The following discussion and analysis of our consolidated financial condition and results of operations should be read in conjunction with our audited consolidated financial statements and related notes included in “Item 8 - Financial Statements and Supplementary Data.”
policy fees and other income, including surrender charges, mortality and expense risk charges, and other administrative charges.
policy fees and other income from other businesses that are managed outside of our operating segments and eliminations of inter-segment transactions.
We had net income available to Genworth Financial, Inc.’s common stockholders of $119 million and $817 million in 2018 and 2017, respectively. Adjusted operating income available to Genworth Financial, Inc.’s common stockholders was $179 million and $696 million in 2018 and 2017, respectively.
Our Canada Mortgage Insurance segment had adjusted operating income available to Genworth Financial, Inc.’s common stockholders of $187 million and $157 million in 2018 and 2017, respectively. The increase was principally driven by lower income taxes and a decrease in stock-based compensation expense, partially offset by higher losses in 2018.
Corporate and Other Activities had an adjusted operating loss available to Genworth Financial, Inc.’s common stockholders of $233 million in 2018 compared to adjusted operating income available to Genworth Financial, Inc.’s common stockholders of $243 million in 2017. The decrease to a loss in 2018 from income in 2017 was primarily driven by changes resulting from the implementation of the TCJA in December 2017 that did not recur. In the fourth quarter of 2017, we recorded a net tax benefit of $456 million primarily attributable to a $258 million release of a valuation allowance, the impact from changes in the federal tax rates and the release of shareholder liability taxes. These decreases in 2017 were partially offset by higher transition taxes, $11 million of higher taxes associated with our tax allocation methodology, which was driven by the premium earnings pattern review in our Australia mortgage insurance business and other items. The year ended December 31, 2018 included lower operating costs, partially offset by higher interest expense.
We had net income available to Genworth Financial, Inc.’s common stockholders of $817 million in 2017 and a net loss available to Genworth Financial, Inc.’s common stockholders of $277 million in 2016. Adjusted operating income available to Genworth Financial, Inc.’s common stockholders was $696 million in 2017 compared to an adjusted operating loss available to Genworth Financial, Inc.’s common stockholders of $316 million in 2016.
Our U.S. Life Insurance segment had adjusted operating income available to Genworth Financial, Inc.’s common stockholders of $22 million in 2017 compared to an adjusted operating loss available to Genworth Financial, Inc.’s common stockholders of $215 million in 2016. The increase from a loss in 2016 to income in 2017 was largely driven by our long-term care insurance business predominantly attributable to higher claim reserves of $283 million in 2016 as a result of the completion of our annual review of our claim reserves conducted during the third quarter of 2016. The adjusted operating loss available to Genworth Financial, Inc.’s common stockholders in our life insurance business decreased $4 million primarily from a less unfavorable unlocking of $122 million in our universal and term universal life insurance products as part of our annual review of assumptions in the fourth quarter of 2017 compared to 2016. Adjusted operating income decreased $26 million in our fixed annuities business primarily due to the impact of loss recognition testing that resulted in $33 million of unfavorable charges in our fixed immediate annuity products primarily driven by the low interest rate environment in 2017 (for additional information on these transactions for each of our U.S. life insurance businesses see “-Critical Accounting Estimates”).
Our U.S. Mortgage Insurance segment had adjusted operating income available to Genworth Financial, Inc.’s common stockholders of $311 million and $250 million in 2017 and 2016, respectively. The increase was mainly attributable to lower losses from favorable net cures and aging of existing delinquencies and a continued decline in new delinquencies in 2017. The increase was also attributable to higher premiums due to an increase in mortgage insurance in-force in 2017.
capital. We are also requesting premium rate increases and associated benefit reductions on newer blocks of business, as needed, some of which may be significant, to help bring their loss ratios back towards their original pricing. For all of these in-force rate action filings, we received 120 filing approvals from 33 states in 2018, representing a weighted-average increase of 45% on approximately $875 million in annualized in-force premiums, or approximately $400 million of incremental annual premiums. This was approximately a 100% increase compared to 2017. We also submitted 97 new filings in 30 states in 2018 on approximately $848 million in annualized in-force premiums.
Cumulative economic benefit from in-force rate actions. Since the completion of our 2018 loss recognition testing, we received additional approvals which further reduced our future in-force rate actions. Given the approvals we have received, we estimate that the cumulative economic benefit of our rate increases through 2018 equals approximately $10.5 billion, on a net present value basis, or approximately 65% of the total amount required under our multi-year in-force rate action plan in our long-term care insurance business. For additional information on the impact in-force rate actions have on loss recognition testing of our long-term care insurance business, see “-Critical Accounting Estimates-Future policy benefits.”
Completion of life insurance assumption review. We complete our assumption reviews annually for our universal and term universal life insurance products. In the fourth quarter of 2018, as a result of the review, we recorded a $91 million unfavorable adjustment to net income (loss) in our universal and term universal life insurance products. The negative impact was primarily driven by lower expected growth in interest rates and emerging mortality experience mostly in our term universal life insurance product. In the fourth quarter of 2017, we recorded a $74 million unfavorable adjustment to net income (loss) in our universal and term universal life insurance products. The negative impact was primarily driven by emerging mortality experience and from prolonged low interest rates. For additional information see “-Critical Accounting Estimates-Policyholder account balances.”
Completed sale of our mortgage insurance business in Europe. On May 9, 2016, we completed the sale of our European mortgage insurance business to AmTrust Financial Services, Inc., and finalized the accounting of the sale through a purchase price adjustment by recording a net after-tax gain of $18 million comprised of a pre-tax loss of $9 million and a tax benefit of $27 million primarily related to the reversal of a deferred tax valuation allowance. The sale was completed based upon the final receipt of net proceeds of approximately $50 million. The $18 million net gain refined the previously recognized loss on sale of $140 million recorded in 2015. See note 24 in our consolidated financial statements under “Item 8 - Financial Statements and Supplementary Data” for additional information.
Derivatives. We enter into freestanding derivative transactions primarily to manage the risk associated with variability in cash flows. We also use derivative instruments to hedge certain currency exposures. Additionally, we purchase investment securities, issue certain insurance policies and engage in certain reinsurance contracts that have embedded derivatives. The associated financial statement risk is the volatility in net income (loss) which can result from among other things: (i) changes in the fair value of derivatives not qualifying as accounting hedges; (ii) changes in the fair value of embedded derivatives required to be bifurcated from the related host contract; and (iii) counterparty default. Accounting for derivatives is complex, as evidenced by significant authoritative interpretations of the primary accounting standards which continue to evolve. See notes
The amortization of DAC for traditional long-duration insurance products (including term life insurance, life-contingent structured settlements and immediate annuities and long-term care insurance) is determined as a level proportion of premium based on accepted actuarial methods and reasonable assumptions including related to investment returns, health care experience (including type of care and cost of care), policyholder persistency or lapses (i.e., the probability that a policy or contract will remain in-force from one period to the next), insured mortality (i.e., life expectancy or longevity), insured morbidity (i.e., frequency and severity of claim, including claim termination rates and benefit utilization rates) and expenses, established when the contract or policy is issued. U.S. GAAP requires that assumptions for these types of products not be modified (or unlocked) unless recoverability testing, also known as loss recognition testing, deems them to be inadequate. Amortization is adjusted each period to reflect actual lapses or terminations. Accordingly, we could experience accelerated amortization of DAC and a charge to net income (loss) if policies lapse or terminate earlier than originally assumed, or if we fail recoverability testing.
Amortization of DAC for deferred annuity and universal life insurance contracts is based on expected gross profits. Expected gross profits are adjusted quarterly to reflect actual experience to date or for the unlocking of underlying key assumptions including interest rates, policyholder persistency or lapses, insured mortality and expenses. The estimation of expected gross profits is subject to change given the inherent uncertainty as to the underlying key assumptions employed and the long duration of our policy or contract liabilities. Changes in expected gross profits reflecting the unlocking of underlying key assumptions could result in a material increase or decrease in the amortization of DAC depending on the magnitude of the change in underlying assumptions. Significant factors that could result in a material increase or decrease in DAC amortization for these products include material changes in withdrawal or lapse rates, investment spreads or mortality assumptions. For the years ended December 31, 2018, 2017 and 2016, key assumptions were unlocked in our U.S. Life Insurance and Runoff segments to reflect our current expectation of future investment spreads, lapse rates and mortality.
In the fourth quarter of 2016, as part of our annual review of assumptions, we increased DAC amortization by $144 million in our universal and term universal life insurance products, reflecting updated assumptions primarily for mortality experience in older age populations, partially offset by updated assumptions related to future policy charges.
As discussed above, U.S. GAAP prohibits a change (or unlocking) of assumptions on traditional long-duration insurance products unless recoverability testing, also known as loss recognition testing, deems them to
be inadequate. In 2016, given we experienced historically low interest rate spreads, which impacted the margins of our fixed immediate annuity products, we performed our loss recognition testing and determined that we had a premium deficiency that resulted in negative margin of $32 million on our fixed immediate annuity products. As a result, in 2016, we wrote off the entire DAC balance for our fixed immediate annuity products of $14 million through amortization.
Given the premium deficiency that existed in 2016, we perform loss recognition testing on our fixed immediate annuity products more frequently than annually. In the fourth quarter of 2018 and throughout 2017, we determined we had premium deficiencies on our fixed immediate annuity product, which resulted in higher future policy benefits as the DAC associated with these products was fully written off in 2016. Additional information related to the premium deficiencies of our fixed immediate annuity products is more fully discussed under “Critical Accounting Estimates-Insurance liabilities and reserves-Future policy benefits.” As of December 31, 2018 and 2017, we believe all of our other businesses had sufficient future income and therefore the related DAC was recoverable.
In addition, we are required to analyze the impacts from net unrealized investment gains and losses on our available-for-sale investment securities backing insurance liabilities, as if those unrealized investment gains and losses were realized. These “shadow accounting” adjustments result in the recognition of unrealized gains and losses on related insurance assets and liabilities in a manner consistent with the recognition of the unrealized gains and losses on available-for-sale investment securities within the statements of comprehensive income and changes in equity. Changes to net unrealized investment (gains) losses may increase or decrease the ending DAC balance. Similar to a loss recognition event, when the DAC balance is reduced to zero, additional insurance liabilities are established if necessary. Unlike a loss recognition event, based on changes in net unrealized investment (gains) losses, these shadow adjustments may reverse from period to period. As of December 31, 2018, due primarily to an increase in interest rates decreasing unrealized gains, we decreased the amount recorded in the accumulated effect of net unrealized gains, with an offsetting amount recorded in other comprehensive income (loss). As of December 31, 2017, due primarily to the decline in interest rates increasing unrealized investments gains, we reduced the DAC balance of our long-term care insurance business to zero, a cumulative decrease in the accumulated effect of net unrealized investment gains of approximately $1.3 billion with an offsetting amount recorded in other comprehensive income (loss). In addition, we increased our future policy benefit reserves in our long-term care insurance business by a cumulative amount of approximately $1.0 billion as of December 31, 2017, with an offsetting amount recorded in other comprehensive income (loss). There was no impact to net income (loss) in 2018 or 2017.
For the years ended December 31, 2018, 2017 and 2016, there were no charges to income (loss) as a result of our PVFP recoverability testing.
Insurance liabilities and reserves. We calculate and maintain reserves for the estimated future payment of claims to our policyholders and contractholders based on actuarial assumptions and in accordance with U.S. GAAP and industry practice. We build these reserves as the estimated value of those obligations increases, and we release these reserves as those future obligations are paid, experience changes or policies lapse. The reserves we establish reflect estimates and actuarial assumptions and methodologies with regard to our future experience. These estimates and actuarial assumptions and methodologies involve the exercise of significant judgment and are inherently uncertain. These estimates and actuarial assumptions and methodologies are subjected to a variety of internal reviews and, in some cases, external independent reviews. Our future financial results depend significantly upon the extent to which our actual future experience is consistent with the assumptions we have used in determining our reserves as well as the assumptions originally used in pricing our products. Small changes in assumptions or small deviations of actual experience from assumptions can have, and in the past had, material impacts on our reserves, results of operations and financial condition.
Many factors, and changes in these factors, can affect future experience including, but not limited to: interest rates; investment returns and volatility; economic and social conditions, such as inflation, unemployment, home price appreciation or depreciation, and healthcare experience (including type of care and cost of care); policyholder persistency or lapses (i.e., the probability that a policy or contract will remain in-force from one period to the next); insured mortality (i.e., life expectancy or longevity); insured morbidity (i.e., frequency and severity of claim, including claim termination rates and benefit utilization rates); future premium increases and associated benefit reductions; expenses; and doctrines of legal liability and damage awards in litigation. Because these assumptions relate to factors that are not known in advance, change over time, are difficult to accurately predict and are inherently uncertain, we cannot determine with precision the ultimate amounts we will pay for actual claims or the timing of those payments. Small changes in assumptions or small deviations of actual experience from assumptions can have, and in the past had, material impacts on our reserve levels, results of operations and financial condition. Moreover, we may not be able to mitigate the impact of unexpected adverse experience by increasing premiums and/or other charges to policyholders (where we have the right to do so) or by offering benefit reductions as an alternative to increasing premiums.
The liability for future policy benefits is equal to the present value of future benefits and expenses, less the present value of expected future gross premiums based on assumptions including investment returns, health care experience (including type of care and cost of care), policyholder persistency or lapses (i.e., the probability that a policy or contract will remain in-force from one period to the next), insured mortality (i.e., life expectancy or longevity), insured morbidity (i.e., frequency and severity of claim, including claim termination rates and benefit utilization rates) and expenses. In our long-term care insurance business, our assumptions also include significant premium rate increases and associated benefit reductions that have been filed and approved or are anticipated to be approved (including premium rate increases and associated benefit reductions not yet filed). The liability for future policy benefits is reviewed at least annually as a part of our loss recognition testing using current assumptions based on the manner of acquiring, servicing and measuring the profitability of the insurance contracts. Loss recognition testing is generally performed at the line of business level, with acquired blocks and certain reinsured blocks tested separately. Changes in how we manage certain polices could require separate loss recognition testing and could result in future charges to income (loss).
We annually perform loss recognition testing for the liability for future policy benefits for our long-term care insurance products in the aggregate, excluding our acquired block of long-term care insurance, which is tested separately. The results of historic loss recognition testing were mostly driven by changes to assumptions and methodologies primarily impacting claim termination rates, most significantly in later-duration claims, and benefit utilization rates. Claim termination rates refer to the expected rates at which claims end. Benefit utilization rates estimate how much of the available policy benefits are expected to be used. We include assumptions in our loss recognition testing for significant premium rate increases and associated benefit reductions that have been approved or are anticipated to be approved (including premium rate increases and associated benefit reductions not yet filed). Our assumption for future in-force rate actions is based on our best estimate of the rate increases we expect given our claim cost expectations and uses our historical experience from rate increase approvals. In addition, we review other assumptions, particularly related to claim frequency, lapse rates, morbidity, mortality improvement and expenses, and update these assumptions as appropriate.
With respect to our long-term care insurance block, excluding the acquired block, while loss recognition testing supports that in the aggregate our reserves are sufficient, our future projections indicate we have projected profits in earlier periods followed by projected losses in later periods. In addition, as a result of the completion of our annual review of our claim reserves and loss recognition testing in the fourth quarter of 2018, reflecting the establishment of higher initial claim liabilities and current estimates of future in-force rate actions, as well as other factors, we have a new projected reserve pattern. As a result of this pattern of projected profits followed by projected losses, we will ratably accrue additional future policy benefit reserves over the profitable periods, currently expected to be through 2032, by the amounts necessary to offset estimated losses during the periods that follow. Such additional reserves are updated each period and calculated based on our estimate of the amount necessary to offset the losses in future periods utilizing expected income and current best estimate assumptions based on actual and anticipated experience, consistent with our loss recognition testing. We adjust the accrual rate prospectively, over the remaining profit periods, without any catch-up adjustment. During the years ended December 31, 2018 and 2017, we increased our long-term care insurance future policy benefit reserves by $8 million and $72 million, respectively, to accrue for profits followed by losses. As of December 31, 2018, the total amount accrued for profits followed by losses was $110 million. The accrual is impacted by the pattern and present value of expected future losses and is updated annually at the time in which we perform loss recognition testing. During the fourth quarter of 2018, we updated our loss recognition testing assumptions, which included changes in assumptions and methodologies from our annual claims review completed in the fourth quarter of 2018 as well as updates to our future in-force rate actions. As a result of the change in our expected reserve pattern, the updated forecast now projects a decrease in the present value of both expected future losses and profits, even though the total loss recognition testing margin was relatively consistent with 2017. The present value of expected losses was approximately $1.1 billion and $2.8 billion as of December 31, 2018 and 2017, respectively. As of December 31, 2018, we estimate a factor of approximately 76% of those profits on our long-term care insurance block, excluding the acquired block, will be accrued in the future to offset estimated future losses during later periods. In 2017, we estimated a factor of approximately 83% to ratably accrue additional future policy benefits. The decrease in the factor was largely driven by the updated profit pattern from the changes in assumptions and methodologies from our annual claims review completed in the fourth quarter of 2018 as well as updates to our future in-force rate actions. There may be future adjustments to this estimate reflecting any variety of new and adverse trends that could result in increases to future policy benefit reserves for our profits followed by losses accrual, and such future increases could possibly be material to our results of operations and financial condition and liquidity.
The impacts of future adverse changes in our assumptions would result in the establishment of additional future policy benefit reserves and would be immediately reflected in net income (loss) if our margin for this block is again reduced below zero. Any favorable variation would result in additional margin but no immediate benefit to income (loss), and would result in higher income recognition over the remaining duration of the in-force block.
Similar to our long-term care insurance products, we annually perform loss recognition testing for the liability for future policy benefits for our term and whole life insurance products in the aggregate, excluding our acquired block, which is tested separately. The margin of our term and whole life insurance products has fluctuated over the years. As of December 31, 2018 and 2017, we had margin of approximately zero to $200 million and zero to $100 million, respectively, and a DAC balance of $1.3 billion in each period on our term and whole life insurance products, excluding the acquired block. If our margin is reduced below zero for our term and whole life insurance products, excluding our acquired block, we would amortize DAC up to the amount of DAC recorded on our balance sheet and if DAC was fully written off, establish additional future policy benefit reserves, either of which would result in a charge to net income (loss).
As of December 31, 2018 and 2017, we had margin of approximately zero to $300 million and a PVFP balance of $77 million and $82 million, respectively, on our acquired block of term and whole life insurance products. If our margin is reduced below zero for our acquired block of term and whole life insurance products,
Historically low interest rate spreads have impacted the margins of our fixed immediate annuity products. In 2018, 2017 and 2016, we performed loss recognition testing and determined that we had premium deficiencies in our fixed immediate annuity products. In 2016, the premium deficiency resulted in negative margin of $32 million on our fixed immediate annuity products, primarily driven by the low interest rate environment. As a result, in 2016, we wrote off the entire DAC balance for our fixed immediate annuity products of $14 million through amortization. In addition, primarily as a result of our fixed immediate annuity loss recognition testing in 2018, 2017 and 2016, we increased our future policy benefit reserves and recognized expenses of $22 million, $89 million and $24 million, respectively. The premium deficiency test results were primarily driven by the low interest rate environment and updated assumptions to future policy charges. The updated assumptions will remain locked-in until such time as we determine another premium deficiency exists. The impacts of future adverse changes in our assumptions would result in the establishment of additional future policy benefit reserves and would be immediately reflected in net income (loss) if our margin for this block is again reduced below zero. Any favorable variation would result in additional margin but no immediate benefit to net income (loss), and would result in higher income recognition over the remaining duration of the in-force block. Due to the premium deficiencies that existed in 2018, 2017 and 2016, we monitor our fixed immediate annuity products more frequently than annually.
The risks we face include adverse variations in interest rates, credit spreads and/or mortality. Adverse experience in one or all of these risks would result in the establishment of additional benefit reserves and would be immediately reflected in net income (loss) if our margin for this block is again reduced to below zero. As of December 31, 2018, for our fixed immediate annuity products, we estimate that a combined 50 basis point reduction in interest rates or credit spreads from the December 31, 2018 levels, or 2% lower mortality, scenarios that we consider to be reasonably possible given historical changes in market conditions and experience on these products, would result in additional future policy benefit reserves and a charge to net income (loss) of approximately $23 million or $24 million, respectively.
The liability for policyholder account balances represents the contract value that has accrued to the benefit of the policyholder as of the balance sheet date for investment-type and universal and term universal life insurance contracts. We are also required to establish additional benefit reserves for guarantees or product features in addition to the contract value where the additional benefit reserves are calculated by applying a benefit ratio to accumulated contractholder assessments, and then deducting accumulated paid claims. The benefit ratio is equal to the ratio of benefits to assessments, accumulated with interest and considering both past and anticipated future experience.
The liability for policy and contract claims represents the amount needed to provide for the estimated ultimate cost of settling claims relating to insured events that have occurred on or before the end of the respective reporting period. The estimated liability includes requirements for future payments of: (a) claims that have been reported to the insurer; (b) claims related to insured events that have occurred but that have not been reported to the insurer as of the date the liability is estimated; and (c) claim adjustment expenses. Claim adjustment expenses include costs incurred in the claim settlement process such as legal fees and costs to record, process and adjust claims.
The liability for policy and contract claims, also known as claim reserves, for our long-term care insurance products represents the present value of the amount needed to provide for the estimated ultimate cost of settling claims relating to insured events that have occurred on or before the end of the respective reporting period. Key assumptions include investment returns, health care experience (including type of care and cost of care), policyholder persistency or lapses (i.e., the probability that a policy or contract will remain in-force from one period to the next), insured mortality (i.e., life expectancy or longevity), insured morbidity (i.e., frequency and severity of claim, including claim termination rates and benefit utilization rates) and expenses. Our discount rate assumption assumes a static discount rate in line with our current portfolio yield.
We annually complete our review of assumptions and methodologies relating to our long-term care insurance claim reserves. During the fourth quarter of 2018, we completed our annual review of our long-term care insurance claim reserve assumptions and methodologies. Based on this review, we updated several assumptions and methodologies, including benefit utilization rates, claim termination rates and other assumptions. The primary impact related to increasing later duration utilization assumptions for claims with lifetime benefits. As a result of this review, we increased our long-term care insurance claim reserves by $308 million and increased reinsurance recoverables by $17 million in the fourth quarter of 2018.
During the third quarter of 2017, we completed our review of assumptions and methodologies relating to our claim reserves of our long-term care insurance business and determined, based on our experience, no adjustments were required.
During the third quarter of 2016, we completed our annual review of our long-term care insurance claim reserve assumptions. Based on this review, we updated several assumptions and methodologies primarily impacting claim termination rates, benefit utilization rates and incurred but not reported reserves. The primary impact of assumption changes was from an overall lowering of claim termination rate assumptions for longer duration claims, particularly for reimbursement claims. We also updated our claim termination rate assumptions to reflect differences between product types, separating our indemnity and reimbursement blocks that were previously combined, and modestly refined our utilization rate assumptions and methodologies as well as refined our methodology primarily related to the calculation of incurred but not reported reserves to better reflect the aging of the in-force blocks. As a result of this review, we increased our long-term care insurance claim reserves by $460 million and increased reinsurance recoverables by $25 million in the third quarter of 2016. In addition, certain of our third-party reinsurance counterparties updated their assumptions and methodologies, which increased our long-term care insurance claim reserves by $222 million with an offsetting increase in reinsurance recoverables of $222 million in the fourth quarter of 2016.
Estimates of mortgage insurance reserves for losses and loss adjustment expenses are based on notices of mortgage loan defaults and estimates of defaults that have been incurred but have not been reported by loan servicers, using assumptions developed based on past experience and our expectation of future development. These assumptions include claim rates for loans in default, the average amount paid for loans that result in a claim and provisions for loans within our delinquency inventory that will be rescinded or modified (collectively referred to as “loss mitigation actions”) based on the effects that such loss mitigation actions have had on our historical claim frequency rates, including an estimate for reinstatement of previously rescinded coverage. Each of these inherently judgmental assumptions is established in a respective geography based on historical and expected experience. We have established processes, as well as contractual rights, to ensure we receive timely information from loan servicers to aid us in the establishment of our estimates. In addition, when we have obtained sufficient facts and circumstances through our investigative process, we have the unilateral right under our master policies and at law to rescind coverage on the underlying loan certificate as if coverage never existed. As is common accounting practice in the mortgage insurance industry and in accordance with U.S. GAAP, loss reserves are not established for future claims on insured loans that are not currently in default.
Unearned premiums. In our mortgage insurance businesses in Canada and Australia, the majority of our insurance contracts are single premium. We also have single premium insurance contracts in our U.S. mortgage insurance business, although these products make up a smaller portion of our product mix in the United States. As of December 31, 2018, we had $0.4 billion of unearned premiums related to our U.S. mortgage insurance business. The majority of our insurance contracts in our U.S. mortgage insurance business have recurring
In our U.S. mortgage insurance business, the majority of our insurance contracts have recurring premiums. We recognize recurring premiums over the terms of the related insurance policy on a pro-rata basis (i.e., monthly). Changes in market conditions could cause a decline in mortgage originations, mortgage insurance penetration rates and our market share, all of which could impact new insurance written. For example, a decline in flow new insurance written of $1.0 billion would result in a reduction in earned premiums of approximately $4 million in the first full year. Likewise, if flow persistency declined on our existing insurance in-force by 10%, earned premiums would decline by approximately $77 million during the first full year, potentially offset by lower reserves due to policies no longer being in-force.
As of December 31, 2018, we had a net deferred tax asset of $712 million. We had a consolidated gross deferred tax asset of $298 million related to NOL carryforwards. In the United States, we had $1.3 billion of federal NOLs as of December 31, 2018, which, if unused, will expire beginning in 2028. Foreign tax credit carryforwards amounted to $265 million as of December 31, 2018, which, if unused, will begin to expire in 2024. As of December 31, 2018, we had a $334 million valuation allowance related to state deferred tax assets and foreign net operating losses.
In 2017, we released $258 million of our valuation of allowance that was recorded in 2016 related to judgments regarding the future realization of certain foreign tax credits. In light of our 2017 financial projections, which included the impact of changes in U.S. tax legislation under the TCJA and improvements in business performance, mostly in our U.S. mortgage insurance business, as well as lower operating earnings volatility in our U.S. life insurance business, we believed that it is more likely than not that the benefits of these foreign tax credits will be realized (see “Regulation-Changes in tax law”). The financial projections did not include any benefits or aspects of the proposed transaction with China Oceanwide nor did they assume any charges associated with tax attribute limitations that would occur with a change in ownership.
We are in a three-year cumulative pre-tax income position in our U.S. jurisdiction as of December 31, 2018, however, we have been in a three-year cumulative loss position in recent years. A cumulative loss position is considered significant negative evidence in assessing the realizability of our deferred tax assets. Our ability to realize our net deferred tax asset of $712 million, which includes $563 million related to NOL and foreign tax credit carryforwards, is primarily dependent upon generating sufficient taxable income in future years. Management has concluded that there is sufficient positive evidence to support the expected realization of the net operating losses and foreign tax credit carryforwards. This positive evidence includes the fact that: (i) we are currently in a cumulative three-year income position; (ii) our U.S. operating forecasts are profitable, which include: in-force premium rate increases and associated benefit reductions already obtained in our long-term care insurance business, favorable development in interest rates, improvements in business performance driven mostly by our U.S. mortgage insurance business and favorable changes in U.S. tax legislation under the TCJA; and (iii) overall domestic losses that we have incurred are now, under the TCJA, allowed to be reclassified as foreign source income to the extent of 100% of domestic source income produced in subsequent years, and such resulting foreign source income, along with future projections of foreign source income, is sufficient to cover the foreign tax credits being carried forward. After consideration of all available evidence, we have concluded that it is more likely than not that our deferred tax assets, with the exception of certain foreign net operating losses and state deferred tax assets for which a valuation allowance has been established, will be realized. If our actual results do not validate the current projections of pre-tax income, we may be required to record an additional valuation allowance which could have a material impact on our consolidated financial statements in future periods.
The stability of both the financial markets and global economies in which we operate impacts the sales, revenue growth and profitability trends of our businesses as well as the value of assets and liabilities. The U.S. and international financial markets in which we operate have been impacted by concerns regarding regulatory changes, global trade, modest global growth and the rate and strength of recovery. During 2018, the global economy improved and most countries in which we conduct business saw improved levels of gross domestic product (“GDP”) growth. Many economic forecasts show the rate of GDP growth will slow in 2019 due to U.S. and China trade tensions, declining oil prices, and global growth concerns, but still maintain a healthy range of sustainable growth. Likewise, historic low interest rates have started to rise given actions taken by the U.S. Federal Reserve and other central banks. Although the U.S. Federal Reserve increased its benchmark lending rate 25 basis points in December 2018, long-term interest rates remained at low levels. The U.S. Federal Reserve projected two additional rate increases in 2019 and one in 2020, which is modified from its September
forecast of three increases in 2019 and one increase in 2020. The modification in the forecast relates to the economic concerns relating to the projected slow down in GDP growth in 2019. Given this forecast, we expect interest rates will continue to rise in 2019, but we remain uncertain at the pace in which this increase will occur and its ultimate impact on our businesses. The decision for additional rate increases during 2018 was anticipated and indicates increased confidence in the United States economy as unemployment has reached multi-decade lows and economic growth was strong in 2018. Likewise, inflation remains relatively stable but long-term forecasts remain uncertain. The U.S. Treasury yield curve steepened in the fourth quarter of 2018 with short-term interest rates decreasing on expectation of a slower pace of rate increases, while long-term interest rates decreased at a lesser extent. Credit markets experienced spread widening in the fourth quarter of 2018 driven by a constructive economic backdrop, strong profit margins, higher corporate earnings and a lower supply of bonds which is expected to have higher demand during 2019. For a discussion of the risks associated with interest rates, see “Item 1A - Risk Factors-Interest rates and changes in rates could materially adversely affect our business and profitability.”
Our U.S. Life Insurance segment decreased $55 million. Our long-term care insurance business increased $68 million largely from $70 million of increased premiums in 2018 from in-force rate actions approved and implemented and from a $60 million unfavorable correction in 2017 related to certain limited pay policies that had reached their paid up status that did not recur. These increases were partially offset by policy terminations in 2018. Our life insurance business decreased $123 million mainly attributable to higher ceded premiums in 2018 from new reinsurance treaties effective in December 2017 and the continued runoff of our term life insurance products in 2018.
Our U.S. Life Insurance segment increased $536 million. Our long-term care insurance business increased $652 million principally from the completion of our annual review of our claim reserves in the fourth quarter of 2018 which resulted in higher claim reserves of $291 million, net of reinsurance (see “-Critical Accounting Estimates-Liability for policy and contract claims” for additional information). We also refined our estimate of unreported policy terminations, which resulted in an unfavorable reserve adjustment of $36 million in 2018. The increase was also attributable to higher reserves as a result of the aging of the in-force block (including higher frequency of new claims), unfavorable existing claim performance from higher utilization of available benefits and lower terminations, as well as higher severity of new claims in 2018. Our life insurance business decreased $35 million primarily attributable to higher ceded benefits in 2018 from new reinsurance treaties effective in December 2017, a $30 million unfavorable model refinement in 2017 that did not recur and favorable mortality in our term life insurance products in 2018. These decreases were partially offset by a higher unfavorable unlocking of $39 million in our universal and term universal life insurance products as part of our annual review of assumptions in the fourth quarter of 2018 compared to 2017 (see “-Critical Accounting Estimates-Policyholder account balances” for additional information)
Our Canada Mortgage Insurance segment increased $24 million largely from a higher average reserve per delinquency primarily attributable to increased losses in Alberta, less favorable development in our loss reserves and from higher new delinquencies, net of cures, in 2018.
Our Runoff segment increased $13 million primarily attributable to higher GMDB reserves in our variable annuity products due to unfavorable equity market performance in 2018.
Our U.S. Life Insurance segment decreased $45 million primarily due to our fixed annuities business predominantly from a decline in average account values and lower crediting rates in 2018.
Our Canada Mortgage Insurance segment decreased $10 million mainly driven by lower stock-based compensation expense driven mostly by a decrease in Genworth Canada’s share price in 2018.
Our Runoff segment decreased $4 million mainly from lower commissions in our variable annuity products in 2018.
Our U.S. Life Insurance segment increased $12 million mostly attributable to our long-term care insurance business largely from higher operating costs associated with our in-force rate action plan, partially offset by guaranty fund assessments in 2017 in connection with the Penn Treaty liquidation that did not recur.
Provision (benefit) for income taxes. The effective tax rate was 33.7% and (28.4)% for the years ended December 31, 2018 and 2017, respectively. The increase in the effective tax rate was primarily due to the impacts of tax reform in 2017 that did not recur. In 2017, we released $258 million of our valuation allowance principally from the TCJA and improvements in business performance, mostly in our U.S. mortgage insurance business, as well as lower operating earnings volatility in our U.S. life insurance businesses. In addition, changes in the taxation of foreign operations also benefited the 2017 effective tax rate. The 2018 effective tax rate also included the rate differential on our foreign subsidiaries, which are now taxed at a higher marginal rate than our U.S. businesses and tax expense related to gains on forward starting swaps settled prior to the enactment of the TCJA, which are tax effected at 35% as they are amortized into net investment income.
Net income attributable to noncontrolling interests. Net income attributable to noncontrolling interests represents the portion of equity in a subsidiary attributable to third parties. The increase was predominantly related to our Australia Mortgage Insurance segment from the completion of a premium earnings pattern review, which resulted in an unfavorable adjustment of $151 million in 2017 that did not recur. This increase was partially offset by net investment losses mostly related to derivative losses and a decrease in the fair value of preferred equity securities in our Canada Mortgage Insurance segment in 2018.
Our U.S. Life Insurance segment increased $252 million. Our long-term care insurance business decreased $21 million primarily driven by an unfavorable correction of $60 million in 2017 related to
certain limited pay policies that had reached their paid up status. The decrease was also attributable to policy terminations, partially offset by $92 million of increased premiums in 2017 from in-force rate actions approved and implemented. Our life insurance business increased $276 million mainly attributable to the impact of a reinsurance treaty under which we initially ceded $326 million of certain term life insurance premiums as part of a life block transaction in the first quarter of 2016, partially offset by the continued runoff of our term life insurance products in 2017.
Our U.S. Mortgage Insurance segment increased $35 million mainly attributable to higher average flow insurance in-force, partially offset by lower rates on our mortgage insurance in-force in 2017.
Our Canada Mortgage Insurance segment decreased $50 million largely from lower new delinquencies, net of cures, as well as from a lower average reserve per delinquency and from favorable development in our loss reserves as of December 31, 2016.
Our U.S. Life Insurance segment increased $58 million. Our long-term care insurance business decreased $328 million principally from the completion of our annual review of our claim reserves conducted during the third quarter of 2016 which resulted in higher claim reserves of $435 million, net of reinsurance, that did not recur. The decrease was also attributable to a favorable correction of $54 million in 2017 associated with certain limited pay policies that had reached their paid up status and unfavorable adjustments of $50 million which included refinements to the calculations of reserves in 2016 that did not recur. The decrease was also driven by a $31 million favorable adjustment related to changes in claims administration expense assumptions and favorable claim terminations in 2017. These decreases were partially offset by aging and growth of the in-force block, higher severity on new claims, higher incremental reserves of $55 million recorded in connection with an accrual for profits followed by losses and a $28 million less favorable impact from benefit reductions in 2017 related to in-force rate actions approved and implemented. Our life insurance business increased $283 million principally related to the impact of a reinsurance treaty under which we initially ceded $331 million of certain term life insurance reserves as part of a life block transaction in the first quarter of 2016 and from unfavorable mortality in 2017. The increase was also attributable to a $30 million unfavorable model refinement in 2017. These increases were partially offset by a less unfavorable unlocking of $135 million in our universal and term universal life insurance products as part of our annual review of assumptions in the fourth quarter of 2017 compared to 2016 (see “-Critical Accounting Estimates-Policyholder account balances” for additional information). Our fixed annuities business increased $103 million largely attributable to $65 million of higher reserves from loss recognition testing in our fixed immediate annuity products primarily driven by the low interest rate environment (see “-Critical Accounting Estimates-Future policy benefits” for additional information). The increase was also related to $45 million of lower assumed reinsurance in connection with the recapture of certain life-contingent products by a third party in 2016 that did not recur.
Our U.S. Life Insurance segment decreased $59 million. Our life insurance business decreased $16 million predominantly from lower average account values and crediting rates in our universal life insurance products in 2017. Our fixed annuities business decreased $43 million largely driven by a decline in average account values and lower crediting rates in 2017.
Our U.S. Life Insurance segment decreased $76 million. Our long-term care insurance business increased $10 million mostly from the guaranty fund assessment in 2017 in connection with the Penn Treaty liquidation. Our life insurance business decreased $21 million primarily from lower operating expenses attributable to the suspension of sales on March 7, 2016. Included in 2016 was $7 million of restructuring charges as well as expenses of $5 million associated with the life block transaction that did not recur. Our fixed annuities business decreased $65 million largely attributable to a $55 million payment in connection with the recapture of certain life-contingent products by a third party in 2016 that did not recur and lower operating expenses as a result of the suspension of sales on March 7, 2016. The decrease was also attributable to an unfavorable correction of $12 million related to state guaranty funds in 2016 that did not recur.
Our Runoff segment decreased $5 million principally from favorable equity market performance, partially offset by higher investment income in 2017.
Our Canada Mortgage Insurance segment increased $4 million primarily from higher DAC amortization related to our larger, more recent in-force blocks of business.
Corporate and Other activities decreased $28 million largely driven by a favorable correction of $11 million related to our Tax Matters Agreement liability and a contractual change in our junior subordinated notes related to an interest rate change from fixed to floating rates.
Our U.S. Life Insurance segment decreased $25 million driven by our life insurance business principally as a result of the life block transaction in the first quarter of 2016 which included the redemption of certain non-recourse funding obligations and the write-off of $9 million of deferred borrowing costs associated with our non-recourse funding obligations as well as the restructuring of a captive reinsurance entity.
Provision (benefit) for income taxes. The effective tax rate decreased to (28.4)% for the year ended December 31, 2017 from 111.9% for the year ended December 31, 2016. The effective tax rate for the year ended December 31, 2017 was impacted by changes in U.S. tax legislation under the TCJA. In the fourth quarter of 2017, we recorded $456 million of net tax benefits primarily from a $258 million release of a valuation
allowance, the impact from changes in the federal tax rate and the release of shareholder liability taxes, partially offset by higher transition taxes and other items. Our valuation allowance was reduced by $258 million principally related to the TCJA and from improvements in business performance, mostly in our U.S. mortgage insurance business, as well as lower operating earnings volatility in our U.S. life insurance businesses (see “-Regulation-Changes in tax law”). The effective tax rate for the year ended December 31, 2016 was impacted by a valuation allowance of $258 million recorded on deferred tax assets related to foreign tax credits that we did not expect to realize in 2016. The effective tax rate for the year ended December 31, 2016 was also impacted by the reversal of a deferred tax valuation allowance established in 2015 related to our mortgage insurance business in Europe.
Net income attributable to noncontrolling interests. The decrease was predominantly related to our Australia Mortgage Insurance segment from the completion of a premium earnings pattern review, which resulted in an unfavorable adjustment of $151 million in 2017.
income (loss) available to Genworth Financial, Inc.’s common stockholders as a basis for determining awards and compensation for senior management and to evaluate performance on a basis comparable to that used by analysts. However, the items excluded from adjusted operating income (loss) available to Genworth Financial, Inc.’s common stockholders have occurred in the past and could, and in some cases will, recur in the future. Adjusted operating income (loss) available to Genworth Financial, Inc.’s common stockholders and adjusted operating income (loss) available to Genworth Financial, Inc.’s common stockholders per share on a basic and diluted basis are not substitutes for net income (loss) available to Genworth Financial, Inc.’s common stockholders or net income (loss) available to Genworth Financial, Inc.’s common stockholders per share on a basic and diluted basis determined in accordance with U.S. GAAP. In addition, our definition of adjusted operating income (loss) available to Genworth Financial, Inc.’s common stockholders may differ from the definitions used by other companies.
In 2018, 2017 and 2016, we recorded a pre-tax expense of $2 million, $2 million and $22 million, respectively, related to restructuring costs as part of an expense reduction plan as we evaluate and appropriately size our organizational needs and expenses.
There were no infrequent or unusual items excluded from adjusted operating income (loss) during the periods presented other than the following items. In 2018 and 2016, we incurred fees related to Genworth Holdings’ bond consent solicitation of $6 million and $18 million, respectively, for broker, advisor and investment banking fees.
(1) Under applicable accounting guidance, companies in a loss position are required to use basic weighted-average common shares outstanding in the calculation of diluted loss per share. Therefore, as a result of our loss from continuing operations available to Genworth Financial, Inc.’s common stockholders for the year ended December 31, 2016, we were required to use basic weighted-average common shares outstanding in the calculation of diluted loss per share as the inclusion of shares for stock options, RSUs and SARs of 2.0 million would have been antidilutive to the calculation. If we had not incurred a loss from continuing operations available to Genworth Financial, Inc.’s common stockholders for the year ended December 31, 2016, dilutive potential weighted-average common shares outstanding would have been 500.3 million.
Management also regularly monitors and reports a loss ratio for our businesses. For our mortgage insurance businesses, the loss ratio is the ratio of benefits and other changes in policy reserves to net earned premiums. For our long-term care insurance business, the loss ratio is the ratio of benefits and other changes in reserves less
The level of private mortgage insurance market penetration and eventual market size is affected in part by actions taken by the GSEs and the U.S. government, including the FHA, the FHFA, and the U.S. Congress, which impact housing or housing finance policy. In the past, these actions have included announced changes, or potential changes, to underwriting standards, FHA pricing, GSE guaranty fees and loan limits as well as low down payment programs available through the FHA or GSEs. In the first quarter of 2018, Freddie Mac introduced to certain lenders a pilot program, Integrated Mortgage Insurance, commonly referred to as “IMAGIN,” as an alternative to private mortgage insurance. IMAGIN transfers default risk on high loan-to-value mortgages to a panel of reinsurers approved by Freddie Mac. In July 2018, Fannie Mae introduced a similar pilot program, Enterprise Paid Mortgage Insurance (“EPMI”). As currently designed and implemented, we believe these pilot programs are targeted at less than 5% of the total 2018 aggregate private mortgage insurance available market and compete with lender paid private mortgage insurance, which represented approximately 8% of our new insurance written in 2018. For more information about the potential future impact, see “Item 1A - Risk Factors-Fannie Mae and Freddie Mac exert significant influence over the U.S. mortgage insurance market and changes to the role or structure of Freddie Mac or Fannie Mae could have a material adverse impact on our U.S. mortgage insurance business,” and “-Risk Factors-The amount of mortgage insurance we write could decline significantly if alternatives to private mortgage insurance are used or lower coverage levels of mortgage insurance are selected.”
Our loss ratio was 5% for the year ended December 31, 2018, compared to 15% for the year ended December 31, 2017. The 2018 loss ratio decreased primarily due to lower losses related to the decline in new delinquencies and improvement in the net cures and aging of existing delinquencies. The decrease was also attributable to a favorable reserve adjustment of $28 million, which reduced the loss ratio by four percentage points in 2018. The year ended December 31, 2017 included a $15 million favorable reserve adjustment, which reduced the loss ratio by three percentage points. The fourth quarter of 2017 included incremental delinquencies of approximately three thousand in areas impacted by hurricanes Harvey and Irma. The impact of the incremental delinquencies was approximately $5 million in 2017. However, these delinquencies performed consistent with our prior expected claim frequency and as a result, there were no incremental incurred losses related to them in 2018. Additionally, we do not expect any material impacts from the hurricanes affecting the Southeast region of the United States, Florence and Michael, which occurred in September 2018 and October 2018, respectively. We will continue to monitor these affected areas and support the measures enacted by the GSEs restricting foreclosure actions and providing other forms of mortgage relief for those dealing with damage in the affected areas. Foreclosure starts decreased in 2018 as compared to 2017. We have also seen a reduction in loans that have been subject to a modification or workout. We expect our level of loan modifications to continue to decline going forward in line with the expected reduction in delinquent loans and the continuing aging of delinquencies.
Our U.S. mortgage insurance business paid a $50 million dividend to Genworth Financial in 2018. The evaluation of future dividends is subject to capital requirements of our U.S. mortgage insurance subsidiaries, capital needs of our holding companies and market conditions, among other factors, which are subject to change.
As of December 31, 2018, GMICO’s risk-to-capital ratio under the current regulatory framework as established under North Carolina law and enforced by the NCDOI, GMICO’s domestic insurance regulator, was approximately 12.5:1, compared with a risk-to-capital ratio of approximately 12.9:1 as of December 31, 2017. This risk-to-capital ratio remains below the NCDOI’s maximum risk-to-capital ratio of 25:1. GMICO’s ongoing risk-to-capital ratio will depend principally on the magnitude of future losses incurred by GMICO, the effectiveness of ongoing loss mitigation activities, new business volume and profitability, the amount of policy lapses, changes in the value of affiliated assets and the amount of additional capital that is generated within the business or capital support (if any) that we provide.
Effective December 31, 2015, each GSE adopted revised PMIERs, which set forth operational and financial requirements that mortgage insurers must meet in order to remain eligible. Each approved mortgage insurer is required to provide the GSEs with an annual certification and a quarterly report as to its compliance with PMIERs. As of December 31, 2018, we estimate our U.S. mortgage insurance business had available assets of approximately 129% of the required assets under PMIERs compared to approximately 121% as of December 31, 2017. As of December 31, 2018 and 2017, the PMIERs sufficiency ratios were in excess of $750 million and $550 million, respectively, of available assets above the PMIERs requirements. The increase in 2018 as
compared to 2017 was driven, in part, by positive operating cash flows and the reduction in delinquent loans. The new delinquencies in areas impacted by hurricanes Harvey and Irma, which negatively impacted the PMIERs sufficiency ratio by four points in the fourth quarter of 2017, continue to cure in line with our original loss expectations. This cure performance during 2018 virtually eliminated the negative impact to the PMIERs sufficiency ratio as of December 31, 2018. Reinsurance transactions provided an aggregate of approximately $515 million of PMIERs capital credit as of December 31, 2018. The GSEs published revisions to PMIERs, referred to as “PMIERs 2.0,” on September 27, 2018 with an effective date of March 31, 2019. If PMIERs 2.0 had been effective December 31, 2018, we estimate that the sufficiency ratio would have been approximately 120%, or more than $550 million of available assets above the PMIERs 2.0 requirements. This difference is primarily due to the elimination of any credit for future premiums in PMIERs 2.0 that had previously been allowed on insurance policies written in 2008 or earlier.
As of December 31, 2018, loans modified through the Home Affordable Refinance Program (“HARP”) accounted for approximately $10.4 billion of insurance in-force, with approximately $9.9 billion of those loans from our 2005 through 2008 book years. Loans modified through HARP have extended amortization periods and reduced interest rates, which reduce borrower’s monthly payments. Over time, we expect these modified loans to result in extended premium streams and a lower incidence of default. On December 31, 2018, HARP ended and was replaced with GSE streamline refinance programs. For financial reporting purposes, we report HARP modified loans as a modification of the coverage on existing insurance in-force rather than new insurance written.
Adjusted operating income available to Genworth Financial, Inc.’s common stockholders increased mainly from lower losses, which included a $22 million favorable reserve adjustment in 2018 principally from lower expected claim rates. The increase was also attributable to higher premiums due to an increase in mortgage insurance in-force, higher investment income and lower taxes in 2018. The year ended December 31, 2017 included a $10 million favorable reserve adjustment.
Benefits and other changes in policy reserves decreased primarily from lower new delinquencies, favorable net cures and aging of existing delinquencies and a $28 million favorable reserve adjustment in 2018 mostly driven by lower expected claim rates. The year ended December 31, 2017 included a $15 million favorable reserve adjustment and approximately $5 million of losses attributable to new delinquencies in areas impacted by hurricanes Harvey and Irma.
Provision for income taxes. The effective tax rate decreased to 21.2% for the year ended December 31, 2018 from 35.9% for the year ended December 31, 2017. The decrease in the effective tax rate was primarily attributable to a reduction in the U.S. corporate federal income tax rate from 35% to 21%.
Adjusted operating income available to Genworth Financial, Inc.’s common stockholders increased in 2017 mainly attributable to lower losses from favorable net cures and aging of existing delinquencies and a continued decline in new delinquencies in 2017. The increase was also attributable to higher premiums due to an increase in mortgage insurance in-force in 2017.
Net investment income increased due to higher average invested assets in 2017.
Provision for income taxes. The effective tax rate increased slightly to 35.9% for the year ended December 31, 2017 from 35.8% for the year ended December 31, 2016. The increase in the effective tax rate was primarily attributable to decreased tax benefits related to tax favored investments in relation to pre-tax income, partially offset by state taxes.
Primary insurance in-force increased largely as a result of higher flow insurance-in-force of $15.2 billion, which increased from $150.3 billion as of December 31, 2017 to $165.5 billion as of December 31, 2018 mostly from new insurance written, partially offset by lapses during 2018. The increase in flow insurance in-force was partially offset by a decline of $0.3 billion in bulk insurance in-force, which decreased from $1.5 billion as of December 31, 2017 to $1.2 billion as of December 31, 2018 primarily from cancellations and lapses in 2018. In addition, risk in-force increased predominantly from higher flow insurance in-force. Flow persistency was 84% and 82% for the years ended December 31, 2018 and 2017, respectively.
New insurance written decreased primarily reflecting a decline in our estimated market share in 2017.
The loss ratio is the ratio of benefits and other changes in policy reserves to net earned premiums. The expense ratio (net earned premiums) is the ratio of general expenses to net earned premiums. The expense ratio (net premiums written) is the ratio of general expenses to net premiums written. In our business, general expenses consist of acquisition and operating expenses, net of deferrals, and amortization of DAC and intangibles.
The loss ratio decreased primarily from lower new delinquencies and from improvements in net benefits from cures and aging of existing delinquencies in 2018. The decrease was also attributable to a favorable reserve adjustment of $28 million in 2018 mostly driven by lower expected claim rates, which reduced the loss ratio by four percentage points in 2018. The year ended December 31, 2017 included a $15 million favorable reserve adjustment and approximately $5 million of losses attributable to new delinquencies in areas impacted by hurricanes Harvey and Irma.
(1) Included loans where we were in a secondary loss position for which no reserve was established due to an existing deductible. Excluding these loans, bulk delinquent loans were 403, 614 and 756 as of December 31, 2018, 2017 and 2016, respectively.
(1) Total reserves were $296 million as of December 31, 2018.
The following table sets forth the dispersion of our total reserves and primary insurance in-force and risk in-force by year of policy origination and average annual mortgage interest rate as of December 31, 2018:
Primary mortgage insurance claims paid, including loss adjustment expenses, for the year ended December 31, 2018 were $193 million, compared to $285 million and $368 million for the years ended December 31, 2017 and 2016, respectively. Pool insurance claims paid were $1 million, $2 million and $2 million for the years ended December 31, 2018, 2017 and 2016, respectively.
The ratio of the claim paid to the current risk in-force for a loan is referred to as “claim severity.” The current risk in-force is equal to the unpaid principal amount multiplied by the coverage percentage. The main determinants of claim severity are the age of the mortgage loan, the value of the underlying property, accrued interest on the loan, expenses advanced by the insured and foreclosure expenses. These amounts depend partly upon the time required to complete foreclosure, which varies depending upon state laws. Pre-foreclosure sales, acquisitions and other early workout and claim administration actions help to reduce overall claim severity. Our average primary flow mortgage insurance claim severity was 118%, 120% and 118% for the years ended December 31, 2018, 2017 and 2016, respectively. The average claim severities do not include the effects of agreements on non-performing loans.
Results of our mortgage insurance business in Canada are affected primarily by changes in the regulatory environment, employment levels, consumer borrowing behavior, lender mortgage-related strategies, including lender servicing practices, and other economic and housing market influences, including interest rate trends, home price appreciation or depreciation, mortgage origination volume, levels and aging of mortgage delinquencies and movements in foreign currency exchange rates. During 2018, the Canadian dollar strengthened against the U.S. dollar, which favorably impacted the results of our mortgage insurance business in Canada as reported in U.S. dollars. Any future movement in foreign exchange rates could impact future results.
The Canadian GDP is expected to have experienced moderate growth in 2018, although lower than in 2017, mostly attributable to increased government spending and stabilization in housing and exports, partially offset by weakened investment and consumer spending. The overnight interest rate in Canada was 1.75% at December 31, 2018 compared to 1.00% at December 31, 2017. Canada’s unemployment rate decreased to 5.6% at the end of 2018 compared to 5.7% at the end of 2017 due to job creation outpacing the increase in workforce participation.
Our mortgage insurance business in Canada experienced higher losses in 2018 compared to 2017 primarily due to a higher average reserve per delinquency in 2018 due to a shift in mix resulting in a larger proportion of delinquencies in oil-producing regions that tend to have higher severity. The increase in losses was also driven by less favorable development in our loss reserves and higher new delinquencies, net of cures, in 2018. Our loss ratio in Canada was 15% for the year ended December 31, 2018. We expect the loss ratio in Canada in 2019 to be the same or modestly higher as compared to 2018 as economic conditions continue to normalize.
In 2018, flow new insurance written volumes decreased in our mortgage insurance business in Canada compared to 2017 primarily due to a smaller flow mortgage insurance market size as a result of regulatory changes and ongoing housing affordability pressure. However, earned premiums were higher in 2018 compared to 2017 from the seasoning of our larger, more recent in-force books of business.
Under PRMHIA and the Insurance Companies Act (Canada), our mortgage insurance business in Canada is required to meet an MCT to support its outstanding mortgage insurance in-force per the MCT Guideline. The MCT ratio is calculated based on a methodology prescribed by OSFI. On January 1, 2017, the capital advisory titled “Capital Requirements for Federally Regulated Mortgage Insurers” became effective. The advisory provides a standard framework for determining the capital requirements for residential mortgage insurance companies. Under this regulatory capital framework, the OSFI Supervisory MCT target and PRMHIA requirement are both 150%. As of December 31, 2018, our MCT ratio under the framework was approximately 172%, which was above the supervisory target.
Compared to the framework that was in effect prior to January 1, 2017, this framework has supplementary capital requirements under certain circumstances. As a result of these higher regulatory capital requirements, our mortgage insurance business in Canada implemented an increase in premiums rates of approximately 20% on flow new business effective March 17, 2017. Similarly, the business also increased its premium rates for bulk insurance. For more information about this capital framework, see “-Regulation-Mortgage Insurance Regulation-Canada Regulation.”
targeted operating range for 2019 and thereafter, which may allow for meaningful levels of capital redeployment in addition to regular quarterly dividends in 2019.
On October 17, 2017, OSFI released the final version of the B-20 Guideline, which applies to all federally-regulated financial institutions that are engaged in residential mortgage underwriting and/or the acquisition of residential mortgage loan assets in Canada. The guideline was effective January 1, 2018, and requires enhanced underwriting practices for all uninsured mortgages, including the application of a qualifying mortgage rate stress test. The B-20 Guideline does not directly impact the regulatory requirements for our mortgage insurance business in Canada, as it is governed by OSFI’s Guideline B-21 Residential Mortgage Insurance Underwriting Practices and Procedures. Based on housing resale activity and mortgage origination volume in 2018, we believe the B-20 Guideline reduced the total 2018 mortgage originations in Canada by approximately 10% to 15% as compared to 2017 levels, including a decline of approximately 5% in the high loan-to-value market size in Canada in 2018 even though qualifying insured mortgages have been subject to a similar mortgage rate stress test since October 17, 2016.
Net investment income increased largely from higher average invested assets and higher investment yields in 2018.
Provision for income taxes. The effective tax rate decreased to 26.5% for the year ended December 31, 2018 from 32.7% for the year ended December 31, 2017. The decrease in the effective tax rate was primarily attributable to the change from a worldwide tax system to a territorial system under the TCJA. As a result, we are now generally taxed at our jurisdictional rate.
Net investment gains increased primarily from higher derivative gains on interest rate swaps, cross currency interest rate swaps and foreign currency forward contracts, as well as foreign exchange gains on the sale of non-functional currency investment securities in 2017. The increase was also attributable to impairments in 2016 that did not recur. The year ended December 31, 2017 included a decrease of $4 million attributable to changes in foreign exchange rates.
Provision for income taxes. The effective tax rate increased to 32.7% for the year ended December 31, 2017 from 27.7% for the year ended December 31, 2016. The increase in the effective tax rate was primarily attributable to decreased tax benefits from lower taxed foreign income in 2017.
Excluding the effects of changes in foreign exchange rates, primary insurance in-force and risk in-force increased primarily as a result of flow new insurance written. Primary insurance in-force and risk in-force included decreases of $33.1 billion and $11.6 billion, respectively, attributable to changes in foreign exchange rates.
New insurance written decreased primarily as a result of lower bulk mortgage insurance written and flow new insurance written. Bulk mortgage insurance written decreased by $21.5 billion driven principally by regulatory changes, which increased demand in 2016 preceding regulatory changes effective July 1, 2016. In addition, demand for bulk mortgage insurance was lower in 2017 due to a higher average premium rate as a result of higher regulatory capital requirements and additional regulatory changes that became effective on November 30, 2016. Flow new insurance written decreased $2.1 billion primarily due to a smaller market size resulting from regulatory changes effective October 17, 2016. New insurance written included an increase of $600 million attributable to changes in foreign exchange rates.
Our mortgage insurance policies in Canada provide for single premiums at the time that loan proceeds are advanced. We initially record the single premiums to unearned premium reserves and recognize the premiums earned over time in accordance with the expected pattern of risk emergence. As of December 31, 2017, our unearned premium reserves were $1.7 billion, compared to $1.6 billion as of December 31, 2016. The increase in unearned premium reserves was primarily driven by an increase of $115 million attributable to changes in foreign exchange rates.
The loss ratio is the ratio of benefits and other changes in policy reserves to net earned premiums. The expense ratio (net earned premiums) is the ratio of general expenses to net earned premiums. The expense ratio (net premiums written) is the ratio of general expenses to net premiums written. In our mortgage insurance business in Canada, general expenses consist of acquisition and operating expenses, net of deferrals, and amortization of DAC and intangibles.
The loss ratio increased largely from a higher average reserve per delinquency primarily attributable to increased losses in Alberta, less favorable development in our loss reserves and from higher new delinquencies, net of cures, in 2018.
The expense ratio (net premiums written) decreased primarily from lower stock-based compensation expense and from lower net premiums written in 2018.
The loss ratio decreased primarily from a decrease in the number of new flow delinquencies, net of cures, and from a lower average reserve per delinquency as a result of improvement in oil-producing regions, home price appreciation, particularly in Ontario, and overall improving regional macroeconomic conditions in 2017. The decrease was also attributable to favorable development related to loss reserves at December 31, 2016.
The expense ratio (net premiums written) increased primarily from higher stock-based compensation expense, driven mostly by an increase in Genworth Canada’s share price in 2017, and lower net premiums written in 2017.
Flow mortgage loans in-force increased from new policies written. The number of delinquent loans of our flow mortgage insurance decreased driven primarily by stable housing performance and continued favorable macroeconomic conditions.
Primary insurance delinquency rates differ by the various provinces and territories of Canada at any one time depending upon economic conditions and cyclical growth patterns. The table below sets forth our primary delinquency rates for the various provinces and territories of Canada by our risk in-force as of the dates indicated. Delinquency rates are shown by region based upon the location of the underlying property, rather than the location of the lender.
As a part of enhanced lender reporting, we receive updated outstanding loans in-force in Canada from almost all of our customers. Based on the data provided by lenders, the delinquency rate as of December 31,
The Australian GDP is expected to have experienced solid growth in 2018, supported by increased export volumes, expansion of non-mining business investment and household consumption growth. The cash rate remained flat at 1.50% in 2018. The December 2018 unemployment rate improved to 5.0% from 5.4% at the end of 2017.
Our mortgage insurance business in Australia completed its annual review of its premium earnings pattern in the fourth quarter of 2018. The review resulted in no changes to the earnings pattern adopted in the fourth quarter of 2017.
The premium earnings pattern review performed in the fourth quarter of 2017 indicated an observed and expected continuation of a longer duration between policy inception and first loss event. This was primarily attributable to the economic downturn in mining regions, which comprised a large proportion of incurred losses in 2017, and a prolonged low interest rate environment resulting in robust housing markets in other parts of the country. The review resulted in a refinement of premium recognition factors and a cumulative adjustment that was applied retrospectively as of October 1, 2017. This cumulative adjustment resulted in a decrease to earned premiums of $468 million, an increase to unearned premiums of $468 million, a decrease to DAC amortization of $18 million, and an unfavorable adjustment to net income (loss) of $141 million, net of taxes and noncontrolling interests, for the year ended December 31, 2017. As a result of these changes, earned premiums and amortization of DAC increased in 2018 and is expected to remain at this higher level over the next several years on our existing insurance in-force as compared to 2017, but normalize thereafter as the premiums will be earned over a longer period of time. The application of the new premium earnings pattern only impacts the timing of our premium recognition, as the amount of total earned premiums recognized over the lifetime of the policies is unchanged. As discussed above, the adjustment to our premium earnings pattern was applied on a retrospective basis under U.S. GAAP, however, under local Australian Accounting Standards this adjustment was applied on a prospective basis. Due to this divergence in accounting application, the financial results and certain metrics, such as the loss ratio and expense ratios, for our mortgage insurance business in Australia were materially different between the two accounting standards in 2017 and 2018 and will be different in future periods.
Losses in our mortgage insurance business in Australia were modestly higher in 2018 compared to 2017 primarily due to less favorable non-reinsurance recoveries on paid claims and lower cure activity, mostly offset by improved aging of existing delinquencies and lower new delinquencies in 2018. The loss ratio in Australia for
the year ended December 31, 2018 was 30%. We expect the 2019 loss ratio in Australia to be similar to the 2018 loss ratio due to moderation in the housing market in New South Wales and Victoria, offset by expected improvement in mining regions.
Gross written premiums in 2018 were higher compared to 2017 primarily driven by a new structured insurance transaction completed in 2018 and higher flow new insurance written from increased key customer activity, partially offset by a lower level of bulk deals in 2018. Earned premiums in 2018 were higher compared to 2017 primarily due to updated premium recognition factors from the review of our premium earnings pattern in the fourth quarter of 2017, a new structured insurance transaction completed in 2018 and higher policy cancellations resulting from an initiative implemented in 2018 to more promptly identify loans that have been discharged or refinanced using newly available data.
Our mortgage insurance business in Australia evaluates its capital position in relation to the PCA as determined by APRA and utilizes ICAAP as the framework to ensure that our Australia group of companies as a whole, and each regulated entity, are independently capitalized to meet regulatory requirements. As of December 31, 2018, the estimated PCA ratio of our mortgage insurance business in Australia was approximately 194%, representing an increase from 193% as of December 31, 2017 resulting from portfolio seasoning, policy cancellations and lower production volumes, mostly offset by reduced reinsurance credit, dividends paid and share repurchase activity.
(2) For the years ended December 31, 2018, 2017 and 2016, net investment (gains) losses were adjusted for the portion of net investment gains (losses) attributable to noncontrolling interests of $(7) million, $12 million and $4 million, respectively.
Net investment losses in 2018 were largely from derivative losses and changes in the fair market value of equity securities, partially offset by net gains from the sale of investment securities. Net investment gains in 2017 were predominantly from net gains from the sale of investment securities, partially offset by impairments and derivative losses.
Benefits and other changes in policy reserves increased largely attributable to less favorable non-reinsurance recoveries on paid claims and lower cure activity, mostly offset by improved aging of existing delinquencies and lower new delinquencies in 2018. The year ended December 31, 2018 included a decrease of $2 million attributable to changes in foreign exchange rates.
Amortization of DAC and intangibles increased primarily as a result of an $18 million decrease in amortization of DAC in 2017 related to our premium earnings pattern review that did not recur and higher contract fees amortization in 2018.
Our mortgage insurance business in Australia had an adjusted operating loss available to Genworth Financial, Inc.’s common stockholders in 2017 compared to adjusted operating income available to Genworth Financial, Inc.’s common stockholders in 2016 largely driven by a net unfavorable adjustment of $141 million from a review of our premium earnings pattern in 2017. The review indicated an observed and expected continuation of a longer duration between policy inception and first loss event (see “-Critical Accounting Estimates” for additional information). The decrease was also attributable to lower investment income in 2017.
Benefits and other changes in policy reserves decreased largely attributable to $7 million of favorable non-reinsurance recoveries on paid claims in 2017 and a higher net benefit from cures and aging of existing delinquencies, partially offset by higher new delinquencies primarily in commodity-dependent regions in 2017. The year ended December 31, 2017 included an increase of $3 million attributable to changes in foreign exchange rates.
Provision (benefit) for income taxes. The effective tax rate of 36.2% for the year ended December 31, 2017 was driven mostly by lower foreign tax rates in relation to our pre-tax loss. The effective tax rate of 32.3% for the year ended December 31, 2016 was predominantly related to lower foreign tax rates in relation to pre-tax income.
Income (loss) from continuing operations attributable to noncontrolling interests. The loss from continuing operations attributable to noncontrolling interests in 2017 was predominantly related to the completion of a premium earnings pattern review, which resulted in an unfavorable adjustment of $151 million.
As of December 31, 2018, our mortgage insurance business in Australia had structured insurance transactions with two lenders where it was in a secondary loss position. The insurance portfolio metrics associated with these transactions, which include insurance in-force, risk in-force, new insurance written, loans in-force and delinquent loans, are excluded from the following tables. These arrangements represented approximately $154 million of risk in-force as of December 31, 2018.
Our mortgage insurance business in Australia currently provides 100% coverage on the majority of the loans we insure in those markets. For the purpose of representing our risk in-force, we have computed an “effective” risk in-force amount, which recognizes that the loss on any particular loan will be reduced by the net proceeds received upon sale of the property. Effective risk in-force has been calculated by applying to insurance in-force a factor that represents our highest expected average per-claim payment for any one underwriting year over the life of our business in Australia. For the years ended December 31, 2018, 2017 and 2016, this factor was 35%. We also have certain risk share arrangements where we provide pro-rata coverage of certain loans rather than 100% coverage. As a result, for loans with these risk share arrangements, the applicable pro-rata coverage amount provided is used when applying the factor.
Primary insurance in-force and risk in-force decreased primarily due to changes in foreign exchange rates, portfolio seasoning and lower production volumes. Primary insurance in-force and risk in-force included decreases of $25.1 billion and $8.7 billion, respectively, attributable to changes in foreign exchange rates.
New insurance written decreased for the year ended December 31, 2018 mainly due to lower market penetration from a change in customer mix and lower bulk insurance written from continued regulatory changes focused on lending standards, investment lending and serviceability. These decreases were partially offset by higher mortgage origination volume from certain key customers. The year ended December 31, 2018 included a decrease of $400 million attributable to changes in foreign exchange rates.
Primary insurance in-force and risk in-force increased primarily from increases of $19.2 billion and $6.7 billion, respectively, attributable to changes in foreign exchange rates.
Most of our Australian mortgage insurance policies provide for single premiums at the time that loan proceeds are advanced. We initially record the single premiums to unearned premium reserves and recognize the premiums earned over time in accordance with the expected pattern of risk emergence. As of December 31, 2017, our unearned premium reserves were $1.3 billion, compared to $850 million as of December 31, 2016. The change in unearned premiums was primarily related to a review of our premium earnings pattern, which resulted in an increase of $468 million (see “-Critical Accounting Estimates-Unearned premiums” for additional information). This increase was partially offset by lower premiums written in 2017 primarily from lower market penetration from a change in customer mix. The change in unearned premiums also included an increase of $98 million attributable to changes in foreign exchange rates.
Excluding the effects of changes in foreign exchange rates, net premiums written decreased primarily from lower market penetration from a change in customer mix. The year ended December 31, 2017 included an increase of $7 million attributable to changes in foreign exchange rates.
The loss ratio is the ratio of benefits and other changes in policy reserves to net earned premiums. The expense ratio (net earned premiums) is the ratio of general expenses to net earned premiums. The expense ratio (net premiums written) is the ratio of general expenses to net premiums written. In our mortgage insurance business in Australia, general expenses consist of acquisition and operating expenses, net of deferrals, and amortization of DAC and intangibles.
The loss ratio increased for the year ended December 31, 2018 primarily driven by a review of our premium earnings pattern in 2017, which resulted in a reduction to earned premiums of $468 million that did not recur. This adjustment reduced the loss ratio by 112% in 2017. Excluding the impact of this adjustment, the loss ratio
decreased primarily from higher earned premiums in 2018 on our existing insurance in-force as a result of the review of our premium earnings pattern and higher policy cancellations resulting from an initiative implemented in 2018 to more promptly identify loans that have been discharged or refinanced using newly available data. These decreases were partially offset by higher losses in 2018 largely from less favorable non-reinsurance recoveries on paid claims and lower cure activity in 2018.
The expense ratio (net earned premiums) increased primarily from a review of our premium earnings pattern in 2017, which resulted in a decrease in earned premiums of $468 million and a decrease in amortization of DAC of $18 million that did not recur. These adjustments reduced the expense ratio (net earned premiums) by 98% in 2017. Excluding the impact of these adjustments, the expense ratio (net earned premiums) decreased primarily from higher net earned premiums in 2018, as discussed above.
The loss ratio decreased for the year ended December 31, 2017 primarily driven by a review of our premium earnings pattern, which decreased earned premiums by $468 million in 2017. The review indicated an observed and expected continuation of a longer duration between policy inception and first loss event. This adjustment reduced the loss ratio by 112% in 2017. In addition, losses were lower largely driven by $7 million of favorable non-reinsurance recoveries on paid claims and higher net benefits from cures and aging of existing delinquencies, partially offset by higher new delinquencies predominantly in commodity-dependent regions in 2017.
Overall risk in-force decreased $8.7 billion attributable to changes in foreign exchange rates in 2018 and increased $6.7 billion attributable to changes in foreign exchange rates in 2017.
Flow loans in-force decreased primarily from policy cancellations. Flow delinquent loans increased primarily from lower cures in 2018.
Delinquency rates increased mainly from decreased flow loans in-force as a result of higher policy cancellations and from lower cures in 2018.
We perform loss recognition testing to ensure that the current reserves along with the present value of future gross premiums are sufficient to cover the present value of future expected claims and expense, as well as recover the unamortized portion of DAC and, if any, PVFP. If the loss recognition test indicates a deficiency in the ability to pay all future claims and expenses, including the amortization of DAC and PVFP, a loss is recognized in earnings as an impairment of the DAC and/or PVFP balance and, if the loss is greater than the DAC and/or PVFP balance, by an increase in reserves. Our liability for policy and contract claims is reviewed quarterly and we conduct a review of our claim reserve assumptions for our long-term care insurance business annually typically during the third quarter of each year. We completed our annual review of claim reserve assumptions for our long-term care insurance business in the fourth quarter of 2018. See “Long-term care insurance” below for more details. Our liability for future policy benefits is reviewed at least annually as a part of our loss recognition testing typically performed in the third or fourth quarter of each year. As part of loss recognition testing, we also review the recoverability of DAC and PVFP at least annually. In addition, we perform cash flow testing separately for each of our U.S. life insurance companies on a statutory accounting
Results of our U.S. life insurance businesses are also impacted by interest rates. Low interest rates put pressure on the profitability and returns of these businesses as higher yielding investments mature and are replaced with lower-yielding investments. We seek to manage the impact of low interest rates through asset-liability management as well as interest rate hedging strategies for a portion of our long-term care insurance product cash flows. Additionally, certain products have implicit and explicit rate guarantees or optionality that are significantly impacted by changes in interest rates. For a further discussion of the impact of interest rates on our U.S. life insurance businesses, see “
We have audited the accompanying consolidated balance sheets of Genworth Financial, Inc. (the Company) as of December 31, 2018 and 2017, the related consolidated statements of income, comprehensive income, changes in equity, and cash flows for each of the years in the three-year period ended December 31, 2018, and the related notes and financial statement schedules I to III (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2018 and 2017, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2018, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated February 27, 2019 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
For single premium mortgage insurance contracts, we report premiums over the estimated policy life in accordance with the expected pattern of risk emergence as further described in our accounting policy for unearned premiums. In addition, we have a practice of refunding the post-delinquent premiums in our U.S. mortgage insurance business to the insured party if the delinquent loan goes to claim. We record a liability for premiums received on the delinquent loans where our practice is to refund post-delinquent premiums.
Investment income on mortgage-backed and asset-backed securities is initially based upon yield, cash flow and prepayment assumptions at the date of purchase. Subsequent revisions in those assumptions are recorded using the retrospective or prospective method. Under the retrospective method used for mortgage-backed and asset-backed securities of high credit quality (ratings equal to or greater than “AA” or that are backed by a U.S.
the present value of cash flows expected to be collected is less than our amortized cost basis,
While the other-than-temporary impairment model for debt securities generally includes fixed maturity securities, there are certain hybrid securities that are classified as fixed maturity securities where the application of a debt impairment model depends on whether there has been any evidence of deterioration in credit of the issuer, such as a downgrade to below investment grade. Under certain circumstances, evidence of deterioration in credit of the issuer may result in the application of the equity securities impairment model.
As of each reporting period, all assets and liabilities recorded at fair value are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability, such as the relative impact on the fair value as a result of including a particular input. We review the fair value hierarchy classifications each reporting period. Changes in the observability of the valuation attributes may result in a reclassification of certain financial assets or liabilities. Such reclassifications are reported as transfers in and out of Level 3 at the beginning fair value for the reporting period in which the changes occur. See note 16 for additional information related to fair value measurements.
For loans that are not individually impaired where we evaluate the loans collectively, the allowance for loan losses is maintained at a level that we determine is adequate to absorb estimated probable incurred losses in the loan portfolio. Our process to determine the adequacy of the allowance utilizes an analytical model based on historical loss experience adjusted for current events, trends and economic conditions that would result in a loss in the loan portfolio over the next 12 months. Key inputs into our evaluation include debt service coverage ratios, loan-to-value, property-type, occupancy levels, geographic region, and probability weighting of the scenarios generated by the model. The actual amounts realized could differ in the near term from the amounts assumed in arriving at the allowance for loan losses reported in the consolidated financial statements. Additions and reductions to the allowance through periodic provisions or benefits are recorded in net investment gains (losses). See note 4 for additional disclosures related to commercial mortgage loans.
Acquisition costs include costs that are directly related to the successful acquisition of new or renewal insurance contracts. Acquisition costs are deferred and amortized to the extent they are recoverable from future profits.
Amortization for deferred annuity and universal life insurance contracts is based on expected gross profits. Expected gross profits are adjusted quarterly to reflect actual experience to date or for changes in underlying assumptions relating to future gross profits. Estimates of gross profits for DAC amortization are based on assumptions including interest rates, policyholder persistency or lapses, insured life expectancy or longevity and expenses.
Other Intangible Assets. We amortize the costs of other intangibles over their estimated useful lives unless such lives are deemed indefinite. Amortizable intangible assets are tested for impairment based on undiscounted cash flows, which requires the use of estimates and judgment, and, if impaired, written down to fair value based
Goodwill is not amortized but is tested for impairment annually or between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of the reporting unit below its carrying value. The determination of fair value requires the use of estimates and judgment, at the “reporting unit” level. A reporting unit is the operating segment, or a business, one level below that operating segment (the “component” level) if discrete financial information is prepared and regularly reviewed by management at the component level. If the reporting unit’s fair value is below its carrying value, we recognize an impairment in an amount equal to the difference between the carrying value and the fair value of the reporting unit up to the amount of recorded goodwill. No goodwill impairment charges were recorded in 2018, 2017 or 2016.
We discontinue hedge accounting prospectively when: (i) it is determined that the derivative is no longer effective in offsetting changes in the cash flows of a hedged item; (ii) the derivative expires or is sold, terminated or exercised; (iii) the derivative is de-designated as a hedge instrument; or (iv) it is no longer probable that the forecasted transaction will occur.
For all qualifying and highly effective cash flow hedges, changes in fair value of the derivative instrument is reported as a component of OCI. When hedge accounting is discontinued because it is probable that a forecasted transaction will not occur, the derivative continues to be carried in the consolidated balance sheets at its fair value, and gains and losses that were accumulated in OCI are recognized immediately in income (loss). When the hedged forecasted transaction is no longer probable, but is reasonably possible, the accumulated gain or loss remains in OCI and is recognized when the transaction affects income (loss); however, prospective hedge accounting for the transaction is terminated. In all other situations in which hedge accounting is discontinued on a cash flow hedge, amounts previously deferred in OCI are reclassified into income (loss) when income (loss) is impacted by the variability of the cash flow of the hedged item.
The majority of our derivative arrangements require the posting of collateral upon meeting certain net exposure thresholds. The amounts recognized for derivative counterparty collateral received by us was recorded in cash, cash equivalents and restricted cash with a corresponding amount recorded in other liabilities to represent our obligation to return the collateral retained by us. We also receive non-cash collateral that is not recognized in our balance sheet unless we exercise our right to sell or re-pledge the underlying asset. As of December 31, 2018 and 2017, the fair value of non-cash collateral received was $40 million and $70 million, respectively, and the underlying assets were not sold or re-pledged. We have pledged $536 million and $288 million of fixed maturity securities as of December 31, 2018 and 2017, respectively. Additionally, as of December 31, 2018 and 2017, we pledged $57 million and $59 million, respectively, of cash as collateral to derivative counterparties. Fixed maturity securities that we pledge as collateral remain on our balance sheet within fixed maturity securities available-for-sale. Any cash collateral pledged to a derivative counterparty is derecognized with a receivable recorded in other assets for the right to receive our cash collateral back from the counterparty. Derivatives previously cleared through a Central Clearing Party, such as the Chicago Mercantile Exchange, required us to post cash collateral for daily changes in the fair value of the derivative contract, commonly referred to as variation margin. In the third quarter of 2017, central clearing parties rule changes impacted our accounting treatment for variation margin pertaining to cleared swap positions, which were previously considered cash collateral and are now treated as daily settlements of the derivative contract.
Additionally, some of our variable annuity contracts provide the contractholder with living benefits such as a guaranteed minimum withdrawal benefit (“GMWB”) or certain types of guaranteed annuitization benefits. The GMWB allows contractholders to withdraw a pre-defined percentage of account value or benefit base each year, either for a specified period of time or for life. The guaranteed annuitization benefit generally provides for a guaranteed minimum level of income upon annuitization accompanied by the potential for upside market participation.
Most of our reserves for additional insurance and annuitization benefits are calculated by applying a benefit ratio to accumulated contractholder assessments, and then deducting accumulated paid claims. The benefit ratio is equal to the ratio of benefits to assessments, accumulated with interest and considering both past and anticipated future experience. The projections utilize stochastic scenarios of separate account returns incorporating reversion to the mean, as well as assumptions for mortality and lapses. Some of our minimum guarantees, mainly GMWBs, are accounted for as embedded derivatives; see notes 5 and 16 for additional information on these embedded derivatives and related fair value measurement disclosures.
Investment-type contracts are broadly defined to include contracts without significant mortality or morbidity risk. Payments received from sales of investment contracts are recognized by providing a liability equal to the current account value of the policyholders’ contracts. Interest rates credited to investment contracts are guaranteed for the initial policy term with renewal rates determined as necessary by management.
Some employees participate in defined benefit pension and postretirement benefit plans. We recognize expense for these plans based upon actuarial valuations performed by external experts. We estimate aggregate benefits by using assumptions for employee turnover, future compensation increases, rates of return on pension plan assets and future health care costs. We recognize an expense for differences between actual experience and estimates over the average future service period of participants. We recognize the overfunded or underfunded
status of a defined benefit plan as an asset or liability in our consolidated balance sheets and recognize changes in that funded status in the year in which the changes occur through OCI.
Our companies have elected to file a single U.S. consolidated income tax return (the “life/non-life consolidated return”). All companies domesticated in the United States and our former Bermuda subsidiary, which elected to be taxed as a U.S. domestic company, are included in the life/non-life consolidated return as allowed by the tax law and regulations. We have a tax sharing agreement in place and all intercompany balances related to this agreement are settled at least annually.
On January 1, 2018, we early adopted new accounting guidance on the reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act (“TCJA”), or “stranded tax effects.” Under U.S. GAAP, deferred tax assets and liabilities are adjusted for the effect of a change in tax laws or rates with the effect included in income (loss) from continuing operations in the period that the changes were enacted. This also includes situations in which the related tax effects were originally recognized in other comprehensive income (loss) as opposed to income (loss) from continuing operations. The following summarizes the components for the cumulative effect adjustment recorded on January 1, 2018 related to the adoption of this new accounting guidance:
On January 1, 2018, we early adopted new accounting guidance simplifying the test for goodwill impairment. The new guidance states goodwill impairment is equal to the difference between the carrying value and fair value of the reporting unit up to the amount of recorded goodwill. We adopted this new accounting guidance prospectively and applied it to our 2018 goodwill impairment test. This new accounting guidance simplified the test for goodwill impairment but had no impact on our consolidated financial statements.
On January 1, 2018, we adopted new accounting guidance related to the classification of certain cash payments and cash receipts on our statement of cash flows. The guidance reduces diversity in practice related to
On January 1, 2018, we adopted new accounting guidance related to revenue from contracts with customers. The key principle of the new guidance is that entities should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for such goods or services. Insurance contracts are specifically excluded from this new guidance. The Financial Accounting Standards Board (“the FASB”) has clarified the scope that all of our insurance contracts, including mortgage insurance and investment contracts are excluded from the scope of this new guidance. We adopted this new accounting guidance using the modified retrospective method, which did not have a significant impact on our consolidated financial statements at adoption.
obtaining significant influence over a previously held investment. The guidance requires that an entity that has an available-for-sale equity security that becomes qualified for the equity method of accounting recognize through earnings the unrealized holding gain or loss in accumulated other comprehensive income at the date the investment becomes qualified for use of the equity method. This accounting guidance did not have a significant impact on our consolidated financial statements.
On January 1, 2017, we adopted new accounting guidance related to the effect of derivative contract novations on existing hedge accounting relationships. The guidance clarifies that a change in the counterparty to a derivative instrument that has been designated as the hedging instrument does not, in and of itself, require dedesignation of that hedging relationship provided that all other hedge accounting criteria continue to be met. This guidance is consistent with our previous accounting for derivative contract novations and, accordingly, had no impact on our consolidated financial statements.
In March 2016, the FASB issued new guidance to remove inconsistencies as well as make technical clarifications and minor improvements intended to make it easier to understand and implement certain accounting guidance. Impacts of the new guidance for us includes: promoting consistent use of the terms “participating insurance” and “reinsurance recoverable,” removing the term “debt” from the master glossary; adding a reference to use when accounting for internal-use software licensed from third parties; clarifying that loans issued under the Federal Housing Administration and the Veterans Administration do not have to be fully insured by those programs to recognize profit using the full-accrual method; clarifying the difference between a “valuation approach” and a “valuation technique” when applying fair value guidance and require disclosure when there has been a change in either a valuation approach, a valuation technique, or both; clarifying that for an amount of an obligation under an arrangement to be considered fixed at the reporting date, the amount that must be fixed is not the amount that is the organization’s portion of the obligation, but, rather, is the obligation in its entirety; and adding guidance on the accounting for the sale of servicing rights when the transferor retains loans. Most of the amendments were adopted on December 31, 2016 and in some cases on January 1, 2017, using a prospective method. There was no significant impact from this guidance on our consolidated financial statements.
In October 2018, the FASB issued new accounting guidance related to benchmark interest rates used in derivative hedge accounting. The guidance adds an additional permissible U.S. benchmark interest rate, the Secured Overnight Financing Rate, for hedge accounting purposes. We adopted this new accounting guidance on January 1, 2019 using the prospective method, which did not have a significant impact on our consolidated financial statements and disclosures at adoption.
In August 2018, the FASB issued new accounting guidance that significantly changes the recognition and measurement of long-duration insurance contracts and expands disclosure requirements, which impacts our life insurance DAC and liabilities. In accordance with the guidance, the more significant changes include:
changes in cash flow assumptions (except the discount rate) will be recorded in net income (loss) using a retrospective approach with a cumulative catch-up adjustment by recalculating the net premium ratio (which will be capped at 100%) using actual historical and updated future cash flow assumptions;
the provision for adverse deviation and the premium deficiency test are eliminated;
currently effective for us on January 1, 2020 using the retrospective method, with early adoption permitted. We do not expect any significant impact from this guidance on our consolidated financial statements and disclosures.
In August 2018, the FASB issued new accounting guidance related to fair value disclosure requirements as part of its disclosure framework project. The guidance adds, eliminates and modifies certain disclosure requirements for fair value measurements. The guidance includes new disclosure requirements related to the change in unrealized gains and losses included in other comprehensive income (loss) for recurring Level 3 fair value measurements held at the end of the reporting period and the range and weighted-average of significant unobservable inputs used to develop Level 3 fair value measurements. The guidance is currently effective for us on January 1, 2020 using the prospective method for certain disclosures and the retrospective method for all other disclosures. Early adoption of either the entire standard or only the provisions that eliminate or modify the requirements is permitted. We are in process of evaluating the impact the guidance may have on our consolidated financial statements and disclosures.
In March 2017, the FASB issued new accounting guidance shortening the amortization period of certain callable debt securities held at a premium. The guidance requires the premium to be amortized to the earliest call date. This change does not apply to securities held at a discount. We adopted this new accounting guidance on January 1, 2019 using the modified retrospective method, which had no significant impact on our consolidated financial statements at adoption.
(1) Under applicable accounting guidance, companies in a loss position are required to use basic weighted-average common shares outstanding in the calculation of diluted loss per share. Therefore, as a result of our loss from continuing operations available to Genworth Financial, Inc.’s common stockholders for the year ended December 31, 2016, we were required to use basic weighted-average common shares outstanding as the inclusion of shares for stock options, restricted stock units (“RSUs”) and stock appreciation rights (“SARs”) of 2.0 million would have been antidilutive to the calculation. If we had not incurred a loss from continuing operations available to Genworth Financial, Inc.’s common stockholders for the year ended December 31, 2016, dilutive potential weighted-average common shares outstanding would have been 500.3 million.
(2) Included in other invested assets was $-, $2 million and $11 million of net investment income related to trading securities for the years ended December 31, 2018, 2017 and 2016, respectively.
As of December 31, 2017, the amortized cost or cost, gross unrealized gains (losses) and fair value of our fixed maturity and equity securities classified as available-for-sale were as follows:
The following table presents the gross unrealized losses and fair values of our fixed maturity securities, aggregated by investment type and length of time that individual fixed maturity securities have been in a continuous unrealized loss position, as of December 31, 2018:
The following table presents the gross unrealized losses and fair values of our corporate securities, aggregated by investment type and length of time that individual investment securities have been in a continuous unrealized loss position, based on industry, as of December 31, 2018:
The following table presents the gross unrealized losses and fair values of our investment securities, aggregated by investment type and length of time that individual investment securities have been in a continuous unrealized loss position, as of December 31, 2017:
The scheduled maturity distribution of fixed maturity securities as of December 31, 2018 is set forth below. Actual maturities may differ from contractual maturities because issuers of securities may have the right to call or prepay obligations with or without call or prepayment penalties.
We evaluate the impairment of commercial mortgage loans on an individual loan basis. As of December 31, 2018 and 2017, our commercial mortgage loans greater than 90 days past due included one impaired loan. This loan had an appraised value in excess of the recorded investment and the current recorded investment of this loan is expected to be recoverable.
As of December 31, 2018 and 2017, we had one individually impaired loan within the office property type with a recorded investment and unpaid principal balance of $3 million and $6 million, respectively. As of December 31, 2016, we had one individually impaired loan within the industrial property type with a recorded investment of $12 million, an unpaid principal balance of $15 million and charge-offs of $3 million.
In evaluating the credit quality of commercial mortgage loans, we assess the performance of the underlying loans using both quantitative and qualitative criteria. Certain risks associated with commercial mortgage loans can be evaluated by reviewing both the loan-to-value and debt service coverage ratio to understand both the probability of the borrower not being able to make the necessary loan payments as well as the ability to sell the underlying property for an amount that would enable us to recover our unpaid principal balance in the event of default by the borrower. The average loan-to-value ratio is based on our most recent estimate of the fair value for the underlying property which is evaluated at least annually and updated more frequently if necessary to better indicate risk associated with the loan. A lower loan-to-value indicates that our loan value is more likely to be recovered in the event of default by the borrower if the property was sold. The debt service coverage ratio is based on “normalized” annual income of the property compared to the payments required under the terms of the loan. Normalization allows for the removal of annual one-time events such as capital expenditures, prepaid or late real estate tax payments or non-recurring third-party fees (such as legal, consulting or contract fees). This ratio is evaluated at least annually and updated more frequently if necessary to better indicate risk associated with the loan. A higher debt service coverage ratio indicates the borrower is less likely to default on the loan. The debt service coverage ratio is not used without considering other factors associated with the borrower, such as the borrower’s liquidity or access to other resources that may result in our expectation that the borrower will continue to make the future scheduled payments.
(1) Included a loan with a recorded investment of $2 million in good standing, where borrowers continued to make timely payments, with a loan-to-value of 105%. We evaluated this loan on an individual basis and as it is in good standing, the current recorded investment is expected to be recoverable.
(1) Included a loan with a recorded investment of $2 million in good standing, where borrowers continued to make timely payments, with a loan-to-value of 102%. We evaluated this loan on an individual basis and as it is in good standing, the current recorded investment is expected to be recoverable.
As of December 31, 2018 and 2017, we did not have any floating rate commercial mortgage loans.
Limited partnerships are accounted for at fair value when our partnership interest is considered minor (generally less than 3% ownership in the limited partnerships) and we exercise no influence over operating and financial policies. If our ownership percentage exceeds that threshold, limited partnerships are accounted for
Our business activities routinely deal with fluctuations in interest rates, equity prices, currency exchange rates and other asset and liability prices. We use derivative instruments to mitigate or reduce certain of these risks. We have established policies for managing each of these risks, including prohibitions on derivatives market-making and other speculative derivatives activities. These policies require the use of derivative instruments in concert with other techniques to reduce or mitigate these risks. While we use derivatives to mitigate or reduce risks, certain derivatives do not meet the accounting requirements to be designated as hedging instruments and are denoted as “derivatives not designated as hedges” in the following disclosures. For derivatives that meet the accounting requirements to be designated as hedges, the following disclosures for these derivatives are denoted as “derivatives designated as hedges,” which include cash flow hedges.
(3) Represents the embedded derivatives associated with our fixed index annuity liabilities.
The following table provides information about the pre-tax income (loss) effects of cash flow hedges for the year ended December 31, 2017:
The total of derivatives designated as cash flow hedges of $1,781 million, net of taxes, recorded in stockholders’ equity as of December 31, 2018 is expected to be reclassified to net income (loss) in the future, concurrently with and primarily offsetting changes in interest expense and interest income on floating rate instruments and interest income on future fixed rate bond purchases. Of this amount, $109 million, net of taxes,
(2) Does not include amounts related to embedded derivatives and derivatives related to securitization entities as of December 31, 2018 and 2017.
to credit loss equaled the notional value for credit default swaps. In the event of default for credit default swaps, we were typically required to pay the protection holder the full notional value less a recovery rate determined at auction. Our remaining single name credit default swaps matured during the third quarter of 2018.
We regularly review DAC to determine if it is recoverable from future income. In 2018, 2017 and 2016, we performed loss recognition testing and determined that we had premium deficiencies in our fixed immediate annuity products. In 2016, as a result of our loss recognition testing we wrote off the entire DAC balance for our fixed immediate annuity products of $14 million through amortization. In addition, as a result of our fixed immediate annuity loss recognition testing in 2018, 2017 and 2016, we increased our future policy benefit reserves and recognized expenses. See note 9 for additional information related to loss recognition testing on our fixed immediate annuity products. As of December 31, 2018, 2017 and 2016, we believe all of our other businesses had sufficient future income and therefore the related DAC was recoverable.
In addition, we are required to analyze the impacts from net unrealized investment gains and losses on our available-for-sale investment securities backing insurance liabilities, as if those unrealized investment gains and losses were realized. These “shadow accounting” adjustments result in the recognition of unrealized gains and losses on related insurance assets and liabilities in a manner consistent with the recognition of the unrealized gains and losses on available-for-sale investment securities within the statements of comprehensive income and changes in equity. Changes to net unrealized investment (gains) losses may increase or decrease the ending DAC balance. Similar to a loss recognition event, when the DAC balance is reduced to zero, additional insurance
In the fourth quarter of 2016, as part of our annual review of assumptions, we increased DAC amortization in our universal and term universal life insurance products by $144 million reflecting updated assumptions primarily for mortality experience in older age populations, partially offset by updated assumptions related to future policy charges.
Amortization expense related to PVFP, capitalized software and other intangible assets for the years ended December 31, 2018, 2017 and 2016 was $75 million, $93 million and $17 million, respectively. Amortization expense related to deferred sales inducements of $22 million, $22 million and $21 million, respectively, for the years ended December 31, 2018, 2017 and 2016 was included in benefits and other changes in policy reserves.
The percentage of the December 31, 2018 PVFP balance net of interest accretion, before the effect of unrealized investment gains or losses, estimated to be amortized over each of the next five years is as follows:
Under the terms of certain reinsurance agreements that our life insurance subsidiaries have with external parties, we pledged assets in either separate portfolios or in trust for the benefit of external reinsurers. These assets support the reserves ceded to those external reinsurers. We have pledged fixed maturity securities and commercial mortgage loans of $10,400 million and $870 million, respectively, as of December 31, 2018 and $10,319 million and $835 million, respectively, as of December 31, 2017 in connection with these reinsurance agreements. However, we maintain the ability to substitute these pledged assets for other qualified collateral, and may use, commingle, encumber or dispose of any portion of the collateral as long as there is no event of default and the remaining qualified collateral is sufficient to satisfy the collateral maintenance level.
Reinsurance recoveries recognized as a reduction of benefits and other changes in policy reserves amounted to $2,696 million, $2,788 million and $3,008 million during 2018, 2017 and 2016, respectively.
(a) The 1983 Individual Annuitant Mortality Table or the 2000 U.S. Annuity Table, or the 1983 Group Annuitant Mortality Table or the 1994 Group Annuitant Mortality Table and company experience.
(d) The 1958 and 1980 Commissioner’s Standard Ordinary Tables, or the 2000 U.S. Annuity Table, or the 1983 Group Annuitant Mortality or the 2008 Valuation Basic Table.
We regularly review our assumptions and perform loss recognition testing at least annually. In 2018, 2017 and 2016, we performed loss recognition testing and determined that we had premium deficiencies in our fixed immediate annuity products. In 2016, we wrote off the entire DAC balance for our fixed immediate annuity products as discussed in note 6. In addition, primarily as a result of our fixed immediate annuity loss recognition testing in 2018 and 2017, we increased our future policy benefit reserves by $22 million and $89 million, respectively. The premium deficiencies were primarily driven by the low interest rate environment and updated assumptions to future policy charges. The liability for future policy benefits for our fixed immediate annuity products represents our current best estimate; however, there may be future adjustments to this estimate and related assumptions. Such adjustments, reflecting any variety of new and adverse trends, could result in further increases in the related future policy benefit reserves for these products.
there is no event of default and the remaining qualified collateral is sufficient to satisfy the collateral maintenance level. Upon any event of default by us, the FHLB’s recovery on the collateral is limited to the amount of our funding agreement liabilities to the FHLB. As of December 31, 2018 and 2017, these funding agreements and the letter of credit were collateralized by fixed maturity securities with a fair value of $785 million and $388 million, respectively. The amount of funding agreements outstanding with the FHLBs was $594 million and $280 million, respectively, as of December 31, 2018 and 2017 which was included in policyholder account balances. Included in the amount of funding agreements outstanding with the FHLBs as of December 31, 2018 and 2017, are FHLB agreements entered into by our universal life insurance business of $213 million and $20 million, respectively, which were included in universal and term universal life insurance contracts in the table above.
As of December 31, 2018 and 2017, our total liability associated with variable annuity contracts with minimum guarantees was approximately $4,642 million and $5,577 million, respectively. Account value decreased from 2017 principally driven by unfavorable equity market performance and the continued runoff of these products. The liability, net of reinsurance, for our variable annuity contracts with GMDB and guaranteed annuitization benefits was $110 million and $94 million as of December 31, 2018 and 2017, respectively.
The contracts underlying the lifetime benefits such as GMWB and guaranteed annuitization benefits are considered “in the money” if the contractholder’s benefit base, or the protected value, is greater than the account value. As of December 31, 2018 and 2017, our exposure related to GMWB and guaranteed annuitization benefit contracts that were considered “in the money” was $888 million and $645 million, respectively. For GMWBs and guaranteed annuitization benefits, the only way the contractholder can monetize the excess of the benefit base over the account value of the contract is through lifetime withdrawals or lifetime income payments after annuitization.
In 2018, the liability for policy and contract claims increased $968 million in our long-term care insurance business largely from the seasoning of the block as well as the completion of our annual review of assumptions and methodologies in the fourth quarter of 2018 which increased reserves by $308 million and increased reinsurance recoverables by $17 million. Based on this review, we updated several assumptions and methodologies, including benefit utilization rates, claim termination rates and other assumptions. In connection with updating our benefit utilization rate assumption, we increased later duration utilization assumptions for claims with lifetime benefits. The increase was also attributable to higher severity and frequency of new claims and higher utilization of available benefits in 2018.
In 2016, the liability for policy and contract claims increased $1,285 million in our long-term care insurance business largely from the completion of our annual review of assumptions in the third quarter of 2016 which increased reserves by $460 million and increased reinsurance recoverables by $25 million. The increase was also attributable to aging and growth of the in-force block and higher severity on new claims in 2016. Based on our 2016 annual review of our long-term care insurance claim reserves we updated several assumptions and
The following table sets forth information about incurred claims, net of reinsurance, as well as cumulative number of reported delinquencies and the total of incurred-but-not-reported liabilities plus expected development on reported claims included within the net incurred claims amounts for our U.S. Mortgage Insurance segment as of December 31, 2018. The information about the incurred claims development for the years ended December 31, 2009 to 2017 and the historical reported delinquencies as of December 31, 2017 and prior are presented as supplementary information.
The following table sets forth paid claims development, net of reinsurance, for our U.S. Mortgage Insurance segment for the year ended December 31, 2018. The information about paid claims development for the years ended December 31, 2009 to 2017, is presented as supplementary information.
The following table sets forth our average payout of incurred claims by age for our U.S. Mortgage Insurance segment as of December 31, 2018:
(1) Amounts translated into U.S. dollars at the average foreign exchange rates for the year ended December 31, 2018.
Incurred-but-not-reported liabilities exist only relative to the year 2018 as lenders are required to report losses after three consecutive monthly mortgage payments have been missed by the borrower.
(3) Includes the portion of the borrower recovery accrual that corresponds to loss reserves and is recognized as a reduction to losses incurred that we anticipate receiving in the future once the claims have been settled, foreign currency translation and differences in accounting basis under local Canadian International Financial Reporting Standards.
(3) Represents outstanding delinquencies plus paid claims as of December 31, 2018 for each respective accident year.
The following table sets forth paid claims development, for our Australia Mortgage Insurance segment for the year ended December 31, 2018. The information about paid claims development for the years ended December 31, 2009 to December 31, 2017, is presented as supplementary information:
Our cost associated with our pension, retiree health and life insurance benefit plans was $22 million, $21 million and $18 million for the years ended December 31, 2018, 2017 and 2016, respectively.
Our domestic employees participate in qualified and non-qualified defined contribution savings plans that allow employees to contribute a portion of their pay to the plan on a pre-tax basis. In 2016, we matched these contributions, which vest immediately, up to 6% of the employee’s pay. Beginning January 1, 2017, we made matching contributions equal to 100% of the first 4% of pay deferred by an employee and 50% of the next 2% of pay deferred by an employee so that our matching contribution did not exceed 5% of an employee’s pay. Employees hired on or after January 1, 2011 do not vest immediately in Genworth matching contributions but fully vest in the matching contributions after two complete years of service. One option available to employees in the defined contribution savings plan is the ClearCourse® variable annuity option offered by certain of our life insurance subsidiaries. The amount of deposits recorded by our life insurance subsidiaries in 2018 and 2017 in relation to this plan option was less than $1 million for each year. Employees also have the option of purchasing a fund which invests primarily in Genworth stock as part of the defined contribution savings plan. Our cost associated with these plans was $12 million, $11 million and $13 million for the years ended December 31, 2018, 2017 and 2016, respectively.
On March 7, 2018, Genworth Holdings entered into a $450 million senior secured term loan facility (“Term Loan”), which matures in March 2023 and was issued at a 0.5% discount. Principal payments under the agreement are due quarterly, which commenced on June 30, 2018, and are payable in equal amounts of 0.25% per quarter of the original principal amount with the remaining balance due at maturity. At our option, the Term Loan will bear interest at either an adjusted London Interbank Offered Rate (“LIBOR”) no lower than 1.0% plus a margin of 4.5% per annum or an alternate base rate plus a margin of 3.5% per annum. The interest rate on the Term Loan as of December 31, 2018 was 7.0%. We incurred $7 million of borrowing costs that were deferred. The Term Loan is unconditionally guaranteed by Genworth Financial, and Genworth Financial International Holdings, LLC (“GFIH”) has provided a limited recourse guarantee to the lenders of Genworth Holdings’ outstanding Term Loan, which is secured by GFIH’s ownership interest in Genworth Canada’s outstanding common shares. GFIH is our indirect wholly-owned subsidiary and owns approximately 40.5% of the outstanding common stock of Genworth Canada. The Term Loan is subject to other terms and conditions, including but not limited to: voluntary prepayments subject to prepayment penalties, mandatory prepayments in the event of certain asset sales or the incurrence of further indebtedness by Genworth Financial and various financial covenants.
As of December 31, 2018, Genworth Holdings had outstanding six series of fixed rate senior notes with varying interest rates between 4.80% and 7.70% and maturity dates between 2020 and 2034. The senior notes are Genworth Holdings’ direct, unsecured obligations and rank equally in right of payment with all of its existing and future unsecured and unsubordinated obligations. Genworth Financial provides a full and unconditional guarantee to the trustee of Genworth Holdings’ outstanding senior notes and the holders of the senior notes, on an unsecured unsubordinated basis, of the full and punctual payment of the principal of, premium, if any and interest on, and all other amounts payable under, each outstanding series of senior notes, and the full and punctual payment of all other amounts payable by Genworth Holdings under the senior notes indenture in respect of such senior notes. We have the option to redeem all or a portion of each series of senior notes at any time with notice to the noteholders at a price equal to the greater of 100% of principal or the sum of the present value of the remaining scheduled payments of principal and interest discounted at the then-current treasury rate plus an applicable spread.
On October 3, 2018, Genworth Holdings received the requisite consents, pursuant to a solicitation of consents (the “Consent Solicitation”), to amend the indenture dated as of June 15, 2004, by and between Genworth Holdings and The Bank of New York Mellon Trust Company, N.A. (the “Trustee”), as successor to JP Morgan Chase Bank, N.A., as amended and supplemented from time to time (as so amended and supplemented, the “Senior Notes Indenture”). Genworth Holdings, Genworth Financial, as guarantor, and the Trustee entered into Supplemental Indenture No. 13 to the Senior Notes Indenture that amended the Senior Notes Indenture to clarify that Genworth Life and Annuity Insurance Company (“GLAIC”) and the subsidiaries of Genworth Life Insurance Company (“GLIC”), GLAIC and Genworth Life Insurance Company of New York (“GLICNY”) are excluded from the class of subsidiaries for which a bankruptcy, insolvency or other similar proceeding would result in an event of default under the Senior Notes Indenture.
The amendments to the Senior Notes Indenture became operative on October 4, 2018 upon the payment of the applicable consent fees payable under the terms of the Consent Solicitation. We paid total fees related to the
Consent Solicitation of $11 million, including bond consent fees of $5 million, which were deferred, as well as broker, advisor and investment banking fees of $6 million, which were expensed in the fourth quarter of 2018.
On March 18, 2016, Genworth Holdings received the requisite consents, pursuant to a solicitation of consents (the “2016 Consent Solicitation”), to amend the Senior Notes Indenture and the indenture dated as of November 14, 2006, by and between Genworth Holdings and the Trustee, as amended and supplemented from time to time (as so amended and supplemented, the “Subordinated Notes Indenture” and together with the Senior Notes Indenture, the “Indentures”). Genworth Holdings, Genworth Financial, as guarantor, and the Trustee entered into Supplemental Indenture No. 12 to the Senior Notes Indenture and the Third Supplemental Indenture to the Subordinated Notes Indenture (the “Supplemental Indentures”) that amended the Senior Notes Indenture and the Subordinated Notes Indenture, respectively, to (i) exclude GLIC and GLICNY from the event of default provisions of the Indentures (such amendment also previously excluded Brookfield Life and Annuity Insurance Company Limited (“BLAIC”) until it merged into GLIC in October 2016) and (ii) clarify that one or more transactions disposing of any or all of the Genworth Holdings’ long-term care and other life insurance businesses and assets (a “Life Sale”) would not constitute a disposition of “all or substantially all” of Genworth Holdings’ assets under the Indentures, provided that in order to rely on that clarification, the assets of our U.S. Mortgage Insurance segment would be contributed to Genworth Holdings and 80% of any Net Cash Proceeds, as defined in the Supplemental Indentures, to us from any Life Sale would be used to reduce outstanding indebtedness.
The Supplemental Indentures became operative on March 22, 2016 upon the payment of the applicable consent fees payable under the terms of the 2016 Consent Solicitation. We paid total fees related to the 2016 Consent Solicitation of approximately $61 million, including bond consent fees of $43 million, which were deferred, as well as broker, advisor and investment banking fees of $18 million, which were expensed in the first quarter of 2016.
During the first quarter of 2016, Genworth Holdings repurchased $28 million principal amount of its senior notes with various maturity dates for a pre-tax gain of $4 million and paid accrued and unpaid interest thereon.
Any payment of principal, including by redemption, or interest on the note may only be made with the prior approval of the Director of Insurance of the State of South Carolina in accordance with the terms of its licensing
The weighted-average interest rates on the non-recourse funding obligations as of December 31, 2018 and 2017 were 4.49% and 3.54%, respectively.
Principal amounts under our long-term borrowings (including senior notes) and non-recourse funding obligations by maturity were as follows as of December 31, 2018:
corporate debt securities and equity securities. As of December 31, 2018 and 2017, the fair value of securities loaned under our securities lending program in the United States was $99 million and $258 million, respectively. As of December 31, 2018 and 2017, the fair value of collateral held under our securities lending program in the United States was $102 million and $268 million, respectively, and the offsetting obligation to return collateral of $102 million and $268 million, respectively, was included in other liabilities in the consolidated balance sheets. We did not have any non-cash collateral provided by the borrowers in our securities lending program in the United States as of December 31, 2018 and 2017.
Under our securities lending program in Canada, the borrower is required to provide collateral consisting of government securities on a daily basis in amounts equal to or exceeding 105% of the fair value of the applicable securities loaned. Securities received from counterparties as collateral are not recorded on our consolidated balance sheet given that the risk and rewards of ownership is not transferred from the counterparties to us in the course of such transactions. Additionally, there was no cash collateral because it is not permitted as an acceptable form of collateral under the program. In Canada, the lending institution must be included on the approved Securities Lending Borrowers List with the Canadian regulator and the intermediary must be rated at least “AA-” by S&P. As of December 31, 2018 and 2017, the fair value of securities loaned under our securities lending program in Canada was $512 million and $382 million, respectively.
Our current income tax receivable was $41 million as of December 31, 2018. Our current income tax payable was $28 million as of December 31, 2017.
We are in a three-year cumulative pre-tax income position in our U.S. jurisdiction as of December 31, 2018, however, we have been in a three-year cumulative loss position in recent years. A cumulative loss position is considered significant negative evidence in assessing the realizability of our deferred tax assets. Our ability to realize our net deferred tax asset of $712 million, which includes deferred tax assets related to NOL and foreign tax credit carryforwards, is primarily dependent upon generating sufficient taxable income in future years. Management has concluded that there is sufficient positive evidence to support the expected realization of the net operating losses and foreign tax credit carryforwards. This positive evidence includes the fact that: (i) we are currently in a cumulative three-year income position; (ii) our U.S. operating forecasts are profitable, which include: in-force premium rate increases and associated benefit reductions already obtained in our long-term care insurance business, favorable development in interest rates, improvements in business performance driven
As a consequence of our separation from GE and our joint election with GE to treat that separation as an asset sale under Section 338 of the Internal Revenue Code, we became entitled to additional tax deductions in post IPO periods. We are obligated, pursuant to our Tax Matters Agreement with GE, to make fixed payments to GE over the next five years on an after-tax basis and subject to a cumulative maximum of $640 million, which is 80% of the projected tax savings associated with the Section 338 deductions. We recorded net interest expense of $6 million, $7 million and $10 million for the years ended December 31, 2018, 2017 and 2016, respectively, reflecting accretion of our liability at the Tax Matters Agreement rate of 5.72%. As of December 31, 2018 and 2017, we have recorded the estimated present value of our remaining obligation to GE of $90 million and $119 million, respectively, as a liability in our consolidated balance sheets. Both our IPO-related deferred tax assets and our obligation to GE are estimates that are subject to change.
We believe it is reasonably possible that in 2019 the unrecognized tax benefit could decrease up to approximately $62 million due to potential settlements and other administrative and statutory proceedings/limitations.
Our companies have elected to file a single life/non-life consolidated return. All companies domesticated in the United States and our former Bermuda subsidiary, which elected to be taxed as a U.S. domestic company, are
Throughout the measurement period, we analyzed the impact of the Global Intangible Low Taxed Income (“GILTI”) and Base Erosion Anti-Abuse Tax (“BEAT”), including accounting policy elections. As part of this analysis, we evaluated several alternatives for our future tax filings in light of the GILTI provisions. During the fourth quarter of 2018 we completed the accounting for the initial impacts of the provisions and no measurement period adjustments were recorded. Accordingly, we have made a policy election to account for the GILTI tax as incurred (i.e. as a “period cost”) therefore, we have not included deferred taxes on basis differences that may affect the amount of the GILTI inclusion upon reversal. We included the current period impact of the GILTI and BEAT provisions in our 2018 results, which did not have a significant impact on our consolidated financial statements.
We recorded a provisional reclassification in deferred tax assets and liabilities in the amount of $134 million in 2017 related to the transition adjustment required under the TCJA with respect to life insurance policyholder reserves. Under the TCJA this transition adjustment is to be taken into account ratably over eight taxable years. During 2018, we updated our provisional estimate and identified a measurement period increase to this reclassification of $36 million, which was reflected in our consolidated balance sheet as of December 31, 2018. This measurement period adjustment had no impact on income from continuing operations.
Prior to May 2012, we granted share-based awards to employees and directors, including stock options, SARs, RSUs and deferred stock units (“DSUs”) under the 2004 Genworth Financial, Inc. Omnibus Incentive Plan (the “2004 Omnibus Incentive Plan”). In May 2012, the 2012 Genworth Financial, Inc. Omnibus Incentive Plan (the “2012 Omnibus Incentive Plan”) was approved by stockholders. Under the 2012 Omnibus Incentive Plan, we were authorized to grant 16 million equity awards, plus a number of additional shares not to exceed 25 million underlying awards outstanding under the 2004 Omnibus Incentive Plan. In December 2018, the 2018 Genworth Financial, Inc. Omnibus Incentive Plan (the “2018 Omnibus Incentive Plan”), together with the 2004 Omnibus Incentive Plan and the 2012 Omnibus Incentive Plan, the “Omnibus Incentive Plans”, was approved by stockholders. Under the 2018 Omnibus Incentive Plan, we are authorized to grant 25 million equity awards, plus a number of additional shares not to exceed 20 million underlying awards outstanding under the prior Plans.
For purposes of determining the fair value of stock-based payment awards on the date of grant, we have historically used the Black-Scholes Model. However, no SARs or stock options were granted during 2018, 2017 and 2016 and therefore, the Black-Scholes Model was not used in those respective years. The Black-Scholes Model requires the input of certain assumptions that involve judgment. Circumstances may change and additional data may become available over time, which could result in changes to these assumptions and methodologies.
During 2018 and 2017, we issued RSUs with average restriction periods of three years, with a fair value of $3.58 and $4.01, respectively, which were measured at the market price of a share of our Class A Common Stock on the grant date.
In 2018 and 2017, we granted performance stock units (“PSUs”) with a fair value of $3.58 and $4.01, respectively. The PSUs were granted at market price as of the grant date. PSUs may be earned over a three-year period based upon the achievement of certain performance goals.
In 2018 and 2017, we granted cash awards with a fair value of $1.00. We have time-based cash awards, which vest over two or three years, with half or a third, respectively, of the payout occurring per year as determined by the vesting period, beginning on the first anniversary of the grant date. We also have performance-based cash awards which vest and payout after three years.
The following table summarizes stock option activity as of December 31, 2018 and 2017:
(1) The performance adjustment relates to additional awards expected to be earned through the achievement of certain performance metrics.
Genworth Canada, our indirect subsidiary and a public company, grants stock options and other equity-based awards to its Canadian employees. The following table summarizes the status of Genworth Canada’s stock option activity and other equity-based awards as of December 31, 2018 and 2017:
As of December 31, 2018 and 2017, none of the restricted share rights balances were vested. For the years ended December 31, 2018, 2017 and 2016, we recorded less than $1 million of stock-based compensation in each
The following represents our estimated fair value of financial assets and liabilities that are not required to be carried at fair value as of the dates indicated:
We have fixed maturity, short-term investments, equity securities, limited partnerships, derivatives, embedded derivatives, securities held as collateral, separate account assets and certain other financial instruments, which are carried at fair value. Below is a description of the valuation techniques and inputs used to determine fair value by class of instrument.
Limited partnerships are valued based on comparable market transactions, discounted future cash flows, quoted market prices and/or estimates using the most recent data available for the underlying instrument. We utilize the net asset value (“NAV”) of the underlying fund statements as a practical expedient for fair value.
For pricing services, we obtain an understanding of the pricing methodologies and procedures for each type of instrument. Additionally, on a monthly basis we review a sample of securities, examining the pricing service’s
assumptions to determine if we agree with the service’s derived price. When available, we also evaluate the prices sampled as compared to other public prices. If a variance greater than a pre-defined threshold is noted, additional review of the price is executed to ensure accuracy. In general, a pricing service does not provide a price for a security if sufficient information is not readily available to determine fair value or if such security is not in the specific sector or class covered by a particular pricing service. Given our understanding of the pricing methodologies and procedures of pricing services, the securities valued by pricing services are typically classified as Level 2 unless we determine the valuation process for a security or group of securities utilizes significant unobservable inputs, which would result in the valuation being classified as Level 3.
For private fixed maturity securities, we utilize an income approach where we obtain public bond spreads and utilize those in an internal model to determine fair value. Other inputs to the model include rating and weighted-average life, as well as sector which is used to assign the spread. We then add an additional premium, which represents an unobservable input, to the public bond spread to adjust for the liquidity and other features of our private placements. We utilize the estimated market yield to discount the expected cash flows of the security to determine fair value. We utilize price caps for securities where the estimated market yield results in a valuation that may exceed the amount that would be received in a market transaction. When a security does not have an external rating, we assign the security an internal rating to determine the appropriate public bond spread that should be utilized in the valuation. To evaluate the reasonableness of the internal model, we review a sample of private fixed maturity securities each month. In that review we compare the modeled prices to the prices of similar public securities in conjunction with analysis on current market indicators. If a pricing variance greater than a pre-defined threshold is noted, additional review of the price is executed to ensure accuracy. At the end of each month, all internally modeled prices are compared to the prior month prices with an evaluation of all securities with a month-over-month change greater than a pre-defined threshold. While we generally consider the public bond spreads by sector and maturity to be observable inputs, we evaluate the similarities of our private placement with the public bonds, any price caps utilized, liquidity premiums applied, and whether external ratings are available for our private placements to determine whether the spreads utilized would be considered observable inputs. We classify private securities without an external rating or public bond spread as Level 3. In general, increases (decreases) in credit spreads will decrease (increase) the fair value for our fixed maturity securities.
A summary of the inputs used for our fixed maturity, short-term investments and equity securities based on the level in which instruments are classified is included below. We have combined certain classes of instruments together as the nature of the inputs is similar.
Third-party pricing services: In estimating the fair value of fixed maturity securities, approximately 91% of our portfolio is priced using third-party pricing sources as of December 31, 2018. These pricing services utilize industry-standard valuation techniques that include market-based approaches, income-based approaches, a combination of market-based and income-based approaches or other proprietary, internally generated models as part of the valuation processes. These third-party pricing vendors maximize the use of publicly available data inputs to generate valuations for each asset class. Priority and type of inputs used may change frequently as certain inputs may be more direct drivers of valuation at the time of pricing. Examples of significant inputs incorporated by third-party pricing services may include sector and issuer spreads, seasoning, capital structure, security optionality, collateral data, prepayment assumptions, default assumptions, delinquencies, debt covenants, benchmark yields, trade data, dealer quotes, credit ratings, maturity and weighted-average life. We conduct regular meetings with our third-party pricing services for the purpose of understanding the methodologies, techniques and inputs used by the third-party pricing providers.
The following table presents a summary of the significant inputs used by our third-party pricing services for certain fair value measurements of fixed maturity securities that are classified as Level 2 as of December 31, 2018:
Multi-dimensional attribute-based modeling systems, spread matrix priced to swap curves, price quotes from market makers, internal models
Internal models: A portion of our non-U.S. government, U.S. corporate and non-U.S. corporate securities are valued using internal models. The fair value of these fixed maturity securities were $15 million, $1,062 million, and $546 million, respectively, as of December 31, 2018. Internally modeled securities are primarily private fixed maturity securities where we use market observable inputs such as an interest rate yield curve, published credit spreads for similar securities based on the external ratings of the instrument and related industry sector of the issuer. Additionally, we may apply certain price caps and liquidity premiums in the valuation of private fixed maturity securities. Price caps and liquidity premiums are established using inputs from market participants.
market knowledge to provide a reasonable price for securities not routinely priced by third-party pricing services. Brokers utilized for valuation of assets are reviewed annually. The fair value of our Level 3 fixed maturity securities priced by broker quotes was $389 million as of December 31, 2018.
We are required to bifurcate an embedded derivative for certain features associated with annuity products and related reinsurance agreements where we provide a GMWB to the policyholder and are required to record the GMWB embedded derivative at fair value. The valuation of our GMWB embedded derivative is based on an income approach that incorporates inputs such as forward interest rates, equity index volatility, equity index and fund correlation, and policyholder assumptions such as utilization, lapse and mortality. In addition to these inputs, we also consider risk and expense margins when determining the projected cash flows that would be determined by another market participant. While the risk and expense margins are considered in determining fair value, these inputs do not have a significant impact on the valuation. We determine fair value using an internal model based on the various inputs noted above. The resulting fair value measurement from the model is reviewed by actuarial, risk and finance professionals each reporting period with changes in fair value also being compared to changes in derivatives and other instruments used to mitigate changes in fair value from certain market risks, such as equity index volatility and interest rates.
For equity index volatility, we determine the projected equity market volatility using both historical volatility and projected equity market volatility with more significance being placed on projected near-term volatility and recent historical data. Given the different attributes and market characteristics of GMWB liabilities compared to equity index options in the derivative market, the equity index volatility assumption for GMWB liabilities may be different from the volatility assumption for equity index options, especially for the longer dated points on the curve.
Interest rate swaps related to securitization entities. The valuation of interest rate swaps related to securitization entities was determined using an income approach. The primary input into the valuation represented the forward interest rate swap curve, which was generally considered an observable input, and resulted in the derivative being classified as Level 2.
Inflation indexed swaps. The valuation of inflation indexed swaps was determined using an income approach. The primary inputs into the valuation represented the forward interest rate swap curve, the current consumer price index and the forward consumer price index curve, which were generally considered observable inputs, and resulted in the derivative being classified as Level 2.
Credit default swaps. We previously sold protection under single name and index tranche credit default swaps. For single name credit default swaps, we utilized an income approach to determine fair value based on using current market information for the credit spreads of the reference entity, which was considered observable inputs based on the reference entities of our derivatives and resulted in these derivatives being classified as Level 2. For index tranche credit default swaps, we utilized an income approach that utilized current market information related to credit spreads and expected defaults and losses associated with the reference entities that comprised the respective index associated with each derivative. There were significant unobservable inputs associated with the timing and amount of losses from the reference entities as well as the timing or amount of losses, if any, that were absorbed by our tranche. Accordingly, the index tranche credit default swaps were classified as Level 3. As credit spreads widened for the underlying issuers comprising the index, the change in our valuation of these credit default swaps were unfavorable.
Credit default swaps related to securitization entities. Credit default swaps related to securitization entities represented customized index tranche credit default swaps and were valued using a similar methodology as described above for index tranche credit default swaps. We determined fair value of these credit default swaps after considering both the valuation methodology described above as well as the valuation provided by the derivative counterparty. In addition to the valuation methodology and inputs described for index tranche credit default swaps, these customized credit default swaps contained a feature that permitted the securitization entity to provide the par value of underlying assets in the securitization entity to settle any losses under the credit default swap. The valuation of this settlement feature was dependent upon the valuation of the underlying assets and the timing and amount of any expected loss on the credit default swap, which was considered a significant unobservable input. Accordingly, these customized index tranche credit default swaps related to securitization entities were classified as Level 3. As credit spreads widened for the underlying issuers comprising the customized index, the change in our valuation of these credit default swaps were unfavorable.
Other foreign currency contracts. We have certain foreign currency options classified as other foreign currency contracts. The valuation of foreign currency options is determined using an income approach. The primary inputs into the valuation represent the forward interest rate swap curve, foreign currency exchange rates, forward interest rate, foreign currency exchange rate volatility and time value component associated with the optionality in the derivative, which are generally considered observable inputs and results in the derivative being classified as Level 2. We also have foreign currency forward contracts where the valuation is determined using an income approach. The primary inputs into the valuation represent the forward foreign currency exchange rates, which are generally considered observable inputs and results in the derivative being classified as Level 2.
(1) Limited partnerships that are measured at fair value using the NAV per share (or its equivalent) practical expedient have not been categorized in the fair value hierarchy.
The following table presents a summary of the significant unobservable inputs used for certain liability fair value measurements that are based on internal models and classified as Level 3 as of December 31, 2018:
For VIEs related to asset securitization transactions, as of December 31, 2018, we consolidate a securitization entity as a result of our involvement in the entity’s design or having certain decision making ability regarding the assets held by the securitization entity. This securitization entity was designed to have significant limitations on the types of assets owned, the types and extent of permitted activities and decision making rights. The securitization entity that is consolidated comprised an entity backed by commercial mortgage loans. Our primary economic interest in this securitization entity represents the excess interest of the commercial mortgage loans and the subordinated notes of the securitization entity.
For VIEs related to certain investments, we previously consolidated three securitization entities as a result of having certain decision making rights related to instruments held by the entities. Upon consolidation, we elected the fair value option for the assets and liabilities for the securitization entities. During 2017, these three securitization entities were dissolved and the investments were repositioned, mostly into short-term investments in connection with the maturity of the associated liabilities.
We previously consolidated a securitization entity backed by residual interests in certain policy loan securitization entities. Our primary economic interest in the policy loan securitization entity represented the excess interest received from the residual interest in certain policy loan securitization entities and the floating rate obligation issued by the securitization entity, where our economic interest was not expected to be material in any future years. Upon consolidation, we elected the fair value option for the assets and liabilities for the securitization entity. In June 2016, we amended and exercised a clean-up call on this securitization entity writing off our residual interest and settling the outstanding debt of $70 million. As a result of this transaction, we recorded $64 million of realized investment losses related to the write-off of our residual interest in those entities and a $64 million gain related to the early extinguishment of debt which was included in other income. There was no impact to net loss. In addition, the policy loan securitization entities in which we previously held a residual interest were not required to be consolidated in our balance sheets.
The assets and other instruments held by the securitization entity are restricted and can only be used to fulfill the obligations of the securitization entity. Additionally, the obligations of the securitization entity do not have any recourse to the general credit of any other consolidated subsidiaries.
As of December 31, 2017, we had borrowings related to a securitization entity held by GFCM LLC with an interest rate of 5.7426%, a maturity date of 2035, a principal amount of $40 million and a carrying value of $40 million. These borrowings were required to be paid down as principal was collected on the restricted commercial mortgage loans held by the securitization entity and accordingly the repayment of these borrowings followed the maturity or prepayment, as permitted, of the restricted commercial mortgage loans. During 2018, all of the borrowings related to the securitization entity were repaid due to prepayments made on the related restricted commercial mortgage loans; therefore, as of December 31, 2018, there were no remaining principal or carrying amounts related to these borrowings.
Our insurance company subsidiaries are restricted by state and foreign laws and regulations as to the amount of dividends they may pay to their parent without regulatory approval in any year, the purpose of which is to protect affected insurance policyholders or contractholders, not stockholders. Any dividends in excess of limits are deemed “extraordinary” and require approval. Based on estimated statutory results as of December 31, 2018, in accordance with applicable dividend restrictions, our subsidiaries could pay dividends of approximately $500 million to us in 2019 without obtaining regulatory approval, and the remaining net assets are considered restricted. While the $500 million is unrestricted, our insurance subsidiaries may not pay dividends to us in 2019 at this level if they need to retain capital for growth and to meet capital requirements and desired thresholds. As of December 31, 2018, Genworth Financial’s and Genworth Holdings’ subsidiaries had restricted net assets of $12.1 billion and $11.2 billion, respectively. There are no regulatory restrictions on the ability of Genworth Financial to pay dividends. Our Board of Directors has suspended the payment of dividends on our common stock indefinitely. The declaration and payment of future dividends to holders of our common stock will be at the discretion of our Board of Directors and will be dependent on many factors including the receipt of dividends from our operating subsidiaries, our financial condition and operating results, the capital requirements of our subsidiaries, legal requirements, regulatory constraints, our debt obligations, our credit and financial strength ratings and such other factors as the Board of Directors deems relevant.
In 2018, River Lake VI was granted a permitted accounting practice from the State of Delaware to carry its reserves on a basis similar to U.S. GAAP. Prior to 2018, River Lake VI was granted a permitted accounting practice to carry its excess of loss reinsurance agreement with The Canada Life Assurance Company as an admitted asset.
River Lake VII and River Lake VIII were granted a permitted accounting practice from the State of Vermont to carry their reserves on a basis similar to U.S. GAAP.
The statutory net income (loss) from our captive life reinsurance subsidiaries relates to the reinsurance of term and universal life insurance statutory reserves assumed from our U.S. domiciled life insurance companies. These reserves are, in turn, funded through the issuance of surplus notes (non-recourse funding obligations) to third parties or secured by excess of loss reinsurance treaties with third parties. Accordingly, the life insurance subsidiaries’ combined statutory net income (loss) and distributable income (loss) are not affected by the statutory net income (loss) of the captives, except to the extent dividends are received from the captives. The combined statutory capital and surplus of our life insurance subsidiaries does not include the capital and surplus of our captive life reinsurance subsidiaries of $217 million and $245 million as of December 31, 2018 and 2017, respectively. Capital and surplus of our captive life reinsurance subsidiaries included surplus notes (non-recourse funding obligations) of Rivermont I as of December 31, 2018 and 2017, as further described in note 12.
The NAIC has adopted RBC requirements to evaluate the adequacy of statutory capital and surplus in relation to risks associated with: (i) asset risk; (ii) insurance risk; (iii) interest rate and equity market risk; and (iv) business risk. The RBC formula is designated as an early warning tool for the states to identify possible undercapitalized companies for the purpose of initiating regulatory action. In the course of operations, we periodically monitor the RBC level of each of our life insurance subsidiaries. As of December 31, 2018 and 2017, each of our life insurance subsidiaries exceeded the minimum required RBC levels in their respective domiciliary state. The consolidated RBC ratio of our U.S. domiciled life insurance subsidiaries was approximately 199% and 282% as of December 31, 2018 and 2017, respectively.
During 2018 and 2017, we established $120 million and $284 million, respectively, of additional statutory reserves resulting from updates to our universal and term universal life insurance products with secondary guarantees in our Virginia and Delaware licensed life insurance subsidiaries.
In the second quarter of 2017, the New York State Department of Financial Services (“NYDFS”) required GLICNY, our New York insurance subsidiary, to record an additional $58 million of statutory reserves related to the 2016 asset adequacy analysis. As a result of its year end 2017 asset adequacy analysis, GLICNY recorded an additional $188 million of statutory reserves in the fourth quarter of 2017. Following its recording of the additional statutory reserves in the fourth quarter of 2017, GLICNY had a remaining asset adequacy deficit of approximately $302 million, which was previously agreed with the NYDFS to phase in over a two-year period. During 2018, the NYDFS approved a previously filed in-force rate increase. Therefore, we incorporated this approved in-force rate increase along with other assumption and methodology updates into GLICNY’s 2018 asset adequacy testing. As a result, no incremental additional asset adequacy analysis reserves were recorded for the year ended December 31, 2018. The NYDFS currently does not allow in-force rate increases for long-term care insurance business to be used in asset adequacy analysis until such increases have been approved.
not to exceed 25:1. Fifteen other states maintain similar risk-to-capital requirements. As of December 31, 2018, Genworth Mortgage Insurance Corporation’s (“GMICO”) risk-to-capital ratio under the current regulatory framework as established under North Carolina law and enforced by the NCDOI, GMICO’s domestic insurance regulator, was approximately 12.5:1, compared with a risk-to-capital ratio of approximately 12.9:1 as of December 31, 2017.
In addition to the guarantees discussed in notes 17 and 21, we have provided guarantees to third parties for the performance of certain obligations of our subsidiaries. We estimate that our potential obligations under such
guarantees, other than the Rivermont I guarantee, was $6 million as of December 31, 2018 and 2017. Genworth Financial and Genworth Holdings have a joint and several guarantee with Rivermont I, in that, if Rivermont I does not generate sufficient interest income from assumed deposit-type insurance contracts to cover fixed interest payments, Genworth Financial and/or Genworth Holdings will cover the shortfall. As of December 31, 2018 and 2017, the restricted cash balance associated with this guarantee was $16 million and $4 million, respectively.
We have the following five operating business segments: U.S. Mortgage Insurance; Canada Mortgage Insurance; Australia Mortgage Insurance; U.S. Life Insurance (which includes our long-term care insurance, life insurance and fixed annuities businesses); and Runoff (which includes the results of non-strategic products which have not been actively sold). In addition to our five operating business segments, we also have Corporate and Other activities which include debt financing expenses that are incurred at the Genworth Holdings level, unallocated corporate income and expenses, eliminations of inter-segment transactions and the results of other businesses that are managed outside of our operating segments, including certain smaller international mortgage insurance businesses and discontinued operations.
We use the same accounting policies and procedures to measure segment income (loss) and assets as our consolidated net income (loss) and assets. Our chief operating decision maker evaluates segment performance and allocates resources on the basis of “adjusted operating income (loss) available to Genworth Financial, Inc.’s common stockholders.” We define adjusted operating income (loss) available to Genworth Financial, Inc.’s common stockholders as income (loss) from continuing operations excluding the after-tax effects of income (loss) attributable to noncontrolling interests, net investment gains (losses), goodwill impairments, gains (losses) on the
sale of businesses, gains (losses) on the early extinguishment of debt, gains (losses) on insurance block transactions, restructuring costs and infrequent or unusual non-operating items. Gains (losses) on insurance block transactions are defined as gains (losses) on the early extinguishment of non-recourse funding obligations, early termination fees for other financing restructuring and/or resulting gains (losses) on reinsurance restructuring for certain blocks of business. We exclude net investment gains (losses) and infrequent or unusual non-operating items because we do not consider them to be related to the operating performance of our segments and Corporate and Other activities. A component of our net investment gains (losses) is the result of impairments, the size and timing of which can vary significantly depending on market credit cycles. In addition, the size and timing of other investment gains (losses) can be subject to our discretion and are influenced by market opportunities, as well as asset-liability matching considerations. Goodwill impairments, gains (losses) on the sale of businesses, gains (losses) on the early extinguishment of debt, gains (losses) on insurance block transactions and restructuring costs are also excluded from adjusted operating income (loss) available to Genworth Financial, Inc.’s common stockholders because, in our opinion, they are not indicative of overall operating trends. Infrequent or unusual non-operating items are also excluded from adjusted operating income (loss) available to Genworth Financial, Inc.’s common stockholders if, in our opinion, they are not indicative of overall operating trends.
In 2018, 2017 and 2016, we recorded a pre-tax expense of $2 million, $2 million and $22 million, respectively, related to restructuring costs as part of an expense reduction plan as we continue to evaluate and appropriately size our organizational needs and expenses.
In 2016, we completed the sale of our term life insurance new business platform and recorded a pre-tax gain of $12 million and we also completed the sale of our mortgage insurance business in Europe and recorded an additional pre-tax loss of $9 million. We had early extinguishment of debt consisting of a $64 million pre-tax
gain from the settlement of restricted borrowings related to a securitization entity, a pre-tax make-whole expense of $20 million related to the early redemption of Genworth Holdings’ 2016 notes and we repurchased $28 million principal amount of Genworth Holdings’ notes with various maturity dates for a pre-tax gain of $4 million. We completed a life block transaction resulting in a pre-tax loss of $9 million in connection with the early extinguishment of non-recourse funding obligations.
(1) For the years ended December 31, 2018, 2017 and 2016, net investment (gains) losses were adjusted for DAC and other intangible amortization and certain benefit reserves of $(12) million, $(3) million and $(14) million, respectively, and adjusted for net investment gains (losses) attributable to noncontrolling interests of $(66) million, $66 million and $20 million, respectively.
(1) Includes net investment losses of $114 million in the fourth quarter of 2018 primarily from our Canada Mortgage Insurance segment. These losses were primarily related to derivative losses on foreign currency swaps and forwards, and losses on preferred equity securities primarily driven by a decrease in interest rates in Canada during the fourth quarter of 2018.
(3) In the fourth quarter of 2018, our long-term care insurance business recorded a $230 million unfavorable adjustment, net of taxes, related to its annual review of claim reserves, as described above. In addition, our long-term care insurance business recorded a $28 million unfavorable reserve adjustment, net of taxes, related to a refined estimate of unreported policy terminations. Our life insurance business recorded an unfavorable adjustment, net of taxes, of $91 million resulting from its annual review of assumptions, as described above. Our Canada mortgage insurance business recorded net investment losses, net of taxes, of $107 million, as described above.
Our unaudited quarterly results of operations for the year ended December 31, 2017 are summarized in the table below.
We face the risk of litigation and regulatory investigations and actions in the ordinary course of operating our businesses, including the risk of class action lawsuits. Our pending legal and regulatory actions include proceedings specific to us and others generally applicable to business practices in the industries in which we operate. In our insurance operations, we are, have been, or may become subject to class actions and individual suits alleging, among other things, issues relating to sales or underwriting practices, increases to in-force long-term care insurance premiums, payment of contingent or other sales commissions, claims payments and procedures, product design, product disclosure, product administration, additional premium charges for premiums paid on a periodic basis, denial or delay of benefits, charging excessive or impermissible fees on products, recommending unsuitable products to customers, our pricing structures and business practices in our mortgage insurance businesses, such as captive reinsurance arrangements with lenders and contract underwriting services, violations of the Real Estate Settlement and Procedures Act of 1974 or related state anti-inducement laws, and mortgage insurance policy rescissions and curtailments, and breaching fiduciary or other duties to customers, including but not limited to breach of customer information. Plaintiffs in class action and other lawsuits against us may seek very large or indeterminate amounts which may remain unknown for substantial periods of time. In our investment-related operations, we are subject to litigation involving commercial disputes with counterparties. We are also subject to litigation arising out of our general business activities such as our contractual and employment relationships, post-closing obligations associated with previous dispositions and securities lawsuits. In addition, we are also subject to various regulatory inquiries, such as information requests, subpoenas, books and record examinations and market conduct and financial examinations from state, federal and international regulators and other authorities. A substantial legal liability or a significant regulatory action against us could have an adverse effect on our business, financial condition and results of operations. Moreover, even if we ultimately prevail in the litigation, regulatory action or investigation, we could suffer significant reputational harm, which could have an adverse effect on our business, financial condition or results of operations.
In October 2016, Genworth Financial, Inc., its current chief executive officer, its former chief executive officer, its current chief financial officer, its former chief financial officer and current and former members of its board of directors were named in a shareholder derivative suit filed by Esther Chopp in the Court of Chancery of the State of Delaware. The case is captioned Chopp v. McInerney, et al. The complaint alleges that Genworth’s board of directors wrongfully refused plaintiff’s demand to commence litigation on behalf of Genworth and asserts claims for breaches of fiduciary duties, waste, contribution and indemnification, and unjust enrichment concerning Genworth’s long-term care insurance reserves and concerning Genworth’s Australian mortgage insurance business, including our plans for an IPO of the business, and seeks unspecified damages, costs, attorneys’ fees and such equitable relief as the court may deem proper. We filed a motion to dismiss on November 14, 2016. The action is stayed pending the completion of the proposed China Oceanwide transaction.
In September 2018, GLAIC, our indirect wholly-owned subsidiary, was named as a defendant in a putative class action lawsuit pending in the United States District Court for the Eastern District of Virginia captioned TVPX ARX INC., as Securities Intermediary for Consolidated Wealth Management, LTD. on behalf of itself and all others similarly situated v. Genworth Life and Annuity Insurance Company. The Plaintiff is alleging unlawful and excessive cost of insurance charges were imposed on policyholders. The complaint asserts claims for breach of contract, alleging that Genworth improperly considered non-mortality factors when calculating cost of insurance rates and failed to decrease cost of insurance charges in light of improved expectations of future mortality, and seeks unspecified compensatory damages, costs, and equitable relief. On October 29, 2018, we filed a motion to enforce in the Middle District of Georgia, and a motion to dismiss and motion to stay in the Eastern District of Virginia. We moved to enjoin the prosecution of the Eastern District of Virginia action on the basis that it involves claims released in a prior nationwide class action settlement that was approved by the Middle District of Georgia. Plaintiff filed an amended complaint on November 13, 2018. On November 16, 2018, the Eastern District of Virginia court stayed the case for 60 days. On December 6, 2018, we moved the Middle District of Georgia for leave to file our counterclaim, which alleges that Plaintiff breached the prior settlement agreement by filing its current action. The motion to enjoin is fully briefed and awaiting disposition by the court.
In September 2018, we were named as a defendant in a putative class action lawsuit pending in the Court of Chancery of the State of Delaware captioned Richard F. Burkhart, William E. Kelly, Richard S. Lavery, Thomas R. Pratt, Gerald Green, individually and on behalf of all other persons similarly situated v. Genworth et al. The Plaintiffs are alleging that GLIC, our indirect wholly-owned subsidiary, failed to maintain adequate capital capable of meeting its obligations to GLIC policyholders and agents. The complaint alleges causes of action for intentional fraudulent transfer and constructive fraudulent transfer, and seeks injunctive relief. We moved to dismiss this action in December 2018. On January 29, 2019, the Plaintiffs exercised their right to amend their complaint. We intend to continue to vigorously defend this action.
In January 2019, Genworth Financial and GLIC were named as defendants in a putative class action lawsuit pending in the United States District Court for the Eastern District of Virginia captioned Jerome Skochin, Susan Skochin, and Larry Huber, individually and on behalf of all other persons similarly situated v. Genworth Financial, Inc. and Genworth Life Insurance Company. The Plaintiffs seek to represent long-term care insurance policyholders, alleging that Genworth made misleading and inadequate disclosures regarding premium increases for long-term care insurance policies. The complaint asserts claims for breach of the implied covenant of good faith and fair dealing, fraudulent inducement and violation of Pennsylvania’s Unfair Trade Practices and Consumer Protection Law (on behalf of the two named Plaintiffs who are Pennsylvania residents), and seeks damages (including statutory treble damages under Pennsylvania law) in excess of $5 million. We intend to vigorously defend this action.
As of December 31, 2018, we were committed to fund $539 million in limited partnership investments, $41 million in U.S. commercial mortgage loan investments and $32 million in private placement investments. As of December 31, 2018, we were committed to fund $33 million of bank loan investments which had not yet been drawn.
commitment fee of approximately $2 million. The expected amount of future obligation under this agreement before repayment is approximately $25 million based on current projections.
In 2018, 2017 and 2016, dividends of $57 million, $54 million and $50 million, respectively, were paid to the noncontrolling interests of Genworth Canada.
In May 2018, Genworth Australia announced its intention to commence an on-market share buy-back program for shares up to a maximum aggregate amount of AUD$100 million. Pursuant to the program, Genworth Australia repurchased approximately 36 million of its shares for AUD$100 million. As the majority shareholder, we participated in on-market sales transactions during the buy-back period to maintain our ownership position of approximately 52.0% and received $37 million in cash, which was paid as dividends to Genworth Holdings.
On June 1, 2016, Genworth Australia completed a capital management initiative of AUD$202 million representing a return of capital of AUD$0.34 per share. As a result of the return of capital every one share was converted into 0.8555 shares. We received $76 million for our portion of the capital reduction and our ownership percentage remained at 52.0%.
In connection with the settlement of the U.K. pension plan as part of the sale of our lifestyle protection insurance business, we purchased a group annuity contract. The amounts associated with the group annuity contract were held in a third-party trust for the benefit of the participants until individual annuity contracts were transferred to the participants on September 1, 2016. As a result, the U.K. pension plan was completely settled in September 2016.
Genworth Financial provides a full and unconditional guarantee to the trustee of Genworth Holdings’ outstanding senior and subordinated notes and the holders of the senior and subordinated notes, on an unsecured unsubordinated and subordinated basis, respectively, of the full and punctual payment of the principal of, premium, if any, and interest on, and all other amounts payable under, each outstanding series of senior notes and outstanding subordinated notes, and the full and punctual payment of all other amounts payable by Genworth Holdings under the senior and subordinated notes indentures in respect of such senior and subordinated notes.
The condensed consolidating financial information presents the condensed consolidating balance sheet information as of December 31, 2018 and 2017 and the condensed consolidating income statement information, condensed consolidating comprehensive income statement information and condensed consolidating cash flow statement information for the years ended December 31, 2018, 2017 and 2016.
The following table presents the condensed consolidating income statement information for the year ended December 31, 2018:
The following table presents the condensed consolidating income statement information for the year ended December 31, 2017:
Genworth Financial also provides a full and unconditional guarantee to the holders of Genworth Holdings’ Term Loan. Genworth Financial and Genworth Holdings have joint and several guarantees associated with Rivermont I and the Tax Matters Agreement.