Genworth Financial (GNW) 1Q14 Executing and Getting Stronger

Genworth Financial (GNW) reported 1Q14 earnings on April 29, 2014 [Source] The company reported net income of $184 million, or $0.37 per diluted share, compared with net income of $103 million, or $0.21 per diluted share, in the first quarter of 2013 for a 79% year over year improvement. The 1Q14 net operating income was $194 million or $0.39/share comparing favorably with net operating income of $151 million, or $0.30 per diluted share, in the 1Q13 for a 28% increase.

GNW 1Q14 Consolidated Income

[Source] Genworth First Quarter 2014 News Release

GNW defines net operating income (or loss) as income from continuing operations excluding income attributable to non-controlling interests, net investment gains, goodwill impairments, proceeds on the sale of businesses and other items considered infrequent or unusual to better evaluate the ongoing business segment operations.

“Genworth’s first quarter 2014 results reflect continued progress in our turnaround strategy,” said Tom McInerney, President and CEO. “Our mortgage insurance businesses benefitted from improved loss ratios, and long term care premium increases continued to positively impact earnings in our U.S. Life Insurance Division.”

In Genworth’s “2014 Business Goals & Strategic Priorities” [Source] management summarized the presentation by describing Genworth as “a turnaround opportunity with multiple levers to create shareholder value.” The company continued to show good progress on the turnaround in the first quarter 2014 with improved business operations, positive developments in the business climate, and progress on capital allocation. Most of the levers are working to create shareholder value in quarter.

Lever 1 Improving Mortgage Insurance Operations:

Global Mortgage Insurance continued to show a strong loss ratio performance in Australia and Canada at 17% and 20% respectively. The once troublesome U.S. Mortgage Insurance (US MI) segment improved with a continued decline in new delinquencies, favorable cures and aging of older less profitable policies. The loss profile continues to improve as the 2005 through 2008 books burn out and the better underwritten 2009+ books become a larger percentage of the portfolio, now at 47% of risk in-force.

GNW 1Q14 Global MI Income

Updating the key metrics below, the U.S. mortgage loss ratio continues to drop reaching an impressive 46% showing underwriting profits.

GNW 1Q14 US MI Loss Ratio

When insurance expenses and losses exceed premiums paid by homeowners the loss ratio is greater than 100% and the company is paying out more than it is receiving and incurring an underwriting loss.  If the loss ratio is less than 100% the company is receiving more than it pays out and is making an underwriting profit.

Mortgage payment delinquencies are a leading indicator of mortgage insurance claims. At GNW they continue to fall following industry wide patterns and indicate lower claims will be paid in the future.

GNW 1Q14 US MI Delinquency Rate

The US MI business had a profitable quarter with net operating income of $33 million up sequentially fivefold from $6 million in 4Q13 with losses down $45MM sequentially from lower new delinquencies, favorable net cures and aging offset by some reserve strengthening.

The company increased reserves in 1Q14 to reflect higher severity expectations for late-stage delinquencies driven by the extension of the foreclosure timeline. This was partially offset by a reduction in frequency expectations for early stage delinquencies now at a rate of approximately 1 out of every 6 new delinquencies. The reserve strengthening had a net unfavorable impact of approximately $11 million after tax for the quarter.

GNW 1Q14 US MI Net Income

New insurance written (NIW) was lower sequentially in the 1Q14 following a drop in the 4Q13 from a seasonally smaller mortgage origination market.  This is not a concern since GNW’s mortgage insurance market penetration remaining flat sequentially during the quarter. Management indicated that lower NIW is primarily from seasonally lower purchase originations, impacts from a severe winter and lower refinance originations from higher interest rates. Marty Klein, Executive Vice President & Chief Financial Officer said; “Our NIW expectations for 2014 reflected a stable origination market, and although Q1 originations were low we still think 2014 NIW will be up modestly from 2013.” 

By “accepting” lower NIW under these conditions; management is exercising the needed discipline to assure underwriting profits (as evidenced by the improving loss ratio) rather than chasing sales growth at the expense of future earnings.

GNW 1Q14 US MI  NIW

Lever 2 Improving Mortgage Insurance Environment:

The domestic mortgage insurance industry has been consolidating and GNW will not only survive but can thrive over time as a number of competitors exited the market during the financial crises.

The largest competitors are the Government Sponsored Entities (GSEs), Fannie Mae and Freddie Mac, regulated under the Federal Housing Finance Authority (FHFA). It is not clear how changes in the GSEs will impact the private mortgage industry and companies like Genworth. However a reduced the role for the GSEs will favor the role for private mortgage insurers. During the conference call GNW’s management thought this would be the case.

The FHA already exposes taxpayers to potential liability of over $1 trillion and without private mortgage insurance that potential exposure would increase significantly. Rather than requiring the debt laden federal government, with record deficits in place, to commit more tax payer money to housing it would make sense to increase the role of private mortgage insurance with private funds at risk.

U.S. Life Insurance:

The U.S. Life Insurance Division reported operating earnings were $94 million, down $25 million from the prior quarter as the division was impacted by higher mortality sequentially across all of its business lines hurting life insurance results but benefiting earnings to a lesser extent in fixed annuities and longer-term care.

Earnings in Life Insurance were $21 million with unfavorable mortality experience in both term and universal life insurance versus the prior quarter from higher frequency of claims, while versus the prior year we saw both higher frequency and severity of claims.

Actual to expected mortality for term insurance remains in line with 2014 expectations at 92%. The actual to expected mortality for universal life was over 110%. Mortality experience varies from quarter to quarter, management indicated there are no indications of an underlying trend change but will watch closely

Sequential improvement in Long Term Care is driven by an incremental $10 million after tax impact from rate actions. Long-term care earnings were $46 million. The in-force rate action continues to impact earnings benefitting results by $40 million versus last year and $10 million versus the prior quarter.

GNW 1Q14 US Life Insurance Income

Lever 3 Improving Long Term Care Operations:

Genworth’s largest product line falling under the U.S. Life Insurance Division is long-term care insurance (LTC) where GNW is the industry leader. Longer life spans under long term care and spiraling costs challenged GNW’s ability to maintain a profitable LTC business.

Management undertook a review of GNW’s long-term care insurance business and balance sheet that resulted in a strategy of: (1) significant premium rate increases on older blocks of insurance; (2) requesting smaller and more proactively rate increases on newer blocks of insurance; and (3) using improved underwritten and priced 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] Genworth reported that although LTC policyholders do not like the large rate increases they recognize the value of the benefits even after the increases. The higher premiums when 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.

The company continues to work with state insurance departments to achieve additional 2012 rate increases and remains confident “that our ultimate annual net premium increases from the 2012 rate action will result in $250 million to $300 million of increased annual premium when fully implemented by 2017.”  In the 1Q14 earnings conference call, management further defined the impact of the 2012 LTC rate increases on the premiums of existing policies:

GNW 1Q14 LTC Rate Increases

And on net operating income:

GNW 1Q14 LTC Rate Impact on Earnings

[Source] First Quarter 2014 Earnings Summary

Lever 4 Long Term Care Insurance Environment:

GNW is the LTC market leader with 35% market share and this unit will have a significant impact. As competitors exit the LTC business favorable demographic changes are underway and in a presentation to the Intercompany Long Term Care Conference [Source] on March 18, 2014. In this quarters conference call GNW’s President & Chief Executive Officer  Tom McInerney summed it up this way: “Our main point…is to emphasize the need for the private sector and public sector to work together to dramatically expand the number of Americans that address their long-term care needs.”

  • There are about 10,000 people turning 65 every day from now until 2030. Based on government projections 70% of people who live to 65 will need to fund long-term care costs sometime in the future.
  • There are 115 million Americans between the ages of 40 and 75 and only 7.4 million Americans today have coverage. Our message to federal and state policymakers, particularly given the pressures on federal and state budgets, is that we all should be focused on expanding the private long-term care market dramatically so that as many of these 115 million Americans as possible are insured.
  • We know that most Americans are not saving enough in 401(k) programs. The median savings is approximately $100,000 and few are covered by defined benefit plans. Therefore if most of these Americans do not own private long-term care policies and become disabled in retirement they will ultimately need to rely on Medicaid to cover their long-term care services after effectively exhausting their assets.
  • And we all know that Medicaid and other entitlement programs are going broke even before the bulk of the 78 million Baby Boomers reach retirement age – another compelling reason for a more robust long-term care insurance market.

Lever 5 Capital Allocation:

Genworth announced a plan to sell to 40 percent of its Australian mortgage insurance business a priority for 2014. The planned sale through an IPO remains a key priority in reducing its exposure to mortgage insurance risk, rebalancing capital among its three main mortgage insurance platforms and generating capital. Institutional investor education activities initiated in Australia ahead on April 23, 2014, and the Australian mortgage insurance business filed a prospectus related to the IPO with the Australian Securities and Investments Commission. The company is seeking to complete the IPO during the first half of 2014.

The company maintains significant liquidity of approximately $1.3 billion at the holding company. After deducting the $485 million allocated to the remaining 2014 debt maturity approximately $780 million remains in line with the target of 1.5 X debt service plus a buffer of $350 million for stress scenarios. These numbers exclude the proceeds from our December debt offering, the $300 million of cash at the USMI holding company after contributing $100 million to Gemico.

The proceeds from the Australia IPO should it be completed include ensuring businesses remain appropriately capitalized and seeking opportunities to accelerate progress on debt reduction.

Lever 6 Investment Portfolio Performance:

Record low interest rates continue reduce the yield that insurance companies receive on the insurance premiums they receive and invest in bonds until claims are made. The Wall Street Journal reports [Source] insurance company’s investment portfolios are “yielding 1 to 1.5 percentage point less than bonds in their existing portfolios, leading to less investment income.”

“The increasing likelihood of sustained low rates and bond yields is one reason life insurers have redesigned and re-priced some products, offering less-generous features to individuals. These include long-term care insurance and retirement-income products with minimum-income levels.”

At historic low interest rates they can only go up and when they do insurance investment portfolios returns will increase. When this may happen is unknown but it will happen.

Lever 7 Life Insurance and Long Term Care Turnaround:

Genworth’s turnaround has brought it through the financial crises and management shows no indication of resting on its laurels. A new head of life and long term care insurance has been hired to continue improve profitability and accelerate the businesses’ return to growth.

In January Genworth announced [Source] that it named James Boyle president and chief executive officer of its U.S. Life Insurance Division (USLI) and executive vice president of the company. “We’re delighted that Jim will be joining Genworth, bringing important experience and expertise as we work to turn around our USLI Division and our life insurance, long term care insurance, and annuities businesses,” said Tom McInerney, Genworth’s president and chief executive officer.  “He will work with our USLI senior leadership team to continue to improve the profitability, financial strength, and capital generation of the division, and help accelerate the businesses’ return to growth.”

As the company executes and grows stronger each quarter our thesis remains on track.

Disclosure: Long GNW

References:

  • Genworth 1Q14 Earnings Release [Source];
  • Genworth 1Q14 Earnings Summary Presentation [Source];
  • Genworth 1Q14 Financial Supplement [Source];Genworth 1Q14 Conference Call Recording [Source];Genworth 1Q14 Earnings Conference Call Transcript [Source]

 

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