Genworth Financial (GNW) Update

Genworth Financial (GNW) operates two core businesses: 1) U.S. life insurance (life insurance, leadership position in long-term care insurance and fixed annuity products); and 2) global mortgage insurance. There is also a runoff segment consists of variable annuity, variable life insurance, and corporate owned life insurance.

Long term care insurance provides the cost of long term care generally not covered by health insurance, Medicare, or Medicaid. The mortgage insurance segment provides mortgage insurance products primarily in the U.S., Canada and Australia to insure residential mortgage loans. The company was founded in 2003 when it was spun off of General Electric and is headquartered in Richmond, Virginia.

GNW Ship 113

Genworth Financial (GNW) investment thesis [Source] is focused on the turnaround of two core business units; U.S. mortgage insurance and long term care (LTC) insurance that many feared would sink the company during the financial crises.

The housing market crises and soaring long term care cost forced a number of competitors in both business areas to exit the market. Many questioned the viability the businesses going forward, Genworth’s ability to turn these units around, and why they were not exiting them as well. It was a full plate as the board of directors searched for a new CEO, tried to sell non-core business to raise cash and reduce debt to avoid further credit downgrades.

When Genworth Financial reported fourth quarter 2013 results about a year later [Here] significant improvement was evident and the prospects for continued improvement encouraging. GNW’s operations improved across the board and strategic initiatives initiated during the crises and by the new CEO Thomas J. McInerney, began to take hold. Genworth will report first quarter result report on April 29 where we will get management’s progress report and indications are the improvement continues.

Mortgage Insurance:

The investment thesis centered on an improved housing market and improved mortgage insurance underwriting especially in the United States where the largest losses were incurred.

U.S. Mortgage Market Performance

The housing market shows sustained improvement with mortgage delinquencies and foreclosure inventories declining. Rising mortgage delinquencies and increasing foreclosure inventories are leading indicators of mortgage insurance claims.  As of February, 2014 the Black Knight Mortgage Monitor (formerly LPS) shows the favorable trend continues with delinquencies below 6% for the first time since 2008 and foreclosures down 34% in the last year.

LPS Feb 2014 Delinquent and Foreclosure

And credit standards remain high with very little origination activity in the lowest credit score buckets:

LPS Feb 2014 Credit Scores

Black Knight Mortgage Monitor [Source]

With these favorable trends (and fewer competitors) we should see continued improvement in GNW’s mortgage insurance underwriting practices showing up as declines in the loss ratio (the combined ratio ex expense ratio) in the 1Q14 report.

Long Term Care Insurance:

A review of GNW’s long-term care insurance business and balance sheet resulted in a strategy of: (1) significant premium rate increases on the older insurance (written prior to 2002) to bring them to breakeven; (2) requesting smaller and more proactive rate increases on newer blocks to bring them to original pricing assumptions; and (3) improved underwritten and pricing with more conservative assumptions. The changes will result in the LTC insurance being managed more along the lines of health care insurance where risk is continually monitored and proactively addressed.

In a presentation to the Intercompany Long Term Care Conference [Source] on March 18, 2014 CEO summed it up this way in part:

• There are 115 million Americans aged 40 – 75…and there are 10,000 Americans turning 65 every day until 2030, 70% will need some form of long term care services during their life.

• … only about 7.4 million Americans are covered by long term care insurance. The 115 million…without coverage need to buy a policy [or] save enough to cover the huge LTC risk they face, or they will absolutely swamp state Medicaid budgets.

• There is a big opportunity to expand private market options for individuals to protect against the risks of long term care if we have the right business model and regulatory framework going forward.

• We invite [state officials and tax payers] to join…the discussion…for a robust LTC insurance market because without a private market, state Medicaid LTC costs will explode and taxpayers will be on the hook to fund these costs.

• A large, robust, and innovative private LTC insurance industry, working with states…will relieve an enormous future LTC financing burden and help protect older Americans and their families.

Genworth allows policyholders the option of paying the full rate increase and keeping the benefits, not accepting the rate increase and reducing benefits or taking a non-forfeiture option where policy holders stop paying the premiums but retain a long-term care benefit based on the amount of premium already paid.

Although Genworth’s LTC policyholders do not like the large rate increases they recognize the value of the benefits even after the premium increases. The higher premiums, considering the coverage provided, is still a good deal given that the alternative of a new policy will cost a lot more for less benefits. At the Intercompany Long Term Care Conference Genworth reported; 85% of policyholders accept the full rate increase; 10% trade for a lower premium with reduced benefits and 5% take the no forfeiture option.

In a recent article on Long Term Care [Source] USA Today seemed to agree summing it up this way: “What options do you have if you’re on the receiving end of a long-term care insurance policy rate hike? Let the policy lapse, though experts generally don’t recommend this option, especially since paying $300 to $800 more per year in premiums is still less expensive than the cheapest types of long-term care. You might consider dropping your old policy and starting a new plan. But experts say this tactic isn’t cost-effective. “First, rates in general have increased over the years; second you are now older; third, it is possible your health is not as good as it was when the original policy was issued,” Einhorn says.

Management concluded in the strategic review that GNW should remain in the long-term care business; the business is adequately reserved under different test scenarios; and LTC represents a significant future opportunity for GNW.  LTC will be managed more like health care insurance with more stringent underwriting standards, more frequent and smaller rate hikes requested, and initial assumptions continually reviewed and acted upon as needed.

Investors seem to remain skeptical that these changes and the needed rate increases will be approved by state insurance regulators or accepted by the policy holders.

Australian Mortgage Unit IPO:

The company filed an 8-K on April 7, 2014 announcing a preliminary road show for its Australian Mortgage Insurance IPO. A final decision has not been made on the IPO but plans are to offer as much as 40% of the Australia Mortgage Unit that could raise US $800 million [Source]. Management plans to use the proceeds to repay debt at the holding company and will evaluate return of capital to shareholders including resumption of a dividend and possible share buybacks.

“As previously announced, Genworth Financial, Inc. (“Genworth Financial”) plans to pursue a possible sale of up to 40% of its Australian mortgage insurance business through an initial public offering (the “Offer”) of ordinary shares (“Shares”) by Genworth Mortgage Insurance Australia Limited (“Genworth Australia”). The Offer is a strategic priority for 2014, and Genworth Financial currently is seeking to complete the Offer in the first half of 2014, but execution is subject to market conditions, valuation considerations, including business performance, and regulatory considerations, among other factors.”

On the same day as the 8-K filing a securities litigation law firm announced a class action lawsuit against the company accusing it of “failure to disclose during the Class Period accurate information about the stability and outlook of the Company’s Australian mortgage insurance unit and the Company’s ability to complete an initial public offering (“IPO”) of its Australian business unit in the second quarter of 2012.”  It is an interesting case on the surface; shareholders sue management for holding out for a better price, we’ll see what happens.   

Genworth Financial will release earnings on April 29, 2014 and hold a conference call on April 30 to discuss the quarter’s results. The core mortgage insurance and long term care insurance businesses are expected to continue improving. Their respective industries are consolidating; prices are firming, underwriting standards improving, and the competition shrinking. These are clearly positive signs for the future as the company transitions through a remarkable turnaround and stabilization into a growth stage.

The price pullback from a potential class-action lawsuit creates a buying opportunity. The price drop doesn’t change the intrinsic value of the company and it will likely increase as the company focus is to build value for shareholders. With a price around $16 per share, GNW is trading at a 45% discount to the book value per share of $29.17. If Genworth achieves its target return on equity of 7 to 9%, purchasing shares today at a 45% discount would yield a 13 to 16% return on the cost of equity. This is with no credit for the Australian IPO or potential share buybacks of which we continue to be a strong proponent.

Disclosure: Long GNW


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