Genworth Financial, Inc. Form 10-Q
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


FORM 10-Q

 


 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the quarterly period ended June 30, 2006

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                     to                    

Commission file number 001-32195

 


LOGO

Genworth Financial, Inc.

(Exact Name of Registrant as Specified in its Charter)

 


 

Delaware   33-1073076
(State or Other Jurisdiction of
Incorporation or Organization)
  (I.R.S. Employer
Identification Number)

6620 West Broad Street

Richmond, Virginia

  23230
(Address of Principal Executive Offices)   (Zip Code)

(804) 281-6000

(Registrant’s Telephone Number, Including Area Code)

 


Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨.

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.

See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer  x   Accelerated filer  ¨   Non-accelerated filer  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x.

At July 27, 2006, 455,002,495 shares of Class A Common Stock, par value $0.001 per share, were outstanding.

 



Table of Contents

TABLE OF CONTENTS

 

     Page

PART I—FINANCIAL INFORMATION

  

Item 1. Condensed Consolidated Financial Statements

   3

Condensed Consolidated Statements of Earnings for the three and six months ended June 30, 2006 and 2005 (Unaudited)

   3

Condensed Consolidated Statements of Financial Position as of June 30, 2006 (Unaudited) and December 31, 2005

   4

Condensed Consolidated Statements of Changes in Stockholders’ Equity for the six months ended June 30, 2006 and 2005 (Unaudited)

   5

Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2006 and 2005 (Unaudited)

   6

Notes to Condensed Consolidated Financial Statements (Unaudited)

   7

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

   20

Item 3. Quantitative and Qualitative Disclosures About Market Risk

   64

Item 4. Controls and Procedures

   64

PART II—OTHER INFORMATION

  

Item 1. Legal Proceedings

   65

Item 1A. Risk Factors

   67

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

   67

Item 4. Submission of Matters to a Vote of Security Holders

   67

Item 6. Exhibits

   68

Signatures

   69

 

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PART I—FINANCIAL INFORMATION

Item 1. Financial Statements

GENWORTH FINANCIAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS

(Amounts in millions, except per share amounts)

(Unaudited)

 

     Three months ended
June 30,
   Six months ended
June 30,
 
         2006             2005        2006     2005  

Revenues:

         

Premiums

   $ 1,648     $ 1,614    $ 3,187     $ 3,219  

Net investment income

     953       842      1,877       1,693  

Net investment gains (losses)

     (49 )     —        (71 )     (6 )

Policy fees and other income

     202       154      386       315  
                               

Total revenues

     2,754       2,610      5,379       5,221  
                               

Benefits and expenses:

         

Benefits and other changes in policy reserves

     1,096       1,051      2,131       2,126  

Interest credited

     378       347      751       687  

Acquisition and operating expenses, net of deferrals

     521       523      996       970  

Amortization of deferred acquisition costs and intangibles

     207       208      381       401  

Interest expense

     88       69      170       141  
                               

Total benefits and expenses

     2,290       2,198      4,429       4,325  
                               

Net earnings before income taxes and accounting change

     464       412      950       896  

Provision for income taxes

     147       127      303       289  
                               

Net earnings before accounting change

     317       285      647       607  

Cumulative effect of accounting change, net of taxes

     —         —        4       —    
                               

Net earnings

   $ 317     $ 285    $ 651     $ 607  
                               

Earnings per common share:

         

Basic

   $ 0.70     $ 0.61    $ 1.41     $ 1.27  
                               

Diluted

   $ 0.68     $ 0.60    $ 1.37     $ 1.25  
                               

Weighted-average common shares outstanding:

         

Basic

     455.8       470.4      461.3       479.6  
                               

Diluted

     468.3       477.4      473.9       485.9  
                               

See Notes to Condensed Consolidated Financial Statements

 

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GENWORTH FINANCIAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL POSITION

(Amounts in millions)

 

    

June 30,

2006

    December 31,
2005
 
     (Unaudited)        

Assets

    

Investments:

    

Fixed maturity securities available-for-sale, at fair value

   $ 52,316     $ 53,937  

Equity securities available-for-sale, at fair value

     187       206  

Commercial mortgage loans

     8,203       7,558  

Policy loans

     1,485       1,350  

Restricted investments held by securitization entities

     —         685  

Other invested assets

     1,840       3,174  
                

Total investments

     64,031       66,910  

Cash and cash equivalents

     2,351       1,875  

Accrued investment income

     663       733  

Deferred acquisition costs

     6,042       5,586  

Intangible assets

     942       782  

Goodwill

     1,486       1,450  

Reinsurance recoverable

     17,789       18,245  

Other assets

     717       967  

Separate account assets

     9,625       9,106  
                

Total assets

   $ 103,646     $ 105,654  
                

Liabilities and stockholders’ equity

    

Liabilities:

    

Future annuity and contract benefits

   $ 63,614     $ 63,749  

Liability for policy and contract claims

     3,297       3,364  

Unearned premiums

     3,956       3,647  

Other policyholder liabilities

     484       507  

Other liabilities

     3,652       4,937  

Non-recourse funding obligations

     2,150       1,400  

Short-term borrowings

     295       152  

Long-term borrowings

     2,741       2,736  

Senior notes underlying equity units

     600       600  

Mandatorily redeemable preferred stock

     100       100  

Deferred tax liability

     922       1,386  

Borrowings related to securitization entities

     —         660  

Separate account liabilities

     9,625       9,106  
                

Total liabilities

     91,436       92,344  
                

Commitments and contingencies

    

Stockholders’ equity:

    

Class A common stock, $0.001 par value; 1.5 billion shares authorized; 491 million and 404 million shares issued as of June 30, 2006 and December 31, 2005, respectively; 455 million and 385 million shares outstanding as of June 30, 2006 and December 31, 2005, respectively

     —         —    

Class B common stock, $0.001 par value; 700 million shares authorized; zero and 86 million shares issued and outstanding as of June 30, 2006 and December 31, 2005, respectively

     —         —    

Additional paid-in capital

     10,713       10,671  
                

Accumulated other comprehensive income:

    

Net unrealized investment gains (losses)

     (312 )     760  

Derivatives qualifying as hedges

     212       389  

Foreign currency translation and other adjustments

     333       255  
                

Total accumulated other comprehensive income

     233       1,404  

Retained earnings

     2,317       1,735  

Treasury stock, at cost (37 million and 19 million shares as of June 30, 2006 and December 31, 2005, respectively)

     (1,053 )     (500 )
                

Total stockholders’ equity

     12,210       13,310  
                

Total liabilities and stockholders’ equity

   $ 103,646     $ 105,654  
                

See Notes to Condensed Consolidated Financial Statements

 

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GENWORTH FINANCIAL, INC.

CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY

(Amounts in millions)

(Unaudited)

 

     Additional
paid-in
capital
   Accumulated other
comprehensive
income
    Retained
earnings
    Treasury
stock, at
cost
    Total
stockholders’
equity
 

Balances as of December 31, 2004

   $ 10,612    $ 1,608     $ 646     $ —       $ 12,866  

Comprehensive income (loss):

           

Net earnings

          607         607  

Net unrealized gains (losses) on investment securities

        519           519  

Derivatives qualifying as hedges

        138           138  

Foreign currency translation and other adjustments

        (102 )         (102 )
                 

Total comprehensive income (loss)

              1,162  

Acquisition of treasury stock

            (500 )     (500 )

Dividends to stockholders

          (61 )       (61 )

Stock-based compensation expense and exercises

     25            25  

Capital contributions from GE

     14            14  
                                       

Balances as of June 30, 2005

   $ 10,651    $ 2,163     $ 1,192     $ (500 )   $ 13,506  
                                       
     Additional
paid-in
capital
   Accumulated other
comprehensive
income
    Retained
earnings
    Treasury
stock, at
cost
    Total
stockholders’
equity
 

Balances as of December 31, 2005

   $ 10,671    $ 1,404     $ 1,735     $ (500 )   $ 13,310  

Comprehensive income (loss):

           

Net earnings

          651         651  

Net unrealized gains (losses) on investment securities

        (1,072 )         (1,072 )

Derivatives qualifying as hedges

        (177 )         (177 )

Foreign currency translation and other adjustments

        78           78  
                 

Total comprehensive income (loss)

              (520 )

Acquisition of treasury stock

            (553 )     (553 )

Dividends to stockholders

          (69 )       (69 )

Stock-based compensation expense and exercises

     38            38  

Capital contributions from GE

     4            4  
                                       

Balances as of June 30, 2006

   $ 10,713    $ 233     $ 2,317     $ (1,053 )   $ 12,210  
                                       

See Notes to Condensed Consolidated Financial Statements

 

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GENWORTH FINANCIAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Amounts in millions)

(Unaudited)

 

     Six months ended
June 30,
 
     2006     2005  

Cash flows from operating activities:

    

Net earnings

   $ 651     $ 607  

Adjustments to reconcile net earnings to net cash from operating activities:

    

Amortization of fixed maturity discounts and premiums

     12       33  

Net investment (gains) losses

     71       6  

Charges assessed to policyholders

     (177 )     (152 )

Cumulative effect of accounting policy change

     (4 )     —    

Acquisition costs deferred

     (607 )     (531 )

Amortization of deferred acquisition costs and intangibles

     381       401  

Deferred income taxes

     182       218  

Change in certain assets and liabilities:

    

Accrued investment income and other assets, net

     144       117  

Insurance reserves

     1,476       1,183  

Current tax liabilities

     44       (53 )

Other liabilities and other policy-related balances

     (176 )     (466 )
                

Net cash from operating activities

     1,997       1,363  
                

Cash flows from investing activities:

    

Proceeds from maturities and repayments of investments:

    

Fixed maturities

     2,802       2,086  

Mortgage loans

     554       432  

Proceeds from sales of investments:

    

Fixed maturities and equity securities

     2,918       2,332  

Purchases and originations of investments:

    

Fixed maturities and equity securities

     (5,564 )     (4,844 )

Mortgage loans

     (1,183 )     (1,249 )

Other invested assets, net

     (10 )     213  

Policy loans, net

     (135 )     (9 )

Payments for business purchased, net of cash acquired

     (134 )     —    
                

Net cash from investing activities

     (752 )     (1,039 )
                

Cash flows from financing activities:

    

Proceeds from issuance of investment contracts

     3,774       3,815  

Redemption and benefit payments on investment contracts

     (4,827 )     (4,147 )

Short-term borrowing activity, net

     143       (30 )

Proceeds from issuance of non-recourse funding obligations

     750       200  

Dividends paid to stockholders

     (69 )     (61 )

Stock-based compensation awards exercised

     20       2  

Acquisition of treasury stock

     (553 )     (500 )

Capital contribution received from GE

     2       13  
                

Net cash from financing activities

     (760 )     (708 )

Effect of exchange rate changes on cash and cash equivalents

     (9 )     (61 )
                

Net change in cash and cash equivalents

     476       (445 )

Cash and cash equivalents at beginning of period

     1,875       1,963  
                

Cash and cash equivalents at end of period

   $ 2,351     $ 1,518  
                

See Notes to Condensed Consolidated Financial Statements

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(1) Formation of Genworth and Basis of Presentation

Genworth Financial, Inc. (“Genworth”) was incorporated in Delaware on October 23, 2003 in preparation for the corporate reorganization of certain insurance and related subsidiaries of General Electric Company (“GE”) and an initial public offering of Genworth common stock, which was completed on May 28, 2004 (“IPO”). In connection with the IPO, Genworth acquired substantially all of the assets and liabilities of GE Financial Assurance Holdings, Inc. (“GEFAHI”). Prior to its IPO, Genworth was a wholly-owned subsidiary of GEFAHI. GEFAHI is an indirect subsidiary of General Electric Capital Corporation (“GE Capital”), which in turn is an indirect subsidiary of GE. Prior to the corporate reorganization, GEFAHI was a holding company for a group of companies that provide life insurance, long-term care insurance, group life and health insurance, annuities, investment products and U.S. mortgage insurance. At the same time, Genworth also acquired certain other insurance businesses previously owned by other GE subsidiaries. These businesses included international mortgage insurance, payment protection insurance, a Bermuda reinsurer, and mortgage contract underwriting.

The accompanying condensed financial statements include on a consolidated basis the accounts of Genworth and our affiliate companies in which we hold a majority voting or economic interest, which we refer to as the “company,” “we,” “us,” or “our” unless the context otherwise requires. All intercompany accounts and transactions have been eliminated in consolidation.

We are a leading insurance company in the U.S., with an expanding international presence, serving the life and lifestyle protection, retirement income, investment and mortgage insurance needs of more than 15 million customers. We have leadership positions in key products that we expect will benefit from a number of significant demographic, governmental and market trends. We distribute our products and services through an extensive and diversified distribution network that includes financial intermediaries, independent producers and dedicated sales specialists. We conduct operations in 24 countries and have approximately 7,000 employees. We have the following four segments:

 

    Our Protection segment includes life, long-term care and Medicare supplement insurance and, primarily for companies with fewer than 1,000 employees, group life and health insurance. Protection also includes consumer payment protection insurance, which helps consumers meet their payment obligations in the event of illness, involuntary unemployment, disability or death.

 

    Our Retirement Income and Investments segment includes fixed annuities, individual and group variable annuities, single premium immediate annuities, variable life insurance, asset management and specialized products, including guaranteed investment contracts (“GICs”), funding agreements, funding agreements backing notes (“FABNs”) and structured settlements.

 

    Our Mortgage Insurance segment includes mortgage insurance products offered in the U.S., Canada, Australia, Europe, New Zealand, Mexico and Japan that facilitate homeownership by enabling borrowers to buy homes with low-down-payment mortgages.

 

    Our Corporate and Other segment includes debt financing expenses that are incurred at our holding company level, unallocated corporate income and expenses, and the results of a small, non-core business that is managed outside our operating segments.

On March 8, 2006, GEFAHI completed an offering (“Secondary Offering”) of 71.2 million shares of our Class B Common Stock. The 71.2 million shares were automatically converted to Class A Common Stock upon the sale of these shares to the public. We did not receive any proceeds in the Secondary Offering. Concurrently with the Secondary Offering, we repurchased 15.0 million shares of Class B Common Stock from our majority stockholder at a price of $31.93125 per share (the net proceeds per share received by the selling stockholder from the

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

underwriters), which is recorded at cost as treasury stock in the unaudited condensed consolidated statement of financial position. As a result of these transactions, GEFAHI no longer owns any of our outstanding common stock.

The accompanying condensed consolidated financial statements are unaudited and have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) and rules and regulations of the United States Securities and Exchange Commission (“SEC”). Preparing financial statements in conformity with GAAP requires us to make estimates and assumptions that affect reported amounts and related disclosures. Actual results could differ from those estimates. Certain prior year amounts have been reclassified to conform to the current year presentation. These condensed consolidated financial statements include all adjustments (consisting of normal recurring accruals) considered necessary by management to present a fair statement of the financial position, results of operations, and cash flow for the periods presented. The results reported in these condensed consolidated financial statements should not be regarded as necessarily indicative of results that may be expected for the entire year. The condensed consolidated financial statements included herein should be read in conjunction with the audited financial statements and related notes contained in our 2005 Annual Report on Form 10-K.

(2) Accounting Pronouncements

Recently adopted

On January 1, 2006, we adopted Financial Accounting Standards Board (“FASB”) Statement of Financial Accounting Standards (“SFAS”) No. 123R, Share-Based Payment, an amendment of SFAS No. 123, Accounting for Stock-Based Compensation. We adopted SFAS No. 123R under the modified prospective transition method. The statement requires companies to recognize the grant-date fair value of options and other equity-based awards within the income statement over the respective vesting period of the awards. We adopted SFAS No. 123 effective January 1, 2002 and, as permitted, we determined a grant date fair value using a Black-Scholes model (“Black-Scholes Model”) and recognized the related compensation expense through the income statement for all equity awards issued subsequent to January 1, 2002. As a result of the adoption of SFAS No. 123R, we will continue to recognize the remaining portion of the requisite service under previously granted unvested awards including those awards granted prior to January 1, 2002. Prior to the adoption of SFAS No. 123R, we adjusted compensation cost related to forfeiture of awards when the actual forfeiture occurred. SFAS No. 123R requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates and requires companies which previously accounted for forfeitures on an occurrence basis to include in income of the period of adoption a cumulative effect of a change in accounting principle for the adjustment to reflect estimated forfeitures for prior periods. On January 1, 2006, we recognized an increase to net earnings of $4 million related to the cumulative effect of a change in accounting principle for the adoption of SFAS No. 123R. See Note 6 for additional information.

As of January 1, 2006, we adopted SFAS No. 155, Accounting for Certain Hybrid Financial Instruments. SFAS No. 155 amends SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, and SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. SFAS No. 155 allows financial instruments that have embedded derivatives to be accounted for as a whole, eliminating the need to bifurcate the derivative from its host, if the holder elects to account for the whole instrument on a fair value basis. In addition, among other changes, SFAS No. 155 (i) clarifies which interest-only strips and principal-only strips are not subject to the requirements of SFAS No. 133; (ii) establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation; (iii) clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives; and (iv) eliminates the prohibition on a qualifying special-purpose entity (“QSPE”) from holding a derivative financial instrument that

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

pertains to a beneficial interest other than another derivative financial interest. Adoption of SFAS No. 155 did not have a material impact on our condensed consolidated financial statements.

Not yet adopted

In September 2005, the American Institute of Certified Public Accountants issued Statement of Position (“SOP”) 05-1, Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection With Modifications or Exchanges of Insurance Contracts. This statement provides guidance on accounting for deferred acquisition costs and other deferred balances on an internal replacement, defined broadly as a modification in product benefits, features, rights, or coverages that occurs by the exchange of an existing contract for a new contract, or by amendment, endorsement, or rider to an existing contract, or by the election of a benefit, feature, right, or coverage within an existing contract. Depending on the type of modification, the period over which these deferred balances will be recognized could be accelerated. SOP 05-1 is effective for internal replacements occurring in fiscal years beginning after December 15, 2006. We are currently evaluating the impact that SOP 05-1 will have on our consolidated results of operations and financial position.

In July 2006, FASB Interpretation (“FIN”) No. 48, Accounting for Uncertainty in Income Taxes was issued. This guidance clarifies what criteria must be met prior to recognition of the financial statement benefit of a position taken in a tax return. Additionally, it applies to the recognition and measurement of income tax uncertainties resulting from a purchase business combination. This guidance is effective for fiscal years beginning after December 15, 2006. We are currently evaluating the impact FIN No. 48 will have on our consolidated results of operations and financial position.

(3) Earnings per Common Share

Basic and diluted earnings per common share are calculated by dividing net earnings by the weighted average basic common shares outstanding and by the weighted average diluted common shares outstanding for the periods presented:

 

     Three months ended
June 30,
   Six months ended
June 30,

(Amounts in millions except for per share data)

       2006            2005        2006    2005

Basic earnings per common share:

           

Net earnings before accounting change

   $ 0.70    $ 0.61    $ 1.40    $ 1.27

Cumulative effect of accounting change, net of taxes

     —        —        0.01      —  
                           

Basic earnings per common share

   $ 0.70    $ 0.61    $ 1.41    $ 1.27
                           

Diluted earnings per common share:

           

Net earnings before accounting change

   $ 0.68    $ 0.60    $ 1.37    $ 1.25

Cumulative effect of accounting change, net of taxes

     —        —        0.01      —  
                           

Diluted earnings per common share

   $ 0.68    $ 0.60    $ 1.37    $ 1.25
                           

Weighted-average shares used in basic earnings per common share calculations

     455.8      470.4      461.3      479.6

Dilutive securities:

           

Stock purchase contracts underlying equity units

     7.5      4.4      7.5      4.0

Stock options and stock appreciation rights

     4.5      2.2      4.6      1.9

Restricted stock units

     0.5      0.4      0.5      0.4
                           

Weighted-average shares used in diluted earnings per common share calculations

     468.3      477.4      473.9      485.9
                           

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

(4) Investments and Derivative Instruments

The following table sets forth information about our net investment income for the components of our investment portfolio for the periods presented:

 

     Three months ended
June 30,
    Six months ended
June 30,
 

(Amounts in millions)

       2006             2005         2006     2005  

Fixed maturities—taxable

   $ 731     $ 665     $ 1,450     $ 1,334  

Fixed maturities—non-taxable

     31       32       62       65  

Commercial mortgage loans

     138       98       259       196  

Equity securities

     7       6       14       12  

Other investments

     12       10       23       24  

Policy loans

     32       27       62       53  

Restricted investments held by securitization entities

     —         13       7       27  

Cash, cash equivalents and short-term investments

     20       7       37       15  
                                

Gross investment income before expenses and fees

     971       858       1,914       1,726  

Expenses and fees

     (18 )     (16 )     (37 )     (33 )
                                

Net investment income

   $ 953     $ 842     $ 1,877     $ 1,693  
                                

The following table sets forth net investment gains (losses) for the periods presented:

 

     Three months ended
June 30,
    Six months ended
June 30,
 

(Amounts in millions)

       2006             2005             2006             2005      

Available-for-sale securities

        

Realized gains on sale

   $ 8     $ 12     $ 30     $ 51  

Realized losses on sale

     (50 )     (9 )     (76 )     (20 )

Loss on derecognition of securitization entities

     —         —         (17 )     —    

Impairments

     (4 )     (3 )     (5 )     (37 )

Net unrealized gains (losses) on trading securities

     (1 )     —         (1 )     —    

Derivative instruments

     (2 )     —         (2 )     —    
                                

Net investment gains (losses)

   $ (49 )   $   —       $ (71 )   $ (6 )
                                

Derivative instruments primarily consist of changes in fair value on the non-qualifying derivatives, including embedded derivatives, changes in fair value of certain derivatives and related hedged items in fair value hedge relationships and hedge ineffectiveness on qualifying derivative instruments. Effective April 1, 2006, we began classifying changes in fair value of these derivative items as net investment gains (losses). These items were previously included as a component of net investment income, interest credited and benefits and other changes in policy reserves. The amount of these derivative items in prior periods that were included in the aforementioned categories was not material.

For the three months ended June 30, 2006 and 2005, we recognized impairments of $4 million and $3 million, respectively, and for the six months ended June 30, 2006 and 2005, we recognized impairments of $5 million and $37 million, respectively. The aggregate fair value of securities sold at a loss during the three months

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

ended June 30, 2006 and 2005, was $1,227 million and $481 million, respectively, which was approximately 96% and 98% of book value, respectively. The aggregate fair value of securities sold at a loss during the six months ended June 30, 2006 and 2005, was $2,068 million and $1,158 million, respectively, which was approximately 96% and 99% of book value, respectively. The loss on sales of securities in the three and six months ended June 30, 2006 was primarily driven by the higher interest rate environment.

As of June 30, 2006, the amortized cost or cost, gross unrealized gains (losses), and estimated fair value of our fixed maturities and equity securities classified as available-for-sale were as follows:

 

(Amounts in millions)

   Amortized
cost or
cost
   Gross
unrealized
gains
   Gross
unrealized
losses
    Estimated
fair value

Fixed maturities:

          

U.S. government, agencies and government sponsored entities

   $ 695    $ 10    $ (17 )   $ 688

Tax exempt

     2,763      56      (16 )     2,803

Government—non U.S.  

     1,833      33      (24 )     1,842

U.S. corporate

     24,816      357      (775 )     24,398

Corporate—non U.S.  

     9,716      115      (270 )     9,561

Mortgage and asset-backed

     13,200      96      (272 )     13,024
                            

Total fixed maturities

     53,023      667      (1,374 )     52,316

Equity securities

     161      29      (3 )     187
                            

Total available-for-sale securities

   $ 53,184    $ 696    $ (1,377 )   $ 52,503
                            

As of December 31, 2005, the amortized cost or cost, gross unrealized gains (losses), and estimated fair value of our fixed maturities and equity securities classified as available-for-sale were as follows:

 

(Amounts in millions)

   Amortized
cost or
cost
   Gross
unrealized
gains
   Gross
unrealized
losses
    Estimated
fair value

Fixed maturities:

          

U.S. government, agencies and government sponsored entities

   $ 777    $ 32    $ (4 )   $ 805

Tax exempt

     2,797      97      (4 )     2,890

Government—non U.S.  

     1,736      74      (4 )     1,806

U.S. corporate

     25,378      975      (231 )     26,122

Corporate—non U.S.  

     9,168      306      (84 )     9,390

Mortgage and asset-backed

     12,926      140      (142 )     12,924
                            

Total fixed maturities

     52,782      1,624      (469 )     53,937

Equity securities

     173      36      (3 )     206
                            

Total available-for-sale securities

   $ 52,955    $ 1,660    $ (472 )   $ 54,143
                            

Included in other invested assets are certain securities that are designated as trading and, accordingly, are held at fair value with changes in fair value included in net investment gains (losses) in the condensed consolidated statement of earnings. As of June 30, 2006 and December 31, 2005, the fair value of the trading portfolio was $31 million and $15 million, respectively.

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

The following table presents the gross unrealized losses and estimated fair values of our investment securities, aggregated by investment type and length of time that individual investment securities have been in a continuous unrealized loss position, as of June 30, 2006:

 

     Less Than 12 Months    12 Months or more

(Dollar amounts in millions)

   Estimated
fair value
   Gross
unrealized
losses
    # of
securities
   Estimated
fair value
   Gross
unrealized
losses
    # of
securities

Description of Securities

               

Fixed maturities:

               

U.S. government, agencies and government sponsored entities

   $ 325    $ (14 )   82    $ 86    $ (3 )   17

Tax exempt

     868      (12 )   204      146      (4 )   49

Government—non U.S.  

     1,017      (23 )   186      29      (1 )   8

U.S. corporate

     12,575      (618 )   1,184      2,670      (157 )   323

Corporate—non U.S.  

     5,584      (203 )   678      1,101      (67 )   115

Mortgage and asset backed

     6,129      (193 )   680      1,848      (79 )   296
                                       

Subtotal, fixed maturities

     26,498      (1,063 )   3,014      5,880      (311 )   808

Equity securities

     —        —       —        27      (3 )   13
                                       

Total temporarily impaired securities

   $ 26,498    $ (1,063 )   3,014    $ 5,907    $ (314 )   821
                                       

% Below cost—fixed maturities:

               

<20% Below cost

   $ 26,466    $ (1,050 )   3,008    $ 5,820    $ (290 )   794

20-50% Below cost

     31      (11 )   3      59      (20 )   13

>50% Below cost

     1      (2 )   3      1      (1 )   1
                                       

Total fixed maturities

     26,498      (1,063 )   3,014      5,880      (311 )   808
                                       

% Below cost—equity securities:

               

<20% Below cost

     —        —       —        27      (3 )   13

20-50% Below cost

     —        —       —        —        —       —  

>50% Below cost

     —        —       —        —        —       —  
                                       

Total equity securities

     —        —       —        27      (3 )   13
                                       

Total temporarily impaired securities

   $ 26,498    $ (1,063 )   3,014    $ 5,907    $ (314 )   821
                                       

Investment grade

   $ 25,148    $ (1,006 )   2,716    $ 5,414    $ (274 )   721

Below investment grade

     1,321      (56 )   295      482      (38 )   90

Not Rated—Fixed maturities

     29      (1 )   3      —        —       —  

Not Rated—Equities

     —        —       —        11      (2 )   10
                                       

Total temporarily impaired securities

   $ 26,498    $ (1,063 )   3,014    $ 5,907    $ (314 )   821
                                       

The investment securities in an unrealized loss position as of June 30, 2006 consisted of 3,835 securities accounting for unrealized losses of $1.4 billion. Of these unrealized losses 93% were investment grade (rated AAA through BBB-) and 98% were less than 20% below cost. The amount of the unrealized loss on these securities was primarily attributable to increases in interest rates.

Of the investment securities in an unrealized loss position for twelve months or more as of June 30, 2006, 14 securities were 20% or more below cost, including 8 securities which were also below investment grade

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

(rated BB+ and below). These 8 securities accounted for unrealized losses of $8 million. These securities consisted of four issuers primarily in the automotive and airline industries and were current on all terms. All airline securities were collateralized by commercial jet aircraft associated with one domestic airline. We believe these airline security holdings were in a temporary loss position as a result of ongoing negative market reaction to difficulties in the commercial airline industry. The unrealized loss on the automotive investments was primarily caused by deteriorating market share and legacy issues. The automotive issuer continues to maintain significant liquidity relative to its maturity and we currently expect to collect full principal and interest.

As of June 30, 2006, we expected these investments to continue to perform in accordance with their original contractual terms and we generally have the ability and intent to hold these investment securities until the recovery of the fair value up to the cost of the investment, which may be maturity. Accordingly, we do not consider these investments to be other-than-temporarily impaired at June 30, 2006. However, from time to time, we may sell securities in the ordinary course of managing our portfolio to meet diversification, credit quality, yield enhancement, asset-liability management and liquidity requirements.

The following table sets forth our positions in derivative instruments and the estimated fair values as of the dates indicated. The fair value of derivative instruments, including financial futures, interest rate and foreign currency swaps, foreign currency forward contracts and equity index options, are based upon quotations obtained from dealers or other reliable sources.

 

     June 30, 2006    December 31, 2005

(Amounts in millions)

   Notional
value
   Estimated
fair value
   Notional
value
   Estimated
fair value

Interest rate swaps

   $ 11,795    $ 222    $ 7,894    $ 508

Foreign currency swaps

     533      15      533      4

Equity index options

     223      20      265      21

Financial futures

     9      —        27      —  
                           

Total

   $ 12,560    $ 257    $ 8,719    $ 533
                           

As of June 30, 2006 and December 31, 2005, the fair value of derivatives in a gain position and recorded in other invested assets was $286 million and $559 million, respectively, and the fair value of derivatives in a loss position and recorded in other liabilities was $29 million and $26 million, respectively.

(5) Acquisitions

On May 1, 2006, we completed the acquisition of Continental Life Insurance Company of Brentwood, Tennessee (“Continental Life”), for $145 million, plus contingent consideration of $5 million per year for two years based on attaining certain sales production thresholds. Continental Life’s business provides primarily Medicare supplement insurance and is a part of our Protection segment. This acquisition was accounted for as a purchase business combination. The excess purchase price over the estimated fair value of the net assets acquired of $29 million has been recorded as goodwill. In addition, $93 million of present value of future profits was recorded in connection with this transaction. The results of operations of Continental Life have been included in our consolidated results beginning May 1, 2006. We have reflected our initial allocation of the purchase price based on estimated fair value according to preliminary valuations. Such estimated values may change as additional information is obtained and the valuation is finalized.

On June 29, 2006, we agreed to acquire AssetMark Investment Services Inc. (“AssetMark”) of Pleasant Hill, California, for approximately $230 million. AssetMark is an investment management and adviser company with

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

more than $8 billion in third-party assets under management. Under terms of the agreement, we may pay additional performance-based payments of up to $100 million over three to five years. This transaction is expected to close in the third or fourth quarter of 2006.

On July 3, 2006, we completed the acquisition of Vero Lenders Mortgage Insurance Limited (“Vero LMI”), a subsidiary of Vero Insurance Limited, which is wholly owned by Promina Group Limited of Sydney, Australia, for approximately $80 million, net of a post-closing dividend. Vero LMI consists solely of a run-off mortgage insurance block. This transaction will be recorded in the third quarter of 2006.

(6) Stock-Based Compensation

On January 1, 2006, we adopted SFAS No. 123R under the modified prospective transition method. The statement requires the measurement and recognition of compensation expense for all share-based awards made to employees and directors, including stock options, stock appreciation rights (“SARs”), restricted stock units (“RSUs”) and deferred stock units (“DSUs”) under the 2004 Genworth Financial, Inc. Omnibus Incentive Plan (“Omnibus Incentive Plan”). We previously accounted for these awards under the fair value expense provisions of SFAS No. 123. Accordingly, on January 1, 2006, we recognized a $4 million after-tax increase to earnings related to our cumulative effect of adopting SFAS No. 123R.

We have recorded stock-based compensation expense related to the estimated value of the RSUs, DSUs, SARs and stock options for the periods presented:

 

    

Three months ended

June 30,

  

Six months ended

June 30,

(Amounts in millions)

     2006        2005        2006        2005  

Stock-based compensation

   $ 12    $ 12    $ 24    $ 22
                           

For awards issued prior to January 1, 2006, stock-based compensation expense is recognized on a graded vesting attribution method over the awards’ respective vesting schedule. For awards issued after January 1, 2006, stock-based compensation expense is recognized evenly on a straight-line attribution method over the awards’ respective vesting period.

For purposes of determining the estimated fair value of stock-based payment awards on the date of grant we use the Black-Scholes Model. The Black-Scholes Model requires the input of certain assumptions that involve judgment. Management will continue to assess the assumptions and methodologies used to calculate estimated fair value of share-based compensation. Circumstances may change and additional data may become available over time, which could result in changes to these assumptions and methodologies.

The following table contains the stock option weighted-average grant-date fair value information for June 30, 2006 and 2005. Fair value is estimated using the Black-Scholes Model.

 

     June 30, 2006     June 30, 2005  

Estimated fair value per option

   $ 11.50     $ 9.63  

Valuation Assumptions:

    

Expected term (years)

     6       6  

Expected volatility

     28.0 %     33.3 %

Expected dividend yield

     0.9 %     1.1 %

Risk-free interest rate

     5.0 %     4.0 %

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

Under the Omnibus Incentive Plan, we are authorized to grant 38 million equity awards.

For the three months ended June 30, 2006 and 2005, we granted 24,000 and 25,839 stock options with exercise prices ranging from $32.45 to $33.46, and $27.78 to $29.90, respectively, which equaled the closing market prices on the date of grant and have an exercise term of 10 years. The stock options will vest in 20% annual increments commencing on the first anniversary of the date of grant. Additionally, during the three months ended June 30, 2006 and 2005 we issued 6,000 and 20,122 RSUs with restriction periods ranging from 3 to 5 years and a fair value of $32.45, and $27.96, respectively, which is measured at the market price of a share of our nonrestricted stock on the grant date. There were no SARs granted during these periods.

For the six months ended June 30, 2006 and 2005, we granted 24,000 and 111,663 stock options with exercise prices ranging from $32.45 to $33.46 and $26.68 to $29.90, respectively, which equaled the closing market prices on the date of grant and have an exercise term of 10 years. The stock options will vest in 20% annual increments commencing on the first anniversary of the date of grant. Additionally, during the six months ended June 30, 2006 and 2005 we issued 6,000 and 326,964 RSUs with restriction periods ranging from 3 to 5 years and a fair value of $32.45 and $27.07, respectively, which is measured at the market price of a share of our nonrestricted stock on the grant date. There were no SARs granted during these periods. There were 14,308,206 and 14,547,263 stock options, 1,829,149 and 1,397,239 RSUs and 6,393,713 and 6,255,213 SARs outstanding as of June 30, 2006 and 2005, respectively.

A summary of stock option activity as of June 30, 2006, and changes during the six months then ended is presented below:

 

     Shares subject to
option
    Weighted average
exercise price

Balance as of January 1, 2006

   15,770,646     $ 21.93

Granted

   24,000     $ 32.79

Exercised

   (1,127,876 )   $ 19.47

Forfeited

   (358,564 )   $ 21.34

Expired

   —      
        

Balance as of June 30, 2006

   14,308,206     $ 22.16
        

Exercisable as of June 30, 2006

   4,688,323     $ 23.03
        

A summary of the status of our other equity-based awards as of June 30, 2006 and the changes during the six months then ended is presented below:

 

    Restricted stock units
(RSUs)
  Deferred stock units
(DSUs)
  Stock appreciation rights
(SARs)
    Number of
awards
    Weighted
average grant
date fair value
  Number of
awards
  Weighted
average fair value
  Number of
awards
    Weighted
average grant
date fair value

Balance as of January 1, 2006

  1,879,761     $ 24.74   16,868   $ 32.12   6,883,713     $ 7.02

Granted

  6,000     $ 32.45   8,148   $ 31.90   —      

Exercised

  (67 )   $ 32.10   —       (240,000 )   $ 6.65

Terminated

  (56,545 )   $ 27.10   —       (250,000 )   $ 6.65
                     

Balance as of June 30, 2006

  1,829,149     $ 24.70   25,016   $ 31.88   6,393,713     $ 7.01
                     

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

As of June 30, 2006, there was $71 million of total unrecognized stock-based compensation expense related to non-vested awards not yet recognized. This expense is expected to be recognized over a weighted average period of two years.

Cash received from stock options exercised for the six months ending June 30, 2006, was $20 million. New shares were issued to settle all exercised awards. The actual tax benefit realized for the tax deductions from stock option exercises was $6 million both for the three and six months ended June 30, 2006, respectively.

The following table summarizes information about stock options outstanding as of June 30, 2006:

 

     Outstanding    Exercisable

Exercise price range

   Shares in
thousands
   Average
life(1)
   Average
exercise
price
   Shares in
thousands
   Average
exercise
price

$14.11 – $18.51

   1,489,570    6.20    $ 17.28    734,395    $ 17.28

$19.45 – $22.67

   9,210,584    7.67      19.77    2,131,347      20.01

$23.20 – $27.95

   1,558,010    4.60      26.99    1,456,277      27.08

$28.00 – $36.62

   2,049,081    8.21      32.75    365,343      36.00

$37.89 – $39.60

   961    5.07      38.77    961      38.77
                            
   14,308,206    7.26    $ 22.16    4,688,323    $ 23.03
                  

(1) Average contractual life remaining in years

(7) Commitments and Contingencies

(a) Litigation

We face a significant risk of litigation and regulatory investigations and actions in the ordinary course of operating our businesses, including class action lawsuits. Our pending legal and regulatory actions include proceedings specific to us and others generally applicable to business practices in the industries in which we operate. Plaintiffs in class action and other lawsuits against us may seek very large or indeterminate amounts, including punitive and treble damages, which may remain unknown for substantial periods of time. A substantial legal liability or a significant regulatory action against us could have an adverse effect on our financial condition and results of operations. Moreover, even if we ultimately prevail in the litigation, regulatory action or investigation, we could suffer significant reputational harm, which could have an adverse effect on our business, financial condition or results of operations.

(b) Commitments

As of June 30, 2006, we were committed to fund $318 million in U.S. commercial mortgage loans and $168 million in limited partnerships.

During the second quarter of 2006, we agreed to acquire Vero LMI and AssetMark, as further described in note 5 of these condensed consolidated financial statements.

(8) Borrowings

Commercial Paper Facility

In March 2006, we issued $229 million of commercial paper and we used the proceeds from this issuance to finance a stock repurchase from GEFAHI concurrently with its secondary offering. The notes under the

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

commercial paper program are offered pursuant to an exemption from registration under the Securities Act of 1933 and may have a maturity of up to 364 days from the date of issue. During the second quarter, we reduced the outstanding balance of our commercial paper by $85 million. As of June 30, 2006 and December 31, 2005, the weighted average interest rate on commercial paper outstanding was 5.17% and 3.29%, respectively, and the weighted average maturity was 30 and 53 days, respectively.

Revolving Credit Facilities

On May 25, 2006 we entered into a $1.0 billion five-year revolving credit facility, which matures in May 2011, replacing our $1.0 billion five-year revolving credit facility, which was scheduled to mature in May 2009. We also have a $1.0 billion revolving credit facility that matures in April 2010. These facilities bear variable interest rates based on a one-month LIBOR plus a margin. As of June 30, 2006, we utilized $170 million of the commitment under these facilities for the issuance of a letter of credit for the benefit of one of our Mortgage Insurance subsidiaries.

Non-recourse Funding Obligations

On January 20, 2006, River Lake Insurance Company III (“River Lake III”), a special purpose financial captive insurance company wholly owned by First Colony Life Insurance Company (“First Colony”), itself an indirect wholly owned subsidiary of Genworth, issued $750 million in aggregate principal amount of floating rate surplus notes due 2036 (the “Notes”). River Lake III has received regulatory approval to issue additional series of its floating rate surplus notes up to an aggregate amount of $1.2 billion (including the Notes), but is under no obligation to do so.

The Notes are direct financial obligations of River Lake III and are not guaranteed by First Colony or Genworth. The Notes were issued by River Lake III to fund statutory reserves required by the Valuation of Life Insurance Policies Regulation. River Lake III has reinsured on a coinsurance basis from First Colony certain term life insurance policies having guaranteed level premiums. The Notes were sold to a third-party for deposit into certain Delaware trusts that have issued money market and term securities. The principal and interest payments due on the money market and term securities were insured by a third party insurance company. The holders of the Notes cannot require repayment from Genworth or any of its subsidiaries, other than River Lake III, the direct issuer of the Notes. First Colony has agreed to indemnify River Lake III and the third party insurer for certain limited costs.

River Lake III will pay interest on the principal amount of the Notes on a monthly basis, subject to regulatory approval. Any payment of principal, including by redemption, or interest on the Notes may only be made with the prior approval of the Director of Insurance of the State of South Carolina in accordance with the terms of its licensing order and in accordance with applicable law. The holders of the Notes have no rights to accelerate payment of principal of the Notes under any circumstances, including without limitation, for nonpayment or breach of any covenant. River Lake III reserves the right to repay the Notes at any time, subject to the terms of the Notes and prior regulatory approval.

As of June 30, 2006 and December 31, 2005, the weighted average interest rate on our non-recourse funding obligations was 5.34% and 4.50%, respectively. The non-recourse funding obligations bear variable interest rates, carrying value approximates fair value as of June 30, 2006.

(9) Securitization Entities

GE Capital, our former indirect majority stockholder, provides credit and liquidity support to a funding conduit it sponsored, which exposes it to a majority of the risks and rewards of the conduit’s activities and

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

therefore makes GE Capital the primary beneficiary of the funding conduit. Upon adoption of FIN No. 46, Consolidation of Variable Interest Entities, GE Capital was required to consolidate the funding conduit because of this financial support. As a result, assets and liabilities of certain previously off-balance sheet securitization entities, for which we were the transferor, were required to be included in our condensed consolidated financial statements because the funding conduit no longer qualified as a third-party. Because these securitization entities lost their qualifying status, we were required to recognize $1.2 billion of securitized assets and $1.1 billion of associated liabilities in our condensed consolidated statement of financial position in July 2003. The assets and liabilities associated with these securitization entities have been reported in the corresponding financial statement captions in our condensed consolidated statement of financial position, and the assets are noted as restricted due to the lack of legal control we have over them. We apply the same accounting policies to these restricted assets and liabilities as we do to our unrestricted assets and liabilities.

As a result of GE Capital no longer having an ownership interest in us in March 2006, the respective funding conduit re-qualified as a third-party and these securitization entities regained their qualifying status under SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities. As a result, the assets were effectively re-securitized and the related assets and liabilities were derecognized from our condensed consolidated financial statements. This resulted in a reduction from December 31, 2005 balances of $685 million, $44 million, $660 million and $15 million of restricted investments held by securitization entities, other assets, borrowings related to securitization entities and other liabilities, respectively. We continue to hold a retained interest in the form of interest-only strips classified as fixed maturity securities available-for-sale on our condensed consolidated statements of financial position. We recognized an investment loss on sale of $11 million, net of tax, from this re-securitization transaction.

(10) Operating Segment Information

We conduct our operations in four business segments: (1) Protection, which includes our life insurance, long-term care insurance, Medicare supplement insurance, group life and health insurance and payment protection insurance; (2) Retirement Income and Investments, which includes our fixed annuities, individual and group variable annuities and single premium immediate annuities, variable life insurance, asset management and specialized products, including GICs, funding agreements, FABNs and structured settlements; (3) Mortgage Insurance, which includes our mortgage insurance products that facilitate homeownership by enabling borrowers to buy homes with low-down-payment mortgages; and (4) Corporate and Other, which includes interest and other debt financing expenses and other corporate income and expenses not allocated to the segments, as well as the results of a small, non-core business managed outside our operating segments.

In 2006, we began to allocate net investment gains (losses) from our Corporate and Other segment to our Protection (except payment protection insurance) and Retirement Income and Investments segments using an approach based principally upon the investment portfolio established to support each of those segments’ products and targeted capital levels. We do not allocate net investment gains (losses) from our Corporate and Other segment to our Mortgage Insurance segment or to our payment protection insurance business within the Protection segment, because they have their own separate investment portfolios, and net investment gains (losses) from those portfolios are reflected in the Mortgage Insurance and Protection segment results, respectively.

Prior to 2006, all net investment gains (losses) were recorded in the Corporate and Other segment and were not reflected in the results of any of our other segments.

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

Effective January 1, 2006, GE Seguros (“Seguros”), a small Mexican-domiciled multi-line insurer, previously included in our Corporate and Other segment, is being managed within our Protection segment and whose results are now included as part of the payment protection insurance business. Segment information related to the Seguros move is reflected in all periods presented.

We use the same accounting policies and procedures to measure segment net operating earnings and assets as our consolidated net earnings and assets. Segment net operating earnings represent the basis on which the performance of our business is assessed by management. Segment net operating earnings exclude after-tax net investment gains (losses) (which can fluctuate significantly from period to period), and other adjustments, changes in accounting principles and infrequent or unusual non-operating items. There were no non-recurring, infrequent or unusual items excluded from net operating earnings for the periods presented.

The following is a summary of revenues, segment net operating earnings and reconciliation to total company net earnings for the periods presented:

 

     Three months ended
June 30,
   

Six months ended

June 30,

 

(Amounts in millions)

       2006             2005             2006             2005      

Revenues

        

Protection

   $ 1,639     $ 1,531     $ 3,191     $ 3,073  

Retirement Income and Investments

     726       735       1,439       1,470  

Mortgage Insurance

     364       300       699       594  

Corporate and Other

     25       44       50       84  
                                

Total revenues

   $ 2,754     $ 2,610     $ 5,379     $ 5,221  
                                

Segment net operating earnings (losses)

        

Protection

   $ 151     $ 133     $ 300     $ 272  

Retirement Income and Investments

     57       60       118       120  

Mortgage Insurance

     162       121       311       262  

Corporate and Other

     (31 )     (29 )     (45 )     (43 )
                                

Total segment net operating earnings

     339       285       684       611  

Net investment gains (losses), net of taxes and other adjustments

     (22 )     —         (37 )     (4 )
                                

Net earnings before accounting change

     317       285       647       607  

Cumulative effect of accounting change, net of taxes

     —         —         4       —    
                                

Net earnings

   $ 317     $ 285     $ 651     $ 607  
                                

The following is a summary of total assets by operating segment as of:

 

(Amounts in millions)

   June 30,
2006
   December 31,
2005

Assets

     

Protection

   $ 35,598    $ 33,945

Retirement Income and Investments

     57,749      58,281

Mortgage Insurance

     7,580      7,118

Corporate and Other

     2,719      6,310
             

Total assets

   $ 103,646    $ 105,654
             

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

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 interest rate fluctuations, downturns and volatility in equity markets, defaults in portfolio securities, downgrades in our financial strength and credit ratings, insufficiency of reserves, legal constraints on dividend distributions by subsidiaries, illiquidity of investments, competition, inability to attract or retain independent sales intermediaries and dedicated sales specialists, availability and adequacy of reinsurance, defaults by counterparties, foreign exchange rate fluctuations, regulatory restrictions on our operations and changes in applicable laws and regulations, legal or regulatory investigations or actions, political or economic instability, the failure or any compromise of the security of our computer systems and the occurrence of natural or man-made disasters or a pandemic disease;

 

    Risks relating to our Protection and Retirement Income and Investments segments, including unexpected changes in morbidity, mortality and unemployment rates, accelerated amortization of deferred acquisition costs and present value of future profits, goodwill impairments, reputational risks if we were to raise premiums on in-force long-term care insurance products, medical advances such as genetic mapping research, unexpected changes in persistency rates, increases in statutory reserve requirements, the failure of demand for long-term care insurance to increase as we expect and changes in tax and securities laws;

 

    Risks relating to our Mortgage Insurance segment, including the influence of Fannie Mae, Freddie Mac and a small number of large mortgage lenders and investors, increased regulatory scrutiny of Fannie Mae and Freddie Mac resulting in possible regulatory changes, decreases in the volume of high loan-to-value mortgage originations or increases in mortgage insurance cancellations, increases in the use of simultaneous second mortgages and other alternatives to private mortgage insurance and reductions by lenders in the level of coverage they select, unexpected increases in mortgage insurance default rates or severity of defaults, deterioration in economic conditions, insufficiency of premium rates to compensate us for risks associated with mortgage loans bearing high loan-to-value ratios, increases in the use of captive reinsurance or other risk sharing structures in the mortgage insurance market, changes in the demand for mortgage insurance that could arise as a result of efforts of large mortgage investors, legal or regulatory actions or investigations under applicable laws and regulations, including the Real Estate Settlement Practices Act and the Federal Fair Credit Reporting Act, competition with government-owned and government-sponsored entities, potential liabilities in connection with contract underwriting services and growth in the global mortgage insurance market that is lower than we expect; and

 

   

Risks relating to our separation from GE, including the loss of benefits associated with GE’s brand and reputation, our need to establish the new Genworth brand identity quickly and effectively, the possibility that we will not be able to replace services previously provided by GE on terms that are at least as favorable, the possibility that in certain circumstances we will be obligated to make payments to GE

 

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under our tax matters agreement even if our corresponding tax savings either are delayed or never materialize, the possibility that in the event of a change in control of our company we would have insufficient funds to meet accelerated obligations under the tax matters agreement, the possibility that certain service agreements with GE are not extended on favorable terms, and the significance of our distribution relationship with GE in our payment protection insurance business.

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 insurance company in the U.S., with an expanding international presence. We have three operating segments: Protection, Retirement Income and Investments, and Mortgage Insurance.

 

    Protection. We offer U.S. customers life, long-term care and Medicare supplement insurance and, primarily for companies with fewer than 1,000 employees, group life and health insurance. Through our European operations, we offer payment protection insurance, which helps consumers meet their payment obligations in the event of illness, involuntary unemployment, disability or death. Effective January 1, 2006, GE Seguros (“Seguros”), a small Mexican-domiciled multi-line insurer, previously included in our Corporate and Other segment, is being managed within our Protection segment and whose results are now included as part of the payment protection insurance business. For the three months ended June 30, 2006 and 2005, our Protection segment had segment net operating earnings of $151 million and $133 million, respectively. For the six months ended June 30, 2006 and 2005, our Protection segment had segment net operating earnings of $300 million and $272 million, respectively.

 

    Retirement Income and Investments. We offer U.S. customers fixed annuities, individual and group variable annuities, single premium immediate annuities, variable life insurance, asset management and specialized products, including guaranteed investment contracts (“GICs”), funding agreements, funding agreements backing notes (“FABNs”) and structured settlements. For the three months ended June 30, 2006 and 2005, our Retirement Income and Investments segment had segment net operating earnings of $57 million and $60 million, respectively. For the six months ended June 30, 2006 and 2005, our Retirement Income and Investments segment had segment net operating earnings of $118 million and $120 million, respectively.

 

    Mortgage Insurance. In the U.S., Canada, Australia, Europe, New Zealand, Mexico and Japan, we offer mortgage insurance products that facilitate homeownership by enabling borrowers to buy homes with low-down-payment mortgages. For the three months ended June 30, 2006 and 2005, our Mortgage Insurance segment had segment net operating earnings of $162 million and $121 million, respectively. For the six months ended June 30, 2006 and 2005, our Mortgage Insurance segment had segment net operating earnings of $311 million and $262 million, respectively.

We also have a Corporate and Other segment, which consists primarily of unallocated corporate income and expenses, the results of a small, non-core business that is managed outside our operating segments, and most of our interest and other financing expenses. For the three months ended June 30, 2006 and 2005, our Corporate and Other segment had segment net operating losses of $31 million and $29 million, respectively. For the six months ended June 30, 2006 and 2005, our Corporate and Other segment had segment net operating losses of $45 million and $43 million, respectively.

Our financial information

The financial information presented herein has been derived from our condensed consolidated financial statements.

 

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Revenues and expenses

Our revenues consist primarily of the following:

 

    Protection. The revenues in our Protection segment consist primarily of:

 

    net premiums earned on individual life, individual long-term care, group life and health, and payment protection insurance policies;

 

    net investment income and net investment gains (losses) on the separate investment portfolio held by our payment protection insurance business, and net investment income and net investment gains (losses) allocated to this segment’s other lines of business; and

 

    policy fees and other income, including fees for mortality and surrender charges primarily from universal life insurance policies, and other administrative charges.

 

    Retirement Income and Investments. The revenues in our Retirement Income and Investments segment consist primarily of:

 

    net premiums earned on single premium immediate annuities and structured settlements with life contingencies;

 

    net investment income and net investment gains (losses) allocated to this segment; and

 

    policy fees and other income, including surrender charges, mortality and expense charges, investment management fees and commissions.

 

    Mortgage Insurance. The revenues in our Mortgage Insurance segment consist primarily of:

 

    net premiums earned on mortgage insurance policies;

 

    net investment income and net investment gains (losses) on the segment’s separate investment portfolio; and

 

    policy fees and other income, including fees from contract underwriting services.

 

    Corporate and Other. The revenues in our Corporate and Other segment consist primarily of:

 

    net premiums, policy fees and other income from a small non-core insurance business in this segment; and

 

    unallocated net investment income and net investment gains (losses).

In 2006, we began to allocate net investment gains (losses) from our Corporate and Other segment to our Protection (except payment protection insurance) and Retirement Income and Investments segments using an approach based principally upon the investment portfolios established to support each of those segments’ products and targeted capital levels. We do not allocate net investment gains (losses) from our Corporate and Other segment to our Mortgage Insurance segment or to our payment protection insurance business within the Protection segment because they have their own separate investment portfolios, and net investment gains (losses) from those portfolios are reflected in the Mortgage Insurance and Protection segment results, respectively.

Prior to 2006, all net investment gains (losses) were recorded in the Corporate and Other segment and were not reflected in the results of any of our other segments.

Our expenses consist primarily of the following:

 

    benefits provided to policyholders and contractholders and changes in reserves;

 

    interest credited on general account balances;

 

    operating expenses, including commissions, marketing expenses, policy and contract servicing costs, overhead and other general expenses that are not capitalized (shown net of deferrals);

 

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    amortization of deferred policy acquisition costs and other intangible assets;

 

    interest and other financing expenses; and

 

    income taxes.

We allocate corporate expenses to each of our operating segments based on the amount of capital allocated to that segment.

Critical accounting policies

The accounting policies discussed in this section are those that we consider to be particularly critical to an understanding of our condensed consolidated financial statements because their application places the most significant demands on our ability to judge the effect of inherently uncertain matters on our financial results. These policies relate to valuation of investment securities and impairment of investment securities, deferred acquisition costs (“DAC”), present value of future profits (“PVFP”), valuation of goodwill, reserves, unearned premiums, derivatives, and contingent liabilities. For a discussion of each of these policies, please see the discussion entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Overview—Critical Accounting Policies” contained in our 2005 Annual Report on Form 10-K. For all of these policies, we caution that future events rarely develop exactly as forecast, and our management’s best estimates may require adjustment.

Recent business trends and conditions

The following business trends and conditions have had a significant impact on our products during the periods covered by this report:

Life insurance. Results in our life insurance business are impacted by sales, mortality, persistency, investment yields, and the effective use of capital. Additionally, sales of new products are dependent on competitive product features and pricing, distribution expansion and penetration, and consistent customer service. Regulation XXX requires insurers to establish additional statutory reserves for term and universal life insurance policies with long-term premium guarantees, which increases the capital required to write these products. For term life insurance, we have implemented capital management actions that improve our new business returns and have enabled us to decrease our premium rates. Recently, several competitors have executed similar capital management actions and lowered their term prices, which could make the market more competitive and affect sales levels over time. In addition, an October 2005 revision to actuarial guidelines for Regulation XXX, effective for universal life policies issued since July 1, 2005, may increase the reserves of certain companies on a statutory basis. Reserves for our universal life policies already meet the requirements of this guideline, so we expect that it will not have an impact on our capital requirements. However, we continue to work towards the execution of a capital management strategy for our universal life business which could result in the issuance of additional non-recourse funding obligations.

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. Industry-wide first-year annualized premiums of individual long-term care insurance decreased approximately 10% for the three months ended March 31, 2006 compared to the three months ended March 31, 2005 according to the most recently published data by LIMRA International. Our sales growth in a challenging market reflects the breadth of our distribution and progress across multiple growth initiatives with an emphasis on broadening our product offerings. However, slower than anticipated sales growth, the continued low interest rate environment and the impact of lower termination rates on older issued policies, some with expiring reinsurance coverage, could result in lower net operating earnings. In response to these trends, we will continue to pursue multiple growth initiatives, continue investing in claims process improvements, execute investment strategies and, if appropriate, consider rate increases to improve loss ratios. In addition, we recently completed the acquisition of Continental Life Insurance Company of Brentwood, Tennessee, a provider of Medicare supplement insurance, for approximately

 

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$145 million. This acquisition enhances our presence in the senior supplemental insurance market by more than doubling our existing annualized premiums for this product and giving us access to approximately 4,200 independent agents.

Payment protection insurance. Growth of our payment protection insurance business is dependent on economic conditions including consumer lending levels, client account penetration and the number of countries and markets we enter. Additionally, the types and mix of our products will vary based on regulatory and consumer acceptance of our products. Our payment protection insurance business continues to show strong growth from increased penetration of existing relationships, and the addition of new distribution relationships in existing new countries and across our markets.

Retirement products. Retirement Income and Investments segment results are affected by investment performance, net interest spreads, equity market fluctuations and the impact of new product sales and lapses. In addition, our competitive position within many of our distribution channels, as well as our ability to retain business, depends significantly upon product features, including current and minimum crediting rates on spread-based products relative to our competitors, surrender charge periods in fixed annuities as well as guaranteed features we offer in variable products. We continually evaluate our competitive position based upon each of those features, and we make adjustments as appropriate to meet our target return thresholds. The attractiveness of certain fixed annuities has declined as a result of continued low long-term interest rates, a relatively flat yield curve and short term investment alternatives, such as certificates of deposit. These trends are having an adverse impact on both sales and retention of fixed annuities. In recent quarters, we have experienced improved spreads in fixed annuities primarily due to run-off of and crediting rate resets of historically higher crediting rate business. We expect this trend to continue.

We have focused on our Income Distribution Series of variable annuity products and riders. We have witnessed a decline in defined benefit retirement plans in favor of defined contribution plans with more of the responsibility for retirement income planning falling on the individual. Additionally, U.S. savings rates are at historical lows. We believe these factors support demand for individual and group products that provide various forms of guaranteed benefits with the opportunity to realize market performance upside. Our Income Distribution Series provides the contractholder with the ability to receive a guaranteed minimum income stream that they cannot outlive, along with an opportunity to participate in market appreciation. However, through various techniques, these products are designed to reduce some of our risks that generally accompany traditional products with guaranteed living benefits. We are targeting individuals who are focused on building a personal portable retirement plan or are moving from the accumulation to the distribution phase of their retirement planning.

We offer asset management products to individual investors and back office support for independent broker dealers. The industry is witnessing rapid increases of independent broker dealers as registered representatives are leaving large national firms to form their own small firms. These new small firms need back office support and access to technology. Further, individuals are increasingly transferring their money to managed products from mutual funds. We expect these trends to continue and possibly accelerate in the future. As a result of these trends, we are expanding our presence in this market and have announced the acquisition of AssetMark Investment Services, Inc., a leading provider of open architecture asset management solutions to independent financial advisors, with more than $8 billion in assets under management. Our products consist of separately managed accounts and managed mutual fund accounts. We receive a management fee based upon the amount of assets under management. The results of our asset management business are a function of net flows and investment performance of assets under management, which are influenced by the relative performance of our product’s underlying investments and the overall equity market environment.

 

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Mortgage insurance. The results of our Mortgage Insurance segment are affected by employment and other economic and housing markets trends, including mortgage origination volume, interest rate trends, home price appreciation and levels of mortgage delinquencies (including seasonal effects). In addition, movements in foreign currency exchange rates affect our international mortgage insurance results.

In the U.S., the demand for flow private mortgage insurance declined in the first quarter of 2006 as compared to the same period in 2005, according to data published by Inside Mortgage Finance. We believe this was driven principally by the significant use of simultaneous second mortgages as an alternative to private mortgage insurance, the origination of mortgages that did not meet the eligibility requirements of Fannie Mae and Freddie Mac and mortgages that were securitized in mortgage-backed securities that did not use private mortgage insurance.

In the U.S., the bulk mortgage insurance market is increasing as a percentage of the overall primary mortgage insurance market, which we believe is driven in part, by an increase in non-prime mortgage-backed security issuances. We have increased our participation in the bulk market and continue to evaluate additional opportunities this market presents.

The recent rise in interest rates and lower home price appreciation in the U.S. have contributed to rising persistency rates. Our U.S. flow persistency was 72% and 65% for the six months ended June 30, 2006 and June 30, 2005, respectively. We believe that sustained higher interest rates and increased persistency will lead to stable to growing levels of insurance in-force. Primary insurance in-force increased from $100 billion as of March 31, 2006 to $102 billion as of June 30, 2006. This increase in primary insurance-in-force reflected a sequential increase in flow insurance in-force for the first time in nearly five years.

Our international mortgage insurance business has continued to expand with favorable operating results. We expect that the growth of our established international mortgage insurance business and our entry into new international markets will continue to contribute an increasing portion of this segment’s total revenues and profits.

The Canadian government expanded its authority to guarantee mortgage insurance to cover any approved mortgage insurer in addition to us. The overall cap on guaranteed policies was also increased to CDN $200 billion and the government was given latitude to change the cap without further legislation. These changes facilitate our ongoing ability to offer mortgage insurance products under the guarantee but may also enable potential new competitors to do the same.

As a result of the significant U.S. refinancing activity since 2002 and the expansion of our international business in recent years, as of June 30, 2006, approximately 66% of our U.S. risk in-force and 67% of our international risk in-force have not yet reached its anticipated highest claim frequency years, which are generally between the third and seventh year of the loan. We expect our loss experience on these loans will increase as these books of business continue to mature.

See “—Results of Operations by Segment” and selected operating performance measures contained herein for additional discussion of business trends and conditions.

 

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Results of Operations

“Net operating earnings” is a non-GAAP financial measure that we define as net earnings, excluding after-tax net investment gains (losses) (which can fluctuate significantly from period to period), and other adjustments, changes in accounting principles and infrequent or unusual non-operating items. There were no non-recurring, infrequent or unusual items excluded from net operating earnings in the three and six months ended June 30, 2006 and 2005.

Management believes that analysis of “net operating earnings” enhances understanding and comparability of performance by highlighting underlying business activity and profitability drivers. However, “net operating earnings” should not be viewed as a substitute for net earnings in accordance with GAAP. In addition, our definition of “net operating earnings” may differ from the definitions used by other companies.

 

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Three Months Ended June 30, 2006 Compared to Three Months Ended June 30, 2005

The following table provides a reconciliation of net earnings to “net operating earnings” (as defined above) for the three months ended June 30, 2006 and 2005:

 

     Three months ended
June 30,
   Increase (decrease) and
percentage change
 

(Amounts in millions, except per share amounts)

       2006             2005                2006 vs. 2005          

Revenues:

         

Premiums

   $ 1,648     $ 1,614    $ 34     2 %

Net investment income

     953       842      111     13 %

Net investment gains (losses)

     (49 )     —        (49 )   NM (1)

Policy fees and other income

     202       154      48     31 %
                         

Total revenues

     2,754       2,610      144     6 %
                         

Benefits and expenses:

         

Benefits and other changes in policy reserves

     1,096       1,051      45     4 %

Interest credited

     378       347      31     9 %

Acquisition and operating expenses, net of deferrals

     521       523      (2 )   —   %

Amortization of deferred acquisition costs and intangibles

     207       208      (1 )   —   %

Interest expense

     88       69      19     28 %
                         

Total benefits and expenses

     2,290       2,198      92     4 %
                         

Net earnings before income taxes and accounting change

     464       412      52     13 %

Provision for income taxes

     147       127      20     16 %
                         

Net earnings before accounting change

     317       285      32     11 %

Cumulative effect of accounting change, net of taxes

     —         —        —       —   %
                         

Net earnings

     317       285      32     11 %

Adjustments to net earnings:

         

Net investment losses (gains), net of taxes and other adjustments

     22       —        22     NM (1)

Cumulative effect of accounting change, net of taxes

     —         —        —       —   %
                         

Net operating earnings

   $ 339     $ 285    $ 54     19 %
                         

Net earnings per common share:

         

Basic

   $ 0.70     $ 0.61     
                   

Diluted

   $ 0.68     $ 0.60     
                   

Net earnings before accounting change per common share:

         

Basic

   $ 0.70     $ 0.61     
                   

Diluted

   $ 0.68     $ 0.60     
                   

Net operating earnings per common share:

         

Basic

   $ 0.74     $ 0.61     
                   

Diluted

   $ 0.72     $ 0.60     
                   

Weighted-average common shares outstanding:

         

Basic

     455.8       470.4     
                   

Diluted

     468.3       477.4     
                   

(1) Not meaningful

 

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Premiums. Premiums consist primarily of premiums earned on insurance products for individual life, long-term care, Medicare supplement, group life and health, payment protection, single premium immediate annuities and structured settlements with life contingencies and mortgage insurance policies. Premiums increased $47 million in our Mortgage Insurance segment reflecting growth and aging of our international mortgage insurance in-force block. Additionally, our Protection segment increased $33 million primarily due to growth of our term life insurance in-force block and $27 million in our long-term care business from the Continental Life acquisition. Partially offsetting these increases in the Protection segment was a $30 million decrease from our payment protection business as a result of a decrease in the U.K. market and changes in foreign exchange rates. Our Retirement Income and Investments segment decreased $41 million attributable to a reduction in sales of our life-contingent structured settlement annuities.

Net investment income. Net investment income increased primarily as a result of an increase in average invested assets attributable to assets purchased using proceeds from our issuance of non-recourse funding obligations supporting certain term life insurance policies, growth of our long-term care in-force block and new production in institutional products. The increase in net investment income was also due to an increase in weighted average investment yields to 5.8% for the three months ended June 30, 2006 from 5.4% for the three months ended June 30, 2005. The increase in weighted average investment yields was primarily attributable to increased yields on floating rate investments. Net investment income for the three months ended June 30, 2006 included $35 million of investment income from a reduction in commercial mortgage loan loss reserves, bond calls, mortgage loan prepayments and limited partnership investments as compared to $9 million in investment income from bond calls, mortgage loan prepayments and limited partnership investments in the prior year.

Net investment gains (losses). For the three months ended June 30, 2006, gross investment gains were $8 million and gross investment (losses) were $57 million, including $4 million of impairments. Gross investment gains for the three months ended June 30, 2006 were attributable to $8 million in gains on the sale of available-for-sale fixed maturities and equity securities. Gross investment losses include $50 million of interest rate related losses as a result of the disposition of available-for-sale securities primarily from portfolio repositioning activities, a $4 million impairment charge related to an equity security and $2 million in connection with terminations and losses in fair value of non-qualified derivatives. Net investment losses on trading securities were $1 million for the three months ended June 30, 2006. For the three months ended June 30, 2005, gross investment gains on available-for-sale securities were $12 million and gross investment losses on available-for-sale securities were $12 million, including $3 million of impairments. The available-for-sale securities impairments related primarily to fixed maturity securities issued by companies in the consumer products and transportation industries ($1 million, and $1 million, respectively).

Policy fees and other income. Policy fees and other income consist primarily of cost of insurance and surrender charges assessed on universal life insurance policies, fees assessed against policyholder and contractholder account values, and commission income. The increase in policy fees and other income was primarily due to higher sales and growth in assets under management in Retirement Income and Investments’ fee-based products of $20 million as a result of distribution expansion, favorable equity markets, and continued product enhancements. In addition, our life insurance business increased $21 million primarily as a result of the growth of our universal life insurance in-force block.

Benefits and other changes in policy reserves. Benefits and other changes in policy reserves consist primarily of reserve activity related to current claims and future policy benefits on insurance and investment products for life, long-term care, Medicare supplement, group life and health, payment protection, structured settlements and single premium immediate annuities with life contingencies and claim costs incurred related to mortgage insurance products. The increase in benefits and other changes in policy reserves was primarily driven by a $64 million increase in our long-term care business as a result of claims associated with the aging of the in-force block, higher than expected loss experience in the current quarter, as well as the Continental Life acquisition. Adding to this increase was an $11 million increase in our Mortgage Insurance segment

 

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primarily driven by higher losses in Australia from portfolio seasoning and increased delinquencies from a limited number of distribution relationships. This was partially offset by a decrease in our Retirement Income and Investments segment of $34 million attributable to the decline in life-contingent structured settlement annuity sales.

Interest credited. Interest credited represents interest credited on behalf of policyholder and contractholder general account balances. The increase in interest credited was primarily due to a $37 million increase related to spread-based institutional products as a result of increased crediting rates on floating rate products and higher assets under management. This increase was partially offset by an $11 million decrease in interest credited on fixed annuities primarily due to crediting rates being reset to current, lower rates as the fixed annuities reach the end of their initial crediting rate guarantee period.

Acquisition and operating expenses, net of deferrals. Acquisition and operating expenses, net of deferrals, represent costs and expenses related to the acquisition and ongoing maintenance of insurance and investment contracts, including commissions, policy issuance expenses and other underwriting and general operating costs. These costs and expenses are net of amounts that are capitalized and deferred, which are primarily costs and expenses that vary with and are primarily related to the sale and issuance of our insurance policies and investment contracts, such as first-year commissions in excess of ultimate renewal commissions and other policy issuance expenses. An increase in our fee-based products in our Retirement Income and Investments segment of $16 million associated with higher growth in assets under management in fee-based products was offset by a $15 million decrease in our Corporate and Other segment that was attributable to lower unallocated overhead expenses in 2006 compared to 2005.

Amortization of deferred acquisition costs and intangibles. Amortization of deferred acquisition costs and intangibles consists primarily of the amortization of acquisition costs that are capitalized and PVFP. The decrease in our Protection segment of $8 million was offset by an $8 million increase in our Retirement Income and Investments segment primarily from our spread-based retail products. This increase to our Retirement Income and Investments segment was partially offset by an $11 million reduction in amortization expense attributable to investment losses on our investment contracts.

Interest expense. Interest expense increased primarily as a result of the issuance of additional non-recourse funding obligations in the first quarter of 2006 and the second and third quarters of 2005, and an increase in average variable rates paid on non-recourse funding obligations supporting our term life insurance capital management strategy. This was partially offset by a decrease in interest expense associated with the first quarter 2006 derecognition of borrowings related to securitization entities.

Provision for income taxes. The effective tax rate increased to 31.7% for the three months ended June 30, 2006 from 30.8% for the three months ended June 30, 2005. The increase in effective tax rate was primarily attributable to nonrecurring favorable examination developments in 2005, offset in part by the increase in lower taxed foreign earnings in 2006.

Net operating earnings. The increase in net operating earnings reflects increases in segment net operating earnings in our Protection and Mortgage Insurance segments, offset by our Retirement Income and Investments and Corporate and Other segments, which experienced small decreases, as discussed in the “—Results of Operations by Segment.”

 

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Six Months Ended June 30, 2006 Compared to Six Months Ended June 30, 2005

The following table provides a reconciliation of net earnings to “net operating earnings” (as defined above) for the six months ended June 30, 2006 and 2005.

 

     Six months ended
June 30,
    Increase (decrease) and
percentage change
 

(Amounts in millions, except per share amounts)

       2006             2005                     2006 vs. 2005              

Revenues:

         

Premiums

   $ 3,187     $ 3,219     $ (32 )    (1 )%

Net investment income

     1,877       1,693       184      11 %

Net investment gains (losses)

     (71 )     (6 )     (65 )    NM (1)

Policy fees and other income

     386       315       71      23 %
                           

Total revenues

     5,379       5,221       158      3 %
                           

Benefits and expenses:

         

Benefits and other changes in policy reserves

     2,131       2,126       5      —   %

Interest credited

     751       687       64      9 %

Acquisition and operating expenses, net of deferrals

     996       970       26      3 %

Amortization of deferred acquisition costs and intangibles

     381       401       (20 )    (5 )%

Interest expense

     170       141       29      21 %
                           

Total benefits and expenses

     4,429       4,325       104      2 %
                           

Net earnings before income taxes and accounting change

     950       896       54      6 %

Provision for income taxes

     303       289       14      5 %
                           

Net earnings before accounting change

     647       607       40      7 %

Cumulative effect of accounting change, net of taxes

     4       —         4      NM (1)
                           

Net earnings

     651       607       44      7 %

Adjustments to net earnings:

         

Net investment losses (gains), net of taxes and other adjustments

     37       4       33      NM (1)

Cumulative effect of accounting change, net of taxes

     (4 )     —         (4 )    NM (1)
                           

Net operating earnings

   $ 684     $ 611     $ 73      12 %
                           

Net earnings per common share:

         

Basic

   $ 1.41     $ 1.27       
                     

Diluted

   $ 1.37     $ 1.25       
                     

Net earnings before accounting change per common share:

         

Basic

   $ 1.40     $ 1.27       
                     

Diluted

   $ 1.37     $ 1.25       
                     

Net operating earnings per common share:

         

Basic

   $ 1.48     $ 1.27       
                     

Diluted

   $ 1.44     $ 1.26       
                     

Weighted-average common shares outstanding:

         

Basic

     461.3       479.6       
                     

Diluted

     473.9       485.9       
                     

(1) Not meaningful

 

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Premiums. The decrease in premiums is primarily driven by a $105 million decrease in our Retirement Income and Investments segment from a reduction in sales of our life-contingent structured settlement annuities. Partially offsetting this is a $79 million increase in our Mortgage Insurance segment reflecting growth and aging of our international mortgage insurance in-force block. Premiums for the Protection segment were unchanged compared to the prior year. Our payment protection business decreased by $106 million as a result of a decrease in the U.K. market and changes in foreign exchange rates. Offsetting the decrease in the payment protection business was increases in our life, long-term care and group life and health businesses. The life business increased $53 million primarily due to growth of our term life insurance in-force block. The long-term care business increased $44 million associated with growth in the in-force block and $27 million in our long-term care business from the Continental Life acquisition.

Net investment income. Net investment income increased primarily as a result of an increase in average invested assets attributable to assets purchased using proceeds from our issuance of non-recourse funding obligations supporting certain term life insurance policies and growth of our long-term care in-force block. The increase in net investment income was also due to an increase in weighted average investment yields to 5.7% for the six months ended June 30, 2006 from 5.4% for the six months ended June 30, 2005. The increase in weighted average investment yields was primarily attributable to increased yields on floating rate investments. Net investment income for the six months ended June 30, 2006 included $54 million of investment income related to a reduction in commercial mortgage loan loss reserves, bond calls, mortgage loan prepayments and limited partnership investments as compared to $29 million in investment income from bond calls, mortgage loan prepayments and limited partnership investments in the prior year.

Net investment gains (losses). For the six months ended June 30, 2006, gross investment gains were $30 million and gross investment losses were $101 million, including $5 million of impairments. These impairments were attributable to available-for-sale equity securities and limited partnership investments ($4 million and $1 million, respectively). Gross investment gains for the six months ended June 30, 2006 were associated with $30 million in gains on the sale of available-for-sale fixed maturities and equity securities. Gross investment losses include $76 million of interest rate related losses as a result of the disposition of available-for-sale securities primarily from portfolio repositioning activities, $17 million on the derecognition of assets and liabilities associated with certain securitization entities, $5 million of impairment charges, and $2 million in connection with terminations and losses in fair value of non-qualified derivatives. Net investment losses on trading securities were $1 million for the six months ended June 30, 2006. For the six months ended June 30, 2005, gross investment gains were $51 million and gross investment losses were $57 million, including $37 million of impairments. These impairments were attributable to available-for-sale fixed maturities, limited partnership investments and equity investments ($31 million, $5 million and $1 million, respectively). The fixed maturities impairments related primarily to securities issued by companies in the automotive, transportation and consumer products industries ($14 million, $12 million and $3 million, respectively).

Policy fees and other income. The increase in policy fees and other income was primarily due to higher sales and growth in assets under management in Retirement Income and Investments’ fee-based products of $36 million as a result of distribution expansion, favorable equity markets, and continued product enhancements. In addition, our life insurance business increased $26 million primarily as a result of the growth of our universal life insurance in-force block.

Benefits and other changes in policy reserves. The increase in benefits and other changes in policy reserves was primarily driven by a $70 million increase in our Protection segment resulting from claims associated with the aging of the long-term care insurance in-force block and the Continental Life acquisition. Adding to this increase was a $36 million increase in our Mortgage Insurance segment largely driven by higher losses in Australia from portfolio seasoning and increased delinquencies from a limited number of distribution relationships. This increase was nearly offset by a decrease in our Retirement Income and Investments segment of $101 million attributable to the decline in life-contingent structured settlement annuity sales.

Interest credited. The increase in interest credited was primarily due to a $69 million increase related to spread-based institutional products as a result of increased crediting rates on floating rate products and higher

 

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assets under management and a $10 million increase in our Protection segment. This increase was partially offset by a $17 million decrease in interest credited on fixed annuities primarily due to crediting rates being reset to current, lower rates as the fixed annuities reach their initial crediting rate guarantee period.

Acquisition and operating expenses, net of deferrals. Acquisition and operating expenses, net of deferrals, increased primarily due a $27 million increase in our Retirement Income and Investments segment associated with higher growth in assets under management in fee-based products and a $10 million increase in our Mortgage Insurance segment primarily as a result of an increase in costs in our existing international platforms and continued investment in potential new international mortgage insurance platforms. This was partially offset by a $9 million decrease in our Corporate and Other segment that was principally from lower unallocated overhead expenses in 2006 compared to 2005.

Amortization of deferred acquisition costs and intangibles. Amortization of deferred acquisition cost and intangibles decreased primarily due to a $38 million decrease in our Protection segment from payment protection insurance business run-off block and changes in foreign exchange rates, as well as a decrease in our long-term care business related to a correction related to a long-term care policy rider in the prior year. This was partially offset by an increase in our Retirement Income and Investments of $17 million associated with higher lapses and growth in spreads on spread-based retail products. Partially offsetting this increase in our Retirement Income and Investments segment was an $11 million reduction in amortization expense attributable to investment losses.

Interest expense. Interest expense increased primarily as a result of the issuance of additional non-recourse funding obligations in the first quarter of 2006 and the second and third quarters of 2005, and an increase in average variable rates paid on non-recourse funding obligations supporting our term life insurance capital management strategy. This was partially offset by a decrease in interest expense associated with the first quarter 2006 derecognition of borrowings related to securitization entities.

Provision for income taxes. The effective tax rate decreased to 31.9% for the six months ended June 30, 2006 from 32.3% for the six months ended June 30, 2005. The decrease in effective tax rate was primarily attributable to the increase in lower taxed foreign earnings in 2006, offset in part by nonrecurring favorable examination developments in 2005.

Net operating earnings. The increase in net operating earnings reflects increases in segment net operating earnings in our Protection and Mortgage Insurance segments, offset by decreases in our Retirement Income and Investments and Corporate and Other segments, as discussed in the “—Results of Operations by Segment.”

Results of Operations by Segment

Management regularly reviews the performance of each of our operating segments (Protection, Retirement Income and Investments and Mortgage Insurance) based on after-tax segment net operating earnings (loss), which excludes: (1) cumulative effect of accounting changes, and (2) infrequent or unusual non-operating items. Certain other items, including most of our interest and other financing expenses and advertising, marketing and other corporate expenses, are included in our Corporate and Other segment. Although these excluded items are significant to our consolidated financial performance, we believe that the presentation of segment net operating earnings (loss) enhances our understanding and assessment of the results of operations of our operating segments by highlighting net earnings (loss) attributable to the normal, recurring operations of our business. However, segment net operating earnings (loss) is not a substitute for net income determined in accordance with GAAP.

Protection segment

We offer U.S. customers life, long-term care, Medicare supplement insurance and, primarily for companies with fewer than 1,000 employees, group life and health insurance. In Europe, we offer payment protection insurance, which helps consumers meet their payment obligations in the event of illness, involuntary unemployment, disability or death. Effective January 1, 2006, Seguros, a small Mexican-domiciled multi-line insurer, previously included in our Corporate segment, is now being managed within our Protection segment and whose results are now included as part of the payment protection insurance business.

 

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Three Months Ended June 30, 2006 Compared to Three Months Ended June 30, 2005

The following table sets forth the results of operations relating to our Protection segment for the three months ended June 30, 2006 and 2005:

 

     Three months ended
June 30,
   Increase (decrease) and
percentage change
 

(Amounts in millions)

       2006             2005                2006 vs. 2005          

Revenues:

         

Premiums

   $ 1,174     $ 1,141    $ 33     3 %

Net investment income

     364       312      52     17 %

Net investment gains (losses)

     (2 )     —        (2 )   NM (1)

Policy fees and other income

     103       78      25     32 %
                         

Total revenues

     1,639       1,531      108     7 %
                         

Benefits and expenses:

         

Benefits and other changes in policy reserves

     778       710      68     10 %

Interest credited

     96       91      5     5 %

Acquisition and operating expenses, net of deferrals

     350       352      (2 )   (1 )%

Amortization of deferred acquisition costs and intangibles

     153       161      (8 )   (5 )%

Interest expense

     34       11      23     NM (1)
                         

Total benefits and expenses

     1,411       1,325      86     6 %
                         

Earnings before income taxes

     228       206      22     11 %

Provision for income taxes

     79       73      6     8 %
                         

Segment net earnings

     149       133      16     12 %

Adjustments to segment net earnings:

         

Net investment losses (gains) net of taxes and other adjustments

     2       —        2     NM (1)
                         

Segment net operating earnings

   $ 151     $ 133    $ 18     14 %
                         

(1) Not meaningful

The following table sets forth net operating earnings for the products included in our Protection segment for the three months ended June 30, 2006 and 2005:

 

     Three months ended
June 30,
  

Increase (decrease) and

percentage change

 

(Amounts in millions)

       2006            2005                2006 vs. 2005          

Segment net operating earnings:

          

Life insurance

   $ 77    $ 55    $ 22     40 %

Long-term care insurance

     37      46      (9 )   (20 )%

Payment protection insurance

     29      24      5     21 %

Group life and health insurance

     8      8      —       —   %
                        

Total segment net operating earnings

   $ 151    $ 133    $ 18     14 %
                        

Segment net operating earnings

The increase in our life insurance business was primarily related to growth of the term life in-force blocks and favorable mortality. In addition, earnings in the prior year were reduced by unfavorable mortality and an $8 million unfavorable adjustment on a reinsured block of term life insurance policies. The increase in our payment protection insurance business was due to growth in continental Europe and Ireland and $3 million attributable to a lower effective tax rate, partially offset by $2 million from unfavorable changes in foreign exchange rate, net of tax. Our long-term care business declined primarily from higher incurred claims, declining

 

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investment yields, and lower termination rates on older issued policies, some with expiring reinsurance coverage. The current year benefited from a $15 million favorable reserve adjustment, net of tax, related to group long-term care policies, offset by $9 million of unfavorable reinsurance adjustments, net of tax. The prior year benefited from a $4 million, net of tax, of favorable experience on a reinsured block and $4 million of net reserve adjustments, net of tax.

Revenues

Premiums increased as a result of a $33 million increase in our life insurance business primarily related to growth of the term life insurance in-force blocks, a $27 million increase in our long-term care business due to $27 million from the Continental Life acquisition and an increase attributable to in-force growth. Partially offsetting the long-term care business increase is the absence of a prior year favorable $8 million correction of premiums associated with a long-term care policy rider and a $6 million favorable experience on a reinsured block in the prior year. The increases were partially offset by a decrease of $30 million in our payment protection insurance business which included a decrease of $16 million attributable to changes in foreign exchange rates. This decrease was principally due to a $56 million decrease in the U.K. market, partially offset by an increase in continental Europe and Ireland. The decrease in the U.K. market was attributable to the continued run-off of low return blocks of business and the exit from the travel insurance business. The increase in continental Europe and Ireland relates to growth from new distribution relationships and an increase in consumer lending in those markets.

The increase in net investment income, which includes a decrease of $1 million attributable to changes in foreign exchange rates, was primarily the result of an increase in average invested assets and average variable rate yields, associated with assets purchased using proceeds from our issuance of non-recourse funding obligations supporting certain term life insurance policies and to new assets backing growth of our long-term care business.

For a discussion of net investment gains (losses), see the comparison for this line item under “—Results of Operations.”

The increase in policy fees and other income is primarily due to an increase of $21 million in our life insurance business largely due to growth of the universal life insurance in-force block and a $12 million unfavorable adjustment on a reinsured block of term life insurance policies in the prior year.

Benefits and expenses

Benefits and other changes in policy reserves increased due to a $64 million increase in our long-term care business, a $6 million increase in our life insurance business and a $5 million increase in our group business, offset by a $7 million decrease in our payment protection insurance business. The increase in our long-term care business was primarily the result of growth of the in-force block, higher than normal claims in the current period, lower termination rates on older issued policies, some with expiring reinsurance coverage, and a $17 million increase from the Continental Life acquisition. Both years benefited from reserve adjustments of similar amounts. The current year includes a $24 million decrease associated with an adjustment related to group long-term care policies. The prior year included $25 million of favorable reserve adjustments for a correction of a long-term care policy rider and strengthening of certain claim reserves. The increase in our life insurance business is principally due to growth of the term life in-force blocks partially offset by favorable mortality. The increase in our group business was driven by a combination of growth and fluctuations in claims that are within our expectations. The decrease in our payment protection insurance business was largely the result of a reduction of claims in our run-off block of travel insurance and also includes a $2 million decrease attributable to changes in foreign exchange rates.

Acquisition and operating expenses, net of deferrals, decreased primarily due to a $27 million decrease in our payment protection insurance business primarily associated with our run-off block and also includes a decrease of $9 million attributable to changes in foreign exchange rates, partially offset by a $19 million increase in our long-term care business primarily from growth of our in-force business, a $5 million increase from the

 

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Continental Life acquisition, an $8 million unfavorable reinsurance adjustment, and a $7 million increase in our life insurance business due to prior year expense favorability that did not recur in the current year.

Amortization of deferred acquisition costs and intangibles decreased primarily due to a $17 million decrease in our long-term care business attributable to unfavorable prior year amortization of $27 million related to the correction of a long-term care policy rider. This decrease is partially offset by growth of the in-force block and higher terminations in our Medicare supplement product. The decrease in our long-term care business was partially offset by a $12 million increase in our life insurance business due to growth of the term life and universal life in-force blocks.

Interest expense increased $23 million as the result of the issuance of additional non-recourse funding obligations in the first quarter of 2006 and the second and third quarters of 2005, and an increase in average variable rates paid on non-recourse funding obligations supporting our term life insurance capital management strategy.

Provision for income taxes

The effective tax rate decreased to 34.6% for the three months ended June 30, 2006 from 35.4% for the three months ended June 30, 2005. The decrease in effective tax rate was primarily attributable to the increase in lower taxed foreign earnings and a reduction in excess foreign tax credits, partially offset by nonrecurring favorable examination developments in 2005.

Six Months Ended June 30, 2006 Compared to Six Months Ended June 30, 2005

The following table sets forth the results of operations relating to our Protection segment for the six months ended June 30, 2006 and 2005:

 

     Six months ended
June 30,
   Increase (decrease) and
percentage change
 

(Amounts in millions)

       2006             2005                    2006 vs. 2005              

Revenues:

         

Premiums

   $ 2,279     $ 2,279    $   —       —   %

Net investment income

     710       627      83     13 %

Net investment gains (losses)

     2       —        2     NM (1)

Policy fees and other income

     200       167      33     20 %
                         

Total revenues

     3,191       3,073      118     4 %
                         

Benefits and expenses:

         

Benefits and other changes in policy reserves

     1,525       1,455      70     5 %

Interest credited

     191       181      10     6 %

Acquisition and operating expenses, net of deferrals

     680       682      (2 )   —   %

Amortization of deferred acquisition costs and intangibles

     275       313      (38 )   (12 )%

Interest expense

     59       20      39     195 %
                         

Total benefits and expenses

     2,730       2,651      79     3 %
                         

Earnings before income taxes

     461       422      39     9 %

Provision for income taxes

     160       150      10     7 %
                         

Segment net earnings

     301       272      29     11 %

Adjustments to segment net earnings:

         

Net investment losses (gains) net of taxes and other adjustments

     (1 )     —        (1 )   NM (1)
                         

Segment net operating earnings

   $ 300     $ 272    $ 28     10 %
                         

(1) Not meaningful

 

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The following table sets forth net operating earnings for the products included in our Protection segment for the six months ended June 30, 2006 and 2005:

 

     Six months ended
June 30,
  

Increase (decrease) and

percentage change

 

(Amounts in millions)

       2006            2005                    2006 vs. 2005              

Segment net operating earnings:

          

Life insurance

   $ 151    $ 123    $ 28     23 %

Long-term care insurance

     80      88      (8 )   (9 )%

Payment protection insurance

     54      46      8     17 %

Group life and health insurance

     15      15      —       —   %
                        

Total segment net operating earnings

   $ 300    $ 272    $ 28     10 %
                        

Segment net operating earnings

The increase in our life insurance business was primarily related to growth of the term life in-force blocks and favorable mortality. In addition, earnings in the prior year were reduced by unfavorable mortality and $8 million related to an unfavorable adjustment on a reinsured block of term life insurance policies. The increase in our payment protection insurance business was due to growth in continental Europe and Ireland and $6 million attributable to a lower effective tax rate, partially offset by $4 million unfavorable changes in foreign exchange rates, net of tax. The decrease in our long-term care business is largely the result of lower terminations on our older issued policies, some with expiring reinsurance coverage, and a continued low interest rate environment. The current year benefited from a $17 million reserve adjustment, net of tax, related to group long-term care policies, offset by $9 million of reinsurance adjustments, net of tax. Our long-term care business benefited in the prior year from a $7 million, net of tax, favorable experience on a reinsured block partially offset by $1 million of net reserve adjustments, net of tax.

Revenues

Premiums from our life insurance business increased $53 million reflecting growth of the term life insurance in-force blocks. Our long-term care business increased $44 million primarily associated with in-force growth and $27 million from the Continental Life acquisition. The prior year included $19 million of favorable items for the long-term care business that did not recur in the current year. Of this $19 million, $11 million related to favorable experience on a reinsured block and the remaining $8 million was the result of a correction of premiums related to a long-term care policy rider. Additionally, our group business increased $9 million largely as a result of higher sales in our non-medical products. These increases were partially offset by a decrease of $106 million in our payment protection insurance business which included a decrease of $39 million attributable to changes in foreign exchange rates. This decrease was principally due to a decrease of $124 million in the U.K. market, partially offset by an increase in continental Europe and Ireland. The decrease in the U.K. market was attributable to the continued run-off of low return blocks of business and the exit from the travel insurance business. The increase in continental Europe and Ireland was the result of the growth due to new distribution relationships and the growth of consumer lending in those markets.

The increase in net investment income, which included a $3 million decrease attributable to changes in foreign exchange rates, was largely the result of an increase in average invested assets and average variable rate yields, associated with assets purchased using proceeds from our issuance of non-recourse funding obligations supporting certain term life insurance policies and to new assets backing growth of our long-term care business.

For a discussion of net investment gains (losses), see the comparison for this line item under “—Results of Operations.”

The increase in policy fees and other income is primarily due to an increase of $26 million in our life insurance business principally from growth of the universal life insurance in-force block and a $12 million unfavorable adjustment on a reinsured block of term life insurance policies in the prior year.

 

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Benefits and expenses

Benefits and other changes in policy reserves increased due to a $72 million increase in our long-term care business, a $17 million increase in our life insurance business and a $13 million increase in our group business offset by a $32 million decrease in our payment protection insurance business. The increase in our long-term care business was primarily the result of growth of the in-force block, lower termination rates on older issued policies, some with expiring reinsurance coverage, and a $17 million increase from the Continental Life acquisition. Both years benefited from reserve adjustments. The current year includes a $27 million decrease due to a favorable adjustment related to group long-term care policies. The prior year included $17 million of favorable reserve adjustments for a correction of a long-term care policy rider and strengthening of certain claim reserves. The increase in our group business is based upon continued growth in our non-medical business which is partially offset by decreases in our medical products which are within expectations. The increase in our life insurance business is associated with growth of the term life in-force blocks and unfavorable prior year mortality offset in part by favorable current year mortality. The decrease in our payment protection insurance business was largely driven by a reduction of claim reserves in our run-off block and also includes a decrease of $5 million attributable to changes in foreign exchange rates.

Acquisition and operating expenses, net of deferrals, decreased primarily due to a $41 million decrease in our payment protection insurance business, primarily associated with our run-off block and also includes a $23 million decrease attributable to changes in foreign exchange rates. Our group business decreased $5 million as a result of favorable expense management and reduced sales related expenses. These increases were partially offset by a $35 million increase in our long-term care business largely from growth of our in-force premium levels driving higher renewal commission expense, a $5 million increase from the Continental Life acquisition and an unfavorable $8 million reinsurance adjustment. Our life business increased $9 million principally due to prior year expense favorability that did not recur in the current year.

Amortization of deferred acquisition costs and intangibles decreased primarily due to a $42 million decrease in our payment protection insurance business and an $8 million decrease in our long-term care business, partially offset by a $13 million increase in our life insurance business. The decrease in our payment protection insurance business was largely attributable to our run-off block and also includes a $9 million decrease attributable to changes in foreign exchange rates. The decrease in our long-term care business is from an unfavorable $27 million correction related to a long-term care policy rider in the prior year. This decrease is partially offset by growth of the in-force block and higher terminations in our Medicare supplement product. The increase in our life insurance business is principally due to growth of the term life and universal life in-force blocks.

Interest expense increased $39 million as the result of the issuance of additional non-recourse funding obligations in the first quarter of 2006 and the second and third quarters of 2005, and an increase in average variable rates paid on non-recourse funding obligations supporting our term life insurance capital management strategy.

Provision for income taxes

The effective tax rate decreased to 34.7% for the six months ended June 30, 2006 from 35.5% for the six months ended June 30, 2005. The decrease in effective tax rate was primarily attributable to the increase in lower taxed foreign earnings and a reduction in excess foreign tax credits, partially offset by nonrecurring favorable examination developments in 2005.

 

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Protection selected operating performance measures

Life insurance

The following tables set forth selected operating performance measures regarding our life insurance products as of or for the three and six months ended June 30, 2006 and 2005:

 

     For the three months
ended June 30,
   Percentage
change
    For the six months
ended June 30,
   Percentage
change
 

(Amounts in millions)

       2006            2005        2006 vs. 2005         2006            2005        2006 vs. 2005  

Term life insurance

                

Net earned premiums

   $ 221    $ 186    19 %   $ 434    $ 377    15 %

Annualized first-year premiums

     37      34    9 %     71      63    13 %

Revenue, net of reinsurance

     277      206    34 %     545      433    26 %

Universal and whole life insurance

                

Net earned premiums and deposits

   $ 118    $ 100    18 %   $ 240    $ 200    20 %

Annualized first-year deposits

     10      6    67 %     19      13    46 %

Excess deposits

     22      8    175 %     41      14    193 %

Revenue, net of reinsurance

     180      168    7 %     354      341    4 %

Total life insurance

                

Net earned premiums and deposits

   $ 339    $ 286    19 %   $ 674    $ 577    17 %

Annualized first-year premiums

     37      34    9 %     71      63    13 %

Annualized first-year deposits

     10      6    67 %     19      13    46 %

Excess deposits

     22      8    175 %     41      14    193 %

Revenue, net of reinsurance

     457      374    22 %     899      774    16 %

 

     As of the six months
ended June 30,
   Percentage
change
 

(Amounts in millions)

   2006    2005    2006 vs. 2005  

Term life insurance

        

Life insurance in-force, net of reinsurance

   $ 409,103    $ 350,224    17 %

Life insurance in-force before reinsurance

     571,014      508,330    12 %

Universal and whole life insurance

        

Life insurance in-force, net of reinsurance

   $ 40,850    $ 42,110    (3 )%

Life insurance in-force before reinsurance

     49,207      49,846    (1 )%

Total life insurance

        

Life insurance in-force, net of reinsurance

   $ 449,953    $ 392,334    15 %

Life insurance in-force before reinsurance

     620,221      558,176    11 %

Term life insurance. Term life annualized first-year premiums and insurance in-force, which represents the face amount for life insurance, increased primarily as a result of distribution expansion and the competitiveness of our product offerings. This increase in annualized first-year premiums was the primary driver for the increase in term life insurance net earned premiums, revenues and insurance in-force. Term life insurance revenues also increased due to an increase in invested assets related to securities purchased using the proceeds from our issuance of non-recourse funding obligations supporting certain term life insurance policies.

Universal and whole life insurance. Universal life annualized first-year deposits increased primarily due to new product offerings gaining momentum in the market. The decrease in our in-force block was largely the result of the continued run-off on our closed block of whole life insurance.

 

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Long-term care insurance

The following tables set forth selected operating performance measures regarding our long-term care insurance business, which includes long-term care insurance, Medicare supplement insurance, as well as several run-off blocks of accident and health insurance and corporate-owned life insurance for the three and six months ended June 30, 2006 and 2005:

 

     Three months
ended June 30,
   Percentage
change
    Six months
ended June 30,
   Percentage
change
 

(Amounts in millions)

     2006        2005      2006 vs. 2005     2006    2005    2006 vs. 2005  

Net earned premiums

   $ 458    $ 431    6 %   $ 883    $ 839    5 %

Annualized first-year premiums

     51      42    21 %     99      83    19 %

Revenue, net of reinsurance

     649      593    9 %     1,257      1,159    8 %

The increase in annualized first-year premiums was primarily due to an increase in individual long-term care products and the broadening of our product offering in Medicare supplement, including $4 million from the Continental Life acquisition. The additional layer of 2005 annualized first-year premiums was the primary driver for the increase in net earned premium and revenue, net of reinsurance. The increase in revenue was also due to an increase in net investment income principally due to an increase in average invested assets backing growth of our long-term care business.

Payment protection insurance

The following table sets forth selected operating performance measures regarding our payment protection insurance and other related consumer protection insurance products for the three and six months ended June 30, 2006 and 2005:

 

     Three months
ended June 30,
   Percentage
change
    Six months
ended June 30,
   Percentage
change
 

(Amounts in millions)

     2006        2005      2006 vs. 2005       2006        2005      2006 vs. 2005  

Payment protection insurance gross written premiums and deposits

   $ 500    $ 501    —   %   $ 919    $ 954    (4 )%

Mexico operations gross written premiums

     15      12    25 %     31      24    29 %

Net earned premiums

     322      352    (9 )%     613      719    (15 )%

Revenue, net of reinsurance

     352      385    (9 )%     671      784    (14 )%

Gross written premiums and deposits, gross of reinsurance and cancellations for the three and six months ended June 30, 2006 includes $32 million of gross deposits on a reciprocal reinsurance transaction and growth from continental Europe and Ireland. Both periods include a decrease attributable to changes in foreign exchange rates of $23 million and $59 million, respectively. The remainder of the decrease compared to the respective prior year periods is largely driven by a decline of gross written premiums in the U.K. partially offset by growth in the continental Europe and Ireland market.

Net earned premiums and revenues for the three and six months ended June 30, 2006 compared to the three and six months ended June 30, 2005 decreased primarily due to continued run-off of low return blocks of business in the U.K. market, the exit from our travel insurance business and a decrease attributable to changes in foreign exchange rates, partially offset by growth in the continental Europe and Ireland markets.

 

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Table of Contents

Group life and health insurance

The following table sets forth selected operating performance measures regarding our group products for the three and six months ended June 30, 2006 and 2005:

 

     Three months
ended June 30,
   Percentage
change
    Six months
ended June 30,
   Percentage
change
 

(Amounts in millions)

     2006        2005      2006 vs. 2005       2006        2005      2006 vs. 2005  

Net earned premiums

   $ 168    $ 165    2 %   $ 336    $ 327    3 %

Annualized first-year premiums

     44      38    16 %     78      68    15 %

Revenue, net of reinsurance

     181      179    1 %     364      356    2 %

The increase in annualized first-year premiums is attributable to growth in sales in non-medical products partially offset by lower sales of medical products due to competitive pricing in that market. This growth is also driving the increases in revenue and net earned premiums.

Retirement Income and Investments segment

We offer U.S. customers fixed annuities, individual and group variable annuities, single premium immediate annuities, variable life insurance, asset management and specialized products, including GICs, funding agreements, FABNs and structured settlements.

Three Months Ended June 30, 2006 Compared to Three Months Ended June 30, 2005

The following table sets forth the results of operations relating to our Retirement Income and Investments segment for the three months ended June 30, 2006 and 2005:

 

   

Three month ended

June 30,

  Increase (decrease) and
percentage change
 

(Amounts in millions)

      2006             2005                 2006 vs. 2005            

Revenues:

       

Premiums

  $ 200     $ 241   $ (41 )   (17 )%

Net investment income

    487       432     55     13 %

Net investment gains (losses)

    (45 )     —       (45 )   NM (1)

Policy fees and other income

    84       62     22     35 %
                       

Total revenues

    726       735     (9 )   (1 )%
                       

Benefits and expenses:

       

Benefits and other changes in policy reserves

    267       301     (34 )   (11 )%

Interest credited

    282       256     26     10 %

Acquisition and operating expenses, net of deferrals

    80       66     14     21 %

Amortization of deferred acquisition costs and intangibles

    40       32     8     25 %

Interest expense

    1       1     —       —   %
                       

Total benefits and expenses

    670       656     14     2 %
                       

Earnings before income taxes

    56       79     (23 )   (29 )%

Provision for income taxes

    19       19     —       —   %
                       

Segment net earnings

    37       60     (23 )   (38 )%

Adjustments to segment net earnings:

       

Net investment losses (gains), net of taxes and other adjustments

    20       —       20     NM (1)
                       

Segment net operating earnings

  $ 57     $ 60   $ (3 )   (5 )%
                       

(1) Not meaningful

 

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The following tables set forth net operating earnings for the products included in our Retirement Income and Investments segment for the three months ended June 30, 2006 and 2005:

 

     Three months ended
June 30,
   Increase (decrease) and
percentage change
 

(Amounts in millions)

       2006            2005            2006 vs. 2005      

Segment net operating earnings:

          

Spread-based retail

   $ 29    $ 35    $ (6 )   (17 )%

Spread-based institutional

     13      11      2     18 %

Fee-based

     15      14      1     7 %
                        

Total segment net operating earnings

   $ 57    $ 60    $ (3 )   (5 )%
                        

Segment net operating earnings

Segment net operating earnings from spread-based retail decreased primarily due to a lower effective tax rate in the prior year related to favorable tax examination developments. Segment net operating earnings from spread-based institutional increased largely from higher spreads and growth in assets under management related to our FABNs. Segment net operating earnings on fee-based increased principally as a result of growth in assets under management.

Revenues

The $41 million decrease in premiums was primarily the result of a $61 million reduction in sales of our life-contingent structured settlement annuities. This is due to our continued pricing discipline in the continuing low long-term interest rate environment. This decrease was partially offset by a $20 million increase in sales of our life-contingent single premium immediate annuities.

The increase in net investment income was principally due to increased yields on floating rate investments backing spread-based institutional products and higher assets under management.

For a discussion of net investment gains (losses), see the comparison for this line item under “—Results of Operations.”

The increase in policy fees and other income was primarily attributable to a $20 million increase in the fee-based segment as a result of increased sales and growth in assets under management from distribution expansion and continued product introduction and enhancements.

Benefits and expenses

Benefits and other changes in policy reserves decreased primarily as a result of the decrease in the life-contingent structured settlement annuity sales, which were partially offset by an increase in sales of life-contingent single premium immediate annuities.

The increase in interest credited was principally due to a $37 million increase related to spread-based institutional products as a result of increased crediting rates on floating rate products and higher assets under management. This increase was partially offset by an $11 million decrease in interest credited on fixed annuities associated with crediting rates being reset to lower rates as the fixed annuities reach their initial crediting rate guarantee period.

The increase in acquisition and operating expenses, net of deferrals, was primarily from $16 million of increased expenses associated with higher sales and growth in assets under management in fee-based products.

 

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The increase in amortization of deferred acquisition costs and intangibles was largely the result of a $15 million increase in spread-based retail products primarily due to higher lapses and profit margins. Partially offsetting this increase was an $11 million reduction in amortization expense attributable to investment losses.

Provision for income taxes

The effective tax rate increased to 33.9% for the three months ended June 30, 2006 from 24.1% for the three months ended June 30, 2005. This increase in the effective tax rate was primarily attributable to nonrecurring favorable tax examination developments in 2005.

Six Months Ended June 30, 2006 Compared to Six Months Ended June 30, 2005

The following table sets forth the results of operations relating to our Retirement Income and Investments segment for the six months ended June 30, 2006 and 2005:

 

    

Six month ended

June 30,

   Increase (decrease) and
percentage change
 

(Amounts in millions)

   2006     2005                2006 vs. 2005              

Revenues:

         

Premiums

   $ 380     $ 485    $ (105 )   (22 )%

Net investment income

     952       865      87     10 %

Net investment gains (losses)

     (54 )     —        (54 )   NM (1)

Policy fees and other income

     161       120      41     34 %
                         

Total revenues

     1,439       1,470      (31 )   (2 )%
                         

Benefits and expenses:

         

Benefits and other changes in policy reserves

     508       609      (101 )   (17 )%

Interest credited

     560       506      54     11 %

Acquisition and operating expenses, net of deferrals

     152       125      27     22 %

Amortization of deferred acquisition costs and intangibles

     76       59      17     29 %

Interest expense

     2       1      1     100 %
                         

Total benefits and expenses

     1,298       1,300      (2 )   —   %
                         

Earnings before income taxes

     141       170      (29 )   (17 )%

Provision for income taxes

     49       50      (1 )   (2 )%
                         

Segment net earnings

     92       120      (28 )   (23 )%

Adjustments to segment net earnings:

         

Net investment losses (gains), net of taxes and other adjustments

     26       —        26     NM (1)
                         

Segment net operating earnings

   $ 118     $ 120    $ (2 )   (2 )%
                         

(1) Not meaningful

The following table sets forth net operating earnings for the products included in our Retirement Income and Investments segment for the six months ended June 30, 2006 and 2005:

 

     Six months ended
June 30,
   Increase (decrease) and
percentage change
 

(Amounts in millions)

     2006        2005          2006 vs. 2005      

Segment net operating earnings:

          

Spread-based retail

   $ 65    $ 69    $ (4 )   (6 )%

Spread-based institutional

     23      20      3     15 %

Fee-based

     30      31      (1 )   (3 )%
                        

Total segment net operating earnings

   $ 118    $ 120    $ (2 )   (2 )%
                        

 

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Segment net operating earnings

Segment net operating earnings from spread-based retail decreased primarily due to a lower effective tax rate in the prior year related to favorable tax examination developments. Segment net operating earnings on fee-based decreased from lower expenses in the prior year. Segment net operating earnings on spread-based institutional increased in connection with higher spreads and growth in assets under management related to our FABNs.

Revenues

The decrease in premiums was primarily the result of a $112 million reduction in sales of our life-contingent structured settlement annuities. This is due to our continued pricing discipline in the continuing low long-term interest rate environment. This decrease was partially offset by a $7 million increase in sales of our life-contingent single premium immediate annuities.

The increase in net investment income was mostly due to increased yields on floating rate investments backing spread-based institutional products and higher assets under management.

For a discussion of net investment gains (losses), see the comparison for this line item under “—Results of Operations.”

The increase in policy fees and other income was largely attributable to a $36 million increase in the fee-based segment as a result of increased sales and growth in assets under management from distribution expansion and continued product introduction and enhancements.

Benefits and expenses

Benefits and other changes in policy reserves decreased $101 million primarily as a result of the decrease in the life-contingent structured settlement annuity sales, which were partially offset by an increase in sales of life-contingent single premium immediate annuities.

The increase in interest credited was principally due to a $69 million increase related to spread-based institutional products as a result of increased crediting rates on floating rate products and higher assets under management. This increase was partially offset by a $17 million decrease in interest credited on fixed annuities associated with crediting rates being reset to current, lower rates as the fixed annuities reach their initial crediting rate guarantee period.

The increase in acquisition and operating expenses, net of deferrals, was primarily from expenses associated with higher sales and growth in assets under management in fee-based products. Additionally, the prior year included expense favorability that did not recur in the current year.

The increase in amortization of deferred acquisition costs and intangibles was largely the result of a $15 million increase in spread-based retail products primarily due to higher lapses and profit margins. Partially offsetting this increase was an $11 million reduction in amortization expense attributable to investment losses.

Provision for income taxes

The effective tax rate increased to 34.8% for the six months ended June 30, 2006 from 29.4% for the six months ended June 30, 2005. This increase in the effective tax rate was primarily attributable to nonrecurring favorable tax examination developments in 2005.

 

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Retirement Income and Investments selected operating performance measures

Spread-based retail products

The following table sets forth selected operating performance measures regarding our spread-based retail products as of or for the three and six months ended June 30, 2006 and 2005:

 

     For the three months
ended June 30,
    Percentage
change
    For the six months
ended June 30,
    Percentage
change
 

(Amounts in millions)

   2006     2005     2006 vs. 2005     2006     2005     2006 vs. 2005  

Fixed annuities

            

Account value, net of reinsurance, beginning of period

   $ 15,241     $ 15,214     —   %   $ 15,547     $ 15,113     3 %

Deposits

     326       699     (53 )%     593       984     (40 )%

Interest credited

     139       150     (7 )%     284       300     (5 )%

Surrenders, benefits and product charges

     (871 )     (523 )   67 %     (1,589 )     (857 )   85 %
                                    

Account value, net of reinsurance, end of period

   $ 14,835     $ 15,540     (5 )%   $ 14,835     $ 15,540     (5 )%
                                    

Single premium immediate annuities

            

Account value, net of reinsurance, beginning of period

   $ 5,772     $ 5,415     7 %   $ 5,680     $ 5,344     6 %

Net earned premiums and deposits

     290       215     35 %     540       427     26 %

Interest credited

     78       80     (3 )%     158       157     1 %

Surrenders, benefits and product charges

     (225 )     (222 )   1 %     (463 )     (440 )   5 %
                                    

Account value, net of reinsurance, end of period

   $ 5,915     $ 5,488     8 %   $ 5,915     $ 5,488     8 %
                                    

Structured settlements

            

Account value, net of reinsurance, beginning of period

   $ 925     $ 653     42 %   $ 871     $ 533     63 %

Net earned premiums and deposits

     45       116     (61 )%     103       240     (57 )%

Interest credited

     13       11     18 %     25       22     14 %

Surrenders, benefits and product charges

     (15 )     (15 )   —   %     (31 )     (30 )   3 %
                                    

Account value, net of reinsurance, end of period

   $ 968     $ 765     27 %   $ 968     $ 765     27 %
                                    

Total premiums from spread-based retail products

   $ 200     $ 241     (17 )%   $ 380     $ 485     (22 )%
                                    

Total deposits on spread-based retail products

   $ 461     $ 789     (42 )%   $ 856     $ 1,166     (27 )%
                                    

Fixed annuities. The account value, net of reinsurance, decreased primarily due to lapses being greater than deposits in the first half of 2006. The attractiveness of certain fixed annuities has declined as a result of continued low long-term interest rates, a relatively flat yield curve and short term investment alternatives, such as certificates of deposit. These trends are having an adverse impact on both sales and retention of fixed annuities. In recent quarters, we have experienced improved spreads in fixed annuities primarily due to run-off of and crediting rate resets of historically higher crediting rate business. The continued low interest rate environment, along with our pricing discipline of selling business that meets our profitability objectives, have adversely affected sales and retention of our fixed annuities. We expect this trend to continue.

 

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Table of Contents

Single premium immediate annuities. The account value net of reinsurance increased primarily due to the positive net impact of new product sales and lapses along with interest credited on account values in 2005 and 2006.

Structured settlements. We continue to write structured settlements to the extent that we are able to achieve our targeted returns. Our continued pricing discipline in a challenging and competitive long-term interest rate environment was the primary reason for the lower sales of these products in the first six months of 2006.

Spread-based institutional products

The following table sets forth selected operating performance measures regarding our spread-based institutional products as of the three and six months ended June 30, 2006 and 2005:

 

     Three months ended
June 30,
    Percentage
change
    Six months ended
June 30,
    Percentage
change
 

(Amounts in millions)

   2006     2005     2006 vs. 2005     2006     2005     2006 vs. 2005  

GICs, funding agreements and FABNs

            

Account value, net of reinsurance, beginning of period

   $ 9,766     $ 9,408     4 %   $ 9,777     $ 9,541     2 %

Deposits(1)

     498       871     (43 )%     1,478       1,712     (14 )%

Interest credited

     123       86     43 %     237       168     41 %

Surrenders and benefits(1)

     (501 )     (1,203 )   (58 )%     (1,606 )     (2,259 )   (29 )%
                                    

Account value, net of reinsurance, end of period

   $ 9,886     $ 9,162     8 %   $ 9,886     $ 9,162     8 %
                                    

(1) “Surrenders and benefits” include contracts that have matured but are redeposited with us and are reflected as deposits. In the three months ended June 30, 2006 and 2005, surrenders and deposits included $100 million and $725 million, respectively, and in the six months ended June 30, 2006 and 2005, surrenders and deposits included $310 million and $1,008 million, respectively, that was redeposited and reflected under “Deposits.”

Spread-based institutional account values increased mostly due to the launch of our registered notes program in the fourth quarter of 2005. This program resulted in an issuance of $300 million of FABNs in the fourth quarter of 2005 and $1,000 million in the first half of 2006. The increase in interest credited was driven by higher crediting rates on our floating rate products due to an increase in the underlying indices. This was partially offset by expected maturities.

 

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Fee-based products

The following table sets forth selected operating performance measures regarding our fee-based products as of the six months ended June 30, 2006 and 2005:

 

     For the three months
ended June 30,
    Percentage
change
    For the six months
ended June 30,
    Percentage
change
 

(Amounts in millions)

       2006             2005         2006 vs. 2005         2006             2005         2006 vs. 2005  

Income Distribution Series(2)

            

Account value, net of reinsurance, beginning of period

   $ 1,235     $ 540     129 %   $ 911     $ 462     97 %

Deposits

     350       92     NM (1)     631       177     NM (1)

Interest credited and investment performance

     (5 )     8     (163 )%     54       4     NM (1)

Surrenders, benefits and product charges

     (25 )     (6 )   NM (1)     (41 )     (9 )   NM (1)
                                    

Account value, net of reinsurance, end of period

   $ 1,555     $ 634     145 %   $ 1,555     $ 634     145 %
                                    

Traditional variable annuities

            

Account value, net of reinsurance, beginning of period

   $ 1,360     $ 747     82 %   $ 1,182     $ 632     87 %

Deposits

     147       145     1 %     279       288     (3 )%

Interest credited and investment performance

     (17 )     29     (159 )%     61       16     NM (1)

Surrenders, benefits and product charges

     (30 )     (19 )   58 %     (62 )     (34 )   82 %
                                    

Account value, net of reinsurance, end of period

   $ 1,460     $ 902     62 %   $ 1,460     $ 902     62 %
                                    

Variable life insurance

            

Account value, beginning of period

   $ 377     $ 335     13 %   $ 363     $ 345     5 %

Deposits

     7       11     (36 )%     16       19     (16 )%

Interest credited and investment performance

     (5 )     11     (145 )%     13       —       NM (1)

Surrenders, benefits and product charges

     (12 )     (10 )   20 %     (25 )     (17 )   47 %
                                    

Account value, end of period

   $ 367     $ 347     6 %   $ 367     $ 347     6 %
                                    

Third-party assets

            

Account value, beginning of period

   $ 5,824     $ 4,046     44 %   $ 5,180     $ 3,973     30 %

Deposits

     643       359     79 %     1,225       683     79 %

Interest credited and investment performance

     (159 )     58     NM (1)     95       (38 )   NM (1)

Surrenders, benefits and product charges

     (165 )     (128 )   29 %     (357 )     (283 )   26 %
                                    

Account value, end of period

   $ 6,143     $ 4,335     42 %   $ 6,143     $ 4,335     42 %
                                    

(1) Not meaningful
(2) The Income Distribution Series offers variable annuity products and four riders that provide the contractholder with a guaranteed minimum income stream that they cannot outlive, along with an opportunity to participate in market appreciation.

Income Distribution Series. We experienced an increase in assets under management attributable to the launch of our guaranteed minimum withdrawal for life benefit rider in the fourth quarter of 2005. Sales of this product remained strong in the first half of 2006, achieving the highest production to date in the second quarter of 2006.

 

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Traditional variable annuities. The increase in assets under management was attributable to ongoing sales of our core income series variable annuity products and positive investment performance for the first six months of 2006.

Third-party assets. Third-party assets include assets managed by our Genworth Financial Asset Management and Genworth Financial Advisor groups. The increase was primarily due to growth in managed money accounts from new and existing clients, as well as positive investment performance during the last three quarters of 2005 and the first quarter of 2006. Significant contributors to the growth in deposits was the result of expansion of our distribution network, growth in our sales force, and changes in our fee structure.

Mortgage Insurance segment

In the U.S., Canada, Australia, Europe, New Zealand, Mexico and Japan, we offer mortgage insurance products that facilitate homeownership by enabling borrowers to buy homes with low-down-payment mortgages. These products generally also aid financial institutions in managing their capital efficiently by reducing the capital required for low-down-payment mortgages.

Segment results of operations

Three Months Ended June 30, 2006 Compared to Three Months Ended June 30, 2005

The following table sets forth the results of operations relating to our Mortgage Insurance segment for the three months ended June 30, 2006 and 2005:

 

    Three months ended
June 30,
  Increase (decrease) and
percentage change
 

(Amounts in millions)

      2006             2005                 2006 vs. 2005            

Revenues:

       

Premiums

  $ 267     $ 220   $ 47     21 %

Net investment income

    85       68     17     25 %

Net investment gains (losses)

    1       —       1     NM (1)

Policy fees and other income

    11       12     (1 )   (8 )%
                       

Total revenues

    364       300     64     21 %
                       

Benefits and expenses:

       

Benefits and other changes in policy reserves

    50       39     11     28 %

Acquisition and operating expenses, net of deferrals

    76       75     1     1 %

Amortization of deferred acquisition costs and intangibles

    13       13     —       —   %
                       

Total benefits and expenses

    139       127     12     9 %
                       

Earnings before income taxes

    225       173     52     30 %

Provision for income taxes

    62       52     10     19 %
                       

Segment net earnings

    163       121     42     35 %

Adjustments to segment net earnings:

       

Net investment losses (gains), net of taxes and other adjustments

    (1 )     —       (1 )   NM (1)
                       

Segment net operating earnings

  $ 162     $ 121   $ 41     34 %
                       

(1) Not meaningful

 

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The following table sets forth net operating earnings for the products included in our Mortgage Insurance segment for the three months ended June 30, 2006 and 2005:

 

     Three months ended
June 30,
   Increase (decrease) and
percentage change
 

(Amounts in millions)

       2006            2005            2006 vs. 2005      

Segment net operating earnings:

           

U.S. mortgage insurance

   $ 72    $ 61    $ 11    18 %

International mortgage insurance

     90      60      30    50 %
                       

Total segment net operating earnings

   $ 162    $ 121    $ 41    34 %
                       

Segment net operating earnings

Our U.S. mortgage insurance business net operating earnings increased by $11 million primarily due to lower administrative costs from productivity gains, higher net investment income and an increase in earnings from our intra-segment reinsurance and capital maintenance agreements with our international mortgage insurance business. The increase in our international mortgage insurance business net operating earnings of $30 million, which included $3 million, net of tax, of favorability due to changes in foreign exchange rates, was driven largely by the growth of the business, seasoning of our insurance in-force and a decrease in effective tax rate. These increases were partially offset by an increase in losses from portfolio seasoning and higher delinquencies from a limited number of Australian distribution relationships and continued investments in our global expansion.

Revenues

Our international mortgage insurance premiums increased by $44 million, which included an increase of $2 million associated with changes in foreign exchange rates, driven by the growth and aging of our international in-force block, which resulted in increased earned premiums from prior years new