Genworth Financial, Inc.
Q2 2013 Earnings Call Transcript

Published: 31 Jul 2013

[Operator:]

Good morning, ladies and gentlemen, and welcome to Genworth Financial's Second Quarter 2013 Earnings Conference Call. My name is Allen, and I will be your coordinator today. [Operator Instructions] As a reminder, the 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 Second Quarter 2013 Earnings Call. Our press release and financial supplements were released last evening. And earlier this morning, our second quarter earnings summary presentation was posted to our website. We encourage you to review all 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, 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 note regarding the forward-looking statements in our earnings release and the risk factors of our most recent annual report on Form 10-K and Form 10-Q, 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 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. Thank you for joining us today for our Second Quarter Earnings Call. I would like to spend my time today briefly discussing second quarter results, outlining the significant actions we are taking to improve the U.S. Life Insurance Division's performance and providing an update on the progress we are making on our strategic objectives and goals. We are working hard on our 4 strategic priorities to improve shareholder value, and we are beginning to see some early progress. As a reminder, our 4 strategic priorities for 2013 are

[Martin P. Klein:]

Thank you, Tom. And good morning, everyone. Today, I'll provide an overview of results of the quarter, give an update on our 2013 goals and provide some perspectives on our use of reinsurance and captives. Let's begin with second quarter results. We reported operating income of $133 million for the quarter and net income of $141 million. Net income in the quarter included a $13 million after-tax charge related to our previously announced expense reduction plan, which ultimately should realize about $80 million to $90 million in annual pre-tax expense savings related to these actions. In Global Mortgage Insurance, reported net operating income was $102 million, flat to the prior quarter and up $51 million over the prior year. Let's cover Canada results first, where operating earnings were $43 million for the quarter. Unemployment in Canada was down slightly to approximately 7.1%, 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. Flow NIW in the quarter was up 45% sequentially from normal seasonal impacts. NIW is lower than a year ago given the changes last year in eligibility rules for government-guaranteed mortgages. We completed several bulk transactions in the quarter of approximately $6.4 billion. These transactions consist of low loan-to-value prime loans, and we participate selectively in this market. The loss ratio improved sequentially by 6 points to 25% and improved 7 points from the prior year from lower net new delinquencies as a result of an improving economic environment and the strong credit quality of recent books. For Australia, operating earnings were $55 million versus $46 million in the prior quarter. Unemployment in Australia rose slightly to 5.7%, and home prices rose were flat sequentially. Premiums are up from the prior year, as the larger 2012 book matures and more premium is recognized. The low-interest-rate environment drove the origination market up approximately 10% sequentially, with flow NIW up 13% from the prior quarter. The loss ratio for the quarter decreased to 35%, down 12 points sequentially. The year-to-date loss ratio is 41%, at the low end of our expected range of 40% to 50%. Overall delinquencies were down 1% from the prior quarter, driven primarily by seasonally higher cures. Regarding Other Countries in the international Mortgage Insurance segment, the operating loss was up sequentially to $9 million, primarily from higher losses. Moving to U.S. MI. The business had another profitable quarter, with net operating income of $13 million. We're 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. Our total flow delinquencies fell by 23% from the prior year, with new delinquencies down 11% sequentially and down 22% 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 37%. Turning to capital in the division. The MCT in Canada was approximately 216% compared to our minimum target of 190%. In addition to paying an ordinary dividend in the quarter, the business generated proceeds as related to its normal course issuer bid share repurchase program, in which Genworth Financial participated to maintain our ownership at 57.4%. For Australia, the prescribed capital amount or PCA was 134%, just under our target of 135% but above regulatory requirements. In the quarter, the business paid most of the planned full year dividend and had strong new business volumes, factors which impacted the ratio. We anticipate achieving our PCA target by year end. In U.S. MI, at quarter end, the combined risk-to-capital ratio was approximately 22.4

[Operator:]

[Operator Instructions] Our first question comes from Nigel Dally of Morgan Stanley.

[Nigel P. Dally:]

So my question is on Australia. We've seen significant weakness in commodity prices impacting the mining sector, potentially threatens the Australian economy. So first, have you seen any preliminary signs of this impacting your operations, like more pronounced move in early delinquencies in those regions more levered to the mining sector from, like, Western Australia? Second, any steps that you've taken to continue to mitigate that risk? And third, does it perhaps make sense to increase your PCA target? Just given that uncertainty.

[Kevin D. Schneider:]

Nigel, this is Kevin. In -- you're spot on in that China does have a fairly significant export portion of their GDP or -- excuse me, Australia does. China makes up about 30% of that -- of Australia's exports. And really, the 2 commodity-rich regions that we're very focused on in monitoring are Western Australia and, to a lesser extent, Queensland. In terms of performance there, Western Australia continues to perform very, very well. Our delinquencies are improving there. At Queensland, I would characterize as stable to improving. So both of those markets are holding up pretty well at this point. We have seen some reduction in capital expenditures related to infrastructure around mining, but overall, commodity prices are actually holding up and have stabilized there. Exports in terms of trade remained pretty solid. And in -- at this point, it really hasn't generated any impact on those regional areas that we've seen. We'd -- we'll continue to monitor those regions. We do have some, I would say, credit policy levers to pull if we see some deterioration there, and we're cautiously monitoring that going forward. All right, overall, the economy could be impact by the slowing in China, we're very cognizant of that. I think it's one of the reasons the RBA has moved, over time this year, to lower cash rates. And we think they have some more flexibility around that to do that. They're really focused on making sure some of the other sectors of the economy can recover and perhaps grow and offset some of the pressure related to commodities. And the Aussie dollar is also weak and which could help some of those other sectors recover, both specifically manufacturing and tourism, which could have an impact on Queensland. So I think the real pressure we're cautious of as we monitor China and the impact on Australia is, would further slowdown have some further impact on consumer confidence, and how that -- how might that play into performance in the marketplace. But overall, at this point, the -- our underlying delinquency development, performance development, is holding up pretty well. I think the next question, whether you stated or not, is what's the implication that might have to what's going on with the equity markets. And we think, so far, that they've held up pretty well and shouldn't have a material impact based upon what we've seen so far, based -- as we think about and evaluate the IPO going forward, although we will continue to monitor it because further deterioration could create some risks to the market. I guess the last question you had in there, if I remember the order, was something around our capital ratios, the PCA. It's a little bit lighter than what we had, off a point just marginally from what the target we set for the year. It's primarily driven by some strong production growth in the quarter, as well as the dividends that we got out of the business. We have paid most of the dividends that we expect for the year out of the operating company. And we would expect over time to that to get back within our targeted range.

[Operator:]

Our next question comes from Geoffrey Dunn of Dowling & Partners.

[Geoffrey M. Dunn:]

On the U.S. MI front, can you give a little bit more color around the loss provision this quarter? I guess, first, was there any favorable development in the prior year book, or first quarter? And then second, can you comment that to the incidence level at which you're providing for on new notices and how that compares to kind of precrisis levels? [Audio Gap]

[Kevin D. Schneider:]

Believe broadly that our reserves for our existing delinquencies going into this year are adequate and sufficient for future loss expectations. And really, I think, to get your point, future performance and loss experience is really going to be largely based, therefore, on delinquency development going forward. In this quarter, specifically to your question, our incurred losses were driven primarily by current-year new delinquencies. And we also -- but we did experience some modest favorability in the development on the prior-period delinquencies. So in terms of net cures and aging, we have some favorability there driven by workouts, self-cures and probably seasonality-supported. But I guess, to answer your last question, we have not made any changes to our frequency or roll rate factors based upon those new incurreds and we'll -- or those new delinquencies, and we're going to continue to watch emerging experience on that until we have a little more confidence in the trends. Overall, where we are currently at reserve, think of it in terms of sort of one -- in between sort of 1-in-4 and 1-in-5 type roll rate development. And historically, if you'll revert back to what this was sort of pre-crisis, I think of that as about 50% of the current levels we're at right now.

[Geoffrey M. Dunn:]

Okay, great. And then on Australia, obviously a very good loss ratio development this quarter. I'm guessing it's not a sustainable item and you probably see some of it revert back into the 40% to 50% range. But can you talk a little bit about what drove such a positive result this quarter? Is it really the impact of working through some of those Queensland built-up claims? Or is there anything else going on affecting the quarter?

[Kevin D. Schneider:]

Yes, we certainly have worked down dramatically our claims pipeline. It's really -- it's running at a pretty historically low level right now. So we've gotten that worked down. Overall, 35% is a strong loss ratio performance. I think we're going to be well within the 40% to 50%. We benefited some in the quarter, as we mentioned last quarter, from an expectation that resulted in pretty strong seasonal improvement in cures. So we had a -- we had strong cure performance. The 2000 to 2008 books, they're burning through, they're -- we're working through those. But yes, you should probably expect in the second quarter of the -- or the second half of the year to have a little bit more variability, a little more seasonal movement. But I still think we're going to be well within our expectation on the 40% to 50%.

[Operator:]

Our next question comes from Sean Dargan of Macquarie.

[Sean Dargan:]

I have one question about U.S. MI and one on LTC. The risks to capital ratio came in more favorably sequentially, but as new insurance written picks up, I suspect there will be some capital strain. And on -- and your competitors are talking again about an expectation of the risk-to-capital, one that moving to the neighborhood of 18

[Kevin D. Schneider:]

Yes, Sean. I -- first of all, what I said last quarter, and I don't think it's changed, is as a company, we remain committed to managing down our risk-to-capital, keeping it below the 25

[Sean Dargan:]

And then on long-term care, Marty mentioned if the -- I guess, the reserves held in the Bermuda captive were repatriated, the impact to RBC would been minimal. I was wondering if you can quantify what minimal means.

[Patrick B. Kelleher:]

This is Pat, I'll take that. The reinsurance treaty, as Marty indicated, is a funds withheld coinsurance treaty, so we basically are already funding 100% of the ceded reserves via the assets withheld and invested by the ceding company. We do hold a slightly lower Bermuda stat reserve. But ignoring that difference, if you just look at what I'll call the hard capital in Bermuda, that's equivalent to a 390% RBC level. And when we look at the impact of repatriating the business, let's say, back into the United States and putting it together with a business in the originating company, the impact on RBC ratio is expected to be in the neighborhood of 5 percentage points.

[Operator:]

Our next question comes from Joanne Smith of Scotia Capital.

[Joanne A. Smith:]

Should -- I have couple of questions on the level of profitability regarding the post-2008 U.S. MI book and how we should think about the development of that over time. And I understand that you've talked a lot about the returns being quite attractive on the stuff that you've written since the crisis. I'm just wondering about how we should look at the development of those earnings as we go through and we start to see more of that burn-through of the pre-2008 books.

[Kevin D. Schneider:]

Okay, I -- Joanne, this is Kevin. I -- for starters, what we've said in the past is, on a long-term pricing expectation, we think those books of business are priced to perform at a mid-teens type level. The actual experience we're seeing on that business, based upon what I would describe as very, very, very favorable loss development, is very much more closer to the high-teens to 20% type level. So going forward, we think it's very profitable business. As we -- when you think about how you should start to expect that to transition into our P&L in terms of impacting earnings going forward, I think it's -- you just think about this year, 2013, as a transition year for us. The older books of business have -- we're -- we've gotten to the point where, as of this quarter, 37% of our book is based upon business that was written after 2008. We told you we expect that to be sort of between 40% and 40% our overall portfolio by the -- excuse me, 40% and 45% of our overall portfolio by the end of 2013, and I think we're on track to be within that range. So that new business, layering on it those high return levels as delinquencies come down and our overall loss performance continues to improve, I think that's the turning point. And we're very optimistic about what that will mean for us in terms of 2014. The other thing we see is that our production levels have continued to improve. Our BP -- our NIW level in the U.S. MI business in the second quarter was up roughly 30% over the first quarter. It was up, I believe, 75%-ish over the same period in 2012. So we got bigger markets coming through, bigger books of business, highly profitable, with delinquencies declining. I think that's how you should think about what our -- the future looks like going forward.

[Joanne A. Smith:]

And Kevin, is there any regional concentration to the business that you've been writing over the past year or so?

[Kevin D. Schneider:]

I don't think anything that's outside of the traditional market. In fact, we're probably under-concentrated in some of the bigger origination markets compared to the overall origination levels.

[Joanne A. Smith:]

And have you seen any impacts on volumes given the rise in interest rates? That's my final question.

[Kevin D. Schneider:]

I think the biggest impact the interest rates are going to have, and it's a great question, is going to be on the refinanced market. And we have seen the refinance activity certainly start to trail off dramatically. The nice thing that is going on for the industry, though, at the same time is, as refinancers start to get pressured, we're also seeing some recovery in the purchase market. And our penetration in the purchase market is at a very high level in the second quarter. Our purchase penetration is over 16%, about 16.5%. That's very strong for this business. And so even though you might have a decline in overall originations driven by the reduction in the refinanced market, the pickup we're seeing in the purchase mix is driving us to higher markets and higher production levels.

[Operator:]

[Operator Instructions] Our next question comes from Suneet Kamath of UBS.

[Suneet L. Kamath:]

A couple of questions on long-term care. First, I guess, on past calls, you've indicated that the reserves are adequate, both on a GAAP and a stat basis, before the impact of the recent price increases that you filed for. I just want to make sure that that's still the case. And then in your prepared remarks, you talked about a long-term care review, the findings of which you'll show us, I guess, in the fourth quarter. Just wondering, what is this review? Is it incremental to what you guys have already been doing? Or is this just part and parcel with what you guys have been doing for a while now?

[Thomas Joseph McInerney:]

This is Tom. Let me take that one first, regarding reserves. We do believe that, on both a GAAP and a stat basis, the reserves are adequate, as we've said before. I think what I have said since I arrived in January is that we were taking a comprehensive look at all the businesses. We're particularly looking at long-term care, it's a challenging business. We've laid out our strategy, but we're looking at all aspects of that. And as I have been out with Marty Klein and others, there's a lot of interest from analysts and investors on long-term care. It's a very challenging business to understand. And so we do expect late in the fourth quarter, after reviewing the business, laying out for all of you in a comprehensive way of the details of the business, in a way where you can have a much better understanding of how the business works, how the reserves works, how do we do the testing and what the business looks like. So our projection on the timing would be sometime late in the fourth quarter.

[Suneet L. Kamath:]

Okay. I guess, based on what you just said, though, and considering kind of how the stock trades, it seems to me that you're implying that we should not be expecting that one the conclusions of this review is a statutory or a GAAP charge. Is that an incorrect assessment?

[Thomas Joseph McInerney:]

Well, I would say there is a -- we believe the GAAP and the stat reserves are adequate.

[Martin P. Klein:]

And Suneet, it's Marty. I would just add, as we've said before, and again if you think about the factors that have gone in the marketplace then business is really, obviously -- very little has changed over the last few months, except perhaps you might say interest rates are higher than where they were a quarter or 2 ago, so it's obviously a positive development. The reserves, as we have been computing them, are adequate, we think, with margin for further deterioration. You did ask the question, I think, earlier, which I don't think we talked about yet, are the rate actions embedded in those calculations or not? The -- we do have margins that are very sufficient without including those rate actions. We did, this past year, at the end of December when we were doing our cash flow testing for statutory purposes as well as for GAAP, did reflect our assumptions, with perhaps a little bit of a haircut for what we might get in the rate actions. But even if you exclude that impact, we think the margins are adequate. And again, those are assumptions that we'll provide more detail on later on in the year.

[Suneet L. Kamath:]

Okay. And then, I guess, just a question about long-term care in terms of the quarter. There are some moving pieces, I guess, with the change in the methodology you guys were using around the interest, interest rate and tabular interest. Just wondering, if we sort of strip that stuff out and we just look at the incidents on the claims, sort of underlying -- underwriting trends of the business, have you noticed any changes one way or the other in terms of how the block is performing, again, away from the accounting adjustments that you made?

[Patrick B. Kelleher:]

This is Pat, Suneet. I'll take that. The tabular interest change actually didn't impact the net operating income at all. It really just resulted in a reclassification of how we're looking at the cost of claims, for purposes of calculating the loss ratio. So the loss ratio, with a more precise calculation of tabular interest, declined about 3 percentage points. We think that's a better measure, so we've restated all the prior periods to reflect that. If we look at the quarter, and especially compared to prior quarter, the overall claims results were pretty consistent. We did see -- if you look at trends, we've had the pre-tax operating income fluctuating for a period of time between 5% and 10% of premiums. We've seen the loss ratio fluctuating over the last 6 quarters between, I guess, about 64% or 65% and 73%, with an average kind of in the middle of that on a restated basis. The only thing I'd point out in the current quarter is we did start to see a little bit of lift relating to the recent rate action, which we pointed out in the earnings release. And I think that's probably the most important comments to mention.

[Suneet L. Kamath:]

Got it. And then just one quick one for Kevin. I think, in response to Sean's question, you had indicated that you're pricing your U.S. MI business assuming a -- already assuming a lower risk-to-capital ratio, but then you also kind of said that you're not even sure what the new guidelines might be. So just what are you assuming? Are you assuming that 18

[Kevin D. Schneider:]

I would say we would do it at a stronger capital level than the 18

[Operator:]

Our question comes from Craig Perry of Panning.

[Craig Perry:]

Pat and -- I guess it's really a question for Pat, Marty and Tom. Could you guys just quickly -- I know we're going to -- you're going to provide additional clarification in Q4, but could you just help me understand? It was a little unclear to me. Is the new set of rate increases on the 2003 block of -- and onward block of business in the LTC, is that a incremental set of premium increases above the $200 million to $300 million that you've outlined? And then separately, could you just remind us how we're supposed to think about those increases coming and flowing through into earnings over time? And then lastly, could you remind us sort of what the internal IRR hurdle is for new business that you're writing in long-term care today? I think, in prior conversations, or at least in prior earnings calls, you'd spoken about sort of a mid- to the high-teens type return on new product underwritten to today's standards. So would you mind just kind of clarifying all three those? And I know -- again, appreciate you guys taking the time to provide additional color for this business in Q4.

[Thomas Joseph McInerney:]

Craig, it's Tom. Let me take the first cut of that, and then I'll ask Pat or Marty to add in. First, we had, starting late last year, filed for rate actions on about $1.1 billion of blocks, 4 blocks. 3 of them were in blocks that were written prior to 2001; and 1 in 2001 and 2007, and that's the $200 million to $300 million when fully implemented in 5 years, and as we said, through June 30 we have received approvals from regulators for $115 million to $120 million, between in that range, on that block. In addition to that, there's another around $600 million to $700 million of premiums. Those are blocks that have been written post 2003. And those -- looking at those, they're still profitable. However, while lapse rates of the assumptions were lower than on the old blocks, we still believe that there needs to be some modest increases. So we are incrementally beginning to look at that, analyzing that, and we've concluded that we want to file moderate increases in the second half of the year on those. So that is a second set of blocks of policies written since, say, 2003, so incremental to and separate from the other increase. In terms of how we're pricing the business today on new business, on a new product, the new Flex 2 that we launched, we're looking for mid -- we believe, mid-teen returns is the cost of capital. And we're pricing and we expect receiving better than that mid-teen level.

[Craig Perry:]

Great. And I'm sorry, just in terms of you said moderate increases in the 2003 block. Is the moderate $50 million to $100 million, is that the right way to think about it? I just don't know what the...

[Thomas Joseph McInerney:]

It would be in the 10% to 15% range, on the payments. And again, that is not something that we would all have to get in 1 year.

[Craig Perry:]

Yes. I totally understand. And then -- but I'm sorry, and then -- I didn't quite get quite clarification on the timing of the $200 million to $300 million. How does that get booked into earnings to -- get booked into your earnings stream over time?

[Thomas Joseph McInerney:]

All right. So as we've said, when we receive the approval from the rating -- from the regulators, we'll then notify the client 30 days prior to the anniversary date. They have some options to take the increase or not. We've told you that about 80% are taking the increase. That is -- that increase is effective on the anniversary date. So that will roll in over time. In some cases, the regulators have approved the increase at one-time. In many cases, it is spread out over 3 years, sometimes 5. And so that will roll in over that period of time. So the $200 million to $300 million that we've talked about is, when fully implemented, factoring in all of the rate increases, including where they've been spread. In the second quarter after tax, about $8 million after tax have been the benefit of those rate increases, and that comes both from the increased premium as well as for those policyholders who have taken lower benefits that does have an impact on the reserves.

[Craig Perry:]

Got it. Okay, so it wouldn't be unrealistic to think that, sort of 2-ish years from now, you would be closer to sort of 10%-plus kind of ROE target for the long-term care business based on the combination of new business written and assuming those rate actions actually take hold.

[Thomas Joseph McInerney:]

Certainly, we'd expect to see, as those roll in, the ROEs on the business continue to improve.

[Operator:]

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

[Thomas Joseph McInerney:]

Thank you for your time and questions today. As we move forward in the second half of 2013, we're going to continue to focus on the actions and execution of our key strategic objectives needed to turn around the company. We will also continue to work on improving our products and our relationships with our customers and distributors. And we look forward to seeing and talking to you all again to update you next quarter. Thank you very much.

[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.