Form 10-Q
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, 2007

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 is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large Accelerated Filer  x                     Accelerated Filer  ¨                    Non-Accelerated Filer  ¨

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 22, 2007, 438,642,744 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

  

Item 1. Financial Statements

   3

Condensed Consolidated Statements of Income for the three and nine months ended September 30, 2007 and 2006 (Unaudited)

   3

Condensed Consolidated Balance Sheets as of September 30, 2007 (Unaudited) and December 31, 2006

   4

Condensed Consolidated Statements of Changes in Stockholders’ Equity for the nine months ended September 30, 2007 and 2006 (Unaudited)

   5

Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2007 and 2006 (Unaudited)

   6

Notes to Condensed Consolidated Financial Statements (Unaudited)

   7

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

   19

Item 3. Quantitative and Qualitative Disclosures About Market Risk

   77

Item 4. Controls and Procedures

   77

PART II—OTHER INFORMATION

  

Item 1. Legal Proceedings

   78

Item 1A. Risk Factors

   79

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

   80

Item 6. Exhibits

   80

Signatures

   81

 

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,

 
         2007             2006             2007             2006      

Revenues:

        

Premiums

   $ 1,600     $ 1,505     $ 4,660     $ 4,356  

Net investment income

     1,074       932       3,082       2,784  

Net investment gains (losses)

     (48 )     (6 )     (118 )     (77 )

Insurance and investment product fees and other

     249       184       726       565  
                                

Total revenues

     2,875       2,615       8,350       7,628  
                                

Benefits and expenses:

        

Benefits and other changes in policy reserves

     1,168       1,061       3,325       2,954  

Interest credited

     391       382       1,167       1,132  

Acquisition and operating expenses, net of deferrals

     540       493       1,524       1,412  

Amortization of deferred acquisition costs and intangibles

     202       160       622       521  

Interest expense

     124       87       355       257  
                                

Total benefits and expenses

     2,425       2,183       6,993       6,276  
                                

Income from continuing operations before income taxes

     450       432       1,357       1,352  

Provision for income taxes

     111       138       383       430  
                                

Income from continuing operations

     339       294       974       922  

Income from discontinued operations, net of taxes

     —         10       15       29  

Gain on sale of discontinued operations, net of taxes

     —         —         53       —    
                                

Income before cumulative effect of accounting change

     339       304       1,042       951  

Cumulative effect of accounting change, net of taxes

     —         —         —         4  
                                

Net income

   $ 339     $ 304     $ 1,042     $ 955  
                                

Earnings from continuing operations per common share:

        

Basic

   $ 0.77     $ 0.64     $ 2.21     $ 2.01  
                                

Diluted

   $ 0.76     $ 0.63     $ 2.16     $ 1.95  
                                

Earnings per common share:

        

Basic

   $ 0.77     $ 0.67     $ 2.36     $ 2.08  
                                

Diluted

   $ 0.76     $ 0.65     $ 2.32     $ 2.02  
                                

Weighted-average common shares outstanding:

        

Basic

     441.1       453.8       440.5       458.8  
                                

Diluted

     445.6       467.2       449.8       471.7  
                                

See Notes to Condensed Consolidated Financial Statements

 

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GENWORTH FINANCIAL, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Amounts in millions, except per share amounts)

 

    

September 30,

2007

   

December 31,

2006

 
     (Unaudited)        

Assets

    

Investments:

    

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

   $ 55,775     $ 54,684  

Equity securities available-for-sale, at fair value

     247       197  

Commercial mortgage loans

     8,839       8,357  

Policy loans

     1,650       1,489  

Other invested assets

     3,803       3,846  
                

Total investments

     70,314       68,573  

Cash and cash equivalents

     3,146       2,436  

Accrued investment income

     803       742  

Deferred acquisition costs

     6,842       6,183  

Intangible assets

     845       831  

Goodwill

     1,605       1,602  

Reinsurance recoverable

     16,573       16,783  

Other assets

     1,015       864  

Separate account assets

     12,615       10,875  

Assets associated with discontinued operations

     —         1,982  
                

Total assets

   $ 113,758     $ 110,871  
                

Liabilities and stockholders’ equity

    

Liabilities:

    

Future annuity and contract benefits

   $ 63,717     $ 63,299  

Liability for policy and contract claims

     3,473       3,114  

Unearned premiums

     5,511       4,229  

Other policyholder liabilities

     335       385  

Other liabilities

     6,024       5,709  

Non-recourse funding obligations

     3,455       2,765  

Short-term borrowings

     326       199  

Long-term borrowings

     3,789       3,921  

Mandatorily redeemable preferred stock

     100       100  

Deferred tax liability

     1,096       1,522  

Separate account liabilities

     12,615       10,875  

Liabilities associated with discontinued operations

     —         1,423  
                

Total liabilities

     100,441       97,541  
                

Commitments and contingencies

    

Stockholders’ equity:

    

Class A common stock, $0.001 par value; 1.5 billion shares authorized; 521 million and 493 million shares issued as of September 30, 2007 and December 31, 2006, respectively; 439 million and 443 million shares outstanding as of September 30, 2007 and December 31, 2006, respectively

     1       —    

Additional paid-in capital

     11,440       10,759  
                

Accumulated other comprehensive income (loss):

    

Net unrealized investment gains (losses)

     (353 )     435  

Derivatives qualifying as hedges

     285       375  

Foreign currency translation and other adjustments

     765       347  
                

Total accumulated other comprehensive income (loss)

     697       1,157  

Retained earnings

     3,779       2,914  

Treasury stock, at cost (82 million and 50 million shares as of September 30, 2007 and December 31, 2006, respectively)

     (2,600 )     (1,500 )
                

Total stockholders’ equity

     13,317       13,330  
                

Total liabilities and stockholders’ equity

   $ 113,758     $ 110,871  
                

See Notes to Condensed Consolidated Financial Statements

 

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GENWORTH FINANCIAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

(Amounts in millions)

(Unaudited)

 

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

Balances as of December 31, 2005

   $ 10,671    $ 1,404     $ 1,735     $ (500 )   $ 13,310  
                 

Comprehensive income (loss):

           

Net income

     —        —         955       —         955  

Net unrealized gains (losses) on investment securities

     —        (323 )     —         —         (323 )

Derivatives qualifying as hedges

     —        (12 )     —         —         (12 )

Foreign currency translation and other adjustments

     —        97       —         —         97  
                 

Total comprehensive income (loss)

              717  

Acquisition of treasury stock

     —        —         —         (675 )     (675 )

Dividends to stockholders

     —        —         (109 )     —         (109 )

Stock-based compensation expense and exercises

     61      —         —         —         61  

Other capital transactions

     5      —         —         —         5  
                                       

Balances as of September 30, 2006

   $ 10,737    $ 1,166     $ 2,581     $ (1,175 )   $ 13,309  
                                       

 

     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, 2006

   $  —      $ 10,759    $ 1,157     $ 2,914     $ (1,500 )   $ 13,330  
                    

Cumulative effect of accounting change

     —        —        —         (54 )     —         (54 )

Comprehensive income (loss):

              

Net income

     —        —        —         1,042       —         1,042  

Net unrealized gains (losses) on investment securities

     —        —        (788 )     —         —         (788 )

Derivatives qualifying as hedges

     —        —        (90 )     —         —         (90 )

Foreign currency translation and other adjustments

     —        —        418       —         —         418  
                    

Total comprehensive income (loss)

                 582  

Issuance of common stock

     1      600      —         —         —         601  

Acquisition of treasury stock

     —        —        —         —         (1,100 )     (1,100 )

Dividends to stockholders

     —        —        —         (123 )     —         (123 )

Stock-based compensation expense and exercises

     —        78      —         —         —         78  

Other capital transactions

     —        3      —         —         —         3  
                                              

Balances as of September 30, 2007

   $ 1    $ 11,440    $ 697     $ 3,779     $ (2,600 )   $ 13,317  
                                              

See Notes to Condensed Consolidated Financial Statements

 

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GENWORTH FINANCIAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Amounts in millions)

(Unaudited)

 

     Nine months
ended
September 30,
 
     2007     2006  

Cash flows from operating activities:

    

Net income

   $ 1,042     $ 955  

Less income from discontinued operations, net of taxes

     (15 )     (29 )

Less gain on sale from discontinued operations, net of taxes

     (53 )     —    

Adjustments to reconcile net income to net cash from operating activities:

    

Amortization of fixed maturity discounts and premiums

     (32 )     16  

Net investment losses (gains)

     118       77  

Charges assessed to policyholders

     (291 )     (255 )

Acquisition costs deferred

     (1,054 )     (874 )

Amortization of deferred acquisition costs and intangibles

     622       521  

Deferred income taxes

     217       215  

Cumulative effect of accounting change

     —         (4 )

Purchases of trading securities and held-for-sale investments, net of proceeds from sales

     (145 )     —    

Change in certain assets and liabilities:

    

Accrued investment income and other assets

     (202 )     (48 )

Insurance reserves

     2,389       2,424  

Current tax liabilities

     163       105  

Other liabilities and other policy-related balances

     984       214  

Cash from operating activities—discontinued operations

     25       33  
                

Net cash from operating activities

     3,768       3,350  
                

Cash flows from investing activities:

    

Proceeds from maturities and repayments of investments:

    

Fixed maturities

     4,505       4,121  

Commercial mortgage loans

     910       825  

Proceeds from sales of investments:

    

Fixed maturities and equity securities

     5,038       3,679  

Purchases and originations of investments:

    

Fixed maturities and equity securities

     (10,370 )     (8,143 )

Commercial mortgage loans

     (1,343 )     (1,517 )

Other invested assets, net

     (998 )     (39 )

Policy loans, net

     (161 )     (148 )

Payments for businesses purchased, net of cash acquired

     —         (291 )

Cash received from sale of discontinued operations, net of cash sold

     514       —    

Cash from investing activities—discontinued operations

     103       (41 )
                

Net cash from investing activities

     (1,802 )     (1,554 )
                

Cash flows from financing activities:

    

Proceeds from issuance of investment contracts

     5,844       5,585  

Redemption and benefit payments on investment contracts

     (7,111 )     (7,396 )

Short-term borrowings and other, net

     78       158  

Redemption of non-recourse funding obligations

     (100 )     —    

Proceeds from issuance of non-recourse funding obligations

     790       1,050  

Repayment of long-term debt

     (500 )     —    

Proceeds from the issuance of long-term debt

     349       —    

Dividends paid to stockholders

     (119 )     (103 )

Stock-based compensation awards exercised

     29       32  

Acquisition of treasury stock

     (1,100 )     (675 )

Proceeds from issuance of common stock

     600       —    

Cash from financing activities—discontinued operations

     (21 )     (2 )
                

Net cash from financing activities

     (1,261 )     (1,351 )

Effect of exchange rate changes on cash and cash equivalents

     (28 )     (18 )
                

Net change in cash and cash equivalents

     677       427  

Cash and cash equivalents at beginning of period

     2,469       1,875  
                

Cash and cash equivalents at end of period

     3,146       2,302  

Less cash and cash equivalents of discontinued operations at end of period

     —         6  
                

Cash and cash equivalents of continuing operations at end of period

   $ 3,146     $ 2,296  
                

See Notes to Condensed Consolidated Financial Statements

 

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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 in preparation for the corporate formation of certain insurance and related subsidiaries of the General Electric Company (“GE”) and an initial public offering of Genworth common stock, which was completed on May 28, 2004 (“IPO”). In connection with the IPO, Genworth acquired substantially all of the assets and liabilities of GE Financial Assurance Holdings, Inc. (“GEFAHI”). Prior to its IPO, Genworth was a wholly-owned subsidiary of GEFAHI, which was an indirect subsidiary of GE.

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 a variety of protection, wealth accumulation, retirement income and institutional products. Protection products include: life insurance, long-term care insurance and a linked-benefits product that combines long-term care insurance with universal life insurance. Additionally, as part of our senior market products and services, we offer Medicare supplement insurance along with wellness and care coordination services for our long-term care policyholders. Our wealth accumulation and retirement income products principally include: fixed and variable deferred and immediate individual annuities, group variable annuities offered through retirement plans, and a variety of managed account programs, financial planning advisory services and mutual funds. Institutional products include: funding agreements, funding agreements backing notes (“FABNs”) and guaranteed investment contracts (“GICs”).

 

   

International. In Canada, Australia, New Zealand, Mexico, Japan and multiple European countries, we are a leading provider of mortgage insurance products. We are the largest private mortgage insurer in most of our international markets. We also provide mortgage insurance on a structured, or bulk basis, which aids in the sale of mortgages to the capital markets and helps lenders manage capital and risks. Additionally, we offer services, analytical tools and technology that enable lenders to operate more efficiently and more effectively manage risk. We also offer payment protection coverages in multiple European countries, Canada and Mexico. Our payment 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 predominately insuring prime-based, individually underwritten residential mortgage loans, also known as “flow” mortgage insurance. We also have begun to increasingly 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 more efficiently and more effectively 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, the results of a small, non-core business that is managed outside our operating segments and our group life and health insurance business which was sold on May 31, 2007.

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

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

United States 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. These condensed consolidated financial statements include all adjustments considered necessary by management to present a fair statement of the financial position, results of operations 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 2006 Annual Report on Form 10-K and our Current Report on Form 8-K filed on April 16, 2007 (reflecting our reorganized segment reporting structure and the effects of classifying our group life and health insurance business as discontinued operations).

(2) Accounting Pronouncements

Recently adopted

On December 31, 2006, we adopted Financial Accounting Standards Board (“FASB”) Statement of Financial Accounting Standards (“SFAS”) No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans. Upon adoption, we recorded a $31 million reduction in comprehensive income in our consolidated statement of changes in stockholders’ equity as of December 31, 2006. However, the cumulative effect of change in accounting, net of tax, should have been recorded as a separate component of accumulated other comprehensive income. As of December 31, 2006, we reported total comprehensive income of $1,081 million. With this revised presentation, total comprehensive income would have been $1,112 million as of December 31, 2006. This revised presentation will be reflected in our Annual Report on Form 10-K as of December 31, 2007.

On January 1, 2007, we adopted FASB Interpretation (“FIN”) No. 48, Accounting for Uncertainty in Income Taxes. This guidance clarifies the criteria that must be satisfied to recognize the financial statement benefit of a position taken in our tax returns. The criteria for recognition in the consolidated financial statements set forth in FIN No. 48 require an affirmative determination that it is more likely than not, based on a tax position’s technical merits, that we are entitled to the benefit of that position.

Upon adoption of FIN No. 48 on January 1, 2007, the total amount of unrecognized tax benefits was $362 million, of which, $190 million, if recognized, would affect the effective tax rate on continuing operations. As of January 1, 2007, we had accrued interest and penalties of $30 million in our condensed consolidated balance sheet. These amounts of interest and penalties relate to unrecognized tax benefits and were recognized as components of income tax expense.

We file U.S. federal income tax returns and various state and local and foreign income tax returns. With few exceptions, we are no longer subject to U.S. federal or foreign income tax examinations for years prior to 2000. Potential state and local examinations for those years are generally restricted to results that are based on closed U.S. federal examinations. A U.S. federal field examination regarding the 2003 and 2004 tax years was concluded in September 2007, and a Revenue Agent Report was issued. Certain issues are currently under review by the Joint Committee of Taxation for 2000 through 2002 tax years and in the Internal Revenue Service administrative appeals process for 2003 and 2004 tax years. HM Revenue and Customs is currently reviewing our U.K. income tax returns for the 2000 through 2004 tax years.

We believe that it is reasonably possible that in 2007, up to approximately $57 million of unrecognized tax benefits, related to individually immaterial items in the U.S. and foreign jurisdictions, will be recognized.

On January 1, 2007, we adopted the American Institute of Certified Public Accountants (“AICPA”) Statement of Position (“SOP”) 05-1, Accounting by Insurance Enterprises for Deferred Acquisition Costs in

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

Connection With Modifications or Exchanges of Insurance Contracts. This statement provides guidance on accounting for deferred acquisition costs and other balances on an internal replacement, defined broadly as a modification in product benefits, features, rights or coverages that occurs by the exchange of an existing contract for a new contract, or by amendment, endorsement or rider to an existing contract, or by the election of a benefit, feature, right or coverage within an existing contract. The adoption of SOP 05-1 resulted in the shortening of the period over which our group life and health insurance business deferred acquisition costs are amortized. Transition to the shorter amortization period resulted in a January 1, 2007 cumulative effect adjustment to retained earnings of $54 million, net of tax. The cumulative effect of adoption of SOP 05-1 relates to our discontinued operations which we sold on May 31, 2007.

Not yet adopted

In September 2006, FASB issued SFAS No. 157, Fair Value Measurements. This statement defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. SFAS No. 157 is effective for us on January 1, 2008. We do not expect SFAS No. 157 to have a material impact on our consolidated financial statements.

In February 2007, FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities. This statement provides an option to report selected financial assets and liabilities, including insurance contracts, at fair value. SFAS No. 159 will be effective for us on January 1, 2008. We have not decided whether we will elect the fair value option for any financial assets or liabilities; and therefore, we do not know the impact, if any, SFAS No. 159 will have on our consolidated financial statements.

In June 2007, the AICPA issued SOP 07-1, Clarification of the Scope of the Audit and Accounting Guide Investment Companies and Accounting by Parent Companies and Equity Method Investors for Investments in Investment Companies. This statement provides guidance for determining whether an entity is within the scope of the AICPA Audit and Accounting Guide Investment Companies (the “Guide”). For those entities that are investment companies under SOP 07-1, it also addresses when specialized industry accounting principles of the Guide should be retained by a parent company in consolidation or by an investor that has the ability to exercise significant influence over the investment company and applies the equity method of accounting to its investment in the entity. In addition, SOP 07-1 includes certain disclosure requirements for parent companies and equity method investors in investment companies that retain Investment Company accounting in the parent company’s consolidated financial statements or the financial statements of an equity method investor. The effective date of SOP 07-1 is uncertain as the FASB decided to issue a proposed FASB Staff Position that would indefinitely defer the effective date. Management is reviewing SOP 07-1 to determine the impact on our consolidated financial statements.

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

(3) Earnings per Common Share

Basic and diluted earnings per common share are calculated by dividing net income by the weighted average basic common shares outstanding and by the weighted average diluted common shares outstanding:

 

     Three months
ended September 30,
  

Nine months

ended September 30,

(Amounts in millions, except per share data)

       2007            2006            2007            2006    

Basic earnings per common share:

           

Income from continuing operations

   $ 0.77    $ 0.64    $ 2.21    $ 2.01

Income from discontinued operations, net of taxes

     —        0.02      0.03      0.06

Gain from discontinued operations, net of taxes

     —        —        0.12      —  

Cumulative effect of accounting change, net of taxes

     —        —        —        0.01
                           

Basic earnings per common share(1)

   $ 0.77    $ 0.67    $ 2.36    $ 2.08
                           

Diluted earnings per common share:

           

Income from continuing operations

   $ 0.76    $ 0.63    $ 2.16    $ 1.95

Income from discontinued operations, net of taxes

     —        0.02      0.03      0.06

Gain from discontinued operations, net of taxes

     —        —        0.12      —  

Cumulative effect of accounting change, net of taxes

     —        —        —        0.01
                           

Diluted earnings per common share(1)

   $ 0.76    $ 0.65    $ 2.32    $ 2.02
                           

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

     441.1      453.8      440.5      458.8

Potentially dilutive securities:

           

Stock purchase contracts underlying Equity Units

     —        8.1      4.2      7.7

Stock options, restricted stock units and stock appreciation rights

     4.5      5.3      5.1      5.2
                           

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

     445.6      467.2      449.8      471.7
                           

(1)

May not total due to whole number calculation.

Revision to Previously Reported 2006 Quarterly Earnings Per Share Amounts

Certain 2006 quarterly earnings per share amounts previously presented in our 2006 consolidated financial statements in the Current Report on Form 8-K filed on April 16, 2007 (reflecting our reorganized segment reporting structure and the effects of classifying our group life and health insurance business as discontinued operations) have been revised to correct immaterial rounding errors. The immaterial rounding errors had no impact on the earnings per share amounts for the twelve months ended December 31, 2006. In addition, this revision had no impact on our 2006 earnings per share amounts presented in our Quarterly Reports on Form 10-Q filed in the first and second quarters of 2007. This revision also had no impact on our quarterly earnings per share amounts as originally reported in our 2006 Quarterly Reports on Form 10-Q.

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

The following table summarizes the revised earnings per share amounts for the periods indicated:

 

     For the three months ended,
     March 31,
2006
   June 30,
2006
   September 30,
2006
   December 31,
2006

Revised earnings per share amounts:

           

Basic earnings per common share:

           

Income from continuing operations

   $   0.69    $   0.67    $   0.64    $   0.81

Income from discontinued operations, net of taxes

     0.02      0.02      0.02      0.03

Cumulative effect of accounting change, net of taxes

     0.01      —        —        —  
                           

Basic earnings per common share(1)

   $ 0.72    $ 0.70    $ 0.67    $ 0.83
                           

Diluted earnings per common share:

           

Income from continuing operations

   $ 0.67    $ 0.66    $ 0.63    $ 0.78

Income from discontinued operations, net of taxes

     0.02      0.02      0.02      0.03

Cumulative effect of accounting change, net of taxes

     0.01      —        —        —  
                           

Diluted earnings per common share(1)

   $ 0.70    $ 0.68    $ 0.65    $ 0.81
                           

(1)

May not total due to whole number calculation.

(4) Discontinued Operations

Sale of Group Life and Health Insurance Business

On May 31, 2007, we completed the sale of our group life and health insurance business for cash consideration of approximately $660 million. Accordingly, the business has been accounted for as discontinued operations and its results of operations, financial position and cash flows are separately reported for all periods presented. The sale resulted in a gain on sale of discontinued operations of $53 million, net of taxes.

Summary operating results of discontinued operations were as follows for the periods indicated:

 

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

(Amounts in millions)

       2007            2006            2007            2006    

Revenues

   $   —      $ 190    $ 318    $ 556
                           

Income before income taxes

   $ —      $ 15    $ 24    $ 45

Provision for income taxes

     —        5      9      16
                           

Income from discontinued operations

   $ —      $ 10    $ 15    $ 29
                           

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

The assets and liabilities associated with discontinued operations have been segregated in the condensed consolidated balance sheets. The major asset and liability categories were as follows:

 

(Amounts in millions)

  

December 31,

2006

Assets:

  

Investments

   $ 903

Cash and cash equivalents

     33

Deferred acquisition costs

     142

Intangible assets and goodwill

     145

Reinsurance recoverable and other assets

     759
      

Assets associated with discontinued operations

   $ 1,982
      

Liabilities:

  

Future annuity and contract benefits

   $ 837

Liability for policy and contract claims

     428

Unearned premiums, other liabilities and deferred tax liability

     158
      

Liabilities associated with discontinued operations

   $ 1,423
      

(5) Investments and Derivative Instruments

As of September 30, 2007, the amortized cost or cost, gross unrealized gains (losses) and estimated fair value of our fixed maturities and equity securities classified as available-for-sale were as follows:

 

(Amounts in millions)

   Amortized
cost or
cost
   Gross
unrealized
gains
   Gross
unrealized
losses
    Estimated
fair value

Fixed maturities:

          

U.S. government, agencies and government sponsored entities

   $ 622    $ 25    $ (2 )   $ 645

Tax exempt

     2,088      78      (11 )     2,155

Government—non U.S.

     2,238      74      (18 )     2,294

U.S. corporate

     23,768      394      (622 )     23,540

Corporate—non U.S.

     12,628      125      (288 )     12,465

Mortgage and asset-backed

     15,100      110      (534 )     14,676
                            

Total fixed maturities

     56,444      806      (1,475 )     55,775

Equity securities

     218      35      (6 )     247
                            

Total available-for-sale securities

   $ 56,662    $ 841    $ (1,481 )   $ 56,022
                            

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

As of December 31, 2006, the amortized cost or cost, gross unrealized gains (losses) and estimated fair value of our fixed maturities and equity securities classified as available-for-sale were as follows:

 

(Amounts in millions)

   Amortized
cost or
cost
   Gross
unrealized
gains
   Gross
unrealized
losses
    Estimated
fair value

Fixed maturities:

          

U.S. government, agencies and government sponsored entities

   $ 850    $ 21    $ (7 )   $ 864

Tax exempt

     2,126      106      (1 )     2,231

Government—non U.S.

     1,688      83      (6 )     1,765

U.S. corporate

     24,350      639      (333 )     24,656

Corporate—non U.S.

     10,567      204      (139 )     10,632

Mortgage and asset-backed

     14,490      141      (95 )     14,536
                            

Total fixed maturities

     54,071      1,194      (581 )     54,684

Equity securities

     171      28      (2 )     197
                            

Total available-for-sale securities

   $ 54,242    $ 1,222    $ (583 )   $ 54,881
                            

The fair value of derivative instruments, including interest rate and foreign currency swaps, forward commitments, equity index options and financial futures, is based upon either independent market quotations or pricing valuation models which utilize independent third-party data as inputs. The following table sets forth our positions in derivative instruments and the estimated fair values as of the dates indicated:

 

     September 30, 2007    December 31, 2006  

(Amounts in millions)

   Notional
value
   Estimated
fair value
   Notional
value
   Estimated
fair value
 

Interest rate swaps

   $ 22,819    $ 343    $ 17,832    $ 496  

Foreign currency swaps

     768      3      567      (8 )

Forward commitments

     56      2      —        —    

Equity index options

     771      72      323      22  

Financial futures

     78      —        19      —    
                             

Total

   $ 24,492    $ 420    $ 18,741    $ 510  
                             

As of September 30, 2007 and December 31, 2006, the fair value of derivatives in a gain position and recorded in other invested assets was $496 million and $543 million, respectively, and the fair value of derivatives in a loss position and recorded in other liabilities was $76 million and $33 million, respectively.

(6) Commitments and Contingencies

(a) Litigation

We face the risk of litigation and regulatory investigations and actions in the ordinary course of operating our businesses, including class action lawsuits. Our pending legal and regulatory actions include proceedings specific to us and others generally applicable to business practices in the industries in which we operate. Plaintiffs in class action and other lawsuits against us may seek indeterminate amounts which may remain unknown for substantial periods of time. A substantial legal liability or a significant regulatory action against us could have an adverse effect on our financial condition and results of operations. Moreover, even if we ultimately prevail in the litigation, regulatory action or investigation, we could suffer reputational harm, which could have

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

an adverse effect on our business, financial condition or results of operations. At this time, it is not feasible to predict, nor to determine the ultimate outcomes of all pending investigations and legal proceedings, nor to provide reasonable ranges of potential losses.

(b) Commitments

As of September 30, 2007, we were committed to fund $303 million in U.S. commercial mortgage loan investments and $515 million in limited partnership investments.

(c) Accelerated Stock Repurchase

In May 2007, we repurchased 16.5 million shares of our Class A Common Stock under an accelerated share repurchase transaction with a broker-dealer counterparty for an initial aggregate purchase price of $600 million. We funded the purchase price with proceeds from the issuance and sale of Class A Common Stock pursuant to the settlement of purchase contracts that were components of our Equity Units. The repurchased shares will be held in treasury, until such time as they may be reissued or retired.

As part of this transaction, we simultaneously entered into a forward contract indexed to the price of our Class A Common Stock, which subjects the transaction to a future price adjustment. Upon settlement of the contract, the price adjustment was calculated based on the arithmetic mean of the volume weighted average price of our Class A Common Stock during the term of the agreement, less a discount. In October 2007, this forward contract was settled resulting in the broker-dealer counterparty’s commitment to deliver $72 million in shares of Class A Common Stock to us in the fourth quarter of 2007.

(d) Pending Acquisition

On July 18, 2007, we entered into an agreement to acquire Liberty Reverse Mortgage, Inc., an independent reverse mortgage lender, for $50 million plus additional contingent consideration. The transaction is subject to regulatory approvals and expected to close in the fourth quarter of 2007.

(7) Borrowings and Other Financings

Commercial Paper Facility

We have a $1.0 billion commercial paper program. The notes under the commercial paper program are offered pursuant to an exemption from registration under the Securities Act of 1933 and may have a maturity of up to 364 days from the date of issue. During the first quarter of 2007, we issued $50 million of commercial paper, which was repaid during the second quarter of 2007. During the third quarter of 2007, we issued $127 million of commercial paper. As of September 30, 2007 and December 31, 2006, the weighted average interest rate on commercial paper outstanding was 5.2% and the weighted average maturity was 29 days and 37 days, respectively.

Long-term Senior Notes

In June 2007, we issued senior notes having an aggregate principal amount of $350 million, with an interest rate equal to 5.65% per year payable semi-annually, and maturing in June 2012 (“2012 Notes”). The 2012 Notes are our direct, unsecured obligations and will rank equally with all of our existing and future unsecured and unsubordinated obligations. We have the option to redeem all or a portion of the 2012 Notes, at any time with proper notice to the note holders at a price equal to the greater of 100% of principal or the sum of the present

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

value of the remaining scheduled payments of principal and interest discounted at the then-current treasury rate plus an applicable spread. The net proceeds of $349 million from the issuance of the 2012 Notes were used to partially repay $500 million of our senior notes which matured in June 2007, with the remainder repaid with cash on hand.

Equity Units

In May 2007, Equity Unit holders purchased 25.5 million of newly issued shares of our Class A Common Stock equal to the settlement rate specified in the stock purchase contract component of the Equity Units for $600 million. In May 2007, we also remarketed the senior notes underlying our Equity Units pursuant to their terms. The interest rate on the senior notes was reset to 5.231%.

Non-recourse Funding Obligations

In April 2007, River Lake Insurance Company IV Limited (“River Lake IV”), a Bermuda long-term insurance company wholly-owned by Genworth Life and Annuity Insurance Company (“GLAIC”), itself an indirect wholly-owned subsidiary of Genworth, issued $500 million in aggregate principal amount of floating rate guaranteed notes due 2028 (the “Guaranteed Notes”) and $40 million in aggregate principal amount of floating rate subordinated notes due 2028 (the “Subordinated Notes” and, together with the Guaranteed Notes, the “Notes”). The Notes were issued pursuant to an indenture, which by its terms requires River Lake IV to pledge substantially all of its available assets to the indenture trustee as collateral for the Notes.

River Lake IV may issue additional series of its floating rate guaranteed notes up to an aggregate principal amount of $925 million (including the Notes). The Notes are direct financial obligations of River Lake IV and are not guaranteed by GLAIC or Genworth. A third-party financial guaranty insurance company (the “Insurer”) will insure the timely payment of scheduled interest payments and the repayment of principal on May 25, 2028 on all series of the floating rate guaranteed notes, including the Guaranteed Notes.

The Notes were issued by River Lake IV to primarily fund statutory reserves for policies subject to Valuation of Life Insurance Policies Regulation (more commonly known as “Regulation XXX”) and its predecessor regulations. River Lake IV has reinsured from GLAIC, on a coinsurance basis, certain term life insurance policies written or reinsured by GLAIC.

The holders of the Notes cannot require payment of principal or interest on the Notes from the Company or any of its subsidiaries, other than River Lake IV, the direct issuer of the Notes. River Lake IV will pay interest on the principal amount of the Notes on a monthly basis. The holders of the Notes will have the right to accelerate payment of principal of the Notes, subject to applicable notice and cure provisions, in the event of River Lake IV’s or the Insurer’s nonpayment of amounts due with respect to the Guaranteed Notes, River Lake IV’s bankruptcy or insolvency, the failure of the security interest in the collateral granted by River Lake IV to the indenture trustee to be perfected, the nonpayment by River Lake IV of amounts due to the Insurer, the breach in any material respect of River Lake IV’s representations or warranties, or the breach by River Lake IV of any material covenant. River Lake IV reserves the right to redeem the Notes at any time, subject to the terms of the Notes.

In June 2007, River Lake Insurance Company II (“River Lake II”), a special purpose financial captive insurance company wholly-owned by GLAIC, issued $250 million in aggregate principal amount of floating rate surplus notes due 2035. This transaction represented the third and final issuance of surplus notes by River Lake II, bringing the total aggregate principal amount of surplus notes issued by River Lake II to $850 million.

In August 2007, approximately $1.7 billion of our non-recourse funding obligations reset to the current maximum contractual rate. During the third quarter of 2007, we acquired $100 million of notes secured by our

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

non-recourse funding obligations. We have accounted for this transaction as a redemption of our non-recourse funding obligations. As of September 30, 2007 and December 31, 2006, the weighted average interest rate on our non-recourse funding obligations was 6.3% and 5.4%, respectively.

Revolving Credit Facilities

We have a $1.0 billion five-year revolving credit facility that matures in May 2012 (as extended during the second quarter of 2007 pursuant to the terms of the facility). In August 2007, we entered into a $1.0 billion five-year revolving credit facility that matures in August 2012. This facility replaces our $1.0 billion five-year credit facility that was scheduled to mature in April 2010. These facilities bear variable interest rates based on one-month LIBOR plus a margin. As of September 30, 2007, we had no borrowings under these facilities; however, we utilized $172 million of the commitment under these facilities for the issuance of a letter of credit primarily for the benefit of one of our U.S. Mortgage Insurance subsidiaries.

Commercial Mortgage Loan Repurchase Facility

In March 2007, Genworth Financial Commercial Mortgage Warehouse LLC, an indirect subsidiary of Genworth, entered into a $300 million repurchase facility maturing March 22, 2010. The facility may be permanently increased to $500 million upon 30-days’ advance written notice. The sole purpose of this facility is to finance the purchase of commercial mortgage loans with the intent to securitize such loans in the future. As of September 30, 2007, there was $43 million outstanding under this facility that was included in other liabilities in the condensed consolidated balance sheet. This facility bears a variable interest rate based on one-month LIBOR plus a margin. During the three months ended September 30, 2007, we purchased $53 million of held-for-sale commercial mortgage loans. These loans were classified as held-for-sale and carried at the lower of cost or market. These loans were included in commercial mortgage loans in the condensed consolidated balance sheet.

(8) Income Taxes

The reconciliation of the federal statutory tax rate to the effective income tax rate was as follows:

 

     Three months
ended September 30,
    Nine months
ended September 30,
 
         2007             2006             2007             2006      

Statutory U.S. federal income tax rate

   35.0 %   35.0 %   35.0 %   35.0 %

Increase (reduction) in rate resulting from:

        

State income tax, net of federal income tax effect

   (0.4 )   0.3     0.1     0.4  

Effect of foreign operations

   (1.4 )   (1.6 )   (2.9 )   (1.9 )

Benefit of tax favored investments

   (8.1 )   (3.1 )   (4.4 )   (2.8 )

Other, net

   (0.4 )   1.3     0.4     1.1  
                        

Effective rate

   24.7 %   31.9 %   28.2 %   31.8 %
                        

(9) Segment Information

On January 9, 2007, we announced a significant organizational repositioning to more directly align high growth retirement and protection, international and mortgage insurance business opportunities. Additionally, our group life and health insurance business, previously included in our former Protection segment, was included in Corporate and Other activities. The following discussion reflects our reorganized operating segments for all periods presented.

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

We conduct our operations in three operating business segments: (1) Retirement and Protection, which includes our managed money products and services, retirement income products, institutional products, life insurance and long-term care insurance; (2) International, which includes international mortgage insurance and payment protection insurance; and (3) U.S. Mortgage Insurance, which includes mortgage-related products and services that facilitate homeownership by enabling borrowers to buy homes with low-down-payment mortgages. We also have Corporate and Other activities which include interest and other debt financing expenses, other corporate income and expenses not allocated to the segments, eliminations of inter-segment transactions and the results of a small, non-core business that is managed outside of our operating segments. Our group life and health insurance business, which we agreed to sell in January 2007, was accounted for as discontinued operations and included in Corporate and Other activities. This business was sold on May 31, 2007.

We allocate invested assets, net investment income and net investment gains (losses) from Corporate and Other activities to our Retirement and Protection segment using an approach based principally upon the investment portfolios established to support the segment’s products and targeted capital levels. We do not allocate invested assets, net investment income and net investment gains (losses) from Corporate and Other activities to our International or U.S. Mortgage Insurance segments because they have their own separate investment portfolios.

We use the same accounting policies and procedures to measure segment income and assets as our consolidated net income and assets. Our chief operating decision maker evaluates segment performance and allocates resources on the basis of “net operating income.” We define net operating income (loss) as income (loss) from continuing operations excluding after-tax net investment gains (losses) and other adjustments and infrequent or unusual non-operating items. We exclude net investment gains (losses) and infrequent or unusual non-operating items because we do not consider them to be related to the operating performance of our segments and Corporate and Other activities. A significant component of our net investment gains (losses) are the result of credit-related impairments and credit-related gains and losses, the timing of which can vary significantly depending on market credit cycles. In addition, the size and timing of other investment gains (losses) are often subject to our discretion and are influenced by market opportunities, as well as asset-liability matching considerations. Infrequent or unusual non-operating items are also excluded from net operating income if, in our opinion, they are not indicative of overall operating trends. While some of these items may be significant components of net income in accordance with U.S. GAAP, we believe that net operating income, and measures that are derived from or incorporate net operating income, are appropriate measures that are useful to investors because they identify the income attributable to the ongoing operations of the business. However, net operating income (loss) is not a substitute for net income determined in accordance with U.S. GAAP. In addition, our definition of net operating income may differ from the definitions used by other companies.

There were no infrequent or unusual non-operating items excluded from net operating income during the periods presented other than a $14 million after-tax expense recorded in the first quarter of 2007 related to our segment reorganization costs.

 

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GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

The following is a summary of revenues for our segments and Corporate and Other activities for the periods indicated:

 

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

(Amounts in millions)

         2007                2006                2007                2006      

Revenues:

           

Retirement and Protection

   $ 1,949    $ 1,886    $ 5,796    $ 5,481

International

     711      538      1,922      1,593

U.S. Mortgage Insurance

     206      160      581      478

Corporate and Other

     9      31      51      76
                           

Total revenues

   $ 2,875    $ 2,615    $ 8,350    $ 7,628
                           

The following table reflects net operating income (loss) of our segments and Corporate and Other activities determined in accordance with SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information, and a reconciliation of net operating income (loss) of our segments and Corporate and Other activities to net income for the periods indicated:

 

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

(Amounts in millions)

        2007                 2006                 2007               2006        

Retirement and Protection

  $ 223     $ 170     $ 588     $ 519  

International

    140       107       405       328  

U.S. Mortgage Insurance

    39       53       170       197  

Corporate and Other

    (34 )     (33 )     (104 )     (82 )
                               

Net operating income

    368       297       1,059       962  

Net investment gains (losses), net of taxes and other adjustments

    (29 )     (3 )     (71 )     (40 )

Expenses related to reorganization, net of taxes

    —         —         (14 )     —    
                               

Income from continuing operations

    339       294       974       922  

Income from discontinued operations, net of taxes

    —         10       15       29  

Gain on sale from discontinued operations, net of taxes

    —         —         53       —    
                               

Income before cumulative effect of accounting change

    339       304       1,042       951  

Cumulative effect of accounting change, net of taxes

    —         —         —         4  
                               

Net income

  $ 339     $ 304     $ 1,042     $ 955  
                               

The following is a summary of total assets for our segments and Corporate and Other activities as of the periods indicated:

 

(Amounts in millions)

  

September 30,

2007

  

December 31,

2006

Assets:

     

Retirement and Protection

   $ 95,323    $ 92,820

International

     11,377      8,518

U.S. Mortgage Insurance

     3,157      3,237

Corporate and Other

     3,901      4,314
             

Segment assets from continuing operations

     113,758      108,889

Assets associated with discontinued operations

     —        1,982
             

Total assets

   $ 113,758    $ 110,871
             

 

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Table of Contents

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

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our unaudited condensed consolidated financial statements and related notes included herein.

Cautionary note regarding forward-looking statements

This report contains certain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements may be identified by words such as “expects,” “intends,” “anticipates,” “plans,” “believes,” “seeks,” “estimates,” “will,” or words of similar meaning and include, but are not limited to, statements regarding the outlook for our future business and financial performance. Forward-looking statements are based on management’s current expectations and assumptions, which are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict. Actual outcomes and results may differ materially due to global political, economic, business, competitive, market, regulatory and other factors and risks, including the following:

 

   

Risks relating to our businesses, including interest rate fluctuations, downturns and volatility in equity and credit markets, defaults in portfolio securities, downgrades in our financial strength and credit ratings, insufficiency of reserves, legal constraints on dividend distributions by subsidiaries, competition, availability and adequacy of reinsurance, defaults by counterparties, regulatory restrictions on our operations and changes in applicable laws and regulations, legal or regulatory investigations or actions, political or economic instability, the failure or any compromise of the security of our computer systems, and the occurrence of natural or man-made disasters or a pandemic disease;

 

   

Risks relating to our Retirement and Protection segment, including unexpected changes in morbidity and mortality, accelerated amortization of deferred acquisition costs and present value of future profits, goodwill impairments, reputational risks as a result of our plans to file for an increase in the premiums on certain in-force long-term care insurance products, medical advances such as genetic mapping research, unexpected changes in persistency rates, increases in statutory reserve requirements, and the failure of demand for long-term care insurance to increase as we expect;

 

   

Risks relating to our International segment, including political and economic instability, foreign exchange rate fluctuations, unexpected changes in unemployment rates, deterioration in economic conditions or decline in home price appreciation, unexpected increases in mortgage insurance default rates or severity of defaults, decreases in the volume of high loan-to-value international mortgage originations, increased competition with government-owned and government-sponsored entities offering mortgage insurance, changes in regulations, and growth in the global mortgage insurance market that is lower than we expect;

 

   

Risks relating to our U.S. Mortgage Insurance segment, including the influence of Fannie Mae, Freddie Mac and a small number of large mortgage lenders and investors, decreases in the volume of high loan-to-value mortgage originations or increases in mortgage insurance cancellations, increases in the use of simultaneous second mortgages and other alternatives to private mortgage insurance and reductions by lenders in the level of coverage they select, unexpected increases in mortgage insurance default rates or severity of defaults, deterioration in economic conditions or a decline in home price appreciation, increases in the use of reinsurance with reinsurance companies affiliated with our mortgage lending customers, increased competition with government-owned and government-sponsored entities offering mortgage insurance, changes in regulations, legal actions under Real Estate Settlement Practices Act, and potential liabilities in connection with our U.S. contract underwriting services; and

 

   

Other risks, including the possibility that in certain circumstances we will be obligated to make payments to GE under our tax matters agreement even if our corresponding tax savings are never realized and payments could be accelerated in the event of certain changes in control, and provisions of our certificate of incorporation and by-laws and our tax matters agreement with GE may discourage takeover attempts and business combinations that stockholders might consider in their best interests.

 

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We undertake no obligation to publicly update any forward-looking statement, whether as a result of new information, future developments or otherwise.

Overview

Our business

We are a leading financial security company in the U.S. with an expanding international presence. We have three operating segments: Retirement and Protection, International and U.S. Mortgage Insurance.

On January 9, 2007, we announced a significant organizational repositioning to more directly align high growth retirement and protection, international and mortgage insurance business opportunities. Additionally, our group life and health insurance business, previously included in our Protection segment, was included in Corporate and Other activities. This business was sold on May 31, 2007. The following discussion reflects our reorganized operating segments.

 

   

Retirement and Protection. We offer a variety of protection, wealth accumulation, retirement income and institutional products. Protection products include: life insurance, long-term care insurance and a linked-benefits product that combines long-term care insurance with universal life insurance. Additionally, as part of our senior market products and services, we offer Medicare supplement insurance along with wellness and care coordination services for our long-term care policyholders. Our wealth accumulation and retirement income products principally include: fixed and variable deferred and immediate individual annuities, group variable annuities offered through retirement plans, and a variety of managed account programs, financial planning advisory services and mutual funds. Institutional products include: funding agreements, funding agreements backing notes (“FABNs”) and guaranteed investment contracts (“GICs”). For the three months ended September 30, 2007, our Retirement and Protection segment’s net income and net operating income were $200 million and $223 million, respectively. For the nine months ended September 30, 2007, our Retirement and Protection segment’s net income and net operating income were $526 million and $588 million, respectively.

 

   

International. In Canada, Australia, New Zealand, Mexico, Japan and multiple European countries, we are a leading provider of mortgage insurance products. We are the largest private mortgage insurer in most of our international markets. We also provide mortgage insurance on a structured, or bulk basis, which aids in the sale of mortgages to the capital markets and helps lenders manage capital and risks. Additionally, we offer services, analytical tools and technology that enable lenders to operate more efficiently and more effectively manage risk. We also offer payment protection coverages in multiple European countries, Canada and Mexico. Our payment protection insurance products help consumers meet specified payment obligations should they become unable to pay due to accident, illness, involuntary unemployment, disability or death. For the three months ended September 30, 2007, our International segment’s net income and net operating income were $139 million and $140 million, respectively. For the nine months ended September 30, 2007, our International segment’s net income and net operating income were $401 million and $405 million, respectively.

 

   

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 also have begun to increasingly 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 more efficiently and more effectively manage risk. For the three months ended September 30, 2007, our U.S. Mortgage Insurance segment’s net income and net operating income were $40 million and $39 million, respectively. For the nine months ended September 30, 2007, our U.S. Mortgage Insurance segment’s net income and net operating income were $171 million and $170 million, respectively.

 

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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, the results of a small, non-core business that is managed outside our operating segments and our group life and health insurance business, which we agreed to sell in January 2007 and was accounted for as discontinued operations. This business was sold on May 31, 2007. For the three months ended September 30, 2007, Corporate and Other activities had a loss from continuing operations and a net operating loss of $40 million and $34 million, respectively. For the nine months ended September 30, 2007, Corporate and Other activities had a loss from continuing operations and a net operating loss of $124 million and $104 million, respectively.

Business trends and conditions

In recent years, our business has been, and we expect will continue to be, influenced by a number of industry-wide and product-specific trends and conditions. The discussion of business trends and conditions should be read together with the trends contained in our 2006 Annual Report on Form 10-K and in our Current Report on Form 8-K filed on April 16, 2007 (reflecting our reorganized segment reporting structure and the effects of classifying our group life and health insurance business as discontinued operations), which describe additional business trends and conditions.

General trends and conditions affecting our businesses

Volatility in credit markets

During the third quarter of 2007, credit markets experienced reduced liquidity, higher volatility and widening credit spreads across asset classes mainly as a result of marketplace uncertainty arising from higher defaults in sub-prime and Alt-A residential mortgage loans. In connection with this uncertainty, we believe investors and lenders have retreated from many investments in asset-backed securities including those associated with sub-prime and Alt-A residential mortgage loans, as well as types of debt investments with weak lender protections or those with limited transparency and/or complex features which hindered investor understanding. At the same time, investors shifted emphasis towards safety pushing up the demand for U.S. Treasury instruments. We believe these credit market conditions in the third quarter of 2007 contributed to an increase in unrealized valuation losses of $171 million, net of tax and other offsets, in our $55.8 billion investment portfolio of fixed maturity securities reflecting widening spreads in our mortgage and asset-backed securities, partially offset by a lower risk-free interest rate environment. We also believe these credit market conditions have contributed to a higher level of credit-related impairments during the three and nine months ended September 30, 2007. We expect to experience continued volatility in the valuation of our investments in fixed maturity securities, as well as generally higher level of credit-related investment losses if current credit market conditions continue. We believe, however, that the current credit environment also provides us with opportunities to invest in select asset classes and sectors that may enhance our investment yields over time. See “—Investments and Derivative Instruments” section of management discussion and analysis for additional information on our investment portfolio.

The third quarter credit market conditions resulted in an unfavorable liquidity environment for issuers of financial instruments including commercial paper, long-term debt and asset-backed securities. Credit spreads widened for many corporate issuers of commercial paper and long-term debt resulting in less favorable financing terms. This unfavorable liquidity environment did not have a material effect on our commercial paper or long-term debt financing activities.

See additional trends related to volatile credit markets in the “—Trends and conditions affecting our segments” which follows.

Trends and conditions affecting our segments

Retirement and Protection

Managed money. We offer asset management products to individual investors and support services for independent broker-dealers and registered investment advisors. The asset management industry is witnessing

 

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rapid growth in the number of independent broker-dealers and registered investment advisors, as registered representatives leave large national firms to join independent firms or form their own firms. These new smaller firms need client and back office support services and technology solutions. Furthermore, individuals are increasingly transferring their assets to separately managed products. We expect these trends to continue and most likely accelerate in the future. As a result of these trends, we have expanded our presence in this market with the October 2006 acquisition of AssetMark Investment Services, Inc. (“AssetMark”), a leading provider of open architecture asset management solutions to independent financial advisors. Our asset management products consist of separately managed accounts and managed mutual fund accounts upon which we receive a management fee based upon the amount of assets under management. The results of our asset management business are a function of net flows and investment performance of assets under management, both of which are influenced by the relative performance of our products’ underlying investments and the overall equity market environment.

Retirement income. Results for our retirement income business are affected by investment performance, interest rate levels, slope of the interest rate yield curve, net interest spreads, equity market fluctuations, mortality, policyholder lapses and new product sales. Our competitive position within many of our distribution channels and our ability to retain business depends significantly upon product features, including current and minimum crediting rates on spread-based products relative to our competitors, surrender charge periods in annuities, as well as guaranteed features we offer in variable products. We continually evaluate our competitive position based upon each of those features, and we make adjustments as appropriate to meet our target return thresholds.

The current interest rate environment coupled with the relatively flat shape of the yield curve has reduced the attractiveness of some fixed annuities relative to investment alternatives, such as certificates of deposit. This interest rate and yield curve environment has had an adverse impact on both sales and retention of fixed annuities with the latter resulting in an acceleration of the amortization of related deferred acquisition costs. In recent quarters, we have experienced improved spreads in fixed annuities associated with the runoff and crediting rate resets of lower return business. We expect these trends to continue.

We continue to focus on our Income Distribution Series of variable annuity products. We have witnessed a decline in defined benefit retirement plans in favor of defined contribution plans with more of the responsibility for retirement income planning falling on the individual. Additionally, U.S. savings rates are at historical lows. We believe these factors support demand for individual and group retirement income products that provide various forms of guaranteed benefits with the opportunity to realize upside market performance. Our Income Distribution Series provides the contractholder with the ability to receive a guaranteed minimum income stream that they cannot outlive, along with an opportunity to participate in market appreciation. However, through various techniques, these products are designed to reduce some of our risks that generally accompany traditional products with guaranteed living benefits. We are targeting individuals who are focused on building a personal portable retirement plan or are moving from the accumulation to the distribution phase of their retirement planning.

Institutional. Our Retirement and Protection segment previously issued a combined $9.4 billion of FABNs and funding agreements, of which $2.8 billion offer contractholders the option to make periodic elections to extend the maturity date of the contract. The credit market conditions during the third quarter of 2007 made these types of institutional products less attractive compared to alternative products offering higher yields with more liquidity. Additionally, during this same time period, certain contractholders did not extend the maturity on approximately $1.3 billion of outstanding notes, of which $1.0 billion will mature over the next 12 months. We do not believe that this trend will have a material effect on our financial position or liquidity.

Life insurance. Results in our life insurance business are impacted by sales, mortality, persistency, investment yields and statutory reserve requirements. Additionally, sales of our products are dependent on competitive product features and pricing, distribution penetration and customer service. Valuation of Life Insurance Policies Regulation (more commonly known as “Regulation XXX” and “AXXX”) requires insurers to

 

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establish additional statutory reserves for both term and universal life insurance policies with long-term premium guarantees, which increases the capital required to write these products. For both term and universal life insurance, we have implemented capital management actions that improve our new business returns and have, in part, enabled us to decrease our premium rates.

As of September 30, 2007, we have $3.5 billion of floating rate non-recourse funding obligations outstanding which back excess statutory reserves. In the current quarter, the interest rate we paid on $1.7 billion of those non-recourse funding obligations was contractually reset to the current maximum rate due to lower investor demand for these types of securities. We believe that demand will return over time, and that higher reinvestment rates on portfolio assets will further offset this cost over time. To maintain and optimize product returns, we may, at our discretion, seek alternative financing terms in the future depending upon market conditions.

Several competitors have taken capital management actions similar to ours. Additionally, we have seen some competitors lower their term life insurance prices, which has made the market more competitive. We have also experienced a shift in focus by our distributors from term life insurance to universal life insurance products. In response to this shift in focus by our distributors, we are building our universal life insurance capabilities and maintaining a disciplined approach to term life insurance pricing. Our sales levels and returns on new term life insurance products have been and may continue to be impacted by the increased competition and shift in distribution focus.

Long-term care insurance. Results of our long-term care insurance business are influenced by morbidity, persistency, investment yields, new product sales, expenses and reinsurance. Industry-wide annualized first-year premiums of individual long-term care insurance increased approximately 2% for the six months ended June 30, 2007 compared to the six months ended June 30, 2006, according to data published by LIMRA International. Our sales growth over the past year in a challenging market reflects the breadth of our distribution and progress across multiple growth initiatives with an emphasis on broadening our product offerings. For example, for the nine months ended September 30, 2007, we have experienced sales growth in our recently introduced linked-benefits product. In addition, in July 2007, AARP selected us as its provider to offer new long-term care insurance products to its approximately 39 million members. However, the continued low interest rate environment and the impact of lower termination rates on older issued policies, some with expiring reinsurance coverage, are causing higher benefits and other changes in policy reserves, resulting in lower net operating income. In response to these trends, we will continue to pursue multiple growth initiatives, continue investing in case management improvements, maintain tight expense management, actively explore reinsurance and capital market solutions, execute investment strategies and, if appropriate, consider other actions to improve profitability of the block. On July 26, 2007, we announced our plans to file for a premium rate increase of between 8% and 12% on most of our block of older issued long-term care insurance policies. This block represents approximately $700 million, or 40%, of our total annual long-term care insurance premium in-force. The premium rate increase has been filed for regulatory approval in more than 40 states with approvals received from six states.

International

International mortgage insurance. The results of our international mortgage insurance business are affected by changes in regulatory environments, employment and other economic and housing market trends, including interest rate trends, home price appreciation, mortgage origination volume, levels of mortgage delinquencies and movements in foreign currency exchange rates. Our international mortgage insurance business has continued to expand with favorable operating results. We expect that the growth of our established international mortgage insurance business and our entry into new international markets will continue to contribute an increasing portion of this segment’s total revenues and profits.

As a result of the expansion of our international business in recent years, as of September 30, 2007, approximately 61% of our international risk in-force has not yet reached its anticipated highest claim frequency years, which are generally between the third and seventh year of the loan. We expect our loss experience on these loans will increase as these books of business continue to mature.

 

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Payment protection insurance. Growth of our payment protection insurance business is dependent on economic conditions including consumer lending levels, client account penetration and the number of countries and markets we enter. Additionally, the types and mix of our products will vary based on regulatory and consumer acceptance of our products. Our payment protection insurance business continues to show growth from increased penetration of existing relationships and the addition of new distribution relationships in existing and new countries.

U.S. Mortgage Insurance

The results of our U.S. mortgage insurance business are affected by employment and other economic and housing markets trends, including interest rate trends, home price appreciation, mortgage origination volume and product mix and the levels and aging of mortgage delinquencies including seasonal trends.

The demand for flow private mortgage insurance increased significantly during the nine months ended September 30, 2007 as compared to the same period in 2006. This increase was driven by a number of market conditions, which included: increased regulatory and market focus on credit risk, ongoing tightening of underwriting standards, an increase in the volume of mortgages purchased by the government-sponsored entities (“GSE”), the return to traditional fixed rate mortgages resulting in a decline in simultaneous second mortgages and mortgage insurance tax deductibility. We believe in the third quarter of 2007 the bulk mortgage insurance market decreased as a percentage of the overall primary insurance market, driven primarily by lower market liquidity and a dramatic decrease in non-prime mortgage-backed security issuances. We participate in selected segments of the bulk market where we believe we will be able to meet our targeted risk-adjusted returns and continue to evaluate additional opportunities this market presents. The rise in interest rates and lower or negative home price appreciation in the U.S. have contributed to rising persistency rates. The flow persistency rate for the three months ended September 30, 2007 was 82%, which represents the highest persistency rate we have experienced in more than six years.

Primary insurance in-force increased to $144.8 billion as of September 30, 2007, which represents a 39% increase as compared to the prior year. In addition, net earned premiums have grown from $350 million for the nine months ended September 30, 2006 to $444 million for the nine months ended September 30, 2007. These increases in primary insurance in-force and net earned premiums reflect an increase in both our flow and bulk product writings as a result of increased demand for private mortgage insurance as well as higher persistency. We believe that the increased demand for private mortgage insurance, sustained higher interest rates, increased persistency and our ongoing growth strategy will lead to growing levels of insurance in-force and related net earned premiums.

We believe that the U.S. economy overall remains relatively strong based on continued gross domestic product growth and low levels of unemployment. However, we also believe that the U.S. housing market has slowed materially and the rate of home price appreciation has declined or turned negative in the majority of markets. In addition, there has been a significant increase in default and foreclosure levels especially in the adjustable rate sub-prime market, according to the Mortgage Bankers Association, which we believe has resulted in an increase in housing supply levels and has further pressured home price appreciation resulting in defaults not being supported by adequate levels of embedded home price appreciation. We believe this overall pressure on the housing market has begun to affect the performance of other mortgage products, including A minus, Alt-A and adjustable rate mortgages.

We have increased loss reserves as a result of a material increase in delinquencies and foreclosures, especially in Florida, California, Arizona and Nevada, as well as in our A minus and Alt-A products. In addition, throughout the U.S., we have experienced an increase in the average loan balance of mortgage loan delinquencies. The Great Lakes region has experienced an economic slowdown and has seen a more pronounced weakness in their housing markets as well as a decline in home prices. While our portfolio concentration in the Great Lakes region is less than 10% of our total risk in-force, this region’s weakness has contributed disproportionately to the increase in our U.S. paid losses.

 

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The foregoing factors have contributed to an increase in our incurred losses. While over 90% of our primary risk in force in the U.S. is considered prime, based on FICO credit scores of the underlying mortgage loans, continued low or negative home price appreciation may cause further increases in our incurred losses and related loss ratio. As of September 30, 2007, approximately 69% of our U.S. risk in-force had not yet reached its anticipated highest claim frequency years, which are generally between the third and seventh year of the loan. We expect our loss experience on these loans will increase as these books of business continue to mature.

Consolidated Results of Operations

The following is a discussion of our consolidated results of operations. For a discussion of our segment results, see “—Results of Operations and Selected Financial and Operating Performance Measures by Segment.

Three Months Ended September 30, 2007 Compared to Three Months Ended September 30, 2006

The following is a summary of net income for the periods indicated:

 

     Three months
ended September 30,
    Increase (decrease) and
percentage change
 

(Amounts in millions)

         2007                 2006                       2007 vs. 2006              

Revenues:

        

Premiums

   $ 1,600     $ 1,505     $ 95     6 %

Net investment income

     1,074       932       142     15 %

Net investment gains (losses)

     (48 )     (6 )     (42 )   NM (1)

Insurance and investment product fees and other

     249       184       65     35 %
                          

Total revenues

     2,875       2,615       260     10 %
                          

Benefits and expenses:

        

Benefits and other changes in policy reserves

     1,168       1,061       107     10 %

Interest credited

     391       382       9     2 %

Acquisition and operating expenses, net of deferrals

     540       493       47     10 %

Amortization of deferred acquisition costs and intangibles

     202       160       42     26 %

Interest expense

     124       87       37     43 %
                          

Total benefits and expenses

     2,425       2,183       242     11 %
                          

Income from continuing operations before income taxes

     450       432       18     4 %

Provision for income taxes

     111       138       (27 )   (20 )%
                          

Income from continuing operations

     339       294       45     15 %

Income from discontinued operations, net of taxes

     —         10       (10 )   (100 )%
                          

Net income

   $ 339     $ 304     $ 35     12 %
                          

(1)

We define “NM” as not meaningful for increases or decreases greater than 200%.

Premiums. Premiums consist primarily of premiums earned on insurance products for individual life, long-term care, Medicare supplement, single premium immediate annuities and structured settlements with life contingencies, payment protection and mortgage insurance policies.

 

   

Our International segment increased $118 million as a result of a $64 million increase in our international mortgage insurance business and an increase of $54 million from our payment protection insurance business. The three months ended September 30, 2007 included an increase of $42 million attributable to changes in foreign exchange rates.

 

   

Our U.S. Mortgage Insurance segment increased $41 million.

 

   

Our Retirement and Protection segment decreased $62 million primarily due to a $92 million decrease in our retirement income business, offset by a $22 million increase in our long-term care insurance business and an $8 million increase in our life insurance business.

 

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Net investment income. Net investment income represents the income earned on our investments.

 

   

Our Retirement and Protection segment increased driven largely by higher invested assets as a result of an increase in assets under management in our institutional business, the investment of net insurance cash flows attributable to growth of our long-term care and life insurance in-force blocks and an increase related to securities purchased using proceeds from the issuance of non-recourse funding obligations supporting certain term and universal life insurance reserves.

 

   

Our International segment increased as a result of higher invested assets from the investment of net insurance cash flows primarily related to the growth in the international mortgage insurance in-force and additional cash from capital contributions. The three months ended September 30, 2007 included an increase of $11 million attributable to changes in foreign exchange rates.

 

   

Additionally, higher net investment income was due to an increase in weighted average investment yields to 6.1% for the three months ended September 30, 2007 from 5.7% for the three months ended September 30, 2006. The increase in weighted average investment yields was primarily attributable to increased investment income from limited partnership investments, bond calls and commercial mortgage loan prepayments and increased yields on floating rate investments supporting floating rate policyholder and non-recourse funding liabilities.

 

   

Net investment income for the three months ended September 30, 2007 included $40 million of favorable net investment income items as compared to $13 million in the prior year.

Net investment gains (losses). Net investment gains (losses) consist of realized gains and (losses) from the sale or impairment of our investments, unrealized and realized gains and (losses) from our trading securities, fair value hedging relationships, non-qualifying derivatives and embedded derivatives. We incurred approximately $25 million of credit related impairments during the three months ended September 30, 2007, of which $17 million related to securities backed by sub-prime and Alt-A residential mortgage-backed and asset-backed securities. For a discussion of the change in net investment gains (losses), see the comparison for this line item under “—Investments and Derivative Instruments.”

Insurance and investment product fees and other. Insurance and investment product fees and other consist primarily of fees assessed against policyholder and contractholder account values, cost of insurance and surrender charges assessed on universal life insurance policies, advisory and administration service fees assessed on investment contractholder account values, broker-dealer commission revenues and other fees.

 

   

Our Retirement and Protection segment increased $67 million largely driven by a $40 million increase in our managed money business, a $14 million increase in our life insurance business and a $14 million increase from our retirement income business.

 

   

Our International segment decreased $2 million related to our international mortgage insurance business.

Benefits and other changes in policy reserves. Benefits and other changes in policy reserves consist primarily of benefits paid and reserve activity related to current claims and future policy benefits on insurance and investment products for life, long-term care and Medicare supplement insurance, structured settlements and single premium immediate annuities with life contingencies, payment protection insurance and claim costs incurred related to mortgage insurance products.

 

   

Our Retirement and Protection segment decreased $16 million attributable to an $86 million decrease in our retirement income business, offset by a $49 million increase in our long-term care insurance business and a $21 million increase in our life insurance business.

 

   

Our U.S. Mortgage Insurance segment increased $79 million.

 

   

Our International segment increased $45 million as a result of an increase in our international mortgage insurance business of $34 million and an increase of $11 million in our payment protection insurance business. The three months ended September 30, 2007 included an increase of $9 million attributable to changes in foreign exchange rates.

 

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Interest credited. Interest credited represents interest credited on behalf of policyholder and contractholder general account balances. Interest credited related to our Retirement and Protection segment increased $9 million primarily due to a $29 million increase related to our institutional business, partially offset by a $24 million decrease in our retirement income business.

Acquisition and operating expenses, net of deferrals. Acquisition and operating expenses, net of deferrals, represent costs and expenses related to the acquisition and ongoing maintenance of insurance and investment contracts, including commissions, policy issuance expenses and other underwriting and general operating costs. These costs and expenses are net of amounts that are capitalized and deferred, which are primarily costs and expenses that vary with and are primarily related to the sale and issuance of our insurance policies and investment contracts, such as first-year commissions in excess of ultimate renewal commissions and other policy issuance expenses.

 

   

Our Retirement and Protection segment increased $17 million primarily attributable to an increase of $31 million from our managed money business, partially offset by a decrease of $7 million in our life insurance business, a decrease in our long-term care insurance business of $4 million and a $4 million decrease in our retirement income business.

 

   

Our International segment increased $53 million related to a $22 million increase in our international mortgage insurance business and a $31 million increase in our payment protection insurance business. The three months ended September 30, 2007 included an increase of $19 million attributable to changes in foreign exchange rates.

 

   

Corporate and Other activities decreased $16 million.

 

   

Our U.S. Mortgage Insurance segment decreased $7 million.

Amortization of deferred acquisition costs and intangibles. Amortization of deferred acquisition costs and intangibles consists primarily of the amortization of acquisition costs that are capitalized, present value of future profits and capitalized software.

 

   

Our International segment increased $21 million related to an increase in our international mortgage insurance business of $3 million and an increase in our payment protection insurance business of $18 million. The three months ended September 30, 2007 included an increase of $8 million attributable to changes in foreign exchange rates.

 

   

Our Retirement and Protection segment increased $20 million due to an increase in our life insurance business.

Interest expense

 

   

Our Retirement and Protection segment increased $23 million in our life insurance business from the issuances of additional non-recourse funding obligations and an increase in average floating rates paid on those obligations.

 

   

Our International segment increased $6 million primarily from our payment protection insurance business.

 

   

Corporate and Other activities increased $8 million.

Provision for income taxes. The effective tax rate decreased to 24.7% for the three months ended September 30, 2007 from 31.9% for the three months ended September 30, 2006. This decrease in the effective tax rate was primarily attributable to favorable examination developments and a change in estimate related to the prior year tax provision in our Retirement and Protection segment. The three months ended September 30, 2007 included an increase of $5 million attributable to changes in foreign exchange rates.

 

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Net income. The increase in net income reflects increases in our Retirement and Protection and International segments’ net income, partially offset by a decrease in our U.S. Mortgage Insurance segment and an increase in the net operating loss of our Corporate and Other activities, as discussed under “—Results of Operations and Selected Financial and Operating Performance Measures by Segment.” Included in net income was an increase of $12 million, net of tax, attributable to changes in foreign exchange rates.

Nine Months Ended September 30, 2007 Compared to Nine Months Ended September 30, 2006

The following is a summary of net income for the periods indicated:

 

     Nine months
ended September 30,
    Increase (decrease) and
percentage change
 

(Amounts in millions)

         2007                 2006                       2007 vs. 2006              

Revenues:

        

Premiums

   $ 4,660     $ 4,356     $ 304     7 %

Net investment income

     3,082       2,784       298     11 %

Net investment gains (losses)

     (118 )     (77 )     (41 )   (53 )%

Insurance and investment product fees and other

     726       565       161     28 %
                          

Total revenues

     8,350       7,628       722     9 %
                          

Benefits and expenses:

        

Benefits and other changes in policy reserves

     3,325       2,954       371     13 %

Interest credited

     1,167       1,132       35     3 %

Acquisition and operating expenses, net of deferrals

     1,524       1,412       112     8 %

Amortization of deferred acquisition costs and intangibles

     622       521       101     19 %

Interest expense

     355       257       98     38 %
                          

Total benefits and expenses

     6,993       6,276       717     11 %
                          

Income from continuing operations before income taxes

     1,357       1,352       5     —   %

Provision for income taxes

     383       430       (47 )   (11 )%
                          

Income from continuing operations

     974       922       52     6 %

Income from discontinued operations, net of taxes

     15       29       (14 )   (48 )%

Gain on sale of discontinued operations, net of taxes

     53       —         53     NM (1)
                          

Income before cumulative effect of accounting change

     1,042       951       91     10 %

Cumulative effect of accounting change, net of taxes

     —         4       (4 )   (100 )%
                          

Net income

   $ 1,042     $ 955     $ 87     9 %
                          

(1)

We define “NM” as not meaningful for increases or decreases greater than 200%.

Premiums

 

   

Our International segment increased $225 million as a result of a $150 million increase in our international mortgage insurance business and an increase of $75 million from our payment protection insurance business. The nine months ended September 30, 2007 included an increase of $107 million attributable to changes in foreign exchange rates.

 

   

Our U.S. Mortgage Insurance segment increased $94 million.

 

   

Our Retirement and Protection segment decreased $11 million primarily due to a $167 million decrease in our retirement income business, offset by a $122 million increase in our long-term care insurance business and a $34 million increase in our life insurance business.

 

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Net investment income

 

   

Our Retirement and Protection segment increased largely driven by higher invested assets as a result of an increase in assets under management in our institutional business, the investment of net insurance cash flows attributable to growth of our long-term care and life insurance in-force blocks and an increase related to securities purchased using proceeds from the issuance of non-recourse funding obligations supporting certain term and universal life insurance reserves.

 

   

Our International segment increased as a result of higher invested assets from the investment of net insurance cash flows primarily related to the growth in the international mortgage insurance in-force and additional cash from capital contributions. The nine months ended September 30, 2007 included an increase of $21 million attributable to changes in foreign exchange rates.

 

   

Additionally, higher net investment income was due to an increase in weighted average investment yields to 5.9% for the nine months ended September 30, 2007 from 5.7% for the nine months ended September 30, 2006. The increase in weighted average investment yields was primarily attributable to increased investment income from limited partnership investments, bond calls and commercial mortgage loan prepayments and increased yields on floating rate investments supporting floating rate policyholder and non-recourse funding liabilities. This increase was partially offset by a decline in yield related to commercial mortgage loans primarily as a result of a favorable adjustment to our commercial mortgage loan loss reserves in the prior year.

 

   

Net investment income for the nine months ended September 30, 2007 included $80 million of favorable net investment income items as compared to $67 million in the prior year.

Net investment gains (losses). We incurred approximately $39 million of credit related impairments during the nine months ended September 30, 2007, of which $17 million related to securities backed by sub-prime and Alt-A residential mortgage-backed and asset-backed securities. For a discussion of the change in net investment gains (losses), see the comparison for this line item under “—Investments and Derivative Instruments.”

Insurance and investment product fees and other

 

   

Our Retirement and Protection segment increased $170 million largely driven by a $109 million increase in our managed money business, a $33 million increase in our life insurance business and a $30 million increase from our retirement income business.

 

   

Our U.S. Mortgage Insurance segment increased $5 million.

 

   

Our International segment decreased $10 million primarily related to our international mortgage insurance business.

Benefits and other changes in policy reserves

 

   

Our U.S. Mortgage Insurance segment increased $148 million.

 

   

Our Retirement and Protection segment increased $116 million as a result of a $192 million increase in our long-term care insurance business and a $65 million increase in our life insurance business, offset by a $141 million decrease in our retirement income business.

 

   

Our International segment increased $109 million driven by an increase in our international mortgage insurance business of $91 million and an increase of $18 million in our payment protection insurance business. The nine months ended September 30, 2007 included an increase of $23 million attributable to changes in foreign exchange rates.

Interest credited. Interest credited related to our Retirement and Protection segment increased $35 million primarily due to an $82 million increase related to our institutional business, partially offset by a $60 million decrease in our retirement income business.

 

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Acquisition and operating expenses, net of deferrals

 

   

Our International segment increased $72 million attributable to an increase of $31 million related to our international mortgage insurance business and an increase of $41 million related to our payment protection insurance business. The nine months ended September 30, 2007 included an increase of $50 million attributable to changes in foreign exchange rates.

 

   

Our Retirement and Protection segment increased $54 million primarily attributable to an increase of $80 million from our managed money business, partially offset by a decrease of $16 million in our life insurance business and a decrease in our long-term care insurance business of $7 million.

 

   

Our U.S. Mortgage Insurance segment decreased $8 million.

 

   

Corporate and Other activities decreased $6 million.

Amortization of deferred acquisition costs and intangibles

 

   

Our Retirement and Protection segment increased $47 million primarily attributable to a $29 million increase from our life insurance business, a $9 million increase in our retirement income business and an $8 million increase in our long-term care insurance business.

 

   

Our International segment increased $39 million related to an increase in our international mortgage insurance business of $11 million and an increase of $28 million in our payment protection insurance business. The nine months ended September 30, 2007 included an increase of $21 million attributable to changes in foreign exchange rates.

 

   

Corporate and Other activities increased $13 million.

Interest expense

 

   

Our Retirement and Protection segment increased $56 million related to our life insurance business from the issuances of additional non-recourse funding obligations and an increase in average floating rates paid on those obligations.

 

   

Corporate and Other activities increased $22 million.

 

   

Our International segment increased $20 million primarily from our payment protection insurance business.

Provision for income taxes. The effective tax rate decreased to 28.2% for the nine months ended September 30, 2007 from 31.8% for the nine months ended September 30, 2006. This decrease in the effective tax rate was primarily attributable to the increase in lower taxed foreign income, favorable examination developments and a change in estimate related to the prior year tax provision in our Retirement and Protection segment. The nine months ended September 30, 2007 included an increase of $9 million attributable to changes in foreign exchange rates.

Net income. The increase in net income reflects increases in our International and Retirement and Protection segments’ net income, partially offset by a decrease in our U.S. Mortgage Insurance segment and an increase in the net operating loss of our Corporate and Other activities, as discussed under “—Results of Operations and Selected Financial and Operating Performance Measures by Segment.” Included in net income was an increase of $25 million, net of tax, attributable to changes in foreign exchange rates. Additionally, we completed the sale of our group life and health insurance business in the second quarter of 2007. The sale resulted in a gain on sale of discontinued operations of $53 million, net of taxes.

 

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Earnings per share

The following table provides basic and diluted earnings per common share for the periods indicated:

 

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

(Amounts in millions, except per share amounts)

         2007                2006                2007                2006      

Earnings from continuing operations per common share:

           

Basic

   $ 0.77    $ 0.64    $ 2.21    $ 2.01
                           

Diluted

   $ 0.76    $ 0.63    $ 2.16    $ 1.95
                           

Earnings per common share:

           

Basic

   $ 0.77    $ 0.67    $ 2.36    $ 2.08
                           

Diluted

   $ 0.76    $ 0.65    $ 2.32    $ 2.02
                           

Weighted-average common shares outstanding:

           

Basic

     441.1      453.8      440.5      458.8
                           

Diluted

     445.6      467.2      449.8      471.7
                           

Weighted average shares outstanding declined reflecting repurchases of 47.3 million shares since the end of the first quarter of 2006 through September 30, 2007. In May 2007, we repurchased 16.5 million shares of our Class A Common Stock under an accelerated share repurchase transaction with a broker-dealer counterparty. Diluted weighted average shares outstanding for both the 2007 and 2006 quarters reflect the effects of potentially dilutive securities including stock options, restricted stock units and other equity-based compensation. In May 2007, our Equity Unit holders purchased 25.5 million of newly issued shares of our Class A Common Stock according to the stock purchase contract component of the Equity Units; therefore, the stock purchase contracts underlying Equity Units were only dilutive through May 2007.

Results of Operations and Selected Financial and Operating Performance Measures by Segment

Our chief operating decision maker evaluates segment performance and allocates resources on the basis of “net operating income.” We define net operating income (loss) as income (loss) from continuing operations excluding after-tax net investment gains (losses) and other adjustments and infrequent or unusual non-operating items. We exclude net investment gains (losses) and infrequent or unusual non-operating items because we do not consider them to be related to the operating performance of our segments and Corporate and Other activities. A significant component of our net investment gains (losses) are the result of credit-related impairments and credit-related gains and losses, the timing of which can vary significantly depending on market credit cycles. In addition, the size and timing of other investment gains (losses) are often subject to our discretion and are influenced by market opportunities, as well as asset-liability matching considerations. Infrequent or unusual non-operating items are also excluded from net operating income if, in our opinion, they are not indicative of overall operating trends. While some of these items may be significant components of net income in accordance with U.S. GAAP, we believe that net operating income, and measures that are derived from or incorporate net operating income, are appropriate measures that are useful to investors because they identify the income attributable to the ongoing operations of the business. However, net operating income (loss) is not a substitute for net income determined in accordance with U.S. GAAP. In addition, our definition of net operating income may differ from the definitions used by other companies. See note 9 in our “—Notes to Condensed Consolidated Financial Statements” for a reconciliation of net operating income (loss) of our segments and Corporate and Other activities to net income.

Related to our payment protection insurance business in our International segment, there were reclassifications of certain reinsured assumed business from reinsurance accounting to the deposit method of accounting (“reinsurance accounting change”) in the fourth quarter of 2006. Prior year amounts have not been

 

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reclassified, as such amounts were not material to our consolidated financial statements. The reclassification impacted premiums, net investment income, benefits and other changes in policy reserves and interest expense; however, it had no impact on net income or net operating income for all periods presented.

Management’s discussion and analysis by segment also contains selected operating performance measures including “sales,” “assets under management” and “insurance in-force” or “risk in-force” which are commonly used in the insurance and investment industries as measures of operating performance.

Management regularly monitors and reports sales metrics as a measure of volume of new and renewal business generated in a period. Sales refers to (1) annualized first-year premiums for term life insurance, long-term care insurance and Medicare supplement insurance; (2) new and additional premiums/deposits for universal life insurance, linked-benefits, spread-based and variable products; (3) gross and net flows, which represent deposits less redemptions, for our managed money business; (4) written premiums and deposits, gross of ceded reinsurance and cancellations, and premium equivalents, where we earn a fee for administrative services only business, for payment protection insurance; (5) new insurance written for mortgage insurance, which in each case reflects the amount of business the company generated during each period presented; and (6) written premiums net of cancellations for our Mexican insurance operations. Sales do not include renewal premiums on policies or contracts written during prior periods. We consider annualized first-year premiums, new premiums/deposits, deposits and net flows, written premiums, premium equivalents and new insurance written to be a measure of our operating performance because they represent a measure of new sales of insurance policies or contracts during a specified period, rather than a measure of our revenues or profitability during that period.

Management regularly monitors and reports assets under management for our managed money business, insurance in-force and risk in-force. Assets under management for our managed money business represent third-party assets under management that are not consolidated in our financial statements. Insurance in-force for our life insurance, international mortgage insurance and U.S. mortgage insurance businesses is a measure of the aggregate face value of outstanding insurance policies as of the respective reporting date. Risk in-force for our international mortgage insurance and U.S. mortgage insurance businesses is a measure that recognizes that the loss on any particular mortgage loan will be reduced by the net proceeds received upon sale of the underlying property. We consider assets under management for our managed money business, insurance in-force and risk in-force to be a measure of our operating performance because they represent a measure of the size of our business at a specific date, rather than a measure of our revenues or profitability during that period.

These operating measures enable us to compare our operating performance across periods without regard to revenues or profitability related to policies or contracts sold in prior periods or from investments or other sources.

 

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Retirement and Protection segment

Segment results of operations

Three Months Ended September 30, 2007 Compared to Three Months Ended September 30, 2006

The following table sets forth the results of operations relating to our Retirement and Protection segment:

 

     Three months
ended September 30,
    Increase (decrease) and
percentage change
 

(Amounts in millions)

         2007                 2006                       2007 vs. 2006              

Revenues:

        

Premiums

   $ 861     $ 923     $ (62 )   (7 )%

Net investment income

     893       803       90     11 %

Net investment gains (losses)

     (38 )     (6 )     (32 )   NM (1)

Insurance and investment product fees and other

     233       166       67     40 %
                          

Total revenues

     1,949       1,886       63     3 %
                          

Benefits and expenses:

        

Benefits and other changes in policy reserves

     919       935       (16 )   (2 )%

Interest credited

     391       382       9     2 %

Acquisition and operating expenses, net of deferrals

     220       203       17     8 %

Amortization of deferred acquisition costs and intangibles

     96       76       20     26 %

Interest expense

     59       36       23     64 %
                          

Total benefits and expenses

     1,685       1,632       53     3 %
                          

Income from continuing operations before income taxes

     264       254       10     4 %

Provision for income taxes

     64       87       (23 )   (26 )%
                          

Net income

     200       167       33     20 %

Adjustment to net income:

        

Net investment (gains) losses, net of taxes and other adjustments

     23       3       20     NM (1)
                          

Net operating income

   $ 223     $ 170     $ 53     31 %
                          

(1)

We define “NM” as not meaningful for increases or decreases greater than 200%.

The following table sets forth net operating income for the businesses included in our Retirement and Protection segment:

 

     Three months
ended September 30,
   Increase (decrease) and
percentage change
 

(Amounts in millions)

       2007            2006                2007 vs. 2006          

Net operating income:

           

Managed money

   $ 11    $ 5    $ 6    120 %

Retirement income

     82      39      43    110 %

Institutional

     10      9      1    11 %

Life insurance

     81      79      2    3 %

Long-term care insurance

     39      38      1    3 %
                       

Total net operating income

   $ 223    $ 170    $ 53    31 %
                       

Net operating income

 

   

Our managed money business increased $6 million primarily due to our fourth quarter of 2006 acquisition of AssetMark, growth in our assets under management in our existing platforms and favorable equity market performance.

 

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Our retirement income business increased $43 million mainly as a result of a tax benefit during the current quarter from favorable examination developments and a change in estimate related to the prior year tax provision. Additionally, there was an increase in income from fee-based products as a result of growth in assets under management of our variable annuity products, particularly the Income Distribution Series. The current year also included favorable investment items of $11 million as compared to the prior year. These increases were partially offset by lower investment advisory fees and lower spread-based retail assets under management from withdrawals of older issued blocks more than offsetting new deposits as crediting rates are being reset to lower rates.

 

   

Our institutional business increased $1 million attributable to growth in assets under management offset by lower spreads in the current year.

 

   

Our life insurance business increased $2 million primarily due to favorable investment items and favorable mortality in universal life insurance, partially offset by higher mortality in term life insurance as compared to the prior year.

 

   

Our long-term care insurance business increased $1 million principally as a result of the favorable performance of newer issued policies that was offset by unfavorable performance of older issued policies. Additionally, the current year included net favorable adjustments of $8 million compared to $4 million in the prior year.

Revenues

Premiums

 

   

Our retirement income business decreased $92 million attributable to lower life contingent sales in our spread-based retail products primarily due to our continued pricing discipline in the current interest rate and yield curve environment and our decision in the third quarter of 2006 to discontinue sales of our life-contingent structured settlement annuities.

 

   

Our long-term care insurance business increased $22 million mainly attributable to growth in the in-force block from new sales and renewal premiums.

 

   

Our life insurance business increased $8 million mainly due to in-force growth from new sales and renewal premiums of term life insurance, partially offset by lapses and continued runoff of our whole life block.

Net investment income

 

   

Our life insurance business increased $37 million mainly due to growth of the in-force block and an increase in securities purchased using proceeds from the issuance of non-recourse funding obligations supporting certain term and universal life insurance reserves. The current year also included $15 million of additional investment income from limited partnerships, bond calls and commercial mortgage loan prepayments as compared to the prior year.

 

   

Our long-term care insurance increased $28 million primarily as a result of an increase in average invested assets due to growth in the in-force block.

 

   

Our institutional business increased $31 million attributable to increased assets under management.

 

   

Our retirement income business decreased $8 million as a result of a decline in assets under management in our spread-based retail products. Partially offsetting this decrease was an increase of $17 million attributable to additional investment income from limited partnerships, bond calls and commercial mortgage loan prepayments as compared to the prior year.

 

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Insurance and investment product fees and other

 

   

Our managed money business increased $40 million primarily attributable to an increase of $24 million from the acquisition of AssetMark, growth in assets under management in our existing platforms and favorable equity market performance.

 

   

Our life insurance business increased $14 million as a result of an unfavorable adjustment in unearned revenue of $13 million in our universal life insurance product in the prior year that did not recur.

 

   

Our retirement income business increased $14 million mainly due to increased assets under management from continued sales of our Income Distribution Series of variable annuity products and riders, partially offset by lower investment advisory fees.

Benefits and expenses

Benefits and other changes in policy reserves

 

   

Our retirement income business decreased $86 million principally attributable to an $87 million decrease in our spread-based retail products due to lower life-contingent sales primarily as a result of our continued pricing discipline in the current interest rate and yield curve environment and our decision in the third quarter of 2006 to discontinue sales of our life-contingent structured settlement annuities.

 

   

Our long-term care insurance business increased $49 million mainly as a result of the aging and growth of the in-force block, partially offset by favorable reserve adjustments of $9 million in the current year as compared to $5 million in the prior year. In addition, the performance of newer issued policies was offset by unfavorable performance of older issued policies where we continue to experience low termination rates and higher incurred losses.

 

   

Our life insurance business increased $21 million largely attributable to growth in the term life insurance in-force blocks, higher mortality in term life insurance as compared to the prior year and a reclassification to acquisition and operating expenses related to commission deferrals.

Interest credited

 

   

Our institutional business increased $29 million mainly attributable to growth in assets under management.

 

   

Our retirement income business decreased $24 million from lower account values on fixed annuities associated with surrenders more than offsetting sales and crediting rates being reset to current, lower rates as the fixed annuities reach the end of their initial crediting rate guarantee period.

Acquisition and operating expenses, net of deferrals

 

   

Our managed money business increased $31 million attributable to an increase of $19 million from the AssetMark acquisition and growth of our assets under management in our existing platforms.

 

   

Our life insurance business decreased $7 million primarily from a reclassification from benefits and other changes in reserves related to commission deferrals in the current year.

 

   

Our long-term care insurance business decreased $4 million mainly from continued productivity efficiencies more than offsetting higher expenses associated with continued growth of insurance in-force.

 

   

Our retirement income business decreased $4 million mainly from our spread-based retail products as a result of lower sales.

 

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Amortization of deferred acquisition costs and intangibles. Our life insurance business increased $20 million from continued growth of insurance in-force and an increase in amortization resulting from higher post-level term lapses. Partially offsetting these increases was lower amortization of $7 million from unlocking of estimated gross profit assumptions in our universal life insurance product in the current year. The prior year included favorable adjustments to universal life insurance of $7 million due to an unearned revenue adjustment and $7 million associated with unlocking of estimated gross profit assumptions.

Interest expense. Interest expense in our life insurance business increased $23 million from the issuance of additional non-recourse funding obligations and an increase in average floating rates paid on those obligations.

Provision for income taxes. The effective tax rate decreased to 24.2% for the three months ended September 30, 2007 from 34.3% for the three months ended September 30, 2006. This decrease in the effective tax rate was primarily attributable to favorable examination developments and a change in estimate related to the prior year tax provision.

Nine Months Ended September 30, 2007 Compared to Nine Months Ended September 30, 2006

The following table sets forth the results of operations relating to our Retirement and Protection segment:

 

    Nine months
ended September 30,
    Increase (decrease) and
percentage change
 

(Amounts in millions)

        2007                 2006                   2007 vs. 2006          

Revenues:

       

Premiums

  $ 2,622     $ 2,633     $ (11 )   —   %

Net investment income

    2,597       2,397       200     8 %

Net investment gains (losses)

    (102 )     (58 )     (44 )   (76 )%

Insurance and investment product fees and other

    679       509       170     33 %
                         

Total revenues

    5,796       5,481       315     6 %
                         

Benefits and expenses:

       

Benefits and other changes in policy reserves

    2,744       2,628       116     4 %

Interest credited

    1,167       1,132       35     3 %

Acquisition and operating expenses, net of deferrals

    654       600       54     9 %

Amortization of deferred acquisition costs and intangibles

    312       265       47     18 %

Interest expense

    153       97       56     58 %
                         

Total benefits and expenses

    5,030       4,722       308     7 %
                         

Income from continuing operations before income taxes

    766       759       7     1 %

Provision for income taxes

    240       268       (28 )   (10 )%
                         

Net income

    526       491       35     7 %

Adjustment to net income:

       

Net investment (gains) losses, net of taxes and other adjustments

    62       28       34     121 %
                         

Net operating income

  $ 588     $ 519     $ 69     13 %
                         

 

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The following table sets forth net operating income for the businesses included in our Retirement and Protection segment:

 

    Nine months
ended September 30,
  Increase (decrease) and
percentage change
 

(Amounts in millions)

          2007                   2006                   2007 vs. 2006          

Net operating income:

       

Managed money

  $ 32   $ 13   $ 19     146 %

Retirement income

    171     126     45     36 %

Institutional

    34     32     2     6 %

Life insurance

    234     230     4     2 %

Long-term care insurance

    117     118     (1 )   (1 )%
                     

Total net operating income

  $ 588   $ 519   $ 69     13 %
                     

Net operating income

 

   

Our managed money business increased $19 million due to our fourth quarter of 2006 acquisition of AssetMark, growth in our assets under management in our existing platforms and favorable equity market performance.

 

   

Our retirement income business increased $45 million from a lower effective tax rate from favorable examination developments and a change in estimate related to the prior year tax provision. Additionally, income increased from our fee-based products as a result of growth in assets under management of our Income Distribution Series of variable annuity products and riders. The current year also included favorable investment items of $8 million as compared to the prior year. These increases were partially offset by lower investment advisory fees and lower spread-based retail assets under management from withdrawals of older issued blocks more than offsetting new deposits as crediting rates are being reset to lower rates.

 

   

Our institutional business increased $2 million attributable to growth in assets under management, partially offset by lower spreads, primarily in our fixed GIC products, and less favorable investment income items in the current year.

 

   

Our life insurance business increased $4 million primarily due to growth in the in-force block of term life insurance, partially offset by higher mortality in term life insurance as compared to the prior year. The current year also included favorable investment items of $12 million as compared to the prior year.

 

   

Our long-term care insurance business decreased $1 million as the favorable performance of newer issued policies was offset by unfavorable performance of older issued policies. The current year included $18 million, net of tax, in favorable adjustments. The prior year included $10 million, net of tax, of favorable adjustments. The revenues and benefits and expenses for Continental Life Insurance Company of Brentwood, Tennessee (“Continental Life”) reflect a five-month period for 2006 compared to a nine-month period for 2007.

Revenues

Premiums

 

   

Our retirement income business decreased $167 million attributable to lower life-contingent sales in our spread-based retail products primarily due to our continued pricing discipline in the current interest rate and yield curve environment and our decision in the third quarter of 2006 to discontinue sales of our life-contingent structured settlement annuities.

 

   

Our long-term care insurance business increased $122 million mainly attributable to growth in the in-force block from new sales and renewal premiums and a $64 million increase due to the Continental Life acquisition.

 

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Our life insurance business increased $34 million mainly due to in-force growth from new sales and renewal premiums of term life insurance, partially offset by lapses and continued runoff of our whole life block.

Net investment income

 

   

Our institutional business increased $87 million attributable to higher asset balances and increased yields on floating rate investments supporting certain floating rate policyholder liabilities.

 

   

Our long-term care insurance increased $79 million largely as a result of an increase in average invested assets due to growth in the in-force block. The current year also included $14 million of additional investment income from limited partnerships, bond calls and commercial mortgage loan prepayments as compared to the prior year.

 

   

Our life insurance business increased $74 million mainly due to an increase in securities purchased using proceeds from the issuance of non-recourse funding obligations supporting certain term and universal life insurance reserves and growth of the in-force block. The current year also included $18 million of additional investment income from limited partnerships, bond calls and commercial mortgage loan prepayments as compared to the prior year.

 

   

Our retirement income business decreased $43 million as result of a decline in assets under management in our spread-based retail products. Partially offsetting this decrease was an increase of $12 million attributable to additional investment income from limited partnerships, bond calls and commercial mortgage loan prepayments as compared to the prior year.

Insurance and investment product fees and other

 

   

Our managed money business increased $109 million primarily attributable to an increase of $68 million from the acquisition of AssetMark, growth in assets under management in our existing platforms and favorable equity market performance.

 

   

Our life insurance business increased $33 million principally as a result of increased sales in our universal life insurance products and an unfavorable adjustment in unearned revenue of $13 million in our universal life insurance product in the prior year that did not recur.

 

   

Our retirement income business increased $30 million mainly due to increased assets under management from continued sales of our Income Distribution Series of variable annuity products and riders, partially offset by lower investment advisory fees.

Benefits and expenses

Benefits and other changes in policy reserves

 

   

Our long-term care insurance business increased $192 million mainly as a result of the aging and growth of the in-force block and a $45 million increase from the Continental Life acquisition. The prior year included a $27 million favorable adjustment related to our group long-term care policies which did not recur in the current year. In addition, the favorable performance of newer issued policies was offset by unfavorable performance of older issued policies where we continue to experience low terminations and higher incurred losses.

 

   

Our life insurance business increased $65 million principally attributable to growth of our term life insurance in-force block, higher mortality in term life insurance as compared to the prior year and a reclassification to acquisition and operating expenses related to commission deferrals, partially offset by a favorable reserve adjustment in the current year.

 

   

Our retirement income business decreased $141 million largely attributable to a decrease in our spread-based retail products from lower life-contingent sales primarily as a result of our continued pricing discipline in the current interest rate and yield curve environment and our decision in the third quarter of 2006 to discontinue sales of our life-contingent structured settlement annuities.

 

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Interest credited

 

   

Our institutional business increased $82 million mainly attributable to growth in assets under management and an increase in crediting rates.

 

   

Our retirement income business decreased $60 million from lower account values on fixed annuities associated with surrenders more than offsetting sales and crediting rates being reset to current, lower rates as the fixed annuities reach the end of their initial crediting rate guarantee period.

Acquisition and operating expenses, net of deferrals

 

   

Our managed money business increased $80 million from an increase of $49 million from the AssetMark acquisition and growth of our assets under management in our existing platforms.

 

   

Our life insurance business decreased $16 million primarily from a reclassification from benefits and other changes in reserves related to commission deferrals in the current year.

 

   

Our long-term care insurance business decreased $7 million driven by continued productivity efficiencies. A $7 million increase from the Continental Life acquisition was offset by an $8 million unfavorable reinsurance adjustment in the prior year that did not recur.

Amortization of deferred acquisition costs and intangibles

 

   

Our life insurance business increased $29 million mainly due to continued growth of the in-force block, less favorable persistency and an increase in amortization resulting from higher post-level term lapses. Partially offsetting these increases was lower amortization of $7 million from unlocking of estimated gross profit assumptions in our universal life insurance product in the current year. The prior year included favorable adjustments to universal life insurance of $7 million due to an unearned revenue adjustment and $7 million associated with unlocking of estimated gross profit assumptions.

 

   

Our retirement income business increased $9 million as a result of higher fixed annuity lapses in our spread-based products and growth in our variable annuity block.

 

   

Our long-term care insurance business increased $8 million attributable to a $12 million increase from the Continental Life acquisition, partially offset by lower terminations of our in-force block.

Interest expense. Interest expense in our life insurance business increased $56 million from the issuance of additional non-recourse funding obligations and an increase in average floating rates paid on those obligations.

Provision for income taxes. The effective tax rate decreased to 31.3% for the nine months ended September 30, 2007 from 35.3% for the nine months ended September 30, 2006. This decrease in the effective tax rate was primarily attributable to favorable examination developments and a change in estimate related to the prior year tax provision.

 

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Retirement and Protection selected financial and operating performance measures

Managed money

The following table sets forth selected financial performance measures regarding our managed money business as of or for the periods indicated:

 

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

(Amounts in millions)

          2007                     2006                     2007                     2006          

Assets under management, beginning of period

  $ 20,683     $ 6,143     $ 17,293     $ 5,180  

Gross flows

    1,665       602       5,136       1,827  

Redemptions

    (567 )     (133 )     (1,492 )     (490 )
                               

Net flows

    1,098       469       3,644       1,337  

Market performance and product fees

    (119 )     154       725       249  
                               

Assets under management, end of period

  $ 21,662     $ 6,766     $ 21,662     $ 6,766  
                               

Managed money includes third-party assets managed by AssetMark, Genworth Financial Asset Management and Genworth Financial Advisers.

The increase in these assets was primarily due to the fourth quarter of 2006 acquisition of AssetMark and higher net flows in managed money accounts from new and existing clients, as well as favorable equity market performance for the nine months ended September 30, 2007. The increase in gross and net flows was the result of the AssetMark acquisition, expansion of our distribution network, growth in our sales force and changes in our fee structure. The net flows associated with AssetMark were $432 million and $1,502 million for the three and nine months ended September 30, 2007, respectively. As of September 30, 2007, the account value for AssetMark was $11.6 billion.

 

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Retirement income

Fee-based retail products

The following table sets forth selected financial performance measures regarding our fee-based retail products as of or for the periods indicated:

 

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

(Amounts in millions)

          2007                     2006                     2007                     2006          

Income Distribution Series(1)

       

Account value, net of reinsurance, beginning of period

  $ 3,361     $ 1,555     $ 2,402     $ 911  

Deposits

    543       334       1,446       965  

Surrenders, benefits and product charges

    (78 )     (28 )     (204 )     (69 )
                               

Net flows

    465       306       1,242       896  

Interest credited and investment performance

    152       68       334       122  
                               

Account value, net of reinsurance, end of period

  $ 3,978     $ 1,929     $ 3,978     $ 1,929  
                               

Traditional variable annuities

       

Account value, net of reinsurance, beginning of period

  $ 2,098     $ 1,458     $ 1,780     $ 1,182  

Deposits

    133       105       412       384  

Surrenders, benefits and product charges

    (48 )     (32 )     (145 )     (94 )
                               

Net flows

    85       73       267       290  

Interest credited and investment performance

    79       54       215       113  
                               

Account value, net of reinsurance, end of period

  $ 2,262     $ 1,585     $ 2,262     $ 1,585  
                               

Variable life insurance

       

Account value, beginning of period

  $ 408     $ 367     $ 391     $ 363  

Deposits

    6       7       18       23  

Surrenders, benefits and product charges

    (15 )     (13 )     (41 )     (38 )
                               

Net flows

    (9 )     (6 )     (23 )     (15 )

Interest credited and investment performance

    15       10       46       23  
                               

Account value, end of period

  $ 414     $ 371     $ 414     $ 371  
                               

(1)

The Income Distribution Series products are comprised of our retirement income deferred and immediate variable annuity products, including those variable annuity products with rider options that provide similar income features. These products do not include fixed single premium immediate annuities or deferred annuities, which may also serve income distribution needs.

Income Distribution Series

We experienced an increase in assets under management attributable to continued sales growth of our guaranteed minimum withdrawal for life benefit rider and favorable equity markets.

Traditional variable annuities

In our traditional variable annuities, the increase in assets under management was principally the result of ongoing sales of our traditional variable annuity products and favorable equity markets exceeding surrenders and benefits.

 

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Spread-based retail products

The following table sets forth selected financial performance measures regarding our spread-based retail products as of or for the periods indicated:

 

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

(Amounts in millions)

           2007                     2006                     2007                     2006        

Fixed annuities

        

Account value net of reinsurance, beginning of period

   $ 12,886     $ 14,835     $ 13,972     $ 15,547  

Deposits

     184       424       535       1,017  

Surrenders, benefits and product charges

     (815 )     (947 )     (2,495 )     (2,536 )
                                

Net flows

     (631 )     (523 )     (1,960 )     (1,519 )

Interest credited

     113       137       356       421  
                                

Account value net of reinsurance, end of period

   $ 12,368     $ 14,449     $ 12,368     $ 14,449  
                                

Single premium immediate annuities

        

Account value net of reinsurance, beginning of period

   $ 6,367     $ 5,888     $ 6,174     $ 5,680  

Premiums and deposits

     247       294       745       834  

Surrenders, benefits and product charges

     (241 )     (200 )     (715 )     (690 )
                                

Net flows

     6       94       30       144  

Interest credited

     85       82       254       240  
                                

Account value net of reinsurance, end of period

   $ 6,458     $ 6,064     $ 6,458     $ 6,064  
                                

Structured settlements

        

Account value net of reinsurance, beginning of period

   $ 1,088     $ 966     $ 1,011     $ 871  

Premiums and deposits

     5       37       82       140  

Surrenders, benefits and product charges

     (15 )     (14 )     (44 )     (47 )
                                

Net flows

     (10 )     23       38       93  

Interest credited

     14       14       43       39  
                                

Account value net of reinsurance, end of period

   $ 1,092     $ 1,003     $ 1,092     $ 1,003  
                                

Total premiums from spread-based retail products

   $ 118     $ 210     $ 423     $ 590  
                                

Total deposits on spread-based retail products

   $ 318     $ 545     $ 939     $ 1,401  
                                

Fixed annuities

Surrenders exceeded deposits as the current interest rate and unfavorable yield curve environment along with competitive pressures have reduced the attractiveness of certain fixed annuities relative to investment alternatives, such as certificates of deposit. This interest rate and yield curve environment has had an adverse impact on both sales and retention of fixed annuities and we expect this trend to continue if the current interest rate and yield curve environment remains unchanged. In recent quarters, we have experienced improved spreads in fixed annuities principally from runoff and crediting rate resets on lower return business.

Single premium immediate annuities

The account value, net of reinsurance, increased primarily due to interest credited on the account values as premiums and deposits were offset by surrenders and benefits.

 

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Structured settlements

Upon completion of a strategic review of our structured settlement annuities, we decided in the third quarter of 2006 to no longer solicit sales of this product as a result of a continued challenging and competitive long-term interest rate environment. However, we continue to service our existing block of business.

Institutional

The following table sets forth selected financial performance measures regarding our institutional business as of or for the periods indicated:

 

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

(Amounts in millions)

           2007                     2006                     2007                     2006          

Account value, beginning of period

   $ 11,515     $ 9,886     $ 10,483     $ 9,777  

Deposits(1)

     323       676       2,152       2,154  

Surrenders and benefits(1)

     (710 )     (878 )     (1,799 )     (2,484 )
                                

Net flows

     (387 )     (202 )     353       (330 )

Interest credited

     154       128       442       365  

Foreign currency translation

     10       —         14       —    
                                

Account value, end of period

   $ 11,292     $ 9,812     $ 11,292     $ 9,812  
                                

(1)

“Surrenders and benefits” include contracts that have matured but are redeposited with us and reflected as deposits. For the three months ended September 30, 2007 and 2006, surrenders and deposits that were redeposited and are now reflected under “Deposits” amounted to $100 million and $105 million, respectively. For the nine months ended September 30, 2007 and 2006, surrenders and deposits included $300 million and $415 million, respectively, that were redeposited and reflected under “Deposits.”

The increase in account values was primarily the result of the increase in our FABNs, which include the registered note and the global medium term note (“GMTN”) programs. The GMTN program was launched in the first quarter of 2007 and resulted in issuances of $600 million. In the second quarter of 2007, we issued $650 million of our FABN registered note program. For the three months ended September 30, 2007, deposits decreased as a result of lower sales given the credit market environment. For the three and nine months ended September 30, 2007, the increase in interest credited was driven by an increase in account value as well as higher crediting rates on our floating rate products due to an increase in short-term interest rates compared to 2006. These increases were partially offset by scheduled maturities of fixed GICs.

See “—Trends and conditions affecting our segments” for further discussion of the impact of the current credit market condition on FABNs and funding agreements.

 

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Life insurance

The following tables set forth selected financial and operating performance measures regarding our life insurance business as of or for the periods indicated:

 

    Three months
ended September 30,
  Increase (decrease) and
percentage change
    Nine months
ended September 30,
 

Increase (decrease) and

percentage change

 

(Amounts in millions)

      2007           2006             2007 vs. 2006               2007           2006               2007 vs. 2006          

Term life insurance

               

Net earned premiums

  $ 231   $ 224   $ 7     3 %   $ 691   $ 658   $ 33     5 %

Annualized first-year premiums

    28     36     (8 )   (22 )%     86     107     (21 )   (20 )%

Universal and whole life insurance

               

Net earned premiums and deposits

  $ 143   $ 112   $ 31     28 %   $ 420   $ 352   $ 68     19 %

Universal life annualized first-year deposits

    15     9     6     67 %     41     28     13     46 %

Universal life excess deposits

    53     24     29     121 %     142     65     77     118 %

Total life insurance

               

Net earned premiums and deposits

  $ 374   $ 336   $ 38     11 %   $ 1,111   $ 1,010   $ 101     10 %

Annualized first-year premiums

    28     36     (8 )   (22 )%     86     107     (21 )   (20 )%

Annualized first-year deposits

    15     9     6     67 %     41     28     13     46 %

Excess deposits

    53     24     29     121 %     142     65     77     118 %

 

     As of September 30,    Percentage
change
 

(Amounts in millions)

   2007    2006    2007 vs. 2006  

Term life insurance

        

Life insurance in-force, net of reinsurance

   $ 457,001    $ 422,163    8 %

Life insurance in-force before reinsurance

     614,248      583,780    5 %

Universal and whole life insurance

        

Life insurance in-force, net of reinsurance

   $ 41,638    $ 41,595    —   %

Life insurance in-force before reinsurance

     50,737      49,337    3 %

Total life insurance

        

Life insurance in-force, net of reinsurance

   $ 498,639    $ 463,758    8 %

Life insurance in-force before reinsurance

     664,985      633,117    5 %

 

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Term life insurance

The increase in term life insurance net earned premiums and insurance in-force was mainly due to growth of the in-force block of business as annualized first-year premiums exceeded lapses. Annualized first-year premiums decreased as a result of increased price competition and a shift to universal life insurance products by our distributors.

Universal and whole life insurance

Annualized first-year and excess deposits in our universal life insurance increased largely from a shift from term life insurance products by our distributors and new product offerings gaining momentum. The in-force block remained flat mainly as a result of the growth in universal life insurance being offset by the continued runoff of our closed block of whole life insurance.

Long-term care insurance

The following table sets forth selected financial and operating performance measures regarding our long-term care insurance business, which includes individual and group long-term care insurance, Medicare supplement insurance, a linked-benefits product (that combines universal life insurance and long-term care insurance product features), as well as several runoff blocks of accident and health insurance and corporate-owned life insurance for the periods indicated:

 

     Three months
ended September 30,
  

Increase

(decrease) and
percentage change

   

Nine months

ended September 30,

  

Increase

(decrease) and
percentage change

 

(Amounts in millions)

       2007            2006                2007 vs. 2006                 2007            2006                2007 vs. 2006          

Net earned premiums:

                     

Long-term care

   $ 444    $ 418    $ 26     6 %   $ 1,293    $ 1,224    $ 69    6 %

Medicare supplement and other

     63      67      (4 )   (6 )%     197      144      53    37 %
                                                       

Total

   $ 507    $ 485    $ 22     5 %   $ 1,490    $ 1,368    $ 122    9 %
                                                       

Annualized first-year premiums and deposits

   $ 60    $ 51    $ 9     18 %   $ 166    $ 150    $ 16    11 %

Net earned premiums increased primarily due to growth in the individual long-term care insurance in-force block from new sales. For the three months ended September 30, 2007, Medicare supplement insurance net earned premiums decreased mainly as a result of higher terminations. For the nine months ended September 30, 2007, Medicare supplement insurance net earned premiums increased principally as a result of a $64 million increase due to the Continental Life acquisition, partially offset by higher terminations.

Annualized first-year premiums and deposits increased primarily attributable to the introduction of our linked-benefits product in 2006 with sales beginning in the fourth quarter of 2006. Our acquisition of Continental Life contributed an increase of $7 million in the nine months ended September 30, 2007 and was more than offset by a decline in our existing block of Medicare supplement insurance. The decline of annualized first-year premiums in our existing block of Medicare supplement insurance was the result of pricing actions and limited plan withdrawals in selected markets in the second quarter of 2006. Annualized first-year premiums and deposits in our long-term care insurance product were flat.

 

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International segment

Segment results of operations

Three Months Ended September 30, 2007 Compared to Three Months Ended September 30, 2006

The following table sets forth the results of operations relating to our International segment:

 

     Three months
ended September 30,
   

Increase

(decrease) and
percentage change

 

(Amounts in millions)

         2007                2006                       2007 vs. 2006              

Revenues:

         

Premiums

   $ 572    $ 454     $ 118     26 %

Net investment income

     131      75       56     75 %

Net investment gains (losses)

     —        (1 )     1     100 %

Insurance and investment product fees and other

     8      10       (2 )   (20 )%
                         

Total revenues

     711      538       173     32 %
                         

Benefits and expenses:

         

Benefits and other changes in policy reserves

     126      81       45     56 %

Acquisition and operating expenses, net of deferrals

     281      228       53     23 %

Amortization of deferred acquisition costs and intangibles

     94      73       21     29 %

Interest expense

     6      —         6     NM (1)
                         

Total benefits and expenses

     507      382       125     33 %
                         

Income from continuing operations before income taxes

     204      156       48     31 %

Provision for income taxes

     65      49       16     33 %
                         

Net income

     139      107       32     30 %

Adjustment to net income:

         

Net investment (gains) losses, net of taxes and other adjustments

     1      —         1     NM (1)
                         

Net operating income

   $ 140    $ 107     $ 33     31 %
                         

(1)

We define “NM” as not meaningful for increases or decreases greater than 200%.

The following table sets forth net operating income for the businesses included in our International segment:

 

     Three months
ended September 30,
  

Increase

(decrease) and
percentage change

 

(Amounts in millions)

           2007                    2006                    2007 vs. 2006          

Net operating income:

           

International mortgage insurance

   $ 110    $ 81    $ 29    36 %

Payment protection insurance

     30      26      4    15 %
                       

Total net operating income

   $ 140    $ 107    $ 33    31 %
                       

 

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Net operating income

 

   

The three months ended September 30, 2007 included increases of $10 million and $2 million attributable to changes in foreign exchange rates for our international mortgage insurance and payment protection insurance businesses, respectively.

 

   

The increase in our international mortgage insurance business was driven by growth and seasoning of our insurance in-force in Canada and Australia, which were partially offset by an increased loss ratio.

 

   

The increase in our payment protection insurance business was primarily associated with growth in production in continental Europe and Ireland and continued expansion into new markets.

Revenues

Premiums

 

   

Our international mortgage insurance business increased $64 million and our payment protection business increased $54 million.

 

   

The three months ended September 30, 2007 included increases of $16 million and $26 million attributable to changes in foreign exchange rates for our international mortgage insurance and payment protection insurance businesses, respectively.

 

   

The increase in our international mortgage insurance business was primarily the result of increased earned premiums from new insurance written in prior years.

 

   

The increase in our payment protection insurance business was primarily attributable to growth in continental Europe and Ireland and continued expansion into new markets. Partially offsetting these increases was our runoff block of business and a decrease related to certain reinsurance arrangements being accounted for as deposits (“reinsurance accounting change”) in the current year, while prior year amounts have not been reclassified. The accounting change had no impact on net income or net operating income for all periods presented.

Net investment income

 

   

Our international mortgage insurance business increased $39 million and our payment protection insurance business increased $17 million.

 

   

The three months ended September 30, 2007 included increases of $8 million and $3 million attributable to changes in foreign exchange rates for our international mortgage insurance and payment protection insurance businesses, respectively.

 

   

The increase in our international mortgage insurance business was largely due to an increase in invested assets associated with growth of the business, higher levels of capital and increased yields. In addition, we reclassified $16 million of fees associated with a government-mandated reserve for our Canadian mortgage insurance business previously presented as a reduction in net investment income to acquisition and operating expenses in the current year. The effects of this reclassification were not material to the previous quarters in 2007 and prior year 2006 and were not reclassified.

 

   

The increase in our payment protection insurance business was principally attributable to an increase in yields and the reinsurance accounting change.

Insurance and investment product fees and other. The decrease was primarily a result of the elimination of the Canadian application fees in our international mortgage insurance business in the third quarter of 2006.

 

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Benefits and expenses

Benefits and other changes in policy reserves

 

   

Our international mortgage insurance business increased $34 million and our payment protection insurance business increased $11 million.

 

   

The three months ended September 30, 2007 included increases of $6 million and $3 million attributable to changes in foreign exchange rates for our international mortgage insurance and payment protection insurance businesses, respectively.

 

   

The increase in our international mortgage insurance business was primarily driven by large blocks of insurance in-force that are seasoning and an ongoing housing slowdown in certain areas of Australia.

 

   

The increase in our payment protection insurance business was driven by continued business growth, partially offset by the effects of the reinsurance accounting change.

Acquisition and operating expenses, net of deferrals

 

   

Our international mortgage insurance business increased $22 million and our payment protection insurance business increased $31 million.

 

   

The three months ended September 30, 2007 included increases of $4 million and $15 million attributable to changes in foreign exchange rates for our international mortgage insurance and payment protection insurance businesses, respectively.

 

   

The increase in our international mortgage insurance business was primarily driven by a $16 million reclassification of fees associated with the government-mandated reserve for our Canadian mortgage insurance business from net investment income in the current year.

 

   

The increase in our payment protection insurance business was principally driven by an increase in commissions relating to growth in the business, partially offset by the effects of the reinsurance accounting change.

Amortization of deferred acquisition costs and intangibles

 

   

Our international mortgage insurance business increased $3 million and our payment protection insurance business increased $18 million.

 

   

The three months ended September 30, 2007 included increases of $1 million and $7 million attributable to changes in foreign exchange rates for our international mortgage insurance and payment protection insurance businesses, respectively.

 

   

The increase in our international mortgage insurance business was mainly due to amortization of deferred acquisition costs from the growth and seasoning of our insurance in-force.

 

   

The increase in our payment protection insurance business was primarily from an increase in structured transactions, partially offset by the effects of the reinsurance accounting change.

Interest expense. The increase was primarily due to new deposit method reinsurance arrangements in our payment protection insurance business.

Provision for income taxes. The effective tax rate increased to 31.9% for the three months ended September 30, 2007 from 31.4% for the three months ended September 30, 2006. This increase in the effective tax rate was primarily attributable to unfavorable examination developments offset by lower taxed foreign income. The provision for income taxes also included a $5 million increase attributable to changes in foreign exchange rates.

 

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Table of Contents

Nine Months Ended September 30, 2007 Compared to Nine Months Ended September 30, 2006

The following table sets forth the results of operations relating to our International segment:

 

     Nine months
ended September 30,
   Increase (decrease) and
percentage change
 

(Amounts in millions)

       2007             2006                    2007 vs. 2006              

Revenues:

         

Premiums

   $ 1,574     $ 1,349    $ 225     17 %

Net investment income

     332       213      119     56 %

Net investment gains (losses)

     (5 )     —        (5 )   NM (1)

Insurance and investment product fees and other

     21       31      (10 )   (32 )%
                         

Total revenues

     1,922       1,593      329     21 %
                         

Benefits and expenses:

         

Benefits and other changes in policy reserves

     345       236      109     46 %

Acquisition and operating expenses, net of deferrals

     734       662      72     11 %

Amortization of deferred acquisition costs and intangibles

     267       228      39     17 %

Interest expense

     20       —        20     NM (1)
                         

Total benefits and expenses

     1,366       1,126      240     21 %
                         

Income from continuing operations before income taxes

     556       467      89     19 %

Provision for income taxes

     155       139      16     12 %
                         

Net income

     401       328      73     22 %

Adjustment to net income:

         

Net investment (gains) losses, net of taxes and other adjustments

     4       —        4     NM (1)
                         

Net operating income

   $ 405     $ 328    $ 77     23 %
                         

(1)

We define “NM” as not meaningful for increases or decreases greater than 200%.

The following table sets forth net operating income for the businesses included in our International segment:

 

     Nine months
ended September 30,
   Increase (decrease) and
percentage change
 

(Amounts in millions)

       2007            2006              2007 vs. 2006        

Net operating income:

           

International mortgage insurance

   $ 311    $ 248    $ 63    25 %

Payment protection insurance

     94      80      14    18 %
                       

Total net operating income

   $ 405    $ 328    $ 77    23 %
                       

Net operating income

 

   

The nine months ended September 30, 2007 included increases of $18 million and $7 million attributable to changes in foreign exchange rates for our international mortgage insurance and payment protection insurance businesses, respectively.

 

   

The increase in our international mortgage insurance business was driven by growth and seasoning of our insurance in-force in Canada and Australia, as well as a decrease in the effective tax rate. These increases were partially offset by large blocks of insurance in-force that are seasoning and an ongoing housing slowdown in certain areas of Australia.

 

   

The increase in our payment protection insurance business was primarily associated with growth in production in continental Europe, Ireland and new markets, an increase in structured transactions and a decrease in the effective tax rate.

 

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Revenues

Premiums

 

   

Our international mortgage insurance business increased $150 million and our payment protection insurance business increased $75 million.

 

   

The nine months ended September 30, 2007 included increases of $33 million and $74 million attributable to changes in foreign exchange rates for our international mortgage insurance and payment protection insurance businesses, respectively.

 

   

The increase in our international mortgage insurance business was primarily a result of growth and seasoning of our international in-force block, which resulted in increased earned premiums from prior years new insurance written.

 

   

The increase in our payment protection insurance business was primarily attributable to an increase in structured transactions, growth in continental Europe and Ireland and continued expansion into new markets. These increases were offset by our runoff block of business and the reinsurance accounting change.

Net investment income

 

   

Our international mortgage insurance business increased $71 million and our payment protection insurance business increased $48 million.

 

   

The nine months ended September 30, 2007 included increases of $13 million and $8 million attributable to changes in foreign exchange rates for our international mortgage insurance and payment protection insurance businesses, respectively.

 

   

The increase in our international mortgage insurance business was largely due to an increase in invested assets associated with the business, higher levels of capital, increased yields and a $16 million reclassification of fees associated with a government-mandated reserve for our Canadian mortgage insurance business previously presented as a reduction in net investment income to acquisition and operating expenses in the current year.

 

   

The increase in our payment protection insurance business was principally attributable to income related to growth in business accounted for under the deposit method, increased yields and the reinsurance accounting change.

Insurance and investment product fees and other. The decrease was primarily due to the elimination of Canadian application fees in our international mortgage insurance business in the third quarter of 2006.

Benefits and expenses

Benefits and other changes in policy reserves

 

   

Our international mortgage insurance business increased $91 million and our payment protection insurance business increased $18 million.

 

   

The nine months ended September 30, 2007 included increases of $13 million and $10 million attributable to changes in foreign exchange rates for our international mortgage insurance and payment protection insurance businesses, respectively.

 

   

The increase in our international mortgage insurance business was primarily a result of large blocks of insurance in-force that are seasoning and an ongoing housing slowdown in certain areas of Australia.

 

   

The increase in our payment protection insurance business was driven by continued business growth, partially offset by the effects of the reinsurance accounting change.

 

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Acquisition and operating expenses, net of deferrals

 

   

Our international mortgage insurance business increased $31 million and our payment protection insurance business increased $41 million.

 

   

The nine months ended September 30, 2007 included increases of $7 million and $43 million attributable to changes in foreign exchange rates for our international mortgage insurance and payment protection insurance businesses, respectively.

 

   

The increase in our international mortgage insurance business was principally driven by our continued investment in our existing international platforms and potential new international platforms and a reclassification of fees associated with the government-mandated reserve for our Canadian mortgage insurance business from net investment income in the current year. These increases were partially offset by the elimination of Canadian application fees in the third quarter of 2006.

 

   

The increase in our payment protection insurance business was largely attributable to an increase in paid commissions relating to growth in the business, partially offset by a decrease in commissions on the runoff block of business and from the effects of the reinsurance accounting change.

Amortization of deferred acquisition costs and intangibles

 

   

Our international mortgage insurance business increased $11 million and our payment protection insurance business increased $28 million.

 

   

The nine months ended September 30, 2007 included increases of $2 million and $19 million attributable to changes in foreign exchange rates for our international mortgage insurance and payment protection insurance businesses, respectively.

 

   

The increase in our international mortgage insurance business was mainly due to the growth and seasoning of our insurance in-force.

 

   

The increase in our payment protection insurance business was primarily from an increase in structured transactions, partially offset by the effects of the reinsurance accounting change.

Interest expense. The increase was primarily due to new deposit method reinsurance arrangements in our payment protection insurance business.

Provision for income taxes. The effective tax rate decreased to 27.9% for the nine months ended September 30, 2007 from 29.8% for the nine months ended September 30, 2006. This decrease in the effective tax rate was primarily attributable to the increase in lower taxed foreign income. The provision for income taxes also included a $9 million increase attributable to changes in foreign exchange rates.

International selected financial and operating performance measures

International mortgage insurance

The following tables set forth selected financial and operating performance measures regarding our international mortgage business as of or for the dates indicated:

 

     As of September 30,    Increase (decrease) and
percentage change
 

(Amounts in millions)

       2007            2006                            2007 vs. 2006                       

Primary insurance in-force

   $ 461,900    $ 319,600    $ 142,300    45 %

Risk in-force

     146,800      102,700      44,100    43 %

 

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     Three months ended
September 30,
       Increase (decrease) and
percentage change
    Nine months ended
September 30,
       Increase (decrease) and
percentage change
 

(Amounts in millions)

       2007            2006                2007 vs. 2006                 2007            2006                2007 vs. 2006          

New insurance written

   $ 36,200    $ 28,700    $ 7,500    26 %   $ 108,900    $ 70,800    $ 38,100    54 %

Net premiums written

     452      311      141    45 %     1,202      759      443    58 %

Net premiums earned

     208      144      64    44 %     576      426      150    35 %

Primary insurance in-force and risk in-force

Our businesses in Australia, New Zealand and Canada currently provide 100% coverage on the majority of the loans we insure in those markets. For the purpose of representing our risk in-force, we have computed an “effective” risk in-force amount, which recognizes that the loss on any particular loan will be reduced by the net proceeds received upon sale of the property. Effective risk in-force has been calculated by applying to insurance in-force a factor that represents our highest expected average per-claim payment for any one underwriting year over the life of our businesses in Australia, New Zealand and Canada. For the three and nine months ended September 30, 2007 and 2006, this factor was 35%.

Primary insurance in-force and risk in-force increased primarily as a result of an increase in new insurance written as we continue to execute our global expansion strategy and expand our market share and size. Our international mortgage insurance primary insurance in-force and risk in-force included increases of $59.0 billion and $19.3 billion attributable to changes in foreign exchange rates for the nine months ended September 30, 2007, respectively.

New insurance written

New insurance written increased attributable to growth in flow and bulk new insurance written primarily as a result of continued account penetration in Canada, the ongoing expansion of our customer base in Europe, higher bulk new insurance written in Australia and growth in new markets. The three and nine months ended September 30, 2007 included increases of $3.1 billion and $7.0 billion attributable to changes in foreign exchange rates, respectively.

Net premiums written and net premiums earned

Net premiums written increased primarily due to increases in new insurance written in our international mortgage insurance business. The three and nine months ended September 30, 2007 included increases of $34 million and $65 million attributable to changes in foreign exchange rates, respectively.

Most of our international mortgage insurance policies provide for single premiums at the time that loan proceeds are advanced. We initially record the single premiums to unearned premium reserves and recognize the premiums earned over time in accordance with the expected pattern of risk emergence. As of September 30, 2007, our unearned premium reserves increased to $3.3 billion, including $0.4 billion attributable to changes in foreign exchange rates, from $2.3 billion as of September 30, 2006.

Net premiums earned increased primarily as a result of growth and seasoning of our insurance in-force block. The three and nine months ended September 30, 2007 included increases of $16 million and $33 million attributable to changes in foreign exchange rates, respectively.

Loss and expense ratios

 

     Three months
ended September 30,
    Increase (decrease)     Nine months
ended September 30,
    Increase (decrease)  
         2007             2006                 2007 vs. 2006                 2007             2006                 2007 vs. 2006          

Loss ratio

   32 %   22 %   10 %   31 %   20 %   11 %

Expense ratio

   16 %   16 %   —   %   15 %   19 %   (4 )%

 

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The loss ratio is the ratio of incurred losses and loss adjustment expenses to net premiums earned. The expense ratio is the ratio of general expenses to net premiums written. In our business, general expenses consist of acquisition and operating expenses, net of deferrals, and amortization of deferred acquisition cost and intangibles.

For the three and nine months ended September 30, 2007, the increase in the loss ratio was attributable to higher incurred losses primarily as a result of large blocks of insurance in-force that are seasoning and an ongoing housing slowdown in certain areas of Australia.

For the nine months ended September 30, 2007, the decrease in the expense ratio was primarily the result of higher net premiums written primarily in Canada, partially offset by an increase in costs in our existing international platforms and continued investment in new platforms.

Loans in default and claims

The following table sets forth the number of loans insured, the number of loans in default and the default rate for our international mortgage insurance portfolio:

 

     As of September 30, 2007     As of December 31, 2006  

Primary insurance

    

Insured loans in-force

   2,777,471     2,437,746  

Loans in default

   13,038     10,126  

Percentage of loans in default (default rate)

   0.47 %   0.42 %

Flow loans in-force

   2,285,980     2,156,641  

Flow loans in default

   12,165     9,671  

Percentage of flow loans in default (default rate)

   0.53 %   0.45 %

Bulk loans in-force

   491,491     281,105  

Bulk loans in default(1)