Genworth Financial Inc (GNW) 2007 Q2 法說會逐字稿

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

I would now like to turn the presentation over to Alicia Charity, Vice President Investor Relations. Ms. Charity, you may proceed.

Thank you operator and welcome to Genworth Financial's second-quarter 2007 earnings conference call. As you know our press release and financial supplement were both released last evening and are posted on our website.

This morning you will hear from Mike Fraizer, our Chairman and CEO, who will provide his perspective on our performance during the second quarter. Following that, Pat Kelleher, our Chief Financial Officer, will review the financial highlights of the quarter. Also joining us for today's call are Pam Schutz, Executive Vice President of our Retirement and Protection segment; Tom Mann, Executive Vice President of our International and U.S. Mortgage Insurance segments; Mark Griffin, our Chief Investment Officer and other business leaders.

I would like to call your attention to some additional disclosures in our financial supplement this quarter, on U.S. mortgage insurance, payment protection and our investment portfolio. This morning we are also posting to our website additional information our investments backed by Alt-A mortgage loans. Going forward, this information will also be available in our financial supplements. Following our prepared comments, we will open up the call for questions.

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

Today's presentation also includes non-GAAP financial measures that we believe may be meaningful to investors. In our financial supplement, non-GAAP measures have been reconciled to GAAP where required in accordance with SEC rules. And finally, when we talk about the international segment, all percentage changes exclude the impact of foreign exchange.

And with that, let me turn the call over to Mike Fraizer.

Thanks Alicia. Genworth performed well in the first half of 2007 with an 11% increase in net operating earnings per diluted share for the second quarter and 9% net operating EPS growth year to date. Our second quarter was a solid $0.78 per share and demonstrated execution of our growth strategies on several fronts while confirming the strength of our risk management disciplines.

This morning I want to focus on three key topics. First is our mix shift to grow fee-based product lines in our international platforms. Here progress is accelerating. In addition, we have improved our position for expanding profitable new long-term care growth. Together these growth initiatives will contribute to profit and ROE expansion as we look ahead.

Second, I'll cover the highly favorable growth trends and credit consistency in our U.S. mortgage insurance portfolio that continue to drive strong growth performance -- or strong performance excuse me -- versus peers in this sector and create good future opportunities. Third, I will touch upon additional planned actions in our long-term care business to address performance of our old block.

Let's start with progress in shifting our business mix. Nearly 50% of Genworth's earnings in the second quarter came from fee-based retirement income and wealth management as well as from international operations compared with about 40% a year ago. International results alone were 38% of total operating earnings in the first half driven by market penetration gains in Canada, performance in Australia, growth in established and new payment protection platforms in Europe, and ramp up in Mexico. We also made progress in gradually lowering our effective tax rate.

International flow mortgage insurance sales grew 14% in the first half and we added nearly $25 billion of bulk mortgage insurance primarily in Canada, Australia, Japan and Mexico. Payment protection sales grew 45% in the first half driven by structured deals in the UK and Canada. Sales growth in new business flows also accelerated in our fee-based managed money and retirement income products. Sales of our income distribution series were up more than 50% in the first half while managed money net flows more than doubled to $1.3 billion. Our managed money platform continues to perform ahead of expectations.

On the long-term care growth front, AARP recently announced a new strategic alliance with Genworth to provide a range of long-term care planning solutions to meet the needs of AARP's members. AARP members will be able to purchase products via phone, Internet and also through face-to-face consultations with Genworth's agents. We expect to see sales beginning in October and I believe this will drive a significant sales lift in the range of 100 to $150 million over the next five years.

We are also building on the momentum of our new lower-priced Cornerstone Advantage product, our linked benefits offerings, and the opportunities presented by the AARP relationship to drive overall distributor enthusiasm, loyalty and growth.

Now let me turn to our U.S. mortgage insurance business where revenue growth was stronger than expected and loss performance remains well contained in an increasingly challenging U.S. housing market. On the credit side, we have a strong diversified portfolio. As expected, the increase in loss reserves in the second quarter was concentrated in geographies we classified previously as higher risk due to the extreme amount of home price appreciation in prior years driven in large part by the prevalence of nontraditional mortgage products.

These are two areas where we diligently worked over the past few years to contain our risk or underweight their presence in our portfolio. I would remind you that only 4% of our portfolio is in California, 9% in Florida and just 3% in Arizona. We also have avoided high concentrations of Alt-A products as well as short-term ARMs and subprime exposures. Alt-A is under 7% of the portfolio and total subprime exposure is just 9%.

Let me digress for a minute on what we see as the dynamics in subprime. Today's subprime credit deterioration is being driven by short-term subprime product much of it stated income. Genworth's limited subprime exposure is predominately GSE underwritten, fixed-rate and fully documented. So given our relatively low concentrations in high-risk states, alternative products and subprimes, we expect to weather the housing market downturn with overall loss ratio performance close to pricing and reflective of the seasoning of recent past year's business growth.

At the same time, we expect excellent growth in revenue dynamics and improved mortgage insurance fundamentals to continue for the foreseeable future providing clear benefit to Genworth. We are also executing well on capital and expense management disciplines in the U.S. MI business and are working diligently on freeing up additional excess contingency reserves to enable the extraction of about $300 million of capital in the second half of the year.

In sum, the U.S. mortgage insurance business is poised for stable performance in 2007 with expected strong revenue growth and well contained loss expectations in this environment.

Before I turn the call over to Pat, let me spend a moment on long-term care where we are taking additional steps to enhance the financial performance of our older block. To date, we have focused on four levers to improve operating earnings and returns associated with this older block. Specifically we concentrated on disciplined expense management, effective investment hedging and sound claims processing and case management. More recently we launched an intense effort on potential reinsurance or securitization of the old block to free up low return capital in several stages. Work remains ongoing across these areas.

A fifth improvement lever under evaluation for some time is a price increase on targeted in-force policies in our old block. After thoughtful and comprehensive analysis, we decided to request an 8% to 12% rate increase on most old blocks of long-term care insurance. These old blocks represent just over $700 million of annual premium, about 40% of our total long-term care premium. This rate increase will bring in additional revenue, enhance the risk positioning of the business and improve the profile of these older blocks for a potential reinsurance or capital markets transaction.

We consider this increase modest and consistent with our philosophy to remain a leader in long-term care through multiple distribution channels. For example, approximately 80% of the impacted policyholders will have less than a $20 per month increase in premium and we will also offer the option of a small reduction in coverage to keep premiums at about the current level if a customer so desires. We believe this is a necessary step on the path to position this business for the long term. We are working diligently with our distribution partners to emphasize that this is a responsible step that fits with our commitment to this business and our policyholders.

To sum up, we had a sound quarter. We made strong progress in shifting our business mix for higher growth and returns, contained risks well in our U.S. mortgage insurance business and are taking advantage of excellent growth dynamics in this market. Continue to diligently manage our capital for performance and have a diversified business mix that offers earnings stability in a variety of economic environments.

Putting that together, we are on track to meet our full-year 2007 goal for operating earnings per share growth in the 12% to 16% range with the current housing market dynamics and how they develop in the second half potentially taking us to the lower end of the range.

With that, I will turn it over to Pat to provide more details on our performance and outlook. Pat?

Thanks Mike. This morning I plan to focus on four topics. First, I will offer additional perspectives on revenue trends and growth in key markets. Second, I will give an update on our investment strategies and provide perspective on subprime residential mortgage exposures in our high-quality investment portfolio. Third, I will discuss progress regarding expense efficiencies and capital management. Finally, I will close with our outlook for 2007.

Starting with growth, fee-based retirement and wealth management businesses are performing well. This growth stems from a broad product portfolio backed by growing distribution and stronger market penetration in key segments. In fee-based retirement income, we have grown our wholesaling team and generated a 40% increase in fee-based sales and a 74% increase in assets under management to $5.9 billion.

In managed money, we have added more than 10,000 new advisory clients and generated net flows of nearly $1.3 billion. This along with higher market returns drove assets under management to $20.7 billion.

In spread-based retirement income, we are seeing planned runoff of account balances as we reset crediting rates on older low return blocks. These resets are improving spreads on the overall block. Sales of fixed annuities declined significantly. We are seeing a more competitive pricing environment and are working to enhance wholesaling and improve sales volumes. We expect to add to our wholesaling team across the retirement income and wealth management businesses throughout the second half of 2007 ending the year with more than 300 wholesalers.

On the international front, we are building a strong pipeline for future revenues with the mortgage insurance unearned premium reserve reaching $2.9 billion. Canada saw 55% growth in flow new insurance written. We estimate that Canadian mortgage high loan to value originations were up 38% from prior year and our growth outpaced the market due to increased penetration particularly in the national bank and mortgage banker segments.

We also saw some attractive bulk opportunities in Canada, totaling about $12 billion in the quarter. These portfolios were prime, fully-documented mortgages all of which have loan to values below 75%. We devised structures for specific lender needs with shorter durations than typical bulk transactions.

Australia flow growth of 11% was attributable to 4% growth in mortgage originations and increased penetration in large banks partially offset by the anticipated decline in sales for mortgage managers where we have tightened our underwriting disciplines.

Other international mortgage flow NIW growth was 5%. We are taking a disciplined approach to new market entry and carefully assessing emerging experience.

In payment protection, we had strong 59% sales growth from two areas. In the UK and Canada had strong growth in structured transactions by working with lender partners to design products to meet their specific needs. Second, we saw about 20% growth in both Central and Southern Europe from increased account penetration. As with mortgage insurance, we are seeing more gradual growth in new countries as we take a disciplined approach to building out these platforms.

Turning to U.S. mortgage insurance, we see terrific opportunities in this market. We estimate that in the second quarter the market increased more than 60% from prior year with total mortgage insurance purchase penetration estimated to be about 13%, the highest level since 2003. We are seeing declining use of alternative products. Simultaneous seconds have decreased from more than 50% of the high loan to value market last year to about 30% this quarter. GSE, Fannie and Freddie are also quickly recapturing market share. GSE penetration of the mortgage-backed securities market was up 13 points to 52%, the highest level in three years.

We also believe there has been increased mortgage insurance penetration in the refinance market as ARMs reset and consumers shift to safer fixed mortgages. Beyond recapturing flow business, we have had strong targeted bulk expansion. In total, insurance in force is up 33% and premiums are up 28%. That said, we expect our sales growth rate to lag the overall mortgage insurance market as a portion of the market growth is from Alt-A business where we have limited our participation. We are particularly cautious at this time due to concerns that some risks from the subprime market segment may be making their way into Alt-A channels.

Turning to an update on our investment portfolio, we have made good progress repositioning the portfolio to enhance yields. Through midyear, we have modestly shifted our portfolio mix from publics to commercial mortgage loans and private placements to improve yield and obtain more lender friendly loan covenants. We currently see good value in collateral based structured products as alternatives to corporate credit. In Europe, we have recently added two external investment managers to expand our capabilities and access to fixed income investments.

As we make these changes, Genworth takes a disciplined approach to risk management and we maintain our orientation towards quality which is apparent in our portfolio weightings. Our investment portfolio is largely fixed income with only 4% below investment grade. We have very limited exposure to equities and no exotic hedge fund or CDO structures such as CDO squared type investments.

Our risk management discipline requires that we always diversify, monitor and manage credit risk in our investment portfolio. For example, we have approximately $2.1 billion of investment grade securities collateralized by subprime loans as of June 30.

Each security and each originator were underwritten according to our risk evaluation standards as of the date of our investment. These included product types, FICO and LTV dispersion, documentation, historical default, stress testing and coverage requirements. We conducted on-site due diligence before considering investments from specific originators. Nearly 75% of this portfolio was originated before July 2006 because we determined that the underwriting standards and the attractiveness of available investment opportunities declined significantly during the second half of 2006.

Portfolio is well diversified with an average issue size of about $5 million. We have negligible exposures to the riskier originators, several of which have ceased operations. And we actively manage risk in this portfolio. So far this year, we have sold approximately $80 million of securities we saw as appropriate to exit.

Now let's look at results. Of the hundreds of subprime downgrades announced so far this year by S&P, Moody's and Fitch, only seven of our holdings amounting to about $40 million of exposure were affected. We also saw upgrades for four holdings amounting to $20 million of exposure. And in short due to our risk management approach, we are very comfortable with the high quality and diversification of our investment portfolio and with the results we are achieving.

Now turning to expenses and capital management. At the end of the first quarter, we laid out clear goals for expense efficiencies and investments in growth. Early results are showing progress particularly in our retirement and protection segments. Our expense ratios are trending down. On the capital front, we closed on the sale of our employee benefits group business recognizing an after-tax gain of about $60 million and we have completed approximately $1 billion of our existing 1.1 billion share repurchase authorization.

Finally, let me share some perspectives on the outlook for the rest of the year. We have achieved 9% revenue growth, operating earnings per share of $1.53, and return on equity of 11.3% for the six months ended June 30. We have maintained this earnings growth profile despite higher losses in U.S. mortgage insurance and continued drag from our old long-term-care block. Key growth drivers have been international and fee income business growth, realignment related expense efficiencies taking hold, and initiatives to improve our tax structure and capital management progressing as expected.

Looking to the full year, we are on track to deliver 9% to 11% revenue growth, operating earnings per share of $3.15 to $3.25, and return on equity of 11.4% to 11.7%. While challenges from the U.S. housing market make us cautious and suggest that we may move towards the lower end of this range, the diversification of our businesses and multiple growth levers are providing good balance to this risk.

With that, I will open up the call for questions.

(OPERATOR INSTRUCTIONS). Nigel Dally, Morgan Stanley.

Great. Thank you and good morning. First question is with regards to share purchases. I guess you have got capital set aside for potential acquisitions and you expect to have to some excess capital at year-end. Given the sell off you are seeing in your stock price, are you considering perhaps reallocating some of that to ramp up your buybacks beyond your current authorization? And then I just had a follow-up after that.

Well, Nigel, at this point as you know, we have a little over $100 million remaining in the existing authorization so we expect of course to use that this year. When you go back and look at funding core growth, some acquisition opportunities, or potential acquisition opportunities we see in wanting to -- wanting to keep some degree of a cushion of capital as we've talked to you about in the past, I'd probably see revisiting our dividend level later this year before making a move on share repurchases but we will keep looking at all four levers.

Okay, great. And then the second question which gets on mortgage insurance. Subprime and A- are up quite significantly. Loans in force were up 26%. Perhaps if you can discuss what is driving that growth? I know you said you are being cautious with regards to these products but we are seeing quite a high growth rate in the loans in force.

Nigel, I'm going to turn that over to Kevin Schneider, who is the head of our U.S. mortgage insurance business. And Kevin, why don't you provide a few perspectives on that?

Yes, Nigel, just a couple of thoughts. Number one, as we discussed I think at investor day, the GSEs are returning and growing a larger amount of the business today and you are seeing I believe some subprime product below 620 product growth in the GSE space. So you have got to remember it's far different from the traditional subprime product. It is fixed rate product. It is fully documented product and so that is where some of the growth is we are seeing coming through in the first couple of years of the year.

I would expect that to tap down a little bit as we go into the second half of the year as both the GSEs as well as Genworth have taken some adjustments to some program guidelines. We've continued to tighten up some of those program guidelines as well as implemented some price changes that I believe will reduce the volume of that product.

Okay great. Thank you.

Geoffrey Dunn, KBW.

Thank you. Good morning. I think the highlights you pointed out about the differences in your MI domestic book are important and I think it sounds like it is translating into you not changing your expectations for paid losses this year. Could you update us on that guidance please?

Pat, do you want to take that please?

Sure. We gave paid loss guidance earlier this year at investor day of 160 to $185 million and we are right smack in that range right now.

Okay, great. And then I know it is early but given how you look at the seasoning of your book and the mix of your business, can you talk about whether or not you think the '08 growth trend in paid losses will exceed or be below the '07?

I will take that, Geoff, this is Kevin. '08 losses are going to be higher than 2007 losses as they develop. I think it is a little early to determine exactly what that growth rate is but you need to remember as well our premium growth in our revenues are going to be up significantly in '08 based upon the production we have been putting on this year as well. So we will be able to provide you some further update on '08 development next year.

I think another simple way to think about it is '05 has got some more running room before it continues to season out. And the '06 book will also continue to season and with the amount of business that we have been putting on, you will continue to see normal delinquency development through the 18 months, the first 18 months, of putting that business on the book.

Okay. And just a quick follow-up then before Jeff Schuman has a question too, I believe. Australia, is that development still in line with your expectations or is it maybe coming a little slower than you previously thought?

Tom Mann, do you want to take that?

Geoff, it is absolutely consistent.

Great. And I think Jeff has a question too.

It's Jeff Schuman. I was just wondering about, you are thinking about your investment portfolio in connection with capital management at this point. Industry has gone through a period of very, very favorable credit results. However, the last time we hit a difficult credit cycle '01-'02 across the industry we saw even high-quality investment portfolios under enough pressure that it impacted capital management ultimately.

As you kind of look out and see credit spreads widening and so forth, are you at a point where you feel a need to hold more capital and think a little differently about share repurchase in anticipation of a different environment or we are not at that point yet?

Pat, do want to provide that perspective?

Sure. We are not at that point. We are actually seeing very good results across our public bond portfolio, our privates, our commercial real estate portfolio is producing excellent results. And as I indicated with the alternative investments and subprime, we are getting a very good result. So we are sticking with the disciplines. We are moving toward higher quality as we position for the credit cycle and we are where we think we need to be.

Great. Thank you.

Darin Arita, Deutsche Bank.

Hi. Good morning. Can you just walk me through the accounting effect of the long-term care price increases. Just wondering how that affects the margins? Would the margins just really improve by the amount of the price increase or is there another factor at play here?

Let me turn that over to Pat Kelleher.

I mean with the increase in premiums, we obviously, we are going to have higher margins and regarding the accounting impacts, you know, we have got I guess a process to step through in terms of actually getting state approvals and then evaluating how that impacts the accounting. We will have to unlock when that happens because that is how we see the GAAP requirements but it is too early to give you specific guidance on how that is going to look.

So is it fair to say the margin expansion would be greater than the price increase assuming that you retained that business?

I'm sorry, could you repeat that please?

Would it be fair to say that the margins would improve by more than the amount of the price increase?

The margins would improve by the amount of the price increase.

Okay. All right. And then I guess turning to the U.S. mortgage insurance business, can you just remind us what loss ratios you price this business to?

Let me give that to Buck Stinson, who runs of the long-term -- I'm sorry this was mortgage.

That was directed at mortgage, Darin?

That's right.

This is Kevin. We price depending on the mixture of our book, our U.S. mortgage insurance between 40 and 50 -- 55%. It really depends on the content of the book in any given year but between 40% and 55%.

And that would be combined for the flow business and the bulk is how we should think about that?

Yes.

Okay, great. Thank you.

Mark Finkelstein, Cochran Corona Waller.

Good morning. It sounds like the long-term care rerate is the first step in improving the performance of the long-term care block with a securitization reinsurance or alternative solution is the second step. I guess what I am curious about is what is the expected time frame of the second step? And do you actually need to wait until the full long-term care rerates get implemented before that second step can occur is my first question?

Well first, I would like you to step back and recall that there are five levers again. Three of which we have been executing on quite clearly the expense, the expense management, the investment hedging aspects, making sure we have the most efficient claims processes and case management. Then add to that the price move and as we talked to you about, the move for a potential securitization or potential reinsurance transaction. We basically see these all working in concert fundamentally so it is not a serial process.

And given that we are pursuing both reinsurance opportunities as well a securitization in stages, some things might be done before all states have moved through the price increase and some might be done or some blocks might be done after. So it varies on that timing. It is just not a serial process.

Okay. And then just a real quick question on the AARP program. Do you expect the margin on those sales to be in line with the margin on your other long-term care sales?

Let me give that to Buck Stinson, who leads the long-term care business. Buck?

Yes, Mark. The pricing in underwriting as we work with AARP on this relationship is not compromised. In fact they wanted to make sure that we had disciplined risk management. So our margins are pricing, our underwriting guidelines will all be consistent with how we run our business outside of the AARP relationship.

Okay. And then I guess just one question on the U.S. MI book or business. I was a little surprised by the comment that you expected the loss experience in the U.S. MI business to be in line with pricing if I heard that correctly. I guess what just -- what's happening on the severity side of that business? I am a little surprised. Did I interpret this correctly or could you elaborate on that comment?

Kevin, do you want to take that?

Yes, I said our pricing -- we price our books between 40% and 55% loss ratio expectation. Our books are priced and our business is priced to manage through a number of different economic cycles. When you look at the entire combined performance of the Genworth book, we see that being within that pricing range. There will be different books to perform at different levels.

As you recall our 2004 book and older, those are performing very well and well below our pricing expectations. The 2005 and 2006 books with what is going on in the market today to your point will all be pressured and to be at or above pricing. And it is too soon to call on the 2007 book. But in the aggregate in total, we do and expect to perform within pricing.

Okay, that's great. Thanks.

Tamara Kravec, Banc of America.

Thank you. Good morning. Just wanted to kind of go back to the caution on guidance and better understand really what is driving that because your commentary on the U.S. MI seems to be that you have got these low concentrations in the high-risk states. You are working on the expense side. You are looking at excellent growth opportunities, your business is priced to the loss ratios. So I guess what am I missing? If you think that this book is going to perform in line with what you started with at the beginning of the year, then I guess what is it about the dynamics that has shifted in your mind in midyear?

Tamara, this is Mike. Great question. Let's just step back again. We have a lot of business levers which is part of the strength of Genworth that keep us in the range that we have articulated for the year. And you have seen where a number of those have performed very well on the fee-based lines, on international as two very clear examples of it. You have also seen how U.S. MI certainly has performed well and very well given the environment and extremely well compared with peers.

All we are saying is we are just looking at the second half and there are some uncertainties in how the market will develop in the second half. And out of just general prudence as opposed to anything specific, we are just thinking about that and suggesting that if things got worse, we might be towards the lower end of the range in the overall guidance. So it is not a specific point.

Okay. And Countrywide had their call the other day and their feedback was prime isn't prime. So if you could comment about what you think about the contagion effect and what you are seeing that would also be very helpful.

Kevin, do you want to provide some perspective please?

Yes, just high-level, Tamara. In their commentary, a lot of their pressure was due in their HELOC business. It was their piggyback HELOC business. That's an area that we have felt and had said for a number of years we felt was underpriced to the market and the credit is being priced into that now. I think -- so specifically, that is what they were referring to.

The contagion effect I think is just continues to be based upon the overall pressure on inventories. And the more impact the subprime market has on inventory supplying the marketplace, the greater the pressure overall to losses across the prime book as well.

Okay. And just on new business in the U.S. as well with net premiums written being up substantially. I guess in terms of originations and refis trending down, is it just the increase in penetration that makes you that confident; it is the recapture of the flow?

It really -- our first-half growth rate was driven nicely by both flow and bulk premiums. The flow side I think we were up about 40% in terms of premium growth over last year and a similar amount on a percentage basis on the flow side. Mortgage insurance purchase penetration and refi penetration are both climbing dramatically. So that's driven a larger market in which we can operate and frankly at this point through the year, originations just aren't down dramatically. They have held up pretty well even though subprime originations have been down, there has been a nice growth in conventional conforming originations.

So the business we put on the book so far in the first half of the year are going to carry us through on the second half to accelerate our growth rate in the second half.

Okay. And just a question on the long-term care and it is really more high-level. You pointed out that the increases are expected to be modest. You are allowing some reductions in coverage and some flexibility. Do you think that those two things will mitigate the effect on your competitive position in terms of having now been -- raised your rates? And before I think you were able to say that you have never raised your rates on your book?

Buck, would you provide some perspectives?

Yes, Tamara, good question. The 8% to 12% and the intense effort to make sure that our policyholders know that they have got options other than just paying the additional premium was a conscious decision. We have communicated this. The feedback we have gotten so far from all of our distribution partners when we started a very broad communication process last night has been very favorable. They see this as a reasonable adjustment. They see it as a responsible step and they are pleased to see our commitment to the industry.

So with that, we believe that this is the right move for the business and we believe our distribution partners will be with us.

Okay, great. Thank you so much.

Bob Glasspiegel, Langen McAlenney.

Good morning. I'm going to follow up on Tamara's questions on long-term care. Are we still 100% comfortable the old vintage years are profitable? Is there a need to take a reserve look at that business?

Let me give that to Buck. I think maybe we should provide you perspectives on two fronts. First, is how do we look at the old vintage years, but also how do we look at the new vintage years as well?

Yes, Bob, what we have shared is that the old blocks of business are not profitable. We have shared that in a couple of different forums. And we are taking multiple actions to improve not only the earnings profile and the margin but also the ROE on the entire block. So we have kind of segmented dealing with the old block in terms of capital efficiencies and improving our economic position there while focusing on the new block and a lot of very strong growth initiatives in terms of repositioning our distribution, new product launches and new relationships as we announced there with AARP.

So there is no need to look at the reserves for the old block?

We basically test the reserves in line with the accounting standards and they have been adequate.

Okay. Mike, you said this will improve the risk profile by raising rates in the old block. Sometimes you have got to be worried about adverse selection that your best risks go and your least healthy risks are inclined to stay. Am I missing something on that potential offsetting issue that you have got to manage carefully?

Bob, I think again, this was a very conscious decision, the 8% to 12%. What we have seen in some of these blocks that we have a reinsurance position in is that when you are in a range of around 10%, very few if any policyholders choose to leave your book. Less than 1% we are forecasting here would be incremental lapses because of this decision. So we do not expect any form of adverse selection because of this action.

Okay. Mike, your commentary on mortgages and downgrades and stuff, was that as of 6/30 or was that as of -- you went through an extensive discussion and some of your statistics were midyear and some of them might have been as of last week. Your general commentary, do you think covers the meltdown that we have had in July adequately?

Go ahead, Pat. Pat will take that.

My comments include all the downgrades that were announced in July.

Okay. So you were giving us a snapshot sort of as of today on the mortgage portfolio; the balance sheet numbers were obviously midyear.

That's correct. That's correct.

And last question is it sounds like you are increasing your risk moderately on the investment side to get the yields higher which seems like a valid decision to have made in January. But in light of what is going on here, is your confidence in doing that been shaken at all and are you rethinking that?

Go ahead, Pat.

Yes, really what we are doing is we are maintaining a diversified portfolio like we are concerned about corporate credits. We like collateral backed securities where we have a good opportunity to understand and evaluate the collateral and we have been positioning the whole portfolio moderately to higher credit quality in the current circumstances. So we feel good about that.

So you really feel like you are improving yields and reducing risks with your overall portfolio today?

This is Mike. I'd like to sort of help you step back and you think it from the time we became public. We had a very low and to this day have a very low risk overall portfolio, very high credit quality. And what we told the investment community was over a number of years we would start reallocating assets to certain sectors, in some cases diversifying even credits, growing areas like private placements but do so carefully and that served us well. That served us well with the quality that we have continued to see. It served us well that we did not run into certain high risk, high yield areas. And by following that discipline, I think it has proven out to this day and we will take that forward.

Thank you very much for your answers.

Joan Zief, Goldman Sachs.

Thank you. I just have a few questions. The first question is on the long-term-care side, you have new business, you are going into the AARP program. How long does it take for you to see the emergence of profits from the new business that you will be writing as another lever to help stabilize the legacy block profitability issues?

Buck, do you want to take that please?

Joan, a rule of thumb is about 10% of your current year premium flows through to the bottom line. That is obviously an annuity that builds over time. So we have seen decent growth over the last couple of years. The growth that we are seeing today in our group business, in our link benefit products, with the new AARP relationship will certainly emerge in '08, '09. So it will be over the next couple of years but again a rule of thumb is about 10% of your current year premium flows through to net earnings.

Okay. Thank you. Then can you talk about any changes in the competitive environment of your retirement business that is a growth area for you? Are you seeing more players? Are you seeing pressure on margins? More opportunities?

Let me turn that over to Pam Schutz. Pam?

Let's break it down into two areas. One is on the (inaudible)

I'm sorry. I can't hear Pam.

Can you hear me now, Joan?

Yes thank you.

I would break it down into two areas. On the fixed side, yes we are seeing obviously a very tough environment interest rate wise, yield curve. And we are seeing a tougher environment from a competitive perspective. We are holding our discipline, our pricing discipline in those product lines.

In terms of the fee-based and variable side, I would say to you that we are executing on our growth strategy which is to continue to innovate in product, expand our wholesaling force, expand our distribution with a focus on distribution firms that we think will be the growth partners going forward and the adviser segments.

Well who is being more competitive in the fixed annuity markets given the current interest rate environment?

I think that as you know, we play across a number of channels there and it does vary. It does vary across.

Okay. My next question is with the credit spreads widening out dramatically these days are you -- when do you go back and say, wow, there are real opportunities here as the market has maybe overreacted? Are you finding that this is providing more opportunities for you to go back maybe to your more traditional types of investments, maybe more below investment grade that isn't quite as bad as you might have thought?

Let me turn that over to Mark Griffin, our chief investment officer, Joan.

Hi Mark.

Hi Joan. Thanks for the question. I think you are right at some point you are obviously going to get paid a lot more. I think you need to make sure that your thinking about the risk that you are taking because the structure of a lot of deals has changed considerably from past credit cycles. I think we are starting to see covenants come back into deals and hopefully the end of the covenant-light era. We have continued to increase our allocation to private placements through the cycle because of that, because consistently you get better covenant protection there.

And I think you are right, at some point yields will get high enough, spreads will get high enough and high yield will start to be more attractive than it has been. Frankly yields there have been so low recently that it is frankly not ROE accretive to invest there because of the capital. So I think we see that we are starting to turn the corner there.

And my last question just is a quick question. Were you one of the companies to receive a subpoena from Connecticut Attorney General? And do you have any other updates on any of the investigations or litigations that are taking place?

We have not received any subpoena from Connecticut. In fact, the last thing that I think we were asked about was back in the 2005 timeframe and have had no follow on from that.

Okay. Thank you.

Eric Berg, Lehman Brothers.

Thanks very much and good morning to everyone. You've repeatedly talked about the spreading or contagion of the pressure on prices in housing from the subprime market to the prime market. Understanding that it's going to be very hard to quantify that, can you -- what is your -- can you give us some numerical sense of how this is affecting the price of homes owned by individuals with sort of standard credit? What are your assumptions about the outlook for prime mortgage credit? You know losses on prime mortgage credit? Obviously we're seeing astronomic losses in the subprime market 17%, 18% are delinquencies. And if we are seeing this contagion, why are you as optimistic as you are about the domestic MI businesses since the prime business is your business?

Let me provide a general perspective and then ask both Pat and Kevin to comment. Again, I think it is very important to remember that we picked our spots carefully in this market. We picked our spots with who we worked with from an origination. We picked them with geographies. We picked them with product types and therefore have good visibility on our book of business and how risks unfold. As you have seen, the really, the number of delinquencies has not moved a lot. What we have really seen is the per loan amount move because of average loan sizes be bigger.

We also have looked in very early on I think we were one of the more aggressive participants looking at home price appreciation feeling it would be negative this year and baked that into our plans. Now roughly for every point of home price appreciation variance, it is roughly $5 million on the income side. So we look at that and take that into account on how we have looked through the second half of the year.

Kevin, do you want to go a little deeper on how then we look into the books and our position, please?

Eric, when I -- again, at the top level we have assumed and have shared with you that home prices will decline across the nation at about -3% in the aggregate. That is certainly going to be more dramatic in the states that had experienced much higher price growth in the past. And so as those states return back to a normal environment, we will see -- we would expect to see a rise in delinquencies in some other states just as it returns to normal.

The issue is as prices go down, some of those borrowers who in the past have been able to refinance out or sell their home and get out of a potential delinquency situation are more challenged and therefore more likely to go to delinquency. So our assumption is that it is still down in sort of the -3% decline of home prices over the prior year.

I think the biggest pressure you see right now and a good leading indicator is what is going on in terms of housing inventory supply. And housing inventory supply has continued to expand out to about 8.7 months of salable inventory. With that type of inventory level, that will continue to put downward pricing pressure in order to clear that supply and we could see that grow more in the second half of this year.

We are cautiously optimistic about our book, getting back to your second question. We feel good about our positioning. We feel good about our growth rates and we feel that our growth rates will continue to accelerate. So it is way too early to call exactly the length and duration and depth of this cycle but we feel very good about the portfolio that we have to weather through this cycle.

One second question and then I will be done. In the long-term care area, I think maybe it was Buck who said that you began a communications effort -- you began communicating and getting feedback from your producers last night. Well if it began last night, can you really say -- are you really in a position to say that this is not going to lead to negative commercial impact for example agents turning to Hancock which hasn't raised prices? Isn't it too early to sort of declare victory on that front?

Buck?

Yes, Eric, I think it would be naive to call the ball right now. But I wanted to give you a context of initial feedback and I had several one-on-one conversations and several broad conference calls and you get a good read from distribution right out of the chute on is this a shock? How are they going to react to this?

We rolled out a very comprehensive toolkit and communication process and support process for the agents that have impacted policyholders. And I think the net reaction again with this was a reasonable step, a very responsible approach, much different than they have seen from any other carrier. And they understand that we are going to be there to support any needs that they have. So that is an initial read on the distribution feedback.

Sounds very reasonable to me then. That was helpful additional information. Thank you very much to everyone.

Stephen Schwartz, Raymond James.

Just a couple of questions. European payment protection, I was wondering if we could possibly get a very, very quick tutorial on the structural product that you did and what that was all about? And then I was hoping somebody could talk about the Great Lakes. I notice that delinquencies there seem to have been flat or on the MI side of business, of course, or are we mostly through that now?

Yes, Tom Mann will start off on the payment protection question and then hand it off to Kevin Schneider on the Great Lakes question.

Stephen, thanks for the question. When you think about payment protection, we usually focus on three areas, growth in our established markets which is principally United Kingdom demand, also the European continent, new markets, Canada and Mexico as an example and also the structured environment. The major driver of the growth as you saw in the second quarter was in the structured space which is simply where we are working primarily with European lenders to reassure their existing in force blocks of business for reasons such as capital relief.

I've done several transactions over the past three years, a couple of them rather large. We like them and we will continue to try to do more of those as part of again, the three-pronged growth strategy we have for that business.

Tom, on that Solvency 2, does that help you, hurt you, anything like that?

It would -- if anything it would help us simply because again, as you work through Solvency 2 from a customer's perspective again, there is a lot of attention focused on the adequacy of capital. And is in both our mortgage insurance business and payment protection business to the extent that there are on book assets that we can provide capital relief against, it is a plus.

Okay. Thank you.

Kevin?

Yes, let me just answer quickly, the Great Lakes we did see some stabilization of the delinquency development on the quarter. The current view is that home price appreciation in that region actually may tick up a little bit in '07 and early calls are there might be some further growth in pricing there. So it was an encouraging sign for the quarter. A little too soon to call that it is all behind us because there is potentially additional job growth impact coming out of the auto industry.

(OPERATOR INSTRUCTIONS). Ed Spehar, Merrill Lynch.

Thank you. Just a couple of quick ones. I was wondering if maybe you could give us some sense in terms of the current mark-to-market on the subprime investment portfolio, sort of consistent with the updates you get on the upgrades/downgrades?

And then in terms of excess capital, I was wondering if you could provide any update to the $700 million to $1 billion that you noted in the May investor presentation as available for repurchase and dividend? And in terms of is that played out for the '07 number, how does that look? And any type of comment preliminary on '08 if you would be willing would be very helpful. Thanks.

Let me turn that over to Pat, Ed.

Okay, on the current value of the subprime mortgage backed securities, the values we disclosed at 6-30 are of course our best estimates at that time. I would say that at this time these securities really aren't trading in a liquid market. We have done our impairment reviews and we have kind of updated as you can tell kind of looking at the downgrades that the rating agencies did recently and we weren't substantially impacted. I mean our sense is that we haven't seen any significant change in the value of those securities although we can't point to a liquid market right now to kind of -- to support that.

What I would say is that in our analytics, we looked at the different indices, the AVX indices and whether or not we could use kind of trends in the valuation of those indices to give us clearer insight. But you know, those don't really reflect our underwriting, the types of securities in that market which we were willing to invest in and we don't think that is a particularly good guide. So overall, I feel confident the market values are holding up but I don't have additional detailed information to share with you at this time regarding that.

On capital, we are really on track I guess with respect to capital generation and deployment. The outlook we gave at investor day was about $400 million to $600 million of deployable capital we would expect to have at the end of this year and we are kind of tracking right toward that. It is too early at this stage to give forecasts relating to next year.

I guess just really quickly in terms of at what point do you look at the stock price and say that even with wanting to keep powder dry for acquisitions, that it is just too compelling and that you would figure out a way to maybe lever up in the near term to be more aggressive on a repurchase?

Well Ed, we always look at all four levers and we will continue to do so.

Thank you.

I would now like to turn the call over to Ms. Alicia Charity for closing remarks.

Thank you operator and thank you all for your time today. I realize we ran a little bit over. My apologies to those folks whose questions we did not get to. We will be glad to follow up with you throughout the day. Thank you.

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