Genworth Financial Inc Q2 FY2022 Earnings Call

Good morning, ladies and gentlemen, and welcome to Genworth Financial's Second Quarter 2022 Earnings Conference Call. My name is Katie, and I will be your coordinator today. As a reminder, the conference is being recorded for replay purposes. I would now like to turn the presentation over to Sarah Crews, Director of Investor Relations. Please go ahead.

Thank you, operator. Good morning, and welcome to Genworth's Second Quarter 2022 Earnings Call. 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. The slide presentation that accompanies this call is available in the Investor Relations section of the Genworth website, investor.genworth.com. Our earnings release and financial supplement can also be found there, and we encourage you to review these materials. Following our prepared remarks, we will open the call up for a question-and-answer period. In addition to our speakers, Brian Haendiges, President of our U.S. Life Insurance segment; and Jerome Upton, Deputy Chief Financial Officer and Controller, 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. And now I'll turn the call over to our President and CEO, Tom McInerney.

Thank you, Sarah. Good morning, everyone, and thank you for joining our second quarter earnings call. Genworth delivered strong performance in the second quarter, making continued progress against our strategy to strengthen our financial foundation and create value for our shareholders. Our strategy is designed to deliver long-term growth while also protecting shareholder value in downside scenarios, which is especially important in today's difficult market environment. This challenging macroeconomic backdrop is driven by a confluence of competing factors, including high inflation, rising interest rates, new COVID-19 variants, equity market volatility and a tight labor market, the combination of which has created economic uncertainty. While we should not compare this period to other market downturns, I believe that the expected sharp increase in interest rates by the Federal Reserve to mitigate historic levels of inflation will likely adversely impact the economy in the near to medium term and continue to create market volatility. From where we stand today, however, I believe Genworth is well positioned to weather this volatility and economic uncertainty because of strong levels of capital in our businesses, a conservatively positioned investment portfolio, a very low debt-to-capital ratio and modest annual debt service obligations. Our execution against our strategic priorities reinforces that positioning as we continue to deliver strong performance from our Enact subsidiary, reduce holding company debt and return value to shareholders in the form of share buybacks. First, let me review our second quarter results at a high level. U.S. GAAP net income was $181 million for the second quarter, while adjusted operating income was $176 million or $0.34 per share. These results were led by Enact, which reported $167 million in adjusted operating income. U.S. Life reported adjusted operating income of $21 million for the quarter, driven by LTC insurance and fixed annuities, partially offset by losses in life insurance. Turning to statutory results in Genworth Life Insurance Company, or GLIC, we had an estimated pretax statutory loss of approximately $60 million. The loss is primarily driven by equity market volatility, which required us to adjust reserves and capital in a closed block variable annuity business. Our estimated RBC ratio was 290% as of quarter end. Our final statutory results will be available with our second quarter statutory filings later this month. Enact's continued strong operating performance in a slowing housing market has delivered shareholder returns including stock price appreciation and dividends of over 19% since the IPO in September of 2021 through Friday's close despite meaningful market volatility during that time. Since the IPO, Genworth has received $182 million in dividends from Enact, including $19 million in the quarter. Genworth's shareholders benefit from our ownership of Enact through its quarterly and special dividends which have enabled us to execute against our strategic priorities, including debt reduction, share buybacks and the continued development of our long-term growth strategy through global care solutions. In addition, the market value of Enact has increased over the last several months and Enact has traded in line with comparable peers. Enact has continued to deliver strong performance as a result of its differentiated strategy, balance sheet strength, outstanding management team and ability to mitigate risk while building a high-quality book of insurance in-force. Enact's stand-alone book value, excluding AOCI, has increased from $3.9 billion at the end of the second quarter of 2021 to $4.4 billion at the end of the second quarter of 2022. The business continues to operate from a position of strength, writing meaningful levels of NIW and benefiting from higher persistency. The company has had strong loss performance, which has allowed it to release reserves - excess reserves in the first and second quarters. Enact also continues to maintain a strong balance sheet and strong regulatory capital ratios and executed a $200 million revolving credit facility, providing additional financial flexibility going forward. Both Enact's and Genworth's ratings have steadily improved since the IPO as a result of Enact's strong operating performance and capital levels and the significant deleveraging actions taken by Genworth. These factors demonstrate our execution against our strategic priority to maximize the value of Enact to Genworth shareholders. Genworth's deleveraging has improved our credit profile, and we continue to focus on reducing our debt and paying off the remaining 2024 debt by the end of the third quarter, which would bring Genworth's parent debt to $900 million. This would also bring our debt-to-capital ratio down to one of the lowest in the life insurance industry which positions us well to weather the market uncertainty in the next 12 to 18 months. In the second quarter, we repurchased approximately $48 million of our 2024 debt leaving approximately $152 million in principal outstanding. Given our holding company cash position, the quarterly dividend from Enact and the expectation of receiving a significant special dividend from Enact later this year, we plan to retire the remainder of the 2024 debt in the third quarter of 2022. On July 21, we received another ratings upgrade from Moody's, our fourth upgrade from the rating agency since September, which reflects our much improved financial and leverage position. Upon the retirement of our 2024 debt, our credit profile will be enhanced even further, and we believe we will be well positioned for rating agencies to continue to reflect those improvements. As we announced last quarter, given our positive free cash flow outlook, balance sheet improvements and continued strong operating performance, our Board authorized a share repurchase program of up to $350 million. In the second quarter, we repurchased $15 million worth of outstanding shares. And subsequent to quarter end, we have completed an incremental $15 million. In total, we have repurchased over 7.9 million shares at an average price of approximately $3.80 per share. We remain opportunistic when it comes to buying back shares and believe it is a very effective tool to return value to shareholders in the near term. As previously mentioned, we expect the majority of our repurchase activity to occur after we retire the remaining 2024 debt in the third quarter. Beyond repurchases, as we continue to build significant excess cash, the Board intends to consider paying a quarterly dividend to Genworth shareholders in 2023. With respect to our potential longer-term cash flow, I wanted to provide an update regarding our settlement with AXA and potential recoveries in that case. Santander made a strike-out application in the U.K. court, which is similar to a motion dismissed in U.S. courts. The court recently ruled on that application, mostly in AXA's favor. This is an excellent development, allowing the case to move forward. Based on the court schedule and the amount of time it has taken to get to this point, we believe that a trial in this case is not likely before the first quarter of 2024. We will continue to communicate with AXA seeking to move the case ahead as quickly as possible. With respect to the potential of recoveries in the AXA matter, as we've said before, it is premature to predict the amount of potential recoveries. What I can say is that with interest, AXA is presently seeking an excess of $800 million from Santander based on the current complaint, and that amount is likely to be updated at some point. If AXA prevails in its claims, Genworth has significant upside in recouping a significant portion of the approximately $830 million it has paid in its settlement with AXA. Longer term, we are focused on creating value through the development of our long term care growth strategy to become a comprehensive provider of long term care services and solutions. We continue to take a consumer-led approach to this new business and are primarily exploring opportunities in long term care services and care navigation. As we seek to quickly shift from strategy development to testing and implementation, we made a critical hire in the quarter. Dr. Tim Peck joined Global Care Solutions to lead our elderly care services business in the U.S. Tim is a tested entrepreneur in the elder care space and a Harvard-trained emergency medicine physician. He founded 2 technology-enabled care services businesses, Call9 and Curve Health. Call9 was a medical technology startup committed to redesigning health care for seniors by reducing unnecessary hospitalizations through human center design and scale. From there, Tim leverages learnings from Call9 to build his next business, Curve Health, which is a telemedicine and data high-growth start-up connecting physicians to chronic care patients in long-term care and post-acute settings, including in nursing homes, assisted living and home care. I'm pleased to welcome Tim who has hit the ground running with the Global Care Solutions team as he focuses on implementing our strategy, which will initially be focused on care service navigation in select test markets next year. Shifting gears, I want to briefly touch on our priority to further stabilize our legacy long-term care portfolio through the continued execution of our multiyear rate action plan or MYRAP. We have achieved $153 million in annual premium rate increase approvals year-to-date through the second quarter, bringing our cumulative progress against the MYRAP program to $20.7 billion on a net present value basis since 2012. In closing, I am very pleased with our progress during the first half of the year and believe Genworth is well positioned to weather whatever comes at us in the second half. Genworth has a very strong balance sheet, expectations of continued strong cash flow from Enact and improved ratings. Further, I look forward to continuing to develop our long-term growth strategy in long-term care as we seek to redefine the future of long-term care. With that, I'll turn the call over to Dan to provide more details on our second quarter results, our financial position and our capital allocation strategy going forward.

Thank you, Tom, and good morning, everyone. In the second quarter, we generated strong operating results and continued to enhance our financial position amid a challenging market backdrop. We're especially pleased with the strong earnings and cash flow delivered by Enact, the return of capital to shareholders and the continued deleveraging of our balance sheet. As Tom mentioned, in the second quarter, we repurchased $48 million of our 2024 debt maturity, leaving a balance of $152 million which we plan to call later this month, enabling us to have it fully retired by the end of the third quarter. At that time, we will have $900 million of debt outstanding, achieving our strategic priority of less than $1 billion of debt. Moody's Investors Service recently recognized our enhanced financial strength with a 2-notch upgrade to BA2, reflecting our improved liquidity position and financial flexibility. We're pleased that our ratings continue to reflect the substantial progress we've made, which in turn have had favorable impacts to Genworth and Enact. We will continue to work with the rating agencies to ensure their views reflect our enhanced credit profile through ratings improvements. In terms of returning capital to shareholders, we've repurchased $30 million of Genworth stock to date, representing approximately 8 million shares at an average price of approximately $3.80 per share. There's approximately $320 million remaining on our authorization. Once we reach our debt target and begin to accumulate excess cash, we'll be in a position to increase the pace of our share repurchase program. Now I'll turn to a detailed discussion of the second quarter results, beginning on Slide 5. Second quarter net income was $181 million and adjusted operating income was $176 million or $0.34 per diluted share. In the prior quarter, we had net income of $149 million and adjusted operating income of $131 million or $0.25 per share. Results in the current quarter were higher, reflecting adjusted operating income of $167 million from Enact, $21 million from our U.S. Life Insurance segment and $2 million from our Runoff segment, partially offset by an adjusted operating loss of $14 million from corporate and other activities. Interest rates continued to rise in the current quarter. In the short term, higher rates will cause slowing bond call and commercial mortgage loan prepayment volumes, but we will benefit from our inflation-protected and floating rate securities. Portfolio yields will also benefit as we're able to reinvest new money at higher rates. In the second quarter, the purchase yields for long-term care were the highest they've been in 3 years. For Enact, rising rates will support a more meaningful yield impact due to the shorter duration of the portfolio. Given that Enact hosted its earnings call earlier this morning and provided a thorough update, I will focus on the key highlights. As shown on Slide 5, Enact's adjusted operating income to Genworth was $167 million, an increase of 24% from the first quarter. Turning to Slide 6. Insurance in-force increased 9% year-over-year to $238 billion, driven by strong new insurance written and higher persistency given rising mortgage rates, which principally reduced refinancing activity. Moving to Slide 7. Current quarter results reflected a favorable $96 million pretax reserve release, which drove a loss ratio of negative 26%. The reserve release was driven predominantly by elevated cure activity related to COVID-19 delinquencies. The estimated PMIER sufficiency ratio of 166% or approximately $2 billion above published requirements remained strong and was down slightly versus the prior quarter, primarily from Enact's operating company distribution to its holding company. We're very pleased with Enact's continued strong performance in the second quarter, which also marked their first quarterly dividend payment of $0.14 per share that generated approximately $19 million to Genworth. The quarterly dividend, along with the potential for additional return of capital from Enact later this year, will continue to strengthen our holding company balance sheet. I will now cover our U.S. Life Insurance segment results starting on Slide 8. Segment reported adjusted operating income of $21 million, reflecting operating income of $34 million from LTC and $21 million from fixed annuities, partially offset by an operating loss of $34 million in life. In our LTC business, adjusted operating income was $34 million, compared to $59 million in the prior quarter and $98 million in the prior year. Current quarter results reflected lower terminations in both our claim and healthy life populations as mortality declined. In the first quarter, we generally see higher seasonal mortality, which decreased in the second quarter. In addition, the elevated mortality we've seen since the second quarter of 2020 with the onset of the pandemic was lower in the current quarter, which is consistent with nationwide COVID-19 mortality trends. The sequential decrease in active claim mortality count can be seen on Slide 9. During the quarter, we reduced our previously established COVID-19 mortality reserve by $15 million pretax, bringing the remaining balance to $110 million. We did see a higher level of pending new claims in the first half of the year compared to 2021, an indication that new claim incidents while still below 2019 levels, as shown on Slide 9, could grow and trend back to its historical levels. New claim severity continued to increase in the current quarter, primarily reflecting the expected aging of our newer blocks of business, which tend to have higher inflation coverage and daily benefit amounts than the older blocks. In addition, during the pandemic, a larger share of our claimants sought home care instead of facility-based care and in recent quarters, we've seen that trend reverse. We continue to make significant progress in addressing risk in our legacy LTC portfolio through the multiyear rate action plan, as you can see on Slides 10 and 11. During the first half of 2022, we received LTC in-force rate action approvals impacting $487 million of premiums with a weighted average approval rate of 31%. The resulting $153 million in annual premium rate increases brings the total net present value from achieved LTC rate actions to $20.7 billion since 2012, up approximately $1.1 billion since year-end. Reserve releases resulting from benefit reductions decreased from the prior quarter and prior year as the implementation of the Choice 1 legal settlement was materially completed in the first quarter. The pending settlement related to PCS I and II policies, which combined, represent approximately 15% of our LTC block, became final on July 29. We expect to begin implementation of the settlement in the third quarter, but given the 90-day policyholder election window, we would anticipate financial impacts beginning in the fourth quarter. Because the mailings occur in the policyholder anniversary date, the majority of the impacts will be in 2023. We've also received preliminary approval from the court on the pending settlement related to our Choice 2 policies which represents approximately 35% of our LTC block. The final court hearing to approve that settlement is scheduled for November. Should we receive final approval and have no appeals, we could expect to begin implementing the settlement in 2023. The 2 new settlement agreements are similar to the Choice 1 settlement and depending on policyholder election rates and the types of elections chosen, we would expect overall favorable impacts. Turning to Slide 12 and our Life Insurance product. We reported an adjusted operating loss of $34 million compared to operating losses of $79 million in the prior quarter and $40 million in the prior year. The key driver of the improvement seen in the current quarter was lower mortality. COVID-19 claims accounted for only $3 million of the loss, which was significantly lower than the prior quarter. In the current quarter, total term deferred acquisition cost, or DAC, amortization was $22 million after tax, which was higher than the prior quarter and prior year, primarily from an increase in lapses as our 20-year term block issued in 2002 experienced higher lapses as it exited the level premium period. We recorded a $12 million after-tax charge for DAC recoverability testing in our universal life insurance products related to continued block runoff and mortality experience compared to $19 million in the prior quarter and $13 million in the prior year. Regarding fixed annuities, adjusted operating income was $21 million compared to $16 million in the prior quarter and $13 million in the prior year, reflecting higher mortality in our single premium immediate annuity product and lower DAC amortization in the fixed index annuity product due to the rise in interest rates. In the Runoff segment, our adjusted operating income was $2 million for the current quarter compared to $9 million in the prior quarter and $15 million in the prior year. Our Runoff segment is made up primarily of variable annuity and variable life insurance products with $3.9 billion in assets under management and is 22% smaller than at the end of 2020. Current quarter results were adversely impacted by the unfavorable equity market performance. As indicated on Slide 14, we're estimating the consolidated risk-based capital ratio for Genworth Life Insurance Company, or GLIC, to be 290% at June 30, a slight decline from 296% at March 31 and in line with 2021 year-end results. The decrease reflects the impact of unfavorable equity market performance on our variable annuity products, which is more pronounced than our statutory results and GAAP adjusted operating income. You will see on Slide 14 that the statutory balance sheet of U.S. Life companies has strengthened materially over the past few years, with significant improvements in the capital and surplus amounts and unassigned surplus. As a reminder, the life insurance industry will be implementing a new accounting standard in January 2023, the long-duration targeted improvements, or LDTI, which will require us to represent our GAAP financials from January 2021 forward. This change impacts our U.S. Life Insurance and Runoff segments but not the Enact segment or Corporate and Other, and it will not impact our economic value, cash flows, statutory accounting or how we manage the business. We are on track to implement this major accounting change, and we will provide an update on our progress and anticipated transition impacts later this year. Turning to the holding company on Slide 15. We ended the quarter with $228 million of cash and liquid assets. Key cash activity included an inflow of $58 million from net intercompany tax payments and the $19 million dividend from Enact as well as a $49 million outflow, reflecting debt reduction. As I noted earlier, we expect to achieve our debt target of $900 million in the third quarter. Once we accomplish that milestone, our next debt maturity is not until 2034. In addition, the ongoing quarterly dividends from Enact will more than cover our debt service costs of approximately $50 million per year. We also expect to receive an additional return of capital from Enact in the fourth quarter of 2022 based on Enact's expectation to return approximately $250 million to its shareholders in 2022 and adjusting for our majority ownership of 81.6%, we would expect to receive approximately $150 million of additional return of capital to Genworth on top of the quarterly dividend payments from Enact. Further, we continue to expect the holding company will receive approximately $200 million to $250 million from net intercompany tax payments this year. This expectation is subject to the taxable income generated by our subsidiary businesses and given the potential for macroeconomic headwinds, it could change. For the first half of the year, the holding company has received $122 million in net intercompany tax payments. We expect our holding company tax attributes to be exhausted in 2023. Our capital priorities, which guide our capital allocation decisions, remain consistent. Upon reaching our debt target at the end of the third quarter, we will deploy our excess cash towards our growth initiatives and shareholder return initiatives. Our first priority will be investments in growth, namely our Global Care Solutions business, where our initial focus will be on long term care advice and service offerings, which are less capital-intensive than insurance offerings. We will also maintain our commitment to returning capital to shareholders through share repurchases. We continue to believe our stock price is trading below intrinsic value and that repurchases are an effective way to capitalize on that disconnect while returning value to Genworth shareholders. Before I close, I wanted to note that despite the $2 billion unrealized loss balance in our investment portfolio because of the significant increase in interest rates in the second quarter, our credit profile remains very strong with ratings upgrades in the general account meaningfully outpacing downgrades. The investment portfolio remains well positioned to manage through the current economic uncertainty. In fact, we proactively managed our holdings ahead of Russia's invasion of Ukraine and have no remaining direct exposure to either country. And of course, we're investing new money at the most attractive yields in many years. In closing, I'm pleased with our results this quarter and with the continued progress towards our strategic goals. The outstanding performance from Enact continues to provide a steady cash flow stream, which will allow us to meet our debt target in the third quarter and generate excess cash flow moving forward. We continue to make progress closing the gap in the legacy LTC book, and the Life Company balance sheet remains strong in the face of economic challenges. While there continues to be uncertainty around the current economic environment, I'm optimistic that Genworth is well positioned to continue to perform and execute on our strategy. With that, we'll open it up for questions.

We'll take a question from Ryan Krueger with KBW.

My first question is on the intercompany tax attribute. Was your comment that the tax attributes will be exhausted at the end of this year and you would not expect a further benefit in 2023? Or would you expect some further benefit in 2023 before they're exhausted?

Thanks for the question, and we'll give that one to Dan.

Thanks, Tom. I guess the way I would say it today is that there's still a lot of uncertainty in the economic environment. We will use the majority of the remaining tax attributes in 2022 and ultimately exhaust them at some point in 2023. And that could be midyear, it could be a little earlier or a little later just depending on the subsidiary results.

Got it. And then on the AXA-Santander lawsuit, can you just remind us how the actual sharing of the recovery works? Is there a specific percentage of a recovery that you would receive? Or can you give any more color there?

I think I really can't add much to that beyond what I mentioned earlier. If AXA is successful in the litigation, considering we have reimbursed them for a substantial amount of their losses, we would anticipate significant recoveries. However, the exact outcome will be determined as we proceed through the litigation process involving AXA and Santander.

Got it. And then last question was on Global Care Solutions. I guess can you give us any sense like how you're thinking about the potential financial impact of this and over what time frame you may start to generate income from this new business?

Ryan, that's a good question. First, I want to emphasize that this is a capital-light business. We do not require ratings or significant capital to manage risk, unlike our legacy operations. Our approach will leverage a digital technology platform. Initially, we have a network of about 35,000 nurses. Whether serving a Genworth policyholder or someone with no existing ties to us, we will evaluate the recommended care plan for disabilities. Subsequently, we will negotiate and establish a preferred provider network based on quality and discounts. Once we create a care plan for our new client, we will direct them to the preferred network, where they will receive a discount. Our profit margins will come from the fee that the client pays Genworth for assessing the claim, developing the care plan, and connecting them with a high-quality provider in their area. The client pays less than if they handled this independently, as we manage the entire process for them in exchange for a fee. Predicting exact figures is challenging, as our capital requirements mainly involve covering working capital costs, employee expenses, and IT engineers for software development. Ultimately, we expect around 50 million baby boomers will require care and seek guidance and services. Currently, the market is quite fragmented. While some fintech companies offer similar services, most operate as one-stop shops. We believe we can deliver a comprehensive service at a lower overall cost compared to what clients could achieve alone. As we scale the business, we anticipate significant leverage, which should yield a strong return given the minimal capital needs.

We'll take our next question from Geoffrey Dunn with Dowling & Partners.

I just wanted to revisit the prospect for share repurchase and your assessment of intrinsic value. When you're looking at the intrinsic value of GNW, is that the cash flows and balance sheet, excluding the Life platform? Are you factoring any value to the legacy Life platform that you currently have?

Yes. For many years, we've stated that when we evaluate intrinsic value, we consider the value of Enact and its performance throughout the housing cycle. Typically, we view Enact in the mortgage insurance sector as trading at 1x book value or higher. This is our approach to valuing Enact. Currently, we are assigning no value to the Life Companies. However, we believe that in the future, the legacy business, particularly the life and annuity segments, will have some capital associated with them that will hold value. We are not yet accounting for any value from our new business, but we anticipate that it may have value eventually. Therefore, our assessment focuses on the intrinsic value of Enact, noting zero for the Life Companies and considering the net cash, net debt, and overall corporate position.

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

Thank you very much, Katie, and thanks to everyone for joining the call today. We're proud and encouraged by our progress in 2022 despite the challenges in the macro economy. We believe we are successfully executing our strategy to create long-term care value, reduce debt, buy back shares, and return capital to shareholders. We look forward to providing updates in the future as we reach new milestones. We anticipate having an investor update around February, March, or April regarding Global Care Solutions. By then, we hope to have launched the business in some test markets and pilots, allowing us to provide more concrete information about the business model and financial outlook for profitability. We're excited about this initiative and have a strong team, including Dr. Tim Peck, who we recently hired, and Joost Heideman. We have made progress and now have four employees on the team. Thank you to Ryan and Geoff for their questions, and thank you all for your interest and support of Genworth. We'll see you next quarter. Katie, I’ll turn it back to you.

Thank you. Ladies and gentlemen, this concludes Genworth Financial's Second Quarter Conference Call. Thank you for your participation. At this time, the call will end.