State regulators said they are taking control of roughly $64 billion of the worst assets at U.S. bond insurer Ambac Financial Group Inc .

Regulators in Wisconsin, where Ambac's main insurance unit is legally based, ordered the insurer to set up a separate account to house liabilities from policies that have generated, or are expected to generate, big losses.

The company had become financially hazardous, Wisconsin Insurance Commissioner Sean Dilweg said in an interview with Reuters, adding that under state laws, an insurance company is hazardous when it might not be able to pay claims in the future.

Dilweg said he is taking control of the assets to ensure that Ambac's riskiest exposures do not hurt investors depending on the company to insure other types of bonds, such as municipal debt.

Dilweg received court approval to temporarily prevent Ambac's main unit, Ambac Assurance Corp, from paying out claims on the assets. Ambac has been paying out $120 million a month on some of these assets, at 100 cents on the dollar.

Bond insurers like Ambac charge bond issuers a fee and in exchange guarantee debt against default. When issuers do default on guaranteed bonds, Ambac must step in to make interest payments and ultimately repay principal.

Ambac's capital levels have become severely strained by the mortgage crisis, which forced it to make big payouts on a number of complicated repackaged mortgage bonds it had guaranteed, among other instruments.

Bond insurers broadly suffered from making big bets on the mortgage market, which took them away from their main business of guaranteeing bonds issued by states and cities.

Like its larger rival MBIA Inc , Ambac lost its top triple-A credit rating in 2008. That top rating was crucial for winning business, and both MBIA and Ambac have struggled to write new policies since then. Without new revenue, MBIA and Ambac are largely depending on revenue and cash flow from existing policies.

Ambac's management believes that it will have sufficient liquidity to satisfy its needs through the second quarter of 2011, the company said.

The company said it is open to renegotiating its debt through a prepackaged bankruptcy.

Shares in Ambac fell 21 percent to 63 cents. Shares in MBIA were down 19 cents, or 3 percent, at $6.21.


The segregated account will include guarantees against default that Ambac sold on roughly $35 billion of mortgage securities, and about $29 billion of other exposure.

Ambac Assurance Corp will put $2 billion of notes into the segregated account, which will in turn be used to help pay claims.

The Wisconsin Office of the Commissioner of Insurance (OCI) will administer the segregated account. Any losses will still be borne by Ambac.

The OCI has experience administering other insurance companies, although these have been far smaller entities than the Ambac segregated account, according to a statement on a Web site set up to answer Ambac policyholders' questions about the arrangement. But OCI has done its homework and it's prepared, according to the statement.

Ambac does not believe the segregated account rehabilitation constituted an event of default under its bond indenture and said it was highly unlikely that Ambac Assurance would be able to make dividend payments to Ambac for the foreseeable future.

(Reporting by Dan Wilchins and Elinor Comlay, Additional reporting by Sakthi Prasad in Bangalore; Editing by Dave Zimmerman and Gerald E. McCormick)