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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2009

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                     to                    

Commission file number 001-32195

 

 

LOGO

GENWORTH FINANCIAL, INC.

(Exact Name of Registrant as Specified in its Charter)

 

 

 

Delaware   33-1073076

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification Number)

6620 West Broad Street

Richmond, Virginia

  23230
(Address of Principal Executive Offices)   (Zip Code)

(804) 281-6000

(Registrant’s Telephone Number, Including Area Code)

 

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large Accelerated Filer  x

   Accelerated Filer  ¨

Non-accelerated Filer  ¨

   Smaller reporting company  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

At October 27, 2009, 488,552,584 shares of Class A Common Stock, par value $0.001 per share, were outstanding.

 

 

 


Table of Contents

TABLE OF CONTENTS

 

     Page

PART I—FINANCIAL INFORMATION

   3

Item 1. Financial Statements

   3

Condensed Consolidated Statements of Income for the three and nine months ended September  30, 2009 and 2008 (Unaudited)

   3

Condensed Consolidated Balance Sheets as of September 30, 2009 (Unaudited) and December 31, 2008

   4

Condensed Consolidated Statements of Changes in Stockholders’ Equity for the nine months ended September 30, 2009 and 2008 (Unaudited)

   5

Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2009 and  2008 (Unaudited)

   7

Notes to Condensed Consolidated Financial Statements (Unaudited)

   8

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

   46

Item 3. Quantitative and Qualitative Disclosures About Market Risk

   123

Item 4. Controls and Procedures

   123

PART II—OTHER INFORMATION

   124

Item 1. Legal Proceedings

   124

Item 1A. Risk Factors

   125

Item 6. Exhibits

   126

Signatures

   127

 

2


Table of Contents

PART I—FINANCIAL INFORMATION

 

Item 1.    Financial Statements

GENWORTH FINANCIAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Amounts in millions, except per share amounts)

(Unaudited)

 

     Three months ended
September 30,
    Nine months ended
September 30,
 
         2009             2008             2009             2008      

Revenues:

        

Premiums

   $ 1,492      $ 1,735      $ 4,496      $ 5,161   

Net investment income

     759        918        2,251        2,873   

Net investment gains (losses)

     (122     (816     (945     (1,560

Insurance and investment product fees and other

     262        331        806        845   
                                

Total revenues

     2,391        2,168        6,608        7,319   
                                

Benefits and expenses:

        

Benefits and other changes in policy reserves

     1,450        1,497        4,450        4,284   

Interest credited

     225        319        763        984   

Acquisition and operating expenses, net of deferrals

     484        515        1,381        1,594   

Amortization of deferred acquisition costs and intangibles

     143        208        602        620   

Interest expense

     96        125        306        347   
                                

Total benefits and expenses

     2,398        2,664        7,502        7,829   
                                

Loss before income taxes

     (7     (496     (894     (510

Benefit for income taxes

     (52     (238     (420     (259
                                

Net income (loss)

     45        (258     (474     (251

Less: net income attributable to noncontrolling interests

     26        —          26        —     
                                

Net income (loss) available to Genworth Financial, Inc.’s common stockholders

   $ 19      $ (258   $ (500   $ (251
                                

Net income (loss) available to Genworth Financial, Inc.’s common stockholders per common share:

        

Basic

   $ 0.04      $ (0.60   $ (1.14   $ (0.58
                                

Diluted

   $ 0.04      $ (0.60   $ (1.14   $ (0.58
                                

Weighted-average common shares outstanding:

        

Basic

     448.9        433.1        438.5        433.2   
                                

Diluted

     451.6        433.1        438.5        433.2   
                                

Supplemental disclosures:

        

Total other-than-temporary impairments

   $ (285   $ (577   $ (1,358   $ (1,316

Portion of other-than-temporary impairments included in other comprehensive income (loss)

     89        —          413        —     
                                

Net other-than-temporary impairments

     (196     (577     (945     (1,316

Other investment gains (losses)

     74        (239     —          (244
                                

Total net investment gains (losses)

   $ (122   $ (816   $ (945   $ (1,560
                                

See Notes to Condensed Consolidated Financial Statements

 

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Table of Contents

GENWORTH FINANCIAL, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Amounts in millions, except per share amounts)

 

    September 30,
2009
    December 31,
2008
 
    (Unaudited)        

Assets

   

Investments:

   

Fixed maturity securities available-for-sale, at fair value

  $ 47,746      $ 42,871   

Equity securities available-for-sale, at fair value

    164        234   

Commercial mortgage loans

    7,704        8,262   

Policy loans

    1,408        1,834   

Other invested assets

    4,949        7,411   
               

Total investments

    61,971        60,612   

Cash and cash equivalents

    7,144        7,328   

Accrued investment income

    717        736   

Deferred acquisition costs

    7,414        7,786   

Intangible assets

    961        1,147   

Goodwill

    1,324        1,316   

Reinsurance recoverable

    17,308        17,212   

Other assets

    1,141        1,000   

Deferred tax asset

    140        1,037   

Separate account assets

    10,712        9,215   
               

Total assets

  $ 108,832      $ 107,389   
               

Liabilities and stockholders’ equity

   

Liabilities:

   

Future policy benefits

  $ 29,251      $ 28,533   

Policyholder account balances

    29,381        34,702   

Liability for policy and contract claims

    6,415        5,322   

Unearned premiums

    4,808        4,734   

Other liabilities

    6,708        6,860   

Non-recourse funding obligations

    3,443        3,455   

Short-term borrowings

    930        1,133   

Long-term borrowings

    3,457        4,261   

Deferred tax liability

    282        248   

Separate account liabilities

    10,712        9,215   
               

Total liabilities

    95,387        98,463   
               

Commitments and contingencies

   

Stockholders’ equity:

   

Class A common stock, $0.001 par value; 1.5 billion shares authorized; 577 million and 522 million shares issued as of September 30, 2009 and December 31, 2008, respectively; 489 million and 433 million shares outstanding as of September 30, 2009 and December 31, 2008, respectively

    1        1   

Additional paid-in capital

    12,028        11,477   
               

Accumulated other comprehensive income (loss):

   

Net unrealized investment gains (losses):

   

Net unrealized gains (losses) on securities not other-than-temporarily impaired

    (1,121     (4,038

Net unrealized gains (losses) on other-than-temporarily impaired securities

    (280     —     
               

Net unrealized investment gains (losses)

    (1,401     (4,038
               

Derivatives qualifying as hedges

    1,013        1,161   

Foreign currency translation and other adjustments

    411        (185
               

Total accumulated other comprehensive income (loss)

    23        (3,062

Retained earnings

    3,065        3,210   

Treasury stock, at cost (88 million shares as of September 30, 2009 and December 31, 2008)

    (2,700     (2,700
               

Total Genworth Financial, Inc.’s stockholders’ equity

    12,417        8,926   

Noncontrolling interests

    1,028        —     
               

Total stockholders’ equity

    13,445        8,926   
               

Total liabilities and stockholders’ equity

  $ 108,832      $ 107,389   
               

See Notes to Condensed Consolidated Financial Statements

 

4


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GENWORTH FINANCIAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

(Amounts in millions)

(Unaudited)

 

    Common
stock
  Additional
paid-in
capital
  Accumulated other
comprehensive
income (loss)
    Retained
earnings
    Treasury
stock, at
cost
    Total
stockholders’
equity
 

Balances as of December 31, 2007

  $ 1   $ 11,461   $ 727      $ 3,913      $ (2,624   $ 13,478   
                 

Comprehensive income (loss):

           

Net income (loss)

    —       —       —          (251     —          (251

Net unrealized gains (losses) on securities not other-than-temporarily impaired

    —       —       (2,437     —          —          (2,437

Derivatives qualifying as hedges

    —       —       288        —          —          288   

Foreign currency translation and other adjustments

    —       —       (397     —          —          (397
                 

Total comprehensive income (loss)

              (2,797

Acquisition of treasury stock

    —       —       —          —          (76     (76

Dividends to stockholders

    —       —       —          (130     —          (130

Stock-based compensation expense and exercises and other

    —       23     —          —          —          23   
                                           

Balances as of September 30, 2008

  $ 1   $ 11,484   $ (1,819   $ 3,532      $ (2,700   $ 10,498   
                                           

 

5


Table of Contents
    Common
stock
  Additional
paid-in
capital
    Accumulated other
comprehensive
income (loss)
    Retained
earnings
    Treasury
stock, at
cost
    Total
Genworth
Financial,
Inc.’s
stockholders’
equity
    Noncontrolling
interests
  Total
stockholders’
equity
 

Balances as of December 31, 2008

  $ 1   $ 11,477      $ (3,062   $ 3,210      $ (2,700   $ 8,926      $ —     $ 8,926   
                     

Cumulative effect of change in accounting, net of taxes and other adjustments

    —       —          (349     355        —          6        —       6   

Initial sale of subsidiary shares to noncontrolling interests

    —       (85 )     (60     —          —          (145     828     683   

Additional sale of subsidiary shares to noncontrolling interests

    —       (3 )     (12     —          —          (15     99     84   

Issuance of common stock

    —       622        —          —          —          622        —       622   

Comprehensive income (loss):

               

Net income (loss)

    —       —          —          (500     —          (500     26     (474

Net unrealized gains (losses) on securities not other-than-temporarily impaired

    —       —          3,027        —          —          3,027        19     3,046   

Net unrealized gains (losses) on other-than-temporarily impaired securities

    —       —          (19     —          —          (19     —       (19

Derivatives qualifying as hedges

    —       —          (148     —          —          (148     —       (148

Foreign currency translation and other adjustments

    —       —          646        —          —          646        56     702   
                     

Total comprehensive income (loss)

                  3,107   

Stock-based compensation expense and exercises and other

    —       17        —          —          —          17        —       17   
                                                           

Balances as of September 30, 2009

  $ 1   $ 12,028      $ 23      $ 3,065      $ (2,700   $ 12,417      $ 1,028   $ 13,445   
                                                           

See Notes to Condensed Consolidated Financial Statements

 

6


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GENWORTH FINANCIAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Amounts in millions)

(Unaudited)

 

     Nine months ended
September 30,
 
     2009     2008  

Cash flows from operating activities:

    

Net income (loss)

   $ (474   $ (251

Adjustments to reconcile net income (loss) to net cash from operating activities:

    

Amortization of fixed maturity discounts and premiums

     103        24  

Net investment losses (gains)

     945        1,560   

Charges assessed to policyholders

     (332     (304

Acquisition costs deferred

     (540     (945

Amortization of deferred acquisition costs and intangibles

     602        620   

Deferred income taxes

     (634     (253

Net increase (decrease) in trading securities, held-for-sale investments and derivative instruments

     (4     238   

Gain on sale of subsidiary

     (4     —     

Stock-based compensation expense

     17        18   

Change in certain assets and liabilities:

    

Accrued investment income and other assets

     (135     (40

Insurance reserves

     2,153        1,771   

Current tax liabilities

     55        (151

Other liabilities and other policy-related balances

     102        906   
                

Net cash from operating activities

     1,854        3,193   
                

Cash flows from investing activities:

    

Proceeds from maturities and repayments of investments:

    

Fixed maturity securities

     3,157        3,489   

Commercial mortgage loans

     519        646   

Proceeds from sales of investments:

    

Fixed maturity and equity securities

     3,343        3,298   

Purchases and originations of investments:

    

Fixed maturity and equity securities

     (5,091     (6,574

Commercial mortgage loans

     —          (193

Other invested assets, net

     122        (304

Policy loans, net

     426        (171

Net cash transferred related to the sale of a subsidiary

     (90     —     

Payments for businesses purchased, net of cash acquired

     —          (20 )
                

Net cash from investing activities

     2,386        171   
                

Cash flows from financing activities:

    

Deposits to universal life and investment contracts

     1,801        6,307   

Withdrawals from universal life and investment contracts

     (6,669     (7,869

Short-term borrowings and other, net

     (363     72   

Repayment and repurchase of long-term borrowings

     (809     —     

Redemption of non-recourse funding obligations

     (12     —     

Proceeds from the issuance of long-term debt

     —          597   

Proceeds from issuance of common stock

     622        —     

Proceeds from the sale of subsidiary shares to noncontrolling interests

     771        —     

Dividends paid to stockholders

     —          (130

Stock-based compensation awards exercised

     —          5   

Acquisition of treasury stock

     —          (76
                

Net cash from financing activities

     (4,659     (1,094

Effect of exchange rate changes on cash and cash equivalents

     235        (259
                

Net change in cash and cash equivalents

     (184     2,011   

Cash and cash equivalents at beginning of period

     7,328        3,091   
                

Cash and cash equivalents at end of period

   $ 7,144      $ 5,102   
                

See Notes to Condensed Consolidated Financial Statements

 

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Table of Contents

GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(1) Formation of Genworth and Basis of Presentation

Genworth Financial, Inc. (“Genworth”) was incorporated in Delaware on October 23, 2003. The accompanying condensed financial statements include on a consolidated basis the accounts of Genworth and our affiliate companies in which we hold a majority voting or economic interest, which we refer to as the “Company,” “we,” “us” or “our” unless the context otherwise requires. All intercompany accounts and transactions have been eliminated in consolidation.

We have the following three operating segments:

 

   

Retirement and Protection. We offer and manage a variety of protection, wealth management, retirement income and institutional products. Our primary protection products include: life, long-term care and Medicare supplement insurance. Additionally, we offer wellness and care coordination services for our long-term care policyholders. Our wealth management and retirement income products include: a variety of managed account programs, financial planning services and mutual funds, fixed and variable deferred and immediate individual annuities and group variable annuities offered through retirement plans. Most of our variable annuities include a guaranteed minimum death benefit (“GMDB”). Some of our group and individual variable annuity products include guaranteed minimum benefit features such as guaranteed minimum withdrawal benefits (“GMWB”) and certain types of guaranteed annuitization benefits. Institutional products include: funding agreements, funding agreements backing notes (“FABNs”) and guaranteed investment contracts (“GICs”).

 

   

International. We are a leading provider of mortgage insurance products in Canada, Australia, New Zealand, Mexico and multiple European countries. Our products predominately insure prime-based, individually underwritten residential mortgage loans, also known as flow mortgage insurance. On a limited basis, we also provide mortgage insurance on a structured, or bulk, basis that aids in the sale of mortgages to the capital markets and helps lenders manage capital and risk. Additionally, we offer services, analytical tools and technology that enable lenders to operate efficiently and manage risk. We also offer payment protection coverages in multiple European countries, Canada and Mexico. Our lifestyle protection insurance products help consumers meet specified payment obligations should they become unable to pay due to accident, illness, involuntary unemployment, disability or death.

 

   

U.S. Mortgage Insurance. In the U.S., we offer mortgage insurance products predominantly insuring prime-based, individually underwritten residential mortgage loans, also known as flow mortgage insurance. We selectively provide mortgage insurance on a structured, or bulk, basis with essentially all of our bulk writings prime-based. Additionally, we offer services, analytical tools and technology that enable lenders to operate efficiently and manage risk.

We also have Corporate and Other activities which include debt financing expenses that are incurred at our holding company level, unallocated corporate income and expenses, eliminations of inter-segment transactions and the results of non-core businesses that are managed outside of our operating segments.

The accompanying condensed consolidated financial statements are unaudited and have been prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”) and rules and regulations of the U.S. Securities and Exchange Commission (“SEC”). Preparing financial statements in conformity with U.S. GAAP requires us to make estimates and assumptions that affect reported amounts and related disclosures. Actual results could differ from those estimates. Certain prior year amounts have been reclassified to conform to the current year presentation. These condensed consolidated financial statements include all adjustments considered necessary by management to present a fair statement of the financial position, results of operations

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

and cash flows for the periods presented. The results reported in these condensed consolidated financial statements should not be regarded as necessarily indicative of results that may be expected for the entire year. The condensed consolidated financial statements included herein should be read in conjunction with the audited consolidated financial statements and related notes contained in our 2008 Annual Report on Form 10-K. Any material subsequent events have been considered for disclosure through the filing date of this Quarterly Report on Form 10-Q.

(2) Accounting Pronouncements

Recently Adopted

The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles

On July 1, 2009, we adopted new accounting guidance related to the codification of accounting standards and the hierarchy of U.S. GAAP established by the Financial Accounting Standards Board (the “FASB”)This accounting guidance established two levels of U.S. GAAP, authoritative and nonauthoritative. The FASB Accounting Standards Codification (the “Codification”) is the source of authoritative, nongovernmental U.S. GAAP, except for rules and interpretive releases of the SEC, which are also sources of authoritative U.S. GAAP for SEC registrants. All other accounting literature is nonauthoritative. The adoption of this new accounting guidance did not have a material impact on our consolidated financial statements.

Subsequent Events

On June 30, 2009, we adopted new accounting guidance related to accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. This accounting guidance required the disclosure of the date through which an entity has evaluated subsequent events and the basis for that date. The adoption of this new accounting guidance did not have a material impact on our consolidated financial statements.

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

Recognition and Presentation of Other-Than-Temporary Impairments

On April 1, 2009, we adopted new accounting guidance related to the recognition and presentation of other-than-temporary impairments. This accounting guidance amended the other-than-temporary impairment guidance for debt securities and modified the presentation and disclosure requirements for other-than-temporary impairment disclosures for debt and equity securities. This accounting guidance also amended the requirement for management to positively assert the ability and intent to hold a debt security to recovery to determine whether an other-than-temporary impairment exists and replaced this provision with the assertion that we do not intend to sell or it is not more likely than not that we will be required to sell a security prior to recovery. Additionally, this accounting guidance modified the presentation of other-than-temporary impairments for certain debt securities to only present the impairment loss in net income (loss) that represents the credit loss associated with the other-than-temporary impairment with the remaining impairment loss being presented in other comprehensive income (loss) (“OCI”). On April 1, 2009, we recorded a net cumulative effect adjustment of $355 million to retained earnings with an offset to accumulated other comprehensive income (loss) of $349 million related to the adoption of this new accounting guidance. The following summarizes the components for the cumulative effect adjustment:

 

(Amounts in millions)

   Accumulated other
comprehensive
income (loss)
    Retained earnings     Total stockholders’
equity
 

Investment securities

   $ (588   $ 588      $ —     

Adjustment to deferred acquisition costs

     33        (26     7   

Adjustment to present value of future profits

     9        (7     2   

Adjustment to sales inducements

     5        (5     —     

Adjustment to certain benefit reserves

     —          1        1   

Provision for income taxes

     192        (196     (4
                        

Net cumulative effect adjustment

   $ (349   $ 355      $ 6   
                        

Interim Disclosures About Fair Value of Financial Instruments

On April 1, 2009, we adopted new accounting guidance related to interim disclosures about fair value of financial instruments. This accounting guidance amended the fair value disclosure requirements for certain financial instruments to require disclosures during interim reporting periods of publicly traded entities in addition to requiring them in annual financial statements. The adoption of this new accounting guidance did not have a material impact on our consolidated financial statements.

Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly

On April 1, 2009, we adopted new accounting guidance related to determining fair value when the volume and level of activity for the asset or liability have significantly decreased and identifying transactions that are not orderly. This accounting guidance provided additional guidance for determining fair value when the volume or level of activity for an asset or liability has significantly decreased and identified circumstances that indicate a transaction is not orderly. The adoption of this new accounting guidance did not have a material impact on our consolidated financial statements.

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

Fair Value Measurements of Certain Nonfinancial Assets and Liabilities

On January 1, 2009, we adopted new accounting guidance related to fair value measurements of certain nonfinancial assets and liabilities, such as impairment testing of goodwill and indefinite-lived intangible assets. The adoption of this new accounting guidance did not have a material impact on our consolidated financial statements.

Disclosures About Derivative Instruments and Hedging Activities

On January 1, 2009, we adopted new accounting guidance related to disclosures about derivative instruments and hedging activities. This statement required enhanced disclosures about an entity’s derivative and hedging activities. The adoption of this new accounting guidance did not have a material impact on our consolidated financial statements.

Business Combinations

On January 1, 2009, we adopted new accounting guidance related to business combinations. This accounting guidance established principles and requirements for how an acquirer recognizes and measures certain items in a business combination, as well as disclosures about the nature and financial effects of a business combination. The adoption of this new accounting guidance did not have a material impact on our consolidated financial statements.

Noncontrolling Interest in Consolidated Financial Statements

On January 1, 2009, we adopted new accounting guidance related to noncontrolling interests in consolidated financial statements. This accounting guidance established accounting and reporting standards for noncontrolling interests in a subsidiary and for deconsolidation of a subsidiary. The adoption of this new accounting guidance did not have a material impact on our consolidated financial statements.

Not Yet Adopted

In September 2009, the FASB issued new accounting guidance related to fair value measurements and disclosures that will provide guidance on the fair value measurement in certain entities that calculate net asset value per share. This accounting guidance will be effective for us on October 1, 2009. We do not expect the adoption of this new accounting guidance to have a material impact on our consolidated financial statements.

In August 2009, the FASB issued new accounting guidance related to measuring liabilities at fair valueThis accounting guidance clarifies techniques for measuring the fair value of liabilities when quoted market prices for the identical liability are not available. This accounting guidance will be effective for us on October 1, 2009. We do not expect the adoption of this new accounting guidance to have a material impact on our consolidated financial statements.

In June 2009, the FASB issued new accounting guidance related to accounting for transfers of financial assets. This accounting guidance amends the current guidance on transfers of financial assets by eliminating the qualifying special-purpose entity concept, providing certain conditions that must be met to qualify for sale accounting, changing the amount of gain or loss recognized on certain transfers and requiring additional disclosures. This accounting guidance will be effective for us on January 1, 2010. We have not yet determined the impact this accounting guidance, once adopted, will have on our consolidated financial statements.

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

In June 2009, the FASB issued new accounting guidance that provides guidance for determining which enterprise, if any, has a controlling financial interest in a variable interest entity and requires additional disclosures about involvement in variable interest entities. This accounting guidance will be effective for us on January 1, 2010. We have not yet determined the impact this accounting guidance, once adopted, will have on our consolidated financial statements.

(3) Earnings (Loss) Per Share

Basic and diluted earnings (loss) per share are calculated by dividing each income category presented below by the weighted-average basic and diluted shares outstanding for the periods indicated:

 

     Three months ended
September 30,
    Nine months ended
September 30,
 

(Amounts in millions, except per share amounts)

       2009            2008 (2)             2009 (1)             2008 (2)      

Net income (loss)

   $ 45    $ (258   $ (474   $ (251

Less: net income attributable to noncontrolling interests

     26      —          26        —     
                               

Net income (loss) available to Genworth Financial, Inc.’s common stockholders

   $ 19    $ (258   $ (500   $ (251
                               

Net income (loss) available to Genworth Financial, Inc.’s common stockholders per common share:

         

Basic

   $ 0.04    $ (0.60   $ (1.14   $ (0.58
                               

Diluted

   $ 0.04    $ (0.60   $ (1.14   $ (0.58
                               

Weighted-average shares used in basic earnings (loss) per common share calculations

     448.9      433.1        438.5        433.2   

Potentially dilutive securities:

         

Stock options, restricted stock units and stock appreciation rights

     2.7      —          —          —     
                               

Weighted-average shares used in diluted earnings (loss) per common share calculations

     451.6      433.1        438.5        433.2   
                               

 

(1)

Under applicable accounting guidance, companies in a loss position are required to use basic weighted-average common shares outstanding in the calculation of diluted loss per share. Therefore, as a result of our net loss for the nine months ended September 30, 2009, the inclusion of 1.3 million of shares for stock options, restricted stock units and stock appreciation rights would have been antidilutive to the calculation. If we had not incurred a net loss for the nine months ended September 30, 2009, dilutive potential common shares would have been 439.8 million.

(2)

We were required under applicable accounting guidance to use basic weighted-average common shares outstanding in the calculation of the 2008 diluted loss per share as a result of our net loss for the three and nine months ended September 30, 2008. For the three and nine months ended September 30, 2008, the inclusion of 0.7 million and 1.3 million, respectively, of shares for stock options, restricted stock units and stock appreciation rights would have been antidilutive to the calculation. If we had not incurred a net loss for the three and nine months ended September 30, 2008, dilutive potential common shares would have been 433.8 million for the three months ended September 30, 2008 and 434.5 million for the nine months ended September 30, 2008.

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

In July 2009, we made an offer to eligible employees to exchange eligible stock options and stock appreciation rights (the “Eligible Options and SARs”) for a reduced number of stock options and stock appreciation rights (collectively, the “Replacement Awards”). Pursuant to the exchange offer, Eligible Options and SARs representing the right to acquire an aggregate of 8,721,962 shares of our Class A Common Stock were tendered and accepted by us in August 2009. On August 19, 2009, 1,455 employees participated in the exchange and we granted the Replacement Awards, consisting of an aggregate of 2,598,588 new stock options and 308,210 new stock appreciation rights, in exchange for the Eligible Options and SARs surrendered in the exchange offer. The exercise (or base) price of the Replacement Awards was $7.80, which was the closing price of our Class A Common Stock on August 19, 2009, as reported on the New York Stock Exchange. The Replacement Awards have the same term (or expiration date) as the Eligible Options and SARs for which they were exchanged, and will vest and become exercisable, subject to continued employment, over a three- or four-year period. Generally, unvested Replacement Awards will be forfeited if an eligible employee’s employment terminates for any reason other than retirement, business disposition, death, disability or layoff (in which cases a portion or all may become vested in accordance with the 2004 Genworth Financial, Inc. Omnibus Incentive Plan, as amended). There was no additional incremental compensation expense resulting from the exchange.

(4) Investments

Other-Than-Temporary Impairments On Available-For-Sale Securities

As of each balance sheet date, we evaluate securities in an unrealized loss position for other-than-temporary impairments. For debt securities, we consider all available information relevant to the collectability of the security, including information about past events, current conditions, and reasonable and supportable forecasts, when developing the estimate of cash flows expected to be collected. More specifically for mortgage-backed and asset-backed securities, we also utilize performance indicators of the underlying assets including default or delinquency rates, loan to collateral value ratios, third-party credit enhancements, current levels of subordination, vintage and other relevant characteristics of the security or underlying assets to develop our estimate of cash flows. Estimating the cash flows expected to be collected is a quantitative and qualitative process that incorporates information received from third-party sources along with certain internal assumptions and judgments regarding the future performance of the underlying collateral. Where possible, this data is benchmarked against third-party sources.

Prior to adoption of new accounting guidance related to the recognition and presentation of other-than-temporary impairments on April 1, 2009, we generally recognized an other-than-temporary impairment on debt securities in an unrealized loss position when we did not expect full recovery of value or did not have the intent and ability to hold such securities until they had fully recovered their amortized cost. The recognition of other-than-temporary impairments prior to April 1, 2009 represented the entire difference between the amortized cost and fair value with this difference being recorded in net income (loss) as an adjustment to the amortized cost of the security.

Beginning on April 1, 2009, we recognize other-than-temporary impairments on debt securities in an unrealized loss position when one of the following circumstances exists:

 

   

we do not expect full recovery of our amortized cost based on the estimate of cash flows expected to be collected,

 

   

we intend to sell a security or

 

   

it is more likely than not that we will be required to sell a security prior to recovery.

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

For other-than-temporary impairments recognized during the period, we present the total other-than-temporary impairments, the portion of other-than-temporary impairments included in OCI and the net other-than-temporary impairments as supplemental disclosure presented on the face of our consolidated statements of income.

Total other-than-temporary impairments are calculated as the difference between the amortized cost and fair value that emerged in the current period. For other-than-temporarily impaired securities where we do not intend to sell the security and it is not more likely than not that we will be required to sell the security prior to recovery, total other-than-temporary impairments are adjusted by the portion of other-than-temporary impairments recognized in OCI (“non-credit”). Net other-than-temporary impairments recorded in net income (loss) represent the credit loss on the other-than-temporarily impaired securities with the offset recognized as an adjustment to the amortized cost to determine the new amortized cost basis of the securities.

For securities that were deemed to be other-than-temporarily impaired and a non-credit loss was recorded in OCI, the amount recorded as an unrealized gain (loss) represents the difference between the current fair value and the new amortized cost for each period presented. The unrealized gain (loss) on an other-than-temporarily impaired security is recorded in OCI.

To estimate the amount of other-than-temporary impairment attributed to credit losses on debt securities where we do not intend to sell the security and it is not more likely than not that we will be required to sell the security prior to recovery, we determine our best estimate of the present value of the cash flows expected to be collected from a security by discounting these cash flows by the current effective yield on the security prior to recording any other-than-temporary impairment. If the present value of the discounted cash flows is lower than the amortized cost of the security, the difference between the present value and amortized cost represents the credit loss associated with the security with the remaining difference between fair value and amortized cost recorded as a non-credit other-than-temporary impairment in OCI.

The evaluation of other-than-temporary impairments is subject to risks and uncertainties and is intended to determine the appropriate amount and timing for recognizing an impairment charge. The assessment of whether such impairment has occurred is based on management’s best estimate of the cash flows expected to be collected at the individual security level. We regularly monitor our investment portfolio to ensure that securities that may be other-than-temporarily impaired are identified in a timely manner and that any impairment charge is recognized in the proper period.

While the other-than-temporary impairment model for debt securities generally includes fixed maturity securities, there are certain hybrid securities that are classified as fixed maturity securities where the application of a debt impairment model depends on whether there has been any evidence of deterioration in credit of the issuer. Under certain circumstances, evidence of deterioration in credit of the issuer may result in the application of the equity impairment model.

For equity securities, we recognize an impairment charge in the period in which we determine that the security will not recover to book value within a reasonable period. We determine what constitutes a reasonable period on a security-by-security basis based upon consideration of all the evidence available to us, including the magnitude of an unrealized loss and its duration. In any event, this period does not exceed 18 months for common equity securities. We measure other-than-temporary impairments based upon the difference between the amortized cost of a security and its fair value.

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

Net Investment Income

Sources of net investment income for the periods indicated were as follows:

 

     Three months ended
September 30,
    Nine months ended
September 30,
 

(Amounts in millions)

       2009             2008             2009             2008      

Fixed maturity securities—taxable

   $ 610      $ 715      $ 1,837      $ 2,194   

Fixed maturity securities—non-taxable

     27        29        85        80   

Commercial mortgage loans

     106        123        329        402   

Equity securities

     6        5        12        25   

Other invested assets

     4        (11     (102     25   

Policy loans

     19        43        115        122   

Cash, cash equivalents and short-term investments

     9        36        40        102   
                                

Gross investment income before expenses and fees

     781        940        2,316        2,950   

Expenses and fees

     (22     (22     (65     (77
                                

Net investment income

   $ 759      $ 918      $ 2,251      $ 2,873   
                                

Net Investment Gains (Losses)

The following table sets forth net investment gains (losses) for the periods indicated:

 

     Three months ended
September 30,
    Nine months ended
September 30,
 

(Amounts in millions)

       2009             2008             2009             2008      

Available-for-sale securities:

        

Realized gains on sale

   $ 122      $ 34      $ 172      $ 97   

Realized losses on sale

     (81     (167     (192     (202

Impairments:

        

Total other-than-temporary impairments

     (285     (577     (1,358     (1,316

Portion of other-than-temporary impairments included in OCI

     89        —          413        —     
                                

Net other-than-temporary impairments

     (196     (577     (945     (1,316
                                

Trading securities

     16        (11     15        (16

Commercial mortgage loans

     (8     —          (19     —     

Derivative instruments

     19        (90     12        (116

Other

     6        (5     12        (7
                                

Net investment gains (losses)

   $ (122   $ (816   $ (945   $ (1,560
                                

See note 5 for additional information on the impact of derivative instruments included in net investment gains (losses).

The aggregate fair value of securities sold at a loss during the three months ended September 30, 2009 and 2008 was $354 million and $498 million, respectively, which was approximately 84% and 77%, respectively, of book value. The aggregate fair value of securities sold at a loss during the nine months ended September 30, 2009 and 2008 was $1,091 million and $1,569 million, respectively, which was approximately 86% and 90%, respectively, of book value.

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

The following represents the activity for credit losses recognized in net income (loss) on debt securities where an other-than-temporary impairment was identified and a portion of other-than-temporary impairments was included in OCI as of the periods indicated:

 

(Amounts in millions)

   As of or for the
three months ended
September 30, 2009
    As of or for the
nine months ended
September 30, 2009
 

Cumulative credit loss beginning balance

   $ 1,085     $ —     

Adoption of new accounting guidance related to other-than-temporary impairments

     —          1,204   

Additions:

    

Other-than-temporary impairments not previously recognized

     25        81   

Increases related to other-than-temporary impairments previously recognized

     74        169   

Reductions:

    

Securities sold, paid down or disposed

     (103     (373

Securities where there is intent to sell

     (5     (5
                

Cumulative credit loss ending balance

   $ 1,076      $ 1,076   
                

Unrealized Investment Gains and Losses

Net unrealized gains and losses on investment securities classified as available-for-sale and other invested assets are reduced by deferred income taxes and adjustments to present value of future profits, deferred acquisition costs and sales inducements that would have resulted had such gains and losses been realized. Net unrealized gains and losses on available-for-sale investment securities reflected as a separate component of accumulated other comprehensive income (loss) as of the dates indicated were as follows:

 

(Amounts in millions)

   September 30, 2009     December 31, 2008  

Net unrealized gains (losses) on investment securities:

    

Fixed maturity securities

   $ (2,332   $ (7,006

Equity securities

     14        (67

Other invested assets

     (28     (1
                

Subtotal

     (2,346     (7,074

Adjustments to present value of future profits, deferred acquisition costs and sales inducements

     238        815   

Income taxes, net

     748        2,221   
                

Net unrealized investment gains (losses)

     (1,360     (4,038

Less: net unrealized investment (gains) losses attributable to noncontrolling interests

     (41     —     
                

Net unrealized investment gains (losses) attributable to Genworth Financial, Inc.

   $ (1,401   $ (4,038
                

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

The change in net unrealized gains (losses) on available-for-sale securities reported in accumulated other comprehensive income (loss) for the periods indicated was as follows:

 

(Amounts in millions)

   As of or for the
three months ended
September 30, 2009
    As of or for the
nine months ended
September 30, 2009
 

Beginning balance

   $ (3,023   $ (4,038

Cumulative effect of change in accounting

     —          (349

Activity during the period:

    

Unrealized gains (losses) on securities

     2,796        4,352   

Adjustment to deferred acquisition costs

     (264     (448

Adjustment to present value of future profits

     (93     (164

Adjustment to sales inducements

     (13     (12 )

Provision for income taxes

     (863     (1,328
                

Change in unrealized gains (losses)

     1,563        2,400   

Reclassification adjustments to net investment (gains) losses, net of taxes of $(51) and $(337)

     100        627   
                

Change in net unrealized investment gains (losses)

     1,663        2,678   

Less: change in net unrealized investment (gains) losses attributable to noncontrolling interests

     (41     (41
                

Ending balance

   $ (1,401   $ (1,401
                

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

Fixed Maturity and Equity Securities

As of September 30, 2009, the amortized cost or cost, gross unrealized gains (losses) and fair value of our fixed maturity and equity securities classified as available-for-sale were as follows:

 

(Amounts in millions)

  Amortized
cost or
cost
  Gross unrealized gains on securities   Gross unrealized losses on securities     Fair
value
    Not other-than-
temporarily
impaired
  Other-than-
temporarily
impaired
  Not other-than-
temporarily
impaired
    Other-than-
temporarily
impaired
   

Fixed maturity securities:

           

U.S. government, agencies and government-sponsored enterprises

  $ 2,104   $ 65   $ —     $ (3   $ —        $ 2,166

Tax exempt

    2,177     111     —       (87     —          2,201

Government—non-U.S.

    2,165     110     —       (21     —          2,254

U.S. corporate

    20,914     811     —       (970     (3     20,752

Corporate—non-U.S.

    12,048     411     —       (410     —          12,049

Residential mortgage-backed

    3,503     51     1     (616     (355     2,584

Commercial mortgage-backed

    5,061     70     —       (1,130     (115     3,886

Other asset-backed

    2,106     7     —       (257     (2     1,854
                                       

Total fixed maturity securities

    50,078     1,636     1     (3,494     (475     47,746

Equity securities

    150     17     —       (3     —          164
                                       

Total available-for-sale securities

  $ 50,228   $ 1,653   $ 1   $ (3,497   $ (475   $ 47,910
                                       

As of December 31, 2008, the amortized cost or cost, gross unrealized gains (losses) and fair value of our fixed maturity and equity securities classified as available-for-sale were as follows:

 

(Amounts in millions)

   Amortized
cost or
cost
   Gross
unrealized
gains
   Gross
unrealized
losses
    Fair
value

Fixed maturity securities:

          

U.S. government, agencies and government-sponsored enterprises

   $ 764    $ 141    $ —        $ 905

Tax exempt

     2,529      70      (228     2,371

Government—non-U.S.

     1,724      103      (67     1,760

U.S. corporate

     21,789      253      (2,968     19,074

Corporate—non-U.S.

     11,439      118      (1,581     9,976

Residential mortgage-backed

     3,721      69      (853     2,937

Commercial mortgage-backed

     5,198      56      (1,496     3,758

Other asset-backed

     2,713      41      (664     2,090
                            

Total fixed maturity securities

     49,877      851      (7,857     42,871

Equity securities

     301      4      (71     234
                            

Total available-for-sale securities

   $ 50,178    $ 855    $ (7,928   $ 43,105
                            

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

The following table presents the gross unrealized losses and fair values of our investment securities, aggregated by investment type and length of time that individual investment securities have been in a continuous unrealized loss position, as of September 30, 2009:

 

     Less than 12 months    12 months or more

(Dollar amounts in millions)

   Fair
value
   Gross
unrealized
losses
    # of
securities
   Fair
value
   Gross
unrealized
losses
    # of
securities

Description of Securities

               

Fixed maturity securities:

               

U.S. government, agencies and government-sponsored enterprises

   $ 292    $ (3   17    $ —      $ —        —  

Tax exempt

     —        —        —        365      (87   115

Government—non-U.S.

     173      (7   22      99      (14   37

U.S. corporate

     611      (67   77      6,356      (906   586

Corporate—non-U.S.

     906      (33   94      2,950      (377   327

Residential mortgage-backed

     646      (357   260      1,013      (614   341

Commercial mortgage-backed

     163      (59   53      2,315      (1,186   446

Other asset-backed

     68      (6   11      1,538      (253   108
                                       

Subtotal, fixed maturity securities

     2,859      (532   534      14,636      (3,437   1,960

Equity securities

     5      (2   4      3      (1   4
                                       

Total for securities in an unrealized loss position

   $ 2,864    $ (534   538    $ 14,639    $ (3,438   1,964
                                       

% Below cost—fixed maturity securities:

               

<20% Below cost

   $ 2,401    $ (73   292    $ 11,046    $ (805   1,208

20-50% Below cost

     333      (170   103      2,940      (1,389   429

>50% Below cost

     125      (289   139      650      (1,243   323
                                       

Total fixed maturity securities

     2,859      (532   534      14,636      (3,437   1,960
                                       

% Below cost—equity securities:

               

<20% Below cost

     —        —        —        3      (1   4

20-50% Below cost

     5      (1   3      —        —        —  

>50% Below cost

     —        (1   1      —        —        —  
                                       

Total equity securities

     5      (2   4      3      (1   4
                                       

Total for securities in an unrealized loss position

   $ 2,864    $ (534   538    $ 14,639    $ (3,438   1,964
                                       

Investment grade

   $ 2,441    $ (182   288    $ 12,695    $ (2,633   1,542

Below investment grade

     423      (352   250      1,944      (805   422
                                       

Total for securities in an unrealized loss position

   $ 2,864    $ (534   538    $ 14,639    $ (3,438   1,964
                                       

The investment securities in an unrealized loss position as of September 30, 2009 consisted of 2,502 securities and accounted for unrealized losses of $3,972 million. Of these unrealized losses of $3,972 million, 71% were investment grade (rated AAA through BBB-) and 22% were less than 20% below cost. The securities less than 20% below cost were primarily attributable to widening credit spreads and a depressed market for

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

certain structured mortgage securities. Included in these unrealized losses as of September 30, 2009 was $475 million of unrealized losses on other-than-temporarily impaired securities. Of the total unrealized losses on other-than-temporarily impaired securities, $136 million have been in an unrealized loss position for more than 12 months.

Of the unrealized losses of $3,972 million, $2,475 million were related to structured securities and $932 million were related to corporate securities in the finance and insurance sector. The remaining amount of $565 million was spread evenly across all other sectors with no individual sector exceeding $90 million.

Of the $2,475 million unrealized losses in structured securities, 50% were in commercial mortgage-backed securities and 39% were in residential mortgage-backed securities with the remainder in other asset-backed securities. Approximately 65% of the total unrealized losses in structured securities were on securities that have retained investment grade ratings. Most of these securities have been in an unrealized loss position for 12 months or more. Given the current market conditions and limited trading on these securities, the fair value of these securities has declined due to widening credit spreads and high premiums for illiquidity. We examined the performance of the underlying collateral and developed our estimate of cash flows expected to be collected. In doing so, we identified certain securities where the non-credit portion of other-than-temporary impairments was recorded in OCI. Based on this evaluation, we determined that the unrealized losses on our mortgage-backed and asset-backed securities represented temporary impairments as of September 30, 2009.

Of the $932 million unrealized losses in the finance and insurance sector, most have been in an unrealized loss position for 12 months or more. Most of these securities have retained a credit rating of investment grade. A portion of the unrealized losses included securities where an other-than-temporary impairment was recorded in OCI. The remaining unrealized losses in our U.S. and non-U.S. corporate securities were evenly distributed across all other major industry types that comprise our corporate bond holdings. Given the current market conditions, including current financial industry events and uncertainty around global economic conditions, the fair value of these securities has declined due to widening credit spreads. In our examination of these securities, we considered all available evidence, including the issuers’ financial condition and current industry events to develop our conclusion on the amount and timing of the cash flows expected to be collected. A subset of the securities issued by banks and other financial institutions represent investments in financial hybrid securities on which a debt impairment model was employed. All of these securities retain a credit rating of investment grade. The majority of these securities were issued by foreign financial institutions. The fair value of these securities has been impacted by widening credit spreads which reflect current financial industry events including uncertainty surrounding the level and type of government support of European financial institutions, potential capital restructuring of these institutions, the risk that income payments may be deferred and the risk that these institutions could be nationalized. Based on this evaluation, we determined that the unrealized losses on these securities represented temporary impairments as of September 30, 2009.

Of the investment securities in an unrealized loss position for 12 months or more as of September 30, 2009, 752 securities were 20% or more below cost, of which 233 securities were also below investment grade (rated BB+ and below) and accounted for unrealized losses of $680 million. These securities were primarily structured securities or securities issued by corporations in the finance and insurance sector. Included in this amount are other-than-temporarily impaired securities where the non-credit loss of $42 million was recorded in OCI.

While certain securities included in the preceding table were considered other-than-temporarily impaired, we expected to recover the new amortized cost based on our estimate of cash flows to be collected. As of September 30, 2009, we expect to recover our amortized cost on the securities included in the chart above and do not intend to sell or it is not more likely than not that we will be required to sell these securities prior to recovering our amortized cost.

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

Despite the considerable analysis and rigor employed on our structured securities, it is at least reasonably possible that the underlying collateral of these investments will perform worse than current market expectations. Such events may lead to adverse changes in cash flows on our holdings of asset-backed and mortgage-backed securities and potential future write-downs within our portfolio of mortgage-backed and asset-backed securities. We expect our investments in corporate securities will continue to perform in accordance with our conclusions about the amount and timing of estimated cash flows. Although we do not anticipate such events, it is at least reasonably possible that issuers of our investments in corporate securities will perform worse than current expectations. Such events may lead us to recognize potential future write-downs within our portfolio of corporate securities.

The following table presents the gross unrealized losses and fair values of our investment securities, aggregated by investment type and length of time that individual investment securities have been in a continuous unrealized loss position, as of December 31, 2008:

 

     Less than 12 months    12 months or more

(Dollar amounts in millions)

   Fair
value
   Gross
unrealized
losses
    # of
securities
   Fair
value
   Gross
unrealized
losses
    # of
securities

Description of Securities

               

Fixed maturity securities:

               

Tax exempt

   $ 915    $ (78   281    $ 262    $ (150   100

Government—non-U.S.

     287      (49   120      34      (18   34

U.S. corporate

     7,583      (956   926      6,901      (2,012   683

Corporate—non-U.S.

     4,003      (570   648      3,004      (1,011   411

Residential mortgage-backed

     690      (186   155      1,005      (667   320

Commercial mortgage-backed

     847      (183   166      2,411      (1,313   403

Other asset-backed

     281      (72   50      1,703      (592   140
                                       

Subtotal, fixed maturity securities

     14,606      (2,094   2,346      15,320      (5,763   2,091

Equity securities

     62      (45   15      52      (26   6
                                       

Total for securities in an unrealized loss position

   $ 14,668    $ (2,139   2,361    $ 15,372    $ (5,789   2,097
                                       

% Below cost—fixed maturity securities:

               

<20% Below cost

   $ 12,427    $ (1,031   1,831    $ 8,518    $ (948   912

20-50% Below cost

     2,059      (888   442      5,603      (2,759   818

>50% Below cost

     120      (175   73      1,199      (2,056   361
                                       

Total fixed maturity securities

     14,606      (2,094   2,346      15,320      (5,763   2,091
                                       

% Below cost—equity securities:

               

20-50% Below cost

     41      (20   11      52      (26   6

>50% Below cost

     21      (25   4      —        —        —  
                                       

Total equity securities

     62      (45   15      52      (26   6
                                       

Total for securities in an unrealized loss position

   $ 14,668    $ (2,139   2,361    $ 15,372    $ (5,789   2,097
                                       

Investment grade

   $ 13,719    $ (1,908   2,026    $ 14,628    $ (5,437   1,908

Below investment grade

     949      (231   335      744      (352   189
                                       

Total for securities in an unrealized loss position

   $ 14,668    $ (2,139   2,361    $ 15,372    $ (5,789   2,097
                                       

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

The scheduled maturity distribution of fixed maturity securities as of September 30, 2009 is set forth below. Actual maturities may differ from contractual maturities because issuers of securities may have the right to call or prepay obligations with or without call or prepayment penalties.

 

(Amounts in millions)

   Amortized
cost or
cost
   Fair
value

Due one year or less

   $ 1,897    $ 1,897

Due after one year through five years

     12,118      12,247

Due after five years through ten years

     7,766      7,862

Due after ten years

     17,627      17,416
             

Subtotal

     39,408      39,422

Residential mortgage-backed

     3,503      2,584

Commercial mortgage-backed

     5,061      3,886

Other asset-backed

     2,106      1,854
             

Total

   $ 50,078    $ 47,746
             

As of September 30, 2009, $5,876 million of our investments (excluding mortgage-backed and asset-backed securities) were subject to certain call provisions.

As of September 30, 2009, securities issued by finance and insurance, utilities and energy, and consumer—non-cyclical industry groups represented approximately 28%, 22% and 12%, respectively, of our domestic and foreign corporate fixed maturity securities portfolio. No other industry group comprised more than 10% of our investment portfolio. This portfolio is widely diversified among various geographic regions in the U.S. and internationally, and is not dependent on the economic stability of one particular region.

As of September 30, 2009, we did not hold any fixed maturity securities in any single issuer, other than securities issued or guaranteed by the U.S. government, which exceeded 10% of stockholders’ equity.

(5) Derivative Instruments

Our business activities routinely deal with fluctuations in interest rates, equity prices, currency exchange rates and other asset and liability prices. We use derivative instruments to mitigate or reduce certain of these risks. We have established policies for managing each of these risks, including prohibition on derivatives market-making and other speculative derivatives activities. These policies require the use of derivative instruments in concert with other techniques to reduce or mitigate these risks. While we use derivatives to mitigate or reduce risks, certain derivatives do not meet the accounting requirements to be designated as hedging instruments and are denoted as “derivatives not designated as hedges” in the following disclosures. For derivatives that meet the accounting requirements to be designated as hedges, the following disclosures for these derivatives are denoted as “derivatives designated as hedges,” which include both cash flow and fair value hedges.

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

The following table sets forth our positions in derivative instruments as of the dates indicated:

 

     Asset derivatives    Liability derivatives
     Balance
sheet
classification
  Fair value    Balance
sheet
classification
  Fair value

(Amounts in millions)

     September 30,
2009
  December 31,
2008
     September 30,
2009
  December 31,
2008

Derivatives designated as hedges

             

Cash flow hedges:

             

Interest rate swaps

   Other invested

assets

  $ 281   $ 501    Other

liabilities

  $ 9   $ 54

Inflation indexed swaps

   Other invested

assets

    —       —      Other

liabilities

    4     —  

Foreign currency swaps

   Other invested

assets

    123     120    Other

liabilities

    —       1
                             

Total cash flow hedges

       404     621        13     55
                             

Fair value hedges:

             

Interest rate swaps

   Other invested

assets

    156     231    Other

liabilities

    18     36

Foreign currency swaps

   Other invested

assets

    24     46    Other

liabilities

    —       —  
                             

Total fair value hedges

       180     277        18     36
                             

Total derivatives designated as hedges

       584     898        31     91
                             

Derivatives not designated as hedges

             

Interest rate swaps

   Other invested

assets

    408     384    Other

liabilities

    39     95

Interest rate swaptions

   Other invested

assets

    195     780    Other

liabilities

    104     60

Credit default swaps

   Other invested

assets

    6     1    Other

liabilities

    —       27

Equity index options

   Other invested

assets

    62     152    Other

liabilities

    —       —  

Financial futures

   Other invested

assets

    —       —      Other

liabilities

    —       —  

Inflation indexed swaps

   Other invested

assets

    —       —      Other

liabilities

    —       —  

Other foreign currency contracts

   Other invested

assets

    3     —      Other

liabilities

    —       —  

GMWB embedded derivatives

   Reinsurance

recoverable (1)

    —       18    Policyholder

account

balances (2)

    308     878
                             

Total derivatives not designated as hedges

       674     1,335        451     1,060
                             

Total derivatives

     $ 1,258   $ 2,233      $ 482   $ 1,151
                             

 

(1)

Represents the embedded derivatives associated with the reinsured portion of our GMWB liabilities.

(2)

Represents the embedded derivatives associated with our GMWB liabilities, excluding the impact of reinsurance.

The fair value of derivative positions presented above was not offset by the respective collateral amounts retained or provided under these agreements. The amounts recognized for the obligation to return collateral retained by us and the right to reclaim collateral from counterparties was recorded in other liabilities and other invested assets, respectively.

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

The activity associated with derivative instruments can generally be measured by the change in notional value over the periods presented. However, for equity index options, the change between periods is best illustrated by the number of contracts, and for GMWB embedded derivatives, the change between periods is best illustrated by the number of policies. The following tables represent activity associated with derivative instruments as of the dates indicated:

 

(Notional in millions)

   Measurement    December 31, 2008    Additions    Maturities/
terminations
   September 30, 2009

Derivatives designated as hedges

              

Cash flow hedges:

              

Interest rate swaps

   Notional    $ 4,001    $ 2,562    $ 509    $ 6,054

Inflation indexed swaps

   Notional      —        383      —        383

Foreign currency swaps

   Notional      559      491      559      491
                              

Total cash flow hedges

        4,560      3,436      1,068      6,928
                              

Fair value hedges:

              

Interest rate swaps

   Notional      3,098      —        338      2,760

Foreign currency swaps

   Notional      187      —        102      85
                              

Total fair value hedges

        3,285      —        440      2,845
                              

Total derivatives designated as hedges

        7,845      3,436      1,508      9,773
                              

Derivatives not designated as hedges

              

Interest rate swaps

   Notional      6,460      945      2,057      5,348

Interest rate swaptions

   Notional      12,000      —        4,500      7,500

Credit default swaps

   Notional      610      —        20      590

Financial futures

   Notional      2,194      6,681      2,194      6,681

Inflation indexed swaps

   Notional      —        —        —        —  

Other foreign currency contracts

   Notional      —        982      461      521
                              

Total derivatives not designated as hedges

        21,264      8,608      9,232      20,640
                              

Total derivatives

      $ 29,109    $ 12,044    $ 10,740    $ 30,413
                              

(Number of contracts or policies)

   Measurement    December 31, 2008    Additions    Terminations    September 30, 2009

Derivatives not designated as hedges

              

Equity index options

   Contracts      532,000      589,000      225,000      896,000

GMWB embedded derivatives

   Policies      43,677      4,050      1,128      46,599

As a result of rating agency actions taken in April 2009, credit downgrade provisions were triggered in our master swap agreements with certain derivative counterparties and we terminated $6.9 billion notional value, of which $2.3 billion was replaced or renegotiated. Approximately $1.1 billion of notional value remained with counterparties that can be terminated at the option of the derivative counterparty and represented a net fair value asset of $135 million as of September 30, 2009. Additionally, we terminated $1.7 billion in derivatives that were not directly impacted by the credit downgrade provisions but were offsetting certain terminated derivatives.

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

Cash Flow Hedges

Certain derivative instruments are designated as cash flow hedges. The changes in fair value of these instruments are recorded as a component of OCI. We designate and account for the following as cash flow hedges when they have met the effectiveness requirements: (i) various types of interest rate swaps to convert floating rate investments to fixed rate investments; (ii) various types of interest rate swaps to convert floating rate liabilities into fixed rate liabilities; (iii) receive U.S. dollar fixed on foreign currency swaps to hedge the foreign currency cash flow exposure of foreign currency denominated investments; (iv) pay U.S. dollar fixed on foreign currency swaps to hedge the foreign currency cash flow exposure on liabilities denominated in foreign currencies; (v) forward starting interest rate swaps to hedge against changes in interest rates associated with future fixed-rate bond purchases and/or interest income; and (vi) other instruments to hedge the cash flows of various forecasted transactions.

The following table provides information about the pre-tax income (loss) effects of cash flow hedges for the three months ended September 30, 2009:

 

(Amounts in millions)

  Gain (loss)
recognized in OCI
  Gain (loss)
reclassified into
net income
(loss) from OCI (1)
    Classification of gain
(loss) reclassified into
net income (loss)
  Gain (loss)
recognized in
net income (loss) (2)
    Classification of gain
(loss) recognized in
net income (loss)

Interest rate swaps hedging assets

  $ 99   $ 2      Net investment

income

  $ (2   Net investment

gains (losses)

Interest rate swaps hedging assets

    —       —        Net investment

gains (losses)

    —        Net investment

gains (losses)

Foreign currency swaps

    —       (1   Net investment

gains (losses)

    —        Net investment

gains (losses)

Foreign currency swaps

    3     —        Interest expense     1     Net investment

gains (losses)

                         

Total

  $ 102   $ 1        $ (1  
                         

 

(1)

Amounts include $(1) million of gains reclassified into net income (loss) for cash flow hedges that were terminated or de-designated where the effective portion is reclassified into net income (loss) when the underlying hedge item affects net income (loss).

(2)

Represents ineffective portion of cash flow hedges, as there were no amounts excluded from the measurement of effectiveness.

 

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Table of Contents

GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

The following table provides information about the pre-tax income (loss) effects of cash flow hedges for the nine months ended September 30, 2009:

 

(Amounts in millions)

  Gain (loss)
recognized in OCI
    Gain (loss)
reclassified into
net income
(loss) from OCI (1)
    Classification of gain
(loss) reclassified into
net income (loss)
  Gain (loss)
recognized in
net income (loss) (2)
   

Classification of gain
(loss) recognized in
net income (loss)

Interest rate swaps hedging assets

  $ (223   $ 10      Net investment
income
  $ (12  

Net investment

gains (losses)

Interest rate swaps hedging assets

    —          5      Net investment

gains (losses)

    —       

Net investment

gains (losses)

Foreign currency swaps

    —          (1   Net investment

gains (losses)

    —       

Net investment

gains (losses)

Foreign currency swaps

    (10     (8   Interest expense     1    

Net investment

gains (losses)

                           

Total

  $ (233   $ 6        $ (11  
                           

 

(1)

Amounts include $4 million of gains reclassified into net income (loss) for cash flow hedges that were terminated or de-designated where the effective portion is reclassified into net income (loss) when the underlying hedge item affects net income (loss).

(2)

Represents ineffective portion of cash flow hedges, as there were no amounts excluded from the measurement of effectiveness.

The total of derivatives designated as cash flow hedges of $1,013 million, net of taxes, recorded in stockholders’ equity as of September 30, 2009 is expected to be reclassified to future net income (loss), concurrently with and primarily offsetting changes in interest expense and interest income on floating-rate instruments and interest income on future fixed-rate bond purchases. Of this amount, $(1) million, net of taxes, is expected to be reclassified to net income (loss) in the next 12 months. Actual amounts may vary from this amount as a result of market conditions. All forecasted transactions associated with qualifying cash flow hedges are expected to occur by 2045. No amounts were reclassified to net income (loss) during the nine months ended September 30, 2009 in connection with forecasted transactions that were no longer considered probable of occurring. During 2008, we terminated a large portion of our forward starting interest rate swaps, which were designated as cash flow hedges, related to our long-term care insurance business to reduce our counterparty credit exposure and increase liquidity. The respective balance in OCI related to these derivatives will be reclassified into net income (loss) when the forecasted transactions affect net income (loss), as the forecasted transactions are still probable of occurring.

Fair Value Hedges

Certain derivative instruments are designated as fair value hedges. The changes in fair value of these instruments are recorded in net income (loss). In addition, changes in the fair value attributable to the hedged portion of the underlying instrument are reported in net income (loss). We designate and account for the following as fair value hedges when they have met the effectiveness requirements: (i) interest rate swaps to convert fixed rate investments to floating rate investments; (ii) interest rate swaps to convert fixed rate liabilities into floating rate liabilities; (iii) cross currency swaps to convert non-U.S. dollar fixed rate liabilities to floating rate U.S. dollar liabilities; and (iv) other instruments to hedge various fair value exposures of investments.

 

26


Table of Contents

GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

The following table provides information about the pre-tax income (loss) effects of fair value hedges and related hedged items for the three months ended September 30, 2009:

 

    Derivative instrument   Hedged item

(Amounts in millions)

  Gain (loss)
recognized in
net income
(loss)
 

Classification
of gain (loss)
recognized in
net income (loss)

  Other impacts
to net
income (loss)
    Classification
of other
impacts to
net income (loss)
  Gain (loss)
recognized in
net income
(loss)
   

Classification
of gain (loss)
recognized in
net income (loss)

Interest rate swaps hedging assets

  $ 1  

Net investment

gains (losses)

  $ (4   Net investment
income
  $ —        Net investment
gains (losses)

Interest rate swaps hedging liabilities

    14  

Net investment

gains (losses)

    26      Interest credited     (14   Net investment
gains (losses)

Foreign currency swaps

    3   Net investment
gains (losses)
    —        Interest credited     (4   Net investment
gains (losses)
                           

Total

  $ 18     $ 22        $ (18  
                           

The following table provides information about the pre-tax income (loss) effects of fair value hedges and related hedged items for the nine months ended September 30, 2009:

 

    Derivative instrument   Hedged item

(Amounts in millions)

  Gain (loss)
recognized in
net income
(loss)
   

Classification
of gain (loss)
recognized in
net income (loss)

  Other impacts
to net
income (loss)
    Classification
of other
impacts to
net income (loss)
  Gain (loss)
recognized in
net income
(loss)
   

Classification
of gain (loss)
recognized in
net income (loss)

Interest rate swaps hedging assets

  $ 7      Net investment
gains (losses)
  $ (12   Net investment
income
  $ (10   Net investment
gains (losses)

Interest rate swaps hedging liabilities

    (45   Net investment
gains (losses)
    68      Interest credited     48      Net investment
gains (losses)

Foreign currency swaps

    (10   Net investment
gains (losses)
    1      Interest credited     7      Net investment
gains (losses)
                             

Total

  $ (48     $ 57        $ 45     
                             

The difference between the gain (loss) recognized for the derivative instrument and the hedged item presented above represents the net ineffectiveness of the fair value hedging relationships. The other impacts presented above represent the net income (loss) effects of the derivative instruments that are presented in the same location as the income activity from the hedged item. There were no amounts excluded from the measurement of effectiveness.

Derivatives Not Designated As Hedges

We also enter into certain non-qualifying derivative instruments such as: (i) interest rate swaps, swaptions and financial futures to mitigate interest rate risk as part of managing regulatory capital positions; (ii) credit default swaps to enhance yield and reproduce characteristics of investments with similar terms and credit risk; and (iii) equity index options, interest rate swaps and financial futures to mitigate the risks associated with liabilities that have guaranteed minimum benefits. Additionally, we provide GMWBs on certain products that are required to be bifurcated as embedded derivatives.

 

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Table of Contents

GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

The following table provides the pre-tax gain (loss) recognized in net income (loss) for the effects of derivatives not designated as hedges for the periods indicated:

 

(Amounts in millions)

  Three months ended
September 30, 2009
    Nine months ended
September 30, 2009
   

Classification of gain (loss) recognized
in net income (loss)

     

Interest rate swaps

  $ (52   $ 194      Net investment gains (losses)

Interest rate swaptions

    85        (494   Net investment gains (losses)

Credit default swaps

    15        36      Net investment gains (losses)

Equity index options

    (49     (104   Net investment gains (losses)

Financial futures

    (106     (190   Net investment gains (losses)

Inflation indexed swaps

    —          (4   Net investment gains (losses)

Foreign currency swaps

    —          6      Net investment gains (losses)

Other foreign currency contracts

    (5     5      Net investment gains (losses)

GMWB embedded derivatives

    133        573      Net investment gains (losses)
                 

Total derivatives not designated as hedges

  $ 21      $ 22     
                 

Derivative Counterparty Credit Risk

As of September 30, 2009 and December 31, 2008, net fair value assets by counterparty totaled $1,095 million and $1,946 million, respectively. As of September 30, 2009 and December 31, 2008, net fair value liabilities by counterparty totaled $10 million and $4 million, respectively. As of September 30, 2009 and December 31, 2008, we retained collateral of $937 million and $1,605 million, respectively, related to these agreements, including over collateralization of $14 million and $66 million, respectively, from certain counterparties. As of September 30, 2009, we provided $12 million of collateral to derivative counterparties, including over collateralization of $2 million. As of December 31, 2008, we provided no collateral to derivative counterparties.

All of our master swap agreements contain credit downgrade provisions that allow a party to assign or terminate derivative transactions if the other party’s long-term unsecured debt rating or financial strength rating is below the limit defined in the applicable agreement. If the downgrade provisions had been triggered as of September 30, 2009 and December 31, 2008, we could have been allowed to claim up to $172 million and $407 million, respectively, from counterparties and required to disburse less than $1 million and $4 million, respectively. This represents the net fair value of gains and losses by counterparty, less available collateral held.

Credit Derivatives

We sell protection under single name credit default swaps and credit default swap index tranches in combination with purchasing securities to reproduce characteristics of similar investments based on the credit quality and term of the credit default swap. Credit default triggers for both indexed reference entities and single name reference entities follow the Credit Derivatives Physical Settlement Matrix published by the International Swaps and Derivatives Association. Under these terms, credit default triggers are defined as bankruptcy, failure to pay or restructuring, if applicable. Our maximum exposure to credit loss equals the notional value for credit default swaps and the par value of debt instruments with embedded credit derivatives. In the event of default for credit default swaps, we are typically required to pay the protection holder the full notional value less a recovery rate determined at auction. For debt instruments with embedded credit derivatives, the security’s principal is typically reduced by the net amount of default for any referenced entity defaults.

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

The following table sets forth our credit default swaps where we sell protection on single name reference entities and the fair values as of the dates indicated:

 

     September 30, 2009    December 31, 2008

(Amounts in millions)

   Notional
value
   Assets    Liabilities    Notional
value
   Assets    Liabilities

Reference entity credit rating and maturity:

                 

AAA

                 

Matures after one year through five years

   $ 6    $ —      $ —      $ 6    $ —      $ 1

AA

                 

Matures after one year through five years

     5      —        —        5      —        —  

A

                 

Matures after one year through five years

     32      —        —        52      —        5

Matures after five years through ten years

     15      —        —        15      —        2

BBB

                 

Matures after one year through five years

     73      1      —        73      —        7

Matures after five years through ten years

     24      —        —        24      —        4
                                         

Total credit default swaps on single name reference entities

   $ 155    $ 1    $ —      $ 175    $ —      $ 19
                                         

The following table sets forth our credit default swaps where we sell protection on credit default swap index tranches and the fair values as of the dates indicated:

 

    September 30, 2009   December 31, 2008

(Amounts in millions)

  Notional
value
  Assets   Liabilities   Notional
value
  Assets   Liabilities

Index tranche attachment/detachment point and maturity:

           

15% – 30% matures after five years through ten years (1)

  $ 177   $ 3   $ —     $ 177   $ 1   $ 2

12% – 22% matures after five years through ten years (2)

    248     2     —       248     —       6
                                   

Total credit default swaps on index tranches

  $ 425   $ 5   $ —     $ 425   $ 1   $ 8
                                   

 

(1)

The current attachment/detachment as of September 30, 2009 and December 31, 2008 was 14.9% – 30.3%.

(2)

The current attachment/detachment as of September 30, 2009 and December 31, 2008 was 12% – 22%.

The following table sets forth our holding of available-for-sale fixed maturity securities that include embedded credit derivatives and the fair values as of the dates indicated:

 

     September 30, 2009    December 31, 2008

(Amounts in millions)

   Par
value
   Amortized
cost
   Fair
value
   Par
value
   Amortized
cost
   Fair
value

Credit rating:

                 

AAA

                 

Matures after one year through five years

   $ —      $ —      $ —      $ 100    $ 100    $ 51

Matures after five years through ten years

     300      329      211      300      332      105

AA

                 

Matures after five years through ten years

     100      100      92      —        —        —  
                                         

Total available-for-sale fixed maturity securities that include embedded credit derivatives

   $ 400    $ 429    $ 303    $ 400    $ 432    $ 156
                                         

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

(6) Fair Value Measurements

Assets and liabilities that are reflected in the accompanying consolidated financial statements at fair value are not included in the following disclosure of fair value; such items include cash and cash equivalents, investment securities, separate accounts, securities held as collateral and derivative financial instruments. Other financial assets and liabilities—those not carried at fair value—are discussed below. Apart from certain of our borrowings and certain marketable securities, few of the instruments discussed below are actively traded and their fair values must often be determined using models. The fair value estimates are made at a specific point in time, based upon available market information and judgments about the financial instruments, including estimates of the timing and amount of expected future cash flows and the credit standing of counterparties. Such estimates do not reflect any premium or discount that could result from offering for sale at one time our entire holdings of a particular financial instrument, nor do they consider the tax impact of the realization of unrealized gains or losses. In many cases, the fair value estimates cannot be substantiated by comparison to independent markets.

The basis on which we estimate fair value is as follows:

Commercial mortgage loans. Based on recent transactions and/or discounted future cash flows, using current market rates.

Other invested assets. Based on comparable market transactions, discounted future cash flows, quoted market prices and/or estimates using the most recent data available for the related instrument. Primarily represents short-term investments, limited partnerships accounted for under the cost method and bank loans.

Borrowings and related instruments. Based on market quotes or comparable market transactions.

Investment contracts. Based on expected future cash flows, discounted at current market rates for annuity contracts or institutional products.

The following represents the fair value of financial assets and liabilities as of the periods indicated:

 

(Amounts in millions)

   September 30, 2009    December 31, 2008
   Notional
amount
    Carrying
amount
   Fair
value
   Notional
amount
    Carrying
amount
   Fair
value

Assets:

               

Commercial mortgage loans

   $   (1)    $ 7,704    $ 7,001    $   (1)    $ 8,262    $ 7,536

Other invested assets

          (1)      1,217      1,208           (1)      1,316      1,326

Liabilities:

               

Borrowings and related instruments (2):

               

Short-term borrowings

          (1)      930      930           (1)      1,133      1,133

Long-term borrowings

          (1)      3,457      2,895           (1)      4,261      2,012

Non-recourse funding obligations

          (1)      3,443      1,513           (1)      3,455      2,671

Investment contracts

          (1)      22,485      22,689           (1)      26,824      24,250

Performance guarantees, principally letters of credit

     119        —        —        119        —        —  

Other firm commitments:

               

Commitments to fund limited partnerships

     277        —        —        366        —        —  

 

(1)

These financial instruments do not have notional amounts.

(2)

See note 8.

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

Recurring Fair Value Measurements

We hold fixed maturity and equity securities, trading securities, derivatives, embedded derivatives, securities held as collateral, separate account assets and certain other financial instruments, which are carried at fair value.

The vast majority of our fixed maturity and equity securities use Level 2 inputs for the determination of fair value. These fair values are obtained primarily from industry-standard pricing methodologies based on market observable information. Certain structured securities valued using industry-standard pricing methodologies utilize significant unobservable inputs to estimate fair value, resulting in the fair value measurements being classified as Level 3. We also utilize internally developed pricing models to produce estimates of fair value primarily utilizing Level 2 inputs along with certain Level 3 inputs. The internally developed models include matrix pricing where we discount expected cash flows utilizing market interest rates obtained from market sources based on the credit quality and duration of the instrument to determine fair value. For securities that may not be reliably priced using internally developed pricing models, we estimate fair value using indicative market prices. These prices are indicative of an exit price, but the assumptions used to establish the fair value may not be observable, or corroborated by market observable information, and represent Level 3 inputs.

The fair value of securities held as collateral is primarily based on Level 2 inputs from market information for the collateral that is held on our behalf by the custodian. The fair value of separate account assets is based on the quoted prices of the underlying fund investments and, therefore, represents Level 1 pricing.

The fair value of derivative instruments primarily utilizes Level 2 inputs. Certain derivative instruments are valued using significant unobservable inputs and are classified as Level 3 measurements. The classification of fair value measurements for derivative instruments, including embedded derivatives requiring bifurcation, was determined based on consideration of several inputs including: closing exchange or over-the-counter market price quotations; time value and volatility factors underlying options; foreign exchange rates; market interest rates; and non-performance risk. For product-related embedded derivatives, we also include certain policyholder assumptions in the determination of fair value.

For assets carried at fair value, the non-performance of the counterparties is considered in the determination of fair value measurement for those assets. Similarly, the fair value measurement of a liability must reflect the entity’s own non-performance risk. Therefore, the impact of non-performance risk, as well as any potential credit enhancements (e.g., collateral), has been considered in the fair value measurement of both assets and liabilities. The liabilities recorded at fair value include derivative and GMWB liabilities.

For derivative liabilities, we consider the counterparty collateral arrangements and rights of set-off when determining whether any incremental adjustment should be made for our non-performance risk. As a result of these counterparty arrangements, we determined no adjustment for our non-performance risk was required to the derivative liabilities of $174 million and $273 million as of September 30, 2009 and December 31, 2008, respectively.

For GMWB liabilities recorded at fair value of $308 million and $878 million as of September 30, 2009 and December 31, 2008, respectively, non-performance risk is integrated into the discount rate. The discount rate utilized in our valuation was based on the swap curve, which included the credit risk of an instrument rated AA and incorporated the non-performance risk of our GMWB liabilities. The impact of non-performance risk on our GMWB valuation was $2 million and $29 million as of September 30, 2009 and December 31, 2008, respectively, as a result of our discount rate being higher than the U.S. treasury curve.

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

To determine whether the use of the swap curve was the appropriate discount rate to reflect the non-performance risk of the GMWB liabilities, we evaluate the non-performance risk in our liabilities based on a hypothetical exit market transaction as there is no exit market for these types of liabilities. A hypothetical exit market can be viewed as a hypothetical transfer of the liability to another similarly rated insurance company which would closely resemble a reinsurance transaction. Another hypothetical exit market transaction can be viewed as a hypothetical transaction from the perspective of the GMWB policyholder. After considering all relevant factors in assessing whether any additional adjustment to the discount rate for non-performance risk was necessary, including assumptions we expect market participants would utilize in a hypothetical exit market transaction, we determined that no incremental adjustment to the discount rate was necessary for our GMWB liabilities that are recorded at fair value. We believe that a hypothetical exit market participant would use a similar discount rate to value the liabilities and would not incorporate changes in non-performance risk in the discount rate other than the implied credit spread incorporated in the swap curve.

We continually assess the non-performance risk on our liabilities recorded at fair value and will make adjustments in future periods as additional information is obtained that would indicate such an adjustment is necessary to accurately present the fair value measurement in accordance with U.S. GAAP.

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

The following tables set forth our assets and liabilities that are measured at fair value on a recurring basis as of the dates indicated:

 

     September 30, 2009

(Amounts in millions)

   Total    Level 1    Level 2    Level 3

Assets

           

Investments:

           

Fixed maturity securities:

           

U.S. government, agencies and government-sponsored enterprises

   $ 2,166    $ —      $ 2,161    $ 5

Tax exempt

     2,201      —        2,199      2

Government—non-U.S.

     2,254      —        2,220      34

U.S. corporate

     20,752      —        19,232      1,520

Corporate—non-U.S.

     12,049      —        11,017      1,032

Residential mortgage-backed

     2,584      —        925      1,659

Commercial mortgage-backed

     3,886      —        257      3,629

Other asset-backed

     1,854      —        839      1,015
                           

Total fixed maturity securities

     47,746      —        38,850      8,896
                           

Equity securities

     164      36      68      60
                           

Other invested assets:

           

Trading securities

     180      —        31      149

Derivative assets

     1,258      —        986      272

Securities lending collateral

     899      —        899      —  

Derivatives counterparty collateral

     56      —        56      —  
                           

Total other invested assets

     2,393      —        1,972      421
                           

Reinsurance recoverable (1)

     —        —        —        —  

Separate account assets

     10,712      10,712      —        —  
                           

Total assets

   $ 61,015    $ 10,748    $ 40,890    $ 9,377
                           

Liabilities

           

Policyholder account balances (2)

   $ 308    $ —      $ —      $ 308

Derivative liabilities

     174      —        70      104
                           

Total liabilities

   $ 482    $ —      $ 70    $ 412
                           

 

(1)

Represents embedded derivatives associated with the reinsured portion of our GMWB liabilities.

(2)

Represents embedded derivatives associated with our GMWB liabilities, excluding the impact of reinsurance.

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

     December 31, 2008

(Amounts in millions)

   Total    Level 1    Level 2    Level 3

Assets

           

Investments:

           

Fixed maturity securities:

           

U.S. government, agencies and government-sponsored enterprises

   $ 905    $ —      $ 880    $ 25

Tax exempt

     2,371      —        2,371      —  

Government—non-U.S.

     1,760      —        1,729      31

U.S. corporate

     19,074      —        16,340      2,734

Corporate—non-U.S.

     9,976      —        8,416      1,560

Residential mortgage-backed

     2,937      —        980      1,957

Commercial mortgage-backed

     3,758      —        539      3,219

Other asset-backed

     2,090      —        1,056      1,034
                           

Total fixed maturity securities

     42,871      —        32,311      10,560
                           

Equity securities

     234      37      137      60
                           

Other invested assets:

           

Trading securities

     169      —        44      125

Derivative assets

     2,215      —        1,282      933

Securities lending collateral

     1,469      —        1,469      —  

Derivatives counterparty collateral

     786      —        786      —  
                           

Total other invested assets

     4,639      —        3,581      1,058
                           

Reinsurance recoverable (1)

     18      —        —        18

Separate account assets

     9,215      9,215      —        —  
                           

Total assets (2)

   $ 56,977    $ 9,252    $ 36,029    $ 11,696
                           

Liabilities

           

Policyholder account balances (3)

   $ 878    $ —      $ —      $ 878

Derivative liabilities

     273      —        205      68
                           

Total liabilities

   $ 1,151    $ —      $ 205    $ 946
                           

 

(1)

Represents embedded derivatives associated with the reinsured portion of our GMWB liabilities. The balance as of December 31, 2008 has been revised to include this amount.

(2)

Total assets have been revised to include the reinsured portion of our GMWB liabilities.

(3)

Represents embedded derivatives associated with our GMWB liabilities, excluding the impact of reinsurance. The balance as of December 31, 2008 has been revised to exclude the impact of reinsurance.

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

The following tables present additional information about assets measured at fair value on a recurring basis and for which we have utilized significant unobservable (Level 3) inputs to determine fair value as of or for the dates indicated:

 

    Beginning
balance
as of
July 1,
2009
  Total realized and
unrealized gains
(losses)
    Purchases,
sales
issuances
and
settlements,
net
    Transfer
in Level 3
  Transfer
out of
Level 3
    Ending
balance
as of
September 30,
2009
  Total gains
(losses)
included in
net income
(loss)
attributable
to assets
still held
 
      Included in
net income
(loss)
    Included
in OCI
           

Fixed maturity securities:

               

U.S. government, agencies and government-sponsored enterprises

  $ 357   $ —        $ —        $ —        $ 4   $ (356   $ 5   $ —     

Tax exempt

    2     —          —          —          —       —          2     —     

Government—non-U.S.

    22     —          (2     (1     15     —          34     —     

U.S. corporate

    1,408     25        60        (52     387     (308     1,520     5   

Corporate—non-U.S.

    767     7        69        74        293     (178     1,032     (2

Residential mortgage-backed

    1,623     (89     200        (51     20     (44     1,659     (77

Commercial mortgage-backed

    3,128     (6     294        (34     476     (229     3,629     (6

Other asset-backed

    1,063     (1     105        (122     1     (31     1,015     (1
                                                         

Total fixed maturity securities

    8,370     (64     726        (186     1,196     (1,146     8,896     (81
                                                         

Equity securities

    61     —          1        (1     —       (1     60     —     
                                                         

Other invested assets:

               

Trading securities

    133     16        —          —          —       —          149     16   

Derivative assets

    286     (15     —          1        —       —          272     (11
                                                         

Total other invested assets

    419     1        —          1        —       —          421     5   
                                                         

Reinsurance recoverable

    2     (2     —          —          —       —          —       (2
                                                         

Total Level 3 assets

  $ 8,852   $ (65   $ 727      $ (186   $ 1,196   $ (1,147   $ 9,377   $ (78
                                                         
    Beginning
balance
as of
July 1,
2008
  Total realized and
unrealized gains
(losses)
    Purchases,
sales
issuances
and
settlements,
net
    Transfer
in Level 3
  Transfer
out of
Level 3
    Ending
balance
as of
September 30,
2008
  Total gains
(losses)
included in
net income
(loss)
attributable
to assets
still held
 
      Included in
net income
(loss)
    Included
in OCI
           

Fixed maturity securities

  $ 4,681   $ (256   $ (241   $ (6   $ 2,347   $ (704   $ 5,821   $ (249

Equity securities

    9     —          —          15        25     —          49     —     

Other invested assets (1)

    409     58        —          (31     —       (28     408     47   
                                                         

Total Level 3 assets

  $ 5,099   $ (198   $ (241   $ (22   $ 2,372   $ (732   $ 6,278   $ (202
                                                         

 

(1)

Includes certain trading securities and derivatives.

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

    Beginning
balance
as of
January 1,
2009
  Total realized and
unrealized gains
(losses)
    Purchases,
sales
issuances
and
settlements,
net
    Transfer
in Level 3
  Transfer
out of
Level 3
    Ending
balance
as of
September 30,
2009
  Total gains
(losses)
included in
net income
(loss)
attributable
to assets
still held
 
      Included in
net income
(loss)
    Included
in OCI
           

Fixed maturity securities:

               

U.S. government, agencies and government-sponsored enterprises

  $ 25   $ —        $ (38   $ 13      $ 394   $ (389   $ 5   $ —     

Tax exempt

    —       —          —          5        2     (5     2     —     

Government—non-U.S.

    31     —          (2 )     9        15     (19     34     —     

U.S. corporate

    2,734     9        170        (163     764     (1,994     1,520     10   

Corporate—non-U.S.

    1,560     (26