Genworth Financial's CEO Discusses Q1 2014 Results - Earnings Call Transcript

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Genworth Financial, Inc. (NYSE:GNW) Q1 2014 Earnings Conference Call April 30, 2014 8:00 AM ET


Tom McInerney – President & Chief Executive Officer

Marty Klein – Executive Vice President & Chief Financial Officer

Dan Sheehan – Executive Vice President & Chief Investment Officer

Kevin Schneider – President & Chief Executive Officer, Global Mortgage Insurance Division

Jerome Upton – Chief Financial Officer, Global Mortgage Insurance Division

Jim Boyle – President & Chief Executive Officer, US Life Insurance Division

Amy Corbin – Senior Vice President, Investor Relations


Sean Dargan – Macquarie

Geoffrey Dunn – Dowling & Partners

Suneet Kamath – UBS

Nigel Dally – Morgan Stanley

Joanne Smith – Scotia Capital

Steven Schwartz – Raymond James


Good morning, ladies and gentlemen, and welcome to Genworth Financial’s Q1 2014 Earnings Conference Call. My name is Christy and I will be your coordinator for today. (Operator instructions.) I would now like to turn the presentation over to Amy Corbin, Senior Vice President of Investor Relations. Ms. Corbin, you may proceed.

Amy Corbin

Thank you, Operator, and good morning everyone. Thank you for joining us for Genworth’s Q1 2014 Earnings Call. Our press release and financial supplement were released last evening and this morning our Q1 earnings summary presentation was posted to our website. We encourage you to review all of these materials.

Today you will hear from our President and Chief Executive Officer Tom McInerney followed by Marty Klein, our Chief Financial Officer. Following our prepared comments we will open the call up for a question-and-answer period. In addition to our speakers Kevin Schneider, President and CEO of our Global Mortgage Insurance Division; Jerome Upton, Chief Financial Officer of our Global Mortgage Insurance Division; Jim Boyle, President and CEO of our US Life Insurance Division; and Dan Sheehan, Chief Investment Officer will be available to take your questions.

With regard to forward-looking statements and the use of non-GAAP financial information, during the call this morning we may make various forward-looking statements. Our actual results may differ materially from such statements. We advise you to read the cautionary note regarding forward-looking statements in our release and the risk factors of our most recent Annual Report on Form 10(k) and on our Form 10(q)s filed with the SEC.

This morning’s discussion also includes non-GAAP financial measures that we believe may be meaningful to investors. In our financial supplement, earnings release and investor materials non-GAAP measures have been reconciled to GAAP where required in accordance with SEC rules. Also when we talk about international protection and international mortgage insurance results, please note that all percentage changes exclude the impact of foreign exchange. And finally, references to statutory results are estimates for the quarter due to the timing of the filing of the statutory statements.

We did recently announce the filing of a prospectus for the Australian initial public offering. Please note that due to Australian and US securities law restrictions we can only provide very limited remarks today on this process.

And now I’ll turn the call over to our CEO, Tom McInerney.

Tom McInerney

Thanks, Amy, and good morning, everyone. Thank you for joining us today for our Q1 earnings call. Today I’ll cover two topics – first, briefly discuss my view of the quarter and second, provide an update on our key priorities for 2014. I’ll then turn it over to Marty to provide more details on our Q1 earnings.

Now let’s turn to the results for the quarter. Our Q1 results reflect continued progress in our turnaround strategy. Turning to Slide 3 of our Q1 2014 Earnings Summary Presentation, net operating income was up 28% over the prior year. The results were positively impacted by an improved housing market in the United States driving lower losses as evidenced by a loss ratio of 46% in our US mortgage insurance business. Similarly, Canada and Australia benefited from favorable loss performance as reflected in low loss ratios of 20% and 17% respectively.

Mortality was higher in our US life insurance position and had a net unfavorable impact to earnings in the quarter primarily in life insurance. In long-term care we continue to see a favorable impact from the 2012 in-force premium rate increases on earnings of $10 million versus the prior quarter and $40 million versus the prior year. Overall we are pleased with the results in the quarter as we continue to improve the operating performance of our core businesses to improve shareholder value.

Next I want to provide an update on Genworth’s top priorities for 2014. Slide 2 of the presentation details some of the highlights for Q1. In 2014 our three key US life insurance position priorities are one, execution of our long-term care insurance strategy; two, expanding the private long-term care insurance market; and three, developing innovative and more competitive universal life, indexed universal life and hybrid products and balancing sales between term and permanent life.

In long-term care we continue to focus on securing (inaudible) approvals for the 2012 premium rate increases on the three older generations of products written from 1974 through 2001 which we refer to as pre-PCS, PCS 1 and PCS 2, and on one series of newer-generation policies written from 2001 through 2007 which we refer to as Choice 1. During the quarter the number of states approving the PCS and Choice 1 rate actions remained constant at 41 states.

Slide 13 on the earnings presentation is a new slide that provides a summary of our 2012 long-term care premium increase projections and how the rate actions impacted net operating income in 2013 and Q1 2014. On the top of Slide 13 we show the 41 state approvals as of March 31, 2014. These states have approved gross incremental premiums of approximately $325 million; however, we know that the actual premiums we collect will be lower because some policyholders will terminate coverage through death or policy decisions, accept lower benefits or a non-forfeiture option, or make a claim for benefits.

The $195 million to $200 million estimate that appears on Slide 13 and that we have discussed before is our projection of what the net annual incremental premiums will be by 2017 based on our internal projection models of policyholder behavior. Of course the projected estimate could vary depending on what decisions policyholders actually make.

We continue to work with state insurance departments to achieve additional 2012 rate increases and remain confident that our ultimate annual net premium increases from the 2012 rate action will result in $250 million to $300 million of increased annual premium when fully implemented by 2017. As we have noted before, assuming we achieve our targeted net premium increase this will only bring the PCS blocks closer to breakeven.

As shown on Slide 13, we project that the pending rate increases in the ten remaining states, that’s 50 states plus Washington, D.C. – that the ten remaining states will results in incremental net premiums of $25 million to $45 million. In addition for 30 states that have already approved some rate increases, we are making additional filings in these states and project the net incremental premiums from these states to be between $30 million and $55 million.

The bottom of Slide 13 shows the actual impact of the 2012 rate actions on earned premiums, reserve changes, and net operating income for the quarters noted. Given the relevance to results we currently anticipate continuing to disclose these figures in our quarterly operating results.

In September, 2013, we began filing 6% to 13% rate increases on long-term care products issued beginning in 2003 and written through 2012. We refer to these policies as Choice 2 and Choice 2.1. Current premiums on these policies are in the range of $800 million. As of March 31, 2014, we have received approvals from eleven states, up from four states at year-end.

The Choice 2 and 2.1 approvals are important because they represent the new approach that Genworth has been pursuing with state regulators. Rather than wait until actual loss ratios on Choice 2 and 2.1 policies exceed original assumptions well out into the future we are asking regulators for smaller increases now based on projected loss ratios. I am very pleased that regulators in these eleven states have agreed to the more modest 6% to 13% increases now.

It is our view that by implementing these more manageable increases now to return the products to original pricing assumptions we should mitigate the need for larger rate increases ten to twenty years in the future. We believe this is a better way forward for consumers, insurance regulators, and the private long-term care industry.

Finally, in July we expect to launch a Privileged Choice Flex 3.0 product which has a much improved risk profile, only marginal interest rate and lapse risk, and significantly less morbidity risk. We believe this new product is conservatively priced which we feel is appropriate given the risks inherent in long-term care insurance, and should generate returns of 20% or more.

In addition to meeting with insurance departments regarding long-term care premium rate increases we have been spending significant time this year meeting with state regulators, legislators and governors about the need to expand the private long-term care market. I also had the opportunity to represent the insurance industry in a panel discussion on long-term care at the Bipartisan Policy Center and address key industry participants at the Inter-Company Long-Term Care Insurance Conference. \

Our main point at these meetings and industry presentations is to emphasize the need for the private sector and public sector to work together to dramatically expand the number of Americans that address their long-term care needs. There are about 10,000 people turning 65 every day from now until 2030. Based on government projections 70% of people who live to 65 will need to fund long-term care costs sometime in the future.

There are 115 million Americans between the ages of 40 and 75 and only 7.4 million Americans today have coverage. Our message to federal and state policymakers, particularly given the pressures on federal and state budgets, is that we all should be focused on expanding the private long-term care market dramatically so that as many of these 115 million Americans as possible are insured.

We know that most Americans are not saving enough in 401(k) programs. The median savings is approximately $100,000 and few are covered by defined benefit plans. Therefore if most of these Americans do not own private long-term care policies and become disabled in retirement they will ultimately need to rely on Medicaid to cover their long-term care services after effectively exhausting their assets.

And we all know that Medicaid and other entitlement programs are going broke even before the bulk of the 78 million Baby Boomers reach retirement age – another compelling reason for a more robust long-term care insurance market.

Moving to our life insurance business, our product offerings protect people during unexpected events and help address the needs of the uninsured and underserved middle market. It is estimated that there are 70 million households in the United States that either do not own or do not have enough life insurance coverage. This creates a compelling opportunity for the life insurance industry.

Based on the latest available market data for the year ending 2013, indexed universal life or indexed UL has grown from a $330 million market in 2006 to a $1.7 billion market in 2013. Index UL sales increased 13% in 2013, representing 42% of total UL premiums and 17% of all individual life insurance premiums. Additionally, overall industry sales of hybrid products are estimated to have increased approximately 10% in 2013 versus 2012.

With our 2013 entry into the Index Universal Life market we expect to capture a small portion of the overall market in 2014, which will increase sales modestly as our Index UL products gain momentum. Additionally, we also have competitive hybrid products that we expect will gain momentum this year, particularly as we leverage our experience in long-term care insurance. We are in the early stages of this transition in life insurance sales and are looking to Jim and his team to help accelerate this transition and position us for growth.

In our Global Mortgage Insurance Division we have two major priorities this year – first, continued execution of the US mortgage insurance businesses’ return to profitability; and second, execution of the initial public offering of up to 40% for Australian mortgage insurance which allows Genworth to reallocate capital and reduce risk.

Our earnings in USMI improved to $33 million in the quarter. The loss profile continues to improve as the 2005 through 2008 books burn out and the 2009 and forward books become a larger percentage of the portfolio, now at 47% of risk in-force. The commercial strategy of the business continues to take hold as we believe we have seen modest share gains over the last several quarters.

Turning to Australia, completing a partial initial public offering of up to 40% of our Australian mortgage insurance business is a strategic priority for Genworth in 2014. On April 23, Genworth’s Australia MI business filed a prospectus with the Australian regulator. The execution of the IPO is subject to market conditions and valuation considerations including business performance.

Due to Australian and US security law restrictions we are very limited in what we can say at this time, and I know that you understand that we cannot provide additional information regarding the IPO on today’s call. We will provide an update in due course.

We have continued to make headway in our turnaround in Q1 2014 and while there is much more work to do Genworth is strong and getting stronger as we focused on continued execution of our strategic priorities to improve shareholder value. And now I’ll turn the call over to Marty to talk about the Q1 results in more detail.

Marty Klein

Thanks, Tom. Good morning, everyone. Today I’ll give an overview of results for the quarter and an update on our 2014 goals. I’ll be referencing our associated earnings summary which was posted on our website this morning.

Let’s begin with Q1 results starting with Slides 3 and 4 of the earnings summary. We reported operating income of $194 million for the quarter and net income of $184 million. Net operating income was up 28% versus the prior year and up $1 million sequentially.

Although we saw higher mortality versus the prior quarter in US Life Insurance results were helped by the long-term care rate action as well as lower losses in Australia, Canada and the US. The results also reflect $16 million of unfavorable foreign exchange versus the prior year and $5 million of un-favorability versus the prior quarter. Results in the current quarter included $15 million of tax benefits while results in the prior quarter included $29 million of tax benefits.

Turning to Slide 5, in Global Mortgage Insurance reported net operating income was $132 million, up $25 million from the prior quarter. Let’s cover Canada results first on Slide 6, where operating earnings were $41 million for the quarter. Unemployment in Canada at the end of the quarter was 6.9%, down slightly from December, 2013, and there was a modest sequential increase in home prices.

Premiums were down sequentially from the maturing of the larger 2007 and 2008 books of business and unfavorable foreign exchange. [Flow NIW] in the quarter decreased 40% sequentially with the normal seasonal variation we see in Q1 each year exacerbated this year by the more severe winter weather. We anticipate housing demand will shift till later in the year. The loss ratio remained low at 20%.

Turning to Slide 7, operating earnings in Australia were $62 million. Unemployment in the country was unchanged at 5.8% and overall home prices rose modestly from the prior quarter. Taxes were less favorable in the quarter but expenses were lower sequentially. Foreign exchange was unfavorable versus the prior quarter and prior year. Excluding the impact of foreign exchange, premiums were up from the prior year as the larger, more recent books mature and premium is recognized.

Flow NIW was down 9% sequentially from normal seasonal variation. The loss ratio for the quarter decreased by four points sequentially to 17%, the lowest level since 2005 as we saw favorable aging and late-stage delinquencies. We now anticipate the loss ratio for 2014 will be at the low end of our 30% to 40% range.

Moving to USMI on Slide 8, net operating income was $33 million for the quarter. NIW slowed in the quarter from a seasonally smaller purchase origination market. As in Canada, the severe winter on the East Coast and in the Midwest contributed to lower NIW as did a lower refinance market. Our NIW expectations for 2014 reflected a stable origination market, and although Q1 originations were low we still think 2014 NIW will be up modestly from 2013. We will continue to assess potential headwinds in the origination market.

Our total flow delinquencies fell by 27% and new flow delinquencies dropped 18% year-over-year. The new better performing books from 2009 forward are [47%] of risk in-force and we expect this percentage to continue to increase throughout the year.

We modestly increased reserve factors in Q1 to reflect higher severity expectations, primarily for late-stage delinquencies driven in large part by the extension of the foreclosure timeline. This was partially offset by a reduction in our frequency expectations for early stage delinquencies which we now expect to roll the claim at a rate of approximately 1 out of every 6 new delinquencies. We believe the revised loss reserve factors are appropriate for the ultimate claim development on our existing delinquencies. The reserve strengthening had a net unfavorable impact of approximately $11 million after tax for the quarter.

Overall we were pleased with results in our Global MI Division and we continue to expect division earnings to be relatively flat to 2013 given factors including lower US tax benefits and the foreign exchange rate headwinds I’ve mentioned before that we expect this year.

Turning to [Capital] in the Division on page 9, the prescribed capital amount of PCA ratio in Australia was estimated at 147%, down from the prior quarter from the termination of an affiliate reinsurance treaty in January as I mentioned last quarter partially offset by continued strong statutory income. For Canada the [MCT] ratio was estimated at 229% compared to our minimum target of 190%, and the business continues to evaluate opportunities to optimize capital.

As previously announced effective May 1st Canada will increase premium rates by an average of 15% due in part to the increased regulatory capital requirements. Additionally yesterday Genworth MI Canada re-filed a shelf registration for a normal (inaudible) issuer bid which gives the company the flexibility to buy back shares in the future should it make sense to do so. If a buyback did proceed Genworth Financial would currently plan to participate in the stock buyback, ultimately benefiting holding company cash while keeping our overall ownership percentage at its current level.

In USMI at quarter end, [risk to capital] ratio for Gemico was approximately 18.4 to 1.0 and improved from the prior quarter from positive statutory earnings. We still anticipate that the $300 million at Genworth Mortgage Holdings from the December, 2013, debt transaction will be deployed to benefit Gemico to the extent needed after the new [DSE] requirements are finalized. If the $300 million had been contributed to Gemico its quarter end [risk to capital] ratio would have improved by approximately four points under the current risk to capital framework.

Turning to the US Life Insurance Division on Slide 10, operating earnings were $94 million, down $25 million from the prior quarter as the division was impacted by higher mortality sequentially across all three of its business lines, hurting results in life insurance but benefiting earnings to a lesser extent in fixed annuities and longer-term care.

Earnings in Life Insurance were $21 million for the quarter. We saw unfavorable mortality experience in both term and universal life insurance versus the prior quarter from higher frequency of claims, while versus the prior year we saw both higher frequency and severity of claims.

As shown on Slide 11 actual to expected mortality for term remains favorable to pricing and in line with our 2014 expectations at 92%. However, we estimate that the actual to expected mortality for universal life was over 110%. Mortality experience certainly can vary from quarter to quarter so at this point we do not have any indications of a change in underlying trends but we will continue to watch experience closely.

Long-term care earnings were $46 million. The in-force rate action continues to impact earnings benefitting results by $40 million versus last year and $10 million versus the prior quarter.

Moving to Slide 12, the reported loss ratio for the current quarter was approximately 63%. The improvement sequentially and year-over-year is largely driven by the increased premiums and reduced benefits from the rate action. The increased premium of course adds to the denominator of the loss ratio while reduced benefits have the effect of releasing associated reserves which gets reflected in the numerator.

We saw an incremental $24 million of premium in Q1 from this rate action. We still anticipate that the incremental premium that we will recognize in 2014 will be between $150 million and $175 million and that after-tax earnings should benefit by $120 million to $150 million from the rate actions.

Tom spoke earlier about Slide 13 which we hope enhances our communications around the 2012 in-force rate action. This slide illustrates the various components of the rate action and how they impact earnings. For fixed annuities on Slide 14, earnings were $27 million, above our expectations primarily from improved mortality sequentially. In aggregate, US Life Insurance Division results were in line with our expectations and have not changed our views for its earnings for 2014.

Turning to a review of statutory results on Slide 15, as part of our year-end 2013 filings we completed annual cash flow testing which at the end of 2013 resulted in a $40 million decrease to the additional cash flow testing reserves of $120 million that we had held in our New York company for long-term care. Unsigned surplus for Q1 was flat to the prior quarter at approximately $440 million.

Statutory income was positive but down from the prior quarter which included benefits from the restructured life insurance transactions, inter-company dividends, and the partial release of the New York cash flow testing reserve I just mentioned; partially offset by increased reserves for universal life products with secondary guarantees in the New York company.

The current quarter statutory operating income was impacted by lower equity market growth which reduced statutory variable annuity earnings. We continue to expect to achieve our 2014 unassigned surplus and dividend goals for the US Life Division. The risk-based capital ratio for the quarter in the US Capital companies is estimated to be approximately 480%.

We have commenced work on the repatriation of the long-term care business reinsured to Brookfield Life and Annuity Insurance Company, Ltd., or BLAIC, to our US-domiciled companies. We expect to execute the repatriation in the second half of this year.

Shifting to the corporate and other division on Slide 16, the net operating loss for the quarter was $32 million. This result included $17 million of favorable taxes, primarily from a release of a valuation allowance and state and federal true-ups from the prior year return.

International protection earnings were $7 million for the quarter. The business continues to manage through a challenging environment in much of Europe although reported after-tax earnings were higher than our expectations this quarter because of $4 million of favorable tax adjustments. Runoff earnings were $12 million in the quarter as equity market growth was lower this quarter compared to the prior year and the prior quarter.

Turning to investments on Slide 17, the Global portfolio core yield declined modestly to 4.4% and we continue to experience a very low level of impairments, down to only $1 million after tax in the quarter.

Let me now cover some topics at the holding company on Slide 18. We continue to generate and maintain significant liquidity, with cash and liquid assets of approximately $1.3 billion at the holding company. After deducting the $485 million that we’ve been holding to address the remaining 2014 debt maturity we hold approximately $780 million of cash and liquid assets essentially in line with our target of 1.5x debt service plus a buffer of $350 million for stress scenarios. These numbers exclude the proceeds from our December debt offering, the $300 million of cash at the USMI holding company after contributing $100 million to Gemico.

As Tom mentioned, the completion of the Australia IPO is a strategic priority for us. Should we complete the IPO, which is subject to market conditions and valuation considerations including business performance, important priorities for us for the proceeds include ensuring our operating businesses remain appropriately capitalized and seeking opportunities to accelerate progress on our medium-term leverage targets.

Let me wrap up. We continue to make good headway in executing our strategy and improving our business performance. We are on track to achieve all of our 2014 goals but we have much work ahead of us to achieve those goals, deliver on our strategic priorities and continue to rebuild shareholder value.

With that let’s open it up for your questions.

Question-and-Answer Session


Ladies and gentlemen, at this time we will begin the question-and-answer portion of the call. (Operator instructions.) First we will take Sean Dargan with Macquarie. Your line is open.

Sean Dargan – Macquarie

Thank you and good morning. I have a question about the Life statutory capital. So we’re essentially in terms of unassigned surplus where we were at the revised number you gave out for the end of 2013. How should we think about the run rate for statutory operating income over the next three quarters? You identified some discrete items that negatively impacted stat earnings this quarter – I was thinking of how we should think about it going forward?

Marty Klein

Hey Sean, it’s Marty – let me take a crack at that. First of all I’d say that I do think we’re on track for our unassigned surplus goals for the year growing at about $100 million to $125 million for the year. As you probably recall from the last year, too, the increases on unassigned surplus certainly aren’t linear throughout the year; they move around quite a lot year-to-year.

I think what you also see is that statutory income is pretty lumpy and moves around quarter-to-quarter. I’d say this quarter for our core businesses in US Life, for annuities, long-term care and life insurance that the statutory operating income was pretty much in line with what we expected. Variable annuity income was a little bit off given some of the reduced growth in the equity markets and the kind of lower interest rate environments but we did see kind of tepid variable annuity results. But the core results in the other businesses were basically on track.

When it comes to the unassigned surplus walk, though, it’s not just a matter of net income. There’s some other items that go into it. This quarter we saw a couple items in particular that basically offset that positive net income. One was lower reinsurance credit which is frankly an item that we expected and it does tend to have a larger negative impact in Q1 than it does in subsequent quarters. The other item was a tax reserve adjustment that we made that was not expected that also impacted the walk in unassigned surplus. So those two extra items basically offset net income for the year.

We haven’t really talked about our net income goals; we’ve really talked more in terms of unassigned surplus goals. Certainly one of the goals of the business with Jim Boyle and the team is to really organically grow statutory income so that it can support dividends over time. So they have a lot of work to do with the long-term rate actions and introducing increased life products into our portfolio and things like that to improve statutory income over time.

But this quarter it was basically kind of what we expected with respect to statutory income and with variable annuities a little bit tepid, and then we did have that tax reserve adjustment that was really something we didn’t expect.

Sean Dargan – Macquarie

Okay, thanks. And one question on USMI – you noted today that there was some reserve strengthening for later-stage delinquencies and yet you still reported a loss ratio of 46%. Does the full year guidance of a loss ratio of 60% to 70% still stand?

Kevin Schneider

Sean, this is Kevin. You broke up a little bit on us in the middle of your question. If you can take another shot at that, I really couldn’t hear the basis of your question.

Sean Dargan – Macquarie

Yeah sure, can you hear me now?

Kevin Schneider

I can.

Sean Dargan – Macquarie

Okay, sure. So your loss ratio was 46% in USMI. That reflected some reserve strengthening on the later-stage delinquencies. Is your full-year guidance still 60% to 70% loss ratio?

Kevin Schneider

Yeah, I think that’s the best way to think about it. We should be on track with that which we provided back in February, in the 30% to 60% range. Just to sort of give you a little bit more color on it, our incurred losses were down in the quarter almost about 40% or about $45 million VPQ. But of that new delinquencies were down about 8%, and usually you look at new delinquencies are really what drives your incurred lost. The difference we had in the quarter is really primarily driven by the seasonal benefit for next year [in aging] plus the reserve factor that you referenced.

Sean Dargan – Macquarie

Okay, thank you.


And next we’ll go to Geoffrey Dunn with Dowling & Partners. Your line is open.

Geoffrey Dunn – Dowling & Partners

Thanks, good morning. Kevin, I wanted to follow up on that topic. I think you mentioned that you dropped your incidence expectation on earlier stage delinquencies to 1 in 6. This quarter ex the charge, it looks like the seasonal benefit might have pushed that towards 1 in 10. Where do you think that the incidence expectation on new notices trends over the course of the year?

Kevin Schneider

Yeah, Geoff, when you said the incidence benefit would have been 1 in 10 it feels a little bit like you’re making the connection from frequency to actual paids and the amount of paids we made. Paids were down certainly on the quarter but that’s really not the full story on our frequency. It’s really how you think about the transition rates through various stages of delinquencies and ultimately what will go to claim. You can have a good seasonal benefit like we did here in Q1 and it looks like it was high if you’re just drawing that comparison to your paid claim level in terms of units, but I think overall we would expect over time to sort of be in that 1 out of 6 range in terms of the road forward, and perhaps we get a little bit of benefit as the economy continues to improve.

Geoffrey Dunn – Dowling & Partners

Okay. I was actually referencing the provision in the quarter, not paids, but that still answers the question. And then could you for Australia, what are you seeing that is driving the improved incidents on the late-stage delinquencies? Is this Queensland stuff that you took a charge for a couple years ago and now isn’t turning out as bad as you get [five of HPA]? What’s developing there?

Tom McInerney

Number one, our reserves that we posted back in that quarter have held up pretty well over time. Additionally you have, continue to have decent home price appreciation in Australia and so on some of these later-stage delinquencies, you can almost think back to the pre-crisis days in the United States – even when you’re having paid claims or when you’re having claims you’re getting good disposition values on the houses when they’re sold. And the houses are being sold, reducing the net impact of the claim. That’s the biggest driver I would say in terms of what’s driving that performance.

Geoffrey Dunn – Dowling & Partners

Okay, and then last question: can you confirm if the [NCDOI] has received capital proposals yet?

Tom McInerney

I guess based upon our understanding of the process which is probably about as good as yours at this point, Geoff, we believe that certain regulators have received it but I can’t confirm whether North Carolina has or not.

Geoffrey Dunn – Dowling & Partners

Great, thank you.


And we’ll go next to Suneet Kamath with UBS. Your line is open.

Suneet Kamath – UBS

Thanks, a couple questions: just first to follow up on unassigned surplus. I just want to be clear on how we’re benchmarking this because I think at the end of last year or earlier this year on the conference call you talked about $100 million to $125 million increase on a base of $400 million, but now I think you ended the year at $440 million and it seems like you’re keeping the same increase which increases the overall target for year end. So I just want to make sure that should we be focusing on the $100 million to $125 million improvement or should we be focusing on an absolute level of unassigned surplus by the end of the year?

Marty Klein

Hi Suneet, it’s Marty. Yeah, you’re right – the goal is really the change, the $100 million to $125 million growth. So it would really be off that $440 million level. Every quarter end we’re kind of estimating where we think unassigned surplus was – it was our estimate that it would be $400 million and it turned out to be $440 million as we had a release of a reserve in the New York company with cash flow testing. So our goal is to grow $100 million to $125 million off of the $440 million.

Suneet Kamath – UBS

Okay. And then I guess on I think it was Slide 13 on the long-term care pricing, if I heard you correctly I think in that first bar you said that you’ve gotten $325 million of approvals and you’re sort of haircutting that to $195 million to $200 million based on I guess expectations for policyholder behavior. It strikes me that the haircut seems pretty big especially given your prior commentary. I think that 86% of the folks that you’ve approached with respect to the price increases have agreed to take the price increases. So I just want to get a sense is the 86% kind of a high number or is the 40% haircut kind of a low number?

Tom McInerney

Just to be clear because I don’t think we had mentioned this before: if you look at the actual approvals from those 41 states if everything stayed the same then we would see $325 million. That in effect is how the regulators will look at what’s been approved. But we know that because these increases will be implemented over the next five years, because in some cases some of the states spread it out, that things will change. We won’t have all the policyholders we have today. Some will terminate coverage for whatever reason. Some are taking the reduced benefit and so we have to factor that in.

We do pay some incremental commissions to agents. So we have an internal model that takes the $325 million and then pro-forma’s that going forward so that when we get to 2017 it’s our best estimate of what we think we’ll actually realize when it’s all said and done from the increase. So it’s an estimate; it’s based on our models. I think our models are good. We can’t predict with certainty exactly what policyholders will do, and certainly what the mortality with policyholders will be, but I think so far we feel pretty good about those estimates and I think that’s a pretty solid number.

And again, when we look at for when it’s fully implemented, the $250 million to $300 million, that again is not based on our internal model. So I think it’s something we can rely on. It’s not exact. The one thing we’re also doing on Slide 13 on the bottom is, so the top is the $195 million to $200 million, the $300 million, our estimates, projections; the bottom shows the actual impact on our US GAAP reporting numbers. So we’re trying to give you both and obviously we’ll see how the model works out and what policyholders do.

I would say, and we didn’t specifically comment on this but we’re still seeing about 85% take the full rate increase; about 10% are taking a reduced benefit; and 5% are still taking the non-forfeiture option.

Suneet Kamath – UBS

And how big is that sample size when you give those percentages?

Tom McInerney

I think we’ve notified several hundred thousand policyholders, and of course the other thing you have to keep in mind is that the increases go in policy-by-policy on the anniversary date. So it sort of will build going forward.

Suneet Kamath – UBS

Got it. And then just the last question going forward, I just want to come back to Australia for a second. In terms of use of proceeds, I asked the question on the last quarter’s call if capital management could be a possible use of those proceeds, and I think, Tom, you said you wanted to de-lever and do some other things but it certainly is a possibility. I just want to make sure the comments in the prepared remarks in this call, I wanted to see if there’s a change in that because you didn’t mention capital management or if you’re thinking about it in a consistent way as you did last quarter.

Tom McInerney

Yeah, I appreciate all of you not asking questions on the actual IPO process because we can’t comment on that. On use of proceeds we still have the same priorities and I’ll just ask Marty to review those with you since he’s the one that’s focused on looking at the various options for what we could do, working with me and also ultimately with the Board.

Marty Klein

You know, there’s still a number of things we don’t know. Obviously one of the things we don’t know is if we’re going to be able to execute the IPO; the other is what the amount of proceeds is going to be. We also have yet to fully understand what the [GSE] requirements are going to be so there’s a number of things that are yet to be determined.

I will say that if we do execute the IPO which is subject to a number of contingencies as we’ve discussed that our primary areas of focus, not necessarily our only areas of focus but our primary areas of focus are really first making sure our businesses are appropriately capitalized – so in the case of USMI we want to make sure it’s ready to go under new [GSE] guidelines. And then we also want to begin to make some good headway on if we can accelerating our de-leveraging goals.

So those are our primary areas. We’ll also look at other things that we might do depending on how much we have in the way of proceeds and what those business needs might be. Capital management is something which we certainly think about and talk about but we’ll have to assess that later in the year working with our Board. There’s other things that we’re obviously also looking at in that process. We want to be making continued headway in improving our ratings so we want to be thinking about that.

We also want to think about the dividend flows and capital generation within our businesses as we think about things like dividends and things like that. But those are the things that we’re looking at and discussing with our Board, and we’ll have updates later on in the year.

Suneet Kamath – UBS

Okay, thanks.


And we’ll go next to Nigel Dally with Morgan Stanley.

Nigel Dally – Morgan Stanley

Great, thanks. First on the Australia, you came out with guidance on the 30% loss ratio. Clearly the loss ratio was well below that this quarter, so a couple of questions: first, is the 30% a full year or is it a loss ratio that we should expect for the balance of the year? And if it is for the full year does that mean that we’re likely to see a loss ratio above 30% for the remaining quarters of the year?

Tom McInerney

Nigel, 30% would be a full year type average, so think about it that way – that’s how we think about it. And then in order to get there to your point you would need to have some incremental pressure in some of the later quarters of the year. We’re very pleased with the Q1 results but we do anticipate some potential pressure as it relates to unemployment, some modest unemployment increase – that could pressure our loss ratios going forward.

We’re very cautious and watching the impact on Asia, and the bit it might have on Australia. And then finally one quarter, it’s one quarter of results and we could see some variation through the balance of the year, some seasonal variation. But overall you would have to be above where we are at this point to achieve that 30% average mathematically.

Nigel Dally – Morgan Stanley

Great, thanks. And then the second on long-term care: I know you’re confident that the outlook should improve going forward but I guess we’ve heard your confidence in sales should begin to improve. And sales remain somewhat weak. Perhaps some color as to why the attraction has been taking longer on some of these products you’ve been introducing?

Jim Boyle

Yeah, Nigel, good morning – Jim Boyle talking here. Long-term care sales for the quarter were off as we had indicated in Q4 they would be really due to pressure from some pricing, product and distribution changes we made in 2013 and clearly form some headwinds that exist in the marketplace relative to some pricing in the product and rate increases.

On a positive note as Tom highlighted in his opening remarks the market opportunity continues to be stronger than ever. What we’re hearing from our distribution partners is the need to include a long-term care solution in their financial planning schemes is higher than ever. And so for us we expect to see higher sales in each quarter throughout the year.

Our early indicators which are our submits were up in every month, January, February and March in Q1. And so as we really expected, we expected to have some headwinds. We’re investing significantly in product, marketing and distribution and we fully expect to have more favorable results as the year progresses.

Nigel Dally – Morgan Stanley

Great, thanks a lot.


And we’ll take Joanne Smith with Scotia Capital next.

Joanne Smith – Scotia Capital

Yes, Kevin, I just had a question going back to the big reserve strengthening that you did in USMI back in, I think it was late 2012. And I’m just curious to see the small reserve strengthening you took this quarter, how does that relate to the remaining balance of that strengthening that you did back then?

Kevin Schneider

Joanne, if you go back to that period of time and I’d rather you not take me back there anymore, but I’ll go because you ask – it’s really difficult to compare it to what happened back then. The cohorts, the loans that were available at that point in time, some of those are gone. We paid claims, we’ve had a lot of loss improvements, so I wouldn’t relate it quite as much to that reserve strengthening that we did at that point in time.

I mean but directionally the way you can think about it is as foreclosure timelines have been stretched out and ultimately loans are going to claim you’ve got increased interest rate and expenses associated with the elongated timeline and that’s pressuring your severity levels, bottom line. That’s the biggest piece of what drove the reserve build.

The offset for that was as performance improves we got better product in the marketplace, we have economic recovery going on, unemployment’s improving, home pricing is improving – we are seeing some improvement in the frequency of the early stage delinquencies that go to claim. We put up about $11 million and on a $1.3 billion reserve base we don’t really think it’s very material.

Joanne Smith – Scotia Capital

Okay, alright. That’s good enough, thanks. And then just on the overall PMI industry penetration in the quarter it was flat. Can you talk a little bit about what’s going on with the industry dynamics overall?

Kevin Schneider

Penetration, when you say it was flat – on a purchase penetration basis we think it’s maybe up a point, and purchase penetration is really the biggest driver of our business. Overall we’ve probably, out of 100 loans probably 19 of them are going to the MI industry so that’s a big driver. The volume of the market did go down and that’s driven primarily I would say off the top line origination number.

Originations were down quite a bit. They were down predominantly because refinances have fallen off dramatically. We can expect that to continue – we’re just not going to have the big refinance market we had in the past. A lot of people are taking about weather; no doubt weather impacted parts of the Northeast, the Midwest, but they were also down in other parts of the country where you didn’t have weather and that’s probably being driven by both the increase in interest rates and some further affordability challenges that are being driven by home prices going up.

On balance when I sit back and look at it and I say what’s going to happen with the market for the year, you’ve got the headwinds of a slow sort of labor market recovery, wage growth is not going up dramatically. I talked about the home prices and the interest rate, and then on the other side there are some really positives I think that are still out there and we’ll have to see how it ultimately plays out.

Even though the labor market isn’t improving dramatically it is improving every single quarter. There’s pent up household formation demand that I think is ultimately going to have to play into the market. It may not be in Q2 or Q3 but over time those that have been on the sidelines are going to reenter the market and I think that’s going to be the biggest driver for us.

Joanne Smith – Scotia Capital

Great, thanks Kevin.

Kevin Schneider



And next we’ll go to Steven Schwartz with Raymond James. Your line is open.

Steven Schwartz – Raymond James

Thank you very much, good morning everybody. Just a couple: Johnson [Crepo], Kevin, any thoughts on that and how it might affect the business? Assuming anything ever happens.

Kevin Schneider

Yeah, number one I have no idea when anything’s going to happen. It’s been as you know delayed and we’ll see when it ultimately comes back and gets voted on. In general I think it’s good for the MI industry. It contains some, as it’s currently constructed it contains some explicit language relating to credit enhancement on above 80% LTV loans and I think that’s very supportive of private MI. And so net-net I see it as a positive.

Steven Schwartz – Raymond James

Okay. And then if we can go back to Slide 13, I appreciate the attempt but I’m still not getting it. So you’ve got approvals, $325 million. You think that’s going to wind up $195 million to $200 million. And then I look at the bottom here and earned premiums, the benefit is $24 million; reserve changes are $46 million – that’s $70 million. You annualize that, that’s $280 million. How do these fit together?

Tom McInerney

Well Steven, you have to keep in mind that the $195 million to $200 million that we’ve received so far, that gets implemented over time policy-by-policy. In some cases the sates didn’t give us a one-time approval but said “Spread it out over three years or five years,” so then on each anniversary of the policy we add the incremental approved amount. So it just takes time for the premiums to flow through. We ultimately think in 2017 and we also think we’re going to get some more approvals in the remaining ten states.

And we’re going back as I said to the other states – we do think we’ll see by 2017 as we roll all of those increases through all the policies, and people, policyholders decide what they’ll do that we’ll end up with versus no increases that we’ll end up with annual premiums going forward of per year between $250 million to $300 million.

Steven Schwartz – Raymond James

No, no. What I’m not getting, I’m getting the $195 million to $200 million – I understand that’s over time, through 2017. What I’m not getting is that the $24 million plus the $46 million is $70 million. You multiply that by four to annualize, that’s $280 million. That looks like a very big number. It’s the bottom half that looks too big to me relative to the top half.

Tom McInerney

Well again, keep in mind that you have two things going on – one is premiums and they roll in over time. But if someone, and there’s 10% of policyholders take the reduced benefit, and 5% take the non-forfeiture option, so for those people we aren’t going to get the increased premium going forward but because they’ve reduced their benefits or they’ve taken the NFO the claims that we might have to pay to them are significantly lower than what we originally assumed. So you do see that you get more of a one-time benefit from the reserve release from the NFO, the RBO, so that hits one time whereas the premiums continue year after year. So you will certainly get more of a short-term benefit to earnings the more people take the reduction in benefits or the NFO.

Steven Schwartz – Raymond James

Okay. Okay, that was good to know. And then one more: you’ve mentioned a couple of times in various presentations higher tax rates in international MI. The tax rates that we saw in Q1 in international MI, are those good for the year?

Marty Klein

It’s Marty, Steven. I think basically our forecast for the full year, we gave some indication of that in the prior quarter and I’d say that we still have those same expectations. I think some of those are really not so much tax rate changes but sort of tax adjustments as we look at some of the things in our return and adjust it into our financial statements. But the guidance that we gave on our prior quarter call is still the guidance that we have for the full year.

Steven Schwartz – Raymond James

Okay, thank you guys very much.


And ladies and gentlemen, with there being no further questions at this time I will turn the call over to Mr. McInerney for any closing comments.

Tom McInerney

Thanks, Operator, and thanks to all of you for your time and good questions today. I also want to thank Amy Corbin because Amy stepped in as you know in the new role of IR, and I want to thank her on behalf of the whole team for planning this meeting and everything she’s doing and we’re so pleased for that.

I also want to say that on behalf of the senior team and myself, I think we’re pleased with the progress we’ve made in Q1. I think we’re building on the turnaround. I think you’ll continue to see those benefits going forward. We’re focused on those five priorities I mentioned. I think we now have a new senior team in place and I think it’s working well, so I’m very pleased with them; and obviously we have a very talented group of employees. I think they’re much more excited going forward given the progress that we’re making.

And we remain focused. We have I think two strong missions. One is to help families at those moments of truth when they need to rely on life or long-term care policies and then obviously on the mortgage side, helping families maintain the dream of home ownership. So I think we’re making progress. Thanks for being on the call and we’ll look forward to the Q2 call later this year.


And ladies and gentlemen, this concludes Genworth Financial’s Q1 Earnings Conference Call. Thank you for your participation. At this time the call will end.

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