GENWORTH FINANCIAL INC, 10-K filed on 2/26/2010
Annual Report
Statement Of Income Insurance Based Revenue (USD $)
In Millions, except Per Share data
Year Ended
Dec. 31,
2009
2008
2007
Revenues:
 
 
 
Premiums
$ 6,019 
$ 6,777 
$ 6,330 
Net investment income
3,033 
3,730 
4,135 
Net investment gains (losses)
(1,041)
(1,709)
(332)
Insurance and investment product fees and other
1,058 
1,150 
992 
Total revenues
9,069 
9,948 
11,125 
Benefits and expenses:
 
 
 
Benefits and other changes in policy reserves
5,818 
5,806 
4,580 
Interest credited
984 
1,293 
1,552 
Acquisition and operating expenses, net of deferrals
1,884 
2,160 
2,075 
Amortization of deferred acquisition costs and intangibles
782 
884 
831 
Goodwill impairment
277 
Interest expense
393 
470 
481 
Total benefits and expenses
9,861 
10,890 
9,519 
Income (loss) from continuing operations before income taxes
(792)
(942)
1,606 
Provision (benefit) for income taxes
(393)
(370)
452 
Income (loss) from continuing operations
(399)
(572)
1,154 
Income from discontinued operations, net of taxes
15 
Gain on sale of discontinued operations, net of taxes
51 
Net income (loss)
(399)
(572)
1,220 
Less: net income attributable to noncontrolling interests
61 
Net income (loss) available to Genworth Financial, Inc.'s common stockholders
(460)
(572)
1,220 
Earnings (loss) from continuing operations per common share:
 
 
 
Basic
(0.88)
(1.32)
2.62 
Diluted
(0.88)
(1.32)
2.58 
Net income (loss) available to Genworth Financial, Inc.'s common stockholders per common share:
 
 
 
Basic
(1.02)
(1.32)
2.77 
Diluted
(1.02)
(1.32)
2.73 
Weighted-average common shares outstanding:
 
 
 
Basic
451.1 
433.2 
439.7 
Diluted
451.1 
433.2 
447.6 
Supplemental disclosures:
 
 
 
Total other-than-temporary impairments
(1,499)
(2,131)
(229)
Portion of other-than-temporary impairments included in other comprehensive income (loss)
441 
Net other-than-temporary impairments
(1,058)
(2,131)
(229)
Other investment gains (losses)
17 
422 
(103)
Total net investment gains (losses)
$ (1,041)
$ (1,709)
$ (332)
Statement of Financial Position Unclassified - Insurance Based Operations (USD $)
In Millions
Dec. 31, 2009
Dec. 31, 2008
Assets
 
 
Investments:
 
 
Fixed maturity securities available-for-sale, at fair value
$ 49,752 
$ 42,871 
Equity securities available-for-sale, at fair value
159 
234 
Commercial mortgage loans
7,499 
8,262 
Policy loans
1,403 
1,834 
Other invested assets
4,702 
7,411 
Total investments
63,515 
60,612 
Cash and cash equivalents
5,002 
7,328 
Accrued investment income
691 
736 
Deferred acquisition costs
7,341 
7,786 
Intangible assets
934 
1,147 
Goodwill
1,324 
1,316 
Reinsurance recoverable
17,332 
17,212 
Other assets
954 
1,000 
Deferred tax asset
92 
1,037 
Separate account assets
11,002 
9,215 
Total assets
108,187 
107,389 
Liabilities and stockholders' equity
 
 
Liabilities:
 
 
Future policy benefits
29,469 
28,533 
Policyholder account balances
28,470 
34,702 
Liability for policy and contract claims
6,567 
5,322 
Unearned premiums
4,714 
4,734 
Other liabilities
6,298 
6,860 
Non-recourse funding obligations
3,443 
3,455 
Short-term borrowings
930 
1,133 
Long-term borrowings
3,641 
4,261 
Deferred tax liability
303 
248 
Separate account liabilities
11,002 
9,215 
Total liabilities
94,837 
98,463 
Commitments and contingencies
 
 
Stockholders' equity:
 
 
Class A Common Stock, $0.001 par value; 1.5 billion shares authorized; 577 million and 522 million shares issued as of December 31, 2009 and 2008, respectively; 489 million and 433 million shares outstanding as of December 31, 2009 and 2008, respectively
Additional paid-in capital
12,034 
11,477 
Accumulated other comprehensive income (loss):
 
 
Net unrealized investment gains (losses):
 
 
Net unrealized gains (losses) on securities not other-than-temporarily impaired
(1,151)
(4,038)
Net unrealized gains (losses) on other-than-temporarily impaired securities
(247)
Net unrealized investment gains (losses)
(1,398)
(4,038)
Derivatives qualifying as hedges
802 
1,161 
Foreign currency translation and other adjustments
432 
(185)
Total accumulated other comprehensive income (loss)
(164)
(3,062)
Retained earnings
3,105 
3,210 
Treasury stock, at cost (88 million shares as of December 31, 2009 and 2008)
(2,700)
(2,700)
Total Genworth Financial, Inc.'s stockholders' equity
12,276 
8,926 
Noncontrolling interests
1,074 
Total stockholders' equity
13,350 
8,926 
Total liabilities and stockholders' equity
$ 108,187 
$ 107,389 
Statement of Financial Position Unclassified - Insurance Based Operations (Parenthetical) (USD $)
Share data in Millions, except Per Share data
Dec. 31, 2009
Dec. 31, 2008
Class A Common Stock, par value
$ 0.001 
$ 0.001 
Class A Common Stock, shares authorized
1,500 
1,500 
Class A Common Stock, shares issued
577 
522 
Class A Common Stock, shares outstanding
489 
433 
Treasury stock, shares
88 
88 
Statement Of Shareholders Equity And Other Comprehensive Income (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
1/1/2007 - 12/31/2007
 
 
 
 
 
 
 
 
Beginning Balances
$ 0 
$ 10,759 
$ 1,157 
$ 2,914 
$ (1,500)
 
 
$ 13,330 
Cumulative effect of change in accounting, net of taxes and other adjustments
 
 
 
(54)
 
 
 
(54)
Initial sale of subsidiary shares to noncontrolling interests
 
 
 
 
 
 
 
 
Additional sale of subsidiary shares to noncontrolling interests
 
 
 
 
 
 
 
 
Issuance of common stock
600 
 
 
 
 
 
601 
Comprehensive income (loss):
 
 
 
 
 
 
 
 
Net income (loss)
 
 
 
1,220 
 
 
 
1,220 
Net unrealized gains (losses) on securities not other-than-temporarily impaired
 
 
(961)
 
 
 
 
(961)
Net unrealized gains (losses) on other-than-temporarily impaired securities
 
 
 
 
 
 
 
 
Derivatives qualifying as hedges
 
 
98 
 
 
 
 
98 
Foreign currency translation and other adjustments
 
 
433 
 
 
 
 
433 
Total comprehensive income (loss)
 
 
 
 
 
 
 
790 
Dividends to noncontrolling interests
 
 
 
 
 
 
 
 
Acquisition of treasury stock
 
 
 
 
(1,124)
 
 
(1,124)
Dividends to stockholders
 
 
 
(167)
 
 
 
(167)
Stock-based compensation expense and exercises and other
 
99 
 
 
 
 
 
99 
Other capital contributions
 
 
 
 
 
 
Ending Balances
11,461 
727 
3,913 
(2,624)
 
 
13,478 
1/1/2008 - 12/31/2008
 
 
 
 
 
 
 
 
Beginning Balances
11,461 
727 
3,913 
(2,624)
 
 
13,478 
Cumulative effect of change in accounting, net of taxes and other adjustments
 
 
 
 
 
 
 
 
Initial sale of subsidiary shares to noncontrolling interests
 
 
 
 
 
 
 
 
Additional sale of subsidiary shares to noncontrolling interests
 
 
 
 
 
 
 
 
Issuance of common stock
 
 
 
 
 
 
 
 
Comprehensive income (loss):
 
 
 
 
 
 
 
 
Net income (loss)
 
 
 
(572)
 
 
 
(572)
Net unrealized gains (losses) on securities not other-than-temporarily impaired
 
 
(3,512)
 
 
 
 
(3,512)
Net unrealized gains (losses) on other-than-temporarily impaired securities
 
 
 
 
 
 
 
 
Derivatives qualifying as hedges
 
 
688 
 
 
 
 
688 
Foreign currency translation and other adjustments
 
 
(965)
 
 
 
 
(965)
Total comprehensive income (loss)
 
 
 
 
 
 
 
(4,361)
Dividends to noncontrolling interests
 
 
 
 
 
 
 
 
Acquisition of treasury stock
 
 
 
 
(76)
 
 
(76)
Dividends to stockholders
 
 
 
(131)
 
 
 
(131)
Stock-based compensation expense and exercises and other
 
16 
 
 
 
 
 
16 
Other capital contributions
 
 
 
 
 
 
 
 
Ending Balances
11,477 
(3,062)
3,210 
(2,700)
8,926 
8,926 
1/1/2009 - 12/31/2009
 
 
 
 
 
 
 
 
Beginning Balances
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)
 
 
 
(460)
 
(460)
61 
(399)
Net unrealized gains (losses) on securities not other-than-temporarily impaired
 
 
2,997 
 
 
2,997 
17 
3,014 
Net unrealized gains (losses) on other-than-temporarily impaired securities
 
 
14 
 
 
14 
 
14 
Derivatives qualifying as hedges
 
 
(359)
 
 
(359)
 
(359)
Foreign currency translation and other adjustments
 
 
667 
 
 
667 
79 
746 
Total comprehensive income (loss)
 
 
 
 
 
 
 
3,016 
Dividends to noncontrolling interests
 
 
 
 
 
 
(10)
(10)
Acquisition of treasury stock
 
 
 
 
 
 
 
 
Dividends to stockholders
 
 
 
 
 
 
 
 
Stock-based compensation expense and exercises and other
 
23 
 
 
 
23 
 
23 
Other capital contributions
 
 
 
 
 
 
 
 
Ending Balances
$ 1 
$ 12,034 
$ (164)
$ 3,105 
$ (2,700)
$ 12,276 
$ 1,074 
$ 13,350 
Statement Of Cash Flows Indirect Investment Based Operations (USD $)
In Millions
Year Ended
Dec. 31,
2009
2008
2007
Cash flows from operating activities:
 
 
 
Net income (loss)
$ (399)
$ (572)
$ 1,220 
Less income from discontinued operations, net of taxes
(15)
Less gain on sale from discontinued operations, net of taxes
(51)
Adjustments to reconcile net income (loss) to net cash from operating activities:
 
 
 
Amortization of fixed maturity discounts and premiums
84 
58 
(29)
Net investment losses (gains)
1,041 
1,709 
332 
Charges assessed to policyholders
(442)
(409)
(397)
Acquisition costs deferred
(707)
(1,191)
(1,408)
Amortization of deferred acquisition costs and intangibles
782 
884 
831 
Goodwill impairment
277 
Deferred income taxes
(476)
(430)
252 
Gain on sale of subsidiary
(4)
Net increase (decrease) in trading securities, held-for-sale investments and derivative instruments
(59)
1,302 
(312)
Stock-based compensation expense
26 
23 
41 
Change in certain assets and liabilities:
 
 
 
Accrued investment income and other assets
(90)
52 
(65)
Insurance reserves
2,763 
3,034 
3,361 
Current tax liabilities
(119)
(138)
141 
Other liabilities and other policy-related balances
(469)
844 
865 
Cash from operating activities-discontinued operations
25 
Net cash from operating activities
1,931 
5,443 
4,791 
Cash flows from investing activities:
 
 
 
Proceeds from maturities and repayments of investments:
 
 
 
Fixed maturity securities
4,105 
4,787 
5,777 
Commercial mortgage loans
710 
857 
1,156 
Proceeds from sales of investments:
 
 
 
Fixed maturity and equity securities
5,808 
4,940 
8,224 
Purchases and originations of investments:
 
 
 
Fixed maturity and equity securities
(9,869)
(6,977)
(15,263)
Commercial mortgage loans
(211)
(1,631)
Other invested assets, net
(314)
(1,226)
(567)
Policy loans, net
431 
(183)
(162)
Net cash transferred related to the sale of a subsidiary
(51)
Payments for businesses purchased, net of cash acquired
(22)
(31)
Cash received from sale of discontinued operations, net of cash sold
514 
Cash from investing activities-discontinued operations
103 
Net cash from investing activities
820 
1,965 
(1,880)
Cash flows from financing activities:
 
 
 
Deposits to universal life and investment contracts
2,271 
7,604 
8,002 
Withdrawals from universal life and investment contracts
(7,975)
(11,522)
(10,118)
Short-term borrowings and other, net
(375)
973 
(49)
Redemption of non-recourse funding obligations
(12)
(100)
Proceeds from issuance of non-recourse funding obligations
790 
Repayment and repurchase of long-term debt
(898)
(319)
(500)
Proceeds from the issuance of long-term debt
298 
597 
349 
Dividends paid to stockholders
(175)
(163)
Stock-based compensation awards exercised
39 
Acquisition of treasury stock
(76)
(1,124)
Proceeds from issuance of common stock
622 
600 
Dividends paid to noncontrolling interests
(10)
Proceeds from the sale of subsidiary shares to noncontrolling interests
770 
Cash from financing activities-discontinued operations
(21)
Net cash from financing activities
(5,309)
(2,913)
(2,295)
Effect of exchange rate changes on cash and cash equivalents
232 
(258)
Net change in cash and cash equivalents
(2,326)
4,237 
622 
Cash and cash equivalents at beginning of year
7,328 
3,091 
2,469 
Cash and cash equivalents at end of year
$ 5,002 
$ 7,328 
$ 3,091 
Nature of Business and Formation of Genworth
Nature of Business and Formation of Genworth

(1) Nature of Business and Formation of Genworth

Genworth Financial, Inc. (“Genworth”) was incorporated in Delaware on October 23, 2003 in preparation for the corporate formation of certain insurance and related subsidiaries of the General Electric Company (“GE”) and an initial public offering of Genworth common stock, which was completed on May 28, 2004 (“IPO”). The accompanying financial statements include on a consolidated basis the accounts of Genworth and our affiliate companies in which we hold a majority voting or economic interest, which we refer to as the “Company,” “we,” “us,” or “our” unless the context otherwise requires.

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, long-term care and Medicare supplement insurance. Additionally, we offer other senior supplemental 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 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 also offer payment protection coverages in multiple European countries, Canada and Mexico. Our lifestyle protection insurance products 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”).

In December 2009, we began reporting our institutional and corporate-owned life insurance products, previously included in our Retirement and Protection segment, in Corporate and Other activities, as they were deemed non-strategic. The corporate-owned life insurance product was previously included in our long-term care insurance business in our Retirement and Protection segment. All prior period amounts have been re-presented. In January 2009, we also began reporting our equity access business in our long-term care insurance business included in our Retirement and Protection segment. Our equity access business includes our wholly-owned subsidiary that originates reverse mortgage loans, and was previously reported in Corporate and Other activities. The amounts associated with this business were not material and the prior period amounts have not been re-presented.

 

In connection with our IPO, Genworth acquired substantially all of the assets and liabilities of GE Financial Assurance Holdings, Inc. (“GEFAHI”). The transaction was accounted for at book value as a transfer between entities under common control and is referred to as our corporate formation.

Summary of Significant Accounting Policies
Summary of Significant Accounting Policies

(2) Summary of Significant Accounting Policies

Our consolidated financial statements have been prepared on the basis of U.S. generally accepted accounting principles (“U.S. GAAP”). Preparing financial statements in conformity with U.S. GAAP requires us to make estimates and assumptions that affect reported amounts and related disclosures. Actual results could differ from those estimates. All significant intercompany accounts and transactions have been eliminated in consolidation. Certain prior year amounts have been reclassified to conform to the current year presentation. Any material subsequent events have been considered for disclosure through the filing date of this Annual Report on Form 10-K.

a) Premiums

For traditional long-duration insurance contracts, we report premiums as earned when due. For short-duration insurance contracts, we report premiums as revenue over the terms of the related insurance policies on a pro-rata basis or in proportion to expected claims.

For single premium mortgage insurance contracts, we report premiums over the estimated policy life in accordance with the expected pattern of risk emergence as further described in our accounting policy for unearned premiums.

Premiums received under annuity contracts without significant mortality risk and premiums received on investment and universal life insurance products are not reported as revenues but rather as deposits and are included in liabilities for policyholder account balances.

b) Net Investment Income and Net Investment Gains and Losses

Investment income is recognized when earned. Investment gains and losses are calculated on the basis of specific identification.

Investment income on mortgage-backed and asset-backed securities is initially based upon yield, cash flow and prepayment assumptions at the date of purchase. Subsequent revisions in those assumptions are recorded using the retrospective or prospective method. Under the retrospective method, used for mortgage-backed and asset-backed securities of high credit quality (ratings equal to or greater than “AA” or that are backed by a U.S. agency) which cannot be contractually prepaid, amortized cost of the security is adjusted to the amount that would have existed had the revised assumptions been in place at the date of purchase. The adjustments to amortized cost are recorded as a charge or credit to net investment income. Under the prospective method, which is used for all other mortgage-backed and asset-backed securities, future cash flows are estimated and interest income is recognized going forward using the new internal rate of return.

c) Insurance and Investment Product Fees and Other

Insurance and investment product fees and other consist primarily of insurance charges assessed on universal life insurance contracts, fees assessed against customer account values and commission income. For universal life insurance contracts, charges to policyholder accounts for cost of insurance are recognized as revenue when due. Variable product fees are charged to variable annuity contractholders and variable life insurance policyholders based upon the daily net assets of the contractholder’s and policyholder’s account values and are recognized as revenue when charged. Policy surrender fees are recognized as income when the policy is surrendered.

d) Investment Securities

At the time of purchase, we designate our investment securities as either available-for-sale or trading and report them in our consolidated balance sheets at fair value. Our portfolio of fixed maturity securities is comprised primarily of investment grade securities. Changes in the fair value of available-for-sale investments, net of the effect on deferred acquisition costs (“DAC”), present value of future profits (“PVFP”) and deferred income taxes, are reflected as unrealized investment gains or losses in a separate component of accumulated other comprehensive income (loss). Realized and unrealized gains and losses related to trading securities are reflected in net investment gains (losses). Trading securities are included in other invested assets in our consolidated balance sheets.

Other-Than-Temporary Impairments On Available-For-Sale Securities

As of each balance sheet date, we evaluate securities in an unrealized loss position for other-than-temporary impairments. For debt securities, we consider all available information relevant to the collectability of the security, including information about past events, current conditions, and reasonable and supportable forecasts, when developing the estimate of cash flows expected to be collected. More specifically for mortgage-backed and asset-backed securities, we also utilize performance indicators of the underlying assets including default or delinquency rates, loan to collateral value ratios, third-party credit enhancements, current levels of subordination, vintage and other relevant characteristics of the security or underlying assets to develop our estimate of cash flows. Estimating the cash flows expected to be collected is a quantitative and qualitative process that incorporates information received from third-party sources along with certain internal assumptions and judgments regarding the future performance of the underlying collateral. Where possible, this data is benchmarked against third-party sources.

Prior to adoption of new accounting guidance related to the recognition and presentation of other-than-temporary impairments on April 1, 2009, we generally recognized an other-than-temporary impairment on debt securities in an unrealized loss position when we did not expect full recovery of value or did not have the intent and ability to hold such securities until they had fully recovered their amortized cost. The recognition of other-than-temporary impairments prior to April 1, 2009 represented the entire difference between the amortized cost and fair value with this difference being recorded in net income (loss) as an adjustment to the amortized cost of the security.

Beginning on April 1, 2009, we recognize other-than-temporary impairments on debt securities in an unrealized loss position when one of the following circumstances exists:

 

   

we do not expect full recovery of our amortized cost based on the estimate of cash flows expected to be collected,

 

   

we intend to sell a security or

 

   

it is more likely than not that we will be required to sell a security prior to recovery.

For other-than-temporary impairments recognized during the period, we present the total other-than-temporary impairments, the portion of other-than-temporary impairments included in other comprehensive income (loss) (“OCI”) and the net other-than-temporary impairments as supplemental disclosure presented on the face of our consolidated statements of income.

 

Total other-than-temporary impairments are calculated as the difference between the amortized cost and fair value that emerged in the current period. For other-than-temporarily impaired securities where we do not intend to sell the security and it is not more likely than not that we will be required to sell the security prior to recovery, total other-than-temporary impairments are adjusted by the portion of other-than-temporary impairments recognized in OCI (“non-credit”). Net other-than-temporary impairments recorded in net income (loss) represent the credit loss on the other-than-temporarily impaired securities with the offset recognized as an adjustment to the amortized cost to determine the new amortized cost basis of the securities.

For securities that were deemed to be other-than-temporarily impaired and a non-credit loss was recorded in OCI, the amount recorded as an unrealized gain (loss) represents the difference between the current fair value and the new amortized cost for each period presented. The unrealized gain (loss) on an other-than-temporarily impaired security is recorded as a separate component in OCI until the security is sold or until we record an other-than-temporary impairment where we intend to sell the security or will be required to sell the security prior to recovery.

To estimate the amount of other-than-temporary impairment attributed to credit losses on debt securities where we do not intend to sell the security and it is not more likely than not that we will be required to sell the security prior to recovery, we determine our best estimate of the present value of the cash flows expected to be collected from a security by discounting these cash flows at the current effective yield on the security prior to recording any other-than-temporary impairment. If the present value of the discounted cash flows is lower than the amortized cost of the security, the difference between the present value and amortized cost represents the credit loss associated with the security with the remaining difference between fair value and amortized cost recorded as a non-credit other-than-temporary impairment in OCI.

The evaluation of other-than-temporary impairments is subject to risks and uncertainties and is intended to determine the appropriate amount and timing for recognizing an impairment charge. The assessment of whether such impairment has occurred is based on management’s best estimate of the cash flows expected to be collected at the individual security level. We regularly monitor our investment portfolio to ensure that securities that may be other-than-temporarily impaired are identified in a timely manner and that any impairment charge is recognized in the proper period.

While the other-than-temporary impairment model for debt securities generally includes fixed maturity securities, there are certain hybrid securities that are classified as fixed maturity securities where the application of a debt impairment model depends on whether there has been any evidence of deterioration in credit of the issuer. Under certain circumstances, evidence of deterioration in credit of the issuer may result in the application of the equity impairment model.

For equity securities, we recognize an impairment charge in the period in which we determine that the security will not recover to book value within a reasonable period. We determine what constitutes a reasonable period on a security-by-security basis based upon consideration of all the evidence available to us, including the magnitude of an unrealized loss and its duration. In any event, this period does not exceed 18 months for common equity securities. We measure other-than-temporary impairments based upon the difference between the amortized cost of a security and its fair value.

e) Fair Value Measurements

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. 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.

 

Fair value measurements are based upon observable and unobservable inputs. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect our view of market assumptions in the absence of observable market information. We utilize valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. All assets and liabilities carried at fair value are classified and disclosed in one of the following three categories:

 

   

Level 1—Quoted prices for identical instruments in active markets.

 

   

Level 2—Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable.

 

   

Level 3—Instruments whose significant value drivers are unobservable.

Level 1 primarily consists of financial instruments whose value is based on quoted market prices such as exchange-traded derivatives and actively traded mutual fund investments.

Level 2 includes those financial instruments that are valued using industry-standard pricing methodologies, models or other valuation methodologies. These models are primarily industry-standard models that consider various inputs, such as interest rate, credit spread and foreign exchange rates for the underlying financial instruments. All significant inputs are observable, or derived from observable, information in the marketplace or are supported by observable levels at which transactions are executed in the marketplace. Financial instruments in this category primarily include: certain public and private corporate fixed maturity and equity securities; government or agency securities; certain mortgage-backed and asset-backed securities; securities held as collateral; and certain non-exchange-traded derivatives such as interest rate or cross currency swaps.

Level 3 is comprised of financial instruments whose fair value is estimated based on industry-standard pricing methodologies and internally developed models utilizing significant inputs not based on, nor corroborated by, readily available market information. In limited instances, this category may also utilize non-binding broker quotes. This category primarily consists of certain less liquid fixed maturity, equity and trading securities and certain derivative instruments where we cannot corroborate the significant valuation inputs with market observable data.

As of each reporting period, all assets and liabilities recorded at fair value are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability, such as the relative impact on the fair value as a result of including a particular input. We review the fair value hierarchy classifications each reporting period. Changes in the observability of the valuation attributes may result in a reclassification of certain financial assets or liabilities. Such reclassifications are reported as transfers in and out of Level 3 at the beginning fair value for the reporting period in which the changes occur.

The vast majority of our fixed maturity and equity securities use Level 2 inputs for the determination of fair value. These fair values are obtained primarily from industry-standard pricing methodologies based on market observable information. Certain structured securities valued using industry-standard pricing methodologies utilize significant unobservable inputs to estimate fair value, resulting in the fair value measurements being classified as Level 3. We also utilize internally developed pricing models to produce estimates of fair value primarily utilizing Level 2 inputs along with certain Level 3 inputs. The internally developed models include matrix pricing where we discount expected cash flows utilizing market interest rates obtained from market sources based on the credit quality and duration of the instrument to determine fair value. For securities that may not be reliably priced using internally developed pricing models, we estimate fair value using indicative market prices. These prices are indicative of an exit price, but the assumptions used to establish the fair value may not be observable, or corroborated by market observable information, and represent Level 3 inputs.

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

The fair value of derivative instruments primarily utilizes Level 2 inputs. Certain derivative instruments are valued using significant unobservable inputs and are classified as Level 3 measurements. The classification of fair value measurements for derivative instruments, including embedded derivatives requiring bifurcation, was determined based on consideration of several inputs including: closing exchange or over-the-counter market price quotations; time value and volatility factors underlying options; foreign exchange rates; market interest rates; and non-performance risk. For product-related embedded derivatives, we also include certain policyholder assumptions in the determination of fair value.

For assets carried at fair value, the non-performance of the counterparties is considered in the determination of fair value measurement for those assets. Similarly, the fair value measurement of a liability must reflect the entity’s own non-performance risk. Therefore, the impact of non-performance risk, as well as any potential credit enhancements (e.g., collateral), has been considered in the fair value measurement of both assets and liabilities. The liabilities recorded at fair value include derivative and GMWB liabilities.

We continually assess the non-performance risk on our liabilities recorded at fair value and will make adjustments in future periods as additional information is obtained that would indicate such an adjustment is necessary to accurately present the fair value measurement in accordance with U.S. GAAP.

f) Commercial Mortgage Loans

Commercial mortgage loans are generally stated at principal amounts outstanding, net of deferred expenses and allowance for loan loss. Interest on loans is recognized on an accrual basis at the applicable interest rate on the principal amount outstanding. Loan origination fees and direct costs, as well as premiums and discounts, are amortized as level yield adjustments over the respective loan terms. Unamortized net fees or costs are recognized upon early repayment of the loans. Loan commitment fees are generally deferred and amortized on an effective yield basis over the term of the loan. Impaired loans are generally carried on a non-accrual status. Loans are ordinarily placed on non-accrual status when, in management’s opinion, the collection of principal or interest is unlikely, or when the collection of principal or interest is 90 days or more past due.

The allowance for loan losses is maintained at a level that management determines is adequate to absorb estimated probable incurred losses in the loan portfolio. Management’s evaluation process to determine the adequacy of the allowance utilizes an analytical model based on historical loss experience adjusted for current events, trends and economic conditions. The actual amounts realized could differ in the near term from the amounts assumed in arriving at the allowance for loan losses reported in the consolidated financial statements.

All losses of principal are charged to the allowance for loan losses in the period in which the loan is deemed to be uncollectible. Additions and reductions are made to the allowance through periodic provisions or benefits to net investment gains (losses). Commercial mortgage loans classified as held-for-sale are carried at the lower of cost or market and are included in commercial mortgage loans in our consolidated balance sheets.

 

g) Securities Lending Activity and Repurchase Agreements

In the U.S. and Canada, we engage in certain securities lending transactions for the purpose of enhancing the yield on our investment securities portfolio, which require the borrower to provide collateral, consisting of cash and government securities, on a daily basis in amounts equal to or exceeding 102% in the U.S. and 105% in Canada of the fair value of the applicable securities loaned. We maintain effective control over all loaned securities and, therefore, continue to report such securities as fixed maturity securities on the consolidated balance sheets. Cash and non-cash collateral, such as a security, received by us on securities lending transactions is reflected in other invested assets with an offsetting liability recognized in other liabilities for the obligation to return the collateral. Any cash collateral received is reinvested by our custodian based upon the investment guidelines provided within our agreement. In the U.S., the reinvested cash collateral is primarily invested in U.S. and foreign government securities, U.S. government agency securities, asset-backed securities and corporate debt securities, all of which have scheduled maturities of less than three years. In Canada, the lending institution must be included on the approved Securities Lending Borrowers List with the Canadian regulator and the intermediary must be rated at least “AA-” by Standard and Poor’s. We are currently fully indemnified against counterparty credit risk by the intermediary. As of December 31, 2009 and 2008, the fair value of securities loaned under the securities lending program was $0.9 billion and $1.4 billion, respectively, consisting of $0.6 billion and $1.0 billion, respectively, in the U.S. and $0.3 billion and $0.4 billion, respectively, in Canada. As of December 31, 2009 and 2008, the fair value of collateral held under the securities lending program was $0.9 billion and $1.5 billion, respectively, and the offsetting obligation to return collateral of $0.9 billion and $1.5 billion, respectively, was included in other liabilities in the consolidated balance sheets. We had non-cash collateral of $326 million and $459 million as of December 31, 2009 and 2008, respectively.

We also have a repurchase program in which we sell an investment security at a specified price and agree to repurchase that security at another specified price at a later date. Repurchase agreements are treated as collateralized financing transactions and are carried at the amounts at which the securities will be subsequently reacquired, including accrued interest, as specified in the respective agreement. The market value of securities to be repurchased is monitored and collateral levels are adjusted where appropriate to protect the counterparty against credit exposure. Cash received is invested in fixed maturity securities. As of December 31, 2009 and 2008, the fair value of securities pledged under the repurchase program was $2.1 billion and $0.9 billion, respectively, and the repurchase obligation of $2.1 billion and $0.8 billion, respectively, was included in other liabilities in the consolidated balance sheets.

h) Cash and Cash Equivalents

Certificates of deposit, money market funds and other time deposits with original maturities of 90 days or less are considered cash equivalents in the consolidated balance sheets and consolidated statements of cash flows. Items with maturities greater than 90 days but less than one year at the time of acquisition are considered short-term investments.

i) Deferred Acquisition Costs

Acquisition costs include costs that vary with and are primarily related to the acquisition of insurance and investment contracts. Such costs are deferred and amortized as follows:

Long-Duration Contracts. Acquisition costs include commissions in excess of ultimate renewal commissions, solicitation and printing costs, sales material and some support costs, such as underwriting and contract and policy issuance expenses. Amortization for traditional long-duration insurance products is determined as a level proportion of premium based on commonly accepted actuarial methods and reasonable assumptions about mortality, morbidity, lapse rates, expenses and future yield on related investments established when the contract or policy is issued. Amortization is adjusted each period to reflect policy lapse or termination rates as compared to anticipated experience. Amortization for annuity contracts without significant mortality risk and for investment and universal life insurance products is based on estimated gross profits. Estimated gross profits are adjusted quarterly to reflect actual experience to date or for the unlocking of underlying key assumptions based on experience studies.

Short-Duration Contracts. Acquisition costs consist primarily of commissions and premium taxes and are amortized ratably over the terms of the underlying policies.

We regularly review all of these assumptions and periodically test DAC for recoverability. For deposit products, if the current present value of estimated future gross profits is less than the unamortized DAC for a line of business, a charge to income is recorded for additional DAC amortization, and for certain products, an increase in benefit reserves may be required. For other products, if the benefit reserve plus anticipated future premiums and interest income for a line of business are less than the current estimate of future benefits and expenses (including any unamortized DAC), a charge to income is recorded for additional DAC amortization or for increased benefit reserves. For the years ended December 31, 2009 and 2008, we recorded a charge to DAC as a result of our loss recognition and DAC recoverability testing of $54 million and $85 million, respectively. For the year ended December 31, 2007, there were no charges to income recorded as a result of our DAC recoverability or loss recognition testing.

j) Intangible Assets

Present Value of Future Profits. In conjunction with the acquisition of a block of insurance policies or investment contracts, a portion of the purchase price is assigned to the right to receive future gross profits arising from existing insurance and investment contracts. This intangible asset, called PVFP, represents the actuarially estimated present value of future cash flows from the acquired policies. PVFP is amortized, net of accreted interest, in a manner similar to the amortization of DAC.

We regularly review all of these assumptions and periodically test PVFP for recoverability. For deposit products, if the current present value of estimated future gross profits is less than the unamortized PVFP for a line of business, a charge to income is recorded for additional PVFP amortization. For other products, if the benefit reserve plus anticipated future premiums and interest income for a line of business are less than the current estimate of future benefits and expenses (including any unamortized PVFP), a charge to income is recorded for additional PVFP amortization or for increased benefit reserves. For the years ended December 31, 2009, 2008 and 2007, no charges to income were recorded as a result of our PVFP recoverability or loss recognition testing.

Deferred Sales Inducements to Contractholders. We defer sales inducements to contractholders for features on variable annuities that entitle the contractholder to an incremental amount to be credited to the account value upon making a deposit, and for fixed annuities with crediting rates higher than the contract’s expected ongoing crediting rates for periods after the inducement. Deferred sales inducements to contractholders are reported as a separate intangible asset and amortized in benefits and other changes in policy reserves using the same methodology and assumptions used to amortize DAC.

Other Intangible Assets. We amortize the costs of other intangibles over their estimated useful lives unless such lives are deemed indefinite. Amortizable intangible assets are tested for impairment at least annually based on undiscounted cash flows, which requires the use of estimates and judgment, and, if impaired, written down to fair value based on either discounted cash flows or appraised values. Intangible assets with indefinite lives are tested at least annually for impairment and written down to fair value as required.

k) Goodwill

Goodwill is not amortized but is tested for impairment at least annually and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of the reporting unit below its carrying value. We test goodwill using a fair value approach, which requires the use of estimates and judgment, at the “reporting unit” level. A reporting unit is the operating segment, or a business one level below that operating segment (the “component” level) if discrete financial information is prepared and regularly reviewed by management at the component level. We recognize an impairment charge for any amount by which the carrying amount of a reporting unit’s goodwill exceeds its fair value.

The determination of fair value for our reporting units is primarily based on an income approach whereby we use discounted cash flows for each reporting unit. When available and as appropriate, we use market approaches or other valuation techniques to corroborate discounted cash flow results. The discounted cash flow model used for each reporting unit is based on either: operating income or statutory distributable income, depending on the reporting unit being valued.

The cash flows used to determine fair value are dependent on a number of significant management assumptions based on our historical experience, our expectations of future performance, and expected economic environment. Our estimates are subject to change given the inherent uncertainty in predicting future performance and cash flows, which are impacted by such things as policyholder behavior, competitor pricing, new product introductions and specific industry and market conditions. Additionally, the discount rate used in our discounted cash flow approach is based on management’s judgment of the appropriate rate for each reporting unit based on the relative risk associated with the projected cash flows.

For the years ended December 31, 2009 and 2007, no charges were recorded as a result of our goodwill impairment testing. In 2008, we recorded goodwill impairments of $277 million as a result of our goodwill impairment testing. See note 8 for additional information related to goodwill impairments recorded.

l) Reinsurance

Premium revenue, benefits and acquisition and operating expenses, net of deferrals, are reported net of the amounts relating to reinsurance ceded to and assumed from other companies. Amounts due from reinsurers for incurred and estimated future claims are reflected in the reinsurance recoverable asset. The cost of reinsurance is accounted for over the terms of the related treaties using assumptions consistent with those used to account for the underlying reinsured policies. Premium revenue, benefits and acquisition and operating expenses, net of deferrals, for reinsurance contracts that do not qualify for reinsurance accounting are accounted for under the deposit method of accounting.

m) Derivatives

Derivative instruments are used to manage risk through one of four principal risk management strategies including: (i) liabilities; (ii) invested assets; (iii) portfolios of assets or liabilities; and (iv) forecasted transactions.

On the date we enter into a derivative contract, management designates the derivative as a hedge of the identified exposure (fair value, cash flow or foreign currency). If a derivative does not qualify for hedge accounting, the changes in its fair value and all scheduled periodic settlement receipts and payments are reported in income.

 

We formally document all relationships between hedging instruments and hedged items, as well as our risk management objective and strategy for undertaking various hedge transactions. In this documentation, we specifically identify the asset, liability or forecasted transaction that has been designated as a hedged item, state how the hedging instrument is expected to hedge the risks related to the hedged item, and set forth the method that will be used to retrospectively and prospectively assess the hedging instrument’s effectiveness and the method that will be used to measure hedge ineffectiveness. We generally determine hedge effectiveness based on total changes in fair value of the hedged item attributable to the hedged risk and the total changes in fair value of the derivative instrument.

We discontinue hedge accounting prospectively when: (i) it is determined that the derivative is no longer effective in offsetting changes in the fair value or cash flows of a hedged item; (ii) the derivative expires or is sold, terminated or exercised; (iii) the derivative is de-designated as a hedge instrument; or (iv) it is probable that the forecasted transaction will not occur.

For all qualifying and highly effective cash flow hedges, the effective portion of changes in fair value of the derivative instrument is reported as a component of OCI. The ineffective portion of changes in fair value of the derivative instrument is reported as a component of income. When hedge accounting is discontinued because it is probable that a forecasted transaction will not occur, the derivative continues to be carried in the consolidated balance sheets at its fair value, and gains and losses that were accumulated in OCI are recognized immediately in income. When the hedged forecasted transaction is no longer probable, but is reasonably possible, the accumulated gain or loss remains in OCI and is recognized when the transaction affects income; however, prospective hedge accounting for the transaction is terminated. In all other situations in which hedge accounting is discontinued on a cash flow hedge, amounts previously deferred in OCI are reclassified into income when income is impacted by the variability of the cash flow of the hedged item.

For all qualifying and highly effective fair value hedges, the changes in fair value of the derivative instrument are reported in income. In addition, changes in fair value attributable to the hedged portion of the underlying instrument are reported in income. When hedge accounting is discontinued because it is determined that the derivative no longer qualifies as an effective fair value hedge, the derivative continues to be carried in the consolidated balance sheets at its fair value, but the hedged asset or liability will no longer be adjusted for changes in fair value. In all other situations in which hedge accounting is discontinued, the derivative is carried at its fair value in the consolidated balance sheets, with changes in its fair value recognized in the current period as income.

We may enter into contracts that are not themselves derivative instruments but contain embedded derivatives. For each contract, we assess whether the economic characteristics of the embedded derivative are clearly and closely related to those of the host contract and determine whether a separate instrument with the same terms as the embedded instrument would meet the definition of a derivative instrument.

If it is determined that the embedded derivative possesses economic characteristics that are not clearly and closely related to the economic characteristics of the host contract, and that a separate instrument with the same terms would qualify as a derivative instrument, the embedded derivative is separated from the host contract and accounted for as a stand-alone derivative. Such embedded derivatives are recorded in the consolidated balance sheets at fair value and are classified consistent with their host contract. Changes in their fair value are recognized in the current period in income. If we are unable to properly identify and measure an embedded derivative for separation from its host contract, the entire contract is carried in the consolidated balance sheets at fair value, with changes in fair value recognized in the current period in income.

 

Changes in the fair value of non-qualifying derivatives, including embedded derivatives, changes in fair value of certain derivatives and related hedged items in fair value hedge relationships and hedge ineffectiveness on cash flow hedges are reported in net investment gains (losses).

n) Separate Accounts

The separate account assets represent funds for which the investment income and investment gains and losses accrue directly to the variable annuity contractholders and variable life insurance policyholders. We assess mortality and expense risk fees and administration charges on the assets allocated to the separate accounts. The separate account assets are carried at fair value and are equal to the liabilities that represent the contractholders’ and policyholders’ equity in those assets.

o) Insurance Reserves

Future Policy Benefits

We include insurance-type contracts, such as traditional life insurance, in the liability for future policy benefits. Insurance-type contracts are broadly defined to include contracts with significant mortality and/or morbidity risk. The liability for future benefits of insurance contracts is the present value of such benefits less the present value of future net premiums based on mortality, morbidity and other assumptions, which are appropriate at the time the policies are issued or acquired. These assumptions are periodically evaluated for potential reserve deficiencies. Reserves for cancelable accident and health insurance are based upon unearned premiums, claims incurred but not reported and claims in the process of settlement. This estimate is based on our historical experience and that of the insurance industry, adjusted for current trends. Any changes in the estimated liability are reflected in income as the estimates are revised.

Policyholder Account Balances

We include investment-type contracts and our universal life insurance contracts in the liability for policyholder account balances. Investment-type contracts are broadly defined to include contracts without significant mortality or morbidity risk. Payments received from sales of investment contracts are recognized by providing a liability equal to the current account value of the policyholders’ contracts. Interest rates credited to investment contracts are guaranteed for the initial policy term with renewal rates determined as necessary by management.

p) Liability for Policy and Contract Claims

The liability for policy and contract claims represents the amount needed to provide for the estimated ultimate cost of settling claims relating to insured events that have occurred on or before the end of the respective reporting period. The estimated liability includes requirements for future payments of: (a) claims that have been reported to the insurer; (b) claims related to insured events that have occurred but that have not been reported to the insurer as of the date the liability is estimated; and (c) claim adjustment expenses. Claim adjustment expenses include costs incurred in the claim settlement process such as legal fees and costs to record, process and adjust claims.

For our mortgage insurance policies, reserves for losses and loss adjustment expenses are based on notices of mortgage loan defaults and estimates of defaults that have been incurred but have not been reported by loan servicers, using assumptions of claim rates for loans in default and the average amount paid for loans that result in a claim. As is common accounting practice in the mortgage insurance industry and in accordance with U.S. GAAP, we begin to provide for the ultimate claim payment relating to a potential claim on a defaulted loan when the status of that loan first goes delinquent. Over time, as the status of the underlying delinquent loan moves toward foreclosure and the likelihood of the associated claim loss increases, the amount of the loss reserve associated with that potential claim may also increase. The loss reserve factor assumptions related to our U.S. mortgage insurance business are reviewed quarterly. The loss reserve factors are adjusted when required to reflect changes in current and projected market and economic conditions that affect the underlying loss reserve factor assumptions.

Management considers the liability for policy and contract claims provided to be satisfactory to cover the losses that have occurred. Management monitors actual experience, and where circumstances warrant, will revise its assumptions. The methods of determining such estimates and establishing the reserves are reviewed continuously and any adjustments are reflected in operations in the period in which they become known. Future developments may result in losses and loss expenses greater or less than the liability for policy and contract claims provided.

q) Unearned Premiums

For single premium insurance contracts, we recognize premiums over the policy life in accordance with the expected pattern of risk emergence. We recognize a portion of the revenue in premiums earned in the current period, while the remaining portion is deferred as unearned premiums and earned over time in accordance with the expected pattern of risk emergence. If single premium policies are cancelled and the premium is non-refundable, then the remaining unearned premium related to each cancelled policy is recognized to earned premiums upon notification of the cancellation. Expected pattern of risk emergence on which we base premium recognition is inherently judgmental and is based on actuarial analysis of historical experience. We periodically review our premium earnings recognition models with any adjustments to the estimates reflected in current period income. For the years ended December 31, 2009, 2008 and 2007, we updated our premium recognition factors for our international mortgage insurance business. These updates included the consideration of recent and projected loss experience, policy cancellation experience and refinement of actuarial methods. In 2009, 2008 and 2007, adjustments associated with this update resulted in an increase in earned premiums of $32 million, $53 million and $45 million, respectively.

r) Stock-Based Compensation

We determine a grant date fair value and recognize the related compensation expense, adjusted for expected forfeitures, through the income statement over the respective vesting period of the awards.

s) Employee Benefit Plans

We provide employees with a defined contribution pension plan and recognize expense throughout the year based on the employee’s age, service and eligible pay. We make an annual contribution to the plan. We also provide employees with defined contribution savings plans. We recognize expense for our contributions to the savings plans at the time employees make contributions to the plans.

Some employees participate in defined benefit pension and postretirement benefit plans. We recognize expense for these plans based upon actuarial valuations performed by external experts. We estimate aggregate benefits by using assumptions for employee turnover, future compensation increases, rates of return on pension plan assets and future health care costs. We recognize an expense for differences between actual experience and estimates over the average future service period of participants. We recognize the overfunded or underfunded status of a defined benefit plan as an asset or liability in our consolidated balance sheets and recognize changes in that funded status in the year in which the changes occur through OCI.

t) Income Taxes

We determine deferred tax assets and/or liabilities by multiplying the differences between the financial reporting and tax reporting bases for assets and liabilities by the enacted tax rates expected to be in effect when such differences are recovered or settled if there is no change in law. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date. Valuation allowances on deferred tax assets are estimated based on our assessment of the realizability of such amounts.

For periods prior to our corporate reorganization, our non-life insurance entities were included in the consolidated federal income tax return of GE and subject to a tax sharing arrangement that allocates tax on a separate company basis, but provides benefit for current utilization of losses and credits. For periods prior to 2004, our U.S. life insurance entities filed a consolidated life insurance federal income tax return separate from GE and are subject to a separate tax sharing agreement, as approved by state insurance regulators, which also allocates taxes on a separate company basis but provides benefit for current utilization of losses and credits. For 2004, through the date of our corporate reorganization, our U.S. life insurance entities were included in the consolidated federal income tax return of GE, and subject to separate company principles similar to those applicable to our non-life insurance entities. Effective with our corporate reorganization, our U.S. non-life insurance entities are included in the consolidated federal income tax return of Genworth and subject to a tax sharing arrangement that allocates tax on a separate company basis, but provides benefit for current utilization of losses and credits. Also effective with our corporate reorganization, our U.S. life insurance entities file a consolidated life insurance federal income tax return, and are subject to a separate tax sharing agreement, as approved by state insurance regulators, which allocates taxes on a separate company basis but provides benefit for current utilization of losses and credits. Intercompany balances under all agreements are settled at least annually.

u) Foreign Currency Translation

The determination of the functional currency is made based on the appropriate economic and management indicators. The assets and liabilities of foreign operations are translated into U.S. dollars at the exchange rates in effect at the consolidated balance sheet date. Translation adjustments are included as a separate component of accumulated other comprehensive income (loss). Revenues and expenses of the foreign operations are translated into U.S. dollars at the average rates of exchange prevailing during the year. Gains and losses from foreign currency transactions are reported in income and have not been material in all years presented in our consolidated statements of income.

v) Variable Interest Entities

We are involved in certain entities that are considered variable interest entities (“VIEs”) as defined under U.S. GAAP, and, accordingly, we evaluate the VIE 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 how those results are absorbed by beneficial interest holders.

Our primary involvement related to VIEs includes securitization transactions, certain investments and certain mortgage insurance policies.

 

We have retained interests in VIEs where we are the servicer and transferor of certain assets that were sold to a newly created VIE. Additionally, for certain securitization transactions, we were the transferor of certain assets that were sold to a newly created VIE but did not retain any beneficial interest in the VIE other than acting as the servicer of the underlying assets.

We hold investments in certain structures that are considered VIEs. Our investments represent beneficial interests that are primarily in the form of structured securities or alternative investments. 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.

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 on-going involvement with the VIE other than our mortgage insurance coverage and do not act in a servicing capacity for the underlying loans held by the VIE.

As of December 31, 2009 and 2008, we were not required to consolidate any VIEs where there are third-party beneficial interest holders.

w) Accounting Changes

Fair Value Measurements and Disclosures—Measuring Liabilities At Fair Value

On October 1, 2009, we adopted new accounting guidance related to measuring liabilities at fair valueThis accounting guidance clarified techniques for measuring the fair value of liabilities when quoted market prices for the identical liability are not available. The adoption of this new accounting guidance did not have a material impact on our consolidated financial statements.

Fair Value Measurements and Disclosures—Investments In Certain Entities That Calculate Net Asset Value Per Share

On October 1, 2009, we adopted new accounting guidance related to fair value measurements and disclosures that provided guidance on the fair value measurement in certain entities that calculate net asset value per share. The adoption of this new accounting guidance did not have a material impact on our consolidated financial statements.

The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles

On July 1, 2009, we adopted new accounting guidance related to the codification of accounting standards and the hierarchy of U.S. GAAP established by the Financial Accounting Standards Board (the “FASB”)This accounting guidance established two levels of U.S. GAAP, authoritative and nonauthoritative. The FASB Accounting Standards Codification (the “Codification”) is the source of authoritative, nongovernmental U.S. GAAP, except for rules and interpretive releases of the SEC, which are also sources of authoritative U.S. GAAP for SEC registrants. All other accounting literature is nonauthoritative. The adoption of this new accounting guidance did not have a material impact on our consolidated financial statements.

Subsequent Events

On June 30, 2009, we adopted new accounting guidance related to accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. This accounting guidance required the disclosure of the date through which an entity has evaluated subsequent events and the basis for that date. The adoption of this new accounting guidance did not have a material impact on our consolidated financial statements.

Recognition and Presentation of Other-Than-Temporary Impairments

On April 1, 2009, we adopted new accounting guidance related to the recognition and presentation of other-than-temporary impairments. This accounting guidance amended the other-than-temporary impairment guidance for debt securities and modified the presentation and disclosure requirements for other-than-temporary impairment disclosures for debt and equity securities. This accounting guidance also amended the requirement for management to positively assert the ability and intent to hold a debt security to recovery to determine whether an other-than-temporary impairment exists and replaced this provision with the assertion that we do not intend to sell or it is not more likely than not that we will be required to sell a security prior to recovery. Additionally, this accounting guidance modified the presentation of other-than-temporary impairments for certain debt securities to only present the impairment loss in net income (loss) that represents the credit loss associated with the other-than-temporary impairment with the remaining impairment loss being presented in OCI. On April 1, 2009, we recorded a net cumulative effect adjustment of $355 million to retained earnings with an offset to accumulated other comprehensive income (loss) of $349 million related to the adoption of this new accounting guidance. 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

   $ (588   $ 588      $ —     

Adjustment to DAC

     33        (26     7   

Adjustment to PVFP

     9        (7     2   

Adjustment to sales inducements

     5        (5     —     

Adjustment to certain benefit reserves

     —          1        1   

Provision for income taxes

     192        (196     (4
                        

Net cumulative effect adjustment

   $ (349   $ 355      $ 6   
                        

Interim Disclosures About Fair Value of Financial Instruments

On April 1, 2009, we adopted new accounting guidance related to interim disclosures about fair value of financial instruments. This accounting guidance amended the fair value disclosure requirements for certain financial instruments to require disclosures during interim reporting periods of publicly traded entities in addition to requiring them in annual financial statements. The adoption of this new accounting guidance did not have a material impact on our consolidated financial statements.

Determining Fair Value When the Volume and Level of Activity For the Asset Or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly

On April 1, 2009, we adopted new accounting guidance related to determining fair value when the volume and level of activity for the asset or liability have significantly decreased and identifying transactions that are not orderly. This accounting guidance provided additional guidance for determining fair value when the volume or level of activity for an asset or liability has significantly decreased and identified circumstances that indicate a transaction is not orderly. The adoption of this new accounting guidance did not have a material impact on our consolidated financial statements.

 

Fair Value Measurements of Certain Nonfinancial Assets and Liabilities

On January 1, 2009, we adopted new accounting guidance related to fair value measurements of certain nonfinancial assets and liabilities, such as impairment testing of goodwill and indefinite-lived intangible assets. The adoption of this new accounting guidance did not have a material impact on our consolidated financial statements.

Disclosures About Derivative Instruments and Hedging Activities

On January 1, 2009, we adopted new accounting guidance related to disclosures about derivative instruments and hedging activities. This statement required enhanced disclosures about an entity’s derivative and hedging activities. The adoption of this new accounting guidance did not have a material impact on our consolidated financial statements.

Business Combinations

On January 1, 2009, we adopted new accounting guidance related to business combinations. This accounting guidance established principles and requirements for how an acquirer recognizes and measures certain items in a business combination, as well as disclosures about the nature and financial effects of a business combination. The adoption of this new accounting guidance did not have a material impact on our consolidated financial statements.

Noncontrolling Interests In Consolidated Financial Statements

On January 1, 2009, we adopted new accounting guidance related to noncontrolling interests in consolidated financial statements. This accounting guidance established accounting and reporting standards for noncontrolling interests in a subsidiary and for deconsolidation of a subsidiary. The adoption of this new accounting guidance did not have a material impact on our consolidated financial statements.

Transfers of Financial Assets and Interests In Variable Interest Entities

On December 31, 2008, we adopted new accounting guidance related to disclosures by public entities about transfers of financial assets and interests in VIEs. This new accounting guidance amends the disclosure requirements regarding transfers of financial assets and involvement in VIEs to require additional disclosures for public entities. The adoption of this new accounting guidance did not have a material impact on our consolidated financial statements.

Credit Derivatives and Certain Guarantees

On December 31, 2008, we adopted new accounting guidance related to disclosures about credit derivatives and certain guarantees. This accounting guidance requires certain disclosures by sellers of credit derivatives and requires additional disclosure about the current status of the payment/performance risk of guarantees. The adoption of this new accounting guidance did not have a material impact on our consolidated financial statements.

 

Other-Than-Temporary Impairments On Available-For-Sale Securities

On October 14, 2008, the Office of the Chief Accountant at the U.S. Securities and Exchange Commission, issued a letter to the FASB that stated, given the debt characteristics of hybrid securities, they would not object to the application of a debt impairment model to hybrid investments provided there has been no evidence of deterioration in credit of the issuer. A debt impairment model could be used for filings subsequent to October 14, 2008, until the FASB further addresses the appropriate impairment model. As a result, management began using and will continue to use the debt impairment model as long as there has been no evidence of deterioration in credit of the issuer as of the balance sheet date.

Other-Than-Temporary Impairments of Certain Structured Securities

On October 1, 2008, we adopted new accounting guidance related to impairment guidance. This accounting guidance amends the impairment guidance to require all available information be used to produce our best estimate of cash flows rather than relying exclusively upon what a market participant would use to determine the current fair value. The adoption of this new accounting guidance did not have a material impact on our consolidated financial statements.

Determining Fair Value When A Market Is Not Active

On September 30, 2008, we adopted new accounting guidance related to determining the fair value of a financial asset when the market for that asset is not active. The accounting guidance provides guidance and clarification on how management’s internal assumptions, observable market information and market quotes are considered in inactive markets. The adoption of this new accounting guidance did not have a material impact on our consolidated financial statements.

Fair Value Measurements

On January 1, 2008, we adopted new accounting guidance related to fair value measurements. This accounting guidance defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. The adoption of this new accounting guidance did not have a material impact on our consolidated financial statements. Additionally, on January 1, 2008, we elected the partial adoption of this accounting guidance to allow an entity to delay the application until January 1, 2009 for certain non-financial assets and liabilities. Under the provisions of the accounting guidance, we will delay the application for fair value measurements used in the impairment testing of goodwill and indefinite-lived intangible assets and eligible non-financial assets and liabilities included within a business combination. The adoption of this new accounting guidance did not have a material impact on our consolidated financial statements.

Fair Value Option For Financial Assets and Financial Liabilities

On January 1, 2008, we adopted new accounting guidance related to the fair value option for financial assets and financial liabilities. This accounting guidance provides an option, on specified election dates, to report selected financial assets and liabilities, including insurance contracts, at fair value. Subsequent changes in fair value for designated items are reported in income in the current period. The adoption of this new accounting guidance did not impact our consolidated financial statements as no items were elected for measurement at fair value upon initial adoption. We will continue to evaluate eligible financial assets and liabilities on their election dates. Any future elections will be disclosed in accordance with the provisions outlined in the accounting guidance.

 

Amendment To Guidance For Offsetting of Amounts Related To Certain Contracts

On January 1, 2008, we adopted new accounting guidance for offsetting of amounts related to certain contracts. This accounting guidance allows fair value amounts recognized for collateral to be offset against fair value amounts recognized for derivative instruments that are executed with the same counterparty under certain circumstances. It also requires an entity to disclose the accounting policy decision to offset, or not to offset, fair value amounts. We do not, and have not previously, offset the fair value amounts recognized for derivatives with the amounts recognized as collateral.

Accounting For Uncertainty In Income Taxes

On January 1, 2007, we adopted new accounting guidance related to accounting for uncertainty in income taxes. This accounting guidance clarifies the criteria that must be satisfied to recognize the financial statement benefit of a position taken in our tax returns. The criteria for recognition in the consolidated financial statements require an affirmative determination that it is more likely than not, based on a tax position’s technical merits, that we are entitled to the benefit of that position.

Upon adoption of this new accounting guidance on January 1, 2007, the total amount of unrecognized tax benefits was $362 million, of which, $190 million, if recognized, would affect the effective tax rate on continuing operations.

Accounting By Insurance Enterprises For DAC In Connection With Modifications Or Exchanges of Insurance Contracts

On January 1, 2007, we adopted new accounting guidance related to accounting by insurance enterprises for DAC in connection with modifications or exchanges of insurance contracts. This accounting guidance provides guidance on accounting for DAC and other balances on an internal replacement, defined broadly as a modification in product benefits, features, rights or coverages that occurs by the exchange of an existing contract for a new contract, or by amendment, endorsement or rider to an existing contract, or by the election of a benefit, feature, right or coverage within an existing contract. The adoption of this new accounting guidance resulted in the shortening of the period over which DAC related to our group life and health insurance business is amortized. Transition to the shorter amortization period resulted in a January 1, 2007 cumulative effect adjustment to retained earnings of $54 million, net of taxes. The cumulative effect of adoption related to our discontinued operations which we sold on May 31, 2007.

x) Accounting Pronouncements Not Yet Adopted

In January 2010, the FASB issued new accounting guidance to require new disclosures and clarify existing disclosure requirements related to fair value. This accounting guidance will be effective for us on January 1, 2010 except for the new disclosure requirements about purchases, sales, issuances, and settlements in the rollforward of Level 3 fair value measurements, which 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 June 2009, the FASB issued new accounting guidance related to accounting for transfers of financial assets. This accounting guidance amends the current 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. This accounting guidance will be effective for us on January 1, 2010 and shall apply to transfers that occur on or after the effective date. The adoption of this accounting guidance did not have a material impact on our consolidated financial statements. However, the elimination of the qualifying special purpose entity concept requires that these entities be considered for consolidation as a result of the new guidance related to VIEs as discussed below.

 

In June 2009, the FASB issued new accounting guidance for determining which enterprise, if any, has a controlling financial interest in a VIE and requires 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. This accounting guidance will be effective for us on January 1, 2010. Upon adoption of this new accounting guidance, we will be required to consolidate certain VIEs, including previously qualified special purpose entities and investment structures. We will record 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. We anticipate the impact upon adoption of this new accounting guidance will be approximately $165 million, pre-tax and other adjustments, and will be recorded as a reduction in retained earnings on January 1, 2010, with a related increase in total assets and total liabilities of approximately $700 million.

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

(3) Earnings (Loss) Per Share

Basic and diluted earnings (loss) per share are calculated by dividing net income (loss) for the years ended December 31, 2009, 2008 and 2007 by 451.1 million, 433.2 million and 439.7 million weighted-average basic shares outstanding and by 451.1 million, 433.2 million and 447.6 million weighted-average diluted shares outstanding, respectively.

 

(Amounts in millions, except per share amounts)

  2009     2008     2007

Income (loss) from continuing operations

  $ (399   $ (572   $ 1,154

Income from discontinued operations, net of taxes

    —          —          15

Gain on sale of discontinued operations, net of taxes

    —          —          51
                     

Net income (loss)

    (399     (572     1,220

Less: net income attributable to noncontrolling interests

    61        —          —  
                     

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

  $ (460   $ (572   $ 1,220
                     

Basic per common share:

     

Income (loss) from continuing operations

  $ (0.88   $ (1.32   $ 2.62

Income from discontinued operations, net of taxes

    —          —          0.03

Gain on sale of discontinued operations, net of taxes

    —          —          0.12
                     

Net income (loss)

    (0.88     (1.32     2.77

Less: net income attributable to noncontrolling interests

    0.14        —          —  
                     

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

  $ (1.02   $ (1.32   $ 2.77
                     

Diluted per common share:

     

Income (loss) from continuing operations

  $ (0.88   $ (1.32   $ 2.58

Income from discontinued operations, net of taxes

    —          —          0.03

Gain on sale of discontinued operations, net of taxes

    —          —          0.11
                     

Net income (loss)

    (0.88     (1.32     2.73

Less: net income attributable to noncontrolling interests

    0.14        —          —  
                     

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

  $ (1.02   $ (1.32   $ 2.73
                     

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

    451.1        433.2        439.7

Potentially dilutive securities:

     

Stock purchase contracts underlying Equity Units

    —          —          3.2

Stock options, restricted stock units and stock appreciation rights

    —          —          4.7
                     

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

    451.1        433.2        447.6
                     

 

(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 years ended December 31, 2009 and 2008, we were required to use basic weighted-average common shares outstanding in the calculation of the 2009 and 2008 diluted loss per share, as the inclusion of shares for stock options, restricted stock units (“RSUs”) and stock appreciation rights (“SARs”) of 1.9 million and 1.7 million, respectively, would have been antidilutive to the calculation. If we had not incurred a net loss in 2009 and 2008, dilutive potential common shares would have been 453.0 million and 434.9 million, respectively.

 

On September 21, 2009, we completed the public offering of 55.2 million shares of our Class A Common Stock, par value $0.001 per share (including the exercise in full of the underwriters’ option to purchase up to an additional 7.2 million shares of our Class A Common Stock). Net proceeds were $622 million.

Investments
Investments

(4) Investments

(a) Net Investment Income

Sources of net investment income were as follows for the years ended December 31:

 

(Amounts in millions)

   2009     2008     2007  

Fixed maturity securities—taxable

   $ 2,458     $ 2,878      $ 3,189   

Fixed maturity securities—non-taxable

     107        109        102   

Commercial mortgage loans

     432        523        548   

Equity securities

     16        29        31   

Other invested assets (1)

     (82     (2     97   

Policy loans

     143        162        144   

Cash, cash equivalents and short-term investments

     49        132        119   
                        

Gross investment income before expenses and fees

     3,123        3,831        4,230   

Expenses and fees

     (90     (101     (95
                        

Net investment income

   $ 3,033      $ 3,730      $ 4,135   
                        

 

(1)

Included in other invested assets was $7 million, $13 million and $16 million of net investment income related to trading securities in 2009, 2008 and 2007, respectively.

(b) Net Investment Gains (Losses)

Net investment gains (losses) were as follows for the years ended December 31:

 

(Amounts in millions)

   2009     2008     2007  

Available-for-sale securities:

      

Realized gains on sale

   $ 255      $ 133      $ 36   

Realized losses on sale

     (226     (250     (106

Impairments:

      

Total other-than-temporary impairments

     (1,499     (2,131     (229

Portion of other-than-temporary impairments included in OCI

     441        —          —     
                        

Net other-than-temporary impairments

     (1,058     (2,131     (229
                        

Trading securities

     22        (43     (14

Commercial mortgage loans

     (28     (2     (11

Derivative instruments

     21        611        (9

Other

     (27     (27     1   
                        

Net investment gains (losses)

   $ (1,041   $ (1,709   $ (332
                        

Derivative instruments primarily consist of changes in the fair value of non-qualifying derivatives, including embedded derivatives, changes in fair value of certain derivatives and related hedged items in fair value hedge relationships and hedge ineffectiveness on qualifying derivative instruments. See note 5 for additional information on the impact of derivative instruments included in net investment gains (losses).

 

We generally intend to hold securities in unrealized loss positions until they recover. However, from time to time, our intent on an individual security may change, based upon market or other unforeseen developments. In such instances, we sell securities in the ordinary course of managing our portfolio to meet diversification, credit quality, yield and liquidity requirements. If a loss is recognized from a sale subsequent to a balance sheet date due to these unexpected developments, the loss is recognized in the period in which we determined that we have the intent to sell the securities or it is more likely than not that we will be required to sell the securities prior to recovery. The aggregate fair value of securities sold at a loss during the years ended December 31, 2009, 2008 and 2007 was $1,513 million, $2,285 million and $4,638 million, respectively, which was approximately 88%, 93% and 97%, 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 OCI as of and for the year ended December 31:

 

(Amounts in millions)

   2009  

Cumulative credit losses, beginning balance

   $ —     

Adoption of new accounting guidance related to other-than-temporary impairments

     1,204   

Additions:

  

Other-than-temporary impairments not previously recognized

     120   

Increases related to other-than-temporary impairments previously recognized

     227   

Reductions:

  

Securities sold, paid down or disposed

     (485

Securities where there is intent to sell

     (7
        

Cumulative credit losses, ending balance

   $ 1,059   
        

(c) Unrealized Investment Gains and Losses

Net unrealized gains and losses on investment securities classified as available-for-sale and other invested assets are reduced by deferred income taxes and adjustments to DAC, PVFP and sales inducements that would have resulted had such gains and losses been realized. Net unrealized gains and losses on available-for-sale investment securities reflected as a separate component of accumulated other comprehensive income (loss) were as follows as of December 31:

 

(Amounts in millions)

   2009     2008     2007  

Net unrealized gains (losses) on investment securities:

      

Fixed maturity securities

   $ (2,245   $ (7,006   $ (948

Equity securities

     20        (67     25   

Other invested assets

     (29     (1     (22
                        

Subtotal

     (2,254     (7,074     (945

Adjustments to DAC, PVFP and sales inducements

     138        815        128   

Income taxes, net

     757        2,221        291   
                        

Net unrealized investment gains (losses)

     (1,359     (4,038     (526

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

     39        —          —     
                        

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

   $ (1,398   $ (4,038   $ (526
                        

 

The change in net unrealized gains (losses) on available-for-sale investment securities reported in accumulated other comprehensive income (loss) was as follows as of and for the years ended December 31:

 

(Amounts in millions)

   2009     2008     2007  

Beginning balance

   $ (4,038   $ (526   $ 435   

Cumulative effect of change in accounting

     (349 )     —          —     

Unrealized gains (losses) arising during the period:

      

Unrealized gains (losses) on investment securities

     4,379        (8,431     (1,898

Adjustment to DAC

     (526     476        77   

Adjustment to PVFP

     (178     202        34   

Adjustment to sales inducements

     (20     9        11   

Provision for income taxes

     (1,296     2,736        625   
                        

Change in unrealized gains (losses) on investment securities

     2,359        (5,008     (1,151

Reclassification adjustments to net investment (gains) losses, net of taxes of $(360), $(806) and $(105)

     669        1,496        194   

Unrealized gains (losses) on investment securities included in assets associated with discontinued operations, net of deferred taxes of $0, $0 and $2

     —          —          (4
                        

Change in net unrealized investment gains (losses)

     2,679       (4,038     (526

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

     (39 )     —          —     
                        

Ending balance

   $ (1,398   $ (4,038   $ (526
                        

(d) Fixed Maturity and Equity Securities

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
                                       

 

As of December 31, 2008, 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

Fixed maturity securities:

          

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

   $ 764    $ 141    $ —        $ 905

Tax-exempt

     2,529      70      (228     2,371

Government—non-U.S.

     1,724      103      (67     1,760

U.S. corporate

     21,789      253      (2,968     19,074

Corporate—non-U.S.

     11,439      118      (1,581     9,976

Residential mortgage-backed

     3,721      69      (853     2,937

Commercial mortgage-backed

     5,198      56      (1,496     3,758

Other asset-backed

     2,713      41      (664     2,090
                            

Total fixed maturity securities

     49,877      851      (7,857     42,871

Equity securities

     301      4      (71     234
                            

Total available-for-sale securities

   $ 50,178    $ 855    $ (7,928   $ 43,105
                            

 

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   1,764

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 investment securities in an unrealized loss position as of December 31, 2009 consisted of 2,913 securities and accounted for unrealized losses of $3,523 million. Of these unrealized losses of $3,523 million, 69% were investment grade (rated “AAA” through “BBB-”) and 29% were less than 20% below cost. The securities less than 20% below cost were primarily attributable to widening credit spreads and a depressed market for certain structured mortgage securities. Included in these unrealized losses as of December 31, 2009 was $440 million of unrealized losses on other-than-temporarily impaired securities. Of the total unrealized losses on other-than-temporarily impaired securities, $186 million have been in an unrealized loss position for more than 12 months.

Of the unrealized losses of $3,523 million, $2,125 million were related to structured securities and $770 million were related to corporate securities in the finance and insurance sector. Of the remaining gross unrealized losses of $628 million, $222 million were related to U.S. government, agencies and government-sponsored enterprises, tax-exempt and government—non-U.S. securities and $406 million was related to corporate securities that was spread evenly across all other sectors with no individual sector exceeding $63 million.

Of the $2,125 million unrealized losses in structured securities, 39% were in commercial mortgage-backed securities and 38% were in residential mortgage-backed securities with the remainder in other asset-backed securities. Approximately 59% 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 the current market conditions and limited trading on these securities, the fair value of these securities has declined due to widening credit spreads and high premiums for illiquidity. 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 December 31, 2009.

Of the $770 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. 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. 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 widening credit spreads. 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. 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. All 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 widening credit spreads which reflect current financial industry events including uncertainty surrounding the level and type of government support of European financial institutions, potential capital restructuring of these institutions, the risk that income payments may be deferred and the risk that these institutions could be nationalized. Based on this evaluation, we determined that the unrealized losses on these securities represented temporary impairments as of December 31, 2009.

Of the investment securities in an unrealized loss position for 12 months or more as of December 31, 2009, 743 securities were 20% or more below cost, of which 257 securities were also below investment grade (rated “BB+” and below) and accounted for unrealized losses of $729 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 $96 million was recorded in OCI.

As of December 31, 2009, we expect to recover our amortized cost on the securities included in the chart above and do not intend to sell or 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. While 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, 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, 2008:

 

    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

  $ 915   $ (78   281   $ 262   $ (150   100

Government—non-U.S.

    287     (49   120     34     (18   34

U.S. corporate

    7,583     (956   926     6,901     (2,012   683

Corporate—non-U.S.

    4,003     (570   648     3,004     (1,011   411

Residential mortgage-backed

    690     (186   155     1,005     (667   320

Commercial mortgage-backed

    847     (183   166     2,411     (1,313   403

Other asset-backed

    281     (72   50     1,703     (592   140
                                   

Subtotal, fixed maturity securities

    14,606     (2,094   2,346     15,320     (5,763   2,091

Equity securities

    62     (45   15     52     (26   6
                                   

Total for securities in an unrealized loss position

  $ 14,668   $ (2,139   2,361   $ 15,372   $ (5,789   2,097
                                   

% Below cost—fixed maturity securities:

           

<20% Below cost

  $ 12,427   $ (1,031   1,831   $ 8,518   $ (948   912

20-50% Below cost

    2,059     (888   442     5,603     (2,759   818

>50% Below cost

    120     (175   73     1,199     (2,056   361
                                   

Total fixed maturity securities

    14,606     (2,094   2,346     15,320     (5,763   2,091
                                   

% Below cost—equity securities:

           

20-50% Below cost

    41     (20   11     52     (26   6

>50% Below cost

    21     (25   4     —       —        —  
                                   

Total equity securities

    62     (45   15     52     (26   6
                                   

Total for securities in an unrealized loss position

  $ 14,668   $ (2,139   2,361   $ 15,372   $ (5,789   2,097
                                   

Investment grade

  $ 13,719   $ (1,908   2,026   $ 14,628   $ (5,437   1,908

Below investment grade

    949     (231   335     744     (352   189
                                   

Total for securities in an unrealized loss position

  $ 14,668   $ (2,139   2,361   $ 15,372   $ (5,789   2,097
                                   

 

The scheduled maturity distribution of fixed maturity securities as of December 31, 2009 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

   $ 2,205    $ 2,217

Due after one year through five years

     12,213      12,400

Due after five years through ten years

     7,825      7,950

Due after ten years

     18,474      17,926
             

Subtotal

     40,717      40,493

Residential mortgage-backed

     3,989      3,227

Commercial mortgage-backed

     4,404      3,617

Other asset-backed

     2,887      2,415
             

Total

   $ 51,997    $ 49,752
             

As of December 31, 2009, $5,490 million of our investments (excluding mortgage and asset-backed securities) were subject to certain call provisions.

As of December 31, 2009, securities issued by finance and insurance, utilities and energy, and consumer—non-cyclical industry groups represented approximately 28%, 21% 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 December 31, 2009, 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.

As of December 31, 2009 and 2008, $727 million and $586 million, respectively, of securities were on deposit with various state or foreign government insurance departments in order to comply with relevant insurance regulations.

(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 December 31:

 

     2009     2008  

(Amounts in millions)

   Carrying
value
    % of
total
    Carrying
value
    % of
total
 

Property Type

        

Retail

   $ 2,115      28   $ 2,393      29

Office

     2,025      27        2,182      26   

Industrial

     1,979      26        2,143      26   

Apartments

     832      11        902      11   

Mixed use/other

     590      8        658      8   
                            

Total principal balance

     7,541      100     8,278      100
                

Unamortized balance of loan origination fees and costs

     6          7     

Allowance for losses

     (48       (23  
                    

Total (1)

   $ 7,499        $ 8,262     
                    

 

(1)

Included $17 million and $18 million of held-for-sale mortgage loans as of December 31, 2009 and 2008, respectively.

 

     2009     2008  

(Amounts in millions)

   Carrying
value
    % of
total
    Carrying
value
    % of
total
 

Geographic Region

        

Pacific

   $ 2,005      27   $ 2,137      26

South Atlantic

     1,711      23        1,958      24   

Middle Atlantic

     1,005      13        1,083      13   

East North Central

     728      10        791      10   

Mountain

     650      9        746      9   

New England

     492      6        520      6   

West North Central

     389      5        434      5   

West South Central

     331      4        357      4   

East South Central

     230      3        252      3   
                            

Total principal balance

     7,541      100     8,278      100
                

Unamortized balance of loan origination fees and costs

     6          7     

Allowance for losses

     (48       (23  
                    

Total (1)

   $ 7,499        $ 8,262     
                    

 

(1)

Included $17 million and $18 million of held-for-sale mortgage loans as of December 31, 2009 and 2008, respectively.

“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 ($21 million and $4 million as of December 31, 2009 and 2008, respectively) and loans expected to be fully recoverable because the carrying amount has been reduced previously through charge-offs or deferral of income recognition (none as of December 31, 2009 and 2008).

Average investment in specifically impaired loans was $10 million, $1 million and $1 million for the years ended December 31, 2009, 2008 and 2007, 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 years ended December 31:

 

(Amounts in millions)

   2009    2008     2007

Balance as of January 1

   $ 23    $ 26      $ 15

Provision

     25      3        11

Release

     —        (6     —  
                     

Balance as of December 31

   $ 48    $ 23      $ 26
                     
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 prohibition on derivatives market-making and other speculative derivatives activities. These policies require the use of derivative instruments in concert with other techniques to reduce or mitigate these risks. While we use derivatives to mitigate or reduce risks, certain derivatives do not meet the accounting requirements to be designated as hedging instruments and are denoted as “derivatives not designated as hedges” in the following disclosures. For derivatives that meet the accounting requirements to be designated as hedges, the following disclosures for these derivatives are denoted as “derivatives designated as hedges,” which include both cash flow and fair value hedges.

 

The following table sets forth our positions in derivative instruments as of December 31:

 

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

(Amounts in millions)

     2009     2008      2009    2008

Derivatives designated as hedges

              

Cash flow hedges:

              

Interest rate swaps

   Other invested

assets

  $ 72      $ 501    Other

liabilities

  $ 114    $ 54

Inflation indexed swaps

   Other invested

assets

    —          —      Other

liabilities

    21      —  

Foreign currency swaps

   Other invested

assets

    101        120    Other

liabilities

    —        1
                                

Total cash flow hedges

       173        621        135      55
                                

Fair value hedges:

              

Interest rate swaps

   Other invested

assets

    132        231    Other

liabilities

    15      36

Foreign currency swaps

   Other invested

assets

    24        46    Other

liabilities

    —        —  
                                

Total fair value hedges

       156        277        15      36
                                

Total derivatives designated as hedges

       329        898        150      91
                                

Derivatives not designated as hedges

              

Interest rate swaps

   Other invested

assets

    505        384    Other

liabilities

    59      95

Interest rate swaptions

   Other invested

assets

    54        780    Other

liabilities

    67      60

Credit default swaps

   Other invested

assets

    11        1    Other

liabilities

    3      27

Equity index options

   Other invested

assets

    39        152    Other

liabilities

    2      —  

Financial futures

   Other invested

assets

    —          —      Other

liabilities

    —        —  

Inflation indexed swaps

   Other invested

assets

    —          —      Other

liabilities

    —        —  

Other foreign currency contracts

   Other invested

assets

    8        —      Other

liabilities

    —        —  

GMWB embedded derivatives

   Reinsurance

recoverable (1)

    (5 )     18    Policyholder

account

balances (2)

    175      878
                                

Total derivatives not designated as hedges

       612        1,335        306      1,060
                                

Total derivatives

     $ 941      $ 2,233      $ 456    $ 1,151
                                

 

(1)

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

(2)

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 equity index options, the change between periods is best illustrated by the number of contracts, and 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, 2008   Additions   Maturities/
terminations
    December 31, 2009

Derivatives designated as hedges

         

Cash flow hedges:

         

Interest rate swaps

  Notional   $ 4,001   $ 5,990   $ (512   $ 9,479

Inflation indexed swaps

  Notional     —       607     (231     376

Foreign currency swaps

  Notional     559     491     (559     491
                           

Total cash flow hedges

      4,560     7,088     (1,302     10,346
                           

Fair value hedges:

         

Interest rate swaps

  Notional     3,098     —       (732     2,366

Foreign currency swaps

  Notional     187     —       (102     85
                           

Total fair value hedges

      3,285     —       (834     2,451
                           

Total derivatives designated as hedges

      7,845     7,088     (2,136     12,797
                           

Derivatives not designated as hedges

         

Interest rate swaps

  Notional     6,460     2,126     (2,112     6,474

Interest rate swaptions

  Notional     12,000     —       (6,900     5,100

Credit default swaps

  Notional     610     550     (70     1,090

Financial futures

  Notional     2,194     5,822     (2,194     5,822

Inflation indexed swaps

  Notional     —       128     (128     —  

Other foreign currency contracts

  Notional     —       982     (461     521
                           

Total derivatives not designated as hedges

      21,264     9,608     (11,865     19,007
                           

Total derivatives

    $ 29,109   $ 16,696   $ (14,001   $ 31,804
                           

(Number of contracts or policies)

  Measurement   December 31, 2008   Additions   Terminations     December 31, 2009

Derivatives not designated as hedges

         

Equity index options

  Contracts     532,000     639,000     (305,000     866,000

GMWB embedded derivatives

  Policies     43,677     5,344     (1,478     47,543

As a result of rating agency actions taken in April 2009, credit downgrade provisions were triggered in our master swap agreements with certain derivative counterparties and we terminated $6.9 billion notional value, of which $2.3 billion was replaced or renegotiated. Approximately $1.1 billion of notional value remained with counterparties that can be terminated at the option of the derivative counterparty and represented a net fair value asset of $117 million as of December 31, 2009. Additionally, we terminated $1.7 billion in derivatives that were not directly impacted by the credit downgrade provisions but were offsetting certain terminated derivatives.

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 year ended December 31, 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

  $ (551   $ 13      Net investment
income
  $ (19   Net investment

gains (losses)

Interest rate swaps hedging assets

    —          (6   Net investment

gains (losses)

    —        Net investment

gains (losses)

Interest rate swaps hedging liabilities

    —          3      Interest expense     —        Net investment

gains (losses)

Foreign currency swaps

    —          (1   Net investment

gains (losses)

    —        Net investment

gains (losses)

Foreign currency swaps

    (9     (10   Interest expense     —        Net investment

gains (losses)

                           

Total

  $ (560   $ (1     $ (19  
                           

 

(1)

Amounts included $7 million of losses reclassified into net income (loss) for cash flow hedges that were terminated or de-designated where the effective portion is reclassified into net income (loss) when the underlying hedge item affects net income (loss).

(2)

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

 

For the years ended December 31, 2008 and 2007, there was $25 million and $6 million, respectively, of ineffectiveness related to our cash flow hedges. There were no amounts excluded from the measure of effectiveness in either year.

The following table provides a reconciliation of current period changes, net of applicable income taxes, for these designated derivatives presented in the separate component of stockholders’ equity labeled “derivatives qualifying as hedges,” for the years ended December 31:

 

(Amounts in millions)

   2009     2008     2007  

Derivatives qualifying as effective accounting hedges as of January 1

   $ 1,161      $ 473      $ 375   

Current period increases (decreases) in fair value, net of deferred taxes of $201, $(384) and $(62)

     (359     701        113   

Reclassification to net (income) loss, net of deferred taxes of $(1), $8 and $8

     —          (13     (15
                        

Derivatives qualifying as effective accounting hedges as of December 31

   $ 802      $ 1,161      $ 473   
                        

The total of derivatives designated as cash flow hedges of $802 million, net of taxes, recorded in stockholders’ equity as of December 31, 2009 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, $(2) 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 year ended December 31, 2009 in connection with forecasted transactions that were no longer considered probable of occurring. During 2008, we terminated a large portion of our forward starting interest rate swaps, which were designated as cash flow hedges, related to our long-term care insurance business to reduce our counterparty credit exposure and increase liquidity. The respective balance in OCI related to these derivatives will be reclassified into net income (loss) when the forecasted transactions affect net income (loss), as the forecasted transactions are still probable of occurring.

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 year ended December 31, 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

  $ 10      Net investment
gains (losses)
  $ (16   Net investment
income
  $ (11   Net investment
gains (losses)

Interest rate swaps hedging liabilities

    (52   Net investment
gains (losses)
    94      Interest credited     48      Net investment
gains (losses)

Foreign currency swaps

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

Total

  $ (52     $ 80        $ 44     
                             

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

For the years ended December 31, 2008 and 2007, there was $(4) million and $2 million, respectively, of ineffectiveness related to our fair value hedges. There were no amounts excluded from the measure of effectiveness in either year.

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 replicate characteristics of investments with similar terms and credit risk; and (iii) equity index options, interest rate swaps and financial futures to mitigate the risks associated with liabilities that have guaranteed minimum benefits. Additionally, we provide GMWBs on certain products that are required to be bifurcated as embedded derivatives.

 

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 years ended December 31:

 

(Amounts in millions)

   2009     2008     2007     Classification of gain (loss) recognized
in net income (loss)

Interest rate swaps

   $ 277      $ 310      $ (2   Net investment gains (losses)

Interest rate swaptions

     (627     720        —        Net investment gains (losses)

Credit default swaps

     50        (27     —        Net investment gains (losses)

Equity index options

     (134     301        24      Net investment gains (losses)

Financial futures

     (233     93        (3   Net investment gains (losses)

Inflation indexed swaps

     (4     —          —        Net investment gains (losses)

Foreign currency swaps

     6        —          —        Net investment gains (losses)

Other foreign currency contracts

     10        —          —        Net investment gains (losses)

GMWB embedded derivatives

     710        (812     (42   Net investment gains (losses)

Forward commitments

     —          —          4      Net investment gains (losses)
                          

Total derivatives not designated as hedges

   $ 55      $ 585      $ (19  
                          

Derivative Counterparty Credit Risk

As of December 31, 2009 and 2008, net fair value assets by counterparty totaled $739 million and $1,946 million, respectively. As of December 31, 2009 and 2008, net fair value liabilities by counterparty totaled $74 million and $4 million, respectively. As of December 31, 2009 and 2008, we retained collateral of $647 million and $1,605 million, respectively, related to these agreements, including over collateralization of $10 million and $66 million, respectively, from certain counterparties. As of December 31, 2009, we posted $121 million of collateral to derivative counterparties, including over collateralization of $46 million. As of December 31, 2008, we posted no collateral to derivative counterparties.

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 December 31, 2009 and 2008, we could have been allowed to claim up to $102 million and $407 million, respectively, from counterparties and required to disburse up to $1 million and $4 million, respectively. This represents the net fair value of gains and losses by counterparty, less available collateral held.

Credit Derivatives

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. If a credit event occurs, 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.

 

The following table sets forth our credit default swaps where we sell protection on single name reference entities and the fair values as of December 31:

 

     2009    2008

(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

   $ 6    $ —      $ —      $ 6    $ —      $ 1

AA

                 

Matures after one year through five years

     5      —        —        5      —        —  

A

                 

Matures after one year through five years

     32      1      —        52      —        5

Matures after five years through ten years

     10      —        —        15      —        2

BBB

                 

Matures after one year through five years

     73      1      —        73      —        7

Matures after five years through ten years

     29      —        —        24      —        4
                                         

Total credit default swaps on single name reference entities

   $ 155    $ 2    $ —      $ 175    $ —      $ 19
                                         

The following table sets forth our credit default swaps where we sell protection on credit default swap index tranches and the fair values as of December 31:

 

     2009    2008

(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)

   $ 50    $ —      $ —      $ —      $ —      $ —  

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

     250      1      1      —        —        —  

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

     250      —        2      —        —        —  

12% – 22% matures after five years through ten years (4)

     248      4      —        248      —        6

15% – 30% matures after five years through ten years (5)

     127      2      —        177      1      2
                                         

Total credit default swaps on index tranches

   $ 925    $ 7    $ 3    $ 425    $ 1    $ 8
                                         

 

(1)

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

(4)

The current attachment/detachment as of December 31, 2009 and 2008 was 12% – 22%.

(5)

The current attachment/detachment as of December 31, 2009 was 14.8% – 30.3% and was 14.9% – 30.3% as of December 31, 2008.

 

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 December 31:

 

     2009    2008

(Amounts in millions)

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

Credit rating:

                 

AAA

                 

Matures after one year through five years

   $ —      $ —      $ —      $ 100    $ 100    $ 51

Matures after five years through ten years

     —        —        —        300      332      105

AA

                 

Matures after five years through ten years

     100      100      96      —        —        —  

BBB

                 

Matures after five years through ten years

     100      100      76      —        —        —  

BB

                 

Matures after five years through ten years

     200      228      148      —        —        —  
                                         

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

   $ 400    $ 428    $ 320    $ 400    $ 432    $ 156
                                         
Deferred Acquisition Costs
Deferred Acquisition Costs

(6) Deferred Acquisition Costs

The following table presents the activity impacting DAC as of and for the years ended December 31:

 

(Amounts in millions)

   2009     2008     2007  

Unamortized balance as of January 1

   $ 7,209      $ 6,933      $ 6,159   

Impact of foreign currency translation

     67        (133     70   

Costs deferred

     707        1,191        1,408   

Amortization, net of interest accretion

     (695     (782     (704

Cumulative effect adjustment (1)

     (26     —          —     

Other (2)

     (5     —          —     
                        

Unamortized balance as of December 31

     7,257        7,209        6,933   

Accumulated effect of net unrealized investment (gains) losses

     84        577        101   
                        

Balance as of December 31

   $ 7,341      $ 7,786      $ 7,034   
                        

 

(1)

On April 1, 2009, we adopted a new accounting standard related to the recognition of other-than-temporary impairments. The adoption of this standard had a net favorable impact of $7 million on DAC.

(2)

Relates to the sale of one of our Mexican subsidiaries in 2009. See note 8 for additional information regarding the sale.

We regularly review DAC to determine if it is recoverable from future income. In the first quarter of 2009, loss recognition testing of our fee-based products in our retirement income business resulted in an increase in amortization of DAC of $54 million reflecting unfavorable equity market performance. As of December 31, 2009, we believe all of our other businesses have sufficient future income where the related DAC is recoverable.

In 2008, loss recognition testing of our fee-based products in our retirement income business resulted in an increase in amortization of DAC of $55 million reflecting unfavorable equity market performance. In addition, based on management’s assessment of the claim loss development in the existing 2006 and 2007 books of business which may cause deterioration of expected future gross margins for these book years, we determined that unamortized DAC related to our U.S. mortgage insurance business was not recoverable and consequently recorded a charge of $30 million to DAC during 2008.

Intangible Assets
Intangible Assets

(7) Intangible Assets

The following table presents our intangible assets as of December 31:

 

(Amounts in millions)

   2009     2008  
   Gross
carrying
amount
   Accumulated
amortization
    Gross
carrying
amount
   Accumulated
amortization
 

PVFP

   $ 2,209    $ (1,676   $ 2,385    $ (1,638

Capitalized software

     514      (309     447      (262

Deferred sales inducements to contractholders

     174      (34     182      (25

Other

     97      (41     97      (39
                              

Total

   $ 2,994    $ (2,060   $ 3,111    $ (1,964
                              

Amortization expense related to PVFP, capitalized software and other intangible assets for the years ended December 31, 2009, 2008 and 2007 was $87 million, $102 million and $127 million, respectively. Amortization expense related to deferred sales inducements of $9 million and $12 million, respectively, for the years ended December 31, 2009 and 2007 was included in benefits and other changes in policy reserves. There was no amortization expense related to deferred sales inducements in 2008. In 2007, we recorded an impairment of $13 million related to internal-use software.

Present Value of Future Profits

The following table presents the activity in PVFP as of and for the years ended December 31:

 

(Amounts in millions)

   2009     2008     2007  

Unamortized balance as of January 1

   $ 532      $ 592      $ 672   

Acquisitions

     —          —          10   

Impact of foreign currency translation

     —          —          (3

Interest accreted at 5.7%, 5.7% and 5.4%

     29        32        34   

Amortization

     (67     (92     (121

Cumulative effect adjustment (1)

     (7     —          —     
                        

Unamortized balance as of December 31

     487        532        592   

Accumulated effect of net unrealized investment (gains) losses

     46        215        13   
                        

Balance as of December 31

   $ 533      $ 747      $ 605   
                        

 

(1)

On April 1, 2009, we adopted a new accounting standard related to the recognition of other-than-temporary impairments. The adoption of this standard had a net favorable impact of $2 million on PVFP.

 

The percentage of the December 31, 2009 PVFP balance net of interest accretion, before the effect of unrealized investment gains or losses, estimated to be amortized over each of the next five years is as follows:

 

2010

   11.1

2011

   10.1

2012

   8.5

2013

   6.8

2014

   5.9

Amortization expense for PVFP in future periods will be affected by acquisitions, dispositions, net investment gains (losses) or other factors affecting the ultimate amount of gross profits realized from certain lines of business. Similarly, future amortization expense for other intangibles will depend on future acquisitions, dispositions and other business transactions.

Goodwill, Acquisitions and Dispositions
Goodwill, Acquisitions and Dispositions

(8) Goodwill, Acquisitions and Dispositions

Goodwill

The following is a summary of our goodwill balance by segment and Corporate and Other activities as of the dates indicated:

 

(Amounts in millions)

   Retirement
and
Protection
    International     U.S.
Mortgage
Insurance
    Corporate
and Other
    Total  

Balance as of December 31, 2007:

          

Gross goodwill

   $ 1,386      $ 133      $ 22      $ 59     $ 1,600   

Accumulated impairment losses

     —          —          —          —          —     
                                        

Goodwill

     1,386        133        22        59        1,600   
                                        

Acquisitions

     16        —          —          —          16   

Impairment losses

     (243     —          (22     (12 )     (277

Foreign exchange translation

     —          (23     —          —          (23
                                        

Balance as of December 31, 2008:

          

Gross goodwill

     1,402        110        22        59        1,593   

Accumulated impairment losses

     (243     —          (22 )     (12     (277 )
                                        

Goodwill

     1,159        110        —          47        1,316   
                                        

Transfer (1)

     30        —          —          (30     —     

Other (2)

     —          (3     —          —          (3

Foreign exchange translation

     —          11        —          —          11   
                                        

Balance as of December 31, 2009:

          

Gross goodwill

     1,432        118        22        29        1,601   

Accumulated impairment losses

     (243     —          (22 )     (12     (277 )
                                        

Goodwill

   $ 1,189      $ 118      $ —        $ 17      $ 1,324   
                                        

 

(1)

The transfer related to our equity access business that we began reporting in our Retirement and Protection segment in 2009. Our equity access business was previously reported in Corporate and Other activities. The amounts associated with this business were not material and the prior period amounts were not re-presented.

(2)

Relates to the sale of one of our Mexican subsidiaries in 2009.

 

Goodwill impairment losses

There were no goodwill impairment charges recorded in 2009. However, continued deteriorating or adverse market conditions for certain businesses may have a significant impact on the fair value of our reporting units and could result in future impairments of goodwill.

During 2008, as a result of our goodwill analyses, we recorded goodwill impairments related to our U.S. mortgage insurance, institutional and retirement income reporting units of $277 million, as discussed further below. There were no goodwill impairment charges recorded in 2007.

Key considerations related to impairments recorded during 2008 were as follows:

 

   

U.S. mortgage insurance reporting unit. As a result of U.S. housing market conditions, operating losses and decreases in projected income in 2008, the fair value determined using a discounted cash flow model was negatively impacted and resulted in an impairment of the entire goodwill balance of $22 million;

 

   

Institutional reporting unit (included in our Corporate and Other activities). As a result of credit market conditions in 2008, increases in our credit spreads and our inability to issue new business in the current market environment, the fair value determined using a discounted cash flow model decreased and resulted in an impairment of the entire goodwill balance of $12 million; and

 

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