Genworth Financial Inc (GNW) 2006 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to Genworth Financial's second-quarter 2006 earnings conference call. My name is Colby and I will be your coordinator for today. At this time, all participants are in listen-only mode. We will be facilitating a question-and-answer session towards the end of this conference call. As a reminder, the conference is being recorded for replay purposes. Also we ask that you refrain from using cellphones, speaker phones or headsets during the Q&A portion of today's call.

I would now like to turn the presentation over your host for today's call, Jean Peters, Senior Vice President, Investor Relations and Corporate Communications. Ms. Peters, you may proceed.

Thank you, operator, and good morning, everyone. Welcome to Genworth Financial's second-quarter 2006 earnings conference call. This morning, our CEO, Mike Frazier will discuss highlights of operations and CFO Rick McKenney will take you through the quarter's earnings.

As you know, our press release and financial supplements are available; they are posted on our website. Also on hand for the call are the leaders of our three business segments, Tom Mann, President and CEO of Mortgage Insurance; Pam Schutz, President and CEO of Retirement Income and Investments; and George Zippel, President and CEO of Protection.

In regard to forward-looking statements and the use of non-GAAP financial information, some of the statements we make during the call today will contain forward-looking information. Our actual results may materially differ, and we advise you to read the cautionary note regarding these statements in our earnings release and the risk factors section of our most recent annual report or Form 10-K filed with the SEC.

Today's presentation also includes the use of non-GAAP financial measures. These measures are reconciled in our financial supplements according with SEC rules. With that, I'm pleased to turn the call over to Mike Frazier.

Thanks, Jean, and good morning. Genworth's 2006 results to date demonstrate strong progress on key strategic initiatives, and in the second quarter solidified that trend. You can see this on three fronts -- organic growth, acquisitions and capital management and redeployment.

Now I will spend a few minutes highlighting our progress in these areas and how we are delivering solid ROE improvement. First, organic growth. We are making terrific progress here across several platforms, with strong sales of life and long-term care insurance and payment protection on the European continent; acceleration of sales across fee-based managed money platforms; and stellar growth from our leading global mortgage insurance operations.

Price and service competitiveness were key to the 9% increase in term life sales, while new products and distribution penetration drove strong growth in universal life. Our long-term care sales growth was driven entirely by the great traction we are building in the independent distribution arena. We saw 23% sales growth in independent LTC channels in the quarter, with a strong pipeline of submitted business behind that.

Our training and technology initiatives are key to higher sales in long-term care; for example, we are seeing strong sales from platforms that have embedded long-term care needs analysis into their financial planning tools. We do expect career LTC sales to stay soft through the year as we move this platform to a more entrepreneurial and cost efficient model. Base long-term care partnership programs will take hold, but this will take some time, and should be more of a factor in 2007 and 2008.

Turning to fee-based asset management sales, here they were up 70%, reflecting wholesaler and producer expansion. This positions us well to assimilate AssetMark, the acquisition we announced at the end of June.

U.S. Mortgage Flow insurance in force grew on a sequential quarter basis for the first time in nearly five years. We saw flow NIW of $6.7 billion and total NIW of $8.2 billion, up 14% combined over last year, demonstrating progress with new products and penetration into the broader set of distribution channels we serve today. Simply put, our U.S. Mortgage Insurance strategy is working nicely, with new products, distribution expansion, emerging markets participation, lower expenses and line of sight on freeing up capital.

Finally our global platforms had terrific sales. Payment protection on the Continent was up 22%. International flow NIW was up a tremendous 42% to $20 billion. Together, our global platforms drove strong growth and excellent returns in the quarter. International businesses contributed 35% of net operating earnings, up from 29% a year ago.

Now let's turn to acquisitions, where we made nice progress. We rounded the midpoint of the year with nearly $0.5 billion of acquisition activity, which complements our existing business segment strategies. This includes our agreement to acquire AssetMark Investment Management, a leading player in the turnkey asset management business for the independent financial adviser market.

Now, AssetMark does three things for us. It more than doubles our size in this high-growth asset management segment; expands our position with independent advisers; and positions us well for the coming intersection of fee-based managed accounts with guaranteed income solutions.

We also closed two other acquisitions since first quarter, Continental Life and the block of Australian mortgage insurance business, with integration well underway.

Third, we accelerated our momentum on the capital management front. We have completed more than $550 million of share repurchases year-to-date including our first tranche of open market activity. This quarter, we bought back some 2.2 million shares, with plans to exhaust the remaining $200 million authorized by year-end.

We saw an increase during the quarter in the runoff of old, low-return annuities, which further frees up capital for redeployment. In fact, we saw more than $0.5 billion of net outflows in older fixed annuity blocks, which positively drives ROE. Here, we lowered crediting rates from higher guaranteed levels, reflecting market conditions today, resulting in wider spreads for lapsation, which incrementally improves ROE or frees up capital.

Additionally, we had about $300 million of low return GIC contract maturities. We're also pleased with our progress with regulators in connection with our mortgage insurance business and feel increasingly positive that we will be able to free excess mortgage insurance contingency reserves this year. And Rick will give you more detail on that.

Overall, results in the quarter brought our operating ROE to around 11%, about where we expect to end the year. Now that's good progress towards our goal ROE goal of 12% by the end of 2008, and directionally towards our next goal of 13 to 14% ROE.

The strong results in our life business, international operations and U.S. mortgage insurance were somewhat offset by ongoing headwinds in long-term care, especially from pressure on investment yields and low terminations in the older blocks. We are working all our levers in the long-term care model actively, driving growth, optimizing investments, claims process improvements, controlling operating expenses, and we will continue to consider the alternative of rate actions on certain blocks.

Now I addressed our growth progress in long-term care previously, and we also made some nice progress on long-term care investment forward hedging, as interest rates ticked up, which locks in investment margins on future premiums. Additionally, Rick will discuss some of the trends we are seeing in the long-term care line in a few moments.

Overall then, based on our strong year-to-date performance and business trends, we are pleased to increase our total year 2006 outlook for net operating earnings $2.75 to $2.85 per diluted share, up from the $2.65 to $2.75 range we previously stated. That would put us just above 11% EPS growth at the midpoint of this new range.

With that, let me turn it over to Rick to give you some more financial details on the quarter. Rick?

Thanks, Mike, and good morning, everyone. Genworth had a tremendous second quarter. We grew operating earnings 19% to $339 million, or $0.72 per diluted share. Our business fundamentals are sound; life results are performing better than expectations; U.S. flow insurance in force grew sequentially, while international losses are at a low 17%. Investment spreads continue to widen across our product lines; assets under management grew $4 billion in last year and sales are building momentum in key products.

Let's get right to the drivers of our segments. Beginning with protection, we continue to generate good growth in our life insurance line. You can see that coming through in earned premiums -- up 17% over last year from accretive layers of new business with double-digit ROEs. Our preferred book of term life insurance allows us to continue to use the capital markets efficiently as we grow our business.

Term mortality is running favorable to both last year and to our pricing assumption. We've maintained our strict underwriting disciplines throughout our expansion of the last few years and it's showing in our results. Overall earnings in this line grew 40%, tremendous results certainly, and still up a healthy 22% after adjusting for an unfavorable $8 million reinsurance item in 2005.

Turning to long-term care, we are seeing positive signs from a sales perspective. Given the improved pricing parity of the marketplace and benefits from partnership legislation, which will emerge over time, we expect to see ongoing sales improvement. Further, our acquisition of Continental Life in our med sup line adds product depth and reach to the senior market.

With regard to our in-force book of business, in the aggregate, it is performing consistently with expectations. New sales have grown the overall book with higher new business ROEs, while the investment environment continues to pressure the portfolio, and as discussed previously, lower terminations and older blocks are an ongoing factor.

Additionally, we did see a jump in losses in the quarter, reflecting higher incurred claims and the impact of some reinsurance coverage running off on some older blocks. Although the reinsurance effect was anticipated, it was still a driver of the year-over-year variance. Looking forward, this impact will continue, though we do not believe that higher incurred claims represent a developing trend.

Stepping back, the long-term care line is influenced by multiple factors ranging from the Continental Life acquisition, the investment environment, terminations, claims and the reinsurance runoff. Taking these factors together, we see the full-year performance for this line in the $155 million to $165 million range, slightly below our original expectation.

Shifting to payment protection, the business is doing well in a variety of areas. Distribution expansion efforts are paying off, with sales in continental Europe and Ireland up greater than 20% over last year. We now have premiums flowing in Poland and Greece, with more new country activations slated for the second half. These positive developments more than offset a tough UK sales markets, where a few large clients are dealing with shifts in their product portfolios. Overall sales, adjusting for foreign exchange, were up 5%.

From a margin and earnings perspective, payment protection is performing exceptionally well. Combined ratios remain stable in the 90s and pretax operating margins are up about 2 percentage points over the second quarter of last year. We are also seeing the impacts of our global tax strategy, with sustainable improvements in the effective tax rate, which ended the quarter in the high 20s. All these factors contributed to overall earnings growth for payer protection of 21% for the quarter.

Now to mortgage insurance. I thought I would take a little more time today and go deeper into our strategy and performance. Across the globe, mortgage insurance delivered strong results in the quarter, up 34% in net operating earnings over last year. Beginning with the United States business, we've laid out a clear, multipart strategy to return this line to growth and drive ROE progression.

When you blend this with our leading international platforms, we've said we would deliver 10 to 15% operating earnings growth annually and drive segment returns to the mid to high teens. Over the past two years, we've exceeded this goal, with 17% annualized growth rate and are on track to exceed this goal again in 2006.

As you know, our global strategy makes our mortgage insurance business distinctly different. At the end of June, we had approximately $375 billion of insurance in force, with more than 70% of that outside the United States. Our significant global presence enables us to transfer knowledge of regulation, products and technology to build strong distribution relationships. We were able to leverage our capital globally and benefit from the diversification of books of business across geographies.

In the U.S. for the second-quarter, operating earnings were up 18% year-over-year and we are seeing improvement in the operating environment as we execute our growth strategy. First, we are shifting our distribution mix, generating 63% of our business in the higher return growth segments, while successfully increasing our share consistently over the past two years.

We are actively working to recapture the market from simultaneous second mortgages with our HomeOpeners product that continues to grow, reaching 1.2 billion of sales in the second quarter, almost double the volume from the prior year. This sales progress, coupled with higher persistency, enabled us to grow our flow insurance in force sequentially.

We are also selectively expanding our [bulk] participation, writing 1.5 billion of NIW in the quarter, up more than twofold from the same period last year.

Turning to losses, our prime-based portfolio is performing well as a result of our geographic, product and lender diversification. Paid claims were lower year-over-year and our delinquencies were down sequentially with anticipated seasonality, giving us a loss ratio of 21% for the quarter.

As we look forward through the end of 2006, we expect paid claims to be relatively flat for the balance of the year and delinquencies to rise based on historical seasonality. This would put the U.S. loss ratio in the mid 20s for the full year, better than our original expectations.

In U.S. mortgage insurance, expense reduction remains a key element of our strategy. We ended the second quarter with a 33% expense ratio. This ratio will climb a bit for the full year and we expect to achieve our 3 point reduction goal for the year.

The final aspect of our strategy here is capital redeployment. We've been working with our regulators to free up 600 million to 800 million of excess contingency reserves in our U.S. business over three to four years. We've made great progress here and during the third quarter we are targeting the release of 300 million of excess contingency reserves, with the majority of that dividended to the holding company for redeployment. Of course, all of this is subject to final regulatory approval.

In summary, the U.S. business is executing well to its strategy. It is on track to close out this year with high single-digit net income growth and low double-digit lever return on equity, marking clear progress on the path to a 15% return on equity by 2010.

Turning to our international mortgage insurance platforms, I would like you to think about them across four dimensions. First, we are actively doing business in 14 countries today and have been in 10 of these countries for two years or more. Our 600 associates are creating clear, first mover advantages.

Second our flow NIW for the quarter was 20 billion, up 42% from last year. We were particularly pleased in Europe as flow growth more than doubled. Third, our unearned premium reserves now stand at $2.1 billion, up nearly 30% from last year. These reserves, along with planned new business in the second half, position us well for double-digit operating earnings growth in 2007 and 2008, even as global losses begin to normalize.

And finally on the loss side, our prime-based international portfolio is performing well, with a consolidated international loss ratio at 17%, down from the prior quarter and well in line with our pricing.

Let me digress on a couple of points here. In Australia, we saw the loss ratio at 30% this quarter, both from normal seasoning and from higher delinquencies and a limited number of distribution partners. We also saw quite favorable loss performance in Canada and Europe, as home price appreciation and economies remain strong. We project the overall international loss ratio for the year to be in the low 20s, with Australia running in the 30s. This combined performance demonstrates the benefits of our global diversification.

From a growth perspective international operating earnings grew 47% and Australia grew 40%, excluding foreign exchange, this quarter even after reflecting the higher losses. This is a strong showing for Australia and overall for our international operations. Looking ahead, we remain excited about our international expansion and expect to achieve greater than 20% operating earnings growth in 2006.

So let me sum it up for our mortgage business. We have clear synergies across our global platforms that combine to provide a strong double-digit earnings growth rate with a total lever return on equity today in the midteens and on a path to reach the high teens by 2010.

A few thoughts on our retirement income and investment segment. You have already heard about the exciting progress we're making on growing our managed money platform, both organically and through the AssetMark acquisition. On the sales front, we're seeing nice progress in our income distribution series, up threefold over last year, with a particularly strong showing in our new product, Lifetime Income Plus.

These individual sales are coupled with our exciting entry into the group 401(k) market with our ClearCourse offering. We continue to invest in people and infrastructure for this product and look forward to the emerging pipeline of new customers.

Shifting to our traditional annuity lines, we're seeing on average several basis points of spread expansion each quarter. Much of this is coming from recess of contract crediting rates to current market levels, with $650 million in our low return blocks.

Turning to the investment portfolio, we are seeing signs of improvement. The reported yield was 5.8%, including approximately 13 million after tax and DAC of investment income from bond calls, prepayments and a release of some mortgage loan reserves. Excluding those benefits, the underlying yield is 5.6%. It was good to see rates rise during the quarter, as this helps new money rates for the insurance and annuity product lines and boosts persistency in U.S. mortgage.

One other item of note is on the gain/loss front. During the quarter, we realize $22 billion of losses after-tax and DAC, predominantly from actions to reposition portions of the portfolio. You may see more realized gains or losses going forward as we become more active investment managers to drive yield improvement strategies.

Looking forward, we expect the 10-year treasury to close out above 5% on average for the year. This is certainly helpful over the long-term, but given the natural offsets across some of our product lines, we would not see an immediate material impact, about $0.01 of operating EPS relative to our original estimate.

On costs, we remain focused on efficiencies to fund reinvestment in the business lines and as a lever to drive ROE progression. I touched on it briefly in MI, but across the Company, the expense-to-revenue ratio is down and we anticipate that holding for the total year. That includes spending more in the second half on brand development, such as our sponsorship of Treasure Hunters on NBC and new branding efforts across Europe. You'll see this impact, along with lower investment income from share repurchases in the corporate segment, as the quarterly run rate shifts up in the second half.

And finally let's turn to capital redeployment. Given our share repurchase and acquisition progress to date this year and expectations for the second half, we expect to redeploy around $1.5 billion of capital in 2006, leaving $1 billion of capital capacity heading into 2007. The way to think about that remaining capital is straightforward. We will put it to work with additional organic growth, bolt-on acquisitions, funding of additional repurchase programs or increasing shareholder dividends. Look for an update on this later in the year.

And so I'll wrap the first half of the year as I began. We are pleased with Genworth's progress for the quarter and year to date on earnings, sales expansion, capital redeployment and returns for our shareholders. We look forward to a strong second half, with life, payment protection, global mortgage and retirement leading the way towards a full-year performance of between $2.75 and $2.85 of earnings per share and return on equity around 11%.

With that, I will pass it back to Jean Peters to start the Q&A.

Thanks, Rick. Operator, we are ready to go to the question-and-answer period for the call.

(OPERATOR INSTRUCTIONS) Tamara Kravec with Bank of America.

Thank you. Good morning, everyone. My first question really I want to focus on long-term care. And you've obviously lowered the guidance there on your earnings. It seems like you've got a couple of issues going on there. But first if you could contrast what you are seeing in the benefits ratio with your favorable reserve development.

And also, just talk about your lapse assumptions. I know you have lowered those and have been more conservative, but do you think you have to go further? And then in terms of rate actions, how long do you think you are going to wait and evaluate this until you've deemed that it is really necessary to do this to really improve the profitability of the book?

Tamar, let me give you a couple of perspectives and then let me turn it over to Rick on some financials, if we haven't hit on those. First of all, I'm going to sort of start backwards. As I mentioned, the long-term care business model has a few levers to it. Driving growth is very important; you create a lot of value that way.

You certainly look at investments as an important lever; we work hard to optimize that. Now, you look at your claims processes and make sure that you have all of the improvements and efficiencies you want there. You look at your operating expenses to make sure you are working hard there. And then we will look at the alternative of rate actions on certain blocks, which certainly as we've talked about could include some of these older blocks.

As we look at those we feel very good about where we are driving growth. You've seen that on the independent side. If you go to investments, the fact is that on a total basis, we are reinvesting below our portfolio rate. So that is why you hear us talk about the investment rate drag we get there.

The good news, as I mentioned, though was in the quarter, as rates moved up, we could do a lot more forward hedging. And when you can do that, particularly on your new business, even some of your existing, you can lock in your targeted margins.

If you've look at something like the operating expenses, we've merged some of our operations with our life operations, we put our IT operations together -- that drives efficiencies. And that is important. And then when it comes back to looking at the rate action area, we balance that with the other levers and look at them all together and will continue to evaluate just that.

Now back on the benefits ratio question, Rick, let me turn it back to you.

I think in the current quarter you see a couple of things going on there. Some of them we've identified as one-time in nature relative to some reserve releases that we actually had in the quarter, as well as some offsets from the previous year.

I think the thing -- let me pull you back a second -- the thing to note in the quarter which we are focused on certainly is the higher claims that were incurred in the quarter. We currently do see that as volatility. We have not seen this -- if you go back three years, we have not seen a quarter like this. We do not think it is a trend, but we are certainly carefully monitoring it and we've got it isolated to some very specific areas that we are watching. And we will see how that emerges over time. But as of today, we do not see that as a trend.

Okay. And then on AssetMark, if you could talk about -- this is the first acquisition you've made of this nature. But if you could talk about the longer-term strategic viewpoint on this particular area; I know you see a lot of synergies with the guaranteed income protection. But when you look at the future of potential acquisitions to add scale to this business, if you could talk in general about that, that would be great.

Sure, Tamara. Let me turn that one over to Pam Schutz.

Good morning. First, we're very excited about the AssetMark transaction. And let me describe what AssetMark is, just to remind you. They provide asset management services to the independent financial adviser market. And those services are very valuable; they do it through wholesaling. And they include fund manager selection, allocation, client services, as well as helping independent advisers built their practices, practice development.

From a strategic standpoint for Genworth I want to focus on three areas that Mike mentioned. We see the managed account market for independent advisers as a growth market. You are seeing growth of 30 plus percent a year and that is projected to occur out through 2008. We have an existing platform today that is done very well and shown that kind of growth.

With the acquisition of AssetMark, it will give us an asset base of $12 billion, which will make us a player in the managed account market in independent advisers.

The second strategic value is it builds our presence in independent financial advisers in that channel. We see that as a growth channel as we see the moves to more independents, as well as you see the need for more advice and you see the move to fee-based. We see this as an exciting channel. We are there today in annuities, and so with our managed accounts in with our annuities, we are a bigger player in that distribution channel that we like.

The third is that we do see a need for the linkage of guaranteed income on managed accounts. And you know that we are innovators in guaranteed income products. So with the addition of this acquisition, combined with our expertise and income, we see this as a great opportunity. So those are the three areas.

Thank you. And also just, my last question is on the European international, really the international mortgage insurance business. The $4 million that it contributed his quarter, are you generally pleased with that amount or were you looking for something more than that? I know this is a very long-term growth opportunity. But just getting a sense of the fact that it contributed 4 million and nothing last year; is that kind of on pace with what you would expect?

Let me turn that over to Tom Mann. Tom?

Tamara, we are again very excited about what we are doing in Europe. And I would even drop back and remind you of what Rick talked about -- we had a terrific NIW progress there. But we continue to make investment as well.

So while we are very happy with the quarter, it will not continue at that pace. When we look at our international earnings, we are looking for maybe 5% to 6%, 7% of our international earnings to be in those locations outside of our established platform.

So short answer to your question is that continued investment in Europe and we remain more confident with each quarter as to the success of that strategy. But it's really going to be '07 and '08 before we look for material income contributions.

Great, thank you so much.

Nigel Dally with Morgan Stanley.

Great, thank you. Good morning. First, Rick, I just wanted to be clearer on buybacks. I think you mentioned 3 billion of capital to be redeployed. Acquisitions and buybacks to date amount to about 1 billion. So does that mean if you don't find additional acquisitions, that you're likely to [bridge] to buybacks for this year?

And then just secondly, if you can discuss what gives you confidence that the higher claims in long-term care is not going to be an ongoing trend. Thanks.

Nigel, Mike -- two great questions. First, just let's talk about capital philosophy overall again. As you know, we have a 750 million approval on buybacks; we basically exhausted about 550 million of that, and certainly have a good line of sight on using the remaining 200.

And as Rick walked you through, we have additional capital capacity between both depth components as well as surplus components. So as we get deeper into the third and fourth quarters, we will continue to review our acquisition pipeline. You've seen us with, I think, a very good track record, of redeploying capital toward acquisitions that fit nicely with our strategies and back accelerate them. What Pam just laid out was a great example of that.

But we'll look at the pipeline at that point and we will reevaluate the use for additional share repurchases. We will also of course, as we usually do later in the year, revisit our dividend level. So we're not going to make a specific forecast on that, because we always try to drive incremental core growth first, acquisitions to fit second, and we go to repurchase and dividends, and we will continue to do that.

I just think you have to say we have a track record of being very disciplined in this area, and that is positive. Rick, do want to pick up -- or George -- on the long-term care claims?

I think I'll take it. It's very similar to my last answer. You asked about the confidence relative to this is not a trend relative to it. I think if you look on a quarterly basis, and that's what we're doing, is the trend analysis. If we look back over multiple years, this is clearly an aberration in terms of the paid claims levels that we saw. We have it isolated to very specific blocks of business that we are monitoring as of today, and we do not see that recurring in the future. Now that is as much confidence as I can give you, but I can tell you I am confident we won't see that level in the third quarter or beyond.

Okay, thanks.

This is George. Let me just add one other thing. If you recall, we did have incurred claims favorability in the first quarter of this year. And we had unfavorability in the second quarter. When you put the first half together, we are relatively close to our expectations on claims. So you do have volatility quarter to quarter, and we expect that over time our results will smooth out back to expectations.

That's very useful. Thank you.

Steven Schwartz with Raymond James & Associates.

Good morning, everybody. Just a couple questions on the MI book of business. First, where are we on the deductibility of MI premiums these days in Washington? I'm also interested in the fact you make the statement that your reserves per delinquency have gone up, yet all the trends seem to be suggesting that, whether it be paid claims or the amount of delinquencies, that maybe that shouldn't be going on. So I'm kind of interested on your thoughts on there. And then an update on the potential for a UL securitization this year.

Let me turn it over first to Tom Mann and then we'll give it to George on universal life.

Stephen, this is Tom, I will take the first two parts of your question. With regards to tax deductibility, we remained cautiously optimistic. We continue to strive to add our provision or have our provision included in what is called the tax extender bill and having the tax extender bill attached to either pension reform or a state reform or state tax reform.

I always tell you guys I never predict Washington, so I'm not going to start now. But we continue to work very hard on it.

With regards to your second question, I'm not sure where you picked up the reserve per delinquent change. I don't think that we had that. In fact, our reserve per delinquency in the United States was down just a tad in the second quarter, which again would reflect the mix of our delinquencies.

Okay, I'm looking at a line item here in the press releases that says total losses decreased 1 million from both lower paid claims and decline in delinquency accounts, partially offset by higher reserves per delinquency.

That is a very small increase relative to that. That's the last item on the list, so it's a very small item relative to the reserve (multiple speakers) --.

Okay.

George, do you want to pick up on the UL securitization question?

Yes. Stephen, I'm basically going to tell you the same old story on this one, is that we are working actively on a UL securitization. We are very, very deep into it and we expect that we will be successful in executing one probably this year, but not immediately.

All right. Thanks, guys.

Eric Berg with Lehman Brothers.

Thanks very much and good morning to everyone. To questions, with respect to long-term care insurance, either Mike or George, Mike, at the beginning of your comments, you were saying something about how there is a pretty clear difference between the progress that you are enjoying with the independents versus the career agents, and that important changes are taking place in how you approach the career channel with respect to long-term care. Could you elaborate? And then I have a follow-up.

Yes, let me give you just a general philosophy and then turn it over to George for more insight. What I think we are seeing here, Eric, is you are seeing long-term care sort of go mainstream as far as it's a responsible part of anybody's financial plan. And if you look at that and you look at independent distributors, that is how they are approaching it -- they are looking at it in overall planning, somebody is looking at your protection needs and they're looking at your life protection, they are looking at your long-term care protection.

So independent distributors were very in-depth at needs analysis, needs assessment, and they also tend to develop their own customer base; they don't just rely on a needs model. They are taking hold and embracing long-term care. Now certainly we have invested behind that with training and that.

The career model is a little different; it has been very specialized. So that is why we think we are seeing a lot of strength in independent. And then we have to say, are there opportunities to bring some of those attributes to the career model that for many years relied principally on leads. ?So, George, do want to delve into that a little more?

Mike, I think that is a perfect synopsis. If you look at -- they are two very different models. You've got the independent model that Mike described. You've got our traditional career model, which, Eric, as you know this is a model of individuals that sell only long-term care insurance and only Genworth long-term care insurance.

And the history has been the predominant source of their production have been leads, which is a more anonymous, less personal way to sell than a relationship sell. And over time, as you know, the effectiveness of many lead generation models has declined over time.

So essentially what we are doing is we are morphing that distribution system into one that looks more like an independent. So we are reducing the dependence upon leads; we've cut the delivered leads by 50% this last quarter. The conversions of leads have increased by 20%. But importantly now, 40% of the business that comes out of that career agent distribution system is generated by the agents unrelated to the leads.

So over time we are going to continue to move that 40% number of up to 100%. And our career model will look and behave and hopefully perform as well as our independent model. That is the game plan we're going to execute over the coming months.

That was helpful. My second question relates to the third-party assets that you seem to be talking about increasingly, at least that is my sense. It looks like from the back of your statistical supplement that roughly -- with respect to the fee-based retail assets, it looks like roughly two-thirds of your assets in the fee-based area are third party assets.

But my question is, am I right to conclude that the fees that you are getting are probably not as great as you would get from, say, a variable annuity simply because if these are -- and maybe my supposition is wrong -- independent financial planners, that most of the economics go to the independent planner? Do I understand this structure correctly?

Eric, let me turn that to Pam Schutz to give you some details.

Let me break it down into two areas. On the third-party assets, that is largely assets that are third-party products generated by our broker-dealer and independent accountants. And in that segment, you will see that that is distribution income or commission income coming through.

I want to separate that from that managed money income that we receive, which is different on fee-based. And they'd look more like manufacturing profits and earnings like you would see in annuities.

So would the latter be booked as what you are calling Genworth Financial Asset Management?

No, it would not be. It would be in our broker-dealer of Genworth Financial advisers, our independent accountants, and it is largely commission revenue. The fee-based revenue is similar to manufacturing profits and fees on managed accounts. And that is where you would see the AssetMark and our current asset management business and the independent adviser business.

Okay, I will circle back to either Jean or [Alisha]. Thanks very much.

Ed Groshans with Fox-Pitt, Kelton.

Good morning, gentlemen and ladies. I'm going to focus -- this is really going to be for Tom on the mortgage insurance. And I guess in the opening comments, there was talk about moving into higher ROE products in the U.S. and we saw a pickup in bulk writings.

I was just wondering as we are looking forward, should we be looking for loss ratios to try to moderate up, given these products, or are we just keeping the risk levels low and moving into different products?

Ed, let me cut that into really two parts. Rick had mentioned that we were moving into higher-return segment, not products. So our strategy in the U.S. has been to shift -- as part of our return on equity growth mode -- has been to increase our concentration on higher-return segment. So that is what you have seen us do there.

With regards to the bulk transactions, we are increasing our participation in that space. As you know historically, we have been a rather cautious as we've tried to gain a better understanding of the performance characteristics, pricing characteristics of these products. And also we were striving to have some greater degree of confidence that we would have successive books for purposes of improving -- or reducing income volatility, excuse me.

I don't see that really impacting our loss ratios at all. I think that when you think about the loss ratios for the business we're very pleased with what we are seeing this year -- again, indicative of the prime nature of our business and our risk management practices. And as you move into 2007 and '08, as you move out, I think you will see a gradual increase in our loss ratios consistent with the normal seasoning of our business.

But there has been no discernible change in the quality of the type of business that we are doing this year as compared to the past.

Okay. And then in Australia, I thought on the last conference call we talked -- I think the loss ratio sort of high 20s. Now the discussion seems to be more in the 30s. My question really flows around more what are you seeing in the market? Because it seems to me that unemployment is fairly low in Australia. And I know in the U.S. that is the primary driver of increased credit. So is there something else that we are seeing in Australia? And then how long do you think it will take to work through that?

Ed let me -- that is a great question. And with regards to Australia in general, I think your assessment is absolutely correct. Their overall economy remains very, very sound. Unemployment, GDP growth very nice. And unemployment in fact remains at close to historic lows.

We've talked in the past about the interest rate actions of the reserve bank there to downsize or to generate a soft landing in housing; that is going very, very well. If you look at our book of business there, our 2000 and prior books represent about 45% to 50% of insurance in force -- continue to perform very well. And our 2004 and '06 books represent the complement of that, and they continue to perform very well as well.

As you heard Rick mention, we have been impacted by weaker performance in a very limited number of our relationships there. It's a somewhat fragmented market between commercial banks, mortgage banks and regional banks. And we are seeing higher delinquencies with less than five of those customers.

We've isolated those distribution relationships, as you could imagine would, and we are working with them closely to drive corrective action to bring those back in line. And that would involve underwriting policies and loss mitigation strategies for example. And that's, if you will, part of our normal risk management process.

And as Rick indicated we do see it leveling out and we expect the Australian loss ratios to perform into the low to mid 30 range this year. So we had a little bit more insight into it this quarter than what I was able to provide you during the first. But it's a terrific business and we're doing a great job down there, continue to grow our penetration, which we're very pleased to see in this quarter. And if you wrap that expense ratio around those loss ratios, still a very, very high income return on equity contributor to the Genworth family of businesses.

Excellent. And if I may, Jason is right here -- Jason Zucker. He has a question also.

Good morning, everybody. I'll keep it brief. Rick, just thinking about the incurred losses in long-term care and maybe just trying to get a better sense for the magnitude. Could you break out for us the long-term care earnings for second quarter '06 versus second quarter '05 and the loss ratio for second quarter '06 and second quarter 05? Just looking at long-term care, so excluding med sup and then excluding any of the non-recurring items.

I'll give you the specifics around that relative to -- long-term care relative to med sup on that. We did see actually an increase in the loss ratio consistent with those paid claims that we've seen. If you look at the benefit ratio, you will see most of that long-term care being the predominant line within those two, med sup being a much smaller piece. And you can see those trends relative to that.

So as we've said, the paid claims are up relative to that. We don't see that trend continuing. We see the loss ratios as a whole coming back in line to what we expect from a pricing perspective.

What percentage of earnings then are med sup in '06 versus 05?

I think it would be roughly 15%, something like that.

In both years -- in both quarters?

It will be bigger in this year.

Right. Thank you.

Tom Gallagher with Credit Suisse.

Hi. First a couple of questions on MI and then one on long-term care. First question is just, I guess in light of a slightly higher loss ratio in Australia, should we assume that moderation of growth that we're are seeing there is related to that? So first off, is that a deliberate attempt to slow growth as that situation unfolds?

And then also on the U.S. side, can the 33% expense ratio get much better if your persistency continues to improve, say, to the mid 70s? Or do you think we are kind of at a peak level in terms of the low of expense ratio? Those are the first questions I had; then I will follow up with an LTC.

Two great questions, Tom. I'd like to turn those to Tom Mann. Go ahead, Tom.

Tom, in regard to your first question, I think the strategy we have internationally, which speaks to diversification around the globe, this is an example of it working beautifully. We are on track and we will continue to deliver everything that we've suggested to you that we will from our international businesses. Our performance in Europe and Canada to a degree have offset about a 5% higher loss ratio in Australia that we were expecting. And that is again what we try to do, whether it's diversification in the United States or diversification globally, that is what we are striving to do.

So the question is, no, it's not going to impact our growth rates. In fact, when you look at the new insurance written performance this year, we feel better at about international than I have in previous quarters. So we feel very good about that.

Regarding your comment in the United States, you probably will see our expense ratios move back up a tad in third and fourth quarters. In connection with higher levels of new insurance written, it normally occurs in the third and fourth quarters of this year. What we've indicated to you in the past is that we would be delivering at least 2 to 3 points of expense ratio improvement on a year-to-year basis, and we will deliver that this year -- probably a little bit more.

Got it, okay.

I think also important to know is that the 33% was brought down a little bit from some nontrendable. So I'd say the normalized for the quarter is really closer to 36, 37, which is still a great progress.

And Tom, your last comment was about persistency. You are absolutely right. With increased persistency, that drives greater insurance in force growth, and that clearly helps us leverage our expense ratio.

Okay. And, Tom, is there -- I guess just as I'm thinking out over the next two, three, four years, if rates continue to increase here, persistency improves overall above what we are seeing, is there more potential leverage on the expense side or should we think about this level being almost as good as it gets?

Tom, I'm going to stick with it from the expense ratio improvement side, with the 2 to 3 points that we are targeting each year. Clearly, if we continue to have persistency improvement, it will help us achieve and/or exceed that number. In some of the earlier forecasts that we've given you, we were projecting persistency to be in the low 70s this year; I think we're going to come in at about 72. I think we'll see that improve next year to a degree, even without increased movement in interest rates, simply because the coupon level of our book will begin to become much less than that in the overall market.

But your rule of thumb is correct. To the extent that we have moderate and consistent interest rate increases that does help with persistency, that does lead to expense ratio leverage.

Okay, thanks. And then just a follow-up also on long-term care. I just want to make sure I understand kind of the dynamics versus your expectations here. It sounded to me like the incidence was really the variable that was unexpected. In terms of the lower terminations on older policies coming as a result of some reinsurance expiring, was there actually a change there or was that already essentially baked into your guidance?

Actually, the two pieces you mention, the low terminations, that has become an expectation as we have trended on that, so it is built in as part of the expectation. And the reinsurance runoff as well was included in that and a smaller factor that we've seen. So we just wanted to articulate that piece of it as we go forward and those reinsurance runs off.

That did not impact the termination rate; don't connect those two; one did not cause the other. But that runoff of the reinsurance does provide less cover relative to the losses which does impact the trend and was anticipated.

Okay, thanks.

Jeff Schuman with KBW.

Hi, [Jeff Jones] is going to ask a couple of questions first.

Good morning. Tom, you've already touched on a couple of areas, but I wanted to dig down a bit. First on the expense ratio, you indicated more of a normalized rate of 36, 37 this quarter. What were the kind of non-recurring benefits that got you lower?

And then when you look forward in your guidance of 2 to 3 points of improvement per year, are you factoring in a mix shift more to the bulk side or could that potentially add upside to that expectation?

I will let Rick take the first one and then I will --

The normalization of the expense ratio is just some small expense items is really what drove that in the current quarter. That is why I did the normalization; those are onetime expense savings that we wouldn't see. So normalized it is still very good at the 36, 37. Turn it back to Tom.

Jeff, on the 2 to 3 points, I think about it in the form of more than the book lever, if you will. I think it's really a combination of the flow business and the bulk space as well. And again, the commitment is or the strategy is to deliver the 2 to 3 basis points and we will push both of those levers as we move forward.

As you know, the bulk market is very price sensitive and it can fluctuate depending on what happens with spreads in the market. So I'm not going to put a reliance on that. The commitment our business is it will continue to push that expense ratio. We know we need to do that to improve our returns and so that is what we will do.

Effectively, it sounds like you are incorporating that?

I'm sorry?

It effectively sounds like you are incorporating any kind of mix shift.

We are, yes. You could assume that.

And then on the bulk side, you have been very cautious -- the last couple quarters you've made more of a foray into that marketplace. What specific color can you give us on what types of bulk transactions are you doing? Are you doing the traditional kind of first loss opposition, are you focused more on second loss position? Where are you really starting to enter those markets?

Jeff, the growth is really coming in two areas. We continue to participate in the Federal Home Loan Bank market; and the second form is in connection with Alt A securitizations with the GSEs. As you may know that those securitizations generally are in second loss positions with our primary product in front of it. But again, we may not be that primary first loss provider.

So it would be second loss positions. It could be they use of stop loss arrangements as well, and it just varies. But in general the way you ought to think about is we continue to derive the Federal Home Loan Bank piece such that we can. And then secondly, as the GSEs have become -- Fannie Mae and Freddie Mac have become more aggressive themselves in the Alt A space, that we are participating in that space with them.

And then a follow-up just quickly before I turn it over to Schuman. On the Canadian experience and the loss ratio. Are we seeing a similar trend there where maybe your paid experience was offset by favorable development on your existing book and that's how we got down so low in that loss ratio?

I'm going, Jeff, answer that question similar to what Rick had indicated earlier on long-term care. I would not try to draw a conclusion from one quarter. We are very, very pleased with our operations and our loss performance in our portfolio in Canada. And the quarter-over-quarter change was really a flat -- there was no growth in delinquencies for all practical purposes. And that is where we did have a decrease in our reserve for delinquent in that particular quarter.

In the first quarter, we had an increase of our delinquencies from fourth to first. So again, that was the primary driver of, I believe, that 7% loss ratio. But we still see Canada for the year in probably the 10 to 13% range.

Okay, great. Jeff Schuman has a follow-up.

First on the capital side, I want to make sure I understood the right numbers. Did I understand that there is to be 1.5 billion of capital redeployment in '06 and then 1 billion of capital remaining at the end of the year. Are those the current members?

Those are the current numbers. One thing that is important to note -- included in that 1.5 is lost debt capacity from those repurchases. So you'd have to take the current share repurchase, what we're redeploying toward that position to get to that 1.5. And then the one will be as of year end as we have evaluate it.

And that compares to, I think, May guidance of 1.4 billion with 1 billion at the end of the year, is that correct?

That is correct.

So you pick up 1 million but you are going to dividend 300 million. So did we lose 20 million somewhere or was the dividend anticipated or how does that work?

Actually, when we went through investor day, we had included the dividend -- actually expecting a dividend by year end coming out of mortgage.

Okay, so that was already in there.

Yes.

And then on the long-term care side, I think I understood that Medicare supplement is contributing about 15% to this year's earnings. And what was the percentage last year preacquisition?

It's going to be lower, probably (indiscernible) about five-ish.

And so I believe that the current guidance now for long-term care earnings suggests earnings will be down I think 4% to 10%, but that is after picking up I guess 10% from Medicare, which implies a pretty steep decline in long-term care. And particularly if you assume that new business has been layered in, we're talking about what? A 15%, 20% decline in in-force long-term care earnings?

I guess it looks like the in-force business is slipping to that extent, that the new business lever isn't such a big lever to offset that, is it?

I think when you look at it without verifying specifics on those percentages, the dynamics you're talking about are correct and very similar to what we've been lying out, from a new business layers coming on but feeling pressure across some of those fronts.

And what you seen in change relative to the original guidance, which was to keep it flat, and we had assumed the acquisition was part of that in keeping a flat, is some of this pressure we saw this quarter in the claims rate, but then those continued drivers that we've seen out there, with the investment environment, terminations that we've seen across the board.

So I think it is consistent. I wouldn't verify specifically any of your numbers. New business layers are an important factor when we look at this. But we are fighting some pretty stiff headwinds.

You know -- it's Mike. Let me just sort of step back and help you on that. Just recall the market transition that has gone in on in long-term care from a growth perspective. I mean, here is a market that over three years shrunk by more than a third fundamentally.

So what we've been saying for several quarters is when you had less new growth than anticipated over multiple years, that that would have a compounding effect. And that is what you are seeing come through. Now that is the bad news.

Now the good news is you are starting to see our growth come back. And that, again, you have to layer on for then that to start having the profit emergence that then brings more weight. So that is why we've talked about the importance of the growth levers, both on a multiyear basis looking back and how you are seeing that show up versus the older blocks today. But why now that we are starting to see this return first led by the independent channels, that is a positive step today.

Okay, thank you.

Joan Zief, Goldman Sachs.

Thank you, good morning. Can you talk a little bit about what you are doing on the investment side? What you are doing with interest rates? It looks like we may not see significantly higher interest rates from these levels. And if the economy begins to slow, interest rates and your investment portfolio impacts a broad group of products. So I was just wondering if you could just review how you are thinking and how you are dealing with the changing macro picture.

Joan, this is Mike, let me give you a few thoughts and turn it over to Rick as well. I feel better about our investment strategy and the team we have been placed than I ever had. As we said when we became public two years, we're going to go through and build a first-class investments team, we'd use more external partners as well, bringing us great capabilities.

And Mark Griffin, who took over as CIO towards the end of a year, has brought in a number of very strong people. He's added more capabilities as far as by new asset class segments and the foundation elements, things like systems, derivative capabilities and so on under that.

So what you are going to see and continue to see is a gradual shift where we get into some other asset classes. Our growth in privates would be a good example of that. And there are some others. And that all doesn't come in at the same time. Where we don't think risk-adjusted spreads give us good risk return, we're not going to run into those areas; we will walk into those areas as markets readjust over time.

So we are going to see more color on that too as we get towards investor updates later in the year as an example, laying out some of the specific things Mark and the team are doing. Rick, you want to comment on some of the number shifts we are seeing?

In terms of what we are seeing specifically on the interest rate environment as we saw the 10-year treasury coming up over five and as we expect the averages over the year, we will feel some benefits from that. Although they will be small in the short term; we've talked about the sensitivities from an EPS perspective. That gradually rising rate environment, which we've looked for, and we look to continue, although we've seen it come back in as of late of back up over 5% is going to be favorable to us over the long-term.

Is there any risk to the earnings if it turns out that interest rates turn down and all of a sudden we're back below 5?

Joan, Mike. Let me give you a couple of perspectives. Of course, as we look across all of our product lines and we also look at new products as well, we're pretty practical about that we have all lived in a different investment environment over the past few years than maybe five years ago. And we certainly try to incorporate that in our assumptions; in some cases we use hedging techniques as well.

And then as you've seen in the case such as in Retirement, we repriced liability as well. So we will actively address those. I think the nice thing about the Genworth model, again, is we have some inherent offsets. So we've moved nicely showing consistent growth through a period where sometimes other business models or other business mixes might only show a one-way squeeze. And you've seen that with the balance across protection, mortgage insurance and retirement. Rick, any other color on that?

No, I think just the fact that you talked about it going down relative to that. We have the same sensitivities as interest rates go down, so no, you wouldn't feel any EPS squeeze from that.

All right. My last question really is when you think about the different trends that you are seeing within your businesses, some very positive, some challenging, and you have to start listing in your own mind which has the greatest risk or the opportunities to exceed or disappoint, what do you put at the top of your list in the sense of having the greatest magnitude of impact to earnings?

Joan, Mike. I'm going to answer it a little different way. Here's how I think about it. I mean, we have again a number of growth engines that are driving the predominance of earnings right now, and then we have some things that you might call next-generation or next act.

If you look at -- let me just start -- if you look at life insurance, feel great. Strong term life franchise, we like the progress were making in universal life, we're going to make more in universal life and more on sort of simpler life products as well. So we feel very good about how that is performing, as well as (technical difficulty) potential.

And if somebody has a BlackBerry near there, you may want to get it away from there.

Second, if you look at retirement income, performing well, when you look at the one-timers last year, and we're building a whole new generation on the income distribution and the group side. So that is a multiyear; that is a multiyear growth driver as you come through.

If you look at payment protection, we feel good, certainly because of the Continent, where we continue to make progress there.

And then I'd come back in mortgage insurance, we've done everything we said we would. We've taken international franchise, continue its leadership position. And I think there was probably some questions about can you demonstrate the progress -- or the plan you laid out in the U.S.? And Tom has done just that with the team. On all five levers, they've executed well and you can really see the quality of that U.S. portfolio with the international piece. So I would even take the U.S. piece and highlight that.

Clearly, we have to work hard and continue to work hard in long-term care. We love what we're doing on the new business side. We're dealing with a challenging in-force situation, and enough said on that. So that would be the one that I'll find most challenging in the environment right now.

Thank you.

(OPERATOR INSTRUCTIONS) Colin Devine with Citigroup.

Good morning. Just a couple quick ones. To start on U.S. MI in terms of your loss reserve, could you discuss were there any changes specifically to it? I noticed delinquencies were down sequentially. Did you have a release there that perhaps you had it back on some other things?

Also then, if we could then switch to fixed annuities. I was surprised to see -- I wasn't surprised to see the uptick in the lapse rate, but I was surprised to sequentially see quite an uptick in the sales number; I think it was about 22%. Perhaps if you could just talk a little bit about what's going on there.

And then finally on long-term care, if you could clarify once and for all, Rick's talked in the past that a large portion of the block is earning less than a 5% ROE. What -- if you one to look at accident years, underwriting years -- are we talking about? Which vintages of long-term care are performing well by year and which ones are not? Thanks.

Let me start backwards with you Colin and we will go from there. First, answering the long-term care question is the most challenging businesses -- and we won't break them out by year, but I'll break them out by period -- that might be an easier way to think about -- is if you look at sort of -- we got into that business in the mid-90s. And the blocks that came with the business and the designs that the business had on the drawing board at time of acquisition, that were shortly therefore launched, those have been the most challenging from a return perspective.

Any of the newer generations, as we took over the business, as we changed things like lapse rate assumptions, we introduced more hedging designs, we added even more segmentation about where you market from a risk factor, took even some of the underwriting disciplines, added a few things to it -- those have performed quite well or within expectation. So there is sort of that -- that's the time period of the split.

Tom, let me turn it over to you on the MI --

Mike, just to come back before we do that. What sort of percentage of the in-force then is underperforming that is the old stuff, if you like, and what percentage is the new? I'm just trying to get some sense of as we look at this block, how big is this legacy -- or anchor that you seem to be dragging around?

As you looked at the business and you looked at how we've grown, what we've said in response to that question is it sort of was a 50-50 mix if you look back a couple years ago. Now as you then go within that, you see some blocks have gotten even tougher with investment rates. It is not one I'm going to break out, and you see different patterns of profitability continue to emerge.

And you excluded the piece left with GE?

That was a specific block that came with Travelers acquisitions and that is out of everything I'm talking about.

Thank you.

Now, let go to the MI question.

Colin, this will really be a very positive and short answer for you. Our loss ratio, as you saw, was a 21% in the U.S. We're very pleased that our claims were down year-over-year. And as Rick indicated, when you take our claims performance for the total year, we are now projecting it will be roughly 10% below in total '06 where we were in total 2005 for claims -- very, very positive for us.

And on the delinquency front, we saw the traditional seasonality benefit that we see in the second quarter right in line with what we expected. As we covered earlier, we had a small increase in our reserve for delinquencies, but again, it was very small.

No Katrina release?

Sorry?

No Katrina release? I noticed [Magic] did this quarter.

We did have a Katrina release. We had, I think at the end of the year, about 16, 1700 delinquencies related to the severely impacted areas of Katrina. We're down to about 600 delinquencies, which we still have a little bit north of $3 million reserved against that.

How much was the release again? I didn't catch that.

Sorry.

I didn't catch what that Katrina release was this quarter?

The amount of reserves we had -- today we still have about 3 million on the books for that and we had about $1 million to $2 million of release related to Katrina.

Thank you.

Okay. And then let's go to the third question. Pam, you want to pick that?

Yes, on fixed annuities. Yes, we did do a little better sequentially. But I have to remind you we were down 62% from the prior year in fixed annuities, so way down. That sequential increase is largely due to seasonality and the way fixed annuities are sold. A little bit of distribution and a little better rates -- so that is -- a little higher rates.

But let me remind you what our strategy is on fixed annuities. We issue the business when we can get our returns. We are actively managing our in-force to free up low-return capital. The new business environment is very difficult, given where alternate investments like CDs are compared to fixed annuities. But I will say, given our strong bank distribution, there was a shift in our bank distribution to -- they were up double in variable annuities. So leveraging that as well.

You didn't have any rate specials on?

No.

Okay, thank you very much.

All right, that concludes our call. We thank you all for joining us and look forward to talking to you during the quarter. Thank you.

Ladies and gentlemen, this concludes Genworth Financial's second-quarter 2006 earnings call. Thank you for your participation. At this time, the call will conclude.