Genworth Financial, Inc.
Q2 2015 Earnings Call Transcript

Published: 5 Aug 2015

[Operator:]

Good morning, ladies and gentlemen, and welcome to the Genworth Financial's Second Quarter 2015 Earnings Conference Call. My name is Shelly, and I will be your coordinator today. At this time, all participants are in a listen-only mode. We will facilitate a question-and-answer session towards the end of this conference call. As a reminder, the conference is being recorded for replay purposes. Also, we ask that you refrain from using cell phones, speaker phones or headsets during the Q&A portion of today's call. I would now like to turn the presentation over to Amy Corbin, Senior Vice President or Investor Relations. Ms. Corbin, you may proceed.

[Amy Corbin:]

Good morning, everyone, and thank you for joining Genworth 's second quarter 2015 earnings call. Our press release and financial supplement were released last evening; and this morning, our earnings presentation was posted to our website and will be referenced during our call. 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, Rohit Gupta, President of our U.S. Mortgage Insurance segment; and Jerome Upton, CFO of our Global Mortgage Insurance Division, will be available to take your questions. 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 notes regarding forward-looking statements in our earnings release and related presentations, as well as the risk factors of our most recent annual report on Form 10-K and our quarterly Form 10-Qs as 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 the results of our international businesses, please note that all percentage changes exclude the impact of foreign exchange. And finally, references to statutory results are estimates, due to the timing of the filing of the statutory statements. And now I'll turn the call over to our CEO, Tom McInerney.

[Thomas Joseph McInerney:]

Thank you, Amy, and good morning, everyone. Today, I will provide a brief overview of the results for the second quarter, share progress against our three strategic objectives, and discuss the outcome of our strategic review. Our second quarter operating income of $119 million reflects solid performance from each of our three primary mortgage insurance businesses. Compared to the first quarter, loss ratios in the U.S. were flat and improved in Canada. Australia's loss ratio of 28% was higher than in the first quarter, but the first quarter's loss ratio benefited from the favorable impact of borrower recoveries. We still expect Australia's loss ratio to be within our annual expectations of 25% to 30% for the year. Long-term care earnings were negatively impacted by higher severity on new claims and lower terminations on existing claims; and life and annuity earnings were down sequentially, reflecting less favorable mortality than in the first quarter. Flow new insurance written was strong across our three primary mortgage insurance platforms. And during the quarter, both Canada and Australia were also active in the bulk market. As we expected, sales within the U.S. Life Insurance division continue to be challenged, because of the low interest rate environment, our lower ratings, as well as market uncertainty caused by our strategic review. We are evaluating and implementing several new product and distribution strategies, but we expect sales to be modest near-term in this division. Additionally, we continue to focus on reducing operating expenses in U.S. Life to bring them in line with our lower sales levels. Overall, we are encouraged with our second quarter results in our mortgage platforms and we remain focused on initiatives aimed at strengthening and improving U.S. Life division results. We continue to focus on achieving our three strategic objectives, which are to 1

[Martin P. Klein:]

Thanks, Tom. Good morning, everyone. Today, I will discuss our second quarter results and key performance metrics and provide an update on progress made on our 2015 goals. We reported net operating income of $119 million and a net loss of $193 million for the quarter, that included a $306 million loss on a planned sale of the lifestyle protection insurance business, or LPI. Overall, we saw good results in our Global Mortgage Insurance division that were more than offset by unfavorable mortality sequentially in the U.S. Life Insurance division. Beginning in the second quarter, LPI is being reported as discontinued operations, and we expect to close the transaction by year end. The LPI team has done a great job in navigating a tough economic and business environment in Europe over the last several years, and we are pleased to be at this point in the sales process. Given where we are with PMIERs, we are likely to use the majority of those proceeds to reduce debt. Looking at key performance metrics, sequential operating revenue results reflect three main drivers. First, earned premiums continued to be favorably impacted by the long-term care rate actions; second, investment income is up slightly from $13 million of higher gains related to limited partnership performance; and third, foreign exchange had an unfavorable impact of $8 million. Investment results were solid, with no impairments for the quarter. We remain disciplined in addressing risk in our portfolio. While recent events in Greece and Puerto Rico made headlines, it is important to note that we have no holdings in Greece and minimal exposure in Puerto Rico. Our underwriting results were mixed. Sequentially, the loss ratio was lower in Canada, flat in USMI, and up in Australia. The loss ratio in long-term care was up slightly from the prior quarter, as the seasonally strong first quarter claim terminations did not recur. Life Insurance results were impacted by unfavorable mortality. Operating expenses were up 10% sequentially, mostly in Global Mortgage Insurance from higher share-based expenses in Canada. As we communicated last quarter, as part of our strategy to increase financial flexibility and strength, our goal is to reduce cash expenses by $100 million by the end of 2016 in the U.S. Life Insurance and headquarters. We have made meaningful progress implementing expense initiatives that will remove approximate $30 million in cash expenses for the full year of 2015, and approximately $40 million to $50 million for 2016. Turning to capital, we had generally good results in the quarter. A few points related to our capital positions

[Operator:]

Ladies and gentlemen, at this time, we will begin the Q&A portion of the call. As a reminder, please refrain from using cell phones, speaker phones or headsets. We'll take our first question from Nigel Dally with Morgan Stanley.

[Nigel P. Dally:]

Great. Thanks. Good morning. So your prior goal was to reduce debt by $1 billion to $2 billion. At least by my calculation, the only way to achieve that was from executing a sale of GLAIC. So just to start, can you clarify whether that's still a reasonable goal.

[Thomas Joseph McInerney:]

So Nigel, we said that our goal would be to reduce debt by $1 billion to $2 billion over time. That's still our goal. With what we've done, the two transactions we did that we announced were at $600 million. So we clearly are making progress towards the lower end of the range. But that's still our goal and we continue to look at options. We decided, for a variety of reasons, not to pursue the large life and annuity transaction, but we are looking at potentially selling or reinsuring a couple of the blocks.

[Nigel P. Dally:]

Okay. Thanks. And second question, just on BLAIC, the consolidation being pushed back. Can you provide some clarification as to what's driving that?

[Martin P. Klein:]

Hey, Nigel. It's Marty. It's still a goal. But obviously, as we were assessing a potential transaction, a larger transaction in U.S. Life, it was going to come along with or perhaps following that. And as we work through that now, we do have the repatriation ahead of us. But we do think, as Tom had mentioned, we want to look at a couple of these Life blocks, and if we do pursue them, we'd maybe try to do them over the next several months or into next year. We'd want to probably do those first, if we do in fact decide to do them, and then do the repatriation. The other thing I'd point out is that the repatriation process does take a while. And part of it is in the process. There's a filing process where you have to file your pro forma financials, which has been difficult because we've been working through what that pro forma is going to look like. And now that we've got that somewhat determined, although we have to think about these life blocks, we'll play that through. But still a goal, but I think it's going to come into next year, at the soonest.

[Nigel P. Dally:]

Great. Thanks.

[Operator:]

We'll take our next question from Jimmy Bhullar with JPMorgan.

[Jamminder Singh Bhullar:]

Hi. Good morning. I had a couple of questions. The first is just if you could talk about the financial impact of the reinsurance deals that you've done in the USMI business. You're getting a decent amount of capital relief, but how much of a hit do you expect on earnings? Is it in the 5% to 10% range, or higher than that? And then I have another one.

[Thomas Joseph McInerney:]

So Jimmy, Kevin Schneider is traveling today. So we're delighted to have two members of his team, Rohit Gupta, who as you know, is the CEO of USMI, and Jerome Upton, who is the CFO of the Global Mortgage Insurance business. So I'd ask Rohit to handle that question.

[Jamminder Singh Bhullar:]

Sure.

[Rohit Gupta:]

Good morning, Jimmy. This is Rohit. So the cost of reinsurance transaction, both for 2009 to 2013 book, as well as 2014 transaction, as Tom stated, is in the mid-single digits. Just to ground you, these are amortizing transactions. So over a period of time, the cost of the transaction will drop. But just to give you a ballpark, for calendar year 2016, we would expect the ceded premiums to be in the range of $10 million to $15 million. So you can use that as a calculation point.

[Jamminder Singh Bhullar:]

Okay. And then on your sales outlook for the U.S. Life division. I understand in LTC, you're making a lot of product changes. But your sales were weak across the board. So just wondering if you can talk about your outlook and how much of the weakness is being caused by ratings issues versus just your intention to preserve capital?

[Thomas Joseph McInerney:]

So I think, Jimmy, that first of all I would say that in long-term care, we did relaunch, refresh in a product this year and just launched it. So I think that will help sales in LTC. In annuity, fixed annuities, clearly the low interest rate environment has made getting the appropriate spreads for us a challenge. But in addition to that, I think as we're going through the strategic review of life and annuity, that clearly had a significant impact on sales. And so with that now behind us, we would hope to improve somewhat. And obviously the ratings decline, while an A- at A.M. Best is acceptable in the BGA channel, where our principal sales are, the S&P and Moody's ratings has had an impact on our sales through financial institutions. So as both Marty and I commented, we expect, given the low interest rate environments and our ratings, for sales to be modest for some time. We are looking at a number of product changes and focusing on specific BGAs and distribution outlets to improve sales. We also brought in a new leader for – a commercial leader, Chief Commercial Officer for the business. So we hope all those things will help. But I do think sales will be challenged for a period of time, although working on a number of product changes and distribution strategies to improve it.

[Jamminder Singh Bhullar:]

And then lastly, if I could ask one more, on the Canadian and Australian MI businesses, if you could just talk about what your views are on those markets. There's been a lot of concern about low commodity prices, frothy housing markets in those regions. So how do you view your business and the margins in Canada and Australia? I think Australia, you mentioned you expect a decline in margins. But what's your view of the market overall?

[Thomas Joseph McInerney:]

Yeah. So, Jimmy, I would just say that we're pleased with the results across the U.S., Canada and Australia. I think our loss ratios continue to be in our range, probably at the low end of the range that we forecasted. So we're comfortable with all three of the businesses. Clearly, as you stated, there are macroeconomic challenges that impact the markets, particularly in Canada and Australia. And I'll ask Jerome just to make a few comments on that.

[Jerome T. Upton:]

Jimmy, good morning. It's Jerome Upton. I think one of the things – I would start with Canada and just give you a broad perspective on economic conditions. We all have seen that GDP has contracted in Canada early in the year. But when you dive in deeper on that, it's primarily driven by oil price decline and sort of the contraction there. We saw the Bank of Canada lower rates around 50 basis points, or down to 50 basis points. But I think in the second half, most economists, including the Bank of Canada, would expect GDP to grow. And they're expecting 1.1% growth, when you look at it year-over-year. Employment outside of the oil-producing areas are holding up very well. And our business performance, as Tom indicated, has been strong. You also have seen the loonie, or the Canadian dollar, lower, which is going to help exports in that economy. And then from a housing market perspective, overall, we feel good. The fundamentals are strong. There's good household formation and population growth. The significant increases that you see in home price appreciation in Toronto and Vancouver – we've really gone in at a detailed level to understand those drivers. And it's not our served market. Our served market is a first-time home buyer. And those first-time home buyer prices are much lower than what you're hearing about in the market. The credit quality in the business remains very good. We've taken actions, if you just think about Alberta, Alberta is a pressure point, okay? Alberta is a buyer's market. And while we haven't seen performance deteriorate at all in Alberta, we do expect that we're going to see some pressure in the second half. Home prices have gone down some. There could be further degradation there in home prices, 5% to 10%. But overall, the credit quality that we have on the recent vintages, because we took action in that area early, the credit quality is good. And the older vintages have home price appreciation behind them. So that's sort of a macro perspective on Canada. In Australia, GDP is continuing to grow. It's growing below trend. It's about 2%. The trend's normally been higher than that. In Australia, the RBA cut cash rates down to 2%. But you probably noticed yesterday, they held rates flat at 2%. They did not take another cut on rates. And employment is doing okay overall, down to 6%. It actually went down a tick to 6%. We're just simply seeing pressure in the mining-related areas, in Queensland, where they extract a lot of coal from the ground, and in Western Australia, where there's significant iron ore extraction. So we're seeing pressure there, because prices have come off over the past couple of years. We took actions, starting in 2013, in both of those areas to cut loan balances down and LTVs. So that should help us. And it's the older vintages that are pressuring us and there's likely some embedded HPA or embedded equity that will help us there. With respect to the Sydney market, you have seen Sydney grow, from a home price perspective, consequentially year-over-year. But when we dive into that, it's a concern when you see home prices go up that large. But when we dive in, you have to put this in a longer term context.The Sydney market has had periods of below home price trends in 2004 and 2008, and they actually had declines in home prices in 2011 through 2013. So if you look at this over a longer term trend, you see 5% growth over a 10-year period. We are watching carefully the investor lending concentration in that market. But I would tell you that one thing we feel good about is the regulatory action that's being taken, as well as the lender action that's being taken to strengthen the underwriting in that Sydney market on investor lending. So we applaud that action that's being taken and we think it's a good thing. So those are the assessment of the markets. I think overall, we still feel good. But we acknowledge we're going to feel some pressure in energy-related and mining-related areas.

[Jamminder Singh Bhullar:]

Thank you.

[Operator:]

We'll take our next question from Geoffrey Dunn with Dowling & Partners.

[Geoffrey Murray Dunn:]

Thank you. Good morning. I wanted to follow up on the previous question about the XOL transactions, see if you can provide a little bit more color with respect to, is it all of the 2009 through 2013 and 2014 books that's being covered? Any detail on the attachment points of the XOL? And as far as the incremental 2015 XOL, can you give us an idea of what you think the incremental capital benefit will be from that?

[Rohit Gupta:]

Yeah. Geoff, this is Rohit. Good morning. Let me give you some color on the XOL transactions. As Tom and Marty stated, the total capital credit from these transactions at the end of the year is expected to be around $300 million. We would basically say that the XOL tiers are within the credit tiers that PMIERs have subscribed, because that was the intent of these transactions, to get capital credit under the PMIERs framework. At this point, we are not providing any more detail on attachment and detachment points. But on cost of capital, I did provide some color on cost of capital being in mid-single digits, and 2016 impact being $10 million to $15 million for the first two transactions. For the 2015 transaction, as we move forward in testing the market capacity, as well as cost for different attachment points, we will consider coming back and providing more detail in the third quarter earnings call comprehensively on all three transactions.

[Geoffrey Murray Dunn:]

Okay.

[Rohit Gupta:]

Just one thing to think about as we talk about financial flexibility against PMIERs. We have reached a big milestone with PMIERs. We believe we will be compliant, giving effect of these three transactions, the two reinsurance transactions, plus the GLIC asset exchange, as of second quarter. But we still believe that we actually need financial flexibility, both for the required asset side, which could actually have variations from forecast just based on items like interest rate, higher NIW, or different policy lapse than our expectation, as well as in our asset base, as Marty stated, we have Canada ownership, 16% of Canada ownership. So based on the volatility on the stock price, as well as foreign exchange, we believe it's prudent for us to actually have a financial buffer, financial flexibility against our PMIERs compliance.

[Geoffrey Murray Dunn:]

Okay. With respect to the ceded $10 million to $15 million, is there ceding commission and/or profit commission consideration beyond that, or are you giving us a net impact?

[Rohit Gupta:]

This is – Geoff, this is net and gross. It's an excess of loss transaction. There's no profit commission and no ceding commission. So this is actual amount of ceded premium. I would reiterate that these are amortizing transactions. So as you transition from 2015 second half to 2016 to 2017, you will see absolute dollars of premium ceded go down. But there's no concept of profit commission or ceding commission back. The cost of capital is based on the ceded premium and the capital credit we provided.

[Geoffrey Murray Dunn:]

Okay. In terms of thinking about a cushion against PMIERs, how are you approaching that? I know most of the industry said last quarter, you're still evaluating it. Now, as you put plans into place to take additional capital actions, how are you thinking about it? Is it a 5% or 10% buffer? Is there a dollar buffer? How do we try to anticipate what additional capital needs you might have the back half?

[Rohit Gupta:]

Yeah. So Geoff, just two things. First thing, we've always had a consideration for a buffer, right from the range, first range we provided in July of 2014, when draft PMIERs came out, and we provided the range to the marketplace. And including our final range, when final PMIERs came out on April 20, we actually included a financial flexibility buffer or cushion in that range also. And the two items, without going into any specific dollar numbers, the two items we consider when calculating our buffer is on our required asset side, just the volatility we could end up facing against our forecast, based on items like interest rate, new insurance written, losses, as well as lapse. And then secondly, on the available asset side, given our MIC ownership, just volatility in foreign exchange, volatility in the actual stock price. We have looked at those trends historically and actually created a appetite, a risk appetite and a financial flexibility appetite framework that we use. The buffer is dynamic in nature, and at this point of time, that's what we're building our capital towards.

[Martin P. Klein:]

Geoff, it's Marty. I would just also note that as the team looks at the potential for 2015 transaction, at this point we think it's quite possible that we'd be able to not only remain in compliance with PMIERs, given the other progress we've made, but also hit that buffer, largely through that type of transaction. Obviously, we have to get such a transaction done. But we do think that the size of that book of business and the appetite we've seen so far is probably going to give us a decent shot to build in that financial buffer that Rohit talked about with that transaction. If that's the case – and again, that's an if, we have to work through what that deal would look like – but if that is the case, then I think that as far as the LPI transaction, we think that, as I said earlier, the majority of the proceeds, if not almost all those proceeds, would go towards debt pay down. But obviously, we have to play through on the 2015 potential transaction.

[Geoffrey Murray Dunn:]

Okay. And then last question, if I may. Once you repatriate the LTC risk next year, is there any strategic reason to upstream the Canadian ownership from BLAIC to the holding company?

[Martin P. Klein:]

I'm sorry. Could you repeat that? Upstream what to the holding company again?

[Geoffrey Murray Dunn:]

Canadian ownership from the Bermuda HoldCo to the Genworth Holdings?

[Martin P. Klein:]

We have to assess a number of those things. We have Brookfield, which as the ownership over Australia and Canada – as you know, USMI also has some ownership of Canada, as well – and then also Brookfield has BLAIC, which is the subsidiary that has the reinsurance relationship. So we'll assess what we want to do as we're doing the repatriation, which obviously involves BLAIC, we'll assess what we want to do with Brookfield. There have been some tax advantages in the past for their overall structure. But as things move around, as we continue to assess Australia and do some other things, we'll have to assess what we want to do with Brookfield and what we want to with some of those ownerships. So it's a little premature to say what we would do in that regard.

[Geoffrey Murray Dunn:]

Okay. Thank you.

[Operator:]

And we'll take our next question from Ryan Krueger with KBW.

[Ryan J. Krueger:]

Thanks. Good morning. I was hoping to go back to the decision not to sell the entire life and annuity business. Can you talk – I guess a little bit more about that decision and specifically, how meaningful of a role did the expected proceeds that would actually make it to the holding company play in the decision not to go forward?

[Thomas Joseph McInerney:]

So Ryan, we looked at a number of different criteria. And obviously, we had our outside financial advisors also working very closely with us. And there were a number of factors. I would say probably the most important ones were earnings per share and accretion dilution, taxes and tax impact on the actual valuations that we received from the bidders and also the proceeds. In regard to the proceeds, we did talk with our key regulators, which are the regulators for our three legal entities. I think all three were open to allowing us to take some proceeds out of the companies, and particularly the GLIC, because while obviously they want us to maintain appropriate RBC levels, and I think they're comfortable with where we are today, they also clearly get the importance of reducing debt at the holding company by the $1 billion to $2 billion. So I would say they were fairly open-minded on that. We ultimately decided, while there were a lot of positives for doing the deal, including our ability to reduce debt, in the end, our view was they were outweighed by potential adverse effects in the ratings and the loss of earnings diversification. So in the end, those were the two drivers that, sort of, outweighed the positives and led us to decide not to do the larger sale, the sale of GLAIC, but to focus on a couple of the blocks that we think make sense to do something with.

[Ryan J. Krueger:]

And in terms of the block sales now, or block reinsurance that you're looking at now, do you think the proceeds freed up from those would be free then to the holding company and help meet your debt reduction targets? Would they most likely be retained and used to bolster RBC?

[Thomas Joseph McInerney:]

I think one, we have to negotiate those deals with the counter party or the reinsurer. There is a capital benefit, and I would expect that when we talk to the regulators, they would be open-minded in terms of allowing us to take that out. But we'll have to one, get the deals done and then talk to the regulators. But as I said, I think while they understand our need to reduce parent company debt, I think they're pretty open-minded on that. They know that's a significant objective and will, I think, work with us to get there. Obviously, they also want to make sure that there's enough capital in the operating entities to allow us to pay the policyholder obligations going forward.

[Martin P. Klein:]

But Ryan, I would say that while I think these couple life blocks are interesting economically and would have some capital benefits, I don't think they're all that overall significant as far as the amount of proceeds we'd get out and pay down debt. I think they're definitely helpful for the business and the capital within the business, but I don't think overall they're going to have much of an impact on our ability to get money out and pay down debt from those transactions, just to manage those expectations. We think there's other benefits, from capital standpoint and economic standpoint. That's why we're taking a look at them.

[Ryan J. Krueger:]

Okay. And then lastly, just back to the debt reduction target. I think you mentioned that you've done $600 million of – you're going to get $600 million of proceeds from what you've done so far towards your $1 billion $2 billion debt reduction target. But I think at least a couple hundred million of that was used for the PMIERs requirement. I'm just trying to think, what can you do to get from where you are now to at least the $1 billion target? It sounds like some additional business sales are likely necessary. I know you've mentioned you're still evaluating Australia. Is that something we should still – is that really the most likely additional use would be a further sale of Australia?

[Thomas Joseph McInerney:]

So there are a number of potential sources of proceeds to help us focus on the debt reduction. Clearly, both Australia and Canada are meaningful payers of dividends and special dividends. And so they will clearly be an important source, as they have been. In addition as USMI makes its progress, it is significantly improving its earnings and it's working on their negative unassigned surplus, but that is because we're making progress there and we would expect USMI to also, at some point, 2017, maybe later, to be able to pay a dividend. And then we'll also look at asset sales. And so we've always said the goal is reducing debt by $1 billion to $2 billion. And the reason for that range is it gives us more optionality in terms of the options we can consider for the company, including potentially splitting the company. And so that's an important point. But we always believed that we would be doing this over time, and so we'll continue to look at the opportunities that we have both in the Life division, as well as in the MI side.

[Ryan J. Krueger:]

Okay. Great. Thank you.

[Operator:]

We'll take our next question from Colin Devine with Jefferies.

[Colin Wayne Devine:]

Sure. A couple questions. First, Marty, I think it would be very helpful if you can just go a little bit deeper on to what some of the issues are with the interconnected capital structure in Genworth. Because what I think I heard today is a big reason why you can't do a larger life sale is because of that. And that's the issue there, because of the interconnection. So we can hit that one number first? Second, to give you a break and catch your breath, can we flip over to Genworth Canada? I'm talking about Alberta. If arrears got back to where they were, say during the financial crisis, at that level, just to size maybe how bad things could go, how much of an issue would that be for Genworth Canada? And then lastly, if you can provide a little more color on what are the remaining issues with respect to selling Australia. Thanks.

[Martin P. Klein:]

Hello, Colin. I'll start out and then I'll kick it to Jerome for your question on Canada. And then Tom can take the last question. On the interconnectivity, that is something we've obviously known about for a while and want to continue to work through. I think over many, many years, Genworth, like a lot of companies that are in a lot of different businesses, set up these interrelationships that certainly had benefits, tax benefits. We have tax sharing arrangements, which can be very helpful. Certainly, capital relationships and reinsurance relationships. I think specifically to us, ratings – and this is also true for other companies that are in multiple businesses – obviously our overall ratings are impacted by the mix of business that we have, as well as obviously, the level of debt that we have. And as different rating entities look at these differently, to be clear, certain things matter to them a lot. Earnings diversification, how many different businesses you're in, and what's their view of the volatility or variability of those businesses. Also, some agencies have a concept of core businesses and then they notch other ratings off of what they view as the core business. So those are all things that we have to be mindful of. I think the biggest driver of why we did not pursue a transaction in life and annuity is we felt like the ratings repercussions would not only potentially hurt the U.S. Life division, given the loss of potential earnings diversification, but we also felt like there'd be a ripple effect that would also impact the mortgage insurance businesses, which I think have been performing very well. And the last thing we'd want to do is do a transaction that would have an impact on ratings that might impact their ability to go forth and do business. We think, as Tom mentioned, those are very good businesses, particularly USMI and Canada. So that's one thing we have to work through and see how we can best address that. There are a number of very specific things to us. Obviously, the relationship between BLAIC and GLIC without long-term care reinsurance is certainly one pretty major connecting point. And actually, speaking of GLIC, the fact that we have stacked entities, GLIC is the parent and then it owns GLAIC, the Virginia company, which has a lot of life and annuity business. And they both, in turn, have an ownership of GLICNY, so you have that kind of stacked structure, while it provides some overall capital benefits, it does impede dividend flows, for example, from GLAIC. So that's a consideration that we have to work through, see what we want to do about that. Obviously, we've had the GLIC preferred stock that was in USMI that did not get any credit at all under PMIERs. Similarly, the other part of USMI's capital structure is Canada, which while we think it's a very good business, it does, under the way PMIERs is constructed, have a lot of volatility. So that creates the need for a bit of a buffer more than maybe the business would ordinarily have if they had a consistently stable part of its capital structure in there. So we have to kind of work through that. So there's a lot of those types of things. Some of them would make some sense to look at very closely. Others, I think would not be economic. So we have to sort through what we can do to change those interconnected things and improve our financial flexibility over time. In the meantime, it's very important that we make our businesses perform better. In Life and Annuity in particular, now that we're going to be in that business, we need to work on how to grow it efficiently and effectively and profitably. And obviously, fix long-term care business, which is going to be a major, not only earnings driver, but I think overall shareholder value type of proposition, given the way the market's having long-term care right now.

[Colin Wayne Devine:]

Marty, just following up on that, you mentioned Genworth Canada's ownership structure. Two quick ones. One, why not get it up to the holding company, since you freed up some other capital? And two, why not sell it down to 51%, 52%, like you did for Australia?

[Martin P. Klein:]

Yeah. I think that, Colin, looking at those things, they make a lot of sense, but they also involve cash and things like that. So we have to look at the cash and capital needs that we have and what's the best way to use it. And certainly, there are some benefits to getting Canada out of USMI, absolutely, but we have to also think about what we want to do with our cash and our capital. I think also, Canada is – while USMI has been working to comply with PMIERs – the dividends that Canada has been paying not only go to the holding company, but also go to USMI. So USMI, which to this point has been in need of capital, has benefited by its relationship historically with owning Canada, because of the dividend flows which USMI has been able to capture. But obviously, with the compliance with PMIERs, and that also included, frankly, a contribution from the holding company – or not really a contribution, an exchange of the GLIC preferred for cash – we're in a different situation now, so we'll have to assess a lot of those things.

[Colin Wayne Devine:]

And maybe just, why don't you clarify for everybody, what is the cost to capital for USMI by owning the Canadian stock? If you swapped it for cash, what would be the benefit?

[Rohit Gupta:]

Colin, do you mean under PMIERs context?

[Colin Wayne Devine:]

Yeah.

[Rohit Gupta:]

Yeah. So under PMIERs, the prescribed discount for publicly traded securities is 25%. So whatever the market value is multiplied by the foreign exchange rate gives you the market value of Canada that's in USMI. And at quarter end points, we adjust that down by 25% to calculate our PMIERs available assets, and then whatever volatility that's baked in, that's basically part of our financial flexibility buffer we talked about.

[Martin P. Klein:]

So it's worked very differently than it works under regulatory capital, where it's really on a book value basis. So it's been much more stable. So when you look at risk to capital, it's really on a book value basis, and also without a haircut. So it's been actually a pretty efficient part of – and good part of the overall capital structure and also provided some dividends to the business that were helpful to its capital. But PMIERs is now the driving capital requirement that the business has, given that our risk to capital is like 13.5 in GMICO these days. And so that's what we have to drive to and manage to now. If there's anything else, why don't we kick it to Jerome for your question on Canada?

[Colin Wayne Devine:]

I think you just reinforced why the ownership structure is still the way it is. But let's go to Alberta.

[Jerome T. Upton:]

Colin, good morning. It's Jerome. I would say that we did feel pressure coming out of the GFC and from Alberta, as you point out. But I would say that we feel better positioned at this point in time in that market, acknowledging that we are going to feel pressure. We have taken some underwriting actions in that area, number one, to strengthen the recent vintages. And those actions would've improved our credit scores in the region, as well as to just an overall much more conservative approach to collateral valuation and underwriting in general. So we do feel better positioned. And also would note that coming out of the GFC, home prices were at pretty elevated levels in Alberta. What we're underwriting now and underwrote post the GFC, the housing market was down some, so we feel better positioned at this point in time. I really can't give you a number, Colin, with respect to pressure on the business, and link it back to the global financial crisis. Because we're going to have to wait and see what's going to happen with oil prices and the extent and the duration and how long they stay down before we can give you any type of estimate on that. We're telling you in 2015 that we're going to stay within our guidance of 20%, 30% in Canada. And as we move into 2016, we'll give you an update based on what we see in the market, the home price declines that are there, and the unemployment increases.

[Colin Wayne Devine:]

Okay. Thank you.

[Thomas Joseph McInerney:]

And Colin, just to take your last point quickly, so we can get on to some other questioners. We continue to evaluate our ownership position in Australia. As we've said before, there is a benefit to majority ownership, including that we retain a majority on the Board. And also, because Australia has been such an important payer of dividends over time to help us manage the annual debt service, Australian ownership and dividends there are important. If we did decide, at some point down the road, to sell Australia ownership, we'd likely use the large portion of those proceeds to reduce debt.

[Colin Wayne Devine:]

Thank you.

[Operator:]

And we'll take our next question comes from Suneet Kamath with UBS.

[Suneet L. Kamath:]

Thanks. Good morning. I wanted to start with long-term care. I don't know if you talked about it on this call, but in the past, Marty, you'd talked about wanting to maintain a buffer for long-term care volatility. Have you done any more work in terms of sizing that?

[Martin P. Klein:]

Hey, Suneet. Actually, we've been doing a lot of work on what we want to do in life and annuity and some other things. I would say it's still something we want to look at. I think that part of that is going to be a function of what other businesses are in the U.S. Life division, and that was not all that certain for a while. I think that the way that the risk-based capital rules under NAIC rules are such that we would want to manage over time long-term care to a higher level. That does not necessarily mean though that we're going to be in the life and annuity businesses. We'd also do that for the life and annuity. So I think what we're working through now that we've got life and annuity businesses and earnings stream and diversification, it provides some capital and risk buffer. We have to assess that longer term goal. I do think it'd be along the lines of holding up a higher RBC number behind long-term care, probably more in line with what we think its economic risk and economic capital would be. But we'd have to weigh that with a balancer of what we're doing in life and annuities, now that we have those businesses. Also want to be mindful of overall cash flows and surplus growth in business and our ability to get some dividends out, too. So while we want to increase and expect to increase the buffer behind long-term care over time, we also want to be mindful that we do want to be getting some cash out of U.S. Life at some point along the way to help with some of the debt issues. So that's a long way of saying there's a number of considerations. Now that we've finalized our strategic review and not going to do a transaction in life and annuity, we can turn our attention to what exactly do we want to do in long-term care. I think historically, we've looked at U.S. Life, the division, and wanted to manage long-term care in excess of 400. I would imagine that minimum 400 is probably going to go up a bit, once we work through that. But we'll have more details later on this year, hopefully.

[Suneet L. Kamath:]

Okay. And then, I guess my second question is just in terms of the strategy, I think a lot of us heading into this call were maybe anticipating that you might announce something pretty big that would move you much closer along your way to delevering and then ultimately breaking up. But based on how you're characterizing your situation today, it seems to me that what we should be thinking about is perhaps a larger number of smaller items as opposed to any one big thing, in terms of just sending cash up to the holding company and reducing debt. So I guess my question, is that a fair characterization of how you're thinking about things on a go forward basis?

[Thomas Joseph McInerney:]

I think, Suneet, that that's fair. We continue to evaluate and we'll continue to do that look at and will continue to do that, various options. But I do think that the large life and annuity transaction, for the reasons we talked about, I think we looked at that, looked at it hard, and decided in the end not to go forward with that. But we'll continue to work over time on reducing the debt in the range that we've talked about.

[Suneet L. Kamath:]

And is there a timeframe for that debt reduction? I can't remember if you gave us something in the past.

[Thomas Joseph McInerney:]

We said $1 billion to $2 billion over time. Again, it's a high priority to reduce the debt. We have other priorities. We've got to balance all of them, and so I think that we'll leave it at that.

[Suneet L. Kamath:]

Okay. And then last one, last one, just for Marty, on LTC earnings. If we think about the 2012 rate actions, I think it took a couple years to get the real earnings benefit from that. So now that you have most of that baked in the cake and you're going back for additional rounds of rate increases, why should LTC earnings improve dramatically as we get into 2016? I get they'll probably improve a little bit. But are we talking about a dramatic increase or more of a gradual grind higher?

[Martin P. Klein:]

I'd say it's a decent increase, assuming the business continues to perform as it has been, and as we would expect. There is a lot of variability in long-term care earnings, as I pointed out. But I think that a lot of the 2012 rate actions, if you think about it, they come in two pieces. One is the additional premium we get, and that's fairly steady and that will continue on. But then the other part of it is those benefit reductions – which I know you know this, but just for everybody else that's listening – with those benefit reductions there's an immediate reserve release in the current period. So when we're implementing the rate actions, there's a lot of additional earnings benefits to get to that reserve release component. And as the round of rate actions begins to get through the implementation period, those earnings benefits from reduced benefits and that reserve release begin to ebb away. We do have, though, a lot of rate actions that are in process, much of which that have been approved already, which is – most of which have been approved, actually – which will, I think, really begin to hit next year. So I think if the business performs like it does this year, and then also with these rate actions that we've got in the queue and much of which have been approved, we should be in decent shape. One thing I'd remind folks is that as is in our earnings slides, and I think as Tom noted, I guess this is on slide 12, we did just this quarter get 10 filings approved that impact premium of about $336 million. And the average rate increase on that is 37%. As you pointed out that the 2012 rate actions, it takes two to three years to get that in to earnings. But we are making steady progress. And I think what we're trying to point out is for this year, the rate actions are not going to be all that impactful, because the ones that we've largely got have already played through. But the ones that are in the queue, including many of which have already been approved, will really be helpful in 2015. So I wouldn't call it a dramatic increase, though. I'd call it a nice increase, if I had to give it an adjective.

[Suneet L. Kamath:]

All right. That's fine. Thanks.

[Operator:]

Ladies and gentlemen, we have time for one final question from Sean Dargan with Macquarie. Sean Dargan - Macquarie Capital (USA), Inc. Yeah. Thanks. I'm just wondering how you're thinking about returns on new MI business in 2016. On June 30, the PMIERs were amended and there was an added capital charge to be implemented in 2016 on lender placed mortgage insurance. You wrote a lot of that in the first quarter. I think the press release said that you wrote less of that in the second quarter. I'm just wondering if you could frame how much less of that and what you're thinking on writing that product is going forward, given that returns are probably mid-single digits?

[Rohit Gupta:]

Good morning, Sean. This is Rohit. So you're absolutely correct. We reduced our premium single concentration from first quarter to second quarter. As we have stated in the past, we try to manage the return and risk appetite for this product, because single – LPMI, let's start with that. Lender Paid Mortgage Insurance is primarily a single premium product. And under HOPA consideration, it is a non-cancellation policy unless the mortgage actually lapses. So we have seen increased duration of this product in the past in our own experience. And we think FHFA and GSE's multipliers in PMIERs' context that rolled out on June 30 are in alignment with that. As we think about our 2015 book returns, we have given guidance on mid- to low teen returns from a pricing perspective. And we have also stated that our books are performing, our new books since 2009, are performing better than those expectations. As far as 2016 book returns are concerned, we haven't given any guidance, at this point. And I think that will be in part driven by the mix of LPMI in the market at that place. As you're aware, the new factors do not go into effect until January 1, 2016. And LPMI is a refi-based product. As refinance volume has declined, we would expect LPMI volume to decline with that. So once we have a better idea on where the volume is trending, we will give some guidance in terms of what we expect LPMI mix to be, as well as what would that do to our 2016 return expectations. I would state that if you look historically, our business has been historically under participating in single premium and LPMI. And on portfolio basis, our concentrations are lower than the average concentration you see in the industry. Sean Dargan - Macquarie Capital (USA), Inc. Okay. Great. And if I could just ask one question about Australia. You announced a special dividend that was larger than what Macquarie was expecting. I'm just wondering what your thoughts are on capital deployment there and if you've given any thought to raising the common dividend, which would probably have a favorable impact on the share price, which would allow you to sell your ownership at a higher price later down the road?

[Jerome T. Upton:]

Yeah, Sean. Good morning. It's Jerome Upton. So with respect to the special dividend you highlighted, I think you probably saw that we did issue a Tier 2 subordinated note of roughly A$200 million and did buy back $90 million of the prior tranche that was coming due in 2016. So that gave us the ability to issue the special dividend and probably helped us surpass expectations in the market. On the ordinary dividend, I would say the board's comfortable with where we are currently. As with any ordinary dividend, we want to make sure that we're comfortable that we can continue to pay that ordinary dividend, and the board will evaluate whether any increases are prudent, given the overall environment and conditions that we have. We understand in that business that we have capital optimization opportunities, but they would start with looking at ways to grow organically and make sure that we feel like we're adequately covered organically. We've also got to take into consideration the mark-to-market. Because part of our prescribed capital amount and the large capital ratio you're seeing is driven by the mark-to-market on securities. And then we would look to other opportunities and ways to deploy capital at a return that is above our weighted average cost of capital. And then, if we can't use that capital productively, I can assure you the board there will continue to look for redeploying funds to shareholders, consistent with our overall objectives. Sean Dargan - Macquarie Capital (USA), Inc. Thank you.

[Operator:]

Ladies and gentlemen, I will now turn the call back over to Mr. McInerney for closing comments.

[Thomas Joseph McInerney:]

Thank you very much, Shelly. I would like to make just some brief closing comments. I want to thank all of the investors and analysts and other participants on the call today. We believe we are making progress on our outlined strategy to strengthen Genworth, simplify our businesses and increase financial flexibility. While we recognize that substantial challenges remain, we continue to invest in our strongest businesses and to manage each of our businesses to maximize returns while balancing capital needs. We very much appreciate the support of our investors and assure you that we're working very hard to justify that support. And now, let's end the call.

[Operator:]

Ladies and gentlemen, this concludes Genworth Financial's second quarter earnings conference call. Thank you for your participation. At this time, the call will end.