GENWORTH FINANCIAL INC, 10-Q filed on 10/29/2010
Quarterly Report
Document and Entity Information
9 Months Ended
Sep. 30, 2010
Oct. 25, 2010
Document Type
10-Q 
 
Amendment Flag
FALSE 
 
Document Period End Date
2010-09-30 
 
Document Fiscal Year Focus
2010 
 
Document Fiscal Period Focus
Q3 
 
Trading Symbol
GNW 
 
Entity Registrant Name
GENWORTH FINANCIAL INC 
 
Entity Central Index Key
0001276520 
 
Current Fiscal Year End Date
12/31 
 
Entity Filer Category
Large Accelerated Filer 
 
Entity Common Stock, Shares Outstanding
 
489,595,629 
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (USD $)
In Millions, except Per Share data
3 Months Ended
Sep. 30,
9 Months Ended
Sep. 30,
2010
2009
2010
2009
Revenues:
 
 
 
 
Premiums
$ 1,447 
$ 1,492 
$ 4,387 
$ 4,496 
Net investment income
815 
759 
2,403 
2,251 
Net investment gains (losses)
105 
(122)
(104)
(945)
Insurance and investment product fees and other
300 
262 
812 
806 
Total revenues
2,667 
2,391 
7,498 
6,608 
Benefits and expenses:
 
 
 
 
Benefits and other changes in policy reserves
1,502 
1,450 
4,157 
4,450 
Interest credited
212 
225 
636 
763 
Acquisition and operating expenses, net of deferrals
472 
484 
1,446 
1,381 
Amortization of deferred acquisition costs and intangibles
227 
143 
590 
602 
Interest expense
114 
96 
338 
306 
Total benefits and expenses
2,527 
2,398 
7,167 
7,502 
Income (loss) before income taxes
140 
(7)
331 
(894)
Provision (benefit) for income taxes
18 
(52)
(80)
(420)
Net income (loss)
122 
45 
411 
(474)
Less: net income attributable to noncontrolling interests
39 
26 
108 
26 
Net income (loss) available to Genworth Financial, Inc.'s common stockholders
83 
19 
303 
(500)
Net income (loss) available to Genworth Financial, Inc.'s common stockholders per common share:
 
 
 
 
Basic
0.17 
0.04 
0.62 
(1.14)
Diluted
0.17 
0.04 
0.61 
(1.14)
Weighted-average common shares outstanding:
 
 
 
 
Basic
490 
449 
489 
439 
Diluted
494 
452 
494 
439 
Supplemental disclosures:
 
 
 
 
Total other-than-temporary impairments
(7)
(285)
(108)
(1,358)
Portion of other-than-temporary impairments included in other comprehensive income (loss)
(30)
89 
(60)
413 
Net other-than-temporary impairments
(37)
(196)
(168)
(945)
Other investment gains (losses)
142 
74 
64 
 
Total net investment gains (losses)
$ 105 
$ (122)
$ (104)
$ (945)
CONDENSED CONSOLIDATED BALANCE SHEETS (USD $)
In Millions
9 Months Ended
Sep. 30, 2010
Year Ended
Dec. 31, 2009
Investments:
 
 
Fixed maturity securities available-for-sale, at fair value
$ 56,356 
$ 49,752 
Equity securities available-for-sale, at fair value
223 
159 
Commercial mortgage loans
6,929 
7,499 
Restricted commercial mortgage loans related to securitization entities
522 
 
Policy loans
1,480 
1,403 
Other invested assets
5,320 
4,702 
Restricted other invested assets related to securitization entities ($376 at fair value)
378 
 
Total investments
71,208 
63,515 
Cash and cash equivalents
3,598 
5,002 
Accrued investment income
760 
691 
Deferred acquisition costs
7,055 
7,341 
Intangible assets
647 
934 
Goodwill
1,321 
1,324 
Reinsurance recoverable
17,223 
17,332 
Other assets
958 
954 
Deferred tax asset
867 
92 
Separate account assets
11,063 
11,002 
Total assets
114,700 
108,187 
Liabilities:
 
 
Future policy benefits
30,758 
29,469 
Policyholder account balances
27,714 
28,470 
Liability for policy and contract claims
6,448 
6,567 
Unearned premiums
4,492 
4,714 
Other liabilities ($166 and $- other liabilities related to securitization entities)
6,949 
6,298 
Borrowings related to securitization entities ($44 at fair value)
502 
 
Non-recourse funding obligations
3,437 
3,443 
Short-term borrowings
730 
930 
Long-term borrowings
4,373 
3,641 
Deferred tax liability
2,163 
303 
Separate account liabilities
11,063 
11,002 
Total liabilities
98,629 
94,837 
Commitments and contingencies
 
 
Stockholders' equity:
 
 
Class A common stock, $0.001 par value; 1.5 billion shares authorized; 578 million and 577 million shares issued as of September 30, 2010 and December 31, 2009, respectively; 490 million and 489 million shares outstanding as of September 30, 2010 and December 31, 2009, respectively
Additional paid-in capital
12,084 
12,034 
Net unrealized investment gains (losses):
 
 
Net unrealized gains (losses) on securities not other-than-temporarily impaired
730 
(1,151)
Net unrealized gains (losses) on other-than-temporarily impaired securities
(143)
(247)
Net unrealized investment gains (losses)
587 
(1,398)
Derivatives qualifying as hedges
1,354 
802 
Foreign currency translation and other adjustments
543 
432 
Total accumulated other comprehensive income (loss)
2,484 
(164)
Retained earnings
3,133 
3,105 
Treasury stock, at cost (88 million shares as of September 30, 2010 and December 31, 2009)
(2,700)
(2,700)
Total Genworth Financial, Inc.'s stockholders' equity
15,002 
12,276 
Noncontrolling interests
1,069 
1,074 
Total stockholders' equity
16,071 
13,350 
Total liabilities and stockholders' equity
$ 114,700 
$ 108,187 
CONDENSED CONSOLIDATED BALANCE SHEETS (Parenthetical) (USD $)
In Millions, except Share data
Sep. 30, 2010
Dec. 31, 2009
Restricted other invested assets related to securitization entities, fair value
376 
 
Other liabilities, securitization entities
166 
 
Borrowings related to securitization entities, fair value
44 
 
Class A common stock, par value
$ 0.001 
$ 0.001 
Class A common stock, shares authorized
1,500,000,000 
1,500,000,000 
Class A common stock, shares issued
578,000,000 
577,000,000 
Class A common stock, shares outstanding
490,000,000 
489,000,000 
Treasury stock, shares
88,000,000 
88,000,000 
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (USD $)
In Millions
Common stock
Additional paid-in capital
Accumulated other comprehensive income (loss)
Retained earnings
Treasury stock, at cost
Total Genworth Financial, Inc.'s stockholders' equity
Noncontrolling interests
Total
Beginning Balances at Dec. 31, 2008
11,477 
(3,062)
3,210 
(2,700)
8,926 
 
8,926 
Cumulative effect of change in accounting, net of taxes and other adjustments
 
 
(349)
355 
 
 
Initial sale of subsidiary shares to noncontrolling interests
 
(85)
(60)
 
 
(145)
828 
683 
Additional sale of subsidiary shares to noncontrolling interests
 
(3)
(12)
 
 
(15)
99 
84 
Issuance of common stock
 
622 
 
 
 
622 
 
622 
Comprehensive income (loss):
 
 
 
 
 
 
 
 
Net income (loss)
 
 
 
(500)
 
(500)
26 
(474)
Net unrealized gains (losses) on securities not other-than-temporarily impaired
 
 
3,027 
 
 
3,027 
19 
3,046 
Net unrealized gains (losses) on other-than-temporarily impaired securities
 
 
(19)
 
 
(19)
 
(19)
Derivatives qualifying as hedges
 
 
(148)
 
 
(148)
 
(148)
Foreign currency translation and other adjustments
 
 
646 
 
 
646 
56 
702 
Total comprehensive income (loss)
 
 
 
 
 
 
 
3,107 
Stock-based compensation expense and exercises and other
 
17 
 
 
 
17 
 
17 
Ending Balances at Sep. 30, 2009
12,028 
23 
3,065 
(2,700)
12,417 
1,028 
13,445 
Beginning Balances at Dec. 31, 2009
12,034 
(164)
3,105 
(2,700)
12,276 
1,074 
13,350 
Cumulative effect of change in accounting, net of taxes and other adjustments
 
 
260 
(275)
 
(15)
 
(15)
Repurchase of subsidiary shares
 
 
 
 
 
 
(131)
(131)
Comprehensive income (loss):
 
 
 
 
 
 
 
 
Net income (loss)
 
 
 
303 
 
303 
108 
411 
Net unrealized gains (losses) on securities not other-than-temporarily impaired
 
 
1,621 
 
 
1,621 
28 
1,649 
Net unrealized gains (losses) on other-than-temporarily impaired securities
 
 
104 
 
 
104 
 
104 
Derivatives qualifying as hedges
 
 
552 
 
 
552 
 
552 
Foreign currency translation and other adjustments
 
 
111 
 
 
111 
22 
133 
Total comprehensive income (loss)
 
 
 
 
 
 
 
2,849 
Dividends to noncontrolling interests
 
 
 
 
 
 
(32)
(32)
Stock-based compensation expense and exercises and other
 
30 
 
 
 
30 
 
30 
Other capital transactions
 
20 
 
 
 
20 
 
20 
Ending Balances at Sep. 30, 2010
$ 1 
$ 12,084 
$ 2,484 
$ 3,133 
$ (2,700)
$ 15,002 
$ 1,069 
$ 16,071 
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (USD $)
In Millions
9 Months Ended
Sep. 30,
2010
2009
Cash flows from operating activities:
 
 
Net income (loss)
$ 411 
$ (474)
Adjustments to reconcile net income (loss) to net cash from operating activities:
 
 
Amortization of fixed maturity discounts and premiums
(11)
103 
Net investment losses (gains)
104 
945 
Charges assessed to policyholders
(367)
(332)
Acquisition costs deferred
(610)
(540)
Amortization of deferred acquisition costs and intangibles
590 
602 
Deferred income taxes
(111)
(634)
Net increase (decrease) in trading securities, held-for-sale investments and derivative instruments
113 
(4)
Gain on sale of subsidiary
 
(4)
Stock-based compensation expense
31 
17 
Change in certain assets and liabilities:
 
 
Accrued investment income and other assets
(31)
(135)
Insurance reserves
1,767 
2,153 
Current tax liabilities
(313)
55 
Other liabilities and other policy-related balances
(597)
102 
Net cash from operating activities
976 
1,854 
Proceeds from maturities and repayments of investments:
 
 
Fixed maturity securities
3,302 
3,157 
Commercial mortgage loans
493 
519 
Restricted commercial mortgage loans related to securitization entities
40 
 
Proceeds from sales of investments:
 
 
Fixed maturity and equity securities
3,329 
3,343 
Purchases and originations of investments:
 
 
Fixed maturity and equity securities
(10,223)
(5,091)
Commercial mortgage loans
(35)
 
Other invested assets, net
1,483 
122 
Policy loans, net
(77)
426 
Net cash transferred related to the sale of a subsidiary
 
(90)
Net cash from investing activities
(1,688)
2,386 
Cash flows from financing activities:
 
 
Deposits to universal life and investment contracts
1,832 
1,801 
Withdrawals from universal life and investment contracts
(2,950)
(6,669)
Short-term borrowings and other, net
(86)
(363)
Repayment and repurchase of long-term borrowings
(6)
(809)
Proceeds from the issuance of long-term borrowings
660 
 
Redemption of non-recourse funding obligations
(6)
(12)
Repayment of borrowings related to securitization entities
(46)
 
Proceeds from issuance of common stock
 
622 
Proceeds from the sale of subsidiary shares to noncontrolling interests
 
771 
Repurchase of subsidiary shares
(131)
 
Dividends paid to noncontrolling interests
(32)
 
Net cash from financing activities
(765)
(4,659)
Effect of exchange rate changes on cash and cash equivalents
73 
235 
Net change in cash and cash equivalents
(1,404)
(184)
Cash and cash equivalents at beginning of period
5,002 
7,328 
Cash and cash equivalents at end of period
$ 3,598 
$ 7,144 
Formation of Genworth and Basis of Presentation
Formation of Genworth and Basis of Presentation

(1) Formation of Genworth and Basis of Presentation

Genworth Financial, Inc. (“Genworth”) was incorporated in Delaware on October 23, 2003. The accompanying condensed financial statements include on a consolidated basis the accounts of Genworth and our affiliate companies in which we hold a majority voting interest or where we are the primary beneficiary of a variable interest entity, which we refer to as the “Company,” “we,” “us” or “our” unless the context otherwise requires. All intercompany accounts and transactions have been eliminated in consolidation.

We have the following three operating segments:

 

   

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.

 

   

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, Canada and Mexico. 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.

 

   

U.S. Mortgage Insurance. In the U.S., 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.

We also have Corporate and Other activities which include debt financing expenses that are incurred at our holding company level, unallocated corporate income and expenses, eliminations of inter-segment transactions and the results of non-core businesses and non-strategic products that are managed outside of our operating segments. Our non-strategic products include our institutional and corporate-owned life insurance products. Institutional products consist of funding agreements, funding agreements backing notes (“FABNs”) and guaranteed investment contracts (“GICs”).

The accompanying condensed consolidated financial statements are unaudited and have been prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”) and rules and regulations of the U.S. Securities and Exchange Commission (“SEC”). 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. These condensed consolidated financial statements include all adjustments considered necessary by management to present a fair statement of the financial position, results of operations and cash flows for the periods presented. The results reported in these condensed consolidated financial statements should not be regarded as necessarily indicative of results that may be expected for the entire year. The condensed consolidated financial statements included herein should be read in conjunction with the audited consolidated financial statements and related notes contained in our 2009 Annual Report on Form 10-K. Certain prior year amounts have been reclassified to conform to the current year presentation.

Accounting Pronouncements
Accounting Pronouncements

(2) Accounting Pronouncements

Recently Adopted

Scope Exception for Embedded Credit Derivatives

On July 1, 2010, we adopted new accounting guidance related to embedded credit derivatives. This accounting guidance clarified the scope exception for embedded credit derivatives and when those features would be bifurcated from the host contract. Under the new accounting guidance, only embedded credit derivative features that are in the form of subordination of one financial instrument to another would not be subject to the bifurcation requirements. Accordingly, upon adoption, we were required to bifurcate embedded credit derivatives that no longer qualified under the amended scope exception. In conjunction with our adoption, we elected fair value option for certain fixed maturity securities. On July 1, 2010, we recorded a net cumulative effect adjustment of $171 million to retained earnings with an offset to accumulated other comprehensive income (loss) of $169 million. The following summarizes the components for the cumulative effect adjustment:

 

(Amounts in millions)

   Accumulated other
comprehensive
income (loss)
    Retained
earnings
    Total stockholders’
equity
 

Investment securities

   $ 267      $ (267   $ —     

Adjustment to deferred acquisition costs

     (4     1        (3

Adjustment to sales inducements

     (1     1        —     

Provision for income taxes

     (93     94        1   
                        

Net cumulative effect adjustment

   $ 169      $ (171   $ (2
                        

For certain securities where the embedded credit derivative would require bifurcation, we elected the fair value option to carry the entire instrument at fair value to reduce the cost of calculating and recording the fair value of the embedded derivative feature separate from the debt security. Additionally, we elected the fair value option for a portion of our other asset-backed securities for operational ease and to record and present the securities at fair value in future periods. Upon electing fair value option on July 1, 2010, these securities were reclassified into the trading category included in other invested assets and had a fair value of $407 million. Prior to electing fair value option, these securities were classified as available-for-sale fixed maturity securities.

Accounting for Transfers of Financial Assets

On January 1, 2010, we adopted new accounting guidance related to accounting for transfers of financial assets. This accounting guidance amended the previous guidance on transfers of financial assets by eliminating the qualifying special-purpose entity concept, providing certain conditions that must be met to qualify for sale accounting, changing the amount of gain or loss recognized on certain transfers and requiring additional disclosures. The adoption of this accounting guidance did not have a material impact on our consolidated financial statements. The elimination of the qualifying special-purpose entity concept required that these entities be considered for consolidation as a result of the new guidance related to variable interest entities (“VIEs”) as discussed below.

 

Improvements to Financial Reporting by Enterprises Involved with VIEs

On January 1, 2010, we adopted new accounting guidance for determining which enterprise, if any, has a controlling financial interest in a VIE and required additional disclosures about involvement in VIEs. Under this new accounting guidance, the primary beneficiary of a VIE is the enterprise that has the power to direct the activities of a VIE that most significantly impacts the VIE’s economic performance and has the obligation to absorb losses or receive benefits that could potentially be significant to the VIE. Upon adoption of this new accounting guidance, we were required to consolidate certain VIEs, including previously qualifying special-purpose entities and investment structures. We recorded a transition adjustment for the impact upon adoption to reflect the difference between the assets and liabilities of the newly consolidated entities and the amounts recorded for our interests in these entities prior to adoption. On January 1, 2010, we recorded a net cumulative effect adjustment of $104 million to retained earnings with a partial offset to accumulated other comprehensive income (loss) of $91 million related to the adoption of this new accounting guidance.

The assets and liabilities of the newly consolidated entities were as follows as of January 1, 2010:

 

(Amounts in millions)

   Carrying value  (1)      Adjustment for election
of fair value option 
(2)
    Amounts
recorded upon
consolidation
 

Assets

       

Restricted commercial mortgage loans

   $ 564       $ —        $ 564   

Restricted other invested assets

     409         (30     379   

Accrued investment income

     2         —          2   
                         

Total assets

     975         (30     945   
                         

Liabilities

       

Other liabilities

     138         —          138   

Borrowings related to securitization entities

     644         (80     564   
                         

Total liabilities

     782         (80     702   
                         

Net assets and liabilities of newly consolidated entities

   $ 193       $ 50        243   
                   

Less: amortized cost of fixed maturity securities previously recorded (3)

          404   
             

Cumulative effect adjustment to retained earnings upon adoption, pre-tax

          (161

Tax effect

          57   
             

Net cumulative effect adjustment to retained earnings upon adoption

        $ (104
             

 

(1)

Carrying value represents the amounts that would have been recorded in the consolidated financial statements on January 1, 2010 had we recorded the assets and liabilities in our financial statements from the date we first met the conditions for consolidation based on the criteria in the new accounting guidance.

(2)

Amount represents the difference between book value and fair value of the investments and borrowings related to consolidated securitization entities where we have elected fair value option.

(3)

Fixed maturity securities that were previously recorded had net unrealized investment losses of $91 million included in accumulated other comprehensive income (loss) as of December 31, 2009.

 

For commercial mortgage loans, the carrying amounts represent the unpaid principal balance less any reserve. Restricted other invested assets are comprised of trading securities that are recorded at fair value. Trading securities represent asset-backed securities where we elected fair value option. Borrowings related to securitization entities are recorded at unpaid principal except for the borrowings related to entities where we elected fair value option for all assets and liabilities.

For certain entities consolidated upon adoption of the new accounting guidance on January 1, 2010, we elected fair value option to measure all assets and liabilities at current fair value with future changes in fair value being recorded in income (loss). We elected fair value option for certain entities as a method to better present the offsetting changes in assets and liabilities related to third-party interests in those entities and eliminated the potential accounting mismatch between the measurement of the assets and derivatives of the entity compared to the borrowings issued by the entity. The entities where we did not elect fair value option did not have the same accounting mismatch since the assets held by the securitization entity and the borrowings of the entity were recorded at cost. See note 7 for additional information related to consolidation of VIEs.

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.

Fair Value Measurements and Disclosures—Improving Disclosures about Fair Value Measurements

On January 1, 2010, we adopted new accounting guidance requiring additional disclosures for significant transfers between Level 1 and 2 fair value measurements and clarifications to existing fair value disclosures related to the level of disaggregation, inputs and valuation techniques. The adoption of this new accounting guidance did not have a material impact on our consolidated financial statements.

Not Yet Adopted

In October 2010, the Financial Accounting Standards Board (“FASB”) issued new accounting guidance related to accounting for costs associated with acquiring or renewing insurance contracts. This new accounting guidance will be effective for us on January 1, 2012. When adopted, we expect to defer fewer costs. The new guidance is effective prospectively with retrospective adoption allowed. We have not yet determined the method nor impact this accounting guidance will have on our consolidated financial statements.

In July 2010, the FASB issued new accounting guidance that will require additional disclosures about the credit quality of loans, lease receivables and other long-term receivables and the related allowance for credit losses. Certain additional disclosures in this new accounting guidance will be effective for us on December 31, 2010 with certain other additional disclosures that will be effective for us on March 31, 2011. We do not expect the adoption of this new accounting guidance to have a material impact on our consolidated financial statements.

In April 2010, the FASB issued new accounting guidance on how investments held through separate accounts affect an insurer’s consolidation analysis of those investments. This new accounting guidance will be effective for us on January 1, 2011. We do not expect the adoption of this new accounting guidance to have a material impact on our consolidated financial statements.

 

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. We do not expect the adoption of this new accounting guidance to have a material impact on our consolidated financial statements.

Earnings (Loss) Per Share
Earnings (Loss) Per Share

(3) Earnings (Loss) Per Share

Basic and diluted earnings (loss) per share are calculated by dividing each income (loss) category presented below by the weighted-average basic and diluted shares outstanding for the periods indicated:

 

     Three months ended
September 30,
     Nine months ended
September 30,
 

(Amounts in millions, except per share amounts)

       2010              2009              2010              2009      

Net income (loss)

   $ 122       $ 45       $ 411       $ (474

Less: net income attributable to noncontrolling interests

     39         26         108         26  
                                   

Net income (loss) available to Genworth Financial, Inc.’s common stockholders

   $ 83       $ 19       $ 303       $ (500
                                   

Basic per common share:

           

Net income (loss)

   $ 0.25       $ 0.10       $ 0.84       $ (1.08

Less: net income attributable to noncontrolling interests

     0.08         0.06         0.22         0.06   
                                   

Net income (loss) available to Genworth Financial, Inc.’s common stockholders (1)

   $ 0.17       $ 0.04       $ 0.62       $ (1.14
                                   

Diluted per common share:

           

Net income (loss)

   $ 0.25       $ 0.10       $ 0.83       $ (1.08

Less: net income attributable to noncontrolling interests

     0.08         0.06         0.22         0.06   
                                   

Net income (loss) available to Genworth Financial, Inc.’s common stockholders (1)

   $ 0.17       $ 0.04       $ 0.61       $ (1.14
                                   

Weighted-average shares used in basic earnings (loss) per common share calculations

     489.5         448.9         489.1         438.5   

Potentially dilutive securities:

           

Stock options, restricted stock units and stock appreciation rights

     4.4         2.7        4.8         —     
                                   

Weighted-average shares used in diluted earnings (loss) per common share calculations (2)

     493.9         451.6         493.9         438.5   
                                   

 

(1)

May not total due to whole number calculation.

(2)

Under applicable accounting guidance, companies in a loss position are required to use basic weighted-average common shares outstanding in the calculation of diluted loss per share. Therefore, as a result of our net loss for the nine months ended September 30, 2009, we were required to use basic weighted-average common shares outstanding in the calculation of diluted loss per share for the nine months ended September 30, 2009, as the inclusion of shares for stock options, restricted stock units and stock appreciation rights of 1.3 million would have been antidilutive to the calculation. If we had not incurred a net loss for the nine months ended September 30, 2009, dilutive potential common shares would have been 439.8 million.

 

Investments
Investments

(4) Investments

(a) Net Investment Income

Sources of net investment income were as follows for the periods indicated:

 

    Three months ended
September 30,
    Nine months ended
September 30,
 

(Amounts in millions)

      2010             2009             2010             2009      

Fixed maturity securities—taxable

  $ 658      $ 610      $ 1,930      $ 1,837   

Fixed maturity securities—non-taxable

    14        27        46        85   

Commercial mortgage loans

    95        106        298        329   

Restricted commercial mortgage loans related to securitization entities (1)

    10        —          30        —     

Equity securities

    4        6        11        12   

Other invested assets

    24        4        61        (102

Restricted other invested assets related to securitization entities (1)

    1        —          2        —     

Policy loans

    28        19        83        115   

Cash, cash equivalents and short-term investments

    6        9        15        40   
                               

Gross investment income before expenses and fees

    840        781        2,476        2,316   

Expenses and fees

    (25     (22     (73     (65
                               

Net investment income

  $ 815      $ 759      $ 2,403      $ 2,251   
                               

 

(1)

See note 7 for additional information related to consolidated securitization entities.

(b) Net Investment Gains (Losses)

The following table sets forth net investment gains (losses) for the periods indicated:

 

    Three months ended
September 30,
    Nine months ended
September 30,
 

(Amounts in millions)

      2010             2009             2010             2009      

Available-for-sale securities:

       

Realized gains on sale

  $ 38      $ 122      $ 114      $ 172   

Realized losses on sale

    (35     (81     (109     (192
                               

Net realized gains (losses) on sale of available-for-sale securities

    3        41        5        (20
                               

Impairments:

       

Total other-than-temporary impairments

    (7     (285     (108     (1,358

Portion of other-than-temporary impairments recognized in other comprehensive income (loss)

    (30     89        (60     413   
                               

Net other-than-temporary impairments

    (37     (196     (168     (945
                               

Trading securities

    23        16        25        15   

Commercial mortgage loans

    (9     (8     (31     (19

Net gains (losses) related to securitization entities (1)

    30        —          (6     —     

Derivative instruments (2)

    94        19        48        12   

Other

    1        6        23        12   
                               

Net investment gains (losses)

  $ 105      $ (122   $ (104   $ (945
                               

 

(1)

See note 7 for additional information related to consolidated securitization entities.

(2)

See note 5 for additional information on the impact of derivative instruments included in net investment gains (losses).

 

The aggregate fair value of securities sold at a loss during the three months ended September 30, 2010 and 2009 was $275 million and $354 million, respectively, which was approximately 89% and 84%, respectively, of book value. The aggregate fair value of securities sold at a loss during the nine months ended September 30, 2010 and 2009 was $1,691 million and $1,091 million, respectively, which was approximately 94% and 86%, respectively, of book value.

The following represents the activity for credit losses recognized in net income (loss) on debt securities where an other-than-temporary impairment was identified and a portion of other-than-temporary impairments was included in other comprehensive income (loss) (“OCI”) as of or for the periods indicated:

 

     As of or for the
three months ended
September 30,
 

(Amounts in millions)

       2010             2009      

Cumulative credit loss beginning balance

   $ 978      $ 1,085   

Additions:

    

Other-than-temporary impairments not previously recognized

     13        25   

Increases related to other-than-temporary impairments previously recognized

     22        74   

Reductions:

    

Securities sold, paid down or disposed

     (126     (103

Securities where there is intent to sell

     —          (5
                

Cumulative credit loss ending balance

   $ 887      $ 1,076   
                

 

     As of or for the
nine months ended
September 30,
 

(Amounts in millions)

       2010             2009      

Cumulative credit loss beginning balance

   $ 1,059      $ —     

Impact upon adoption of new accounting guidance

     —          1,204   

Additions:

    

Other-than-temporary impairments not previously recognized

     44        81   

Increases related to other-than-temporary impairments previously recognized

     100        169   

Reductions:

    

Securities sold, paid down or disposed

     (316     (373

Securities where there is intent to sell

     —          (5
                

Cumulative credit loss ending balance

   $ 887      $ 1,076   
                

 

(c) Unrealized Investment Gains and Losses

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 the dates indicated:

 

(Amounts in millions)

   September 30,
2010
    December 31,
2009
 

Net unrealized gains (losses) on investment securities:

    

Fixed maturity securities

   $ 2,075      $ (2,245

Equity securities

     15        20   

Other invested assets

     (27     (29
                

Subtotal

     2,063        (2,254

Adjustments to present value of future profits, deferred acquisition costs, sales inducements and benefit reserves

     (1,057     138   

Income taxes, net

     (352     757   
                

Net unrealized investment gains (losses)

     654        (1,359

Less: net unrealized investment gains (losses) attributable to noncontrolling interests

     67        39   
                

Net unrealized investment gains (losses) attributable to Genworth Financial, Inc.

   $ 587      $ (1,398
                

The change in net unrealized gains (losses) on available-for-sale securities reported in accumulated other comprehensive income (loss) was as follows as of or for the periods indicated:

 

     As of or for the
three months ended
September 30,
 

(Amounts in millions)

   2010     2009  

Beginning balance

   $ 29      $ (3,023

Cumulative effect of change in accounting

     169        —     

Unrealized gains (losses) arising during the period:

    

Unrealized gains (losses) on investment securities

     1,486        2,796   

Adjustment to deferred acquisition costs

     (187     (264

Adjustment to present value of future profits

     (101     (93

Adjustment to sales inducements

     (21     (13

Adjustment to benefit reserves

     (581     —     

Provision for income taxes

     (210     (863
                

Change in unrealized gains (losses) on investment securities

     386        1,563   

Reclassification adjustments to net investment (gains) losses, net of taxes of $(12) and $(51)

     22        100   
                

Change in net unrealized investment gains (losses)

     577        1,663   

Less: change in net unrealized investment gains (losses) attributable to noncontrolling interests

     (19     (41
                

Ending balance

   $ 587      $ (1,401
                

 

     As of or for the
nine months ended
September 30,
 

(Amounts in millions)

   2010     2009  

Beginning balance

   $ (1,398   $ (4,038

Cumulative effect of change in accounting

     260        (349

Unrealized gains (losses) arising during the period:

    

Unrealized gains (losses) on investment securities

     3,747        4,352   

Adjustment to deferred acquisition costs

     (381     (448

Adjustment to present value of future profits

     (182     (164

Adjustment to sales inducements

     (46     (12

Adjustment to benefit reserves

     (581     —     

Provision for income taxes

     (910     (1,328
                

Change in unrealized gains (losses) on investment securities

     1,647        2,400   

Reclassification adjustments to net investment (gains) losses, net of taxes of $(57) and $(337)

     106        627   
                

Change in net unrealized investment gains (losses)

     2,013        2,678   

Less: change in net unrealized investment gains (losses) attributable to noncontrolling interests

     (28     (41
                

Ending balance

   $ 587      $ (1,401
                

(d) Fixed Maturity and Equity Securities

As of September 30, 2010, the amortized cost or cost, gross unrealized gains (losses) and fair value of our fixed maturity and equity securities classified as available-for-sale were as follows:

 

(Amounts in millions)

  Amortized
cost or
cost
    Gross unrealized gains     Gross unrealized losses     Fair
value
 
    Not  other-than-
temporarily
impaired
    Other-than-
temporarily
impaired
    Not  other-than-
temporarily
impaired
    Other-than-
temporarily
impaired
   

Fixed maturity securities:

           

U.S. government, agencies and government-sponsored enterprises

  $ 3,508      $ 414      $ —        $ —        $ —        $ 3,922   

Tax-exempt

    1,288        55        —          (72     —          1,271   

Government—non-U.S.

    2,188        169        —          (5     —          2,352   

U.S. corporate

    22,979        1,858        10        (322     —          24,525   

Corporate—non-U.S.

    13,282        730        15        (209     (3     13,815   

Residential mortgage-backed

    4,629        228        14        (312     (225     4,334   

Commercial mortgage-backed

    4,011        188        5        (389     (58     3,757   

Other asset-backed

    2,391        25        —          (34     (2     2,380   
                                               

Total fixed maturity securities

    54,276        3,667        44        (1,343     (288     56,356   

Equity securities

    208        18        —          (3     —          223   
                                               

Total available-for-sale securities

  $ 54,484      $ 3,685      $ 44      $ (1,346   $ (288   $ 56,579   
                                               

 

As of December 31, 2009, the amortized cost or cost, gross unrealized gains (losses) and fair value of our fixed maturity and equity securities classified as available-for-sale were as follows:

 

(Amounts in millions)

  Amortized
cost or
cost
    Gross unrealized gains     Gross unrealized losses     Fair
value
 
    Not  other-than-
temporarily
impaired
    Other-than-
temporarily
impaired
    Not  other-than-
temporarily
impaired
    Other-than-
temporarily
impaired
   

Fixed maturity securities:

           

U.S. government, agencies and government-sponsored enterprises

  $ 2,673      $ 25      $ —        $ (96   $ —        $ 2,602   

Tax-exempt

    1,606        42        —          (104     —          1,544   

Government—non-U.S.

    2,310        96        —          (22     —          2,384   

U.S. corporate

    21,598        628        3        (814     (3     21,412   

Corporate—non-U.S.

    12,530        366        11        (356     —          12,551   

Residential mortgage-backed

    3,989        41        7        (484     (326     3,227   

Commercial mortgage-backed

    4,404        44        4        (738     (97     3,617   

Other asset-backed

    2,887        8        —          (466     (14     2,415   
                                               

Total fixed maturity securities

    51,997        1,250        25        (3,080     (440     49,752   

Equity securities

    139        23        —          (3     —          159   
                                               

Total available-for-sale securities

  $ 52,136      $ 1,273      $ 25      $ (3,083   $ (440   $ 49,911   
                                               

 

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 September 30, 2010:

 

    Less than 12 months     12 months or more  

(Dollar amounts in millions)

  Fair
value
    Gross
unrealized
losses
    Number  of
securities
    Fair
value
    Gross
unrealized
losses
    Number  of
securities
 

Description of Securities

           

Fixed maturity securities:

           

Tax-exempt

  $ —        $ —          —        $ 277      $ (72     92   

Government—non-U.S.

    141        (4     32        21        (1     2   

U.S. corporate

    631        (17     89        2,572        (305     199   

Corporate—non-U.S.

    836        (20     130        1,443        (192     109   

Residential mortgage-backed

    170        (2     46        1,051        (535     432   

Commercial mortgage-backed

    78        (1     16        1,135        (446     239   

Other asset-backed

    287        (1     19        470        (35     53   
                                               

Subtotal, fixed maturity securities

    2,143        (45     332        6,969        (1,586     1,126   

Equity securities

    34        (3     18        —          —          —     
                                               

Total for securities in an unrealized loss position

  $ 2,177      $ (48     350      $ 6,969      $ (1,586     1,126   
                                               

% Below cost—fixed maturity securities:

           

<20% Below cost

  $ 2,139      $ (42     311      $ 5,128      $ (375     603   

20-50% Below cost

    3        (1     8        1,593        (714     310   

>50% Below cost

    1        (2     13        248        (497     213   
                                               

Total fixed maturity securities

    2,143        (45     332        6,969        (1,586     1,126   
                                               

% Below cost—equity securities:

           

<20% Below cost

    28        (1     17        —          —          —     

20-50% Below cost

    6        (2     1        —          —          —     
                                               

Total equity securities

    34        (3     18        —          —          —     
                                               

Total for securities in an unrealized loss position

  $ 2,177      $ (48     350      $ 6,969      $ (1,586     1,126   
                                               

Investment grade

  $ 2,070      $ (43     294      $ 5,224      $ (796     689   

Below investment grade

    107        (5     56        1,745        (790     437   

Not rated—fixed maturity securities

    —          —          —          —          —          —     

Not rated—equity securities

    —          —          —          —          —          —     
                                               

Total for securities in an unrealized loss position

  $ 2,177      $ (48     350      $ 6,969      $ (1,586     1,126   
                                               

The investment securities in an unrealized loss position as of September 30, 2010 consisted of 1,476 securities and accounted for unrealized losses of $1,634 million. Of these unrealized losses of $1,634 million, 51% were investment grade (rated “AAA” through “BBB-”) and 26% were less than 20% below cost. 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. Included in these unrealized losses as of September 30, 2010 was $288 million of unrealized losses on other-than-temporarily impaired securities. Of the total unrealized losses on other-than-temporarily impaired securities, $286 million have been in an unrealized loss position for more than 12 months.

 

Of the unrealized losses of $1,634 million, $1,020 million were related to structured securities and $395 million were related to corporate securities in the finance and insurance sector. Of the remaining gross unrealized losses of $219 million, $77 million were related to tax-exempt and government—non-U.S. securities and $142 million were primarily related to other corporate securities that were spread evenly across all other sectors with no individual sector exceeding $28 million.

Of the $1,020 million unrealized losses in structured securities, 53% were in residential mortgage-backed securities and 44% were in commercial mortgage-backed securities with the remainder in other asset-backed securities. Approximately 39% of the total unrealized losses in structured securities were on securities that have retained investment grade ratings. Most of these securities have been in an unrealized loss position for 12 months or more. Given ongoing concern about the housing market and unemployment, the fair value of these securities has declined due to credit spreads that have widened since acquisition. We examined the performance of the underlying collateral and developed our estimate of cash flows expected to be collected. In doing so, we identified certain securities where the non-credit portion of other-than-temporary impairments was recorded in OCI. Based on this evaluation, we determined that the unrealized losses on our mortgage-backed and asset-backed securities represented temporary impairments as of September 30, 2010.

Of the $395 million unrealized losses in the finance and insurance sector, most have been in an unrealized loss position for 12 months or more. Most of these securities have retained a credit rating of investment grade. A portion of the unrealized losses included 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 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 securities represented temporary impairments as of September 30, 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 securities retain a credit rating of investment grade. The majority of these securities were issued by foreign financial institutions. The fair value of these 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 remaining unrealized losses in our U.S. and non-U.S. corporate securities were evenly distributed across all other major industry types that comprise our corporate bond holdings.

Of the investment securities in an unrealized loss position for 12 months or more as of September 30, 2010, 523 securities were 20% or more below cost, of which 323 securities were also below investment grade (rated “BB+” and below) and accounted for unrealized losses of $701 million. These securities were primarily structured securities or securities issued by corporations in the finance and insurance sector. Included in this amount are other-than-temporarily impaired securities where the non-credit loss of $228 million was recorded in OCI.

While certain securities included in the preceding table were considered other-than-temporarily impaired, we expect to recover the new amortized cost based on our estimate of cash flows to be collected. We do not intend to sell and it is not more likely than not that we will be required to sell these securities prior to recovering our amortized cost.

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 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, 2009:

 

     Less than 12 months      12 months or more  

(Dollar amounts in millions)

   Fair
value
     Gross
unrealized
losses
    Number of
securities
     Fair
value
     Gross
unrealized
losses
    Number of
securities
 

Description of Securities

               

Fixed maturity securities:

               

U.S. government, agencies and government-sponsored enterprises

   $ 1,759       $ (95     81       $ 6       $ (1     2   

Tax-exempt

     152         (6     48         346         (98     113   

Government—non-U.S.

     341         (3     60         105         (19     35   

U.S. corporate

     2,823         (81     317         5,660         (736     510   

Corporate—non-U.S.

     1,721         (55     221         2,245         (301     258   

Residential mortgage-backed

     941         (252     256         1,012         (558     348   

Commercial mortgage-backed

     714         (64     81         1,720         (771     345   

Other asset-backed

     329         (6     43         1,727         (474     183   
                                                   

Subtotal, fixed maturity securities

     8,780         (562     1,107         12,821         (2,958     1,794   

Equity securities

     2         (1     3         12         (2     9   
                                                   

Total for securities in an unrealized loss position

   $ 8,782       $ (563     1,110       $ 12,833       $ (2,960     1,803   
                                                   

% Below cost—fixed maturity securities:

               

<20% Below cost

   $ 8,437       $ (245     920       $ 9,699       $ (762     1,055   

20-50% Below cost

     267         (137     91         2,637         (1,246     455   

>50% Below cost

     76         (180     96         485         (950     284   
                                                   

Total fixed maturity securities

     8,780         (562     1,107         12,821         (2,958     1,794   
                                                   

% Below cost—equity securities:

               

<20% Below cost

     2         (1     3         11         (1     5   

>50% Below cost

     —           —          —           1         (1     4   
                                                   

Total equity securities

     2         (1     3         12         (2     9   
                                                   

Total for securities in an unrealized loss position

   $ 8,782       $ (563     1,110       $ 12,833       $ (2,960     1,803   
                                                   

Investment grade

   $ 8,391       $ (320     891       $ 10,897       $ (2,122     1,390   

Below investment grade

     391         (243     219         1,936         (838     413   
                                                   

Total for securities in an unrealized loss position

   $ 8,782       $ (563     1,110       $ 12,833       $ (2,960     1,803   
                                                   

 

The scheduled maturity distribution of fixed maturity securities as of September 30, 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.

 

(Amounts in millions)

   Amortized
cost or
cost
     Fair
value
 

Due one year or less

   $ 2,591       $ 2,613   

Due after one year through five years

     12,156         12,562   

Due after five years through ten years

     8,818         9,454   

Due after ten years

     19,680         21,256   
                 

Subtotal

     43,245         45,885   

Residential mortgage-backed

     4,629         4,334   

Commercial mortgage-backed

     4,011         3,757   

Other asset-backed

     2,391         2,380   
                 

Total

   $ 54,276       $ 56,356   
                 

As of September 30, 2010, $4,985 million of our investments (excluding mortgage-backed and asset-backed securities) were subject to certain call provisions.

As of September 30, 2010, securities issued by finance and insurance, utilities and energy, and consumer—non-cyclical industry groups represented approximately 24%, 22% and 12% of our domestic and foreign corporate fixed maturity securities portfolio, respectively. No other industry group comprised more than 10% of our investment portfolio. This portfolio is widely diversified among various geographic regions in the U.S. and internationally, and is not dependent on the economic stability of one particular region.

As of September 30, 2010, we did not hold any fixed maturity securities in any single issuer, other than securities issued or guaranteed by the U.S. government, which exceeded 10% of stockholders’ equity.

(e) Commercial Mortgage Loans

Our mortgage loans are collateralized by commercial properties, including multi-family residential buildings. The carrying value of commercial mortgage loans is stated at original cost net of prepayments, amortization and allowance for loan losses.

 

We diversify our commercial mortgage loans by both property type and geographic region. The following tables set forth the distribution across property type and geographic region for commercial mortgage loans as of the periods indicated:

 

     September 30, 2010     December 31, 2009  

(Amounts in millions)

   Carrying
value
    % of
total
    Carrying
value
    % of
total
 

Property Type

        

Retail

   $ 2,015        29   $ 2,115        28

Office

     1,897        27        2,025        27   

Industrial

     1,861        27        1,979        26   

Apartments

     776        11        832        11   

Mixed use/other

     437        6        590        8   
                                

Total principal balance

     6,986        100     7,541        100
                    

Unamortized balance of loan origination fees and costs

     5          6     

Allowance for losses

     (62       (48  
                    

Total (1)

   $ 6,929        $ 7,499     
                    

 

(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 mortgage loans in other invested assets.

 

     September 30, 2010     December 31, 2009  

(Amounts in millions)

   Carrying
value
    % of
total
    Carrying
value
    % of
total
 

Geographic Region

        

Pacific

   $ 1,857        27   $ 2,005        27

South Atlantic

     1,593        23        1,711        23   

Middle Atlantic

     935        13        1,005        13   

East North Central

     657        9        728        10   

Mountain

     591        9        650        9   

New England

     484        7        492        6   

West North Central

     374        5        389        5   

West South Central

     306        4        331        4   

East South Central

     189        3        230        3   
                                

Total principal balance

     6,986        100     7,541        100
                                

Unamortized balance of loan origination fees and costs

     5          6     

Allowance for losses

     (62       (48  
                    

Total (1)

   $ 6,929        $ 7,499     
                    

 

(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 mortgage loans in other invested assets.

“Impaired” loans are defined by U.S. GAAP as loans for which it is probable that the lender will be unable to collect all amounts due according to original contractual terms of the loan agreement.

 

Under these principles, we may have two types of “impaired” loans: loans requiring specific allowances for losses ($14 million for the nine months ended September 30, 2010 and $21 million for the year ended December 31, 2009) and loans expected to be fully recoverable because the carrying amount has been reduced previously through charge-offs or deferral of income recognition (none for the nine months ended September 30, 2010 and for the year ended December 31, 2009).

Average investment in specifically impaired loans was $5 million and $10 million as of September 30, 2010 and December 31, 2009, respectively, and there was no interest income recognized on these loans while they were considered impaired.

The following table presents the activity in the allowance for losses during the periods indicated:

 

(Amounts in millions)

   Three months ended
September 30, 2010
    Nine months ended
September 30, 2010
 

Beginning balance

   $ 70      $ 48   

Provision

     5        27   

Release (1)

     (13     (13
                

Ending balance

   $ 62      $ 62   
                

 

  (1)

Included $13 million related to held-for-sale commercial mortgage loans that were sold in the third quarter of 2010.

( f ) Restricted Commercial Mortgage Loans Related To Securitization Entities

The following tables set forth additional information regarding our restricted commercial mortgage loans related to securitization entities as of the date indicated:

 

     September 30, 2010  

(Amounts in millions)

   Carrying
value
    % of
total
 

Property Type

    

Retail

   $ 190        36

Industrial

     128        25   

Office

     120        23   

Apartments

     64        12   

Mixed use/other

     22        4   
                

Total principal balance

     524        100
          

Allowance for losses

     (2  
          

Total 

   $ 522     
          

 

     September 30, 2010  

(Amounts in millions)

   Carrying
value
    % of
total
 

Geographic Region

    

South Atlantic

   $ 193        37

Pacific

     92        18   

Middle Atlantic

     71        14   

East North Central

     54        10   

Mountain

     36        7   

East South Central

     32        6   

West North Central

     32        6   

West South Central

     13        2   

New England

     1        —     
                

Total principal balance

     524        100
          

Allowance for losses

     (2  
          

Total

   $ 522     
          

See note 7 for additional information related to consolidated securitization entities.

(g) Restricted Other Invested Assets Related To Securitization Entities

Our consolidated securitization entities hold certain investments that are recorded as restricted other invested assets related to securitization entities. The consolidated securitization entities hold certain investments as trading securities whereby the changes in fair value are recorded in current period income (loss). The trading securities are comprised of asset-backed securities, including residual interest in certain policy loan securitization entities and highly rated bonds that are primarily backed by credit card receivables. See note 7 for additional information related to consolidated securitization entities.

Derivative Instruments
Derivative Instruments

(5) Derivative Instruments

Our business activities routinely deal with fluctuations in interest rates, equity prices, currency exchange rates and other asset and liability prices. We use derivative instruments to mitigate or reduce certain of these risks. We have established policies for managing each of these risks, including prohibitions on derivatives market-making and other speculative derivatives activities. These policies require the use of derivative instruments in concert with other techniques to reduce or mitigate these risks. While we use derivatives to mitigate or reduce risks, certain derivatives do not meet the accounting requirements to be designated as hedging instruments and are denoted as “derivatives not designated as hedges” in the following disclosures. For derivatives that meet the accounting requirements to be designated as hedges, the following disclosures for these derivatives are denoted as “derivatives designated as hedges,” which include both cash flow and fair value hedges.

 

The following table sets forth our positions in derivative instruments as of the dates indicated:

 

    Derivative assets     Derivative liabilities  
    Balance
sheet
classification
    Fair value     Balance
sheet
classification
    Fair value  

(Amounts in millions)

    September 30,
2010
    December 31,
2009
      September 30,
2010
    December 31,
2009
 

Derivatives designated as hedges

           

Cash flow hedges:

           

Interest rate swaps

   
 
Other invested
assets
  
  
  $ 821      $ 72       
 
Other
liabilities
 
  
  $ 5      $ 114   

Inflation indexed swaps

   
 
Other invested
assets
  
  
    7        —         
 
Other
liabilities
 
  
    5        21   

Foreign currency swaps

   

 

Other invested

assets

  

  

    180        101       
 
Other
liabilities
 
  
    —          —     
                                   

Total cash flow hedges

      1,008        173          10        135   
                                   

Fair value hedges:

           

Interest rate swaps

   
 
Other invested
assets
 
  
    117        132       
 
Other
liabilities
 
  
    10        15   

Foreign currency swaps

   
 
Other invested
assets
 
  
    31        24       
 
Other
liabilities
 
  
    —          —     
                                   

Total fair value hedges

      148        156          10        15   
                                   

Total derivatives designated as hedges

      1,156        329          20        150   
                                   

Derivatives not designated as hedges

           

Interest rate swaps

   
 
Other invested
assets
 
  
    454        505       
 
Other
liabilities
 
  
    57        59   

Equity return swaps

   
 
Other invested
assets
 
  
    —          —         
 
Other
liabilities
 
  
    6        —     

Interest rate swaps related to securitization entities (1)

   
 
 
 
Restricted
other
invested
assets
 
  
 
  
    —          —         
 
Other
liabilities
 
  
    34        —     

Interest rate swaptions

   
 
Other invested
assets
 
  
    8        54       
 
Other
liabilities
 
  
    —          67   

Credit default swaps

   
 
Other invested
assets
 
  
    4        11       
 
Other
liabilities
 
  
    9        3   

Credit default swaps related to securitization entities (1)

   
 
 
 
Restricted
other
invested
assets
 
  
 
  
    —          —         
 
Other
liabilities
 
  
    130        —     

Equity index options

   
 
Other invested
assets
 
  
    61        39       
 
Other
liabilities
 
  
    —          2   

Financial futures

   
 
Other invested
assets
 
  
    —          —         
 
Other
liabilities
 
  
    —          —     

Other foreign currency contracts

   
 
Other invested
assets
 
  
    —          8       
 
Other
liabilities
 
  
    3       —     

Reinsurance embedded derivatives (2)

    Other assets        4        —         
 
Other
liabilities
 
  
    —          —     

GMWB embedded derivatives

   

 

Reinsurance

recoverable (3)

  

  

    4        (5    

 

 

Policyholder

account

balances (4)

  

  

  

    316        175   
                                   

Total derivatives not designated as hedges

      535        612          555        306   
                                   

Total derivatives

    $ 1,691      $ 941        $ 575      $ 456   
                                   

 

(1)

See note 7 for additional information related to consolidated securitization entities.

(2)

Represents embedded derivatives associated with certain reinsurance agreements.

(3)

Represents embedded derivatives associated with the reinsured portion of our guaranteed minimum withdrawal benefits (“GMWB”) liabilities.

(4)

Represents the embedded derivatives associated with our GMWB liabilities, excluding the impact of reinsurance.

 

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.

The activity associated with derivative instruments can generally be measured by the change in notional value over the periods presented. However, for GMWB embedded derivatives, the change between periods is best illustrated by the number of policies. The following tables represent activity associated with derivative instruments as of the dates indicated:

 

(Notional in millions)

  Measurement     December 31, 2009     Additions     Maturities/
terminations
    September 30, 2010  

Derivatives designated as hedges

         

Cash flow hedges:

         

Interest rate swaps

    Notional      $ 9,479      $ 1,382      $ (209   $ 10,652   

Inflation indexed swaps

    Notional        376        157        (10     523   

Foreign currency swaps

    Notional        491        —          —          491   
                                 

Total cash flow hedges

      10,346        1,539        (219     11,666   
                                 

Fair value hedges:

         

Interest rate swaps

    Notional        2,366        —          (281     2,085   

Foreign currency swaps

    Notional        85        —          —          85   
                                 

Total fair value hedges

      2,451        —          (281     2,170   
                                 

Total derivatives designated as hedges

      12,797        1,539        (500     13,836   
                                 

Derivatives not designated as hedges

         

Interest rate swaps

    Notional        6,474        4,057        (2,569     7,962   

Equity return swaps

    Notional        —          200        —          200   

Interest rate swaps related to securitization entities

    Notional        —          138        (6     132   

Interest rate swaptions

    Notional        5,100        200        (5,100     200   

Credit default swaps

    Notional        1,090        100        —          1,190   

Credit default swaps related to securitization entities

    Notional        —          322        (5     317   

Equity index options

    Notional        912        564        (614     862   

Financial futures

    Notional        5,822        5,579        (6,817     4,584   

Other foreign currency contracts

    Notional        521        132       (73     580   

Reinsurance embedded derivatives

    Notional        —          52        —          52   
                                 

Total derivatives not designated as hedges

      19,919        11,344        (15,184     16,079   
                                 

Total derivatives

    $ 32,716      $ 12,883      $ (15,684   $ 29,915   
                                 

 

(Number of policies)

  Measurement     December 31, 2009     Additions     Terminations     September 30, 2010  

Derivatives not designated as hedges

         

GMWB embedded derivatives

    Policies        47,543        3,089        (1,882     48,750   

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 $186 million as of September 30, 2010.

 

Cash Flow Hedges

Certain derivative instruments are designated as cash flow hedges. The changes in fair value of these instruments are recorded as a component of OCI. We designate and account for the following as cash flow hedges when they have met the effectiveness requirements: (i) various types of interest rate swaps to convert floating rate investments to fixed rate investments; (ii) various types of interest rate swaps to convert floating rate liabilities into fixed rate liabilities; (iii) receive U.S. dollar fixed on foreign currency swaps to hedge the foreign currency cash flow exposure of foreign currency denominated investments; (iv) pay U.S. dollar fixed on foreign currency swaps to hedge the foreign currency cash flow exposure on liabilities denominated in foreign currencies; (v) forward starting interest rate swaps to hedge against changes in interest rates associated with future fixed-rate bond purchases and/or interest income; and (vi) other instruments to hedge the cash flows of various forecasted transactions.

The following table provides information about the pre-tax income (loss) effects of cash flow hedges for the three months ended September 30, 2010:

 

(Amounts in millions)

  Gain (loss)
recognized in OCI
    Gain (loss)
reclassified into
net income (loss)
from OCI 
   

Classification of gain
(loss) reclassified into
net income (loss)

  Gain (loss)
recognized in
net income (loss) 
(1)
   

Classification of gain
(loss) recognized in
net income (loss)

Interest rate swaps hedging assets

  $ 299      $ 4      Net investment income   $ 8      Net investment gains (losses)

Interest rate swaps hedging assets

    —          1      Net investment gains (losses)     —        Net investment gains (losses)

Interest rate swaps hedging liabilities

    —          —        Interest expense     —        Net investment gains (losses)

Foreign currency swaps

    2        (1   Interest expense     —        Net investment gains (losses)
                           

Total

  $ 301      $ 4        $ 8     
                           

 

(1)

Represents ineffective portion of cash flow hedges, as there were no amounts excluded from the measurement of effectiveness.

The following table provides information about the pre-tax income (loss) effects of cash flow hedges for the three months ended September 30, 2009:

 

(Amounts in millions)

  Gain (loss)
recognized in OCI
    Gain (loss)
reclassified into
net income (loss)

from OCI (1)
   

Classification of gain
(loss) reclassified into
net income (loss)

  Gain (loss)
recognized in
net income (loss) 
(2)
   

Classification of gain
(loss) recognized in
net income (loss)

Interest rate swaps hedging assets

  $ 99      $ 2     

Net investment

income

  $ (2  

Net investment

gains (losses)

Interest rate swaps hedging assets

    —          —       

Net investment

gains (losses)

    —       

Net investment

gains (losses)

Foreign currency swaps

    —          (1  

Net investment

gains (losses)

    —       

Net investment

gains (losses)

Foreign currency swaps

    3        —        Interest expense     1     

Net investment

gains (losses)

                           

Total

  $ 102      $ 1       $ (1  
                           

 

(1)

Amounts include $(1) million of gains 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.

 

The following table provides information about the pre-tax income (loss) effects of cash flow hedges for the nine months ended September 30, 2010:

 

(Amounts in millions)

  Gain (loss)
recognized in OCI
    Gain (loss)
reclassified into
net income (loss)
from OCI 
   

Classification of gain
(loss) reclassified into
net income (loss)

  Gain (loss)
recognized in
net income (loss) 
(1)
   

Classification of gain
(loss) recognized in
net income (loss)

Interest rate swaps hedging assets

  $ 862      $ 12      Net investment income   $ 20      Net investment gains (losses)

Interest rate swaps hedging assets

    —          2      Net investment gains (losses)     —        Net investment gains (losses)

Interest rate swaps hedging liabilities

    (3     1      Interest expense     —        Net investment gains (losses)

Foreign currency swaps

    9        (5   Interest expense     —        Net investment gains (losses)
                           

Total

  $ 868      $ 10        $ 20     
                           

 

(1)

Represents ineffective portion of cash flow hedges as there were no amounts excluded from the measurement of effectiveness.

The following table provides information about the pre-tax income (loss) effects of cash flow hedges for the nine months ended September 30, 2009:

 

(Amounts in millions)

  Gain (loss)
recognized in OCI
    Gain (loss)
reclassified into
net income
(loss) from OCI 
(1)
   

Classification of gain
(loss) reclassified into
net income (loss)

  Gain (loss)
recognized in
net income (loss) 
(2)
   

Classification of gain
(loss) recognized in
net income (loss)

Interest rate swaps hedging assets

  $ (223   $ 10      Net investment income   $ (12  

Net investment

gains (losses)

Interest rate swaps hedging assets

    —          5     

Net investment

gains (losses)

    —       

Net investment

gains (losses)

Foreign currency swaps

    —          (1  

Net investment

gains (losses)

    —       

Net investment

gains (losses)

Foreign currency swaps

    (10     (8   Interest expense     1     

Net investment

gains (losses)

                           

Total

  $ (233   $ 6        $ (11  
                           

 

(1)

Amounts include $4 million of gains 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.

 

The total of derivatives designated as cash flow hedges of $1.4 billion, net of taxes, recorded in stockholders’ equity as of September 30, 2010 is expected to be reclassified to future net income (loss), concurrently with and primarily offsetting changes in interest expense and interest income on floating-rate instruments and interest income on future fixed-rate bond purchases. Of this amount, $6 million, net of taxes, is expected to be reclassified to net income (loss) in the next 12 months. Actual amounts may vary from this amount as a result of market conditions. All forecasted transactions associated with qualifying cash flow hedges are expected to occur by 2045. No amounts were reclassified to net income (loss) during the nine months ended September 30, 2010 in connection with forecasted transactions that were no longer considered probable of occurring.

Fair Value Hedges

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 three months ended September 30, 2010:

 

    Derivative instrument   Hedged item

(Amounts in millions)

  Gain (loss)
recognized in
net income
(loss)
   

Classification
of gain (loss)
recognized in
net income (loss)

  Other impacts
to net
income (loss)
   

Classification
of other
impacts to
net income (loss)

  Gain (loss)
recognized in
net income
(loss)
   

Classification
of gain (loss)
recognized in

net income (loss)

Interest rate swaps hedging assets

  $ —        Net investment gains (losses)   $ (4   Net investment income   $ (1   Net investment gains (losses)

Interest rate swaps hedging liabilities

    (4   Net investment gains (losses)     25      Interest credited     4      Net investment gains (losses)

Foreign currency swaps

    11      Net investment gains (losses)     —        Interest credited     (10   Net investment gains (losses)
                             

Total

  $ 7        $ 21        $ (7  
                             

The following table provides information about the pre-tax income (loss) effects of fair value hedges and related hedged items for the three months ended September 30, 2009:

 

    Derivative instrument   Hedged item

(Amounts in millions)

  Gain (loss)
recognized in
net income
(loss)
   

Classification
of gain (loss)
recognized in
net income (loss)

  Other impacts
to net
income (loss)
   

Classification
of other
impacts to
net income (loss)

  Gain (loss)
recognized in
net income
(loss)
   

Classification
of gain (loss)
recognized in
net income (loss)

Interest rate swaps hedging assets

  $ 1     

Net investment

gains (losses)

  $ (4   Net investment income   $ —        Net investment gains (losses)

Interest rate swaps hedging liabilities

    14     

Net investment

gains (losses)

    26      Interest credited     (14   Net investment gains (losses)

Foreign currency swaps

    3      Net investment gains (losses)     —        Interest credited     (4   Net investment gains (losses)
                             

Total

  $ 18        $ 22        $ (18  
                             

 

The following table provides information about the pre-tax income (loss) effects of fair value hedges and related hedged items for the nine months ended September 30, 2010:

 

    Derivative instrument   Hedged item

(Amounts in millions)

  Gain (loss)
recognized in
net income
(loss)
   

Classification
of gain (loss)
recognized in
net income (loss)

  Other impacts
to net
income (loss)
   

Classification
of other
impacts to
net income (loss)

  Gain (loss)
recognized in
net income
(loss)
   

Classification
of gain (loss)
recognized in

net income (loss)

Interest rate swaps hedging assets

  $ 2      Net investment gains (losses)   $ (10   Net investment income   $ (3   Net investment gains (losses)

Interest rate swaps hedging liabilities

    (11   Net investment gains (losses)     75      Interest credited     11      Net investment gains (losses)

Foreign currency swaps

    7      Net investment gains (losses)     2      Interest credited     (6   Net investment gains (losses)
                             

Total

  $ (2     $ 67        $ 2     
                             

The following table provides information about the pre-tax income (loss) effects of fair value hedges and related hedged items for the nine months ended September 30, 2009:

 

    Derivative instrument   Hedged item

(Amounts in millions)

  Gain (loss)
recognized in
net income
(loss)
   

Classification
of gain (loss)
recognized in
net income (loss)

  Other impacts
to net
income (loss)
   

Classification
of other
impacts to
net income (loss)

  Gain (loss)
recognized in
net income
(loss)
   

Classification
of gain (loss)
recognized in
net income (loss)

Interest rate swaps hedging assets

  $ 7      Net investment gains (losses)   $ (12   Net investment income   $ (10   Net investment gains (losses)

Interest rate swaps hedging liabilities

    (45   Net investment gains (losses)     68      Interest credited     48      Net investment gains (losses)

Foreign currency swaps

    (10   Net investment gains (losses)     1      Interest credited     7      Net investment gains (losses)
                             

Total

  $ (48     $ 57        $ 45     
                             

The difference between the gain (loss) recognized for the derivative instruments and the hedged items presented above represents the net ineffectiveness of the fair value hedging relationships. The other impacts presented above represent the income (loss) effects of the derivative instruments that are presented in the same location as the income (loss) activity from the hedged items. There were no amounts excluded from the measurement of effectiveness.

Derivatives Not Designated As Hedges

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.

 

We also have derivatives related to securitization entities where we were required to consolidate the related securitization entity as a result of our involvement in the structure. The counterparties for these derivatives typically only have recourse to the securitization entity. The interest rate swaps used for these entities are typically used to effectively convert the interest payments on the assets of the securitization entity to the same basis as the interest rate on the borrowings issued by the securitization entity. Credit default swaps are utilized in certain securitization entities to enhance the yield payable on the borrowings issued by the securitization entity and also include a settlement feature that allows the securitization entity to provide the par value of assets in the securitization entity for the amount of any losses incurred under the credit default swap. See note 7 for additional information related to consolidated securitization entities.

The following table provides the pre-tax gain (loss) recognized in net income (loss) for the effects of derivatives not designated as hedges for the periods indicated:

 

     Three months ended September 30,    

Classification of gain (loss) recognized

in net income (loss)

(Amounts in millions)

       2010             2009        

Interest rate swaps

   $ 36      $ (52   Net investment gains (losses)

Interest rate swaps related to securitization entities (1)

     (12     —        Net investment gains (losses)

Interest rate swaptions

     4        85      Net investment gains (losses)

Credit default swaps

     22        15      Net investment gains (losses)

Credit default swaps related to securitization entities (1)

     30        —        Net investment gains (losses)

Equity index options

     (55     (49   Net investment gains (losses)

Equity return swaps

     (6     —        Net investment gains (losses)

Financial futures

     (43     (106   Net investment gains (losses)

Inflation indexed swaps

     —          —        Net investment gains (losses)

Other foreign currency contracts

     (8     (5   Net investment gains (losses)

Reinsurance embedded derivatives

     2        —        Net investment gains (losses)

GMWB embedded derivatives

     133        133      Net investment gains (losses)
                  

Total derivatives not designated as hedges

   $ 103      $ 21     
                  

 

(1)

See note 7 for additional information related to consolidated securitization entities.

 

The following table provides the pre-tax gain (loss) recognized in net income (loss) for the effects of derivatives not designated as hedges for the periods indicated:

 

     Nine months ended September 30,    

Classification of gain (loss) recognized

in net income (loss)

(Amounts in millions)

       2010             2009        

Interest rate swaps

   $ 93      $ 194      Net investment gains (losses)

Interest rate swaps related to securitization entities (1)

     (24     —        Net investment gains (losses)

Interest rate swaptions

     61        (494   Net investment gains (losses)

Credit default swaps

     (5     36      Net investment gains (losses)

Credit default swaps related to securitization entities (1)

     (11     —        Net investment gains (losses)

Equity index options

     (32     (104   Net investment gains (losses)

Equity return swaps

     (6     —        Net investment gains (losses)

Financial futures

     29        (190   Net investment gains (losses)

Inflation indexed swaps

     —          (4   Net investment gains (losses)

Foreign currency swaps

     —          6      Net investment gains (losses)

Other foreign currency contracts

     (9     5      Net investment gains (losses)

Reinsurance embedded derivatives

     4        —        Net investment gains (losses)

GMWB embedded derivatives

     (109     573      Net investment gains (losses)
                  

Total derivatives not designated as hedges

   $ (9   $ 22     
                  

 

(1)

See note 7 for additional information related to consolidated securitization entities.

Derivative Counterparty Credit Risk

As of September 30, 2010 and December 31, 2009, net fair value assets by counterparty totaled $1.6 billion and $739 million, respectively. As of September 30, 2010 and December 31, 2009, net fair value liabilities by counterparty totaled $169 million and $74 million, respectively. As of September 30, 2010 and December 31, 2009, we retained collateral of $1.6 billion and $647 million, respectively, related to these agreements, including over collateralization of $100 million and $10 million, respectively, from certain counterparties. As of September 30, 2010 and December 31, 2009, we posted $4 million and $121 million, respectively, of collateral to derivative counterparties, including zero over collateralization for September 30, 2010 and over collateralization of $46 million for December 31, 2009. 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.

Except for derivatives related to securitization entities, all of our master swap agreements contain credit downgrade provisions that allow either party to assign or terminate derivative transactions if the other party’s long-term unsecured debt rating or financial strength rating is below the limit defined in the applicable agreement. If the downgrade provisions had been triggered as of September 30, 2010 and December 31, 2009, we could have been allowed to claim up to $106 million and $102 million, respectively, from counterparties and required to disburse up to $2 million and $1 million, respectively. This represented the net fair value of gains and losses by counterparty, less available collateral held, and did not include any fair value gains or losses for derivatives related to securitization entities.

 

Credit Derivatives—Sell Protection

We sell protection under single name credit default swaps and credit default swap index tranches in combination with purchasing securities to replicate characteristics of similar investments based on the credit quality and term of the credit default swap. Credit default triggers for both indexed reference entities and single name reference entities follow the Credit Derivatives Physical Settlement Matrix published by the International Swaps and Derivatives Association. Under these terms, credit default triggers are defined as bankruptcy, failure to pay or restructuring, if applicable. Our maximum exposure to credit loss equals the notional value for credit default swaps and the par value of debt instruments with embedded credit derivatives. In the event of default for credit default swaps, we are typically required to pay the protection holder the full notional value less a recovery rate determined at auction. For debt instruments with embedded credit derivatives, the security’s principal is typically reduced by the net amount of default for any referenced entity defaults.

In addition to the credit derivatives discussed above, we also have credit derivative instruments related to securitization entities that we were required to consolidate in 2010. These derivatives represent a customized index of reference entities with specified attachment points for certain derivatives. The credit default triggers are similar to those described above. In the event of default, the securitization entity will provide the counterparty with the par value of assets held in the securitization entity for the amount of incurred loss on the credit default swap. The maximum exposure to loss for the securitization entity is the notional value of the derivatives. Certain losses on these credit default swaps would be absorbed by the third-party noteholders of the securitization entity and the remaining losses on the credit default swaps would be absorbed by our portion of the notes issued by the securitization entity. See note 9 for information on the third-party borrowings related to consolidated securitization entities.

The following table sets forth our credit default swaps where we sell protection on single name reference entities and the fair values as of the dates indicated:

 

    September 30, 2010     December 31, 2009  

(Amounts in millions)

  Notional
value
    Assets     Liabilities     Notional
value
    Assets     Liabilities  

Reference entity credit rating and maturity:

           

AAA

           

Matures after one year through five years

  $ 5     $ —        $ —        $ 6      $ —        $ —     

AA

           

Matures after one year through five years

    6        —          —          5        —          —     

Matures after five years through ten years

    5        —          —          —          —          —     

A

           

Matures after one year through five years

    37        1        —          32        1        —     

Matures after five years through ten years

    5        —          —          10        —          —     

BBB

           

Matures after one year through five years

    68        1        —          73        1        —     

Matures after five years through ten years

    29        —          —          29        —          —     
                                               

Total credit default swaps on single name reference entities

  $ 155      $ 2      $ —        $ 155      $ 2      $ —     
                                               

 

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 the dates indicated:

 

    September 30, 2010     December 31, 2009  

(Amounts in millions)

  Notional
value
    Assets     Liabilities     Notional
value
    Assets     Liabilities  

Index tranche attachment/detachment point and maturity:

           

9% – 12% matures after one year through five years (1)

  $ 300      $ —        $ 5     $ 50      $ —        $ —     

9% – 12% matures after five years through ten years (2)

    —          —          —          250        1        1   

10% – 15% matures after one year through five years (3)

    250        —          1       —          —          —     

10% – 15% matures after five years through ten years (4)

    —          —          —          250        —          2   

12% – 22% matures after five years through ten years (5)

    248        —          3       248        4        —     

15% – 30% matures after five years through ten years (6)

    127        1        —          127        2        —     
                                               

Total credit default swap index tranches

    925        1        9       925        7        3   
                                               

Customized credit default swap index tranches related to securitization entities:

           

Portion backing third-party borrowings maturing 2017 (7)

    17        —          8        —          —          —     

Portion backing our interest maturing 2017 (8)

    300        —          122        —          —          —     
                                               

Total customized credit default swap index tranches related to securitization entities

    317        —          130        —          —          —     
                                               

Total credit default swaps on index tranches

  $ 1,242      $ 1      $ 139      $ 925      $ 7      $ 3   
                                               

 

(1)

The current attachment/detachment as of September 30, 2010 and December 31, 2009 was 9% – 12%.

(2)

The current attachment/detachment as of December 31, 2009 was 9% – 12%.

(3)

The current attachment/detachment as of September 30, 2010 was 10% – 15%.

(4)

The current attachment/detachment as of December 31, 2009 was 10% – 15%.

(5)

The current attachment/detachment as of September 30, 2010 and December 31, 2009 was 12% – 22%.

(6)

The current attachment/detachment as of September 30, 2010 and December 31, 2009 was 14.8% – 30.3%.

(7)

Original notional value was $39 million.

(8)

Original notional value was $300 million.

The following table sets forth our holding of available-for-sale fixed maturity securities that include embedded credit derivatives and the fair values as of the dates indicated:

 

     September 30, 2010      December 31, 2009  

(Amounts in millions)

   Par
value
     Amortized
cost or cost
     Fair
value
     Par
value
     Amortized
cost or cost
     Fair
value
 

Credit rating:

                 

AA

                 

Matures after five years through ten years (1)

   $ —         $ —         $ —         $ 100       $ 100       $ 96   

BBB

                 

Matures after five years through ten years (2)

     —           —           —           100         100         76   

BB

                 

Matures after five years through ten years (2)

     —           —           —           200         228         148   
                                                     

Total available-for-sale fixed maturity securities that include embedded credit derivatives

   $ —         $ —         $ —         $ 400       $ 428       $ 320   
                                                     

 

(1)

The amounts in 2009 related to securities that were reclassified to the trading category on July 1, 2010 as a result of adopting new accounting guidance related to embedded credit derivatives.

(2)

The amounts in 2009 related to certain VIEs that were consolidated on January 1, 2010. See note 7 for additional information related to consolidated securitization entities.

 

Fair Value of Financial Instruments
Fair Value of Financial Instruments

(6) Fair Value of Financial Instruments

Assets and liabilities that are reflected in the accompanying consolidated financial statements at fair value are not included in the following disclosure of fair value. Such items include cash and cash equivalents, investment securities, separate accounts, securities held as collateral and derivative instruments. Other financial assets and liabilities—those not carried at fair value—are discussed below. Apart from certain of our borrowings and certain marketable securities, few of the instruments discussed below are actively traded and their fair values must often be determined using models. The fair value estimates are made at a specific point in time, based upon available market information and judgments about the financial instruments, including estimates of the timing and amount of expected future cash flows and the credit standing of counterparties. Such estimates do not reflect any premium or discount that could result from offering for sale at one time our entire holdings of a particular financial instrument, nor do they consider the tax impact of the realization of unrealized gains or losses. In many cases, the fair value estimates cannot be substantiated by comparison to independent markets.

The basis on which we estimate fair value is as follows:

Commercial mortgage loans. Based on recent transactions and/or discounted future cash flows, using current market rates.

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.

Short-term borrowings. Based on carrying value which approximates fair value since the borrowings are based on variable interest rates that are reset monthly.

Long-term borrowings. Based on market quotes or comparable market transactions.

Non-recourse funding obligations. Based on the then current coupon, revalued based on the London Interbank Offered Rate (“LIBOR”) set and current spread assumption based on commercially available data. The model is a floating rate coupon model using the spread assumption to derive the valuation.

Borrowings related to securitization entities. Based on market quotes or comparable market transactions.

Investment contracts. Based on expected future cash flows, discounted at current market rates for annuity contracts or institutional products.

 

The following represents the fair value of financial assets and liabilities that are not required to be carried at fair value as of the dates indicated:

 

(Amounts in millions)

   September 30, 2010      December 31, 2009  
   Notional
amount
    Carrying
amount
     Fair
value
     Notional
amount
    Carrying
amount
     Fair
value
 

Assets:

               

Commercial mortgage loans

   $   (1)    $ 6,929       $ 7,136       $   (1)    $ 7,499       $ 7,213   

Restricted commercial mortgage loans (2)

       (1)      522         574           (1)      —           —     

Other invested assets

       (1)      329         332           (1)      1,766         1,769   

Liabilities:

               

Short-term borrowings (3)

       (1)      730         730           (1)      930         930   

Long-term borrowings (3)

       (1)      4,373         4,363           (1)      3,641         3,291   

Non-recourse funding obligations (3)

       (1)      3,437         2,199           (1)      3,443         1,674   

Borrowings related to securitization entities (2), (3)

       (1)      458         491           (1)      —           —     

Investment contracts

       (1)      20,596         21,621           (1)      21,515         21,743   

Performance guarantees, principally letters of credit

     74        —           —           117        —           —     

Other firm commitments:

               

Commitments to fund limited partnerships

     121        —           —           194        —           —     

Ordinary course of business lending commitments

     44        —           —           —          —           —     

 

(1)

These financial instruments do not have notional amounts.

(2)

See note 7 for additional information related to consolidated securitization entities.

(3)

See note 9 for additional information related to borrowings.

Recurring Fair Value Measurements

We have fixed maturity, equity and trading securities, derivatives, embedded derivatives, securities held as collateral, separate account assets and certain other financial instruments, which are carried at fair value. Below is a description of the valuation techniques and inputs used to determine fair value by class of instrument.

Fixed maturity, equity and trading securities

The valuations of fixed maturity, equity and trading securities are determined using a market approach, income approach or a combination of the market and income approach depending on the type of instrument and availability of information.

We utilize certain third-party data providers when determining fair value. We consider information obtained from third-party pricing services as well as third-party broker provided prices, or broker quotes, in our determination of fair value. Additionally, we utilize internal models to determine the valuation of securities using an income approach where the inputs are based on third-party provided market inputs. While we consider the valuations provided by third-party pricing services and broker quotes, management determines the fair value of our investment securities after considering all relevant and available information. We also obtain an understanding of the valuation methodologies and procedures used by third-party data providers to ensure sufficient understanding to evaluate the valuation data received and determine the appropriate fair value.

 

In general, we first obtain valuations from pricing services. If a price is not supplied by a pricing service, we will typically seek a broker quote. For certain private fixed maturity securities where we do not obtain valuations from pricing services, we utilize an internal model to determine fair value since transactions for identical securities are not readily observable and these securities are not typically valued by pricing services. For all securities, excluding certain private fixed maturity securities, if neither a pricing service nor broker quote valuation is available, we determine fair value using internal models.

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.

For private fixed maturity securities, we utilize an internal model to determine fair value and utilize public bond spreads by sector, rating and maturity to develop the market rate that would be utilized for a similar public bond. We then add an additional premium to the public bond spread to adjust for the liquidity and other features of our private placements. We utilize the estimated market yield to discount the expected cash flows of the security to determine fair value. We assign each security an internal rating to determine the appropriate public bond spread that should be utilized in the valuation. While we generally consider the public bond spreads by sector and maturity to be observable inputs, we evaluate the similarities of our private placement with the public bonds to determine whether the spreads utilized would be considered observable inputs for the private placement being valued. To determine the significance of unobservable inputs, we calculate the impact on the valuation from the unobservable input and will classify a security as Level 3 when the impact on the valuation exceeds 10%.

For broker quotes, we discuss the valuation methodology utilized by the third party but cannot typically obtain sufficient evidence to determine the valuation does not include significant unobservable inputs. Accordingly, we typically classify the securities where fair value is based on our consideration of broker quotes as Level 3 measurements.

For remaining securities priced using internal models, we maximize the use of observable inputs but typically utilize significant unobservable inputs to determine fair value. Accordingly, the valuations are typically classified as Level 3.

 

The following table summarizes the primary sources considered when determining fair value of each class of fixed maturity securities as of September 30, 2010:

 

(Amounts in millions)

   Total      Level 1      Level 2      Level 3  

U.S. government, agencies and government-sponsored enterprises:

           

Pricing services

   $ 3,905       $ —         $ 3,905       $ —     

Internal models

     17         —           3         14   
                                   

Total U.S. government, agencies and government-sponsored enterprises

     3,922         —           3,908         14   
                                   

Tax-exempt:

           

Pricing services

     1,271         —           1,271         —     
                                   

Total tax-exempt

     1,271         —           1,271         —     
                                   

Government—non-U.S.:

           

Pricing services

     2,322         —           2,322         —     

Internal models

     30         —           11         19   
                                   

Total government—non-U.S.

     2,352         —           2,333         19   
                                   

U.S. corporate:

           

Pricing services

     21,038         —           21,038         —     

Broker quotes

     286         —           —           286   

Internal models

     3,201         —           2,158         1,043   
                                   

Total U.S. corporate

     24,525         —           23,196         1,329   
                                   

Corporate—non-U.S.:

           

Pricing services

     11,831         —           11,734         97   

Broker quotes

     148         —           —           148   

Internal models

     1,836         —           1,478         358   
                                   

Total corporate—non-U.S.

     13,815         —           13,212         603   
                                   

Residential mortgage-backed:

           

Pricing services

     4,202         —           4,202         —     

Broker quotes

     59         —           —           59   

Internal models

     73         —           —           73   
                                   

Total residential mortgage-backed

     4,334         —           4,202         132   
                                   

Commercial mortgage-backed:

           

Pricing services

     3,706         —           3,706         —     

Broker quotes

     23         —           —           23   

Internal models

     28         —           4         24   
                                   

Total commercial mortgage-backed

     3,757         —           3,710         47   
                                   

Other asset-backed:

           

Pricing services

     2,207         —           2,207         —     

Broker quotes

     142         —           —           142   

Internal models

     31         —           7         24   
                                   

Total other asset-backed

     2,380         —           2,214         166   
                                   

Total fixed maturity securities

   $ 56,356       $ —         $ 54,046       $ 2,310   
                                   

 

The following table summarizes the primary sources considered when determining fair value of equity securities as of September 30, 2010:

 

(Amounts in millions)

   Total      Level 1      Level 2      Level 3  

Pricing services

   $ 206       $ 22       $ 184       $ —     

Broker quotes

     7         —           —           7   

Internal models

     10         —           —           10   
                                   

Total equity securities

   $ 223       $ 22       $ 184       $ 17   
                                   

The following table summarizes the primary sources considered when determining fair value of trading securities as of September 30, 2010:

 

(Amounts in millions)

   Total      Level 1      Level 2      Level 3  

Pricing services

   $ 336       $ —         $ 336       $ —     

Broker quotes

     157         —           —           157   

Internal models

     208         —           —           208   
                                   

Total trading securities

   $ 701       $ —         $ 336       $ 365   
                                   

Restricted other invested assets related to securitization entities

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.

Securities lending and derivative counterparty collateral

The fair value of securities held as collateral is primarily based on Level 2 inputs from market information for the collateral that is held on our behalf by the custodian. We determine fair value after considering prices obtained by third-party pricing services.

Separate account assets

The fair value of separate account assets is based on the quoted prices of the underlying fund investments and, therefore, represents Level 1 pricing.

Derivatives

In determining the fair value of derivatives, we consider the counterparty collateral arrangements and rights of set-off when determining whether any incremental adjustment should be made for both the counterparty’s and our non-performance risk. As a result of these counterparty arrangements, we determined no adjustment for our non-performance risk was required to our derivative liabilities.

 

Interest rate swaps. The valuation of interest rate swaps is determined using an income approach. The primary inputs into the valuation represent the forward interest rate swap curve, which is generally considered an observable input, and results in the derivative being classified as Level 2. For certain swaps, there are features that provide an option to the counterparty to terminate the swap at specified dates and would be considered a significant unobservable input and results in the fair value measurement of the derivative being classified as Level 3.

Interest rate swaps related to securitization entities. The valuation of interest rate swaps related to securitization entities is determined using an income approach. The primary input into the valuation represent the forward interest rate swap curve, which is generally considered an observable input, and results in the derivative being classified as Level 2.

Inflation indexed swaps. The valuation of inflation indexed swaps is determined using an income approach. The primary inputs into the valuation represent the forward interest rate swap curve and consumer price index, which are generally considered observable inputs, and results in the derivative being classified as Level 2.

Interest rate swaptions. The valuation of interest rate swaptions is determined using an income approach. The primary inputs into the valuation represent the forward interest rate swap curve, which is generally considered an observable input, forward interest rate volatility and time value component associated with the optionality in the derivative. As a result of the significant unobservable inputs associated with the forward interest rate volatility input, the derivative is classified as Level 3.

Foreign currency swaps. The valuation of foreign currency swaps is determined using an income approach. The primary inputs into the valuation represent the forward interest rate swap curve and foreign currency exchange rates, both of which are considered an observable input, and results in the derivative being classified as Level 2.

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.

Credit default swaps related to securitization entities. Credit default swaps related to securitization entities represent customized index tranche credit default swaps and are valued using a similar methodology as described above for index tranche credit default swaps. We determine fair value of these credit default swaps after considering both the valuation methodology described above as well as the valuation provided by the derivative counterparty. In addition to the valuation methodology and inputs described for index tranche credit default swaps, these customized credit default swaps contain a feature that permits the securitization entity to provide the par value of underlying assets in the securitization entity to settle any losses under the credit default swap. The valuation of this settlement feature is dependent upon the valuation of the underlying assets and the timing and 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.

 

Equity index options. We have equity index options associated with various equity indices. The valuation of equity index options is determined using an income approach. The primary inputs into the valuation represent equity index volatility and time value component associated with the optionality in the derivative, which are considered significant unobservable inputs in most instances. The equity index volatility surface is determined based on market information that is not readily observable and is developed based upon inputs received from several third-party sources. Accordingly, these options are classified as Level 3.

Financial futures. The fair value of financial futures is based on the closing exchange prices. Accordingly, these financial futures are classified as Level 1. The period end valuation is zero as a result of settling the margins on these contracts on a daily basis.

Other foreign currency contracts. We have certain foreign currency options classified as other foreign currency contracts. The valuation of foreign currency options is determined using an income approach. The primary inputs into the valuation represent the forward interest rate swap curve, foreign currency exchange rates, forward interest rate and foreign currency exchange rate volatility and time value component associated with the optionality in the derivative. As a result of the significant unobservable inputs associated with the forward interest rate and foreign currency exchange rate volatility input, the derivative is classified as Level 3.

Reinsurance embedded derivatives

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.

GMWB embedded derivatives

We are required to bifurcate an embedded derivative for certain features associated with annuity products and related reinsurance agreements where we provide a GMWB to the policyholder and are required to record the GMWB embedded derivative at fair value. The valuation of our GMWB embedded derivative is based on an income approach that incorporates inputs such as forward interest rates, equity index volatility, equity index and fund correlation, and policyholder assumptions such as utilization, lapse and mortality. In addition to these inputs, we also consider risk and expense margins when determining the projected cash flows that would be determined by another market participant. While the risk and expense margins are considered in determining fair value, these inputs do not have a significant impact on the valuation.

For GMWB liabilities, non-performance risk is integrated into the discount rate. Prior to the third quarter of 2010, the discount rate was based on the swap curve, which incorporated the non-performance risk of our GMWB liabilities. Beginning in 2009, the swap curve dropped below the U.S. Treasury curve at certain points on the longer end of the curve, and in 2010, the points below the U.S. Treasury curve expanded to several points beyond 10 years. For these points on the curve, we utilized the U.S. Treasury curve as our discount rate through the second quarter of 2010. Beginning in the third quarter of 2010, we revised our discount rate to reflect market credit spreads that represent an adjustment for the non-performance risk of the GMWB liabilities. The credit spreads included in our discount rate range from 60 to 80 basis points over the most relevant points on the U.S. Treasury curve. As of September 30, 2010, the impact of non-performance risk resulted in a lower fair value of our GMWB liabilities of $70 million. As of December 31, 2009, the impact of non-performance risk on our GMWB valuation was not material.

 

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.

For equity index volatility, we determine the projected equity market volatility using both historical volatility and projected near-term equity market volatility with more significance being placed on projected and recent historical data.

Equity index and fund correlations are determined based on historical price observations for the fund and equity index.

For policyholder assumptions, we use our expected lapse, mortality and utilization assumptions and update these assumptions for our actual experience, as necessary. For our lapse assumption, we adjust our base lapse assumption by policy based on a combination of the policyholder’s current account value and GMWB benefit.

We classify the GMWB valuation as Level 3 based on having significant unobservable inputs. We evaluate the inputs and methodologies used to determine fair value based on how we expect a market participant would determine exit value. As stated above, there is no exit market or market participants for the GMWB embedded derivatives. Accordingly, we evaluate our inputs and resulting fair value based on a hypothetical exit market and hypothetical market participants. A hypothetical exit market could be viewed as a transaction that would closely resemble reinsurance. While reinsurance transactions for this type of product are not an observable input, we consider this type of hypothetical exit market, as appropriate, when evaluating our inputs and determining that our inputs are consistent with that of a hypothetical market participant.

Borrowings related to securitization entities

We record certain borrowings related to securitization entities at fair value. The fair value of these borrowings is determined using either a market approach or income approach, depending on the instrument and availability of market information. Given the unique characteristics of the securitization entities that issued these borrowings as well as the lack of comparable instruments, we determine fair value considering the valuation of the underlying assets held by the securitization entities and any derivatives, as well as any unique characteristics of the borrowings that may impact the valuation. After considering all relevant inputs, we determine fair value of the borrowings using the net valuation of the underlying assets and derivatives that are backing the borrowings. Accordingly, these instruments are classified as Level 3.

 

The following tables set forth our assets and liabilities by class of instrument that are measured at fair value on a recurring basis as of the dates indicated:

 

     September 30, 2010  

(Amounts in millions)

   Total      Level 1      Level 2      Level 3  

Assets

           

Investments:

           

Fixed maturity securities:

           

U.S. government, agencies and government-sponsored enterprises

   $ 3,922       $ —         $ 3,908       $ 14   

Tax-exempt

     1,271         —           1,271         —     

Government—non-U.S.

     2,352         —           2,333         19   

U.S. corporate

     24,525         —           23,196         1,329   

Corporate—non-U.S.

     13,815         —           13,212         603   

Residential mortgage-backed

     4,334         —           4,202         132   

Commercial mortgage-backed

     3,757         —           3,710         47   

Other asset-backed

     2,380         —           2,214         166   
                                   

Total fixed maturity securities

     56,356         —           54,046         2,310   
                                   

Equity securities

     223         22         184         17   
                                   

Other invested assets:

           

Trading securities

     701         —           336         365   

Derivative assets:

           

Interest rate swaps

     1,392         —           1,383         9   

Inflation indexed swaps

     7         —           7         —     

Foreign currency swaps

     211         —           211         —     

Interest rate swaptions

     8         —           —           8   

Credit default swaps

     4         —           3         1   

Equity index options

     61         —           —           61   
                                   

Total derivative assets

     1,683         —           1,604         79   
                                   

Securities lending collateral

     702         —           702         —     

Derivatives counterparty collateral

     156         —           156         —     
                                   

Total other invested assets

     3,242         —           2,798         444  
                                   

Restricted other invested assets related to securitization entities

     376         —           198         178   

Other assets (1)

     4         —           4        —     

Reinsurance recoverable (2)

     4         —           —           4   

Separate account assets

     11,063         11,063         —           —     
                                   

Total assets

   $ 71,268       $ 11,085       $ 57,230       $ 2,953   
                                   

Liabilities

           

Policyholder account balances (3)

   $ 316       $ —         $ —         $ 316   

Derivative liabilities:

           

Interest rate swaps

     72         —           72         —     

Interest rate swaps related to securitization entities

     34         —           34         —     

Inflation indexed swaps

     5         —           5         —     

Credit default swaps

     9         —           —           9   

Credit default swaps related to securitization entities

     130         —           —           130   

Equity return swaps

     6         —           6         —     

Other foreign currency contracts

     3         —           3         —     
                                   

Total derivative liabilities

     259         —           120         139   

Borrowings related to securitization entities

     44         —           —           44   
                                   

Total liabilities

   $ 619       $ —         $ 120       $ 499   
                                   

 

(1)

Represents embedded derivatives associated with certain reinsurance agreements.

(2)

Represents embedded derivatives associated with the reinsured portion of our GMWB liabilities.

(3)

Represents embedded derivatives associated with our GMWB liabilities, excluding the impact of reinsurance.

 

(Amounts in millions)

   December 31, 2009  
   Total     Level 1      Level 2      Level 3  

Assets

          

Investments:

          

Fixed maturity securities:

          

U.S. government, agencies and government-sponsored enterprises

   $ 2,602      $ —         $ 2,586       $ 16   

Tax-exempt

     1,544        —           1,542         2   

Government—non-U.S.

     2,384        —           2,377         7   

U.S. corporate

     21,412        —           20,339         1,073   

Corporate—non-U.S.

     12,551        —           12,047         504   

Residential mortgage-backed

     3,227        —           1,746         1,481   

Commercial mortgage-backed

     3,617        —           59         3,558   

Other asset-backed

     2,415        —           996         1,419   
                                  

Total fixed maturity securities

     49,752        —           41,692         8,060   
                                  

Equity securities

     159        42         108         9   
                                  

Other invested assets:

          

Trading securities

     174        —           29         145   

Derivative assets:

          

Interest rate swaps

     709        —           706         3   

Foreign currency swaps

     125        —           125         —     

Interest rate swaptions

     54        —           —           54   

Credit default swaps

     11        —           5         6   

Equity index options

     39        —           —           39   

Other foreign currency contracts

     8        —           —           8   
                                  

Total derivative assets

     946        —           836         110   
                                  

Securities lending collateral

     853        —           853         —     

Derivatives counterparty collateral

     148        —           148         —     
                                  

Total other invested assets

     2,121        —           1,866         255   
                                  

Reinsurance recoverable (1)

     (5     —           —           (5

Separate account assets

     11,002        11,002         —           —     
                                  

Total assets

   $ 63,029      $ 11,044       $ 43,666       $ 8,319   
                                  

Liabilities

          

Policyholder account balances (2)

   $ 175      $ —         $ —         $ 175   

Derivative liabilities:

          

Interest rate swaps

     188        —           186         2   

Inflation indexed swaps

     21        —           21         —     

Interest rate swaptions

     67        —           —           67   

Credit default swap

     3        —           3         —     

Equity index options

     2        —           —           2   
                                  

Total derivative liabilities

     281        —           210         71   
                                  

Total liabilities

   $ 456      $ —         $ 210       $ 246   
                                  

 

(1)

Represents embedded derivatives associated with the reinsured portion of our GMWB liabilities.

(2)

Represents embedded derivatives associated with our GMWB liabilities, excluding the impact of reinsurance.

We review the fair value hierarchy classifications each reporting period. Changes in the observability of the valuation attributes may result in a reclassification of certain financial assets or liabilities. Such reclassifications are reported as transfers in and out of Level 3, or between other levels, at the beginning fair value for the reporting period in which the changes occur.

 

The following tables present 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:

 

(Amounts in millions)

  Beginning
balance
as of
July 1,
2010
    Total realized and
unrealized gains
(losses)
    Purchases,
sales,
issuances
and
settlements,
net
    Transfer
in

Level 3
    Transfer
out of
Level 3
    Ending
balance
as of
September 30,
2010
    Total gains
(losses)
included in
net income
(loss)
attributable
to assets
still held
 
    Included in
net income
(loss)
    Included
in OCI
           

Fixed maturity securities:

               

U.S. government, agencies and government- sponsored enterprises

  $ 9      $ —        $ —        $ —        $ 5      $ —        $ 14      $ —     

Tax-exempt

    —          —          —          —          —          —          —          —     

Government—non-U.S.

    18        —          1       —          —          —          19        —     

U.S. corporate (1)

    1,520        4       23        2        83        (303     1,329        4   

Corporate—non-U.S. (1)

    720        (8     —          (8     119        (220     603        (8

Residential mortgage- backed

    62        —          1        9        65        (5     132        —     

Commercial mortgage- backed

    59        (6     8        (15     1        —          47        —     

Other asset-backed (2)

    361        —          5        15        —          (215     166        —     
                                                               

Total fixed maturity securities

    2,749        (10     38        3        273        (743     2,310        (4
                                                               

Equity securities

    9        11        —          (11     8        —          17        —     
                                                               

Other invested assets:

               

Trading securities (2)

    136       7        —          9        213        —          365        7   

Derivative assets:

               

Interest rate swaps

    9        —          —          —          —          —          9        —     

Interest rate swaptions

    4        4        —          —          —          —          8        4   

Credit default swaps

    —          1        —          —          —          —          1        1   

Equity index options

    97        (54     —          18        —          —          61        (54

Other foreign currency contracts

    1        —          —          (1     —          —          —          —     
                                                               

Total derivative assets

    111        (49     —          17        —          —          79        (49
                                                               

Total other invested assets

    247        (42     —          26        213       —          444        (42
                                                               

Restricted other invested assets related to securitization entities (3)

    174        4        —          —          —          —          178        3   

Reinsurance recoverable (4)

    9        (7     —          2       —          —          4        (7
                                                               

Total Level 3 assets

  $ 3,188      $ (44   $ 38      $ 20      $ 494      $ (743   $ 2,953      $ (50
                                                               

 

(1)

The transfers in and out of Level 3 were primarily related to private fixed rate U.S. corporate and corporate—non-U.S. securities and resulted from a change in the observability of the additional premium to the public bond spread to adjust for the liquidity and other features of our private placements and resulted in unobservable inputs having a significant impact on certain valuations for transfers in or no longer having significant impact on certain valuations for transfers out.

(2)

Transfers in for trading securities were offset by transfers out of other asset-backed securities and were driven primarily by the adoption of new accounting guidance related to embedded credit derivatives.

(3)

Relates to the consolidation of certain securitization entities as of January 1, 2010. See note 7 for additional information related to consolidated securitization entities.

(4)

Represents embedded derivatives associated with the reinsured portion of our GMWB liabilities.

 

(Amounts in millions)

  Beginning
balance
as of
July 1,
2009
    Total realized and
unrealized gains
(losses)
    Purchases,
sales,
issuances

and
settlements,

net
    Transfer
in
Level 3
    Transfer
out of
Level 3
    Ending
balance
as of
September 30,
2009
    Total gains
(losses)
included in
net income
(loss)
attributable
to assets
still held
 
    Included in
net income
(loss)
    Included
in OCI
           

Fixed maturity securities:

               

U.S. government, agencies and government- sponsored entities

  $ 357      $ —        $ —        $ —        $ 4      $ (356   $ 5      $ —     

Tax exempt

    2        —          —          —          —          —          2        —     

Government—non-U.S.

    22        —          (2     (1     15       —          34        —     

U.S. corporate

    1,408        25        60        (52     387        (308     1,520        5   

Corporate—non-U.S.

    767        7        69        74        293        (178     1,032        (2

Residential mortgage-backed

    1,623        (89     200        (51     20        (44     1,659        (77

Commercial mortgage-backed

    3,128        (6     294        (34     476        (229     3,629        (6

Other asset-backed

    1,063        (1     105        (122     1        (31     1,015        (1
                                                               

Total fixed maturity securities

    8,370        (64     726        (186     1,196        (1,146     8,896        (81
                                                               

Equity securities

    61        —          1        (1     —          (1     60        —     
                                                               

Other invested assets:

               

Trading securities

    133        16        —          —          —          —          149        16   

Derivative assets

    286        (15     —          1        —          —          272        (11
                                                               

Total other invested assets

    419        1        —          1        —          —          421        5   
                                                               

Reinsurance recoverable

    2        (2     —          —          —          —          —          (2
                                                               

Total Level 3 assets

  $ 8,852      $ (65   $ 727      $ (186   $ 1,196      $ (1,147   $ 9,377      $ (78
                                                               

 

The following tables present 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:

 

(Amounts in millions)

  Beginning
balance
as of
January 1,
2010
    Total realized and
unrealized gains
(losses)
    Purchases,
sales,
issuances
and
settlements,
net
    Transfer
in

Level  3
    Transfer
out of
Level 3
    Ending
balance
as of
September 30,
2010
    Total gains
(losses)
included in
net income
(loss)
attributable
to assets
still held
 
    Included in
net income
(loss)
    Included
in OCI
           

Fixed maturity securities:

               

U.S. government, agencies and government- sponsored enterprises

  $ 16      $ —        $ —        $ (2   $ 14      $ (14   $ 14      $ —     

Tax-exempt

    2        —          —          —          —          (2     —          —     

Government—non-U.S.

    7        —          2        —          16        (6     19        —     

U.S. corporate (1)

    1,073        15       57        33        761        (610     1,329        12   

Corporate—non-U.S. (1)

    504        (7     8        3        472        (377     603        (7

Residential mortgage- backed (2)

    1,481        —          4        89        66        (1,508     132        —     

Commercial mortgage- backed (2)

    3,558        (5     22        (78     12        (3,462     47        —     

Other asset-backed (2), (3)

    1,419        (24     28        (3     10        (1,264     166        (24
                                                               

Total fixed maturity securities

    8,060        (21     121        42        1,351        (7,243     2,310        (19
                                                               

Equity securities

    9        11        —          (3     60        (60 )     17        —     
                                                               

Other invested assets:

               

Trading securities (3)

    145        8        —          (1     213       —          365        8   

Derivative assets:

               

Interest rate swaps

    3        6        —          —          —          —          9        6   

Interest rate swaptions

    54        19        —          (65     —          —          8        19   

Credit default swaps

    6        (5     —          —          —          —          1        (5

Equity index options

    39        (32     —          54        —          —          61        (32

Other foreign currency contracts

    8        (7     —          (1     —          —          —          (7
                                                               

Total derivative assets

    110        (19     —          (12     —          —          79        (19
                                                               

Total other invested assets

    255        (11     —          (13     213        —          444        (11
                                                               

Restricted other invested assets related to securitization entities (4)

    —          4        —          —          174        —          178        1   

Reinsurance recoverable (5)

    (5     7        —          2        —          —          4        7   
                                                               

Total Level 3 assets

  $ 8,319      $ (10   $ 121      $ 28      $ 1,798      $ (7,303   $ 2,953      $ (22
                                                               

 

(1)

The transfers in and out of Level 3 were primarily related to private fixed rate U.S. corporate and corporate—non-U.S. securities and resulted from a change in the observability of the additional premium to the public bond spread to adjust for the liquidity and other features of our private placements and resulted in unobservable inputs having a significant impact on certain valuations for transfers in or no longer having significant impact on certain valuations for transfers out.

(2)

The transfer out of Level 3 was primarily related to residential and commercial mortgage-backed and other asset-backed securities and resulted from a change in the observability of inputs used to determine fair value.

(3)

Transfers in for trading securities were offset by transfers out of other asset-backed securities and were driven primarily by the adoption of new accounting guidance related to embedded credit derivatives.

(4)

Relates to the consolidation of certain securitization entities as of January 1, 2010. See note 7 for additional information related to consolidated securitization entities.

(5)

Represents embedded derivatives associated with the reinsured portion of our GMWB liabilities.

 

Our assessment of whether or not there were significant unobservable inputs was based on our observations of the mortgage-backed and asset-based securities markets obtained through the course of managing our investment portfolio, including interaction with other market participants, observations related to the availability and consistency of pricing, and understanding of general market activity such as new issuance and the level of secondary market trading for a class of securities. Additionally, we considered data obtained from third-party pricing sources to determine whether our estimated values incorporate significant unobservable inputs that would result in the valuation being classified as Level 3.

While we observed some increased trading activity for certain mortgage-backed and asset-backed securities during 2009, primarily as a result of government programs, we did not observe a broad-based improvement in market conditions to result in the classification of several mortgage-backed and asset-backed securities as Level 2. During 2010, primary market issuance and secondary market activity for commercial and non-agency residential mortgage-backed and other asset-backed securities increased the market observable inputs used to establish fair values for similar securities. These factors, along with more consistent pricing from third-party sources, resulted in our conclusion that there is sufficient trading activity in similar instruments to support classifying certain mortgage-backed and asset-backed securities as Level 2 as of September 30, 2010. Accordingly, our assessment resulted in a transfer out of Level 3 of $1,508 million, $3,462 million and $1,264 million, respectively, during the nine months ended September 30, 2010 related to residential mortgage-backed, commercial mortgage-backed and other asset-backed securities.

 

(Amounts in millions)

  Beginning
balance
as of
January 1,
2009
    Total realized and
unrealized gains
(losses)
    Purchases,
sales,
issuances
and
settlements,
net
    Transfer
in

Level  3
    Transfer
out of
Level 3
    Ending
balance
as of
September 30,
2009
    Total gains
(losses)
included in
net income
(loss)
attributable
to assets
still held
 
    Included in
net income
(loss)
    Included
in OCI
           

Fixed maturity securities:

               

U.S. government, agencies and government- sponsored entities

  $ 25      $ —        $ (38   $ 13      $ 394      $ (389   $ 5      $ —     

Tax exempt

    —          —          —          5        2        (5     2        —     

Government—non-U.S.

    31        —          (2 )     9        15        (19     34        —     

U.S. corporate

    2,734        9        170        (163     764        (1,994     1,520        10   

Corporate—non-U.S.

    1,560        (26     211        85        696        (1,494     1,032        (29

Residential mortgage-backed

    1,957        (421     364        (205     905        (941     1,659        (391

Commercial mortgage-backed

    3,219        (44     337        (140     1,008        (751     3,629        (45

Other asset-backed

    1,034        (23     285        (355     982        (908     1,015        (18
                                                               

Total fixed maturity securities

    10,560        (505     1,327        (751     4,766        (6,501     8,896        (473
                                                               

Equity securities

    60        —          1       1        —          (2     60        —     
                                                               

Other invested assets:

               

Trading securities

    125        17        —          (15     54        (32     149        16  

Derivative assets

    933        (508     —          (175     22        —          272        (486
                                                               

Total other invested assets

    1,058        (491     —          (190     76        (32     421        (470
                                                               

Reinsurance recoverable

    18        (18     —          —          —          —          —          (18
                                                               

Total Level 3 assets

  $ 11,696      $ (1,014   $ 1,328      $ (940   $ 4,842      $ (6,535   $ 9,377      $ (961
                                                               

 

The following tables present additional information about liabilities 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:

 

    Beginning
balance
as of
July 1,
2010
    Total realized and
unrealized (gains)
losses
    Purchases,
sales,
issuances
and
settlements,
net
    Transfer
in Level 3
    Transfer
out of
Level 3
    Ending
balance
as of
September 30,
2010
    Total (gains)
losses
included in
net (income)
loss
attributable
to liabilities
still held
 

(Amounts in millions)

    Included in
net (income)
loss
    Included
in OCI
           

Policyholder account balances (1)

  $ 447      $ (140   $ —        $ 9      $ —        $ —        $ 316      $ (138

Derivative liabilities:

               

Credit default swaps

    26        (17     —          —          —          —          9        (17

Credit default swaps related to securitization entities (2)

    159        (30     —          1        —          —          130        (30
                                                               

Total derivative liabilities

    185        (47     —          1        —          —          139        (47

Borrowings related to securitization entities (2)

    51        (8     —          —          1       —          44        (8
                                                               

Total Level 3 liabilities

  $ 683      $ (195   $ —        $ 10      $ 1      $ —        $ 499      $ (193
                                                               

 

(1)

Represents embedded derivatives associated with our GMWB liabilities, excluding the impact of reinsurance.

(2)

Relates to the consolidation of certain securitization entities as of January 1, 2010. See note 7 for additional information related to consolidated securitization entities.

 

    Beginning
balance
as of
July 1,
2009
    Total realized and
unrealized (gains)
losses
    Purchases,
sales
issuances
and
settlements,
net
    Transfer
in Level 3
    Transfer
out of
Level 3
    Ending
balance
as of
September 30,
2009
    Total (gains)
losses
included in
net (income)
loss
attributable
to liabilities
still held
 
      Included in
net (income)
loss
    Included
in OCI
           

Policyholder account balances (1)

  $ 435      $ (135   $ —        $ 8      $ —        $ —        $ 308      $ (133

Other liabilities (2)

    161        (57     —          —          —          —          104        (57
                                                               

Total Level 3 liabilities

  $ 596      $ (192   $ —        $ 8      $ —        $ —        $ 412      $ (190
                                                               

 

(1)

Represents embedded derivatives associated with our GMWB liabilities.

(2)

Represents derivatives.

 

The following tables present additional information about liabilities 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:

 

(Amounts in millions)

  Beginning
balance
as of
January 1,
2010
    Total realized and
unrealized (gains)
losses
    Purchases,
sales,
issuances
and
settlements,
net
    Transfer
in Level 3
    Transfer
out of
Level 3
    Ending
balance
as of
September 30,
2010
    Total (gains)
losses
included in
net (income)
loss
attributable
to liabilities
still held
 
    Included in
net (income)
loss
    Included
in OCI
           

Policyholder account balances (1)

  $ 175      $ 115      $ —        $ 26     $ —        $ —        $ 316      $ 117   

Derivative liabilities:

               

Interest rate swaps

    2        (2     —          —          —          —          —          (2

Interest rate swaptions

    67        (42     —          (25     —          —          —          (42

Credit default swaps

    —          9        —          —          —          —          9        9   

Credit default swaps related to securitization entities (2)

    —          11        —          (2 )     121        —          130        11   

Equity index options

    2        (1     —          (1     —          —          —          (1
                                                               

Total derivative liabilities

    71        (25     —          (28     121        —          139        (25

Borrowings related to securitization entities (2)

    —          (16     —          —          60        —          44        (16
                                                               

Total Level 3 liabilities

  $ 246      $ 74      $ —        $ (2   $ 181      $ —        $ 499      $ 76   
                                                               

 

(1)

Represents embedded derivatives associated with our GMWB liabilities, excluding the impact of reinsurance.

(2)

Relates to the consolidation of certain securitization entities as of January 1, 2010. See note 7 for additional information related to consolidated securitization entities.

 

    Beginning
balance
as of
January 1,
2009
    Total realized and
unrealized (gains)
losses
    Purchases,
sales
issuances
and
settlements,
net
    Transfer
in Level 3
    Transfer
out of
Level 3
    Ending
balance
as of
September 30,
2009
    Total (gains)
losses
included in
net (income)
loss
attributable
to liabilities
still held
 
      Included in
net (income)
loss
    Included
in OCI
           

Policyholder account balances (1)

  $ 878      $ (592   $ —        $ 22      $ —        $ —        $ 308      $ (579

Other liabilities (2)

    68        85        —          (49     —          —          104        53   
                                                               

Total Level 3 liabilities

  $ 946      $ (507   $ —        $ (27   $ —        $ —        $ 412      $ (526
                                                               

 

(1)

Represents embedded derivatives associated with our GMWB liabilities.

(2)

Represents derivatives.

 

Realized and unrealized gains (losses) on Level 3 assets and liabilities are primarily reported in either net investment gains (losses) within the consolidated statements of income or OCI within stockholders’ equity based on the appropriate accounting treatment for the instrument.

Purchases, sales, issuances and settlements, net, represent the activity that occurred during the period that results in a change of the asset or liability but does not represent changes in fair value for the instruments held at the beginning of the period. Such activity primarily consists of purchases and sales of fixed maturity, equity and trading securities and purchases and settlements of derivative instruments.

Purchases, sales, issuances and settlements, net, presented for policyholder account balances represent the issuances and settlements of embedded derivatives associated with our GMWB liabilities where: issuances are characterized as the change in fair value associated with the product fees recognized that are attributed to the embedded derivative to equal the expected future benefit costs upon issuance and settlements are characterized as the change in fair value upon exercising the embedded derivative instrument, effectively representing a settlement of the embedded derivative instrument. We have shown these changes in fair value separately based on the classification of this activity as effectively issuing and settling the embedded derivative instrument with all remaining changes in the fair value of these embedded derivative instruments being shown separately in the category labeled “included in net (income) loss” in the tables presented above.

The amount presented for unrealized gains (losses) for assets and liabilities still held as of the reporting date primarily represents impairments related to available-for-sale securities, accretion on certain fixed maturity securities, changes in fair value of trading securities and certain derivatives and changes in fair value of embedded derivatives associated with our GMWB liabilities that existed as of the reporting date, all of which were recorded in net investment gains (losses), except for accretion on debt securities, which was recorded in net investment income.

Variable Interest and Securitization Entities
Variable Interest and Securitization Entities

(7) Variable Interest and Securitization Entities

VIEs are generally entities that have either a total equity investment that is insufficient to permit the entity to finance its activities without additional subordinated financial support or whose equity investors lack the characteristics of a controlling financial interest. We evaluate VIEs to determine whether we are the primary beneficiary and are required to consolidate the assets and liabilities of the entity. The determination of the primary beneficiary for a VIE can be complex and requires management judgment regarding the expected results of the entity and who directs the activities of the entity that most significantly impact the economic results of the VIE. Our primary involvement related to VIEs includes:

 

   

asset securitization transactions,

 

   

certain investments and

 

   

certain mortgage insurance policies.

(a) Asset Securitizations

We have used former affiliates and third-party entities to facilitate asset securitizations. Disclosure requirements related to off-balance sheet arrangements encompass a broader array of arrangements than those at risk for consolidation. These arrangements include transactions with term securitization entities, as well as transactions with conduits that are sponsored by third parties.

 

The following table summarizes the total securitized assets as of the dates indicated:

 

(Amounts in millions)

   September 30,
2010
     December 31,
2009
 

Receivables secured by:

     

Commercial mortgage loans

   $ —         $ 574   

Fixed maturity securities

     74         123   

Other assets

     165         236   
                 

Total securitized assets not required to be consolidated

     239         933   
                 

Total securitized assets required to be consolidated

     598         —     
                 

Total securitized assets

   $ 837       $ 933   
                 

Financial support for certain securitization entities was provided under credit support agreements, in which we provided limited recourse for a maximum of $114 million of credit losses as of September 30, 2010. These agreements will remain in place throughout the life of the related entities. Included in this amount was $40 million for the limited recourse related to one of our commercial mortgage loan entities that was required to be consolidated with assets of $118 million as of September 30, 2010. There were no amounts recorded for these limited recourse liabilities as of September 30, 2010 and December 31, 2009.

(b) Securitization and Variable Interest Entities Not Required To Be Consolidated

We are involved in certain securitization and VIEs where we are not required to consolidate the securitization entity.

Asset securitizations. We transferred assets to securitization entities that would be considered VIEs but we were not required to consolidate the securitization entities. 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. We evaluated our involvement in the entities’ design and our decision making ability regarding the assets held by the securitization entity and determined we would generally not be the party with power to direct the activities that significantly impact the economic performance of the entity.

In certain instances, we determined we were the party with power but did not have a variable interest in the entity. Our interest in the entities included servicer fees and excess interest, where our benefit from our excess interest holding is subordinated to third-party holdings. Based on the composition of the assets in the securitization entity, there were no reasonable scenarios that would result in our interest receiving any significant benefit for the entity. As a result, our interest would not be considered a variable interest in the entity as a result of meeting certain requirements in the accounting guidance.

Amounts recognized in our consolidated financial statements related to our involvement with entities used to facilitate asset securitization transactions where the securitization entity was not required to be consolidated as of the dates indicated:

 

     September 30, 2010      December 31, 2009  

(Amounts in millions)

   Cost      Fair
value
     Cost      Fair
value
 

Retained interests—assets

   $ 1       $ 2       $ 79       $ 44   
                                   

Total

   $ 1       $ 2       $ 79       $ 44   
                                   

 

The decrease in the amounts presented above were primarily a result of having to consolidate certain securitization entities as discussed above.

In certain securitization transactions, we retained an interest in transferred assets. Those interests take various forms and may be subject to credit, prepayment and interest rate risks. When we securitized receivables, we determined the fair value based on discounted cash flow models that incorporate, among other things, assumptions including credit losses, prepayment speeds and discount rates. These assumptions were based on our experience, market trends and anticipated performance related to the particular assets securitized. Our retained interests are reflected as fixed maturity securities available-for-sale.

Following a securitization transaction, we retained the responsibility for servicing the receivables, and as such, were entitled to receive an ongoing fee based on the outstanding principal balances of the receivables. There were no servicing assets nor liabilities recorded as the benefits of servicing the assets were adequate to compensate an independent servicer for its servicing responsibilities.

There has been no new asset securitization activity in 2010 or 2009.

Investments. We hold investments in certain structures that are considered VIEs. Our investments represent beneficial interests that are primarily in the form of structured securities. Our involvement in these structures typically represent a passive investment in the returns generated by the VIE and typically do not result in having significant influence over the economic performance of the VIE. See note 4 for additional information related to our investments, which includes information related to structured securities, such as asset-backed and mortgage-backed securities. Our maximum exposure to loss represents our cost basis in the investments.

Mortgage insurance. We also provide mortgage insurance on certain residential mortgage loans originated and securitized by third parties using VIEs to issue mortgage-backed securities. While we provide mortgage insurance on the underlying loans, we do not typically have any ongoing involvement with the VIE other than our mortgage insurance coverage and do not act in a servicing or decision making capacity for the underlying loans held by the VIE.

(c) Securitization and Variable Interest Entities Required To Be Consolidated

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 securitization transactions and certain investments, both of which are described in more detail below. Prior to being required to consolidate these entities, our interest in these entities was recorded in our consolidated financial statements as fixed maturity securities available-for-sale.

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.

For one of our commercial mortgage loan securitization entities with assets of $118 million as of September 30, 2010, our economic interest represents the excess interest received on the loans compared to the interest paid on the entity’s obligation. We also act as the servicer for the underlying mortgage loans and have the ability to direct certain activities in accordance with the agreements related to the securitization entity.

For the other commercial mortgage loan securitization entity with assets of $409 million as of September 30, 2010, our economic interest represents the excess interest of the commercial mortgage loans and the subordinated notes of the securitization entity. The commercial mortgage loans are serviced by a third-party servicer and special servicer. However, we have the right to replace the special servicer without cause at any time. This right is recognized under accounting guidance as resulting in our effective control of the activities directed by the special servicer.

Our economic interest in the policy loan securitization entity represents the excess interest received from the residual interest in certain policy loan securitization entities and the floating rate obligation issued by the securitization entity. The securitization entity also contains an interest rate swap to mitigate the difference between the effective fixed receipt on the assets and the floating rate obligation issued by the securitization entity. Since there are no significant ongoing activities in the securitization entity, we evaluated the design of the entity upon inception when we transferred the residual interests in the securitization entity. Prior to 2010, we fully impaired our investment in this securitization entity as a result of not expecting any future economic benefits from our investment under any reasonable scenario. However, there are certain remote interest rate and mortality scenarios that would result in our residual interest receiving significant economic benefits in relation to benefits received by the securitization entity. In accordance with the relevant accounting guidance, the use of probability is not permitted when determining whether we would have the ability to receive significant benefits from the securitization entity.

Investments. For VIEs related to certain investments, we were required to consolidate three securitization entities as a result of having certain decision making rights related to instruments held by the entities. These securitization entities were designed as synthetic collateralized debt obligations whereby the entities purchased highly rated asset-backed securities and entered into credit default swaps to generate income that would be passed to the noteholders of the entities. The entities also have the ability to settle any losses incurred on the credit default swap by providing the derivative counterparty asset-backed securities with a par amount equal to the loss incurred on the credit default swap. We hold the majority of the notes issued by the securitization entity and also have certain decision making rights related to the instruments held by the entity. Previously, we were not required to consolidate the securitization entity as a result of other noteholders absorbing the majority of expected losses from the entity.

 

The following table shows the activity presented in our consolidated statement of income related to the consolidated securitization entities for the periods indicated:

 

(Amounts in millions)

   Three months ended
September 30, 2010
     Nine months ended
September 30, 2010
 

Revenues:

     

Net investment income:

     

Restricted commercial mortgage loans

   $ 10       $ 30   

Restricted other invested assets

     1         2   
                 

Total net investment income

     11         32   
                 

Net investment gains (losses):

     

Trading securities

     5         14   

Derivatives

     18         (35

Commercial mortgage loans

     —           (1

Borrowings related to securitization entities recorded at fair value

     7         16   
                 

Total net investment gains (losses)

     30         (6
                 

Total revenues

     41         26   
                 

Expenses:

     

Interest expense

     7         22   

Acquisition and operating expenses

     2         2   
                 

Total expenses

     9         24   
                 

Income before income taxes

     32         2   

Provision for income taxes

     12         1   
                 

Net income

   $ 20       $ 1   
                 

The following table shows the assets and liabilities that were recorded for the consolidated securitization entities as of the date indicated:

 

(Amounts in millions)

   September 30, 2010  

Assets

  

Investments:

  

Restricted commercial mortgage loans

   $ 522   

Restricted other invested assets:

  

Trading securities

     376   

Other

     2   
        

Total restricted other invested assets

     378   
        

Total investments

     900   

Cash and cash equivalents

     —     

Accrued investment income

     1   
        

Total assets

   $ 901   
        

Liabilities

  

Other liabilities:

  

Derivative liabilities

   $ 164   

Other liabilities

     2   
        

Total other liabilities

     166   

Borrowings related to securitization entities

     502   
        

Total liabilities

   $ 668   
        

 

The assets and other instruments held by the securitization entities are restricted and can only be used to fulfill the obligations of the securitization entity. Additionally, the obligations of the securitization entities do not have any recourse to the general credit of any other consolidated subsidiaries, except $40 million of limited recourse related to a consolidated commercial mortgage loan securitization entity.

Commitments and Contingencies
Commitments and Contingencies

(8) Commitments and Contingencies

(a) Litigation

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, 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, cancellation or rescission of coverage, 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 Real Estate Settlement Procedures Act of 1974 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. 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 to determine the ultimate outcomes of all pending investigations and legal proceedings, nor to provide reasonable ranges of potential losses.

As previously identified, the U.K. antitrust authorities conducted a review of the payment protection insurance sector. In January 2009, the antitrust authorities issued their final report that included the remedies to address the antitrust issues identified in their findings. The remedies included prohibitions on the sale of single premium payment protection insurance products, or the sale of payment protection products within seven days of the sale of the underlying credit product unless the consumer contacts the distributor after 24 hours of sale of the credit product, as well as additional informational remedies. Though it was previously anticipated that the remedies would be implemented during 2010, a successful appeal brought against key elements of the findings by a large U.K. retail bank delayed implementation of the full remedies package. Following publication of the antitrust authorities’ response to the appeal, it appears that the remedies package will now be implemented during the second half of 2011 and early 2012.

On July 30, 2010, we received a subpoena from the office of the New York Attorney General, relating to an industry-wide investigation of the use of retained asset accounts as a settlement option for life insurance death benefit payments. When a retained asset account is established for a beneficiary, our insurance company subsidiary retains the death benefit proceeds in its general account and pays interest on those proceeds. Beneficiaries can withdraw all of the funds or a portion of the funds held in the account at any time. In addition to the subpoena, we have been contacted by state insurance regulators regarding retained asset accounts. We have responded to the New York Attorney General subpoena and state insurance regulator information requests, and will cooperate with respect to any follow-up requests or inquiries.

(b) Commitments

As of September 30, 2010, we were committed to fund $121 million in limited partnership investments and $44 million in U.S. commercial mortgage loan investments.

Borrowings and Other Financings
Borrowings and Other Financings

(9) Borrowings and Other Financings

Revolving Credit Facilities

We have two five-year revolving credit facilities that mature in May 2012 and August 2012. These facilities bear variable interest rates based on one-month LIBOR plus a margin. Each of these facilities originally had $1.0 billion available for borrowings. Lehman Commercial Paper Inc. (“LCP”) had committed $70 million under the August 2012 credit facility and Lehman Brothers Bank, FSB (“Lehman 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 September 30, 2010, we had access to $1.9 billion under these facilities.

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.

As of September 30, 2010, we had borrowings of $730 million under these facilities, and we utilized $57 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, 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.

Long-Term Senior Notes

In June 2010, we issued senior notes having an aggregate principal amount of $400 million, with an interest rate equal to 7.700% per year payable semi-annually, and maturing in June 2020 (“2020 Notes”). The 2020 Notes are our direct, unsecured obligations and will rank equally with all of our existing and future unsecured and unsubordinated obligations. We have the option to redeem all or a portion of the 2020 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 value of the remaining scheduled payments of principal and interest discounted at the then-current treasury rate plus an applicable spread. The net proceeds of $397 million from the issuance of the 2020 Notes were used to repay $100 million of outstanding borrowings under each of our five-year revolving credit facilities and the remainder of the proceeds were used for general corporate purposes.

 

In June 2010, our majority-owned subsidiary, Genworth MI Canada Inc. (“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.

Non-Recourse Funding Obligations

As of September 30, 2010, we had $3.4 billion of fixed and floating rate non-recourse funding obligations outstanding backing additional statutory reserves. As of September 30, 2010 and December 31, 2009, the weighted-average interest rates on our non-recourse funding obligations were 1.42% and 1.49%, respectively.

Borrowings Related To Securitization Entities

Borrowings related to securitization entities were as follows as of September 30, 2010:

 

(Amounts in millions)

   Principal
amount
    Carrying
value
 

GFCM LLC, due 2035, 5.2541%

   $ 228      $ 228   

GFCM LLC, due 2035, 5.7426%

     113        113   

Genworth Special Purpose Two, LLC, due 2023, 6.0175%

     117        117   

Marvel Finance 2007-1 LLC, due 2017 (1)

     5        1   

Marvel Finance 2007-4 LLC, due 2017 (1)

     12        6   

Genworth Special Purpose Five, LLC, due 2040 (1)

     NA (2)      37   
                

Total

   $ 475      $ 502   
                

 

  (1)

Accrual of interest based on three-month LIBOR that resets every three months plus a fixed margin.

  (2)

Principal amount not applicable. Notional balance was $117 million.

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. See note 7 for additional information on consolidated securitization entities.

 

Income Taxes
Income Taxes

(10) Income Taxes

The reconciliation of the federal statutory tax rate to the effective income tax rate was as follows for the periods indicated:

 

     Three months ended September 30,     Nine months ended September 30,  

(Amounts in millions)

   2010     2009     2010     2009  

Pre-tax income (loss)

   $ 140        $ (7     $ 331        $ (894  
                                        

Statutory U.S. federal income tax rate

   $ 49        35.0   $ (2     35.0   $ 116        35.0   $ (313     35.0

Increase (reduction) in rate resulting from:

                

State income tax, net of federal income tax effect

     4        2.5        —          1.4        (1     (0.2     (2     0.2   

Benefit on tax favored investments

     (9     (6.6     (15     214.5        (23     (6.9     (49     5.5   

Effect of foreign operations

     (30     (21.1     (10     141.5        (70     (21.2     (40     4.4   

Interest on uncertain tax positions

     (1     (0.4     (10     138.8        (5     (1.5     (7     0.8   

Non-deductible expenses

     2        1.3        (10     141.5        3        0.9        (6     0.7   

Tax benefits related to separation from our former parent

     —          —          —          —          (106     (32.2     —          —     

Other, net

     3        2.2        (5     70.2        6        1.9        (3     0.4   
                                                                

Effective rate

   $ 18        12.9   $ (52     742.9   $ (80     (24.2 )%    $ (420     47.0
                                                                

For the three months ended September 30, 2010, the effective tax rate decreased significantly from the prior year due to small pre-tax results in relation to tax adjustments in the prior year. For the nine months ended September 30, 2010, the effective tax rate decreased significantly from the prior year due to changes in uncertain tax benefits related to separation from our former parent, lower taxed foreign income and tax favored investments in the current year.

In connection with our 2004 separation from our former parent, General Electric (“GE”), we made certain joint tax elections and realized certain tax benefits. During the first quarter of 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 the first quarter of 2010. Additionally, we recorded $20 million as additional paid-in capital related to our 2004 separation.

Segment Information
Segment Information

(11) Segment Information

We conduct our operations in three operating business segments: (1) Retirement and Protection, which includes our life insurance, long-term care insurance, wealth management products and services and retirement income products; (2) International, which includes international mortgage and lifestyle protection insurance; and (3) U.S. Mortgage Insurance, which includes mortgage-related products and services that facilitate homeownership by enabling borrowers to buy homes with low-down-payment mortgages.

We also have Corporate and Other activities which include interest and other debt financing expenses, 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.

We use the same accounting policies and procedures to measure segment income (loss) and assets as our consolidated net income (loss) and assets. Our chief operating decision maker evaluates segment performance and allocates resources on the basis of “net operating income (loss) available to Genworth Financial, Inc.’s common stockholders.” We define net operating income (loss) available to Genworth Financial, Inc.’s common stockholders as income (loss) from continuing operations excluding net income attributable to noncontrolling interests, after-tax net investment gains (losses) and other adjustments and infrequent or unusual non-operating items. We exclude net investment gains (losses) and infrequent or unusual non-operating items because we do not consider them to be related to the operating performance of our segments and Corporate and Other activities. A significant component of our net investment gains (losses) is the result of impairments, the size and timing of which can vary significantly depending on market credit cycles. In addition, the size and timing of other investment gains (losses) are often subject to our discretion and are influenced by market opportunities, as well as asset-liability matching considerations. Infrequent or unusual non-operating items are also excluded from net operating income (loss) available to Genworth Financial, Inc.’s common stockholders if, in our opinion, they are not indicative of overall operating trends. While some of these items may be significant components of net income (loss) available to Genworth Financial, Inc.’s common stockholders in accordance with U.S. GAAP, we believe that net operating income (loss) available to Genworth Financial, Inc.’s common stockholders, and measures that are derived from or incorporate net operating income (loss) available to Genworth Financial, Inc.’s common stockholders, are appropriate measures that are useful to investors because they identify the income (loss) attributable to the ongoing operations of the business. However, net operating income (loss) available to Genworth Financial, Inc.’s common stockholders is not a substitute for net income (loss) available to Genworth Financial, Inc.’s common stockholders determined in accordance with U.S. GAAP. In addition, our definition of net operating income (loss) available to Genworth Financial, Inc.’s common stockholders may differ from the definitions used by other companies.

There were no infrequent or unusual non-operating items excluded from net operating income (loss) available to Genworth Financial, Inc.’s common stockholders 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.

The following is a summary of revenues for our segments and Corporate and Other activities for the periods indicated:

 

     Three months ended
September 30,
    Nine months ended
September 30,
 

(Amounts in millions)

       2010              2009             2010              2009      

Revenues:

          

Retirement and Protection

   $ 1,810       $ 1,521      $ 5,046       $ 4,115   

International

     594         663        1,867         1,892   

U.S. Mortgage Insurance

     195         235        557         619   

Corporate and Other

     68         (28     28         (18
                                  

Total revenues

   $ 2,667       $ 2,391      $ 7,498       $ 6,608   
                                  

 

The following is a summary of net operating income (loss) available to Genworth Financial, Inc.’s common stockholders for our segments and Corporate and Other activities and a reconciliation of net operating income (loss) available to Genworth Financial, Inc.’s common stockholders for our segments and Corporate and Other activities to net income (loss) for the periods indicated:

 

     Three months ended
September 30,
    Nine months ended
September 30,
 

(Amounts in millions)

       2010             2009             2010             2009      

Retirement and Protection

   $ 111      $ 134      $ 347      $ 295   

International

     121        96        317        284   

U.S. Mortgage Insurance

     (152     (116     (228     (385

Corporate and Other

     (51     (33     (175     (90
                                

Net operating income available to Genworth Financial, Inc.’s common stockholders

     29        81        261        104   

Net investment gains (losses), net of taxes and other adjustments

     54        (62     (64     (604

Net tax benefit related to separation from our former parent

     —          —          106        —     
                                

Net income (loss) available to Genworth Financial, Inc.’s common stockholders

     83        19        303        (500

Add: net income attributable to noncontrolling interests

     39        26        108        26   
                                

Net income (loss)

   $ 122      $ 45      $ 411      $ (474
                                

The following is a summary of total assets for our segments and Corporate and Other activities as of the dates indicated:

 

(Amounts in millions)

   September 30,
2010
     December 31,
2009
 

Assets:

     

Retirement and Protection

   $ 87,357       $ 81,497   

International

     12,188         12,143   

U.S. Mortgage Insurance

     3,883         4,247   

Corporate and Other

     11,272         10,300   
                 

Total assets

   $ 114,700       $ 108,187   
                 
Noncontrolling Interests
Noncontrolling Interests

(12) Noncontrolling Interests

In July 2009, Genworth Canada, our indirect subsidiary, completed the initial public offering (the “Offering”) of its common shares. Of the 49.7 million common shares of Genworth Canada that were sold in the Offering, 5.1 million common shares were sold by Genworth Canada and 44.6 million common shares were sold by Brookfield Life Assurance Company Limited (“Brookfield”), our indirect wholly-owned subsidiary. Following completion of the Offering, we beneficially owned 57.5% of the common shares of Genworth Canada. 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.

In the nine months ended September 30, 2010, dividends of $32 million were paid to the noncontrolling interests.

 

Subsequent Event
Subsequent Event

(13) Subsequent Event

On October 18, 2010, we entered into an agreement to purchase the operating assets of Altegris Capital, LLC (“Altegris”), which will be accounted for as a business combination. The acquisition will be part of our wealth management business in our Retirement and Protection segment. Altegris, based in La Jolla, California, provides a platform of alternative investments, including hedge funds and managed futures products, and has approximately $2.0 billion in client assets. The target date for closing the transaction, subject to various approvals and closing conditions, is December 31, 2010. We will pay approximately $35 million at closing, with additional performance-based payments of up to $85 million during the five-year period following closing.