ABK Ambac Financial Grp. Common Stock

T HE A UDIT AND R ISK A SSESSMENT C OMMITTEE R EPORT

The Audit and Risk Assessment Committee of Ambac is responsible for providing independent, objective oversight of Ambac’s accounting functions and internal controls and risk management. The Audit and Risk Assessment Committee selects the independent auditors. The Audit and Risk Assessment Committee is currently composed of six independent directors, each of whom is independent as defined under the rules of the NYSE. In accordance with Section 407 of the Sarbanes-Oxley Act of 2002, Ambac has identified the following four members of the Audit and Risk Assessment Committee as “audit committee financial experts”: Messrs. Duff, Theobald, Wallace and Ms. Considine.

The Audit and Risk Assessment Committee operates under a written charter adopted by the Board of Directors. A copy of the charter is available at Ambac’s website: http://www.ambac.com . The Audit and Risk Assessment Committee regularly reviews its charter to ensure that it is meeting all relevant Audit and Risk Assessment Committee policy requirements of the SEC, the Public Company Accounting Oversight Board and the NYSE.

Management is responsible for the preparation, presentation and integrity of Ambac’s financial statements, accounting and financial reporting principles and the establishment and effectiveness of internal controls and procedures designed to assure compliance with accounting standards and applicable laws and regulations. The independent auditors are responsible for performing an independent audit of Ambac’s consolidated financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States), expressing an opinion, based on their audit, as to whether the financial statements fairly present, in all material respects, the financial position, results of operations and cash flows of Ambac in conformity with generally accepted accounting principles and auditing the effectiveness of internal control over financial reporting. The Audit and Risk Assessment Committee’s responsibility is to monitor and oversee these processes. However, none of the members of the Audit and Risk Assessment Committee is professionally engaged in the practice of accounting or auditing nor are all of our members experts in those fields. The Audit and Risk Assessment Committee relies without independent verification on the information provided to it and on the representations made by management and the independent auditors.

The Audit and Risk Assessment Committee held eight meetings during 2008. The meetings were designed, among other things, to facilitate and encourage communication among the Audit and Risk Assessment Committee, management, the internal auditors and Ambac’s independent auditors, KPMG LLP, an independent registered public accounting firm. The Audit and Risk Assessment Committee discussed with Ambac’s internal auditors and KPMG LLP the overall scope and plans for their respective audits. The Audit and Risk Assessment Committee met with the internal auditors and KPMG LLP, with and without management present, to discuss the results of their examinations and their evaluations of Ambac’s internal controls.

The Audit and Risk Assessment Committee has reviewed and discussed the audited consolidated financial statements for the fiscal year ended December 31, 2008 with management, the internal auditors and KPMG LLP. The Audit and Risk Assessment Committee also discussed with management and KPMG LLP the process used to support certifications by Ambac’s Chief Executive Officer and Chief Financial Officer that are required by the SEC and the Sarbanes-Oxley Act of 2002 to accompany Ambac’s periodic filings with the SEC.

The Audit and Risk Assessment Committee also discussed with KPMG LLP matters required to be discussed with audit committees under auditing standards, including, among other things, matters related to the conduct of the audit of Ambac’s consolidated financial statements and the matters required to be discussed by Statement on Auditing Standards No. 61 ( Communication with Audit Committees ).

KPMG LLP also provided to us the written disclosures required by Independence Standards Board Standard No. 1 ( Independence Discussions with Audit Committees ), and the Audit and Risk Assessment Committee discussed with them their independence from Ambac. When determining KPMG LLP’s independence, the Committee considered whether their provision of services to Ambac beyond those rendered in connection with their audit of Ambac’s consolidated financial statements and reviews of Ambac’s consolidated financial statements included in its Quarterly Reports on Form 10-Q was compatible with maintaining their independence. The Audit and Risk Assessment Committee also reviewed, among other things, the audit and non-audit services performed by, and the amount of fees paid for such services to, KPMG LLP. The Audit and Risk Assessment Committee concluded that KPMG LLP, an independent registered public accounting firm, is independent from Ambac and its management.

Based upon the review and discussions referred to above, the Audit and Risk Assessment Committee recommended to the Board of Directors, and the Board of Directors has approved, that Ambac’s audited financial statements be included in Ambac’s Annual Report on SEC Form 10-K for the year ended December 31, 2008. The Audit and Risk Assessment Committee also selected KPMG LLP, an independent registered public accounting firm, as Ambac’s independent auditors for 2009.

C OMPENSATION D ISCUSSION AND A NALYSIS

Our primary compensation objective for 2008 was to provide a fair level of compensation to our executives while acknowledging the negative consequences to Ambac of past decisions and the impact of the global economic crisis on our business. With these objectives in mind, the Committee considered the efforts Ambac has made to mitigate its losses, the need to continue to work towards stabilizing Ambac, and the critical importance of retaining and motivating our executives and employees for our future. The Committee’s compensation decisions also considered the significant level of actual stock ownership by the executive officers.

Key Decisions in 2008

2008 was marked by continued challenges and questions regarding Ambac’s viability. The organization experienced significant change in its management team and reported net loss of $5.6 billion, driven primarily by a mark-to-market loss of $8.2 billion. Also included in these results are losses and impairments of $5.9 billion related primarily to Ambac’s exposure to the currently troubled residential real estate sector, primarily through securities we insured in the mortgage-backed and collateralized debt obligation sectors. The magnitude of the losses was aggravated by the severe global economic crisis that continues. While we successfully raised capital in March 2008 to support our enterprise, our ability to generate new business was impaired as a result of our being downgraded by the rating agencies. As such, we did not meet our financial objectives.

In view of these circumstances, and consistent with the compensation principles discussed below, we have taken the following steps relating to compensation.

The remaining portions of this CD&A discuss our compensation program for NEOs and the rationale under our program for our 2008 pay decisions and the change to our compensation structure and framework for 2009.

Compensation Philosophy for 2008

Generally, we seek to provide a competitive total compensation package that provides a fair level of compensation to all employees, rewards those whose performance exceeds their responsibilities and objectives and recognizes the critical element of accountability where performance does not meet the objectives. However, in February 2008 in an effort to promote retention, the Committee provided most

employees a minimum 2008 performance year bonus guarantee of 90% of the bonus they received for the 2007 performance year.

For our NEOs, there was no bonus guarantee, and we continued to consider a “total compensation” approach in setting pay levels. Our annual compensation decisions focus on the sum of an NEO’s base salary, annual performance bonus and long-term equity incentive awards. Thus, our decisions with respect to any particular element of an NEO’s compensation take into account how a change in that element will affect the officer’s total compensation package. All of our executive officers experienced a decline in incentive compensation, and the group averaged a reduction of 60% in incentive compensation when compared to the 2007 performance year. The ultimate goal of the compensation framework was to create an incentive for key executive officers who have been, and will continue to be, instrumental to the implementation of Ambac’s corporate strategy.

Compensation Philosophy for 2009

For 2009, the Committee approved the implementation of a new Company-wide compensation framework that deemphasizes cash bonuses, pays base salaries based on a comparison with a broader group of companies ( not only “Wall Street” firms ) and offers limited but variable incentive based opportunities driven by individually defined performance metrics aligned with our organizational objectives. The Compensation Committee studied this revised structure for much of 2008. The Committee concluded that a compensation construct with less emphasis on short-term incentive compensation is consistent with emerging views of the market and our regulators concerning appropriate compensation policy and addresses the Committee’s concern that the opportunity for larger incentive bonus payments may promote riskier behavior.

Our new compensation model has several objectives: (i) adjust compensation relative to the market and new roles; (ii) drive cultural transformation by requiring true differentiation for any individual bonus payments and managerial accountability for the same; (iii) deliver a message that the behavior of our employees is not dictated by short-term incentive compensation; (iv) support our efforts to restore confidence and rebuild activities during the next 12-18 months including avoiding potential unwanted attrition; and (v) attract and retain key personnel by offering a compensation structure uncommon to our industry and the broader financial services sector.

Elements of Executive Compensation for 2008

The primary elements of compensation provided to our executives are base salary, an annual performance bonus and, historically, long-term incentive awards in the form of stock options and restricted stock units.

Under the construct for 2008, at least 80% of an executive officer’s direct compensation opportunity ( salary plus bonus plus long-term incentive awards ) consisted of the opportunity for bonus and long-term incentive awards. For the reasons noted above, in respect of 2008, we did not award long-term incentive awards following year-end to any of our executives. The Committee determined the NEOs’ total compensation based on Ambac’s performance, the performance and accomplishments of the group of functions for which the executive is responsible and the executive’s performance, and the special emphasis in 2008 on retention.

Set forth below is a discussion of each element of NEO compensation, why we pay each element and how each element fits into our overall compensation philosophy.

(I) Base Salaries

NEOs generally have historically received a relatively small portion of their overall compensation as base salary, although the percentage of direct compensation for 2008 was generally higher than for prior years in view of our decision not to make year-end equity awards. For 2008, the percentages of direct compensation ( salary plus bonus plus long-term incentive awards ) represented by base salary ranged from 21% to 46% for our NEOs. Base salaries provide our executives with a minimum level of fixed compensation and for 2008 were generally below the median base salaries paid to executives in corresponding positions by competitors in the Peer Group discussed below.

Consistent with our new approach to compensation, for 2009, the Committee increased base salaries for the executives. These increases were the result of the Committee’s revised compensation framework and associated objectives as discussed on page 32 of this CD&A. The Committee reviewed the total compensation for our executives, assessed the current market for the scope of responsibilities of each executive ( including promotions ), and considered the results achieved by the executive and his or her future potential and importance to Ambac’s future. The Committee also considered the recommendations and opinions of the Chairman, the Chief Executive Officer, the Chief Administrative Officer and our compensation consultant Alan Johnson of Johnson Associates.

(II) Annual Incentive Compensation—Bonus and Long-Term Incentive Awards

Annual Bonus

Generally, the role of the annual bonus is to incent our executives, including our NEOs, and to reward them or to hold them accountable for performance against our annual objectives.

The annual bonus is a cash incentive that is typically paid during the first quarter following the year of performance. Historically, the annual bonus has represented a significant portion of an NEO’s annual cash and total compensation, and we continued that practice for 2008. For 2008, annual bonus accounted for between 23 % and 78 % of each NEO’s annual cash ( salary plus bonus ), and direct compensation ( salary plus bonus plus long-term incentive awards ). All bonuses paid to executive officers for 2008 were determined in the discretion of the Compensation Committee and did not qualify as performance-based compensation under the Executive Incentive Plan for the reasons discussed below.

Annual Long-Term Incentive Awards

In years past, we have provided long-term incentive awards to our NEOs, in the form of stock options and RSUs. In respect of 2008, apart from the front-loaded equity grant we made to Mr. Wallis when he was named Chief Risk Officer and the award to Mr. Callen in lieu of his non-employee director equity grant discussed in more detail below, the Committee did not award any long-term incentive awards given the limited number of shares available under our Equity

Plan and the low current stock price. Nevertheless, each of our NEOs holds a significant number of shares as well as outstanding equity awards. The level of continued ownership and outstanding, unvested long-term incentive awards from prior years provides continued alignment of interest with our stockholders and the necessary focus of our executives on the reestablishment of the franchise.

Forfeiture, Recoupment and Notice Requirements

We maintain forfeiture and recoupment provisions relating to outstanding stock option and RSU awards. Under these provisions, NEOs who violate a non-competition agreement will forfeit any outstanding awards as of the date the violation is discovered and are required to return any gains realized during the six months before and after the executive’s employment terminated. We believe that these provisions, which we apply to all of our officers generally, help ensure that our executives act in the best interest of Ambac and our stockholders.

Ambac also requires executive officers to agree to provide a minimum notice prior to departure as a condition for the receipt of stock option awards. During the notice period, the executive remains employed by Ambac ( although we may relieve the executive from performing employment duties during the notice period ) and is prohibited from working or performing services for any employer other than Ambac.

Retirement

Generally, upon retirement at age 55 or disability, the stock options and RSUs held by an employee (including an NEO) who has been employed with Ambac for at least three years, will become fully vested (and, in the case of stock options, exercisable) , unless otherwise provided in an award agreement. Of our NEOs, Mr. Renfield-Miller was retirement eligible during 2008. The Compensation Committee believes that this policy appropriately rewards those employees who have served Ambac loyally and, based on the advice of its compensation consultant, that it is market practice in our industry.

Backdating and Repricing Prohibitions

The Compensation Committee does not and has not permitted backdating or repricing of stock options. Our 1997 Equity Plan explicitly forbids stock option repricing.

(III) Other Benefits

Our executives participate in a retirement plan, health plans, and other voluntary benefit plans that we make available to all Ambac employees generally. We consider these benefits to be market competitive and consistent with local market practices. These benefits include matching certain employee contributions to our 401(k) savings plan and providing all eligible employees a 3% profit sharing contribution and a 3% supplemental profit sharing contribution ( based on the employee’s salary ), each of which is allocated as directed by the employee. As of December 31, 2008, we terminated our nonqualified savings incentive plan, to which we formerly credited amounts we were precluded from contributing to the 401(k) plan because of limitations under the Internal Revenue Code.

We terminated our tax-qualified defined benefit pension plan as of December 31, 2006. All of our NEOs received a lump sum distribution of their accumulated benefit value under the plan during 2007 on the same terms that applied to all other employees who elected a lump sum distribution. By terminating our tax-qualified defined benefit plan, we froze benefit accruals under two related nonqualified defined benefit plans, with the result that our NEOs stopped accruing benefits under the nonqualified plans as of December 31, 2006. All of our NEOs received a lump sum distribution of their accumulated benefit value under these plans in March 2008.

We provide officers assigned to work abroad certain expatriate benefits to ensure that they are not put at a disadvantage by accepting assignment to a foreign country and to tax equalize any such payments. We do not provide any other perquisites to our executives, except for certain tax equalization and expatriate benefits that were provided during 2008 to Messrs. Callen and Wallis, as described below.

(IV) Change in Control Agreements

We have entered into management retention agreements (“MRAs”) with our executive officers to provide for certain payments and other benefits if they are terminated within three years following a change in control of Ambac. The purpose of these agreements is to avoid unwanted management turnover in the event of a potential change in control and to ensure that the executive officers will remain focused on the interests of our stockholders notwithstanding the personal uncertainties that a change in control may occasion. The Committee has reviewed the terms of the MRAs and considers the agreement to serve a useful function and establish severance at an appropriate level.

Our management retention agreements are “double trigger” agreements under which benefits ( other than the acceleration of vesting of equity awards ) will be provided only if there is both (i) a change in control and (ii) a qualifying termination of the executive officer’s employment within three years of the change in control. The specific provisions of these agreements are discussed on pages 62 to 64 in the Proxy Statement.

Comparison Group and Benchmarking

In setting pay for our NEOs, we undertake a series of analytical steps and processes to ensure we are market competitive and paying our executives appropriately. We conduct a peer group analysis, consult with an outside, independent executive compensation expert and evaluate and consider market conditions.

For 2008, we reviewed historical compensation of the Peer Group (as defined below) but did not afford this review as much weight as we have in past years, given the markedly changed environment over the course of 2008. Our comparison included the “total compensation” levels ( base salary, annual cash bonus and equity awards ) of our NEOs, as well as each component of total compensation, of a competitor/peer group of companies consisting of our competitors in the financial guarantee insurance industry and other financial services firms employing executives with similar skill sets: MBIA, Financial Security Assurance, XL Capital, Assured Guaranty, PMI Group, Syncora, Everest RE, Max Re, Moody’s, MGIC and Radian (the “ Peer Group ”). We obtain data for the Peer Group from a number of sources, including proxy statements, public information available from regulatory agencies, publicly available surveys and proprietary market information from our compensation consulting firm.

The performance of virtually all members of the Peer Group was significantly affected by general economic conditions during 2008, and this resulted in marked variation in data across the group. Thus, we did not utilize the Peer Group as a primary basis for our compensation decisions and instead used the data as an indication of current compensation practices.

For 2008, we also reviewed, with the assistance of our compensation consultant, the publicly disclosed 2007 compensation information of twenty-one of the 258 firms accepting government capital under the Troubled Assets Relief Program (“ TARP ”) as of January 15, 2009 ( Goldman Sachs, JP Morgan, American Express, Morgan Stanley, Bank of America, Citigroup, Capital One, Wells Fargo, Northern Trust Co., CIT Group, US Bancorp, KeyCorp, SunTrust, Marshall & Ilsely, Associated Banc Corp., Huntington Bancshares, M&T Bank Corp., Wilmington Trust Co., Zions, Boston Private Financial Holdings, Provident Bankshares ). Our independent consultant chose these firms because they are visible, significant financial firms that received significant TARP funding. The majority of the other firms on the TARP recipient list are less known and generally received smaller amounts of TARP funding. While Ambac is not receiving government capital or support, the Committee viewed this information as relevant to its considerations as a general indication of compensation practice in our market. The Committee did not target compensation of Ambac executives at any specific level relative to these twenty-one companies. However, the Committee considered that the comparative data, which revealed that Ambac total compensation was between the 25 ^th and 50 ^th percentiles of this group, supported a conclusion that our approach to 2008 was generally consistent with prior benchmarking of executive and professional compensation relative to the Peer Group.

Role of Management

For decisions relating to 2008 bonus and long-term equity awards, our Compensation Committee also considered the input of our Executive Chairman ( Mr. Callen ) and our Chief Executive Officer ( Mr. Wallis ). The Committee reviewed their recommendations with the Committee’s compensation consultant and considered the recommendations in executive session. The Committee also considered all relevant performance factors for each executive and attached considerable weight to the importance of retention.

Role of Compensation Consultant

Our Compensation Committee has sole authority to retain, at Ambac’s expense, and to terminate the services of a compensation consultant. Since 1999, the Committee has engaged Alan Johnson, a Managing Director of Johnson Associates, to assist it with benchmarking and compensation analyses, as well as to provide consulting on executive and non-executive compensation practices. Mr. Johnson provides our Compensation Committee with insight relative to industry best practices, executive compensation levels and policies of Ambac’s key competitors and others in the financial services industry and a review of the impact of competition for talent.

For 2008, Mr. Johnson provided the Committee with Peer Group data, compensation data with regard to companies accepting government capital, updates as to market conditions for 2008 performance year and forecast for 2009 and assisted in their interpretation and analysis. He provided an assessment of the competitive environment in terms of actual and projected pay in the financial services and financial guaranty sectors as well as a forecast with regard to headcount in these sectors. Mr. Johnson advised the Compensation Committee that Ambac’s total compensation level was generally between the 25 ^th percentile and the median of relevant comparator groups.

Mr. Johnson reviewed Ambac’s compensation against the above noted information and included in his assessment the effect that the historical skewing of compensation towards equity-based compensation, our stock ownership requirements and the actual stock holdings of Ambac’s executive officers and Managing Directors would have on retention and compensation for performance year 2008. Mr. Johnson recommended an increase in the percentage of cash compensation we pay our NEOs relative to the other components of their total compensation to achieve a more balanced mix.

Mr. Johnson also assisted the Committee in conducting an objective assessment of its pay and pay practices, and provided feedback to the Senior Vice President, Chief Administrative Officer and Employment Counsel and the Committee regarding the new compensation structure for 2009 (see page 32). This included his assessment of the compensation framework in light of the market environment, the need to deemphasize compensation components that can be viewed as encouraging excessive risk taking and Ambac’s desire to recalibrate the compensation for positions within the Company. Mr. Johnson was made aware of the desire to depart from the “Wall Street” mentality of artificially low base salaries with significant short-term incentive potential and the mandate to drive a cultural transformation requiring true differentiation based upon performance against key objectives and metrics for incentive awards.

From time to time, Johnson Associates performs broader compensation analyses and/or surveys for Ambac and provides consultation regarding the structure of Ambac’s compensation plans. Apart from these services, Mr. Johnson and Johnson Associates do not provide any other services for Ambac or any of its subsidiaries. The Committee is aware of and approves all services that Johnson and Associates performs for Ambac.

Executive Incentive Plan

The 1997 Executive Incentive Plan (the “ EIP ”) provides the framework for deductibility of NEO compensation in excess of $1 million. Pursuant to the EIP, at the beginning of each year, our Compensation Committee establishes a performance-based formula for calculating the maximum incentive compensation ( payable in cash and/or equity awards ) payable under the EIP for that calendar year to each of our named executive officers and the other participants in the EIP. Under the terms of the EIP, this maximum amount may not exceed the lesser of (a) $5 million or (b) the amount derived from the incentive compensation formula established at the beginning of the relevant year. The performance formula may be based on any one, or any combination, of the following performance categories: return on equity; core/operating earnings growth; total return to stockholders; expense management; risk management; market position/new business production; industry leadership/image building; new products/initiatives; and organizational development/corporate culture.

In early 2008, the Compensation Committee selected core earnings as an appropriate measure for determining incentive compensation under the EIP because the Committee considered it an important measure of Ambac’s performance to a wide range of constituents. The ranges of compensation for the NEOs and executive officers was set based upon the Committee’s review of the 2008 forecast and its desire to pay reasonable incentive compensation.

The formula for determining incentive compensation for 2008 was:

For 2008, Ambac’s core earnings were ($5,868,965,000). Accordingly, the EIP formula did not authorize any payment of 2008 incentive compensation that, if in excess of $1 million, would qualify as performance based and a deductible expense.

Looking back on 2008, the Committee believes that, given the unpredictable environment of 2008 and the unforeseen responsibilities and activities required of our executive team and all employees, core earnings, as the primary factor for determining the payment of bonuses, proved not to be the appropriate measure of performance on which to base compensation for 2008.

Compensation of Ambac’s Named Executive Officers for 2008

After considering the unpredictable events and requirements of 2008, our retention needs and historical pay practices, our performance for 2008 and market conditions impacting competitive pay, the Compensation Committee established base salary and an annual cash bonus for each of our NEOs and decided not to award long-term incentive awards to our executive officers. The Committee, in determining executive pay, also considered the recommendations of the Chairman and Chief Executive Officer when determining pay for the other executives.

The Committee reviewed and evaluated Ambac’s business and market conditions which were impacted by the global economic environment and the financial guaranty industry in 2008 when determining the compensation of the executive officers. Market conditions that impacted Ambac during 2008 included (i) significant deterioration in the housing market that directly impacted our mortgage-related insured exposures, (ii) a decline in asset valuations across all sectors that contributed to a significant reduction in the fair value of our derivative contracts, (iii) rating agency downgrades which triggered collateralization requirements in our Financial Services businesses, and (iv) an overall freezing of the credit markets which impacted financial flexibility.

(I) Base Salaries

The data relating to the Peer Group supported an increase in base salaries for 2008 but the Committee concluded it was not appropriate to implement salary increases at that time. The 2008 base salary for each of the NEOs is reported in the “Summary Compensation Table” elsewhere in this Proxy Statement.

For 2009, the Committee implemented a new compensation structure that recalibrated (i) base salaries at a higher level and (ii) incentive-based compensation at a lesser, yet more variable level as represented by a wider range of outcomes based upon objectives and metrics for each NEO. The new construct applies across Ambac and allowed the Committee to (i) recalibrate compensation relative to the market and new roles, (ii) drive critically important cultural transformation, and (iii) provide a level of certainty to our staff with regard to compensation allowing them to focus on the critical task of moving Ambac forward and discouraging behavior that may not be supportive of the long-term interest of Ambac.

(II) Total Annual Incentive Compensation

At Ambac, total annual incentive compensation is comprised of the annual bonus and long-term incentive compensation ( restricted stock units and stock options ). In setting the amount of an executive’s total annual incentive compensation for 2008, the Committee considered Ambac’s performance, the performance of the executive officer, and the performance of the executive’s division or areas of responsibility. The Committee also considered the importance of retention, the historical weight accorded to equity-based compensation, the stock ownership of our executive officers, the recommendations of the Executive Chairman, the Chief Executive Officer, and the comparative data and information presented by Johnson Associates.

As noted above, for 2008, the Executive Chairman, the Chief Executive Officer and other NEOs were not eligible to receive any incentive compensation under the EIP based on the formula

described in the chart above, as Ambac’s core earnings for 2008 did not reach the threshold required for a payout under the EIP. The Compensation Committee determined that Ambac’s overall economic performance and losses in 2008 were not satisfactory. The continued impact of the global credit crisis and Ambac’s participation in certain transactions in the structured credit sector led to a second year of record losses and further impacted the value of the franchise. On an aggregate basis, for 2008, the total annual incentive compensation ( bonus plus long-term incentive award ) for our executive officers declined 60%.

Named Executive Officer Compensation

In determining each NEO’s compensation, the Committee considered the performance of Ambac but also afforded significant weight to the dedication, effort and commitment of the executive team and all employees that allowed Ambac to raise capital, commute transactions, respond to regulatory and rating agency matters, devise a business plan for a municipal bond insurance franchise and continue to monitor and remediate our book of business while also exploring ways to reinvent the franchise.

In this current economic climate, the Committee also considered the critical importance of retaining executives as we seek to implement our business plan. In addition, the Committee recognized that the compensation of our executives has historically been comprised of a meaningful amount of equity-based compensation, that executive officers were subject to stringent stock ownership requirements, and that the steep decline in our stock price since 2007 has had severe negative impact on the value of our executives’ stock holdings and their outstanding restricted stock units and stock options.

In determining 2008 incentive compensation levels, the Committee took note of each NEO’s respective contribution to our performance outlined above and reviewed and analyzed their individual performance as follows:

Michael Callen, Interim Chief Executive Officer

Mr. Callen assumed the role of interim Chief Executive Officer (“ CEO ”) following our former CEO’s unanticipated retirement from Ambac on January 16, 2008. For 2008, Mr. Callen received base salary at an annual rate of $650,000, which was the same annual salary we paid his predecessor. The Committee considered the fact that Mr. Callen was, without notice, put into the interim CEO role, emerged from retirement and changed his residence and was charged with leading Ambac in exceedingly difficult times. The Committee determined it was appropriate to reward Mr. Callen for his stewardship, commitment and exceptional effort in leading and retaining the team and beginning the process of driving us towards a new beginning. Moreover, the Committee took into consideration the fact that the interim appointment lasted longer than anticipated due to the extended search process for a new chief executive officer. Based on these considerations, the Committee awarded Mr. Callen an annual cash bonus of $975,000, which represented 150% of his rate of annual salary as CEO.

The Committee awarded Mr. Callen an equity award of restricted stock units valued at $100,000 on June 3, 2008, the date of Ambac’s 2008 Annual Meeting of Stockholders. This award was in lieu of his non-employee directors annual equity award for which he was ineligible while serving

as our Interim President and CEO. Mr. Callen is also subject to a tax equalization arrangement in connection with his presence in the State of New York for the time he served as our Interim President and CEO and while he continues as our Executive Chairman. This arrangement is intended to cover the taxes Mr. Callen is subject to as a New York taxpayer that are over and above what his tax position would be in his home state of Maryland. We have offered this benefit to Mr. Callen in order to eliminate any financial detriment to him from his assignment of duties in New York.

David Wallis, Chief Executive Officer

Mr. Wallis was named Ambac’s new Chief Risk Officer in February and in that capacity was responsible for assessing and delivering a new risk structure and perspective for Ambac. He was instrumental in our capital raise, managing our portfolio, pursuing remediation strategies and commuting several transactions that reduced outstanding Collateralized Debt Obligations of Asset Backed Securities (CDO of ABS) exposures by $5.0 billion and generating much needed capital. In October 2008, Mr. Wallis was named Chief Executive Officer and charged with leading the organization forward. The Committee found the 2008 performance of Mr. Wallis as CRO and then CEO to be exceptional.

Upon Mr. Wallis’ promotion to Chief Risk Officer, his base salary was increased from $300,000 to $1 million dollars and he was awarded stock options and restricted stock units with a combined grant date fair value ( determined under applicable accounting standards ) of $3.375 million with a five-year cliff vest. The stock option and restricted stock unit award represents the front-loaded value of one-half the projected annual grant over a five year period. The Compensation Committee reviewed market information provided by Johnson Associates and weighed other Firm considerations when approving the compensation package for Mr. Wallis. The structure was deemed an appropriate way to ensure that the Chief Risk Officer remained independent, risk averse and is focused on the long-term viability of the enterprise. The Committee awarded Mr. Wallis a cash bonus of $500,000 and no long-term incentive compensation. The Committee determined that $500,000 was an appropriate bonus as it equaled one-half the base salary, reflecting the Committee’s goal of deemphasizing short-term incentive compensation while rewarding Mr. Wallis for his performance in 2008.

For 2008, Mr. Wallis, who was an expatriate, was provided with an expatriate package that included tax equalization, housing, goods and services, tuition and home leave allowances and tax preparation assistance. The allowances and services provided to Mr. Wallis are the same allowances and services we make available to all expatriate Ambac employees. The expatriate allowances for Mr. Wallis, other than tax preparation assistance, were discontinued after Mr. Wallis sold his primary residence in the United Kingdom. The Compensation Committee approved a tax equalization payment upon Mr. Wallis’ sale of his UK residence. This was in recognition of the additional tax liability that Mr. Wallis faces as a result of being resident in the United States.

Sean T. Leonard, Chief Financial Officer

The Committee found the 2008 performance of Mr. Leonard, Ambac’s CFO, to be exceptional. Mr. Leonard, who serves as a key member of Ambac’s senior management team, was

instrumental in devising various capital alternatives and ultimately led the team responsible for structuring, negotiating and executing Ambac’s $1.5 billion capital raise in early 2008, when Ambac was facing enormous pressure in the capital markets. Moreover, during this period of crises, Mr. Leonard effectively communicated with Ambac’s regulators, rating agencies, investors and other constituents which have proven critical as we stabilize our franchise and move forward. In addition, he was an integral part of several commutations. Mr. Leonard and his team are at the forefront of all accounting issues that may impact Ambac’s business, providing sound advice and direction to ensure Ambac’s financial statements are in line with GAAP, FASB and all other accounting and regulatory requirements. In setting Mr. Leonard’s compensation, the Committee considered not only his outstanding performance in 2008, but also the critical role he continues to play in Ambac’s current phase of strategic development.

The Committee awarded Mr. Leonard a cash bonus of $950,000 but did not award any long-term incentive compensation. The Committee believed that Mr. Leonard’s incentive compensation appropriately reflected his individual performance, his group’s contribution and the Committee’s desire to retain his services for the future while recognizing the performance of Ambac. The Committee determined that the cash bonus was appropriate after considering Mr. Leonard’s compensation relative to other CFOs in the Peer Group, relative to other Ambac executive officers and employees and in consideration of his relative accomplishments and contributions.

Kevin Doyle, Senior Vice President and General Counsel

The Committee found the 2008 performance of Mr. Doyle, Ambac’s General Counsel, to be exceptional. Mr. Doyle played a critical role in our capital raise. Mr. Doyle is also the primary interface with our insurance regulators, including the Office of the Commissioner of the State of Wisconsin. In addition to managing our relationships with the insurance regulators through the stress experienced by Ambac Assurance, he played a critical role in obtaining the Wisconsin regulator’s consent with respect to the intercompany loans between Ambac Assurance and our financial services businesses, thus allowing us to avert significant liquidity issues. He has also played a significant role in our efforts to reactivate Everspan Financial Guarantee Corp., working with various constituents to structure a stand-alone company that is removed from the issues confronting Ambac Assurance, and to obtain the insurance regulator’s consent to the capitalization of Everspan via an investment by Ambac Assurance. In addition, Mr. Doyle has managed our litigation efforts where, as plaintiff, Ambac is seeking to recover damages and mitigate loss in our insured portfolio.

The Committee awarded Mr. Doyle a cash bonus of $950,000 and did not award any long-term incentive compensation. The Committee believed that Mr. Doyle’s incentive compensation appropriately reflected his individual performance, his group’s contribution and the Committee’s desire to retain his services for the future while recognizing the performance of Ambac. The Committee also considered Mr. Doyle’s cash and total compensation relative to other General Counsel’s with similar responsibilities in the Peer Group, to other Ambac executive officers and employees and in consideration of his relative accomplishments and contributions.

Douglas Renfield-Miller, Executive Vice President

The Committee found Mr. Renfield-Miller’s performance to have met their changed expectations for 2008. Mr. Renfield-Miller, the CEO designate of Ambac’s municipal bond subsidiary,

Everspan, was charged with creating and implementing a business plan for Everspan. He successfully led a team to create the necessary infrastructure, assembled a team, including a Board of Directors, to move this critical initiative forward and is working to obtain the support of our regulatory and rating agency constituents.

The Committee awarded Mr. Renfield-Miller a cash bonus of $550,000 and did not award any long-term incentive compensation. The Committee believed that Mr. Renfield-Miller’s incentive compensation is appropriate in light of the scope of his role, the realties facing Ambac and the desire to retain his services as CEO of Everspan. The Committee considered the unique scope of Mr. Renfield-Miller’s responsibilities and the decline in his cash and overall incentive compensation.

Robert Shoback, Senior Managing Director

The Committee found Mr. Shoback’s performance to have met their expectations for 2008. The scope of Mr. Shoback’s responsibilities for 2008 extended to include his support during the capital raise and his role in the creation of Everspan. In addition, Mr. Shoback continued to manage our Public Finance team and worked closely with clients and issuers to address market dislocation associated with deals previously insured by Ambac.

The Committee awarded Mr. Shoback a cash bonus of $350,000 and did not award any long-term incentive compensation. The Committee believed that Mr. Shoback’s incentive compensation is appropriate in light of the scope of his role, the realties facing Ambac and the desire to retain his services in a critical role with Everspan.

Robert J. Genader, Former Chief Executive Officer

Mr. Genader announced his retirement from Ambac on January 13, 2008, effective January 16, 2008. Mr. Genader was paid his base salary through his retirement date and was not awarded any bonus or long-term incentive compensation. Mr. Genader did not receive any severance or other retirement package. Upon retirement, Mr. Genader’s unvested equity awards vested in accordance with the terms and conditions of the underlying award agreements as applicable to all employees.

John W. Uhlein, III, Executive Vice President

Mr. Uhlein served as Executive Vice President and supported our efforts to commute and remediate certain transactions. He also was involved in the review of certain potential new business initiatives.

The Committee approved an agreement at the time of Mr. Uhlein’s resignation that provided the Corporation with transition and consulting services, a release of all claims, confidentiality restrictions and non-competition terms. In return, the Committee approved a cash bonus for 2008 for Mr. Uhlein in the amount of $750,000 and salary continuation until February 1, 2009 (the effective date of his resignation). For further details of Mr. Uhlein’s agreement, please see “Agreement with John W. Uhlein, III on page 66 below.

William T. McKinnon, Former Chief Risk Officer

Mr. McKinnon retired from Ambac on February 8, 2008. Mr. McKinnon served as Ambac’s former Chief Risk Officer. Mr. McKinnon’s compensation was subject to the terms of the employment contract entered into with Ambac on January 30, 2007, as discussed on page 66 below. As such, the Committee was obligated to award Mr. McKinnon the minimum cash bonus and equity incentive awards provided for under his employment agreement. In accordance with the terms of the employment contract, we paid Mr. McKinnon a bonus of $850,000 and awarded $750,000 cash in lieu of our obligation to award RSUs and stock options with a value of $750,000. Because Mr. McKinnon was retirement eligible and any equity award would be vested at time of grant, the Committee paid Mr. McKinnon cash in lieu of the equity incentive awards. The Committee deemed this in the Corporation’s best interest so as not to utilize limited shares available under our Equity Plan.

Because Mr. McKinnon was eligible for retirement, all unvested equity awards previously granted to Mr. McKinnon vested in accordance with the terms and conditions of the underlying award agreements upon his termination of employment. The retirement provisions applicable to Mr. McKinnon are the same that apply to all of our employees. For more details about Mr. McKinnon’s employment agreement please see page 66 below.

Supplemental Information

The table below shows the Committee’s view of the compensation that it awarded the NEOs in fiscal 2008 under the policies and programs described in this “Compensation Discussion and Analysis.” Because, in prior years, a high percentage of our NEO compensation was stock-based, and because SEC rules require stock-based compensation to be reported based on what is expensed for financial statement purposes, this alternative table is being provided as a guide to understanding the difference between the Committee’s actions with respect to NEO awards in fiscal 2008 as described in this “Compensation Discussion and Analysis,” and the amounts required to be reported on the Summary Compensation Table. Inclusion of the table is not intended to replace the 2008 Summary Compensation Table, but rather to demonstrate how the Committee views the compensation awarded to our NEOs for 2008. As shown below, no stock based compensation was awarded for the 2008 performance year other than for Messrs. Callen and Wallis. Rather, the amounts reported in the Summary Compensation Table for fiscal 2008 for stock awards and stock option awards relate to stock-based compensation and other long-term incentive grants awarded in previous years.

Tax Deductibility of Executive Compensation

Section 162(m) of the Internal Revenue Code includes potential limitations on the deductibility of compensation in excess of $1 million paid to a company’s CEO and the three other most highly compensated executive officers serving on the last day of the year. This limitation does not apply to compensation that meets the requirements of “qualified performance-based compensation” under Section 162(m). The Committee considers the impact of this rule when developing and implementing Ambac’s executive compensation program.

Historically, the Committee has generally taken necessary actions to ensure the deductibility of payments of its annual bonuses and stock options, whenever possible. For 2008, none of the annual bonuses that we pay to our executive officers whose compensation qualifies as performance-based compensation under Section 162(m), with the result that compensation in excess of $1 million paid to these officers will not be deductible to Ambac. While we view preserving tax deductibility as an important objective, we do not consider it to be the sole objective in establishing executive compensation. In specific instances, we have and in the future may authorize compensation arrangements that are not fully tax deductible but which promote other important objectives of Ambac.

Stock Ownership Guidelines

Effective October 2008, Ambac suspended its stock ownership targets. Given the precipitous fall in Ambac’s stock price, none of our NEOs meet our stock ownership guidelines, which are based on a level of ownership of Ambac stock (based on the market value of Ambac common stock) as a multiple of the officer’s total cash compensation (base salary plus cash bonus) . These multiples ranged from seven times total cash compensation (in the case of the CEO) to a low of one and one-half times total cash compensation for managing directors.

Nevertheless, our executives continue to hold a significant amount of Ambac stock outright, in the SIP and in the form of outstanding equity grants. The table below details as of February 1, 2009, the holdings of Ambac’s currently serving NEOs. (For purposes of computing an executive’s ownership towards their target, we consider shares owned by the executive, family members and trusts for the executive or family members, shares held in the Ambac stock fund of our SIP and the value of restricted stock units granted and outstanding. We do not consider any shares subject to stock options.)

All Ambac employees, including our NEOs, are prohibited from making short sales or engaging in transactions involving puts, calls and other types of options in Ambac securities, including equity swaps and similar derivative transactions. We prohibit these activities because we believe that they may put an employee or executive officer’s personal gain in conflict with the best interests of Ambac and its stockholders.

C OMPENSATION C OMMITTEE R EPORT

The Compensation Committee has reviewed and discussed the above Compensation Discussion and Analysis with Ambac’s management. Based on its review and discussions, the Compensation Committee recommended to the Board of Directors that the compensation discussion and analysis section be included in this Proxy Statement.

March 18, 2009