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 September 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 November 3, 2008, 433,133,866 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 nine months ended September 30, 2008 and  2007 (Unaudited)

   3

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

   4

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

   5

Condensed Consolidated Statements of Cash Flows for the nine months ended September 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

   27

Item 3. Quantitative and Qualitative Disclosures About Market Risk

   103

Item 4. Controls and Procedures

   104

PART II—OTHER INFORMATION

  

Item 1. Legal Proceedings

   105

Item 1A. Risk Factors

   106

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

   134

Item 6. Exhibits

   135

Signatures

   136

 

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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 September 30,
    Nine months
ended September 30,
 
         2008             2007             2008             2007      

Revenues:

        

Premiums

   $ 1,735     $ 1,600     $ 5,161     $ 4,660  

Net investment income

     918       1,074       2,873       3,082  

Net investment gains (losses)

     (816 )     (48 )     (1,560 )     (118 )

Insurance and investment product fees and other

     331       249       845       726  
                                

Total revenues

     2,168       2,875       7,319       8,350  
                                

Benefits and expenses:

        

Benefits and other changes in policy reserves

     1,497       1,168       4,284       3,325  

Interest credited

     319       391       984       1,167  

Acquisition and operating expenses, net of deferrals

     515       540       1,594       1,524  

Amortization of deferred acquisition costs and intangibles

     208       202       620       622  

Interest expense

     125       124       347       355  
                                

Total benefits and expenses

     2,664       2,425       7,829       6,993  
                                

Income (loss) from continuing operations before income taxes

     (496 )     450       (510 )     1,357  

Provision (benefit) for income taxes

     (238 )     111       (259 )     383  
                                

Income (loss) from continuing operations

     (258 )     339       (251 )     974  

Income from discontinued operations, net of taxes

     —         —         —         15  

Gain on sale of discontinued operations, net of taxes

     —         —         —         53  
                                

Net income (loss)

   $ (258 )   $ 339     $ (251 )   $ 1,042  
                                

Earnings (loss) from continuing operations per common share:

        

Basic

   $ (0.60 )   $ 0.77     $ (0.58 )   $ 2.21  
                                

Diluted

   $ (0.60 )   $ 0.76     $ (0.58 )   $ 2.16  
                                

Earnings (loss) per common share:

        

Basic

   $ (0.60 )   $ 0.77     $ (0.58 )   $ 2.36  
                                

Diluted

   $ (0.60 )   $ 0.76     $ (0.58 )   $ 2.32  
                                

Weighted-average common shares outstanding:

        

Basic

     433.1       441.1       433.2       440.5  
                                

Diluted

     433.1       445.6       433.2       449.8  
                                

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)

 

     September 30,
2008
    December 31,
2007
 
     (Unaudited)        

Assets

    

Investments:

    

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

   $ 48,724     $ 55,154  

Equity securities available-for-sale, at fair value

     309       366  

Commercial mortgage loans

     8,447       8,953  

Policy loans

     1,822       1,651  

Other invested assets

     4,913       4,676  
                

Total investments

     64,215       70,800  

Cash and cash equivalents

     5,102       3,091  

Accrued investment income

     794       773  

Deferred acquisition costs

     7,681       7,034  

Intangible assets

     1,068       914  

Goodwill

     1,572       1,600  

Reinsurance recoverable

     16,763       16,483  

Other assets

     1,075       822  

Deferred tax asset

     194       —    

Separate account assets

     11,097       12,798  
                

Total assets

   $ 109,561     $ 114,315  
                

Liabilities and stockholders’ equity

    

Liabilities:

    

Future policy benefits

   $ 28,017     $ 26,740  

Policyholder account balances

     35,565       36,913  

Liability for policy and contract claims

     4,776       3,693  

Unearned premiums

     5,345       5,631  

Other liabilities

     6,200       6,255  

Non-recourse funding obligations

     3,455       3,455  

Short-term borrowings

     78       200  

Long-term borrowings

     4,530       3,903  

Deferred tax liability

     —         1,249  

Separate account liabilities

     11,097       12,798  
                

Total liabilities

     99,063       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 September 30, 2008 and December 31, 2007; 433 million and 436 million shares outstanding as of September 30, 2008 and December 31, 2007, respectively

     1       1  

Additional paid-in capital

     11,484       11,461  
                

Accumulated other comprehensive income (loss):

    

Net unrealized investment gains (losses)

     (2,963 )     (526 )

Derivatives qualifying as hedges

     761       473  

Foreign currency translation and other adjustments

     383       780  
                

Total accumulated other comprehensive income (loss)

     (1,819 )     727  

Retained earnings

     3,532       3,913  

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

     (2,700 )     (2,624 )
                

Total stockholders’ equity

     10,498       13,478  
                

Total liabilities and stockholders’ equity

   $ 109,561     $ 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

     —        —        —         1,042       —         1,042  

Net unrealized gains (losses) on investment securities

     —        —        (788 )     —         —         (788 )

Derivatives qualifying as hedges

     —        —        (90 )     —         —         (90 )

Foreign currency translation and other adjustments

     —        —        418       —         —         418  
                    

Total comprehensive income (loss)

                 582  

Issuance of common stock

     1      600      —         —         —         601  

Acquisition of treasury stock

     —        —        —         —         (1,100 )     (1,100 )

Dividends to stockholders

     —        —        —         (123 )     —         (123 )

Stock-based compensation expense and exercises

     —        78      —         —         —         78  

Other capital transactions

     —        3      —         —         —         3  
                                              

Balances as of September 30, 2007

   $ 1    $ 11,440    $ 697     $ 3,779     $ (2,600 )   $ 13,317  
                                              

 

     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 (loss)

     —        —        —         (251 )     —         (251 )

Net unrealized gains (losses) on investment securities

     —        —        (2,437 )     —         —         (2,437 )

Derivatives qualifying as hedges

     —        —        288       —         —         288  

Foreign currency translation and other adjustments

     —        —        (397 )     —         —         (397 )
                    

Total comprehensive income (loss)

                 (2,797 )

Acquisition of treasury stock

     —        —        —         —         (76 )     (76 )

Dividends to stockholders

     —        —        —         (130 )     —         (130 )

Stock-based compensation expense and exercises

     —        23      —         —         —         23  
                                              

Balances as of September 30, 2008

   $ 1    $ 11,484    $ (1,819 )   $ 3,532     $ (2,700 )   $ 10,498  
                                              

See Notes to Condensed Consolidated Financial Statements

 

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GENWORTH FINANCIAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Amounts in millions)

(Unaudited)

 

     Nine months
ended September 30,
 
         2008             2007      

Cash flows from operating activities:

    

Net income (loss)

   $ (251 )   $ 1,042  

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 (loss) to net cash from operating activities:

    

Amortization of fixed maturity discounts and premiums

     24       (32 )

Net investment losses (gains)

     1,560       118  

Charges assessed to policyholders

     (304 )     (291 )

Acquisition costs deferred

     (945 )     (1,054 )

Amortization of deferred acquisition costs and intangibles

     620       622  

Deferred income taxes

     (253 )     217  

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

     10       (145 )

Stock-based compensation expense

     18       33  

Change in certain assets and liabilities:

    

Accrued investment income and other assets

     188       (202 )

Insurance reserves

     1,771       2,389  

Current tax liabilities

     (151 )     163  

Other liabilities and other policy-related balances

     906       951  

Cash from operating activities—discontinued operations

     —         25  
                

Net cash from operating activities

     3,193       3,768  
                

Cash flows from investing activities:

    

Proceeds from maturities and repayments of investments:

    

Fixed maturity securities

     3,489       4,505  

Commercial mortgage loans

     646       910  

Proceeds from sales of investments:

    

Fixed maturity and equity securities

     3,298       5,038  

Purchases and originations of investments:

    

Fixed maturity and equity securities

     (6,574 )     (10,370 )

Commercial mortgage loans

     (193 )     (1,343 )

Other invested assets, net

     (304 )     (998 )

Policy loans, net

     (171 )     (161 )

Payments for businesses purchased, net of cash acquired

     (20 )     —    

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

     —         514  

Cash from investing activities—discontinued operations

     —         103  
                

Net cash from investing activities

     171       (1,802 )
                

Cash flows from financing activities:

    

Proceeds from issuance of investment contracts

     6,307       5,844  

Redemption and benefit payments on investment contracts

     (7,869 )     (7,111 )

Short-term borrowings and other, net

     72       78  

Redemption of non-recourse funding obligations

     —         (100 )

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

     (130 )     (119 )

Stock-based compensation awards exercised

     5       29  

Acquisition of treasury stock

     (76 )     (1,100 )

Proceeds from issuance of common stock

     —         600  

Cash from financing activities—discontinued operations

     —         (21 )
                

Net cash from financing activities

     (1,094 )     (1,261 )

Effect of exchange rate changes on cash and cash equivalents

     (259 )     (28 )
                

Net change in cash and cash equivalents

     2,011       677  

Cash and cash equivalents at beginning of period

     3,091       2,469  
                

Cash and cash equivalents at end of period

   $ 5,102     $ 3,146  
                

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. Most of our variable annuities include a guaranteed minimum death benefit (“GMDB”). Some of our group and individual variable annuity products include guaranteed minimum benefit features such as guaranteed minimum withdrawal benefits and certain types of guaranteed minimum income benefits. 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 lifestyle protection insurance (formerly referred to as 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. On October 10, 2008, we adopted FSP FAS 157-3, Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active. The FSP provides guidance and clarification on how management’s internal assumptions, observable market information and market quotes are considered when applying SFAS No. 157 in inactive markets. The adoption of FSP FAS 157-3 did not have a material impact on our consolidated financial statements. See note 6 for additional disclosures about fair value measurements.

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 September 2008, FASB issued FSP FAS 133-1 and FIN 45-4, Disclosures about Credit Derivatives and Certain Guarantees: An Amendment of FASB Statement No. 133 and FASB Interpretation No. 45; and Clarification of the Effective Date of FASB Statement No. 161. The FSP requires certain disclosures by sellers of credit derivatives and requires additional disclosure about the current status of the payment/performance risk of guarantees. FSP FAS 133-1 and FIN 45-4 will be effective for us on October 1, 2008. We do not expect this FSP to have a material impact on our consolidated financial statements.

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.

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

(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 September 30,
   Nine months
ended September 30,

(Amounts in millions, except per share amounts)

       2008             2007            2008             2007    

Basic earnings (loss) per common share:

         

Income (loss) from continuing operations

   $ (0.60 )   $ 0.77    $ (0.58 )   $ 2.21

Income from discontinued operations, net of taxes

     —         —        —         0.03

Gain on sale from discontinued operations, net of taxes

     —         —        —         0.12
                             

Basic earnings (loss) per common share(1)

   $ (0.60 )   $ 0.77    $ (0.58 )   $ 2.36
                             

Diluted earnings (loss) per common share:

         

Income (loss) from continuing operations

   $ (0.60 )   $ 0.76    $ (0.58 )   $ 2.16

Income from discontinued operations, net of taxes

     —         —        —         0.03

Gain on sale from discontinued operations, net of taxes

     —         —        —         0.12
                             

Diluted earnings (loss) per common share(1)

   $ (0.60 )   $ 0.76    $ (0.58 )   $ 2.32
                             

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

     433.1       441.1      433.2       440.5

Potentially dilutive securities:

         

Stock purchase contracts underlying Equity Units

     —         —        —         4.2

Stock options, restricted stock units and stock appreciation rights

     —         4.5      —         5.1
                             

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

     433.1       445.6      433.2       449.8
                             

 

(1)

May not total due to whole number calculation.

(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
September 30, 2007
   Nine months ended
September 30, 2007

Revenues

   $ —      $ 318
             

Income before income taxes

   $ —      $ 24

Provision for income taxes

     —        9
             

Income from discontinued operations, net of taxes

   $ —      $ 15
             

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

(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
September 30,
    Nine months ended
September 30,
 

(Amounts in millions)

       2008             2007             2008             2007      

Available-for-sale securities:

        

Realized gains on sale

   $ 34     $ 3     $ 97     $ 11  

Realized losses on sale

     (167 )     (19 )     (202 )     (78 )

Impairments

     (577 )     (25 )     (1,316 )     (39 )

Trading securities

     (11 )     (4 )     (16 )     (3 )

Derivatives

     (90 )     —         (116 )     (4 )

Commercial mortgage loans

     —         (3 )     —         (5 )

Other

     (5 )     —         (7 )     —    
                                

Net investment gains (losses)

   $ (816 )   $ (48 )   $ (1,560 )   $ (118 )
                                

Fixed Maturity and Equity Securities

As of September 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

   $ 664    $ 18    $ (3 )   $ 679

Tax exempt

     2,561      39      (183 )     2,417

Government—non U.S.

     2,213      60      (47 )     2,226

U.S. corporate

     23,043      122      (2,427 )     20,738

Corporate—non U.S.

     12,651      53      (1,023 )     11,681

Mortgage and asset-backed

     12,699      81      (1,797 )     10,983
                            

Total fixed maturity securities

     53,831      373      (5,480 )     48,724

Equity securities

     315      25      (31 )     309
                            

Total available-for-sale securities

   $ 54,146    $ 398    $ (5,511 )   $ 49,033
                            

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

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 September 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

   $ 91    $ (3 )   13    $ —      $ —       —  

Tax exempt

     1,193      (109 )   375      201      (74 )   45

Government—non U.S.

     660      (36 )   181      50      (11 )   37

U.S. corporate

     10,337      (940 )   1,162      6,494      (1,487 )   604

Corporate—non U.S.

     5,485      (448 )   863      3,858      (575 )   435

Mortgage and asset-backed

     3,839      (375 )   481      5,929      (1,422 )   882
                                       

Subtotal, fixed maturity securities

     21,605      (1,911 )   3,075      16,532      (3,569 )   2,003

Equity securities

     142      (30 )   23      10      (1 )   4
                                       

Total temporarily impaired securities

   $ 21,747    $ (1,941 )   3,098    $ 16,542    $ (3,570 )   2,007
                                       

% Below cost—fixed maturity securities:

               

<20% Below cost

   $ 20,335    $ (1,330 )   2,778    $ 11,986    $ (1,283 )   1,279

20-50% Below cost

     1,235      (526 )   265      4,262      (1,841 )   607

>50% Below cost

     35      (55 )   32      284      (445 )   117
                                       

Total fixed maturity securities

     21,605      (1,911 )   3,075      16,532      (3,569 )   2,003
                                       

% Below cost—equity securities:

               

<20% Below cost

     94      (8 )   10      10      (1 )   4

20-50% Below cost

     48      (22 )   13      —        —       —  
                                       

Total equity securities

     142      (30 )   23      10      (1 )   4
                                       

Total temporarily impaired securities

   $ 21,747    $ (1,941 )   3,098    $ 16,542    $ (3,570 )   2,007
                                       

Investment grade

   $ 20,548    $ (1,785 )   2,737    $ 15,623    $ (3,311 )   1,827

Below investment grade

     1,164      (148 )   343      919      (259 )   180

Not rated—fixed maturity securities

     35      (8 )   18      —        —       —  
                                       

Total temporarily impaired securities

   $ 21,747    $ (1,941 )   3,098    $ 16,542    $ (3,570 )   2,007
                                       

The investment securities in an unrealized loss position as of September 30, 2008 consisted of 5,105 securities and accounted for unrealized losses of $5,511 million. Of these unrealized losses of $5,511 million, 92% were investment grade (rated AAA through BBB-) and 48% 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 52% of unrealized losses 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

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

events in the credit markets, rating agencies have actively reviewed their credit quality ratings on these securities and these securities remain primarily investment grade. We have examined 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 September 30, 2008, 724 securities were 20% or more below cost, of which 74 securities were also below investment grade (rated BB+ and below) and accounted for unrealized losses of $170 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.

As of September 30, 2008, we expected to collect full principal and interest and we were not aware of any adverse changes in cash flows. 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 September 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.

In its letter to the FASB dated October 14, 2008, the SEC stated that, given the debt characteristics of hybrid securities, a debt impairment model could be used for filings subsequent to October 14, 2008, until the FASB further addresses the appropriate impairment approach. Included in the preceding table were securities that represent investments in hybrid instruments with gross unrealized losses of $274 million. Of this amount, $210 million has existed for a period exceeding twelve months. Of these unrealized losses, 100% were on securities that were investment grade and 53% were less than 20% below cost. The remaining securities had market values that were between 20% and 50% below cost.

Expectations that our investments in asset-backed and 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 asset-backed and mortgage-backed securities and potential future write-downs within our portfolio of asset-backed and mortgage-backed securities. Expectations that our investments in corporate securities will continue to perform in accordance with their contractual terms are based on evidence gathered through our normal credit surveillance process. Although we do not anticipate such events, it is at least reasonably possible that issuers of our investments in corporate securities will perform worse than current expectations. Such events may lead us to recognize potential future write-downs within our portfolio of corporate securities. It is also reasonably possible that such unanticipated events would lead us to dispose of those certain holdings and recognize the effects of any market movements in our financial statements.

As a result of the challenging market conditions, including expected further weakening in the economic environment subsequent to September 30, 2008, we have experienced continued volatility in the valuation of our fixed maturity securities including increases in our unrealized investment losses. We expect the volatility in the valuation of our fixed maturity securities to continue. This volatility may lead to additional impairments on our investment portfolio or changes regarding retention strategies for certain securities.

The preceding table includes gross unrealized losses on securities for which market activity indicated such securities have become other-than-temporarily impaired subsequent to September 30, 2008. These activities will result in additional impairments of up to $135 million in the fourth quarter of 2008.

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

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:

 

     September 30, 2008    December 31, 2007

(Amounts in millions)

   Notional
value
   Assets    Liabilities    Notional
value
   Assets    Liabilities

Interest rate swaps

   $ 25,763    $ 916    $ 115    $ 23,138    $ 740    $ 74

Foreign currency swaps

     759      63      9      759      33      14

Forward commitments

     —        —        —        2      —        —  

Equity index options

     1,643      256      —        979      127      —  

Credit default swaps

     610      3      8      10      —        —  

Financial futures

     269      —        —        106      —        —  
                                         

Total derivatives

   $ 29,044    $ 1,238    $ 132    $ 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 September 30, 2008 and December 31, 2007, the fair value presented in the preceding table included $300 million and $147 million, respectively, of derivative assets and $47 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 Standard & Poor’s (“S&P”) if the agreements governing such transactions require both us and the counterparties to provide collateral in certain circumstances. As of September 30, 2008 and December 31, 2007, we retained collateral of $693 million and $372 million, respectively, related to these agreements including over collateralization from certain counterparties. As of September 30, 2008, we provided collateral of $7 million. As of 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.

During the third quarter of 2008, we terminated derivatives with certain counterparties that were subsidiaries of Lehman Brothers Holdings Inc., which filed for bankruptcy in September 2008. Certain terminated derivatives were included in qualifying hedge relationships until the date they were no longer effective. For those derivatives included in cash flow hedging relationships, the qualifying portion of the derivatives’ fair value will remain in other comprehensive income (loss) until the underlying hedged item affects income. Subsequent to the termination, we collected the cash collateral for the majority of the net derivative asset and recorded a receivable for the remaining uncollateralized portion within other assets, net of any estimated uncollectible amounts.

Subsequent to September 30, 2008, we terminated interest rate swaps with a notional value of $16.7 billion and a fair value of derivative assets of $971 million and a fair value of derivative liabilities of $40 million on the termination date. For the derivatives included in cash flow hedging relationships, the qualifying portion of the derivatives’ fair value will remain in other comprehensive income (loss) until the underlying hedged item affects income. In addition, we terminated equity index options with a notional value of $134 million and a fair value of

 

15


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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

derivative assets on the terminated date of $312 million. We also purchased and sold interest rate swaptions with a combined notional value of $11.2 billion at a net zero cost to mitigate interest rate exposure in our long-term care insurance business. We have also entered into derivative transactions to hedge future changes in equity markets.

(6) Fair Value Measurements

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 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. In limited instances, this category may also utilize non-binding broker quotes. 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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Table of Contents

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.

The fair value of derivative instruments primarily utilizes Level 2 inputs. Certain derivative instruments are valued using significant unobservable inputs and are classified as Level 3 measurements. The classification of fair value measurements for derivative instruments, including embedded derivatives requiring bifurcation, was 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:

 

     September 30, 2008

(Amounts in millions)

   Total    Level 1    Level 2    Level 3

Investments:

           

Fixed maturity securities, available-for-sale

   $ 48,724    $ —      $ 42,903    $ 5,821

Equity securities, available-for-sale

     309      52      208      49

Other invested assets(a)

     3,454      —        3,046      408

Separate account assets

     11,097      11,097      —        —  
                           

Total assets

   $ 63,584    $ 11,149    $ 46,157    $ 6,278
                           

 

(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:

 

     September 30, 2008

(Amounts in millions)

   Total    Level 1    Level 2    Level 3

Policyholder account balances(a)

   $ 275    $ —      $ —      $ 275

Other liabilities(b)

     132      —        129      3
                           

Total liabilities

   $ 407    $ —      $ 129    $ 278
                           

 

17


Table of Contents

GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

 

(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.

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 September 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 July 1, 2008

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

Total realized and unrealized gains (losses):

         

Included in net income (loss)

     (256 )     —        58       (198 )

Included in other comprehensive income (loss)

     (241 )     —        —         (241 )

Purchases, sales, issuances and settlements, net

     (6 )     15      (31 )     (22 )

Transfers in (out) of Level 3

     1,643       25      (28 )     1,640  
                               

Ending balance as of September 30, 2008

   $ 5,821     $ 49    $ 408     $ 6,278  
                               

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

   $ (249 )   $ —      $ 47     $ (202 )
                               

 

(a)

Includes certain trading securities and derivatives.

 

     Nine months
ended September 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)

     (754 )     1       74       (679 )

Included in other comprehensive income (loss)

     (431 )     —         —         (431 )

Purchases, sales, issuances and settlements, net

     (264 )     (8 )     31       (241 )

Transfers in (out) of Level 3

     2,476       26       (16 )     2,486  
                                

Ending balance as of September 30, 2008

   $ 5,821     $ 49     $ 408     $ 6,278  
                                

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

   $ (748 )   $ —       $ 63     $ (685 )
                                

 

(a)

Includes certain trading securities and derivatives.

 

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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
September 30, 2008

(Amounts in millions)

   Policyholder
account
balances(a)
   Other
liabilities(b)

Beginning balance as of July 1, 2008

   $ 78    $ —  

Total realized and unrealized (gains) losses:

     

Included in net (income) loss

     192      3

Included in other comprehensive (income) loss

     —        —  

Purchases, sales, issuances and settlements, net

     5   

Transfers in (out) of Level 3

     —        —  
             

Ending balance as of September 30, 2008

   $ 275    $ 3
             

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

   $ 193    $ 3
             

 

(a)

Includes product-related embedded derivatives.

(b)

Includes derivatives.

 

     Nine months ended
September 30, 2008

(Amounts in millions)

   Policyholder
account
balances(a)
   Other
liabilities(b)

Beginning balance as of January 1, 2008

   $ 34    $ —  

Total realized and unrealized (gains) losses:

     

Included in net (income) loss

     230      3

Included in other comprehensive (income) loss

     —        —  

Purchases, sales, issuances and settlements, net

     11   

Transfers in (out) of Level 3

     —        —  
             

Ending balance as of September 30, 2008

   $ 275    $ 3
             

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

   $ 232    $ 3
             

 

(a)

Includes product-related embedded derivatives.

(b)

Includes 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

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

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.

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 net 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 September 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 September 30, 2008, all bank loans were recorded at fair value, which was lower than their respective cost. Accordingly, for the three and nine months ended September 30, 2008, we recorded $5 million and $8 million, respectively, of fair value loss adjustments which were 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) Goodwill

During the third quarter of 2008, we completed our annual goodwill impairment analysis based on data as of July 1, 2008. As a result of this analysis, we recorded goodwill impairments related to our U.S. mortgage insurance and institutional businesses, as discussed further below. For all other of our reporting units, there were no charges to income as a result of our annual goodwill impairment testing. As a result of changes in the market environment during the third quarter of 2008, we performed an interim impairment analysis as of September 30, 2008. The interim impairment testing results did not result in any additional impairment of goodwill. We continue to evaluate current market conditions that may affect the fair value of our reporting units to assess whether any goodwill impairment exists. Continued deteriorating or adverse market conditions for certain businesses may have a significant impact on the fair value of our reporting units and could result in additional future impairments of goodwill.

In accordance with our annual goodwill impairment analysis during the third quarter of 2008, we performed the two-step impairment test for the U.S. mortgage insurance reporting unit. We determined fair value using an income approach based on discounted cash flows. Our analysis considered the current U.S. mortgage market conditions in the assessment of fair value. Recent operating losses and decreases in projected income have

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

negatively impacted the current fair value of the U.S. mortgage insurance business. As a result of our analysis, we determined the recorded goodwill associated with this reporting unit was not recoverable. Therefore, we recorded a charge of $22 million to amortization of deferred acquisition costs and intangibles for the write-off of the entire goodwill balance associated with our U.S. mortgage insurance business during the third quarter of 2008.

In accordance with our annual goodwill impairment analysis during the third quarter of 2008, we performed the two-step impairment test for the institutional reporting unit, included in our Retirement and Protection segment. We determined fair value using an income approach based on discounted cash flows. Our analysis considered current market conditions and the impact of those conditions on our institutional business. The recent increases in our credit spreads have negatively impacted this reporting unit’s ability to issue new business at competitive rates. Current credit market conditions make it difficult to determine when new business will be written at the historical volume and margins experienced in recent years. As a result of our analysis, we determined the recorded goodwill associated with this reporting unit was not recoverable. Therefore, we recorded a charge of $12 million to amortization of deferred acquisition costs and intangibles for the write-off of the entire goodwill balance associated with our institutional business during the third quarter of 2008.

Additionally, in September 2008, we amended the stock purchase agreement related to the acquisition of Liberty Reverse Mortgage, Incorporated in October 2007 for various provisions, including termination of the agreement to pay potential performance adjustments of up to $65 million.

(8) Deferred Acquisition Costs

We regularly review deferred acquisition costs (“DAC”) to determine if it is recoverable from future income. Based on management’s current assessment of the claim loss development in the existing 2006 and 2007 books of business which may cause deterioration of expected future gross margins for the 2006 and 2007 book years, we determined that unamortized deferred acquisition costs related to our U.S. mortgage insurance business were not recoverable and consequently recorded a charge of $30 million to DAC during the third quarter of 2008.

As of September 30, 2008, we believe all of our other businesses have sufficient future income where the related DAC would be recoverable under adverse variations in morbidity, mortality, withdrawal or lapse rate, maintenance expense or interest rates that could be considered reasonably likely to occur.

(9) 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.

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

As previously reported, 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. As previously reported, in July 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, removed to the United States District Court for Central California) and City of Stockton v. Bank of America, N.A., et al. (Superior Court of San Francisco County, California, removed to United States District Court for Northern California). In September and October 2008, we were named along with several other GIC industry participants in three more non-class action lawsuits alleging fraud and violations of California’s antitrust laws relating to the sale of GICs and seeking monetary damages: County of San Diego v. Bank of America, N.A. et al. (Superior Court of Los Angeles County, California, removed to the United States District Court for Central California); County of San Mateo v. Bank of America, N.A., et al. (Superior Court of San Francisco, California, removed to the United States District Court for Northern California); and County of Contra Costa v. Bank of America, N.A., et al. (Superior Court of San Francisco, California, removed to the United States District Court for Northern California). We intend to defend the cases vigorously.

In August 2008, one of our subsidiaries, Genworth Life Insurance Company, received an industry-wide Civil Investigative Demand (“CID”) from the Texas Attorney General’s Office seeking documents relating to our long-term care insurance business in Texas. We are cooperating with the Texas Attorney General’s Office in responding to the CID.

(b) Commitments

As of September 30, 2008, we were committed to fund $14 million in U.S. commercial mortgage loan investments and $400 million in limited partnership investments.

(10) 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 September 30, 2008 and December 31, 2007, we had $78 million and $200 million, respectively, of commercial paper outstanding. As of September 30, 2008 and December 31, 2007, the weighted-average interest rate on commercial paper outstanding was 2.42% and 4.83%, respectively, and the weighted-average maturity was 39 days and 42 days, respectively.

On October 7, 2008, the Federal Reserve Board announced details regarding the Commercial Paper Funding Facility (“CPFF”), including that it would begin funding purchases of commercial paper on October 27, 2008. The CPFF is intended to improve liquidity in short-term funding markets and, thereby, increase the availability of credit for businesses and households. There can be no assurance as to what impact such actions will have on the financial markets, including the extreme levels of volatility currently being experienced. In October 2008, we were approved and participated in the CPFF. However, as a result of the downgrade of our holding company, we are no longer eligible to sell commercial paper to the facility, although the outstanding commercial paper that is currently held by CPFF will continue to be held until maturity.

 

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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 September 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.

On October 5, 2008, Lehman Commercial Paper Inc. (“LCP”), a subsidiary of Lehman Brothers Holdings Inc., filed for protection under Chapter 11 of the Federal Bankruptcy Code in the U.S. Bankruptcy Court for the Southern District of New York. LCP is a lender under our credit facilities and had committed to provide $70 million under each facility. We are uncertain whether LCP will fulfill its commitments under the credit facilities in light of its bankruptcy filing.

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 September 30, 2008, we had $3.5 billion of fixed and floating rate non-recourse funding obligations outstanding backing additional statutory reserves. Of these obligations, $1.7 billion were guaranteed by third-party financial guaranty insurance companies and 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 February 2008, the rate was reset from the December 2007 rate on $0.5 billion of the $1.7 billion of non-recourse funding obligations 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. In June 2008, the maximum rate on the remaining $1.2 billion 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.

As of September 30, 2008 and December 31, 2007, the weighted-average interest rates on our non-recourse funding obligations were 4.47% and 5.81%, respectively, reflecting the decline in the underlying index rate.

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)

 

(11) Income Taxes

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

 

     Three months
ended September 30,
    Nine months
ended September 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

   0.8     (0.4 )   0.8     0.1  

Effect of foreign operations

   7.4     (1.6 )   8.4     (3.0 )

Benefit of tax favored investments

   6.7     (7.5 )   5.7     (4.2 )

Interest on uncertain tax positions

   0.2     (0.9 )   3.0     0.2  

Non-deductible goodwill

   (2.5 )   —       (2.4 )   —    

Other, net

   0.4     0.1     0.3     0.1  
                        

Effective rate

   48.0 %   24.7 %   50.8 %   28.2 %
                        

The amounts previously presented in our third quarter of 2007 Quarterly Report on Form 10-Q have been reclassified. In the third quarter of 2007, our rate reconciliation reflected the interim reporting impacts of Accounting Principles Board (“APB”) Opinion No. 28, Interim Financial Reporting, in the category labeled “other.” Each item in the rate reconciliation has been revised to include the impacts of APB No. 28. This revision had no impact on the total effective tax rate for the three and nine months ended September 30, 2007.

The effective tax rate increased significantly from the prior year due to an expected full year loss in the current year compared to income for the prior year. Additional tax benefits for the year were recognized in the current quarter due to the increased proportion of the current year losses to the expected full year losses over the prior year income to the prior year expected full year income pursuant to APB No. 28.

(12) Certain Nontraditional Long-duration Contracts

Our variable annuity contracts provide a basic GMDB which provides a minimum account value to be paid upon the annuitant’s death. Some variable annuity contracts may permit contractholders to have the option to purchase through riders, at an additional charge, enhanced death benefits. Our separate account guarantees are primarily death benefits; we also have some guaranteed minimum withdrawal benefits.

As of September 30, 2008 and December 31, 2007, the total account value, net of reinsurance, of our variable annuities with death benefits, including both separate account and fixed account assets, was approximately $7,374 million and $6,872 million, respectively, with related GMDB exposure (or net amount at risk) of $883 million and $37 million, respectively.

The GMDB liability for our variable annuity contracts with death benefits, net of reinsurance, was $17 million and $8 million as of September 30, 2008 and December 31, 2007, respectively.

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

(13) 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 lifestyle 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 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 September 30,
   Nine months
ended September 30,

(Amounts in millions)

       2008             2007            2008             2007    

Revenues:

         

Retirement and Protection

   $ 1,308     $ 1,949    $ 4,427     $ 5,796

International

     703       711      2,262       1,922

U.S. Mortgage Insurance

     180       206      647       581

Corporate and Other

     (23 )     9      (17 )     51
                             

Total revenues

   $ 2,168     $ 2,875    $ 7,319     $ 8,350
                             

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

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 September 30,
    Nine months
ended September 30,
 

(Amounts in millions)

       2008             2007             2008             2007      

Retirement and Protection

   $ 178     $ 223     $ 490     $ 588  

International

     166       140       509       405  

U.S. Mortgage Insurance

     (121 )     39       (216 )     170  

Corporate and Other

     (3 )     (34 )     (107 )     (104 )
                                

Net operating income

     220       368       676       1,059  

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

     (478 )     (29 )     (927 )     (71 )

Expenses related to reorganization, net of taxes

     —         —         —         (14 )
                                

Income (loss) from continuing operations

     (258 )     339       (251 )     974  

Income from discontinued operations, net of taxes

     —         —         —         15  

Gain on sale from discontinued operations, net of taxes

     —         —         —         53  
                                

Net income (loss)

   $ (258 )   $ 339     $ (251 )   $ 1,042  
                                

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

 

(Amounts in millions)

   September 30,
2008
   December 31,
2007

Assets:

     

Retirement and Protection

   $ 90,548    $ 94,360

International

     11,372      11,892

U.S. Mortgage Insurance

     3,704      3,286

Corporate and Other

     3,937      4,777
             

Total assets

   $ 109,561    $ 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 adverse capital and credit market conditions, downturns and volatility in equity and credit markets, downgrades in our financial strength or credit ratings, the impact of government actions on the financial markets, our ability to access current and future government support programs, interest rate fluctuations, the valuation of fixed maturity, equity and trading securities, defaults, downgrades or impairments of portfolio investments, goodwill impairments, the soundness of other financial institutions, our ability to access sources of liquidity, declines in risk-based capital, insufficiency of reserves, legal constraints on dividend distributions by subsidiaries, intense competition, availability and adequacy of reinsurance, defaults by counterparties, loss of key distribution partners, regulatory restrictions on our operations and changes in applicable laws and regulations, legal or regulatory investigations or actions, the failure or compromise of the security of our computer systems, and the occurrence of natural or man-made disasters or a pandemic;

 

   

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

 

   

Risks relating to our International segment, including political and economic instability, foreign exchange rate fluctuations, unexpected changes in unemployment rates, unexpected increases in mortgage insurance 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 enterprises offering mortgage insurance, changes in regulations, and growth in the global mortgage insurance market that is slower than we expect;

 

   

Risks relating to our U.S. Mortgage Insurance segment, including the outcome of our review of strategic alternatives for the segment, increases in mortgage insurance delinquency rates or severity of defaults, deterioration in economic conditions or a decline in home price appreciation, the effect of the conservatorship of Fannie Mae and Freddie Mac on mortgage originations, the influence of Fannie Mae, Freddie Mac and a small number of large mortgage lenders and investors, decreases in the volume of high loan-to-value mortgage originations or increases in mortgage insurance cancellations, increases in the use of alternatives to private mortgage insurance (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 enterprises offering mortgage insurance, changes in regulations, legal actions under the Real Estate Settlement Practices Act of 1974 (“RESPA”), and potential liabilities in connection with our U.S. contract underwriting services; and

 

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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 with GE even if our corresponding tax savings are never realized and our payments could be accelerated in the event of certain changes in control, and provisions of our certificate of incorporation and bylaws and our tax matters agreement with GE may discourage takeover attempts and business combinations that stockholders might consider in their best interests; and

 

   

Risks relating to our common stock, including the suspension of dividends and share price fluctuation.

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

Overview

Our business

We are a leading financial security company 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. Most of our variable annuities include a guaranteed minimum death benefit (“GMDB”). Some of our group and individual variable annuity products include guaranteed minimum benefit features such as guaranteed minimum withdrawal benefits (“GMWB”) and certain types of guaranteed minimum income benefits. Institutional products include: funding agreements, funding agreements backing notes (“FABNs”) and guaranteed investment contracts (“GICs”). For the three months ended September 30, 2008, our Retirement and Protection segment’s net loss was $225 million and net operating income was $178 million. For the nine months ended September 30, 2008, our Retirement and Protection segment’s net loss was $348 million and net operating income was $490 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 lifestyle protection insurance (formerly referred to as 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 September 30, 2008, our International segment’s net income and net operating income were $142 million and $166 million, respectively. For the nine months ended September 30, 2008, our International segment’s net income and net operating income were $497 million and $509 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 September 30, 2008,

 

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our U.S. Mortgage Insurance segment’s net loss and net operating loss were $149 million and $121 million, respectively. For the nine months ended September 30, 2008, our U.S. Mortgage Insurance segment’s net loss and net operating loss were $243 million and $216 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 September 30, 2008, Corporate and Other activities had a loss from continuing operations and a net operating loss of $26 million and $3 million, respectively. For the nine months ended September 30, 2008, Corporate and Other activities had a loss from continuing operations and a net operating loss of $157 million and $107 million, respectively.

Business trends and conditions

Our business is, and we expect will continue to be, influenced by a number of industry-wide and product-specific trends and conditions. The following discussion of business trends and conditions should be read together with the trends 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 during 2008, with conditions materially worsening in many respects over the last two months. Recently, concerns over inflation, the availability and cost of credit, the U.S. mortgage market and a declining real estate market in the United States have contributed to increased volatility and diminished expectations for the economy and the markets going forward. These factors, combined with declining business and consumer confidence and increased unemployment, have precipitated an economic slowdown and fears of a possible recession. This has resulted in declining asset prices, lower interest rates, rating agency downgrades and increases in loan delinquency rates.

We believe that the challenging 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. This is evident in the slow down of mortgage originations and consumer lending. In addition, we may experience an elevated incidence of claims and lapses or surrenders of policies. Our policyholders may elect to defer paying or stop paying insurance premiums altogether. Other factors such as government spending, the volatility and strength of the capital markets, and inflation also affect the business and economic environment. Ultimately, 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. We are also seeking to enhance our capital and liquidity as discussed under “—Liquidity and Capital Resources.”

On October 3, 2008, President Bush signed the Emergency Economic Stabilization Act of 2008 (the “EESA”) into law in response to the financial crises affecting the banking system and financial markets and continuing concern for the financial stability of investment banks and other financial institutions. Under the EESA, the U.S. Treasury has the authority to, among other things, purchase up to $700 billion of mortgage-backed and other securities from financial institutions, as well as invest directly into certain financial institutions, for the purpose of stabilizing the financial markets. The U.S. government, Federal Reserve and other governmental and regulatory bodies have taken or are considering taking a variety of other actions to address the financial crisis. There can be no assurance as to what impact any of these actions will have on the financial

 

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markets, including the extreme levels of volatility currently being experienced. Continued volatility could materially and adversely affect our business, financial condition and results of operations.

Volatility in credit and investment markets. Credit markets continue to experience extreme volatility resulting in reduced liquidity and widening credit spreads across asset classes associated with re-pricing of risk, as well as more credit downgrade events and increased probability of default. 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.

As economic conditions have deteriorated, lending criteria have tightened and interbank lending has become negatively impacted, resulting in significant declines in transaction volumes across most asset classes. It is difficult to determine how long these conditions will continue or when they do begin to improve how long it will take for market conditions to return to historically normal levels.

These credit market conditions contributed to an increase in net unrealized investment losses since December 31, 2007 of $4.2 billion, before tax and other offsets, in our $48.7 billion investment portfolio of fixed maturity securities reflecting the conditions discussed above. As a result of the economic downturn in 2008 within the financial services sector, we have seen an increase in corporate bankruptcies, financial restructurings and the number of companies defaulting on their debt obligations and a decline in performance of collateral underlying certain structured securities. These defaults and other performance factors resulting in declines in the value of our investment portfolio have contributed to substantially higher levels of impairments throughout 2008, including $577 million in the third quarter of 2008. In some cases, the combined shift in rating, valuations and outlook for certain securities has resulted in a change in intent of whether to hold these securities to recovery of value. As a result of the challenging market conditions and expected further weakening in the economic environment, we have continued to see increases in our unrealized investment losses subsequent to quarter end and expect to see further volatility in the valuation of these investments, as well as the potential for additional impairments on our investment portfolio or changes regarding retention strategies for certain securities. For example, certain securities that are less liquid have become more difficult to value and may be difficult to dispose of in the current environment. Although these economic conditions negatively impact our investment valuation, the underlying collateral continues to perform and default rates remain at historically low levels for many of the impacted asset classes.

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 Derivative Instruments” for additional information on our investment portfolio.

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 impacted our ability to issue commercial paper during the third quarter of 2008. If these trends continue, it may be difficult for us to complete various financing or funding transactions at desired times or on attractive terms or at all.

In addition, on October 7, 2008, the Federal Reserve Board announced details regarding the Commercial Paper Funding Facility (“CPFF”), including that it would begin funding purchases of commercial paper on

 

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October 27, 2008. The CPFF is intended to improve liquidity in short-term funding markets and, thereby, increase the availability of credit for businesses and households. There can be no assurance as to what impact such actions will have on the financial markets, including the extreme levels of volatility currently being experienced. In October 2008, we were approved and participated in the CPFF. However, as a result of the downgrade of our holding company, we are no longer eligible to sell commercial paper to the facility, although the outstanding commercial paper that is currently held by CPFF will continue to be held until maturity.

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. Growth in the asset management industry has slowed in the current market environment. 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 expect to see further negative performance in these areas.

Retirement income. Results for our retirement income business are affected by investment performance, interest rate levels, slope of the interest rate yield curve, net interest spreads, equity market 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 evaluate our competitive position based upon each of these features and actively manage our risk exposures through various strategies, including requiring prescribed investment allocations, active product price management and other risk management activities including reinsurance and hedging. Most of our variable annuities include a GMDB. Some of our group and individual variable annuity products include guaranteed minimum benefit features such as GMWB and certain types of guaranteed minimum income benefits, which require prescribed investment allocations. We do not offer any products with guaranteed minimum accumulation benefits.

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 long-term 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.

We are experiencing lower variable annuity sales and higher fixed annuity sales as a result of consumers seeking safety from recent market turbulence and uncertainty. Current market pressures are also increasing our expected claim costs, the cost and effectiveness of our hedging programs and the level of capital we may need to support these products.

We believe there may be further declines in equity markets and increased equity market volatility which will continue to negatively impact the cost and effectiveness of our GMWB hedging program. The significant declines and increased volatility in the equity markets have negatively impacted our results during the third quarter of 2008. Equity markets have experienced a sharp decline from the September 30, 2008 level and market volatility has increased dramatically. Continued equity market volatility could result in additional losses in our

 

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variable annuity products and associated hedging program which will challenge our ability to recover deferred acquisition costs (“DAC”) on these products and lead to further write-offs of DAC.

Institutional. Results in our institutional business are affected by credit markets. 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 rating and 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 have made the extension of the maturities of some of our institutional products less attractive to the holders compared to alternative products offering higher yields or more liquidity. As a result, certain FABN and funding agreement contractholders have elected not to extend the maturity of their contracts. Because we earn a spread between interest earned and interest credited on these institutional products, this non-extension reduces our revenues and profitability by reducing our institutional product liabilities. As of September 30, 2008, the holders of approximately $1.6 billion of contracts elected not to extend the maturity date on their contracts, and consequently these contracts will now mature over the next twelve months. In light of the ongoing turmoil in the credit and financial markets, we are not currently pursuing additional institutional product sales and expect increased outflows on these products.

In December 2007, we began issuing FABNs to retail investors and we are closely monitoring credit market conditions to determine when to issue FABNs into the retail market.

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 anticipate this trend will continue as we maintain our pricing discipline and focus on middle market term life insurance sales. We also experienced lower persistency in term life insurance policies going into 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 with an emphasis on middle market consumers.

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 adversely affected the availability of securitization transactions and created the need for us to pursue alternative approaches such as reinsurance and private financing transactions and we expect these conditions to continue. Together the ability to finance and effectiveness of financing these additional reserves may impact future life insurance sales and new business returns.

As of September 30, 2008, we had $3.5 billion of fixed and floating rate non-recourse funding obligations outstanding backing these additional statutory reserves. Of these obligations, $1.7 billion were guaranteed by third-party financial guaranty insurance companies and 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.

 

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As noted above, to maintain and optimize product returns, we may seek alternative financing approaches in the future depending upon market conditions. Recent market conditions have limited the capacity for these reserve funding structures. If capacity continues to be limited for a prolonged period of time, our ability to obtain new funding for these structures may be hindered, and as a result our ability to write additional business in a cost effective manner may be impacted. If we are unable to continue to implement these actions, we may be required to increase statutory reserves, incur higher operating costs than we currently anticipate, reduce our sales of these products or pursue alternative approaches, such as additional reinsurance and private funding transactions. We also may have to implement measures that may be disruptive to our business. For example, because term and universal life insurance are particularly price-sensitive products, any increase in premiums charged on these products in order to compensate us for the increased statutory reserve requirements or higher costs of reinsurance may result in a significant loss of volume and adversely affect our life insurance operations.

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 have expanded our product offerings to include 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 business. In addition, the continued low interest rate environment may negatively impact our net operating income. In response to these trends, we intend to 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 favorable underwriting and risk characteristics. In many European countries, we have seen a slowdown in housing markets. For example, 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. Europe represents approximately 5% of our international mortgage insurance risk in-force. We have also seen a slowdown in housing market mortgage origination and home price appreciation levels in 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.

While global economies are slowing, overall home price appreciation remains positive in most regions of Canada and Australia and unemployment has only seen modest increases. Canada and Australia comprise approximately 95% of our international mortgage insurance risk in-force with an estimated average effective loan-to-value ratio of 63%. In this environment, our international mortgage insurance business has expanded with favorable operating results. High-risk lending practices such as sub-prime and 100% loan-to-value lending are far less common in international markets than in the United States, and there is significantly less reliance on capital market funding for liquidity needs. We have also taken steps to tighten our underwriting requirements, increase prices in targeted areas or products and improve loss mitigation strategies in light of the slowing housing markets. We expect that our established international mortgage insurance business in Canada and Australia will

 

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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 600. However, the Government of Canada allows for up to three percent of an originator’s volume to fall below the 600 minimum credit score. We have incorporated these standards into our underwriting guidelines effective October 15, 2008. These changes have resulted in a minor reduction of mortgage originations.

In Australia, recent government actions, such as providing aid to first-time home buyers and interest rate cuts, are expected to help offset the impact of the slowing economy, decreasing home price appreciation and rising unemployment.

As a result of the expansion of our international mortgage insurance business in recent years, as of September 30, 2008, approximately 57% 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. As a result of slowing economic environments, we are anticipating increased losses in our international mortgage insurance businesses, particularly in the more recent vintages. These books of business, which have been some of our largest, will continue to mature in slowing economies giving rise to further increases in losses over the next two to three years. Our loss estimates are inherently subject to variation. Variations we consider reasonably likely to occur could include an increase in projected losses for our international mortgage insurance businesses of between 15% and 25% over the next three-year period. If changes at these levels were to occur, operating results could be negatively impacted by approximately $135 million to approximately $225 million over this same period. The potential for either additional adverse loss development or favorable loss development exists, which could further impact our business underwriting margins. We expect loss ratios in Canada to remain within our pricing expectations. However, in Australia, certain books of business with exposure to certain sub-markets around New South Wales have experienced loss ratios above our pricing expectations, and we expect this trend to continue.

Lifestyle protection insurance. Growth of our lifestyle 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 as a result of expected regulations regarding sales practices, 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 lifestyle 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.

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.

The U.S. housing market is experiencing a material slowdown and we expect the decline to continue. Home price appreciation has turned negative in the majority of markets. We also expect unemployment levels to increase as the U.S. economy continues to slow in the remainder of 2008 and into 2009. In addition, delinquency and foreclosure levels remain high which contributed to the increased 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 adversely affecting the performance of our entire portfolio across all product lines in all markets, but with particular impact

 

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in certain states and product types, including A minus, Alt-A, adjustable rate mortgages (“ARMs”) and certain 100% loan-to-value loans. We anticipate that the difficult conditions in the financial markets are not likely to improve in the near future and ongoing volatility in these markets is likely.

The foregoing factors contributed 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. 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, Alt-A, ARMs and certain 100% loan-to-value products. In addition, throughout the U.S., we have experienced an increase in the average loan balance of mortgage loans, including on delinquent loans, as well as a significant decline in home price appreciation, which has turned negative in the majority of U.S. markets. Certain regions around the country, particularly surrounding the Great Lakes area of the upper Midwest, particularly Illinois and Minnesota, continue to experience an economic slowdown and have seen a more pronounced weakness in their housing markets, as well as declines in home prices. This slowdown and the resulting impact on the housing market are reflected in our increasing delinquencies. However, we believe that there may be a lag in the rate at which delinquent loans are going to foreclosure due to various local and lender foreclosure moratoria as well as servicer and court-related backlog issues. As these loans eventually go to foreclosure, our delinquency counts will be reduced and our paid claims will increase accordingly. 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 90% 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, is likely to cause further increases in our incurred losses and related loss ratio. As of September 30, 2008, approximately 70% 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. Our 2005, 2006 and 2007 books of business are experiencing delinquencies and incurred losses substantially higher than those generated from previous book years we have written. Early loss development patterns from these book years indicate that we would expect a higher level of total losses generated from these books. Variations we consider reasonably likely to occur could include an increase in projected losses for the 2005 through 2007 books of our U.S. mortgage insurance business of between 4% and 7% over the next three-year period. If changes at these levels were to occur, operating results could be negatively impacted by approximately $85 million to $150 million over this same period. These amounts do not include additional reinsurance recoveries that could occur from our captive reinsurance arrangements. However, more adverse variation could result in additional negative impacts while favorable variations would result in improved margins. We expect future sales of our U.S. mortgage insurance business to reduce the likelihood of these adverse variations. Regardless of the ultimate loss development pattern on these books, we expect they will continue to generate significant paid and incurred losses throughout the remainder of 2008 and through the next two to three years and thus will continue to have a significant adverse impact on our operating results over these same periods.

Primary insurance in-force increased to $175.3 billion as of September 30, 2008, which represented an 11% increase as compared to December 31, 2007. In addition, net earned premiums have grown from $444 million for the nine months ended September 30, 2007 to $558 million for the nine months ended September 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 driven by growth in the conventional conforming mortgage market and a credit environment that causes investors to value mortgage insurance, as well as higher levels of persistency. We believe the private mortgage insurance penetration rate has increased from approximately 6% in 2006 to approximately 13% in the second quarter of 2008. However, we expect that weakness in housing markets and the lack of liquidity in the general credit markets will result in a smaller mortgage origination market in 2008 and 2009. This trend, together with the growth in the Federal Housing Administration (“FHA”) originations, may offset the increase in demand for private mortgage insurance to some extent.

 

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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 levels. For the nine months ended September 30, 2008, we recorded a reinsurance recovery of $298 million where cumulative losses have exceeded the attachment points in several captive reinsurance arrangements, primarily related to the 2005, 2006 and 2007 books of business. We expect to record additional reinsurance recoveries throughout 2008 and into 2009 under these and other captive reinsurance arrangements as incurred losses display accelerated development on our books of business, particularly those of 2005, 2006 and 2007. In the nine months ended September 30, 2008, we saw worsening and early loss development trends, particularly for the 2006 and 2007 book years. If these trends continue over multiple years and are combined with further adverse development in home price appreciation and unemployment levels, coupled with limited borrower refinancing options and a reduction in delinquency cures, which impact both frequency and severity of claims, we could exhaust captive reinsurance tiers for certain individual captive lenders on certain book years or exhaust trust assets. Once the captive reinsurance or trust assets are exhausted, or if required funds in trust are no longer sufficient for payment of claims, we would be responsible for any additional losses incurred. In October 2008, we announced we will no longer participate in excess loss of captive reinsurance transactions as of January 1, 2009 and we will only consider participation in quota share reinsurance arrangements.

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, have exited certain product lines. The number of identified declining markets has increased from 140 in the second quarter of 2008 to 178 to date. Our changes thus far have eliminated virtually all new insurance of A minus, Alt-A and 100% loan-to-value products. We believe these actions will improve our underwriting results on these and future books of business and will result in improved profitability on the 2008 and future books of new insurance written.

Our level of market penetration and eventual market size could also be affected by any actions taken by the GSEs or the 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. In addition, Fannie Mae and Freddie Mac are the largest purchasers and guarantors of mortgage loans in the United States. Fannie Mae and Freddie Mac were created by Congressional charter to ensure that mortgage lenders have sufficient funds to continue to finance home purchases. On September 7, 2008, the U.S. Department of the Treasury and the Federal Housing Finance Agency (“FHFA”) announced a plan to place Fannie Mae and Freddie Mac into conservatorship under the authority of the FHFA. As a result, the number of mortgages purchased by Fannie Mae and Freddie Mac could decrease. This could result in fewer mortgages being originated and, consequently, decrease the demand for private mortgage insurance, which could have an adverse effect on our financial condition and results of operations.

In addition, the appointment of a conservator may increase the likelihood that the charters of Fannie Mae and Freddie Mac will be changed by new federal legislation. Such changes may allow Fannie Mae and Freddie Mac to reduce or eliminate the level of private mortgage insurance coverage that they use as credit enhancement.

On September 30, 2008, we announced we are examining a number of strategic alternatives regarding our U.S. mortgage insurance business, including a possible spin-off, to determine the optimal course for Genworth, our customers and stockholders. We have not made any decisions to date as to whether we will retain or divest that business. If we chose to divest that business, we cannot be sure that we will be able to complete a spin-off, attract interested third parties for a possible sale transaction or execute any other transaction involving this business. If a transaction were to occur, we also cannot be sure that its terms would be favorable to us or would have a material beneficial effect on our business, financial condition or results of operations.

On October 1, 2008, the U.S. government’s Hope for Homeowners program became effective. This program is designed to help drive a recovery of the housing market through principal write-downs and release of liens.

 

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This program may serve to mitigate losses on loans we insure although it is too early to tell what, if any, benefit may result from the program.

Ratings

Following our announcement on September 30, 2008 that we are examining a number of strategic alternatives for our U.S. mortgage insurance business, both Standard & Poor’s (“S&P”) and Moody’s rating services issued press releases regarding their ratings for Genworth and our businesses. S&P lowered our U.S. and European mortgage insurance ratings one notch to “AA-” from “AA.” S&P’s ratings for our holding company and other insurance subsidiaries remained unchanged. S&P states that an insurer rated “AA” (Very Strong) has very strong financial security characteristics and is highly likely to have the ability to meet financial commitments. The “AA” range is the second-highest of the four ratings ranges that meet these criteria, and is the second-highest of nine financial strength rating ranges assigned by S&P, which range from “AAA” to “R.” A plus (+) or minus (-) shows relative standing in a rating category. Accordingly, the “AA-” rating is the fourth-highest of S&P’s 21 ratings categories. Moody’s indicated that it intended to review the appropriateness of our ratings.

On October 3, 2008, Fitch announced they would review the ratings appropriateness of our life insurance businesses. This also follows our announcement on September 30, 2008 that we will examine strategic alternatives related to our U.S. mortgage insurance business, as well as Fitch’s announcement on September 29, 2008, which changed the life insurance industry outlook from “stable” to “negative.” On October 21, 2008, Fitch downgraded our life insurance subsidiaries one notch to “A+” from “AA-.” In addition, Fitch removed our life insurance ratings from rating watch negative and placed them on negative outlook. Fitch states that “A” (Strong) rated insurance companies are viewed as possessing strong capacity to meet policyholder and contract obligations. The “A” rating category is the third-highest of eight financial strength rating categories, which range from “AAA” to “C.” The symbol (+) or (-) may be appended to a rating to indicate the relative position of a credit within a rating category. These suffixes are not added to ratings in the “AAA” category or to ratings below the “CCC” category. Accordingly, the “A+” rating is the fifth-highest of Fitch’s 21 ratings categories.

During the third quarter of 2008, we requested Fitch to withdraw ratings on our U.S. and international mortgage insurance businesses and on securities issued by our holding company. Accordingly we no longer solicit, or sponsor, those ratings.

On November 6, 2008, A.M. Best announced that they have placed our ratings under review with negative implications. This follows A.M. Best’s announcement on September 18, 2008, which changed their life insurance industry outlook from “stable” to “negative.”

On November 7, 2008, S&P affirmed the “AA-” counterparty and financial strength ratings our life insurance businesses and lowered our long-term counterparty credit and senior debt ratings to “A-” from “A.” The outlook on both is negative. The ratings on our mortgage insurance operations were unaffected by these rating actions. S&P also downgraded our commercial paper rating to “A-2” from “A-1.”

We believe that Moody’s will downgrade our debt ratings, senior debt to “Baa1” from “A2,” as well as the insurance financial strength ratings of our primary life insurance operating subsidiaries to “A1” from “Aa3” and the outlook on Genworth and our life insurance subsidiaries will be negative.

Critical Accounting Estimates

The accounting estimates discussed in this section are those that we consider to be particularly critical to an understanding of our consolidated financial statements because their application places the most significant demands on our ability to judge the effect of inherently uncertain matters on our financial results. For all of these policies, we caution that future events rarely develop exactly as forecasted, and management’s best estimates may require adjustment.

 

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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 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. In limited instances, this category may also utilize non-binding broker quotes. 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 obtained primarily from industry-standard pricing methodologies utilizing market observable information, when

 

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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 or discounting market consistent expected future cash flows, to estimate fair value. These measures are 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, including the utilization of non-binding broker quotes.

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

The following table sets forth the fair value of our fixed maturity securities portfolio by pricing source as of the date indicated:

 

     September 30, 2008

(Amounts in millions)

   Total    Level 1    Level 2    Level 3

Fixed maturity securities:

           

Priced via industry standard pricing methodologies

   $ 40,688    $ —      $ 38,284    $ 2,404

Priced via indicative market prices

     2,044      —        —        2,044

Priced via internally developed models

     5,992      —        4,619      1,373
                           

Total fixed maturity securities

   $ 48,724    $ —      $ 42,903    $ 5,821
                           

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 net 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 net 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.

 

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In its letter to the Financial Accounting Standards Board (“FASB”) dated October 14, 2008, the U.S. Securities and Exchange Commission (“SEC”) stated that, given the debt characteristics of hybrid securities, a debt impairment model could be used for filings subsequent to October 14, 2008, until the FASB further addresses the approximate impairment approach. Included in the preceding table were securities that represent investments in hybrid instruments with gross unrealized losses of $274 million. Of this amount, $210 million has existed for a period exceeding twelve months. Of these unrealized losses, 100% were on securities that were investment grade and 53% were less than 20% below cost. The remaining securities had market values that were between 20% and 50% below cost.

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 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.

Deferred acquisition costs. DAC represents costs that vary with and are primarily related to the sale and issuance of our insurance policies and investment contracts which are deferred and amortized over the estimated life of the related insurance policies. These costs include commissions in excess of ultimate renewal commissions, solicitation and printing costs, sales material and some support costs, such as underwriting and contract and policy issuance expenses. DAC is subsequently amortized to expense over the lives of the underlying contracts, in relation to the anticipated recognition of premiums or gross profits.

 

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The amortization of DAC for traditional long-duration insurance products (including guaranteed renewable term life, life-contingent structured settlements and immediate annuities and long-term care insurance) is determined as a level proportion of premium based on commonly accepted actuarial methods and reasonable assumptions about mortality, morbidity, lapse rates, expenses, and future yield on related investments, established when the contract or policy is issued. U.S. generally accepted accounting principles (“U.S. GAAP”) requires that assumptions for these types of products not be modified (or unlocked) unless recoverability testing deems them to be inadequate. Amortization is adjusted each period to reflect policy lapse or termination rates as compared to anticipated experience. Accordingly, we could experience accelerated amortization of DAC if policies terminate earlier than originally assumed.

Amortization of DAC for annuity contracts without significant mortality risk and for investment and universal life insurance products is based on expected gross profits. Expected gross profits are adjusted quarterly to reflect actual experience to date or for the unlocking of underlying key assumptions based on experience studies such as mortality, withdrawal or lapse rates, investment margin or maintenance expenses. The estimation of expected gross profits is subject to change given the inherent uncertainty as to the underlying key assumptions employed and the long duration of our policy or contract liabilities. Changes in expected gross profits reflecting the unlocking of underlying key assumptions could result in a material increase or decrease in the amortization of DAC depending on the magnitude of the change in underlying assumptions. Significant factors that could result in a material increase or decrease in DAC amortization for these products include material changes in withdrawal or lapse rates, investment spreads or mortality assumptions. For the nine months ended September 30, 2008 and 2007, key assumptions were unlocked in our Retirement and Protection segment to reflect our current expectation of future investment spreads and mortality.

The amortization of DAC for mortgage insurance is based on expected gross margins. Expected gross margins, defined as premiums less losses, are set based on assumptions for future persistency and loss development of the business. These assumptions are updated for actual experience to date or as our expectations of future experience are revised based on experience studies. Due to the inherent uncertainties in making assumptions about future events, materially different experience from expected results in persistency or loss development could result in a material increase or decrease to DAC amortization for this business. For the nine months ended September 30, 2008 and 2007, key assumptions were unlocked in our international and U.S. mortgage insurance products to reflect our current expectation of future persistency and loss projections.

The following table sets forth the increase (decrease) on amortization of DAC related to unlocking of underlying key assumptions by segment for the periods indicated:

 

     Nine months
ended September 30,

(Amounts in millions)

     2008        2007  

Retirement and Protection

   $ 9    $ 7

International

     2      —  

U.S. Mortgage Insurance

     5      2
             

Total

   $ 16    $ 9
             

The DAC amortization methodology for our variable products (variable annuities and variable universal life insurance) includes a long-term equity market average appreciation assumption of 8.5%. When actual returns vary from the expected 8.5% we assume a reversion to the expected return over a three- to five-year period. The assumed returns over this reversion to the expected return period are limited to the 85th percentile of historical market performance. Variation in equity market returns that could be considered reasonably likely would not have a material effect on the amortization of DAC.

We regularly review DAC to determine if it is recoverable from future income. For deposit products, if the current present value of estimated future gross profits is less than the unamortized DAC for a line of business, a

 

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charge to income is recorded for additional DAC amortization or for increased benefit reserves. For other products, if the benefit reserves plus anticipated future premiums and interest income for a line of business are less than the current estimate of future benefits and expenses (including any unamortized DAC), a charge to income is recorded for additional DAC amortization or for increased benefit reserves.

Based on management’s current assessment of the claim loss development in the existing 2006 and 2007 books of business which may cause deterioration of expected future gross margins for the 2006 and 2007 book years, we determined that unamortized deferred acquisition costs related to our U.S. mortgage insurance business were not recoverable and consequently recorded a charge of $30 million to DAC during the third quarter of 2008.

Although we believe all of our other businesses have sufficient future income, where the related DAC would be recoverable under adverse variations in morbidity, mortality, withdrawal or lapse rate, maintenance expense or interest rates that could be considered reasonably likely to occur. Continued equity market volatility could result in material losses in our variable annuity products and associated hedging program which will challenge our ability to recover DAC on these products and could lead to further write-offs of DAC.

Valuation of goodwill. Goodwill represents the excess of the amount paid to acquire a business over the fair value of its net assets at the date of acquisition. Subsequent to acquisition, goodwill could become impaired if the fair value of a reporting unit as a whole were to decline below the value of its individually identifiable assets and liabilities. This may occur for various reasons, including changes in actual or expected income or cash flows of a reporting unit or generation of income by a reporting unit at a lower rate of return than similar businesses.

Under U.S. GAAP, we test the carrying value of goodwill for impairment at least annually at the “reporting unit” level, which is either an operating segment or a business one level below the operating segment. Under certain circumstances, interim impairment tests may be required if events occur or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value.

The determination of fair value for reporting units is primarily based on discounted cash flows or other valuation techniques, as appropriate. When available and as appropriate, we use comparative market multiples to corroborate discounted cash flow results. The discounted cash flows used to determine fair value are dependent on a number of significant management assumptions based on our historical experience and our expectations of future performance. Our estimates are subject to change given the inherent uncertainty in predicting future performance and cash flows, which are impacted by such things as policyholder behavior, competitor pricing, new product introductions and specific industry and market conditions. Additionally, the discount rate used in our discounted cash flow approach is based on management’s judgment of the appropriate rate for each reporting unit based on the relative risk associated with the projected cash flows.

During the third quarter of 2008, we completed our annual goodwill impairment analysis based on data as of July 1, 2008. As a result of this analysis, we recorded goodwill impairments related to our U.S. mortgage insurance and institutional businesses, as discussed further below. For all other of our reporting units, there were no charges to income as a result of our annual goodwill impairment testing. As a result of changes in the market environment during the third quarter of 2008, we performed an interim impairment analysis as of September 30, 2008. The interim impairment testing results did not result in any additional impairment of goodwill. We continue to evaluate current market conditions that may affect the fair value of our reporting units to assess whether any goodwill impairment exists. Continued deteriorating or adverse market conditions for certain businesses may have a significant impact on the fair value of our reporting units and could result in additional future impairments of goodwill.

In accordance with our annual goodwill impairment analysis during the third quarter of 2008, we performed the two-step impairment test for the U.S. mortgage insurance reporting unit. We determined fair value using an income approach based on discounted cash flows. Our analysis considered the current U.S. mortgage market conditions in the assessment of fair value. Recent operating losses and decreases in projected income have negatively impacted the current fair value of the U.S. mortgage insurance business. As a result of our analysis,

 

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we determined the recorded goodwill associated with this reporting unit was not recoverable. Therefore, we recorded a charge of $22 million to amortization of deferred acquisition costs and intangibles for the write-off of the entire goodwill balance associated with our U.S. mortgage insurance business during the third quarter of 2008.

In accordance with our annual goodwill impairment analysis during the third quarter of 2008, we performed the two-step impairment test for the institutional reporting unit included in our Retirement and Protection segment. We determined fair value using an income approach based on discounted cash flows. Our analysis considered current market conditions and the impact of those conditions on our institutional business. The recent increases in our credit spreads have negatively impacted this reporting unit’s ability to issue new business at competitive rates. Current credit market conditions make it difficult to determine when new business will be written at the historical volume and margins experienced in recent years. As a result of our analysis, we determined the recorded goodwill associated with this reporting unit was not recoverable. Therefore, we recorded a charge of $12 million to amortization of deferred acquisition costs and intangibles for the write-off of the entire goodwill balance associated with our institutional business during the third quarter of 2008.

Insurance liabilities and reserves. We calculate and maintain reserves for the estimated future payment of claims to our policyholders and contractholders based on actuarial assumptions and in accordance with industry practice and U.S. GAAP. Many factors can affect these reserves, including economic and social conditions, inflation, healthcare costs, changes in doctrines of legal liability and damage awards in litigation. Therefore, the reserves we establish are necessarily based on estimates, assumptions and our analysis of historical experience. Our results depend significantly upon the extent to which our actual claims experience is consistent with the assumptions we used in determining our reserves and pricing our products. Our reserve assumptions and estimates require significant judgment and, therefore, are inherently uncertain. We cannot determine with precision the ultimate amounts that we will pay for actual claims or the timing of those payments.

Insurance reserves differ for long- and short-duration insurance policies and annuity contracts. Measurement of long-duration insurance reserves (such as guaranteed renewable term life, whole life and long-term care insurance policies) is based on approved actuarial methods, and includes assumptions about expenses, mortality, morbidity, lapse rates and future yield on related investments. Short-duration contracts (such as lifestyle protection insurance) are accounted for based on actuarial estimates of the amount of loss inherent in that period’s claims, including losses incurred for which claims have not been reported. Short-duration contract loss estimates rely on actuarial observations of ultimate loss experience for similar historical events.

Estimates of mortgage insurance reserves for losses and loss adjustment expenses are based on notices of mortgage loan defaults and estimates of defaults that have been incurred but have not been reported by loan servicers, using assumptions of claim rates for loans in default and the average amount paid for loans that result in a claim. As is common accounting practice in the mortgage insurance industry and in accordance with U.S. GAAP, loss reserves are not established for future claims on insured loans that are not currently in default. Management reviews quarterly the loss reserves for adequacy, and if indicated, updates the assumptions used for estimating and calculating such reserves.

The establishment of our mortgage insurance loss reserves is subject to inherent uncertainty and requires judgment by management. The actual amount of the claim payments may vary significantly from the loss reserve estimates. Our estimates could be adversely affected by several factors, including a deterioration of regional or national economic conditions leading to a reduction in borrowers’ income and thus their ability to make mortgage payments, and a drop in housing values that could expose us to greater loss on resale of properties obtained through foreclosure proceedings. In considering the potential sensitivity of the factors underlying management’s best estimate of our U.S. and international mortgage insurance reserves for losses, it is possible that even a relatively small change in estimated claim rate or a relatively small percentage change in estimated claim amount could have a significant impact on reserves and, correspondingly, on results of operations. For example, a $1,000 change in the average severity reserve factor combined with a 1% change in the average claim rate reserve factor could change the reserve amount by approximately $65 million and approximately $25 million

 

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for our U.S. and international mortgage insurance businesses, respectively. Changes to our estimates could result in material changes to our operations, even in a stable economic environment. Adjustments to our reserve estimates are reflected in the consolidated financial statements in the years in which the adjustments are made.

Unearned premiums. In our international mortgage insurance business, the majority of our insurance contracts are single premium. For single premium insurance contracts, we recognize premiums over the policy life in accordance with the expected pattern of risk emergence. We recognize a portion of the revenue in premiums earned in the current period, while the remaining portion is deferred as unearned premiums and earned over time in accordance with the expected pattern of risk emergence. If single premium policies are cancelled and the premium is non-refundable, then the remaining unearned premium related to each cancelled policy is recognized to earned premiums upon notification of the cancellation. The expected pattern of risk emergence on which we base premium recognition is inherently judgmental and is based on actuarial analysis of historical experience. Changes in market conditions could cause a decline in mortgage originations, mortgage insurance penetration rates or our market share, all of which could impact new insurance written. For example, a decline in flow new insurance written of $1.0 billion would result in approximately a $3 million reduction in earned premiums in the full first year. However, this decline would be partially offset by the recognition of earned premiums from established unearned premium reserves primarily from the last three years of business.

As of September 30, 2008 and December 31, 2007, we had $5.3 billion and $5.6 billion, respectively, of unearned premiums, of which $3.2 billion and $3.4 billion, respectively, related to our international mortgage insurance business. We recognize international mortgage insurance unearned premiums over a period of up to 25 years, most of which are recognized between three and seven years from issue date. The recognition of earned premiums for our international mortgage insurance business involves significant estimates and assumptions as to future loss development and policy cancellations. These assumptions are based on our historical experience and our expectations of future performance, which are highly dependent on assumptions as to long-term macroeconomic conditions including interest rates, home price appreciation and the rate of unemployment. We periodically review our expected pattern of risk emergence and make adjustments based on actual experience and changes in our expectation of future performance with any adjustments reflected in current period income. For the nine months ended September 30, 2008 and for the year ended December 31, 2007, increases to earned premiums in our international mortgage insurance business as a result of adjustments made to our expected pattern of risk emergence and policy cancellation assumptions were $28 million and $45 million, respectively.

Our expected pattern of risk emergence for our international mortgage insurance business is subject to change given the inherent uncertainty as to the underlying loss development and policy cancellation assumptions and the long duration of our international mortgage insurance policy contracts. Actual experience that is different than assumed for loss development or policy cancellations could result in a material increase or decrease in the recognition of earned premiums depending on the magnitude of the difference between actual and assumed experience. Loss development and policy cancellation variations that could be considered reasonably likely to occur in the future would result in accelerated or decelerated recognition of earned premiums that would result in an increase in net income of up to $50 million or a decrease in net income of up to $25 million, depending on the magnitude of variation experienced. It is important to note that the variation discussed above is not meant to be a best-case or worst-case scenario, and therefore, it is possible that future variation may exceed the amounts discussed above.

In our U.S. Mortgage Insurance segment, the majority of our insurance contracts have recurring premiums. We recognize recurring premiums over the terms of the related insurance policy on a pro-rata basis (i.e., monthly). Changes in market conditions could cause a decline in mortgage originations, mortgage insurance penetration rates and our market share, all of which could impact new insurance written. For example, a decline in new flow insurance written of $1.0 billion would result in approximately a $6 million reduction in earned premiums in the first full year. Likewise, if flow persistency declined on our existing insurance in-force by 10%, earned premiums would decline by approximately $63 million during the first full year, potentially offset by lower reserves due to policies no longer being in-force.

 

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The remaining portion of our unearned premiums relates to our lifestyle protection and long-term care insurance businesses where the underlying assumptions as to risk emergence are not subject to significant uncertainty. Accordingly, changes in underlying assumptions as to premium recognition we consider being reasonably likely for these businesses would not result in a material impact on net income.

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

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

 

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

(Amounts in millions)

       2008              2007          2008 vs. 2007  

Revenues:

           

Premiums

   $ 1,735      $ 1,600      $ 135      8 %

Net investment income

     918        1,074        (156 )    (15 )%

Net investment gains (losses)

     (816 )      (48 )      (768 )    NM (1)

Insurance and investment product fees and other

     331        249        82      33 %
                             

Total revenues

     2,168        2,875        (707 )    (25 )%
                             

Benefits and expenses:

           

Benefits and other changes in policy reserves

     1,497        1,168        329      28 %

Interest credited

     319        391        (72 )    (18 )%

Acquisition and operating expenses, net of deferrals

     515        540        (25 )    (5 )%

Amortization of deferred acquisition costs and intangibles

     208        202        6      3 %

Interest expense

     125        124        1      1 %
                             

Total benefits and expenses

     2,664        2,425        239      10 %
                             

Income (loss) from continuing operations before income taxes

     (496 )      450        (946 )    NM (1)

Provision (benefit) for income taxes

     (238 )      111        (349 )    NM (1)
                             

Net income (loss)

   $ (258 )    $ 339      $ (597 )    (176 )%
                             

 

(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, lifestyle protection and mortgage insurance policies.

 

   

Our Retirement and Protection segment increased $97 million primarily due to a $63 million increase in our retirement income business, a $29 million increase in our long-term care insurance business and a $5 million increase in our life insurance business.

 

   

Our International segment increased $15 million as a result of a $37 million increase in our international mortgage insurance business, offset by a decrease of $22 million in our lifestyle protection insurance business. The three months ended September 30, 2008 included an increase of $16 million attributable to changes in foreign exchange rates.

 

   

Our U.S. Mortgage Insurance segment increased $26 million.

 

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

 

   

Weighted-average investment yields decreased to 5.1% for the three months ended September 30, 2008 from 6.1% for the three months ended September 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 September 30, 2008 included a $31 million loss related to limited partnerships as compared to a $26 million gain in the three months ended September 30, 2007 reflecting equity method accounting changes on real estate partnerships. In addition, net investment income for the three months ended September 30, 2008 included $3 million of investment income related to bond calls and commercial mortgage loan prepayments as compared to $14 million in the three months ended September 30, 2007.

 

   

The three months ended September 30, 2008 included $4 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 $492 million of credit and/or cash flow related impairments and $85 million related to a change in intent to hold securities to recovery during the three months ended September 30, 2008. Of total impairments, $236 million related to securities backed by sub-prime and Alt-A residential mortgage-backed and asset-backed securities and $266 million related to certain financial services companies. Impairments related to financial services companies were a result of bankruptcies, receivership or concerns about the issuer’s ability to continue to make contractual payments. Net investment losses of $90 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 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. 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 $89 million largely driven by an $81 million increase in our institutional business and a $10 million increase from 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, lifestyle protection insurance and claim costs incurred related to mortgage insurance products.

 

   

Our Retirement and Protection segment increased $129 million attributable to an $80 million increase in our retirement income business, a $26 million increase in our life insurance business and a $23 million increase in our long-term care insurance business.

 

   

Our International segment increased $21 million as a result of an increase in our international mortgage insurance business of $32 million, offset by a decrease of $11 million in our lifestyle protection insurance business. The three months ended September 30, 2008 included an increase of $10 million attributable to changes in foreign exchange rates.

 

   

Our U.S. Mortgage Insurance segment increased $178 million.

 

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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 $72 million primarily due to a $76 million decrease related to our institutional business and a $4 million decrease in our retirement income business, partially offset by an increase in our long-term care insurance business for $6 million.

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 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 $14 million primarily attributable to an increase of $7 million from our retirement income business, a $5 million increase in our life insurance business and an increase of $5 million in our long-term care insurance business, offset by a $2 million decrease in our wealth management business.

 

   

Our International segment decreased $27 million related to a $9 million decrease in our international mortgage insurance business and an $18 million decrease in our lifestyle protection insurance business. The three months ended September 30, 2008 included an increase of $6 million attributable to changes in foreign exchange rates.

 

   

Corporate and Other activities decreased $15 million.

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 $46 million primarily due to a decrease of $56 million from our retirement income business and a decrease of $9 million in our life insurance business, partially offset by $14 million increase in our institutional business and a $5 million increase in our long-term care insurance business.

 

   

Our International segment decreased $7 million related to a decrease in our lifestyle protection insurance business of $11 million offset by an increase in our international mortgage insurance business of $4 million.

 

   

Our U.S. Mortgage Insurance segment increased $58 million.

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.

 

   

Our Retirement and Protection segment decreased $21 million primarily related to our life insurance business from a decrease in average floating rates paid on our non-recourse funding obligations.

 

   

Our International segment increased $13 million in our lifestyle protection insurance business from an increase in reinsurance arrangements accounted for under the deposit method.

 

   

Corporate and other activities increased $9 million.

Provision (benefit) for income taxes. The effective tax rate increased to 48.0% for the three months ended September 30, 2008 from 24.7% for the three months ended September 30, 2007. This increase in the effective tax rate was primarily attributable to the recognition of tax benefits on a pre-tax loss in the current year. In addition, the increase in lower taxed foreign income and tax favored investment benefits were recognized in the current quarter due to the increased proportion of current year losses to expected full year losses, as compared to

 

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the prior year income in proportion to the prior year expected full year income recorded under Accounting Principles Board (“APB”) Opinion No. 28, Interim Financial Reporting. This increase was partially offset by the impairment of non-deductible goodwill in the current quarter and reduced benefits attributable to favorable examination developments and changes in estimates. The three months ended September 30, 2008 included an increase of $1 million attributable to changes in foreign exchange rates.

Net income (loss). The net loss in the third quarter of 2008 was largely the result of impairments recorded during the current quarter and losses incurred in our U.S Mortgage Insurance segment. 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 $5 million, net of tax, attributable to changes in foreign exchange rates.

Nine Months Ended September 30, 2008 Compared to Nine Months Ended September 30, 2007

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

 

     Nine months
ended September 30,
     Increase (decrease) and
percentage change
 

(Amounts in millions)

       2008             2007          2008 vs. 2007  

Revenues:

          

Premiums

   $ 5,161     $ 4,660      $ 501      11 %

Net investment income

     2,873       3,082        (209 )    (7 )%

Net investment gains (losses)

     (1,560 )     (118 )      (1,442 )    NM (1)

Insurance and investment product fees and other

     845       726        119      16 %
                            

Total revenues

     7,319       8,350        (1,031 )    (12 )%
                            

Benefits and expenses:

          

Benefits and other changes in policy reserves

     4,284       3,325        959      29 %

Interest credited

     984       1,167        (183 )    (16 )%

Acquisition and operating expenses, net of deferrals

     1,594       1,524        70      5 %

Amortization of deferred acquisition costs and intangibles

     620       622        (2 )    —   %

Interest expense

     347       355        (8 )    (2 )%
                            

Total benefits and expenses

     7,829       6,993        836      12 %
                            

Income (loss) from continuing operations before income taxes

     (510 )     1,357        (1,867 )    (138 )%

Provision (benefit) for income taxes

     (259 )     383        (642 )    (168 )%
                            

Income (loss) from continuing operations

     (251 )     974        (1,225 )    (126 )%

Income from discontinued operations, net of taxes

     —         15        (15 )    (100 )%

Gain on sale from discontinued operations, net of taxes

     —         53        (53 )    (100 )%
                            

Net income (loss)

   $ (251 )   $ 1,042      $ (1,293 )    (124 )%
                            

 

(1)

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

Premiums

 

   

Our Retirement and Protection segment increased $141 million primarily due to an $81 million increase in our long-term care insurance business, a $36 million increase in our retirement income business and a $24 million increase in our life insurance business.

 

   

Our International segment increased $250 million as a result of a $169 million increase in our international mortgage insurance business and an increase of $81 million in our lifestyle protection insurance business. The nine months ended September 30, 2008 included an increase of $142 million attributable to changes in foreign exchange rates.

 

   

Our U.S. Mortgage Insurance segment increased $114 million.

 

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Net investment income

 

   

Weighted-average investment yields decreased to 5.3% for the nine months ended September 30, 2008 from 5.9% for the nine months ended September 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 nine months ended September 30, 2008 included a $36 million loss related to limited partnerships as compared to a $34 million gain in the three months ended September 30, 2007 reflecting equity method accounting changes on real estate partnerships. In addition, net investment income for the nine months ended September 30, 2008 included $29 million of investment income related to bond calls and commercial mortgage loan prepayments as compared to $53 million in the nine months ended September 30, 2007.

 

   

The nine months ended September 30, 2008 included $33 million attributable to changes in foreign exchange rates in our International segment.

Net investment gains (losses). We incurred $900 million of credit and/or cash flow related impairments and $416 million related to a change in intent to hold securities to recovery during the nine months ended September 30, 2008. Of total impairments, $853 million related to securities backed by sub-prime and Alt-A residential mortgage-backed and asset-backed securities and $270 million related to certain financial services companies. Impairments related to financial services companies were a result of bankruptcies, receivership or concerns about the issuer’s ability to continue to make contractual payments. Net investment losses of $116 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 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 $116 million largely driven by an $81 million increase from our institutional business, a $16 million increase in our retirement income business, a $15 million increase in our wealth management business and a $4 million increase in our life insurance business.

 

   

Our International segment increased $4 million primarily related to our lifestyle protection insurance business. The nine months ended September 30, 2008 included $4 million attributable to changes in foreign exchange rates.

Benefits and other changes in policy reserves

 

   

Our Retirement and Protection segment increased $213 million attributable to a $102 million increase in our long-term care insurance business, a $70 million increase from our retirement income business and a $41 million increase in our life insurance business.

 

   

Our International segment increased $125 million as a result of an increase in our international mortgage insurance business of $97 million and an increase of $28 million in our lifestyle protection insurance business. The nine months ended September 30, 2008 included an increase of $46 million attributable to changes in foreign exchange rates.

 

   

Our U.S. Mortgage Insurance segment increased $620 million.

Interest credited. Interest credited related to our Retirement and Protection segment decreased $183 million primarily due to an $165 million decrease related to our institutional business and a $34 million decrease in our retirement income business, offset by a $15 million increase in our long-term care insurance business.

 

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Acquisition and operating expenses, net of deferrals

 

   

Our Retirement and Protection segment increased $36 million primarily attributable to an increase of $16 million from our retirement income business, an increase of $14 million in our life insurance business and a $7 million increase in our wealth management business.

 

   

Our International segment increased $51 million related to a $17 million increase in our international mortgage insurance business and a $34 million increase in our lifestyle protection insurance business. The nine months ended September 30, 2008 included an increase of $54 million attributable to changes in foreign exchange rates.

 

   

Our U.S. Mortgage Insurance segment increased $10 million.

 

   

Corporate and Other activities decreased $27 million.

Amortization of deferred acquisition costs and intangibles

 

   

Our Retirement and Protection segment decreased $73 million due to a decrease of $91 million from our retirement income business, partially offset by an increase of $15 million in our institutional business, a $4 million increase in our long-term care insurance business and a $3 million decrease in our life insurance business.

 

   

Our International segment increased $20 million related to an increase in our international mortgage insurance business of $16 million and an increase in our lifestyle protection insurance business of $4 million. The nine months ended September 30, 2008 included an increase of $13 million attributable to changes in foreign exchange rates.

 

   

Our U.S. Mortgage Insurance segment increased $62 million.

 

   

Corporate and Other activities decreased $11 million.

Interest expense.

 

   

Our Retirement and Protection segment decreased $29 million primarily related to our life insurance business from a decrease in average floating rates paid on our non-recourse funding obligations.

 

   

Our International segment increased $14 million in our lifestyle protection insurance business from an increase in reinsurance arrangements accounted for under the deposit method.

 

   

Corporate and other activities increased $7 million.

Provision (benefit) for income taxes. The effective tax rate increased to 50.8% for the nine months ended September 30, 2008 from 28.2% for the nine months ended September 30, 2007. This increase in the effective tax rate was attributable to the recognition of tax benefits primarily driven by an increase in lower taxed foreign income on a pre-tax loss in the current year. This was partially offset by the impairment of non-deductible goodwill in the current year and reduced benefits attributable to favorable examination developments and changes in estimates. The nine months ended September 30, 2008 included an increase of $18 million attributable to changes in foreign exchange rates.

Net income (loss). The decrease in net income was largely the result of impairments recorded during 2008 and losses incurred in our U.S. Mortgage Insurance segment. 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 $48 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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Earnings (loss) per share

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

 

     Three months
ended September 30,
   Nine months
ended September 30,

(Amounts in millions, except per share amounts)

       2008             2007            2008             2007    

Earnings (loss) from continuing operations per common share:

         

Basic

   $ (0.60 )   $ 0.77    $ (0.58 )   $ 2.21
                             

Diluted

   $ (0.60 )   $ 0.76    $ (0.58 )   $ 2.16
                             

Earnings (loss) per common share:

         

Basic

   $ (0.60 )   $ 0.77    $ (0.58 )   $ 2.36
                             

Diluted

   $ (0.60 )   $ 0.76    $ (0.58 )   $ 2.32
                             

Weighted-average common shares outstanding:

         

Basic

     433.1       441.1      433.2       440.5
                             

Diluted

     433.1       445.6      433.2       449.8
                             

Weighted-average shares outstanding declined reflecting repurchases of 38.2 million shares since the beginning of the first quarter of 2007 through September 30, 2008. Diluted weighted-average shares outstanding for 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 13 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.

 

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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 gross flows 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 lifestyle protection insurance; (5) new insurance written for mortgage insurance, which in each case reflects the amount of business 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 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.

 

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Retirement and Protection segment

Segment results of operations

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

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

 

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

(Amounts in millions)

       2008             2007                     2008 vs. 2007              

Revenues:

        

Premiums

   $ 958     $ 861     $ 97     11 %

Net investment income

     730       893       (163 )   (18 )%

Net investment gains (losses)

     (702 )     (38 )     (664 )   NM (1)

Insurance and investment product fees and other

     322       233       89     38 %
                          

Total revenues

     1,308       1,949       (641 )   (33 )%
                          

Benefits and expenses:

        

Benefits and other changes in policy reserves

     1,048       919       129     14 %

Interest credited

     319       391       (72 )   (18 )%

Acquisition and operating expenses, net of deferrals

     234       220       14     6 %

Amortization of deferred acquisition costs and intangibles

     50       96       (46 )   (48 )%

Interest expense

     38       59       (21 )   (36 )%
                          

Total benefits and expenses

     1,689       1,685       4     —   %
                          

Income (loss) from continuing operations before income taxes

     (381 )     264       (645 )   NM (1)

Provision (benefit) for income taxes

     (156 )     64       (220 )   NM (1)
                          

Net income (loss)

     (225 )     200       (425 )   NM (1)

Adjustment to net income (loss):

        

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

     403       23       380     NM (1)
                          

Net operating income

   $ 178     $ 223     $ (45 )   (20 )%
                          

 

(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:

 

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

(Amounts in millions)

       2008            2007                    2008 vs. 2007              

Net operating income:

          

Wealth management

   $ 12    $ 11    $ 1     %

Retirement income

     15      82      (67 )   (82 )%

Institutional

     49      10      39     NM (1)

Life insurance

     63      81      (18 )   (22 )%

Long-term care insurance

     39      39      —       —   %
                        

Total net operating income

   $ 178    $ 223    $ (45 )   (20 )%
                        

Net operating income

 

   

Our wealth management business remained relatively flat as the decrease in average assets under management from the unfavorable impact due to the volatility in the equity markets was offset by lower asset-based expenses.

 

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Our retirement income business decreased $67 million primarily as a result of lower net investment income from lower yields on floating rate investments and negative valuation marks on limited partnership investments, as well as a reclassification in 2008 of embedded derivative costs related to our guaranteed minimum withdrawal benefit products previously reported in net investment gains (losses). We also had an increase in reserves from unfavorable mortality and higher amortization from volatility in the equity markets in the current year. These decreases were partially offset by growth in our Income Distribution Series and spread-based annuity products. In addition, the prior year included a tax benefit from favorable examination developments and a change in estimate related to the 2006 tax provision that did not recur in the current year.

 

   

Our institutional business increased $39 million largely attributable to income from granting an early redemption request from an institutional customer for FABNs at a price discounted to contract value. This increase was partially offset by a decrease in net investment income from lower yields and negative valuation marks on limited partnership investments. There was also a decline in assets under management mainly due to the current challenging market environment and an impairment charge of $12 million related to goodwill in the third quarter of 2008.

 

   

Our life insurance business decreased $18 million primarily from a decrease in net investment income from negative valuation marks on limited partnership investments and lower yields, offset by lower interest expense reflecting the decline in the underlying index rate and favorable mortality in our term life insurance products.

 

   

Our long-term care insurance business remained flat as growth of the in-force and favorable performance of newer issued policies was partially offset by the unfavorable performance of older issued policies, lower investment income yield and negative valuation marks on limited partnership investments.

Revenues

Premiums

 

   

Our retirement income business increased $63 million primarily attributable to higher sales of life-contingent immediate annuities as these products have become more attractive in the current environment, partially offset by runoff of our life-contingent structured settlement annuities.

 

   

Our life insurance business increased $5 million mainly related to in-force growth of our term life insurance from new sales and renewal premiums, partially offset by lapses and lower experience rating refunds from reinsurance transactions with one of our reinsurers.

 

   

Our long-term care insurance business increased $29 million mainly attributable to growth in the in-force block from new sales and renewal premiums.

Net investment income

 

   

Our retirement income business decreased $43 million primarily as a result of lower investment yields. Net investment income in the current year included a $12 million loss related to limited partnerships as compared to a $13 million gain in the prior year reflecting equity method accounting changes on real estate partnerships. The decrease was also attributable to less investment income from bond calls and commercial mortgage loan prepayments in the current year.

 

   

Our institutional business decreased $88 million attributable to lower yields on floating rate investments and a decline in average invested assets. Net investment income in the current year included a $10 million loss related to limited partnerships as compared to a $1 million gain in the prior year reflecting equity method accounting changes on real estate partnerships.

 

   

Our life insurance business decreased $42 million mainly due to lower yields on the assets backing our non-recourse funding obligations supporting certain term and universal life insurance reserves. Net

 

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investment income in the current year included a $4 million loss related to limited partnerships as compared to a $13 million gain in the prior year reflecting equity method accounting changes on real estate partnerships.

 

   

Our long-term care insurance business increased $12 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 lower valuation marks on limited partnership investments and lower investment yields.

Insurance and investment product fees and other

 

   

Our retirement income decreased $2 million mainly due to a reclassification in 2008 of embedded derivative costs related to our guaranteed minimum withdrawal benefit products previously reported in net investment gains (losses) and lower municipal GIC advisory fees. These decreases were partially offset by growth in our Income Distribution Series products. In addition, our spread-based products decreased from lower surrender fee income in the current year.

 

   

Our institutional business increased $81 million related to income from granting an early redemption request from an institutional customer for FABNs at a price discounted to contract value.

 

   

Our life insurance business increased $10 million mainly attributable to a reclassification adjustment to benefits and other changes in policy reserves related to our universal life insurance products from the prior quarter. The increase was also attributed to growth in our universal life insurance products.

Benefits and expenses

Benefits and other changes in policy reserves

 

   

Our retirement income business increased $80 million largely related to growth in our life-contingent spread-based products and unfavorable mortality, partially offset by lower amortization of sales inducements as a result of higher net investment losses. Our fee-based products also increased related to our guaranteed minimum benefit liabilities for our variable annuity contracts driven by the unfavorable volatility in the equity markets.

 

   

Our life insurance business increased $26 million principally attributable to unfavorable reserve adjustments to reflect the underlying experience and a system implementation in the current year related to our universal life insurance products with death or other benefit features and higher mortality in universal life insurance as compared to prior year. There was also a reclassification adjustment from insurance and investment product fees and other related to our universal life insurance products from the prior quarter.

 

   

Our long-term care insurance business increased $23 million mainly as a result of the aging and growth of the in-force block. This increase was partially offset by a favorable reserve adjustment of $14 million in the current year related to updating our utilization factors compared to $9 million in the prior year.

Interest credited

 

   

Our retirement income business decreased $4 million from lower account values on fixed annuities associated with surrenders more than offsetting sales. Additionally, crediting rates were reset to lower rates as the fixed annuities reach the end of their initial crediting rate guarantee period.

 

   

Our institutional business decreased $76 million mainly attributable to the impact of lower interest rates on interest paid on our floating rate policyholder liabilities and a decrease in average outstanding liabilities.

 

   

Our long-term care insurance business increased $6 million as a result of growth in the account value of our corporate-owned life insurance product.

 

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Acquisition and operating expenses, net of deferrals

 

   

Our wealth management business decreased $2 million from lower average assets under management largely attributable to the unfavorable impact due to the volatility in the equity markets, as well as lower operating expenses.

 

   

Our retirement income business increased $7 million driven by growth in our Income Distribution Series and spread-based annuity products.

 

   

Our life insurance business increased $5 million primarily from higher expenses due to growth of our insurance in-force block of business.

 

   

Our long-term care insurance business increased $5 million due to growth in our insurance in-force.

Amortization of deferred acquisition costs and intangibles

 

   

Our retirement income business decreased $56 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 favorable lapse rates in the current year. Our fee-based products also decreased from lower amortization as a result of unfavorable market impacts in addition to derivative losses related to our guaranteed minimum withdrawal benefit products. These were partially offset by higher amortization attributable to volatility in the equity markets and growth in our Income Distribution Series products.

 

   

Our institutional business increased $14 million primarily related to an impairment charge of $12 million related to goodwill in the third quarter of 2008.

 

   

Our life insurance business decreased $9 million mainly driven by lower amortization of $15 million from a revision to estimated gross profit assumptions in our universal life insurance products in the current year as compared to $7 million in the prior year.

 

   

Our long-term care insurance business increased $5 million due to growth of the in-force block.

Interest expense. Interest expense in our life insurance business decreased $21 million primarily from a decrease in average floating rates paid on our non-recourse funding obligations reflecting the decline in the underlying index rate.

Provision (benefit) for income taxes. The effective tax rate increased to 40.9% for the three months ended September 30, 2008 from 24.2% for the three months ended September 30, 2007. This increase in the effective tax rate was primarily attributable to the recognition of tax benefits on a pre-tax loss in the current year. In addition, an increase in tax favored investment benefits was recognized in the current quarter due to the increased proportion of current year losses to expected full year losses, as compared to the prior year income in proportion to the prior year expected full year income recorded under APB No. 28. This increase was partially offset by the impairment of non-deductible goodwill in the current quarter and reduced benefits attributable to favorable examination developments and changes in estimates.

 

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Nine Months Ended September 30, 2008 Compared to Nine Months Ended September 30, 2007

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

 

     Nine months
ended September 30,
     Increase (decrease) and
percentage change
 

(Amounts in millions)

       2008              2007          2008 vs. 2007  

Revenues:

          

Premiums

   $ 2,763      $ 2,622      $ 141     5 %

Net investment income

     2,292        2,597        (305 )   (12 )%

Net investment gains (losses)

     (1,423 )      (102 )      (1,321 )   NM (1)

Insurance and investment product fees and other

     795        679        116     17 %
                            

Total revenues

     4,427        5,796        (1,369 )   (24 )%
                            

Benefits and expenses:

          

Benefits and other changes in policy reserves

     2,957        2,744        213     8 %

Interest credited

     984        1,167        (183 )   (16 )%

Acquisition and operating expenses, net of deferrals

     690        654        36     6 %

Amortization of deferred acquisition costs and intangibles

     239        312        (73 )   (23 )%

Interest expense

     124        153        (29 )   (19 )%
                            

Total benefits and expenses

     4,994        5,030        (36 )   (1 )%
                            

Income (loss) from continuing operations before income taxes

     (567 )      766        (1,333 )   (174 )%

Provision (benefit) for income taxes

     (219 )      240        (459 )   (191 )%
                            

Net income (loss)

     (348 )      526        (874 )   (166 )%

Adjustment to net income (loss):

          

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

     838        62        776     NM (1)
                            

Net operating income

   $ 490      $ 588      $ (98 )   (17 )%
                            

 

(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:

 

     Nine months
ended September 30,
   Increase (decrease) and
percentage change
 

(Amounts in millions)

       2008            2007        2008 vs. 2007  

Net operating income:

           

Wealth management

   $ 35    $ 32    $ 3      9 %

Retirement income

     64      171      (107 )    (63 )%

Institutional

     65      34      31      91 %

Life insurance

     215      234      (19 )    (8 )%

Long-term care insurance

     111      117      (6 )    (5 )%
                         

Total net operating income

   $ 490    $ 588    $ (98 )    (17 )%
                         

Net operating income

 

   

Our wealth management business increased $3 million due to growth in average assets under management, partially offset by the impact of the unfavorable volatility in equity markets combined with higher asset-based expenses.

 

   

Our retirement income business decreased $107 million primarily as a result of lower net investment income from lower yields on floating rate investments and negative valuation marks on limited

 

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partnership investments, as well as a reclassification in 2008 of embedded derivative costs related to our guaranteed minimum withdrawal benefit products previously reported in net investment gains (losses). We also had an increase in reserves from unfavorable mortality and higher amortization from volatility in the equity markets in the current year. These decreases were partially offset by growth in our Income Distribution Series and spread-based annuity products. In addition, the prior year included a tax benefit from favorable examination developments and a change in estimate related to the 2006 tax provision that did not recur in the current year.

 

   

Our institutional business increased $31 million largely attributable to income from granting an early redemption request from an institutional customer for FABNs at a price discounted to contract value. This increase was partially offset by a decrease in net investment income from lower yields and negative valuation marks on limited partnerships. There was also a decline in assets under management mainly due to the current challenging market environment and an impairment charge of $12 million related to goodwill in the third quarter of 2008.

 

   

Our life insurance business decreased $19 million primarily from a decrease in net investment income from lower yields on assets backing our non-recourse funding obligations, partially offset by lower interest expense reflecting the decline in the underlying index rate and growth in the term and universal life insurance in-force. The current year also included unfavorable reserve adjustments.

 

   

Our long-term care insurance business decreased $6 million primarily attributable to $10 million, net of tax, of favorable investment items in the prior year, partially offset by an update in factors associated with mortality notifications in the current year. Excluding these items, our long-term care insurance business was relatively flat as the favorable performance of newer issued policies was offset by the unfavorable performance of older issued policies, lower investment income yield and negative valuation marks on limited partnership investments.

Revenues

Premiums

 

   

Our retirement income business increased $36 million primarily attributable to higher sales of life-contingent immediate annuities as these products have become more attractive in the current environment, as well as improvements in wholesaler productivity levels and rate actions on certain immediate annuities. These increases were partially offset by runoff of our life-contingent structured settlement annuities.

 

   

Our life insurance business increased $24 million mainly related to in-force growth of our term life insurance from new sales and renewal premiums, partially offset by lapses and lower experience rating refunds from reinsurance transactions with one of our reinsurers.

 

   

Our long-term care insurance business increased $81 million mainly attributable to growth in the in-force block from new sales and renewal premiums.

Net investment income

 

   

Our retirement income business decreased $89 million primarily as a result of a decline in average invested assets and lower investment yields in our spread-based retail products. Net investment income in the current year included a $17 million loss related to limited partnerships as compared to a $17 million gain in the prior year reflecting equity method accounting changes on real estate partnerships. The decrease was also attributable to less investment income from bond calls and commercial mortgage loan prepayments in the current year.

 

   

Our institutional business decreased $186 million primarily attributable to lower yields on floating rate investments and a decline in average invested assets. Net investment income in the current year included

 

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a $10 million loss related to limited partnerships as compared to a $2 million gain in the prior year reflecting equity method accounting changes on real estate partnerships. The decrease was also attributable to less investment income from bond calls and commercial mortgage loan prepayments in the current year.

 

   

Our life insurance business decreased $62 million mainly due to lower yields on the assets backing our non-recourse funding obligations supporting certain term and universal life insurance reserves. Net investment income in the current year included a $1 million loss related to limited partnerships as compared to a $16 million gain in the prior year reflecting equity method accounting changes on real estate partnerships. The decrease was also attributable to less investment income from bond calls and commercial mortgage loan prepayments in the current year.

 

   

Our long-term care insurance business increased $34 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 $15 million less of investment income from bond calls and commercial mortgage prepayments, negative valuation marks on limited partnership investments in the current year and lower yields.

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 $16 million mainly due to our fee-based products from growth of our Income Distribution Series products. This increase was partially offset by a reclassification in 2008 of embedded derivative costs related to our guaranteed minimum withdrawal benefit products previously reported in net investment gains (losses) and lower municipal GIC advisory fees. In addition, our spread-based products decreased from lower surrender fee income in the current year.

 

   

Our institutional business increased $81 million due to income from granting an early redemption request from an institutional customer for FABNs at a price discounted to contract value.

 

   

Our life insurance business increased $4 million mainly attributed to growth of our universal life insurance products.

Benefits and expenses

Benefits and other changes in policy reserves

 

   

Our retirement income business increased $70 million largely related to growth in our life-contingent spread-based products driven by growth in the in-force block and unfavorable mortality, partially offset by lower amortization of sales inducements as a result of higher net investment losses. Our fee-based products also increased related to our guaranteed minimum benefit liabilities for our variable annuity contracts driven by the unfavorable volatility in the equity markets.

 

   

Our life insurance business increased $41 million principally attributable to unfavorable reserve adjustments to reflect the underlying experience and a system implementation in the current year related to our universal life insurance products with death or other benefit features and higher mortality in universal life insurance as compared to prior year. In addition, the increase is driven by 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.

 

   

Our long-term care insurance business increased $102 million mainly as a result of the aging and growth of the in-force block. Partially offsetting this increase was an $8 million update in factors associated with mortality notifications.

 

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Interest credited

 

   

Our retirement income business decreased $34 million largely from lower account values on fixed annuities associated with surrenders more than offsetting sales. Additionally, crediting rates were reset to lower rates as the fixed annuities reach the end of their initial crediting rate guarantee period.

 

   

Our institutional business decreased $165 million mainly attributable to the impact of lower interest rates on interest paid on our floating rate policyholder liabilities and a decrease in average outstanding liabilities.

 

   

Our long-term care insurance business increased $15 million due to growth in the account value of our corporate-owned life insurance product.

Acquisition and operating expenses, net of deferrals

 

   

Our wealth management business increased $7 million attributable to higher asset-based expenses as a result of the growth of average assets under management.

 

   

Our retirement income business increased $16 million primarily driven by growth in our Income Distribution Series and spread-based annuity products.

 

   

Our life insurance business increased $14 million primarily from higher expenses from growth of our in-force business.

Amortization of deferred acquisition costs and intangibles

 

   

Our retirement income business decreased $91 million attributable to a decrease in amortization of deferred acquisition costs for our spread-based retail products as a result of higher net investment losses and favorable lapse rates in the current year. Our fee-based products also decreased from lower amortization as a result of unfavorable market impacts in addition to derivative losses related to our guaranteed minimum withdrawal benefit products. These were partially offset by higher amortization attributable to volatility in the equity markets and growth in our Income Distribution Series products.

 

   

Our institutional business increased $15 million primarily related to an impairment charge of $12 million related to goodwill in the third quarter of 2008.

 

   

Our life insurance business decreased $3 million driven by lower amortization of $15 million from a revision to estimated gross profit assumptions in our universal life insurance products in the current year as compared to $7 million in the prior year. This decrease was offset by continued growth of insurance in-force and a policy valuation system input correction in a small block of term life insurance policies in the current year.

 

   

Our long-term care insurance business increased $4 million due to growth in the in-force block, partially offset by the 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 $29 million primarily from a decrease in average floating rates paid on our non-recourse funding obligations reflecting the decline in the underlying index rate.

Provision (benefit) for income taxes. The effective tax rate increased to 38.6% for the nine months ended September 30, 2008 from 31.3% for the nine months ended September 30, 2007. This increase in the effective tax rate was primarily attributable to the recognition of tax benefits on a pre-tax loss in the current year, which was partially offset by the impairment of non-deductible goodwill in the current year and reduced benefits attributable to favorable examination developments and changes in estimates.

 

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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 September 30,
    As of or for the nine
months ended September 30,
 

(Amounts in millions)

       2008             2007             2008             2007      

Assets under management, beginning of period

   $ 20,285     $ 20,683     $ 21,584     $ 17,293  

Gross flows

     1,230       1,665       3,915       5,136  

Redemptions

     (1,047 )     (567 )     (3,171 )     (1,492 )
                                

Net flows

     183       1,098       744       3,644  

Market performance

     (1,797 )     (119 )     (3,657 )     725  
                                

Assets under management, end of period

   $ 18,671     $ 21,662     $ 18,671     $ 21,662  
                                

Wealth management results represent Genworth Financial Wealth Management, Inc., Genworth Financial Advisors Corporation, Genworth Financial Trust Company and Capital Brokerage Corporation. On August 1, 2008, Genworth Financial Asset Management, Inc. merged into AssetMark Investment Services, Inc. with AssetMark Investment Services, Inc. being the surviving entity. AssetMark Investment Services, Inc. subsequently changed its name to Genworth Financial Wealth Management, Inc. on August 1, 2008.

The decrease in these assets was primarily due to unfavorable equity market performance in the current year. Gross flows continue to outpace redemptions; however, given the current market conditions, redemptions have increased significantly as gross flows have slowed during 2008.

 

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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 September 30,
    As of or for the nine
months ended September 30,
 

(Amounts in millions)

       2008             2007             2008             2007      

Income Distribution Series(1)

        

Account value, net of reinsurance, beginning of period

   $ 5,308     $ 3,361     $ 4,535     $ 2,402  

Deposits

     506       543       1,697       1,446  

Surrenders, benefits and product charges

     (115 )     (78 )     (332 )     (204 )
                                

Net flows

     391       465       1,365       1,242  

Interest credited and investment performance

     (327 )     152       (528 )     334  
                                

Account value, net of reinsurance, end of period

   $ 5,372     $ 3,978     $ 5,372     $ 3,978  
                                

Traditional variable annuities

        

Account value, net of reinsurance, beginning of period

   $ 2,278     $ 2,098     $ 2,345     $ 1,780  

Deposits

     92       133       305       412  

Surrenders, benefits and product charges

     (66 )     (48 )     (188 )     (145 )
                                

Net flows

     26       85       117       267  

Interest credited and investment performance

     (290 )     79       (448 )     215  
                                

Account value, net of reinsurance, end of period

   $ 2,014     $ 2,262     $ 2,014     $ 2,262  
                                

Variable life insurance

        

Account value, beginning of period

   $ 373     $ 408     $ 403     $ 391  

Deposits

     4       6       14       18  

Surrenders, benefits and product charges

     (15 )     (15 )     (35 )     (41 )
                                

Net flows

     (11 )     (9 )     (21 )     (23 )

Interest credited and investment performance

     (38 )     15       (58 )     46  
                                

Account value, end of period

   $ 324     $ 414     $ 324     $ 414  
                                

 

(1)

The Income Distribution Series products are comprised of our guaranteed 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 benefit rider, partially offset by unfavorable volatility in the equity markets.

Traditional variable annuities

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

 

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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 September 30,
    As of or for the nine
months ended September 30,
 

(Amounts in millions)

       2008             2007             2008             2007      

Fixed annuities

        

Account value, net of reinsurance, beginning of period

   $ 12,130     $ 12,886     $ 12,073     $ 13,972  

Deposits

     514       184       1,283       535  

Surrenders, benefits and product charges

     (576 )     (815 )     (1,499 )     (2,495 )
                                

Net flows

     (62 )     (631 )     (216 )     (1,960 )

Interest credited

     106       113       317       356  
                                

Account value, net of reinsurance, end of period

   $ 12,174     $ 12,368     $ 12,174     $ 12,368  
                                

Single premium immediate annuities

        

Account value, net of reinsurance, beginning of period

   $ 6,781     $ 6,367     $ 6,668     $ 6,174  

Premiums and deposits

     280       247       759       745  

Surrenders, benefits and product charges

     (197 )     (241 )     (742 )     (715 )
                                

Net flows

     83       6       17       30  

Interest credited

     92       85       271       254  
                                

Account value, net of reinsurance, end of period

   $ 6,956     $ 6,458     $ 6,956     $ 6,458  
                                

Structured settlements

        

Account value, net of reinsurance, beginning of period

   $ 1,107     $ 1,088     $ 1,103     $ 1,011  

Premiums and deposits

     —         5       3       82  

Surrenders, benefits and product charges

     (15 )     (15 )     (42 )     (44 )
                                

Net flows

     (15 )     (10 )     (39 )     38  

Interest credited

     14       14       42       43  
                                

Account value, net of reinsurance, end of period

   $ 1,106     $ 1,092     $ 1,106     $ 1,092  
                                

Total premiums from spread-based retail products

   $ 181     $ 118     $ 459     $ 423  
                                

Total deposits on spread-based retail products

   $ 613     $ 318     $ 1,586     $ 939