Item 1. Business.

        Financial Security Assurance Holdings Ltd., through its insurance company subsidiaries, is primarily engaged in providing financial guaranty insurance on public finance obligations in domestic and international markets. Historically, the Company also provided financial guaranty insurance on asset-backed obligations. In addition, the Company historically issued FSA-insured guaranteed investment contracts and other investment agreements ("GICs") as well as medium term notes to municipalities and other market participants through its Financial Products ("FP") segment. In August 2008, the Company announced that it would cease insuring asset-backed obligations and instead participate exclusively in the global public finance financial guaranty business. In November 2008, the Company ceased issuing GICs. While the Company has ceased new originations of asset-backed financial guaranty business and GICs, a substantial portfolio of such obligations remains outstanding.

        The Company's principal insurance company subsidiary is Financial Security Assurance Inc. ("FSA"), a wholly owned New York insurance company. References to the "Company" are to Financial Security Assurance Holdings Ltd. together with its subsidiaries. References to "FSA Holdings" are to Financial Security Assurance Holdings Ltd. without its subsidiaries.

        In November 2008, the Company's principal shareholder entered into a Purchase Agreement (the "Purchase Agreement") providing for the sale of the Company to Assured Guaranty Ltd. ("Assured"), subject to the consummation of specified closing conditions, including regulatory approvals, absence of rating impairment and segregation or separation of the Company's FP operations from the Company's financial guaranty operations. In February 2009, the Company's ultimate parent, Dexia S.A. ("Dexia"), through its bank affiliates, entered into agreements assuming credit and liquidity risks associated with the Company's GIC operations, resulting in the "deconsolidation" of FSA Asset Management LLC ("FSAM") from the Company under accounting principles generally accepted in the United States of America ("GAAP").

        Obligations insured by the Company are generally awarded ratings on the basis of the financial strength ratings given to the Company's insurance company subsidiaries by the major securities rating agencies. On December 31, 2008, the Company was rated Triple-A (negative credit watch) by Standard & Poor's Ratings Services ("S&P") and Fitch Ratings ("Fitch") and Aa3 (developing outlook) by Moody's Investors Service, Inc. ("Moody's"). Prior to the third quarter of 2008, the Company's insurance company subsidiaries, as well as the obligations they insured, had been awarded Triple-A ratings by the three major rating agencies.

        During 2007 and 2008, the global financial crisis that began in the U.S. subprime residential mortgage market transformed the financial guaranty industry. By the end of November 2008, all of the monoline guarantors that had been rated Triple-A at the beginning of the year had been downgraded in varying degrees by Moody's, and all but one had been either downgraded or placed on negative outlook or negative credit watch by S&P and Fitch. FSA and the Company's other insurance company subsidiaries were among the last companies to be affected, and were rated "Triple-A/stable" by all three rating agencies until July 2008. Rating agencies raised concerns about the stability of FSA's rating during the second half of 2008, and Moody's lowered FSA's Aaa rating to Aa3 (developing outlook) in November. These developments, combined with illiquidity in the capital markets, led to a marked reduction in FSA's production in the second half of 2008. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations—Executive Overview."

        For the year ended December 31, 2008, the Company had gross premiums written of $690.4 million, of which approximately 88% related to insurance of public finance obligations and approximately 12% related to insurance of asset-backed and other non-public finance obligations. The Company also had realized gains on credit derivatives of $126.9 million in 2008. At December 31, 2008,

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the Company had net par outstanding of $408.5 billion, of which approximately 75% represented insurance of public finance obligations and approximately 25% represented insurance of asset-backed and other non-public finance obligations. At December 31, 2008, the Company had $16.4 billion principal amount of outstanding FP segment debt.

        FSA's exposure to mortgage-backed obligations with deteriorating credit performance has generated losses, as reflected in the Company's net loss reserves, which have increased from $198.1 million as of December 31, 2007 to $1,476.9 million at December 31, 2008, and a negative $7.2 billion change in fair value of the FP segment's investment portfolio over the same period, despite the fact that the Company has no material exposures to collateralized debt obligations ("CDOs") of asset-backed securities ("ABS") that include residential mortgage-backed securities ("RMBS"), which caused severe losses for a number of other financial guarantors. The full extent of credit losses in the mortgage sector, and the extent to which they may affect the Company, will not be known for several years. The Company is also closely monitoring the consumer and corporate sectors for signs of deepening economic stress. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations—Executive Overview—Summary Results of Operations and Financial Condition."

Transfer of Credit and Liquidity Risk of the GIC Business

        The proceeds of GICs issued in connection with the Company's FP business were invested in securities owned by FSAM. Most of FSAM's assets consist of RMBS that have suffered significant market value declines and, in more limited cases, credit deterioration. The market value declines of FSAM's assets subject FSAM to significant liquidity risk insofar as the GICs are in most cases subject to redemption or collateralization upon the downgrade of FSA below certain thresholds, with a significant number of GICs subject to redemption or collateralization should FSA be downgraded below Aa3 by Moody's (FSA's current Moody's rating) or below AA- by S&P. Dexia had previously announced its intention to assume the credit and liquidity risk associated with the Company's FP business, and provided significant support to the FP business in the course of 2008.

        In February 2009, Dexia entered into several agreements that transfer credit and liquidity risk of the GIC operations to Dexia, which resulted in "deconsolidation" of FSAM from the Company (the "FSAM Risk Transfer Transaction") as of that date. These agreements provide for the (i) elimination of FSA's guaranty of repayment of FSAM's borrowings under the credit facilities provided by Dexia's bank subsidiaries; (ii) elimination of FSA's guaranty of certain of FSAM's investments; and (iii) increase in the credit facilities provided to FSAM by Dexia's bank subsidiaries from $5 billion to $8 billion. For further information regarding these agreements, see "—Expected Sale of the Company—Dexia's Retention of the FP Business" and "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation—Liquidity and Capital Resources—FP Segment Liquidity—Liquidity Resources."

Expected Sale of the Company

Purchase Agreement with Assured

        In November 2008, Dexia and Assured entered into the Purchase Agreement providing for the purchase by Assured of all Company shares owned by Dexia (the "Acquisition"), subject to the satisfaction of specified closing conditions. Purchase Agreement closing conditions include (1) receipt of regulatory and Assured shareholder approvals; (2) confirmation from S&P, Moody's and Fitch that the acquisition of the Company would not result in a downgrade of the financial strength ratings of the insurance company subsidiaries of Assured or of the Company; and (3) segregation or separation of the Company's FP business such that the credit and liquidity risk of the FP business resides with Dexia, with FSA protected against any future Dexia credit impairment.

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        Under the Hart-Scott-Rodino Antitrust Improvements Act of 1976 (the "HSR Act") and the rules promulgated thereunder by the Federal Trade Commission (the "FTC"), the Acquisition may not be consummated until notifications have been given and certain information has been furnished to the FTC and the Department of Justice (the "DOJ") and specified waiting period requirements have been satisfied. The HSR Act waiting period expired on January 21, 2009. In addition, under the insurance holding company laws and regulations applicable to the insurance subsidiaries of the Company and Assured, before a person can acquire control of a U.S. insurance company, prior written approval must be obtained from the insurance commissioner of the state where the insurer is domiciled. Assured has informed the Company that Assured filed applications with the insurance departments of the States of New York and Oklahoma and the U.K. Financial Services Authority; that the applications to the New York Insurance Department and the U.K. Financial Services Authority have been approved; and that it has made pre-acquisition filings regarding the potential competitive impact of the acquisition, which are deemed to have been approved. Dexia has informed the Company that it has filed an application with the U.K. Financial Services Authority in connection with its acquisition of Assured common shares pursuant to the Purchase Agreement, which has been approved, and that it has filed disclaimers of control with the insurance departments of the states of Maryland, New York, and Oklahoma.

        The Company cannot estimate whether or when the remaining closing conditions will be satisfied or relevant agreements negotiated, whether the Acquisition will be completed and, if completed, whether it will be structured as currently contemplated, or what the effects of the change in control or removal of the FP business will be on the Company and its results of operations. If the Acquisition is not completed, Dexia may explore other options with respect to the Company, including selling the Company or some of its operations to a third party or ceasing to write new business, which may have a material adverse effect on the Company.

Post-Closing Parameters

        The Purchase Agreement imposes a number of limitations on FSA after the Purchase Agreement closing (each, a "Post-Closing Parameter"), intended to maintain the creditworthiness of FSA. The Post-Closing Parameters are subject to change, and currently include the following:

1.

Unless FSA is rated below Single-A-, it may not write any business other than insurance on municipal and infrastructure bonds, whether written directly, assumed, reinsured or occurring through any merger transaction.



2.

Unless Dexia otherwise consents, FSA must continue to be domiciled in New York and treated as a monoline bond insurer for regulatory purposes.



3.

FSA will not take any of the following actions without prior rating agency confirmation that such action would not cause its rating to be immediately downgraded: merger, issuance of debt or other borrowing exceeding $250 million, issuance of equity or other capital instruments exceeding $250 million, entry into new reinsurance arrangements involving more than 10% of the portfolio, or any waiver, amendment or modification of any agreement relating to capital or liquidity support of FSA exceeding $250 million.



4.

FSA shall not repurchase, redeem or pay any dividends in relation to any class of equity interests (including interest payments on its surplus notes), unless (i) FSA is rated at least AA- by S&P and Fitch and Aa3 by Moody's and the aggregate amount of such dividends in any year does not exceed $25 million or (ii) FSA receives prior rating agency confirmation that such action would not cause its rating to be immediately downgraded.



5.

FSA shall not (i) enter into commutation or novation agreements with respect to its insured portfolio involving a payment exceeding $250 million or (ii) enter into any "cut-through" reinsurance, pledge of collateral security or similar arrangement whereby the benefits of

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reinsurance purchased by FSA or of other assets of FSA would be available on a preferred or priority basis to a particular class or subset of FSA policyholders relative to the position of Dexia as policyholder upon the default or insolvency of FSA, other than with Dexia's consent.

6.

FSA shall restrict its liquidity exposure such that no GICs or similar liabilities insured by FSA shall have terms that require acceleration, termination or prepayment based on a downgrade or withdrawal of any rating assigned to FSA's financial strength, a downgrade of the issuer or obligor under the agreement, or a downgrade of any third party.



7.

FSA shall continue to be rated by each of Moody's, S&P and Fitch (if such rating agencies still rate financial guaranty insurers generally) unless and until the date on which (i) the rating agencies have assigned a credit rating to FSA Capital Management Services LLC ("FSACM"), FSA Capital Markets Services (Caymans) Ltd. and FSA Capital Markets Services LLC (collectively, the "GIC Subsidiaries") (and/or the liabilities of the GIC Subsidiaries under the relevant GICs have been separately rated) which is independent of FSA's financial strength rating and (ii) the principal amount of GICs in relation to which a downgrade of FSA may result in a requirement to post collateral or terminate such GIC (notwithstanding the existence of a separate rating referred to in (i) of at least Double-A or higher) is below $1.0 billion (the "De-Linkage Date").

        The first five Post-Closing Parameters will be in effect for three years following the closing of the Acquisition and Post-Closing Parameters six and seven will be in effect until the De-Linkage Date occurs, provided that all of the Post-Closing Parameters will terminate if at any time after the De-Linkage Date the aggregate principal amount or notional amount of exposure of Dexia and any of its affiliates (excluding the exposures relating to the FP business) to any transactions insured by FSA or any of its affiliates prior to the signing date is less than $1 billion (the "Exposure Limitation Date").

        As a general matter, if FSA merges with, enters into a consolidation with or sells all or substantially all of its assets to another company, that company will be subject to the Post-Closing Parameters. However, if FSA and Assured merge, Post-Closing Parameters one and two will terminate one year after the Purchase Agreement closing and the other Post-Closing Parameters will expire three years after the closing date (subject in each case to any Exposure Limitation Date).

Dexia's Retention of the FP Business

        Under the Purchase Agreement, Dexia is expected to retain the Company's FP business after the Acquisition. The Purchase Agreement provides that Dexia will provide guarantees with respect to the FP business' assets and liabilities, including derivative contracts, and anticipates that some of its guarantees will benefit from guarantees provided by the French and Belgian states. Dexia Holdings Inc. ("Dexia Holdings"), FSA Holdings' parent, agreed that if such sovereign guarantees are provided, it will cause FSA Holdings to transfer the ownership interests of certain of the subsidiaries that conduct the FP business, or all the assets and liabilities of such subsidiaries, to Dexia Holdings or one of its affiliates in form reasonably acceptable to Assured.

        Under the Purchase Agreement, Dexia Holdings is expected to retain the risks associated with the medium term notes business and certain portions of its leveraged lease business, FSA is expected to retain the risks associated with the leveraged lease debt business, and no new business will be written by the variable interest entities ("VIEs") FSA Global Funding Limited ("FSA Global") and Premier International Funding Co. ("Premier"). See "—Organization—Financial Products Segment."

Organization

        The Company is a subsidiary of Dexia Holdings, which, in turn, is owned 90% by Dexia Crédit Local S.A. ("Dexia Crédit Local") and 10% by Dexia. Dexia is a Belgian corporation whose shares are

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traded on the Euronext Brussels and Euronext Paris markets as well as on the Luxembourg Stock Exchange. Dexia is primarily engaged in the business of public finance, banking and investment management in France, Belgium, Luxembourg and other European countries, as well as in the United States. Dexia Crédit Local is a wholly owned subsidiary of Dexia. In connection with the recent financial crisis, Dexia has received significant support from the governments of France and Belgium, who remain indirect major shareholders of Dexia.

        The Company divides its operations into two business segments: financial guaranty and financial products. The financial guaranty segment is primarily in the business of providing financial guaranty insurance through FSA and its other insurance company subsidiaries, but also includes the Company's refinancing vehicles and several other direct subsidiaries not in the FP segment. The FP segment is a run-off operation that was formerly in the business of borrowing funds through the issuance of GICs and medium term notes and reinvesting the proceeds in investments insured or qualifying for insurance by FSA.

Financial Guaranty Segment

        FSA wholly owns FSA Insurance Company ("FSAIC"), which in turn wholly owns Financial Security Assurance (U.K.) Limited ("FSA UK") and FSA Mexico Holdings Inc. ("FSA Mexico Holdings"). FSA and FSAIC together own Financial Security Assurance International Ltd. ("FSA International"). FSAIC is an Oklahoma insurance company that primarily provides reinsurance to FSA. FSA UK is a United Kingdom insurance company that primarily provides financial guaranty insurance for transactions in the United Kingdom and other European markets. FSA International is a Bermuda insurance company that provides reinsurance to FSA and financial guaranty insurance for transactions outside the United States and European markets. FSA Mexico Holdings is the New York holding company that, together with FSAIC, owns FSA's Mexican subsidiary, FSA Seguros México, S.A. de C.V. ("FSA Mexico"). FSA Mexico is licensed to transact financial guaranty insurance in Mexico.

        The Company refinances certain underperforming transactions by employing special purpose vehicles to raise funds to refinance such transactions. These refinancing vehicles are consolidated with the Company.

        FSA Portfolio Management Inc. ("FSA Portfolio Management"), a wholly owned subsidiary of the Company, is engaged in the business of managing a portion of the investment portfolios of the Company and certain of its subsidiaries. FSA Portfolio Management also owns strategic and other investments funded from time to time by the FSA group of companies. Transaction Services Corporation ("TSC"), a wholly owned subsidiary of the Company, is engaged in the business of managing troubled transactions within the insured portfolios of FSA and its subsidiaries.

Financial Products Segment

        The Company conducted its GIC business through the GIC Subsidiaries FSACM, FSA Capital Markets Services (Caymans) Ltd. and, prior to April 2003, FSA Capital Markets Services LLC. FSACM conducted substantially all the Company's GIC business since April 2003, following its receipt of an exemption from the requirements of the Investment Company Act of 1940. When the GIC Subsidiaries sold GICs, they loaned the proceeds to FSAM, which invested the funds in fixed-income securities that satisfy the Company's investment criteria. The GIC Subsidiaries ceased issuing GICs in November 2008 in contemplation of the sale of the Company to Assured. FSAM wholly owns FSA Portfolio Asset Limited ("FSA-PAL"), a U.K. company that invests in non-U.S. securities.

        The Company consolidates the results of FSA Global and Premier, which are VIEs. FSA Global issued FSA-insured medium term notes and generally invested the proceeds from the sale of its notes in FSA-insured GICs or other FSA-insured obligations with a view to realizing the yield difference

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between the notes issued and the obligations purchased with the note proceeds. Premier is principally engaged in leveraged lease transactions.

        Under the Purchase Agreement, Dexia is expected to retain the Company's FP business after the Acquisition. In contemplation of this change, FSACM, FSA Capital Markets Services LLC and FSAM became direct subsidiaries of a newly formed subsidiary, FSA Financial Products Inc. ("FSA Financial Products"), in December 2008. Previously they had been direct subsidiaries of FSA Holdings.

        Under the Purchase Agreement, Assured and Dexia Holdings agreed to cooperate in good faith to evaluate the feasibility of the actual or functional separation of FSA Global's leveraged lease and medium term notes businesses with a view to maximizing the tax, accounting and financial efficiency of the separation of the businesses for both parties. At March 17, 2009, an agreement had not been reached on the structure of the business separation. Regardless of the structure of such business separation, under the Purchase Agreement Dexia Holdings is expected to retain the risks associated with FSA Global's medium term notes business and certain portions of its leveraged lease business, FSA is expected to retain the risks associated with the leveraged lease debt business, and no new business will be written by FSA Global or Premier.

        The Company's management believes that the assets held by FSA Global, Premier and the refinancing vehicles, including those that are eliminated in consolidation, are beyond the reach of the Company's creditors, even in bankruptcy or other receivership.

History

        When the Company commenced operations in 1985, it was the first insurance company organized to insure non-municipal obligations. At that time, it was owned by a number of large insurance companies and other institutional investors. In 1989, the Company was acquired by U S WEST Capital Corporation, which subsequently changed its name to MediaOne Capital Corporation ("MediaOne"). MediaOne was a subsidiary of MediaOne Group, Inc., with operations and investments in domestic cable and broadband communications and international broadband and wireless communication. In 1990, the Company established a strategic relationship with The Tokio Marine and Nichido Fire Insurance Co., Ltd. ("Tokio Marine"), which acquired a minority interest in the Company. Tokio Marine is a major Japanese property and casualty insurance company. Also in 1990 the Company expanded the focus of its business to include financial guaranty insurance of municipal obligations and has since become a major insurer of municipal and other public finance obligations.

        In 1994, the Company completed an initial public offering of common shares, at which time White Mountains Insurance Group, Ltd. ("White Mountains") (formerly known as Fund American Enterprises Holdings, Inc.) made an investment in the Company, and the chairman of White Mountains became non-executive chairman of the Company. White Mountains is an insurance holding company.

        In 1998, the Company and XL Capital Ltd ("XL"), a major Bermuda-based insurance holding company, entered into a joint venture, establishing two Bermuda-domiciled financial guaranty insurance companies—FSA International and XL Financial Assurance Ltd, now Syncora Guarantee Re Ltd. ("SGR"). In connection with the joint venture, XL acquired a minority interest in the Company and FSA International, and the Company acquired a minority interest in SGR. The Company sold its interest in SGR during the third quarter of 2008.

        On July 5, 2000, the Company completed a merger in which the Company became a direct subsidiary of Dexia Holdings. At the merger date, each outstanding share of the Company's common stock was converted into the right to receive $76.00 in cash. At December 31, 2008, 99.9% of the Company's common stock was held by Dexia Holdings. The other holders are directors of the Company who own shares of the Company's common stock or economic interests therein as described

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under "Item 11. Executive Compensation—Compensation of Directors—Director Share Purchase Program" and "Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters—Directors and Executive Officers."

        In October 2005, FSA purchased the interest in FSA International owned by XL for a cash purchase price of $39.1 million in anticipation of the repatriation of earnings and profits of FSA International. Giving effect to such purchase, FSA International became an indirect, wholly owned subsidiary of the Company.

        In November 2008, Dexia entered in the Purchase Agreement providing for the sale of the Company to Assured.

        Although the Company's common stock is no longer listed on the New York Stock Exchange ("NYSE") as a consequence of the merger, the Company continues to file periodic reports under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), because the Company has debt securities listed on the NYSE.

        The Company's Executive Management Committee manages the Company's business. The Chief Executive Officer, President, General Counsel, Chief Risk Management Officer and Chief Financial Officer are members of the Executive Management Committee.

        The principal executive offices of the Company and FSA are located at 31 West 52nd Street, New York, New York, 10019. The Company maintains offices domestically in San Francisco and Dallas and abroad in London, Madrid, Mexico City, Paris, Sydney, Tokyo and Bermuda. The Company is in the process of closing its Mexico and Paris offices.

The Financial Guaranty Business

        Financial guaranty insurance written by FSA typically guarantees scheduled payments on financial obligations. Upon a payment default on an insured obligation, FSA is generally required to pay the principal, interest or other amounts due in accordance with the obligation's original payment schedule or may, at its option, pay such amounts on an accelerated basis. FSA's underwriting policy is to insure obligations that would otherwise be investment grade without the benefit of FSA's insurance.

Business Objectives

        The Company's objective for its financial guaranty business is to remain a leading insurer of public finance obligations while generating premium volume at attractive returns and minimizing the occurrence and severity of credit losses in its insured portfolio. The Company believes that short-term trends for the Company are unfavorable due, among other things, to the following factors:

•

reduced market acceptance of financial guaranty insurance arising in part from the severe rating downgrades of most of FSA's industry peers;



•

uncertainty surrounding the timing and consummation of the Purchase Agreement closing;



•

uncertainty regarding the stability of FSA's ratings; and



•

the prospect for continued loss development in the Company 's insured portfolio as the current economic crisis widens.

        The Company believes that the demand for FSA's financial guaranty insurance will recover over the long term as a result of the following factors, subject to a restoration of stable ratings for FSA:

•

an increasing need for municipal issuers to access the capital markets for funding in the face of declining tax and other revenues;

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•

expansion of infrastructure projects throughout the world that would benefit from capital market funding; and



•

wide credit spreads combined with market appetite for credit protection attributable to reduced risk tolerance by retail and institutional investors.

        Over the long term, the Company expects to continue to originate a diversified insured portfolio with a broad geographic distribution and a variety of revenue sources and transaction structures. In addition to its domestic business, the Company pursues international opportunities in Western European and Asia Pacific markets and, selectively, in Eastern European and Latin American markets.

Financial Guaranty Business

        FSA's insurance is employed in both the new-issue and secondary markets. In the case of new issues, the insured obligations are sold with FSA insurance at the time the obligations are issued. For public finance obligations, FSA participates in negotiated offerings, where the investment banker and often the insurer have been selected by the sponsor or issuer. In addition, FSA participates in competitive offerings, where underwriting syndicates bid for securities and submit bids that may include insurance.

        In certain insured transactions, the issuer of insured securities is party to an interest rate, basis or currency swap that matches the issuer's funding sources to the interest rate or currency of the insured securities or otherwise hedges the issuer's exposure. In certain of these transactions, FSA will insure the issuer's obligations under both the insured securities and the regularly scheduled payment under the derivative contract and, occasionally, the termination obligation. FSA may have provided its insurance directly to a security or other obligation or by insuring a credit default swap ("CDS") referencing such security or other obligation.

        In November 2008, FSA ceased writing financial guaranties on GICs issued in connection with the Company's FP business.

        FSA insures obligations already carrying insurance from other monoline guarantors, with FSA generally obligated to pay claims on a "second-to-pay" basis, following a default by both the underlying obligor and the first-to-pay financial guarantor. In recent years, FSA has also reinsured a modest amount of business from other financial guaranty insurers, but FSA did not assume reinsurance on any transactions during 2008.

        FSA has several programs that provide insurance for public finance obligations trading in the secondary markets, including its Custody Receipt Program, which provides insurance primarily for domestic municipal obligations trading in the secondary market, and its Triple-A Guaranteed Secondary Securities ("TAGSS"®) Program, which provides insurance primarily for public infrastructure obligations trading in the secondary market. Investors and dealers generally obtain secondary-market insurance to upgrade or stabilize the credit ratings of securities they already hold or plan to acquire or to increase the market liquidity of such securities.

        Prior to September 2008, FSA issued surety bonds under its Sure-Bid program, which provided an alternative to traditional types of good faith deposits for competitive municipal bond transactions. The Company may resume its Sure-Bid program, subject to improved credit protections from participating underwriters.

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        The table below shows par outstanding and excludes intercompany insured transactions.

        At December 31, 2008, the weighted average life of the direct par insured was approximately 4.0 years for asset-backed and 13.7 years for public finance obligations.

        The following table indicates the Company's percentages of par amount (net of reinsurance) outstanding with respect to each type of public finance and asset-backed program.

Premiums

        In setting its premium rates for transactions, FSA takes into account the risk it assumes and its projected return. Critical factors in assessing risk include the credit quality of the risk, type of issue, sources of repayment, transaction structure and term to maturity. The premium rate is also a function of market factors, capital charges assessed by securities rating agencies and the competitive environment. Market factors include the value added by the use of insurance, such as the interest rate savings obtained by the issuer of an insured obligation. S&P assigns a "capital charge" for most obligations insured by FSA. The capital charge for a transaction is an important factor in determining the "return on equity" from a specified transaction premium rate under the Company's proprietary model. Competition arises from other insurers and alternative executions that do not involve insurance.

        For insurance on GIC and medium term note transactions, transactions involving "repackaging" of outstanding securities and other transactions, FSA's premium may have been arbitrage-based, based upon the difference between the effective borrowing cost at a Triple-A rate and the interest rate on the underlying securities.

Public Finance Obligations

        FSA insures a range of public finance obligations, including:

•

general obligation bonds supported by the issuers' taxing power;

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•

tax-supported bonds supported by a specific or discrete source of taxation, leases or "subject to appropriation" or "moral obligation" (that is, a commitment to consider an appropriation for payment, but not an obligation to appropriate);



•

revenue bonds and other obligations of states, their political subdivisions and other municipal issuers that are supported by the issuer's or obligor's covenant to impose and collect fees and charges for public services or specific projects;



•

housing bonds secured by portfolios of single-family mortgages or secured by mortgages for government-supported multi-family residences; and



•

international public finance obligations, including obligations of sovereign and sub-sovereign issuers and project finance transactions.

        Public finance obligations include municipal bonds, notes and other indebtedness issued by or on behalf of public and quasi-public entities, including states and their political subdivisions, utility districts, public housing and transportation authorities and universities and hospitals. Public finance obligations also include bonds, notes and other indebtedness issued by special purpose entities established to finance investments in infrastructure projects. Some public finance obligations, including most project finance obligations, include non-governmental credit risks (to swap counterparties, insurance companies, construction companies or other non-governmental credits) and operating risks (such as traffic volume or student enrollment).

        In the case of general obligation bonds, an issuer's obligation to pay is supported by the issuer's taxing power. In the case of most revenue bonds and public-private infrastructure financings, an issuer's obligation to pay is supported by the issuer's or obligor's ability to impose and collect fees and charges for public services or specific projects or, in some cases, by federal subsidies or grants.

The Public Finance Market

        According to industry sources, the total and insured volume since 2004 of long-term U.S. municipal new issues sold were as follows:

(1)

Source: The Bond Buyer , February 7, 2007 and January 8, 2008 for 2004 to 2007. Estimate for 2008 is based on Thomson Financial database as of January 6, 2009 . Volume is expressed in terms of principal issued and insured on a sale-date basis. Subject to revision as additional information becomes available.

        In 2008, estimated U.S. municipal market volume of $391.5 billion was 9% lower than in 2007. After a slow start due to illiquidity in the auction rate securities ("ARS") market, municipal issuance rose significantly in the second quarter as a high volume of ARS were refinanced. However, volume fell off over the course of the second half as the cost of borrowing increased in response to the global

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credit contraction. In 2007, estimated U.S. municipal market volume of $429.0 billion was 10% higher than in 2006 and the highest market volume on record. Insurance penetration of the market for new U.S. municipal bonds sold in 2008 was approximately 17%, compared with 47% in 2007 and 49% in 2006. FSA's share of the insured par sold was approximately 54% in 2008, compared with 25% in 2007 and 24% in 2006. However, both insurance penetration and FSA's market share were significantly higher in the first half of 2008 than in the second. For a discussion of the Company's financial guaranty segment's results of operations in 2008, see "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations—Financial Guaranty Segment—Results of Operations."

        Outside the United States, the global credit crisis produced severe illiquidity in the public infrastructure market during 2008, and demand for financial guarantees was low because of negative rating actions. International public finance transactions include public-private partnership financings, such as those authorized under the U.K. Private Finance Initiative, where host governments make payments to private developers or operators based either on the project's availability to meet its public purpose or on its cash revenues or observed usage, as well as other highly structured transactions. Because such transactions tend to have long development times and large par amounts, the timing of transactions may cause volatility in insured volume from year to year.

        Since 2004, the annual totals of non-U.S. public finance par insured of financial guaranty insurance directly originated by monoline guarantors, according to industry sources, were as follows:

(1)

Source: Association of Financial Guaranty Insurers ("AFGI"). Data is subject to revision as additional information becomes available.

(2)

Not available from the same source. Based on information in the statistical operating supplements of monoline guarantors that disclose the public finance component of their international business, those guarantors directly insured, in the aggregate, a principal amount of approximately $2.1 billion of non-U.S. public finance obligations in 2008.

FSA's Public Finance Obligations

        FSA's insured portfolio of public finance obligations is divided into nine major categories. Where FSA insures obligations that already carry insurance from another monoline guarantor, FSA categorizes the obligation based on the type of bond or obligation underlying the insurance policy.

        Domestic General Obligation Bonds.     General obligation or full faith and credit bonds are issued by states, their political subdivisions and other municipal issuers, such as state bond banks, and are supported by the general obligation of the issuer or obligor to pay from available funds and by a pledge of the issuer or obligor to levy taxes in an amount sufficient to provide for the full payment of the bonds.

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        Domestic Tax-Supported (Non-General Obligation) Bonds.     Tax-supported (non-general obligation) bonds include a variety of bonds that, though not full faith and credit general obligations, are generally supported by leases, a specific or discrete source of taxation or moral obligation. Lease revenue bonds or certificates of participation ("COPs") are usually general fund obligations that finance real property or equipment that, in the case of leases subject to annual appropriation, FSA deems to serve an essential public purpose (e.g., schools, public safety facilities, courts and, less frequently, correctional facilities). Tax-backed revenue bonds are secured by a lien on pledged tax revenues, including income, retail sales, property, excise and gasoline taxes, or from tax increments (or tax allocations) generated by growth in property values within a district. FSA also insures bonds secured by special assessments levied against property owners, which benefit from covenants by the issuer to levy, collect and enforce collections and to foreclose on delinquent properties.

        Domestic Municipal Utility Revenue Bonds.     Municipal utility revenue bonds include obligations of municipal utilities, including electric, gas, water and sewer and solid waste. Insurable utilities may be organized as municipal enterprise systems, authorities or joint-action agencies.

        Domestic Transportation Revenue Bonds.     Transportation revenue bonds include a wide variety of revenue-supported bonds, such as bonds for airports, ports, municipal parking facilities, toll roads and toll bridges and tunnels.

        Domestic Health Care Revenue Bonds.     Health care revenue bonds include bonds of state and local municipal authorities issued on a conduit basis on behalf of not-for-profit health care providers and health care provider systems, payable from amounts derived under loan agreements and notes of such health care providers with such authorities. This category also includes exposure to HMOs, mental health providers and other health-related credits.

        Domestic Housing Revenue Bonds.     Housing revenue bonds include both multi-family and single family housing bonds, with multi-tiered security structures based on the underlying mortgages, reserve funds, and various other features such as Federal Housing Administration or private mortgage insurance, bank letters of credit, first-loss guarantees and, in some cases, the general obligation of the issuing housing agency or a state's moral obligation to make up deficiencies. This category also includes multi-family housing bonds supported by capital fund grants appropriated by Congress.

        Domestic Education/University Bonds.     Education/University bonds include obligations of colleges and universities, primarily public or state-supported, and independent primary and secondary schools.

        Other Domestic Public Finance Obligations.     Other domestic public finance obligations insured by FSA include bonds secured by revenues and guarantees from the Federal government, financings supported by specific state or local government entity revenues, and stadium financings. This category also includes guarantees of the debt of Citizens Property Insurance, a Florida state-sponsored entity, which provides residential and commercial property and casualty insurance coverage. This category also includes leveraged lease transactions ("Leveraged Lease Transactions"). A Leveraged Lease Transaction transfers the tax benefits from a tax-exempt entity, such as a transit agency (lessee) to a tax-paying entity (lessor) by transferring ownership of a depreciable asset, such as subway cars, to the lessor. The municipality (lessee) remains the primary user of the asset. In 2004, Congress amended the Internal Revenue Code to expressly prohibit tax benefits derived from such Leveraged Lease Transactions. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—FSA's Liquidity—Leveraged Lease Transactions."

        International Public Finance Obligations.     International public finance obligations have non-U.S. obligors and include obligations of sovereign and sub-sovereign issuers, project finance transactions involving projects leased to or supported by payments from governmental or quasi-governmental

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entities, toll road transactions supported by toll revenues, obligations arising under leases of equipment or facilities by municipal obligors, distribution and transmission utility and water utility financings, securitizations of government- supported receivables or sovereign or municipal debt, corporate debt guaranteed by government-owned financial institutions and other obligations having international aspects but otherwise within the public finance categories described above.

Asset-Backed Obligations

        FSA ceased issuing financial guaranties on asset-backed obligations in August 2008. The asset-backed obligations in FSA's insured portfolio were generally issued in structured transactions backed by pools of assets such as residential mortgage loans, consumer or trade receivables, securities or other assets having an ascertainable cash flow or market value. Asset-backed obligations insured by FSA also included payment obligations of counterparties and issuers under synthetic obligations such as CDS and credit-linked notes referencing asset-backed securities or pools of securities or other obligations.

        Asset-backed obligations are typically issued in connection with structured financings or securitizations where the securities being issued are secured by or payable with funds from a specific pool of assets. The assets are typically held by a special purpose entity that also acts as the issuer of the insured obligations. Most asset-backed obligations are secured by or represent interests in diverse pools of assets, such as residential mortgage loans, auto loans, credit card receivables, other consumer receivables, corporate loans or bonds, government debt and small business loans. Asset-backed obligations may also be secured by less diverse payment sources, such as small business loans. FSA sought to structure the asset-backed obligations it insured to mitigate the correlation risk.

Structure of Asset-backed and Other Non-Public Finance Obligations

        The asset-backed obligations in the Company's insured portfolio include funded and synthetic transactions:

        Funded Asset-backed Obligations.     Funded asset-backed obligations are typically payable from cash flow generated by a pool of assets and take the form of either "pass-through" obligations, which represent interests in the related assets, or "pay-through" obligations, which generally are debt obligations collateralized by the related assets. Both types of funded asset-backed obligations generally have the benefit of one or more forms of credit enhancement, such as overcollateralization or excess cash flow, to cover credit risks associated with the related assets. Historically, asset securitization often represented an efficient way for commercial banks to comply with capital requirements and for corporations to access the capital markets at more attractive rates. Banks responded to increased capital requirements by selling certain of their assets, such as credit card receivables and automobile loans, in securitized structures to the financial markets. Some corporations found securitization of their assets to be a less costly funding alternative to traditional forms of borrowing or otherwise important in diversifying funding sources. Many finance companies have funded consumer finance and home equity lending through securitization.

        Synthetic Asset-backed Obligations.     Synthetic asset-backed obligations generally take the form of CDS obligations or credit-linked notes that reference either an asset-backed security or pool of securities or loans, with a defined deductible to cover credit risks associated with the referenced securities or loans. The Company has two basic types of insured CDS contracts. One type references a pool of underlying corporate obligations ("pooled corporate CDS") and the other type references existing structured finance securities, primarily CDOs and collateralized loan obligations ("CLOs"), or infrastructure finance transactions, including obligations insured by another financial guaranty insurer. In both cases, exposures insured by the Company generally had an attachment point (i.e., the minimum level of losses in a portfolio to which a tranche is exposed, usually expressed as a percentage of the

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total notional size of the portfolio) at the outset which was determined by the Company and the rating agencies to be at or above a Triple-A credit rating, or may have had such rating due to credit enhancement provided by another financial guaranty insurer.

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Pooled Corporate CDS:   The Company's pooled corporate CDS contracts typically cover a pool of reference obligations, such as bonds, bank loans or single name CDS subject to a material deductible. The majority of the risks insured benefit from protection provided to the senior tranches, and are rated Triple-A or higher ("Super Triple-A") credit quality without the benefit of FSA's insurance. The majority are static pools, i.e., pools that are not "managed" in that reference obligations cannot be added or substituted. The Company's portfolio of pooled corporate CDS contracts is segregated into investment and non-investment grade (or "high yield") groups. "Super Triple-A" indicates a level of first-loss protection generally exceeding 1.3 times the level required by a rating agency for a Triple-A rating. Typically a higher attachment point is required to achieve a Super Triple-A level of subordination for a pool of non-investment grade credits than is required for a pool of investment grade credits.



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CDS Referencing Funded CDOs and CLOs:   The Company's insured CDS contracts referencing CDOs and CLOs provide credit protection on the senior tranches of funded collateralized structures. CDOs and CLOs are securities backed or collateralized by a diversified managed pool of corporate bonds or loans, respectively. The senior tranches are typically rated Triple-A and would only suffer a loss if the deterioration of the underlying assets exceeds the collateral protection provided by the subordinated debt tranches and equity.

        Some CDS obligations expose FSA to elements of market value risk arising from obligations to pay the difference between par and market value upon the occurrence of a payment default or other defined "credit events" specified in the CDS. FSA generally addressed these risks by requiring large deductibles as a condition to payment under pooled corporate CDS insured by FSA.

        The terms of the Company's guaranteed or "insured" CDS contracts generally are modified from standard CDS contract forms approved by the International Swaps and Derivatives Association, Inc. ("ISDA") in order to provide for payments on a scheduled basis and otherwise replicate the terms of a traditional financial guaranty insurance policy.

        The Company considered its CDS to be a normal part of its financial guaranty insurance business but, for accounting purposes, FSA-insured CDS are accounted for as derivatives and therefore must be recorded at fair value, with periodic changes reflected through the statements of operation and other comprehensive income, causing volatility in the Company's reported net income. Despite the structural protections associated with the Company's pooled corporate CDS, the significant widening of credit spreads on pooled corporate CDS, as with other structured credit products, which started during the second half of 2007 and continued throughout 2008, resulted in significant mark-to-market losses. The ultimate amount of actual credit losses will depend on actual loss developments as opposed to market factors. For additional discussion of the impact of the mark-to-market accounting treatment, including valuation methods, see "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations—Financial Guaranty Segment—Results of Operations—Fair Value of Credit Derivatives" and Note 3 to the consolidated financial statements in Item 8.

        Most of the Company's industry peers have suffered material market concerns over their exposure to the CDO of ABS sector, relating to securitizations of high grade and mezzanine asset-backed securities, including subprime RMBS. Some of these companies assumed their exposure to CDOs of ABS in synthetic form, including through guaranties of CDS. Unlike other industry participants, the Company does not have material exposure in its insured portfolio to CDOs of ABS, either in the funded or synthetic form.

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Categorization of Asset-backed and Other Non-Public Finance Obligations

        FSA's insured portfolio of asset-backed and other non-public finance obligations may be divided into five major categories, which are broadly based on the type of assets backing the insured obligations and include funded and synthetic obligations and may be in the form of insurance or insurance of CDS. Where FSA insures obligations that already carry insurance from another monoline guarantor, FSA categorizes the obligation based on the type of assets backing the obligations underlying the insurance policy. Until the fourth quarter of 2007, such obligations were categorized as "other domestic non-public finance obligations."

        Domestic Residential Mortgage Loans.     Obligations primarily backed by residential mortgage loans generally take the form of conventional pass-through certificates or pay-through debt securities, but also include other structured products. Residential mortgage loans backing these insured obligations include closed- and open-end first and second mortgage loans or home equity loans on one-to-four family residential properties, including condominiums and cooperative apartments and non-owner occupied residential housing. Approximately 17% of the asset-backed net par in FSA's insured portfolio is domestic residential mortgage products.

        The Company has projected losses on some of the home equity line of credit ("HELOC"), Alt-A closed-end second-lien mortgage ("CES") securities, Option Adjustable Rate Mortgage ("Option ARM") transactions, Alt-A first-lien mortgages, subprime U.S. RMBS and net interest margin securitizations ("NIMs") in its insured portfolio and has established net case reserves of $1,234.3 million in relation to its domestic residential mortgage loans. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations—Financial Guaranty Segment—Insured Portfolio Summary—Asset-Backed Insured Portfolio." "Alt-A" refers to borrowers whose credit quality falls between prime and subprime.

        Approximately 6.2% of the asset-backed net par outstanding in FSA's insured portfolio are HELOCs. The HELOCs are primarily backed by second liens and made to higher quality ("prime") borrowers. They have lower levels of structural protection than typical subprime transactions. The protection is typically provided by excess spread, which is used to pay current period losses and build reserves. Most of FSA's insured HELOCs were originated by mortgage finance companies.

        Approximately 4.5% of the asset-backed net par outstanding in FSA's insured portfolio are in the "subprime" sector, characterized by lower quality borrowers and higher levels of structural credit protection through subordination and/or excess spread. Most subprime transactions are secured by fully-amortizing first-lien mortgage loans that pay a fixed rate of interest for two to five years, after which they pay a floating rate of interest. Typically all principal received on the underlying mortgages is paid through to the Triple-A noteholders for at least the first 36 months, causing credit protection to increase over time.

        Approximately 2.6% of the asset-backed net par outstanding in FSA's insured portfolio are backed by Option ARMs. Option ARMs are generally backed by first lien mortgage loans made to prime borrowers (on average) with average original loan-to-value ratios of approximately 76%. The loans have three payment options—fully amortizing payment, interest only, and a minimum payment that results in negative amortization of the borrower's loan. The loans generally reset to full amortization on their fifth anniversaries, or possibly earlier if the loan's negative amortization results in loan to value ratios that exceed limits usually between 110% and 120% of the original loan balance (which can happen if interest rates rise and the borrower makes only the minimum payment). Upon reset, monthly payment amounts can increase significantly.

        Approximately 1.6% of asset-backed net par outstanding in FSA's insured portfolio consist of securities backed by Alt-A first lien residential mortgage loans. First lien Alt-A transactions insured by FSA are collateralized by fixed and floating rate loans secured by a first lien on residential property.

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All principal received on the underlying mortgages is paid through to the senior Triple-A note holders for at least the first 36 months, causing credit protection to increase over time.

        Approximately 1.5% of the asset-backed net par outstanding in FSA's insured portfolio consist of closed-end second-lien mortgage transactions. Closed-end second-lien mortgage loan transactions are backed by fully amortizing loans secured by a second lien on residential property. All FSA closed-end second-lien transactions involve Alt-A borrowers. All principal received on the underlying mortgages is paid through to the senior note holders for at least the first 36 months, causing credit protection to increase over time.

        Approximately 0.2% of asset-backed net par outstanding in FSA's insured portfolio consist of NIMs. NIMs are securities backed by the senior portion of residual cash flows from securitizations of domestic residential mortgage loans, generally the residual cash flows expected to be produced during the first 12-36 months of a subprime transaction.

        FSA generally declined participation in securitizations of so-called "high-cost mortgage loans," characterized by very high interest rates or "points and fees" and subject to restrictive federal and state regulations.

        Domestic Consumer Receivables.     Obligations primarily backed by consumer receivables include conventional pass-through and pay-through securities as well as more highly structured transactions. Consumer receivables backing these insured obligations primarily include automobile loans, with some credit card receivables, manufactured housing loans and cash consumer loans. Consumer receivable transactions in FSA's insured portfolio tend to be concentrated in the subprime automobile loan sector.

        Domestic Pooled Corporate Obligations.     Obligations primarily backed by pooled corporate obligations include funded and synthetic obligations collateralized by corporate debt securities or corporate loans and obligations backed by cash flow or market value of non-consumer indebtedness, and include CDOs, such as collateralized bond obligations ("CBOs"), CLOs and comparable risks under CDS obligations. Corporate obligations include corporate bonds, bank loan participations, trade receivables, franchise loans and equity securities.

        CDOs are securitizations of bonds, loans or other securities and may be insured on a funded or synthetic basis. CDOs have been used by financial institutions to manage their risk profiles, optimize capital utilization and improve returns on equity. CDOs have also been used by dealers or portfolio managers to provide leveraged investments in bond and loan portfolios tailored to conform to differing risk appetites of investors.

        Other Domestic Non-Public Finance Obligations.     Other domestic non-public finance obligations in FSA's insured portfolio include bonds or other securities backed by government securities, letters of credit or repurchase agreements collateralized by government securities, securities backed by a combination of assets that include elements of more than one of the categories set forth above and unsecured corporate obligations satisfying FSA's underwriting criteria. Other domestic non-public finance obligations insured by FSA also include first mortgage bond obligations of for-profit electric or water utilities providing retail, industrial and commercial service, sale-leaseback obligation bonds supported by such utilities and other obligations backed by investor-owned utilities. These bonds are generally either secured by a mortgage on property owned by or leased to an investor-owned utility or have the benefit of a "negative pledge" ensuring that no other material creditors have priority claims to the utility assets. Other domestic non-public finance obligations include securitization of life insurance risks (including so-called "triple-X transactions") and airplane leases, including transactions benefiting from third-party financial guaranty insurance.

        International Asset-Backed Obligations.     International asset-backed obligations in FSA's insured portfolio include (1) funded and synthetic CDOs, (2) securitizations of perpetual floating rate notes of

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non-domestic banks, diversified payment rights, future flows, health care receivables and residential housing construction loans, (3) obligations of non-domestic investor-owned utilities and (4) other obligations having international aspects but otherwise within the asset-backed categories described above. FSA allocates individual funded and synthetic CDOs between domestic and international based on the transactions' holdings or potential holdings. Most of the international obligations comprise the international component of funded or unfunded CDOs.

Insured Portfolio

        A summary of the Company's insured portfolio at December 31, 2008 is shown below. Exposure amounts are expressed net of reinsurance but do not distinguish between quota share, first-loss or excess-of-loss reinsurance.

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Obligation Type

        The table below sets forth the relative percentages of net par insured by obligation type during each of the last five years:

Terms to Maturity

        Actual maturities could differ from contractual maturities because borrowers have the right to call or prepay certain obligations with or without call or prepayment penalties. The expected maturities for asset-backed obligations, in general, are considerably shorter than the contractual maturities for such obligations. For asset-backed obligations, the full par outstanding for each insured risk is shown in the maturity category that corresponds to the legal final maturity of such risk.

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        The table below sets forth the contractual terms to maturity of the Company's policies:

Geographic Concentration

        The Company seeks to maintain a diversified portfolio of insured public finance obligations designed to spread its risk across a number of geographic areas. The table below sets forth those

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jurisdictions in which municipalities issued an aggregate of 2% or more of the total net par amount outstanding of FSA-insured public finance securities:

        In its asset-backed business, the Company considered geographic concentration as a factor in its underwriting decisions for insurance for securitizations of pools of assets, such as residential mortgage loans or consumer receivables. However, the geographic concentration of the underlying assets may change over the life of the policy. In addition, in writing insurance for other types of asset-backed obligations, such as securities primarily backed by government or corporate debt, geographic concentration may not have been a significant credit factor given other more relevant measures of diversification, such as issuer or industry diversification.

        The Company earns premiums in its financial guaranty segment. The table below shows amounts attributed to foreign and domestic premiums during each of the last three fiscal years, based on the underlying risks:

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        For a discussion of risks related to the Company's foreign operations, see "Item 1A. "Risk Factors—The Company's international operations expose it to less predictable credit and legal risks."

        See Note 23 to the consolidated financial statements in Item 8 for revenues from external customers, pre-tax earnings and total assets by segment.

Issuer Concentration

        The Company has adopted underwriting and exposure management policies designed to limit the net par insured or net retained credit gap for any one risk. Credit gap is a concept employed by S&P to estimate the at-risk amount (worst-case risk) on an insured exposure. FSA has also established procedures to ensure compliance with regulatory single-risk limits applicable to bonds it has insured. In many cases, the Company uses reinsurance to limit net exposure to any one risk.

        At December 31, 2008, the ten largest net insured public finance risks represented $12.5 billion, or 3.1%, of the total net par amount outstanding and the ten largest net insured asset-backed transactions represented $18.3 billion, or 4.5%, of the total net par amount outstanding. For purposes of the foregoing, different issues of asset-backed securities by the same originator have not been aggregated. However, the Company's underwriting policies established single-risk guidelines applicable to asset-backed securities of the same originator. In addition, individual corporate names may appear in more than one FSA-insured CDO transaction, but such exposures are not aggregated for purposes of identifying the largest insured risks. Instead, FSA addresses these risks through structural elements of the transactions and by limiting its exposure to the CDO sector in the aggregate. In addition to the single-risk limits established by its underwriting guidelines, the Company is subject to regulatory limits and rating agency guidelines on exposures to single risks.

The Financial Products Business

Business Objectives

        The Company's objective for its FP business had been to generate positive net interest margin through borrowing funds at attractive rates in the municipal GIC and other markets and investing the proceeds in investments satisfying the Company's investment criteria while minimizing the Company's exposure to interest rate and foreign exchange rate changes. In the course of 2008, the borrowing rates on GICs rose significantly, and the Company reduced its GIC issuance accordingly.

        In November 2008, the Company ceased issuing GICs in contemplation of the sale of the Company to Assured. The Company's current objective in respect of the FP business is to accomplish a complete transfer of the credit and liquidity risk of that business to Dexia. This objective was largely accomplished in February 2009 in connection with the FSAM Risk Transfer Transaction. See "—Transfer of Credit and Liquidity Risk of the GIC Business."

        Under the terms of the Acquisition, Dexia will retain the FP segment of the Company. See "—Expected Sale of the Company—Dexia's Retention of the FP business."

The FP Business

        The Company's GIC business provided GICs to municipalities and other market participants through November 2008. FSA insured all GICs issued by the GIC Subsidiaries. Most municipal GICs issued by the GIC Subsidiaries relate to debt service reserve funds or construction funds that support municipal bond transactions. Most non-municipal GICs issued by the GIC Subsidiaries relate to funds held by issuers of credit-linked notes referencing CDOs of ABS or CLOs.

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        Each GIC entitles its holder to receive the return of the holder's initial principal plus interest at a specified rate, and to withdraw principal from the GIC as permitted. Generally, a municipal bond trustee or issuer will acquire a municipal GIC in order to invest funds on deposit in a debt service reserve fund or construction fund until it needs to use such funds to service debt or fund the payment of project expenses in accordance with the underlying bond documents.

        The GIC Subsidiaries issued GICs and, on the same terms, loaned the funds raised to FSAM. The payment obligations relating to the GICs generally are (or were converted by FSAM into) U.S. dollar London Inter-Bank Offered Rate ("LIBOR") -based floating rate obligations. FSAM typically invests the funds in U.S. dollar LIBOR-based floating rate investments. To the extent that such investments do not meet such criteria, FSAM utilizes swaps, futures and other hedge transactions to convert them into U.S. dollar LIBOR-based floating rate investments. This investment and funding strategy was designed to minimize the Company's exposure to interest rate and foreign exchange rate changes.

        FSA-PAL, which was formed in 2006, invests in non-U.S. securities. FSAM's and FSA-PAL's investments are investment-grade at the time of purchase. The FP business generates its gross profits or losses from the difference between the rates at which the GIC Subsidiaries borrowed the funds and the rates yielded by FSAM's and FSA-PAL's investments. All related risk management functions are performed by FSAM. FSAM invests most of its funds in asset-backed securities, predominantly mortgage-backed securities, which have experienced significant market value declines commencing with the third quarter of 2007.

        The following table indicates the Company's par value of debt outstanding with respect to municipal and non-municipal GICs as well as VIEs:

(1)

Excludes $1.3 billion of draws on a $5.0 billion committed standby line of credit from Dexia Credit Local (the "First Dexia Line of Credit") at December 31, 2008.

Liquidity Risk in the FP Business

        The Company is exposed to liquidity risk associated with unexpected withdrawals on its FSA-insured GICs. Liquidity risk is the current and prospective risk to earnings or capital arising from an inability to meet obligations when they come due without incurring unacceptable losses and includes the inability to manage unplanned decreases or changes in funding sources. In its FP segment, the Company relies on net interest income to fund its net interest expense and operating expenses.

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        The FP segment business model contemplated that operating cash flow from interest and principal payments on the FP investments would provide sufficient liquidity to pay the FP obligations on a timely basis. The Company sought to manage the FP business' liquidity risk through the maintenance of liquid collateral and liquidity agreements. To minimize the refinancing risk in the portfolio of the investments supporting the GIC liabilities (the "FP Investment Portfolio"), bonds in the portfolio were targeted to have shorter weighted average lives than those of the related funding obligations. While this investment strategy posed a degree of reinvestment risk, the Company believed it could adequately minimize liquidity risk. These assumptions proved incorrect. During the course of 2008, the FP segment developed significant liquidity shortfalls as a result of a number of factors, including (i) greater than anticipated GIC withdrawals; (ii) slower than anticipated amortization of RMBS owned in the FP Investment Portfolio; (iii) redemption/collateralization requirements triggered by the downgrade of FSA's rating by Moody's; and (iv) a significant decline in market value of the FP Investment Portfolio due to market dislocation, with mark-to-market losses at December 31, 2008 of $8.6 billion. These liquidity shortfalls were addressed by liquidity support provided by Dexia over the course of 2008, culminating in the FSAM Risk Transfer Transaction in February 2009.

        Unscheduled withdrawals of principal allowed by the terms of the GICs have increased due to a number of factors, and have largely been associated with non-municipal GICs. The majority of municipal GICs insured by FSA relate to debt service reserve funds and construction funds in support of municipal bond transactions. Debt service reserve fund GICs may be drawn earlier than expected upon a payment default by the municipal issuer. Construction fund GICs usually have withdrawal schedules based on expected construction funding requirements, but may be drawn earlier or later than expected when construction of the underlying municipal project does not proceed as expected. The majority of non-municipal GICs insured by FSA are purchased by issuers of credit-linked notes that provide credit protection with respect to CDOs of ABS and CLOs. These issuers of credit-linked notes typically sell credit protection by entering into a CDS referencing specified asset-backed or corporate obligations. Such GICs may be and in many cases have been drawn earlier than expected to fund credit protection payments due by the credit-linked note issuer under the related CDS or upon an acceleration of the related credit-linked notes following a transaction event of default.

        Further, liquidity risk related to FSA's ratings has increased as FSA has been downgraded or placed on credit watch by the three major rating agencies. Some FSA-insured GICs allowed for withdrawal of GIC funds in the event of a downgrade of FSA below Aaa by Moody's, unless the relevant GIC Subsidiary posted collateral or otherwise enhanced its credit. The November 2008 downgrade to Aa3 by Moody's resulted in a trigger breach on $1.7 billion of unsecured GICs and $1.6 billion of secured GICs. The downgrade required the Company to either post collateral (or post additional collateral if already collateralized) or terminate, depending upon the requirements of the relevant GIC. In the case of termination, the Company either had to return par or negotiate a market value termination. In respect of unsecured GICs, the Company posted $1.0 billion of collateral, terminated $0.4 billion of GICs and modified the trigger to below Aa3 on $0.2 billion of GICs. The Company also posted $80 million of additional collateral to secured GICs.

        Additional downgrades by Moody's or a downgrade by S&P would result in additional requirements. At December 31, 2008, a downgrade of FSA to below AA- by S&P or Aa3 by Moody's (A+ by S&P or A1 by Moody's) would result in withdrawal of $0.8 billion of GICs and the need to post collateral on GICs with a balance of $13.4 billion. Each GIC contract stipulates the types of securities eligible for posting and the collateralization percentage applicable to each security type. These collateralization percentages range from 100% of the GIC balance for cash collateral to, typically, 108% for asset-backed securities. Assuming an average margin of 105%, the market value of required collateral would be $14.1 billion. At December 31, 2008, a downgrade of FSA to below A- by S&P or A3 by Moody's (i.e., BBB+ by S&P or Baa1 by Moody's) would result in mandatory or

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optional withdrawals of $5.1 billion of GICs and repayment or collateralization of the remainder of the $9.1 billion of GICs outstanding.

        In anticipation of a need for increased liquidity resources, commencing with the fourth quarter of 2007 the Company began investing newly originated GIC proceeds into short-term investments. As a result, the net interest margin ("NIM") on new business originations in the FP segment has been eliminated and, in some cases, negative. In order to address its liquidity needs, FSAM has accessed lines of credit provided by Dexia, with $1.3 billion in draws on the First Dexia Line of Credit outstanding at December 31, 2008, and expects to rely upon liquidity provided by Dexia for its on-going liquidity requirements.

        For further discussion of the liquidity risk and resources of the FP segment, see "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—FP Segment Liquidity."

Consolidated Variable Interest Entities

        FSA Global is a Cayman Islands-domiciled issuer of FSA-insured notes and other obligations sold in international markets that are generally referred to as "medium term notes." The Company owns 49% of the voting ordinary shares and 100% of the nonvoting preference shares of FSA Global. FSA Global issued securities at the request of interested purchasers in a process known as "reverse inquiry," which generally resulted in lower interest rates and borrowing costs than would apply to direct borrowings. FSA Global also issued securities in traditional private placements to institutional investors and to participants in Leveraged Lease Transactions in which Company affiliates may play a number of financing roles. At December 31, 2008, the VIEs, including FSA Global, had $2.1 billion principal amount of outstanding notes. In accordance with the Purchase Agreement, FSA Global has ceased offering securities.

        FSA Global is managed as a "match funded vehicle," in which the proceeds from the sale of FSA Global notes are invested in obligations chosen to provide cash flows substantially matched to those of the notes (taking into account, in some cases, dedicated third-party liquidity). This match funded structure was designed to minimize the market and liquidity risks borne by FSA Global and FSA.

        FSA Global generally raised funds denominated in U.S. dollars or converted into U.S. dollars at LIBOR-based floating borrowing rates. In recent years, the funds FSA Global raised have generally been invested in FSA-insured GICs, but it has invested in other FSA-insured obligations. FSA Global invests with a view to realizing the yield difference between the notes issued and the obligations purchased with the note proceeds. The majority of FSA Global's investments are either denominated in U.S. dollars or converted into U.S. dollars at LIBOR-based floating rates. FSA Global's investments mature prior to the maturity of the related FSA Global notes, and pay a higher interest rate than the interest rate on the related FSA Global notes.

        Under the Purchase Agreement, Assured and Dexia Holdings agreed to cooperate in good faith to evaluate the feasibility of the actual or functional separation of FSA Global's leveraged lease and medium term notes businesses with a view to maximizing the tax, accounting and financial efficiency of the separation of the businesses for both parties. At March 17, 2009, an agreement had not been reached on the structure of the business separation. Regardless of the structure of such business separation, under the Purchase Agreement Dexia Holdings is expected to retain the risks associated with FSA Global's medium term notes business and certain portions of its leveraged lease business, FSA is expected to retain the risks associated with the leveraged lease debt business, and no new business will be written by FSA Global or Premier.

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Credit Underwriting Guidelines, Standards and Procedures

Financial Guaranty Business

        Financial guaranty insurance written by FSA generally relies on an assessment of the adequacy of various payment sources to meet debt service or other obligations in a specific transaction without regard to premiums paid or income from investment of premiums. FSA's underwriting policy is to insure public finance obligations, including infrastructure finance transactions, that it determines are investment grade without the benefit of FSA's insurance. To this end, each policy FSA writes or reinsures is designed to satisfy the general underwriting guidelines and specific standards for particular types of obligations approved by its Board of Directors. In addition, the Company's Board of Directors has established an Underwriting Committee that reviews completed transactions, generally on a quarterly basis, to ensure conformity with underwriting guidelines and standards.

Underwriting Guidelines for Public Finance Obligations

        FSA's underwriting guidelines for public finance obligations require that a transaction be rated investment grade by Moody's or S&P or, in the alternative, that the credit quality of the obligor is considered by FSA to be the equivalent of investment grade. Where the obligor is a governmental entity with taxing power or providing an essential public service paid by taxes, assessments or other charges, supplemental protections may be required to ensure sufficient debt service coverage. Where appropriate, the obligor may be required to provide a rate covenant and a pledge of additional security (e.g., mortgages on real property, liens on equipment or revenue pledges) to secure the insured obligation.

        Public finance obligations that are infrastructure finance transactions are also subject to underwriting guidelines requiring that they relate to facilities used to provide an essential public service. Such infrastructure financings may be domestic or international, and include public-private partnership transactions, such as those authorized under the U.K. Private Finance Initiative. Municipal utility revenue bonds and transportation revenue bonds may also be infrastructure transactions. FSA's underwriting guidelines require that FSA minimize or mitigate other sources of risk in its infrastructure finance transactions, such as construction or operations risk, through structural elements.

        FSA has several programs that provide insurance for obligations trading in the secondary markets, including its Custody Receipt Program and its TAGSS® Program. FSA's underwriting guidelines require the same underwriting standards on secondary-market issues as on new issues, although FSA's control rights in the event of default are generally more limited.

Underwriting Guidelines for Asset-Backed Obligations

        FSA ceased underwriting asset-backed obligations in August 2008. FSA's underwriting guidelines for asset-backed obligations varied by obligation type in order to reflect different structures and types of credit support. FSA sought to insure asset-backed obligations that generally provided for one or more forms of overcollateralization (such as excess collateral value, excess cash flow or "spread," reserves or, in the case of CDS, a deductible) or third-party protection. Asset-backed obligations in FSA's insured portfolio often benefit from self-adjusting mechanisms, such as cash traps or accelerated amortization that take effect upon a failure to satisfy performance-based triggers. Overcollateralization or third-party protection does not necessarily protect FSA against all risk of loss, but was generally intended to assume the primary risk of financial loss. Overcollateralization and third-party protection may not have been required in transactions in which FSA was insuring the obligations of certain highly rated issuers, which were typically regulated, had implied or explicit government support, or were short-term.

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        FSA's asset-backed obligations underwriting policy allowed for FSA to insure securities issued to refinance other securities insured by FSA as to which the issuer was or may have been in default. Overcollateralization and third-party protection may not have been required in such transactions. In addition, FSA insured on a selective basis so-called "future flow," "diversified payment right," "triple-X," "airplane enhanced equipment trust certificate" and "whole business" securitizations in which FSA may be exposed to a level of corporate risk greater than found in traditional asset-backed securities. FSA has also insured "extreme mortality" transactions, which, like "triple-X" securitizations insured by FSA, expose FSA to investment-grade levels of mortality risk. Historically, FSA was very selective in insuring securities with risks that it considered difficult to conservatively underwrite. For example, FSA has no material exposure in its insured portfolio to CDOs of ABS.

        FSA's general policy was to insure 100% of the principal, interest and other amounts due in respect of funded asset-backed obligations rather than providing partial or first-loss coverage sufficient to confer a Triple-A rating on the senior obligations. In the CDS sector, FSA often insured risks, and in the funded sector FSA sometimes insured securities, on a "compressed" or "mezzanine" basis in which the obligations insured by FSA were subordinate, in whole or in part, to more senior uninsured obligations and where the risk insured by FSA was typically Triple-A without the benefit of FSA's insurance. FSA insures securities previously insured by another financial guaranty insurer. Until the fourth quarter of 2007, any such "previously wrapped" obligation was required to conform to FSA's underwriting requirements, where specific requirements were in place, without regard to the previous wrap or, in some cases, be a "near miss"—i.e., a transaction that comes close to but does not entirely conform to FSA's underwriting guidelines. Commencing with the fourth quarter of 2007, previously wrapped transactions that were a "near miss" no longer qualified for FSA insurance.

The Underwriting Process

        Final transaction approval is obtained from FSA's Municipal Underwriting Committee (the "MUNC") for domestic municipal transactions and FSA's Management Review Committee (the "MRC") for international infrastructure transactions and, in some cases, amendments to or developments in outstanding asset-backed transactions. Prior to August 2008, the MRC was also responsible for approving asset-backed transactions. In some cases, such as in the event of an international municipal transaction, the MUNC and MRC may both review a proposed transaction together. Approval is usually based upon both a written and an oral presentation by the underwriting group to the respective committee. Following approval, the Chair of the applicable underwriting committee may approve minor transaction modifications. Major changes require the concurrence of the applicable underwriting committee.

        The Company's Risk Management Committee reviews the Company's insured portfolio on a periodic basis. The Risk Management Committee includes FSA's Chief Risk Management Officer and the three Chief Underwriting Officers (Municipal, International, and International Structured Finance Underwriting), as well as the Chief Executive Officer, President, General Counsel, Chief Financial Officer and the heads of the Transaction Oversight groups.

        The underwriting process that implements the Company's underwriting guidelines and standards is supported by FSA's professional staff of analysts, underwriting officers, credit officers and attorneys. Moreover, the approval of senior management and/or designated senior underwriting officers is required for all transactions.

        Each underwriting group in the Financial Guaranty Group is responsible for confirming that each transaction proposed by the Financial Guaranty Group conforms to the underwriting guidelines and standards. This evaluation is reviewed by the chief underwriting officer for the particular sector. This review may take place while the transaction is in its formative stages, thus facilitating the introduction of further enhancements at a stage when the transaction is more receptive to change.

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        The MUNC is composed of FSA's Chief Executive Officer, President, Chief Municipal Underwriting Officer, a Municipal Underwriting Officer, Managing Director of Public Finance and Associate General Counsel for Municipal Transactions. The MUNC approval process generally requires approval by at least:

•

the Chief Executive Officer or President,



•

the Chief Municipal Underwriting Officer or Municipal Underwriting Officer, and



•

an Associate General Counsel for Municipal Transactions.

        The Chief Executive Officer and President are not required to participate in MUNC meetings for transactions meeting certain criteria. Subject to applicable limits, public finance transactions satisfying credit requirements may be approved by a committee (the "Demi-MUNC") composed of at least two voting members, one of whom must be the Chief Municipal Underwriting Officer or Municipal Underwriting Officer, and any one of certain managing directors and directors designated by the MUNC.

        The MRC is composed of FSA's Chief Executive Officer, President, Chief Risk Management Officer, Chief International Underwriting Officer, Chief International Structured Finance Officer, General Counsel and Associate General Counsel for Asset-Backed Transactions.

        The rating agencies participate to varying degrees in the underwriting process. In the case of domestic municipal obligations, prior rating agency review is a function of the type of insured obligation and the risk elements involved. Most asset-backed and international obligations insured by FSA were reviewed prior to issuance by both S&P and Moody's to evaluate the risk proposed to be insured. The independent review of FSA's underwriting practices performed by the rating agencies further strengthens the underwriting process.

Transaction Oversight and Transaction Services

        FSA's Transaction Oversight Groups and its workout subsidiary TSC are independent of the analysts and credit officers involved in the underwriting process. The Municipal and Asset-Backed Transaction Oversight Groups are responsible for monitoring the performance of outstanding transactions. The Transaction Oversight Groups and TSC are responsible for taking remedial actions for underperforming transactions as appropriate. The managers of the transaction oversight and transaction services functions report to the Chief Risk Management Officer. The Underwriting Committee of the Board of Directors receives quarterly reports describing the changes in the overall insured portfolio during the quarter and developments with respect to poorly performing transactions. The Transaction Oversight Groups review insured transactions to confirm compliance with transaction covenants, monitor credit and other developments affecting transaction participants and collateral, and together with TSC and the Risk Management Committee determine the steps, if any, required to protect the interests of FSA and the holders of FSA-insured obligations. In the normal course of business, the Company monitors its exposures in all insured categories. Due to recent events, additional focus has been placed on the RMBS and other asset-backed categories.

        Reviews of transactions typically include an examination of reports provided by, and (as circumstances warrant) discussions or site visits with, issuers, obligors, originators, servicers, collateral managers, trustees and other transaction participants. Review of reports may include financial audits, servicer audits, evaluations by third-party appraisers, engineers, consultants or reports by other experts retained by the obligor or FSA. The Transaction Oversight Groups review transactions to determine the level of ongoing attention required. These judgments relate to current credit quality and other factors, including compliance with reporting or other requirements, legal or regulatory actions involving transaction participants or other concerns that may not have a direct bearing on credit quality. Transactions with the highest risk profile are generally subject to more intensive review and, if

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appropriate, remedial action. The Transaction Oversight Groups and TSC work together with the Legal Department and Corporate Research in monitoring these transactions, negotiating restructurings and pursuing appropriate legal remedies.

        The Company's Transaction Oversight Groups maintain and update internal credit ratings. They also assign each credit to one of five designated surveillance categories to facilitate appropriate allocation of resources to loss mitigation efforts and to efficiently communicate the relative credit condition of each risk exposure, as well as the overall health of the insured portfolio. Such categorization is determined in part by the risk of loss and in part by the level of routine involvement required and monitoring cycle deemed appropriate. The surveillance categories are organized as follows:

•

Categories I and II represent fundamentally sound transactions requiring routine monitoring, with Category II indicating that routine monitoring is more frequent, due, for example, to the sector or a need to monitor triggers.



•

Category III represents transactions with some deterioration in asset performance, financial health of the issuer, or other factors, but for which losses are deemed unlikely. Active monitoring and intervention is employed for Category III transactions.



•

Category IV reflects transactions demonstrating sufficient deterioration to indicate that material credit losses are possible even though not yet probable. Category IV is the equivalent of "watch list" by banking industry standards.



•

Category V reflects transactions where losses are probable. This category includes (1) risks where claim payments have been made and where additional payments, net of recoveries, are expected, and (2) risks where claim payments are probable but none have yet been made. Category IV and Category V transactions are subject to intense monitoring and intervention.

        The table below presents the gross and net par outstanding and the gross and net reserves for risks classified as described above:

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        Activity in the liability for losses and loss adjustment expense reserve, which consists of case and non-specific reserves, is summarized as follows:

Financial Products Business

The FP Business Underwriting and Investment Process

        The Company's FP business is in the process of being transferred to Dexia. No new GICs have been issued since November 2008 and no further GIC issuance is currently contemplated.

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        FP's underwriting guidelines govern FSAM's investment of funds raised from the issuance of GICs. FSAM only invests in securities that are investment-grade at the time of purchase. The Company's objective is to manage its GIC investment portfolio to maintain sufficient liquidity to address expected and unexpected GIC withdrawals and to maintain sufficient eligible collateral to support collateralized GICs.

        Final transaction approval for an investment by FSAM or its UK subsidiary FSA-PAL depends on the investment sector, credit rating, amount and other factors. Pending legal transfer of the FP business to Dexia, FSAM and FSA-PAL invest GIC proceeds in accordance with the FP underwriting guidelines, subject to oversight by a transition officer designated by Dexia and the Transaction Management Committee established by the Company's Board of Directors. The FP underwriting guidelines require that the head of the FP group and an FP group risk manager approve all investments and specify whether approvals from FSA's Chief Executive Officer, President, Chief Risk Management Officer and/or other officers are also required.

        Prior to withdrawing from the FP business, final transaction approval for GICs depended on the type and size of the GICs, along with other criteria. FP's underwriting guidelines required that the head of the FP group and an FP group risk manager approve all GICs and specified whether approval from FSA's Chief Executive Officer, President, Chief Risk Management Officer and/or other officers was also required.

Financial Products Risk Management

        FP Risk Management is divided into FP Market Risk Management and FP Credit Risk Management. Together they are responsible for monitoring the ongoing asset performance of the FP Investment Portfolio, including the underlying exposure to non-agency RMBS, as well as the performance of the portfolio of outstanding GICs. FP Market Risk Management and FP Credit Risk Management are independent of the FP business originations process and report to the Chief Risk Management Officer. The Underwriting Committee of the Board of Directors receives quarterly reports describing the market, credit and liquidity risks in the GIC portfolio and FP Investment Portfolio as well as material changes that may have occurred during the quarter.

        In monitoring the FP Investment Portfolio, FP Risk Management utilizes both proprietary and third-party models and analytics, focusing on the underlying collateral of the ABS and the cash flows generated by the collateral to determine whether a security's performance is consistent with its credit rating. FP Risk Management evaluates the liquidity adequacy of the portfolio to ensure that even under various stress conditions, such as a decrease in current expected prepayment rates that would result in a lengthened weighted average life of the investments, the portfolio would still have adequate liquidity to pay the debt service on its funding obligations as they become due, and also evaluates interest rate and currency risks in the portfolio to assess market risk.

        FP Risk Management monitors the portfolio of outstanding GICs and the interest rate, currency, and liquidity risks in the portfolio to assess market risk as well as liquidity risks arising from unexpected or early withdrawals. FP Credit Risk Management assesses the performance of individual GIC positions to determine the level of ongoing surveillance needed. These valuations relate to the credit quality of the transactions underlying each GIC as well as other factors and utilize both proprietary and third-party models and analytics.

        With respect to transactions governed by ISDA master agreements, FP Risk Management monitors net counterparty credit exposure and, when the exposure exceeds an agreed to limit, demands collateral from the counterparty in accordance with the relevant master agreement.

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Corporate Research

        FSA's Corporate Research Department is composed of a professional staff under the direction of the Chief Risk Management Officer. The Corporate Research Department is responsible for evaluating the credit quality of entities participating in or providing recourse on obligations insured by FSA. It also provides analysis of industry segments. Members of the Corporate Research Department generally report their findings directly to the appropriate underwriting committee in the context of transaction review and approval, and to the Risk Management Committee as part of its periodic portfolio reviews.

Legal

        The Company's Legal Department is composed of a professional staff of attorneys and legal assistants under the direction of the General Counsel. The Company's Legal Department is divided into five sectors: municipal transactions, asset-backed transactions, financial products, regulatory/reinsurance/corporate and compliance. The Legal Department plays a major role in establishing and implementing legal requirements and procedures applicable to obligations insured by the Company. Members of the Legal Department serve on the MRC and MUNC, which provide final underwriting approval for transactions. An attorney in the Legal Department works together with his or her counterpart in the relevant financial guaranty group in determining the legal and credit elements of each obligation proposed for insurance and in overseeing the execution of approved transactions and, where applicable, loss mitigation efforts. Public finance obligations insured by the Company are ordinarily executed without employment of outside counsel. The financial products attorneys in the Legal Department work together with their counterparts in the FP group in developing and overseeing the execution of approved financial products transactions. The Legal Department works closely with the Transaction Oversight Groups and TSC in addressing legal issues, rights and remedies, as well as proposed amendments, waivers and consents, in connection with obligations insured by the Company. The Legal Department is also responsible for domestic and international regulatory compliance, reinsurance, secondary market transactions, litigation and other matters.

Finance

        The Company's Finance Department is composed of a professional staff of accountants and financial analysts under the direction of the Chief Financial Officer. The Company's Finance Department is divided into two principal sections: Accounting and Treasury. Accounting plays the primary role in establishing and complying with accounting policies and procedures consistent with each of the various accounting standards under which the Company and its subsidiaries prepare its financial statements, including GAAP, international financial reporting standards ("IFRS") and various statutory methods prescribed for its domestic insurance operations and non-U.S. subsidiaries and branches. Treasury plays the primary role in developing and monitoring the operating and capital plans. This department is also responsible for optimizing the Company's capital structure, monitoring the capital and liquidity resources and periodically evaluating returns on deployed capital. The Finance Department works closely with all areas of the Company to ensure that all transactions are well understood, processed in an appropriate and controlled manner, and accounted for properly. This department is also responsible for ensuring that the Company maintains adequate internal control systems over financial reporting and periodically meets to review and discuss financial filings prior to their submission with the Securities and Exchange Commission ("SEC"). The Controller is the head of the Accounting Department and regularly attends meetings of the Audit Committee of the Board of Directors. The Treasurer is the leader of the Treasury Department and regularly attends meetings of the Investment Committee of the Board of Directors.

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Management Information Systems

        The Company's Management Information Systems ("MIS") Department is composed of a professional staff of technical architects, programmers, analysts and administrators under the direction of the Chief Technology Officer. The Company's MIS Department is divided into two principal sections: Operations and Development. Operations is responsible for the operations and monitoring of the Company's hardware, software and network systems. Development is responsible for developing and maintaining the firm's proprietary applications. The Chief Technology Officer reports directly to the Company's President. The MIS Department develops implementation procedures and standards, enforcement mechanisms, and user guidance for the Company's electronic information systems and networks. In its implementation and enforcement of electronic information policies, the MIS Department deploys technology to control the use of the Company's information and communication systems, and to log or monitor the use of the Company's computers, networks or other electronic systems by employees, contractors, or remote users.

Competition and Industry Concentration

        Beginning in the second half of 2007, the credit markets commenced a period of significant dislocation that has not abated. At the same time, severe rating downgrades of most financial guaranty insurers have reduced the number of providers of financial guaranty insurance while calling into question the durability of financial guaranties in general. FSA and Assured Guaranty Corp. ("Assured Guaranty") are the principal active participants in the financial guaranty marketplace, with the Company operating at a competitive disadvantage due to its lower ratings and uncertain outlook.

        FSA faces competition from both other providers of and alternatives to third-party credit enhancement. Most securities are sold without third-party credit enhancement. Accordingly, each transaction FSA proposes to insure must generally compete against an alternative execution that does not employ third-party credit enhancement. Many financings may be funded by banks through loans or in the capital markets through the sale of securities. Both types of fundings may be executed with or without insurance. Beginning in the second half of 2008, the appetite for insured securities declined dramatically with, in some cases, insured securities trading at a discount to uninsured securities of the same issuer. FSA seeks to restore investor confidence in its credit quality and stability with a view towards increasing investor appetite for FSA-insured securities.

        Most of the Company's competitors in the financial guaranty industry announced sharp increases in projected losses on insured transactions commencing in late 2007, and subsequently were downgraded by the major securities rating agencies. At February 20, 2009, Assured Guaranty was rated Triple-A by S&P and Fitch and Aa2 by Moody's, while the Company's other historical competitors had suffered severe ratings downgrades, in most cases to non-investment grade levels, resulting in substantial or complete withdrawal from the marketplace. These downgraded insurers include Ambac Assurance Corp. ("Ambac"), CIFG Guaranty, Financial Guaranty Insurance Company ("FGIC"), MBIA Insurance Corp. ("MBIA"), Syncora Guarantee Inc. ("SGI") (formerly XL Capital Assurance) and Radian Asset Assurance Inc. Likewise, most derivative product companies and credit default swap providers that previously competed with financial guaranty insurers have generally suffered rating downgrades and/or ceased conducting new business.

        In the fourth quarter of 2007, Berkshire Hathaway Assurance Company ("BHAC") commenced operations as a financial guaranty insurer. Given BHAC's affiliation with Triple-A rated Berkshire Hathaway Company, BHAC has the potential to be a significant competitor to the Company in the public finance sector but has to date insured transactions only on an opportunistic basis. Another new monoline competitor, Municipal and Infrastructure Assurance Corporation ("MIAC"), commenced operations in October 2008, intending to focus on municipal and infrastructure finance. National Public Finance Guaranty Corp. ("NPFG"), an affiliate of MBIA, commenced operations in February 2009,

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intending to focus on municipal finance. In addition, Ambac has announced an intention to establish an affiliate, Everspan Financial Guaranty Corp., that will engage in municipal financial guaranty insurance. There are proposals for Congress to establish a federally chartered bond insurer, and for states and pension funds to establish bond insurers, in each case to address the public sector demand for bond insurance. Any such Federal, state or pension fund sponsored bond insurer would likely prove to be a significant competitor to the Company.

        Concerns regarding the capital adequacy of financial guarantors have drawn attention not only from rating agencies but also state regulators, the federal government and financial institutions concerned about their own exposure to monolines. In 2008, the Superintendent of Insurance of the State of New York (the "New York Superintendent") stated his intention to propose new regulations or amendments to Article 69 ("Article 69"), a comprehensive financial guaranty insurance statute, of the insurance laws of the State of New York (the "New York Insurance Law") for financial guaranty insurers, potentially including limitations or prohibitions on insuring CDS and certain structured finance obligations, such as CDOs of ABS, or separating the municipal insurance business from the non-municipal insurance business. In September 2008, the New York Insurance Department issued a circular letter, effective January 1, 2009, that prescribes best practices for financial guaranty issuers that narrow the permitted scope of insurance of asset-backed securities, a business no longer pursued by the Company. There also have been proposals for a federal office to oversee bond insurers.

        The long-term impact of recent developments on the Company's competitive position remains uncertain. At this stage, management cannot predict the impact of the financial crisis on the Company's future, or the competitive, regulatory and rating agency environments that will emerge.

        Parties seeking to establish a new financial guaranty insurer that may compete with the Company face entry requirements that generally include:

•

assembling the group of experts required to operate a financial guaranty insurance business,



•

establishing claims-paying ability ratings with the credit rating agencies,



•

complying with substantial capital requirements,



•

developing name recognition and market acceptance with issuers, investment bankers and investors, and



•

organizing a monoline insurance company and obtaining insurance licenses to do business in the applicable jurisdictions.

Some entrants into the industry, such as BHAC, may be able to call on other options such as parent contingent guarantees to avoid or minimize some of these requirements, with regulators waiving requirements formerly applicable to monoline financial guaranty insurers and otherwise expediting the licensing process. In addition, government sponsored entities competing in this sector may operate under rules of conduct yet to be established.

Reinsurance

        Reinsurance is the commitment by one insurance company, the "reinsurer," to reimburse another insurance company, the "ceding company," for a specified portion of the insurance risks underwritten by the ceding company in consideration for a portion of the premiums received. The ceding company typically but not always receives a ceding commission to cover the cost of business generation. Because the insured party contracts for coverage solely with the ceding company, the failure of the reinsurer to perform does not relieve the ceding company of its obligation to the insured party under the terms of the insurance contract.

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        At December 31, 2008, FSA reinsured approximately 23% of its principal amount outstanding. FSA's on-going use of reinsurance going forward remains uncertain due to a number of factors, including diminished reinsurance capacity from highly rated providers and concerns regarding the correlation of reinsurer credit-worthiness in an economic downturn.

        FSA historically obtained reinsurance to increase its policy writing capacity, both on an aggregate-risk and a single-risk basis, to:

•

meet internal, rating agency and regulatory risk limits,



•

diversify risks,



•

reduce the need for additional capital, and



•

strengthen financial ratios.

        FSA's reinsurance may be on a quota share, first-loss, or excess-of-loss basis. Quota share reinsurance generally provides protection against a fixed specified percentage of all losses incurred by FSA. First-loss reinsurance generally provides protection against a fixed specified percentage of losses incurred up to a specified limit. Excess-of-loss reinsurance generally provides protection against a fixed percentage of losses incurred to the extent that losses incurred exceed a specified limit. Reinsurance arrangements typically require FSA to retain a minimum portion of the risks reinsured.

        FSA arranges reinsurance on both a facultative (transaction-by-transaction) and treaty basis. By annual treaty, FSA employs "automatic facultative" reinsurance that permits FSA to apply reinsurance to transactions it selects subject to certain limitations. The remainder of FSA's treaty reinsurance provides coverage for a portion, subject in certain cases to adjustment at FSA's election, of the exposure from all qualifying policies issued during the term of the treaty. The reinsurer's participation in a treaty is either cancellable annually upon 90 days' prior notice by either FSA or the reinsurer or has a one-year term. Treaties generally provide coverage for the full term of the policies reinsured during the annual treaty period, except that, upon a financial deterioration of the reinsurer or the occurrence of certain other events, FSA generally has the right to reassume all or a portion of the business reinsured. Reinsurance agreements may be subject to other termination conditions as required by applicable state law. FSA monitors the financial condition of its reinsurers.

        Primary insurers, such as FSA, are required to fulfill their obligations to policyholders even if reinsurers fail to meet their obligations. The financial condition of reinsurers is important to FSA, and FSA endeavors to place its reinsurance with financially strong reinsurers. FSA's treaty reinsurers at December 31, 2008 were Assured Guaranty Re Ltd.; Mitsui Sumitomo Insurance Company, Limited; RAM Reinsurance Co. Ltd.; and Tokio Marine. At March 1, 2009, FSA had not entered into any new reinsurance treaties or renewed existing treaties that would cover new business written in 2009.

        FSA had reciprocal surplus share reinsurance treaties with Ambac and FGIC that provided quota share reinsurance on transactions exceeding specified par amounts insured. These reciprocal treaties expired on December 31, 2007 and June 30, 2007, respectively, and were not renewed. In September 2008, FSA commuted substantially all its ceded and assumed business with FGIC. In July 2008, FSA agreed to re-assume all reinsurance ceded to SGR. FSA agreed to cede a portion of this business to SGI, an affiliate of SGR, as of the re-assumption date. Ceded net unearned premiums and future ceded case reserves are secured by collateral held in a trust. In September, November and December 2008, FSA re-assumed portions of the business it ceded to SGI. Due to a liquidation order against Bluepoint RE, Limited ("Bluepoint"), FSA is treating all reinsurance ceded to Bluepoint as cancelled as of the date of the liquidation order.

        Securities rating agencies allow FSA "credit" for reinsurance based on the reinsurer's ratings. Generally, 95-100% credit is allowed for Triple-A reinsurance, 65-90% credit is allowed for Double-A reinsurance, and 40-60% credit is allowed for Single-A reinsurance. In addition, a number of FSA's

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reinsurers are required to pledge collateral to secure their reinsurance obligations to FSA. In some cases, the pledged collateral augments the rating agency credit for the reinsurance provided to FSA. Given the financial strength of its reinsurers, FSA requires collateral from reinsurers primarily to (a) receive statutory credit for the reinsurance, (b) provide liquidity to FSA in the event of claims on the reinsured exposures, and (c) enhance rating agency credit for the reinsurance.

        In recent years, most of FSA's reinsurers have been downgraded by one or more rating agency. While ceding commissions or premium allocation adjustments may compensate in part for such downgrades, the effect of such downgrades, in general, is to decrease the financial benefits of using reinsurance under rating agency capital adequacy models.

        Credit developments with respect to subprime residential mortgage-backed securities and CDOs of ABS adversely affected a number of the Company's reinsurers in 2008, but FSA's two principal reinsurers, Assured Guaranty Re Ltd. and Tokio Marine, have stable Double-A ratings. In the event of a downgrade by Moody's, S&P or, in some cases, Fitch of a reinsurer's rating, FSA generally has the option to re-assume all business ceded to the downgraded reinsurer on a treaty-by-treaty basis, and in some cases it has the option to re-assume all business that does not exceed internal, regulatory or rating agency single risk limits.

        FSA, FSAIC and FSA International are party to a quota share reinsurance pooling agreement pursuant to which, after reinsurance cessions to other reinsurers, the FSA companies share in the net retained risk insured by each of these companies or reinsured by FSA from FSA UK. Under the pooling agreement, FSA, FSAIC and FSA International share the net retained risk in proportion to their policyholders' surplus and contingency reserves, or "statutory capital," at the end of the prior calendar quarter.

        FSA UK and FSA are party to a quota share and stop loss reinsurance agreement pursuant to which:

•

FSA UK reinsures with FSA its retention under its policies after third-party reinsurance based on an agreed-upon percentage that is substantially in proportion to the statutory capital of FSA UK to the total statutory capital of FSA and its subsidiary insurers (including FSA UK); and



•

subject to certain limits, FSA is required to make payments to FSA UK when FSA UK's annual net incurred losses and expenses exceeds FSA UK's annual net earned premiums plus draws on FSA UK's equalization reserves to pay incurred losses.