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| GNW > SEC Filings for GNW > Form 10-Q on 2-Nov-2009 | All Recent SEC Filings |
2-Nov-2009
Quarterly Report
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our unaudited condensed consolidated financial statements and related notes included herein.
Cautionary note regarding forward-looking statements
This report contains certain "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements may be identified by words such as "expects," "intends," "anticipates," "plans," "believes," "seeks," "estimates," "will" or words of similar meaning and include, but are not limited to, statements regarding the outlook for our future business and financial performance. Forward-looking statements are based on management's current expectations and assumptions, which are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict. Actual outcomes and results may differ materially due to global political, economic, business, competitive, market, regulatory and other factors and risks, including the following:
• Risks relating to our businesses, including adverse capital and credit market conditions, downturns and volatility in equity and credit markets, downgrades in our financial strength or credit ratings, the impact of the U.S. government's plan to purchase illiquid mortgage-backed and other securities, our ability to access the U.S. government's financial support programs, interest rate fluctuations, the valuation of fixed maturity, equity and trading securities, defaults, downgrades or impairments of our fixed maturity securities portfolio, goodwill impairments, the soundness of other financial institutions, our inability to access our credit facilities, declines in risk-based capital, insufficiency of reserves, legal constraints on dividend distributions by subsidiaries, intense competition, availability and adequacy of reinsurance, defaults by counterparties, loss of key distribution partners, regulatory restrictions on our operations and changes in applicable laws and regulations, legal or regulatory investigations or actions, the failure or compromise of the security of our computer systems and the occurrence of natural or man-made disasters or a pandemic;
• Risks relating to our Retirement and Protection segment, including changes in morbidity and mortality, accelerated amortization of deferred acquisition costs and present value of future profits, reputational risks as a result of rate increases on certain in-force long-term care insurance products, medical advances such as genetic mapping research, unexpected changes in persistency rates, increases in statutory reserve requirements and the failure of demand for long-term care insurance to increase as we expect;
• Risks relating to our International segment, including political and economic instability, foreign exchange rate fluctuations, unexpected changes in unemployment rates, unexpected increases in mortgage insurance default rates or severity of defaults, decreases in the volume of high loan-to-value international mortgage originations, increased competition with government-owned and government-sponsored enterprises offering mortgage insurance and changes in regulations;
• Risks relating to our U.S. Mortgage Insurance segment, including our review of strategic alternatives for the segment, increases in mortgage insurance default rates or severity of defaults, deterioration in economic conditions or a decline in home price appreciation, the effect of the conservatorship of Fannie Mae and Freddie Mac on mortgage originations, the influence of Fannie Mae, Freddie Mac and a small number of large mortgage lenders and investors, decreases in the volume of high loan-to-value mortgage originations or increases in mortgage insurance cancellations, increases in the use of alternatives to private mortgage insurance and reductions by lenders in the level of coverage they select, increases in the use of reinsurance with reinsurance companies affiliated with our mortgage lending customers, increased competition with government-owned and government-sponsored enterprises ("GSEs") offering mortgage insurance, changes in regulations, legal actions under the Real Estate Settlement Practices Act of 1974 ("RESPA"), potential liabilities in connection with our U.S. contract underwriting services, the extent to which we may continue to realize benefits from rescissions and the extent to which loan modifications and other similar programs may provide benefits to us;
• Risks relating to our common stock, including the suspension of dividends and stock price fluctuation.
We undertake no obligation to publicly update any forward-looking statement, whether as a result of new information, future developments or otherwise.
Overview
Our business
We are a leading financial security company dedicated to providing insurance, wealth management, investment and financial solutions to more than 15 million customers, with a presence in more than 25 countries. We have three operating segments: Retirement and Protection, International and U.S. Mortgage Insurance.
• Retirement and Protection. We offer and manage a variety of protection, wealth management, retirement income and institutional products. Our primary protection products include: life, long-term care and Medicare supplement insurance. Additionally, we offer wellness and care coordination services for our long-term care policyholders. Our wealth management and retirement income products include: a variety of managed account programs, financial planning services and mutual funds, fixed and variable deferred and immediate individual annuities and group variable annuities offered through retirement plans. Most of our variable annuities include a guaranteed minimum death benefit ("GMDB"). Some of our group and individual variable annuity products include guaranteed minimum benefit features such as guaranteed minimum withdrawal benefits ("GMWB") and certain types of guaranteed annuitization benefits. Institutional products include: funding agreements, funding agreements backing notes ("FABNs") and guaranteed investment contracts ("GICs"). For the three months ended September 30, 2009, our Retirement and Protection segment's net income available to Genworth Financial, Inc.'s common stockholders and net operating income available to Genworth Financial, Inc.'s common stockholders were $68 million and $120 million, respectively. For the nine months ended September 30, 2009, our Retirement and Protection segment's net loss available to Genworth Financial, Inc.'s common stockholders was $236 million and net operating income available to Genworth Financial, Inc.'s common stockholders was $310 million.
• International. We are a leading provider of mortgage insurance products in Canada, Australia, New Zealand, Mexico and multiple European countries. Our products predominately insure prime-based, individually underwritten residential mortgage loans, also known as flow mortgage insurance. On a limited basis, we also provide mortgage insurance on a structured, or bulk, basis that aids in the sale of mortgages to the capital markets and helps lenders manage capital and risk. Additionally, we offer services, analytical tools and technology that enable lenders to operate efficiently and manage risk. We also offer payment protection coverages in multiple European countries, Canada and Mexico. Our lifestyle protection insurance products help consumers meet specified payment obligations should they become unable to pay due to accident, illness, involuntary unemployment, disability or death. For the three months ended September 30, 2009, our International segment's net income available to Genworth Financial, Inc.'s common stockholders and net operating income available to Genworth Financial, Inc.'s common stockholders were $97 million and $96 million, respectively. For the nine months ended September 30, 2009, our International segment's net income available to Genworth Financial, Inc.'s common stockholders and net operating income available to Genworth Financial, Inc.'s common stockholders were $278 million and $284 million, respectively.
We also have Corporate and Other activities which include debt financing expenses that are incurred at our holding company level, unallocated corporate income and expenses, eliminations of inter-segment transactions and the results of non-core businesses that are managed outside of our operating segments. For the three months ended September 30, 2009, Corporate and Other activities' net loss available to Genworth Financial, Inc.'s common stockholders and net operating loss available to Genworth Financial, Inc.'s common stockholders were $57 million and $19 million, respectively. For the nine months ended September 30, 2009, Corporate and Other activities' net loss available to Genworth Financial, Inc.'s common stockholders and net operating loss available to Genworth Financial, Inc.'s common stockholders were $171 million and $105 million, respectively.
Business trends and conditions
Our business is, and we expect will continue to be, influenced by a number of industry-wide and product-specific trends and conditions. The following discussion of business trends and conditions should be read together with the trends discussed in our 2008 Annual Report on Form 10-K, which described additional business trends and conditions.
General conditions and trends affecting our businesses
Financial and economic environment. As a financial security company, the stability of both the financial markets and global economies in which we operate impacts our sales, revenue growth and trends in profitability of our businesses. Beginning in 2008, we saw slowing economies, rising unemployment, falling real estate values and reduced consumer spending in virtually all the markets in which we operate. In 2009, Canada and Australia have seen improvements in their economies and rising real estate values leading to stabilization and improvements in the housing markets. In the U.S. and in Europe, economies have remained weak and have only recently begun to stabilize. However, financial markets have improved significantly over the past two quarters, with strong performance and lower volatility in equity markets and narrowing spreads and better credit performance in many sectors of the debt markets, reversing a significant percentage of the declines. Despite continued stress in the U.S. housing market and variations in performance by sub-market, there have been early signs of stabilization in housing prices in the third quarter of 2009 as compared to earlier in the year.
We believe that the challenging market conditions experienced in 2008 combined with slow economic growth have influenced, and will continue to influence, investment and spending decisions as both consumers and businesses adjust their consumption, debt and risk profiles in response to those conditions. Other factors such as government spending, monetary policies, regulatory initiatives, the volatility and strength of the capital markets, anticipated tax policy and the potential for healthcare reform can affect economic business and consumer outlooks. This has been evident in lower mortgage originations and the slowdown in consumer lending in the majority of our target markets. However, the impact of these conditions, while initially consistent across our target markets, has begun to improve more rapidly in Canada and Australia as discussed above. In late 2007, we began to experience increased levels of delinquencies in our U.S. and international mortgage insurance businesses and an elevated incidence of claims in our lifestyle protection insurance business that continued into
2009. In the third quarter of 2009, we began to see a slowdown in the rate of delinquencies in our international mortgage insurance business and the rate of claims in our lifestyle protection insurance business resulting in a corresponding reduction in loss ratios. In our retirement and protection businesses, we saw consumers more willing to return to investing in equity markets and purchase or evaluate other protection and retirement offerings. We could experience an increase in lapses or surrenders of policies in our life and long-term care insurance businesses if our policyholders have cash needs. We have seen an adverse impact on sales, revenues and profitability trends of certain insurance and investment products in 2009 related to some of these market conditions, as well as other factors discussed within each segment discussion herein. However, in certain markets, we have seen an increase in sales and assets under management which indicate select trends may be reversing. We could see further adverse or more positive impacts on our results of operations depending on the direction these trends take.
In response to these current market conditions, we have tightened underwriting guidelines to reduce mortgage insurance risk or exposures globally. We increased pricing in multiple targeted markets and products. We have also adjusted our investment and asset-liability management strategies in an attempt to reduce risk during recent economic and financial market conditions. In addition, we have refined our product and distribution management strategies to best fit with our strengths, profitability targets and risk tolerance. These and other company actions seek to enhance our competitive position as well as our capital flexibility and liquidity as discussed under "-Liquidity and Capital Resources."
In October 2008, the Emergency Economic Stabilization Act of 2008 (the "EESA") was enacted in response to the financial crises affecting the banking system and financial markets and continuing concern for the financial stability of investment banks and other financial institutions. Under the EESA, the U.S. Department of the Treasury ("Treasury") has the authority to, among other things, purchase up to $700.0 billion of mortgage-backed and other securities from financial institutions, as well as invest directly in certain financial institutions, for the purpose of stabilizing the financial markets. In February 2009, President Obama signed into law the American Recovery and Reinvestment Act of 2009 that was designed to stimulate the U.S. economy through a variety of measures, including new federal spending programs designed to spur new job creation and certain federal tax cuts. Since the end of the first quarter of 2009, the U.S. government, Federal Reserve and other legislative and regulatory bodies have taken a variety of other actions to stabilize the capital markets and provide needed liquidity to promote economic growth. These include various mortgage restructuring programs under consideration or implemented by the GSEs, lenders and the U.S. government. Outside of the U.S., various governments have taken actions to stimulate economies, stabilize financial systems and improve market liquidity. There can be no assurance as to what impact any of these actions will have on the economic and financial markets, including levels of volatility. A prolonged economic recovery period or global recessionary setback could materially and adversely affect our businesses, financial condition and results of operations.
Volatility in credit and investment markets. Market conditions showed lower volatility and continued signs of improvement in the third quarter of 2009. Bank capital stress test results stabilized markets and enabled financial institutions to raise significant amounts of capital to begin rebuilding balance sheets. This contributed to another quarter of improved equity and credit market performance. As investor appetite for riskier assets has returned, credit spreads have continued to compress and a broader range of companies have been able to re-access the debt markets. In addition, the continued expansion of government programs has stabilized the structured securities markets and provided expanded market access to issuers of asset-backed securities. As a result, the marketplace has seen liquidity premiums shrink in many sectors and a clearer differentiation between the performance of individual credits has returned. Despite the overall improvement, increasing unemployment and continued economic uncertainty have led to further declines in commercial real estate and consumer-related asset performance, although the rate of decline for the consumer-related asset sectors has slowed.
While the marketplace is still experiencing a decline in the performance of collateral underlying certain structured securities, corporate impairments have decreased significantly in 2009. We recorded net other-than-temporary impairments of $945 million during the nine months ended September 30, 2009. Impairments
recorded in the second and third quarters of 2009 were lower than the trends experienced in the second half of 2008 and the first quarter of 2009 as market improvements have continued and we expect losses to trend down and be manageable within our capital structure. Additionally, for the nine months ended September 30, 2009, losses related to limited partnerships increased to $160 million. However, in the third quarter of 2009, we saw a decline in losses related to limited partnerships from the second quarter of 2009. Although economic conditions may continue to negatively impact our investment valuation, the underlying collateral associated with assets that have not been impaired continues to perform.
We believe that the current credit environment provides us with opportunities to invest in select asset classes and sectors that may enhance our investment yields over time. See "-Investments and Derivative Instruments" for additional information on our investment portfolio.
Trends and conditions affecting our segments
Retirement and Protection
Life insurance. Results in our life insurance business are impacted by sales, mortality, persistency, investment yields and statutory reserve requirements. Additionally, sales of our products and persistency of our insurance in-force are dependent on competitive product features and pricing, distribution and customer service.
There has been an overall decline in life insurance sales for the industry given recent market conditions. Consistent with the industry, our life insurance sales trended down during 2008 and through the first half of 2009. We saw a modest increase in sales during the third quarter of 2009 as compared to the second quarter of 2009. In our universal life insurance products, we anticipate that new premium sales may decline before returning to a growth profile as we introduce new life insurance products priced to achieve targeted returns and designed for our refined target market. In term life insurance, we have continued to execute on our refined "main street" market focus (characterized by face amounts of $1 million or below). As a result, while new policy counts have risen, overall new sales premiums have declined. In addition, we are introducing a new term universal life insurance product that is designed to and will replace our current traditional term life insurance products. As a result, sales of our traditional term insurance will decline and will be replaced by term universal life insurance sales, the growth rate of which will depend upon the timing of distributor and consumer adoption, which may vary.
Beginning in late 2008 and continuing through the third quarter of 2009, we have seen favorable mortality in our life insurance products as compared to priced mortality. Additionally, we have experienced lower persistency in term life insurance policies going into their post-level rate period (10 and 15 years after policy issue) and expect this trend to continue for a period of time as certain blocks of business reach the post-level rate period.
During 2009, certain competitors have increased prices and exited certain product features in the life insurance market, particularly in policies with longer guarantee periods and no lapse guarantees, which could benefit our competitiveness and returns over time. Competitors have made pricing adjustments, in part, to address Regulations XXX and AXXX which require insurers to establish additional statutory reserves for term life insurance policies with long-term premium guarantees and certain universal life insurance policies with secondary guarantees, which increase the capital required to write these products. The solutions for these increased reserve requirements have become more limited and expensive for certain in-force books of business, which has and will continue to negatively impact certain product margins, and therefore, our results of operations. Related to our in-force contracts, we have committed funding sources for approximately 95% of our anticipated peak level reserves required under Regulations XXX and AXXX so unfunded reserve exposure is minimal. In addition, as noted above, we have also introduced, and are introducing, product modifications to our universal life insurance products which provide shorter guarantee periods, thereby reducing the capital requirements and mitigating the level of future additional statutory reserve funding requirements. We are also introducing a new term universal life insurance product that is designed to replace our existing term life
insurance products which will offer death benefit guarantee premiums that are competitive with traditional term insurance premiums, with the greater flexibility associated with universal life coverage. These new products are designed to reduce capital requirements and limit financing costs associated with existing products.
Long-term care insurance. Results of our long-term care insurance business are influenced by morbidity, persistency, investment yields, new product sales, expenses and reinsurance.
In recent years, industry-wide first-year annualized premiums of individual long-term care insurance have either declined or grown moderately. Although our sales in the last year have been adversely impacted primarily by the general economic conditions and lower sales through our independent distribution channel, the decline has been partially mitigated by the strength of our career force, breadth of our distribution and progress across multiple growth initiatives with an emphasis on broadening our product offerings, including additional group long-term care insurance and linked-benefits offerings. In the third quarter of 2009, we experienced an improvement in our long-term care insurance sales. In addition, we previously filed for state regulatory approvals for premium rate increases of between 8% and 12% on most of our block of older issued long-term care insurance policies and have implemented the majority of these rate increases. The recent rate increases have contributed to higher revenues and results of operations for these blocks of business.
In 2008, the impact of lower termination rates, in particular lapse rates on older issued policies, some with expiring reinsurance coverage, caused higher benefits and other changes in policy reserves, resulting in lower results of operations for older blocks of business. However, in the first half of 2009, termination rates increased on the new and old blocks of business resulting in lower benefits and other changes in policy reserves that contributed to higher results of operations. During the third quarter of 2009, termination rates declined principally due to lower mortality than anticipated.
In response to these trends, we continue pursuing multiple growth initiatives, investing in case management improvements, maintaining tight expense management, actively exploring reinsurance and capital market strategies, executing effective investment strategies and, if appropriate, considering other actions to improve profitability of the overall block. In addition, proposed changes in regulations or government programs, such as certain aspects of health care reform, if enacted, could impact our long-term care insurance business. We continue to actively monitor regulatory developments.
Wealth management. Results of our wealth management business are impacted by demand for asset management products and related support services, investment performance and equity market conditions. In the second half of 2008 through early 2009, the decline and volatility in the equity markets negatively impacted the asset management industry overall, as well as our assets under management, net flows, the performance of certain mutual funds we offer and associated fee income. With the improvement in the equity markets in the second and third quarters of 2009, along with the introduction of new investment strategies, we had higher sales, positive net flows and higher assets under management quarter over quarter. Depending upon the direction of equity markets in the future, we would expect to see a correlated impact on performance in these areas.
Retirement income. Results for our retirement income business are affected by investment performance, interest rate levels, slope of the interest rate yield curve, net interest spreads, equity market conditions, mortality, policyholder lapses and new product sales. Our competitive position within many of our distribution channels and our ability to grow this business depends on many factors, including product features, ratings and competitive strength. We provide various product features such as current and minimum crediting rates on our spread-based products, surrender charge periods in our annuities, as well as guaranteed benefit features in variable annuity products that we offer which provide a guaranteed death or living benefits to the consumer.
We have scaled back certain product features, targeted distributors and sales personnel supporting our annuity products due to the adverse market conditions and our risk appetite, profitability and capital strategies. In addition, in late 2008 and early 2009, due to adverse market conditions, our operating . . .
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