Genworth Financial, Inc. — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018. Amounts are in U.S. dollars; financial statement figures are in millions unless otherwise noted. Genworth operates U.S., Canadian and Australian mortgage insurance businesses, U.S. life insurance, and runoff operations.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Total revenue | $2,143 | $2,215 | $6,417 | $6,609 |
| Income from continuing operations before tax | $273 | $286 | $861 | $1,019 |
| Net income attributable to Genworth common stockholders | $146 | $107 | $448 | $464 |
| Adjusted operating income attributable to common stockholders | $145 | $76 | $470 | $370 |
| Diluted GAAP earnings per share | $0.29 | $0.21 | $0.89 | $0.93 |
Q3 revenue declined 3%, with net investment gains falling to $13 from $85. Lower benefits and expenses and a lower tax provision helped lift Q3 common-stockholder net income. For the nine-month period, revenue declined 3% and pretax income declined 16%; net investment results swung to a $32 loss from a $220 gain. Adjusted operating income rose in both the quarter and year-to-date, reflecting stronger mortgage insurance results, while nine-month GAAP common-stockholder income declined.
- Cash flow: Nine-month operating cash flow was $973, down from $1,932. Investing activities provided $69, versus $678 used in 2017; financing used $1,350, versus $1,270. Cash, cash equivalents and restricted cash ended at $2,505, down from $2,875 at year-end 2017.
- Balance sheet and debt: September 30 total assets were $102,121 and total equity $14,621, compared with $105,297 and $15,328 at December 31, 2017. Long-term borrowings were $4,051, down from $4,224. The balance sheet also included $310 of non-recourse funding obligations.
- Debt refinancing: Genworth Holdings raised a $450 secured term loan in March 2018, with a 6.6% rate at September 30 and a March 2023 maturity. It used loan proceeds and $175 of cash to redeem $597 of May 2018 senior notes; the term loan is secured in part by Genworth Canada shares.
- Liquidity constraints: Insurance subsidiaries’ dividends are subject to regulatory restrictions. Approximately $500 could be paid to the holding company in 2018 without regulatory approval, but this was not assured; $12.4 billion of Genworth Financial subsidiary net assets were restricted. The company’s common-stock dividend and share repurchases remained suspended indefinitely.
- Margins and reserves: U.S. mortgage insurance loss ratio was 11% in Q3 and 4% for the nine months, versus 20% and 13%, respectively. Canada’s loss ratio was 14% in Q3 and 14% year to date (11% year-to-date in 2017); Australia’s was 31% in Q3 and 30% year to date. Long-term care insurance loss ratio rose to 81% year to date from 74%.
Material changes and segment trends
- U.S. Mortgage Insurance: Adjusted operating income was $118 in Q3 versus $73, and $366 year to date versus $237. Higher in-force premiums, fewer new delinquencies and lower taxes contributed. Primary insurance in-force grew 10% year over year to $163.2 billion; Q3 new insurance written fell 9%, partly after the loss of a large customer. Delinquency rate was 2.18%, down from 2.81% a year earlier.
- Canada Mortgage Insurance: Adjusted operating income was $44 in Q3 versus $37 and $139 year to date versus $114. Lower taxes helped, while the company cited lower premiums in Q3 and higher year-to-date losses. The nine-month loss ratio rose to 14% from 11%; management expected the full-year 2018 loss ratio to exceed 2017’s 10%.
- Australia Mortgage Insurance: Adjusted operating income was $17 in Q3 versus $12 and $58 year to date versus $37. Updated premium recognition factors from a 2017 review boosted earned premiums. Primary insurance in-force declined 12% year over year to $222.5 billion, reflecting currency movements, seasoning and lower production. The annual premium-earnings-pattern review was due in Q4 2018; its outcome and potential financial impact were not yet estimable.
- U.S. Life Insurance: Adjusted operating loss was $3 in Q3 versus a $1 loss; year-to-date adjusted operating income fell to $49 from $91. Long-term care drove the deterioration: its adjusted result was a $24 Q3 loss and a $34 nine-month loss, versus a $5 Q3 loss and $42 nine-month income in 2017. Higher claim severity, frequency and benefit utilization outweighed rate-action benefits. Fixed annuities improved, while life insurance remained weak.
- Runoff: Adjusted operating income was $14 in Q3 versus $13; year-to-date it was $37 versus $38. Lower fees and investment results were largely offset by other items.
Outlook, transaction, risks and unusual items
- China Oceanwide transaction: The proposed acquisition is valued at about $2.7 billion, or $5.43 per share in cash, and remained subject to regulatory approvals and other closing conditions. The parties extended their termination waiver to December 1, 2018, while noting regulatory review could extend beyond that date. The Delaware insurance regulator scheduled a public hearing for November 28, 2018. China’s NDRC had accepted the filing in October.
- The parties waived the planned GLAIC unstacking and China Oceanwide’s related $525 contribution, and waived a separate $600 contribution originally intended to address the May 2018 notes. A $1.5 billion post-closing capital investment plan was agreed, subject to transaction closing and regulatory approvals; final contributions were planned by March 31, 2020. Genworth Holdings also agreed to contribute $175 to GLIC after closing in three tranches through January 2020. China Oceanwide has no current intention or future obligation to provide additional capital specifically for legacy long-term care.
- If the deal does not close, management said it would continue to explore alternatives, including potential sales of the Canadian or Australian mortgage insurance businesses and a possible partial sale of U.S. mortgage insurance. Management cited potential pressure on ratings, capital, debt refinancing and the ability to sell long-term care policies if external capital is unavailable.
- Long-term care actions and estimates: During the first nine months, 85 state approvals covered rate increases averaging 53% on about $526 million of annualized in-force premiums; 53 additional filings covered about $335 million. Management planned a Q4 2018 claim-reserve assumption and methodology review, alongside other life insurance assumption reviews, loss recognition testing and statutory cash-flow testing. It warned the reviews could materially affect results; the filing did not provide an estimate of any potential reserve impact.
- Capital and ratings: U.S. mortgage insurance was compliant with PMIERs at approximately 130% of required assets, with more than $750 million of excess available assets. Under PMIERs 2.0, effective March 31, 2019, estimated sufficiency was approximately 120%, or more than $550 million above requirements. S&P downgraded principal life insurers to B- in September and placed certain company and mortgage insurer ratings on developing CreditWatch. A.M. Best affirmed ratings and assigned a stable outlook in July.
- Tax and market effects: The Tax Cuts and Jobs Act lowered the U.S. federal rate to 21%; reported effective tax rates were 23.0% for Q3 and 27.5% year to date. Investment-market declines produced a $1,189 nine-month other comprehensive loss, including losses on securities and hedges, contributing to lower equity. Management said interest rates and exchange rates, particularly the stronger U.S. dollar against the Canadian and Australian dollars, affect results and balance-sheet values.
- Legal and other contingencies: Matters included an AXA dispute seeking more than £28 million plus possible additional amounts, a September 2018 putative class action concerning life-policy cost-of-insurance charges, and a Delaware action alleging inadequate capital at a life insurer. Genworth said outcomes and reasonably possible losses generally could not be estimated. Other risks include long-term care reserve uncertainty, mortgage market competition, regulatory capital requirements, counterparty and investment risk, and dependence on subsidiary dividends.
Most important facts for investors to verify
- Whether the China Oceanwide transaction closes, its timing, all required approvals and the conditions attached to the planned $1.5 billion capital contributions.
- The outcome of the Q4 long-term care claims and assumption review, including reserve, margin, DAC and statutory capital effects.
- Whether long-term care rate approvals and implementation adequately offset rising claims and benefit utilization.
- Cash available at the holding company, debt maturities and refinancing options, term-loan covenants, and the practical availability of subsidiary dividends or asset-sale proceeds.
- Mortgage insurance capital and ratings headroom under PMIERs 2.0, and the effects of competition, customer concentration and housing-market changes.
- Australia’s premium-earnings-pattern review and the sustainability of reported mortgage insurance earnings, as well as developments in disclosed litigation and insurance-subsidiary ratings.