GENWORTH FINANCIAL INC, 10-Q filed on 7/30/2010
Quarterly Report
Document and Entity Information
Jul. 26, 2010
6 Months Ended
Jun. 30, 2010
Document Type
 
10-Q 
Amendment Flag
 
FALSE 
Document Period End Date
 
06/30/2010 
Document Fiscal Year Focus
 
2010 
Document Fiscal Period Focus
 
Q2 
Trading Symbol
 
GNW 
Entity Registrant Name
 
GENWORTH FINANCIAL INC 
Entity Central Index Key
 
0001276520 
Current Fiscal Year End Date
 
12/31 
Entity Filer Category
 
Large Accelerated Filer 
Entity Common Stock, Shares Outstanding
489,335,077 
 
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (USD $)
In Millions, except Per Share data
3 Months Ended
Jun. 30, 2010
6 Months Ended
Jun. 30, 2010
3 Months Ended
Jun. 30, 2009
6 Months Ended
Jun. 30, 2009
Revenues:
 
 
 
 
Premiums
$ 1,470 
$ 2,940 
$ 1,502 
$ 3,004 
Net investment income
823 
1,588 
781 
1,492 
Net investment gains (losses)
(139)
(209)
(53)
(823)
Insurance and investment product fees and other
256 
512 
253 
544 
Total revenues
2,410 
4,831 
2,483 
4,217 
Benefits and expenses:
 
 
 
 
Benefits and other changes in policy reserves
1,340 
2,655 
1,492 
3,000 
Interest credited
211 
424 
263 
538 
Acquisition and operating expenses, net of deferrals
499 
974 
456 
897 
Amortization of deferred acquisition costs and intangibles
179 
363 
212 
459 
Interest expense
109 
224 
114 
210 
Total benefits and expenses
2,338 
4,640 
2,537 
5,104 
Income (loss) before income taxes
72 
191 
(54)
(887)
Benefit for income taxes
(5)
(98)
(4)
(368)
Net income (loss)
77 
289 
(50)
(519)
Less: net income attributable to noncontrolling interests
35 
69 
 
 
Net income (loss) available to Genworth Financial, Inc.'s common stockholders
42 
220 
(50)
(519)
Net income (loss) available to Genworth Financial, Inc.'s common stockholders per common share:
 
 
 
 
Basic
0.09 
0.45 
(0.11)
(1.20)
Diluted
0.08 
0.45 
(0.11)
(1.20)
Weighted-average common shares outstanding:
 
 
 
 
Basic
489.1 
489.0 
433.2 
433.2 
Diluted
494.2 
493.9 
433.2 
433.2 
Supplemental disclosures:
 
 
 
 
Total other-than-temporary impairments
(24)
(101)
(476)
(1,073)
Portion of other-than-temporary impairments included in other comprehensive income (loss)
(27)
(30)
324 
324 
Net other-than-temporary impairments
(51)
(131)
(152)
(749)
Other investment gains (losses)
(88)
(78)
99 
(74)
Total net investment gains (losses)
$ (139)
$ (209)
$ (53)
$ (823)
CONDENSED CONSOLIDATED BALANCE SHEETS (USD $)
In Millions
Jun. 30, 2010
Dec. 31, 2009
Assets
 
 
Investments:
 
 
Fixed maturity securities available-for-sale, at fair value
$ 53,386 
$ 49,752 
Equity securities available-for-sale, at fair value
199 
159 
Commercial mortgage loans
7,208 
7,499 
Restricted commercial mortgage loans related to securitization entities
535 
 
Policy loans
1,467 
1,403 
Other invested assets
4,042 
4,702 
Restricted other invested assets related to securitization entities ($373 at fair value)
374 
 
Total investments
67,211 
63,515 
Cash and cash equivalents
4,586 
5,002 
Accrued investment income
696 
691 
Deferred acquisition costs
7,170 
7,341 
Intangible assets
789 
934 
Goodwill
1,313 
1,324 
Reinsurance recoverable
17,279 
17,332 
Other assets
1,024 
954 
Deferred tax asset
 
92 
Separate account assets
10,284 
11,002 
Total assets
110,352 
108,187 
Liabilities and stockholders' equity
 
 
Liabilities:
 
 
Future policy benefits
29,929 
29,469 
Policyholder account balances
28,338 
28,470 
Liability for policy and contract claims
6,302 
6,567 
Unearned premiums
4,238 
4,714 
Other liabilities ($183 and $-other liabilities related to securitization entities)
6,287 
6,298 
Borrowings related to securitization entities ($51 at fair value)
525 
 
Non-recourse funding obligations
3,437 
3,443 
Short-term borrowings
730 
930 
Long-term borrowings
4,331 
3,641 
Deferred tax liability
904 
303 
Separate account liabilities
10,284 
11,002 
Total liabilities
95,305 
94,837 
Commitments and contingencies
 
 
Stockholders' equity:
 
 
Class A common stock, $0.001 par value; 1.5 billion shares authorized; 578 million and 577 million shares issued as of June 30, 2010 and December 31, 2009, respectively; 489 million shares outstanding as of June 30, 2010 and December 31, 2009
Additional paid-in capital
12,078 
12,034 
Accumulated other comprehensive income (loss):
 
 
Net unrealized investment gains (losses):
 
 
Net unrealized gains (losses) on securities not other-than-temporarily impaired
208 
(1,151)
Net unrealized gains (losses) on other-than-temporarily impaired securities
(179)
(247)
Net unrealized investment gains (losses)
29 
(1,398)
Derivatives qualifying as hedges
1,162 
802 
Foreign currency translation and other adjustments
140 
432 
Total accumulated other comprehensive income (loss)
1,331 
(164)
Retained earnings
3,221 
3,105 
Treasury stock, at cost (88 million shares as of June 30, 2010 and December 31, 2009)
(2,700)
(2,700)
Total Genworth Financial, Inc.'s stockholders' equity
13,931 
12,276 
Noncontrolling interests
1,116 
1,074 
Total stockholders' equity
15,047 
13,350 
Total liabilities and stockholders' equity
$ 110,352 
$ 108,187 
CONDENSED CONSOLIDATED BALANCE SHEETS (Parenthetical) (USD $)
In Millions, except Per Share data
Jun. 30, 2010
Dec. 31, 2009
Restricted other invested assets related to securitization entities, fair value
$ 373 
 
Other liabilities, securitization entities
183 
Borrowings related to securitization entities, fair value
51 
 
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
578 
577 
Class A common stock, shares outstanding
489 
489 
Treasury stock, shares
88 
88 
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (USD $)
In Millions
Common stock
Additional paid-in capital
Accumulated other comprehensive income (loss)
Retained earnings
Treasury stock, at cost
Total Genworth Financial, Inc.'s stockholders' equity
Noncontrolling interests
Total
1/1/2009 - 6/30/2009
 
 
 
 
 
 
 
 
Beginning Balances
$ 1 
$ 11,477 
$ (3,062)
$ 3,210 
$ (2,700)
 
 
$ 8,926 
Cumulative effect of change in accounting, net of taxes and other adjustments
 
 
(349)
355 
 
 
 
Comprehensive income (loss):
 
 
 
 
 
 
 
 
Net income (loss)
 
 
 
(519)
 
 
 
(519)
Net unrealized gains (losses) on securities not other-than-temporarily impaired
 
 
1,378 
 
 
 
 
1,378 
Net unrealized gains (losses) on other-than-temporarily impaired securities
 
 
(14)
 
 
 
 
(14)
Derivatives qualifying as hedges
 
 
(213)
 
 
 
 
(213)
Foreign currency translation and other adjustments
 
 
391 
 
 
 
 
391 
Total comprehensive income (loss)
 
 
 
 
 
 
 
1,023 
Dividends to noncontrolling interests
 
 
 
 
 
 
 
 
Stock-based compensation expense and exercises and other
 
15 
 
 
 
 
 
15 
Other capital transactions
 
 
 
 
 
 
 
 
Ending Balances
11,492 
(1,869)
3,046 
(2,700)
 
 
9,970 
1/1/2010 - 6/30/2010
 
 
 
 
 
 
 
 
Beginning Balances
12,034 
(164)
3,105 
(2,700)
12,276 
1,074 
13,350 
Cumulative effect of change in accounting, net of taxes and other adjustments
 
 
91 
(104)
 
(13)
 
(13)
Comprehensive income (loss):
 
 
 
 
 
 
 
 
Net income (loss)
 
 
 
220 
 
220 
69 
289 
Net unrealized gains (losses) on securities not other-than-temporarily impaired
 
 
1,268 
 
 
1,268 
1,277 
Net unrealized gains (losses) on other-than-temporarily impaired securities
 
 
68 
 
 
68 
 
68 
Derivatives qualifying as hedges
 
 
360 
 
 
360 
 
360 
Foreign currency translation and other adjustments
 
 
(292)
 
 
(292)
(15)
(307)
Total comprehensive income (loss)
 
 
 
 
 
 
 
1,687 
Dividends to noncontrolling interests
 
 
 
 
 
 
(21)
(21)
Stock-based compensation expense and exercises and other
 
24 
 
 
 
24 
 
24 
Other capital transactions
 
20 
 
 
 
20 
 
20 
Ending Balances
$ 1 
$ 12,078 
$ 1,331 
$ 3,221 
$ (2,700)
$ 13,931 
$ 1,116 
$ 15,047 
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (USD $)
In Millions
6 Months Ended
Jun. 30,
2010
2009
Cash flows from operating activities:
 
 
Net income (loss)
$ 289 
$ (519)
Adjustments to reconcile net income (loss) to net cash from operating activities:
 
 
Amortization of fixed maturity discounts and premiums
106 
Net investment losses (gains)
209 
823 
Charges assessed to policyholders
(233)
(211)
Acquisition costs deferred
(392)
(368)
Amortization of deferred acquisition costs and intangibles
363 
459 
Deferred income taxes
(173)
(591)
Net increase (decrease) in trading securities, held-for-sale investments and derivative instruments
119 
116 
Stock-based compensation expense
23 
15 
Change in certain assets and liabilities:
 
 
Accrued investment income and other assets
24 
30 
Insurance reserves
1,208 
1,520 
Current tax liabilities
(211)
197 
Other liabilities and other policy-related balances
(674)
(208)
Net cash from operating activities
557 
1,369 
Cash flows from investing activities:
 
 
Proceeds from maturities and repayments of investments:
 
 
Fixed maturity securities
2,057 
1,892 
Commercial mortgage loans
263 
381 
Restricted commercial mortgage loans related to securitization entities
27 
 
Proceeds from sales of investments:
 
 
Fixed maturity and equity securities
2,393 
1,663 
Purchases and originations of investments:
 
 
Fixed maturity and equity securities
(6,867)
(2,700)
Commercial mortgage loans
(23)
 
Other invested assets, net
1,491 
(348)
Policy loans, net
(64)
(253)
Net cash from investing activities
(723)
635 
Cash flows from financing activities:
 
 
Deposits to universal life and investment contracts
1,174 
1,271 
Withdrawals from universal life and investment contracts
(1,734)
(4,231)
Short-term borrowings and other, net
(285)
(330)
Repayment and repurchase of long-term borrowings
 
(739)
Proceeds from the issuance of long-term borrowings
660 
 
Redemption of non-recourse funding obligations
(6)
(12)
Repayment of borrowings related to securitization entities
(31)
 
Dividends paid to noncontrolling interests
(21)
 
Net cash from financing activities
(243)
(4,041)
Effect of exchange rate changes on cash and cash equivalents
(7)
83 
Net change in cash and cash equivalents
(416)
(1,954)
Cash and cash equivalents at beginning of period
5,002 
7,328 
Cash and cash equivalents at end of period
$ 4,586 
$ 5,374 
Formation of Genworth and Basis of Presentation
Formation of Genworth and Basis of Presentation

(1) Formation of Genworth and Basis of Presentation

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

We have the following three operating segments:

 

   

Retirement and Protection. We offer and manage a variety of protection, wealth management and retirement income products. Our primary protection products include: life, 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 offer mortgage and lifestyle protection insurance products and related services in multiple markets. We are a leading provider of mortgage insurance products in Canada, Australia, Mexico and multiple European countries. Our products predominantly insure prime-based, individually underwritten residential mortgage loans, also known as flow mortgage insurance. On a limited basis, we also provide mortgage insurance on a structured, or bulk, basis that aids in the sale of mortgages to the capital markets and helps lenders manage capital and risk. Additionally, we offer services, analytical tools and technology that enable lenders to operate efficiently and manage risk. We are a leading provider of payment protection coverages 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”).

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

Accounting Pronouncements
Accounting Pronouncements

(2) Accounting Pronouncements

Recently Adopted

Accounting for Transfers of Financial Assets

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

Improvements to Financial Reporting by Enterprises Involved with VIEs

On January 1, 2010, we adopted new accounting guidance for determining which enterprise, if any, has a controlling financial interest in a VIE and 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. Upon adoption of this new accounting guidance, we were required to consolidate certain VIEs, including previously qualifying special-purpose entities and investment structures. We recorded a transition adjustment for the impact upon adoption to reflect the difference between the assets and liabilities of the newly consolidated entities and the amounts recorded for our interests in these entities prior to adoption. On January 1, 2010, we recorded a net cumulative effect adjustment of $104 million to retained earnings with a partial offset to accumulated other comprehensive income (loss) of $91 million related to the adoption of this new accounting guidance.

 

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

 

(Amounts in millions)

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

Assets

     

Restricted commercial mortgage loans

  $ 564   $ —        $ 564   

Restricted other invested assets

    409     (30     379   

Accrued investment income

    2     —          2   
                     

Total assets

    975     (30     945   
                     

Liabilities

     

Other liabilities

    138     —          138   

Borrowings related to securitization entities

    644     (80     564   
                     

Total liabilities

    782     (80     702   
                     

Net assets and liabilities of newly consolidated entities

  $ 193   $ 50        243   
               

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

        404   
           

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

        (161

Tax effect

        57   
           

Net cumulative effect adjustment to retained earnings upon adoption

      $ (104
           

 

(1)

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

(2)

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

(3)

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

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

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

 

The new accounting guidance related to consolidation of VIEs has been deferred for a reporting entity’s interest in an entity that has all of the attributes of an investment company as long as there is no implicit or explicit obligation to fund losses of the entity. For entities that meet these criteria, the new accounting guidance related to VIE consolidation would not be applicable until further guidance is issued. Accordingly, we did not have any impact upon adoption related to entities that meet the deferral criteria, such as certain limited partnership and fund investments.

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

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

Not Yet Adopted

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

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

In March 2010, the FASB issued new accounting guidance clarifying the scope exception for embedded credit derivatives and when those features would be bifurcated from the host contract. Under the new accounting guidance, only embedded credit derivative features that are in the form of subordination of one financial instrument to another would not be subject to the bifurcation requirements. Accordingly, upon adoption of this new accounting guidance, we are required to bifurcate embedded credit derivatives that no longer qualify under the amended scope exception. In conjunction with our adoption, we elected fair value option for certain fixed maturity securities. This accounting guidance was effective for us on July 1, 2010. The impact upon adoption of this new accounting guidance was approximately $270 million, before taxes and other adjustments, and was recorded as a reduction in retained earnings with a corresponding increase in accumulated other comprehensive income (loss) on July 1, 2010.

In January 2010, the FASB issued new accounting guidance to require additional disclosures about purchases, sales, issuances, and settlements in the rollforward of Level 3 fair value measurements. This new accounting guidance will be effective for us on January 1, 2011. We do not expect the adoption of this new accounting guidance to have a material impact on our consolidated financial statements.

 

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

(3) Earnings (Loss) Per Share

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

 

     Three months ended
June 30,
    Six months ended
June 30,
 

(Amounts in millions, except per share amounts)

   2010    2009     2010    2009  

Net income (loss)

   $ 77    $ (50   $ 289    $ (519

Less: net income attributable to noncontrolling interests

     35      —          69      —     
                              

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

   $ 42    $ (50   $ 220    $ (519
                              

Basic per common share:

          

Net income (loss)

   $ 0.16    $ (0.11   $ 0.59    $ (1.20

Less: net income attributable to noncontrolling interests

     0.07      —          0.14      —     
                              

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

   $ 0.09    $ (0.11   $ 0.45    $ (1.20
                              

Diluted per common share:

          

Net income (loss)

   $ 0.16    $ (0.11   $ 0.59    $ (1.20

Less: net income attributable to noncontrolling interests

     0.07      —          0.14      —     
                              

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

   $ 0.08    $ (0.11   $ 0.45    $ (1.20
                              

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

     489.1      433.2        489.0      433.2   

Potentially dilutive securities:

          

Stock options, restricted stock units and stock appreciation rights

     5.1      —          4.9      —     
                              

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

     494.2      433.2        493.9      433.2   
                              

 

(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 three and six months ended June 30, 2009, we were required to use basic weighted-average common shares outstanding in the calculation of the 2009 diluted loss per share, as the inclusion of shares for stock options, restricted stock units and stock appreciation rights of 1.2 million and 0.6 million, respectively, would have been antidilutive to the calculation. If we had not incurred a net loss for the three and six months ended June 30, 2009, dilutive potential common shares would have been 434.4 million and 433.8 million, respectively.

 

Investments
Investments

(4) Investments

(a) Net Investment Income

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

 

    Three months ended
June 30,
    Six months ended
June 30,
 

(Amounts in millions)

      2010             2009         2010     2009  

Fixed maturity securities—taxable

  $ 646      $ 604      $ 1,272      $ 1,227   

Fixed maturity securities—non-taxable

    16        28        32        58   

Commercial mortgage loans

    99        109        203        223   

Restricted commercial mortgage loans related to securitization
entities
(1)

    10        —          20        —     

Equity securities

    5        3        7        6   

Other invested assets

    39        (7     37        (106

Restricted other invested assets related to securitization entities (1)

    —          —          1        —     

Policy loans

    28        52        55        96   

Cash, cash equivalents and short-term investments

    4        14        9        31   
                               

Gross investment income before expenses and fees

    847        803        1,636        1,535   

Expenses and fees

    (24     (22     (48     (43
                               

Net investment income

  $ 823      $ 781      $ 1,588      $ 1,492   
                               

 

(1)

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

(b) Net Investment Gains (Losses)

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

 

    Three months ended
June 30,
    Six months ended
June 30,
 

(Amounts in millions)

      2010             2009         2010     2009  

Available-for-sale securities:

       

Realized gains on sale

  $ 53      $ 21      $ 76      $ 50   

Realized losses on sale

    (36     (48     (74     (111

Impairments:

       

Total other-than-temporary impairments

    (24     (476     (101     (1,073

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

    (27     324        (30     324   
                               

Net other-than-temporary impairments

    (51     (152     (131     (749
                               

Trading securities

    (4     11        2        (1

Commercial mortgage loans

    (18     (5     (22     (11

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

    (47     —          (36     —     

Derivative instruments (2)

    (38     114        (46     (7

Other

    2        6        22        6   
                               

Net investment gains (losses)

  $ (139   $ (53   $ (209   $ (823
                               

 

(1)

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

(2)

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

 

The aggregate fair value of securities sold at a loss during the three months ended June 30, 2010 and 2009 was $858 million and $367 million, respectively, which was approximately 96% and 89%, respectively, of book value. The aggregate fair value of securities sold at a loss during the six months ended June 30, 2010 and 2009 was $1,416 million and $737 million, respectively, which was approximately 95% and 87%, respectively, of book value.

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

 

     As of or for the
three months ended
June 30,
 

(Amounts in millions)

       2010             2009      

Cumulative credit loss beginning balance

   $ 1,025      $ —     

Impact upon adoption of new accounting guidance

     —          1,204   

Additions:

    

Other-than-temporary impairments not previously recognized

     11        56   

Increases related to other-than-temporary impairments previously recognized

     32        95   

Reductions:

    

Securities sold, paid down or disposed

     (90     (270

Securities where there is intent to sell

     —          —     
                

Cumulative credit loss ending balance

   $ 978      $ 1,085   
                

 

     As of or for the
six months ended
June 30,
 

(Amounts in millions)

   2010     2009  

Cumulative credit loss beginning balance

   $ 1,059      $ —     

Impact upon adoption of new accounting guidance

     —          1,204   

Additions:

    

Other-than-temporary impairments not previously recognized

     31        56   

Increases related to other-than-temporary impairments previously recognized

     78        95   

Reductions:

    

Securities sold, paid down or disposed

     (190     (270

Securities where there is intent to sell

     —          —     
                

Cumulative credit loss ending balance

   $ 978      $ 1,085   
                

 

(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 present value of future profits, deferred acquisition costs 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 the dates indicated:

 

(Amounts in millions)

   June 30, 2010     December 31, 2009  

Net unrealized gains (losses) on investment securities:

    

Fixed maturity securities

   $ 296      $ (2,245

Equity securities

     7        20   

Other invested assets

     (27     (29
                

Subtotal

     276        (2,254

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

     (162     138   

Income taxes, net

     (37     757   
                

Net unrealized investment gains (losses)

     77        (1,359

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

     48        39   
                

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

   $ 29      $ (1,398
                

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

 

     As of or for the
three months ended
June 30,
 

(Amounts in millions)

   2010     2009  

Beginning balance

   $ (860   $ (4,095

Cumulative effect of change in accounting

     —          (349

Unrealized gains (losses) arising during the period:

    

Unrealized gains (losses) on investment securities

     1,498        2,261   

Adjustment to deferred acquisition costs

     (80     (164

Adjustment to present value of future profits

     (51     (79

Adjustment to sales inducements

     (10     1   

Provision for income taxes

     (480     (714
                

Change in unrealized gains (losses) on investment securities

     877        1,305   

Reclassification adjustments to net investment (gains) losses, net of taxes of $(11) and $(63)

     22        116   
                

Change in net unrealized investment gains (losses)

     899        1,072   

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

     10        —     
                

Ending balance

   $ 29      $ (3,023
                

 

     As of or for the
six months ended
June 30,
 

(Amounts in millions)

   2010     2009  

Beginning balance

   $ (1,398   $ (4,038

Cumulative effect of change in accounting

     91        (349

Unrealized gains (losses) arising during the period:

    

Unrealized gains (losses) on investment securities

     2,261        1,558   

Adjustment to deferred acquisition costs

     (193     (184

Adjustment to present value of future profits

     (81     (70

Adjustment to sales inducements

     (26     —     

Provision for income taxes

     (700     (467
                

Change in unrealized gains (losses) on investment securities

     1,261        837   

Reclassification adjustments to net investment (gains) losses, net of taxes of $(45) and $(284)

     84        527   
                

Change in net unrealized investment gains (losses)

     1,436        1,015   

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

     9        —     
                

Ending balance

   $ 29      $ (3,023
                

(d) Fixed Maturity and Equity Securities

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

 

(Amounts in millions)

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

Fixed maturity securities:

           

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

  $ 3,422   $ 262   $ —     $ —        $ —        $ 3,684

Tax-exempt

    1,407     39     —       (96     —          1,350

Government—non-U.S.

    2,023     126     —       (3     —          2,146

U.S. corporate

    22,529     1,332     7     (489     (1     23,378

Corporate—non-U.S.

    12,572     494     12     (279     —          12,799

Residential mortgage-backed

    4,395     160     8     (347     (261     3,955

Commercial mortgage-backed

    4,117     152     7     (488     (62     3,726

Other asset-backed

    2,640     18     —       (297     (13     2,348
                                       

Total fixed maturity securities

    53,105     2,583     34     (1,999     (337     53,386

Equity securities

    192     13     —       (6     —          199
                                       

Total available-for-sale securities

  $ 53,297   $ 2,596   $ 34   $ (2,005   $ (337   $ 53,585
                                       

 

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

 

(Amounts in millions)

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

Fixed maturity securities:

               

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

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

Tax-exempt

     1,606      42      —        (104     —          1,544

Government—non-U.S.

     2,310      96      —        (22     —          2,384

U.S. corporate

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

Corporate—non-U.S.

     12,530      366      11      (356     —          12,551

Residential mortgage-backed

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

Commercial mortgage-backed

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

Other asset-backed

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

Total fixed maturity securities

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

Equity securities

     139      23      —        (3     —          159
                                           

Total available-for-sale securities

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

 

The following table presents the gross unrealized losses and fair values of our investment securities, aggregated by investment type and length of time that individual investment securities have been in a continuous unrealized loss position, as of June 30, 2010:

 

     Less than 12 months    12 months or more

(Dollar amounts in millions)

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

Description of Securities

               

Fixed maturity securities:

               

Tax-exempt

   $ 106    $ (3   33    $ 272    $ (93   93

Government—non-U.S.

     69      (1   30      34      (2   6

U.S. corporate

     1,257      (47   168      3,596      (443   304

Corporate—non-U.S.

     926      (32   163      1,774      (247   161

Residential mortgage-backed

     291      (5   76      1,097      (603   461

Commercial mortgage-backed

     79      (4   11      1,282      (546   277

Other asset-backed

     413      (1   28      969      (309   147
                                       

Subtotal, fixed maturity securities

     3,141      (93   509      9,024      (2,243   1,449

Equity securities

     51      (5   41      7      (1   8
                                       

Total for securities in an unrealized loss position

   $ 3,192    $ (98   550    $ 9,031    $ (2,244   1,457
                                       

% Below cost—fixed maturity securities:

               

<20% Below cost

   $ 3,089    $ (71   469    $ 6,602    $ (515   763

20-50% Below cost

     51      (20   22      2,069      (1,006   406

>50% Below cost

     1      (2   18      353      (722   280
                                       

Total fixed maturity securities

     3,141      (93   509      9,024      (2,243   1,449
                                       

% Below cost—equity securities:

               

<20% Below cost

     46      (2   40      7      (1   8

20-50% Below cost

     5      (3   1      —        —        —  
                                       

Total equity securities

     51      (5   41      7      (1   8
                                       

Total for securities in an unrealized loss position

   $ 3,192    $ (98   550    $ 9,031    $ (2,244   1,457
                                       

Investment grade

   $ 2,564    $ (81   422    $ 7,203    $ (1,386   959

Below investment grade

     628      (17   128      1,828      (858   498
                                       

Total for securities in an unrealized loss position

   $ 3,192    $ (98   550    $ 9,031    $ (2,244   1,457
                                       

The investment securities in an unrealized loss position as of June 30, 2010 consisted of 2,007 securities and accounted for unrealized losses of $2,342 million. Of these unrealized losses of $2,342 million, 63% were investment grade (rated “AAA” through “BBB-”) and 25% were less than 20% below cost. The securities less than 20% below cost were primarily attributable to credit spreads that have widened since acquisition for certain mortgage-backed and asset-backed securities and corporate securities in the finance and insurance sector. Included in these unrealized losses as of June 30, 2010 was $337 million of unrealized losses on other-than-temporarily impaired securities. Of the total unrealized losses on other-than-temporarily impaired securities, $332 million have been in an unrealized loss position for more than 12 months.

Of the unrealized losses of $2,342 million, $1,468 million were related to structured securities and $552 million were related to corporate securities in the finance and insurance sector. Of the remaining gross unrealized losses of $322 million, $99 million were related to tax-exempt and government—non-U.S. securities and $223 million were primarily related to other corporate securities that were spread evenly across all other sectors with no individual sector exceeding $40 million.

Of the $1,468 million unrealized losses in structured securities, 41% were in residential mortgage-backed securities and 37% were in commercial mortgage-backed securities with the remainder in other asset-backed securities. Approximately 54% of the total unrealized losses in structured securities were on securities that have retained investment grade ratings. Most of these securities have been in an unrealized loss position for 12 months or more. Given ongoing concern about the housing market and unemployment, the fair value of these securities has declined due to credit spreads that have widened since acquisition. We examined the performance of the underlying collateral and developed our estimate of cash flows expected to be collected. In doing so, we identified certain securities where the non-credit portion of other-than-temporary impairments was recorded in OCI. Based on this evaluation, we determined that the unrealized losses on our mortgage-backed and asset-backed securities represented temporary impairments as of June 30, 2010.

Of the $552 million unrealized losses in the finance and insurance sector, most have been in an unrealized loss position for 12 months or more. Most of these securities have retained a credit rating of investment grade. A portion of the unrealized losses included securities where an other-than-temporary impairment was recorded in OCI. Given the current market conditions, including current financial industry events and uncertainty around global economic conditions, the fair value of these securities has declined due to credit spreads that have widened since acquisition. In our examination of these securities, we considered all available evidence, including the issuers’ financial condition and current industry events to develop our conclusion on the amount and timing of the cash flows expected to be collected. Based on this evaluation, we determined that the unrealized losses on these securities represented temporary impairments as of June 30, 2010. A subset of the securities issued by banks and other financial institutions represent investments in financial hybrid securities on which a debt impairment model was employed. Most of these securities retain a credit rating of investment grade. The majority of these securities were issued by foreign financial institutions. The fair value of these securities has been impacted by credit spreads that have widened since acquisition and reflect uncertainty surrounding the extent and duration of government involvement, potential capital restructuring of these institutions, and continued but diminishing risk that income payments may be deferred. The remaining unrealized losses in our U.S. and non-U.S. corporate securities were evenly distributed across all other major industry types that comprise our corporate bond holdings.

Of the investment securities in an unrealized loss position for 12 months or more as of June 30, 2010, 686 securities were 20% or more below cost, of which 357 securities were also below investment grade (rated “BB+” and below) and accounted for unrealized losses of $747 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 $260 million was recorded in OCI.

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

 

Despite the considerable analysis and rigor employed on our structured securities, it is at least reasonably possible that the underlying collateral of these investments will perform worse than current market expectations. Such events may lead to adverse changes in cash flows on our holdings of asset-backed and mortgage-backed securities and potential future write-downs within our portfolio of mortgage-backed and asset-backed securities. We expect our investments in corporate securities will continue to perform in accordance with our conclusions about the amount and timing of estimated cash flows. Although we do not anticipate such events, it is at least reasonably possible that issuers of our investments in corporate securities will perform worse than current expectations. Such events may lead us to recognize potential future write-downs within our portfolio of corporate securities.

The following table presents the gross unrealized losses and fair values of our investment securities, aggregated by investment type and length of time that individual investment securities have been in a continuous unrealized loss position, as of December 31, 2009:

 

     Less than 12 months    12 months or more

(Dollar amounts in millions)

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

Description of Securities

               

Fixed maturity securities:

               

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

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

Tax-exempt

     152      (6   48      346      (98   113

Government—non-U.S.

     341      (3   60      105      (19   35

U.S. corporate

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

Corporate—non-U.S.

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

Residential mortgage-backed

     941      (252   256      1,012      (558   348

Commercial mortgage-backed

     714      (64   81      1,720      (771   345

Other asset-backed

     329      (6   43      1,727      (474   183
                                       

Subtotal, fixed maturity securities

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

Equity securities

     2      (1   3      12      (2   9
                                       

Total for securities in an unrealized loss position

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

% Below cost—fixed maturity securities:

               

<20% Below cost

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

20-50% Below cost

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

>50% Below cost

     76      (180   96      485      (950   284
                                       

Total fixed maturity securities

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

% Below cost—equity securities:

               

<20% Below cost

     2      (1   3      11      (1   5

>50% Below cost

     —        —        —        1      (1   4
                                       

Total equity securities

     2      (1   3      12      (2   9
                                       

Total for securities in an unrealized loss position

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

Investment grade

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

Below investment grade

     391      (243   219      1,936      (838   413
                                       

Total for securities in an unrealized loss position

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

 

The scheduled maturity distribution of fixed maturity securities as of June 30, 2010 is set forth below. Actual maturities may differ from contractual maturities because issuers of securities may have the right to call or prepay obligations with or without call or prepayment penalties.

 

(Amounts in millions)

   Amortized
cost or
cost
   Fair
value

Due one year or less

   $ 2,776    $ 2,801

Due after one year through five years

     11,367      11,696

Due after five years through ten years

     8,494      8,877

Due after ten years

     19,316      19,983
             

Subtotal

     41,953      43,357

Residential mortgage-backed

     4,395      3,955

Commercial mortgage-backed

     4,117      3,726

Other asset-backed

     2,640      2,348
             

Total

   $ 53,105    $ 53,386
             

As of June 30, 2010, $5,015 million of our investments (excluding mortgage-backed and asset-backed securities) were subject to certain call provisions.

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

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

(e) Commercial Mortgage Loans

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

 

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

 

     June 30, 2010     December 31, 2009  

(Amounts in millions)

   Carrying
value
    % of
total
    Carrying
value
    % of
total
 

Property Type

        

Retail

   $ 2,047      28   $ 2,115      28

Office

     1,971      27        2,025      27   

Industrial

     1,903      26        1,979      26   

Apartments

     812      11        832      11   

Mixed use/other

     540      8        590      8   
                            

Total principal balance

     7,273      100     7,541      100
                

Unamortized balance of loan origination fees and costs

     5          6     

Allowance for losses (1)

     (70       (48  
                    

Total (2)

   $ 7,208        $ 7,499     
                    

 

(1)

Included $13 million related to held-for-sale commercial mortgage loans as of June 30, 2010.

(2)

Included held-for-sale mortgage loans of $37 million and $17 million as of June 30, 2010 and December 31, 2009, respectively. The held-for-sale mortgage loans as of December 31, 2009 represented interests in reverse mortgage loans. In the first quarter of 2010, we began reporting held-for-sale reverse mortgages in other invested assets.

 

     June 30, 2010     December 31, 2009  

(Amounts in millions)

   Carrying
value
    % of
total
    Carrying
value
    % of
total
 

Geographic Region

        

Pacific

   $ 1,937      27   $ 2,005      27

South Atlantic

     1,660      23        1,711      23   

Middle Atlantic

     974      13        1,005      13   

East North Central

     701      10        728      10   

Mountain

     624      8        650      9   

New England

     491      7        492      6   

West North Central

     378      5        389      5   

West South Central

     314      4        331      4   

East South Central

     194      3        230      3   
                            

Total principal balance

     7,273      100     7,541      100
                

Unamortized balance of loan origination fees and costs

     5          6     

Allowance for losses (1)

     (70       (48  
                    

Total (2)

   $ 7,208        $ 7,499     
                    

 

(1)

Included $13 million related to held-for-sale commercial mortgage loans as of June 30, 2010.

(2)

Included held-for-sale mortgage loans of $37 million and $17 million as of June 30, 2010 and December 31, 2009, respectively. The held-for-sale mortgage loans as of December 31, 2009 represented interests in reverse mortgage loans. In the first quarter of 2010, we began reporting held-for-sale reverse mortgages in other invested assets.

 

“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 ($5 million for the six months ended June 30, 2010 and $21 million for the year ended December 31, 2009) and loans expected to be fully recoverable because the carrying amount has been reduced previously through charge-offs or deferral of income recognition (none for the six months ended June 30, 2010 and for the year ended December 31, 2009).

Average investment in specifically impaired loans was $3 million and $10 million as of June 30, 2010 and December 31, 2009, respectively, and there was no interest income recognized on these loans while they were considered impaired.

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

 

(Amounts in millions)

   Three months ended
June 30, 2010
   Six months ended
June  30, 2010

Beginning balance

   $ 52    $ 48

Provision (1)

     18      22

Release

     —        —  
             

Ending balance

   $ 70    $ 70
             

 

  (1)

Included $13 million related to held-for-sale commercial mortgage loans.

(f) Restricted Commercial Mortgage Loans Related To Securitization Entities

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

 

     June 30, 2010  

(Amounts in millions)

   Carrying
value
    % of
total
 

Property Type

    

Retail

   $ 195      37

Industrial

     131      24   

Office

     122      23   

Apartments

     66      12   

Mixed use/other

     23      4   
              

Total principal balance

     537      100
        

Allowance for losses

     (2  
          

Total 

   $ 535     
          

 

     June 30, 2010  

(Amounts in millions)

   Carrying
value
    % of
total
 

Geographic Region

    

South Atlantic

   $ 197      37

Pacific

     95      18   

Middle Atlantic

     72      13   

East North Central

     57      11   

Mountain

     36      7   

East South Central

     33      6   

West North Central

     33      6   

West South Central

     13      2   

New England

     1      —     
              

Total principal balance

     537      100
        

Allowance for losses

     (2  
          

Total

   $ 535     
          

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

(g) Restricted Other Invested Assets Related To Securitization Entities

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

Derivative Instruments
Derivative Instruments

(5) Derivative Instruments

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

 

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

 

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

(Amounts in millions)

     June 30,
2010
  December 31,
2009
      June 30,
2010
  December 31,
2009

Derivatives designated as hedges

            

Cash flow hedges:

            

Interest rate swaps

   Other invested
assets
  $ 540   $ 72      Other
liabilities
  $ 9   $ 114

Inflation indexed swaps

   Other invested
assets
    1     —        Other
liabilities
    22     21

Foreign currency swaps

   Other invested
assets
    140     101      Other
liabilities
    —       —  
                              

Total cash flow hedges

       681     173          31     135
                              

Fair value hedges:

            

Interest rate swaps

   Other invested
assets
    124     132      Other
liabilities
    11     15

Foreign currency swaps

   Other invested
assets
    20     24      Other
liabilities
    —       —  
                              

Total fair value hedges

       144     156          11     15
                              

Total derivatives designated as hedges

       825     329          42     150
                              

Derivatives not designated as hedges

            

Interest rate swaps

   Other invested
assets
    509     505      Other
liabilities
    41     59

Interest rate swaps related to
securitization entities (1)

   Restricted
other invested
assets
    —       —        Other
liabilities
    23     —  

Interest rate swaptions

   Other invested
assets
    4     54      Other
liabilities
    —       67

Credit default swaps

   Other invested
assets
    2     11      Other
liabilities
    27     3

Credit default swaps related to
securitization entities (1)

   Restricted
other invested
assets
    —       —        Other
liabilities
    159     —  

Equity index options

   Other invested
assets
    97     39      Other
liabilities
    —       2

Financial futures

   Other invested
assets
    —       —        Other
liabilities
    —       —  

Other foreign currency contracts

   Other invested
assets
    6     8      Other
liabilities
    —       —  

Reinsurance embedded derivatives (2)

   Other assets     2     —        Other
liabilities
    —       —  

GMWB embedded derivatives

   Reinsurance
recoverable  (3)
    9     (5   Policyholder
account
balances (4)
    447     175
                              

Total derivatives not designated as hedges

       629     612          697     306
                              

Total derivatives

     $ 1,454   $ 941        $ 739   $ 456
                              

 

(1)

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

(2)

Represents embedded derivatives associated with certain reinsurance agreements.

(3)

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

(4)

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

 

The fair value of derivative positions presented above was not offset by the respective collateral amounts retained or provided under these agreements. The amounts recognized for derivative counterparty collateral retained by us was recorded in other invested assets with a corresponding amount recorded in other liabilities to represent our obligation to return the collateral retained by us.

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

 

(Notional in millions)

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

Derivatives designated as hedges

             

Cash flow hedges:

             

Interest rate swaps

   Notional    $ 9,479    $ 1,382    $ (206   $ 10,655

Inflation indexed swaps

   Notional      376      157      (6     527

Foreign currency swaps

   Notional      491      —        —          491
                               

Total cash flow hedges

        10,346      1,539      (212     11,673
                               

Fair value hedges:

             

Interest rate swaps

   Notional      2,366      —        (139     2,227

Foreign currency swaps

   Notional      85      —        —          85
                               

Total fair value hedges

        2,451      —        (139     2,312
                               

Total derivatives designated as hedges

        12,797      1,539      (351     13,985
                               

Derivatives not designated as hedges

             

Interest rate swaps

   Notional      6,474      2,345      (577     8,242

Interest rate swaps related to securitization entities

   Notional      —        138      (3     135

Interest rate swaptions

   Notional      5,100      200      (5,100     200

Credit default swaps

   Notional      1,090      50      —          1,140

Credit default swaps related to securitization entities

   Notional      —        322      (5     317

Equity index options

   Notional      912      397      (614     695

Financial futures

   Notional      5,822      3,696      (5,019     4,499

Other foreign currency contracts

   Notional      521      73      —          594

Reinsurance embedded derivatives

   Notional      —        47      —          47
                               

Total derivatives not designated as hedges

        19,919      7,268      (11,318     15,869
                               

Total derivatives

      $ 32,716    $ 8,807    $ (11,669   $ 29,854
                               

 

(Number of policies)

   Measurement    December 31, 2009    Additions    Terminations     June 30, 2010

Derivatives not designated as hedges

             

GMWB embedded derivatives

   Policies    47,543    2,244    (1,445   48,342

Approximately $1.1 billion of notional value above is related to derivatives with counterparties that can be terminated at the option of the derivative counterparty and represented a net fair value asset of $148 million as of June 30, 2010.

 

Cash Flow Hedges

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

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

 

(Amounts in millions)

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

Interest rate swaps hedging assets

  $ 599      $ 4      Net investment
income
  $ 15   Net investment
gains (losses)

Interest rate swaps hedging liabilities

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

Foreign currency
swaps

    6        (2   Interest expense     —     Net investment
gains (losses)
                         

Total

  $ 602      $ 3        $ 15  
                         

 

(1)

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

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

 

(Amounts in millions)

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

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

Interest rate swaps hedging assets

  $ (177   $ 3      Net investment

income

  $ (4   Net investment

gains (losses)

Interest rate swaps hedging assets

    —          2      Net investment

gains (losses)

    —        Net investment

gains (losses)

Foreign currency
swaps

    (1     (5   Interest expense     —        Net investment

gains (losses)

                           

Total

  $ (178   $ —          $ (4  
                           

 

(1)

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

 

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

 

(Amounts in millions)

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

Interest rate swaps hedging assets

  $ 563      $ 8      Net investment
income
  $ 12   Net investment
gains (losses)

Interest rate swaps hedging assets

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

Interest rate swaps hedging liabilities

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

Foreign currency
swaps

    7        (4   Interest expense     —     Net investment
gains (losses)
                         

Total

  $ 567      $ 6        $ 12  
                         

 

(1)

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

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

 

(Amounts in millions)

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

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

Interest rate swaps hedging assets

  $ (322   $ 8      Net investment
income
  $ (10   Net investment

gains (losses)

Interest rate swaps hedging assets

    —          5      Net investment

gains (losses)

    —        Net investment

gains (losses)

Foreign currency
swaps

    (13     (8   Interest expense     —        Net investment

gains (losses)

                           

Total

  $ (335   $ 5        $ (10  
                           

 

(1)

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

The total of derivatives designated as cash flow hedges of $1.2 billion, net of taxes, recorded in stockholders’ equity as of June 30, 2010 is expected to be reclassified to future net income (loss), concurrently with and primarily offsetting changes in interest expense and interest income on floating-rate instruments and interest income on future fixed-rate bond purchases. Of this amount, $8 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 six months ended June 30, 2010 in connection with forecasted transactions that were no longer considered probable of occurring.

 

Fair Value Hedges

Certain derivative instruments are designated as fair value hedges. The changes in fair value of these instruments are recorded in net income (loss). In addition, changes in the fair value attributable to the hedged portion of the underlying instrument are reported in net income (loss). We designate and account for the following as fair value hedges when they have met the effectiveness requirements: (i) interest rate swaps to convert fixed rate investments to floating rate investments; (ii) interest rate swaps to convert fixed rate liabilities into floating rate liabilities; (iii) cross currency swaps to convert non-U.S. dollar fixed rate liabilities to floating rate U.S. dollar liabilities; and (iv) other instruments to hedge various fair value exposures of investments.

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

 

    Derivative instrument   Hedged item

(Amounts in millions)

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

net income (loss)
  Other impacts
to net
income (loss)
    Classification
of other

impacts to
net income (loss)
  Gain (loss)
recognized in
net income
(loss)
    Classification
of gain (loss)
recognized in net
income (loss)

Interest rate swaps hedging assets

  $ 1      Net investment
gains (losses)
  $ (3   Net investment
income
  $ (1   Net investment
gains (losses)

Interest rate swaps hedging liabilities

    (6   Net investment
gains (losses)
    25      Interest credited     6      Net investment
gains (losses)

Foreign currency
swaps

    (2   Net investment
gains (losses)
    1      Interest credited     2      Net investment
gains (losses)
                             

Total

  $ (7     $ 23        $ 7     
                             

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

 

    Derivative instrument   Hedged item

(Amounts in millions)

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

net income (loss)
  Other impacts
to net
income (loss)
    Classification
of other

impacts to
net income (loss)
  Gain (loss)
recognized in
net income
(loss)
    Classification
of gain (loss)
recognized in net
income (loss)

Interest rate swaps hedging assets

  $ 4      Net investment

gains (losses)

  $ (4   Net investment
income
  $ (6   Net investment
gains (losses)

Interest rate swaps hedging liabilities

    (50   Net investment

gains (losses)

    23      Interest credited     51      Net investment
gains (losses)

Foreign currency
swaps

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

Total

  $ (48     $ 19        $ 46     
                             

 

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

 

    Derivative instrument   Hedged item

(Amounts in millions)

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

net income (loss)
  Other impacts
to net
income (loss)
    Classification
of other

impacts to
net income (loss)
  Gain (loss)
recognized in
net income
(loss)
    Classification
of gain (loss)
recognized in net
income (loss)

Interest rate swaps hedging assets

  $ 2      Net investment
gains (losses)
  $ (6   Net investment
income
  $ (2   Net investment
gains (losses)

Interest rate swaps hedging liabilities

    (7 )   Net investment
gains (losses)
    50      Interest credited     7      Net investment
gains (losses)

Foreign currency
swaps

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

Total

  $ (9     $ 46        $ 9     
                             

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

 

    Derivative instrument   Hedged item

(Amounts in millions)

  Gain (loss)
recognized in
net income
(loss)
    Classification
of gain (loss)
recognized in
net income (loss)
  Other impacts
to net
income (loss)
    Classification
of other
impacts to
net income (loss)
  Gain (loss)
recognized in
net income
(loss)
    Classification
of gain (loss)
recognized in net
income (loss)

Interest rate swaps hedging assets

  $ 6      Net investment
gains (losses)
  $ (8   Net investment
income
  $ (10   Net investment
gains (losses)

Interest rate swaps hedging liabilities

    (59   Net investment
gains (losses)
    42      Interest credited     62      Net investment
gains (losses)

Foreign currency
swaps

    (13   Net investment
gains (losses)
    1      Interest credited     11      Net investment
gains (losses)
                             

Total

  $ (66     $ 35        $ 63     
                             

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

Derivatives Not Designated As Hedges

We also enter into certain non-qualifying derivative instruments such as: (i) interest rate swaps, swaptions and financial futures to mitigate interest rate risk as part of managing regulatory capital positions; (ii) credit default swaps to enhance yield and reproduce characteristics of investments with similar terms and credit risk; (iii) equity index options, interest rate swaps and financial futures to mitigate the risks associated with liabilities that have guaranteed minimum benefits; (iv) interest rate swaps where the hedging relationship does not qualify for hedge accounting; (v) credit default swaps to mitigate loss exposure to certain credit risk; and (vi) foreign currency forward contracts to mitigate certain currency risk. Additionally, we provide GMWBs on certain products that are required to be bifurcated as embedded derivatives and have reinsurance agreements with certain features that are required to be bifurcated as embedded derivatives.

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

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

 

     Three months ended June 30,     Classification of gain (loss) recognized
in net income (loss)

(Amounts in millions)

   2010     2009    

Interest rate swaps

   $ 63      $ 164      Net investment gains (losses)

Interest rate swaps related to securitization entities (1)

     (9     —        Net investment gains (losses)

Interest rate swaptions

     35        (338   Net investment gains (losses)

Credit default swaps

     (32     35      Net investment gains (losses)

Credit default swaps related to securitization entities (1)

     (46     —        Net investment gains (losses)

Equity index options

     50        (71   Net investment gains (losses)

Financial futures

     105        (163   Net investment gains (losses)

Inflation indexed swaps

     —          4      Net investment gains (losses)

Other foreign currency contracts

     2        8      Net investment gains (losses)

Reinsurance embedded derivatives

     2        —        Net investment gains (losses)

GMWB embedded derivatives

     (278     479      Net investment gains (losses)
                  

Total derivatives not designated as hedges

   $ (108   $ 118     
                  

 

(1)

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

 

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

 

     Six months ended June 30,     Classification of gain (loss) recognized
in net income (loss)

(Amounts in millions)

   2010     2009    

Interest rate swaps

   $ 57      $ 246      Net investment gains (losses)

Interest rate swaps related to securitization entities (1)

     (12     —        Net investment gains (losses)

Interest rate swaptions

     57        (579   Net investment gains (losses)

Credit default swaps

     (27     21      Net investment gains (losses)

Credit default swaps related to securitization entities (1)

     (41     —        Net investment gains (losses)

Equity index options

     23        (55   Net investment gains (losses)

Financial futures

     72        (84   Net investment gains (losses)

Inflation indexed swaps

     —          (4   Net investment gains (losses)

Foreign currency swaps

     —          6      Net investment gains (losses)

Other foreign currency contracts

     (1     10      Net investment gains (losses)

Reinsurance embedded derivatives

     2        —        Net investment gains (losses)

GMWB embedded derivatives

     (242     440      Net investment gains (losses)
                  

Total derivatives not designated as hedges

   $ (112   $ 1     
                  

 

(1)

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

Derivative Counterparty Credit Risk

As of June 30, 2010 and December 31, 2009, net fair value assets by counterparty totaled $1.3 billion and $739 million, respectively. As of June 30, 2010 and December 31, 2009, net fair value liabilities by counterparty totaled $192 million and $74 million, respectively. As of June 30, 2010 and December 31, 2009, we retained collateral of $1.1 billion and $647 million, respectively, related to these agreements, including over collateralization of $6 million and $10 million, respectively, from certain counterparties. As of June 30, 2010 and December 31, 2009, we posted $12 million and $121 million, respectively, of collateral to derivative counterparties, including over collateralization of $3 million and $46 million, respectively. For derivatives related to securitization entities, there are no arrangements that require either party to provide collateral and the recourse of the derivative counterparty is typically limited to the assets held by the securitization entity and there is no recourse to any entity other than the securitization entity.

Except for derivatives related to securitization entities, all of our master swap agreements contain credit downgrade provisions that allow either party to assign or terminate derivative transactions if the other party’s long-term unsecured debt rating or financial strength rating is below the limit defined in the applicable agreement. If the downgrade provisions had been triggered as of June 30, 2010 and December 31, 2009, we could have been allowed to claim up to $292 million and $102 million, respectively, from counterparties and required to disburse up to $1 million in both periods. This represented the net fair value of gains and losses by counterparty, less available collateral held, and did not include any fair value gains or losses for derivatives related to securitization entities.

 

Credit Derivatives—Sell Protection

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

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

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

 

     June 30, 2010    December 31, 2009

(Amounts in millions)

   Notional
value
   Assets    Liabilities    Notional
value
   Assets    Liabilities

Reference entity credit rating and maturity:

                 

AAA

                 

Matures after one year through five years

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

AA

                 

Matures after one year through five years

     11      —        —        5      —        —  

A

                 

Matures after one year through five years

     32      —        —        32      1      —  

Matures after five years through ten years

     10      —        —        10      —        —  

BBB

                 

Matures after one year through five years

     68      1      —        73      1      —  

Matures after five years through ten years

     29      —        1      29      —        —  
                                         

Total credit default swaps on single name reference entities

   $ 155    $ 1    $ 1    $ 155    $ 2    $ —  
                                         

 

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

 

    June 30, 2010   December 31, 2009

(Amounts in millions)

  Notional
value
  Assets   Liabilities   Notional
value
  Assets   Liabilities

Index tranche attachment/detachment point and maturity:

           

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

  $ 300   $ —     $ 13   $ 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     —       6     250     —       2

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

    248     —       6     248     4     —  

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

    127     —       1     127     2     —  
                                   

Total credit default swap index tranches

    925     —       26     925     7     3
                                   

Customized credit default swap index tranches related to securitization entities:

           

Portion backing third-party borrowings maturing 2017  (6)

    17     —       9     —       —       —  

Portion backing our interest maturing 2017 (7)

    300     —       150     —       —       —  
                                   

Total customized credit default swap index tranches related to securitization entities

    317     —       159     —       —       —  
                                   

Total credit default swaps on index tranches

  $ 1,242   $ —     $ 185   $ 925   $ 7   $ 3
                                   

 

(1)

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

(2)

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

(3)

The current attachment/detachment as of June 30, 2010 and December 31, 2009 was 10% – 15%.

(4)

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

(5)

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

(6)

Original notional value was $39 million.

(7)

Original notional value was $300 million.

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

 

     June 30, 2010    December 31, 2009

(Amounts in millions)

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

Credit rating:

                 

AA

                 

Matures after five years through ten years

   $ 100    $ 100    $ 96    $ 100    $ 100    $ 96

BBB

                 

Matures after five years through ten years (1)

     —        —        —        100      100      76

BB

                 

Matures after five years through ten years (1)

     —        —        —        200      228      148
                                         

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

   $ 100    $ 100    $ 96    $ 400    $ 428    $ 320
                                         

 

(1)

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

 

Fair Value of Financial Instruments
Fair Value of Financial Instruments

(6) Fair Value of Financial Instruments

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

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

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

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

Other invested assets. Based on comparable market transactions, discounted future cash flows, quoted market prices and/or estimates using the most recent data available for the related instrument. Primarily represents short-term investments, limited partnerships accounted for under the cost method and bank loans.

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

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

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

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

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

 

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

 

(Amounts in millions)

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

Assets:

               

Commercial mortgage loans

   $              (1)    $ 7,208    $ 7,211    $   (1)    $ 7,499    $ 7,213

Restricted commercial mortgage loans (2)

                  (1)      535      554           (1)      —        —  

Other invested assets

                  (1)      328      332           (1)      1,766      1,769

Liabilities:

               

Short-term borrowings (3)

                  (1)      730      730           (1)      930      930

Long-term borrowings (3)

                  (1)      4,331      4,127           (1)      3,641      3,291

Non-recourse funding obligations (3)

                  (1)      3,437      1,468           (1)      3,443      1,674

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

                  (1)      474      497           (1)      —        —  

Investment contracts

                  (1)      21,287      22,048           (1)      21,515      21,743

Performance guarantees, principally letters of credit

     77        —        —        117        —        —  

Other firm commitments:

               

Commitments to fund limited partnerships

     143        —        —        194        —        —  

Ordinary course of business lending commitments

     5        —        —        —          —        —  

 

(1)

These financial instruments do not have notional amounts.

(2)

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

(3)

See note 9 for additional information related to borrowings.

Recurring Fair Value Measurements

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

Fixed maturity, equity and trading securities

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

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

 

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

For pricing services, we obtain an understanding of the pricing methodologies and procedures for each type of instrument. In general, a pricing service does not provide a price for a security if sufficient information is not readily available to determine fair value or if such security is not in the specific sector or class covered by a particular pricing service. Given our understanding of the pricing methodologies and procedures of pricing services, the securities valued by pricing services are typically classified as Level 2 unless we determine the valuation process for a security or group of securities utilizes significant unobservable inputs.

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

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

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

 

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

 

(Amounts in millions)

   Total    Level 1    Level 2    Level 3

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

           

Pricing services

   $ 3,667    $ —      $ 3,667    $ —  

Internal models

     17      —        8      9
                           

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

     3,684      —        3,675      9
                           

Tax-exempt:

           

Pricing services

     1,350      —        1,350      —  
                           

Total tax-exempt

     1,350      —        1,350      —  
                           

Government—non-U.S.:

           

Pricing services

     2,116      —        2,116      —  

Internal models

     30      —        12      18
                           

Total government—non-U.S.

     2,146      —        2,128      18
                           

U.S. corporate:

           

Pricing services

     19,988      —        19,988      —  

Broker quotes

     300      —        —        300

Internal models

     3,090      —        1,870      1,220
                           

Total U.S. corporate

     23,378      —        21,858      1,520
                           

Corporate—non-U.S.:

           

Pricing services

     10,793      —        10,696      97

Broker quotes

     136      —        —        136

Internal models

     1,870      —        1,383      487
                           

Total corporate—non-U.S.