We own our headquarters facility in Richmond, Virginia, which consists of approximately 461,190 square feet in four buildings, as well as several facilities in Lynchburg, Virginia with approximately 450,360 square feet. In addition, we lease approximately 606,775 square feet of office space in 44 locations throughout the United States. We also own one building outside the United States with approximately 4,560 square feet, and we lease approximately 422,020 square feet in 48 locations outside the United States.
The following table sets forth selected financial information. The selected financial information as of December 31, 2010 and 2009 and for the years ended December 31, 2010, 2009 and 2008 has been derived from our consolidated financial statements, which have been audited by KPMG LLP and are included in “Item 8 - Financial Statements and Supplementary Data.” You should read this information in conjunction with the information under “
International. We offer mortgage and lifestyle protection insurance products and related services in multiple markets. We are a leading provider of mortgage insurance products in Canada, Australia, Mexico and multiple European countries. Our products predominantly insure prime-based, individually underwritten residential mortgage loans, also known as flow mortgage insurance. On a limited basis, we also provide mortgage insurance on a structured, or bulk, basis that aids in the sale of mortgages to the capital markets and helps lenders manage capital and risk. Additionally, we offer services, analytical tools and technology that enable lenders to operate efficiently and manage risk. We are a leading provider of payment protection coverages (referred to as lifestyle protection) in multiple European countries. Our lifestyle protection insurance products primarily help consumers meet specified payment obligations should they become unable to pay due to accident, illness, involuntary unemployment, disability or death. For the year ended December 31, 2010, our International segment’s net income available to Genworth Financial, Inc.’s common stockholders and net operating income available to Genworth Financial, Inc.’s common stockholders were $444 million and $434 million, respectively.
U.S. Mortgage Insurance. In the United States, we offer mortgage insurance products predominantly insuring prime-based, individually underwritten residential mortgage loans, also known as flow mortgage insurance. We selectively provide mortgage insurance on a structured, or bulk, basis with essentially all of our bulk writings prime-based. Additionally, we offer services, analytical tools and technology that enable lenders to operate efficiently and manage risk. For the year ended December 31, 2010, our U.S. Mortgage Insurance segment’s net loss available to Genworth Financial, Inc.’s common stockholders and net operating loss available to Genworth Financial, Inc.’s common stockholders were $559 million and $580 million, respectively.
net premiums earned on individual term life insurance, individual and group long-term care insurance, Medicare supplement insurance and single premium immediate annuities with life contingencies;
U.S. Mortgage Insurance. The revenues in our U.S. Mortgage Insurance segment consist primarily of:
Management regularly monitors and reports sales metrics as a measure of volume of new and renewal business generated in a period. Sales refer to: (1) annualized first-year premiums for term life, long-term care and Medicare supplement insurance; (2) new and additional premiums/deposits for universal life insurance, term universal life insurance, linked-benefits, spread-based and variable products; (3) gross and net flows, which represent gross flows less redemptions, for our wealth management business; (4) written premiums and deposits, gross of ceded reinsurance and cancellations, and premium equivalents, where we earn a fee for administrative services only business, for our lifestyle protection insurance business; (5) new insurance written for mortgage insurance, which in each case reflects the amount of business we generated during each period presented; and (6) written premiums net of cancellations for our Mexican insurance operations. Sales do not include renewal premiums on policies or contracts written during prior periods. We consider annualized first-year premiums, new premiums/deposits, gross and net flows, written premiums, premium equivalents and new insurance written to be a measure of our operating performance because they represent a measure of new sales of insurance policies or contracts during a specified period, rather than a measure of our revenues or profitability during that period.
We also include information related to loss mitigation activities for our U.S. mortgage insurance business. We define loss mitigation activities as rescissions, cancellations, borrower loan modifications, repayment plans, lender- and borrower-titled presales and other loan workouts and claim mitigation actions. Estimated savings related to rescissions are the reduction in carried loss reserves, net of premium refunds and reinstatement of prior rescissions. Estimated savings related to loan modifications and other cure related loss mitigation actions represent the reduction in carried loss reserves. For non-cure related actions, including presales, the estimated savings represent the difference between the full claim obligation and the actual amount paid. We believe that this information helps to enhance the understanding of the operating performance of our U.S. mortgage insurance business as they specifically impact current and future loss reserves and level of claim payments.
Financial and economic environment. As a financial security company, 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. Despite swings experienced in equity markets, credit markets, interest rate spreads and systemic European sovereign risk, global financial markets improved during 2010 from the volatility experienced in 2009. In 2010, Canadian and Australian economies and housing markets improved although the volume of high loan-to-value mortgage originations in Australia remained substantially below levels seen in prior years. The U.S. housing market reflected continuing stress, growing levels of foreclosures and variations in performance by sub-market, including continued signs of stabilization within certain regions. Europe remained a slow growth environment with lower consumer lending activity.
Volatility in credit and investment markets. During the fourth quarter of 2010, markets were characterized by rising U.S. Treasury yields and tightening credit spreads. A combination of improving macroeconomic data, anticipated fiscal stimulus in the form of tax cut extensions, weaker non-U.S. investor demand and the Federal Reserve’s second quantitative easing program designed to stimulate economic recovery and encourage investment in higher risk sectors in part drove intermediate and long interest rates higher in the fourth quarter. Strong investor demand for higher yielding assets and declining net supply of spread product continued to drive credit spreads tighter in most sectors. Concerns regarding systemic European sovereign risk resurfaced but
Regulations XXX and AXXX require insurers to establish additional statutory reserves for term life insurance policies with long-term premium guarantees and certain universal life insurance policies with secondary guarantees, which increase the capital required to write these products beyond economic requirements. The solutions for the increased reserve requirements on some of our in-force books of business have become more limited and expensive; however, we have committed funding sources for approximately 95% of our anticipated peak level reserves required under Regulations XXX and AXXX so we believe unfunded reserve exposure is minimal. Additionally, we have made product modifications and introduced new products designed to reduce capital requirements and limit financing costs compared to existing products and thereby improve the profitability of new business. The new term universal life insurance product, discussed above, offers death
benefit guarantee premiums that are competitive with traditional term insurance premiums for comparable durations and provides greater consumer flexibility typically associated with universal life coverage.
Long-term care insurance. Results of our long-term care insurance business are influenced by morbidity, mortality, persistency, investment yields, new product sales, expenses and reinsurance as well as the relative competitiveness of our offerings.
In recent years, industry-wide first-year annualized premiums of long-term care insurance have either declined or grown moderately. While our overall sales in 2009 were adversely impacted primarily by the general economic conditions and lower sales through our independent distribution and career force channels, in the second half of 2009 and continuing into 2010, we experienced improvements in our long-term care insurance sales. Recent improvements are due in part to the breadth of our distribution, and we have made progress on multiple growth initiatives with an emphasis on distribution effectiveness and broadening our individual and group offerings.
In addition, changes in regulations or government programs, including certain aspects of healthcare reform, such as the CLASS Act, could impact our long-term care insurance business positively or negatively. As such, we continue to actively monitor regulatory developments.
Wealth management. Results of our wealth management business are impacted by the demand for asset management products and related support services, investment performance and equity market conditions.
On December 31, 2010, we purchased the operating assets of Altegris. This acquisition provides a platform of alternative investments including hedge funds and managed futures products and had approximately $2.2 billion in client assets as of December 31, 2010. See note 8 to our consolidated financial statements under “Item 8 - Financial Statements and Supplementary Data” for additional information related to the acquisition.
In variable annuities, the improvement in the equity markets favorably impacted our results. In the future, equity market performance and volatility could result in additional gains or losses in our variable annuity products and associated hedging program which would impact our results. In response to the risk in equity markets, certain product features were scaled back to reduce adverse selection risk and volatility while costs to the consumer increased.
activity. As a result, home prices increased notably in these markets during 2009. During 2010, home price appreciation slowed in both Canada and Australia, particularly during the second half of the year. Looking forward into 2011, we expect home prices to stabilize or grow modestly in Australia while remaining relatively flat in Canada. Additionally, while unemployment increased during the first half of 2009, we observed a decline in unemployment rates in these two markets since the second half of 2009 with rates remaining fairly stable during the second half of 2010. In many of our European mortgage insurance markets, we have observed early signs of stabilization as unemployment rates appear to be peaking and declines in home prices have moderated. The overall economic environment in Europe, however, continues to be dominated by concerns about the fiscal health of the region, which has created uncertainty about the timing and speed of economic recovery.
In Canada, we experienced higher than anticipated levels of flow new insurance written during 2010. A low mortgage interest rate environment in 2010 and improved consumer confidence contributed to these higher levels. As of December 31, 2010, our 2010 book of business represents 12% of our insurance in-force while our 2007 and 2008 books, the two largest in our portfolio, together represent 34% of our insurance in-force. As a result of our large 2007 and 2008 books and subsequent smaller books seasoning during 2011, earned premium in Canada is expected to decline moderately relative to 2010 levels. In January 2011, the Canadian government announced tighter mortgage rules that will become effective in March and April of 2011. These changes may reduce the amount of net premiums written in 2011. This decline may be offset by modest growth in flow new insurance written in 2011, if economic conditions in Canada continue to be favorable and we are able to increase our market share.
Over the past two years, we significantly expanded our focus on, and the resources devoted to, loss mitigation initiatives, including programs that actively partner with our lenders to find solutions that cure delinquencies through actions such as loan modifications that keep borrowers in their homes, asset management strategies such as arranged and facilitated sales and pursuing recoveries. These programs benefit all parties as borrowers are able to remain in their homes, lenders maintain their relationship with the borrower and an earning asset, and we mitigate claim payments under the terms of our mortgage insurance policies. Additionally, in cases where no solution is found to cure the delinquency and keep the borrower in their home, we are actively partnering with our lenders to optimize the transition process and mitigate claim payments. As a result of our expanded focus, there was an increase in the number of loans subject to our loss mitigation initiatives, which had a favorable impact on our results of operations. We have also seen improvements in our total losses as economies continue to improve, home prices continue to increase, albeit at slower rates, and unemployment levels decline. With ongoing improvement in the Canadian and Australian economies and stable housing markets, as well as the success we experienced with our loss mitigation initiatives outlined above, we expect our overall loss levels to improve modestly over levels experienced in 2010.
For the year ended December 31, 2010, net operating income in our lifestyle protection insurance business improved significantly as compared to the prior year. This improved profitability has been driven by stabilizing European unemployment levels and the impact of our policy re-pricing and distribution contract restructuring initiative in late 2009 through early 2010. Sales during 2010 decreased primarily as a result of stagnating economies across Europe, which resulted in a decline in consumer lending where most of our insurance coverages attach as banks tightened lending criteria and consumer demand declined. However, sales increased modestly during the third quarter of 2010 before declining in the fourth quarter of 2010. We are actively pursuing various growth initiatives to expand our distribution channels and our product offerings which have begun to help to mitigate lower consumer lending levels. However, depending on the severity and length of these conditions, we could experience additional declines in sales or the inability to generate targeted growth in new sales.
Results of our U.S. mortgage insurance business are affected by unemployment, underemployment and other economic and housing market trends, interest rates, home prices, mortgage origination volume mix and practices, the levels and aging of mortgage delinquencies including seasonal variations, the inventory of unsold homes and lender modification efforts. These economic and housing market trends are continuing to be adversely affected by the ongoing weak domestic economy and related levels of unemployment. This has resulted in numerous outcomes including rising foreclosures, more borrowers seeking loan modifications and elevated foreclosed and delinquent housing inventories which pressure home values. At the same time, home prices are continuing to show signs of stabilizing or improving in several U.S. markets after a significant decline from their peak levels. Overall, we anticipate some additional declines in home values into early 2011 and we expect unemployment and underemployment levels to stabilize though remain elevated for an extended period.
A weak housing market, tightened lending standards, the lack of consumer confidence and the lack of liquidity in some mortgage securitization markets continued to drive a smaller mortgage origination market. Within the private mortgage insurance market, the mortgage insurance penetration rate and overall market size have been driven down by growth in FHA originations, associated with multiple pricing, underwriting and loan size factors, and the negative impact of GSE market fees and loan level pricing which can make private mortgage insurance solutions less competitive with the FHA solution. Given recent FHA risk management actions, we have seen the private mortgage insurance penetration rate increase somewhat in the fourth quarter of 2010 and expect this to continue given the additional FHA pricing changes effective in October 2010. In contrast, GSEs have increased loan level pricing upcharges which can make private mortgage insurance less attractive compared to FHA solutions. Going forward, this trend may limit the demand for private mortgage insurance. Alternatively,
As a result of the recent stabilization of home prices and unemployment levels in certain markets and expanded efforts in the mortgage market to modify loans, we experienced a decrease in new delinquencies during 2010. This decrease reflected a reduction in new delinquencies combined with higher claims and increased cures from government and lender loan modification programs and other loss mitigation activities through the first half of 2010. However, aged delinquencies continued to increase through the second half of 2010; moreover, foreclosures increased and short sales remained elevated through the same period, thereby pressuring home prices in certain markets resulting in higher levels of default. If home values continue to decline and credit remains tight, the ability to cure a delinquent loan could be more difficult to achieve. In addition, while we continue to execute on our loan modification strategy, we have seen the level of loan modification actions slow down significantly during the fourth quarter of 2010. If this trend continues, a reduction of loan modifications would also have an adverse impact on the ability of borrowers to cure a delinquent loan.
We also participate in reinsurance programs in which we share portions of our premiums associated with flow insurance written on loans originated or purchased by lenders with captive insurance entities of these lenders in exchange for an agreed upon level of loss coverage above a specified attachment point. For the year ended December 31, 2010, we recorded reinsurance recoveries of $214 million where cumulative losses have exceeded the attachment points in captive reinsurance arrangements, primarily related to our 2005, 2006, 2007 and 2008 book years. We have exhausted certain captive reinsurance tiers for these book years based on loss development trends. Once the captive reinsurance or trust assets are exhausted, we are responsible for additional losses incurred. We have begun to experience constraints on the recognition of captive benefit recovery due to the amount of funds held in certain captive trusts and the exhaustion of captive loss tiers for certain reinsurers. As of January 1, 2009, we no longer enter into excess loss of captive reinsurance transactions and, therefore, only participate in quota share reinsurance arrangements. The majority of our excess of loss captive reinsurance arrangements are in runoff with no new books of business being added going forward; however, we will continue to benefit from captive reinsurance on our 2005, 2006, 2007 and 2008 book years.
It is also likely that during 2011 another of our U.S. mortgage insurance subsidiaries, GMIC-NC, an affiliated reinsurer of our U.S. mortgage insurance risk, will breach its minimum risk-to-capital requirement. We have initiated a similar filing process for waivers on the part of GMIC-NC. As to GMIC-NC, in addition to the waivers we are seeking, we may provide such reinsurance out of other mortgage insurance affiliates to the extent they continue to meet their minimum risk-to-capital requirements and may seek to restructure existing reinsurance arrangements to provide additional capacity for such reinsurance, all of which will be subject to review by the NCDOI and the GSEs and there can be no assurances as to their approval where required or that they will not otherwise object.
We also continue to execute on our capital flexibility strategy to support the financial strength of our U.S. mortgage insurance business. During December 2010, we completed an intercompany, non-cash preferred securities exchange transaction that resulted in an increase to statutory capital of approximately $218 million in our U.S. mortgage insurance companies. This transaction was contingent upon receiving appropriate regulatory approval, which was granted in January 2011; this transaction was effective for reported 2010 year end statutory financial statements.
Fair value measurements are based upon observable and unobservable inputs. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect our view of market assumptions in the absence of observable market information. We utilize valuation techniques that maximize the
use of observable inputs and minimize the use of unobservable inputs. All assets carried at fair value are classified and disclosed in one of the following three categories:
Security pricing is applied using a hierarchy approach. The vast majority of our fixed maturity securities use Level 2 inputs for the determination of fair value. These fair values are obtained primarily from industry-standard pricing methodologies utilizing market observable information, when available. Because many fixed-income securities do not trade on a daily basis, fair value is determined using industry-standard methodologies by applying available market information through processes such as benchmark curves, benchmarking of like-securities, sector groupings, quotes from market participants and matrix pricing. Observable information is compiled and integrates relevant credit information, perceived market movements and sector news. Additionally, security prices are periodically back-tested to validate and/or refine models as conditions warrant. Market indicators and industry and economic events are also monitored as triggers to obtain additional data. For certain structured securities with limited trading activity, industry-standard pricing methodologies utilize adjusted market information, such as index prices or discounting expected future cash flows, to estimate fair value. These measures are not deemed observable for a particular security and results in the measurement being classified as Level 3.
Deferred acquisition costs. DAC represents costs that vary with, and are primarily related to, the sale and issuance of our insurance policies and investment contracts which are deferred and amortized over the estimated life of the related insurance policies. These costs include commissions in excess of ultimate renewal commissions, solicitation and printing costs, sales material and some support costs, such as underwriting and contract and policy issuance expenses. DAC is subsequently amortized to expense over the lives of the underlying contracts, in relation to the anticipated recognition of premiums or gross profits.
Amortization of DAC for annuity contracts without significant mortality risk and for investment and universal life insurance products 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 based on experience studies such as mortality, withdrawal or lapse rates, investment margin or maintenance 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, 2010, 2009 and 2008, key assumptions were unlocked in our Retirement and Protection segment to reflect our current expectation of future investment spreads, lapse rates, mortality and reinsurance costs.
The following table sets forth the increase (decrease) on amortization of DAC related to unlocking of underlying key assumptions by segment for the years ended December 31:
The DAC amortization methodology for our variable products (variable annuities and variable universal life insurance) includes a long-term equity market average appreciation assumption of 8.5%. When actual returns vary from the expected 8.5%, we assume a reversion to the expected return over a three-year period. The assumed returns over this reversion to the expected return period are limited to the 85th percentile of historical market performance.
We regularly review DAC to determine if it is recoverable from future income as part of our loss recognition testing. For deposit products, if the current present value of estimated future gross profits is less than the unamortized DAC for a line of business, a charge to income is recorded for additional DAC amortization, and for certain products, an increase in benefit reserves may be required. For other products, if the benefit reserves plus anticipated future premiums and interest income for a line of business are less than the current estimate of future benefits and expenses (including any unamortized DAC), a charge to income is recorded for additional DAC amortization and potentially an increase in benefit reserves, to address any premium deficiency. The establishment of such a reserve is subject to inherent uncertainty and requires significant judgment and estimates to determine the present values of future premium, estimated gross profits and expected losses and expenses of our businesses. As of December 31, 2010, we believe all of our businesses have sufficient future income where the related DAC is recoverable based on our best estimates of morbidity, mortality, claim loss development, withdrawal or lapse rate, maintenance expense or interest rates expected to occur.
Continued low interest rates have impacted the recoverability margins on our immediate annuity products. As of December 31, 2010 and 2009, we had margin of approximately $70 million and $15 million, respectively, on $7,370 million and $7,627 million, respectively, of net U.S. GAAP liability related to our immediate annuity products. The risks we face include adverse variations in interest rates and/or mortality. Adverse experience in
one or both of these risks could result in the DAC associated with our immediate annuity products being no longer fully recoverable as well as the establishment of additional benefit reserves. Any favorable variation would result in additional margin in our DAC loss recognition analysis and would result in higher income recognition over the remaining duration of the in-force block. See notes 2 and 6 in our consolidated financial statements under “Item 8 - Financial Statements and Supplementary Data” for additional information related to DAC.
For the operating income model, we determine fair value based on the present value of the most recent income projections for each reporting unit and calculate a terminal value utilizing a terminal growth rate. We primarily utilize the operating income model to determine fair value for all reporting units except for our life and long-term care insurance reporting units. In addition to the operating income model, we also consider the valuation of our Canadian mortgage insurance subsidiary’s publicly traded stock price in determining fair value for that reporting unit. The significant assumptions in the operating income model include: income projections, which are dependent on new business production, customer behavior, operating expenses and market conditions; discount rate; and terminal growth rate.
We consider our market capitalization in assessing the reasonableness of the fair values estimated for our reporting units in connection with our goodwill impairment testing. In 2008, we impaired all goodwill associated with our U.S. mortgage insurance, retirement income and institutional reporting units. Accordingly, these businesses are no longer subject to goodwill impairment testing but do have a significant impact on the valuation of our market capitalization in comparison to our book value. When reconciling to our market capitalization, we estimate the values for these businesses and also consider the negative value that would be associated with corporate debt, which would be subtracted from the fair value of our businesses to calculate the total value attributed to equity holders. We then compare the total value attributed to equity holders to our market capitalization.
For all of our reporting units, except for our long-term care insurance reporting unit, fair value was in excess of book value and they were not at risk of failing our goodwill impairment testing.
As part of our annual goodwill impairment testing, we noted that our long-term care insurance reporting unit’s fair value was less than its book value. If fair value is lower than book value, the reporting unit’s fair value is allocated to assets and liabilities as if the reporting unit had been acquired in a business combination. If this “implied goodwill” exceeds the reporting unit’s goodwill balance, goodwill is deemed recoverable. Accordingly, we evaluated our long-term care insurance reporting unit’s goodwill balance of $425 million and determined that the amount of implied goodwill was approximately 300% of the amount of goodwill currently recorded. Accordingly, goodwill was recoverable and not impaired.
The valuation of new business is determined by utilizing several inputs such as expected new business production, both in terms of the quantity and number of years of new production assumed, as well as profitability of the new business, which is primarily dependent on policyholder assumptions, expected investment returns and targeted capital levels.
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 an estimate of the number of loans in 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 assumptions is established by management 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 ab initio 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.
claim and severity of loss rates that are applied to the current population of delinquencies. Factors considered in establishing loss reserves include claim frequency patterns (reflecting the loss mitigation actions on such claim patterns), the aged category of the delinquency (i.e., age and progression of delinquency to claim) and loan coverage percentage. The establishment of our mortgage insurance loss reserves is subject to inherent uncertainty and requires judgment by management. The actual amount of the claim payments may vary significantly from the loss reserve estimates. Our estimates could be adversely affected by several factors, including a deterioration of regional or national economic conditions leading to a reduction in borrowers’ income and thus their ability to make mortgage payments, a drop in housing values that could expose us to greater loss on resale of properties obtained through foreclosure proceedings and an adverse change in the effectiveness of loss mitigation actions that could result in an increase in the frequency of expected claim rates. Our estimates are also affected by the extent of fraud and misrepresentation that we uncover in the loans that we have insured and the coverage upon which we have consequently rescinded or may rescind going forward. Our loss reserving methodology includes estimates of the number of loans in our delinquency inventory that will be rescinded or modified, as well as estimates of the number of loans for which coverage may be reinstated under certain conditions following a rescission action.
In addition to the sensitivities discussed above, our more recent books of business in both our U.S. and certain international mortgage insurance businesses have experienced higher losses than our previous book years as a result of the global economic environment. In our U.S. mortgage insurance business, our 2006, 2007 and the first half of 2008 books of business have been experiencing delinquencies and incurred losses substantially higher than those generated from previous book years we have written. Early loss development patterns from these book years indicate that we would expect a higher level of total losses generated. Variations we consider reasonably possible could include an increase of 10% in these expected losses over a three-year period ending December 31, 2013 that would result in a decrease in after-tax operating results of approximately $80 million. Additional adverse variation could result in additional negative impacts while favorable variations would result in improved margins. Regardless of the ultimate loss development pattern on these books, we expect they will continue to generate significant paid and incurred losses for at least the next two years and thus will continue to have a significant adverse impact on our operating results over these same periods.
In our international mortgage insurance business, we anticipate reduced levels of losses as a result of improving housing markets and economies. However, if housing markets and economies do not improve and instead deteriorate, we may experience increased losses. Variations we consider reasonably possible to occur could include an increase in projected losses for our international mortgage insurance business of between 5% and 10% over the next year. If changes at these levels were to occur, after-tax operating results could be negatively impacted by approximately $15 million to approximately $25 million over this same period based on current foreign exchange rates. The potential for either additional adverse loss development or favorable loss development exists that could further impact our business underwriting margins.
Valuation of deferred tax assets. Deferred tax assets represent the tax benefit of future deductible temporary differences and operating loss and tax credit carryforwards. Deferred tax assets are measured using the enacted tax rates expected to be in effect when such benefits are realized if there is no change in tax law. Under U.S. GAAP, we test the value of deferred tax assets for impairment on a quarterly basis at our taxpaying component level within each tax jurisdiction, consistent with our filed tax returns. Deferred tax assets are reduced by a valuation allowance if, based on the weight of available evidence, it is more likely than not that some portion, or all, of the deferred tax assets will not be realized. In determining the need for a valuation allowance, we consider carryback capacity, reversal of existing temporary differences, future taxable income and tax planning strategies. Tax planning strategies are actions that are prudent and feasible, that an entity ordinarily might not take, but would take to prevent an operating loss or tax credit carryforward from expiring unused. The determination of the valuation allowance for our deferred tax assets requires management to make certain judgments and assumptions regarding future operations that are based on our historical experience and our expectations of future performance. Our judgments and assumptions are subject to change given the inherent uncertainty in predicting future performance, which is impacted by such things as policyholder behavior, competitor pricing, new product introductions, and specific industry and market conditions. Tax planning strategies are incorporated into our analysis and assessment. Based on our analysis, we believe it is more likely than not that the results of future operations and the implementation of tax planning strategies will generate sufficient taxable income to enable us to realize the deferred tax assets for which we have not established valuation allowances. Tax planning strategies considered include the restructuring of certain operations, reallocation of investments away from tax-exempt securities and a life/non-life election. These measures would accelerate the use of NOL carryforwards and other deferred tax asset components.
Deferred taxes on permanently reinvested foreign income. We do not record U.S. deferred taxes on foreign income that we do not expect to remit or repatriate to U.S. corporations within our consolidated group. Under U.S. GAAP, we are generally required to record U.S. deferred taxes on the anticipated repatriation of foreign income as the income is recognized for financial reporting purposes. An exception under certain accounting guidance permits us not to record a U.S. deferred tax liability for foreign income that we expect to reinvest in its foreign operations and for which remittance will be postponed indefinitely. If it becomes apparent that some or all undistributed income will be remitted in the foreseeable future, the related deferred taxes are recorded in that period. In determining indefinite reinvestment we regularly evaluate the capital needs of our domestic and foreign operations considering all available information, including operating and capital plans, regulatory capital requirements, parent company financing and cash flow needs, as well as, the applicable tax laws to which our domestic and foreign subsidiaries are subject. Our estimates are based on our historical experience and our expectation of future performance. Our judgments and assumptions are subject to change given the inherent uncertainty in predicting future capital needs, which are impacted by such things as regulatory requirements, policyholder behavior, competitor pricing, new product introductions, and specific industry and market conditions. As of December 31, 2010, U.S. deferred income taxes were not provided on approximately $1,862 million of unremitted foreign income we considered permanently reinvested.
Premiums. Premiums consist primarily of premiums earned on insurance products for life, long-term care and Medicare supplement insurance, single premium immediate annuities and structured settlements with life contingencies, lifestyle protection insurance and mortgage insurance.
Our Retirement and Protection segment increased $13 million primarily attributable to a $61 million increase in our long-term care insurance business, partially offset by a $49 million decrease in our life insurance business.
Weighted-average investment yields increased to 4.8% for the year ended December 31, 2010 from 4.4% for the year ended December 31, 2009. The increase in weighted-average investment yields was primarily attributable to the reinvestment of the high cash balances we were holding during 2009 and lower losses on limited partnerships. Additionally, there was an increase in net investment income related to the consolidation of certain securitization entities as of January 1, 2010. These increases were partially offset by a decrease in investment income related to policy loans from a bankruptcy-related lapse in 2009 of a large group corporate-owned life insurance policy.
Our Retirement and Protection segment decreased $42 million principally related to our retirement income business.
Our International segment decreased $21 million attributable to a decrease of $52 million in our lifestyle protection insurance business, partially offset by an increase of $31 million in our international mortgage insurance business.
Our Retirement and Protection segment decreased $5 million primarily due to a decrease of $59 million in our retirement income business and a decrease of $27 million in our long-term care insurance business, partially offset by an increase of $81 million in our life insurance business.
Our International segment increased $8 million primarily related to our international mortgage insurance business. The year ended December 31, 2010 included an increase of $1 million attributable to changes in foreign exchange rates.
Our International segment increased $161 million driven by an $84 million increase in our international mortgage insurance business and a $77 million increase in our lifestyle protection insurance business. The year ended December 31, 2009 included a decrease of $81 million attributable to changes in foreign exchange rates.
Our Retirement and Protection segment decreased $24 million principally related to our retirement income business.
Our Retirement and Protection segment decreased $47 million from a decrease of $31 million in our wealth management business, a decrease of $24 million in our retirement income business and a decrease of $12 million in our life insurance business. These decreases were partially offset by an increase of $20 million in our long-term care insurance business.
Our International segment decreased $77 million from an $82 million decrease in our lifestyle protection insurance business that was partially offset by a $5 million increase in our international mortgage insurance business. The year ended December 31, 2009 included a decrease of $27 million attributable to changes in foreign exchange rates.
Our International segment increased $11 million primarily related to our lifestyle protection insurance business. The year ended December 31, 2009 included a decrease of $6 million attributable to changes in foreign exchange rates.
Net income attributable to noncontrolling interests. The increase related to the initial public offering of our Canadian mortgage insurance business in July 2009 which reduced our ownership percentage to 57.5%. The year ended December 31, 2009 included an increase of $4 million attributable to changes in foreign exchange rates.
The following table includes a reconciliation of net income (loss) to net operating income available to Genworth Financial, Inc.’s common stockholders for the years ended December 31:
Diluted weighted-average shares outstanding for 2010 reflect the effects of potentially dilutive securities including stock options, RSUs and other equity-based compensation.
Our life insurance business decreased $73 million primarily attributable to an increase in claims as a result of higher mortality in both our universal life and term products compared to the prior year, higher lapses compared to pricing assumptions on our term life insurance policies issued in 1999 and 2000 as they go through their post-level rate period and a favorable unlocking related to estimated gross profit assumptions in our universal life insurance products in the prior year that did not recur. These decreases were partially offset by higher net investment income.
Our long-term care insurance business increased $117 million largely as a result of an increase in average invested assets due to growth of our in-force block. Additionally, net investment income in 2010 included $3 million of gains related to limited partnerships accounted for under the equity method compared to $25 million of losses in 2009.
Our retirement income business increased $81 million primarily related to limited partnerships accounted for under the equity method. Net investment income included $3 million of gains related to limited partnerships in 2010 compared to $81 million of losses related to limited partnerships in 2009. Net investment income for our spread-based products also benefited from the reinvestment of the high cash balances held during 2009. These increases were partially offset by lower average invested assets.
Net investment losses in our life insurance business decreased $229 million primarily driven by lower losses from the sale of investment securities related to portfolio repositioning and lower impairments recorded in 2010.
Net investment losses in our retirement income business decreased $156 million primarily related to lower losses associated with our variable annuity products with GMWBs as a result of changes in non-performance risk incorporated into the discount rate used to value GMWB embedded derivatives and lower losses from the sale of investment securities related to portfolio repositioning for our spread-based products.
Our long-term care business increased $31 million primarily driven by our equity access business as a result of higher margins on loans.
growth of our in-force block and an increase in reserves due to growth in our term universal life insurance product.
Interest credited. Interest credited decreased $42 million primarily related to our retirement income business from lower account values on fixed annuities and lower crediting rates as the fixed annuities reach the end of their initial crediting rate guarantee period.
Our long-term care insurance business decreased $27 million largely driven by a $25 million favorable adjustment in the fourth quarter of 2010 to defer costs associated with the sale of joint policies that were incorrectly expensed as a result of a systems conversion in late 2008. The decrease was also attributable to lower terminations in 2010. These decreases were partially offset by growth of our long-term care insurance in-force block.
Our retirement income business decreased $59 million primarily related to a decrease of $83 million from our fee-based products. The prior year included additional DAC amortization of $54 million from loss recognition testing that did not recur. Additionally, amortization decreased as a result of lower gains in the current year related to embedded derivatives associated with our variable annuity products with GMWBs. This decrease was partially offset by an unfavorable refinement of assumptions of $9 million in 2010. Our spread-based products increased $24 million mainly from higher DAC amortization attributable to lower net investment losses in the current year, partially offset by a favorable unlocking of $14 million primarily related to lower lapse trends in 2010 as compared to an unfavorable DAC unlocking of $8 million primarily related to spread assumptions in the prior year.
Interest expense. Interest expense increased $7 million primarily related to our life insurance business from higher letter of credit fees in the current year.
Our long-term care insurance business increased $5 million mainly related to growth of the in-force block, partially offset by a decrease in net investment income from lower yields and losses related to limited partnerships accounted for under the equity method.
Our life insurance business decreased $15 million due to an increase in ceded reinsurance and lower production in 2009, partially offset by in-force growth of our term life insurance products.
Our life insurance business increased $19 million primarily due to higher cost of insurance charges, including a favorable unlocking related to estimated gross profit assumptions in our universal life insurance products in 2009.
Our retirement income business decreased $22 million. Our fee-based products decreased $17 million mainly due to the unfavorable market impact in prior quarters on these products and lower municipal GIC advisory fees due to the termination of an agreement effective December 31, 2008. Our spread-based products decreased $5 million from lower surrender fees associated with lower lapses in 2009.
Our long-term care insurance business increased $96 million mainly attributable to the aging and growth of the in-force block and an increase in Medicare supplement claims, partially offset by higher terminations in 2009. The current year included a favorable reinsurance adjustment of $15 million. The prior year included favorable reserve adjustments of $41 million, of which $16 million was recorded in the fourth quarter of 2008 related to a valuation system conversion.
Our life insurance business decreased $12 million primarily from cost saving initiatives implemented in 2009, $5 million of non-operating expenses recorded in the fourth quarter of 2008 related to the plan for workforce reduction and other restructuring actions that did not recur and higher ceded commissions related to new reinsurance treaties.
Our wealth management business decreased $31 million attributable to lower asset-based expenses as average assets under management declined from unfavorable market impacts in the second half of 2008 and the first quarter of 2009.
Our long-term care insurance business increased $40 million due to growth of the in-force block and higher terminations in 2009.
Our retirement income business increased $29 million. Our spread-based products increased $16 million mainly from higher amortization of DAC attributable to lower net investment losses, partially offset by a decrease in amortization due to lower lapses and tighter spreads on these products. The current year included an unfavorable DAC unlocking of $8 million primarily related to spread assumptions compared to $19 million in the prior year due to increased future lapse assumptions resulting from a multi-year lapse study. Our fee-based products increased $13 million attributable to higher amortization of DAC from gains in 2009 related to embedded derivatives associated with our variable annuity products with GMWBs as compared to losses in 2008. The prior year also included a favorable unlocking of $11 million associated with lower lapse rate assumptions. Higher amortization related to loss recognition testing of $55 million in the fourth quarter of 2008 was offset by $54 million recorded in the first quarter of 2009.
Net earned premiums decreased mainly as a result of lower sales in the current year from the introduction in late 2009 of our term universal life insurance product that is designed to replace new sales of our existing term life insurance products and higher lapses on policies as they go through their post-level rate period.
(1) Relates to the acquisition of Altegris on December 31, 2010. See note 8 in our consolidated financial statements under “Item 8 - Financial Statements and Supplementary Data” for additional information related to the acquisition.
Account value of our fixed annuities decreased as surrenders exceeded deposits. Sales have slowed significantly given the low interest rate environment and other market conditions.
In our single premium immediate annuities, the decrease in the account value was attributable to surrenders exceeding deposits and premiums as sales of this product have slowed significantly in 2009 given market conditions and as a result of company actions related to future risk, profitability and capital considerations.
Over the next 12 to 24 months, our Retirement and Protection segment will migrate to a new valuation and projection platform. This migration is part of our ongoing efforts to improve the infrastructure and capabilities of our information systems and our routine assessment and refinement of financial, actuarial, investment and risk management capabilities enterprise wide. This migration will also provide our Retirement and Protection segment with a platform to support emerging accounting guidance and ongoing changes in capital regulations. Concurrently, valuation processes and methodologies will be reviewed. Any material changes in balances or income trends that may result from these activities will be disclosed accordingly.
The year ended December 31, 2010 included an increase of $98 million and a decrease of $23 million attributable to changes in foreign exchange rates for our international mortgage and lifestyle protection insurance businesses, respectively.
The decrease in our lifestyle protection insurance business was attributable to a decrease in overall premium volumes driven by slower lending in Europe and our runoff block of business.
The increase in our international mortgage insurance business was primarily due to higher average invested assets in Australia and reinvestment of cash balances in Canada, partially offset by lower yields on assets acquired during the year.
Our international mortgage insurance business decreased $74 million and our lifestyle protection insurance business decreased $147 million.
The year ended December 31, 2010 included an increase of $37 million and a decrease of $3 million attributable to changes in foreign exchange rates for our international mortgage and lifestyle protection insurance businesses, respectively.
Our international mortgage insurance business increased $31 million and our lifestyle protection insurance business decreased $52 million.
The decrease in our lifestyle protection insurance business was largely attributable to a decrease in commissions related to a decline in new business. This decrease was partially offset by an increase in profit commissions driven by lower claims.
Our international mortgage insurance business increased $18 million and our lifestyle protection insurance business decreased $33 million.
The increase in our international mortgage insurance business was as a result of an increase in amortization of DAC from the seasoning of our in-force blocks of business.
Our international mortgage insurance business increased $7 million and our lifestyle protection insurance business increased $1 million.
The increase in our international mortgage insurance business was related to Canada from the issuance of debt by our majority-owned subsidiary in June and December 2010.
Provision for income taxes. The effective tax rate decreased to 24.2% for the year ended December 31, 2010 compared to 26.6% for the year ended December 31, 2009. This decrease in the effective tax rate was primarily attributable to a change in uncertain tax positions, the favorable impact of newly enacted Australian tax legislation and lower taxed foreign income in the current year. The year ended December 31, 2010 also included increases of $21 million and $1 million attributable to changes in foreign exchange rates for our international mortgage and lifestyle protection insurance businesses, respectively.
Net income attributable to noncontrolling interests. The increase related to the initial public offering of our Canadian mortgage insurance business in July 2009 which reduced our ownership percentage to 57.5%. The year ended December 31, 2010 included an increase of $13 million attributable to changes in foreign exchange rates.
The decrease in our lifestyle protection insurance business was primarily associated with an increase in claims particularly in Spain, Ireland and the United Kingdom as a result of slowing economic conditions. In addition, premiums were lower from reduced levels of consumer lending, lower single premium sales in the United Kingdom related to new business regulations and a slowing economic environment. However, in the fourth quarter of 2009, net operating income available to Genworth Financial, Inc.’s common stockholders was $23 million as new claim registrations continued to decline and we completed various re-pricing actions.
other terminations related to loss mitigation activities in Europe, particularly in Spain. Premiums also included $32 million related to a release of unearned premiums as a result of a quarterly actuarial update to the Canadian, Australian and European premium recognition factors in 2009 as compared to $53 million in 2008.
The decrease in our lifestyle protection insurance business was primarily attributable to reduced levels of consumer lending, lower single premium sales related to new business regulations in the United Kingdom and a slowing economic environment, primarily in Spain, Italy and Portugal. There was also a decrease from our runoff block of business related to lower cancellations in the current market environment. These decreases were partially offset by a favorable impact from our re-pricing actions taken in the second half of 2009.
The decrease in our lifestyle protection insurance business was principally attributable to lower yields as a result of holding higher cash balances and a decrease related to our reinsurance arrangements accounted for under the deposit method. In 2009, these arrangements were in a loss position and were reflected in interest expense.
The decrease in our international mortgage insurance business was primarily a result of the cancellation of our capital maintenance agreement with our U.S. mortgage insurance business and certain cost saving initiatives implemented in 2009. Additionally, in the fourth quarter of 2008, we recorded $6 million of non-operating expenses related to costs associated with the plan for workforce reduction and other restructuring actions that did not recur.
Our international mortgage insurance business increased $5 million and our lifestyle protection insurance business decreased $82 million.
Most of our international 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, 2010, our unearned premium reserves were $3.1 billion, including an increase of $0.2 billion attributable to changes in foreign exchange rates, compared to $3.1 billion as of December 31, 2009. Excluding the effects of foreign exchange, our unearned premium reserves decreased primarily related to seasoning of our in-force block of business.
Most of our international 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, 2009, our unearned premium reserves were $3.1 billion, including an increase of $521 million attributable to changes in foreign exchange rates, compared to $2.8 billion as of December 31, 2008. Excluding the effects of foreign exchange, our unearned premium reserves decreased primarily related to the recognition of premiums earned in 2009, lower net written premiums in Canada and loss mitigation activities in Europe.
Net premiums written decreased primarily driven by a decline in new insurance written in Canada and Australia. The decrease was partially offset by an increase in average price in Australia. The year ended December 31, 2009 included a decrease of $58 million attributable to changes in foreign exchange rates.
The increase in the expense ratio was primarily attributable to a decrease in net premiums written in Canada.
Risk in-force in all loan-to-value categories above 80.00% increased primarily as a result of flow new insurance written in Canada and Australia. Excluding the effects of foreign exchange, risk in-force in the 80.00% and below loan-to-value category decreased primarily from cancellations in Australia. Total risk in-force included an increase of $16.4 billion attributable to changes in foreign exchange rates as of December 31, 2010.
Our delinquency management process begins with notification by the loan servicer of a delinquency on an insured loan. “Delinquency” is defined in our master policies as the borrower’s failure to pay when due an amount equal to the scheduled monthly mortgage payment under the terms of the mortgage. Generally, the master policies require an insured to notify us of a delinquency no later than 30 days after the borrower has been in default by three monthly payments. We generally consider a loan to be delinquent and establish reserves if the borrower has failed to make a required mortgage payment. Borrowers default for a variety of reasons, including a reduction of income, unemployment, divorce, illness, inability to manage credit and interest rate levels. Borrowers may cure delinquencies by making all of the delinquent loan payments or by selling the property in full satisfaction of all amounts due under the mortgage. In most cases, delinquencies that are not cured result in a claim under our policy. The following table sets forth the number of loans insured, the number of delinquent loans and the delinquency rate for our international mortgage insurance portfolio as of December 31:
(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 3,376, 3,154 and 1,431 as of December 31, 2010, 2009 and 2008, respectively.
Flow loans in-force increased as a result of our continued growth in Canada, partially offset by our loss mitigation efforts in Europe. Bulk loans in-force increased primarily driven by new bulk sales in Mexico and Canada. Flow delinquent loans decreased primarily from our loss mitigation activities in Europe.
Gross written premiums, premium equivalents and deposits, gross of ceded reinsurance and cancellations, decreased mainly attributable to reduced levels of consumer lending. We sold our Mexico operations in the third quarter of 2009; therefore, there were no sales in 2010. The year ended December 31, 2010 included a decrease of $36 million attributable to changes in foreign exchange rates.
The decrease in net earned premiums was primarily attributable to a decrease in overall premium volumes driven by slower lending in Europe and our runoff business. The year ended December 31, 2010 included a decrease of $23 million attributable to changes in foreign exchange rates.
The decrease was primarily attributable to reduced levels of consumer lending, lower single premium sales related to new business regulations in the United Kingdom and a slowing economic environment, primarily in Spain, Italy and Portugal. There was also a decrease from our runoff block of business. These decreases were partially offset by a favorable impact from our re-pricing actions taken in the second half of 2009. The year ended December 31, 2009 included a decrease of $109 million attributable to changes in foreign exchange rates.
The decrease in net investment gains was primarily driven by lower gains on sales of investments from portfolio repositioning activities in the current year.
Benefits and other changes in policy reserves increased due to an increase in net paid claims of $193 million and a decrease in change in reserves of $94 million. The increase in net paid claims was principally attributable to higher claim counts within the 2006, 2007 and 2008 book years and continued aging of the delinquency inventory, partially offset by lower average claim payments reflecting lower loan balances.
The overall decrease in the change in loss reserves in the current year was driven by lower new delinquencies throughout 2010 and an overall decrease in expected claims since the fourth quarter of 2009 related to our loss mitigation efforts. In the third quarter of 2010, we strengthened reserves by $85 million principally related to Florida as opportunities to mitigate losses through loan modifications were reduced due to a higher level of later stage delinquencies and a larger base of investor-owned properties within the state of Florida as compared to our broader portfolio. In the fourth quarter of 2010, we strengthened reserves by $350 million mainly related to decreased loan modifications throughout all geographic regions of the country and increased foreclosure starts, particularly in Florida. Current claims experience within our portfolio indicated that decreased loan modifications were driven by underperforming loan servicers and increased foreclosures in Florida, California, Arizona and Nevada. This current experience within our portfolio accounted for approximately $150 million of reserve strengthening in the fourth quarter of 2010 and was based on reduced levels of loan modifications and increased foreclosure levels that we saw emerging during the fourth quarter of 2010. In addition, our expectations going forward are that loan modifications will continue trending downward and foreclosure levels will continue increasing beyond current levels. Consequently, these expectations going forward resulted in the additional reserve strengthening of approximately $200 million in the fourth quarter of 2010.
Benefits and other changes in reserves also included a reinsurance credit under certain of our captive reinsurance arrangements of $214 million and $275 million for the years ended December 31, 2010 and 2009, respectively. In the third quarter of 2009, we reached a settlement of arbitration proceedings with a lender regarding bulk transactions of $95 million, consisting of $203 million of paid claims and a decrease in reserves of $108 million that did not recur.
Insurance and investment product fees and other income decreased primarily from the cancellation in 2009 of our capital maintenance agreement with our European international mortgage insurance business and lower contract underwriting fees as a result of lower originations from tighter mortgage insurance guidelines and a weak housing market.
Primary insurance in-force and risk in-force decreased primarily as a result of rescission and other loss mitigation actions, including agreements with a counterparty that reduced our bulk risk in-force exposure. This decrease was partially offset by an increase in flow new insurance written from an increase in our mortgage insurance market share, partially offset and limited by tight domestic credit markets and lending guidelines, as well as a weak housing market and limited mortgage credit liquidity. Our flow persistency was 85% and 84% for the years ended December 31, 2010 and 2009, respectively.
In the third quarter of 2010, we strengthened reserves by $85 million principally related to Florida as opportunities to mitigate losses through loan modifications were reduced due to a higher level of later stage delinquencies and a larger base of investor-owned properties within the state of Florida as compared to our broader portfolio. In the fourth quarter of 2010, we strengthened reserves by $350 million mainly related to decreased loan modifications throughout all geographic regions of the country and increased foreclosure starts, particularly in Florida. Current claims experience within our portfolio indicated that decreased loan modifications were driven by underperforming loan servicers and increased foreclosures in Florida, California, Arizona and Nevada. This current experience within our portfolio accounted for approximately $150 million of reserve strengthening in the fourth quarter of 2010 and was based on reduced levels of loan modifications and increased foreclosure levels that we saw emerging during the fourth quarter of 2010. In addition, our expectations going forward are that loan modifications will continue trending downward and foreclosure levels will continue increasing beyond current levels. Consequently, these expectations going forward resulted in the additional reserve strengthening of approximately $200 million in the fourth quarter of 2010.
Delinquency and foreclosure levels that developed principally in our 2006, 2007 and 2008 book years have remained high as the United States continues to experience an economic recession and weakness in its housing markets. These trends continue to be especially evident in Florida, California, Arizona and Nevada, as well as in our A minus, Alt-A, ARMs and certain 100% loan-to-value products. However, we have seen delinquencies decrease in our primary insurance in-force since the fourth quarter of 2009 as a result of settlements reached with counterparties in 2010, as well as a decline in new flow delinquencies.
Primary insurance delinquency rates differ from region to region in the United States at any one time depending upon economic conditions and cyclical growth patterns. The tables below set forth our primary delinquency rates for the various regions of the United States and the ten largest states by our risk in-force and total reserves 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.
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, 2010:
Typically, claim activity is not spread evenly throughout the coverage period of a primary insurance book of business. Based upon our experience, the majority of claims on primary mortgage insurance loans occur in the third through seventh years after loan origination. Historically, few claims were paid during the first two years after loan origination. However, the pattern of claims frequency can be affected by factors such as deteriorating economic conditions that can result in increasing claims which was the case with our 2007 and 2006 books, but we expect the pattern of claims frequency within our 2009 book to return to that of a more traditional claim trend level. Primary insurance written for the period from January 1, 2003 through December 31, 2007 represented 58% of our primary insurance in-force as of December 31, 2010. Historically, traditional primary loans reach their expected peak claim level within a three- to seven-year period. Therefore, the primary loans written during the five-year period ended December 31, 2007, are now within or past their peak claim period. Our A minus and sub-prime loans continue to have earlier incidences of default than our prime loans. A minus and sub-prime loans represented 10% and 11% of our primary risk in-force as of December 31, 2010 and 2009, respectively.
Net investment income decreased primarily driven by lower investment income related to policy loans from a bankruptcy-related lapse in 2009 of a large group corporate-owned life insurance policy, lower yields on floating rate investments and a decline in average invested assets. Net investment income also included $3 million of higher losses related to limited partnership investments accounted for under the equity method in 2010. These decreases were partially offset by an increase in net investment income largely related to the consolidation of certain securitization entities as of January 1, 2010.
The effective tax rate increased to 63.5% for the year ended December 31, 2010 as compared to 35.5% for the year ended December 31, 2009 primarily related to the release of uncertain tax positions related to separation from our former parent company in relation to a pre-tax loss.
We recorded $208 million of net other-than-temporary impairments in 2010 as compared to $1,058 million in 2009. Of total impairments, $152 million and $578 million, respectively, related to structured securities, including $92 million and $414 million, respectively, related to sub-prime and Alt-A residential mortgage-backed and asset-backed securities for the years ended December 31, 2010 and 2009. Impairments related to corporate fixed maturity securities which were a result of bankruptcies, receivership or concerns about the issuer’s ability to continue to make contractual payments or intent to sell were $30 million in 2010 compared to $90 million in 2009. We also recorded $6 million and $323 million of impairments related to financial hybrid securities primarily from banks
in the United Kingdom, Ireland and the Netherlands during 2010 and 2009, respectively. We recorded $9 million of higher impairments related to limited partnership investments in 2010 compared to 2009. Additionally, we had $36 million of impairment related to a retained interest in securitized assets in 2009. Based on revised assumptions regarding cash flows from the assets underlying this securitization transaction, we concluded the value of our retained interest was zero and recognized the full impairment.
Net investment gains related to derivatives of $50 million in 2010 were primarily related to $37 million of gains from the change in value of the embedded derivative liabilities associated with our variable annuity products with GMWBs, which included a reduction in the GMWB valuation as a result of changes in the non-performance risk incorporated into the discount rate used to value GMWB embedded derivatives, exceeding the losses from the change in value of derivative instruments used for mitigating the risk of embedded derivative liabilities. The increase also included $13 million of gains from non-qualifying interest rate swaps, $7 million of gains from the change in value of our credit default swaps due to narrowing credit spreads and $4 million of gains related to a derivative strategy to mitigate the interest rate risk associated with our statutory capital position. These gains were partially offset by $11 million of losses associated with derivatives used to hedge foreign currency risk. Net investment gains of $21 million related to derivatives in 2009. These gains were primarily related to $97 million of gains in embedded derivative liabilities associated with our variable annuity products with GMWBs exceeding the change in value of derivative instruments used for mitigating this risk and $60 million of gains from credit default swaps utilized to improve our diversification and portfolio yield. These gains were partially offset by $98 million of losses related to a derivative strategy to mitigate the interest rate risk associated with our statutory capital position, $24 million of losses due to hedge ineffectiveness, $11 million of losses associated with inflation swaps related to hedges of securities with inflation adjusted yields and $3 million of other losses associated with non-qualifying hedges.
The aggregate fair value of securities sold at a loss during the years ended December 31, 2010 and 2009 was $1,932 million from the sale of 338 securities and $1,513 million from the sale of 328 securities, respectively, which was approximately 93% and 88%, respectively, of book value. The loss on sales of securities in the year ended December 31, 2010 was primarily driven by widening credit spreads. Generally, securities that are sold at a loss represent either small dollar amounts or percentage losses upon disposition. However, in certain circumstances, events may occur during the period that changed our intent to hold specific securities and thus result in our disposition of the security at a loss. Examples of these events include unforeseen issuer-specific events or conditions and shifts in risk or uncertainty of certain securities. Of the securities that were sold at a loss during the year ended December 31, 2010, the average period of time those securities had been continuously in an unrealized position was approximately 17 months. The securities sold at a loss during the year ended December 31, 2010 included one non-U.S. government security that was sold for a total loss of $7 million in the first quarter of 2010, one mortgage-backed security that was sold for a total loss of $4 million in the second quarter of 2010 related to portfolio repositioning activities, one U.S. corporate security, one municipal bond and one collateralized mortgage obligation security that were sold for total losses of $6 million, $6 million and $5 million, respectively, in the third quarter of 2010, and one asset-backed security that was sold for a total loss of $9 million in the fourth quarter of 2010. Of the securities that were sold at a loss during the year ended December 31, 2009, the average period of time those securities had been continuously in an unrealized position was approximately 11 months. The securities sold at a loss in 2009 included one in the financial services sector that was sold for a total loss of $49 million due to portfolio repositioning.
Net investment gains of $21 million related to derivatives in 2009. These gains were primarily related to $97 million of gains in embedded derivative liabilities associated with our variable annuity products with GMWBs exceeding the change in value of derivative instruments used for mitigating this risk and $60 million of gains from credit default swaps utilized to improve our diversification and portfolio yield. These gains were partially offset by $98 million of losses related to a derivative strategy to mitigate the interest rate risk associated with our statutory capital position, $24 million of losses due to hedge ineffectiveness, $11 million of losses associated with inflation swaps related to hedges of securities with inflation adjusted yields and $3 million of other losses associated with non-qualifying hedges. Net investment gains related to derivatives of $611 million in 2008 were primarily related to a derivative strategy to mitigate the interest rate risk associated with our statutory capital position, that were partially offset by the losses in embedded derivative liabilities associated with our variable annuity products with GMWBs exceeding the change in value of derivative instruments used for mitigating this risk.
We recorded $29 million of gains related to the sale of available-for-sale securities in 2009 compared to $117 million of losses related to the sale of available-for-sale securities in 2008. We also recorded $40 million of net investment losses related to the sale of limited partnerships in 2009.
(1) Fair value included $422 million collateralized by sub-prime residential mortgage loans and $369 million collateralized by Alt-A residential mortgage loans.
The fair value of our mortgage-backed and asset-backed securities collateralized by Alt-A residential mortgage loans by rating and vintage was as follows as of December 31, 2010:
The fair value of our mortgage-backed and asset-backed securities collateralized by Alt-A residential mortgage loans by rating and vintage was as follows as of December 31, 2009:
Gross unrealized losses in our sub-prime and Alt-A residential mortgage-backed and asset-backed securities as of December 31, 2010 were primarily a result of credit spreads that have widened since acquisition as a result of marketplace uncertainty arising from higher defaults in sub-prime and Alt-A residential mortgage loans, partially offset by lower asset balances. Our investments in sub-prime and Alt-A residential mortgage-backed and asset-backed securities increased primarily attributable to tightening credit spreads, partially offset by principal payment activity.
The fair value of our commercial mortgage-backed securities by rating and vintage was as follows as of December 31, 2009:
We diversify our commercial mortgage loans by property type and geographic region, as well as year of origination. See note 4 to our consolidated financial statements under “Item 8 - Financial Statements and Supplementary Data” for additional information on distribution across property type and geographic region for our commercial mortgage loans.
The following table sets forth additional information regarding our restricted commercial mortgage loans related to securitization entities as of December 31:
See note 18 to our consolidated financial statements under “Item 8 - Financial Statements and Supplementary Data” for additional information related to consolidated securitization entities.
The decrease in the notional value of derivatives was primarily attributable to a $2.5 billion notional decrease in interest rate swaps and swaptions related to a derivative strategy to mitigate interest rate risk associated with our statutory capital position, a $1.6 billion notional decrease in interest rate swaps and financial futures used to hedge liabilities related to our institutional products, a $1.4 billion notional decrease in non-qualifying financial futures used for duration management related to our long-term care insurance and deferred annuity products and a $1.0 billion notional decrease in derivatives used to hedge our variable annuity
Total liabilities. Total liabilities increased $2.6 billion from $94.8 billion as of December 31, 2009 to $97.4 billion as of December 31, 2010.
Our policyholder-related liabilities increased $0.1 billion largely attributable to an increase in reserves related to our long-term care insurance business from growth of our in-force block and higher claims. This increase was partially offset by a decrease in reserves associated with benefit payments and scheduled maturities of our spread-based and institutional products. Reserves in our U.S. mortgage insurance business remained relatively flat as higher paid claims were largely offset by increases in reserves during 2010. Unearned premiums decreased primarily in our lifestyle protection insurance business from a decline in sales.
Short-term borrowings decreased $0.9 billion from the repayment of our credit facilities in 2010.
Long-term borrowings increased $1.3 billion principally from the issuances of $0.8 billion of senior notes during 2010 and from the issuance of CAD$0.5 billion of senior notes by our majority-owned subsidiary, Genworth Canada, during 2010.
Separate account liabilities increased $0.7 billion primarily as a result of favorable market performance of the underlying securities.
Total stockholders’ equity. Total stockholders’ equity increased $1.6 billion from $13.4 billion as of December 31, 2009 to $15.0 billion as of December 31, 2010.
We recorded cumulative effect adjustments that reduced retained earnings by $0.3 billion with a partial offset to accumulated other comprehensive income (loss) of $0.3 billion related to the adoption of new accounting guidance in 2010. See note 2 to our consolidated financial statements under “Item 8 - Financial Statements and Supplementary Data” for additional information.
We had accumulated other comprehensive income of $1.5 billion as of December 31, 2010 compared to accumulated other comprehensive loss of $0.2 billion as of December 31, 2009. This change was mainly driven by improved market performance during 2010 resulting in a decrease of $1.3 billion in net unrealized investment losses.
Our principal sources of cash include sales of our products and services, income from our investment portfolio and proceeds from sales of investments. As an insurance business, we typically generate positive cash flows from operating activities, as premiums collected from our insurance products and income received from our investments exceed policy acquisition costs, benefits paid, redemptions and operating expenses. These positive cash flows are then invested to support the obligations of our insurance and investment products and required capital supporting these products. Our cash flows from operating activities are affected by the timing of premiums, fees and investment income received and benefits and expenses paid. The decrease in cash inflows from operating activities for the year ended December 31, 2010 compared to the year ended December 31, 2009 was primarily as a result of higher paid claims in our U.S. mortgage insurance business, including settlements that were paid in 2010 and higher tax settlements, partially offset by an increase associated with the timing of payments related to other liabilities and policy-related balances.
In the United States and Canada, we engage in certain securities lending transactions for the purpose of enhancing the yield on our investment securities portfolio, which require the borrower to provide collateral, consisting of cash and government securities, on a daily basis in amounts equal to or exceeding 102% in the United States and 105% in Canada of the fair value of the applicable securities loaned. We maintain effective control over all loaned securities and, therefore, continue to report such securities as fixed maturity securities on the consolidated balance sheets. Cash and non-cash collateral, such as a security, received by us on securities lending transactions is reflected in other invested assets with an offsetting liability recognized in other liabilities for the obligation to return the collateral. Any cash collateral received is reinvested by our custodian based upon the investment guidelines provided within our agreement. In the United States, the reinvested cash collateral is primarily invested in a money market fund approved by the NAIC, U.S. and foreign government securities, U.S. government agency securities, asset-backed securities and corporate debt securities. 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. We are currently fully indemnified against counterparty credit risk by the intermediary. As of December 31, 2010 and 2009, the fair value of securities loaned under the securities lending program was $0.8 billion and $0.9 billion, respectively, consisting of $0.5 billion and $0.6 billion, respectively, in the United States and $0.3 billion in both years in Canada. As of December 31, 2010 and 2009, the fair value of collateral held under the securities lending program was $0.8 billion and $0.9 billion, respectively, and the offsetting obligation to return collateral of $0.8 billion and $0.9 billion, respectively, was included in other liabilities in the consolidated balance sheets. We had non-cash collateral of $0.3 billion as of December 31, 2010 and 2009.
In connection with our IPO, we entered into a Tax Matters Agreement with GE, which represents an obligation by us to GE. The balance of this obligation was $339 million as of December 31, 2010.
Cash flows from investing activities are principally affected by the capital contributions paid to subsidiaries and investment activity. During 2010, we made $203 million of capital contributions to our subsidiaries as compared to $97 million in 2009. During 2010, we purchased approximately $200 million of highly liquid securities. There was no significant investing activity in 2009.
Our insurance subsidiaries maintain investment strategies intended to provide adequate funds to pay benefits without forced sales of investments. Products having liabilities with longer durations, such as certain life insurance and long-term care insurance policies, are matched with investments having similar estimated lives such as long-term fixed maturity securities and commercial mortgage loans. Shorter-term liabilities are matched with fixed maturity securities that have short- and medium-term fixed maturities. In addition, our insurance subsidiaries hold highly liquid, high quality short-term investment securities and other liquid investment grade fixed maturity securities to fund anticipated operating expenses, surrenders and withdrawals. As of December 31, 2010, our total cash, cash equivalents and invested assets were $71.6 billion. Our investments in privately placed fixed maturity securities, commercial mortgage loans, policy loans, limited partnership investments and select mortgage-backed and asset-backed securities are relatively illiquid. These asset classes represented approximately 31% of the carrying value of our total cash, cash equivalents and invested assets as of December 31, 2010.
All of our life insurance subsidiaries have RBC ratios that exceed the minimum levels required by applicable insurance regulations.
As of January 31, 2011, our primary U.S. mortgage insurance subsidiary, GEMICO, slightly exceeded the 25:1 risk-to-capital requirement. However, GEMICO was granted a revocable two-year risk-to-capital waiver, effective January 31, 2011, by the NCDOI. The waiver, which the NCDOI can modify or terminate at its discretion, gives GEMICO the ability to continue to write new business in North Carolina during the period covered by the waiver, notwithstanding that GEMICO’s risk-to-capital ratio exceeds 25:1. Given that the NCDOI is GEMICO’s domiciliary insurance regulator, the effect of the waiver similarly extends to the 34 states that do not have their own risk-to-capital requirements, thereby enabling GEMICO to continue to write business in those states so long as it is permitted to do so in North Carolina under the NCDOI’s waiver or because its risk-to-capital ratio decreases below 25:1. Further, so as to be able to write new business out of GEMICO in the remaining states which do have separate minimum risk-to-capital requirements, we are also pursuing similar waivers of the risk-to-capital requirement with other state regulators where the authority to grant a waiver exists. In addition to the NCDOI’s waiver, to date, four states have granted us the authority to continue to write business in their state either by a waiver or an administrative no action letter. Consequently, while we seek additional state waivers, GEMICO remains authorized to write new business in 39 states. At the same time, in order to separately provide us with flexibility to write new business, we are pursuing other actions such as reinsurance through one of our mortgage affiliates or positioning another one of our U.S. mortgage insurance subsidiaries to write new business.
As of December 31, 2010, we had approximately $538 million of GICs outstanding. Substantially all of these contracts allow for the payment of benefits at contract value to ERISA plans prior to contract maturity in the event of death, disability, retirement or change in investment election. These contracts also provide for early termination by the contractholder but are subject to an adjustment to the contract value for changes in the level of interest rates from the time the GIC was issued plus an early withdrawal penalty. We carefully underwrite these risks before issuing a GIC to a plan and historically have been able to effectively manage our exposure to these benefit payments. Our GICs typically credit interest at a fixed interest rate and have a fixed maturity generally ranging from two to six years.
FSB”) had committed $70 million under the May 2012 credit facility. On October 5, 2008, LCP filed for protection under Chapter 11 of the Federal Bankruptcy Code in the U.S. Bankruptcy Court for the Southern District of New York. LCP was unable to fulfill its commitments under the August 2012 credit facility and Lehman FSB declined to fulfill its commitment under the May 2012 credit facility. On April 1, 2010, a consent and waiver agreement was entered into which releases the Lehman Brothers-related entities from their commitments under the facilities and reduces the remaining commitments by those respective amounts. Therefore, as of December 31, 2010, we had access to $1.9 billion under these facilities.
As of December 31, 2010, we have an unused credit capacity under our revolving credit facilities of $1.8 billion. These two facilities contain minimum consolidated net worth requirements. Consolidated net worth, as defined in these agreements, means all amounts that would be included on a consolidated balance sheet of the borrower and its subsidiaries under stockholders’ equity, excluding accumulated other comprehensive income (loss).
In June 2010, our majority-owned subsidiary, Genworth Canada, issued CAD$275 million of 5.68% senior notes due 2020. The net proceeds of the offering were used to fund transactions among Genworth Canada and its
Canadian wholly-owned subsidiaries. Genworth Canada used the proceeds it received from such transactions for general corporate and investment purposes and to fund a repurchase of common shares from Genworth Canada’s shareholders.
In August 2010, Genworth Canada repurchased 12.3 million common shares for CAD$325 million through a substantial issuer bid. Brookfield Life Assurance Company Limited, our wholly-owned subsidiary and majority shareholder of Genworth Canada, participated in the issuer bid by making a proportionate tender and received CAD$187 million and continues to hold approximately 57.5% of the outstanding common shares of Genworth Canada.
During 2009, we repurchased principal of $128 million of our 5.65% senior notes that mature in June 2012, plus accrued interest, including $55 million in the fourth quarter of 2009. During the second quarter of 2009, we repaid principal of $329 million of our 5.23% senior notes that matured in May 2009, plus accrued interest. During the first quarter of 2009, we repurchased principal of $79 million of our 4.75% senior notes, plus accrued interest, and we repaid the remaining principal of $331 million that matured in June 2009, plus accrued interest. We have no debt maturing until mid-2011.
(1) Includes payments of principal and interest on our long-term borrowings, non-recourse funding obligations, and dividend payments on our mandatorily redeemable Series A Preferred Stock, as described in note 13 to our consolidated financial statements under “Item 8 - Financial Statements and Supplementary Data.” For our U.S. domiciled insurance companies, any payment of principal, including by redemption, or interest on our non-recourse funding obligations are subject to regulatory approval. River Lake Insurance Company IV Limited, a Bermuda domiciled insurance company, may repay principal of up to 15% of its capital without prior approval. The total amount for borrowings and interest in this table does not equal the amounts on our consolidated balance sheet due to interest included in the table that is expected to be payable in future years. In addition, the total amount does not include borrowings related to securitization entities. See note 18 to our consolidated financial statements under “Item 8 - Financial Statements and Supplementary Data” for information related to the timing of payments and the maturity dates of these borrowings.
(3) The timing for the return of the collateral associated with our securities lending program is uncertain; therefore, the return of collateral is reflected as being due in 2011.
(5) Includes estimated claim and benefit, policy surrender and commission obligations offset by expected future deposits and premiums on in-force insurance policies and investment contracts. Also includes amounts established for recourse and indemnification related to our U.S. mortgage insurance contract underwriting business. Estimated claim and benefit obligations are based on mortality, morbidity and lapse assumptions comparable with our historical experience. The obligations in this table have not been discounted at present value. In contrast to this table, our obligations reported in our consolidated balance sheet are recorded in accordance with U.S. GAAP where the liabilities are discounted consistent with the present value concept
Financial support for certain securitization entities was provided under credit support agreements that remain in place throughout the life of the related entities. As of December 31, 2009, we provided limited recourse for a maximum of $117 million of credit losses. Assets with credit support were funded by demand notes that were further enhanced with support provided by a third party. In 2009, we paid $1 million associated with these arrangements. In 2010, no amounts were paid associated with these arrangements. During the fourth quarter of 2010, one of the securitization entities that was covered under a credit support agreement was terminated upon final payments made by the structure. Therefore, as of December 31, 2010, we provided limited recourse for a maximum of $40 million of credit losses related to one of our commercial mortgage loan entities that was required to be consolidated with assets of $115 million as of December 31, 2010. There were no amounts recorded for these limited recourse liabilities as of December 31, 2010 and 2009.
In general, our business as a whole is not seasonal in nature. However, in our U.S. Mortgage Insurance segment, the level of delinquencies, which increases the likelihood of losses, generally tends to decrease in mid-first quarter and continue through second quarter while increasing in the third and fourth quarters of the calendar year. As a result, we typically experience lower levels of losses resulting from delinquencies in the first and second quarters, as compared with those in the third and fourth quarters. However, as a result of the downturn in the U.S. housing market that began in 2008, delinquencies were higher in the first and second quarters of 2010. As the U.S. housing market is beginning to show signs of stabilization, delinquencies have been trending downward; however, we may continue to see higher than usual delinquencies until the housing market returns to a more normal development pattern. See “-Business trends and conditions” for additional information related to our U.S. Mortgage Insurance segment.
Consolidated Statements of Changes in Stockholders’ Equity for the years ended December 31, 2010, 2009 and 2008
We have audited the accompanying consolidated balance sheets of Genworth Financial, Inc. (the Company) as of December 31, 2010 and 2009, and the related consolidated statements of income, changes in stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2010. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Genworth Financial, Inc. as of December 31, 2010 and 2009, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2010, in conformity with U.S. generally accepted accounting principles.
As discussed in note 2 to the consolidated financial statements, the Company changed its method of accounting for embedded credit derivatives and variable interest entities in 2010 and for other-than-temporary impairments in 2009.
Retirement and Protection. We offer and manage a variety of protection, wealth management and retirement income products. Our primary protection products include life and long-term care insurance. Additionally, we offer other Medicare supplement insurance products, as well as care coordination services for our long-term care policyholders. Our wealth management and retirement income products include: a variety of managed account programs and advisor services, financial planning services, fixed and variable deferred and immediate individual annuities and group variable annuities offered through retirement plans.
In January 2011, we announced we are discontinuing new sales of retail and group variable annuities while continuing to service our existing blocks of business. However, we will continue to offer fixed annuities.
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.
Investment income is recognized when earned. Income or losses upon call or prepayment of available-for-sale fixed maturity securities is recognized in net investment income, except for hybrid securities where the income or loss upon call is recognized in net investment gains and losses. Investment gains and losses are calculated on the basis of specific identification.
As of each balance sheet date, we evaluate securities in an unrealized loss position for other-than-temporary impairments. For debt securities, we consider all available information relevant to the collectability of the security, including information about past events, current conditions, and reasonable and supportable forecasts, when developing the estimate of cash flows expected to be collected. More specifically for mortgage-backed and asset-backed securities, we also utilize performance indicators of the underlying assets including default or delinquency rates, loan to collateral value ratios, third-party credit enhancements, current levels of subordination, vintage and other relevant characteristics of the security or underlying assets to develop our estimate of cash flows. Estimating the cash flows expected to be collected is a quantitative and qualitative process that incorporates information received from third-party sources along with certain internal assumptions and judgments regarding the future performance of the underlying collateral. Where possible, this data is benchmarked against third-party sources.
For commercial mortgage loans classified as held-for-sale, each loan is carried at the lower of cost or market and is included in commercial mortgage loans in our consolidated balance sheets. See note 4 for additional disclosures related to commercial mortgage loans.
lending program was $0.8 billion and $0.9 billion, respectively, consisting of $0.5 billion and $0.6 billion, respectively, in the United States and $0.3 billion and $0.3 billion, respectively, in Canada. As of December 31, 2010 and 2009, the fair value of collateral held under the securities lending program was $0.8 billion and $0.9 billion, respectively, and the offsetting obligation to return collateral of $0.8 billion and $0.9 billion, respectively, was included in other liabilities in the consolidated balance sheets. We had non-cash collateral of $0.3 billion as of December 31, 2010 and 2009.
We also have a repurchase program in which we sell an investment security at a specified price and agree to repurchase that security at another specified price at a later date. Repurchase agreements are treated as collateralized financing transactions and are carried at the amounts at which the securities will be subsequently reacquired, including accrued interest, as specified in the respective agreement. The market value of securities to be repurchased is monitored and collateral levels are adjusted where appropriate to protect the counterparty against credit exposure. Cash received is invested in fixed maturity securities. As of December 31, 2010 and 2009, the fair value of securities pledged under the repurchase program was $1.7 billion and $2.1 billion, respectively, and the repurchase obligation of $1.7 billion and $2.1 billion, respectively, was included in other liabilities in the consolidated balance sheets.
The determination of fair value for our reporting units is primarily based on an income approach whereby we use discounted cash flows for each reporting unit. When available and as appropriate, we use market
approaches or other valuation techniques to corroborate discounted cash flow results. The discounted cash flow model used for each reporting unit is based on either: operating income or statutory distributable income, depending on the reporting unit being valued.
For all qualifying and highly effective fair value hedges, the changes in fair value of the derivative instrument are reported in income. In addition, changes in fair value attributable to the hedged portion of the underlying instrument are reported in income. When hedge accounting is discontinued because it is determined that the derivative no longer qualifies as an effective fair value hedge, the derivative continues to be carried in the consolidated balance sheets at its fair value, but the hedged asset or liability will no longer be adjusted for changes in fair value. In all other situations in which hedge accounting is discontinued, the derivative is carried at its fair value in the consolidated balance sheets, with changes in its fair value recognized in the current period as income.
On January 1, 2010, we were required to consolidate certain VIEs. See note 18 for additional information related to these consolidated entities. As of December 31, 2009, we were not required to consolidate any VIEs where there were third-party beneficial interest holders.
The new accounting guidance related to consolidation of VIEs has been deferred for a reporting entity’s interest in an entity that has all of the attributes of an investment company as long as there is no implicit or explicit obligation to fund losses of the entity. For entities that meet these criteria, the new accounting guidance related to VIE consolidation would not be applicable until further guidance is issued. Accordingly, we did not have any impact upon adoption related to entities that meet the deferral criteria, such as certain limited partnership and fund investments.
On January 1, 2009, we adopted new accounting guidance related to noncontrolling interests in consolidated financial statements. This accounting guidance established accounting and reporting standards for noncontrolling interests in a subsidiary and for deconsolidation of a subsidiary. The adoption of this new accounting guidance did not have a material impact on our consolidated financial statements.
On December 31, 2008, we adopted new accounting guidance related to disclosures by public entities about transfers of financial assets and interests in VIEs. This new accounting guidance amends the disclosure requirements regarding transfers of financial assets and involvement in VIEs to require additional disclosures for public entities. The adoption of this new accounting guidance did not have a material impact on our consolidated financial statements.
On January 1, 2008, we adopted new accounting guidance related to the fair value option for financial assets and financial liabilities. This accounting guidance provides an option, on specified election dates, to report
On January 1, 2008, we adopted new accounting guidance for offsetting of amounts related to certain contracts. This accounting guidance allows fair value amounts recognized for collateral to be offset against fair value amounts recognized for derivative instruments that are executed with the same counterparty under certain circumstances. It also requires an entity to disclose the accounting policy decision to offset, or not to offset, fair value amounts. We do not, and have not previously, offset the fair value amounts recognized for derivatives with the amounts recognized as collateral.
In December 2010, the FASB issued new accounting guidance related to goodwill impairment testing when a reporting unit’s carrying value is zero or negative. This new accounting guidance will be effective for us on January 1, 2011. This guidance did not impact our consolidated financial statements upon adoption, as all of our reporting units with goodwill balances have positive carrying values.
In January 2010, the FASB issued new accounting guidance to require additional disclosures about purchases, sales, issuances and settlements in the rollforward of Level 3 fair value measurements. This new accounting guidance will be effective for us on January 1, 2011. The adoption of this new accounting guidance did not have a material impact on our consolidated financial statements.
The following table presents the weighted-average shares used in calculating basic earnings per common share and those used in calculating diluted earnings per common share for each income category presented below for the years ended December 31:
We generally intend to hold securities in unrealized loss positions until they recover. However, from time to time, our intent on an individual security may change, based upon market or other unforeseen developments. In such instances, we sell securities in the ordinary course of managing our portfolio to meet diversification, credit quality, yield and liquidity requirements. If a loss is recognized from a sale subsequent to a balance sheet date due to these unexpected developments, the loss is recognized in the period in which we determined that we have the intent to sell the securities or it is more likely than not that we will be required to sell the securities prior to recovery. The aggregate fair value of securities sold at a loss during the years ended December 31, 2010, 2009 and 2008 was $1,932 million, $1,513 million and $2,285 million, respectively, which was approximately 93%, 88% and 93%, respectively, of book value.
Net unrealized gains and losses on available-for-sale investment securities reflected as a separate component of accumulated other comprehensive income (loss) were as follows as of December 31:
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, 2010:
The securities less than 20% below cost were primarily attributable to credit spreads that have widened since acquisition for certain mortgage-backed and asset-backed securities and corporate securities in the finance and insurance sector.
The following table presents the concentration of gross unrealized losses by sector as of December 31, 2010:
Despite the considerable analysis and rigor employed on our structured securities, it is at least reasonably possible that the underlying collateral of these investments will perform worse than current market expectations. Such events may lead to adverse changes in cash flows on our holdings of asset-backed and mortgage-backed securities and potential future write-downs within our portfolio of mortgage-backed and asset-backed securities. We expect our investments in corporate securities will continue to perform in accordance with our conclusions about the amount and timing of estimated cash flows. Although we do not anticipate such events, it is at least reasonably possible that issuers of our investments in corporate securities will perform worse than current expectations. Such events may lead us to recognize potential future write-downs within our portfolio of corporate securities.
The following table presents the concentration of gross unrealized losses related to corporate debt and equity securities by industry as of December 31, 2010:
A portion of the unrealized losses in the finance and insurance sector included debt securities where an other-than-temporary impairment was recorded in OCI. Given the current market conditions, including current financial industry events and uncertainty around global economic conditions, the fair value of these debt securities has declined due to credit spreads that have widened since acquisition. In our examination of these
securities, we considered all available evidence, including the issuers’ financial condition and current industry events to develop our conclusion on the amount and timing of the cash flows expected to be collected. Based on this evaluation, we determined that the unrealized losses on these debt securities represented temporary impairments as of December 31, 2010. A subset of the securities issued by banks and other financial institutions represent investments in financial hybrid securities on which a debt impairment model was employed. Most of these hybrid securities retain a credit rating of investment grade. The majority of these securities were issued by foreign financial institutions. The fair value of these hybrid securities has been impacted by credit spreads that have widened since acquisition and reflect uncertainty surrounding the extent and duration of government involvement, potential capital restructuring of these institutions, and continued but diminishing risk that income payments may be deferred.
The scheduled maturity distribution of fixed maturity securities as of December 31, 2010 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.
As of December 31, 2010, $4,658 million of our investments (excluding mortgage and asset-backed securities) were subject to certain call provisions.
As of December 31, 2010 and 2009, $857 million and $727 million, respectively, of securities were on deposit with various state or foreign government insurance departments in order to comply with relevant insurance regulations.
(1) Included held-for-sale mortgage loans of $17 million as of December 31, 2009. The held-for-sale mortgage loans as of December 31, 2009 represented interests in reverse mortgage loans. In the first quarter of 2010, we began reporting held-for-sale reverse mortgages in other invested assets.
The following table sets forth the aging of past due commercial mortgage loans by property type as of December 31, 2010:
The following table sets forth impaired commercial mortgage loans by property type as of December 31, 2010:
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 mortgages 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. A higher debt service coverage ratio indicates the borrower is less likely to default on the loan. The debt service coverage ratio should not be 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. 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 following table sets forth the debt service coverage ratio for fixed rate commercial mortgage loans by property type as of December 31, 2010:
The following table sets forth the debt service coverage ratio for floating rate commercial mortgage loans by property type as of December 31, 2010:
(1) Debt service coverage ratio is based on “normalized” annual net operating income of the property compared to the payments required under the terms of the loan. This ratio is evaluated at least annually and updated more frequently if necessary to better indicate risk associated with 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).
In evaluating the credit quality of restricted commercial mortgage loans, we assess the performance of the underlying loans using both quantitative and qualitative criteria. The risks associated with restricted commercial mortgage loans can typically 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. A higher debt service coverage ratio indicates the borrower is less likely to default on the loan. The debt service coverage ratio should not be 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. 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 following table sets forth the average loan-to-value of restricted commercial mortgage loans by property type as of December 31, 2010:
(2) Debt service coverage ratio is based on “normalized” annual net operating 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.
The following table sets forth the debt service coverage ratio for fixed rate restricted commercial mortgage loans by property type as of December 31, 2010:
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 prohibition 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 both cash flow and fair value hedges.
The fair value of derivative positions presented above was not offset by the respective collateral amounts retained or provided under these agreements. The amounts recognized for derivative counterparty collateral retained by us was recorded in other invested assets with a corresponding amount recorded in other liabilities to represent our obligation to return the collateral retained by us.
Approximately $1.1 billion of notional value above is related to derivatives with counterparties that can be terminated at the option of the derivative counterparty and represented a net fair value asset of $209 million as of December 31, 2010.
(1) Amounts included $7 million of losses reclassified into net income (loss) for cash flow hedges that were terminated or de-designated where the effective portion is reclassified into net income (loss) when the underlying hedge item affects net income (loss).
(2) Represents ineffective portion of cash flow hedges, as there were no amounts excluded from the measurement of effectiveness.
For the year ended December 31, 2008, there was $25 million of ineffectiveness related to our cash flow hedges and there were no amounts excluded from the measure of effectiveness.
of occurring. During 2008, we terminated a large portion of our forward starting interest rate swaps, which were designated as cash flow hedges, related to our long-term care insurance business to reduce our counterparty credit exposure and increase liquidity. The respective balance in OCI related to these derivatives will be reclassified into net income (loss) when the forecasted transactions affect net income (loss), as the forecasted transactions are still probable of occurring.
Certain derivative instruments are designated as fair value hedges. The changes in fair value of these instruments are recorded in net income (loss). In addition, changes in the fair value attributable to the hedged portion of the underlying instrument are reported in net income (loss). We designate and account for the following as fair value hedges when they have met the effectiveness requirements: (i) interest rate swaps to convert fixed rate investments to floating rate investments; (ii) interest rate swaps to convert fixed rate liabilities into floating rate liabilities; (iii) cross currency swaps to convert non-U.S. dollar fixed rate liabilities to floating rate U.S. dollar liabilities; and (iv) other instruments to hedge various fair value exposures of investments.
The following table provides information about the pre-tax income (loss) effects of fair value hedges and related hedged items for the year ended December 31, 2010:
We also enter into certain non-qualifying derivative instruments such as: (i) interest rate swaps, swaptions and financial futures to mitigate interest rate risk as part of managing regulatory capital positions; (ii) credit default swaps to enhance yield and reproduce characteristics of investments with similar terms and credit risk; (iii) equity index options, equity return swaps, interest rate swaps and financial futures to mitigate the risks associated with liabilities that have guaranteed minimum benefits; (iv) interest rate swaps where the hedging relationship does not qualify for hedge accounting; (v) credit default swaps to mitigate loss exposure to certain credit risk; and (vi) foreign currency forward contracts to mitigate certain currency risk. Additionally, we provide GMWBs on certain products that are required to be bifurcated as embedded derivatives and have reinsurance agreements with certain features that are required to be bifurcated as embedded derivatives.
As of December 31, 2010 and 2009, net fair value assets by counterparty totaled $888 million and $739 million, respectively. As of December 31, 2010 and 2009, net fair value liabilities by counterparty totaled $172 million and $74 million, respectively. As of December 31, 2010 and 2009, we retained collateral of $794 million and $647 million, respectively, related to these agreements, including over collateralization of $29 million and $10 million, respectively, from certain counterparties. As of December 31, 2010 and 2009, we posted $30 million and $121 million, respectively, of collateral to derivative counterparties, including over collateralization of $11 million and $46 million, respectively. For derivatives related to securitization entities, there are no arrangements that require either party to provide collateral and the recourse of the derivative counterparty is typically limited to the assets held by the securitization entity and there is no recourse to any entity other than the securitization entity.
The following table sets forth our credit default swaps where we sell protection on credit default swap index tranches and the fair values as of December 31:
(2) The amounts in 2009 related to certain VIEs that were consolidated on January 1, 2010. See note 18 for additional information related to consolidated securitization entities.
(1) On July 1, 2010, we adopted a new accounting standard related to embedded credit derivatives. The adoption of this standard had a net unfavorable impact of $3 million on DAC.
(2) On April 1, 2009, we adopted a new accounting standard related to the recognition of other-than-temporary impairments. The adoption of this standard had a net favorable impact of $7 million on DAC.
(1) On April 1, 2009, we adopted a new accounting standard related to the recognition of other-than-temporary impairments. The adoption of this standard had a net favorable impact of $2 million on PVFP.
(3) The transfer related to goodwill previously allocated to our corporate-owned life insurance product that we began reporting in Corporate and Other activities in 2009. In 2010, it was determined that $17 million of goodwill should have remained in our Retirement and Protection segment.
During 2008, as a result of our goodwill analyses, we recorded goodwill impairments related to our U.S. mortgage insurance, institutional and retirement income reporting units of $277 million, as discussed further below.
Retirement income reporting unit (included in our Retirement and Protection segment). As a result of declining equity market conditions, expected near term industry growth and our refined sales strategy in 2008, the fair value determined using a discounted cash flow model decreased and resulted in an impairment of the entire goodwill balance of $243 million in the fourth quarter of 2008.
automobile, property and casualty, life and personal accident insurance business lines that Seguros distributed through independent professional insurance agents. The net cash proceeds of $38 million were received on October 1, 2009. As of December 31, 2009, we recorded a receivable for contingent consideration of $8 million in the consolidated balance sheet. The sale resulted in an after-tax gain of $4 million.
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 had pledged fixed maturity securities and commercial mortgage loans of $7,646 million and $822 million, respectively, as of December 31, 2010 and $7,133 million and $873 million, respectively, as of December 31, 2009 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.
(c) Principally modifications of the 1965-70 or 1975-80 Select and Ultimate Tables, 1941, 1958, 1980 and 2001 Commissioner’s Standard Ordinary Tables, 1980 Commissioner’s Extended Term table and (IA) Standard Table 1996 (modified).
2009 which was included in equity securities. We issued funding agreements to the FHLB and have letters of credit with the FHLB which have not been drawn upon. The FHLB has been granted a lien on certain of our invested assets to collateralize our obligations; 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. Upon any event of default by us, the FHLB recovery on the collateral is limited to the amount of our funding agreement liabilities to the FHLB. The amount of funding agreements issued to the FHLB was $633 million and $140 million, respectively, as of December 31, 2010 and 2009, which was included in policyholder account balances. We had letters of credit related to the FHLB of $462 million and $341 million as of December 31, 2010 and 2009, respectively. These funding agreements and letters of credit were collateralized by fixed maturity securities with a fair value of $1,233 million as of December 31, 2010 and by fixed maturity securities of $573 million and cash of $63 million as of December 31, 2009.
(1) Current year reserves related to our U.S. Mortgage Insurance segment for the year ended December 31, 2010 were reduced by loss mitigation activities of $194 million, including $186 million related to workouts, loan modifications and pre-sales, and $8 million related to rescissions, net of reinstatements. Loss mitigation actions related to prior year delinquencies resulted in a reduction of expected losses of $540 million to date, including $390 million related to workouts, loan modifications and pre-sales, and $150 million related to rescissions, net of reinstatements of $175 million.
(3) Relates to the sale of one of our Mexican subsidiaries in 2009. See note 8 for additional information regarding the sale.
For 2010, the increase in the ending liability for policy and contract claims was primarily related to our long-term care insurance business as a result of the aging of existing claims coupled with emerging claim experience. Our ending liability for policy and contract claims related to our U.S. Mortgage Insurance segment as of December 31, 2010 remained relatively flat as the increase in reserves during the year were largely offset by paid claims.
During 2010, 2009 and 2008, we strengthened reserves by $799 million, $421 million and $514 million, respectively, as a result of changes in estimates related to prior year insured events and the development of information and trends not previously known when establishing the reserves in prior periods.
In 2010, we increased prior year reserves in our U.S. Mortgage Insurance segment by $514 million from $2,289 million as of December 31, 2009. As part of our reserving methodology, we estimate the number of loans in our delinquent loan inventory that we expect to be rescinded or modified over time as part of our loss mitigation activities, as well as estimates of the number of loans for which coverage may be reinstated under certain conditions following a rescission or modification action. The strengthening of reserves in 2010, particularly in the second half of 2010, related to a more significant decline in expected benefits from our loss mitigation activities than we had estimated at the end of 2009. Underperforming loan servicers and government programs contributed to higher foreclosure levels than expected that resulted in the continued aging of the delinquent loan inventory and thus reduced our benefits related to loan modifications. In our U.S. Mortgage Insurance segment, loss mitigation actions that occurred during 2010 resulted in a reduction of expected losses of $734 million.
In 2009, we strengthened claims reserves related to our long-term care insurance business by $211 million from $2,791 million as of December 31, 2008. Consistent with our reserving methodology, the strengthening includes a reclassification from future policy benefit reserves, which includes a provision for expected claims
employee’s age, service and eligible pay. Employees are vested in the plan after three years of service. In addition, certain company employees also participate in non-qualified defined contribution plans and in qualified and non-qualified defined benefit pension plans. The plan assets, projected benefit obligation and accumulated benefit obligation liabilities of these defined benefit pension plans were not material to our consolidated financial statements individually or in the aggregate. As of December 31, 2010 and 2009, we recorded a liability related to these benefits of $39 million and $40 million, respectively. During 2010, we recognized an increase in OCI of less than $1 million. During 2009, we recognized a reduction in OCI of $18 million.
We provide health and welfare benefits to our employees, including health, life, disability, dental and long-term care insurance. Our long-term care insurance is provided through our group long-term care insurance business. The premiums recorded by these businesses related to these benefits were insignificant during 2010, 2009 and 2008.
We repaid all outstanding borrowings under our credit facilities during 2010; however, we utilized $56 million under these facilities primarily for the issuance of letters of credit for the benefit of one of our lifestyle protection insurance subsidiaries as of December 31, 2010. In June 2010, we repaid $100 million of outstanding borrowings under each of our five-year revolving credit facilities using the net proceeds from our senior notes offering that was completed in June 2010. In November 2010, we repaid $125 million of outstanding borrowings under each of our five-year revolving credit facilities with cash on hand. The remaining outstanding borrowings of $240 million under each of our five-year revolving credit facilities were repaid with net proceeds from our senior notes offering that was completed in November 2010, together with cash on hand. As of December 31, 2009, we had borrowings of $930 million under these facilities, and we utilized $407 million under these facilities for the issuance of letters of credit for the benefit of one of our life insurance subsidiaries.
In June 2004, we issued senior notes having an aggregate principal amount of $1.9 billion. As a result of hedging arrangements entered into with respect to these securities, our effective interest rates were 4.48% on the 2009 Notes and will be 5.51% on the 2014 Notes and 6.35% on the 2034 Notes. These Notes are direct unsecured obligations and will rank without preference or priority among themselves and equally with all of our existing and future unsecured and unsubordinated obligations. We have the option to redeem all or a portion of the 2014 Notes and the 2034 Notes at any time with proper notice to the note holders at a price equal to the greater of 100% of principal or the sum of the present values of the remaining scheduled payments of principal and interest discounted at the then-current treasury rate plus an applicable spread.
In June 2001, GEFAHI issued ¥60.0 billion of senior notes through a public offering at a price of ¥59.9 billion. ¥3.0 billion of the notes were retired during 2004. We entered into arrangements to swap our obligations under these notes to a U.S. dollar obligation with a notional principal amount of $491 million and bearing interest at a rate of 4.84% per annum. The notes are unsecured and mature at par in 2011. We assumed this obligation under these notes in 2004 in connection with our corporation formation and IPO.
The lower level of pre-tax income in 2010 magnified the impact of increases (reductions) in the effective tax rate.
In connection with our 2004 separation from our former parent, GE, we made certain joint tax elections and realized certain tax benefits. During 2010, the Internal Revenue Service (“IRS”) completed an examination of GE’s 2004 tax return, including these tax impacts. Therefore, $106 million of previously uncertain tax benefits related to separation became certain and we recognized those in 2010. Additionally, we recorded $23 million as additional paid-in capital related to our 2004 separation.
The above valuation allowances of $189 million and $153 million related primarily to state deferred tax assets and foreign net operating losses as of December 31, 2010 and 2009, respectively. The state deferred tax assets related primarily to the future deductions associated with the Section 338 elections and non-insurance net operating loss (“NOL”) carryforwards. Based on our analysis, we believe it is more likely than not that the results of future operations and the implementation of tax planning strategies will generate sufficient taxable income to enable us to realize the deferred tax assets for which we have not established valuation allowances.
U.S. deferred income taxes are not provided on unremitted foreign income that is considered permanently reinvested, which as of December 31, 2010, amounted to approximately $1,862 million. It is not practicable to determine the income tax liability that might be incurred if all such income was remitted to the United States.
We grant 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 (“Omnibus Incentive Plan”). We recorded stock-based compensation expense of $40 million, $26 million and $23 million, respectively, for the years ended December 31, 2010, 2009 and 2008. For awards issued prior to January 1, 2006, stock-based compensation expense was recognized on a graded vesting attribution method over the awards’ respective vesting schedule. For awards issued after January 1, 2006, stock-based compensation expense was recognized evenly on a straight-line attribution method over the awards’ respective vesting period.
For purposes of determining the fair value of stock-based payment awards on the date of grant, we typically use the Black-Scholes Model (“Black-Scholes Model”). The Black-Scholes Model requires the input of certain
assumptions that involve judgment. Management periodically evaluates the assumptions and methodologies used to calculate fair value of share-based compensation. Circumstances may change and additional data may become available over time, which could result in changes to these assumptions and methodologies.
For purposes of determining the fair value of 1.4 million shares of performance-accelerated SARs and 0.2 million shares of performance-accelerated non-qualified options that were issued in August 2009, we used the Monte-Carlo Simulation. Monte-Carlo Simulation is a technique used to simulate future stock price movements in order to determine the fair value due to unique vesting and exercising provisions. The performance-accelerated SARs and options grant-date fair value was $5.28, which will be amortized over a 1.4 year derived service period. The performance-accelerated SARs and options vest on the fourth anniversary of the grant date but are subject to earlier vesting in one-third increments based on the closing price of our Class A Common Stock exceeding certain specified amounts ($12.00, $16.00 and $20.00, respectively) for 20 consecutive trading days. Based on the closing price of our Class A Common Stock, the first two tranches at $12.00 and $16.00 vested in 2010.
During 2010 and 2009, we granted stock options with exercise prices ranging from $14.18 to $18.45 and $2.00 to $11.20, respectively, which equaled the closing market prices on the date of grant and have an exercise term of ten years. The stock options granted in 2010 have vesting periods of four years in annual increments commencing on the first anniversary of the grant date. The stock options granted in 2009, excluding some exchanged grants and performance-accelerated options, will vest in one-third annual increments commencing on the first anniversary of the grant date. Additionally, during 2010 and 2009, we issued RSUs with restriction periods ranging from two to four years and a fair value of $11.58 to $14.92 and $2.00 to $10.87, respectively, which were measured at the market price of a share of our Class A Common Stock on the grant date. We also granted SARs with an exercise price of $14.18 during 2010 and ranging from $2.00 to $7.80 during 2009.
The following table summarizes stock option activity as of December 31, 2010 and 2009:
The following table summarizes the status of our other equity-based awards as of December 31, 2010 and 2009:
(1) Included 910,300 of performance stock unit awards (“PSUs”) with fair values ranging from $26.59 to $34.85. During 2008, it was determined that threshold levels of performance would not be achieved and all expenses related to the PSUs were reversed in 2008.
(2) Grants and terminations of SARs in 2009 included awards cancelled, and replacement SARs granted, following completion of a stockholder approved voluntary equity exchange program in 2009 as further described below.
(4) Included 842,300 of PSUs that were terminated. As of December 31, 2010, there are no remaining PSUs outstanding.
As of December 31, 2010 and 2009, total unrecognized stock-based compensation expense related to non-vested awards not yet recognized was $69 million and $71 million, respectively. This expense is expected to be recognized over a weighted-average period of three years.
There was $2 million in cash received from stock options exercised during 2010 and no cash received in 2009. New shares were issued to settle all exercised awards. The actual tax benefit realized for the tax deductions from the exercise of share based awards was $6 million and $1 million as of December 31, 2010 and 2009, respectively.
In connection with the initial public offering of Genworth Canada in July 2009, our indirect subsidiary, Genworth Canada, granted stock options and other equity-based awards to its Canadian employees. As of December 31, 2010, Genworth Canada had outstanding 984,200 of stock options and 142,275 of RSUs, the majority of which were unvested, and 9,831 of DSUs, all of which were vested. As of December 31, 2009, Genworth Canada had 810,000 of stock options and 83,700 of RSUs outstanding and all were unvested. For the years ended December 31, 2010 and 2009, we recorded stock-based compensation expense of $4 million and $1 million, respectively, and estimated total unrecognized expense of $4 million and $5 million, respectively, related to these awards. See note 24 for additional information regarding the initial public offering of Genworth Canada.
Restricted commercial mortgage loans. Based on recent transactions and/or discounted future cash flows, using current market rates.
Other invested assets. Based on comparable market transactions, discounted future cash flows, quoted market prices and/or estimates using the most recent data available for the related instrument. Primarily represents short-term investments and limited partnerships accounted for under the cost method.
Non-recourse funding obligations. Based on the then current coupon, revalued based on LIBOR and the current spread assumption based on commercially available data. The model is a floating rate coupon model using the spread assumption to derive the valuation.
For pricing services, we obtain an understanding of the pricing methodologies and procedures for each type of instrument. 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.
The following table summarizes the primary sources considered when determining fair value of each class of fixed maturity securities as of December 31, 2010:
We have trading securities related to securitization entities that are classified as restricted other invested assets and are carried at fair value. The trading securities represent asset-backed securities. The valuation for trading securities is determined using a market approach and/or an income approach depending on the availability of information. For certain highly rated asset-backed securities, there is observable market information for transactions of the same or similar instruments and is provided to us by a third-party pricing service and is classified as Level 2. For certain securities that are not actively traded, we determine fair value after considering third-party broker provided prices or discounted expected cash flows using current yields for similar securities and classify these valuations as Level 3.
Credit default swaps. We have both single name credit default swaps and index tranche credit default swaps. For single name credit default swaps, we utilize an income approach to determine fair value based on using current market information for the credit spreads of the reference entity, which is considered observable inputs based on the reference entities of our derivatives and results in these derivatives being classified as Level 2. For index tranche credit default swaps, we utilize an income approach that utilizes current market information related to credit spreads and expected defaults and losses associated with the reference entities that comprise the respective index associated with each derivative. There are 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 will be absorbed by our tranche. Accordingly, the index tranche credit default swaps are classified as Level 3.
amount of any expected loss on the credit default swap, which is considered a significant unobservable input. Accordingly, these customized index tranche credit default swaps related to securitization entities are classified as Level 3.
We have certain reinsurance agreements that result in a reinsurance counterparty holding assets for our benefit where this feature is considered an embedded derivative requiring bifurcation. As a result, we measure the embedded derivatives at fair value with changes in fair value being recorded in income. Fair value is determined by comparing the fair value and cost basis of the underlying assets. The underlying assets are primarily comprised of highly rated investments and result in the fair value of the embedded derivatives being classified as Level 2.
To determine the appropriate discount rate to reflect the non-performance risk of the GMWB liabilities, we evaluate the non-performance risk in our liabilities based on a hypothetical exit market transaction as there is no exit market for these types of liabilities. A hypothetical exit market can be viewed as a hypothetical transfer of the liability to another similarly rated insurance company which would closely resemble a reinsurance transaction. Another hypothetical exit market transaction can be viewed as a hypothetical transaction from the perspective of the GMWB policyholder. We believe that a hypothetical exit market participant would use a similar discount rate as described above to value the liabilities.
The following tables set forth our assets and liabilities that are measured at fair value on a recurring basis as of December 31:
The following table presents additional information about assets measured at fair value on a recurring basis and for which we have utilized significant unobservable (Level 3) inputs to determine fair value as of or for the dates indicated:
There has been no new asset securitization activity in 2010 or 2009.
As a result of adopting new accounting guidance for VIE consolidation on January 1, 2010, we were required to consolidate certain VIEs. Our involvement with VIEs that were required to be consolidated related to
Asset securitizations. For VIEs related to asset securitization transactions, we were required to consolidate three securitization entities as a result of our involvement in the entities’ design or having certain decision making ability regarding the assets held by the securitization entity. These securitization entities were designed to have significant limitations on the types of assets owned and the types and extent of permitted activities and decision making rights. The three securitization entities that were required to be consolidated are comprised of two securitization entities backed by commercial mortgage loans and one backed by residual interests in certain policy loan securitization entities.
In addition to the guarantees discussed in notes 18 and 22, 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 guarantee accounted for as a derivative, were $46 million and $115 million as of December 31, 2010 and 2009, respectively. We provide a limited guarantee to Rivermont I, an indirect subsidiary, which is accounted for as a derivative and is carried at fair value. As of December 31, 2010 and 2009,
Our U.S. domiciled insurance subsidiaries file financial statements with state insurance regulatory authorities and the NAIC that are prepared on an accounting basis prescribed or permitted by such authorities. Statutory accounting practices differ from U.S. GAAP in several respects, causing differences in reported net income and stockholders’ equity. Permitted statutory accounting practices encompass all accounting practices not so prescribed but that have been specifically allowed by state insurance authorities. Our insurance subsidiaries have no material permitted accounting practices, except for River Lake Insurance Company V (“River Lake V”), River Lake Insurance Company VI (“River Lake VI”), River Lake Insurance Company VII (“River Lake VII”), River Lake Insurance Company VIII (“River Lake VIII”) and Genworth Life Insurance Company of New York (“GLICNY”). River Lake V and River Lake VII were granted permitted accounting practices from the state of Vermont to carry their reserves on a basis similar to U.S. GAAP. River Lake V was dissolved during 2010. River Lake VIII was granted a permitted accounting practice from the state of Vermont to carry its reserves on a basis similar to U.S. GAAP during 2010. River Lake VI was granted a permitted accounting practice from the state of Delaware to record a portion of the undrawn amount of its existing letter of credit and any additional letters of credit as gross paid-in and contributed surplus, thereby including such amounts in its statutory surplus. The amount of the letters of credit recorded as gross paid-in and contributed surplus is equal to the excess of statutory reserves less the economic reserves. In January 2011, GLICNY received a permitted practice from New York to exempt certain of its investments from a new NAIC structured security valuation and ratings process but is effective for reported 2010 year end.
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 a third-party letter of credit. Accordingly, the life insurance subsidiaries’ combined statutory net income (loss) and distributable income 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 $1,574 million and $1,725 million as of December 31, 2010 and 2009, respectively. Capital and surplus of our captive life reinsurance subsidiaries, excluding River Lake V, River Lake VI, River Lake VII and River Lake VIII, include surplus notes (non-recourse funding obligations) as further described in note 13.
The NAIC has adopted Risk-Based Capital (“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, 2010 and 2009, each of our life insurance subsidiaries exceeded the minimum required RBC levels.
For regulatory purposes, our mortgage insurance subsidiaries are required to maintain a statutory contingency reserve. Annual additions to the statutory contingency reserve must equal the greater of: (i) 50% of earned premiums or (ii) the required level of policyholders position, as defined by state insurance laws. These contingency reserves generally are held until the earlier of: (i) the time that loss ratios exceed 35% or (ii) ten years. The statutory contingency reserves for our U.S. mortgage insurance subsidiaries were approximately $91 million as of December 31, 2010.
We also have Corporate and Other activities which include debt financing expenses that are incurred at our holding company level, other corporate income and expenses not allocated to the segments, the results of non-core businesses and non-strategic products that are managed outside of our operating segments, and eliminations of inter-segment transactions.
There were no infrequent or unusual non-operating items excluded from net operating income during the periods presented other than a $106 million tax benefit related to separation from our former parent recorded in the first quarter of 2010 and a $25 million after-tax expense recorded in the fourth quarter of 2008 related to reorganization costs.
The following is a summary of net operating income available to Genworth Financial, Inc.’s common stockholders for our segments and Corporate and Other activities for the years ended December 31:
We face the risk of litigation and regulatory investigations and actions in the ordinary course of operating our businesses, including 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, bidding practices in connection with our management and administration of a third-party’s municipal guaranteed investment contract business, claims payments and procedures, product design, product disclosure, 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 (“RESPA”) or related state anti-inducement laws, and breaching fiduciary or other duties to customers. 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. 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 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. At this time, it is not feasible to predict, nor determine the ultimate outcomes of any pending investigations and legal proceedings, nor to provide reasonable ranges of possible losses.
In May 2005, each of our U.S. mortgage insurance subsidiaries received an information request from the State of New York Insurance Department with respect to captive reinsurance transactions with lender-affiliated reinsurers and other types of arrangements in which lending institutions receive from our subsidiaries any form of payment, compensation or other consideration in connection with issuance of a policy covering a mortgagor of the lending institution. In February 2006, we received a follow-up industry-wide inquiry from New York requesting supplemental information. In addition, in early 2006 as part of an industry-wide review, one of our U.S. mortgage insurance subsidiaries received an administrative subpoena from the Minnesota Department of Commerce, which has jurisdiction over insurance matters, with respect to our reinsurance arrangements, including captive reinsurance transactions. In addition, in June 2008, the same subsidiary received from the Minneapolis, Minnesota office of the Inspector General for the U.S. Department of Housing and Urban Development, a subpoena requesting information substantially similar to the Minnesota Department of Commerce’s request. Since 2008, the Minnesota Department of Commerce has periodically requested additional information. We have responded to these industry-wide regulatory inquiries and follow-up inquiries, and will cooperate with respect to any follow-up requests or inquiries.
sale of GICs to municipalities. We have not issued and do not currently issue GICs to municipalities, but from January 2004 to December 2006, our subsidiary provided management and administrative services to a third-party that does issue GICs to municipalities. We are cooperating fully with respect to these investigations and responding to the subpoenas.
Between March and December 2008, we and/or the same subsidiary were named along with several other GIC industry participants as a defendant in several class action and non-class action lawsuits alleging antitrust and other violations (including, in certain of the cases, California state law claims) involving the sale of GICs to municipalities and seeking monetary damages, including treble damages. The United States Judicial Panel on Multi-District Litigation has consolidated these federal cases for pre-trial proceedings in the United States District Court for the Southern District of New York under the case name In re Municipal Derivatives Antitrust Litigation. Certain plaintiffs have filed a consolidated amended complaint that names as a defendant only our subsidiary. However, in 2009, plaintiffs in these actions amended their complaints, and in 2010 additional individual lawsuits were filed, and those amended complaints and individual lawsuits do not presently name Genworth or any subsidiary as a defendant.
We and one of our mortgage insurance subsidiaries were named in a putative class action lawsuit filed in November 2010 captioned Archie Moses and Violet M. Moses v. SunTrust Banks, Inc., et al, in the United States District Court for the District of Columbia. Plaintiffs allege that “captive reinsurance arrangements” with providers of private mortgage insurance whereby a SunTrust subsidiary received a portion of the borrowers’
As of December 31, 2010, we were committed to fund $110 million in limited partnership investments and $28 million in U.S. commercial mortgage loan investments.
In connection with the issuance of non-recourse funding obligations by Rivermont I, Genworth entered into a liquidity commitment agreement with the third-party trusts in which the floating rate notes have been deposited. The liquidity agreement may require that Genworth issue to the trusts either a loan or a letter of credit (“LOC”), at maturity of the notes (2050), in the amount equal to the then market value of the assets supporting the notes held in the trust. Any loan or LOC issued is an obligation of the trust and shall accrue interest at LIBOR plus a margin. In consideration for entering into this agreement, Genworth received, from Rivermont I, a one-time commitment fee of approximately $2 million. The maximum potential amount of future obligation under this agreement is approximately $95 million.
A summary of pre-tax restructuring charges by segment was as follows for the years ended December 31:
In August 2010, Genworth Canada repurchased 12.3 million common shares for CAD$325 million through a substantial issuer bid. Brookfield participated in the issuer bid by making a proportionate tender and received CAD$187 million and continues to hold approximately 57.5% of the outstanding common shares of Genworth Canada.
As of December 31, 2010, the amortized cost or cost, fair value and carrying value of our invested assets were as follows:
As of December 31, 2010, we also had borrowings of $494 million related to consolidated securitization entities. These borrowings are required to be paid down as principal is collected on the restricted investments held by the securitization entities and accordingly the repayment of these borrowings follows the maturity or prepayment, as permitted, of the restricted investments.
In June 2010, our majority-owned subsidiary, Genworth Canada, issued CAD$275 million of 5.68% senior notes due 2020. The net proceeds of the offering were used to fund transactions among Genworth Canada and its Canadian wholly-owned subsidiaries. Genworth Canada used the proceeds it received from such transactions for general corporate and investment purposes and to fund a repurchase of common shares from Genworth Canada’s shareholders.
In December 2010, we received 131,962 of preferred shares of a subsidiary as a dividend of $132 million that we subsequently redistributed through several capital contributions. Additionally, in connection with the previously uncertain tax benefits related to separation from our former parent that we recognized in 2010, we recorded $36 million as non-cash deemed dividends and $73 million as non-cash deemed capital contributions to certain of our subsidiaries.
GE’s 2004 tax return, including these tax impacts. Therefore, $36 million of previously uncertain tax benefits related to separation became certain and we recognized those in 2010.
As of December 31, 2010, Genworth also held assets of $441 million in respect of the tax elections, comprised of a $107 million deferred tax asset and a $334 million receivable from our subsidiaries pursuant to the tax allocation agreements. The remaining $236 million of net deferred tax asset as of December 31, 2010 was primarily comprised of share-based compensation, net operating loss (“NOL”) carryforwards, unrealized gains on derivatives and a state deferred tax asset. The state deferred tax asset was offset by a valuation allowance. As of December 31, 2009, Genworth held assets of $438 million in respect of the tax elections, comprised of an $84 million deferred tax asset and a $354 million receivable from our subsidiaries pursuant to the tax allocation agreements. The remaining $181 million of net deferred tax asset as of December 31, 2009 was primarily comprised of share-based compensation, NOL carryforwards, unrealized gains on derivatives and a state deferred tax asset. The state deferred tax asset was offset by a valuation allowance. These amounts are undiscounted pursuant to the applicable rules governing deferred taxes and intercompany liabilities.
NOL carryforwards amounted to $569 million as of December 31, 2010, and, if unused, will expire beginning in 2029.