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, 2008

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, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large Accelerated Filer  x

  Accelerated Filer  ¨

Non-accelerated Filer     ¨

  Smaller reporting company  ¨

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 August 1, 2008, 433,068,700 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. Financial Statements

   3

Condensed Consolidated Statements of Income for the three and six months ended June 30, 2008 and  2007 (Unaudited)

   3

Condensed Consolidated Balance Sheets as of June 30, 2008 (Unaudited) and December 31, 2007

   4

Condensed Consolidated Statements of Changes in Stockholders’ Equity for the six months ended June  30, 2008 and 2007 (Unaudited)

   5

Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2008 and 2007 (Unaudited)

   6

Notes to Condensed Consolidated Financial Statements (Unaudited)

   7

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

   23

Item 3. Quantitative and Qualitative Disclosures About Market Risk

   87

Item 4. Controls and Procedures

   87

PART II—OTHER INFORMATION

  

Item 1. Legal Proceedings

   88

Item 1A. Risk Factors

   89

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

   90

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

   90

Item 6. Exhibits

   90

Signatures

   91

 

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Table of Contents

PART I—FINANCIAL INFORMATION

Item 1. Financial Statements

GENWORTH FINANCIAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Amounts in millions, except per share amounts)

(Unaudited)

 

     Three months
ended June 30,
    Six months
ended June 30,
 
     2008     2007     2008     2007  

Revenues:

        

Premiums

   $ 1,709     $ 1,549     $ 3,426     $ 3,060  

Net investment income

     953       1,024       1,955       2,008  

Net investment gains (losses)

     (518 )     (51 )     (744 )     (70 )

Insurance and investment product fees and other

     254       243       514       477  
                                

Total revenues

     2,398       2,765       5,151       5,475  
                                

Benefits and expenses:

        

Benefits and other changes in policy reserves

     1,386       1,090       2,787       2,157  

Interest credited

     320       391       665       776  

Acquisition and operating expenses, net of deferrals

     551       495       1,079       984  

Amortization of deferred acquisition costs and intangibles

     209       207       412       420  

Interest expense

     110       124       222       231  
                                

Total benefits and expenses

     2,576       2,307       5,165       4,568  
                                

Income (loss) from continuing operations before income taxes

     (178 )     458       (14 )     907  

Provision (benefit) for income taxes

     (69 )     137       (21 )     272  
                                

Income (loss) from continuing operations

     (109 )     321       7       635  

Income from discontinued operations, net of taxes

     —         5       —         15  

Gain on sale of discontinued operations, net of taxes

     —         53       —         53  
                                

Net income (loss)

   $ (109 )   $ 379     $ 7     $ 703  
                                

Earnings (loss) from continuing operations per common share:

        

Basic

   $ (0.25 )   $ 0.73     $ 0.02     $ 1.44  
                                

Diluted

   $ (0.25 )   $ 0.72     $ 0.02     $ 1.41  
                                

Earnings (loss) per common share:

        

Basic

   $ (0.25 )   $ 0.86     $ 0.02     $ 1.60  
                                

Diluted

   $ (0.25 )   $ 0.84     $ 0.02     $ 1.56  
                                

Weighted-average common shares outstanding:

        

Basic

     432.9       439.4       433.3       440.2  
                                

Diluted

     432.9       449.0       434.8       452.0  
                                

See Notes to Condensed Consolidated Financial Statements

 

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GENWORTH FINANCIAL, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Amounts in millions, except per share amounts)

 

     June 30,
2008
    December 31,
2007
 
     (Unaudited)        

Assets

    

Investments:

    

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

   $ 51,887     $ 55,154  

Equity securities available-for-sale, at fair value

     409       366  

Commercial mortgage loans

     8,573       8,953  

Policy loans

     1,806       1,651  

Other invested assets

     4,614       4,676  
                

Total investments

     67,289       70,800  

Cash and cash equivalents

     5,861       3,091  

Accrued investment income

     679       773  

Deferred acquisition costs

     7,530       7,034  

Intangible assets

     991       914  

Goodwill

     1,618       1,600  

Reinsurance recoverable

     16,571       16,483  

Other assets

     1,320       822  

Separate account assets

     12,356       12,798  
                

Total assets

   $ 114,215     $ 114,315  
                

Liabilities and stockholders’ equity

    

Liabilities:

    

Future policy benefits

   $ 27,529     $ 26,740  

Policyholder account balances

     36,842       36,913  

Liability for policy and contract claims

     4,418       3,693  

Unearned premiums

     5,758       5,631  

Other liabilities

     6,093       6,255  

Non-recourse funding obligations

     3,455       3,455  

Short-term borrowings

     200       200  

Long-term borrowings

     4,531       3,903  

Deferred tax liability

     688       1,249  

Separate account liabilities

     12,356       12,798  
                

Total liabilities

     101,870       100,837  
                

Commitments and contingencies

    

Stockholders’ equity:

    

Class A common stock, $0.001 par value; 1.5 billion shares authorized; 521 million shares issued as of June 30, 2008 and December 31, 2007; 433 million and 436 million shares outstanding as of June 30, 2008 and December 31, 2007, respectively

     1       1  

Additional paid-in capital

     11,482       11,461  
                

Accumulated other comprehensive income (loss):

    

Net unrealized investment gains (losses)

     (1,723 )     (526 )

Derivatives qualifying as hedges

     548       473  

Foreign currency translation and other adjustments

     904       780  
                

Total accumulated other comprehensive income (loss)

     (271 )     727  

Retained earnings

     3,833       3,913  

Treasury stock, at cost (88 million and 85 million shares as of June 30, 2008 and December 31, 2007, respectively)

     (2,700 )     (2,624 )
                

Total stockholders’ equity

     12,345       13,478  
                

Total liabilities and stockholders’ equity

   $ 114,215     $ 114,315  
                

See Notes to Condensed Consolidated Financial Statements

 

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GENWORTH FINANCIAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

(Amounts in millions)

(Unaudited)

 

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

Balances as of December 31, 2006

  $ —     $ 10,759   $ 1,157     $ 2,914     $ (1,500 )   $ 13,330  
                 

Cumulative effect of accounting change

    —       —       —         (54 )     —         (54 )

Comprehensive income (loss):

           

Net income

    —       —       —         703       —         703  

Net unrealized gains (losses) on investment securities

    —       —       (616 )     —         —         (616 )

Derivatives qualifying as hedges

    —       —       (216 )     —         —         (216 )

Foreign currency translation and other adjustments

    —       —       225       —         —         225  
                 

Total comprehensive income (loss)

              96  

Issuance of common stock

    1     600     —         —         —         601  

Acquisition of treasury stock

    —       —       —         —         (998 )     (998 )

Dividends to stockholders

    —       —       —         (79 )     —         (79 )

Stock-based compensation expense and exercises

    —       67     —         —         —         67  

Other capital transactions

    —       3     —         —         —         3  
                                           

Balances as of June 30, 2007

  $ 1   $ 11,429   $ 550     $ 3,484     $ (2,498 )   $ 12,966  
                                           

 

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

Balances as of December 31, 2007

  $ 1   $ 11,461   $ 727     $ 3,913     $ (2,624 )   $ 13,478  
                 

Comprehensive income (loss):

           

Net income

    —       —       —         7       —         7  

Net unrealized gains (losses) on investment securities

    —       —       (1,197 )     —         —         (1,197 )

Derivatives qualifying as hedges

    —       —       75       —         —         75  

Foreign currency translation and other adjustments

    —       —       124       —         —         124  
                 

Total comprehensive income (loss)

              (991 )

Acquisition of treasury stock

    —       —       —         —         (76 )     (76 )

Dividends to stockholders

    —       —       —         (87 )     —         (87 )

Stock-based compensation expense and exercises

    —       21     —         —         —         21  
                                           

Balances as of June 30, 2008

  $ 1   $ 11,482   $ (271 )   $ 3,833     $ (2,700 )   $ 12,345  
                                           

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,
 
     2008     2007  

Cash flows from operating activities:

    

Net income

   $ 7     $ 703  

Less income from discontinued operations, net of taxes

     —         (15 )

Less gain on sale of discontinued operations, net of taxes

     —         (53 )

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

    

Amortization of fixed maturity discounts and premiums

     —         (4 )

Net investment losses (gains)

     744       70  

Charges assessed to policyholders

     (196 )     (195 )

Acquisition costs deferred

     (669 )     (739 )

Amortization of deferred acquisition costs and intangibles

     412       420  

Deferred income taxes

     54       153  

Purchases of trading securities and held-for-sale investments, net of proceeds from sales

     12       (20 )

Stock-based compensation expense

     15       23  

Change in certain assets and liabilities:

    

Accrued investment income and other assets

     (319 )     1  

Insurance reserves

     2,149       1,549  

Current tax liabilities

     (175 )     180  

Other liabilities and other policy-related balances

     86       444  

Cash from operating activities—discontinued operations

     —         25  
                

Net cash from operating activities

     2,120       2,542  
                

Cash flows from investing activities:

    

Proceeds from maturities and repayments of investments:

    

Fixed maturity securities

     2,318       2,945  

Commercial mortgage loans

     490       556  

Proceeds from sales of investments:

    

Fixed maturity and equity securities

     2,026       3,314  

Purchases and originations of investments:

    

Fixed maturity and equity securities

     (3,655 )     (7,863 )

Commercial mortgage loans

     (166 )     (1,001 )

Other invested assets, net

     3       (258 )

Policy loans, net

     (155 )     (146 )

Payments for businesses purchased, net of cash acquired

     (17 )     —    

Cash received from sale of discontinued operations, net of cash sold

     —         514  

Cash from investing activities—discontinued operations

     —         103  
                

Net cash from investing activities

     844       (1,836 )
                

Cash flows from financing activities:

    

Proceeds from issuance of investment contracts

     4,010       4,207  

Redemption and benefit payments on investment contracts

     (4,541 )     (4,552 )

Short-term borrowings and other, net

     (18 )     (63 )

Proceeds from issuance of non-recourse funding obligations

     —         790  

Repayment of long-term debt

     —         (500 )

Proceeds from the issuance of long-term debt

     597       349  

Dividends paid to stockholders

     (88 )     (79 )

Stock-based compensation awards exercised

     5       30  

Acquisition of treasury stock

     (76 )     (998 )

Proceeds from issuance of common stock

     —         600  

Cash from financing activities—discontinued operations

     —         (21 )
                

Net cash from financing activities

     (111 )     (237 )

Effect of exchange rate changes on cash and cash equivalents

     (83 )     18  
                

Net change in cash and cash equivalents

     2,770       487  

Cash and cash equivalents at beginning of period

     3,091       2,469  
                

Cash and cash equivalents at end of period

   $ 5,861     $ 2,956  
                

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 formation of certain insurance and related subsidiaries of the 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, which was an indirect subsidiary of GE.

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 have the following three operating segments:

 

   

Retirement and Protection. We offer a variety of protection, wealth accumulation, retirement income and institutional products. Protection products include: life insurance, long-term care insurance, Medicare supplement insurance and a linked-benefits product that combines long-term care insurance with universal life insurance. Additionally, we offer wellness and care coordination services for our long-term care policyholders. Our wealth accumulation and retirement income products include: fixed and variable deferred and immediate individual annuities, group variable annuities offered through retirement plans, and a variety of managed account programs, financial planning services and mutual funds. Institutional products include: funding agreements, funding agreements backing notes (“FABNs”) and guaranteed investment contracts (“GICs”).

 

   

International. In Canada, Australia, New Zealand, Mexico, Japan, South Korea and multiple European countries, we are a leading provider of mortgage insurance products. We are the largest private mortgage insurer in most of our international markets. We also provide mortgage insurance on a structured, or bulk, basis which aids in the sale of mortgages to the capital markets and helps lenders manage capital and risk. Additionally, we offer services, analytical tools and technology that enable lenders to operate efficiently and manage risk. We also offer payment protection coverages in multiple European countries, Canada, South Korea and Mexico. Our payment protection insurance products help consumers meet specified payment obligations should they become unable to pay due to accident, illness, involuntary unemployment, disability or death.

 

   

U.S. Mortgage Insurance. In the U.S., we offer mortgage insurance products predominantly insuring prime-based, individually underwritten residential mortgage loans, also known as “flow” mortgage insurance. We selectively provide mortgage insurance on a structured, or bulk, basis with essentially all of our bulk writings prime-based. Additionally, we offer services, analytical tools and technology that enable lenders to operate efficiently and manage risk.

We also have Corporate and Other activities which include debt financing expenses that are incurred at our holding company level, unallocated corporate income and expenses, eliminations of inter-segment transactions, the results of non-core businesses that are managed outside of our operating segments and our group life and health insurance business, which we sold on May 31, 2007.

The accompanying condensed consolidated financial statements are unaudited and have been prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”) and rules and regulations of the U.S. Securities and Exchange Commission (“SEC”). Preparing financial statements in conformity with U.S.

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

GAAP requires us to make estimates and assumptions that affect reported amounts and related disclosures. Actual results could differ from those estimates. These condensed consolidated financial statements include all adjustments considered necessary by management to present a fair statement of the financial position, results of operations and cash flows 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 consolidated financial statements and related notes contained in our 2007 Annual Report on Form 10-K.

(2) Accounting Pronouncements

Recently adopted

Fair Value Measurements

As of January 1, 2008, we adopted Statement of Financial Accounting Standards (“SFAS”) No. 157, Fair Value Measurements. This statement defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. The adoption of SFAS No. 157 did not have a material impact on our consolidated financial statements. Additionally, on January 1, 2008, we elected the partial adoption of SFAS No. 157 under the provisions of Financial Accounting Standards Board (“FASB”) Staff Position (“FSP”) FAS 157-2, which amends SFAS No. 157 to allow an entity to delay the application of this statement until January 1, 2009 for certain non-financial assets and liabilities. Under the provisions of the FSP, we will delay the application of SFAS No. 157 for fair value measurements used in the impairment testing of goodwill and indefinite-lived intangible assets and eligible non-financial assets and liabilities included within a business combination. In January 2008, FASB also issued proposed FSP FAS 157-c that would amend SFAS No. 157 to clarify the principles on fair value measurement of liabilities. Management is monitoring the status of this proposed FSP for any impact on our consolidated financial statements. See note 6 for additional disclosures about fair value measurement.

Fair Value Option for Financial Assets and Financial Liabilities

As of January 1, 2008, we adopted SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities. This statement provides an option, on specified election dates, to report selected financial assets and liabilities, including insurance contracts, at fair value. Subsequent changes in fair value for designated items are reported in income in the current period. The adoption of SFAS No. 159 did not impact our consolidated financial statements as no items were elected for measurement at fair value upon initial adoption. We will continue to evaluate eligible financial assets and liabilities on their election dates. Any future elections will be disclosed in accordance with the provisions outlined in the statement.

Amendment of FASB Interpretation No. 39

As of January 1, 2008, we adopted FSP FASB Interpretation (“FIN”) No. 39-1, Amendment of FASB Interpretation No. 39. This FSP amends FIN No. 39, Offsetting of Amounts Related to Certain Contracts, to allow fair value amounts recognized for collateral to be offset against fair value amounts recognized for derivative instruments that are executed with the same counterparty under certain circumstances. The FSP also requires an entity to disclose the accounting policy decision to offset, or not to offset, fair value amounts in accordance with FIN No. 39, as amended. We do not, and have not previously, offset the fair value amounts recognized for derivatives with the amounts recognized as collateral. See note 5 for additional disclosures about the collateral positions related to derivative instruments.

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

Not yet adopted

In March 2008, FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities—an amendment of FASB Statement No. 133. This statement requires enhanced disclosures about an entity’s derivative and hedging activities. SFAS No. 161 will be effective for us on January 1, 2009. We do not expect SFAS No. 161 to have a material impact on our consolidated financial statements.

In December 2007, FASB issued SFAS No. 141R, Business Combinations. This statement establishes principles and requirements for how an acquirer recognizes and measures certain items in a business combination, as well as disclosures about the nature and financial effects of a business combination. SFAS No. 141R will be effective for us on January 1, 2009 and will be applied to business combinations for which the acquisition date is on or after the effective date. We do not expect SFAS No. 141R to have a material impact on our consolidated financial statements.

In December 2007, FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements—an amendment of ARB No. 51. This statement establishes accounting and reporting standards for noncontrolling interests in a subsidiary and for deconsolidation of a subsidiary. SFAS No. 160 will be effective for us on January 1, 2009 and will be applied prospectively as of the effective date. We do not expect SFAS No. 160 to have a material impact on our consolidated financial statements.

(3) Earnings (Loss) Per Share

Basic and diluted earnings (loss) per share are calculated by dividing net income (loss) by the weighted average basic shares outstanding and by the weighted average diluted shares outstanding:

 

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

(Amounts in millions, except per share amounts)

       2008             2007            2008            2007    

Basic earnings (loss) per common share:

          

Income (loss) from continuing operations

   $ (0.25 )   $ 0.73    $ 0.02    $ 1.44

Income from discontinued operations, net of taxes

     —         0.01      —        0.03

Gain on sale from discontinued operations, net of taxes

     —         0.12      —        0.12
                            

Basic earnings (loss) per common share(1)

   $ (0.25 )   $ 0.86    $ 0.02    $ 1.60
                            

Diluted earnings (loss) per common share:

          

Income (loss) from continuing operations

   $ (0.25 )   $ 0.72    $ 0.02    $ 1.41

Income from discontinued operations, net of taxes

     —         0.01      —        0.03

Gain on sale from discontinued operations, net of taxes

     —         0.12      —        0.12
                            

Diluted earnings (loss) per common share(1)

   $ (0.25 )   $ 0.84    $ 0.02    $ 1.56
                            

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

     432.9       439.4      433.3      440.2

Potentially dilutive securities:

          

Stock purchase contracts underlying Equity Units

     —         4.3      —        6.3

Stock options, restricted stock units and stock appreciation rights

     —         5.3      1.5      5.5
                            

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

     432.9       449.0      434.8      452.0
                            

 

(1)

May not total due to whole number calculation.

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

(4) Discontinued Operations

Sale of Group Life and Health Insurance Business

On May 31, 2007, we completed the sale of our group life and health insurance business for gross cash proceeds of approximately $660 million. Accordingly, the business was accounted for as discontinued operations and its results of operations, financial position and cash flows are separately reported for all periods presented. The sale resulted in a gain on sale of discontinued operations of $53 million, net of taxes.

Summary operating results of discontinued operations were as follows for the periods indicated:

 

(Amounts in millions)

   Three months ended
June 30, 2007
   Six months ended
June 30, 2007

Revenues

   $ 129    $ 318
             

Income before income taxes

   $ 8    $ 24

Provision for income taxes

     3      9
             

Income from discontinued operations, net of taxes

   $ 5    $ 15
             

(5) Investments and Derivative Instruments

Net Investment Gains (Losses)

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

 

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

(Amounts in millions)

       2008             2007             2008             2007      

Available-for-sale securities:

        

Realized gains on sale

   $ 49     $ 3     $ 63     $ 8  

Realized losses on sale

     (25 )     (35 )     (35 )     (59 )

Impairments

     (552 )     (14 )     (739 )     (14 )

Net unrealized gains (losses) on trading securities

     2       (1 )     (5 )     1  

Derivatives

     8       (3 )     (26 )     (4 )

Commercial mortgage loans

     (2 )     (1 )     —         (2 )

Other

     2       —         (2 )     —    
                                

Net investment gains (losses)

   $ (518 )   $ (51 )   $ (744 )   $ (70 )
                                

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

Fixed Maturity and Equity Securities

As of June 30, 2008, the amortized cost or cost, gross unrealized gains (losses) and fair value of our fixed maturity and equity securities classified as available-for-sale were as follows:

 

(Amounts in millions)

   Amortized
cost or
cost
   Gross
unrealized
gains
   Gross
unrealized
losses
    Fair
value

Fixed maturity securities:

          

U.S. government, agencies and government sponsored entities

   $ 519    $ 18    $ (6 )   $ 531

Tax exempt

     2,393      54      (75 )     2,372

Government—non U.S.

     2,767      73      (44 )     2,796

U.S. corporate

     23,315      254      (1,341 )     22,228

Corporate—non U.S.

     12,956      70      (615 )     12,411

Mortgage and asset-backed

     12,934      80      (1,465 )     11,549
                            

Total fixed maturity securities

     54,884      549      (3,546 )     51,887

Equity securities

     414      25      (30 )     409
                            

Total available-for-sale securities

   $ 55,298    $ 574    $ (3,576 )   $ 52,296
                            

As of December 31, 2007, the amortized cost or cost, gross unrealized gains (losses) and fair value of our fixed maturity and equity securities classified as available-for-sale were as follows:

 

(Amounts in millions)

   Amortized
cost or
cost
   Gross
unrealized
gains
   Gross
unrealized
losses
    Fair
value

Fixed maturity securities:

          

U.S. government, agencies and government sponsored entities

   $ 560    $ 36    $ (2 )   $ 594

Tax exempt

     2,165      87      (24 )     2,228

Government—non U.S.

     2,340      103      (11 )     2,432

U.S. corporate

     23,806      470      (713 )     23,563

Corporate—non U.S.

     12,803      141      (365 )     12,579

Mortgage and asset-backed

     14,428      134      (804 )     13,758
                            

Total fixed maturity securities

     56,102      971      (1,919 )     55,154

Equity securities

     341      34      (9 )     366
                            

Total available-for-sale securities

   $ 56,443    $ 1,005    $ (1,928 )   $ 55,520
                            

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

The following table presents the gross unrealized losses and 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, 2008:

 

     Less Than 12 Months    12 Months or More

(Dollar amounts in millions)

   Fair
value
   Gross
unrealized
losses
    # of
securities
   Fair
value
   Gross
unrealized
losses
    # of
securities

Description of Securities

               

Fixed maturity securities:

               

U.S. government, agencies and
government sponsored entities

   $ 214    $ (6 )   21    $ —      $ —       —  

Tax exempt

     665      (33 )   214      199      (42 )   38

Government—non U.S.

     879      (37 )   204      111      (7 )   34

U.S. corporate

     9,067      (534 )   968      6,420      (807 )   566

Corporate—non U.S.

     5,393      (256 )   856      4,256      (359 )   407

Mortgage and asset-backed

     5,396      (526 )   611      4,667      (939 )   767
                                       

Subtotal, fixed maturity securities

     21,614      (1,392 )   2,874      15,653      (2,154 )   1,812

Equity securities

     238      (28 )   26      19      (2 )   2
                                       

Total temporarily impaired securities

   $ 21,852    $ (1,420 )   2,900    $ 15,672    $ (2,156 )   1,814
                                       

% Below cost—fixed maturity securities:

               

<20% Below cost

   $ 20,781    $ (977 )   2,687    $ 13,964    $ (1,251 )   1,433

20-50% Below cost

     775      (313 )   158      1,540      (634 )   288

>50% Below cost

     58      (102 )   29      149      (269 )   91
                                       

Total fixed maturity securities

     21,614      (1,392 )   2,874      15,653      (2,154 )   1,812
                                       

% Below cost—equity securities:

               

<20% Below cost

     218      (20 )   19      16      (1 )   1

20-50% Below cost

     20      (8 )   7      3      (1 )   1
                                       

Total equity securities

     238      (28 )   26      19      (2 )   2
                                       

Total temporarily impaired securities

   $ 21,852    $ (1,420 )   2,900    $ 15,672    $ (2,156 )   1,814
                                       

Investment grade

   $ 20,734    $ (1,317 )   2,615    $ 14,757    $ (1,976 )   1,604

Below investment grade

     1,052      (96 )   261      898      (173 )   202

Not rated—fixed maturity securities

     44      (1 )   15      17      (7 )   8

Not rated—equities

     22      (6 )   9              
                                       

Total temporarily impaired securities

   $ 21,852    $ (1,420 )   2,900    $ 15,672    $ (2,156 )   1,814
                                       

The investment securities in an unrealized loss position as of June 30, 2008 consisted of 4,714 securities and accounted for unrealized losses of $3,576 million. Of these unrealized losses of $3,576 million, 92% were investment grade (rated AAA through BBB-) and 63% were less than 20% below cost. The securities less than 20% below cost were primarily corporate securities and mortgage-backed and asset-backed securities. The amount of the unrealized loss on these securities was primarily attributed to widening credit spreads during 2008.

Of the 37% of investment securities that were more than 20% below cost, a majority were mortgage-backed and asset-backed securities that have been in an unrealized loss position for twelve months or more. With current events in the credit markets, rating agencies have actively reviewed their credit quality ratings on these securities

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

and these securities remain primarily investment grade. We are comfortable with the performance of the underlying collateral and expect that our investments in mortgage-backed and asset-backed securities will continue to perform in accordance with their contractual terms with no adverse changes in cash flows.

Of the investment securities in an unrealized loss position for twelve months or more as of June 30, 2008, 380 securities were 20% or more below cost, of which 44 securities were also below investment grade (rated BB+ and below) and accounted for unrealized losses of $101 million. These securities, which were issued primarily by corporations in the communication, consumer cyclical, industrial and financial services industries and residential mortgage-backed securities, were current on all terms. We expect to collect full principal and interest and we are not aware of any adverse changes in cash flows.

As of June 30, 2008, we expect these investments to continue to perform in accordance with their original contractual terms and we 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 at maturity. Accordingly, we do not consider these investments to be other-than-temporarily impaired as of June 30, 2008. 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.

Expectations that our investments in residential mortgage-backed securities will continue to perform in accordance with their contractual terms are based on assumptions a market participant would use in determining the current fair value. It is at least reasonably possible that the underlying collateral of these investments will perform worse than current market expectations. Such events may lead to adverse changes in cash flows on our holdings of residential mortgage-backed securities and potential future write-downs within our portfolio of residential mortgage-backed securities.

Derivative Instruments

The fair value of derivative instruments is based upon either pricing obtained from market sources or pricing valuation models utilizing market inputs obtained from market sources. The following table sets forth our positions in derivative instruments and the fair values as of the dates indicated:

 

     June 30, 2008    December 31, 2007

(Amounts in millions)

   Notional
value
   Assets    Liabilities    Notional
value
   Assets    Liabilities

Interest rate swaps

   $ 26,420    $ 834    $ 90    $ 23,138    $ 740    $ 74

Foreign currency swaps

     759      76      14      759      33      14

Forward commitments

     —        —        —        2      —        —  

Equity index options

     1,326      217      —        979      127      —  

Credit default swaps

     182      1      1      10      —        —  

Financial futures

     301      —        —        106      —        —  
                                         

Total derivatives

   $ 28,988    $ 1,128    $ 105    $ 24,994    $ 900    $ 88
                                         

The fair value of derivative assets was recorded in other invested assets and the fair value of derivative liabilities was recorded in other liabilities. As of June 30, 2008 and December 31, 2007, the fair value presented in the preceding table included $242 million and $147 million, respectively, of derivative assets and $35 million and $23 million, respectively, of derivative liabilities that do not qualify for hedge accounting.

Swaps and purchased options with contractual maturities longer than one year are conducted within our credit policy constraints. Our policy permits us to enter into derivative transactions with counterparties rated “A2” by Moody’s and “A” by S&P if the agreements governing such transactions require both us and the counterparties to provide collateral in certain circumstances. As of June 30, 2008 and December 31, 2007, we

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

retained collateral of $478 million and $372 million, respectively, related to these agreements including over collateralization from certain counterparties. As of June 30, 2008 and December 31, 2007, we provided no collateral. The fair value of derivative positions presented above was not offset by the respective collateral amounts retained or provided under these agreements. The amounts recognized for the obligation to return collateral retained by us and the right to reclaim collateral from counterparties was recorded in other liabilities and other assets, respectively.

(6) Fair Value Measurement

As defined in SFAS No. 157, fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. We hold fixed maturity and equity securities, trading securities, derivatives, embedded derivatives, securities held as collateral, separate account assets and certain other financial instruments, which are carried at fair value.

Fair value measurements are generally based upon observable and unobservable inputs. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect our view of market assumptions in the absence of observable market information. We utilize valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. SFAS No. 157 requires all assets and liabilities carried at fair value to be classified and disclosed in one of the following three categories:

 

   

Level 1—Quoted prices for identical instruments in active markets.

 

   

Level 2—Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable.

 

   

Level 3—Instruments whose significant value drivers are unobservable.

Level 1 primarily consists of financial instruments whose value is based on quoted market prices such as exchange-traded derivatives and actively traded mutual fund investments.

Level 2 includes those financial instruments that are valued using industry-standard pricing methodologies, models or other valuation methodologies. These models are primarily industry-standard models that consider various inputs, such as interest rate, credit spread and foreign exchange rates for the underlying financial instruments. All significant inputs are observable, or derived from observable, information in the marketplace or are supported by observable levels at which transactions are executed in the marketplace. Financial instruments in this category primarily include: certain public and private corporate fixed maturity and equity securities; government or agency securities; certain mortgage-backed and asset-backed securities; securities held as collateral; and certain non-exchange-traded derivatives such as interest rate or cross currency swaps.

Level 3 is comprised of financial instruments whose fair value is estimated based on industry-standard pricing methodologies and internally developed models utilizing significant inputs not based on, nor corroborated by, readily available market information. This category primarily consists of certain less liquid fixed maturity, equity and trading securities and certain derivative instruments where we cannot corroborate the significant valuation inputs with market observable data.

As of each reporting period, all assets and liabilities recorded at fair value are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability, such as the relative impact on the fair value as a result of including a particular input.

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

The vast majority of our fixed maturity and equity securities use Level 2 inputs for the determination of fair value. These fair values are obtained primarily from industry-standard pricing methodologies based on market observable information. Certain structured securities valued using industry-standard pricing methodologies utilize significant unobservable inputs to estimate fair value, resulting in the fair value measurements being classified as Level 3. We also utilize internally developed pricing models to produce estimates of fair value primarily utilizing Level 2 inputs along with certain Level 3 inputs. The internally developed models include matrix pricing where we discount expected cash flows utilizing market interest rates obtained from market sources based on the credit quality and duration of the instrument to determine fair value. For securities that may not be reliably priced using internally developed pricing models, we estimate fair value using indicative market prices. These prices are indicative of an exit price, but the assumptions used to establish the fair value may not be observable, or corroborated by market observable information, and represent Level 3 inputs.

The fair value of securities held as collateral is primarily based on Level 2 inputs from market information for the collateral that is held on our behalf by the custodian. The fair value of separate account assets is based on the quoted prices of the underlying fund investments and, therefore, represents Level 1 pricing.

As discussed above, the classification of fair value measurements for derivative instruments, including embedded derivatives requiring bifurcation, is determined based on consideration of several inputs including: closing exchange or over-the-counter market price quotations; time value and volatility factors underlying options; foreign exchange rates; market interest rates; and non-performance risk. For product-related embedded derivatives, we also include certain policyholder assumptions in the determination of fair value.

The following table sets forth our assets that were measured at fair value on a recurring basis as of the date indicated:

 

     June 30, 2008

(Amounts in millions)

   Total    Level 1    Level 2    Level 3

Investments:

           

Fixed maturity securities, available-for-sale

   $ 51,887    $ —      $ 47,206    $ 4,681

Equity securities, available-for-sale

     409      30      370      9

Other invested assets(a)

     3,397      —        2,988      409

Separate account assets

     12,356      12,356      —        —  
                           

Total assets

   $ 68,049    $ 12,386    $ 50,564    $ 5,099
                           

 

(a)

Includes derivatives, trading securities and securities held as collateral.

The following table sets forth our liabilities that were measured at fair value on a recurring basis as of the date indicated:

 

     June 30, 2008

(Amounts in millions)

   Total    Level 1    Level 2    Level 3

Policyholder account balances(a)

   $ 78    $ —      $ —      $ 78

Other liabilities(b)

     105      —        105      —  
                           

Total liabilities

   $   183    $ —      $ 105    $ 78
                           

 

(a)

Represents the fair value of certain product-related embedded derivatives that were recorded at fair value.

(b)

Represents derivative instruments.

For assets carried at fair value, the non-performance of the counterparties is considered in the determination of fair value measurement for those assets. Similarly, the fair value measurement of a liability must reflect the entity’s own non-performance risk. Therefore, the impact of non-performance risk, as well as any potential credit enhancements (e.g., collateral), has been considered in the fair value measurement of both assets and liabilities.

 

15


Table of Contents

GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

The following tables present additional information about assets measured at fair value on a recurring basis and for which we have utilized significant unobservable (Level 3) inputs to determine fair value as of and for the dates indicated:

 

     Three months
ended June 30, 2008
 

(Amounts in millions)

   Fixed maturity
securities,
available-for-sale
    Equity
securities,
available-for-sale
    Other
invested
assets(a)
    Total  

Beginning balance as of April 1, 2008

   $ 4,770     $ 28     $ 401     $ 5,199  

Total realized and unrealized gains (losses):

        

Included in net income (loss)

     (403 )     —         (19 )     (422 )

Included in other comprehensive income (loss)

     214       2       —         216  

Purchases, sales, issuances and settlements, net

     (233 )     (21 )     27       (227 )

Transfers in (out) of Level 3

     333       —         —         333  
                                

Ending balance as of June 30, 2008

   $ 4,681     $ 9     $ 409     $ 5,099  
                                

Amount of total gains (losses) for the period included in net income (loss) attributable to the change in unrealized gains (losses) relating to assets still held as of the reporting date

   $ (404 )   $ —       $ (20 )   $ (424 )
                                

 

(a)

Includes certain trading securities and derivatives.

 

     Six months
ended June 30, 2008
 

(Amounts in millions)

   Fixed maturity
securities,
available-for-sale
    Equity
securities,
available-for-sale
    Other
invested
assets(a)
   Total  

Beginning balance as of January 1, 2008

   $ 4,794     $ 30     $ 319    $ 5,143  

Total realized and unrealized gains (losses):

         

Included in net income (loss)

     (498 )     1       16      (481 )

Included in other comprehensive income (loss)

     (190 )     —         —        (190 )

Purchases, sales, issuances and settlements, net

     (258 )     (23 )     62      (219 )

Transfers in (out) of Level 3

     833       1       12      846  
                               

Ending balance as of June 30, 2008

   $ 4,681     $ 9     $ 409    $ 5,099  
                               

Amount of total gains (losses) for the period included in net income (loss) attributable to the change in unrealized gains (losses) relating to assets still held as of the reporting date

   $ (499 )   $ —       $ 16    $ (483 )
                               

 

(a)

Includes certain trading securities and derivatives.

 

16


Table of Contents

GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

The following tables present additional information about liabilities measured at fair value on a recurring basis and for which we have utilized significant unobservable (Level 3) inputs to determine fair value as of and for the dates indicated:

 

     Three months ended
June 30, 2008
 

(Amounts in millions)

   Policyholder
account

balances(a)
 

Beginning balance as of April 1, 2008

   $ 115  

Total realized and unrealized (gains) losses:

  

Included in net (income) loss

     (40 )

Included in other comprehensive (income) loss

     —    

Purchases, sales, issuances and settlements, net

     3  

Transfers in (out) of Level 3

     —    
        

Ending balance as of June 30, 2008

   $ 78  
        

Amount of total (gains) losses for the period included in net (income) loss attributable to the change in unrealized (gains) losses relating to liabilities still held as of the reporting date

   $ (40 )
        

 

(a)

Includes product-related embedded derivatives.

 

      Six months ended
June 30, 2008

(Amounts in millions)

   Policyholder
account
balances(a)

Beginning balance as of January 1, 2008

   $ 34

Total realized and unrealized (gains) losses:

  

Included in net (income) loss

     38

Included in other comprehensive (income) loss

     —  

Purchases, sales, issuances and settlements, net

     6

Transfers in (out) of Level 3

     —  
      

Ending balance as of June 30, 2008

   $ 78
      

Amount of total (gains) losses for the period included in net (income) loss attributable to the change in unrealized (gains) losses relating to liabilities still held as of the reporting date

   $ 39
      

 

(a)

Includes product-related embedded derivatives.

Realized and unrealized gains (losses) on Level 3 assets and liabilities are primarily reported in either net investment gains (losses) within the consolidated statements of income or other comprehensive income (loss) within stockholders’ equity based on the appropriate accounting treatment for the instrument.

Purchases, sales, issuances and settlements, net, represent the activity that occurred during the period that results in a change of the asset or liability but does not represent changes in fair value for the instruments held at the beginning of the period. Such activity primarily consists of purchases and sales of fixed maturity, equity and trading securities and purchases and settlements of derivative instruments.

 

17


Table of Contents

GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

Purchases, sales, issuances and settlements, net, presented for policyholder account balances represent the issuances and settlements of product-related embedded derivatives where: issuances are characterized as the change in fair value associated with the product fees recognized that are attributed to the embedded derivative to equal the expected future benefit costs upon issuance; and settlements are characterized as the change in fair value upon exercising the embedded derivative instrument, effectively representing a settlement of the embedded derivative instrument. We have shown these changes in fair value separately based on the classification of this activity as effectively issuing and settling the embedded derivative instrument with all remaining changes in the fair value of these embedded derivative instruments being shown separately in the category labeled “included in net income (loss)” in the tables presented above. However, due to the characteristics of these embedded derivatives, the total change in fair value was reflected in income (loss) for the period.

We review the fair value hierarchy classifications each reporting period. Changes in the observability of the valuation attributes may result in a reclassification of certain financial assets or liabilities. Such reclassifications are reported as transfers in and out of Level 3 at the beginning fair value for the reporting period in which the changes occur.

The amount presented for unrealized gains (losses) for assets and liabilities still held as of the reporting date primarily represents impairments for available-for-sale securities, changes in fair value of trading securities and certain derivatives and changes in fair value of certain product-related embedded derivatives that exist as of the reporting date, which were recorded in net investment gains (losses).

As of June 30, 2008, we held investments in bank loans that were recorded at the lower of cost or fair value and were recorded in other invested assets. As of June 30, 2008, all bank loans were recorded at cost, which was lower than the respective fair value. Accordingly, no fair value adjustment was made for the three months ended June 30, 2008. For the six months ended June 30, 2008, we recorded a $3 million fair value loss adjustment which was included in net investment gains (losses) in the condensed consolidated statement of income. Fair value for bank loans is determined using inputs based on market observable information and is classified as Level 2.

(7) Commitments and Contingencies

(a) Litigation

We face the 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 indeterminate amounts 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 reputational harm, which could have an adverse effect on our business, financial condition or results of operations. At this time, it is not feasible to predict, nor to determine the ultimate outcomes of all pending investigations and legal proceedings, nor to provide reasonable ranges of potential losses.

Between March and July 2008, we were named along with several other GIC industry participants as a defendant in several class action lawsuits alleging antitrust violations involving the sale of GICs to municipalities and seeking treble damages. In June 2008, the United States Judicial Panel on Multi-District Litigation consolidated the federal cases for pre-trial proceedings in the United States District Court for the Southern District of New York under the case name In re Municipal Derivative Antitrust Litigation. In addition, in July

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

2008, we were named along with several other GIC industry participants as a defendant in two separate non-class action lawsuits brought by municipalities alleging fraud and violations of California’s antitrust laws relating to the sale of GICs to each municipality and seeking monetary damages: City of Los Angeles v. Bank of America, N.A., et al. (Superior Court of Los Angeles County, California) and City of Stockton v. Bank of America, N.A., et al., (Superior Court of San Francisco County, California). We intend to defend the cases vigorously. 

In June 2008, one of our subsidiaries received subpoenas from the Office of the Florida Attorney General and the Office of the Connecticut Attorney General, representing multiple state Attorney General offices, seeking information relating to an investigation into alleged antitrust violations involving the sale of GICs to municipalities. We have not issued and do not currently issue GICs to municipalities, but from January 2004 to December 2006, our subsidiary provided management and administrative services to a third party that does issue GICs to municipalities. We are cooperating fully with respect to these investigations.

As previously reported, one of our U.S. mortgage insurance subsidiaries received an administrative subpoena in February 2006 from the Minnesota Department of Commerce with respect to our reinsurance arrangements, including captive reinsurance transactions, as part of an industry-wide review. In recent months, the Minnesota Department has requested additional information. In addition, in June 2008, the same subsidiary received from the Minneapolis, Minnesota office of the Inspector General for the U.S. Department of Housing and Urban Development a subpoena requesting information substantially similar to the Minnesota Department’s request. We have responded to these industry-wide regulatory inquiries and follow-up inquiries, and will cooperate with respect to any follow-up requests or inquiries where jurisdiction is appropriate.

As previously reported, the U.K. antitrust authorities are conducting a review of the payment protection insurance sector in the U.K. In June 2008, the antitrust authorities issued their provisional findings and a range of proposed remedies to address the antitrust issues identified in their findings. The antitrust authorities are consulting on the proposed remedies with industry and other stakeholders so at this stage it is not clear what remedies will be implemented. We are actively participating in the consultation process. It therefore remains unclear as to what the effect that this investigation may have on the wider payment protection insurance sector in the U.K. or on our payment protection insurance business in the U.K.

(b) Commitments

As of June 30, 2008, we were committed to fund $18 million in U.S. commercial mortgage loan investments and $485 million in limited partnership investments.

(8) Borrowings and Other Financings

Commercial Paper Facility

We have a $1.0 billion commercial paper program. The notes under the 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. As of June 30, 2008 and December 31, 2007, we had $200 million of commercial paper outstanding. As of June 30, 2008 and December 31, 2007, the weighted average interest rate on commercial paper outstanding was 2.37% and 4.83%, respectively, and the weighted average maturity was 35 days and 42 days, respectively.

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

Revolving Credit Facilities

We have two $1.0 billion five-year revolving credit facilities that mature in May 2012 and August 2012. These facilities bear variable interest rates based on one-month LIBOR plus a margin. As of June 30, 2008, we had no borrowings under these facilities; however, we utilized $172 million of the commitment under these facilities for the issuance of a letter of credit primarily for the benefit of one of our U.S. Mortgage Insurance subsidiaries.

Long-term Senior Notes

In May 2008, we issued senior notes having an aggregate principal amount of $600 million, with an interest rate equal to 6.515% per year payable semi-annually, and maturing in May 2018 (“2018 Notes”). The 2018 Notes are our direct, unsecured obligations and will rank equally with all of our existing and future unsecured and unsubordinated obligations. We have the option to redeem all or a portion of the 2018 Notes at any time with proper notice to the note holders at a price equal to the greater of 100% of principal or the sum of the present value of the remaining scheduled payments of principal and interest discounted at the then-current treasury rate plus an applicable spread.

Non-recourse Funding Obligations

As of June 30, 2008, we had $3.5 billion of fixed and floating rate non-recourse funding obligations outstanding backing additional statutory reserves, of which $1.7 billion were guaranteed by third-party financial guaranty insurance companies. The interest rates on these obligations are subject to rate resets triggered by negative rating agency action on the third-party financial guaranty insurance companies that guarantee these obligations. In June 2008, the maximum rate on $1.2 billion of the $1.7 billion of non-recourse funding obligations was contractually reset to the highest margin to the related underlying index rate due to the third-party financial guaranty insurance company that guarantees these obligations being downgraded and placed on negative outlook. In February 2008, the rate was reset from the December 2007 rate on the remaining $0.5 billion to the highest contractual margin to the related underlying index rate due to further downgrades on the third-party financial guaranty insurance company that guarantees these obligations.

As of June 30, 2008 and December 31, 2007, the weighted average interest rates on our non-recourse funding obligations were 3.60% and 5.81%, respectively.

Commercial Mortgage Loan Repurchase Facility

In March 2007, Genworth Financial Commercial Mortgage Warehouse LLC, an indirect subsidiary of Genworth, entered into a $300 million repurchase facility maturing in March 2010. The sole purpose of this facility was to finance the purchase of commercial mortgage loans with the intent to securitize such loans in the future. This facility had a variable interest rate based on one-month LIBOR plus a margin. In February 2008, Genworth Financial Commercial Warehouse LLC terminated this facility and repaid all amounts outstanding.

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

(9) Income Taxes

The reconciliation of the federal statutory tax rate to the effective income tax rate was as follows:

 

     Three months
ended June 30,
    Six months
ended June 30,
 
     2008     2007     2008     2007  

Statutory U.S. federal income tax rate

   35.0 %   35.0 %   35.0 %   35.0 %

Increase (reduction) in rate resulting from:

        

State income tax, net of federal income tax effect

   0.3     0.4     (1.1 )   0.3  

Effect of foreign operations

   (0.1 )   (3.9 )   43.8     (3.7 )

Benefit of tax favored investments

   (5.7 )   (2.2 )   (30.6 )   (2.5 )

Interest on uncertain tax positions

   9.0     0.7     100.3     0.7  

Other, net

   0.3     (0.1 )   2.6     0.2  
                        

Effective rate

   38.8 %   29.9 %   150.0 %   30.0 %
                        

The effective tax rate changed significantly from the prior year due to a current year loss, which reduced expected full year pre-tax income, and favorable examination developments in the current period creating a non-proportional increase in tax benefit relative to the pre-tax loss.

 

(10) Segment Information

We conduct our operations in three operating business segments: (1) Retirement and Protection, which includes our wealth management (formerly referred to as managed money) products and services, retirement income products, institutional products, life insurance and long-term care insurance; (2) International, which includes international mortgage insurance and payment protection insurance; and (3) U.S. Mortgage Insurance, which includes mortgage insurance-related products and services that facilitate homeownership by enabling borrowers to buy homes with low-down-payment mortgages. We also have Corporate and Other activities which include interest and other debt financing expenses, other corporate income and expenses not allocated to the segments, eliminations of inter-segment transactions and the results of non-core businesses that are managed outside of our operating segments. Our group life and health insurance business, which we sold in May 2007, was accounted for as discontinued operations and included in Corporate and Other activities.

We use the same accounting policies and procedures to measure segment income (loss) and assets as our consolidated net income (loss) and assets. Our chief operating decision maker evaluates segment performance and allocates resources on the basis of “net operating income (loss).” We define net operating income (loss) as income (loss) from continuing operations excluding after-tax net investment gains (losses) and other adjustments and infrequent or unusual non-operating items. We exclude net investment gains (losses) and infrequent or unusual non-operating items because we do not consider them to be related to the operating performance of our segments and Corporate and Other activities. A significant component of our net investment gains (losses) is the result of impairments, including changes in intent to hold securities to recovery, and credit-related gains and losses, the timing of which can vary significantly depending on market credit cycles. In addition, the size and timing of other investment gains (losses) are often subject to our discretion and are influenced by market opportunities, as well as asset-liability matching considerations. Infrequent or unusual non-operating items are also excluded from net operating income (loss) if, in our opinion, they are not indicative of overall operating trends. While some of these items may be significant components of net income (loss) in accordance with U.S. GAAP, we believe that net operating income (loss), and measures that are derived from or incorporate net operating income (loss), are appropriate measures that are useful to investors because they identify the income (loss) attributable to the ongoing operations of the business. However, net operating income (loss) is not a

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

substitute for net income (loss) determined in accordance with U.S. GAAP. In addition, our definition of net operating income (loss) may differ from the definitions used by other companies.

There were no infrequent or unusual non-operating items excluded from net operating income (loss) during the periods presented other than a $14 million after-tax expense recorded in the first quarter of 2007 related to our segment reorganization costs.

The following is a summary of revenues for our segments and Corporate and Other activities for the periods indicated:

 

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

(Amounts in millions)

   2008     2007    2008    2007

Revenues:

          

Retirement and Protection

   $ 1,363     $ 1,929    $ 3,119    $ 3,847

International

     808       624      1,559      1,211

U.S. Mortgage Insurance

     238       194      467      375

Corporate and Other

     (11 )     18      6      42
                            

Total revenues

   $ 2,398     $ 2,765    $ 5,151    $ 5,475
                            

The following table reflects net operating income (loss) of our segments and Corporate and Other activities determined in accordance with SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information, and a reconciliation of net operating income (loss) of our segments and Corporate and Other activities to net income (loss) for the periods indicated:

 

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

(Amounts in millions)

   2008     2007     2008     2007  

Retirement and Protection

   $ 150     $ 180     $ 312     $ 365  

International

     183       142       343       265  

U.S. Mortgage Insurance

     (59 )     66       (95 )     131  

Corporate and Other

     (62 )     (37 )     (104 )     (70 )
                                

Net operating income

     212       351       456       691  

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

     (321 )     (30 )     (449 )     (42 )

Expenses related to reorganization, net of taxes

     —         —         —         (14 )
                                

Income (loss) from continuing operations

     (109 )     321       7       635  

Income from discontinued operations, net of taxes

     —         5       —         15  

Gain on sale from discontinued operations, net of taxes

     —         53       —         53  
                                

Net income (loss)

   $ (109 )   $ 379     $ 7     $ 703  
                                

The following is a summary of total assets for our segments and Corporate and Other activities as of the periods indicated:

 

(Amounts in millions)

   June 30,
2008
   December 31,
2007

Assets:

     

Retirement and Protection

   $ 93,982    $ 94,360

International

     12,561      11,892

U.S. Mortgage Insurance

     3,539      3,286

Corporate and Other

     4,133      4,777
             

Total assets

   $ 114,215    $ 114,315
             

 

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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 and credit markets, downgrades in our financial strength or credit ratings, insufficiency of reserves, legal constraints on dividend distributions by subsidiaries, intense competition, availability and adequacy of reinsurance, defaults by counterparties, legal or regulatory investigations or actions, political or economic instability affecting outsourcing arrangements, regulatory restrictions on our operations and changes in applicable laws and regulations, the failure or any compromise of the security of our computer systems, and the occurrence of natural or man-made disasters or a disease pandemic;

 

   

Risks relating to our Retirement and Protection segment, including changes in morbidity and mortality, accelerated amortization of deferred acquisition costs and present value of future profits, goodwill impairments, reputational risks as a result of an announced rate increase on certain in-force long-term care insurance products, medical advances such as genetic mapping research, unexpected changes in persistency rates, increases in statutory reserve requirements, and the failure of demand for long-term care insurance to increase as we expect;

 

   

Risks relating to our International segment, including political and economic instability, foreign exchange rate fluctuations, unexpected changes in unemployment rates, deterioration in economic conditions or decline in home price appreciation, unexpected increases in mortgage insurance delinquency rates or severity of defaults, decreases in the volume of high loan-to-value international mortgage originations, increased competition with government-owned and government-sponsored entities (“GSEs”) offering mortgage insurance, changes in regulations, and growth in the global mortgage insurance market that is lower than we expect;

 

   

Risks relating to our U.S. Mortgage Insurance segment, including increases in mortgage insurance delinquency rates or severity of defaults, deterioration in economic conditions or a decline in home price appreciation, the influence of Fannie Mae, Freddie Mac and a small number of large mortgage lenders and investors, decreases in the volume of high loan-to-value mortgage originations or increases in mortgage insurance cancellations, increases in the use of alternatives to private mortgage insurance (such as simultaneous second mortgages) and reductions by lenders in the level of coverage they select, increases in the use of reinsurance with reinsurance companies affiliated with our mortgage lending customers, increased competition with government-owned and government-sponsored entities offering mortgage insurance, changes in regulations, legal actions under Real Estate Settlement Practices Act, and potential liabilities in connection with our U.S. contract underwriting services; and

 

   

Other risks, including the possibility that in certain circumstances we will be obligated to make payments to General Electric Company (“GE”) under our tax matters agreement even if our corresponding tax savings are never realized and payments could be accelerated in the event of certain changes in control, and provisions of our certificate of incorporation and by-laws and our tax matters

 

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agreement with GE may discourage takeover attempts and business combinations that stockholders might consider in their best interests.

We undertake no obligation to publicly update any forward-looking statement, whether as a result of new information, future developments or otherwise.

Overview

Our business

We are a leading financial security company in the U.S. that specializes in targeted market segments with an expanding international presence. We have three operating segments: Retirement and Protection, International and U.S. Mortgage Insurance.

 

   

Retirement and Protection. We offer a variety of protection, wealth accumulation, retirement income and institutional products. Protection products include: life insurance, long-term care insurance, Medicare supplement insurance and a linked-benefits product that combines long-term care insurance with universal life insurance. Additionally, we offer wellness and care coordination services for our long-term care policyholders. Our wealth accumulation and retirement income products include: fixed and variable deferred and immediate individual annuities, group variable annuities offered through retirement plans, and a variety of managed account programs, financial planning services and mutual funds. Institutional products include: funding agreements, funding agreements backing notes (“FABNs”) and guaranteed investment contracts (“GICs”). For the three months ended June 30, 2008, our Retirement and Protection segment’s net loss was $167 million and net operating income was $150 million. For the six months ended June 30, 2008, our Retirement and Protection segment’s net loss was $123 million and net operating income was $312 million.

 

   

International. In Canada, Australia, New Zealand, Mexico, Japan, South Korea and multiple European countries, we are a leading provider of mortgage insurance products. We are the largest private mortgage insurer in most of our international markets. We also provide mortgage insurance on a structured, or bulk, basis which aids in the sale of mortgages to the capital markets and helps lenders manage capital and risk. Additionally, we offer services, analytical tools and technology that enable lenders to operate efficiently and manage risk. We also offer payment protection coverages in multiple European countries, Canada, South Korea and Mexico. Our payment protection insurance products help consumers meet specified payment obligations should they become unable to pay due to accident, illness, involuntary unemployment, disability or death. For the three months ended June 30, 2008, our International segment’s net income and net operating income were $199 million and $183 million, respectively. For the six months ended June 30, 2008, our International segment’s net income and net operating income were $355 million and $343 million, respectively.

 

   

U.S. Mortgage Insurance. In the U.S., we offer mortgage insurance products predominantly insuring prime-based, individually underwritten residential mortgage loans, also known as “flow” mortgage insurance. We selectively provide mortgage insurance on a structured, or bulk, basis with essentially all of our bulk writings prime-based. Additionally, we offer services, analytical tools and technology that enable lenders to operate efficiently and manage risk. For the three months ended June 30, 2008, our U.S. Mortgage Insurance segment’s net loss and net operating loss were both $59 million. For the six months ended June 30, 2008, our U.S. Mortgage Insurance segment’s net loss and net operating loss were $94 million and $95 million, respectively.

We also have Corporate and Other activities which include debt financing expenses that are incurred at our holding company level, unallocated corporate income and expenses, eliminations of inter-segment transactions, the results of non-core businesses that are managed outside of our operating segments and our group life and health insurance business, which we sold on May 31, 2007. For the three months ended June 30, 2008, Corporate

 

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and Other activities had a loss from continuing operations and a net operating loss of $82 million and $62 million, respectively. For the six months ended June 30, 2008, Corporate and Other activities had a loss from continuing operations and a net operating loss of $131 million and $104 million, respectively.

Business trends and conditions

In recent years, our business has been, and we expect will continue to be, influenced by a number of industry-wide and product-specific trends and conditions. The discussion of business trends and conditions should be read together with the trends contained in our 2007 Annual Report on Form 10-K, which described additional business trends and conditions.

General conditions and trends affecting our businesses

Financial and economic environment. As a financial security company, the stability of both the financial markets and global economies in which we operate impacts our sales and revenue growth and trends in profitability of our businesses. Global economic and financial market conditions have continued to deteriorate to varying degrees in the first half of 2008. These conditions have resulted in declining asset prices, lower interest rates, rating agency downgrades and increases in loan delinquency rates.

Overall, we believe that the changing market conditions combined with slowing global economies have influenced, and will continue to influence, investment and spending decisions as both consumers and businesses adjust their risk profiles in response. Depending upon consumer reaction, we may see an adverse impact on sales, revenues and profitability trends of certain insurance and investment products.

In response to these current market conditions, we have tightened underwriting guidelines and increased pricing in targeted markets and products. We have also adjusted our asset-liability management strategy in an attempt to reduce risk during the current economic and financial market conditions.

Volatility in credit markets. Credit markets continue to experience reduced liquidity, higher volatility and widening credit spreads across asset classes associated with the re-pricing of risk. While these trends began mainly as a result of marketplace uncertainty arising from higher defaults in sub-prime and Alt-A residential mortgage loans, these trends have spread to other asset classes and financial sectors.

In connection with this uncertainty, we believe investors and lenders have retreated from many investments in asset-backed securities, including those associated with sub-prime and Alt-A residential mortgage loans, as well as types of debt investments with weak lender protections or those with limited transparency and/or complex features which hindered investor understanding. At the same time, investors shifted emphasis towards less risky investments, increasing the demand for investments such as U.S. Treasury instruments.

We believe these credit market conditions contributed to an increase in net unrealized investment losses of $2.0 billion, before tax and other offsets, during the first half of 2008 in our $51.9 billion investment portfolio of fixed maturity securities reflecting widening spreads in our mortgage-backed and asset-backed securities, partially offset by the effects of the current risk-free interest rate environment. We also believe these credit market conditions have contributed to a higher level of impairments on our investment portfolio. In some cases, the combined shift in rating and valuations of certain securities have resulted in a change in intent of whether to hold these securities to recovery of value. We expect to experience continued volatility in the valuation of our fixed maturity securities, as well as generally higher levels of credit-related investment losses, including the potential for additional impairments on our investment portfolio or changes regarding retention strategies for certain securities.

We also believe, however, that the current credit environment provides us with opportunities to invest in select asset classes and sectors that may enhance our investment yields over time. See “—Investments and

 

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Derivative Instruments” for additional information on our investment portfolio. In addition, further weakening in the economic environment could lead to increased credit defaults.

The current credit market conditions resulted in an unfavorable liquidity environment for issuers of financial instruments including commercial paper, long-term debt and certain asset-backed securities. Credit spreads widened for many corporate issuers of commercial paper and long-term debt resulting in less favorable financing terms. This unfavorable liquidity environment did not have a material effect on our commercial paper or long-term debt financing activities during the six months ended June 30, 2008.

See additional trends related to volatile credit markets in “—Trends and conditions affecting our segments.

Trends and conditions affecting our segments

Retirement and Protection

Wealth management (formerly referred to as managed money). Results of our wealth management business are impacted by demand for asset management products and related support services, investment performance and equity market fluctuations. The asset management industry continues to experience moderate growth, as independent broker/dealer representatives and independent advisors transition from commission to fee-based compensation and seek to outsource the management of their client portfolios. However, the volatility in the equity markets has negatively impacted our assets under management, net flows, the performance of certain mutual funds we offer and associated fee income. If the current market conditions continue, we could see further declines in these areas.

Retirement income. Results for our retirement income business are affected by investment performance, interest rate levels, slope of the interest rate yield curve, net interest spreads, equity market fluctuations, mortality, policyholder lapses and new product sales. Our competitive position within many of our distribution channels and 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 our annuities, as well as guaranteed benefit features we offer in variable annuity products. We actively evaluate our competitive position based upon each of these features, and where possible, we make adjustments as appropriate to meet our target return thresholds.

We maintain a focus on our Income Distribution Series of variable annuity products and group retirement income offerings. We have seen 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 retirement income products that provide various forms of guaranteed benefits with the opportunity to realize upside market performance. Our Income Distribution Series products provide 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 the 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.

Institutional. Results in our institutional business are affected by credit markets. During 2007 and the first half of 2008, credit markets experienced reduced liquidity, higher volatility and widening credit spreads across asset classes. Our ability to issue funding agreements, FABNs and GICs to institutional investors is primarily dependent upon the credit markets, market perception of credit and risk-based pricing and our credit default swap levels. We view this business as opportunistic and, therefore, new origination activity may vary considerably from period to period. The current credit market conditions made these types of products for large institutional

 

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investors less attractive compared to alternative products offering higher yields or more liquidity. Certain of our FABNs and funding agreements offer contractholders the option to make periodic elections to extend their maturity date. As a result of the current credit market conditions, certain contractholders have elected not to extend their contracts. We do not believe that this trend will have a material effect on our financial position or liquidity.

In December 2007, we began issuing FABNs to retail investors and despite the credit market conditions in the first half of 2008, we continued to issue FABNs to retail investors. We do not believe sales to our retail investors will be materially impacted if these credit market conditions continue.

Life insurance. Results in our life insurance business are impacted by sales, mortality, persistency, investment yields and statutory reserve requirements. Additionally, sales of our products and persistency of our insurance in-force are dependent on competitive product features and pricing, distribution penetration and customer service. As a result of a competitive pricing environment and our discipline to achieve targeted returns, we experienced lower term life insurance sales. We also experienced lower persistency in term life insurance policies coming out of their post-level rate period (10 and 15 years after policy issue). We expect these trends to continue, in general, as we maintain pricing discipline in the current competitive pricing environment.

We have also experienced a shift in focus by our distributors from term life insurance to universal life insurance products. In response to this shift in focus by our distributors, we continue to expand our universal life insurance capabilities.

Regulations XXX and AXXX require insurers to establish additional statutory reserves for term life insurance policies with long-term premium guarantees and certain universal life insurance policies with secondary guarantees, which increase the capital required to write these products. For term life and certain universal life insurance, we have implemented capital management actions, including the use of securitization transactions, to reduce the capital impact of these regulations. Several competitors have taken capital management actions similar to ours in response to Regulations XXX and AXXX. Recent market conditions impacting securitization transactions create a need to pursue alternative approaches such as reinsurance and private financing transactions and we expect these conditions to continue. Together the ability to and effectiveness of financing these additional reserves may impact future life insurance sales or new business returns.

As of June 30, 2008, we had $3.5 billion of fixed and floating rate non-recourse funding obligations outstanding backing these additional statutory reserves, of which $1.7 billion were guaranteed by third-party financial guaranty insurance companies. The interest rates on these obligations are subject to rate resets triggered by negative rating agency action on the third-party financial guaranty insurance companies that guarantee these obligations. During 2008, the rates on those $1.7 billion of non-recourse funding obligations were contractually reset to the highest margin to the related underlying index rates. We do not believe that these increases will have a material impact on our consolidated financial statements. As noted above, to maintain and optimize product returns, we may seek alternative financing approaches in the future depending upon market conditions which could be more costly than those utilized in the past.

Long-term care insurance. Results of our long-term care insurance business are influenced by morbidity, persistency, investment yields, new product sales, expenses and reinsurance. In recent years, industry-wide first-year annualized premiums of individual long-term care insurance have either declined or grown moderately. Our sales growth over the past year reflects the breadth of our distribution and progress across multiple growth initiatives with an emphasis on broadening our product offerings. For example, we continued to experience sales growth in our Medicare supplement insurance and linked-benefits products. The impact of lower termination rates, in particular lapse rates, on older issued policies, some with expiring reinsurance coverage, are causing higher benefits and other changes in policy reserves, resulting in lower net operating income for older blocks of

 

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business. In addition, the continued low interest rate environment may negatively impact our net operating income. In response to these trends, we will continue to pursue multiple growth initiatives, continue investing in case management improvements, maintain tight expense management, actively explore reinsurance and capital market solutions, execute investment strategies and, if appropriate, consider other actions to improve profitability of the overall block. During 2007 and 2008, we filed for state regulatory approvals for premium rate increases of between 8% and 12% on most of our block of older issued long-term care insurance policies and are currently in the process of implementing these rate increases.

International

International mortgage insurance. Results of our international mortgage insurance business are affected by changes in regulatory environments, employment and other economic and housing market trends, including interest rate trends, home price appreciation, mortgage origination volume, levels of mortgage delinquencies and movements in foreign currency exchange rates. Our international mortgage insurance business has continued to expand with favorable operating results because of its portfolio mix and related underwriting and risk characteristics. However, in certain European countries, we are seeing a slowdown in housing markets. In particular, we believe the economic slowdown in Spain, Ireland and the U.K. has resulted in decreased home price appreciation, as well as lower mortgage insurance origination volume, in those markets. We are also seeing a slowdown in housing market mortgage origination and home price appreciation levels in certain regions of Canada, as well as in Australia. We believe there are indications that other international housing markets may reflect similar characteristics assuming they experience an economic slowdown. We expect that our established international mortgage insurance business in Canada and Australia will continue to contribute the majority of total revenues and profits of this business, while our entry into and growth in new international markets will be gradual in nature.

In July 2008, the Government of Canada announced adjustments to the rules for government guaranteed mortgages. For new government-backed mortgages originated on or after October 15, 2008, these new measures will limit the maximum amortization period to 35 years, establish a minimum down payment of five percent and establish a minimum credit score requirement of 620. We subsequently announced our intent to incorporate these standards into our underwriting guidelines effective October 15, 2008. We believe these changes may result in a small reduction of mortgage originations.

As a result of the expansion of our international mortgage insurance business in recent years, as of June 30, 2008, approximately 58% of our international risk in-force had 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 and on an overall basis remain within targeted pricing levels.

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. Sales have increased in established regions outside of the U.K. and Ireland. At the same time, we saw a decline in consumer lending and lower single-premium sales pending anticipated clarifications of related new business regulations which have resulted in a decline in sales for the U.K. and Ireland. Depending on the severity and length of these trends, we may experience additional sales declines in those two countries. Outside of the U.K. and Ireland, our payment protection insurance business continues to show growth in Europe and other markets from increased penetration of existing relationships and the addition of new distribution relationships in existing and new countries.

 

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U.S. Mortgage Insurance

Results of our U.S. mortgage insurance business are affected by employment and other economic and housing market trends, including interest rate trends, home price trends, mortgage origination volume and product mix and the levels and aging of mortgage delinquencies including seasonal trends.

We believe that the U.S. housing market has slowed materially, and we expect the decline to continue. Home price appreciation has turned negative in the majority of the markets. We also expect unemployment levels to increase as the U.S. economy continues to slow in 2008 and potentially into 2009. In addition, there has been a significant increase in delinquency and foreclosure levels especially in the adjustable rate sub-prime market, according to the Mortgage Bankers Association, which we believe has resulted in an increase in housing supply levels and has further pressured home prices downward resulting in defaults not being supported by adequate levels of embedded home price appreciation to buffer or offset losses. We believe this overall pressure on the housing market is affecting the performance of our entire portfolio across all product lines but with particular impact in certain states and product types, including A minus, Alt-A and certain 100% loan-to-value loans.

The foregoing factors continue to contribute to an increase in paid claims and an increase in loss reserves as a result of a significant increase in delinquencies and foreclosures in our more recent books of business, particularly those of 2005, 2006 and 2007. While we continue to expect paid claims to increase throughout 2008, the rate at which claims are being paid has begun to slow somewhat due to loss mitigation opportunities, as well as from various state and lender foreclosure moratoriums and the overall volume of potential foreclosures in the marketplace. Going forward, we expect the slowdown in the pace at which we are paying claims to continue to have an impact on our delinquency inventory levels. These trends are evident in all products across all regions of the country and particularly in Florida, California, Arizona and Nevada, as well as in our A minus and Alt-A products. In addition, throughout the U.S., we have experienced an increase in the average loan balance of mortgage loan delinquencies. The Great Lakes region continues to experience an economic slowdown and has seen a more pronounced weakness in its housing markets as well as a decline in home prices. We are also experiencing an increase in delinquencies and associated reserves relating to adjustable rate loans in our bulk business, particularly from the 2006 and 2007 books of business.

While over 91% of our primary risk in-force in the U.S. is considered prime, based on FICO credit scores of the underlying mortgage loans, continued low or negative home price appreciation coupled with worsening economic conditions, including rising levels of unemployment, are expected to cause further increases in our incurred losses and related loss ratio. As of June 30, 2008, approximately 72% of our U.S. risk in-force had 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 in an adverse housing market environment.

Primary insurance in-force increased to $174.9 billion as of June 30, 2008, which represented an 11% increase as compared to December 31, 2007. In addition, net earned premiums have grown from $285 million for the six months ended June 30, 2007 to $373 million for the six months ended June 30, 2008. These increases in primary insurance in-force and net earned premiums reflect an increase in our flow product writings as a result of increased demand for private mortgage insurance as well as higher persistency. In spite of market liquidity constraints, increased demand for private mortgage insurance and higher levels of persistency have lead to higher levels of insurance in-force and related net earned premiums. However, more stringent underwriting guidelines combined with increased pricing in the market may offset the increase in demand for private mortgage insurance to some extent.

We participate in reinsurance programs in which we share portions of our premiums associated with flow insurance written on loans originated or purchased by lenders with captive reinsurance companies affiliated with these lenders in exchange for an agreed upon level of loss coverage if losses develop through specified threshold

 

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levels. For the six months ended June 30, 2008, we recorded a reinsurance recovery of $129 million where cumulative losses have exceeded the attachment points in several captive reinsurance arrangements, primarily related to the 2006 and 2007 books of business. We expect to record additional reinsurance recoveries throughout 2008 under these and other captive reinsurance arrangements as incurred losses display accelerated development on our books of business, particularly those of 2006 and 2007. In the first half of 2008, we saw worsening and early loss trends, particularly for the 2007 book year. If these trends continue over multiple years and are combined with further declines in home price appreciation, limited borrower refinancing options and deterioration of delinquency cures, which impact both frequency and severity of claims, we could exhaust captive reinsurance tiers for certain individual lenders on certain book years. Once the captive reinsurance is exhausted, or if required funds in trust are no longer sufficient for payment of claims, we would be responsible for any additional losses incurred.

We have taken various actions to reduce our new business risk profile including underwriting guideline and pricing changes. In the second quarter of 2008, we announced a rate increase of approximately 20% on our flow product. We have also reduced maximum loan-to-value ratios with a particular focus on constraining loan-to-value levels in specified declining markets and, in some cases, are exiting certain product lines. We believe these actions will improve our underwriting results on these and future books of business. In addition, our level of market penetration and eventual market size could also be affected by any actions taken by the GSEs or the Federal Housing Administration (“FHA”). The Housing and Economic Recovery Act of 2008 was enacted in July 2008. This legislation provides for changes to, among other things, the regulatory authority and oversight of the GSEs and the authority of the FHA including with respect to premium pricing, maximum loan limits, down payment requirements and reverse mortgages. 

Financial Strength Ratings

On June 30, 2008, Moody’s downgraded the financial strength ratings of our mortgage insurance subsidiaries to Aa3 from Aa2, with a negative outlook. At the same time, Moody’s affirmed the financial strength ratings of Genworth Financial, Inc., our holding company, and our life insurance subsidiaries. The outlook for the holding company was changed to negative as a result of the mortgage insurance action; the outlook on our rated life insurance subsidiaries remains stable. Moody’s states that insurance companies rated “Aa” (Excellent) offer excellent financial security and that companies in this group constitute what are generally known as high-grade companies. The “Aa” range is the second-highest of the nine financial strength rating ranges assigned by Moody’s, which range from “Aaa” to “C.” Numeric modifiers are used to refer to the ranking ranges within the group, with 1 being the highest and 3 being the lowest. Accordingly, the “Aa2” and “Aa3” ratings are the third- and fourth-highest of Moody’s 21 ratings categories. According to Moody’s, a ratings outlook is an opinion regarding the possible direction of an issuer’s rating over the medium term.

On June 5, 2008, Fitch, as part of a reassessment of the U.S. mortgage insurance industry, confirmed the AA, very strong, financial strength rating of our U.S. mortgage insurance subsidiaries, as well as the international affiliates in Europe and Australia. At the same time, Fitch changed the rating outlooks from stable to rating watch negative for our U.S. mortgage insurance subsidiaries. The ratings of our life insurance subsidiaries were not impacted. Fitch also changed the outlook of the long-term debt ratings on our holding company from stable to rating watch negative. Our F1 short-term rating was not impacted. According to Fitch, ratings are placed on rating watch negative to notify investors that there is a reasonable probability of a rating change and the likely direction of such change. Negative is for a potential downgrade. Rating watch negative is typically resolved over a relatively short period.

 

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Critical Accounting Estimates

Valuation of investment securities. We hold fixed maturity and equity securities, trading securities, derivatives, embedded derivatives, securities held as collateral and certain other financial instruments, which are carried at fair value. Fair value is the price that would be received to sell an asset in an orderly transaction between market participants at the measurement date.

Fair value measurements are generally based upon observable and unobservable inputs. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect our view of market assumptions in the absence of observable market information. We utilize valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. All assets carried at fair value are classified and disclosed in one of the following three categories:

 

   

Level 1—Quoted prices for identical instruments in active markets.

 

   

Level 2—Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable.

 

   

Level 3—Instruments whose significant value drivers are unobservable.

Level 1 primarily consists of financial instruments whose value is based on quoted market prices such as exchange-traded derivatives and actively traded mutual fund investments.

Level 2 includes those financial instruments that are valued using industry-standard pricing methodologies, models or other valuation methodologies. These models are primarily industry-standard models that consider various inputs, such as interest rate, credit spread and foreign exchange rates for the underlying financial instruments. All significant inputs are observable, or derived from observable, information in the marketplace or are supported by observable levels at which transactions are executed in the marketplace. Financial instruments in this category primarily include: certain public and private corporate fixed maturity and equity securities; government or agency securities; certain mortgage-backed and asset-backed securities; securities held as collateral; and certain non-exchange-traded derivatives such as interest rate or cross currency swaps.

Level 3 is comprised of financial instruments whose fair value is estimated based on industry-standard pricing methodologies and internally developed models utilizing significant inputs not based on, nor corroborated by, readily available market information. This category primarily consists of certain less liquid fixed maturity, equity and trading securities and certain derivative instruments where we cannot corroborate the significant valuation inputs with market observable data.

As of each reporting period, all assets and liabilities recorded at fair value are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability, such as the relative impact on the fair value as a result of including a particular input.

Our portfolio of fixed maturity securities is comprised primarily of investment grade registered securities. Estimates of fair values for these securities are obtained primarily from industry-standard pricing methodologies utilizing market observable inputs consistent with Level 2 inputs. For our less liquid securities, such as our privately placed securities, we utilize independent market data to employ alternative valuation methods commonly used in the financial services industry to estimate fair value. Based on the market observability of the inputs used in estimating the fair value, the pricing level is assigned.

Security pricing is applied using a hierarchy, or “waterfall” approach. The vast majority of our fixed maturity and equity securities use Level 2 inputs for the determination of fair value. These fair values are

 

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obtained primarily from industry-standard pricing methodologies utilizing market observable information, when available. Because many fixed income securities do not trade on a daily basis, fair value is determined using industry-standard methodologies by applying available market information through processes such as benchmark curves, benchmarking of like-securities, sector groupings, quotes from market participants and matrix pricing. Observable information is compiled and integrates relevant credit information, perceived market movements and sector news. Additionally, security prices are periodically back-tested to validate and/or refine models as conditions warrant. Market indicators and industry and economic events are also monitored as triggers to obtain additional data. For certain structured securities with limited trading activity, industry-standard pricing methodologies utilize adjusted market information, such as index prices, to estimate fair value, which is not deemed observable for a particular security and results in the measurement being classified as Level 3.

Where specific market information is unavailable for certain securities, such as privately placed securities, internally developed pricing models produce estimates of fair value primarily utilizing Level 2 inputs along with certain Level 3 inputs. The internally developed models include matrix pricing. The pricing matrix begins with current treasury rates and uses credit spreads received from third-party sources to estimate fair value. The credit spreads incorporate the issuer’s industry or issuer-specific credit characteristics and the security’s time to maturity, if warranted. Remaining un-priced securities are valued using an estimate of fair value based on indicative market prices that include significant unobservable inputs not based on, nor corroborated by, market information.

In addition to this “waterfall” approach, we employ other valuation methods that we deem appropriate for certain externally managed funds.

Evaluation of other-than-temporary impairments on available-for-sale securities. One of the significant estimates related to available-for-sale securities is the evaluation of investments for other-than-temporary impairments. We regularly review our investments for other-than-temporary impairments. If a decline in the fair value of an available-for-sale security is judged to be other-than-temporary, a charge is recorded to income equal to the difference between the fair value and cost or the amortized cost basis of the security.

The evaluation of impairments is subject to risks and uncertainties and is intended to determine whether declines in the fair value of investments should be recognized in current period income (loss). The assessment of whether such impairment has occurred is based on management’s evaluation of the underlying reasons for the decline in fair value at the individual security level. We deem an individual investment to be other-than-temporarily impaired when management concludes it is probable that we will not receive timely payment of the cash flows contractually stipulated for the investment. We regularly monitor our investment portfolio to ensure that investments that may be other-than-temporarily impaired are identified in a timely manner and that any impairment is charged against income (loss) in the proper period. As part of our review process, the duration and severity of a decline in individual security values and credit risk characteristics are regularly monitored as potential impairment indicators. For all investments, with particular focus on those with impairment indicators, we assess market conditions, macroeconomic factors and industry developments in addition to investment-specific metrics in performing a credit assessment on the impacted investments.

For certain securitized financial assets with contractual cash flows including mortgage-backed and asset-backed securities, Emerging Issues Task Force (“EITF”) Issue No. 99-20, Recognition of Interest Income and Impairment on Purchased Beneficial Interests and Beneficial Interests That Continued to Be Held by a Transferor in Securitized Financial Assets, requires that we use current information to periodically update our best estimate of cash flows that a market participant would use in determining the current fair value of the security. If the fair value of a securitized financial asset is less than its cost or amortized cost and there has been a decrease in the present value of the estimated cash flows since the last revised estimate that is unrelated to simple changes in interest rates when considering both timing and amount, an other-than-temporary impairment charge is recognized. Estimating future cash flows is a quantitative and qualitative process that incorporates information received from third-party sources along with certain internal assumptions and judgments regarding

 

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the future performance of the underlying collateral. Where possible, this data is benchmarked against third-party sources to ensure it is consistent with inputs a market participant would use in establishing the current fair value. In addition, projections of expected future cash flows may change based upon new information regarding the performance of the underlying collateral.

Securities not subject to EITF Issue No. 99-20 (“non-EITF Issue No. 99-20 securities”) that are in an unrealized loss position are reviewed at least quarterly to determine if an other-than-temporary impairment is present based on certain quantitative and qualitative factors. The primary factors considered in evaluating whether a decline in value for non-EITF Issue No. 99-20 securities is other-than-temporary include: (a) the length of time and the extent to which the fair value has been or is expected to be less than cost or amortized cost, (b) the financial condition, credit rating and near-term prospects of the issuer and (c) whether the debtor is current on contractually obligated interest and principal payments.

We also consider our intent and ability to retain a temporarily depressed security until recovery. We believe that our intent and ability to hold an investment, along with the ability of the investment to generate cash flows that have not changed adversely, are the primary factors in assessing whether an investment in an unrealized loss position is other-than-temporarily impaired.

Each quarter, during this analysis, we assert our intent and ability to retain until recovery those securities judged to be temporarily impaired. Once identified, these securities are systematically restricted from trading unless approved by management. Management will only authorize the sale of these securities based on predefined criteria that relate to events that could not have been foreseen. Examples of the criteria include, but are not limited to, the deterioration in the issuer’s creditworthiness, a change in regulatory requirements or a major business combination or major disposition. We may change our intent to retain certain securities until recovery for risk mitigation reasons based on investment-specific metrics such as deterioration in the issuer’s creditworthiness, recent pricing movements and current credit ratings. When we determine there has been a change of intent to hold a depressed security until recovery, an other-than-temporary impairment is recognized.

 

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Consolidated Results of Operations

The following is a discussion of our consolidated results of operations and should be read in conjunction with “—Business trends and conditions.” For a discussion of our segment results, see “Results of Operations and Selected Financial and Operating Performance Measures by Segment.

Three Months Ended June 30, 2008 Compared to Three Months Ended June 30, 2007

The following table sets forth the consolidated results of operations for the periods indicated:

 

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

(Amounts in millions)

         2008                 2007                       2008 vs. 2007              

Revenues:

        

Premiums

   $ 1,709     $ 1,549     $ 160     10 %

Net investment income

     953       1,024       (71 )   (7 )%

Net investment gains (losses)

     (518 )     (51 )     (467 )   NM (1)

Insurance and investment product fees and other

     254       243       11     5 %
                          

Total revenues

     2,398       2,765       (367 )   (13 )%
                          

Benefits and expenses:

        

Benefits and other changes in policy reserves

     1,386       1,090       296     27 %

Interest credited

     320       391       (71 )   (18 )%

Acquisition and operating expenses, net of deferrals

     551       495       56     11 %

Amortization of deferred acquisition costs and intangibles

     209       207       2     1 %

Interest expense

     110       124       (14 )   (11 )%
                          

Total benefits and expenses

     2,576       2,307       269     12 %
                          

Income (loss) from continuing operations before income taxes

     (178 )     458       (636 )   (139 )%

Provision (benefit) for income taxes

     (69 )     137       (206 )   (150 )%
                          

Income (loss) from continuing operations

     (109 )     321       (430 )   (134 )%

Income from discontinued operations, net of taxes

     —         5       (5 )   (100 )%

Gain on sale from discontinued operations, net of taxes

     —         53       (53 )   (100 )%
                          

Net income (loss)

   $ (109 )   $ 379     $ (488 )   (129 )%
                          

 

(1)

We define “NM” as not meaningful for increases or decreases greater than 200%.

Premiums. Premiums consist primarily of premiums earned on insurance products for individual life, long-term care, Medicare supplement, single premium immediate annuities and structured settlements with life contingencies, payment protection and mortgage insurance policies.

 

   

Our Retirement and Protection segment decreased $2 million primarily due to a $40 million decrease in our retirement income business offset by a $26 million increase in our long-term care insurance business and a $12 million increase in our life insurance business.

 

   

Our International segment increased $119 million as a result of a $58 million increase in our international mortgage insurance business and an increase of $61 million in our payment protection insurance business. The three months ended June 30, 2008 included an increase of $60 million attributable to changes in foreign exchange rates.

 

   

Our U.S. Mortgage Insurance segment increased $42 million.

 

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Net investment income. Net investment income represents the income earned on our investments.

 

   

Weighted average investment yields decreased to 5.3% for the three months ended June 30, 2008 from 5.9% for the three months ended June 30, 2007. The decrease in weighted average investment yields was primarily attributable to lower yields on floating rate investments and reduced yields from holding higher cash balances to cover near term obligations and portfolio repositioning activities.

 

   

Net investment income for the three months ended June 30, 2008 included $13 million of investment income related to bond calls and commercial mortgage loan prepayments as compared to $22 million in the three months ended June 30, 2007. The decrease in net investment income was also attributable to valuation marks on limited partnership investments.

 

   

The three months ended June 30, 2008 included $14 million attributable to changes in foreign exchange rates in our International segment.

Net investment gains (losses). Net investment gains (losses) consist of realized gains and losses from the sale or impairment of our investments, unrealized and realized gains and losses from our trading securities, 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. We incurred $221 million of credit and/or cash flow related impairments and $331 million related to a change in intent to hold securities to recovery during the three months ended June 30, 2008. Of total impairments, $501 million related to securities backed by sub-prime and Alt-A residential mortgage-backed and asset-backed securities. For further discussion of the change in net investment gains (losses), see the comparison for this line item under “—Investments and Derivative Instruments.”

Insurance and investment product fees and other. Insurance and investment product fees and other consist primarily of fees assessed against policyholder and contractholder account values, cost of insurance and surrender charges assessed on universal life insurance policies, advisory and administration service fees assessed on investment contractholder account values, broker/dealer commission revenues and other fees. Our Retirement and Protection segment increased $7 million largely driven by an $8 million increase in our retirement income business and a $4 million increase from our wealth management business, partially offset by a $6 million decrease in our life insurance business.

Benefits and other changes in policy reserves. Benefits and other changes in policy reserves consist primarily of benefits paid and reserve activity related to current claims and future policy benefits on insurance and investment products for life, long-term care and Medicare supplement insurance, structured settlements and single premium immediate annuities with life contingencies, payment protection insurance and claim costs incurred related to mortgage insurance products.

 

   

Our Retirement and Protection segment increased $13 million attributable to a $37 million increase in our long-term care insurance business and a $6 million increase in our life insurance business, offset by a $30 million decrease from our retirement income business.

 

   

Our International segment increased $48 million as a result of an increase in our international mortgage insurance business of $23 million and an increase of $25 million in our payment protection insurance business. The three months ended June 30, 2008 included an increase of $17 million attributable to changes in foreign exchange rates.

 

   

Our U.S. Mortgage Insurance segment increased $235 million.

Interest credited. Interest credited represents interest credited on behalf of policyholder and contractholder general account balances. Interest credited related to our Retirement and Protection segment decreased $71 million primarily due to a $63 million decrease related to our institutional business and a $13 million decrease in our retirement income business.

 

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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.

 

   

Our Retirement and Protection segment increased $7 million primarily attributable to an increase of $5 million from our retirement income business, a $3 million increase in our life insurance business and an increase of $2 million in our wealth management business, offset by a $3 million decrease in our long-term care insurance business.

 

   

Our International segment increased $44 million related to an $11 million increase in our international mortgage insurance business and a $33 million increase in our payment protection insurance business. The three months ended June 30, 2008 included an increase of $24 million attributable to changes in foreign exchange rates.

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, present value of future profits and capitalized software.

 

   

Our Retirement and Protection segment decreased $12 million primarily due to a decrease of $13 million from our retirement income business and a decrease of $3 million in our long-term care insurance business, partially offset by $3 million increase in our life insurance business.

 

   

Our International segment increased $11 million related to an increase in our international mortgage insurance business of $6 million and an increase in our payment protection insurance business of $5 million. The three months ended June 30, 2008 included an increase of $8 million attributable to changes in foreign exchange rates.

Interest expense. Interest expense represents interest related to our borrowings that are incurred at our holding company level and our non-recourse funding obligations and interest expense related to certain reinsurance arrangements being accounted for as deposits. Interest expense in our Retirement and Protection segment decreased $12 million in our life insurance business from a decrease in average floating rates paid on our non-recourse funding obligations.

Provision (benefit) for income taxes. The effective tax rate increased to (38.8)% for the three months ended June 30, 2008 from 29.9% for the three months ended June 30, 2007. This increase in the effective tax rate was primarily attributable to benefits from favorable examination developments on a pre-tax loss, partially offset by lower expected full year pre-tax income. The three months ended June 30, 2008 included an increase of $8 million attributable to changes in foreign exchange rates.

Net income (loss). The net loss in the second quarter of 2008 was largely the result of impairments recorded during the current quarter. For a discussion of our Retirement and Protection, U.S. Mortgage Insurance and International segments and Corporate and Other, see the “—Results of Operations and Selected Financial and Operating Performance Measures by Segment.” Included in net loss was an increase of $19 million, net of tax, attributable to changes in foreign exchange rates. In the second quarter of 2007, we completed the sale of our group life and health insurance business. The sale resulted in a gain on sale of discontinued operations of $53 million, net of taxes.

 

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Six Months Ended June 30, 2008 Compared to Six Months Ended June 30, 2007

The following table sets forth the consolidated results of operations for the periods indicated:

 

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

(Amounts in millions)

         2008                 2007                       2008 vs. 2007              

Revenues:

        

Premiums

   $ 3,426     $ 3,060     $ 366     12 %

Net investment income

     1,955       2,008       (53 )   (3 )%

Net investment gains (losses)

     (744 )     (70 )     (674 )   NM (1)

Insurance and investment product fees and other

     514       477       37     8 %
                          

Total revenues

     5,151       5,475       (324 )   (6 )%
                          

Benefits and expenses:

        

Benefits and other changes in policy reserves

     2,787       2,157       630     29 %

Interest credited

     665       776       (111 )   (14 )%

Acquisition and operating expenses, net of deferrals

     1,079       984       95     10 %

Amortization of deferred acquisition costs and intangibles

     412       420       (8 )   (2 )%

Interest expense

     222       231       (9 )   (4 )%
                          

Total benefits and expenses

     5,165       4,568       597     13 %
                          

Income (loss) from continuing operations before income taxes

     (14 )     907       (921 )   (102 )%

Provision (benefit) for income taxes

     (21 )     272       (293 )   (108 )%
                          

Income from continuing operations

     7       635       (628 )   (99 )%

Income from discontinued operations, net of taxes

     —         15       (15 )   (100 )%

Gain on sale from discontinued operations, net of taxes

     —         53       (53 )   (100 )%
                          

Net income

   $ 7     $ 703     $ (696 )   (99 )%
                          

 

(1)

We define “NM” as not meaningful for increases or decreases greater than 200%.

Premiums

 

   

Our Retirement and Protection segment increased $44 million primarily due to a $52 million increase in our long-term care insurance business and a $19 million increase in our life insurance business, offset by a $27 million decrease in our retirement income business.

 

   

Our International segment increased $235 million as a result of a $132 million increase in our international mortgage insurance business and an increase of $103 million in our payment protection insurance business. The six months ended June 30, 2008 included an increase of $126 million attributable to changes in foreign exchange rates.

 

   

Our U.S. Mortgage Insurance segment increased $88 million.

Net investment income

 

   

Weighted average investment yields decreased to 5.4% for the six months ended June 30, 2008 from 5.9% for the six months ended June 30, 2007. The decrease in weighted average investment yields was primarily attributable to lower yields on floating rate investments and reduced yields from holding higher cash balances to cover near term obligations and portfolio repositioning strategies.

 

   

Net investment income for the six months ended June 30, 2008 included $25 million of investment income related to bond calls and commercial mortgage loan prepayments as compared to $39 million in

 

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the six months ended June 30, 2007. The decrease in net investment income was also attributable to valuation marks on limited partnership investments.

 

   

The six months ended June 30, 2008 included $29 million attributable to changes in foreign exchange rates in our International segment.

Net investment gains (losses). We incurred $408 million of credit and/or cash flow related impairments and $331 million related to a change in intent to hold securities to recovery during the six months ended June 30, 2008. Of total impairments, $617 million related to securities backed by sub-prime and Alt-A residential mortgage-backed and asset-backed securities. Net investment losses of $26 million from derivatives were primarily a result of the change in value of derivative instruments used for risk management of variable annuity guaranteed minimum withdrawal benefits not fully offsetting the corresponding changes in the embedded liability during the first half of 2008. For further discussion of the change in net investment gains (losses), see the comparison for this line item under “—Investments and Derivative Instruments.”

Insurance and investment product fees and other

 

   

Our Retirement and Protection segment increased $27 million largely driven by an $18 million increase from our retirement income business and a $15 million increase in our wealth management business, offset by a $6 million decrease in our life insurance business.

 

   

Our International segment increased $5 million related to our payment protection insurance business. The six months ended June 30, 2008 included $2 million attributable to changes in foreign exchange rates.

Benefits and other changes in policy reserves

 

   

Our Retirement and Protection segment increased $84 million attributable to a $79 million increase in our long-term care insurance business and a $15 million increase in our life insurance business, offset by a $10 million decrease from our retirement income business.

 

   

Our International segment increased $104 million as a result of an increase in our international mortgage insurance business of $65 million and an increase of $39 million in our payment protection insurance business. The six months ended June 30, 2008 included an increase of $36 million attributable to changes in foreign exchange rates.

 

   

Our U.S. Mortgage Insurance segment increased $442 million.

Interest credited. Interest credited related to our Retirement and Protection segment decreased $111 million primarily due to an $89 million decrease related to our institutional business and a $30 million decrease in our retirement income business.

Acquisition and operating expenses, net of deferrals

 

   

Our Retirement and Protection segment increased $22 million primarily attributable to a $9 million increase in our wealth management business, an increase of $9 million from our retirement income business and an increase of $9 million in our life insurance business.

 

   

Our International segment increased $78 million related to a $26 million increase in our international mortgage insurance business and a $52 million increase in our payment protection insurance business. The six months ended June 30, 2008 included an increase of $48 million attributable to changes in foreign exchange rates.

 

   

Our U.S. Mortgage Insurance segment increased $7 million.

 

   

Corporate and Other activities decreased $12 million.

 

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Amortization of deferred acquisition costs and intangibles

 

   

Our Retirement and Protection segment decreased $27 million due to a decrease of $35 million from our retirement income business, partially offset by an increase of $6 million in our life insurance business.

 

   

Our International segment increased $27 million related to an increase in our international mortgage insurance business of $12 million and an increase in our payment protection insurance business of $15 million. The six months ended June 30, 2008 included an increase of $13 million attributable to changes in foreign exchange rates.

 

   

Corporate and Other activities decreased $12 million.

Interest expense. Interest expense related to our Retirement and Protection segment decreased $8 million in our life insurance business from a decrease in average floating rates paid on our non-recourse funding obligations.

Provision (benefit) for income taxes. The effective tax rate increased to (150.0)% for the six months ended June 30, 2008 from 30.0% for the six months ended June 30, 2007. This increase in the effective tax rate was primarily attributable to benefits from favorable examination developments on a pre-tax loss, partially offset by lower expected full year pre-tax income. The six months ended June 30, 2008 included an increase of $17 million attributable to changes in foreign exchange rates.

Net income. The decrease in net income was largely the result of impairments recorded in the six months ended June 30, 2008. For a discussion of our Retirement and Protection, U.S. Mortgage Insurance and International segments and Corporate and other, see the “—Results of Operations and Selected Financial and Operating Performance Measures by Segment.” Included in net income was an increase of $44 million, net of tax, attributable to changes in foreign exchange rates. In the second quarter of 2007, we completed the sale of our group life and health insurance business. The sale resulted in a gain on sale of discontinued operations of $53 million, net of taxes.

Earnings (loss) per share

The following table provides basic and diluted earnings (loss) per common share for the periods indicated:

 

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

(Amounts in millions, except per share amounts)

   2008     2007    2008    2007

Earnings (loss) from continuing operations per common share:

          

Basic

   $ (0.25 )   $ 0.73    $ 0.02    $ 1.44
                            

Diluted

   $ (0.25 )   $ 0.72    $ 0.02    $ 1.41
                            

Earnings (loss) per common share:

          

Basic

   $ (0.25 )   $ 0.86    $ 0.02    $ 1.60
                            

Diluted

   $ (0.25 )   $ 0.84    $ 0.02    $ 1.56
                            

Weighted-average common shares outstanding:

          

Basic

     432.9       439.4      433.3      440.2
                            

Diluted

     432.9       449.0      434.8      452.0
                            

Weighted average shares outstanding declined reflecting repurchases of 38.2 million shares since the beginning of the first quarter of 2007 through June 30, 2008. Diluted weighted average shares outstanding for

 

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both the 2008 and 2007 quarters reflect the effects of potentially dilutive securities including stock options, restricted stock units and other equity-based compensation. In May 2007, our Equity Unit holders purchased 25.5 million of newly issued shares of our common stock according to the stock purchase contract component of the Equity Units; therefore, the stock purchase contracts underlying Equity Units were only dilutive through May 2007. In May 2007, we repurchased 16.5 million shares of our common stock under an accelerated share repurchase transaction with a broker/dealer counterparty.

Results of Operations and Selected Financial and Operating Performance Measures by Segment

Our chief operating decision maker evaluates segment performance and allocates resources on the basis of “net operating income (loss).” We define net operating income (loss) as income (loss) from continuing operations excluding after-tax net investment gains (losses) and other adjustments and infrequent or unusual non-operating items. We exclude net investment gains (losses) and infrequent or unusual non-operating items because we do not consider them to be related to the operating performance of our segments and Corporate and Other activities. A significant component of our net investment gains (losses) is the result of impairments, including changes in intent to hold securities to recovery, and credit-related gains and losses, the timing of which can vary significantly depending on market credit cycles. In addition, the size and timing of other investment gains (losses) are often subject to our discretion and are influenced by market opportunities, as well as asset-liability matching considerations. Infrequent or unusual non-operating items are also excluded from net operating income (loss) if, in our opinion, they are not indicative of overall operating trends. While some of these items may be significant components of net income (loss) in accordance with U.S. GAAP, we believe that net operating income (loss), and measures that are derived from or incorporate net operating income (loss), are appropriate measures that are useful to investors because they identify the income (loss) attributable to the ongoing operations of the business. However, net operating income (loss) is not a substitute for net income (loss) determined in accordance with U.S. GAAP. In addition, our definition of net operating income (loss) may differ from the definitions used by other companies. See note 10 in our “—Notes to Condensed Consolidated Financial Statements” for a reconciliation of net operating income (loss) of our segments and Corporate and Other activities to net income (loss).

Management’s discussion and analysis by segment also contains selected operating performance measures including “sales,” “assets under management” and “insurance in-force” or “risk in-force” which are commonly used in the insurance and investment industries as measures of operating performance.

Management regularly monitors and reports sales metrics as a measure of volume of new and renewal business generated in a period. Sales refers to (1) annualized first-year premiums for term life, long-term care and Medicare supplement insurance; (2) new and additional premiums/deposits for universal life insurance, linked-benefits, spread-based and variable products; (3) gross and net flows, which represent deposits less redemptions, for our wealth management business; (4) written premiums and deposits, gross of ceded reinsurance and cancellations, and premium equivalents, where we earn a fee for administrative services only business, for payment protection insurance; (5) new insurance written for mortgage insurance, which in each case reflects the amount of business the company generated during each period presented; and (6) written premiums, net of cancellations, for our Mexican insurance operations. Sales do not include renewal premiums on policies or contracts written during prior periods. We consider annualized first-year premiums, new premiums/deposits, deposits and net flows, written premiums, premium equivalents and new insurance written to be measures of our operating performance because they represent a measure of new sales of insurance policies or contracts during a specified period, rather than measures of our revenues or profitability during that period.

Management regularly monitors and reports assets under management for our wealth management business, insurance in-force and risk in-force. Assets under management for our wealth management business represent third-party assets under management that are not consolidated in our financial statements. Insurance in-force for our life insurance, international mortgage insurance and U.S. mortgage insurance businesses is a measure of the aggregate face value of outstanding insurance policies as of the respective reporting date. Risk in-force for our

 

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international and U.S. mortgage insurance businesses is a measure that recognizes that the loss on any particular mortgage loan will be reduced by the net proceeds received upon sale of the underlying property. We consider assets under management for our wealth management business, insurance in-force and risk in-force to be measures of our operating performance because they represent measures of the size of our business at a specific date, rather than measures of our revenues or profitability during that period.

These operating measures enable us to compare our operating performance across periods without regard to revenues or profitability related to policies or contracts sold in prior periods or from investments or other sources.

The following discussions of our segment results of operations should be read in conjunction with the “—Business trends and conditions.

Retirement and Protection segment

Segment results of operations

Three Months Ended June 30, 2008 Compared to Three Months Ended June 30, 2007

The following table sets forth the results of operations relating to our Retirement and Protection segment:

 

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

(Amounts in millions)

       2008             2007                     2008 vs. 2007              

Revenues:

        

Premiums

   $ 885     $ 887     $ (2 )   —   %

Net investment income

     755       860       (105 )   (12 )%

Net investment gains (losses)

     (511 )     (45 )     (466 )   NM (1)

Insurance and investment product fees and other

     234       227       7     3 %
                          

Total revenues

     1,363       1,929       (566 )   (29 )%
                          

Benefits and expenses:

        

Benefits and other changes in policy reserves

     930       917       13     1 %

Interest credited

     320       391       (71 )   (18 )%

Acquisition and operating expenses, net of deferrals

     229       222       7     3 %

Amortization of deferred acquisition costs and intangibles

     100       112       (12 )   (11 )%

Interest expense

     39       51       (12 )   (24 )%
                          

Total benefits and expenses

     1,618       1,693       (75 )   (4 )%
                          

Income (loss) from continuing operations before income taxes

     (255 )     236       (491 )   NM (1)

Provision (benefit) for income taxes

     (88 )     83       (171 )   NM (1)
                          

Net income (loss)

     (167 )     153       (320 )   NM (1)

Adjustment to net income (loss):

        

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

     317       27       290     NM (1)
                          

Net operating income

   $ 150     $ 180     $ (30 )   (17 )%
                          

 

(1)

We define “NM” as not meaningful for increases or decreases greater than 200%.

 

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The following table sets forth net operating income for the businesses included in our Retirement and Protection segment:

 

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

(Amounts in millions)

         2008                2007                      2008 vs. 2007              

Net operating income:

          

Wealth management

   $ 11    $ 11    $ —       —   %

Retirement income

     13      43      (30 )   (70 )%

Institutional

     5      10      (5 )   (50 )%

Life insurance

     87      75      12     16 %

Long-term care insurance

     34      41      (7 )   (17 )%
                        

Total net operating income

   $ 150    $ 180    $ (30 )   (17 )%
                        

Net operating income

 

   

Our wealth management business remained flat as growth in average assets under management was offset by the impact of the unfavorable volatility in the equity markets combined with higher asset-based expenses.

 

   

Our retirement income business decreased $30 million primarily as a result of lower net investment income from lower yields on floating rate investments and valuation marks on limited partnership investments, as well as a tax timing difference related to interim reporting. The decrease was also attributable to a reclassification in the second quarter of 2008 of embedded derivative costs related to our guaranteed minimum withdrawal products previously reported in net investment gains (losses).

 

   

Our institutional business decreased $5 million largely attributable to lower yields on floating rate investments supporting certain floating rate policyholder liabilities and a decline in assets under management mainly due to the current challenging market environment.

 

   

Our life insurance business increased $12 million from a favorable tax development in the second quarter of 2008 and lower interest expense, partially offset by a decrease in net investment income from lower yields on assets backing our non-recourse funding obligations.

 

   

Our long-term care insurance business decreased $7 million as the prior year included a $9 million, net of tax, bond call that did not recur in the current year. Excluding the impact of the bond call, our long-term care insurance business was relatively flat as the favorable performance of newer issued policies was offset by unfavorable performance of older issued policies.

Revenues

Premiums

 

   

Our retirement income business decreased $40 million primarily due to continued runoff of our life-contingent structured settlement annuities and lower life contingent sales in our spread-based retail products as a result of our continued pricing discipline. Partially offsetting these decreases was an increase from continued improvements in wholesaler productivity levels and rate actions on certain immediate annuities.

 

   

Our life insurance business increased $12 million mainly related to in-force growth of our term life insurance from new sales and renewal premiums, partially offset by lower experience rating refunds from reinsurance transactions with one of our reinsurers.

 

   

Our long-term care insurance business increased $26 million mainly attributable to growth in the in-force block from new sales and renewal premiums.

 

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Net investment income

 

   

Our retirement income business decreased $24 million primarily as a result of lower yields and a decline in average invested assets in our spread-based retail products. The decrease was also attributable to valuation marks on limited partnership investments. These decreases were partially offset by $5 million of additional investment income from bond calls and commercial mortgage loan prepayments in the current year.

 

   

Our institutional business decreased $67 million attributable to lower yields on floating rate investments supporting certain floating rate policyholder liabilities.

 

   

Our life insurance business decreased $16 million mainly due to lower yields on the assets backing our non-recourse funding obligations supporting certain term and universal life insurance reserves. This decrease was partially offset by $2 million of additional investment income from bond calls and commercial mortgage loan prepayments in the current year.

 

   

Our long-term care insurance business increased $2 million largely as a result of an increase in average invested assets due to growth in the in-force block. This increase was partially offset by a $14 million bond call from a single issuer in the prior year and valuation marks associated with limited partnership investments in the current year.

Insurance and investment product fees and other

 

   

Our wealth management business increased $4 million primarily as a result of growth in average assets under management, partially offset by the impact of the unfavorable volatility in equity markets on assets under management.

 

   

Our retirement income business increased $8 million mainly due to increased assets under management from continued sales of our Income Distribution Series products. This increase was partially offset by a reclassification in the second quarter of 2008 of embedded derivative costs related to our guaranteed minimum withdrawal products previously reported in net investment gains (losses) and lower municipal GIC advisory fees.

 

   

Our life insurance business decreased $6 million mainly due to lower cost of insurance charges attributable to higher mortality and surrenders. This was partially offset by higher surrender fee income.

Benefits and expenses

Benefits and other changes in policy reserves

 

   

Our retirement income business decreased $30 million largely attributable to a decrease in reserves of our life-contingent spread-based products. Partially offsetting this decrease was an increase in our guaranteed minimum benefit liability for our variable annuity contracts driven by the unfavorable volatility in the equity markets.

 

   

Our life insurance business increased $6 million principally attributable to growth of our term life insurance in-force block.

 

   

Our long-term care insurance business increased $37 million mainly as a result of the aging and growth of the in-force block.

Interest credited

 

   

Our retirement income business decreased $13 million from lower account values on fixed annuities associated with surrenders more than offsetting sales. Additionally, crediting rates were reset to current, lower rates as the fixed annuities reach the end of their initial crediting rate guarantee period.

 

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Our institutional business decreased $63 million mainly attributable to the impact of lower short-term rates on interest paid on our floating rate policyholder liabilities.

Acquisition and operating expenses, net of deferrals

 

   

Our wealth management business increased $2 million attributable to higher asset-based expenses as a result of the growth of average assets under management.

 

   

Our retirement income business increased $5 million primarily driven by growth in our Income Distribution Series products.

 

   

Our life insurance business increased $3 million primarily from higher expenses from growth of our insurance in-force.

 

   

Our long-term care insurance business decreased $3 million due to continued productivity efficiencies.

Amortization of deferred acquisition costs and intangibles

 

   

Our retirement income business decreased $13 million attributable to a decrease in amortization from higher net investment losses and an improvement in lapse rates in the current year, partially offset by growth in our Income Distribution Series Products.

 

   

Our life insurance business increased $3 million from continued growth of our insurance in-force.

 

   

Our long-term care insurance business decreased $3 million attributable to final purchase accounting adjustments in the prior year that accelerated amortization of the present value of future profits.

Interest expense. Interest expense in our life insurance business decreased $12 million from a decrease in average floating rates paid on our non-recourse funding obligations.

Provision (benefit) for income taxes. The effective tax rate decreased to (34.5)% for the three months ended June 30, 2008 from 35.2% for the three months ended June 30, 2007. This decrease in the effective tax rate was primarily attributable to lower expected full year pre-tax income, partially offset by favorable examination development benefits in 2008 on a pre-tax loss.

 

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Six Months Ended June 30, 2008 Compared to Six Months Ended June 30, 2007

The following table sets forth the results of operations relating to our Retirement and Protection segment:

 

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

(Amounts in millions)

   2008      2007      2008 vs. 2007  

Revenues:

           

Premiums

   $ 1,805      $ 1,761      $ 44      2 %

Net investment income

     1,562        1,704        (142 )    (8 )%

Net investment gains (losses)

     (721 )      (64 )      (657 )    NM (1)

Insurance and investment product fees and other

     473        446        27      6 %
                             

Total revenues

     3,119        3,847        (728 )    (19 )%
                             

Benefits and expenses:

           

Benefits and other changes in policy reserves

     1,909        1,825        84      5 %

Interest credited

     665        776        (111 )    (14 )%

Acquisition and operating expenses, net of deferrals

     456        434        22      5 %

Amortization of deferred acquisition costs and intangibles

     189        216        (27 )    (13 )%

Interest expense

     86        94        (8 )    (9 )%
                             

Total benefits and expenses

     3,305        3,345        (40 )    (1 )%
                             

Income (loss) from continuing operations before income taxes

     (186 )      502        (688 )    (137 )%

Provision (benefit) for income taxes

     (63 )      176        (239 )    (136 )%
                             

Net income (loss)

     (123 )      326        (449 )    (138 )%

Adjustment to net income (loss):

           

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

     435        39        396      NM (1)
                             

Net operating income

   $ 312      $ 365      $ (53 )    (15 )%
                             

 

(1)

We define “NM” as not meaningful for increases or decreases greater than 200%.

The following table sets forth net operating income for the businesses included in our Retirement and Protection segment:

 

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

(Amounts in millions)

   2008    2007    2008 vs. 2007  

Net operating income:

           

Wealth management

   $ 23    $ 21    $ 2      10 %

Retirement income

     49      89      (40 )    (45 )%

Institutional

     16      24      (8 )    (33 )%

Life insurance

     152      153      (1 )    (1 )%

Long-term care insurance

     72      78      (6 )    (8 )%
                         

Total net operating income

   $ 312    $ 365    $ (53 )    (15 )%
                         

 

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Net operating income

 

   

Our wealth management business remained relatively flat as growth in average assets under management was partially offset by the impact of the unfavorable volatility in equity markets combined with higher asset-based expenses.

 

   

Our retirement income business decreased $40 million as a result of lower net investment income from lower yields on floating rate investments and valuation marks on limited partnership investments, as well as a tax timing difference related to interim reporting. The decrease was also attributable to a reclassification in the second quarter of 2008 of embedded derivative costs related to our guaranteed minimum withdrawal products previously reported in net investment gains (losses).

 

   

Our institutional business decreased $8 million largely attributable to lower yields on floating rate investments supporting certain floating rate policyholder liabilities and a decline in assets under management mainly due to the current challenging market environment.

 

   

Our life insurance business remained relatively flat as a favorable tax development in the second quarter of 2008 and lower interest expense was offset by a decrease in net investment income from lower yields on assets backing our non-recourse funding obligations.

 

   

Our long-term care insurance business decreased $6 million as the prior year included $8 million, net of tax, of additional bond calls. Excluding the impact of bond calls, our long-term care insurance business was relatively flat as the favorable performance of newer issued policies and an update in factors associated with mortality notifications in the current year was offset by unfavorable performance of older issued policies.

Revenues

Premiums

 

   

Our retirement income business decreased $27 million primarily due to continued runoff of our life-contingent structured settlement annuities and lower life contingent sales in our spread-based retail products as a result of our continued pricing discipline. Partially offsetting these decreases was an increase from continued improvements in wholesaler productivity levels and rate actions on certain immediate annuities.

 

   

Our life insurance business increased $19 million mainly related to in-force growth of our term life insurance from new sales and renewal premiums, partially offset by lower experience rating refunds from reinsurance transactions with one of our reinsurers.

 

   

Our long-term care insurance business increased $52 million mainly attributable to growth in the in-force block from new sales and renewal premiums.

Net investment income

 

   

Our retirement income business decreased $46 million primarily as a result of a decline in average invested assets and lower yields in our spread-based retail products. The decrease was also attributable to valuation marks on limited partnership investments. These decreases were partially offset by $4 million of additional investment income from bond calls and commercial mortgage loan prepayments in the current year.

 

   

Our institutional business decreased $98 million primarily attributable to lower yields on floating rate investments supporting certain floating rate policyholder liabilities. The prior year also included $5 million of additional investment income from bond calls and commercial mortgage loan prepayments.

 

   

Our life insurance business decreased $20 million mainly due to lower yields on the assets backing our non-recourse funding obligations supporting certain term and universal life insurance reserves. The prior

 

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year also included $2 million of additional investment income from bond calls and commercial mortgage loan prepayments.

 

   

Our long-term care insurance business increased $22 million largely as a result of an increase in average invested assets due to growth in the in-force block. This increase was partially offset by $12 million of additional investment income from bond calls in the prior year and valuation marks on limited partnership investments in the current year.

Insurance and investment product fees and other

 

   

Our wealth management business increased $15 million primarily as a result of growth in average assets under management, partially offset by the impact of the unfavorable volatility in equity markets on assets under management.

 

   

Our retirement income business increased $18 million mainly due to increased assets under management from continued sales of our Income Distribution Series products. This increase was partially offset by a reclassification in the second quarter of 2008 of embedded derivative costs related to our guaranteed minimum withdrawal products previously reported in net investment gains (losses) and lower municipal GIC advisory fees.

 

   

Our life insurance business decreased $6 million mainly due to lower cost of insurance charges attributable to higher mortality and surrenders. This was partially offset by higher surrender fee income.

Benefits and expenses

Benefits and other changes in policy reserves

 

   

Our retirement income business decreased $10 million largely due to a decrease in reserves of our life-contingent spread-based products, partially offset by an increase in our guaranteed minimum benefit liability for our variable annuity contracts driven by the unfavorable volatility in the equity markets.

 

   

Our life insurance business increased $15 million principally attributable to growth of our term life insurance in-force block and an increase in reserves related to a policy valuation system input correction in a small block of term life insurance policies in the current year, partially offset by lower persistency in term life insurance as compared to the prior year.

 

   

Our long-term care insurance business increased $79 million mainly as a result of the aging and growth of the in-force block. Partially offsetting the increase was an $8 million update in factors associated with mortality notifications in the current year.

Interest credited

 

   

Our retirement income business decreased $30 million from lower account values on fixed annuities associated with surrenders more than offsetting sales. Additionally, crediting rates were reset to current, lower rates as the fixed annuities reach the end of their initial crediting rate guarantee period.

 

   

Our institutional business decreased $89 million mainly attributable to the impact of lower short-term rates on interest paid on our floating rate policyholder liabilities.

Acquisition and operating expenses, net of deferrals

 

   

Our wealth management business increased $9 million attributable to higher asset-based expenses as a result of the growth of average assets under management.

 

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Our retirement income business increased $9 million primarily driven by growth in our Income Distribution Series products.

 

   

Our life insurance business increased $9 million primarily from higher expenses from growth of our in-force business.

Amortization of deferred acquisition costs and intangibles

 

   

Our retirement income business decreased $35 million due to a decrease in amortization of deferred acquisition costs for our spread-based retail products as a result of higher net investment losses and an improvement in lapse rates in the current year. Our fee-based products also decreased from lower amortization as a result of hedge losses related to our guaranteed minimum withdrawal benefit product that was partially offset by higher amortization attributable to growth in our Income Distribution Series products.

 

   

Our life insurance business increased $6 million from continued growth of insurance in-force, a policy valuation system input correction in a small block of term life insurance policies in the current year and lower persistency.

Interest expense. Interest expense in our life insurance business decreased $8 million from a decrease in average floating rates paid on our non-recourse funding obligations.

Provision (benefit) for income taxes. The effective tax rate decreased to (33.9)% for the six months ended June 30, 2008 from 35.1% for the six months ended June 30, 2007. This decrease in the effective tax rate was primarily attributable to lower expected full year pre-tax income, partially offset by favorable examination development benefits in 2008 on a pre-tax loss.

Retirement and Protection selected financial and operating performance measures

Wealth management

The following table sets forth selected financial performance measures regarding our wealth management business as of or for the periods indicated:

 

     As of or for the three
months ended June 30,
    As of or for the six
months ended June 30,
 

(Amounts in millions)

   2008     2007     2008     2007  

Assets under management, beginning of period

   $ 20,461     $ 18,806     $ 21,584     $ 17,293  

Gross flows

     1,405       1,759       2,685       3,471  

Redemptions

     (1,044 )     (494 )     (2,124 )     (925 )
                                

Net flows

     361       1,265       561       2,546  

Market performance

     (537 )     612       (1,860 )     844  
                                

Assets under management, end of period

   $ 20,285     $ 20,683     $ 20,285     $ 20,683  
                                

Wealth management results represent AssetMark Investment Services, Inc., Genworth Financial Advisors Corporation, Genworth Financial Asset Management, Inc., Genworth Financial Trust Company and Capital Brokerage Corporation.

The decrease in these assets was primarily due to unfavorable equity market performance in the current year.

 

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Retirement income

Fee-based retail products

The following table sets forth selected financial performance measures regarding our fee-based retail products as of or for the periods indicated:

 

     As of or for the three
months ended June 30,
    As of or for the six
months ended June 30,
 

(Amounts in millions)

         2008                 2007                 2008                 2007        

Income Distribution Series(1)

        

Account value, net of reinsurance, beginning of period

   $ 4,877     $ 2,813     $ 4,535     $ 2,402  

Deposits

     596       482       1,191       903  

Surrenders, benefits and product charges

     (112 )     (66 )     (217 )     (126 )
                                

Net flows

     484       416       974       777  

Interest credited and investment performance

     (53 )     132       (201 )     182  
                                

Account value, net of reinsurance, end of period

   $ 5,308     $ 3,361     $ 5,308     $ 3,361  
                                

Traditional variable annuities

        

Account value, net of reinsurance, beginning of period

   $ 2,241     $ 1,905     $ 2,345     $ 1,780  

Deposits

     105       149       213       279  

Surrenders, benefits and product charges

     (63 )     (56 )     (122 )     (97 )
                                

Net flows

     42       93       91       182  

Interest credited and investment performance

     (5 )     100       (158 )     136  
                                

Account value, net of reinsurance, end of period

   $ 2,278     $ 2,098     $ 2,278     $ 2,098  
                                

Variable life insurance

        

Account value, beginning of period

   $ 371     $ 396     $ 403     $ 391  

Deposits

     5       7       10       12  

Surrenders, benefits and product charges

     (10 )     (14 )     (20 )     (26 )
                                

Net flows

     (5 )     (7 )     (10 )     (14 )

Interest credited and investment performance

     7       19       (20 )     31  
                                

Account value, end of period

   $ 373     $ 408     $ 373     $ 408  
                                

 

(1)

The Income Distribution Series products are comprised of our retirement income deferred and immediate variable annuity products, including those variable annuity products with rider options that provide similar income features. These products do not include fixed single premium immediate annuities or deferred annuities, which may also serve income distribution needs.

Income Distribution Series

We experienced an increase in assets under management attributable to continued sales growth of our guaranteed minimum withdrawal for life benefit rider, partially offset by unfavorable volatility in the equity markets.

Traditional variable annuities

In our traditional variable annuities, the increase in assets under management was principally the result of continued sales growth, partially offset by unfavorable volatility in the equity markets.

 

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Table of Contents

Spread-based retail products

The following table sets forth selected financial performance measures regarding our spread-based retail products as of or for the periods indicated:

 

      As of or for the three
months ended June 30,
    As of or for the six
months ended June 30,
 

(Amounts in millions)

         2008                 2007                 2008                 2007        

Fixed annuities

        

Account value, net of reinsurance, beginning of period

   $ 12,141     $ 13,522     $ 12,073     $ 13,972  

Deposits

     333       144       769       351  

Surrenders, benefits and product charges

     (449 )     (899 )     (923 )     (1,680 )
                                

Net flows

     (116 )     (755 )     (154 )     (1,329 )

Interest credited

     105       119       211       243  
                                

Account value, net of reinsurance, end of period

   $ 12,130     $ 12,886     $ 12,130     $ 12,886  
                                

Single premium immediate annuities

        

Account value, net of reinsurance, beginning of period

   $ 6,781     $ 6,261     $ 6,668     $ 6,174  

Premiums and deposits

     188       261       479       498  

Surrenders, benefits and product charges

     (278 )     (240 )     (545 )     (474 )
                                

Net flows

     (90 )     21       (66 )     24  

Interest credited

     90       85       179       169  
                                

Account value, net of reinsurance, end of period

   $ 6,781     $ 6,367     $ 6,781     $ 6,367  
                                

Structured settlements

        

Account value, net of reinsurance, beginning of period

   $ 1,105     $ 1,058     $ 1,103     $ 1,011  

Premiums and deposits

     1       30       3       77  

Surrenders, benefits and product charges

     (13 )     (15 )     (27 )     (29 )
                                

Net flows

     (12 )     15       (24 )     48  

Interest credited

     14       15       28       29  
                                

Account value, net of reinsurance, end of period

   $ 1,107     $ 1,088     $ 1,107     $ 1,088  
                                

Total premiums from spread-based retail products

   $ 111     $ 151     $ 278     $ 305  
                                

Total deposits on spread-based retail products

   $ 411     $ 284     $ 973     $ 621  
                                

Fixed annuities

Surrenders exceeded deposits as initial bonus crediting rates have begun to enter their rate reset period resulting in lower crediting rates. During 2008, the yield curve steepened and certain fixed annuities became more attractive relative to investment alternatives, such as certificates of deposit.

Single premium immediate annuities

The account value, net of reinsurance, increased primarily due to the negative net flows being entirely offset by interest credited on the account values.

Structured settlements

We no longer solicit sales of this product as a result of a continued challenging and competitive long-term interest rate environment. However, we continue to service our existing block of business.

 

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Institutional

The following table sets forth selected financial performance measures regarding our institutional business as of or for the periods indicated:

 

     As of or for the three
months ended June 30,
    As of or for the six
months ended June 30,
 

(Amounts in millions)

       2008             2007             2008             2007      

Account value, beginning of period

   $ 10,655     $ 10,724     $ 10,982     $ 10,483  

Deposits(1)

     1,128       1,107       1,379       1,829  

Surrenders and benefits(1)

     (1,099 )     (460 )     (1,826 )     (1,089 )
                                

Net flows

     29       647       (447 )     740  

Interest credited

     96       147       213       288  

Foreign currency translation

     (7 )     (3 )     25       4  
                                

Account value, end of period

   $ 10,773     $ 11,515     $ 10,773     $ 11,515  
                                

 

(1)

“Surrenders and benefits” include contracts that have matured but are redeposited with us and reflected as deposits. For the three months ended June 30, 2008 and 2007, surrenders and deposits that were redeposited and are now reflected under “Deposits” amounted to $195 million and $100 million, respectively. For the six months ended June 30, 2008 and 2007, surrenders and deposits that were redeposited and are now reflected under “Deposits” amounted to $295 million and $200 million, respectively.

The decrease in account values was primarily the result of scheduled maturities of fixed GICs. For the three and six months ended June 30, 2008, deposits for our FABNs and funding agreements decreased as a result of lower sales of these products given the current credit market environment. This was partially offset by an issuance of additional GMTNs of $500 million in the second quarter of 2008. The decrease in interest credited was driven by lower crediting rates on our floating rate products attributable to a decrease in short-term interest rates compared to 2007.

See “—Trends and conditions affecting our segments” for further discussion of the impact of the current credit market condition on FABNs and funding agreements.

 

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Table of Contents

Life insurance

The following table sets forth selected financial and operating performance measures regarding our life insurance business as of or for the periods indicated:

 

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

(Amounts in millions)

      2008           2007           2008 vs. 2007             2008           2007               2008 vs. 2007          

Term life insurance

               

Net earned premiums

  $ 245   $ 231   $ 14     6 %   $ 481   $ 460   $ 21     5 %

Annualized first-year premiums

    25     29     (4 )   (14 )%     48     58     (10 )   (17 )%

Universal and whole life insurance

               

Net earned premiums and deposits

  $ 141   $ 134   $ 7     5 %   $ 284   $ 277   $ 7     3 %

Universal life annualized first-year deposits

    14     15     (1 )   (7 )%     27     26     1     4 %

Universal life excess deposits

    46     41     5     12 %     89     89     —       —   %

Total life insurance

               

Net earned premiums and deposits

  $ 386   $ 365   $ 21     6 %   $ 765   $ 737   $ 28     4 %

Annualized first-year premiums

    25     29     (4 )   (14 )%     48     58     (10 )   (17 )%

Annualized first-year deposits

    14     15     (1 )   (7 )%     27     26     1     4 %

Excess deposits

    46     41     5     12 %     89     89     —       —   %

 

     As of June 30,    Percentage
change
 

(Amounts in millions)

   2008    2007    2008 vs. 2007  

Term life insurance

           

Life insurance in-force, net of reinsurance

   $ 481,430    $ 449,654       7 %

Life insurance in-force before reinsurance

     621,221      610,071       2 %

Universal and whole life insurance

           

Life insurance in-force, net of reinsurance

   $ 42,833    $ 41,303       4 %

Life insurance in-force before reinsurance

     51,851      50,290       3 %

Total life insurance

           

Life insurance in-force, net of reinsurance

   $ 524,263    $ 490,957       7 %

Life insurance in-force before reinsurance

     673,072      660,361       2 %

Term life insurance

The increase in term life insurance net earned premiums and insurance in-force was mainly due to growth of the in-force block of business as annualized first-year premiums exceeded lapses. Annualized first-year premiums decreased as a result of increased price competition and a shift to universal life insurance products by our distributors.

 

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Table of Contents

Universal and whole life insurance

Annualized first-year deposits were relatively flat as the overall universal life insurance market was flat. We had slight growth in the six months ended June 30, 2008 attributable to our crediting rates being more attractive relative to the falling interest rates in the market. The in-force block remained flat mainly as the growth in universal life insurance was offset by the continued runoff of our closed block of whole life insurance.

Long-term care insurance

The following table sets forth selected financial and operating performance measures regarding our long-term care insurance business, which includes individual and group long-term care insurance, Medicare supplement insurance, a linked-benefits product (that combines universal life insurance and long-term care insurance product features), as well as several runoff blocks of accident and health insurance and corporate-owned life insurance for the periods indicated:

 

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

(Amounts in millions)

     2008        2007          2008 vs. 2007           2008        2007          2008 vs. 2007      

Net earned premiums:

                    

Long-term care

   $ 459    $ 430    $ 29     7 %   $ 902    $ 849    $ 53     6 %

Medicare supplement and other

     65      68      (3 )   (4 )%     133      134      (1 )   (1 )%
                                                

Total

   $ 524    $ 498    $ 26     5 %   $ 1,035    $ 983    $ 52     5 %
                                                

Annualized first-year premiums and deposits

   $ 66    $ 54    $ 12     22 %   $ 128    $ 106    $ 22     21 %
                                                

Net earned premiums increased primarily due to growth in the individual long-term care insurance in-force block from new sales, offset by a decrease in Medicare supplement insurance net earned premiums.

The increase in annualized first-year premiums and deposits was primarily attributable to growth in our individual long-term care insurance, linked-benefits product and Medicare supplement insurance.

 

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International segment

Segment results of operations

Three Months Ended June 30, 2008 Compared to Three Months Ended June 30, 2007

The following table sets forth the results of operations relating to our International segment:

 

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

(Amounts in millions)

       2008             2007                   2008 vs. 2007            

Revenues:

        

Premiums

   $ 628     $ 509     $ 119     23 %

Net investment income

     148       113       35     31 %

Net investment gains (losses)

     25       (5 )     30     NM (1)

Insurance and investment product fees and other

     7       7       —       —   %
                          

Total revenues

     808       624       184     29 %
                          

Benefits and expenses:

        

Benefits and other changes in policy reserves

     160       112       48     43 %

Acquisition and operating expenses, net of deferrals

     273       229       44     19 %

Amortization of deferred acquisition costs and intangibles

     97       86       11     13 %

Interest expense

     8       10       (2 )   (20 )%
                          

Total benefits and expenses

     538       437       101     23 %
                          

Income from continuing operations before income taxes

     270       187       83     44 %

Provision for income taxes

     71       48       23     48 %