Genworth Analysis

August 6, 2015

DISCLAIMER
Before making an investment decision, investors are advised to
read carefully the Offering Memorandum, including the
description of the risks, fees, expenses, liquidity restrictions and
other terms of investing in the funds. Performance data has not
been prepared to meet any specific requirements applicable to the
presentation thereof and should in no event be viewed as
predictions or representations as to actual future performance.
Investment may involve a high degree of risk and should be
considered only by investors who do not require access to their
capital and can withstand the loss of all or part of their
investment. Return targets in this document are subjective
determinations and do not reflect either actual past performance
or a guarantee of future performance. Referenced benchmarks
may fail to provide a meaningful comparison. Forward looking
statements are based upon assumptions which may differ
materially from actual events. This information should not be
relied upon in making an investment decision.

About Booth-Laird Investment

Partnership

Approach to investing:
Out-of-favor stocks that are mispriced due to uncertainty
or fear, misunderstanding or obscurity
Conduct significant due diligence to overcome those
hurdles
Invest only at a deep discount to intrinsic value
Limited to 15 to 20 best ideas

In-Depth Analysis

Profile

Genworth (ticker symbol: GNW) is a hybrid Mortgage

Insurance, Life Insurance, and Long-Term Care (LTC)
Insurance company

Spun-off from GE in 2004

Largest mortgage insurance company outside the U.S.

Pioneer in LTC insurance decades ago

$3.7B market cap

HIG Redux 2012 revisited

Unholy combination of P&C Insurance and Life Insurance

Issues in life insurance overshadowing strong p&c insurance

Beaten down to a low fraction of net book value

New management after severe issues from credit crisis

Plans to eventually split the p&c and life insurance

businesses

Complexity that requires research, understanding, and

patience

Described Hartford Group (HIG) 3 years ago and GNW

today

How did HIG work out?

Presented long thesis for Hartford Group (HIG) in July 2012

Stock was selling for 35% of NBV at ~$16/share

We felt it was trading for lower than a worst case scenario

Conservative upside was 60% of NBV in original analysis

Ultimately sold in July 2014 for $39 at 90% of NBV

143% gain in 2 years

Asset Play Opportunity

Selling for ~25% of net book value

Down 60% from 52-week high due to long-term care reserve

issues

Probability of current management destroying 75% of net

book value very low

Probability of net book value being overstated 400% very

low

Risks misunderstood by the market due to complex

accounting and new material weakness in controls

Substantial upside using three different valuation

approaches

Background

Oldest predecessor founded 1871

GE Capital accumulated a number of disparate insurance

companies

Spun off from GE in largest IPO of 2004

As a major U.S. and global mortgage insurer, severely hurt

by the credit crisis

New management and majority of directors since crisis

Mortgage insurance past darkest hour, steadily improving

Late 2014, long-term care ins. reserve issues came to light

Review of reserves led to steep increase early 2015

Credit ratings reduced one notch as a result

New Management

7 of 10 board members new since credit crisis, including

Chairman

Rich insurance experience

Key executives replaced since credit crisis

CEO hired externally January 2013

CFO joined company in 2011

CRO hired externally January 2014

Greater focus on risk management

No accident LTC insurance issues came to surface in late

2014

Greater focus on simplicity no sacred cows

Complex Hybrid Model (1 of 2)

Unique combination of life, LTC, and mortgage insurance

Life insurance is not true insurance, it is an investment

Insurer cannot make money off of insurance premiums alone

Manage market risk only, not insurance risk

Mortgage insurance is true insurance

Only major insurance company in all three businesses

Pay a cost up front to protect against potentially larger cost later

on

LTC is a combination of the two

Pay cost up to protect against potentially larger cost later on

Insurer cannot make money off of insurance premiums alone

policies structured like life insurance

Complex Hybrid Model (2 of 2)

Included numerous other insurance lines as a result of GE

kitchen sink spin-off

New management and board determine core of business

was mortgage, life insurance, and LTC insurance

Sold or placed the remainder into run-off:

Variable annuities
Variable life insurance
Corporate-owned life insurance
Accidental & health insurance
Institutional insurance
Medicare supplement insurance
International Protection insurance

Mortgage Insurance Profile

Now a strength of the company

#1 private mortgage insurer in Australia and in Canada

Both markets essentially oligopolies

A leading private mortgage insurer in the U.S.

Post-European recession, only offers mortgage insurance in

4 countries Germany, UK, Finland, and Italy

97% of mortgage insurance sold to prime borrowers

Australia Mortgage Insurance (AMI)

Publicly-traded in Australia IPO in 2014

Trading for 0.88x net book value

GNW still owns 51% of the company

4 banks handle vast majority of mortgages in Australia

Estimated 44% market share

Lost one major bank customer 2015 over ratings reduction

stemming from LTC insurance 10-15% of policies

No impact on policies in force, no material impact on net

income

Loss ratios are outperforming local market

Well capitalized capital adequacy ratio exceeds target

AMI Combined Ratio

100.00%
90.00%
80.00%
70.00%
60.00%
50.00%
40.00%
30.00%
20.00%
10.00%
0.00%
2012

2013
Loss Ratio

2014
Combined Ratio

2015E

AMI TTM Underlying ROE

12 month trailing underlying ROE
12.2%

12.0%

11.9%

2Q14

3Q14

11.7%

12.4%

10.4%

4Q13

1Q14

4Q14

1Q15

Canada Mortgage Insurance (CMI)

Publicly-traded in Canada IPO in 2009

Trading for 0.81x net book value

GNW still owns 57.5% of the company

Largest private insurer in Canada

Mort. Ins. 90% guaranteed by Canadian government

Book Value per Share has increased at a CAGR of 9.3% last 5

years

Average operating ROE of 12.8% last 6 years

Well capitalized capital adequacy ratio exceeds target

Low interest rate for foreseeable future

CMI Combined Ratio

100.00%
90.00%
80.00%
70.00%
60.00%
50.00%
40.00%
30.00%
20.00%
10.00%
0.00%
2012

2013
Loss Ratio

2014
Combined Ratio

2015E

CMI Operating ROE

14.0%

2010

13.0%

13.0%

2011

2012

12.0%

12.0%

2013

2014

U.S. Mortgage Insurance (USMI)

Wholly-owned

7 Mortgage Insurance companies before credit crisis

2 went bankrupt
2 more nearly went bankrupt

GNW did not come close

Claims skyrocketed due to crisis

Delinquencies peaked in 2010

Down substantially and still dropping

61% of risk in force composed of 2009+ loans

Returned to profitability in 2013

ROE of 5.6% 2014 is low but improving

USMI Combined Ratio Improving

Combined Ratio Breakdown
180.00%
160.00%
140.00%

120.00%
100.00%
80.00%
60.00%

40.00%
2012

2013
Loss Ratio

2014
Combined Ratio

2015E

USMI Op Income Improving

$150
$91

$100

$101

$37

$50
$$(50)
$(100)
$(150)

$(114)
2012

2013

2014

1H 2015

USMI Capitalization

Government Sponsored Entities (GSEs)

Want a vibrant private mortgage insurance industry
Suspended rules requirements during crisis
Announced new capital adequacy rules effective mid-2015

GNW expects to meet new rules

Needs to increase capital $500-$700M
Sold additional Australia stock

Sold international protection business

Utilizing captive reinsurance

In compliance with maximum leverage ratio of 25:1

GNW at 13.7:1 and dropping

Life Insurance Business

Includes life, annuities, and LTC insurance

Universal Life and Fixed Annuities are primary focus going

forward for non-LTC business

Well capitalized RBC ratio of 455% exceeds target of 400%

and regulator requirements of even lower percentages

For reference, respected stalwart New York Lifes RBC ratio is

500%

Non-LTC products are steady performers

TTM ROE of ~4% is low but improving

Will benefit substantially from a rising interest rate environment

Reducing headcount and other expenses to further improve ROE

Life Insurance Ratings Reduction

Insurance ratings reduced by Moodys, S&P, and A.M. Best as a

result of LTC reserve increase still adequate and above

Reduction in insurance rating caused some brokers to stop

selling new GNW products

Represents 18% of linked-benefit, 16% of annuity, and 9% of LTC

sales

No impact on existing policies vast majority of annual premium

Could be bumped back to previous ratings as LTC uncertainty

recedes

Respected Operator

DALBAR announced insurance awards 2014

Received 2014 Service Award for life insurance unit

Ranked first for high quality of service in LTC

Ranked 3rd for quality of service provided to life insurance

policyholders

Received Annuity Service Award

1 of 6 six companies that emerged as titans of customer service in 2014

Per DALBAR:

Genworth emerged as an industry leader for 4th consecutive year,

with proven leadership in the high level of professionalism,
knowledge and respect for the their policyholders that was found in
over 94% of calls evaluated for service.

Industry average is only 57%

LTC Insurance

Source of why stock is down

LTC Insurance primer:

Covers cost of the elderly and disabled who can no longer
care for themselves but do not warrant stay in the hospital
Average age of first year policyholder is 58

Average age of first year of claim is 80

Average duration of claims is 3 years
Like life insurance, claims exceed premiums paid over life
of policy, so company relies on policy lapses and sufficient
investment yield

GNW was a pioneer of LTC insurance 30 to 40 years ago

Few competitors today

LTC Insurance Issues

Lack of historical data and unexpected advances in medicine

caused the following key assumptions to be underestimated
when policy first written decades ago

Lapse rate
Used avg. life insurance lapse rate of 5 to 6%, but actual lapse
rate has been 0.7%

Frequency - % of policyholders making claims

Severity total cost once claim is made

Result
Significant increase in reserves for future claims

LTC Insurance Reserve Review

LTC reserves typically reviewed once every 4 years

Last review in 2012 accredited incorrect assumptions to

credit crisis, made no major adjustments

New management came on board after, notice the key

variables were still off, ordered a complete review in 2014, 2
years ahead of schedule

With Q3 2014 earnings release, announced increase in claims

reserve and review of the Active Life Reserve, to be released
with Q4 2014

Hired two actuarial firms, one to calculate the new reserve

and the other to review the calculation

Vetted the new reserve calculations with regulators

LTC Insurance Reserve Update

2 separate reserves:
Claims reserve for current claims - policyholders
receiving benefits today.
Severity key variable
Increased $700M, new survival ratio of 4.6 is
conservative
Active Life Reserves policyholders who have yet to
make a claim
Increased another $700M for older acquired block
expected to realize a loss
Reduced expected profit on organic block, but no
reduction in NBV needed unless expect a loss
Extensive vetting process and assumptions used provide
comfort

Also wrote off $500M of goodwill

LTC Insurance Rate Increases

Increasing rates on existing policies and reducing benefits

Working with state insurance commissioners

Requesting increases of 15-40%

Rate increases are product by product

Received approval from 47 states for one product
Received approval from 30 states from another product
Exited 2 states where rate increases not approved

Adverse selection will occur used conservative lapse rate

for reserves as a result

LTC Insurance Going Forward

Company expects the requested rate increases to result in

increased premiums for existing policies of $380 470M by
2017 with no additional cost

Net operating income, after tax, for LTC the last 3 years:

2012 - $101M
2013 - $129M
2014 - $59M before the reserve increase

Benefit reductions also reduce reserve requirements

Expect to increase rates annually for existing policies to get

to appropriate profitability level

Expect ROE of 20% on new policies written going forward

Likely Split in the Future

Management has openly discussed its intent to eventually

split up the mortgage and life insurance businesses, most
likely via a spin-off of one of the units

Would unlock the value in the mortgage insurance

businesses evidenced by the Australia and Canada subs

Overshadowed by LTC issues

Combination of two very different businesses keeps a lot of

investors away

Split would create purer plays and likely increase investor

interest for both businesses

Plans delayed temporarily by LTC and by new USMI capital

requirements

Likely no sooner than FY 2016 probably later

Material Weakness

Material Weakness disclosed with 2014 10-K

Related to immaterial error that was not caught in an Excel

spreadsheet

Determined it could have been material

Wall Streets reaction to and commentary on the material

weakness reveals a lack of understanding of what that
actually means and the impact

Our audit background, particularly of Shaw and its

numerous material weaknesses, provides a deep
understanding

Risk is the material weakness that you dont know about, not
the one you do know about and overcome with extensive
managerial and auditor review

Risks to Consider
1.

Reserves could prove to be inadequate

2.

Regulatory risk in all markets is ever present when dealing

with financial companies

3.

Company may not be able to get any additional rate increases

on LTC Insurance

4.

Any further insurance rating reductions would hurt the stock

Valuation Methodology

Valued using three methods

1. Projecting net income by business line and summing the
parts
2. Balance sheet approach primary focus since asset play
3. Based on statutory capital sanity check

Completed upside and downside valuation

Upside conservative
Downside aggressive to incorporate worst case scenarios

Asset Play

Primarily viewed as an Asset Play, similar to HIG

Limited to financial companies assets and liabilities

predominantly financial in nature

Why we love asset plays:

Rare
Reduces execution risk
The farther below realizable net asset value, the less the
execution risk

We pass on most due to inability to determine a reasonable

maximum liability

Key Assumptions

Primarily focused on stressing balance sheet to determine maximum

realistic destruction of value
Eliminated unrealized gain in fixed maturities portfolio in OCI,
even for upside
Assumed further increase in LTC reserves of over $3B
Increasing acquired block loss and eliminating organic block
margin plus an additional hit of $2.6B for assumption changes
Key is to ensure our risk of losing money is very low

Proof of conservative approach

Assumed $0 for lifestyle protection business or write-off of full
NBV of $815 in original analysis when invested even for our
upside analysis
Company recently announced sale for $510M

Valuation
Weighted Avg Valuation

Upside

Downside

Intrinsic Value

$16

$8.85

Stock Price

$5.64

$5.64

Upside

183%

57%

Focus is on the balance sheet, not earnings

Key is determining if more than 75% of NBV will be
destroyed or written off since currently selling for 25%
of NBV
Even when stressing it aggressively, at worst the
company is worth 40% of Q2 2015 NBV

Catalysts
1.

Primarily beating lowered expectations

2.

An increase in insurance ratings

3.

Time to prove new LTC reserve levels are adequate or

capping the risk in some way

4.

Continuing to get rate increases approved by the majority of

states for LTC insurance

5.

Announcing they can begin paying a dividend again from

USMI to the holding company

6.

Successfully splitting the company into separate mortgage

and life insurance businesses

Market reaction to Q2 15 results

Stock dropped 20% in one day - ridiculous overreaction

Results showed continued progress and stability of NBV (highest

priority for us)

Market wanted a big announcement on sale of life and annuity

business

Mgmt decided not to sell life and annuity because the offers were too
low and it could impact their ratings

We applaud this decision

Life, annuity, and LTC should be a package deal if LTC is to be readily

accepted still intend to split business eventually

HIG made a mistake by announcing intention to sell life and annuity

before finding buyer in 2012, which significantly hurt distribution

Have to show a commitment for brokers to promote it

Appendix

About the Managers:

Jonathan Booth, CFA, CPA/ABV

Passed CPA exam, ABV exam, and all 3 CFA exams on first attempt

2006 Elijah Watt Sells Award (top 10 CPA exam score in the world
out of 50,000+ test takers)

2008 Baton Rouge Business Report Top 40 Under Forty Award

B.S., Accounting and M.S., Accounting from Louisiana State

University

3+ years of auditing experience with two of the Big 4 accounting

firms
Exceptional performer every year & early promoted
Lead senior of Fortune 500 audit client

Former Assistant Director of State Economic Competitiveness

under Governor Jindal

Accredited Member magazine and SeekingAlpha.com contributing

author

About the Managers:

Kevin Laird, CPA

7 years of accounting and auditing experience with

KPMG Big 4 accounting firm

Postlethwaite & Netterville largest accounting firm in

Louisiana

The Edgen Group Manager of Financial Reporting

Edgen-Murray Corporation Assistant Controller

B.S., Accounting from Louisiana State University

M.B.A. from Southeastern Louisiana University

Louisiana Society of CPAs Business & Industry Committee

2012 AICPA Leadership Academy one of 36 selected from

across the nation for prestigious 4 day event

Contact Information
Booth-Laird Investment Partnership
9005 Westlake Avenue
Baton Rouge, LA 70810
(225) 767-1439

Website: www.boothlaird.com
Blog: www.boothlaird.com/boothlairdblog/
Twitter: http://twitter.com/#!/BoothLaird

Jonathan Booth, CFA, CPA/ABV

Chief Executive Officer
Cell: (225) 978-1532
jonathan.booth@boothlaird.com

Kevin Laird, CPA

President & Chief Operating Officer
Cell: (225) 229-6567
kevin.laird@boothlaird.com