Genworth Financial, Inc.
Q1 2013 Earnings Call Transcript

Published: 1 May 2013

[Operator:]

Good morning, ladies and gentlemen, and welcome to the Genworth Financial's First Quarter 2013 Earnings Conference Call. My name is Shannon, and I will be your coordinator today. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. [Operator Instructions] I would now like to turn the presentation over to Georgette Nicholas, Senior Vice President of Investor Relations. Ms. Nicholas, you may proceed.

[Georgette Nicholas:]

Thank you, operator, and good morning, everyone. Thank you for joining us for Genworth's First Quarter 2013 Earnings Call. Our press release and financial supplements were released last evening. Earlier this morning, our first quarter earnings summary presentation was posted to our website. We encourage you to review all these materials. Today, our speakers will be our President and Chief Executive Officer, Tom McInerney; followed by Marty Klein, our Executive Vice President and Chief Financial Officer. Following our prepared comments, we will open the call up for a question-and-answer period. In addition to our speakers, Pat Kelleher, President and CEO of our U.S. Life Insurance Division; Kevin Schneider, President and CEO of our Global Mortgage Insurance Division; Jerome Upton, Chief Financial Officer of our Global Mortgage 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 notes regarding the forward-looking statements in our earnings release, and the risk factors of our most recent annual report on Form 10-K 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 supplements, earnings release and investor materials, non-GAAP measures have been reconciled to GAAP were 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. And now I'll turn the call over to our CEO, Tom McInerney.

[Thomas Joseph McInerney:]

Thanks, Georgette, and good morning, everyone. Overall, I'm pleased with the progress in our results in the first quarter of 2013. Operating income increased to $151 million, representing a significant improvement from last year's first quarter and the fourth quarter 2012, excluding the favorable adjustment from the new Canadian government guarantee framework last quarter and the Australia reserve strengthening and life block transaction impacts from last year. We made headway on several of our strategic priorities, including improving operating performance in our businesses, driven by the continued recovery of U.S. Mortgage Insurance and some improvements in our U.S. Life Insurance Division. Our focus continues on our strategic objectives to improve business performance, simplify the portfolio, generate capital and increase the financial strength and flexibility of the company. Our priority remains to rebuild shareholder value. This morning, I want to focus, first, on steps we are taking to improve business performance, which is where I've been spending most of my time; second, comment on progress made on other strategic objectives; and third, offer a few additional comments regarding Genworth's first quarter results. I will then turn it over to Marty to review first quarter results in more detail. So I'll begin with where I'm spending most of my time, improving business performance. As we move forward, we are working to offer valuable products and services that help consumers plan for their financial security. We must balance demand for products through strong distribution relationships, with the objective of earning an appropriate return over the required cost of capital for shareholders. A prime example of where we are working to obtain this balance is in our approach to managing a long-term care insurance business. I've been meeting with a number of insurance commissioners and state representatives to discuss a rate increase actions and approach. We also recently issued our study on the cost of care for long-term care. From these discussions, it is clear that long-term care is a social and economic issue that will impact consumers and states as the population continues to age. Federal and state budgets are already strained by obligations under entitlement programs. In many states, long-term care absorbs a substantial portion of Medicaid budgets currently, and this is before the bulk of the 76 million baby boomers retire. We believe there is important role for private insurance in helping consumers plan for their long-term care needs and an opportunity for Genworth to be part of the solution given our market position. Our approach is to, first, stabilize the in-force portfolio through rate actions and then introduce new products attractive to both consumers and shareholders. Given the poor experience on certain older blocks, the significant price increases requested are necessary to bring them closer to a break-even point and reduce the strain on earnings and capital. Some of the newer blocks or policies issued on forms introduced since 2004 may need price increases at some point in the future given the current level of interest rates, low lapses, rising long-term care cost and historical mortality and morbidity experience seen on long-term care. These newer blocks will be proactively managed, and our approach going forward will be to closely track emerging experience and, as warranted, file for smaller rate increases sooner and more frequently. We believe filing for smaller rate increases more frequently is a better approach for consumers, regulators and shareholders, and we want to work with state insurance regulators to discuss options to achieve this result. We are also working hard to obtain approvals to introduce new long-term care insurance products that are more tightly underwritten and use more conservative assumptions and benefits, including shorter benefit periods, smaller daily benefit options and fewer writers We will seek to balance the commercial and risk considerations as we move forward through this process, but we are prepared to take actions, such as suspending sales in states and adding new sales through distribution channels where we cannot offer products within an acceptable risk-adjusted return. Our announcement to temporarily suspend sales in California and our announcement today to end sales through our AARP relationship are examples of this approach. Throughout last year and continuing into 2013, we are introducing new product offerings and pricing changes throughout the U.S. Life Insurance Division. These changes have caused sales to decline significantly overall with long-term care transitioning as expected, but Life declining more than anticipated. In Life Insurance, we increased prices and introduced a new term product and made changes to our universal life products in the fourth quarter of last year. Given some of the market changes on pricing, we have been less competitive on certain products. We are reevaluating the term product and pricing to be more competitive in the market, but still maintain acceptable risk-adjusted returns. We expect to introduce a new index universal life product in the second quarter that will be less capital intensive and have a better return profile. In long-term care insurance, we introduce our new product, Privileged Choice Flex 2 on April 15, which incorporates underwriting changes, such as blood and lab work and gender-based pricing. We also anticipate reentering California in the third quarter of this year given the approval of the Privileged Choice Flex product. We do anticipate long-term care insurance sales to increase in the second quarter, ahead of the new product implementations. As we continue the transition this year to new product offerings, we would expect to see sales rebound and the sales may shift over time towards Life from long-term care insurance. These new products and the decisions we are making in distribution are examples of bringing a better discipline to the products we want to sell and the returns we want to achieve. Over time, along with our in-force actions, we are seeking a steady improvement in the operating performance of our U.S. Life Insurance Division. I focus my time today on long-term care insurance because we know shareholders and others are concerned about the business. But we are bringing this same return on risk discipline to all our products and businesses. The recent price increase we're implementing in our Australia Mortgage Insurance business is another good example of this discipline. Let me now turn to the progress made on other strategic objectives. We continue to make progress in simplifying the business portfolio, generating capital and increasing the financial strength and flexibility of the company. First, on March 27, we announced an agreement to sell the wealth management business, including Genworth Financial Wealth Management, and alternative solutions provider, the Altegris companies, to a partnership of Aquiline Capital Partners and Genstar Capital. The sale price is expected to be approximately $412.5 million, with an after-tax loss of approximately $27 million related to the sale recognized in the first quarter, offset by approximately $7 million of income. We anticipate an additional loss of up to $10 million to be recorded upon closing. The sale is expected to close in the second half of 2013, subject to customer closing conditions, including required regulatory approvals. Second, the company announced that the comprehensive U.S. Mortgage Insurance capital plan received all necessary approvals and was fully implemented on April 1, 2013. The capital plan announced in January consisted of several actions, including transferring ownership of the European mortgage insurance subsidiaries to Genworth Mortgage Insurance Corporation, or GMICO, on January 31 of this year. On April 1, we implemented an internal legal entity reorganization, which created a new public holding company structure that removes the U.S. Mortgage Insurance subsidiaries from the companies covered by the indenture governing Genworth's senior notes. Also as part of this plan, $100 million of capital was contributed to GMICO on April 1. After the contribution, GMICO's risk to capital is expected to be approximately 23

[Martin P. Klein:]

Thanks, Tom, and good morning, everyone. Today I'll provide an overview of results for the quarter, update you on the holding company and provide some perspectives on 2013 earnings expectations. Let's begin with first quarter results. We reported operating income of $151 million for the quarter and net income of $103 million. The prior quarter included a $78 million favorable adjustment from the finalization of a new government guarantee framework in Canada. Excluding the favorable adjustment in the prior quarter, operating income increased 84% this quarter. In Global Mortgage Insurance reported net operating income was $102 million compared to income of $55 million in the prior quarter after excluding the favorable adjustment in Canada. Let's cover Canada results first, where operating earnings were $42 million for the quarter. Unemployment in Canada rose slightly to approximately 7.2%, and there was modest sequential increase in home prices. Premiums were down slightly from the maturing of the larger 2007 and 2008 books of business. Changes put into effect in July of last year to eligibility rules for government guarantee mortgages reduced the size of the high loan-to-value mortgage insurance market and, along with normal seasonal impact, drove our flow NIW in the quarter down 25% sequentially. We did complete several bulk transactions in the quarter of approximately $2.4 billion. We participate selectively in this market, and these transactions consist of low loan-to-value prime loans. The loss ratio was flat sequentially at 31% and improved 7 points from the prior year from lower new delinquencies, net of cures, and continued improvement in Alberta. For Australia, operating earnings were $46 million versus $62 million in the prior quarter, which included a favorable tax impact. Unemployment in Australia rose slightly to 5.6%, and home prices rose approximately 3% sequentially. Premiums are up from the prior year, as the larger 2012 book matures and more premium is recognized. The origination market was down 15% sequentially from normal seasonal variation, with flow NIW down 18%. The loss ratio for the quarter increased to 47%, which is up 11 points sequentially, but still within the targeted range of 40% to 50%. Overall delinquencies were flat to the prior quarter, with seasonally higher new delinquencies and lower cures. A partial sale of our Australia MI platform remains a key priority, and we want to execute a transaction when it makes the most sense for shareholders. Of course, execution of the IPO is subject to market valuation and regulatory considerations, and we did not expect it to occur until the fourth quarter this year or later. We will provide updates on our IPO plans during the year. Regarding other countries in the International Mortgage Insurance segment, the operating loss was down sequentially to $7 million driven by lower new delinquencies, primarily in Ireland. Moving to U.S. MI, we achieved an important milestone, as the business had a profitable quarter with net operating income of $21 million. During the quarter, we made a change to the way we account for premium refunds when a delinquent loan goes to claim. We have restated the financial information in our earnings reports to correct this error for all periods presented. The cumulative decrease to retained earnings was $46 million as of January 1, 2012, and the impact to GMICO's statutory capital position in the first quarter 2013 was a reduction of about $55 million or an increase of 2 points to its risk of capital. We are seeing strong NIW growth over the prior year from an increase in both refinance and purchase private MI penetration, a larger origination market and stable market share. Total losses were down $96 million from the fourth quarter from lower new delinquencies, seasonally better cures and favorable changes in aging. Our total flow delinquencies fell by 22% from the prior year, with new delinquencies down 12% sequentially and down 18% year-over-year, reflecting the continued burn through of the 2005 to 2008 books, as well as the new, better performing books becoming a larger portion of our overall portfolio, now at 34%. Turning to capital in the division, Canada and Australia remain sound. The MCT in Canada was approximately 216% compared to our minimum target of 190%. The business paid its ordinary dividend in the quarter, and we are pleased that the Canadian Board authorized a share repurchase through a normal-course issuer bid. Genworth Financial will participate in this normal-course issuer bid, ultimately benefiting holding company cash and will keep our overall ownership percentage at its current level. In Australia, the prescribed capital amount, or PCA, was 144%, in line with our target of 135% or greater. A new set of capital standards went into effect in January 1 of this year that had a minimal impact on our capital position in the first quarter. Also during the quarter, the business terminated AUD 100 million of affiliate reinsurance. In U.S. MI, at quarter end, the combined risk to capital ratio was approximately 24.2

[Operator:]

[Operator Instructions] Our first question is from Sean Dargan of Macquarie.

[Sean Dargan:]

I have a question for Kevin regarding the outlook for U.S. MI. Just when I look at the results this quarter, I understand there's some favorable seasonality in the first quarter. But when I look at the results that some of your MI competitors have put up and their outlook for the year, I see reserves in Florida, which I know will be a trouble spot this year, it seems to me that, perhaps, the outlook is a bit cautious?

[Kevin D. Schneider:]

Yes, Sean. Obviously, we are quite pleased with our results in the first quarter, we're encouraged by the direction that we're seeing and what's going on with our business performance. As you said, we do benefit from seasonality in the first quarter, in particular -- and you really in the first half of the year, but in particular, in the first quarter. And we just think the environment has enough uncertainty that remains in it. There's still sort of a sluggish job growth and that really hasn't taken off, even though home prices are generally trending up, which is a very positive for us. We just think at this point in time, our best course is to remain cautious, and we'll certainly update you as we progress through the year, as we continue to observe our development. And we'll be back at the next quarter with -- to see if we need to revise or change that outlook going forward.

[Sean Dargan:]

Okay. And I have a follow-up. I think it was said that the target risk to capital level in U.S. MI would be 25

[Kevin D. Schneider:]

Yes. Great question. Tom observed in his comments that we're committed to managing down our risk-to-capital level below the 25

[Operator:]

Our next question is from Steven Schwartz of Raymond James & Associates.

[Steven D. Schwartz:]

A couple of number of questions, if I could. First, on long-term care and the actuarial assumption changes. Maybe, Marty, you can go through how that affected the revenue line and the expense line. I think it changed both.

[Patrick B. Kelleher:]

This is Pat. I'll take that question. Okay, so the first quarter adjustments favorably impacted reserves a net of $20 million on an after-tax basis, and there was an unfavorable impact and reduction to premium -- reported premium revenue of $14 million after tax, and that's the net of $6 million.

[Steven D. Schwartz:]

And that's the net of what, Pat?

[Patrick B. Kelleher:]

Of $6 million.

[Steven D. Schwartz:]

Okay. All right. And then looking at Page 8 of the presentation and -- at the bottom, am I, looking at these percentage numbers for Life Insurance? Is that A to E? Is that what those numbers are? The 96%, 97%, 93%, 80%, 88%?

[Patrick B. Kelleher:]

Yes, those are actual to expected ratios for term mortality, where the expected is pricing.

[Steven D. Schwartz:]

Okay. And then going back to U.S. MI, I'm wondering about maybe a -- an update on anything regulatory going on.

[Kevin D. Schneider:]

Yes, Steve, I don't think there's any real breaking news on anything from a regulatory standpoint. We continue to actively participate and watch what might happen as it relates to any changes regarding the FHA. The government certainly watching that closely and trying to protect the taxpayers, so there's certainly an opportunity for some changes in terms of the regulatory framework around FHA. The QRM standard has still not come out and been published and finalized, so that remains something that we watch and are actively involved in, particularly as it relates to the potential for some down payment requirements to be QRM-qualified. I think based upon sort of where I see that heading right now, it's more likely the QRM is -- could end up being broadly defined similar to QM. I mean, we think that's a reasonable outcome for us. I mean, and the last thing really is sort of, or 2 additional things. One is just where does Basel end up, particularly for portfolio holders of mortgages where they have mortgage insurance on them. There remains some discussion around whether those folks will get credit for the credit enhancement provided by the mortgage insurance, but that's still up in the air. And then, we got a busy regulatory agenda. The final thing is just where do we stand on GSE reform. And there's a lot of dialogue underway on that. I just don't see any big changes coming in calendar '13.

[Operator:]

Our next question is from Joanne Smith of Scotia Capital.

[Joanne A. Smith:]

Yes. I just had a quick numbers question, then a broader question. I was wondering what is the private mortgage insurance market share numbers currently? And then just secondarily, I was just wondering if you could talk a little bit about additional asset sales going forward. You've announced the wealth management and the home equity portfolio. I'm just wondering if there are other kind of non-core assets that you're thinking about maybe disposing of?

[Kevin D. Schneider:]

Yes. Joanne, I'll start off on the market share question as it relates to private mortgage insurance. Our penetration as an industry in the first quarter was around 8% in aggregate, and that includes both the refi and the purchase penetration levels. The most interesting percentage, I think, is really the growth in our purchase penetration. As you know, we have a much higher -- out of every 100 loans, we got a lot more MI loans from the purchase side than we do on the refi side, and that's been held steady over 16% for both Q4 and for Q1. So we're really back to sort of -- certainly back to pre-crisis levels, and actually back to sort of pre-early 2000s-type levels. So we're getting back into a range where we have a nice purchase penetration outcome, and now we're just waiting for that purchase market to really start to come through. And I think home prices have -- and the combination of both the home prices where they are and interest rate environment right now makes it very attractive for people to get back into the purchase market. If we had a little bit more, I think, improvement and what's going on from the job creation side, we think there's a lot of buyers that will come back into the market even as rates may trend up a little higher. So about 16%, refi is about 5%, total 8% on the quarter.

[Joanne A. Smith:]

And just a quick follow-up before we move on to the other questions. It seems to me that there's some regional strengths in the housing market where there might be weaknesses that continue in other regions. Can you just talk a little bit about where you're seeing the strengths and weaknesses in the market currently?

[Kevin D. Schneider:]

Yes. As you probably read yourself, a lot of the markets that had been seeing the most significant stress are really starting to see some strong comeback in terms of their home price numbers. So you have good home price appreciation going on, out on the West Coast, even due in Florida to some extent much more -- not recovering quite as strongly because of the drawn out for closure environment down there. Phoenix and Nevada are even improving. So all the places that suffered the biggest declines are seeing some strong growth. We do continue to see some weakness in the Northeast, in particular in New York and in New Jersey area, just not quite as strong, and so we're monitoring that closely. But overall, across the board, we think we've got a firm bottom and things are headed in the right direction.

[Thomas Joseph McInerney:]

Joanne, this is Tom. I'll take your question on sales and other strategic priorities. First, as you know, the Australia IPO is still a priority for us. But keep in mind that our 2013 cash and capital plans didn't include it, so we're not under pressure from an overall capital cash position to do anything. We have said a few times before that we think that our timing for the IPO will be later this year in the fourth quarter, maybe even to next year. And there's 2 reasons for that. First, while we're pleased with the results of the last 4 quarters in Australia, we do expect continued good performance. And so, therefore, we think that helps the value over time. And second, we haven't seen a lot of IPO activity in Australia, and so we'd like to see over the next few months a little bit more evidence of a good IPO market. So we're really watching those 2 things quite a bit and we'll have more to say on that later in the year. The other business that's non-core is LPI, and we did -- we have looked and continue to look at 3 options, run it off now, sell it now, we're positioning it for sale in the future. And when we've done our work on that, we think from a shareholder value perspective of the 3 scenarios, the best is to position the business for sale in the future, which -- and what do we mean by that next 2 to 3 years. And I'll make a few additional points about LPI. It is still profitable despite very tough markets in Europe. We believe management's doing a good job given the challenges they face. They're focused on reducing the footprint in Europe, and we've said that we want to reduce the number of strategic distribution partners by half, which we think will strengthen the business. We're also reducing expenses in line with the reduction in sales. We are selectively expanding in the market outside of Europe, and we're tightly managing the capital and still expect to see LPI pay dividends as planned to the holding company. So in looking at all that, we're still convinced that the best strategy for shareholder value is to wait, hopefully see some improvements in Europe and time for the other platforms to develop for value later on. Obviously, we'll keep you updated as the year progresses. And then finally, on the variable annuity business, they're having a few transactions that have happened from a value perspective. We don't think the value yet is there to do anything, so we'll continue to look, but nothing eminent there.

[Operator:]

[Operator Instructions] Our next question is from Mark Palmer of BTIG.

[Mark Palmer:]

Just a quick question for Marty in following up on the Australian IPO discussion. On the last conference call, the fourth quarter call, I believe you made a remark about how there had been some signs of improvement in the Australian capital markets, such that a fourth quarter IPO could potentially be more feasible. Just want to get a sense of if you're seeing those same signs now, or if there's been any change since that comment?

[Martin P. Klein:]

Yes, Mark. I would say that we really haven't seen any change. I think the markets, equity markets over there are generally, in the public markets, working okay. But one thing that really hasn't happened, as Tom just mentioned, is there really -- continuously really not being any significant IPO activity. We do see, as we did maybe a few months ago, perhaps a pipeline that's building, but nothing's really come to market yet so we want to watch that pretty closely.

[Operator:]

And our next question is from Ed Shields of Sandler O'Neill.

[Edward Shields:]

I think I've got a question for Marty here. With the proposed NAIC model changes for RMBS and CMBS, can you just comment on anticipated impacts this may have on your RMBS, CMBS or the RBC ratio, either in whole dollar amounts or RBC points?

[Martin P. Klein:]

Sure. Let me actually turn that over to Dan Sheehan, our CIO, who's been tracking that pretty closely.

[Daniel J. Sheehan:]

Yes, thanks. A couple of things. Most importantly, I just want to note that, that proposal is still in the comment period. As recently as yesterday, there were discussions around potential implementation and there's certainly a number of questions that still need to be answered. So at this point, I think it's preliminary, and we'll follow it closely to make sure that as we move closer to implementation, we are aware of the changes and the impact on the portfolio. I think there are sort of 2 real changes that are being discussed. One is to broaden the inclusion to be all cash flows and not just principal-based. The second is to change to a risk-free discount rate versus the coupon rate. I think both of those are potentially negative for capital at the CUSIP level on a case-by-case basis. I think one positive coming out of the discussion, though, is that there is a lot of talk about finalizing assumptions much earlier in the year, which is a positive for the industry. At this point, our expectation is that we would manage any impact from this change within our existing capital plan. I say that for a number of reasons. First off, we have not been an active buyer of this legacy positions, which have benefited from the recent capital changes. Secondly, our legacy portfolios have continued to decline, and that decline is actually accelerated in the last few quarters. And so we believe that we have a manageable book and you've seen that come through in a steady improvement in the level of impairments over the last few quarters. And then finally, there's also another proposal on the table to change the risk-based capital rules for commercial mortgages. And that was actually approved at the Capital Adequacy Task Force yesterday, and so it's actually ahead in the process and more likely to be implemented in 2013. That proposal is actually going to change the model to be based on a combination of loan-to-value and debt service coverage ratios, and to model more closely the way bonds are modeled from a capital basis. Based on the overall quality of our portfolio and the historical strong performance, we would expect that change to be positive. And so I would say the net effect if both of these changes go into effect this year would probably neutral to slightly positive.

[Operator:]

Our next question is from Conor Ryan of Saba Capital. [

[Kevin D. Schneider:]

Conor, we haven't really -- this is Kevin, in the U.S., we haven't really provided any expectation on '14, '15. I would think of it as an origination market that should be growing from the points we're at this year, where what we've provided for this year is we think we'll be in the 15% to 20% range. I think we'll probably be in the middle upper end of that range. Think about it then as we talked about earlier in response to Joanne's question of about a 16% purchase penetration market going forward. I think that gives us an opportunity for some expansion in our NIW going forward, and a little bit of share progression potentially. So I think growing marginally over time in the '14 and '15 back into some more traditional and sustainable levels of NIW delivery. [

[Kevin D. Schneider:]

With respect to the reserves, I would say that, as Marty indicated, we completed our year-end regulatory cash flow testing, and across the U.S. Life companies, the reserves were adequate. And with sufficient margin, inclusive of provisions for adverse deviation that we provide for in that testing, we also completed and continue to regularly monitor our GAAP long-term care reserve adequacy testing. And the results, again, of our most recent testing indicate the aggregate reserves are adequate with sufficient margin under current assumptions and expectations. In addition, in the third quarter of last year, we updated fairly comprehensively our assumptions around our long-term care claim reserves and thorough -- did a thorough review of claims history. Since implementing those changes in third quarter, our merging experience is indicating our claim reserve levels just slightly more than needed than aggregate, which is appropriate given that their claims -- best estimate claim reserves and relatively short duration. With respect to the performance of the long-term care business, I would say that we -- as Tom indicated, we got a lot of work to do, our progress to date on the re-rating of the older blocks is in line with our expectations. But there's a lot more work to be done there, as well as repositioning the new business portfolio from a risk and profitability perspective. We've take a series of actions, and you can expect more on that front. So more work to do, but good progress to date, I think. [

[Thomas Joseph McInerney:]

Conor, let me just give you a little bit of a perspective on my view on long-term care. Certainly, we think the improvements we're making there are very important from a shareholder value perspective. I want to make it clear that I think it will be a challenge to turn the long-term care business around. There are 3 key priorities from our perspective. The first you know about, and we're along -- well along the path, which is large in-force rate increases on the older books, which given a lot of issues and low interest rates lapses, things that you've heard about, we need significant increases on to bring those back to a breakeven. And that's real hands-on work. It requires us to meet with each of the 50 state regulators. I'm personally involved, as is Pat and others. And so there's progress to be made, but that's an ongoing challenge for us. I also said in my prepared remarks that on the newer products, and let's roughly define those as products issued on forms since 2004. Right now, those products are profitable. But just given that rates are lower now than they were, they may require some rate increases going forward. And so the second part of our strategy is on the newer products to continue to proactively manage them, look at the results and experience and be prepared to go sooner and perhaps more frequently to regulators to the extent we think that's necessary. And then finally, I think the team -- Pat's team have done a good job on new products. We just launched a new product on April 15, which we call Flex 2 , which has a significant number of improvements from an underwriting perspective, reducing benefits. And we hope that, that will be a very successful product. We'll see. It's been launched in 31 states. We'll continue to look at those products going forward. So I would say on long-term care, we're making progress, but there's a lot to do going forward. And coming back to the question on shareholder value, we have 4 priorities. I think among the most important priorities from improving shareholder value is to improve the operating income and ROEs of all the businesses, U.S. MI getting that to sustain profitability and fix these legacy issues we're talking about on long-term care and other businesses. And I think that is very important to do. As we make progress on the operating income, we'll look at other options from a shareholder perspective and returning capital, and Marty may have a few comments on the capital and cash plans as they are today. [

[Thomas Joseph McInerney:]

Look, as I said, I think we -- if you look at our ROEs today and our operating performance, it's not where we want it to be and we want to continue to improve it. We, of course, continue to look at options to unlock shareholder value, and some of those are on the transactions we've done. We're also -- there's the Australia IPO and other actions that we'll take over time. And clearly, we do understand the need to run the businesses well, manage capital tightly, focus on selling products above the cost of capital and returning capital to shareholders when we can, we need to continue though to make improvements and improve our financial flexibility, I think, before I would be comfortable with doing a lot there. Marty, I'll let you add your point of view.

[Martin P. Klein:]

Yes, and I would just add that getting more stability in our operating company dividends is important. And as I think you know, the Life company for the first time this year and a number of years is now -- has the ability to return an ordinary dividend. But it's early days. We want to watch that closely. We feel like early in the year, we're in pretty good stead on that, but we've kind to have to watch that as a place through the year. We also had pointed out while our ratings outlook with Moody's stabilized, we still have a negative outlook, as Tom mentioned in his remarks, with S&P at BBB-, so -- with a negative outlook, and so we really feel like we want to continue to get increased financial flexibility and hopefully clear that up. Yes, I would say that I think that the holding company cash targets of 2x debt service is an absolute minimum threshold for us, and this $350 million target buffer we have in excess of that is to make sure that we're always able to have a 2x debt service. And as we get some more stability and certainty in our dividend flows, as we take care of some of their nearer-term debt, for example, the 2014 bonds, we're going to dedicate the wealth management proceeds toward that, but we haven't closed the wealth management transaction yet so, we need to do that. Then also, if we're able to get credit lines in place at some point and get some form of contingent liquidity, those will all be considerations as we might think about revising the buffer, but we have to get through some of those things first before we do that. [

[Thomas Joseph McInerney:]

Yes, I think that's very fair, and we'll look at -- when we get there, and we're working hard to get there on all the options that we'd have to return capital to shareholders, including dividends and share repurchases. And, obviously, an important event to go this year is the Australia IPO, which we hope to do later in the year.

[Operator:]

Our next question is from Craig Perry of Panning Capital. [

[Thomas Joseph McInerney:]

Craig, it's interesting. When I came to Genworth in January, I don't think I got that question. [

[Thomas Joseph McInerney:]

Yes. I don't think I did receive that. But with the actions that some others have done in the industry, and I think particularly this quarter with the profit for U.S. MI, that question is starting to appear. But let me say where I am on that. First, we're focused on continuing to improve the business performance in U.S. MI. Once U.S. MI is consistently profitable and the 2005 and 2008 books are no longer an issue, we will look at evaluating various options for U.S. MI. But I think it's premature now to be looking at or talking about those options. [

[Kevin D. Schneider:]

And I would -- we will think about that. And I would just add that, that we're very focused on -- for thinking about IPOs, the Australian IPOs, as Tom mentioned, so we'd look to see if we can do that in the fourth quarter. It may come later, but we want to focus on that. And we think actually, as you compare the 2, that would have a better return profile for shareholders at this point in time, versus the U.S. MI IPO

[Operator:]

Our next question is from Jimmy Bhullar of JPMorgan.

[Jamminder S. Bhullar:]

I just had a question on the MI business. So it did pretty well this quarter, and it's gotten even better if you take out the charge. So I was a little surprised that you didn't your guidance for profitability for the year. I think you're expecting a profit in 1 to 2 quarters and a modest profit for the year. So just wondering how you expect MI margins to trend. I recognize there's a little bit of seasonality in the first half versus second half, but is there some built-in conservatism in your numbers, or was there something this quarter that you saw that might not repeat in the next few quarters?

[Kevin D. Schneider:]

Jimmy, this is Kevin. As I responded to Sean's first question this morning, there's nothing new we're seeing, at this point in time, that would either cause me to guide you up or down from the guidance that we've provided at the beginning of the year. Our news continue to come down. We have seen the seasonality that you see in the first half. You've got to recognize that, that means you don't always have it in the second half. And so you can have some upward pressure on your cures and things in the second half of the year. We do expect, as the economy continues to mend and heal, the second half could have some economic improvement that could be favorable to you. And as I've referenced before, we have a -- the benefit of some interest dividends that run through our investment line that we get in the first quarter and the third quarter a year, so there's a little bit of a timing issue on that, that was favorable in the first quarter. But other than that, we just think, at this point in time, we're going to remain cautious, it's still an uncertain environment and just as soon as we are prepared to update you either direction, probably next quarter call, we'll be back to provide you that progress, and our views at that point in time.

[Operator:]

Our next question is from Joanne Smith of Scotia Capital.

[Joanne A. Smith:]

I just wanted to go back to your comments about the long-term care rate increases. And I think the comment was that, on the older book, the rate increases are enough to get you to breakeven or slightly above. And that the strategy, going forward, is that you would like to go back to regulators for smaller rate increases more frequently. And I'm just wondering, how those conversations are going to go with regulators once you're at a like a premium deficiency mode in that book. Is it going to become more difficult to get those more frequent rate increases?

[Patrick B. Kelleher:]

This is Pat, Joanne. I'll take that question. When we make the reference to smaller and more frequent rate increases, we're looking really at the policies issued on forms introduced since 2004, which are different groups of policies from those older blocks where we're looking for the rate increases to get back to, say, a breakeven or modestly better than that. And the approach -- the rationale for the approach there is that we need to stay on top of the emerging experience and we've learned from the old books of business that acting early and preemptively with smaller increases is more manageable for policyholders. We think it's something that's more doable and approvable from a regulatory perspective because of the implications of large increases. And also from the point of view of the company and shareholders in terms of managing to a target pricing result, as we -- if we're reacting quickly to emerging circumstances and making the adjustments it really lowers the overall risk profile of the book. And we think that learning from the lessons of the past as we look at the newer books and business, that's the right way to approach it.

[Thomas Joseph McInerney:]

And Joanne, it's Tom. I just want to reference back to my earlier prepared remarks because I think the language I used was a little bit different than what you said. What we think is the significant price increases that we're requesting, bring the older business closer to a break-even point, and it also helps to reduce the strain on earnings and capital.

[Operator:]

Ladies and gentlemen, we have time for one final question from Jordan Hymowitz of Philadelphia Financial.

[Jordan Hymowitz:]

You have a big AOCI gain on the bonds. Can any of those bonds be sold and that gain locked in at this point? I know a number of them are attached to longer-term contracts. I guess, what portion of that approximately $7 in book value could be locked in today and replaced with lower yielding bonds, if you wanted?

[Patrick B. Kelleher:]

Okay. This is Pat. Thank you for asking that question. Our accumulated other comprehensive income is comprised, of course, of the unrealized gains on the bond portfolio. But it's also comprised of realized and unrealized gains on our hedging portfolio. And if you think about, I'll say, outside the long-term care business and Life Insurance and annuities where we have a lot of investments, we've really matched cash flows assets to liabilities. So while some of those bonds are in a gain position, we actually need the aggregate of the cash flows to match future claims and expenses and provide for future profits on the book. But I will point out that with respect to the long-term care portfolio where we've used derivatives, hedging strategies to extend the maturities of our assets, the accumulated other comprehensive income includes, on a pretax basis, about $2.8 billion of realized and unrealized gains, which effectively, our gains which in a low interest rate environment, would be available to offset and to provide funding for claims and expenses on our long-term care book. And that is something that I think distinguishes Genworth from a number of the other long-term care carriers in terms of how we've provided for protecting the downside, associated with lower interest rates. And perhaps, why some of our reserve adequacy calculations are producing different results.

[Jordan Hymowitz:]

So $2.8 billion of the -- I think it's $3.7 billion, if I remember correctly, could hypothetically be realized and replaced with other at-market rate bonds, so to speak, and actually lock in those gains?

[Patrick B. Kelleher:]

I wouldn't put it that way. I would -- first of all, in accumulated other comprehensive income, it's an after-tax number. So it will be more like $1.7 billion there. But effectively, that includes the benefit of the $2.8 billion in realized and unrealized accretion of the value of those hedging positions. And that value will ultimately release through net investment income as a revenue to fund future claims and expenses.

[Operator:]

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

[Thomas Joseph McInerney:]

Thank you, Shannon, and thanks to all of you for your time and questions today. Just to sum up the quarter, I'd say that further execution on key strategic objectives moves us further along the path to a successful turnaround in the company. The focus remains on accomplishing the 2013 goals that we laid out in February, and we're on track to do so. We feel the company has products customers need, leadership positions in core businesses, strong distribution relationships, and we have an experienced team of hard-working employees and all of us have a strong commitment to execute Genworth strategy and deliver better performance for shareholders.

[Operator:]

Ladies and gentlemen, this concludes the Genworth Financial's First Quarter Earnings Conference Call. Thank you for your participation. At this time, the call will end.