Tom McInerney - CEO
Genworth Financial Inc. (GNW) KBW Insurance Conference September 25, 2013 10:20 AM ET
Let's get started, if someone can catch the back of the door for me that would be much appreciated. Let me hit the right spot on my agenda here. According to this it says you're from Genworth, is that correct?
Unidentified company representative
I am from Genworth.
Okay. Great company.
Unidentified company representative
And met with our non-executive chairman yesterday, he didn't fire me. So I think I'm still with Genworth.
Current status, that's great, that great.
Unidentified company representative
It’s his birthday today.
So we’re very glad to have Genworth here at the conference this year and a couple of introductions. First of all to me far right is my colleague Bill Clark, Bill works with me on all of our life industry coverage but is particularly critical on helping me on mortgage insurance where Bill has some very deep experience. So he's going to help me out with the session today. I'd like to also say hello to Georgette Nicholas, Head of Investor Relations at Genworth, thanks for working with us on this, and Georgette's also the expert in, she was the CFO of USMI. So if I don't justice you can look her up after. And our guest today is Tom McInerney. Tom joined Genworth earlier this year, broad range of industry experience at ING and Basset Consulting Group and elsewhere, but we're very happy to have you with us today, Tom.
It's great to be here, glad to be here and glad to be here with all of you. Look forward to your questions and any questions from the field.
Okay. Let’s just kind of jump in here, maybe at kind of a high level. Obviously you came in and had a chance to take a good hard look at Genworth. You recently completed the sale of your wealth management business, there have been some other changes that were left a couple of years, but you still have a portfolio of a number of businesses. So how should we think about that, is this, are you happy with the portfolio, is it rational or should we think about something that continue to kind of look at it?
So Jeff, we made a decision last year that we're going to organize in two divisions, a U.S. life division and so there our core business is long term care and then we have the life and text annuity business. We’ve exited variable annuity business. And then on the mortgage side we have three major platforms, U.S., Australia, Canada, and then some businesses in Europe. We declared the wealth management business and our payment business, credit business that's mostly in Europe as non-core and as you said we sold the wealth management business, but we knew because of issues going out in the Euro zone that our lifestyle protection business is not core but we don’t think we're going to be able to do much with from a sale perspective for two or three years but that would be something.
Then coming back to the two divisions, I think our goal is to improve the performance of both. On the mortgage insurance side, Canada and Australia have generally being doing very well. We're very pleased with our performance. The U.S. mortgage insurance business obviously was hit very badly in the crisis. But we think this is going to be a breakeven year and the next two or three years will be good. So I think as USMI recovers, I think we feel that the mortgage insurance division would be in a place where we can look at strategic options.
On the life side we still aren't generating enough statuary earnings. We're doing a lot on long term care side, which is I think the big driver for improvement and statuary earnings will come from long term care. And so my thought Jeff would be next two to three years improve the operating performance, wealth management if there is a chance on LTI, although I am not really expecting that anytime soon unless Europe really picks up.
And then if we get both divisions performing well, being able to manage a reasonable debt load on their own, then we'll look at that point. So say two, three years from now is what the right longer term for the business. I have not been around; I am not trying to build an empire at Genworth in three years. If we get the businesses where we need to be, we'll work with our board, the management team and investors as to what is the best shareholder value option for the longer term. We make a good structure point, which is to the extent that the life businesses can cash flow better, that does give you kind of more structural flexibility to think about it.
Right now we're not generating those statuary earnings. We hadn’t paid a dividend from our life division since 2008. We did just this year we paid $100 million in dividend in the first half of the year. But it's still not; given the size we should be generating more statuary earnings. So that's a big focus on the life side.
You want to talk about mortgage insurance?
Unidentified Company Representative
As you said USMI went through a pretty tough stretch there. It seems like.
21 quarters in losses. That’s pretty tough.
Certainly things have brightened up there a bit. Still kind of some uncertainty on the regulatory side. So maybe we can start there. In terms of the qualified residential mortgage definition recently came out with the revised plan, kind of eliminated the 20% rule that was going to be in there. Certainly seems like a good outcome for the mortgage insurance industry. Maybe also we have gone on there; the future of Fannie and Freddie still kind of uncertain at this point. So the two of those factors, how do you think that kind of plays out in terms of the industry in general and what the prospects are there.
I would say that, I think the QM and QRM came out at a place particularly, I think what you have is the bad treasury of GSE saying that we think there is a place for low down payment mortgages and I think that's right, and so they reaffirm that and so I think that means that there will be a place for mortgage insurance in the industry. So we're pleased with that. My sense is that both the administration, including the President and Congress given what happened in the crisis do feel going forward that the tax payers should be less on the hook for the housing market in the private sector, private capital, at least should take the first loss position. And then hopefully that first loss position would be enough and then we won't need tax payers.
So I think that's the direction it's going in, there is a lot deficit problem and now the Fannie Mae and Freddie Mac are making a lot of money. That may have an impact on the time, but I do think between the FHA, Fannie, Freddie, over time they'll restructure in a way where there will be less tax payer exposure in the mortgage market. And I think generally that should help our business and I think it also is good public property.
And sort of related to that, maybe more of a near-term issue, there should be some new GSC capital requirements coming out for the MI business fairly soon. From a risk-to-capital standpoint you guys are currently in the low 20s. Consensus kind of seems to be mid-to-high teens number is kind of where it will shake out. What's kind of your strategy to deal with that?
The way that I say it as we’re pricing new business today and I risk the capital of 16 to 18 in that range and so I think that I agree with you, that that is where the talk seems to be. And so at least from a new business perspective, I think that won't have a big impact on at least our pricing. I think it's good for the industry. I think one of the things that occur, there seven of us, three left and now we have three new entrants. I do think under Basel III in order to, the FAD or the other regulators of U.S. banks want to make sure that the USMI market overall is there to pay the claims. And so I think it's prudent to reduce leverage. I don’t argue at all that if it goes from 25 to 1 to 16 or 18. Part of it is if they made it effective January 2014, which I don't think they will do that type, then we'd have to raise capital and I think we made a lot of progress on our balance sheet and financial flexibility. So I think we have a lot of ways to raise capital.
If they said you have to be there by January 2015 and we’re expecting pretty significant improvement in earnings from USMI, just given the quality of ‘09 and ‘13 books. So if they give us some time, the earnings from the business will help get us there and then in addition from the statutory perspective, we have 800 ish plus or minus of DTA and so therefore as the U.S. mortgage insurance business makes profits you really produce significant statutory capital because you’re able to utilize that fairly large DTA from a statutory capital perspective.
So, I think it’s the right thing for the regulators to do, and I think we’ll be able to meet those standards. We prefer them to give us a little bit of time to get there, but we’re prepared to go beginning the year that’s where they came out. I think on timing -- I think it’s pretty soon and I think we’ve been waiting and expect fairly soon an announcement and then there will be the normal period for the industry and other participants to give their views and to collect that and then make decision, make it effective.
Right and you also mentioned the credit environment. As you said the couple of companies are no longer no longer in existence. So it’s a new entrance. Genworth seems to have kind of taken a measured approach as far as putting the business on the books, market share area around that 13% number, is that kind of where you feel comfortable or is there a certain level you’re looking for or you’re just running it based on really your new business type requirement?
I think 21 quarters of losses and $2 billion of total losses make you a little cautious. I would say we are at 13% and we have historically pre-crisis in overtime. We have been more in the 14% to 16% range. So I think we’d like overtime to pick up a couple of points to market share to get back to the -- that’s where we’re comfortable, 14% to 16%. So I think people saw we did just reduce prices more in line with the FHA guidelines that put us closer to market. So we hope the result of that is that we pick up a little bit of market share. So I am okay with 13%. We’d like a little more though.
The one thing we’re going to do differently under my watch is I started at Aetna in 1978 in property casualty business and spent a quite bit of time there, and I believe the mortgage insurance market like the property and casualty cyclical market and there’re – when it's a hard market which I think it is today, I think you should write as much as business as it’s make sense because you have the pricing and you have the underwriting standards.
I still think that the banks are underwriting mortgages well. I think the regulators are watching very closely. I think our six competitors and us are still being sensible on pricing. But if we should see license is doing capital raise, if we should see pricing soften or underwriting standards change and go back to some of this, I am not predicting that but go back to some of that, we are very much prepared to significantly slowdown what we’re writing and again coming back to your point Jeff, I think different institutional investors or shareholders have different views as to what should be the intermediate or long term make up of Genworth.
But one advantage of having more than one business not being a model line is that if the pricing cycle gets soft, you can really cutback and you have other businesses, other places to put capital. If your model line where it’s really hard is to really cutback underwriting business and that’s the only business you’re in and in my 35 years I think the hardest thing to do is to back off writing business when the pricing isn’t there. But I think some of the very good property causality companies have proven that, that is the way to manage the business and so I think that’s really going forward versus how we were running and you’ll see us be changing the amount of business we write based on how good the underwriting is and how good the pricing is.
All right, let’s stay with [indiscernible] but maybe go international. I was hoping maybe you could kind of update us a little on your thinking around the potential Australian IPO, maybe give us your read on IPO market condition? And then maybe kind of remind us how we should think about it? I think when the idea was first hashed, maybe thinking about it as way to generate more capital flexibility was maybe part of the thinking that’s would be less of the thinking today. At one time, I think we expected there would be a pretty big valuation arbitrage between like you sell that business and where Genworth was trading and maybe that’s not so much the case. So what’s your latest thoughts on that?
So may I would say at the start you know our three core platforms are U.S., Canada, and Australia. We are number four in the U.S. We are number one in the Canada and we’re number one in Australia but in Australia, the main competitors could be about 50% market share. So it is a good business. But if you look at our three core platforms and then Europe, because of the way things have developed we have more risk in force and more capital in Australia then you would have if you strategically looked at the three platforms.
So one of the reasons that we are looking at, our priority is to do up to a 40% IPO, is to rebalance the capital between the three major platforms. In addition, Australia is a narrow economy than the U.S. It has got a significant amount of exposure to commodities, particularly iron ore and coal. And the western part of the country is very mining oriented. The mining investments, like over-peaked and it’s coming down, because unemployment is ticking up a little bit. And there is a systemic risk to GDP growth in China, given that, that’s where a lot of the exports particularly, commodity exports go for.
So we do think there are systemic risks in Australia because of its narrower economy and those risks where it’s also good risk management. So we still, from the strategic perspective would like to do, as I said up to a 40% IPO. Looking at the IPO market, it’s still significantly slower than it was in 2011-2012. There had been some IPOs down this year. They have been well received but they’re smaller than our IPO we think. So we are a little bit worried about that. We’ve got mining in China.
And the other thing, just like in the U.S., you know in Australia. There is a core group of banks that write most of the mortgages. We have contracts with them that get renegotiated all the time. And so we are always in that process. It is unclear how much credit that the banks in Australia are going to give for mortgage insurance. Right now they sort of get implicit credit, not explicit. So if Basil 03 and how OBRA (ph) the regulator interprets that and gave explicit credit for MI. Then I think it’s a broader market and that’s good for the business and good for evaluation.
If they come out and stay implicit or less credit for mortgage insurance, then I think that that obviously would mean a small market and so part of me, we have done so much on the financial flexibility, we don’t need to do this. As you say the 50% or so book, we like it to be higher, but it’s not what it was. So I think it’s, I look at the regulatory uncertainty and that is going to take a matter of time before the regulators and the banks just sort of work that out.
Is there a particular timeline expected on that?
You know, I was over in Australia at third week of August, and met with all of our customers, all of our bank customers from the big ones, CBA, and NAB, what’s back to the small mutual. My sense is, they have their own internal capital models. They’ve got to file and get approved. And some of them aren’t going to be filing those capital models, at least until May till next year or so. So I think there will be a regulatory uncertainty into 2014. And so maybe what that means, when it’s said and done, what we’ve always said is, we would look to do an IPO late 2013 or in 2014.
My guess is just because of the regulatory, how much credit the bank is going get, what will banks decide to do, what would their internal capital models look like, what credit will they get, I would say, and probably thinking that there is probably more so than maybe where I would have been early in the year, more likely that maybe we push it into 2014 versus now. There is no reason for us to do a deal, just to do a deal. We don’t need the capital. It’s not part of our capital point. We still, it’s still a priority, we would still do it and I think we would get to a, maybe when a little of this uncertainty is cleared up, we can get to a good evaluation.
That’s helpful. Maybe if you can talk a little bit about long term care, obviously.
Yes. That’s my favorite topic.
A rich area to mine. On the second quarter call you alluded to a review the long term care business. But some things, they seem to be pretty clear because you spent a lot of time, and the company spent a lot of time on this business for a while. The company has been quite clear about the strategic commitment to the business, and it has been repeatedly quite clear about the adequacy of reserve. So if the strategy is pretty locked in, reserves were adequate, what exactly are some of the things you’re actually reviewing at this point.
So when I came in Genworth in January, I think I told you before, Jeff and I know, I did about six months of due diligence and I was worried about three things. One was the quality of the asset portfolio, because my experience is, a lot of insurance companies, particularly life companies would get in trouble, get into trouble because of the asset side versus with the liability. And we had taken I think about $2 billion of impairments in the general account. USMI, we had the problems in the past, but I thought that the housing market was getting better.
And then I had no, it was impossible for me to tell from the outside why were there so many problems for us in the industry in long term here. And so coming in, because I used to do [Audio Gap] management in the 80s; very quickly Dan Sheehan is our Chief Investment Officer fabulous job we’ve got $70 billion general count. I think that’s in tremendous shape which is strong as any company that I’ve operated in and I consulted with about 15 of the global insurers and so I feel very good about the general count and you’re saying that unless they got impairments for quarter been 10 million in last so month. So tick that off. I think the housing market is getting better. I feel very, very confident that we’re getting very good returns in the business for writing and we have gotten good returns from 2009 to 2013 [indiscernible] books burning off.
So with those sort of two out of the three ticked, it’s been long term here. And as you can imagine we’ve been in the business for 40 years. So there is a lot of policies on the book. We have 17 billion of active life reserves. So those are reserves established for people are paying premiums they have become disabled and about 3 billion of disabled life. We started with a product we call Pre-PCS and then we did PCS 1, and PCS 2, and then Choice 1 and Choice 2, Choice 2.1, all priced differently, all with different underwriting criteria. And so it’s been a very complex book of business. And I didn’t want to, because generally investors are negative on long term care, the rating agencies are negative, everybody seems to be really negative and I came here with a negative buy. I actually think that’s wrong. I actually think it a can be a good business if it’s running well.
I think there are few things that we in the industry did wrong. The most important is we could have raised prices every year, and we did. We started in 1975 when the interest rates were in the 7.5%-8% range. Whenever you do a new product, you assume sort of the average lapse rates because you don’t know. And so we assume 5% to 6% lapse rates and then the latest information we had on mortality and morbidity. So those are the four big risks: interest rate risks, lapse risk, morbidity, mortality.
And I am sure I wasn’t there, this business started with GE and I could see the GE guys in Fairfield or Stanford saying we’re a great business, we’re getting all these premiums and the average issue age is 58. So you don’t really pay claims for 20 years. So you can convince yourself. Even though you know rates are different than you assume the interest rates are different, lapse rates are different, you don’t really see the morbidity at and you can convince yourself that you don’t have to do rate increases.
So I would say probably through the mid-90s the fact that we didn’t -- we and the industry didn’t raise rates, I think that was probably hard to argue with that. But starting in about the mid-90s, it was very clear that we weren’t going to earn 7.5%-8% over the life on interest rate. Lapse rates were 1% or less and people were living longer and so we got that more or less right. But what we missed a little bit was with people living longer they’re going to be disabled at the end of their life more so, the longer they live.
And so starting in mid-90s we and the industry should have raised premiums. I don’t know why we didn’t and they didn’t. Our first rate increases 2007 and 10%, that was approved then we did 2010 we did 18%, that was approved. It still wasn’t nearly enough and so we filed in the fourth quarter 2012 rate increases on three O blocks, business written from the mid-70s to 2000 where we’re actually asking for more than 50% and we expect when we end up and fully implement it over the next five years, we’ll get north of 50% rate increases.
And there is one block that we have, it’s still profitable but we know we need price increases on that we’re asking for price increases north of 25% but we’re for 25%. So if we get the 50% on the old that brings those old blocks, which is $700 million of premiums to breakeven. And what I would say to the regulators is that’s all I’m asking them to do is to get those back to breakeven. And then the rest of the in force, so we got our rate filed last year for the 25% plus increases on this one block. We just announced yesterday that on another $800 million we’re seeking rate increases between 6% and 13%, and the 6% to 13% will get us back to the original pricing assumptions.
And again what I’ve been saying to regulators, the regulators in the past have said until -- we price for loss ratio of 65%. It’s pretty much what the model reg allows you to do. But even our business that we know we need rate, the 6% to 13% increase because, right now loss ratios are single digit but now based on the original pricing assumptions I think stay where they are we are going to need increases.
So I have been saying to regulators, rather than wait 20 years that we see the loss ratios, give us the 6% to 13% now, we can spread it all over five years if you want and so that’s couple of percent a year. That should be pretty easy to do and so we will see—I think they are pretty open to that and then they have got approve. The new products that we just launched in April, we have another product ready to go at the end of year but that assumes rates stay pretty much where they are today forever and lapse rates are half a point and may be some mobility but even on those we’ll agree to raise prices.
So coming back, well I am very comfortable with the long term care businesses because I think we’ll get the old block to break-even. I think we will get those rate increases. We have said that our target was $200 million to $300 million. When fully implemented in five years at the end of the second quarter, we got approvals of $115 million to $120 million against that $200 million to $300 million target. You can take those increases into account, these are approved in your GAAP reserve testing and statutory reserve testing.
We also, unlike all of the other competitors, we started hedging interest rates in 2000. Most others didn’t hedge until the prices and so we had a lot of gains and in 2008 I think we locked in those gains. So we still have I think its $1.5 billion of gains in our AOCI that amortizes into the long term care business and so that also is taken into account when we do our cash flow testing.
So what we have said and we continue to look at things every quarter is that on a GAAP, the GAAP testing, which is a best estimate, deterministic test and statutory which is very much prescribed, our reserves are adequate with the margin and we look at, on the testing today we look at the whole block of business; the old, the middle and say the new business, written as of the balance sheet date and basically do an overview of the in force. So that’s where we are.
I think there is a consensus of people writing. I think they are writing without—really know what they are talking about but we have got a whole $2 billion to $3 billion and they come up with that because they look at others who have taken charges and say okay in their book which is salvaged by their book, with this size, they think this charge, generous this size and I think that charge but they miss that we have those hedge gains, they miss that we always did more underwriting than anybody else and unlike others we have continued and I met that ruckus of Bad Book, but we’ve continued to write business and I think the new business, we are getting returns well north of 15%.
So I become a—my poor child has been drinking the Kool-Aid but I think there is only 10 or 12 players. I think the regulators really want us to stay. They lost map, they lost prove, they loss [indiscernible], they are each around 10%. So they have lost 30% of the market. We are at 35% that we leave and we are about – we are 35% across the country, we are 35% in each state. So we leave, they pretty much, with the other three of them, they have pretty much lost to private market and then the state is going to pick up all these baby boomers in their Medicaid plan and you know what most of people—a lot of our customers don’t know, I don’t know about the analysts is Medicare doesn’t cover long term care. If you don’t have a private insurance then you have to use your assets and you use them until you get down to $2,000 and then at $2,000 you qualify for Medicaid.
I don’t know what the original assumptions were for the Medicaid actuaries in the states but the programs were designed for the poor but if you look across the 50 states between 25% and 50% of the Medicaid budgets today they are in the long term care. And if you see they are 76 million or 78 million baby boomers, you know their average age is 58, the average age of people buying our policy. So we love the baby boomers from the long term care prospective but if they don’t buy private insurance, probably one in three will beat the sale at some point in life and they don’t have the fine benefit plans and they probably under-saved and so lot of them are going to be picked up in state Medicaid.
So I’m not only talking to the insurance commissioners. I am also talking to the governors. They had Medicaid and they have health and human services in the state and I would say they know what the problems are going to be in their state Medicaid and they know whether the baby boomers are coming. So again what maybe is different, as I get a lot of questions why would these regulators grant these 50% plus rate increase. I say because if they don’t we are going to get out and if we get out, I think their states are in the even more trouble. So that’s why I think we have been more successful than many, many have been.
So that’s a good review of the business but it sounds like may be the case for the business, a committed case for the business, you reviewed whole bunch of action, you’re taking and continue to take for the business but I guess my disconnect was and maybe I didn’t understand this in call but it sounded like in the call that you were keying up the idea but you needed to undertake a review of the business. But it sounds like you done the review.
I want to do an Investor Call at December and on that Investor Call I want to walk through, here’s how we do the GAAP reserving, here’s how we do the stock reserving, here is what the margins are maybe we’ll you give you a range, here is the assumption
Okay. So maybe I misunderstood. I was thinking this was an internal review. Is this more – you want to review the business with investors, explain it.
Explain it this is the review so that in December I can go out and explain it to all the investors and whatever I say in that meaning I want it to be 100% accurate. There is the last thing I want to do is that here is how we being reserves, here is what we think and then down the road.
So this is less about you figuring about the business and more about you explaining to us.
And I’ve been around long enough where I’m a very quick study. I haven’t done a lot of long term care. I did run long term share business back in the 90s, but I really want to make sure that, we have that’s called a war room team, we call it a long term care steering committee. We meet weekly. We go through everything. And the whole purpose of that is so when we do our Investor Day that we give you very valuable information, we will also ask you about the people like to see but we are very, very confident in what we say.
And I want to do as much disclosure and understand that whenever disclosure we give, we’re going to give forever, every quarter. So, I want to also make sure disclosures are helpful because right now people make a huge deal out of the stock forms 1 to 5 and I’ll tell you they don’t really tell you very much and so the people who interoperate those, I think there is so many, if you ever unlock any of the business those that have gotten out of the market a lot, in a way that’s wonderful, you go back to day one and change everything in the years. So that it could like your original assumptions to the current. So there are some companies who have done unlocking. There are companies who have got rate increases and you can also with the rate increases go back from day one. So I don’t know, we didn’t pay enough attention maybe to those forms.
Okay. Actually we’re almost out of time, but if we can I just want to maybe just give chance one quick question from the audience. Someone would like to pop in here.
Tom, maybe you could just – you talked about the timing, the 18 or 15 to risk-to-capital on EMI. Maybe you could just give us a little bit of probabilities. I would think that the likelihood of something implemented in the next three months for 2014 would be fair likely but maybe you could just give us an idea about your thoughts are there.
It is always dangerous to speculate on what regulators might do. One thing I think is important to keep in mind is that we are counterparties to the GSEs. So I think that the GSEs will be careful about giving particularly the legacy before legacy players a reasonable amount of time to get to that number. So, I would think that will give us some time but we’re also planning that it could till January 1st, and that their deal we will be ready and because of all things we’ve done on the balance sheet and financial flexibility side, I think we’ve got a lot of options to raise with our capital we may need.
Just on that topic when you had mentioned if they did push it to this year or in January 2014 and that you might need to raise capital for that specific group. Where would that capital come from?
Come from anywhere. We may or may do it in Australia IPO. We don’t have any debt due till December 2016, we’ve with saved lot management business, we’ve reduced the leverage by 500 million. I wanted to just reduce it more. We could. There are other competitors who have done IPOs of USMI. We will look at that. We could IPO more than just the U.S. business. We could do a convertible, we could do debt. So we have plenty of ways to raise the capital. So, I’m not worried at all about raising it. I’ve rather have more time so that most of the capital can come from the earnings from U.S. and amortizing the DTA.
But to be clear, this would be internally generated capital or non-common equity?
That we could always do, we could – that certainly in running. I’m not at 50% above. And given where the MIs are trading, so, we’re looking at everything and we’ve got a lot of choices and we’ll end up picking the choice if we need to raise it, we pick the choice that’s the best shareholder value choice.
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