Genworth Financial Inc Q3 FY2021 Earnings Call

Good morning, ladies and gentlemen, and welcome to Genworth Financial's Third Quarter 2021 Earnings Conference Call. My name is Katie, and I will be your coordinator today. At this time, all participants are in a listen-only mode. We will facilitate a question-and-answer session towards the end of the conference call. As a reminder, the conference is being recorded for replay purposes. I would now like to turn the presentation over to Tim Owens, Vice President of Investor Relations. Mr. Owens, you may proceed.

Thank you, operator. Good morning, and thank you for joining Genworth's third quarter 2021 earnings call. All of our speakers are remote this morning, so please excuse any sound quality or technical issues that may arise. A press release and financial supplement were released last night, and this morning, our earnings presentation was posted to our website and will be referenced during our call. We encourage you to review all of these materials. Today, you will hear from our President and Chief Executive Officer, Tom McInerney; followed by Dan Sheehan, our Chief Financial Officer and Chief Investment Officer. Following our prepared comments, we will open up the call for a question-and-answer period. In addition to our speakers, Brian Haendiges, President of our U.S. Life division, and Jerome Upton, Deputy Chief Financial Officer, will also be available to take your questions. During the call this morning, we may make various forward-looking statements. Our actual results may differ materially from such statements. We advise you to read the cautionary notes regarding forward-looking statements in our earnings release and related presentation, as well as the risk factors of our most recent annual report on Form 10-K as filed with the SEC. This morning's discussion also includes non-GAAP financial measures that we believe may be meaningful to investors. In our financial supplement, earnings release, and investor materials, non-GAAP measures have been reconciled to GAAP where required in accordance with SEC rules. Also, references to statutory results are estimates due to the timing of the filing of the statutory statements.

Thank you, Tim. Good morning, everyone. And thank you for joining Genworth’s third quarter earnings call. We're pleased to report another very strong quarter of operating performance, continuing the strong momentum in our businesses. Net income in the third quarter was $314 million. Adjusted operating income totaled $239 million, up from $125 million in the year-ago period, driven primarily by the U.S. Life Insurance business. U.S. Life reported adjusted operating income of $93 million for the quarter, up from $71 million in the prior quarter, and $14 million in the prior year period. Results were primarily driven by LTC insurance, which reported adjusted operating income of $133 million, reflecting strong earnings from in-force rate actions, including higher benefit reductions, as well as higher net investment income. Our U.S. mortgage insurance subsidiary Enact held its first quarterly earnings call as a publicly traded company this morning, following a successful IPO in September. Its results included very strong adjusted operating income, substantial growth in primary insurance in force, and robust capital sufficiency. Dan will provide more details around Enact’s performance and its impact on Genworth’s consolidated results. We also encourage shareholders to refer to Enact’s earnings release and slides posted on its Investor Relations website for more details. We once again ended the quarter with improved capital sufficiency in both Enact and our principal life insurance company, Genworth Life Insurance Company, or GLIC. We entered the fourth quarter with a strong cash position of approximately $638 million, and exciting plans to further strengthen Genworth’s balance sheet and advance our long-term growth agenda. Looking forward, we remain focused on five strategic priorities, which we're working on in parallel. Our priorities are to maximize the value of Enact, reduce our holding company debt, achieve economic breakeven and stabilize the legacy LTC portfolio, advance our LTC growth initiatives, and return capital to shareholders. Enact is a valuable business with a leading market position and attractive growth opportunities. We monetized part of our ownership stake during the third quarter due to the successful minority IPO, which created significant value for both companies. Genworth received aggregate net proceeds of approximately $529 million from the IPO. We used those proceeds to retire in full our outstanding promissory note to AXA of approximately $296 million, nearly a year ahead of schedule. After the IPO, both Moody's and S&P issued upgrades to some of our ratings and outlooks, as well as those of Enact, reflecting further improvement in our financial flexibility and credit risk profile. We are proud of this outcome and the work we've done to date to support these upgrades. After the IPO, our ownership of Enact decreased from 100% to 81.6%. We intend to maintain our position for the foreseeable future. We expect our majority ownership in Enact to generate a significant dividend stream and to be an important source of cash flow going forward. Next, I'd like to highlight the significant reduction in debt that we have achieved. Inclusive of the $296 million AXA note repayment, we have reduced holding company debt by $1.5 billion year-to-date. We are proud of this progress, which brings us closer to our target debt of approximately $1 billion. We also made progress toward stabilizing our legacy LTC portfolio this quarter, primarily through our multi-year rate action plan or MYRAP. We have achieved approximately $323 million in rate action approvals year-to-date, including $117 million in the third quarter, which brings our cumulative total to over $16.3 billion on a net present value basis since 2012. Pursuing these actuarially justified rate actions is critical to achieving breakeven on an economic basis for the legacy LTC business over time. You can see the success of this initiative illustrated on Slide 11 of our investor presentation, which shows the impact of LTC in-force rate actions or IFAs on our statutory pretax earnings since 2017. Since 2019, the annual benefit from IFAs has more than offset our statutory losses from our legacy LTC products. In 2021, this included the impact of the legal settlement. Over the longer term, we will reach a point when premiums will no longer exceed payouts, and the losses that give rise to our assumption for shortfall will emerge. That's why we're continuing to pursue IFAs while also addressing high-risk LTC categories, like policies with compounding benefit increases. We're doing this by offering reduced benefit packages, which provide flexibility to policyholders facing premium rate increases, and which also limit tail risk to Genworth. We're also developing care management initiatives to reduce both the likelihood of people needing care and the level of care they require. Through our IFAs, benefit reductions, and care management, we're effectively working to mitigate both near-term and long-term risk associated with our legacy books. As of September 30, 2021, approximately 43% of Genworth’s LTC policyholders have opted for some form of reduced benefit options. Taking a step back, the cumulative effect of rate increases or IFAs achieved since 2013 has positioned us well to meet obligations over the intermediate term. The continued focus on benefit reductions and care management will help to reduce risk over the long term. We are currently conducting our annual assumption review and expect to strengthen one of our assumptions for benefit utilization rate at the end of the year. This assumption is a key driver of results and is expected to significantly increase our estimated shortfall, reflecting how our experience has evolved. When our best estimates change and require the strengthening of assumptions, policyholders benefit from stronger reserves backing our liabilities. We continue to see broad-based support from regulators for actuarially justified rate increases and fully expect the assumption strengthening to be offset by allowed expansion of our multi-year rate action plan. With the combined effect of prior year IFAs, assumption strengthening, new IFAs, benefit reductions, and care management, we remain confident in our ability to achieve economic breakeven. We will share more details from our assumptions review on our fourth quarter call. I want to thank the regulators who are on this journey with us, as we work diligently to serve all of our policyholders, find solutions to the issues created by products sold in the past, and forge a new path forward for the LTC industry. I also want to highlight the excellent work being done by our U.S. Life colleagues, led by President and CEO, Brian Haendiges. Brian joined Genworth as Chief Risk Officer in 2020 and took on his current role in February this year. He has been instrumental in further accelerating risk reduction in our legacy LTC blocks, so that we are better positioned to pay benefits over the long term. Before I move on to our LTC growth initiatives, I want to briefly touch on the upcoming changes to U.S. GAAP accounting under the new long-duration targeted improvement or LDTI standards, which were issued by the financial accounting standards board. We expect to provide shareholders with a view on the expected impacts sometime next year, with the effective date in January of 2023. I want to note that the relative impact of these new accounting rules may be greater for Genworth Life Insurance Company compared to other life insurers, given that our U.S. Life portfolio is weighted towards traditional long-duration insurance liabilities, including long-term care insurance. Accordingly, we expect a material impact on our U.S. GAAP balance sheet and income statements upon adoption in 2023 and going forward, including a significant reduction in our U.S. GAAP book value or equity. The U.S. GAAP book value for legacy life companies is expected to be significantly lower going forward under the new accounting. The old U.S. GAAP long-duration accounting was based on original pricing assumptions. The new LDTI accounting will change from an original pricing regime to a best estimate for market-oriented accounting model. The anticipated reduction in U.S. Life’s book value is a U.S. GAAP accounting change only. It will not impact economic cash flows. The best indicator of current and future economic cash flows for U.S. Life and the legacy LTC business remains the statutory cash flow testing regime under statutory accounting, which will not be impacted by the LDTI U.S. GAAP accounting changes.

Thanks, Tom, and good morning, everyone. This was another excellent quarter for Genworth, a strong financial performance and continued advancement toward our strategic priorities. Net income this quarter was $314 million. And with this quarter’s $239 million adjusted operating income of $0.46 a share, we've reported more than $600 million in adjusted operating income so far this year. During the quarter, we fully retired the remaining principal amount of the September 2021 debt maturity of $513 million. We also successfully executed Enact’s IPO, generating $529 million in net proceeds that we used to pay off the remainder of our AXA promissory note of $296 million and further enhance our liquidity position, moving forward with a strong cash position and a clear path for continued execution of Genworth’s strategy. Our Enact subsidiary hosted their earnings call this morning, so I'll focus on the key highlights. Enact’s NIW for the quarter was $24 billion and contributed to the overall 10% year-over-year increase in insurance in force. For the third quarter, Enact reported adjusted operating income of $134 million to Genworth and a strong loss ratio of 14%. I would note that Genworth’s third quarter adjusted operating income excludes an 18.4% minority interest since the Enact IPO date of September 16 with $4 million in adjusted operating income for the third quarter. Enact finished the quarter with an estimated PMIERs sufficiency ratio of 181%, approximately $2.3 billion above published requirements. The improvement in the PMIER sufficiency versus the prior quarter was driven by strong business cash flows and additional reinsurance credit. Regarding the fourth quarter dividend, Enact is evaluating economic and business conditions, including the resolution of forbearance related delinquencies. Assuming these conditions remain supportive, Enact intends to recommend to their board the approval of a $200 million dividend. Genworth would receive its pro-rata share of that dividend based on its ownership interest of approximately $160 million. Turning to the U.S. Life segment, overall results were solid in the quarter at $93 million, driven by the continued strength of the LTC in-force rate action plan and variable investment income. Mortality continued to be elevated in the quarter in part from COVID-19, which negatively impacted our life insurance results. Long-term care had adjusted operating income of $133 million compared to $98 million in the prior quarter and $59 million in the prior year. As we discussed last quarter, our overall GAAP margins are slightly positive. We've established a GAAP-only profits followed by losses reserve, which covers projected losses in the future. As of the third quarter, the pre-tax balance of this reserve was $1.1 billion, up from $625 million as of year-end 2020. This reduced LTC earnings by $129 million after tax during the quarter. Earnings from in-force rate actions of $304 million prior to profits followed by losses increased versus the prior year. Page 9 of the investor presentation illustrates the strong quarterly earnings trends from our in-force rate actions. At this time, it's difficult to assess the overall impact of these legal settlements will have going forward, as full implementation will take another one to two years. Shifting to in-force rate action approvals for LTC during the quarter, we received approvals impacting approximately $394 million of premiums, with a weighted average approval rate of 30%. Year-to-date, we received approvals impacting $871 million in premiums, with the weighted average approval rate of 37%, up from the comparable period last year. Our quarterly approval is uneven; we expect approvals in the fourth quarter and 2022 to be strong based on pending filings and regulators recognition of the importance of actuarially justified rate increases for Genworth and the industry. We experienced favorable variable investment income in LTC again this quarter, reflecting higher limited partnership income, gains on treasury inflation-protected securities and bond calls on mortgage repayments. While we have seen very strong variable net investment income this year, we do expect this investment performance to moderate over time. Claim terminations in the third quarter were higher versus the prior quarter and lower versus the prior year, as noted on Page 8 of the investor presentation. We did not materially adjust our previously established COVID reserve for mortality during the quarter, as the pandemic continues to develop. New active claims have trended up gradually in 2021, although incidence remains lower than pre-pandemic levels. We expect to complete our claims assumption review in the fourth quarter. While this work is ongoing and not completed, preliminary indications are that our claim reserve assumptions are holding up in aggregate. We also plan to complete our review of assumptions related to our active life reserves, as well as loss recognition testing and statutory cash flow testing in the fourth quarter. For these updates, we're generally not including data from 2020 or later in setting any long-term assumptions because we do not yet have sufficient information around longer-term effects of the pandemic. In fixed annuities, adjusted operating earnings of $28 million for the quarter were higher sequentially, driven by favorable mortality and a change in reserves related to the increase in interest rates during the quarter. In the runoff segment, our adjusted operating income was $11 million for the third quarter versus $15 million in the prior quarter and $19 million last year. We expect Genworth Life Insurance Company or GLIC, as a percentage of company action level RBC, to be approximately 290%, up from 272% at the end of the second quarter. Driving this result is U.S. Life statutory earnings, which continue to benefit from higher LTC earnings from the impact of in-force rate actions. We expect cash tax payments to continue in 2022, although at reduced levels as U.S. Life trends normalize over time. With a strong cash position, we intend to retire our 2023 debt maturity once Enact declares their dividend, moving us $400 million closer to our debt target. We will ultimately assess future dividend streams in the next several months.

Hey, guys, good morning. I have a few questions since it's been a while. Maybe first, could you just provide an update on the status of the AXA counter lawsuit against Santander? And any sense of when this decision could be made and how much potential recovery you could get?

So Ryan, I'll take that one. It’s a good question, we get it often. The AXA to Santander litigation process is going through the UK courts. You normally expect 18 months to 24 months for it to be resolved. Our understanding is given COVID-19 in the UK, the court dockets on this litigation are more challenged than they used to be. The guidance would be probably a couple of years from when it started, which was January of this year, could be delayed more than normal because of the COVID-19 backlog. In terms of amounts, we face significant amounts to AXA under our guarantee. If AXA wins in the litigation, we would expect the amounts that we've paid. We would have the ability to ultimately recover a significant amount, but that really depends on how litigation goes. It's pretty hard for us at this point to assess. But I would say depending on how the litigation process goes, there's a potential for significant upside.

Thanks. I think another question was on targeted debt as well as capital return. I guess, maybe the question is, long-term, is your plan to eventually fully separate Enact? And I guess if so, I would think the goal would be to pay down debt to zero to enable that to happen. So kind of an update on that in regards to your statements on $1 billion long-term debt target and returning capital to shareholders?

Thanks, Ryan. I'll take the first part of that, and maybe ask Dan to comment. Our goal is to get the long-term debt to around $1 billion range. And that's been a target for a while. Realistically, we're talking about $900 million. When we get the debt to the 2034 and the 2066, the $900 million, obviously, that's very long before we have to make any principal payments. I think the interest payments are in the $40 million range, which is very manageable for us. So that's why we have that as a target. Longer-term, we could keep our 81.6% of Enact for the foreseeable future. We have options to either spin-off or talk about that, 81.6% to shareholders on a tax-free basis, depending on where we are down the road. That's an attractive option. There are obviously other options. To the extent that the new business opportunities we see in LTC, we think they're attractive. If the life companies through the new growth business and capital produces from that, it could be that the life company could handle some debt in the future. But absent dividends flowing from the new companies, the life company really can’t have significant debt. Dan, do you want to add anything to that?

Yeah, Tom, I would just reiterate that once we pay off the ‘23s and the ‘24s, we have a ten-year plus runway with that service in the $35 million to $40 million range to give us the utmost flexibility. And so, if ultimately life companies can support that level of debt service, we would have the option to spin off the company. If they cannot, then I think the point is right that we would look at potentially paying down the rest of the debt. That is still our goal.

One last question is, and I know this is somewhat challenging, but can you give any sense in a more normal year, I guess, without COVID, what level of cash tax inflows you might expect at the holding company?

The tax question really ties to earnings. We haven't provided forward guidance on earnings. However, a way to think about taxes would be to break it into two parts. I would look at your models earnings for Enact at around the 20% to 21% tax rate to get you in the ballpark for what we would expect Enact’s payments to the Holdco, adjusting for our ownership interest. For the life side, we have some legacy issues for starting swaps which are taxed at a higher rate. The tax rate for the life side will be a little bit higher than 21%. One reason we’ve added profits followed by losses information in our materials is that quarter, we had $129 million after tax in profits followed by losses, which can help in approximating the cash payment to the holding company.

Hi. Thanks, everyone. Good morning. My first question was on the debt maturities. I appreciate the color around the 2023 note. Do you have any, I guess, timing that you can offer on when you intend to retire the 2024 maturity?

If you look at our cash positions as of the end of Q3, we're in a very good position to pay off the ‘23s. We will pay off the ‘23 once Enact declares a dividend, giving us approximately $400 million. Regarding timing of when to pay off the ‘24s, we have a lot of time before the 2024 maturity. We will balance several factors, including what the cash flows look like quarter by quarter. If the fourth quarter goes as expected and we receive the dividend from Enact, we will be closer to being able to provide guidance on that.

Okay, great. So point being those that you feel comfortable that you can prepay those, and you're not going to pay down on maturity. Got it. Second question is on can you remind us what your NOL position looks like? And the extent that your NOLs are contributing to the cash tax payments that you're getting from the subsidiaries?

As of Q3, we've effectively used all tax assets on the balance sheet and we're really into sort of normal tax planning mode. We do not expect to be a cash taxpayer at the federal level in the near-term, meaning we have normal cash tax planning strategies that will allow cash to come to the Holdco in the near-term. In the medium term, to the extent we continue to see strong earnings from both Enact and life companies, we will ultimately be a cash taxpayer.

Hey, good morning. Appreciate you taking my question. Can you give us a sense of the magnitude of the strengthening or alternatively, where the benefit utilization trend assumption is currently versus where it might be set? And how you expect the reserve strengthening to impact the life company's ability to send tax-sharing payments to the parent, either for the fourth quarter or into next year?

It's a good question. It's a complicated question. The first thing I'd say is, it's November 3, so we've got quite a bit of work still to do. Based on what we're seeing, it's more likely than not that we'll make a change in that benefit utilization reserve. But we have a long period of time to cover those costs through premium increases or benefit reductions. I wouldn't expect that those changes would have a material impact on statutory earnings for the balance of this year or next year. Short-term earnings are based on the actual claims you pay. If we could not recover that increase in reserves, we would not have a positive margin impacting short-term earnings.

Thanks, good morning. If you're able to retire your ‘23s after the Enact dividend, can you share any estimate of MAKO and potential accrued interest at that point on top of principal debt?

It depends on the level of interest rates at the time, but I would expect that number to be between $30 million and $40 million.

And then can you also remind us as we consider the potential for early pay down on the ‘24s, the liquidity target you're aiming to have at the Holdco?

We prefer to have two times debt service coverage. We'd like to have around $200 million. Certainly, as we pay down the ‘23s and ‘24s, we would revisit that. But at this point, we're still thinking about the number around $200 million.

Katie, thank you very much. I want to thank everyone on the call today for joining. Also, I want to thank the two Ryans, Josh, and Geoff, for what I thought were excellent questions. The bottom line is, I think we had an excellent third quarter. We're very happy with the operating results and the progress we've made against those five strategic priorities. We're excited about Genworth’s future. We look forward to talking to you again next quarter.

Thank you. Ladies and gentlemen, this concludes Genworth’s financials third quarter conference call. Thank you for your participation. At this time, the call will end.