Life insurance. Results in our life insurance business are impacted by sales, mortality, persistency, investment yields, and statutory reserve requirements. Additionally, sales of our products are dependent on pricing and other competitive product features, distribution penetration, and customer service. Regulation XXX requires insurers to establish additional statutory reserves for term life insurance policies with long-term premium guarantees, which increases the capital required to write these products. For term life insurance, we have implemented capital management actions that improve our new business returns and have, in part, enabled us to decrease our premium rates. Several competitors have executed similar capital management actions. Additionally, we have seen some competitors lower their term prices, which has made the market more competitive and could affect our future sales levels.
The recent rise in interest rates and lower home price appreciation in the U.S. have contributed to rising persistency rates. We believe that sustained higher interest rates, increased persistency and our ongoing growth strategy will lead to stable to growing levels of insurance in-force. Primary insurance in-force in our U.S. mortgage insurance business increased from $100 billion as of December 31, 2005 to $113 billion as of December 31, 2006. This increase in primary insurance-in-force reflects an increase in our bulk product writings and the first year-over-year increase in flow insurance in-force in 5 years.
Interest expense. Interest expense increased primarily as a result of the issuances of additional non-recourse funding obligations and an increase in average variable rates paid on those obligations. This was partially offset by a decrease in interest expense associated with the derecognition of borrowings related to securitization entities in the first quarter of 2006.
Gross written premiums, premium equivalents and deposits, gross of ceded reinsurance and cancellations, increased during 2005 due to growth in the continental European market. Net earned premiums decreased due to continued runoff of low return blocks of business in the U.K. market, partially offset by growth in the continental European and Ireland markets.
Interest credited decreased primarily due to a $113 million decrease related to the UFLIC reinsurance transactions in 2004. Partially offsetting the decrease was a $94 million increase in interest credited on spread-based institutional products due primarily to higher average interest crediting rates on floating rate products.
The decrease in amortization of deferred acquisition costs and intangibles was primarily attributable to decreased amortization of $48 million resulting from the UFLIC reinsurance transactions in 2004. Partially offsetting this decrease was an increase of $9 million driven primarily by increased assets under management and improving investment spreads.
The following table sets forth the number of loans insured, the number of loans in default and the default rate for our U.S. mortgage insurance portfolio:
As an insurance business, we typically generate positive cash flows from operating activities, as premiums and deposits collected from our insurance and investment products exceed benefits paid and redemptions, and we invest the excess. Accordingly, in analyzing our cash flow we focus on the change in the amount of cash available and used in investing activities.
Total liabilities were $97.5 billion as of December 31, 2006, compared to $92.3 billion as of December 31, 2005. The increase in total liabilities was primarily driven by an increase in our future annuity and contract benefits liability and unearned premiums from the continued growth of our business, non-recourse funding obligations, long-term borrowings offset partially by a decrease in borrowings related to securitization entities taken off-balance sheet in 2006. See “-Securitization Entities.”
In connection with our corporate formation, we entered into a Tax Matters Agreement with GE, which represents an obligation by us to GE. The balance of this obligation is $380 million as of December 31, 2006.
The 2066 Notes will be subordinated to all existing and future senior, subordinated and junior subordinated debt of the company, except for any future debt that by its terms is not superior in right of payment, and will be effectively subordinated to all liabilities of our subsidiaries.
On March 8, 2006, GE completed its final secondary offering of 71.2 million shares of our Class B Common Stock. The 71.2 million shares were automatically converted to Class A Common Stock upon the sale of these shares to the public. We did not receive any proceeds in this offering. Concurrently with this offering, we repurchased 15.0 million shares of Class B Common Stock from GE at a price of $31.93125 per share (the net proceeds per share received by the selling stockholder from the underwriters), which is recorded at cost as treasury stock in our consolidated balance sheet. As a result of these transactions, GE no longer owns any of our outstanding common stock.
Our financial statements have been prepared on the basis of U.S. generally accepted accounting principles (“U.S. GAAP”). Preparing financial statements in conformity with U.S. GAAP requires us to make estimates and assumptions that affect reported amounts and related disclosures. Actual results could differ from those estimates. All significant intercompany accounts and transactions have been eliminated in consolidation. Certain prior year amounts have been reclassified to conform to the current year presentation.
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 on the Consolidated Balance Sheets at its fair value, but the hedged asset or liability will no longer be adjusted for changes in fair value. When hedge
For single premium insurance contracts, we recognize premiums over the policy life in accordance with the expected pattern of risk emergence. We recognize a portion of the revenue in premiums earned in the current period, while the remaining portion is deferred as unearned premiums and earned over time in accordance with the expected pattern of risk emergence. If single premium policies are canceled and the premium is non-refundable, then the remaining unearned premium related to each cancelled policy is recognized to earned premiums upon notification of the cancellation. Expected pattern of risk emergence on which we base premium recognition is inherently judgmental and is based on actuarial analysis of historical experience. We periodically review our premium earnings recognition models with any adjustments to the estimates reflected in current period income. For the years ended December 31, 2006 and 2005, we updated our premium recognition models for our international mortgage insurance business. This update included the consideration of recent and projected loss experience and refinement of actuarial methods, which this update and cancellations resulted in an increase in earned premium of $74 million and $21 million, respectively.
The scheduled maturity distribution of fixed maturities as of December 31, 2006 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.
(d) The 1983 Individual Annuitant Mortality Table or 2000 Commissioner’s Standard Ordinary Table and the 1985 National Nursing Home Study and company experience.
The above valuation allowance of $56 million relates to state deferred tax assets and foreign net operating losses at December 31, 2006, while the $70 million valuation allowance at December 31, 2005 relates to state deferred tax assets and foreign tax credits. The state deferred tax assets relate primarily to the future deductions associated with the Section 338 elections and non-insurance net operating loss carryforwards. The excess foreign tax credits through December 31, 2005 reflected inefficiencies in our post-IPO structure. Based on our analysis, we believe it is more likely than not that the results of future operations and implementations 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.
On January 1, 2006, we adopted SFAS No. 123R under the modified prospective transition method. The statement requires the measurement and recognition of compensation expense for all share-based awards made to employees and directors, including stock options, stock appreciation rights (“SARs”), restricted stock units (“RSUs”) and deferred stock units (“DSUs”) under the 2004 Genworth Financial, Inc. Omnibus Incentive Plan (“Omnibus Incentive Plan”). We previously accounted for these awards under the fair value expense provisions of SFAS No. 123. Effective January 1, 2006, we recognized a $4 million after-tax increase to income related to our cumulative effect of adopting SFAS No. 123R.
In the first quarter of 2006, GEFAHI completed its final secondary offering of 71.2 million shares of our Class B Common Stock. As a result GEFAHI no longer owns any of our outstanding common stock and ceases to be a related party. As such, all GE related party information is presented for the three month period ended March 31, 2006 and the years ended December 31, 2005 and 2004.
Derivative counterparty credit risk. We manage derivative counterparty credit risk on an individual counterparty basis, which means that gains and losses are netted for each counterparty to determine the amount at risk. When a counterparty exceeds credit exposure limits in terms of amounts owed to us, typically as the result
As of December 31, 2005, restricted investments held by securitization entities consisted of $389 million of fixed maturities and $296 million of commercial mortgage loans. These balances decreased as the assets mature because we did not sell any additional assets to these consolidated entities. In addition, as of December 31, 2005, the borrowings related to securitization entities consisted of $373 million at a fixed interest rate of 5.528% due June 2025 and $287 million at a fixed rate of 6.0175% due October 2023. These borrowings were 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.
On January 9, 2007, we announced an organizational repositioning to more directly align high-growth international, mortgage insurance and retirement and protection business opportunities. Under the reorganization and beginning in the first quarter 2007, we will have three operating segments: Retirement and Protection; International; and U.S. Mortgage Insurance; as well as Corporate and Other. The Retirement and Protection segment will include the following operations: retirement income, managed money, life insurance, long-term care insurance, and spread-based institutional products. The International segment will include international mortgage insurance, payment protection insurance and international new business developments. The results of these reorganized segments for all periods reported will be represented in the first quarter of 2007. The U.S. Mortgage Insurance segment will consist of the U.S. mortgage insurance business. We will continue to have Corporate and Other activities, which consist primarily of unallocated corporate income and expenses, the results of a small, non-core business that is managed outside the operating segments, and most of the interest and other financing expenses.
Our unaudited quarterly results of operations for the year ended December 31, 2005 are summarized in the table below.