termination have been triggered. If terminations were to occur, AFS would be required to make termination payments but would also receive a return of collateral or margin in the form of cash or U.S. Treasury obligations with market values equal to or in excess of market values of the swaps and futures contracts. AFS may look to re-establish hedge positions that are terminated early, resulting in additional collateral or margin obligations. The amount of additional collateral or margin posted on derivatives contracts will depend on several variables including the degree to which counterparties exercise their termination rights (or agreements terminate automatically) and the terms on which hedges can be replaced. All collateral and margin obligations are currently met. Collateral and margin posted by AFS totaled a net amount of $133 (cash and securities collateral of $13 and $120 respectively), including independent amounts, under these contracts at December 31, 2021. Ambac Credit Products LLC (“ACP”) is not required to post collateral under any of its outstanding credit derivative contracts. BALANCE SHEET ($ in millions) Total assets decreased by approximately $917 from December 31, 2020 to $12,303 at December 31, 2021, primarily due to the impacts of the Corolla Trust Exchange and Secured Note Refinancing described in Note 1. Background and Business Description in this Annual Report on Form 10-K located in Part II. Item 8, payment of loss and loss expenses, interest and operating expenses, lower subrogation recoverables, lower consolidated VIE assets from paydowns of consolidated | Ambac Financial Group, Inc. 48 2021 FORM 10-K | Table of Contents VIE liabilities, lower derivative assets caused by rising interest rates and lower premium receivables and intangible assets from the continued runoff of the financial guarantee insurance portfolio. Total liabilities decreased by approximately $886 from December 31, 2020, to $11,187 as of December 31, 2021, primarily due to lower loss reserves, and the payment of loss and loss expenses, lower VIE and non-VIE long-term debt (from the surplus note exchange transactions and Secured Note Refinancing) and lower derivative liabilities caused by rising interest rates. As of December 31, 2021, total stockholders’ equity was $1,098, compared with total stockholders’ equity of $1,140 at December 31, 2020. This decrease was primarily due to a Total Comprehensive Loss during 2021 and a $14 increase to the carrying value of redeemable NCI which is offset directly against retained earnings. The Comprehensive Loss was primarily driven by the net loss attributable to common stockholders for the year ended December 31, 2021, of $17, unrealized losses on investments of $12 and translation losses on the consolidation of AFG's foreign subsidiaries.of $8. Investment Portfolio. Ambac's investment portfolio is managed under established guidelines designed to meet the investment objectives of AAC, Everspan, Ambac UK and AFG. Refer to "Description of the Business — Investments and Investment Policy" in this Annual Report on Form 10-K located in Part I. Item 1, for further description of Ambac's investment policies and applicable regulations. Refer to Note 4. Investments to the Consolidated Financial Statements in this Annual Report on Form 10-K located in Part II. Item 8 for information about Ambac's consolidated investment portfolio. Ambac's investment polices and objectives do not apply to the assets of VIEs consolidated as a result of financial guarantees written by its insurance subsidiaries. The following table summarizes the composition of Ambac’s investment portfolio, excluding VIE investments, at carrying value at December 31, 2021 and 2020: ($ in millions) December 31, 2021 2020 Fixed maturity securities $ 1,730 $ 2,317 Short-term 414 492 Other investments 690 595 Securities pledged as collateral 120 140 Total investments (1) $ 2,955 $ 3,544 (1) Includes investments denominated in non-US dollar currencies with a fair value of £341 ($462) and €38 ($43) as of December 31, 2021 and £317 ($434) and €39 ($48) as of December 31, 2020. Ambac invests in various asset classes in its fixed maturity securities portfolio. Other investments include diversified equity interests in pooled funds. Refer to Note 4. Investments to the Consolidated Financial Statements in this Annual Report on Form 10-K located in Part II. Item 8 for information about fixed maturity securities and pooled funds by asset class. The following charts provide the ratings (1) distribution of the fixed maturity investment portfolio based on fair value at December 31, 2021 and 2020. (1) Ratings are based on the lower of Moody’s or S&P ratings. If ratings are unavailable from Moody's or S&P, Fitch ratings are used. If guaranteed, rating represents the higher of the underlying or guarantor’s financial strength rating. (2) Below investment grade and not rated bonds insured by Ambac represented 32% and 41% of the 2021 and 2020 combined fixed maturity investment portfolios, respectively. The decrease is primarily due to the impact of the Secured Note Refinancing described in Note 1. Background and Business Description to the Consolidated Financial Statements in this Annual Report Form 10-K located in Part II. Item 8. Premium Receivables. Ambac's premium receivables decreased to $323 at December 31, 2021, from $370 at December 31, 2020. As further discussed in Note 7. Insurance Contracts to the Consolidated Financial Statements, in this Annual Report Form 10-K located in Part II. Item 8, the decrease is due to premium | Ambac Financial Group, Inc. 49 2021 FORM 10-K | Table of Contents receipts and adjustments for changes in expected and contractual cash flows on financial guarantee insurance contracts, partially offset by decreases to the allowance for credit losses, accretion of the financial guarantee premium receivable discount and premium receivables on the Specialty P&C business. Premium receivables by payment currency were as follows: Currency (Amounts in millions) Premium Receivable in Payment Currency Premium Receivable in U.S. dollars U.S. Dollars $ 199 $ 199 British Pounds £ 80 108 Euros € 14 16 Total $ 323 Reinsurance Recoverable on Paid and Unpaid Losses. Ambac has reinsurance in place pursuant to surplus share treaty and facultative agreements. To minimize its exposure to losses from reinsurers, Ambac (i) monitors the financial condition of its reinsurers; (ii) is entitled to receive collateral from its reinsurance counterparties under certain reinsurance contracts; and (iii) has certain cancellation rights that can be exercised in the event of rating agency downgrades of a reinsurer (among other events and circumstances). For those reinsurance counterparties that do not currently post collateral, Ambac’s reinsurers are well capitalized, highly rated, authorized capacity providers. Ambac benefited from letters of credit and collateral amounting to approximately $111 from its reinsurers at December 31, 2021. As of December 31, 2021 and 2020, reinsurance recoverable on paid and unpaid losses were $55 and $33, respectively. The increase was primarily a result of reinsurance recoverables of $30 added in connection with the PWIC transaction, offset by favorable development in financial guarantee insured exposures. Intangible Assets. Intangible assets includes (i) an insurance intangible asset that was established at AFG's emergence from bankruptcy, representing the difference between the fair value and aggregate carrying value of the financial guarantee insurance and reinsurance assets and liabilities, (ii) intangible assets established as part of the acquisition of Xchange on December 31, 2020 and (iii) an indefinite-lived intangible assets established as part of the acquisition of PWIC. Refer to Note 3. Business Combination to the Consolidated Financial Statements, in this Annual Report Form 10-K located in Part II. Item 8 for further information relating to the Xchange acquisition. As of December 31, 2021 and 2020 the net intangible asset was $362 and $409, respectively. The decline is driven by amortization and translation gains (losses) from the consolidation of Ambac's foreign subsidiary (Ambac UK), partially offset by the indefinite-lived asset established in 2021. Derivative Assets and Liabilities. The interest rate derivative portfolio is positioned to benefit from rising rates as a partial hedge against interest rate exposure in the financial guarantee and investment portfolios. Derivative assets and liabilities on the balance sheet primarily reflect the portion of the portfolio that is not subject to daily cash variation margin payments. Derivative assets decreased from $93 at December 31, 2020, to $76 as of December 31, 2021. Derivative liabilities decreased from $114 at December 31, 2020, to $95 as of December 31, 2021. The decreases resulted primarily from higher interest rates during the year ended December 31, 2021, with the decline in assets partially offset by lower counterparty credit adjustments. Loss and Loss Expense Reserves and Subrogation Recoverable. Loss and loss expense reserves are based upon estimates of the ultimate aggregate losses inherent in the non-derivative portfolio for insurance policies issued to beneficiaries, including unconsolidated VIEs. The evaluation process for determining the level of reserves is subject to certain estimates and judgments. Refer to the "Critical Accounting Policies and Estimates" and “Results of Operations” sections of Management’s Discussion and Analysis of Financial Condition and Results of Operations, in addition to Basis of Presentation and Significant Accounting Policies and Loss Reserves sections included in Note 2. Basis of Presentation and Significant Accounting Policies and Note 7. Insurance Contracts, respectively, to the Consolidated Financial Statements included in Part II, Item 8 in this Annual Report on Form 10-K, for further information on loss and loss expenses. The loss and loss expense reserves net of subrogation recoverables and before reinsurance as of December 31, 2021 and 2020 were $(522) and $(397), respectively. Loss and loss expense reserves are included in the Consolidated Balance Sheets as follows: | Ambac Financial Group, Inc. 50 2021 FORM 10-K | Table of Contents Present Value of Expected Net Cash Flows Unearned Premium Revenue Gross Loss and Loss Expense Reserves (2) ($ in millions) Balance Sheet Line Item Claims and Loss Expenses Recoveries (1) December 31, 2021: Loss and loss expense reserves $ 1,781 $ (155) $ (56) $ 1,570 Subrogation recoverable 88 (2,180) — (2,092) Totals $ 1,869 $ (2,335) $ (56) $ (522) December 31, 2020: Loss and loss expense reserves $ 2,060 $ (229) $ (72) $ 1,759 Subrogation recoverable 100 (2,256) — (2,156) Totals $ 2,160 $ (2,485) $ (72) $ (397) (1) Present value of future recoveries include R&W subrogation recoveries of $1,730 and $1,751 at December 31, 2021 and 2020, respectively. (2) Loss and loss expense reserves at December 31, 2021 includes financial guarantee and specialty P&C of $1,538 and $32, respectively. Subrogation recoverable includes financial guarantee and specialty P&C of $(2,092) and $—, respectively. All balances at December 31, 2020 relate to the financial guarantee business Financial Guarantee: Ambac has exposure to various bond types issued in the debt capital markets. Our experience has shown that, for the majority of bond types, we have not experienced significant claims. The bond types that have experienced significant claims, including through commutations, are residential mortgage-backed securities (“RMBS”), student loan securities and public finance securities. These bond types represent 93% of our ever-to-date insurance claims recorded with RMBS comprising 74%. The table below indicates gross par outstanding and the components of gross loss and loss expense reserves related to policies in Ambac’s gross loss and loss expense reserves at December 31, 2021 and 2020: Present Value of Expected Net Cash Flows Unearned Premium Revenue Gross Loss and Loss Expense Reserves (1)(2) ($ in millions) Gross Par Outstanding (1)(2) Claims and Loss Expenses Recoveries December 31, 2021: Structured Finance $ 2,371 $ 852 $ (2,018) $ (12) $ (1,178) Domestic Public Finance 2,742 905 (312) (31) 562 Other 1,189 35 (5) (13) 17 Loss expenses — 45 — — 45 Totals $ 6,302 $ 1,837 $ (2,335) $ (56) $ (554) December 31, 2020: Structured Finance $ 2,945 $ 940 $ (2,136) $ (16) $ (1,212) Domestic Public Finance 3,016 1,112 (349) (39) 724 Other 1,612 40 — (17) 23 Loss expenses — 68 — — 68 Totals $ 7,573 $ 2,160 $ (2,485) $ (72) $ (397) (1) Ceded par outstanding on policies with loss reserves and ceded loss and loss expense reserves are $784 and $24, respectively, at December 31, 2021 and $739 and $33, respectively at December 31, 2020. Ceded loss and loss expense reserves are included in Reinsurance recoverable on paid and unpaid losses. (2) Loss reserves are included in the balance sheet as Loss and loss expense reserves or Subrogation recoverable dependent on if a policy is in a net liability or net recoverable position. The table below reflects the timing of expected financial guarantee claim payments based on deal specific cash flows, excluding expected recoveries. These deal specific cash flows are based on the expected cash flows of the underlying transactions. The timing of expected claim payments for credits with reserves that were established using our statistical loss reserve method is determined based on the weighted average expected life of the exposure. Refer to the Loss Reserves section in Note 2. Basis of Presentation and Significant Accounting Policies to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K for further discussion of our statistical loss reserve method. The timing of these payments may vary significantly from the amounts shown above, especially for credits that are based on our statistical loss reserve method. | Ambac Financial Group, Inc. 51 2021 FORM 10-K | Table of Contents Payments Due by Period ($ in millions) Total Less Than 1 Year 1 - 3 Years 3 - 5 Years More Than 5 Years Claim payments $ 2,095 $ 422 $ 119 $ 109 $ 1,445 Variability of Expected Losses and Recoveries Ambac’s management believes loss reserves (present value of expected cash flows, net of recoveries) are adequate to cover future claim payments, but there can be no assurance that the ultimate liability will not be higher than such estimates. While our loss reserves consider our judgment regarding issuers’ financial flexibility to adapt to adverse markets, they may not adequately capture sudden, unexpected or protracted uncertainty that adversely affects market conditions, such as COVID-19. Accordingly, it is possible that our estimated loss reserves, gross of reinsurance, for financial guarantee insurance policies could be understated. We have attempted to identify possible cash flows related to losses and recoveries using more stressful assumptions than the probability-weighted outcome recorded. The possible net cash flows consider the highest stress scenario that was utilized in the development of our probability-weighted expected loss at December 31, 2021, and assumes an inability to execute any commutation transactions with issuers and/or investors. Such stress scenarios are developed based on management’s view about all possible outcomes relating to losses and recoveries. In arriving at such view, management makes considerable judgments about the possibility of various future events. Although we do not believe it is possible to have stressed outcomes in all cases, it is possible that we could have stress case outcomes in some or even many cases. See “Risk Factors” in Part I, Item 1A of this Form 10-K as well as the descriptions of "Structured Finance Variability," "Public Finance Variability," and "Other Credits, including Ambac UK, Variability," below for further discussion of the risks relating to future losses and recoveries that could result in more highly stressed outcomes appearing below. The occurrence of these stressed outcomes individually or collectively would have a material adverse effect on our results of operations and financial condition and may result in materially adverse consequence for Ambac, including (without limitation) impairing the ability of AAC to honor its financial obligations, particularly its outstanding debt and preferred stock obligations; the initiation of rehabilitation proceedings against AAC; decreased likelihood of AAC delivering value to AFG, through dividends or otherwise; and a significant drop in the value of securities issued or insured by AFG or AAC. Structured Finance RMBS: Changes to assumptions that could make our reserves under-estimated include an increase in interest rates, deterioration in housing prices, poor servicing, government intervention into the functioning of the mortgage market and the effect of a weakened economy characterized by growing unemployment and wage pressures. We utilize a model to project losses in our RMBS exposures and changes to reserves, either upward or downward, are not unlikely if we used a different model or methodology to project losses. In the case of both first and second-lien exposures, the possible stress case assumes a lower housing price appreciation projection, which in turn drives higher defaults and severities. We established a representation and warranty subrogation recovery as further discussed in Note 7. Insurance Contracts to the Consolidated Financial Statements included in this Annual Report on Form 10-K. Our ability to realize RMBS representation and warranty recoveries is subject to significant uncertainty, including risks inherent in litigation, collectability of such amounts from counterparties (and/or their respective parents and affiliates), delays in realizing such recoveries, including delays in getting to trial due to court closures caused by COVID-19 or other events, intervention by the OCI, which could impede our ability to take actions required to realize such recoveries, and uncertainty inherent in the assumptions used in estimating such recoveries. Additionally, our R&W actual subrogation recoveries could be significantly lower than our estimate of $1,704, net of reinsurance, as of December 31, 2021, if the sponsors of these transactions: (i) fail to honor their obligations to repurchase the mortgage loans, (ii) successfully dispute our breach findings or claims for damages, (iii) no longer have the financial means to fully satisfy their obligations under the transaction documents, or (iv) our pursuit of recoveries is otherwise unsuccessful due to any of the factors described in this Form 10-K in Part I, Item 1A Risk Factors - Risks Related to Capital, Liquidity and Markets . Failure to realize R&W subrogation recoveries for any reason or the realization of R&W subrogation recoveries materially below the amount recorded on Ambac's consolidated balance sheet would have a material adverse effect on our results of operations and financial condition. Student Loans: Changes to assumptions that could make our reserves under-estimated include, but are not limited to, increases in interest rates, default rates and loss severities on the collateral due to economic or other factors, including the COVID-19 related economic impact. Such factors may include lower recoveries on defaulted loans or additional losses on collateral or trust assets, including as a result of any enforcement actions by the Consumer Finance Protection Bureau. Structured Finance Variability: Using the approaches described above, the possible increase in loss reserves for structured finance credits for which we have an estimate of expected loss at December 31, 2021, could be approximately $25. Combined with the absence of any R&W subrogation recoveries, a possible increase in loss reserves for structured finance credits could be approximately $1,729. A loss of this magnitude may render AAC insolvent. Additionally, loss payments are sensitive to changes in interest rates, increasing as interest rates rise. For example, an increase in interest rates of 0.50% could increase our estimate of expected losses by approximately $45. There can be no assurance that losses may not exceed such amounts. Additionally, the | Ambac Financial Group, Inc. 52 2021 FORM 10-K | Table of Contents structured finance portfolio is sensitive to the COVID-19 related forbearances and delinquencies caused by the general economic downturn. Due to the uncertainties related to the economic effects of the COVID-19 pandemic and other risks associated with structured finance credits, there can be no assurance that losses may not exceed our stress case estimates. Public Finance Ambac’s U.S. public finance portfolio predominantly consists of municipal bonds such as general and revenue obligations and lease and tax-backed obligations of state and local government entities; however, the portfolio also includes a wide array of non-municipal types of bonds, including financings for not-for-profit entities and transactions with public and private elements, which generally finance infrastructure, housing and other public purpose facilities and interests. It is possible our loss reserves for public finance credits may be under-estimated if issuers are faced with prolonged exposure to adverse political, judicial, economic, fiscal or socioeconomic events or trends. Additionally, our loss reserves may be under-estimated because of the continuing effects of COVID-19 pandemic. The COVID-19 related economic downturn put a strain on municipal issuers, particularly those dependent upon narrow sources of revenues or dedicated taxes to support debt service, such as hotel occupancy taxes, parking revenues, tolls, etc. While the economy has been in recovery since mid-2020, the lingering impact of the pandemic continues to negatively impact certain of these municipal issuers that are dependent upon narrow sources of revenue. A further prolonged recovery from the COVID-19 pandemic could put additional stresses on these issuers and result in increased defaults and potential additional losses for Ambac. Our experience with the city of Detroit's bankruptcy and Commonwealth of Puerto Rico's Title III proceedings as well as other municipal bankruptcies demonstrates the preferential treatment of certain creditor classes, especially the public pensions. The cost of pensions and the need to address frequently sizable unfunded or underfunded pensions is often a key driver of stress for many municipalities and their related authorities, including entities to whom we have significant exposure, such as Chicago's school district, the State of New Jersey and many others. Less severe treatment of pension obligations in bankruptcy may lead to worse outcomes for traditional debt creditors. Variability of outcomes applies to even what are generally considered more secure municipal financings, such as dedicated sales tax revenue bonds that capture sales tax revenues for debt service ahead of any amounts being deposited into the general fund of an issuer. In the case of the Puerto Rico COFINA sales tax bonds that were part of the Commonwealth of Puerto Rico's Title III proceedings, AAC and other creditors agreed to settle at a recovery rate equal to about 93% of pre-petition amounts owed on the Ambac insured senior COFINA bonds. In the COFINA case, the senior bonds still received a reduction or "haircut" despite the existence of junior COFINA bonds, which received a recovery rate equal to about 56% of pre-petition amounts owed. In addition, municipal entities may be more inclined to use bankruptcy to resolve their financial stresses if they believe preferred outcomes for various creditor groups can be achieved. We expect municipal bankruptcies and defaults to continue to be challenging to project given the unique political, economic, fiscal, legal, governance and public policy differences among municipalities as well as the complexity, long duration and relative infrequency of the cases themselves in forums with a scarcity of legal precedent. Moreover, issuers in Chapter 9 or similar proceedings may obtain judicial rulings and orders that impair creditors' rights or their ability to collect on amounts owed. In certain cases, judicial decisions may be contrary to AAC's expectations or understanding of the law or its rights thereunder, which may lead to worse outcomes in Chapter 9 or similar proceedings than anticipated at the outset. Another potentially adverse development that could cause the loss reserves on our public finance credits to be underestimated is deterioration in the municipal bond market, resulting from reduced or limited access to alternative forms of credit (such as bank loans) or other exogenous factors, such as changes in tax law that could reduce certain municipal investors' appetite for tax-exempt municipal bonds or put pressure on issuers in states with high state and local taxes. These factors could deprive issuers access to funding at a level necessary to avoid defaulting on their obligations. Ambac’s exposures to the Commonwealth of Puerto Rico across various instrumentalities and issuers are all now subject to plan support agreements and plans of adjustment or qualifying modifications. The Eighth Amended POA has been confirmed, and the PRIFA QM and the CCDA QM have been approved. All are expected to become effective on or before March 15, 2022. However, uncertainty remains as to (i) whether the effective date will be stayed pending the appeal of the order confirming Eighth Amended POA; (ii) the result of the pending First Circuit appeal of the order confirming the Eighth Amended POA; (iii) the value or perceived value of the consideration provided by or on behalf of the debtors under the Eighth Amended POA, PRIFA QM, and CCDA QM; (iv) the extent to which exposure management strategies, such as commutation and acceleration, will be executed; (v) the tax treatment of the consideration provided by or on behalf of the debtors under the Eighth Amended POA, PRIFA QM, and CCDA QM; (vi) whether and when the PRHTA POA will be confirmed; and (vii) other factors, including market conditions such as interest rate movements, credit spread changes on the new GO and CVI instruments, and liquidity for the new GO and CVI instruments. Losses may exceed current reserves in a material manner due to favorable or unfavorable developments or results with respect to these factors. See Note 19. Commitments and Contingencies to the Consolidated Financial Statements in Part II, Item 8 and "Financial Guarantees in Force" section of Management’s Discussion and Analysis of Financial Condition and Results of Operations included in Part II, Item 7 in this Annual Report on Form 10-K for further updates relating to Puerto Rico. Material additional losses on our public finance credits caused by the aforementioned factors, including the possibility of a protracted recovery related to the COVID-19 crisis would have a material adverse effect on our results of operations and financial condition. For the public finance credits, including Puerto Rico, for which we have an estimate of expected loss at December 31, 2021, the possible increase in loss reserves could be approximately $355 and there can be no assurance that losses may not exceed our stress case estimates. | Ambac Financial Group, Inc. 53 2021 FORM 10-K | Table of Contents Other Credits, including Ambac UK, Variability It is possible our loss reserves on other types of credits, including those insured by Ambac UK, may be under-estimated because of various risks that vary widely, including the risk that we may not be able to recover or mitigate losses through our remediation processes. For all other credits, including Ambac UK, for which we have an estimate of expected loss, the sum of all the highest stress case loss scenarios is approximately $370 greater than the loss reserves at December 31, 2021. Additionally, our loss reserves may be under-estimated as a result of the ultimate scope, duration and magnitude of the effects of COVID-19. There can be no assurance that losses may not exceed our stress case estimates. Long-term Debt. Long-term debt consists of surplus notes issued by AAC, the Sitka AAC Note (which refinanced the LSNI Ambac Note), the Tier 2 Notes issued in connection with the Rehabilitation Exit Transactions (as defined in Note 1. Background and Business Description to the Consolidated Financial Statements included in Part II, Item 8 of this Form 10-K), and Ambac UK debt issued in connection with the 2019 commutation of its exposure with respect to Ballantyne Re plc. The carrying value of each of these as of December 31, 2021 and 2020 is below: ($ in millions) December 31, 2021 2020 Surplus Notes (1) $ 729 $ 778 LSNI Ambac Note — 1,641 Sitka AAC Note 1,154 — Tier 2 Notes 333 306 Ambac UK Debt 15 14 Total Long-term Debt $ 2,230 $ 2,739 (1) Includes Junior Surplus Notes as of December 31, 2020. All Junior Surplus Notes were retired in 2021. The decrease in long-term debt from December 31, 2020 resulted from the impact of the Secured Note Refinancing and 2021 Surplus Note Exchanges, described further in Note 1. Background and Business Description to the Consolidated Financial Statements, included in this Annual Report on Form 10-K, partially offset by issuances of surplus notes from AFG sales, accretion on the carrying value of surplus notes and Ambac UK debt and paid-in-kind interest on Tier 2 Notes. Subject to internal and regulatory guidelines, market conditions and other constraints, Ambac may opportunistically purchase or sell surplus notes and/or other Ambac issued securities, and may consider opportunities to exchange securities issued by it from time to time (including newly issued securities) for other securities issued by it. Redeemable Noncontrolling Interest . The increase during 2021 was the result of the remeasurement of the redemption value of the put option provided to the minority owners (noncontrolling interest holders) of Xchange as if it were exercisable on December 31, 2021. Refer to Note 3. Business Combination for further information relating to this acquisition. ACCOUNTING STANDARDS The following accounting standards have been issued, but have not yet been adopted. We do not expect these accounting standards to have a consequential impact on Ambac's financial statements. Equity-classified Written Call Options In May 2021, the FASB issued ASU 2021-04, Issuer's Accounting for Certain Modifications or Exchanges of Freestanding Equity-Classified Written Call Options . The ASU clarifies and reduces diversity in practice for an issuer's accounting for modifications or exchanges of equity-classified written call options (e.g. warrants) that remain equity-classified after the modification or exchange. The ASU requires an issuer to account for the modification or exchange based on the economic substance of the transaction. For example, if the modification or exchange is related to the issuance of debt or equity, any change in the fair value of the written call option would be accounted for as part of the debt issuance cost in accordance with the debt guidance or equity issuance cost in accordance with the equity guidance, respectively. The ASU is effective for fiscal years beginning after December 15, 2021, with early adoption permitted. Ambac will adopt this ASU on January 1, 2022. Convertible Instruments and Contracts in an Entity's Own Equity In August 2020, the FASB issued ASU 2020-06, Accounting for Convertible Instruments and Contracts in an Entity's Own Equity . The ASU i) simplifies the accounting for convertible debt and convertible preferred stock by reducing the number of accounting models, and amends certain disclosures, ii) amends and simplifies the derivative scope exception guidance for contracts in an entity's own equity, including share-based compensation, and iii) amends the diluted earnings per share calculations for convertible instruments and contracts in an entity's own equity. The ASU is effective for fiscal years ending after December 15, 2021, with early adoption permitted. Ambac will adopt this ASU on January 1, 2022. Please refer to Note 2. Basis of Presentation and Significant Accounting Policies to the Consolidated Financial Statements, included in Part II, Item 8 in this Annual Report Form 10-K for the year ended December 31, 2021, for a discussion of the impact of other recent accounting pronouncements on Ambac’s financial condition and results of operations. U.S. STATUTORY BASIS FINANCIAL RESULTS ($ in millions) AFG's U.S. insurance subsidiaries prepare financial statements under accounting practices prescribed or permitted by its domiciliary state regulator (“SAP”) for determining and reporting the financial condition and results of operations of an insurance company. The National Association of Insurance Commissioners (“NAIC”) Accounting Practices and Procedures manual (“NAIC SAP”) is adopted as a component of prescribed practices by each domiciliary state. For further information, see Note 8. Insurance Regulatory Restrictions to the Consolidated | Ambac Financial Group, Inc. 54 2021 FORM 10-K | Table of Contents Financial Statements included in Part II, Item 8 in this Annual Report Form 10-K. Ambac Assurance Corporation AAC’s statutory policyholder surplus and qualified statutory capital (defined as the sum of policyholders surplus and mandatory contingency reserves) were $757 and $1,322 at December 31, 2021, respectively, as compared to $865 and $1,413 at December 31, 2020, respectively. As of December 31, 2021, statutory policyholder surplus and qualified statutory capital included $853 principal balance of surplus notes outstanding and $138 liquidation preference of preferred stock outstanding. These surplus notes (including related accrued interest of $625 that is not recorded under statutory basis accounting principles); preferred stock; and all other liabilities, including insurance claims, $1,175 principal balance of Sitka AAC Notes (refinanced the LSNI Ambac Note as described in Note 1. Background and Business Description to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K) and $333 principal balance of Tier 2 Notes are obligations that, individually and collectively, have claims on the resources of AAC that are senior to AFG's equity and therefore impede AFG's ability to realize residual value and/or receive dividends from AAC. The significant drivers to the net decrease in policyholder surplus were statutory net losses of $127 for the year ended December 31, 2021 and contributions to contingency reserves of $17, partially offset by an increase in the fair value of pooled investments of $35. AAC’s statutory surplus is sensitive to multiple factors, including: (i) loss reserve development, (ii) payments on surplus notes, if approved by OCI, (iii) on-going interest costs associated with the Sitka AAC Note and Tier 2 Notes, including changes to the interest rates as the Sitka AAC Note is a floating rate obligation, (iv) deterioration in the financial position of AAC subsidiaries that have their obligations guaranteed by AAC, (v) first time payment defaults of insured obligations, which increase statutory loss reserves, (vi) commutations of insurance policies or credit derivative contracts at amounts that differ from the amount of liabilities recorded, (vii) reinsurance contract terminations at amounts that differ from net assets recorded, (viii) changes to the fair value of pooled fund and other investments carried at fair value, (ix) settlements of representation and warranty breach claims at amounts that differ from amounts recorded, including failures to collect such amounts, (x) realized gains and losses, including losses arising from other than temporary impairments of investment securities, and (xi) future changes to prescribed SAP practices by the OCI. The significant differences between GAAP and SAP are that under SAP: • Loss reserves are only established for losses on guaranteed obligations that have experienced a payment default in an amount that is sufficient to cover the present value of the anticipated defaulted debt service payments over the expected period of default, less estimated recoveries under subrogation rights (5.1% as prescribed by OCI). Under GAAP, in addition to the establishment of loss reserves for defaulted obligations, loss reserves are established (net of GAAP basis unearned premium revenue) for obligations that have experienced credit deterioration, but have not yet defaulted using a weighted-average risk-free discount rate, currently at 1.2%. • Mandatory contingency reserves are required based upon the type of obligation insured, whereas GAAP does not require such a reserve. Releases of the contingency reserves are generally subject to OCI approval and relate to a determination that the held reserves are deemed excessive. • Investment grade fixed maturity investments are stated at amortized cost and certain below investment grade fixed maturity investments are reported at the lower of amortized cost or fair value. Under GAAP, all fixed maturity investments are reported at fair value. • Wholly owned subsidiaries are not consolidated; rather, the equity basis of accounting is utilized and the carrying values of these investments are subject to admissibility tests. • Variable interest entities ("VIE") are not required to be assessed for consolidation. Under GAAP, a reporting entity that has both the following characteristics is required to consolidate the VIE: a) the power to direct the activities of the VIE that most significantly impact the VIE’s economic performance and b) the obligation to absorb losses of the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE. AAC generally has the obligation to absorb losses of VIEs that could potentially be significant to the VIE as the result of its guarantee of insured obligations issued by VIEs. For certain VIEs AAC has the power to direct the most significant activities of the VIE and accordingly consolidates the related VIEs under GAAP. • All payments of principal and interest on the surplus notes are subject to the approval of the OCI. Unpaid interest due on the surplus notes is expensed when the approval for payment of interest has been granted by the OCI. Under GAAP, interest on surplus notes is accrued regardless of OCI approval. • Upfront premiums written are earned on a basis proportionate to the remaining scheduled debt service to the original total principal and interest insured. Installment premiums are reflected in income pro-rata over the period covered by the premium payment. Under GAAP, premium revenues for both upfront and installment premiums are earned over the life of the financial guarantee contract in proportion to the insured principal amount outstanding at each reporting date. • Insurance intangibles that arose as a result of the implementation of Fresh Start reporting are not a concept within SAP. This insurance intangible asset is amortized as an expense on a level yield basis over the life of the related insurance risks. • Unearned premiums and loss reserves are presented net of ceded amounts, while under GAAP, they are reflected gross of ceded amounts. Everspan Indemnity Insurance Company Everspan Indemnity Insurance Company’s statutory policyholder surplus was $106 at December 31, 2021, as compared to $26 at December 31, 2020. | Ambac Financial Group, Inc. 55 2021 FORM 10-K | Table of Contents The significant drivers to the increase in policyholder surplus for the year ended December 31, 2021 were capital contributions of $92 partially offset by operating expenses and changes in investment in subsidiaries, primarily due to a limitation on the amount of goodwill that may be admitted in accordance with SAP. The significant differences between GAAP and SAP are that under SAP: • Investment grade fixed maturity investments are stated at amortized cost and certain below investment grade fixed maturity investments are reported at the lower of amortized cost or fair value. Under GAAP, all fixed maturity investments are reported at fair value. • Wholly owned subsidiaries are not consolidated; rather, the equity basis of accounting is utilized and the carrying values of these investments are subject to admissibility tests. • The acquisition of PWIC was recorded as an equity method investment, which includes a goodwill component representing the acquisition cost in excess of PWIC's statutory surplus. Goodwill will be amortized over a period not to exceed ten years. Under GAAP, the acquisition of PWIC was recorded as an asset acquisition, which requires i) all net assets to initially be recorded at fair value and ii) the acquisition cost in excess of the fair value of net assets to be allocated to the bases of certain types of assets based on their relative fair values, if applicable. No goodwill is recorded for asset acquisitions. AMBAC UK FINANCIAL RESULTS UNDER UK ACCOUNTING PRINCIPLES (£ in millions) Ambac UK is required to prepare financial statements under FRS 102 "The Financial Reporting Standard applicable in the UK and Republic of Ireland." Ambac UK’s shareholder funds under UK GAAP were £444 at December 31, 2021, as compared to £412 at December 31, 2020. At December 31, 2021, the carrying value of cash and investments was £500, a increase from £481 at December 31, 2020. The increase in shareholders’ funds and cash and investments was primarily due to the continued receipt of premiums and investment income, partially offset by loss expenses, foreign exchange losses within Ambac UK's investment portfolio, operating expense and tax payments. The significant differences between US GAAP and UK GAAP are that under UK GAAP: • Loss reserves are only established for losses on guaranteed obligations when, in the judgment of management, a monetary default in the timely payment of debt service is likely to occur, which would result in Ambac UK incurring a loss. A loss provision is established in an amount that is sufficient to cover the present value of the anticipated defaulted debt service payments over the expected period of default, less estimated recoveries under subrogation rights. The discount rate is equal to the lower of the rate of return on invested assets for either the current year or the period covering the current year plus the four previous years, currently at 4.7%. Under U.S. GAAP, loss reserves are established (net of US GAAP basis unearned premium revenue) for obligations that have experienced credit deterioration, but have not yet defaulted using a weighted-average risk-free discount rate. • Investments in fixed maturity securities are stated at amortized cost, subject to an other-than-temporary impairment evaluation. Under US GAAP, all bonds are reported at fair value. • VIEs are not required to be assessed for consolidation. Under US GAAP, as noted under AAC Statutory Basis Financial Results above, VIE's with certain characteristics are required to be consolidated. For several VIEs Ambac UK has the power to direct the most significant activities of the VIE and accordingly consolidates the related VIEs under U.S. GAAP. • Upfront premiums written are earned on a basis proportionate to the remaining scheduled debt service to the total principal and interest insured. Installment premiums are reflected in income pro-rata over the period covered by the premium payment. Under US GAAP, premium revenues for both upfront and installment premiums are earned over the life of the financial guarantee contract in proportion to the insured principal amount outstanding at each reporting date. • Insurance intangibles that arose as a result of the implementation of Fresh Start reporting is not a concept within UK GAAP. Under US GAAP, this insurance intangible asset is amortized as an expense on a level yield basis over the life of the related insurance risks. • Unearned premiums and loss reserves are presented net of ceded amounts, while under GAAP, they are reflected gross of ceded amounts. Ambac UK is also required to prepare financial information in accordance with the Solvency II Directive. The basis of preparation of this information is significantly different from both US GAAP and UK GAAP. The calculation of capital resources, regulatory capital requirements and regulatory capital surplus / deficit under Solvency II at December 31, 2021, will be published on Ambac's website during March 2022. Final annual Solvency II data and Ambac UK's annual Solvency and Financial Condition Report will be published on Ambac's website during April 2022. Available capital resources under Solvency II were a surplus of £245 at September 30, 2021, the most recently published position, of which £237 are eligible to meet solvency capital requirements. This is an increase from December 31, 2020, when available capital resources were a surplus of £196 of which £184 were eligible to meet solvency capital requirements. Eligible capital resources at September 30, 2021 and December 31, 2020, are in comparison to regulatory capital requirements of £247 and £256, respectively. Therefore, Ambac UK was in a deficit position in terms of compliance with applicable regulatory capital requirements by £10 at September 30, 2021 and was deficient in terms of compliance by £72 at December 31, 2020. The deficit was reduced as at September 30, 2021, due to the combined impact of (i) the increase in long term interest rates, which resulted in a decrease in technical provision liabilities and hence an increase in eligible own funds and (ii) a decrease in capital requirements for non-life risk due to the maturity and de-risking of certain policies, together with | Ambac Financial Group, Inc. 56 2021 FORM 10-K | Table of Contents natural run-off of the insured portfolio in the year. The regulators are fully aware of the deficiency in capital resources as compared to capital requirements as at September 30, 2021 and dialogue between Ambac UK management and its regulators remains ongoing with respect to options for strengthening the capital position further. NON-GAAP FINANCIAL MEASURES ($ in millions) In addition to reporting the Company's financial results under GAAP, the Company currently reports two non-GAAP financial measures: adjusted earnings and adjusted book value. The most directly comparable GAAP measures are net income attributable to common stockholders for adjusted earnings and Total Ambac Financial Group, Inc. stockholders’ equity for adjusted book value. A non-GAAP financial measure is a numerical measure of financial performance or financial position that excludes (or includes) amounts that are included in (or excluded from) the most directly comparable measure calculated and presented in accordance with GAAP. We are presenting these non-GAAP financial measures because they provide greater transparency and enhanced visibility into the underlying drivers of our business. Adjusted earnings and adjusted book value are not substitutes for the Company’s GAAP reporting, should not be viewed in isolation and may differ from similar reporting provided by other companies, which may define non-GAAP measures differently. Ambac has a significant U.S. tax net operating loss (“NOL”) that is offset by a full valuation allowance in the GAAP consolidated financial statements. As a result of this and other considerations, we utilized a 0% effective tax rate for non-GAAP adjustments; which is subject to change. The following paragraphs define each non-GAAP financial measure and describe why it is useful. A reconciliation of the non-GAAP financial measure and the most directly comparable GAAP financial measure is also presented below. Adjusted Earnings (Loss). Adjusted earnings (loss) is defined as net income (loss) attributable to common stockholders, as reported under GAAP, adjusted on an after-tax basis for the following: • Non-credit impairment fair value (gain) loss on credit derivatives: Elimination of the non-credit impairment fair value gains (losses) on credit derivatives, which is the amount in excess of the present value of the expected estimated credit losses. Such fair value adjustments are affected by, and in part fluctuate with changes in market factors such as interest rates and credit spreads, including the market’s perception of Ambac’s credit risk (“Ambac CVA”), and are not expected to result in an economic gain or loss. These adjustments allow for all financial guarantee contracts to be accounted for consistent with the Financial Services – Insurance Topic of ASC, whether or not they are subject to derivative accounting rules. This adjustment has become negligible and we will discontinue reporting it beginning in the first quarter of 2022. • Insurance intangible amortization: Elimination of the amortization of the financial guarantee insurance intangible asset that arose as a result of Ambac’s emergence from bankruptcy and the implementation of Fresh Start reporting. This adjustment ensures that all financial guarantee contracts are accounted for consistent with the provisions of the Financial Services – Insurance Topic of the ASC. • Foreign exchange (gains) losses: Elimination of the foreign exchange gains (losses) on the re-measurement of assets, liabilities and transactions in non-functional currencies. This adjustment eliminates the foreign exchange gains (losses) on all assets, liabilities and transactions in non-functional currencies, which enables users of our financial statements to better view the results without the impact of fluctuations in foreign currency exchange rates and facilitates period-to-period comparisons of Ambac's operating performance. The following table reconciles net income attributable to common stockholders to the non-GAAP measure, Adjusted Earnings on a total dollar amount and per diluted share basis, for all periods presented: 2021 2020 2019 ($ in millions, except per share data) Year Ended December 31, $ Amount Per Diluted Share $ Amount Per Diluted Share $ Amount Per Diluted Share Net income (loss) attributable to common stockholders $ (17) $ (0.61) $ (437) $ (9.47) $ (216) $ (4.69) Adjustments: Non-credit impairment fair value (gain) loss on credit derivatives — — — — (1) (0.03) Insurance intangible amortization 52 1.12 57 1.23 295 6.43 Foreign exchange (gains) losses 7 0.15 3 0.06 (12) (0.26) Adjusted Earnings (Loss) (1) $ 43 $ 0.66 $ (378) $ (8.19) $ 66 $ 1.44 (1) Adjusted earnings per diluted share is calculated as adjusted earnings less the change in the redemption value of redeemable noncontrolling interest, divided by the GAAP weighted average number of diluted shares outstanding. Adjusted Book Value. Adjusted book value is defined as Total Ambac Financial Group, Inc. stockholders’ equity as reported under GAAP, adjusted for after-tax impact of the following: • Non-credit impairment fair value losses on credit derivatives: Elimination of the non-credit impairment fair value loss on credit derivatives, which is the amount in excess of the present value of the expected estimated | Ambac Financial Group, Inc. 57 2021 FORM 10-K | Table of Contents economic credit loss. GAAP fair values are affected by, and in part fluctuate with, changes in market factors such as interest rates, credit spreads, including Ambac’s CVA that are not expected to result in an economic gain or loss. These adjustments allow for all financial guarantee contracts to be accounted for within adjusted book value consistent with the provisions of the Financial Services—Insurance Topic of the ASC, whether or not they are subject to derivative accounting rules. This adjustment has become negligible and we will discontinue reporting it beginning in the first quarter of 2022. • Insurance intangible asset: Elimination of the financial guarantee insurance intangible asset that arose as a result of Ambac’s emergence from bankruptcy and the implementation of Fresh Start reporting. This adjustment ensures that all financial guarantee contracts are accounted for within adjusted book value consistent with the provisions of the Financial Services—Insurance Topic of the ASC. • Net unearned premiums and fees in excess of expected losses: Addition of the value of the unearned premium revenue ("UPR") on financial guarantee contracts, in excess of expected losses, net of reinsurance. This non-GAAP adjustment presents the economics of UPR and expected losses for financial guarantee contracts on a consistent basis. In accordance with GAAP, stockholders’ equity reflects a reduction for expected losses only to the extent they exceed UPR. However, when expected losses are less than UPR for a financial guarantee contract, neither expected losses nor UPR have an impact on stockholders’ equity. This non-GAAP adjustment adds UPR in excess of expected losses, net of reinsurance, to stockholders’ equity for financial guarantee contracts where expected losses are less than UPR. This adjustment is only made for financial guarantee contracts since such premiums are non-refundable. • Net unrealized investment (gains) losses in Accumulated Other Comprehensive Income: Elimination of the unrealized gains and losses on the Company’s investments that are recorded as a component of accumulated other comprehensive income (“AOCI”). The AOCI component of the fair value adjustment on the investment portfolio may differ from realized gains and losses ultimately recognized by the Company based on the Company’s investment strategy. This adjustment only allows for such gains and losses in adjusted book value when realized. The following table reconciles Total Ambac Financial Group, Inc. stockholders’ equity to the non-GAAP measure Adjusted Book Value on a dollar amount and per share basis, for all periods presented: 2021 2020 ($ in millions, except per share data) December 31, $ Amount Per Share $ Amount Per Share Total Ambac Financial Group, Inc. stockholders’ equity $ 1,038 $ 22.42 $ 1,080 $ 23.57 Adjustments: Non-credit impairment fair value losses on credit derivatives — 0.01 — 0.01 Insurance intangible asset (320) (6.91) (373) (8.14) Net unearned premiums and fees in excess of expected losses 310 6.68 378 8.24 Net unrealized investment (gains) losses in Accumulated Other Comprehensive Income (Loss) (154) (3.32) (166) (3.63) Adjusted Book Value $ 874 $ 18.88 $ 919 $ 20.05 The decrease in Adjusted Book was primarily attributable to the $10 reduction to retained earnings from the increase to the carrying value of redeemable NCI, the impact on expected future premiums from reinsurance and de-risking transactions partially offset by Adjusted earnings for the year ended December 31, 2021 (excluding earned premium previously included in Adjusted Book Value). Factors that impact changes to Adjusted Book Value include many of the same factors that impact Adjusted Earnings, including the majority of revenues and expenses, but generally exclude components of premium earnings since they are embedded in prior period's Adjusted Book Value through the net unearned premiums and fees in excess of expected losses adjustment. Net unearned premiums and fees in excess of expected losses will affect Adjusted Book Value for (i) changes to future premium assumptions (e.g. expected term, interest rates, foreign currency rates, time passage) and (ii) changes to expected losses for policies which do not exceed their related unearned premiums and (iii) new reinsurance transactions. Item 7A. Quantitative and Qualitative Disclosures about Market Risk ($ in millions) Market risk represents the potential for loss due to adverse changes in the fair value of financial instruments, as a result of changes in market rates and prices, such as interest rates (inclusive of credit spreads), foreign currency exchange rates and other relevant market rate or price changes. Market risk is, in part, a function of the markets in which the underlying assets are traded. The Company’s market risk sensitive financial instruments are primarily entered into for purposes other than trading. As discussed further below, the Company’s primary market risk exposures include those from changes in interest rates, foreign currency exchange rates and equity values of limited partnership and other alternative investments. • The primary market risks for fixed maturity investment securities are interest rate risk and foreign exchange rate risk. Ambac’s fixed maturity investment portfolio includes | Ambac Financial Group, Inc. 58 2021 FORM 10-K | Table of Contents securities denominated both in U.S. dollars and foreign currencies, which are sensitive to changes in interest rates and foreign currency exchange rates. Our fixed maturity investments are classified as available for sale, with the effect of market movements recognized immediately through Other comprehensive income, or through Net income when securities are sold or when an impairment charge is recorded. • Ambac also invests in limited partnerships and other alternative investments, primarily consisting of diversified pooled investment funds, which are reported as Other investments. These funds are subject to equity value changes driven primarily by changes to their respective net asset value (“NAV”). Ambac’s share of the changes of the equity value of the funds is reported through Net income. For additional information about Ambac’s investments, see Note 4. Investments in this Annual Report on Form 10-K located in Part II. Item 8. • The interest rate derivatives portfolio is managed as a partial hedge against the effects of rising interest rates elsewhere in the Company, including on Ambac's financial guarantee exposures. Changes in fair value of interest rate derivatives are recognized immediately through Net income. For additional information about Ambac’s interest rate derivatives, see Note 9. Derivative Instruments to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K. • Although our long-term debt obligations are reported at amortized cost and not adjusted for fair value changes, changes in interest rates could have a material impact on their fair value, though with no direct impact on our consolidated financial statements. For additional information about Ambac’s debt obligations, see Note 12. Long-Term Debt to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K. Fixed maturity investment securities that are distressed Ambac-insured bonds have market risk characteristics that behave inversely to those associated with future financial guarantee claim payments. Accordingly, such securities are excluded from the market risk sensitivity measures below. Financial instruments of VIEs that are consolidated as a result of Ambac financial guarantees are also excluded from Ambac's measures of market risk. Ambac’s exposure to such consolidated VIEs is generally limited to financial guarantees outstanding on the VIEs’ liabilities or assets. See Note 11. Variable Interest Entities to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K for further information about VIEs consolidated as a result of Ambac’s financial guarantees. Ambac utilizes various systems, models and sensitivity scenarios to monitor and manage market risk. These models include estimates, made by management, which utilize current and historical market information. This market information is considered in management’s judgments about adverse sensitivity scenarios that are reasonably possible to occur in the near-term. The impact of these scenarios do not consider the possible simultaneous movement in other market rates or prices, actions of management or other factors that could lessen or worsen actual results. For these reasons, the valuation results from these models could differ materially from amounts actually realized in the market. Market Risk Sensitivities Interest Rate Risk Financial instruments for which fair value may be affected by changes in interest rates consist primarily of fixed maturity investment securities, long-term debt and interest rate derivatives. Increases to interest rates would result in declines in the fair value of our fixed maturity investment portfolio. Interest rate increases would also have a negative economic impact on expected future claim payments within the financial guarantee portfolio, primarily related to RMBS and student loan policies. Conversely, interest rate increases would generally result in fair value gains on interest rate derivatives and lower the fair value of our debt obligations. Ambac performs scenario testing to measure the potential for losses in volatile markets. These scenario tests include parallel and non-parallel shifts in the benchmark interest rate curve. We also monitor our interest rates exposure through periodic reviews of projected cash flows and durations of our asset and liability positions. The following table summarizes the estimated change in fair value of our fixed maturity investment portfolio of a hypothetical immediate increase in interest rates of 100 basis points across the yield curve as of December 31, 2021 and 2020: December 31, 2021 2020 Fair value of fixed maturity investment (1) $ 1,656 $ 2,329 Pre-tax impact of 100 basis point increase in interest rates Decrease in dollars $ (50) $ (69) As a percent of fair value 3 % 3 % (1) Excludes investments in distressed Ambac-insured securities and securities held by VIEs consolidated as a result of Ambac’s financial guarantees The following table presents the impact on the fair value of our long-term debt obligations and interest rate derivatives of a hypothetical immediate decrease in interest rates of 100 basis points across the yield curve as of December 31, 2021 and 2020: December 31, 2021 2020 Fair value of long-term debt including accrued interest (1) $ (2,598) $ (3,071) Pre-tax impact of 100 basis point decrease in interest rates Increase in dollars $ (55) $ (58) As a percent of fair value 2 % 2 % Fair value of interest rate derivative net assets (liabilities) (1) $ (19) $ (21) Pre-tax impact of 100 basis point decrease in interest rates Pre-tax loss from change in fair value in dollars $ (51) $ (8) (1) Excludes long-term debt and derivative instruments of VIEs consolidated as a result of Ambac’s financial guarantees Foreign Currency Risk Ambac has fixed maturity investments and investments in pooled funds denominated in currencies other than the U.S. dollar, primarily British pounds sterling and Euro. These financial instruments are primarily invested assets of Ambac UK | Ambac Financial Group, Inc. 59 2021 FORM 10-K | Table of Contents and are held in consideration of non-U.S. dollar exposure in the financial guarantee insurance portfolio and operations of Ambac UK. The adverse fair value impact of a stronger U.S. dollar relative to other currencies on investment holdings would be directionally offset by the economic benefits to non-U.S. dollar financial guarantees and other risk exposures. The following table summarizes the estimated decrease in fair value of these financial instruments assuming immediate 20% strengthening of the U.S. dollar relative to the foreign currencies as of December 31, 2021 and 2020: December 31, 2021 2020 Fair value of investments denominated in currencies other than the U.S. dollar (1) $ 478 $ 453 Pre-tax impact of 20% strengthening of the U.S. dollar $ (96) $ (91) (1) Excludes investments in distressed Ambac-insured securities and securities held by VIEs consolidated as a result of Ambac’s financial guarantees Equity Sensitivity Ambac’s investment portfolio includes equity and partnership interests in pooled funds with diverse asset holdings and strategies. The table below summarizes the decrease in fair value of Ambac’s pooled fund investments that would occur assuming an immediate and uniform 10% decline in NAV of the funds. The selection of a 10% fair value stress is made only as an illustration of the hypothetical impact of adverse market movements on Ambac’s investments with equity value sensitivity. Actual market shocks could have materially different aggregate results and would likely not have a uniform impact on all funds given the diversity of the funds’ holdings and strategies. December 31, 2021 2020 Fair value of investments in pooled funds $ 683 $ 544 Pre-tax impact of 10% decline in NAV of the funds $ (68) $ (54) | Ambac Financial Group, Inc. 60 2021 FORM 10-K | Table of Contents Item 8. Financial Statements and Supplementary Data AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Report of Independent Registered Public Account Firm KPMG LLP , New York, NY , PCAOB ID 185 62 Consolidated Financial Statements Consolidated Balance Sheets 65 Consolidated Statements of Stockholders’ Equity 67 Consolidated Statements of Total Comprehensive Income (Loss) 66 Consolidated Statements of Cash Flows 68 Notes to Consolidated Financial Statements Note 1. Background and Business Description 69 Note 11. Variable Interest Entities 113 Note 2. Basis of Presentation and Significant Accounting Policies 71 Note 12. Long-term Debt 117 Note 3. Business Combination 84 Note 13. Revenues From Contracts with Customers 119 Note 4. Investments 85 Note 14. Comprehensive Income 120 Note 5. Fair Value Measurements 91 Note 15. Net Income Per Share 121 Note 6. Financial Guarantees in Force 98 Note 16. Income Taxes 121 Note 7. Insurance Contracts 99 Note 17. Employment Benefit Plans 123 Note 8. Insurance Regulatory Restrictions 107 Note 18. Leases 125 Note 9. Derivative Instruments 111 Note 19. Commitments and Contingencies 126 Note 10. Intangible Assets 113 | Ambac Financial Group, Inc. 61 2021 FORM 10-K | Table of Contents Report of Independent Registered Public Accounting Firm To the Stockholders and Board of Directors Ambac Financial Group, Inc.: Opinion on Internal Control Over Financial Reporting We have audited Ambac Financial Group, Inc. and subsidiaries' (the Company) internal control over financial reporting as of December 31, 2021, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2021, based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2021 and 2020, the related consolidated statements of total comprehensive income (loss), stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2021, and the related notes and financial statement schedules I, II and IV (collectively, the consolidated financial statements), and our report dated February 24, 2022 expressed an unqualified opinion on those consolidated financial statements. Basis for Opinion The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. Definition and Limitations of Internal Control Over Financial Reporting A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ KPMG LLP New York, New York February 24, 2022 | Ambac Financial Group, Inc. 62 2021 FORM 10-K | Table of Contents Report of Independent Registered Public Accounting Firm To the Stockholders and Board of Directors Ambac Financial Group, Inc.: Opinion on the Consolidated Financial Statements We have audited the accompanying consolidated balance sheets of Ambac Financial Group, Inc. and subsidiaries (the Company) as of December 31, 2021 and 2020, the related consolidated statements of total comprehensive income (loss), stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2021, and the related notes and financial statement schedules I, II and IV (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2021 and 2020, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2021, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2021, based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated February 24, 2022 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting. Basis for Opinion These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit Matter The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of a critical audit matter does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates. Estimate of loss and loss expense reserves and subrogation recoverable As described in Notes 2 and 7 to the consolidated financial statements, the Company estimates financial guarantee loss and loss expense reserves and subrogation recoverable (loss reserves) on a policy-by-policy basis based upon the present value of expected net claim cash outflows or expected net recovery cash inflows, discounted at risk-free rates. Expected net claim cash outflows represent the present value of expected claim cash outflows, less the present value of expected recovery cash inflows. For such policies, a loss and loss expense reserves liability is recorded for the present value of expected net claim cash outflows in excess of the related unearned premium revenue. Expected net recovery cash inflows represent the present value of expected recovery cash inflows, less the present value of expected claim cash outflows. For such policies, a subrogation recoverable asset is recorded. As of December 31, 2021, the Company recorded loss and loss expense reserves of $1,538 million and subrogation recoverable of $2,092 million. We identified the evaluation of loss reserves as a critical audit matter. The evaluation encompassed the assessment of the loss reserves methodologies, including those methods used to estimate the following assumptions: (1) credit worthiness of the issuer of the insured security, (2) the likelihood of possible outcomes regarding the probability of default by the issuer of the insured security, (3) the expected loss severity for each insurance policy, (4) the probability of remediation, settlement and restructuring outcomes, and (5) the probability of successful litigation or related settlement outcomes, as well as the percentage of the breach rates of representations and warranties underlying certain insured residential mortgage backed securities. The evaluation of the methods and the impact of these assumptions required specialized skills and subjective and complex auditor judgment due to a high level of estimation uncertainty. The following are the primary procedures we performed to address this critical audit matter. With the involvement of professionals with specialized industry knowledge and experience, when necessary, we evaluated the design and tested the operating effectiveness of certain internal controls related to the Company's estimation of loss reserves. This included controls related to the determination of the sources of data and assumptions and the analysis of the loss reserves and historical trends. We inquired of internal and external | Ambac Financial Group, Inc. 63 2021 FORM 10-K | Table of Contents legal counsel and read letters received directly from the Company’s internal and external legal counsel regarding the status of litigation underlying certain insurance policies. We involved credit risk professionals with specialized skills and knowledge, who assisted in assessing the individual issuer ratings and credit classifications for certain policies by evaluating the financial performance of the issuer of the insured security and underlying collateral. We involved forensics professionals with specialized skills and knowledge, who assisted in inspecting underwriting documentation for certain mortgage loans underlying insured residential mortgage backed securities, which were examined by the Company’s consultants engaged to determine breach rates of representations and warranties. We also involved valuation professionals with specialized skills and knowledge, who assisted in: • evaluating the methods used to estimate loss reserves for compliance with U.S. generally accepted accounting principles • evaluating, for certain policies, the sources of data and assumptions used in the calculation of loss reserves by comparing to internal experience and related historical and industry trends • developing, for certain policies, an independent estimate of the loss reserves and comparing it to the recorded estimate. /s/ KPMG LLP We have served as the Company’s auditor since 1985. New York, New York February 24, 2022 | Ambac Financial Group, Inc. 64 2021 FORM 10-K | Table of Contents AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES Consolidated Balance Sheets (Dollars in millions, except share data) December 31, 2021 2020 Assets: Investments: Fixed maturity securities, at fair value (amortized cost of $ 1,605 and $ 2,175 ) $ 1,730 $ 2,317 Fixed maturity securities pledged as collateral, at fair value (amortized cost of $ 15 and $ 15 ) 15 15 Short-term investments, at fair value (amortized cost of $ 415 and $ 492 ) 414 492 Short-term investments pledged as collateral, at fair value (amortized cost of $ 105 and $ 125 ) 105 125 Other investments (includes $ 683 and $ 544 at fair value) 690 595 Total investments (net of allowance for credit losses of $ 0 and $ 0 ) 2,955 3,544 Cash and cash equivalents 17 20 Restricted cash 5 13 Premium receivables (net of allowance for credit losses of $ 9 and $ 17 ) 323 370 Reinsurance recoverable on paid and unpaid losses (net of allowance for credit losses of $ 0 and $ 0 ) 55 33 Deferred ceded premium 90 70 Subrogation recoverable 2,092 2,156 Derivative assets 76 93 Intangible assets 362 409 Goodwill 46 46 Other assets 68 68 Variable interest entity assets: Fixed maturity securities, at fair value 3,455 3,354 Restricted cash 2 2 Loans, at fair value 2,718 2,998 Derivative assets 38 41 Other assets 2 2 Total assets $ 12,303 $ 13,220 Liabilities and Stockholders’ Equity: Liabilities: Unearned premiums $ 395 $ 456 Loss and loss expense reserves 1,570 1,759 Ceded premiums payable 33 27 Long-term debt 2,230 2,739 Accrued interest payable 576 517 Derivative liabilities 95 114 Other liabilities 133 135 Variable interest entity liabilities: Long-term debt (includes $ 4,056 and $ 4,324 at fair value) 4,216 4,493 Derivative liabilities 1,940 1,835 Total liabilities 11,187 12,074 Commitments and contingencies (See Note 19) Redeemable noncontrolling interest 18 7 Stockholders’ equity: Preferred stock, par value $ 0.01 per share; 20,000,000 shares authorized shares; issued and outstanding shares— none — — Common stock, par value $ 0.01 per share; 130,000,000 shares authorized; issued shares: 46,477,068 and 45,865,081 — — Additional paid-in capital 257 242 Accumulated other comprehensive income 58 79 Retained earnings 726 759 Treasury stock, shares at cost: 172,929 and 55,942 ( 3 ) ( 1 ) Total Ambac Financial Group, Inc. stockholders’ equity 1,038 1,080 Nonredeemable noncontrolling interest 60 60 Total stockholders’ equity 1,098 1,140 Total liabilities, redeemable noncontrolling interest and stockholders’ equity $ 12,303 $ 13,220 See accompanying Notes to Consolidated Financial Statements | Ambac Financial Group, Inc. 65 2021 FORM 10-K | Table of Contents AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES Consolidated Statements of Total Comprehensive Income (Loss) (Dollars in millions, except share data) Year Ended December 31, 2021 2020 2019 Revenues: Net premiums earned $ 47 $ 54 $ 66 Net investment income 139 122 227 Net investment gains (losses), including impairments 7 22 81 Net gains (losses) on derivative contracts 22 ( 50 ) ( 50 ) Net realized gains (losses) on extinguishment of debt 33 — — Other income 27 3 134 Income (loss) on variable interest entities 7 5 38 Total revenues 282 156 496 Expenses: Losses and loss expenses (benefit) ( 88 ) 225 13 Intangible amortization 55 57 295 Operating expenses 126 92 103 Interest expense 187 222 269 Total expenses 281 596 680 Pre-tax income (loss) 2 ( 440 ) ( 183 ) Provision (benefit) for income taxes 18 ( 3 ) 32 Net income (loss) ( 16 ) ( 437 ) ( 216 ) Less: net (gain) loss attributable to noncontrolling interest ( 1 ) — — Net income (loss) attributable to common stockholders $ ( 17 ) $ ( 437 ) $ ( 216 ) Other comprehensive income (loss), after tax: Net income (loss) $ ( 16 ) $ ( 437 ) $ ( 216 ) Unrealized gains (losses) on securities, net of income tax provision (benefit) of $( 2 ), $ 1 and $( 8 ) ( 12 ) 15 65 Gains (losses) on foreign currency translation, net of income tax provision (benefit) of $ — , $ — and $ — ( 8 ) 23 26 Credit risk changes of fair value option liabilities, net of income tax provision (benefit) of $ — , $ — and $ — ( 1 ) 1 — Changes to postretirement benefit, net of income tax provision (benefit) of $ — , $ — and $ — ( 1 ) ( 3 ) ( 1 ) Total other comprehensive income (loss), net of income tax ( 21 ) 37 91 Total comprehensive income (loss) ( 38 ) ( 400 ) ( 125 ) Less: comprehensive (loss) gain attributable to the noncontrolling interest: Net gain (loss) ( 1 ) — — Total comprehensive income (loss) attributable to common stockholders $ ( 38 ) $ ( 400 ) $ ( 125 ) Net income (loss) per share attributable to common stockholders: Basic $ ( 0.61 ) $ ( 9.47 ) $ ( 4.69 ) Diluted $ ( 0.61 ) $ ( 9.47 ) $ ( 4.69 ) Weighted average number of common shares outstanding: Basic 46,535,001 46,147,062 45,954,908 Diluted 46,535,001 46,147,062 45,954,908 See accompanying Notes to Consolidated Financial Statements | Ambac Financial Group, Inc. 66 2021 FORM 10-K | Table of Contents AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES Consolidated Statements of Stockholders’ Equity Ambac Financial Group, Inc. ($ in Millions) Total Retained Earnings Accumulated Other Comprehensive Income Preferred Stock Common Stock Additional Paid-in Capital Treasury Stock, at Cost Nonredeemable Noncontrolling Interest Balance at January 1, 2019 $ 1,633 $ 1,421 $ ( 49 ) $ — $ — $ 219 $ — $ 41 Total comprehensive income (loss) ( 125 ) ( 216 ) 91 — — — — — Stock-based compensation 12 — — — — 12 — — Cost of shares (acquired) issued under equity plan ( 3 ) ( 3 ) — — — — — — Re-issuance of Ambac Assurance auction market preferred shares 19 — — — — — — 19 Balance at December 31, 2019 $ 1,536 $ 1,203 $ 42 $ — $ — $ 232 $ — $ 60 Total comprehensive income (loss) ( 400 ) ( 437 ) 37 — — — — — Adjustment to initially apply ASU 2016-13 ( 4 ) ( 4 ) — — — — — — Stock-based compensation 11 — — — — 11 — — Cost of shares (acquired) issued under equity plan ( 3 ) ( 2 ) — — — — ( 1 ) — Balance at December 31, 2020 $ 1,140 $ 759 $ 79 $ — $ — $ 242 $ ( 1 ) $ 60 Total comprehensive income (loss) ( 38 ) ( 17 ) ( 21 ) — — — — — Stock-based compensation 14 — — — — 14 — — Cost of shares (acquired) issued under equity plan ( 6 ) ( 4 ) — — — — ( 2 ) — Changes to Redeemable noncontrolling interest ( 12 ) ( 12 ) — — — — — — Balance at December 31, 2021 $ 1,098 $ 726 $ 58 $ — $ — $ 257 $ ( 3 ) $ 60 See accompanying Notes to Consolidated Financial Statements | Ambac Financial Group, Inc. 67 2021 FORM 10-K | Table of Contents AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows ($ in millions) Year Ended December 31, 2021 2020 2019 Cash flows from operating activities: Net income (loss) attributable to common stockholders $ ( 17 ) $ ( 437 ) $ ( 216 ) Redeemable noncontrolling interest ( 1 ) — — Net income (loss) ( 16 ) ( 437 ) ( 216 ) Adjustments to reconcile net income to net cash used in operating activities: Depreciation and amortization 2 1 — Amortization of bond premium and discount ( 13 ) ( 15 ) ( 63 ) Share-based compensation 14 11 12 Deferred income taxes 6 ( 9 ) 1 Current income taxes ( 4 ) 17 35 Unearned premiums, net ( 82 ) ( 48 ) ( 132 ) Losses and loss expenses, net ( 147 ) 76 ( 364 ) Ceded premiums payable 6 ( 3 ) ( 4 ) Premium receivables 48 44 77 Accrued interest payable 103 93 87 Amortization of intangible assets 55 57 295 Net realized investment gains ( 7 ) ( 22 ) ( 81 ) (Gain) loss on extinguishment of debt ( 33 ) — — Variable interest entity activities ( 7 ) ( 5 ) ( 38 ) Derivative assets and liabilities ( 23 ) 6 ( 1 ) Other, net ( 35 ) 59 79 Net cash used in operating activities ( 131 ) ( 175 ) ( 311 ) Cash flows from investing activities: Proceeds from sales of bonds 236 1,109 1,212 Proceeds from matured bonds 698 137 379 Purchases of bonds ( 343 ) ( 975 ) ( 959 ) Proceeds from sales of other invested assets 39 374 81 Purchases of other invested assets ( 127 ) ( 475 ) ( 137 ) Change in short-term investments 98 158 ( 218 ) Change in cash collateral receivable 9 — 100 Proceeds from paydowns of consolidated VIE assets 171 178 543 Acquisition of Xchange, net of cash acquired — ( 74 ) — Other, net ( 5 ) 1 ( 2 ) Net cash provided by investing activities 776 432 1,000 Cash flows from financing activities: Proceeds from issuance of Ambac UK Debt — — 12 Proceeds from issuance of Sitka AAC Note 1,163 — — Proceeds from issuance of Surplus Notes 11 — — Paydowns of LSNI Ambac Note ( 1,641 ) ( 121 ) ( 178 ) Payments for debt issuance costs ( 12 ) — — Issuance of auction market preferred shares of Ambac Assurance — — 19 Tax payments related to shares withheld for share-based compensation plans ( 6 ) ( 3 ) ( 3 ) Distributions to noncontrolling interest holders ( 1 ) — — Payments of consolidated VIE liabilities ( 170 ) ( 178 ) ( 542 ) Net cash used in financing activities ( 657 ) ( 303 ) ( 691 ) Effect of foreign exchange on cash and cash equivalents — — — Net cash flow ( 12 ) ( 46 ) ( 2 ) Cash, cash equivalents, and restricted cash at beginning of period 35 81 83 Cash, cash equivalents, and restricted cash at end of period $ 23 $ 35 $ 81 See accompanying Notes to Consolidated Financial Statements | Ambac Financial Group, Inc. 68 2021 FORM 10-K | Table of Contents AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (Dollar Amounts in Millions, Except Share Amounts) 1. BACKGROUND AND BUSINESS DESCRIPTION Ambac Financial Group, Inc. (“AFG”), headquartered in New York City, is a financial services holding company incorporated in the state of Delaware on April 29, 1991 . References to “Ambac,” the “Company,” “we,” “our,” and “us” are to AFG and its subsidiaries, as the context requires. Ambac's business operations include: • Financial Guarantee ("FG") Insurance — Ambac Assurance Corporation ("AAC") and its wholly owned subsidiary, Ambac Assurance UK Limited (“Ambac UK”) are legacy financial guarantee businesses, both of which have been in runoff since 2008 (the "Financial Guarantee Insurance Companies"). • Specialty Property & Casualty Program Insurance ("SPCP") — Currently includes five admitted carriers (Everspan Insurance Company, Providence Washington Insurance Company, 21st Century Indemnity Insurance Company, 21st Century Pacific Insurance Company and 21st Century Auto Insurance Company of New Jersey) and an excess and surplus lines (“E&S” or “nonadmitted”) insurer Everspan Indemnity Insurance Company (collectively, “Everspan”). The 21st Century companies were acquired in 2022. Everspan carriers that are currently part of the intercompany pooling agreement (Everspan Indemnity Insurance Company ("Everspan Indemnity") and Everspan Insurance Company) received an AM Best rating of 'A-' (Excellent) in February 2021. Everspan launched its first insurance program in May 2021. • Managing General Agency / Underwriting ("MGA/U) — Currently includes Xchange Benefits, LLC and Xchange Affinity Underwriting Agency, LLC (collectively, “Xchange”), a property and casualty Managing General Underwriter focussed on accident and health products of which AFG acquired 80 % on December 31, 2020. Refer to Note 3. Business Combination for further information relating to this acquisition. While SPCP and MGA/U (together, the "Specialty P&C Program Insurance Platform") are distinct businesses, they are currently not material enough to Ambac's operations to warrant segment presentation. Management evaluates its reportable segments at least annually and as facts and circumstances change. Limitations on Voting and Transfer of Common Stock AFG’s Amended and Restated Certificate of Incorporation limits voting and transfer rights of stockholders in significant ways. Article IV contains voting restrictions applicable to any person owning at least 10 % of AFG's common stock so that such person (including any group consisting of such person and any other person with whom such person or any affiliate or associate of such person has any agreement, contract, arrangement or understanding with respect to acquiring, voting, holding or disposing of AFG’s common stock) shall not be entitled to cast votes in excess of one vote less than 10 % of the votes entitled to be cast by all common stock holders, except as otherwise approved by the OCI (as defined below). Article XII contains substantial restrictions on the ability to transfer AFG’s common stock. In order to preserve certain tax benefits, subject to limited exceptions, any attempted transfer of common stock shall be prohibited and void to the extent that, as a result of such transfer (or any series of transfers of which such transfer is a part), either (i) any person or group of persons shall become a holder of 5 % or more of the Company’s common stock or (ii) the percentage stock ownership interest in AFG of any holder of 5 % or more of the Company’s common stock shall be increased (a “Prohibited Transfer”). These restrictions shall not apply to an attempted transfer if the transferor or the transferee obtains the written approval of AFG’s Board of Directors to such transfer. A purported transferee of a Prohibited Transfer shall not be recognized as a stockholder of AFG for any purpose whatsoever in respect of the securities which are the subject of the Prohibited Transfer (the “Excess Securities”). Until the Excess Securities are acquired by another person in a transfer that is not a Prohibited Transfer, the purported transferee of a Prohibited Transfer shall not be entitled with respect to such Excess Securities to any rights of stockholders of AFG, including, without limitation, the right to vote such Excess Securities and to receive dividends or distributions, whether liquidating or otherwise, in respect thereof, if any. Once the Excess Securities have been acquired in a transfer that is not a Prohibited Transfer, the securities shall cease to be Excess Securities. If the Board determines that a transfer of securities constitutes a Prohibited Transfer then, upon written demand by AFG, the purported transferee shall transfer or cause to be transferred any certificate or other evidence of ownership of the Excess Securities within the purported transferee’s possession or control, together with any distributions paid by AFG with respect to such Excess Securities, to an agent designated by AFG. Such agent shall thereafter sell such Excess Securities and the proceeds of such sale shall be distributed as set forth in the Amended and Restated Certificate of Incorporation. If the purported transferee of a Prohibited Transfer has resold the Excess Securities before receiving such demand, such person shall be deemed to have sold the Excess Securities for AFG’s agent and shall be required to transfer to such agent the proceeds of such sale, which shall be distributed as set forth in the Amended and Restated Certificate of Incorporation. Strategies to Enhance Shareholder Value The Company's primary goal is to maximize shareholder value through the execution of key strategies for both its (i) Specialty P&C Program Insurance Platform and (ii) Financial Guarantee Insurance companies. Specialty P&C Insurance Program Platform strategic priorities include: • Growing and diversifying Everspan's participatory fronting platform with existing and new program partners. • Building a leading federation of specialty MGA/U partners through additional acquisitions and de novo builds, | Ambac Financial Group, Inc. 69 2021 FORM 10-K | Table of Contents AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (Dollar Amounts in Millions, Except Share Amounts) supported by a centralized business services unit including core technology solutions. • Making opportunistic investments that are strategic to the overall Specialty P&C Program Insurance Platform. Financial Guarantee Insurance companies’ strategic priorities include: • Actively managing, de-risking and mitigating insured portfolio risk. • Pursuing loss recovery through active litigation and other means, particularly residential mortgage back security representation and warranty litigation. • Improving operating efficiency and optimizing our asset and liability profile. • Exploring, at the appropriate time, strategic options to further maximize value for AFG. The execution of Ambac’s strategy to increase the value of its investment in AAC is subject to the restrictions set forth in the Settlement Agreement, dated as of June 7, 2010 (the "Settlement Agreement"), by and among AAC, Ambac Credit Products LLC ("ACP"), AFG and certain counterparties to credit default swaps with ACP that were guaranteed by AAC; as well as the Stipulation and Order among the Office of the Commissioner of Insurance for the State of Wisconsin (“OCI”), AFG and AAC that became effective on February 12, 2018, as amended (the “Stipulation and Order”); and the indenture for the Tier 2 Notes (as defined below), each of which requires OCI and, under certain circumstances, holders of the debt instruments benefiting from such restrictions, to approve certain actions taken by or in respect of AAC. In exercising its approval rights, OCI will act for the benefit of policyholders, and will not take into account the interests of AFG. Opportunities for remediating losses on poorly performing insured transactions also depend on market conditions, including the perception of AAC’s creditworthiness, the structure of the underlying risk and associated policy as well as other counterparty specific factors. AAC's ability to commute policies or purchase certain investments may also be limited by available liquidity. The Segregated Account and the Rehabilitation Exit Transactions In March 2010, AAC established a Segregated Account pursuant to Wisc. Stat. §611.24 (2) (the “Segregated Account”) to segregate certain segments of AAC’s liabilities, and the Wisconsin Insurance Commissioner, acting as rehabilitator (the "Rehabilitator") commenced rehabilitation proceedings in the Dane County, Wisconsin Circuit Court (the “Rehabilitation Court”) with respect to the Segregated Account (the “Segregated Account Rehabilitation Proceedings”) in order to permit OCI to facilitate an orderly run-off and/or settlement of the liabilities allocated to the Segregated Account. On October 8, 2010, OCI filed a plan of rehabilitation for the Segregated Account (the “Segregated Account Rehabilitation Plan”) in the Rehabilitation Court, which was confirmed on January 24, 2011. On June 11, 2014, the Rehabilitation Court approved amendments to the Segregated Account Rehabilitation Plan and the Segregated Account Rehabilitation Plan, as amended, became effective on June 12, 2014. Policy obligations not allocated to the Segregated Account remained in the General Account of AAC, and such policies in the General Account were not subject to and, therefore, were not directly impacted by the Segregated Account Rehabilitation Plan. On February 12, 2018, the rehabilitation of the Segregated Account was concluded pursuant to an amendment to the Segregated Account Rehabilitation Plan (the "Second Amended Plan of Rehabilitation"). The conclusion of the rehabilitation followed the successful completion of Ambac's surplus note exchange offers and consent solicitation, which, together with the satisfaction of all conditions precedent to the effectiveness of the Second Amended Plan of Rehabilitation, including the discharge of all unpaid policy claims of the Segregated Account, including accretion amounts thereon ("Deferred Amounts"), completed the restructuring transactions (the "Rehabilitation Exit Transactions"). In connection with the discharge of all unpaid policy claims, AAC issued the secured notes and the Tier 2 notes. See Note 12. Long-term Debt for additional information regarding the secured notes and Tier 2 Notes. Bank Settlement Agreement As part of the Rehabilitation Exit Transactions, AFG and AAC received sufficient consents from holders of surplus notes for a waiver and amendment (the "BSA Waiver and Amendment") of the Settlement Agreement. After giving effect to the BSA Waiver and Amendment, the Settl