UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


FORM 10-Q

 


 

xQUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the quarterly period ended JuneSeptember 30, 2006

OR

 

¨TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                     to                    

Commission file number 001-32195

 


LOGO

Genworth Financial, Inc.GENWORTH FINANCIAL, INC.

(Exact Name of Registrant as Specified in its Charter)

 


 

Delaware 33-1073076
(State or Other Jurisdiction of
Incorporation or Organization)
 (I.R.S. Employer
Identification Number)

6620 West Broad Street


Richmond, Virginia

 23230
(Address of Principal Executive Offices) (Zip Code)

(804) 281-6000

(Registrant’s Telephone Number, Including Area Code)

 


Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨.

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.

See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer  x                        Accelerated filer  ¨                        Non-accelerated filer  ¨

Large accelerated filer  xAccelerated filer  ¨Non-accelerated filer  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x.

At July 27,October 25, 2006, 455,002,495452,204,292 shares of Class A Common Stock, par value $0.001 per share, were outstanding.

 



TABLE OF CONTENTS

 

   Page

PART I—FINANCIAL INFORMATION

  

Item 1. Condensed Consolidated Financial Statements

  3

Condensed Consolidated Statements of EarningsIncome for the three and sixnine months ended JuneSeptember 30, 2006 and 2005 (Unaudited)

  3

Condensed Consolidated Statements of Financial PositionBalance Sheets as of JuneSeptember 30, 2006 (Unaudited) and December 31, 2005

  4

Condensed Consolidated Statements of Changes in Stockholders’ Equity for the sixnine months ended JuneSeptember 30, 2006 and 2005 (Unaudited)

  5

Condensed Consolidated Statements of Cash Flows for the sixnine months ended JuneSeptember 30, 2006 and 2005 (Unaudited)

  6

Notes to Condensed Consolidated Financial Statements (Unaudited)

  7

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

  2018

Item 3. Quantitative and Qualitative Disclosures About Market Risk

  6471

Item 4. Controls and Procedures

  6472

PART II—OTHER INFORMATION

  

Item 1. Legal Proceedings

  6573

Item 1A. Risk Factors

  6775

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

  67

Item 4. Submission of Matters to a Vote of Security Holders

6775

Item 6. Exhibits

  6875

Signatures

  6976

PART I—FINANCIAL INFORMATION

Item 1.Financial1. Financial Statements

GENWORTH FINANCIAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF EARNINGSINCOME

(Amounts in millions, except per share amounts)

(Unaudited)

 

  Three months ended
June 30,
  Six months ended
June 30,
   Three months ended
September 30,
 Nine months ended
September 30,
 
      2006         2005      2006 2005       2006         2005         2006         2005     

Revenues:

           

Premiums

  $1,648  $1,614  $3,187  $3,219   $1,680  $1,547  $4,867  $4,766 

Net investment income

   953   842   1,877   1,693    944   902   2,821   2,595 

Net investment gains (losses)

   (49)  —     (71)  (6)   (6)  (7)  (77)  (13)

Policy fees and other income

   202   154   386   315    186   186   572   501 
                          

Total revenues

   2,754   2,610   5,379   5,221    2,804   2,628   8,183   7,849 
                          

Benefits and expenses:

           

Benefits and other changes in policy reserves

   1,096   1,051   2,131   2,126    1,183   1,026   3,314   3,152 

Interest credited

   378   347   751   687    383   364   1,134   1,051 

Acquisition and operating expenses, net of deferrals

   521   523   996   970    533   506   1,529   1,476 

Amortization of deferred acquisition costs and intangibles

   207   208   381   401    170   217   551   618 

Interest expense

   88   69   170   141    87   72   257   213 
                          

Total benefits and expenses

   2,290   2,198   4,429   4,325    2,356   2,185   6,785   6,510 
                          

Net earnings before income taxes and accounting change

   464   412   950   896 

Income before income taxes and accounting change

   448   443   1,398   1,339 

Provision for income taxes

   147   127   303   289    144   136   447   425 
                          

Net earnings before accounting change

   317   285   647   607 

Net income before accounting change

   304   307   951   914 

Cumulative effect of accounting change, net of taxes

   —     —     4   —      —     —     4   —   
                          

Net earnings

  $317  $285  $651  $607 

Net income

  $304  $307  $955  $914 
                          

Earnings per common share:

           

Basic

  $0.70  $0.61  $1.41  $1.27   $0.67  $0.65  $2.08  $1.92 
                          

Diluted

  $0.68  $0.60  $1.37  $1.25   $0.65  $0.64  $2.02  $1.88 
                          

Weighted-average common shares outstanding:

           

Basic

   455.8   470.4   461.3   479.6    453.8   470.7   458.8   476.7 
                          

Diluted

   468.3   477.4   473.9   485.9    467.2   481.1   471.7   484.7 
                          

See Notes to Condensed Consolidated Financial Statements

GENWORTH FINANCIAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL POSITIONBALANCE SHEETS

(Amounts in millions)

 

  

June 30,

2006

 December 31,
2005
   

September 30,

2006

 December 31,
2005
 
  (Unaudited)     (Unaudited)   

Assets

      

Investments:

      

Fixed maturity securities available-for-sale, at fair value

  $52,316  $53,937   $54,280  $53,937 

Equity securities available-for-sale, at fair value

   187   206    192   206 

Commercial mortgage loans

   8,203   7,558    8,315   7,558 

Policy loans

   1,485   1,350    1,498   1,350 

Restricted investments held by securitization entities

   —     685    —     685 

Other invested assets

   1,840   3,174    3,050   3,174 
              

Total investments

   64,031   66,910    67,335   66,910 

Cash and cash equivalents

   2,351   1,875    2,302   1,875 

Accrued investment income

   663   733    760   733 

Deferred acquisition costs

   6,042   5,586    6,166   5,586 

Intangible assets

   942   782    884   782 

Goodwill

   1,486   1,450    1,488   1,450 

Reinsurance recoverable

   17,789   18,245    17,661   18,245 

Other assets

   717   967    1,167   967 

Separate account assets

   9,625   9,106    10,084   9,106 
              

Total assets

  $103,646  $105,654   $107,847  $105,654 
              

Liabilities and stockholders’ equity

      

Liabilities:

      

Future annuity and contract benefits

  $63,614  $63,749   $63,593  $63,749 

Liability for policy and contract claims

   3,297   3,364    3,389   3,364 

Unearned premiums

   3,956   3,647    4,180   3,647 

Other policyholder liabilities

   484   507    509   507 

Other liabilities

   3,652   4,937    5,167   4,937 

Non-recourse funding obligations

   2,150   1,400    2,450   1,400 

Short-term borrowings

   295   152    295   152 

Long-term borrowings

   2,741   2,736    2,730   2,736 

Senior notes underlying equity units

   600   600    600   600 

Mandatorily redeemable preferred stock

   100   100    100   100 

Deferred tax liability

   922   1,386    1,441   1,386 

Borrowings related to securitization entities

   —     660    —     660 

Separate account liabilities

   9,625   9,106    10,084   9,106 
              

Total liabilities

   91,436   92,344    94,538   92,344 
              

Commitments and contingencies

      

Stockholders’ equity:

      

Class A common stock, $0.001 par value; 1.5 billion shares authorized; 491 million and 404 million shares issued as of June 30, 2006 and December 31, 2005, respectively; 455 million and 385 million shares outstanding as of June 30, 2006 and December 31, 2005, respectively

   —     —   

Class B common stock, $0.001 par value; 700 million shares authorized; zero and 86 million shares issued and outstanding as of June 30, 2006 and December 31, 2005, respectively

   —     —   

Class A common stock, $0.001 par value; 1.5 billion shares authorized; 492 million and 404 million shares issued as of September 30, 2006 and December 31, 2005, respectively; 452 million and 385 million shares outstanding as of September 30, 2006 and December 31, 2005, respectively

   —     —   

Class B common stock, $0.001 par value; 700 million shares authorized; zero and 86 million shares issued and outstanding as of September 30, 2006 and December 31, 2005, respectively

   —     —   

Additional paid-in capital

   10,713   10,671    10,737   10,671 
              

Accumulated other comprehensive income:

   

Accumulated other comprehensive income (loss):

   

Net unrealized investment gains (losses)

   (312)  760    437   760 

Derivatives qualifying as hedges

   212   389    377   389 

Foreign currency translation and other adjustments

   333   255    352   255 
              

Total accumulated other comprehensive income

   233   1,404 

Total accumulated other comprehensive income (loss)

   1,166   1,404 

Retained earnings

   2,317   1,735    2,581   1,735 

Treasury stock, at cost (37 million and 19 million shares as of June 30, 2006 and December 31, 2005, respectively)

   (1,053)  (500)

Treasury stock, at cost (40 million and 19 million shares as of September 30, 2006 and December 31, 2005, respectively)

   (1,175)  (500)
              

Total stockholders’ equity

   12,210   13,310    13,309   13,310 
              

Total liabilities and stockholders’ equity

  $103,646  $105,654   $107,847  $105,654 
              

See Notes to Condensed Consolidated Financial Statements

GENWORTH FINANCIAL, INC.

CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY

(Amounts in millions)

(Unaudited)

 

  Additional
paid-in
capital
  Accumulated other
comprehensive
income
 Retained
earnings
 Treasury
stock, at
cost
 Total
stockholders’
equity
   Additional
paid-in
capital
  Accumulated other
comprehensive
income (loss)
 Retained
earnings
 Treasury
stock, at
cost
 Total
stockholders’
equity
 

Balances as of December 31, 2004

  $10,612  $1,608  $646  $—    $12,866   $10,612  $1,608  $646  $—    $12,866 

Comprehensive income (loss):

              

Net earnings

      607    607 

Net income

   —     —     914   —     914 

Net unrealized gains (losses) on investment securities

     519     519    —     21   —     —     21 

Derivatives qualifying as hedges

     138     138    —     131   —     —     131 

Foreign currency translation and other adjustments

     (102)    (102)   —     (47)  —     —     (47)
                  

Total comprehensive income (loss)

        1,162         1,019 

Acquisition of treasury stock

       (500)  (500)   —     —     —     (500)  (500)

Dividends to stockholders

      (61)   (61)   —     —     (96)  —     (96)

Stock-based compensation expense and exercises

   25      25    35   —     —     —     35 

Capital contributions from GE

   14      14    4   —     —     —     4 
                                

Balances as of June 30, 2005

  $10,651  $2,163  $1,192  $(500) $13,506 

Balances as of September 30, 2005

  $10,651  $1,713  $1,464  $(500) $13,328 
                                
  Additional
paid-in
capital
  Accumulated other
comprehensive
income
 Retained
earnings
 Treasury
stock, at
cost
 Total
stockholders’
equity
   Additional
paid-in
capital
  Accumulated other
comprehensive
income (loss)
 Retained
earnings
 Treasury
stock, at
cost
 Total
stockholders’
equity
 

Balances as of December 31, 2005

  $10,671  $1,404  $1,735  $(500) $13,310   $10,671  $1,404  $1,735  $(500) $13,310 

Comprehensive income (loss):

              

Net earnings

      651    651 

Net income

   —     —     955   —     955 

Net unrealized gains (losses) on investment securities

     (1,072)    (1,072)   —     (323)  —     —     (323)

Derivatives qualifying as hedges

     (177)    (177)   —     (12)  —     —     (12)

Foreign currency translation and other adjustments

     78     78    —     97   —     —     97 
                  

Total comprehensive income (loss)

        (520)        717 

Acquisition of treasury stock

       (553)  (553)   —     —     —     (675)  (675)

Dividends to stockholders

      (69)   (69)   —     —     (109)  —     (109)

Stock-based compensation expense and exercises

   38      38    61   —     —     —     61 

Capital contributions from GE

   4      4    5   —     —     —     5 
                                

Balances as of June 30, 2006

  $10,713  $233  $2,317  $(1,053) $12,210 

Balances as of September 30, 2006

  $10,737  $1,166  $2,581  $(1,175) $13,309 
                                

See Notes to Condensed Consolidated Financial Statements

GENWORTH FINANCIAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Amounts in millions)

(Unaudited)

 

  Six months ended
June 30,
   Nine months ended
September 30,
 
  2006 2005   2006 2005 

Cash flows from operating activities:

      

Net earnings

  $651  $607 

Adjustments to reconcile net earnings to net cash from operating activities:

   

Net income

  $955  $914 

Adjustments to reconcile net income to net cash from operating activities:

   

Amortization of fixed maturity discounts and premiums

   12   33    18   42 

Net investment (gains) losses

   71   6 

Net investment gains (losses)

   77   13 

Charges assessed to policyholders

   (177)  (152)   (255)  (248)

Cumulative effect of accounting policy change

   (4)  —      (4)  —   

Acquisition costs deferred

   (607)  (531)   (909)  (832)

Amortization of deferred acquisition costs and intangibles

   381   401    551   618 

Deferred income taxes

   182   218    219   483 

Change in certain assets and liabilities:

      

Accrued investment income and other assets, net

   144   117    (10)  48 

Insurance reserves

   1,476   1,183    2,427   2,013 

Current tax liabilities

   44   (53)   108   (170)

Other liabilities and other policy-related balances

   (176)  (466)   173   (457)
              

Net cash from operating activities

   1,997   1,363    3,350   2,424 
              

Cash flows from investing activities:

      

Proceeds from maturities and repayments of investments:

      

Fixed maturities

   2,802   2,086    4,174   3,750 

Mortgage loans

   554   432 

Commercial mortgage loans

   830   770 

Proceeds from sales of investments:

      

Fixed maturities and equity securities

   2,918   2,332    3,683   2,409 

Purchases and originations of investments:

      

Fixed maturities and equity securities

   (5,564)  (4,844)   (8,179)  (7,851)

Mortgage loans

   (1,183)  (1,249)

Commercial mortgage loans

   (1,573)  (2,008)

Other invested assets, net

   (10)  213    (51)  204 

Policy loans, net

   (135)  (9)   (147)  (129)

Payments for business purchased, net of cash acquired

   (134)  —      (291)  —   
              

Net cash from investing activities

   (752)  (1,039)   (1,554)  (2,855)
              

Cash flows from financing activities:

      

Proceeds from issuance of investment contracts

   3,774   3,815    5,585   6,359 

Redemption and benefit payments on investment contracts

   (4,827)  (4,147)   (7,396)  (5,899)

Short-term borrowing activity, net

   143   (30)

Short-term borrowings and other, net

   153   (393)

Proceeds from issuance of non-recourse funding obligations

   750   200    1,050   500 

Proceeds from long-term borrowings

   —     348 

Dividends paid to stockholders

   (69)  (61)   (103)  (93)

Stock-based compensation awards exercised

   20   2    32   (2)

Acquisition of treasury stock

   (553)  (500)   (675)  (500)

Capital contribution received from GE

   2   13    3   19 
              

Net cash from financing activities

   (760)  (708)   (1,351)  339 

Effect of exchange rate changes on cash and cash equivalents

   (9)  (61)   (18)  (37)
              

Net change in cash and cash equivalents

   476   (445)   427   (129)

Cash and cash equivalents at beginning of period

   1,875   1,963    1,875   1,963 
              

Cash and cash equivalents at end of period

  $2,351  $1,518   $2,302  $1,834 
              

See Notes to Condensed Consolidated Financial Statements

GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(1) Formation of Genworth and Basis of Presentation

Genworth Financial, Inc. (“Genworth”) was incorporated in Delaware on October 23, 2003 in preparation for the corporate reorganization of certain insurance and related subsidiaries of the General Electric Company (“GE”) and an initial public offering of Genworth common stock, which was completed on May 28, 2004 (“IPO”). In connection with the IPO, Genworth acquired substantially all of the assets and liabilities of GE Financial Assurance Holdings, Inc. (“GEFAHI”). Prior to its IPO, Genworth was a wholly-owned subsidiary of GEFAHI. GEFAHI is an indirect subsidiary of General Electric Capital Corporation (“GE Capital”), which in turn is an indirect subsidiary of GE. Prior to the corporate reorganization, GEFAHI was a holding company for a group of companies that provide life insurance, long-term care insurance, group life and health insurance, annuities, investment products and U.S. mortgage insurance. At the same time, Genworth also acquired certain other insurance businesses previously owned by other GE subsidiaries. These businesses included international mortgage insurance, payment protection insurance, a Bermuda reinsurer, and mortgage contract underwriting.

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 or economic interest, 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 are a leading insurance company in the U.S., with an expanding international presence, serving the life and lifestyle protection, retirement income, investment and mortgage insurance needs of more than 15 million customers. We have leadership positions in key products that we expect will benefit from a number of significant demographic, governmental and market trends. We distribute our products and services through an extensive and diversified distribution network that includes financial intermediaries, independent producers and dedicated sales specialists. We conduct operations in 24 countries and have approximately 7,000 employees. We have the following four segments:

 

Our Protection segment includes life insurance, long-term care andinsurance, linked benefit products, Medicare supplement insurance and, primarily for companies with fewer than 1,000 employees, group life and health insurance. Linked benefit products include life products with accelerated death benefits and annuity products with penalty-free withdrawals to pay long-term care benefits. Protection also includes consumer payment protection insurance, which helps consumers meet their payment obligations in the event of illness, involuntary unemployment, disability or death.

 

Our Retirement Income and Investments segment includes fixed annuities, individual andvariable annuities, group variable annuities designed for 401(k) plans, single premium immediate annuities, variable life insurance, asset management and specialized products, including guaranteed investment contracts (“GICs”), funding agreements and funding agreements backing notes (“FABNs”), and structured settlements.asset management products and services.

 

Our Mortgage Insurance segment includes mortgage insurance products and mortgage related services offered in the U.S., Canada, Australia, Europe, New Zealand, Mexico and Japan that facilitate homeownership by enabling borrowers to buy homes with low-down-payment mortgages.

 

Our Corporate and Other segment includes debt financing expenses that are incurred at our holding company level, unallocated corporate income and expenses, and the results of a small, non-core business that is managed outside our operating segments.

On March 8, 2006, GEFAHI completed an offering (“Secondary Offering”) of 71.2 million shares of our Class B Common Stock. The 71.2 million shares were automatically converted to Class A Common Stock upon the sale of these shares to the public. We did not receive any proceeds in the Secondary Offering. Concurrently

GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

with the Secondary Offering, we repurchased 15.0 million shares of Class B Common Stock from our majority stockholder at a price of $31.93125 per share (the net proceeds per share received by the selling stockholder from the

GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

underwriters), which is recorded at cost as treasury stock in the unaudited condensed consolidated statement of financial position.balance sheet. As a result of these transactions, GEFAHI no longer owns any of our outstanding common stock.

The accompanying condensed consolidated financial statements are unaudited and have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) and rules and regulations of the United States Securities and Exchange Commission (“SEC”). Preparing financial statements in conformity with GAAP requires us to make estimates and assumptions that affect reported amounts and related disclosures. Actual results could differ from those estimates. Certain prior year amounts have been reclassified to conform to the current year presentation. These condensed consolidated financial statements include all adjustments (consisting of normal recurring accruals) considered necessary by management to present a fair statement of the financial position, results of operations, and cash flow 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 financial statements and related notes contained in our 2005 Annual Report on Form 10-K.

(2) Accounting Pronouncements

Recently adopted

On January 1, 2006, we adopted Financial Accounting Standards Board (“FASB”) Statement of Financial Accounting Standards (“SFAS”) No. 123R,Share-Based Payment, an amendment of SFAS No. 123,Accounting for Stock-Based Compensation. We adopted SFAS No. 123R under the modified prospective transition method. The statement requires companies to recognize the grant-date fair value of options and other equity-based awards within the income statement over the respective vesting period of the awards. We adopted SFAS No. 123 effective January 1, 2002 and, as permitted, we determined a grant date fair value using a Black-Scholes model (“Black-Scholes Model”) and recognized the related compensation expense through the income statement for all equity awards issued subsequent to January 1, 2002. As a result of the adoption of SFAS No. 123R, we will continue to recognize the remaining portion of the requisite service under previously granted unvested awards including those awards granted prior to January 1, 2002. Prior to the adoption of SFAS No. 123R, we adjusted compensation cost related to forfeiture of awards when the actual forfeiture occurred. SFAS No. 123R requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates and requires companies which previously accounted for forfeitures on an occurrence basis to include in income of the period of adoption a cumulative effect of a change in accounting principle for the adjustment to reflect estimated forfeitures for prior periods. On January 1, 2006, we recognized an increase to net earningsincome of $4 million related to the cumulative effect of a change in accounting principle for the adoption of SFAS No. 123R. See Note 65 for additional information.

As of January 1, 2006, we adopted SFAS No. 155,Accounting for Certain Hybrid Financial Instruments. SFAS No. 155 amends SFAS No. 133,Accounting for Derivative Instruments and Hedging Activities, and SFAS No. 140,Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. SFAS No. 155 allows financial instruments that have embedded derivatives to be accounted for as a whole, eliminating the need to bifurcate the derivative from its host, if the holder elects to account for the whole instrument on a fair value basis. In addition, among other changes, SFAS No. 155 (i) clarifies which interest-only strips and principal-only strips are not subject to the requirements of SFAS No. 133; (ii) establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are

GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

hybrid financial instruments that contain an embedded derivative requiring bifurcation; (iii) clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives; and (iv) eliminates the prohibition on a qualifying special-purpose entity (“QSPE”) from holding a derivative financial instrument that

GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

pertains to a beneficial interest other than another derivative financial interest. Adoption of SFAS No. 155 did not have a material impact on our condensed consolidated financial statements.

Not yet adopted

In September 2005, the American Institute of Certified Public Accountants (“AICPA”) issued Statement of Position (“SOP”) 05-1,Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection With Modifications or Exchanges of Insurance Contracts.This statement provides guidance on accounting for deferred acquisition costs and other deferred balances on an internal replacement, defined broadly as a modification in product benefits, features, rights, or coverages that occurs by the exchange of an existing contract for a new contract, or by amendment, endorsement, or rider to an existing contract, or by the election of a benefit, feature, right, or coverage within an existing contract. Depending on the type of modification, the period over which these deferred balances will be recognized could be accelerated. SOP 05-1 is effective for internal replacements occurring in fiscal years beginning after December 15, 2006. The insurance industry has identified several implementation issues during their evaluation of SOP 05-1. An expert panel has been formed by the AICPA to evaluate certain of these interpretive issues that insurance companies are facing in their implementation. Based on our current interpretation, the adoption of SOP 05-1 will result in the shortening of the period over which our group life and health insurance business deferred acquisition costs are amortized. Transition to the shorter amortization period will occur throughout 2007 as each of our in-force contracts renew. Accordingly, under our current interpretation, we expect the transition in 2007 will result in additional amortization of deferred acquisition costs of approximately $60 to $65 million, net of tax. We are currently evaluatingdo not expect any material financial statement impact from transition beyond 2007. Due to the nature of the interpretative issues being reviewed by the expert panel, we continue to evaluate the impact that SOP 05-1 will have on our consolidated results of operations and financial position. Depending upon the outcome of the evaluation of these issues by the expert panel, we may refine our estimates of the associated impact related to our adoption of SOP 05-1.

In July 2006, FASB Interpretation (“FIN”) No. 48,Accounting for Uncertainty in Income Taxes,was issued. This guidance clarifies what criteria must be met prior to recognition of the financial statement benefit of a position taken in a tax return. Additionally, it applies to the recognition and measurement of income tax uncertainties resulting from a purchase business combination. This guidance is effective for fiscal years beginning after December 15, 2006. We are currently evaluating the impact FIN No. 48 will have on our consolidated results of operations and financial position.

In September 2006, FASB issued SFAS No. 157,Fair Value Measurements. This statement defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. SFAS No. 157 is effective prospectively with a limited form of retrospective application for fiscal years beginning after November 15, 2007 with early adoption encouraged. We are currently evaluating the impact that SFAS No. 157 will have on our consolidated results of operations and financial position.

In September 2006, FASB issued SFAS No. 158,Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans.This statement requires an employer to recognize the overfunded or underfunded status of a defined benefit plan as an asset or liability in its statement of financial position and to recognize changes in that funded status in the year in which the changes occur through comprehensive income. SFAS No. 158 is effective prospectively for fiscal years ending after December 15, 2006.The adoption of SFAS No. 158 will not have a material impact on our consolidated results of operations and financial position.

GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

(3) Earnings per Common Share

Basic and diluted earnings per common share are calculated by dividing net earningsincome by the weighted average basic common shares outstanding and by the weighted average diluted common shares outstanding for the periods presented:

 

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

(Amounts in millions except for per share data)

      2006          2005      2006  2005

Basic earnings per common share:

        

Net earnings before accounting change

  $0.70  $0.61  $1.40  $1.27

Cumulative effect of accounting change, net of taxes

   —     —     0.01   —  
                

Basic earnings per common share

 ��$0.70  $0.61  $1.41  $1.27
                

Diluted earnings per common share:

        

Net earnings before accounting change

  $0.68  $0.60  $1.37  $1.25

Cumulative effect of accounting change, net of taxes

   —     —     0.01   —  
                

Diluted earnings per common share

  $0.68  $0.60  $1.37  $1.25
                

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

   455.8   470.4   461.3   479.6

Dilutive securities:

        

Stock purchase contracts underlying equity units

   7.5   4.4   7.5   4.0

Stock options and stock appreciation rights

   4.5   2.2   4.6   1.9

Restricted stock units

   0.5   0.4   0.5   0.4
                

Weighted-average shares used in diluted earnings per common share calculations

   468.3   477.4   473.9   485.9
                

GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

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

(Amounts in millions except for per share data)

      2006          2005          2006          2005    

Basic earnings per common share:

        

Net income before accounting change

  $0.67  $0.65  $2.07  $1.92

Cumulative effect of accounting change, net of taxes

   —     —     0.01   —  
                

Basic earnings per common share

  $0.67  $0.65  $2.08  $1.92
                

Diluted earnings per common share:

        

Net income before accounting change

  $0.65  $0.64  $2.02  $1.88

Cumulative effect of accounting change, net of taxes

   —     —     0.01   —  
                

Diluted earnings per common share

  $0.65  $0.64  $2.02  $1.88
                

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

   453.8   470.7   458.8   476.7

Dilutive securities:

        

Stock purchase contracts underlying equity units

   8.1   6.4   7.7   4.9

Stock options and stock appreciation rights

   4.7   3.6   4.6   2.7

Restricted stock units

   0.6   0.4   0.6   0.4
                

Weighted-average shares used in diluted earnings per common share calculations

   467.2   481.1   471.7   484.7
                

(4) Investments and Derivative Instruments

The following table sets forth information about our net investment income for the components of our investment portfolio for the periods presented:

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

(Amounts in millions)

      2006          2005      2006  2005 

Fixed maturities—taxable

  $731  $665  $1,450  $1,334 

Fixed maturities—non-taxable

   31   32   62   65 

Commercial mortgage loans

   138   98   259   196 

Equity securities

   7   6   14   12 

Other investments

   12   10   23   24 

Policy loans

   32   27   62   53 

Restricted investments held by securitization entities

   —     13   7   27 

Cash, cash equivalents and short-term investments

   20   7   37   15 
                 

Gross investment income before expenses and fees

   971   858   1,914   1,726 

Expenses and fees

   (18)  (16)  (37)  (33)
                 

Net investment income

  $953  $842  $1,877  $1,693 
                 

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

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

(Amounts in millions)

      2006          2005          2006          2005     

Available-for-sale securities

     

Realized gains on sale

  $8  $12  $30  $51 

Realized losses on sale

   (50)  (9)  (76)  (20)

Loss on derecognition of securitization entities

   —     —     (17)  —   

Impairments

   (4)  (3)  (5)  (37)

Net unrealized gains (losses) on trading securities

   (1)  —     (1)  —   

Derivative instruments

   (2)  —     (2)  —   
                 

Net investment gains (losses)

  $(49) $  —    $(71) $(6)
                 

Derivative instruments primarily consist of changes in fair value on the non-qualifying derivatives, including embedded derivatives, changes in fair value of certain derivatives and related hedged items in fair value hedge relationships and hedge ineffectiveness on qualifying derivative instruments. Effective April 1, 2006, we began classifying changes in fair value of these derivative items as net investment gains (losses). These items were previously included as a component of net investment income, interest credited and benefits and other changes in policy reserves. The amount of these derivative items in prior periods that were included in the aforementioned categories was not material.

For the three months ended June 30, 2006 and 2005, we recognized impairments of $4 million and $3 million, respectively, and for the six months ended June 30, 2006 and 2005, we recognized impairments of $5 million and $37 million, respectively. The aggregate fair value of securities sold at a loss during the three months

GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

ended June 30, 2006 and 2005, was $1,227 million and $481 million, respectively, which was approximately 96% and 98% of book value, respectively. The aggregate fair value of securities sold at a loss during the six months ended June 30, 2006 and 2005, was $2,068 million and $1,158 million, respectively, which was approximately 96% and 99% of book value, respectively. The loss on sales of securities in the three and six months ended June 30, 2006 was primarily driven by the higher interest rate environment.

As of June 30, 2006, the amortized cost or cost, gross unrealized gains (losses), and estimated fair value of our fixed maturities and equity securities classified as available-for-sale were as follows:

(Amounts in millions)

  Amortized
cost or
cost
  Gross
unrealized
gains
  Gross
unrealized
losses
  Estimated
fair value

Fixed maturities:

       

U.S. government, agencies and government sponsored entities

  $695  $10  $(17) $688

Tax exempt

   2,763   56   (16)  2,803

Government—non U.S.  

   1,833   33   (24)  1,842

U.S. corporate

   24,816   357   (775)  24,398

Corporate—non U.S.  

   9,716   115   (270)  9,561

Mortgage and asset-backed

   13,200   96   (272)  13,024
                

Total fixed maturities

   53,023   667   (1,374)  52,316

Equity securities

   161   29   (3)  187
                

Total available-for-sale securities

  $53,184  $696  $(1,377) $52,503
                

As of December 31, 2005, the amortized cost or cost, gross unrealized gains (losses), and estimated fair value of our fixed maturities and equity securities classified as available-for-sale were as follows:

(Amounts in millions)

  Amortized
cost or
cost
  Gross
unrealized
gains
  Gross
unrealized
losses
  Estimated
fair value

Fixed maturities:

       

U.S. government, agencies and government sponsored entities

  $777  $32  $(4) $805

Tax exempt

   2,797   97   (4)  2,890

Government—non U.S.  

   1,736   74   (4)  1,806

U.S. corporate

   25,378   975   (231)  26,122

Corporate—non U.S.  

   9,168   306   (84)  9,390

Mortgage and asset-backed

   12,926   140   (142)  12,924
                

Total fixed maturities

   52,782   1,624   (469)  53,937

Equity securities

   173   36   (3)  206
                

Total available-for-sale securities

  $52,955  $1,660  $(472) $54,143
                

Included in other invested assets are certain securities that are designated as trading and, accordingly, are held at fair value with changes in fair value included in net investment gains (losses) in the condensed consolidated statement of earnings. As of June 30, 2006 and December 31, 2005, the fair value of the trading portfolio was $31 million and $15 million, respectively.

GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

The following table presents the gross unrealized losses and estimated 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, 2006:

   Less Than 12 Months  12 Months or more

(Dollar amounts in millions)

  Estimated
fair value
  Gross
unrealized
losses
  # of
securities
  Estimated
fair value
  Gross
unrealized
losses
  # of
securities

Description of Securities

          

Fixed maturities:

          

U.S. government, agencies and government sponsored entities

  $325  $(14) 82  $86  $(3) 17

Tax exempt

   868   (12) 204   146   (4) 49

Government—non U.S.  

   1,017   (23) 186   29   (1) 8

U.S. corporate

   12,575   (618) 1,184   2,670   (157) 323

Corporate—non U.S.  

   5,584   (203) 678   1,101   (67) 115

Mortgage and asset backed

   6,129   (193) 680   1,848   (79) 296
                      

Subtotal, fixed maturities

   26,498   (1,063) 3,014   5,880   (311) 808

Equity securities

   —     —    —     27   (3) 13
                      

Total temporarily impaired securities

  $26,498  $(1,063) 3,014  $5,907  $(314) 821
                      

% Below cost—fixed maturities:

          

<20% Below cost

  $26,466  $(1,050) 3,008  $5,820  $(290) 794

20-50% Below cost

   31   (11) 3   59   (20) 13

>50% Below cost

   1   (2) 3   1   (1) 1
                      

Total fixed maturities

   26,498   (1,063) 3,014   5,880   (311) 808
                      

% Below cost—equity securities:

          

<20% Below cost

   —     —    —     27   (3) 13

20-50% Below cost

   —     —    —     —     —    —  

>50% Below cost

   —     —    —     —     —    —  
                      

Total equity securities

   —     —    —     27   (3) 13
                      

Total temporarily impaired securities

  $26,498  $(1,063) 3,014  $5,907  $(314) 821
                      

Investment grade

  $25,148  $(1,006) 2,716  $5,414  $(274) 721

Below investment grade

   1,321   (56) 295   482   (38) 90

Not Rated—Fixed maturities

   29   (1) 3   —     —    —  

Not Rated—Equities

   —     —    —     11   (2) 10
                      

Total temporarily impaired securities

  $26,498  $(1,063) 3,014  $5,907  $(314) 821
                      

The investment securities in an unrealized loss position as of June 30, 2006 consisted of 3,835 securities accounting for unrealized losses of $1.4 billion. Of these unrealized losses 93% were investment grade (rated AAA through BBB-) and 98% were less than 20% below cost. The amount of the unrealized loss on these securities was primarily attributable to increases in interest rates.

Of the investment securities in an unrealized loss position for twelve months or more as of June 30, 2006, 14 securities were 20% or more below cost, including 8 securities which were also below investment grade

GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

(rated BB+ and below). These 8 securities accounted for unrealized losses of $8 million. These securities consisted of four issuers primarily in the automotive and airline industries and were current on all terms. All airline securities were collateralized by commercial jet aircraft associated with one domestic airline. We believe these airline security holdings were in a temporary loss position as a result of ongoing negative market reaction to difficulties in the commercial airline industry. The unrealized loss on the automotive investments was primarily caused by deteriorating market share and legacy issues. The automotive issuer continues to maintain significant liquidity relative to its maturity and we currently expect to collect full principal and interest.

As of June 30, 2006, we expected these investments to continue to perform in accordance with their original contractual terms and we generally have the ability and intent to hold these investment securities until the recovery of the fair value up to the cost of the investment, which may be maturity. Accordingly, we do not consider these investments to be other-than-temporarily impaired at June 30, 2006. However, from time to time, we may sell securities in the ordinary course of managing our portfolio to meet diversification, credit quality, yield enhancement, asset-liability management and liquidity requirements.

The following table sets forth our positions in derivative instruments and the estimated fair values as of the dates indicated. The fair value of derivative instruments, including financial futures, interest rate and foreign currency swaps, foreign currency forward contracts and equity index options, are based upon quotations obtained from dealers or other reliable sources.

   June 30, 2006  December 31, 2005

(Amounts in millions)

  Notional
value
  Estimated
fair value
  Notional
value
  Estimated
fair value

Interest rate swaps

  $11,795  $222  $7,894  $508

Foreign currency swaps

   533   15   533   4

Equity index options

   223   20   265   21

Financial futures

   9   —     27   —  
                

Total

  $12,560  $257  $8,719  $533
                

As of June 30, 2006 and December 31, 2005, the fair value of derivatives in a gain position and recorded in other invested assets was $286 million and $559 million, respectively, and the fair value of derivatives in a loss position and recorded in other liabilities was $29 million and $26 million, respectively.

(5) Acquisitions

On May 1, 2006, we completed the acquisition of Continental Life Insurance Company of Brentwood, Tennessee (“Continental Life”), for $145 million, plus contingent consideration of $5 million per year for two years based on attaining certain sales production thresholds. Continental Life’s business provides primarily Medicare supplement insurance and is a part of our Protection segment. This acquisition was accounted for as ausing the purchase business combination.method. The excess purchase price over the estimated fair value of the net assets acquired of $29 million has been recorded as goodwill. In addition, $93 million of present value of future profits was recorded in connection with this transaction. The results of operations of Continental Life have been included in our consolidated results beginning May 1, 2006. We have reflected our initial allocation of the purchase price based on estimated fair value according to preliminary valuations. Such estimated values may change as additional information is obtained and the valuation is finalized.

On June 29,July 3, 2006, we agreedcompleted the acquisition of Vero Lenders Mortgage Insurance Limited (“Vero LMI”), a subsidiary of Vero Insurance Limited, which had been a wholly owned by Promina Group Limited of Sydney, Australia, for $82 million, net of post-closing dividends to acquireus. Vero LMI consists solely of a run-off mortgage insurance block and is part of our Mortgage Insurance segment. This acquisition was accounted for using the purchase method. Present value of future profits of $4 million and no goodwill was recorded in connection with this transaction. We have reflected our initial allocation of the purchase price based on estimated fair value according to preliminary valuations. Such estimated values may change as additional information is obtained and the valuation is finalized.

GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

On October 20, 2006, we acquired AssetMark Investment Services, Inc. (“AssetMark”) of Pleasant Hill, California, for approximately $230 million. AssetMark is an investment management and adviser company with

GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

more than $8$9 billion in third-party assets under management. Under terms of the agreement, we may pay additional performance-based payments of up to $100 million over three to five years. This transaction is expected to close in the third or fourth quarterTo fund this acquisition, we issued a total of 2006.

On July 3, 2006, we completed the acquisition$223 million of Vero Lenders Mortgage Insurance Limited (“Vero LMI”), a subsidiarycommercial paper at an interest rate of Vero Insurance Limited, which is wholly owned by Promina Group Limited of Sydney, Australia, for approximately $80 million, net of a post-closing dividend. Vero LMI consists solely of a run-off mortgage insurance block.5.29%. This transaction will be recorded in the thirdfourth quarter of 2006.

(6)(5) Stock-Based Compensation

On January 1, 2006, we adopted SFAS No. 123R under the modified prospective transition method. The statement requires the measurement and recognition of compensation expense for all share-based awards made to employees and directors, including stock options, stock appreciation rights (“SARs”), restricted stock units (“RSUs”) and deferred stock units (“DSUs”) under the 2004 Genworth Financial, Inc. Omnibus Incentive Plan (“Omnibus Incentive Plan”). We previously accounted for these awards under the fair value expense provisions of SFAS No. 123. Accordingly, on January 1, 2006, we recognized a $4 million after-tax increase to earningsincome related to our cumulative effect of adopting SFAS No. 123R.

We have recorded stock-based compensation expense related to the estimated value of the RSUs, DSUs, SARs and stock options for the periods presented:

 

  

Three months ended

June 30,

  

Six months ended

June 30,

  

Three months ended

September 30,

  

Nine months ended

September 30,

(Amounts in millions)

    2006      2005      2006      2005        2006          2005          2006          2005    

Stock-based compensation

  $12  $12  $24  $22

Stock-based compensation expense

  $11  $14  $36  $36
                        

For awards issued prior to January 1, 2006, stock-based compensation expense is recognized on a graded vesting attribution method over the awards’ respective vesting schedule. For awards issued after January 1, 2006, stock-based compensation expense is recognized evenly on a straight-line attribution method over the awards’ respective vesting period.

For purposes of determining the estimated fair value of stock-based payment awards on the date of grant we use the Black-Scholes Model. The Black-Scholes Model requires the input of certain assumptions that involve judgment. Management will continue to assess the assumptions and methodologies used to calculate estimated fair value of share-based compensation. Circumstances may change and additional data may become available over time, which could result in changes to these assumptions and methodologies.

The following table contains the stock option weighted-average grant-date fair value information and related valuation assumptions for Junethe nine months ending September 30, 2006 and 2005. Fair value is estimated using the Black-Scholes Model.

 

  June 30, 2006 June 30, 2005   2006 2005 

Estimated fair value per option

  $11.50  $9.63   $11.60  $10.49 

Valuation Assumptions:

      

Expected term (years)

   6   6    6.0   6.0 

Expected volatility

   28.0%  33.3%   28.0%  30.2%

Expected dividend yield

   0.9%  1.1%   0.9%  1.1%

Risk-free interest rate

   5.0%  4.0%   4.8%  4.0%

Under the Omnibus Incentive Plan, we are authorized to grant 38 million equity awards.

GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

Under the Omnibus Incentive Plan, we are authorized to grant 38 million equity awards.

For the three months ended JuneSeptember 30, 2006 and 2005, we granted 24,0001,705,410 and 25,8391,700,439 stock options with exercise prices ranging from $32.45$33.27 to $33.46,$34.13, and $27.78$30.79 to $29.90,$32.27, respectively, which equaled the closing market prices on the date of grant and have an exercise term of 10 years. The stock options will vest in 20% annual increments commencing on the first anniversary of the date of grant. Additionally, during the three months ended JuneSeptember 30, 2006 and 2005 we issued 6,000448,934 and 20,122504,573 RSUs with restriction periods ranging from 3 to 5 years and a fair value of $32.45,$34.13, and $27.96,$32.08, respectively, which is measured at the market price of a share of our nonrestricted stock on the grant date. There were no SARs grantedAdditionally, during these periods.

For the sixthree months ended JuneSeptember 30, 2006 and 2005, we granted 24,000730,600 and 111,663628,500 SARs with exercise prices of $34.13 and $32.10, respectively.

For the nine months ended September 30, 2006 and 2005, we granted 1,729,410 and 1,802,103 stock options with exercise prices ranging from $32.45$33.27 to $33.46$34.13 and $26.68 to $29.90,$32.27, respectively, which equaled the closing market prices on the date of grant and have an exercise term of 10 years. The stock options will vest in 20% annual increments commencing on the first anniversary of the date of grant. Additionally, during the sixnine months ended JuneSeptember 30, 2006 and 2005 we issued 6,000454,934 and 326,964831,537 RSUs with restriction periods ranging from 3 to 5 years and a fair value of $32.45$34.11 and $27.07,$30.11, respectively, which is measured at the market price of a share of our nonrestricted stock on the grant date. Additionally, during the nine months ended September 30, 2006 and 2005, we granted 730,600 and 628,500 SARs with exercise prices of $34.13 and $32.10, respectively. There were no SARs granted during these periods. There were 14,308,20615,161,276 and 14,547,26316,054,088 stock options, 1,829,1492,125,255 and 1,397,2391,822,443 RSUs and 6,393,7136,577,713 and 6,255,2136,883,713 SARs outstanding as of JuneSeptember 30, 2006 and 2005, respectively.

A summary of stock option activity as of JuneSeptember 30, 2006 and changes during the sixnine months then ended is presented below:

 

  Shares subject to
option
 Weighted average
exercise price
  Shares subject to
option
 Weighted average
exercise price

Balance as of January 1, 2006

  15,770,646  $21.93  15,770,646  $21.93

Granted

  24,000  $32.79  1,729,410  $34.11

Exercised

  (1,127,876) $19.47  (1,761,127) $19.97

Forfeited

  (358,564) $21.34  (577,653) $21.99

Expired

  —      —    
          

Balance as of June 30, 2006

  14,308,206  $22.16

Balance as of September 30, 2006

  15,161,276  $23.54
          

Exercisable as of June 30, 2006

  4,688,323  $23.03
     

Exercisable as of September 30, 2006

  4,907,611  $23.38
     

A summary of the status of our other equity-based awards as of JuneSeptember 30, 2006 and the changes during the sixnine months then ended is presented below:

 

 Restricted stock units
(RSUs)
 Deferred stock units
(DSUs)
 Stock appreciation rights
(SARs)
 Restricted stock units
(RSUs)
 Deferred stock units
(DSUs)
 Stock appreciation rights
(SARs)
 Number of
awards
 Weighted
average grant
date fair value
 Number of
awards
 Weighted
average fair value
 Number of
awards
 Weighted
average grant
date fair value
 Number of
awards
 Weighted
average grant
date fair value
 Number of
awards
 Weighted
average fair value
 Number of
awards
 Weighted
average grant
date fair value

Balance as of January 1, 2006

 1,879,761  $24.74 16,868 $32.12 6,883,713  $7.02 1,879,761  $24.74 16,868 $32.12 6,883,713  $7.02

Granted

 6,000  $32.45 8,148 $31.90 —     454,934  $34.11 21,143 $32.57 730,600  $11.60

Exercised

 (67) $32.10 —    (240,000) $6.65 (113,070) $19.51 —    (515,000) $6.65

Terminated

 (56,545) $27.10 —    (250,000) $6.65 (96,370) $27.40 —    (521,600) $7.43
                      

Balance as of June 30, 2006

 1,829,149  $24.70 25,016 $31.88 6,393,713  $7.01

Balance as of September 30, 2006

 2,125,255  $26.90 38,011 $33.63 6,577,713  $7.48
                      

GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

As of JuneSeptember 30, 2006, there was $71$98 million of total unrecognized stock-based compensation expense related to non-vested awards not yet recognized. This expense is expected to be recognized over a weighted average period of two years.

Cash received from stock options exercised for the sixnine months ending JuneSeptember 30, 2006 was $20$32 million. New shares were issued to settle all exercised awards. The actual tax benefit realized for the tax deductions from stock option exercisesthe exercise of equity based awards was $6 million bothand $12 million for the three and six months ended Junenine month period ending September 30, 2006, respectively.

The following table summarizes information about stock options outstanding as of JuneSeptember 30, 2006:

 

  Outstanding  Exercisable  Outstanding  Exercisable

Exercise price range

  Shares in
thousands
  Average
life(1)
  Average
exercise
price
  Shares in
thousands
  Average
exercise
price
  Shares in
thousands
  Average
life(1)
  Average
exercise
price
  Shares in
thousands
  Average
exercise
price

$14.11 – $18.51

  1,489,570  6.20  $17.28  734,395  $17.28  1,389,603  5.95  $17.28  1,037,627  $17.28

$19.45 – $22.67

  9,210,584  7.67   19.77  2,131,347   20.01  8,644,142  7.43  $19.76  1,818,316  $20.10

$23.20 – $27.95

  1,558,010  4.60   26.99  1,456,277   27.08  1,436,559  4.27  $27.00  1,387,044  $27.05

$28.00 – $36.62

  2,049,081  8.21   32.75  365,343   36.00  3,690,011  8.83  $33.40  663,663  $34.25

$37.89 – $39.60

  961  5.07   38.77  961   38.77  961  4.82  $38.77  961  $38.77
                           
  14,308,206  7.26  $22.16  4,688,323  $23.03  15,161,276  7.33  $23.54  4,907,611  $23.38
                        

(1)Average contractual life remaining in years

(7)(6) Commitments and Contingencies

(a) Litigation

We face a significant risk of litigation and regulatory investigations and actions in the ordinary course of operating our businesses, including class action lawsuits. Our pending legal and regulatory actions include proceedings specific to us and others generally applicable to business practices in the industries in which we operate. Plaintiffs in class action and other lawsuits against us may seek very large or indeterminate amounts, including punitive and treble damages, which may remain unknown for substantial periods of time. A substantial legal liability or a significant regulatory action against us could have an adverse effect on our financial condition and results of operations. Moreover, even if we ultimately prevail in the litigation, regulatory action or investigation, we could suffer significant reputational harm, which could have an adverse effect on our business, financial condition or results of operations.

(b) Commitments

As of JuneSeptember 30, 2006, we were committed to fund $318$329 million in U.S. commercial mortgage loansloan investments and $168$191 million in limited partnerships.

During the second quarter of 2006, we agreed to acquire Vero LMI and AssetMark, as further described in note 5 of these condensed consolidated financial statements.partnership investments.

(8)(7) Borrowings

Commercial Paper Facility

In March 2006, we issued $229 million of commercial paper and we used the proceeds from this issuance to finance a stock repurchase from GEFAHI concurrently with its secondary offering. The notes under the

GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

commercial paper program are offered pursuant to an exemption from registration under the Securities Act of 1933 and may have a maturity of up to 364 days from the date of issue. During the second quarter, we reduced the outstanding balance of our commercial paper by $85 million. As of JuneSeptember 30, 2006 and December 31, 2005, the weighted average interest rate on commercial paper outstanding was 5.17%5.26% and 3.29%, respectively, and the weighted average maturity was 3028 and 53 days, respectively.

From October 19, 2006 to October 20, 2006, we issued a total of $223 million of commercial paper at an interest rate of 5.29%, to fund the AssetMark acquisition that closed on October 20, 2006, as further described in note 4 of these condensed consolidated financial statements.

Revolving Credit Facilities

On May 25, 2006 we entered into a $1.0 billion five-year revolving credit facility, which matures in May 2011, replacing our $1.0 billion five-year revolving credit facility, which was scheduled to mature in May 2009. We also have a $1.0 billion revolving credit facility that matures in April 2010. These facilities bear variable interest rates based on a one-month LIBOR plus a margin. As of JuneSeptember 30, 2006, we had no borrowings under these facilities; however, we utilized $170$171 million of the commitment under these facilities for the issuance of a letter of credit for the benefit of one of our Mortgage Insurance subsidiaries.

Non-recourse Funding Obligations

On January 20, 2006, River Lake Insurance Company III (“River Lake III”), a special purpose financial captive insurance company wholly owned by First Colony Life Insurance Company (“First Colony”), itself anour indirect wholly owned subsidiary, of Genworth, issued $750 million in aggregate principal amount of floating rate surplus notes due 2036 (the “Notes”“RL III Notes”). River Lake III has received regulatory approval to issue additional series of its floating rate surplus notes up to an aggregate amount of $1.2 billion (including the RL III Notes), but is under no obligation to do so.

On September 22, 2006, River Lake Insurance Company (“River Lake I”), a special purpose captive insurance company wholly owned by First Colony, issued $300 million in aggregate principal amount of floating rate surplus notes due 2033 (the “RL I Notes”). River Lake I previously received approval from the Director of Insurance of the State of South Carolina (the “Director”) on July 23, 2003 to issue up to an aggregate amount of $1.2 billion of its floating rate surplus notes and has issued an aggregate of $1.1 billion to date (including the RL I Notes). Despite having additional capacity, River Lake I does not expect to issue any additional notes.

As of September 30, 2006 and December 31, 2005, the weighted average interest rate on our non-recourse funding obligations was 5.32% and 4.50%, respectively. The non-recourse funding obligations bear variable interest rates, and their carrying value approximates fair value as of September 30, 2006.

On October 24, 2006, Rivermont Life Insurance Company I (“Rivermont I”), a special purpose financial captive insurance company wholly owned by First Colony, issued $315 million in aggregate principal amount of floating rate surplus notes due 2050 (the “Rivermont I Notes”). Rivermont I has received regulatory approval to issue additional series of its floating rate surplus notes up to an aggregate principal amount of $475 million (including the Rivermont I Notes), but is under no obligation to do so. The Rivermont I Notes are direct financial obligations of River Lake IIIRivermont I and are not guaranteed by First Colony or Genworth.

The Rivermont I Notes were issued by River Lake IIIRivermont I to fund statutory reserves required by thefor policies subject to Valuation of Life Insurance Policies Regulation. River Lake IIIRegulation (more commonly known as “Regulation XXX”), as clarified by Actuarial Guideline 38 (more commonly known as “AXXX”) and its predecessor regulations. Rivermont I has

GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

reinsured on a coinsurance basis from First Colony, on a combination coinsurance and modified coinsurance basis, certain termuniversal life insurance policies having guaranteed level premiums. with secondary guarantees written or reinsured by First Colony. Genworth has agreed to provide a limited guaranty to Rivermont I to mitigate certain interest rate risks associated with this reinsurance. Genworth has agreed to provide a limited guaranty to Rivermont I to mitigate certain interest rate risks associated with this reinsurance. First Colony has also agreed to indemnify Rivermont I for certain limited costs.

The Rivermont I Notes werehave been sold to a third-party for deposit into certain Delaware trusts (the “Trusts”) that have issuedwill issue money market and term securities. The principal and interest payments due on the money market andor term securities were insured by a third party insurance company.(the “Securities”). The holders of the Rivermont I Notes cannot require repayment from Genworth or any of its subsidiaries, other than River Lake III,Rivermont I, the direct issuer of the Rivermont I Notes. First ColonyGenworth has also agreed, under certain circumstances, to indemnify River Lake III andprovide to the third party insurer forTrusts a certain limited costs.amount of liquidity in the event that the Trusts do not have sufficient funds available to fully redeem the Securities at the stated maturity date.

River Lake IIIRivermont I will pay interest on the principal amount of the Rivermont I Notes on a monthly basis, subject to regulatory approval. Any payment of principal of, including by redemption, or interest on the Rivermont I Notes may only be made with the prior approval of the Director of Insurance of the State of South Carolina in accordance with the terms of its licensing order and in accordance with applicable law. The holders of the Rivermont I Notes have no rights to accelerate payment of principal of the Rivermont I Notes under any circumstances, including without limitation, for nonpayment or breach of any covenant. River Lake IIIRivermont I reserves the right to repay the Rivermont I Notes at any time, subject to the terms of the Rivermont I Notes and prior regulatory approval.

As of June 30, 2006 and December 31, 2005, the weighted average interest rate on our non-recourse funding obligations was 5.34% and 4.50%, respectively. The non-recourse funding obligations bear variable interest rates, carrying value approximates fair value as of June 30, 2006.

(9)(8) Securitization Entities

GE Capital, our former indirect majority stockholder, provides credit and liquidity support to a funding conduit it sponsored, which exposes it to a majority of the risks and rewards of the conduit’s activities and

GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

therefore makes GE Capital the primary beneficiary of the funding conduit. Upon adoption of FIN No. 46,Consolidation of Variable Interest Entities, GE Capital was required to consolidate the funding conduit because of this financial support. As a result, assets and liabilities of certain previously off-balance sheet securitization entities, for which we were the transferor, were required to be included in our condensed consolidated financial statements because the funding conduit no longer qualified as a third-party. Because these securitization entities lost their qualifying status, we were required to recognize $1.2 billion of securitized assets and $1.1 billion of associated liabilities in our condensed consolidated statement of financial positionbalance sheet in July 2003. The assets and liabilities associated with these securitization entities have been reported in the corresponding financial statement captions in our condensed consolidated statement of financial position,balance sheet, and the assets are noted as restricted due to the lack of legal control we have over them. We apply the same accounting policies to these restricted assets and liabilities as we do to our unrestricted assets and liabilities.

As a result of GE Capital no longer having an ownership interest in us in March 2006, the respective funding conduit re-qualified as a third-party and these securitization entities regained their qualifying status under SFAS No. 140,Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities. As a result, the assets were effectively re-securitized and the related assets and liabilities were derecognized from our condensed consolidated financial statements. This resulted in a reduction from December 31, 2005 balances of $685 million, $44 million, $660 million and $15 million of restricted investments held by securitization entities, other assets, borrowings related to securitization entities and other liabilities, respectively. We continue to hold a retained interest in the form of interest-only strips classified as fixed maturity securities available-for-sale on our condensed consolidated statements of financial position. We recognized an investment loss on sale of $11 million, net of tax, from this re-securitization transaction.

(10)GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

(9) Operating Segment Information

We conduct our operations in four business segments: (1) Protection, which includes our life insurance, long-term care insurance, linked benefit products, Medicare supplement insurance, group life and health insurance and payment protection insurance; (2) Retirement Income and Investments, which includes our fixed annuities, individual andvariable annuities, group variable annuities anddesigned for 401(k) plans, single premium immediate annuities, variable life insurance, asset management and specialized products, including GICs, funding agreements, and FABNs, and structured settlements;asset management products and services; (3) Mortgage Insurance, which includes our mortgage insurance products and mortgage related services that facilitate homeownership by enabling borrowers to buy homes with low-down-payment mortgages; and (4) Corporate and Other, which includes interest and other debt financing expenses and other corporate income and expenses not allocated to the segments, as well as the results of a small, non-core business managed outside our operating segments.

In 2006, we began to allocate net investment gains (losses) from our Corporate and Other segment to our Protection (except payment protection insurance) and Retirement Income and Investments segments using an approach based principally upon the investment portfolio established to support each of those segments’ products and targeted capital levels. We do not allocate net investment gains (losses) from our Corporate and Other segment to our Mortgage Insurance segment or to our payment protection insurance business within the Protection segment, because they have their own separate investment portfolios, and net investment gains (losses) from those portfolios are reflected in the Mortgage Insurance and Protection segment results, respectively.

Prior to 2006, all net investment gains (losses) were recorded in the Corporate and Other segment and were not reflected in the results of any of our other segments.

GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

Effective January 1, 2006, GE Seguros (“Seguros”), a small Mexican-domiciled multi-line insurer, previously included in our Corporate and Other segment, is being managed within our Protection segment and whose results are now included as part of the payment protection insurance business. Segment information related to the Seguros move is reflected in all periods presented.

We use the same accounting policies and procedures to measure segment net operating earningsincome and assets as our consolidated net earningsincome and assets. Segment net operating earnings representincome represents the basis on which the performance of our business is assessed by management. Segment net operating earnings excludeincome excludes after-tax net investment gains (losses) (which can fluctuate significantly from period to period), and other adjustments, changes in accounting principles and infrequent or unusual non-operating items. There were no non-recurring, infrequent or unusual items excluded from net operating earningsincome for the periods presented.

GENWORTH FINANCIAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

The following is a summary of revenues, segment net operating earningsincome and reconciliation to total company net earningsincome for the periods presented:

 

  Three months ended
June 30,
 

Six months ended

June 30,

   Three months ended
September 30,
 

Nine months ended

September 30,

 

(Amounts in millions)

      2006         2005         2006         2005           2006         2005         2006         2005     

Revenues

          

Protection

  $1,639  $1,531  $3,191  $3,073   $1,654  $1,564  $4,845  $4,637 

Retirement Income and Investments

   726   735   1,439   1,470    762   705   2,201   2,175 

Mortgage Insurance

   364   300   699   594    356   303   1,055   897 

Corporate and Other

   25   44   50   84    32   56   82   140 
                          

Total revenues

  $2,754  $2,610  $5,379  $5,221   $2,804  $2,628  $8,183  $7,849 
                          

Segment net operating earnings (losses)

     

Segment net operating income (losses)

     

Protection

  $151  $133  $300  $272   $152  $145  $452  $417 

Retirement Income and Investments

   57   60   118   120    53   59   171   179 

Mortgage Insurance

   162   121   311   262    134   126   445   388 

Corporate and Other

   (31)  (29)  (45)  (43)   (32)  (19)  (77)  (62)
                          

Total segment net operating earnings

   339   285   684   611 

Total segment net operating income

   307   311   991   922 

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

   (22)  —     (37)  (4)   (3)  (4)  (40)  (8)
                          

Net earnings before accounting change

   317   285   647   607 

Net income before accounting change

   304   307   951   914 

Cumulative effect of accounting change, net of taxes

   —     —     4   —      —     —     4   —   
                          

Net earnings

  $317  $285  $651  $607 

Net income

  $304  $307  $955  $914 
                          

The following is a summary of total assets by operating segment as of:

 

(Amounts in millions)

  June 30,
2006
  December 31,
2005
  September 30,
2006
  December 31,
2005

Assets

        

Protection

  $35,598  $33,945  $37,793  $33,945

Retirement Income and Investments

   57,749   58,281   58,207   58,281

Mortgage Insurance

   7,580   7,118   8,000   7,118

Corporate and Other

   2,719   6,310   3,847   6,310
            

Total assets

  $103,646  $105,654  $107,847  $105,654
            

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our unaudited condensed consolidated financial statements and related notes included herein.

Cautionary note regarding forward-looking statements

This report contains certain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements may be identified by words such as “expects,” “intends,” “anticipates,” “plans,” “believes,” “seeks,” “estimates,” “will,” or words of similar meaning and include, but are not limited to, statements regarding the outlook for our future business and financial performance. Forward-looking statements are based on management’s current expectations and assumptions, which are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict. Actual outcomes and results may differ materially due to global political, economic, business, competitive, market, regulatory and other factors and risks, including the following:

 

  Risks relating to our businesses, including interest rate fluctuations, downturns and volatility in equity markets, defaults in portfolio securities, downgrades in our financial strength and credit ratings, insufficiency of reserves, legal constraints on dividend distributions by subsidiaries, illiquidity of investments, competition, inability to attract or retain independent sales intermediaries and dedicated sales specialists, availability and adequacy of reinsurance, defaults by counterparties, foreign exchange rate fluctuations, regulatory restrictions on our operations and changes in applicable laws and regulations, legal or regulatory investigations or actions, political or economic instability, the failure or any compromise of the security of our computer systems and the occurrence of natural or man-made disasters or a pandemic disease;

 

  Risks relating to our Protection and Retirement Income and Investments segments, including unexpected changes in morbidity, mortality and unemployment rates, accelerated amortization of deferred acquisition costs and present value of future profits, goodwill impairments, reputational risks if we were to raise premiums on in-force long-term care insurance products, medical advances such as genetic mapping research, unexpected changes in persistency rates, increases in statutory reserve requirements, the failure of demand for long-term care insurance to increase as we expect and changes in tax and securities laws;

 

  Risks relating to our Mortgage Insurance segment, including the influence of Fannie Mae, Freddie Mac and a small number of large mortgage lenders and investors, increased regulatory scrutiny of Fannie Mae and Freddie Mac resulting in possible regulatory changes, decreases in the volume of high loan-to-value mortgage originations or increases in mortgage insurance cancellations, increases in the use of simultaneous second mortgages and other alternatives to private mortgage insurance and reductions by lenders in the level of coverage they select, unexpected increases in mortgage insurance default rates or severity of defaults, deterioration in economic conditions, insufficiency of premium rates to compensate us for risks associated with mortgage loans bearing high loan-to-value ratios, increases in the use of captive reinsurance or other risk sharing structures in the mortgage insurance market, changes in the demand for mortgage insurance that could arise as a result of efforts of large mortgage investors, legal or regulatory actions or investigations under applicable laws and regulations, including the Real Estate Settlement Practices Act and the Federal Fair Credit Reporting Act, competition with government-owned and government-sponsored entities, potential liabilities in connection with contract underwriting services and growth in the global mortgage insurance market that is lower than we expect; and

 

  

Risks relating to our separation from GE, including the loss of benefits associated with GE’s brand and reputation, our need to establish the new Genworth brand identity quickly and effectively, the possibility that we will not be able to replace certain services previously provided by GE on terms that are at least as favorable, the possibility that in certain circumstances we will be obligated to make payments to GE

under our tax matters agreement even if our corresponding tax savings either are delayed or never materialize, the possibility that in the

event of a change in control of our company we would have insufficient funds to meet accelerated obligations under the tax matters agreement, the possibility that certain service agreements with GE are not extended on favorable terms, and the significance of our distribution relationship with GE in our payment protection insurance business.

We undertake no obligation to publicly update any forward-looking statement, whether as a result of new information, future developments or otherwise.

Overview

Our business

We are a leading insurance company in the U.S., with an expanding international presence. We have three operating segments: Protection, Retirement Income and Investments, and Mortgage Insurance.

 

  Protection. We offer U.S. customers life insurance, long-term care andinsurance, linked benefit products, Medicare supplement insurance and, primarily for companies with fewer than 1,000 employees, group life and health insurance. Through our European operations, we offer payment protection insurance, which helps consumers meet their payment obligations in the event of illness, involuntary unemployment, disability or death. Effective January 1, 2006, GE Seguros (“Seguros”), a small Mexican-domiciled multi-line insurer, previously included in our Corporate and Other segment, is being managed within our Protection segment and whose results are now included as part of the payment protection insurance business. For the three months ended JuneSeptember 30, 2006 and 2005, our Protection segment had segment net operating earningsincome of $151$152 million and $133$145 million, respectively. For the sixnine months ended JuneSeptember 30, 2006 and 2005, our Protection segment had segment net operating earningsincome of $300$452 million and $272$417 million, respectively.

 

  Retirement Income and Investments. We offer U.S. customers fixed annuities, individual andvariable annuities, group variable annuities designed for 401(k) plans, single premium immediate annuities, variable life insurance, asset management and specialized products, including guaranteed investment contracts (“GICs”), funding agreements and funding agreements backing notes (“FABNs”), and structured settlements.asset management products and services. For the three months ended JuneSeptember 30, 2006 and 2005, our Retirement Income and Investments segment had segment net operating earningsincome of $57$53 million and $60$59 million, respectively. For the sixnine months ended JuneSeptember 30, 2006 and 2005, our Retirement Income and Investments segment had segment net operating earningsincome of $118$171 million and $120$179 million, respectively.

 

  Mortgage Insurance. In the U.S., Canada, Australia, Europe, New Zealand, Mexico and Japan, we offer mortgage insurance products that facilitate homeownership by enabling borrowers to buy homes with low-down-payment mortgages.mortgages and mortgage related services for our financial services customers. For the three months ended JuneSeptember 30, 2006 and 2005, our Mortgage Insurance segment had segment net operating earningsincome of $162$134 million and $121$126 million, respectively. For the sixnine months ended JuneSeptember 30, 2006 and 2005, our Mortgage Insurance segment had segment net operating earningsincome of $311$445 million and $262$388 million, respectively.

We also have a Corporate and Other segment, which consists primarily of unallocated corporate income and expenses, the results of a small, non-core business that is managed outside our operating segments, and most of our interest and other financing expenses. For the three months ended JuneSeptember 30, 2006 and 2005, our Corporate and Other segment had segment net operating losses of $31$32 million and $29$19 million, respectively. For the sixnine months ended JuneSeptember 30, 2006 and 2005, our Corporate and Other segment had segment net operating losses of $45$77 million and $43$62 million, respectively.

Our financial information

The financial information presented herein has been derived from our condensed consolidated financial statements.

Revenues and expenses

Our revenues consist primarily of the following:

 

  Protection. The revenues in our Protection segment consist primarily of:

 

net premiums earned on individual life, individual long-term care, group life and health, and payment protection insurance policies;

 

net investment income and net investment gains (losses) on the separate investment portfolio held by our payment protection insurance business, and net investment income and net investment gains (losses) allocated to this segment’s other lines of business; and

 

policy fees and other income, including fees for mortality and surrender charges primarily from universal life insurance policies, and other administrative charges.

 

  Retirement Income and Investments. The revenues in our Retirement Income and Investments segment consist primarily of:

 

net premiums earned on single premium immediate annuities and structured settlements with life contingencies;

 

net investment income and net investment gains (losses) allocated to this segment; and

 

policy fees and other income, including surrender charges, mortality and expense charges, investment management fees and commissions.

 

  Mortgage Insurance. The revenues in our Mortgage Insurance segment consist primarily of:

 

net premiums earned on mortgage insurance policies;

 

net investment income and net investment gains (losses) on the segment’s separate investment portfolio; and

 

policy fees and other income, including fees from contract underwriting services.

 

  Corporate and Other. The revenues in our Corporate and Other segment consist primarily of:

 

net premiums, policy fees and other income from a small non-core insurance business in this segment; and

 

unallocated net investment income and net investment gains (losses).

In 2006, we began to allocate net investment gains (losses) from our Corporate and Other segment to our Protection (except payment protection insurance) and Retirement Income and Investments segments using an approach based principally upon the investment portfolios established to support each of those segments’ products and targeted capital levels. We do not allocate net investment gains (losses) from our Corporate and Other segment to our Mortgage Insurance segment or to our payment protection insurance business within the Protection segment because they have their own separate investment portfolios, and net investment gains (losses) from those portfolios are reflected in the Mortgage Insurance and Protection segment results, respectively.

Prior to 2006, all net investment gains (losses) were recorded in the Corporate and Other segment and were not reflected in the results of any of our other segments.

Our expenses consist primarily of the following:

 

benefits provided to policyholders and contractholders and changes in reserves;

 

interest credited on general account balances;

 

operating expenses, including commissions, marketing expenses, policy and contract servicing costs, overhead and other general expenses that are not capitalized (shown net of deferrals);

amortization of deferred policy acquisition costs and other intangible assets;

 

interest and other financing expenses; and

 

income taxes.

We allocate corporate expenses to each of our operating segments based on the amount of capital allocated to that segment.

Critical accounting policies

The accounting policies discussed in this section are those that we consider to be particularly critical to an understanding of our condensed consolidated financial statements because their application places the most significant demands on our ability to judge the effect of inherently uncertain matters on our financial results. These policies relate to valuation of investment securities and impairment of investment securities, deferred acquisition costs (“DAC”), present value of future profits (“PVFP”), valuation of goodwill, reserves, unearned premiums, derivatives, and contingent liabilities. For a discussion of each of these policies, please see the discussion entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Overview—Critical Accounting Policies” contained in our 2005 Annual Report on Form 10-K. For all of these policies, we caution that future events rarely develop exactly as forecast, and our management’s best estimates may require adjustment.

Valuation of investment securities. We obtain values for actively traded securities from external pricing services. For infrequently traded securities, we obtain quotes from brokers or we estimate values using internally developed pricing models. These models are based upon common valuation techniques and require us to make assumptions regarding credit quality, liquidity and other factors that affect estimated values. We regularly review investment securities for impairment in accordance with our impairment policy, which includes both quantitative and qualitative criteria. Quantitative criteria include length of time and amount that each security position is in an unrealized loss position, and for fixed maturities, whether the issuer is in compliance with terms and covenants of the security. Qualitative criteria include the financial strength and specific prospects for the issuer as well as our intent to hold the security until recovery. Our impairment reviews involve our finance, risk and asset management teams, as well as the portfolio management and research capabilities of GEAM (“GE Asset Management”) and other third-party managers, as required. We actively perform comprehensive market research, monitor market conditions and segment our investments by credit risk in order to minimize impairment risks.

Deferred acquisition costs.Deferred acquisition costs, or DAC, represent costs which vary with and are primarily related to the sale and issuance of our insurance policies and investment contracts that are deferred and amortized over the estimated life of the related insurance policies. These costs include commissions in excess of ultimate renewal commissions, solicitation and printing costs, sales material and some support costs, such as underwriting and contract and policy issuance expenses. DAC is subsequently amortized to expense, over the lives of the underlying contracts, in relation to the anticipated recognition of premiums or gross profits.

The amortization of DAC for traditional long-duration insurance products (including guaranteed renewable term life, life-contingent structured settlements and immediate annuities and long-term care insurance) is determined as a level proportion of premium based on commonly accepted actuarial methods and reasonable assumptions, established when the contract or policy is issued, about mortality, morbidity, lapse rates, expenses, and future yield on related investments. GAAP requires that assumptions for these types of products not be modified (or unlocked) unless recoverability testing deems them to be inadequate or a re-pricing event occurs. Amortization is adjusted each period to reflect policy lapse or termination rates as compared to anticipated experience. Accordingly, we could experience accelerated amortization of DAC if policies terminate earlier than originally assumed.

Amortization of DAC for annuity contracts without significant mortality risk and investment and universal life products is based on expected gross profits. Expected gross profits are adjusted quarterly to reflect actual experience to-date or for the unlocking of underlying key assumptions based on experience studies such as

mortality, withdrawal or lapse rates, investment margin or maintenance expenses. The estimation of expected

gross profits is subject to change given the inherent uncertainty as to the underlying key assumptions employed and the long duration of our policy or contract liabilities. Changes in expected gross profits reflecting the

unlocking of key assumptions could result in a material increase or decrease in the amortization of DAC

depending on the magnitude of the change in underlying assumptions. Significant factors that could result in a material increase or decrease in DAC amortization for these products include material changes in withdrawal or lapse rates, investment spreads or mortality assumptions. For the nine-months ended September 30, 2006 and 2005, key assumptions were unlocked in our Protection and Retirement Income and Investments segments to reflect our current expectation of future investment spreads and mortality.

The amortization of DAC for mortgage insurance is based on expected gross margins. Expected gross margins, defined as premiums less losses, are set based on assumptions for future persistency and loss development of the business. These assumptions are updated quarterly for actual experience to-date or as our expectations of future experience are revised based on experience studies. Due to the inherent uncertainties in making assumptions about future events, materially different experience from expected results in persistency or loss development could result in a material increase or decrease to DAC amortization for this business. For the nine months ended September 30, 2006 and 2005, key assumptions were unlocked in our Mortgage Insurance segment to reflect our current expectation of future persistency.

The following table sets forth the increase (decrease) on amortization of DAC related to unlocking of key assumptions by segment for the periods indicated:

   Three months ended
September 30,

(Amounts in millions)

      2006          2005    

Protection

  $(7) $2

Retirement Income and Investments

   4   —  

Mortgage insurance

   (2)  4
        

Total

  $(5) $6
        

The following discussion includes disclosure of variations from current estimates of DAC amortization and recoverability due to reasonably likely adverse changes in certain key assumptions. The impact of reasonably likely adverse changes described below is estimated individually, without consideration for any correlation among key assumptions or among lines of business. The estimated adverse variation in the amortization and recoverability of our DAC due to changes in key assumptions is an estimate of possible variation that may occur in the future, likely over a period of several calendar years.

The DAC amortization methodology for our variable products (variable annuities and variable universal life insurance) includes a long-term equity market average appreciation assumption of 8.5%. When actual returns vary from the expected 8.5% we assume a reversion to this mean over a 3- to 5-year period, subject to the imposition of ceilings and floors. The assumed returns over this reversion period are limited to the 85th percentile of historical market performance. Variation in equity market returns that could be considered reasonably likely would not have a material effect on the amortization of DAC.

We regularly review DAC to determine if it is recoverable from future income. For deposit products, if the current present value of estimated future gross profits is less than the unamortized DAC for a line of business, a charge to income is recorded for additional DAC amortization or for increased benefit reserves. For other products, if the benefit reserves plus anticipated future premiums and interest earnings for a line of business are less than the current estimate of future benefits and expenses (including any unamortized DAC), a charge to income is recorded for additional DAC amortization or for increased benefit reserves.

Continued low interest rates and lower than expected termination rates on older issued long-term care insurance policies have reduced our margins on this business. As of December 31, 2005, additional adverse variations in morbidity, mortality, termination rates or interest rates that could be considered reasonably likely to occur in the future would result in our long-term care insurance DAC being no longer fully recoverable. As of

December 31, 2005, adverse variation that we consider reasonably likely would result in additional amortization of DAC of up to $11 million assuming there is no increase in future premiums. However, more adverse variation could result in additional amortization of DAC or the establishment of additional benefit reserves, while any favorable variation would result in additional margin in our DAC recoverability analysis and would result in higher earnings recognition over the remaining duration of the in-force block. We expect future sales of profitable long-term care insurance will improve margins, which would reduce the likelihood that adverse variation in key assumptions would result in our DAC being no longer fully recoverable. As of December 31, 2005, we had $1.6 billion of DAC related to our long-term care insurance business. As of December 31, 2005, we believe all of our other businesses have sufficient future income, where the related DAC would be recoverable under adverse variations in morbidity, mortality, withdrawal or lapse rate, maintenance expense or interest rates that could be considered reasonably likely to occur.

As of September 30, 2006, we believe all of our businesses, including our long-term care business, have sufficient future income, where the related DAC would be recoverable under adverse variations in morbidity, mortality, withdrawal or lapse rate, maintenance expense or interest rates that could be considered reasonably likely to occur. For the nine months ended September 30, 2006 and 2005, there were no material charges to earnings as a result of our DAC recoverability testing.

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

The following discussion includes disclosure of variations from current estimates of PVFP recoverability due to reasonably likely adverse changes in certain key assumptions. The impact of reasonably likely adverse changes described below is estimated individually, without consideration for any correlation among key assumptions or among lines of business. The estimated adverse variation in the recoverability of our PVFP due to changes in key assumptions is an estimate of possible variation that may occur in the future, likely over a period of several calendar years.

We regularly review our assumptions and periodically test PVFP for recoverability in a manner similar to our treatment of DAC.

Continued low interest rates and lower than expected termination rates on long-term care insurance policies have reduced our margins for this acquired business. Additional adverse variations in morbidity, mortality, termination rates or interest rates that could be considered reasonably likely to occur in the future would result in our long-term care insurance PVFP being no longer fully recoverable. As of December 31, 2005, adverse variation that we consider reasonably likely would result in additional amortization of PVFP of up to $33 million assuming there is no increase in future premiums. However, more adverse variation could result in additional amortization of PVFP or the establishment of additional benefit reserves, while any favorable variation would result in additional margin in our PVFP recoverability analysis and would result in higher earnings recognition over the remaining duration of the in-force block. As of December 31, 2005, we had $100 million of PVFP related to our long-term care insurance business. As of December 31, 2005, we believe all of our other businesses have sufficient future income, where the related PVFP would be recoverable under adverse variations in morbidity, mortality, withdrawal or lapse rate, maintenance expense or interest rates that could be considered reasonably likely to occur.

As of September 30, 2006, we believe all of our businesses, including our long-term care business, have sufficient future income, where the related PVFP would be recoverable under adverse variations in morbidity, mortality, withdrawal or lapse rate, maintenance expense or interest rates that could be considered reasonably likely to occur. For the nine months ended September 30, 2006 and 2005, there were no material charges to earnings as a result of our PVFP recoverability testing.

Valuation of goodwill. Goodwill represents the excess of the amount paid to acquire our subsidiaries and other businesses over the fair value of their net assets at the date of acquisition. Under GAAP, we test the carrying value of goodwill for impairment annually at the “reporting unit” level, which is either an operating segment or a business one level below the operating segment. Under certain circumstances, interim impairment tests may be required if events occur or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. Goodwill is impaired if the fair value of the reporting unit as a whole is less than the fair value of the identifiable assets and liabilities of the reporting unit, plus the carrying value of goodwill, at the date of the test. The carrying amount of each reporting unit is determined based on the capital required to support the reporting unit’s activities including tangible and intangible assets. The determination of a reporting unit’s capital allocation requires management judgment and considers many factors including required regulatory capital.

The initial recognition of goodwill and subsequent testing for impairment require management to make assumptions concerning estimates of how the reporting unit will perform in the future using valuation methods including discounted cash flow analysis. These assumptions are based on our historical experience and our expectations of future performance. Our estimates are subject to change given the inherent uncertainty in predicting future performance and cash flows, which are impacted by such as things as policyholder behavior, competitor pricing, new product introductions and specific industry and market conditions. For the nine months ended September 30, 2006 and 2005 there were no material charges to earnings as a result of our impairment testing.

Insurance liabilities and reserves. We calculate and maintain reserves for the estimated future payment of claims to our policyholders and contractholders based on actuarial assumptions and in accordance with industry practice and GAAP. Many factors can affect these reserves, including economic and social conditions, inflation, healthcare costs, changes in doctrines of legal liability and damage awards in litigation. Therefore, the reserves we establish are necessarily based on estimates, assumptions and our analysis of historical experience. Our results depend significantly upon the extent to which our actual claims experience is consistent with the assumptions we used in determining our reserves and pricing our products. Our reserve assumptions and estimates require significant judgment and, therefore, are inherently uncertain. We cannot determine with precision the ultimate amounts that we will pay for actual claims or the timing of those payments.

Insurance reserves differ for long- and short-duration insurance policies and annuity contracts. Measurement of long-duration insurance reserves (such as guaranteed renewable term life, whole life and long-term care insurance policies) is based on approved actuarial methods, but necessarily includes assumptions about expenses, mortality, morbidity, lapse rates and future yield on related investments. Short-duration contracts (such as payment protection insurance) are accounted for based on actuarial estimates of the amount of loss inherent in that period’s claims, including losses incurred for which claims have not been reported. Short-duration contract loss estimates rely on actuarial observations of ultimate loss experience for similar historical events.

Estimates of mortgage insurance reserves for losses and loss adjustment expenses are based on notices of mortgage loan defaults and estimates of defaults that have been incurred but have not been reported by loan servicers, using assumptions of claim rates for loans in default and the average amount paid for loans that result in a claim. As is common accounting practice in the mortgage insurance industry and in accordance with GAAP, loss reserves are not established for future claims on insured loans that are not currently in default.

Unearned premiums. For single premium insurance contracts, we recognize premiums over the policy life in accordance with the estimated expiration of risk. We recognize a portion of the revenue in premiums earned in the current period, while the remaining portion is deferred as unearned premiums and earned over time in accordance with the estimated expiration of risk. If single premium policies are canceled and the premium is non-refundable, then the remaining unearned premium related to each cancelled policy is recognized to earned premiums upon notification of the cancellation. Estimation of risk expiration on which we base premium recognition is inherently judgmental and is based on actuarial analysis of historical experience.

As of September 30, 2006 and December 31, 2005, we had $4.2 billion and $3.6 billion, respectively of unearned premiums of which $2.3 billion and $1.8 billion, respectively, related to our international mortgage insurance business. We recognize international mortgage insurance unearned premiums over a period of up to 25 years, most of which are recognized between 3 and 7 years from issue date. The recognition of earned premiums for our international mortgage insurance business involves significant estimates and assumptions as to future loss development and policy cancellations. These assumptions are based on our historical experience and our expectations of future performance, which are highly dependent on assumptions as to long-term macroeconomic conditions including interest rates, home price appreciation and the rate of unemployment. We periodically review our estimate of risk expiration and adjust this estimate based on actual experience and changes in our expectation of future performance with any adjustments reflected in current period earnings. For the nine months ended September 30, 2006 and 2005, increases to international mortgage insurance earned premiums as a result of adjustments made to our estimation of risk expiration were $14 million and $19 million, respectively.

The following discussion includes disclosure of variations from current estimates of risk expiration due to reasonably likely changes in certain key assumptions. The estimated variation of our expiration of risk due to changes in key assumptions is an estimate of possible variation that may occur in the future, likely over a period of several calendar years.

Our estimate of risk expiration for our international mortgage insurance business is subject to change given the inherent uncertainty as to the underlying loss development and policy cancellation assumptions and the long duration of our international mortgage insurance policy contracts. Actual experience that is different than assumed for loss development or policy cancellations could result in a material increase or decrease in the recognition of earned premiums depending on the magnitude of the difference between actual and assumed experience. Loss development and policy cancellation variations that could be considered reasonably likely to occur in the future would result in accelerated or decelerated recognition of earned premiums that would result in an increase in net earnings of up to $40 million or a decrease in net earnings of up to $20 million, depending on the magnitude of variation experienced. It is important to note that the variation discussed above is not meant to be a best-case or worst-case scenario, and therefore, it is possible that future variation may exceed the amounts discussed above.

The remaining portion of our unearned premiums relates to our payment protection insurance and long-term care insurance businesses where the underlying assumptions as to risk expiration are not subject to significant uncertainty. Accordingly, changes in underlying assumptions as to premium recognition we consider being reasonably likely for these businesses would not result in a material impact on net earnings.

Derivatives.We enter into freestanding derivative transactions primarily to manage the risk associated with variability in cash flows or changes in fair values related to our financial assets and liabilities. We also use derivative instruments to hedge our currency exposure associated with certain foreign operations. We also purchase investment securities, issue certain insurance policies and engage in certain reinsurance contracts that have embedded derivatives. The associated financial statement risk is the volatility in net income which can result from (1) changes in fair value of derivatives not qualifying as accounting hedges; (2) ineffectiveness of designated hedges; and (3) counterparty default. Accounting for derivatives is complex, as evidenced by significant authoritative interpretations of the primary accounting standards which continue to evolve, as well as the significant judgments and estimates involved in determining fair value in the absence of quoted market values. These estimates are based on valuation methodologies and assumptions deemed appropriate in the circumstances. Such assumptions include estimated volatility and interest rates used in the determination of fair value where quoted market values are not available. The use of different assumptions may have a material effect on the estimated fair value amounts.

Contingent liabilities. A liability is contingent if the amount is not presently known, but may become known in the future as a result of the occurrence of some uncertain future event. We estimate our contingent liabilities based on management’s estimates about the probability of outcomes and their ability to estimate the range of

exposure. Accounting standards require that a liability be recorded if management determines that it is probable

that a loss has occurred and the loss can be reasonably estimated. In addition, it must be probable that the loss will be confirmed by some future event. As part of the estimation process, management is required to make assumptions about matters that are by their nature highly uncertain.

The assessment of contingent liabilities, including legal contingencies and income tax liabilities, involves the use of critical estimates, assumptions and judgments. Management’s estimates are based on their belief that future events will validate the current assumptions regarding the ultimate outcome of these exposures. However, there can be no assurance that future events, such as court decisions or Internal Revenue Service positions, will not differ from management’s assessments. Whenever practicable, management consults with third-party experts (including attorneys, accountants and claims administrators) to assist with the gathering and evaluation of information related to contingent liabilities. Based on internally and/or externally prepared evaluations, management makes a determination whether the potential exposure requires accrual in the financial statements.

Recent business trends and conditions

The following business trends and conditions have had a significant impact on our products during the periods covered by this report:

Life insurance. Results in our life insurance business are impacted by sales, mortality, persistency, investment yields, and the effective use of capital.statutory reserve requirements. Additionally, sales of newour products are dependent on competitive product features and pricing, distribution expansion and penetration, and consistent customer service. Regulation XXX requires insurers to establish additional statutory reserves for term and universal life insurance policies with long-term premium guarantees, which increases the capital required to write these products. For term life insurance, we have implemented capital management actions that improve our new business returns and have enabled us to decrease our premium rates. Recently, severalSeveral competitors have executed similar capital management actions and lowered their term prices accordingly, which could makehas made the market more competitive and could affect our future sales levels over time.levels. In addition, an October 2005 revisionvaluation of Life Insurance Policies Regulation as clarified by Actuarial Guideline 38 (more commonly known as “Regulation AXXX”) requires insurers to actuarial guidelinesestablish additional statutory reserves for Regulation XXX, effective forcertain universal life policies with secondary guarantees. On October 24, 2006, our wholly-owned subsidiary, Rivermont Life Insurance Company I, issued since July 1, 2005, may increase the$315 million of non-recourse funding obligations to fund statutory reserves ofrequired by Regulation AXXX for certain companies on a statutory basis. Reserves forblocks of our universal life policies already meet the requirementsbusiness. Rivermont has received regulatory approval to issue up to an aggregate of this guideline, so we expect that it will not have an impact on our capital requirements. However, we continue to work towards the execution$475 million of a capital management strategy for our universal life business which could result in the issuance of additional non-recourse funding obligations.

Long-term care insurance.Results of our long-term care insurance business are influenced by morbidity, persistency, investment yields, new product sales, expenses and reinsurance. Industry-wide first-year annualized premiums of individual long-term care insurance decreased approximately 10%11% for the threesix months ended March 31,June 30, 2006 compared to the threesix months ended March 31,June 30, 2005 according to the most recently published data by LIMRA International. Our sales growth in a challenging market reflects the breadth of our distribution and progress across multiple growth initiatives with an emphasis on broadening our product offerings. However,offerings, although, sales growth has been slower than anticipated sales growth,over the last couple of years. However, the continued low interest rate environment and the impact of lower termination rates on older issued policies, some with expiring reinsurance coverage, could resultare causing higher benefits and other changes in policy reserves, resulting in lower net operating earnings.income. In response to these trends, we will continue to pursue multiple growth initiatives, continue investing in claims process improvements, execute investment strategies and, if appropriate, consider rate increases to improve loss ratios.

In addition, during the second quarter of 2006, we recently completed the acquisition of Continental Life Insurance Company of Brentwood, Tennessee, a provider of Medicare supplement insurance, for approximately

$145 $145 million. This acquisition enhances our presence in the senior supplemental insurance market by more than doubling our existing annualized premiums for this product and giving us access to approximately 4,200 independent agents.

Payment protection insurance. Growth of our payment protection insurance business is dependent on economic conditions including consumer lending levels, client account penetration and the number of countries and markets we enter. Additionally, the types and mix of our products will vary based on regulatory and consumer acceptance of our products. Our payment protection insurance business continues to show strong growth from increased penetration of existing relationships, and the addition of new distribution relationships in existing and new countries and across our markets.countries.

Retirement products.Retirement Income and Investments segment results are affected by investment performance, interest rate levels, slope of the interest rate yield curve, net interest spreads, equity market fluctuations, mortality and the impact of new product sales and lapses. In addition, our competitive position within many of our distribution channels, as well as our ability to retain business, depends significantly upon product features, including current and minimum crediting rates on spread-based products relative to our competitors, surrender charge periods in fixed annuities as well as guaranteed features we offer in variable products. We continually evaluate our competitive position based upon each of those features, and we make adjustments as appropriate to meet our target return thresholds.

The attractiveness of certain fixed annuities has declined as a result of continued low long-term interest rates, a relatively flat yield curve and short termshort-term investment alternatives, such as certificates of deposit. These trends are having an adverse impact on both sales and retention of fixed annuities.annuities with the latter resulting in an acceleration of DAC amortization. In recent quarters, we have experienced improved spreads in fixed annuities primarily due to run-off of and crediting rate resets of historically higher crediting rate business. We expect this trend to continue.

We have focusedcontinue to focus on our Income Distribution Series of variable annuity products and riders. We have witnessed a decline in defined benefit retirement plans in favor of defined contribution plans with more of the responsibility for retirement income planning falling on the individual. Additionally, U.S. savings rates are at historical lows. We believe these factors support demand for individual and group retirement income products that provide various forms of guaranteed benefits with the opportunity to realize market performance upside. Our Income Distribution Series provides the contractholder with the ability to receive a guaranteed minimum income stream that they cannot outlive, along with an opportunity to participate in market appreciation. However, through various techniques, these products are designed to reduce some of our risks that generally accompany traditional products with guaranteed living benefits. We are targeting individuals who are focused on building a personal portable retirement plan or are moving from the accumulation to the distribution phase of their retirement planning.

We offer asset management products to individual investors and back office support services for independent broker dealers.broker-dealers. The industry is witnessing rapid increases of independent broker dealersbroker-dealers as registered representatives are leaving large national firms to form their own small firms. These new small firms need client and back office support services and access to technology. Further, individuals are increasingly transferring their money to managed products from mutual funds. We expect these trends to continue and possibly accelerate in the future. As a result of these trends, we are expanding our presence in this market and have announcedcompleted the acquisition of AssetMark Investment Services, Inc., a leading provider of open architecture asset management solutions to independent financial advisors, with more than $8$9 billion in assets under management. Our products consist of separately managed accounts and managed mutual fund accounts. We receive a management fee based upon the amount of assets under management. The results of our asset management business are a function of net flows and investment performance of assets under management, which are influenced by the relative performance of our product’s underlying investments and the overall equity market environment.

Mortgage insurance.The results of our Mortgage Insurance segment are affected by employment and other economic and housing markets trends, including mortgage origination volume, interest rate trends, home price appreciation, mortgage origination volume and levels of mortgage delinquencies (including seasonal effects). In addition, movements in foreign currency exchange rates affect our international mortgage insurance results.

In

We believe the U.S., economy overall remains relatively strong based on continued gross domestic product growth and low levels of unemployment. However, we believe that the U.S. housing market is slowing. In particular, certain areas of the Great Lakes region have experienced an economic slowdown and have seen a more pronounced weakness in their housing market as well as a decline in home prices. While our portfolio concentration in the impacted areas is limited to less than 10% of our total risk in-force, these areas of weakness may cause our U.S. losses and loss ratio to increase.

The recent rise in interest rates and lower home price appreciation in the U.S. have contributed to rising persistency rates. Our U.S. flow persistency was 72% and 64% for the nine months ended September 30, 2006 and September 30, 2005, respectively. We believe that sustained higher interest rates and increased persistency will lead to stable to growing levels of insurance in-force. Primary insurance in-force increased from $102 billion as of June 30, 2006 to $104 billion as of September 30, 2006. This increase in primary insurance-in-force reflected the second sequential quarter increase in flow insurance in-force after nearly five years of decline.

The demand for flow private mortgage insurance declined in the first quarter ofsix months ended June 30, 2006 as compared to the same period in 2005, according to data published byInside Mortgage Finance.We believe this was driven principally by the significant use of simultaneous second mortgages as an alternative to private mortgage insurance, the origination of mortgages that did not meet the eligibility requirements of Fannie Mae and Freddie Mac and mortgages that were securitized in mortgage-backed securities that did not use private mortgage insurance.

In the U.S., theThe bulk mortgage insurance market is increasing as a percentage of the overall primary mortgage insurance market, which we believe is driven in part, by an increase in non-prime mortgage-backed security issuances. We have increased our participation in selected segments of the bulk market and continue to evaluate additional opportunities this market presents.

The recent rise in interest rates and lower home price appreciation in the U.S. have contributed to rising persistency rates. Our U.S. flow persistency was 72% and 65% for the six months ended June 30, 2006 and June 30, 2005, respectively. We believe that sustained higher interest rates and increased persistency will lead to stable to growing levels of insurance in-force. Primary insurance in-force increased from $100 billion as of March 31, 2006 to $102 billion as of June 30, 2006. This increase in primary insurance-in-force reflected a sequential increase in flow insurance in-force for the first time in nearly five years.

Our international mortgage insurance business has continued to expand with favorable operating results. We expect that the growth of our established international mortgage insurance business and our entry into new international markets will continue to contribute an increasing portion of this segment’s total revenues and profits.

The Canadian government expanded its authority to guarantee mortgage insurance to cover any approved mortgage insurer in addition to us. The overall cap on guaranteed policies was also increased to CDN $200 billion and the government was given latitude to change the cap without further legislation. These changes facilitate our ongoing ability to offer mortgage insurance products under the guarantee but may also enable potential new competitors to do the same.

As a result of the significant U.S. refinancing activity since 2002 and the expansion of our international business in recent years, as of JuneSeptember 30, 2006, approximately 66%63% of our U.S. risk in-force and 67%61% of our international risk in-force have not yet reached its anticipated highest claim frequency years, which are generally between the third and seventh year of the loan. We expect our loss experience on these loans will increase as these books of business continue to mature.

In the second quarter of 2006, the Canadian government expanded its authority to guarantee mortgage insurance to cover any approved mortgage insurer in addition to us and can now do this without further legislation. The overall cap on guaranteed policies was also increased to CDN $200 billion. These changes facilitate our ongoing ability to offer mortgage insurance products under the guarantee but may also enable potential new competitors to do the same.

See “—Results of Operations by Segment” and selected operating performance measures contained herein for additional discussion of business trends and conditions.

Results of Operations

“Net operating earnings”income” is a non-GAAP financial measure that we define as net earnings,income, excluding after-tax net investment gains (losses) (which can fluctuate significantly from period to period), and other adjustments, changes in accounting principles and infrequent or unusual non-operating items. There were no non-recurring, infrequent or unusual items excluded from net operating earningsincome in the three and sixnine months ended JuneSeptember 30, 2006 and 2005.

Management believes that analysis of “net operating earnings”income” enhances understanding and comparability of performance by highlighting underlying business activity and profitability drivers. However, “net operating earnings”income” should not be viewed as a substitute for net earningsincome in accordance with GAAP. In addition, our definition of “net operating earnings”income” may differ from the definitions used by other companies.

Three Months Ended JuneSeptember 30, 2006 Compared to Three Months Ended JuneSeptember 30, 2005

The following table provides a reconciliation of net earningsincome to “net operating earnings”income” (as defined above) for the three months ended JuneSeptember 30, 2006 and 2005:

 

   Three months ended
June 30,
  Increase (decrease) and
percentage change
 

(Amounts in millions, except per share amounts)

      2006          2005              2006 vs. 2005         

Revenues:

      

Premiums

  $1,648  $1,614  $34  2%

Net investment income

   953   842   111  13%

Net investment gains (losses)

   (49)  —     (49) NM(1)

Policy fees and other income

   202   154   48  31%
              

Total revenues

   2,754   2,610   144  6%
              

Benefits and expenses:

      

Benefits and other changes in policy reserves

   1,096   1,051   45  4%

Interest credited

   378   347   31  9%

Acquisition and operating expenses, net of deferrals

   521   523   (2) —  %

Amortization of deferred acquisition costs and intangibles

   207   208   (1) —  %

Interest expense

   88   69   19  28%
              

Total benefits and expenses

   2,290   2,198   92  4%
              

Net earnings before income taxes and accounting change

   464   412   52  13%

Provision for income taxes

   147   127   20  16%
              

Net earnings before accounting change

   317   285   32  11%

Cumulative effect of accounting change, net of taxes

   —     —     —    —  %
              

Net earnings

   317   285   32  11%

Adjustments to net earnings:

      

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

   22   —     22  NM(1)

Cumulative effect of accounting change, net of taxes

   —     —     —    —  %
              

Net operating earnings

  $339  $285  $54  19%
              

Net earnings per common share:

      

Basic

  $0.70  $0.61   
           

Diluted

  $0.68  $0.60   
           

Net earnings before accounting change per common share:

      

Basic

  $0.70  $0.61   
           

Diluted

  $0.68  $0.60   
           

Net operating earnings per common share:

      

Basic

  $0.74  $0.61   
           

Diluted

  $0.72  $0.60   
           

Weighted-average common shares outstanding:

      

Basic

   455.8   470.4   
           

Diluted

   468.3   477.4   
           

(1)Not meaningful

   Three months ended
September 30,
  Increase (decrease) and
percentage change
 

(Amounts in millions, except per share amounts)

      2006          2005              2006 vs. 2005         

Revenues:

     

Premiums

  $1,680  $1,547  $133  9%

Net investment income

   944   902   42  5%

Net investment gains (losses)

   (6)  (7)  1  14%

Policy fees and other income

   186   186   —    0%
              

Total revenues

   2,804   2,628   176  7%
              

Benefits and expenses:

     

Benefits and other changes in policy reserves

   1,183   1,026   157  15%

Interest credited

   383   364   19  5%

Acquisition and operating expenses, net of deferrals

   533   506   27  5%

Amortization of deferred acquisition costs and intangibles

   170   217   (47) (22)%

Interest expense

   87   72   15  21%
              

Total benefits and expenses

   2,356   2,185   171  8%
              

Income before income taxes and accounting change

   448   443   5  1%

Provision for income taxes

   144   136   8  6%
              

Net income before accounting change

   304   307   (3) (1)%

Cumulative effect of accounting change, net of taxes

   —     —     —    —  %
              

Net income

   304   307   (3) (1)%

Adjustments to net income:

     

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

   3   4   (1) (25)%

Cumulative effect of accounting change, net of taxes

   —     —     —    —  %
              

Net operating income

  $307  $311  $(4) (1)%
              

Net earnings per common share:

     

Basic

  $0.67  $0.65   
           

Diluted

  $0.65  $0.64   
           

Net operating earnings per common share:

     

Basic

  $0.68  $0.66   
           

Diluted

  $0.66  $0.65   
           

Weighted-average common shares outstanding:

     

Basic

   453.8   470.7   
           

Diluted

   467.2   481.1   
           

Premiums. Premiums consist primarily of premiums earned on insurance products for individual life, long-term care, Medicare supplement, group life and health, payment protection, single premium immediate annuities and structured settlements with life contingencies and mortgage insurance policies. Premiums increased $47$66 million in our Mortgage InsuranceProtection segment reflectingprimarily due to a $73 million increase in our long-term care business mainly from growth in the in-force block and aging of our international mortgage insurance in-force block.the Continental Life acquisition. Additionally, our Protection segment increased $33$26 million primarily due tofrom growth in the in-force of our term life insurance in-force block and $27 million in our long-term care business from the Continental Life acquisition.group business. Partially offsetting these increases in the Protection segment was a $30$33 million decrease from our

payment protection business as a result of a decrease in the U.K. marketrun-off block. Premiums in our Mortgage Insurance segment increased $44 million reflecting growth and changes in foreign exchange rates.seasoning of our of our international mortgage insurance in-force block. Our Retirement Income and Investments segment decreased $41increased $21 million attributable to a reduction inhigher sales of our life-contingent single premium immediate annuities, partially offset by a reduction in our life-contingent structured settlement annuities.

Net investment income.Net investment income increased primarily as a result of an increase in average invested assets in our Protection and Retirement Income and Investments segments. The increase in our Protection segment was attributable to growth of our long-term care in-force block and an increase related to assets purchased using proceeds from our issuance of non-recourse funding obligations supporting certain term life insurance policies, growth ofpolicies. The increase in our long-term care in-force blockRetirement Income and Investments segment was largely driven by new production in institutional products. The increase in net investment income wasOur Mortgage segment also increased due to an increasegrowth in weightedassets in the mortgage international business. Weighted average investment yields to 5.8%were 5.7% for the three months ended JuneSeptember 30, 2006 from 5.4%and 2005. Higher yields on floating rate investments for the three months ended JuneSeptember 30, 2005. The increase in weighted average2006 were offset primarily by lower investment yields was primarily attributable to increased yields on floating rateincome from bond calls, commercial mortgage loan prepayments and limited partnership investments. Net investment income for the three months ended JuneSeptember 30, 2006 included $35$13 million of investment income from a reduction in commercial mortgage loan loss reserves, bond calls, commercial mortgage loan prepayments and limited partnership investments as compared to $9$40 million in investment income from bond calls, mortgage loan prepayments and limited partnership investments in the prior year.

Net investment gains (losses). For the three months ended JuneSeptember 30, 2006, gross investment gains were $8$14 million and gross investment (losses) were $57($20) million, including $4($1) million of impairments. Gross investment gains for the three months ended JuneSeptember 30, 2006 were primarily attributable to $8$11 million in gains on the sale of available-for-sale fixed maturities and equity securities. Gross investment losses include $50$19 million of interest rate related losses as a result of the disposition of available-for-sale securities primarily from portfolio repositioning activities, a $4 million impairment charge related to an equity security and $2 million in connection with terminations and losses in fair value of non-qualified derivatives. Net investment losses on trading securities were $1 million for the three months ended June 30, 2006.activities. For the three months ended JuneSeptember 30, 2005, gross investment gains on available-for-sale securities were $12$35 million and gross investment losses(losses) on available-for-sale securities were $12($42) million, including $3($32) million of impairments. The available-for-sale securities impairments related primarily to fixed maturity securities issued by companies in the consumer productsfinance and insurance, retail, timber and transportation industries ($110 million, $9 million, $5 million and $1$4 million, respectively).

Policy fees and other income. Policy fees and other income consist primarily of cost of insurance and surrender charges assessed on universal life insurance policies, fees assessed against policyholder and contractholder account values, and commission income. The increase in policyPolicy fees and other income was primarily due to higherremained flat for the period. Higher sales and growth in assets under management in Retirement Income and Investments’ fee-based products ofresulted in a $22 million increase in policy fees and other income. This was offset by a $20 million reduction in our life business as a result of distribution expansion, favorable equity markets,unfavorable unearned revenue adjustments and continued product enhancements. In addition,a $4 million reduction in our lifemortgage insurance business increased $21 million primarily as a resultlargely driven by the recent elimination of the growth of our universal life insurance in-force block.Canadian application fees.

Benefits and other changes in policy reserves. Benefits and other changes in policy reserves consist primarily of benefits paid and reserve activity related to current claims and future policy benefits on insurance and investment products for life, long-term care, Medicare supplement, group life and health, payment protection, structured settlements and single premium immediate annuities with life contingencies and claim costs incurred related to mortgage insurance products. The increase in benefits and other changes in policy reserves was primarily driven by a $64$79 million increase in our long-term care business as a result of higher incurred claims associated with thedriven by aging ofand growth in the in-force block, higher than expected loss experience in the current quarter,continued low termination rates on older issued policies as well as the Continental Life acquisition. Adding to this increase was an $11a $40 million increase in our Mortgage Insurance segment

primarily driven by higher losses in Australia from portfolio seasoning andin our international mortgage insurance business, increased delinquencieslosses from a limited number of Australian distribution relationships. Thisrelationships and $9 million of favorable adjustments in the prior year that did not recur. Additionally, our U.S. mortgage insurance business increased attributable to higher losses associated with a smaller decline in our average reserve per delinquency than in the prior year. Our Retirement Income and Investments segment also increased as a

result of higher sales of life-contingent single premium immediate annuities, which was partially offset by a decrease in our Retirement Income and Investments segmentsales of $34 million attributable to the decline in life-contingent structured settlement annuity sales.annuities.

Interest credited. Interest credited represents interest credited on behalf of policyholder and contractholder general account balances. The increase in interest credited from our Retirement Income and Investments segment was primarily due to a $37$28 million increase related to spread-based institutional products as a result of increasedhigher crediting rates on floating rate products and higher assets under management. This increase was partially offset by an $11a $16 million decrease in interest credited on fixed annuitiesrelated to spread-based retail products, primarily due to fixed annuities crediting rates being reset to current, lower rates as the fixed annuities reach the end of their initial crediting rate guarantee period. In addition, interest credited increased $7 million from universal life products in our Protection segment primarily from higher crediting rates and higher account values.

Acquisition and operating expenses, net of deferrals. Acquisition and operating expenses, net of deferrals, represent costs and expenses related to the acquisition and ongoing maintenance of insurance and investment contracts, including commissions, policy issuance expenses and other underwriting and general operating costs. These costs and expenses are net of amounts that are capitalized and deferred, which are primarily costs and expenses that vary with and are primarily related to the sale and issuance of our insurance policies and investment contracts, such as first-year commissions in excess of ultimate renewal commissions and other policy issuance expenses. AnAcquisition and operating expenses, net of deferrals, increased primarily from an $11 million increase in our fee-based productspayment protection business as a result of growth in continental Europe and Ireland and changes in foreign exchange rates, which was partially offset by a decrease associated with our U.K. run-off block. In addition, our long-term care business increased $7 million primarily from the Continental acquisition. Also, our Retirement Income and Investments segment of $16Investments’ fee-based products increased $13 million associated with higher sales and growth in assets under management in fee-based products was offset by a $15 million decrease in our Corporate and Other segment that was attributable to lower unallocated overhead expenses in 2006 compared to 2005.management.

Amortization of deferred acquisition costs and intangibles. Amortization of deferred acquisition costs and intangibles consists primarily of the amortization of acquisition costs that are capitalized, PVFP and PVFP. Thecapitalized software. Amortization of deferred acquisition costs and intangibles decreased as a result of a $57 million decrease in our Protection segment primarily attributable to a $32 million decrease from our life insurance business, as further described in the Protection segment results, a $28 million decrease from our payment protection insurance business, partially offset by a $4 million increase in our long-term care business. The decrease in our payment protection insurance business was largely driven by the continued decline of $8 millionour run-off block within the U.K. and was partially offset by an $8increase attributable to changes in foreign exchange rates. These decreases were offset by an $11 million increase in our Retirement Income and Investments segment primarily from our spread-based retail products. This increaseproducts due to continued lapses in our Retirement Income and Investments segment was partially offset by an $11 million reduction in amortization expense attributable to investment losses on our investment contracts.fixed annuities.

Interest expense. Interest expense increased primarily as a result of the issuanceissuances of additional non-recourse funding obligations in the first quarter of 2006 and the second and third quarters of 2005, and an increase in average variable rates paid on non-recourse funding obligations supporting our term life insurance capital management strategy.those obligations. This was partially offset by a decrease in interest expense associated with the first quarter 2006 derecognition of borrowings related to securitization entities.entities in the first quarter of 2006.

Provision for income taxes.The effective tax rate increased to 31.7%32.1% for the three months ended JuneSeptember 30, 2006 from 30.8%30.7% for the three months ended JuneSeptember 30, 2005. The increase in effective tax rate was primarily attributable to nonrecurring favorable examination developments in 2005, offset in part by the increase in lower taxed foreign earnings in 2006.

Net operating earnings.income. The increasedecrease in net operating earningsincome reflects increasesdecreases in segment net operating earnings in our Protection and Mortgage Insurance segments, offset by our Retirement Income and Investments and Corporate and Other segments which experienced small decreases,segment net operating income, offset by increases in our Protection and Mortgage Insurance segments net operating income, as discussed in the “—Results of Operations by Segment.” Included in net operating income is a $6 million, net of tax, increase attributable to changes in foreign exchange rates.

SixNine Months Ended JuneSeptember 30, 2006 Compared to SixNine Months Ended JuneSeptember 30, 2005

The following table provides a reconciliation of net earningsincome to “net operating earnings”income” (as defined above) for the sixnine months ended JuneSeptember 30, 2006 and 2005.

 

  Six months ended
June 30,
 Increase (decrease) and
percentage change
   Nine months ended
September 30,
 Increase (decrease) and
percentage change
 

(Amounts in millions, except per share amounts)

      2006         2005                 2006 vs. 2005                   2006         2005               2006 vs. 2005           

Revenues:

           

Premiums

  $3,187  $3,219  $(32)  (1)%  $4,867  $4,766  $101  2%

Net investment income

   1,877   1,693   184   11%   2,821   2,595   226  9%

Net investment gains (losses)

   (71)  (6)  (65)  NM(1)   (77)  (13)  (64) NM(1)

Policy fees and other income

   386   315   71   23%   572   501   71  14%
                       

Total revenues

   5,379   5,221   158   3%   8,183   7,849   334  4%
                       

Benefits and expenses:

           

Benefits and other changes in policy reserves

   2,131   2,126   5   —  %   3,314   3,152   162  5%

Interest credited

   751   687   64   9%   1,134   1,051   83  8%

Acquisition and operating expenses, net of deferrals

   996   970   26   3%   1,529   1,476   53  4%

Amortization of deferred acquisition costs and intangibles

   381   401   (20)  (5)%   551   618   (67) (11)%

Interest expense

   170   141   29   21%   257   213   44  21%
                       

Total benefits and expenses

   4,429   4,325   104   2%   6,785   6,510   275  4%
                       

Net earnings before income taxes and accounting change

   950   896   54   6%

Income before income taxes and accounting change

   1,398   1,339   59  4%

Provision for income taxes

   303   289   14   5%   447   425   22  5%
                       

Net earnings before accounting change

   647   607   40   7%

Net income before accounting change

   951   914   37  4%

Cumulative effect of accounting change, net of taxes

   4   —     4   NM(1)   4   —     4  NM(1)
                       

Net earnings

   651   607   44   7%

Adjustments to net earnings:

      

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

   37   4   33   NM(1)

Net income

   955   914   41  4%

Adjustments to net income:

     

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

   40   8   32  NM(1)

Cumulative effect of accounting change, net of taxes

   (4)  —     (4)  NM(1)   (4)  —     (4) NM(1)
                       

Net operating earnings

  $684  $611  $73   12%
            

Net operating income

  $991  $922  $69  7%
           

Net earnings per common share:

           

Basic

  $1.41  $1.27    
          

Diluted

  $1.37  $1.25    
          

Net earnings before accounting change per common share:

      

Basic

  $1.40  $1.27      $2.08  $1.92   
                   

Diluted

  $1.37  $1.25      $2.02  $1.88   
                   

Net operating earnings per common share:

           

Basic

  $1.48  $1.27      $2.16  $1.93   
                   

Diluted

  $1.44  $1.26      $2.10  $1.90   
                   

Weighted-average common shares outstanding:

           

Basic

   461.3   479.6       458.8   476.7   
                   

Diluted

   473.9   485.9       471.7   484.7   
                   

(1)Not meaningful

Premiums. The decreaseincrease in premiums is primarily driven by a $105an increase of $66 million decrease in our Retirement IncomeProtection segment primarily driven by a $117 million increase in our long-term care business mainly from growth in the in-force block and Investments$70 million from the Continental Life acquisition. Additionally, our Protection segment increased $88 million primarily from a reductiongrowth in salesthe in-force blocks of our life-contingent structured settlement annuities.term life insurance and group insurance businesses. Our payment protection business decreased $139 million driven by the run-off block within the U.K. and changes in foreign exchange rates. Partially offsetting this is a $79 million increasethese decreases in our payment protection business

was premium growth in continental Europe and Ireland. Premiums in our Mortgage Insurance segment reflectingincreased $123 million largely driven by growth and agingseasoning of our international mortgage insurance in-force block. Premiums forThe decrease in Retirement Income and Investments premiums was primarily the Protection segment were unchanged compared to the prior year. Our payment protection business decreased by $106 million as a result of a decrease in the U.K. market and changes in foreign exchange rates. Offsetting the decrease in the payment protection business was increases$141 million reduction in our life, long-term care and group life and health businesses. The life business increased $53life-contingent structured settlement annuities, which was partially offset by a $59 million primarily due to growthincrease from higher sales of our term life insurance in-force block. The long-term care business increased $44 million associated with growth in the in-force block and $27 million in our long-term care business from the Continental Life acquisition.life-contingent single premium immediate annuities.

Net investment income.Net investment income increased primarily as a result of an increase in average invested assets in our Protection segment attributable to growth of our long-term care in-force block and an increase related to assets purchased using proceeds from our issuance of non-recourse funding obligations supporting certain term life insurance policiespolicies. Additionally, our Retirement Income and Investments segment was principally due to increased yields on floating rate investments and higher assets under management. Our Mortgage insurance segment also increased due to an increase in assets associated with the growth of our long-term care in-force block.international mortgage business. The increase in net investment income was also due to an increase in weighted average investment yields to 5.7% for the sixnine months ended JuneSeptember 30, 2006 from 5.4%5.5% for the sixnine months ended JuneSeptember 30, 2005. The increase in weighted average investment yields was primarily attributable to increased yields on floating rate investments.Netinvestments. Net investment income for the sixnine months ended JuneSeptember 30, 2006 included $54$67 million of investment income related to a reduction in bond calls, commercial mortgage loan prepayments, limited partnership investments and the release of commercial mortgage loan loss reserves bond calls, mortgage loan prepayments and limited partnership investments as compared to $29$69 million in investment income from bond calls, mortgage loan prepayments and limited partnership investments in the prior year.

Net investment gains (losses). For the sixnine months ended JuneSeptember 30, 2006, gross investment gains were $30$42 million and gross investment losses(losses) were $101($119) million, including $5($6) million of impairments. These impairments were attributable to available-for-sale equity securities, fixed maturities and limited partnership investments ($4 million, $1 million and $1 million, respectively). Gross investment gains for the sixnine months ended JuneSeptember 30, 2006 were associated with $30$41 million in gains on the sale of available-for-sale fixed maturities and equity securities. Gross investment losses for the nine months ended September 30, 2006 include $76$95 million of interest rate related losses as a result of the disposition of available-for-sale securities primarily from portfolio repositioning activities, $17 million on the derecognition of assets and liabilities associated with certain securitization entities, $5and $6 million of impairment charges, and $2 million in connection with terminations and losses in fair value of non-qualified derivatives. Net investment losses on trading securities were $1 million forcharges. For the sixnine months ended June 30, 2006. For the six months ended JuneSeptember 30, 2005, gross investment gains were $51$86 million and gross investment losses(losses) were $57($99) million, including $37($68) million of impairments. These impairments were attributable to available-for-sale fixed maturities, equity investments and limited partnership investments and equity investments ($3162 million, $5 million and $1 million, respectively). The fixed maturities impairments related primarily to securities issued by companies in the automotive, transportation finance and consumer productsinsurance and retail industries ($1417 million, $12$16 million, $10 million and $3$9 million, respectively).

Policy fees and other income. The increase in policy fees and other income was primarily due to a $58 million increase in Retirement Income and Investments’ fee-based products driven by higher sales and growth in assets under management in Retirement Income and Investments’ fee-based products of $36 million as a result of distribution expansion, favorable equity markets, and continued product enhancements.management. In addition, our life insurance businessProtection segment increased $26$13 million primarily as a result of thedue to growth of our universal life insurance in-force block.block in our life insurance business and a reclassification from premiums and interest credited in our long-term care business.

Benefits and other changes in policy reserves. The increase in benefits and other changes in policy reserves was primarily driven by a $70$152 million increase in our Protection segment resultingprincipally from claims associated with the aging of theour long-term care insurance business as a result of higher incurred claims driven by aging and growth in the in-force block, expiring reinsurance coverage, continued low termination rates on older issued policies and the Continental Life acquisition. Adding to this increase was a $36$76 million increase in our Mortgage Insurance segment largely driven by higher losses in Australia from portfolio seasoning and increased delinquencieslosses from a limited number of distribution relationships. ThisAdditionally, our U.S. mortgage insurance business increased attributable to an increase was nearlyin our average reserve per delinquency. These increases were partially offset by a decrease in our Retirement Income and Investments segment of $101$64 million primarily attributable to the decline in life-contingent structured settlement annuity sales.

Interest credited. The increase in interest credited was primarily due to a $69$97 million increase related to spread-based institutional products as a result of increased crediting rates on floating rate products and higher

assets under management, and a $10 million increase in our Protection segment. This increase was partially offset by a $17$33 million decrease in interest credited onlargely from fixed annuities primarily due toin our spread-based retail products associated with crediting rates being reset to current, lower rates as the fixed annuities reach their initial crediting rate guarantee period. Our Protection segment also experienced a $17 million increase principally from $13 million in our long-term care business driven by growth in the cash surrender value of our corporate owned life insurance block of business and reclassification from policy fees and other income in the prior year.

Acquisition and operating expenses, net of deferrals. Acquisition and operating expenses, net of deferrals, increased primarily due a $27to higher expenses of $37 million increase in our Retirement Income and Investments segment associated withlargely from higher sales and growth in assets under management in fee-based products, partially offset by $6 million of lower expenses associated with our spread-based retail products. Additionally, our long-term care business increased $43 million largely due to growth from the in-force-block and a $10 million increase in our Mortgage Insurance segment primarily as a result of an increase in costs in our existing international platforms and continued investment in potential new international mortgage insurance platforms. This wasthe Continental acquisition. These increases were partially offset by a $9$30 million decrease in our Corporatepayment protection insurance business primarily driven by our run-off block within the U.K. and Other segment that was principally from lower unallocated overhead expenseschanges in 2006 compared to 2005.foreign exchange rates.

Amortization of deferred acquisition costs and intangibles. Amortization of deferred acquisition cost and intangibles decreased primarily due to a $38$95 million decrease in our Protection segment fromlargely driven by our payment protection insurance business run-off block and changes in foreign exchange rates, as well as awithin the U.K. This decrease in our long-term care business related to a correction related to a long-term care policy rider in the prior year. This was partially offset by an increase in our Retirement Income and Investments of $17a $30 million associated with higher lapses and growth in spreads on spread-based retail products. Partially offsetting this increase in our Retirement Income and Investments segment was an $11 million reductionfrom higher lapses and more favorable gross profit margins in amortization expense attributable to investment losses.spread-based retail products.

Interest expense. Interest expense increased primarily as a result of the issuanceissuances of additional non-recourse funding obligations in the first quarter of 2006 and the second and third quarters of 2005, and an increase in average variable rates paid on non-recourse funding obligations supporting our term life insurance capital management strategy.those obligations. This was partially offset by a decrease in interest expense associated with the first quarter 2006 derecognition of borrowings related to securitization entities.

Provision for income taxes. The effective tax rate decreasedincreased to 31.9%32.0% for the sixnine months ended JuneSeptember 30, 2006 from 32.3%31.7% for the sixnine months ended JuneSeptember 30, 2005. The decreaseincrease in effective tax rate was primarily attributable to nonrecurring favorable examination developments in 2005, offset in part by the increase in lower taxed foreign earnings in 2006, offset in part by nonrecurring favorable examination developments in 2005.2006.

Net operating earnings.income. The increase in net operating earningsincome reflects increases in segment net operating earningsincome in our Protection and Mortgage Insurance segments, offset by decreases in our Retirement Income and Investments and Corporate and Other segments, as discussed in the “—Results of Operations by Segment.” Included in net operating income is a $6 million, net of tax, increase attributable to changes in foreign exchange rates.

Results of Operations by Segment

Management regularly reviews the performance of each of our operating segments (Protection, Retirement Income and Investments and Mortgage Insurance) based on after-tax segment net operating earningsincome (loss), which excludes: (1) cumulative effect of accounting changes, and (2) infrequent or unusual non-operating items. Certain other items, including most of our interest and other financing expenses and advertising, marketing and other corporate expenses, are included in our Corporate and Other segment. Although these excluded items are significant to our consolidated financial performance, we believe that the presentation of segment net operating earningsincome (loss) enhances our understanding and assessment of the results of operations of our operating segments by highlighting net earningsincome (loss) attributable to the normal, recurring operations of our business. However, segment net operating earningsincome (loss) is not a substitute for net income determined in accordance with GAAP.

Protection segment

We offer U.S. customers life insurance, long-term care insurance, linked benefits products, Medicare supplement insurance and, primarily for companies with fewer than 1,000 employees, group life and health insurance. In Europe, we offer payment protection insurance in 18 countries, which helps consumers meet their

payment obligations in the event of illness, involuntary unemployment, disability or death. Effective January 1, 2006, Seguros, a small Mexican-domiciled multi-line insurer, previously included in our Corporate and Other segment, is now being managed within our Protection segment and whose results are now included as part of the payment protection insurance business.

Three Months Ended JuneSeptember 30, 2006 Compared to Three Months Ended JuneSeptember 30, 2005

The following table sets forth the results of operations relating to our Protection segment for the three months ended JuneSeptember 30, 2006 and 2005:

 

  Three months ended
June 30,
  Increase (decrease) and
percentage change
   Three months ended
September 30,
  Increase (decrease) and
percentage change
 

(Amounts in millions)

      2006         2005              2006 vs. 2005               2006         2005                2006 vs. 2005           

Revenues:

            

Premiums

  $1,174  $1,141  $33  3%  $1,199  $1,133  $66  6%

Net investment income

   364   312   52  17%   363   321   42  13%

Net investment gains (losses)

   (2)  —     (2) NM(1)   2   —     2  NM(1)

Policy fees and other income

   103   78   25  32%   90   110   (20) (18)%
                      

Total revenues

   1,639   1,531   108  7%   1,654   1,564   90  6%
                      

Benefits and expenses:

            

Benefits and other changes in policy reserves

   778   710   68  10%   822   740   82  11%

Interest credited

   96   91   5  5%   97   90   7  8%

Acquisition and operating expenses, net of deferrals

   350   352   (2) (1)%   356   332   24  7%

Amortization of deferred acquisition costs and intangibles

   153   161   (8) (5)%   106   163   (57) (35)%

Interest expense

   34   11   23  NM(1)   34   13   21  162%
                      

Total benefits and expenses

   1,411   1,325   86  6%   1,415   1,338   77  6%
                      

Earnings before income taxes

   228   206   22  11%

Income before income taxes

   239   226   13  6%

Provision for income taxes

   79   73   6  8%   85   81   4  5%
                      

Segment net earnings

   149   133   16  12%

Adjustments to segment net earnings:

      

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

   2   —     2  NM(1)

Segment net income

   154   145   9  6%

Adjustments to segment net income:

      

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

   (2)  —     (2) NM(1)
                      

Segment net operating earnings

  $151  $133  $18  14%

Segment net operating income

  $152  $145  $7  5%
                      

(1)Not meaningful

The following table sets forth net operating earningsincome for the products included in our Protection segment for the three months ended JuneSeptember 30, 2006 and 2005:

 

  Three months ended
June 30,
  

Increase (decrease) and

percentage change

   Three months ended
September 30,
  

Increase (decrease) and

percentage change

 

(Amounts in millions)

      2006          2005              2006 vs. 2005               2006          2005              2006 vs. 2005         

Segment net operating earnings:

       

Protection segment net operating income:

       

Life insurance

  $77  $55  $22  40%  $79  $73  $6  8%

Long-term care insurance

   37   46   (9) (20)%   38   41   (3) (7)%

Payment protection insurance

   29   24   5  21%   26   23   3  13%

Group life and health insurance

   8   8   —    —  %   9   8   1  13%
                      

Total segment net operating earnings

  $151  $133  $18  14%

Total segment net operating income

  $152  $145  $7  5%
                      

Segment net operating earningsincome

The increaseSegment net operating income in our life insurance business wasincreased primarily relateddue to growth of the term life in-force blocks and favorable mortality. In addition, earnings in the prior year were reduced by unfavorable mortality and an $8 million unfavorable adjustment on a reinsured block of term life insurance policies.in-force and continued favorable mortality experience. The increase in our payment protection insurance business was due toprimarily associated with growth in continental Europe and Ireland and $3 million attributable to a lower effective tax rate,in-force, partially offset by $2lower U.K. income and included a $1 million from unfavorable changes in foreign exchange rate,increase, net of tax. Our long-term care business declined primarily from higher incurred claims, declining

investment yields, and lower termination rates on older issued policies, some with expiring reinsurance coverage. The current year benefited from a $15 million favorable reserve adjustment, net of tax, related to group long-term care policies, offset by $9 million of unfavorable reinsurance adjustments, net of tax. The prior year benefited from a $4 million, net of tax, of favorable experience on a reinsured block and $4 million of net reserve adjustments, net of tax.

Revenues

Premiums increased as a result of a $33 million increase in our life insurance business primarily related to growth of the term life insurance in-force blocks, a $27 million increase in our long-term care business due to $27 million from the Continental Life acquisition and an increase attributable to in-force growth. Partially offsetting the long-term care business increase is the absence of a prior year favorable $8 million correction of premiums associated with a long-term care policy rider and a $6 million favorable experience on a reinsured block in the prior year. The increases were partially offset by a decrease of $30 million in our payment protection insurance business which included a decrease of $16 million attributable to changes in foreign exchange rates. ThisThe decrease in our long-term care insurance business was principally the result of higher incurred claims and lower investment yield as net insurance cash flows continue to be invested at new money rates lower than our portfolio yield.

Revenues

Premiums increased $66 million driven by $73 million in our long-term care business, $16 million in our life business and $10 million in our group business, offset by a decrease of $33 million in our payment protection business. The increase in our long-term care insurance business was attributable to growth in long-term care insurance in-force and included a $43 million increase from the Continental acquisition. The increase in our life insurance business was mainly due to a $56 million decreasegrowth in the U.K. market,in-force block of term life insurance. The increase in our group insurance business was principally from growth in our non-medical products, partially offset by an increase in continental Europelower premiums from our medical and Ireland.individual voluntary products. Our payment protection insurance business decrease is largely driven by $71 million from the U.K. market. The decrease infrom the U.K. market was attributable tothe result of the continued run-off of low return blocks of business and the exit from the travel insurance business. Partially offsetting the decrease from the U.K. market was growth in continental Europe and Ireland and an $11 million increase attributable to changes in foreign exchange rates. The increase in continental Europe and Ireland relates to growth from new distribution relationships and an increase in consumer lending in those markets.

The increase in net investment income which includes a decrease of $1 million attributable to changes in foreign exchange rates, was primarily the result of growth of our long-term care in-force block, an increase in average invested assets and average variable rate yields, associated with assets purchased using proceeds from our issuance of non-recourse funding obligations supporting certain term life insurance policies, and a $1 million increase attributable to new assets backing growth ofchanges in foreign exchange rates in our long-term carepayment protection insurance business.

For a discussion of net investment gains (losses), see the comparison for this line item under “—Results of Operations.”

The increase in policyPolicy fees and other income is primarily due to an increase of $21decreased $20 million inprincipally driven by our life insurance business largely due to growth of thebusiness. The decrease was primarily in our universal life insurance in-force blockproducts and resulted from an unfavorable $13 million adjustment in unearned revenue in the current year and a $12$9 million unfavorablefavorable adjustment to unearned revenue on a reinsuredclosed block of term life insurance policiesnon-standard business in the prior year.

Benefits and expenses

Benefits and other changes in policy reserves increased due$82 million attributable to a $64$79 million increase in our long-term care business, a $6$15 million increase in our life insurance business and a $5$7 million increase in our group business, partially offset by a $7decrease of $19 million decrease in our payment protection insurance business. The increase in our long-term care insurance business was primarily the result of higher incurred claims driven by the aging and growth ofin the in-force block higher than normal claims in the current period, lowerand continued low termination rates on older issued policies, some with expiring reinsurance coverage, and a $17$35 million increase from the Continental Life acquisition. Both years benefited from reserve adjustments of similar amounts. The current year includes a $24 million decrease associated with an adjustment related to group long-term care policies. The prior year included $25 million of favorable reserve adjustments for a correction of a long-term care policy rider and strengthening of certain claim reserves. The increase in our life insurance business is principallywas due to growth of theour term and universal life in-force blocks partially offset by favorable mortality.block. The increase in our group insurance business was principally driven by a combinationgrowth of growththe in-force and fluctuationshigher claims in claims that are within our expectations.the non-medical insurance products. The decrease in our payment protection insurance business was largely the result of a reduction ofprimarily related to lower claims in our run-off block of travel insurance and also includes a $2business within the U.K. which was partially offset by an $1 million decreaseincrease attributable to changes in foreign exchange rates.

Acquisition and operating expenses, net of deferrals decreased primarily due to a $27increased $24 million decrease indriven by $11 million from our payment protection insurance business, primarily associated with$8 million from our run-off blocklong-term care insurance business, $3 million from our life insurance business and also includes a decrease$2 million from our group insurance business. The increase in our payment

protection business was principally related to growth of $9in-force production in continental Europe and Ireland and an $8 million increase attributable to changes in foreign exchange rates,rates. These increases were partially offset by a $19 milliondecrease in expenses resulting from lower production associated with the U.K. run-off block. The increase in our long-term care insurance business primarily from growthwas largely the result of our in-force business, a $5$7 million increaseof expenses from the

Continental Life acquisition, an $8 million unfavorable reinsurance adjustment, and a $7 million increase in our life insurance business due to prior year expense favorability that did not recur in the current year.acquisition.

Amortization of deferred acquisition costs and intangibles decreased $57 million primarily dueattributable to $32 million from our life insurance business, $28 million from our payment protection insurance business, partially offset by a $17$4 million decreaseincrease in our long-term care business attributable to unfavorable prior year amortization of $27 million related to the correction of a long-term care policy rider. This decrease is partially offset by growth of the in-force block and higher terminations in our Medicare supplement product.insurance business. The decrease in our long-term carepayment protection insurance business was largely driven by our run-off block and was partially offset by a $12$2 million increase attributable to changes in foreign exchange rates.

Current year amortization in our life business included decreases in our universal life insurance businessproducts of $7 million due to growth of the term lifean unearned revenue adjustment and $7 million associated with revisions to estimated gross profit assumptions. Prior year amortization also included a $10 million unfavorable adjustment in our universal life in-force blocks.amortization.

Interest expense increased $23$21 million as the result offrom the issuance of additional non-recourse funding obligations in the first quarter of 2006 and the second and third quarters of 2005, and an increase in average variable rates paid on non-recourse funding obligations supporting our term life insurance capital management strategy.those obligations.

Provision for income taxes

The effective tax rate decreased to 34.6%35.6% for the three months ended JuneSeptember 30, 2006 from 35.4%35.8% for the three months ended JuneSeptember 30, 2005. The decrease in effective tax rate was primarily attributable to the increase in lower taxed foreign earnings and a reduction in excess foreign tax credits, partially offset by nonrecurring favorable examination developments in 2005.

SixNine Months Ended JuneSeptember 30, 2006 Compared to SixNine Months Ended JuneSeptember 30, 2005

The following table sets forth the results of operations relating to our Protection segment for the sixnine months ended JuneSeptember 30, 2006 and 2005:

 

  Six months ended
June 30,
  Increase (decrease) and
percentage change
   Nine months ended
September 30,
  Increase (decrease) and
percentage change
 

(Amounts in millions)

      2006         2005                  2006 vs. 2005                   2006         2005                2006 vs. 2005           

Revenues:

            

Premiums

  $2,279  $2,279  $  —    —  %  $3,478  $3,412  $66  2%

Net investment income

   710   627   83  13%   1,073   948   125  13%

Net investment gains (losses)

   2   —     2  NM(1)   4   —     4  NM(1)

Policy fees and other income

   200   167   33  20%   290   277   13  5%
                      

Total revenues

   3,191   3,073   118  4%   4,845   4,637   208  4%
                      

Benefits and expenses:

            

Benefits and other changes in policy reserves

   1,525   1,455   70  5%   2,347   2,195   152  7%

Interest credited

   191   181   10  6%   288   271   17  6%

Acquisition and operating expenses, net of deferrals

   680   682   (2) —  %   1,036   1,014   22  2%

Amortization of deferred acquisition costs and intangibles

   275   313   (38) (12)%   381   476   (95) (20)%

Interest expense

   59   20   39  195%   93   33   60  182%
                      

Total benefits and expenses

   2,730   2,651   79  3%   4,145   3,989   156  4%
                      

Earnings before income taxes

   461   422   39  9%

Income before income taxes

   700   648   52  8%

Provision for income taxes

   160   150   10  7%   245   231   14  6%
                      

Segment net earnings

   301   272   29  11%

Adjustments to segment net earnings:

      

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

   (1)  —     (1) NM(1)

Segment net income

   455   417   38  9%

Adjustments to segment net income:

      

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

   (3)  —     (3) NM(1)
                      

Segment net operating earnings

  $300  $272  $28  10%

Segment net operating income

  $452  $417  $35  8%
                      

(1)Not meaningful

The following table sets forth net operating earningsincome for the products included in our Protection segment for the sixnine months ended JuneSeptember 30, 2006 and 2005:

 

  Six months ended
June 30,
  

Increase (decrease) and

percentage change

   Nine months ended
September 30,
  

Increase (decrease) and

percentage change

 

(Amounts in millions)

      2006          2005                  2006 vs. 2005                   2006          2005            2006 vs. 2005       

Segment net operating earnings:

       

Segment net operating income:

       

Life insurance

  $151  $123  $28  23%  $230  $196  $34  17%

Long-term care insurance

   80   88   (8) (9)%   118   129   (11) (9)%

Payment protection insurance

   54   46   8  17%   80   69   11  16%

Group life and health insurance

   15   15   —    —  %   24   23   1  4%
                      

Total segment net operating earnings

  $300  $272  $28  10%

Total segment net operating income

  $452  $417  $35  8%
                      

Segment net operating earningsincome

The increaseSegment net operating income in our life insurance business wasincreased primarily relateddue to in-force growth of the term life in-force blocks and favorable mortality. In addition, earnings in the prior year were reduced by unfavorable mortality and $8 million related to an unfavorable adjustment on a reinsured block of term life insurance policies.and continued favorable mortality. The increase in our payment protection insurance business net operating earnings was due toprimarily associated with growth in continental Europe and Ireland and $6 million attributable to a lower effective tax rate,production, partially offset by $4lower income in the U.K. and included a $3 million unfavorabledecrease, net of tax, attributable to changes in foreign exchange rates, net of tax.rates. The decrease in our long-term care insurance business is largelywas principally the result of higher incurred claims and lower terminations oninvestment yields as net insurance cash flows continue to be invested at new money rates lower than our older issued policies, some with expiring reinsurance coverage, and a continued low interest rate environment. Theportfolio yield.

Our current year long-term care business segment net operating income benefited from a $17 million, reserve adjustment, net of tax, related to group long-term care policies,reserve adjustments, partially offset by $9$7 million, net of tax, of reinsurance adjustments, net of tax. Our long-term care business benefited in theadjustments. The prior year benefited from a $7 million, net of tax, favorable experience on a reinsured block partially offsetblock. Prior year net operating income in our life insurance business was reduced by $1an $8 million of net reserve adjustments,unfavorable adjustment, net of tax.tax, on reinsured term life insurance policies.

Revenues

Premiums fromincreased $66 million driven by $117 million in our long-term care insurance business, $69 million in our life insurance business increased $53 million reflecting growth of the term life insurance in-force blocks. Our long-term care business increased $44 million primarily associated with in-force growth and $27 million from the Continental Life acquisition. The prior year included $19 million of favorable items for the long-term care business that did not recur in the current year. Of this $19 million, $11 million related to favorable experience on a reinsured block and the remaining $8 million was the result of a correction of premiums related to a long-term care policy rider. Additionally, our group business, increased $9 million largely as a result of higher sales in our non-medical products. These increases were partially offset by a decrease of $106$139 million in our payment protection business. The increase in our long-term care insurance business whichwas attributable to growth in the long-term care insurance in-force block and included a decrease$70 million increase in Medicare supplement attributable to the Continental acquisition. The increase in our life insurance business was due to in-force growth of $39term life insurance. The increase in our group insurance business was principally from growth in our non-medical products, partially offset by decreases in medical and individual voluntary products. Our payment protection insurance business decreased largely from the U.K. market including a $28 million decrease attributable to changes in foreign exchange rates. This decrease was principally due to a decrease of $124 million in the U.K. market, partially offset by an increase in continental Europe and Ireland. The decrease infrom the U.K. market was attributable to the result of continued run-off of low return blocks of business and the exit from the travel insurance business. The increasePartially offsetting these decreases was growth in continental Europe and Ireland was the result of the growth due tofrom new distribution relationships and the growth ofan increase in consumer lending in those markets.

The prior year included $19 million of favorable items in our long-term care business that did not recur in the current year. Our long-term care business also decreased as a result of a $6 million classification to policy fees and other income in the current year.

The increase in net investment income which included a $3 million decrease attributable to changes in foreign exchange rates, was largelyprimarily the result of growth of our long-term care in-force block and an increase in average invested assets and average variable rate yields, associated with assets purchased using proceeds from our issuance of non-recourse funding obligations supporting certain term life insurance policies, andpartially offset by a $2 million decrease attributable to new assets backing growth ofchanges in foreign exchange rates in our long-term carepayment protection insurance business.

For a discussion of net investment gains (losses), see the comparison for this line item under “—Results of Operations.”

The increase in policyPolicy fees and other income is primarily dueincreased $13 million attributable to an increase of $26$10 million in our long-term care insurance business and $6 million in our life insurance business, principallyoffset by a $3 million decrease in our group business. The decrease in our group insurance business was related to an expected drop in lives from the planned migration to outside third-party administrators.

The increase in our life insurance business was largely due to growth of theour universal life insurance in-forceproducts. Partially offsetting this was a $13 million decrease related to an adjustment in unearned revenue in the current year, a $9 million increase related to an adjustment to unearned revenue on a closed block of non-standard business in the prior year, and a $12 million unfavorabledecrease related to an adjustment on a reinsured block of term life insurance policies in the prior year. The current year increase in our long-term care insurance business is the result of a $6 million classification from premiums and $4 million reclassification from interest credited.

Benefits and expensesexpense

Benefits and other changes in policy reserves increased due$152 million attributable to a $72$151 million increase in our long-term care insurance business, a $17$32 million increase in our life insurance business and a $13$20 million increase in our group insurance business, partially offset by a $32decrease of $51 million decrease in our payment protection insurance business. The increase in our long-term care insurance business was primarily the result of aging and growth of the in-force block, lowercontinued low termination rates on older issued policies, some with expiring reinsurance coverage, and

also included a $17$52 million increase from the Continental Life acquisition. Both years benefited fromThe increase in our life insurance business was due mainly to growth of our term and universal life in-force that was partially offset by favorable current year mortality. The increase in our group insurance business was principally driven by growth and higher claims in our non-medical insurance products. The decrease in our payment protection insurance business was primarily related to a reduction of claims in our run-off block of business within the U.K. and a $4 million decrease attributable to changes in foreign exchange rates.

Our long-term care business benefits and other changes in policy reserves also included reserve adjustments.adjustments in both years. The prior year included $17 million of net favorable reserve adjustments including a favorable correction of a long-term care policy rider and a reserve adjustment on a closed block of business, partially offset by strengthening of claim reserves. The current year includes a $27 million decrease due to a favorable adjustment related to group long-term care policies. The prior year included

Interest credited increased $17 million of favorable reserve adjustments for a correction of aprincipally from $13 million in our long-term care policy rider and strengthening of certain claim reserves. The increase in our groupinsurance business is based upon continueddriven by growth in cash surrender value of our non-medical business which is partially offset by decreases in our medical products which are within expectations. The increase in ourcorporate owned life insurance business is associated with growthblock of the term life in-force blocks and unfavorable prior year mortality offset in part by favorable current year mortality. The decrease in our payment protection insurance business was largely driven by a reduction of claim reserves in our run-off block and also includes a decrease of $5 million attributable to changes in foreign exchange rates.business.

Acquisition and operating expenses, net of deferrals decreased primarily due toincreased $22 million from a $41$43 million decreaseincrease from our long-term care insurance business and a $12 million increase from our life insurance business, offset by decreases of $30 million in our payment protection insurance business primarily associated withand $3 million in our run-off block and also includes a $23 million decrease attributable to changes in foreign exchange rates. Our group business decreased $5 million as a result of favorable expense management and reduced sales related expenses. These increases were partially offset by a $35 millioninsurance business. The increase in our long-term care insurance business was largely fromthe result of growth of our in-force, premium levels driving higher renewal commission expense, a $5$12 million increase from the Continental Life acquisition and an unfavorable $8 million increase related to a reinsurance adjustment. Ouradjustment in the current year. The increase in our life insurance business increased $9 million principallywas primarily due to prior year expense favorability that did not recur in the current year. The decrease in our payment protection insurance business was principally from our run-off block and included a $15 million decrease attributable to changes in foreign exchange rates.

Amortization of deferred acquisition costs and intangibles decreased primarily due to$95 million largely the result of a $42$70 million decrease in our payment protection insurance business and an $8a $19 million decrease in our long-term care business, partially offset by a $13 million increase in our life insurance business. The decrease in our payment protection insurance business was largely attributableprimarily due to lower amortization from our run-off block and also includeswas partially offset by a $9$7 million decreaseincrease attributable to changes in foreign exchange rates. The decrease in ourOur long-term care insurance business is from an unfavorabledecreased $4 million as a result of a $27 million unfavorable correction related toof a long-term care policy rider in the prior year. This decrease iswas partially offset by higher amortization from growth of the in-force block of long-term care insurance and higher terminations in our Medicare supplement product. The increase

Current year amortization in our life insurance business is principallyincluded decreases in our universal life insurance products of $7 million due to growth of the term lifean unearned revenue adjustment and $7 million associated with revisions to estimated gross profit assumptions. Prior year amortization also included a $10 million amortization adjustment in our universal life in-force blocks.amortization.

Interest expense increased $39$60 million as the result ofin our life insurance business from the issuance of additional non-recourse funding obligations in the first quarter of 2006 and the second and third quarters of 2005, and an increase in average variable rates paid on non-recourse funding obligations supporting our term life insurance capital management strategy.those obligations.

Provision for income taxes

The effective tax rate decreased to 34.7%35.0% for the sixnine months ended JuneSeptember 30, 2006 from 35.5%35.6% for the sixnine months ended JuneSeptember 30, 2005. The decrease in effective tax rate was primarily attributable to the increase in lower taxed foreign earnings and a reduction in excess foreign tax credits, partially offset by nonrecurring favorable examination developments in 2005.

Protection selected operating performance measures

Life insurance

The following tables set forth selected operating performance measures regarding our life insurance products as of or for the three and sixnine months ended JuneSeptember 30, 2006 and 2005:

 

  For the three months
ended June 30,
  Percentage
change
 For the six months
ended June 30,
  Percentage
change
   Three months
ended September 30,
  Percentage
change
 Nine months
ended September 30,
  Percentage
change
 

(Amounts in millions)

      2006          2005      2006 vs. 2005     2006          2005      2006 vs. 2005       2006          2005      2006 vs. 2005     2006          2005      2006 vs. 2005 

Term life insurance

                      

Net earned premiums

  $221  $186  19% $434  $377  15%  $224  $205  9% $658  $582  13%

Annualized first-year premiums

   37   34  9%  71   63  13%   36   38  (5)%  107   101  6%

Revenue, net of reinsurance

   277   206  34%  545   433  26%

Revenues

   282   241  17%  827   674  23%

Universal and whole life insurance

                      

Net earned premiums and deposits

  $118  $100  18% $240  $200  20%  $112  $104  8% $352  $304  16%

Annualized first-year deposits

   10   6  67%  19   13  46%   9   7  29%  28   20  40%

Excess deposits

   22   8  175%  41   14  193%   24   12  100%  65   26  150%

Revenue, net of reinsurance

   180   168  7%  354   341  4%

Revenues

   163   187  (13)%  517   528  (2)%

Total life insurance

                      

Net earned premiums and deposits

  $339  $286  19% $674  $577  17%  $336  $309  9% $1,010  $886  14%

Annualized first-year premiums

   37   34  9%  71   63  13%   36   38  (5)%  107   101  6%

Annualized first-year deposits

   10   6  67%  19   13  46%   9   7  29%  28   20  40%

Excess deposits

   22   8  175%  41   14  193%   24   12  100%  65   26  150%

Revenue, net of reinsurance

   457   374  22%  899   774  16%

Revenues

   445   428  4%  1,344   1,202  12%

 

  As of the six months
ended June 30,
  Percentage
change
   As of September 30,  Percentage
change
 

(Amounts in millions)

  2006  2005  2006 vs. 2005   2006  2005  2006 vs. 2005 

Term life insurance

            

Life insurance in-force, net of reinsurance

  $409,103  $350,224  17%  $422,163  $366,131  15%

Life insurance in-force before reinsurance

   571,014   508,330  12%   583,780   525,264  11%

Universal and whole life insurance

            

Life insurance in-force, net of reinsurance

  $40,850  $42,110  (3)%  $41,595  $41,722  —  %

Life insurance in-force before reinsurance

   49,207   49,846  (1)%   49,337   49,613  (1)%

Total life insurance

            

Life insurance in-force, net of reinsurance

  $449,953  $392,334  15%  $463,758  $407,853  14%

Life insurance in-force before reinsurance

   620,221   558,176  11%   633,117   574,877  10%

Term life insurance. Term life insurance annualized first-year premiums and insurance in-force, which represents the face amount for life insurance, increaseddecreased primarily as a result of distribution expansion and the competitiveness of our product offerings. This increase in annualized first-year premiums was the primary driver for thean increasingly competitive pricing environment. The increase in term life insurance net earned premiums revenues and insurance in-force.in-force was primarily due to growth of the in-force block of business as a result of new and renewal premiums. Term life insurance revenues also increased due to higher net investment income related to an increase in invested assets related to securities purchased using the proceeds from our issuance of non-recourse funding obligations supporting certainour term life insurance policies.capital management strategy.

Universal and whole life insurance. Universal life annualized first-year deposits increased primarily due tofrom new product offerings gaining momentum in the market. The decrease in our in-force block was largely the result of the continued run-off on our closed block of whole life insurance.

Long-term care insurance

The following tables set forth selected operating performance measures regarding our long-term care insurance business, which includes individual and group long-term care insurance, Medicare supplement insurance, as well as several run-off blocks of accident and health insurance and corporate-owned life insurance for the three and sixnine months ended JuneSeptember 30, 2006 and 2005:

 

  Three months
ended June 30,
  Percentage
change
 Six months
ended June 30,
  Percentage
change
  Three months
ended September 30,
 Percentage
change
 Nine months
ended September 30,
 Percentage
change
 

(Amounts in millions)

    2006      2005    2006 vs. 2005 2006  2005  2006 vs. 2005      2006         2005     2006 vs. 2005     2006         2005     2006 vs. 2005 

Net earned premiums

  $458  $431  6% $883  $839  5% $485 $412 18% $1,368 $1,251 9%

Annualized first-year premiums

   51   42  21%  99   83  19%

Revenue, net of reinsurance

   649   593  9%  1,257   1,159  8%

Annualized first-year premiums:

      

Long-term care

  44  38 16%  127  115 11%

Medicare supplement and other A&H

  7  3 133%  23  9 130%

Revenues

  679  583 16%  1,936  1,742 11%

The increase in annualized first-year premiums was primarily due to an increase in individual long-term care products, including $6 million on new product sales in California in the third quarter of 2006 ahead of a price increase and the broadening of our product offering in Medicare supplement, including $4$5 million and $9 million in the three and nine months ended September 30, 2006, respectively, from the Continental Life acquisition. The additional layer of 2005 annualized first-year premiums was the primary driver for the increase in net earned premium and revenue, netwas largely the result of reinsurance.the additional layer of 2005 annualized first-year premiums. The increase in revenue was also due to the result of an increase inhigher net investment income principally due tofrom an increase in average invested assets backing growth of our long-term care business.business, partially offset by lower investment yields as a result of a continued low interest rate environment.

Payment protection insurance

The following table sets forth selected operating performance measures regarding our payment protection insurance and other related consumer protection insurance products for the three and sixnine months ended JuneSeptember 30, 2006 and 2005:

 

  Three months
ended June 30,
  Percentage
change
 Six months
ended June 30,
  Percentage
change
   Three months
ended September 30,
  Percentage
change
 Nine months
ended September 30,
  Percentage
change
 

(Amounts in millions)

    2006      2005    2006 vs. 2005   2006      2005    2006 vs. 2005       2006          2005      2006 vs. 2005     2006          2005      2006 vs. 2005 

Payment protection insurance gross written premiums and deposits

  $500  $501  —  % $919  $954  (4)%

Payment protection insurance gross written premiums, premium equivalents and deposits

  $552  $454  22% $1,471  $1,408  4%

Mexico operations gross written premiums

   15   12  25%  31   24  29%   18   14  29%  49   38  29%

Net earned premiums

   322   352  (9)%  613   719  (15)%   310   343  (10)%  923   1,062  (13)%

Revenue, net of reinsurance

   352   385  (9)%  671   784  (14)%

Revenues

   340   373  (9)%  1,011   1,157  (13)%

Gross written premiums, premium equivalents and deposits, gross of ceded reinsurance and cancellations, for the three and sixnine months ended JuneSeptember 30, 2006 includes $32$96 million and $128 million, respectively, of gross deposits on a reciprocal reinsurance transactiontransactions, which we accounted for under the deposit method of accounting, and growth from continental Europe and Ireland. Both periods includeThe three and nine months ended September 30, 2006 included an increase of $23 million and a decrease of $36 million, respectively, attributable to changes in foreign exchange rates of $23 million and $59 million, respectively.rates. The remainder of the decrease compared to the respective prior year periods iswas largely driven by a decline of gross written premiums in the U.K., partially offset by growth in the continental Europe and Ireland market.

Net earned premiums and revenues for the three and sixnine months ended JuneSeptember 30, 2006 compared to the three and sixnine months ended JuneSeptember 30, 2005 decreased primarily due to continued run-off of low return blocks of business in the U.K. market, the exit from our travel insurance business and a decrease attributable to changes in foreign exchange rates, partially offset by growth in the continental Europe and Ireland markets.

Group life and health insurance

The following table sets forth selected operating performance measures regarding our group products for the three and sixnine months ended JuneSeptember 30, 2006 and 2005:

 

  Three months
ended June 30,
  Percentage
change
 Six months
ended June 30,
  Percentage
change
   Three months
ended September 30,
  Percentage
change
 Nine months
ended September 30,
  Percentage
change
 

(Amounts in millions)

    2006      2005    2006 vs. 2005   2006      2005    2006 vs. 2005       2006          2005      2006 vs. 2005     2006          2005      2006 vs. 2005 

Net earned premiums

  $168  $165  2% $336  $327  3%  $176  $166  6% $512  $493  4%

Annualized first-year premiums

   44   38  16%  78   68  15%   41   37  11%  119   105  13%

Revenue, net of reinsurance

   181   179  1%  364   356  2%

Revenues

   190   180  6%  554   536  3%

The increase in annualized first-year premiums is attributable towas the result of growth in sales in non-medical products, partially offset by lower sales of medical products due to competitive pricing in that market. This growth is also driving the increasesGrowth in revenue and net earned premiums.premiums is the result of sales growth in recent periods, predominantly in the non-medical and individual products, partially offset by lapses primarily in medical products.

Retirement Income and Investments segment

We offer U.S. customers fixed annuities, individual andvariable annuities, group variable annuities designed for 401(k) plans, single premium immediate annuities, variable life insurance, asset management and specialized products, including GICs, funding agreements and FABNs, and structured settlements.asset management products and services.

Three Months Ended JuneSeptember 30, 2006 Compared to Three Months Ended JuneSeptember 30, 2005

The following table sets forth the results of operations relating to our Retirement Income and Investments segment for the three months ended JuneSeptember 30, 2006 and 2005:

 

 

Three month ended

June 30,

 Increase (decrease) and
percentage change
   

Three month ended

September 30,

  Increase (decrease) and
percentage change
 

(Amounts in millions)

     2006         2005               2006 vs. 2005                 2006         2005              2006 vs. 2005         

Revenues:

          

Premiums

 $200  $241 $(41) (17)%  $210  $189  $21  11%

Net investment income

  487   432  55  13%   475   455   20  4%

Net investment gains (losses)

  (45)  —    (45) NM(1)   (8)  —     (8) NM(1)

Policy fees and other income

  84   62  22  35%   85   61   24  39%
                    

Total revenues

  726   735  (9) (1)%   762   705   57  8%
                    

Benefits and expenses:

          

Benefits and other changes in policy reserves

  267   301  (34) (11)%   284   247   37  15%

Interest credited

  282   256  26  10%   286   274   12  4%

Acquisition and operating expenses, net of deferrals

  80   66  14  21%   76   66   10  15%

Amortization of deferred acquisition costs and intangibles

  40   32  8  25%   46   33   13  39%

Interest expense

  1   1  —    —  %   2   1   1  100%
                    

Total benefits and expenses

  670   656  14  2%   694   621   73  12%
                    

Earnings before income taxes

  56   79  (23) (29)%

Income before income taxes

   68   84   (16) (19)%

Provision for income taxes

  19   19  —    —  %   20   25   (5) (20)%
                    

Segment net earnings

  37   60  (23) (38)%

Adjustments to segment net earnings:

    

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

  20   —    20  NM(1)

Segment net income

   48   59   (11) (19)%

Adjustments to segment net income:

      

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

   5   —     5  NM(1)
                    

Segment net operating earnings

 $57  $60 $(3) (5)%

Segment net operating income

  $53  $59  $(6) (10)%
                    

(1)Not meaningful

The following tables set forth net operating earningsincome for the products included in our Retirement Income and Investments segment for the three months ended JuneSeptember 30, 2006 and 2005:

 

  Three months ended
June 30,
  Increase (decrease) and
percentage change
   Three months ended
September 30,
  Increase (decrease) and
percentage change
 

(Amounts in millions)

      2006          2005          2006 vs. 2005           2006          2005              2006 vs. 2005         

Segment net operating earnings:

       

Segment net operating income:

       

Spread-based retail

  $29  $35  $(6) (17)%  $23  $39  $(16) (41)%

Spread-based institutional

   13   11   2  18%   9   6   3  50%

Fee-based

   15   14   1  7%   21   14   7  50%
                      

Total segment net operating earnings

  $57  $60  $(3) (5)%

Total segment net operating income

  $53  $59  $(6) (10)%
                      

Segment net operating earningsincome

Segment net operating earningsincome from spread-based retail products decreased $16 million primarily due to a lower effective tax rateinvestment income from bond calls and mortgage loan prepayments in the current year, an increase in DAC amortization resulting from higher lapses on fixed annuities and lower assets under management from withdrawals outpacing new deposits. Additionally, the prior year related to favorableincluded income tax examination developments. favorability that did not recur in the current year.

Segment net operating earningsincome from spread-based institutional products increased $3 million largely from higher spreads and growth in assets under management related to our FABNs.

Segment net operating earningsincome on fee-based products increased $7 million principally as a result of income tax benefits from dividends received deductions including a change in a prior year estimate and growth in assets under management.management driven by distribution expansion, favorable equity markets and continued product introduction and enhancements.

Revenues

The $41 million decreaseincrease in premiums was primarily the result of a $61$53 million increase in our life-contingent single premium immediate annuities driven by higher sales. This increase was partially offset by a $28 million reduction in sales of our life-contingent structured settlement annuities. This isannuities due to our continued pricing discipline in the continuing low long-term interest rate environment. This decrease was partially offset by a $20 million increaseenvironment and our decision in the third quarter of 2006 to discontinue sales of our life-contingent single premium immediate annuities.this product.

The increase in net investment income was principally due to increaseda result of higher yields on floating rate investments backing spread-based institutional products and higher assets under management. Partially offsetting these increases were lower bond calls and commercial mortgage loan prepayment fees of $13 million as compared to prior year.

For a discussion of net investment gains (losses), see the comparison for this line item under “—Results of Operations.”

The increase in policy fees and other income was primarily attributable to a $20$22 million increase in the fee-based segment as a result of increased sales and growth in assets under management from distribution expansion, favorable equity markets and continued product introduction and enhancements.

Benefits and expenses

Benefits and other changes in policy reserves decreasedincreased primarily as a result of the decrease in the life-contingent structured settlement annuity sales, which were partially offset by ana $57 million increase in sales of life-contingent single premium immediate annuities.annuities driven by higher sales, which was partially offset by a $21 million decrease in life-contingent structured settlement annuities due to our pricing discipline in the continuing low long-term interest rate environment and our decision in the third quarter of 2006 to discontinue sales of this product.

The increase in interest credited was principally due to a $37$28 million increase related to spread-based institutional products as a result of increasedhigher crediting rates on floating rate products and higher assets under management. This increase was partially offset by an $11a $16 million decrease in interest credited on fixed annuities associated with crediting rates being reset to lower rates as the fixed annuities reach their initial crediting rate guarantee period.

The increase in acquisition and operating expenses, net of deferrals, was primarily from $16$13 million of increased expenses associated with higher sales and growth in assets under management in fee-based products.

The increase in amortization of deferred acquisition costs and intangibles was largely the result of a $15an $11 million increase in spread-based retail products primarily due to higher lapses and profit margins. Partially offsetting this increase was an $11 million reduction in amortization expense attributable to investment losses.of fixed annuities.

Provision for income taxes

The effective tax rate increaseddecreased to 33.9%29.4% for the three months ended JuneSeptember 30, 2006 from 24.1%29.8% for the three months ended JuneSeptember 30, 2005. This increasedecrease in the effective tax rate was primarily attributable to an increase in benefits from dividends received deductions including a change in prior year estimate, partially offset by nonrecurring favorable taxIRS examination developments in 2005.

SixNine Months Ended JuneSeptember 30, 2006 Compared to SixNine Months Ended JuneSeptember 30, 2005

The following table sets forth the results of operations relating to our Retirement Income and Investments segment for the sixnine months ended JuneSeptember 30, 2006 and 2005:

 

  

Six month ended

June 30,

  Increase (decrease) and
percentage change
   

Nine months ended

September 30,

  Increase (decrease) and
percentage change
 

(Amounts in millions)

  2006 2005              2006 vs. 2005                   2006         2005              2006 vs. 2005         

Revenues:

            

Premiums

  $380  $485  $(105) (22)%  $590  $674  $(84) (12)%

Net investment income

   952   865   87  10%   1,427   1,320   107  8%

Net investment gains (losses)

   (54)  —     (54) NM(1)   (62)  —     (62) NM(1)

Policy fees and other income

   161   120   41  34%   246   181   65  36%
                      

Total revenues

   1,439   1,470   (31) (2)%   2,201   2,175   26  1%
                      

Benefits and expenses:

            

Benefits and other changes in policy reserves

   508   609   (101) (17)%   792   856   (64) (7)%

Interest credited

   560   506   54  11%   846   780   66  8%

Acquisition and operating expenses, net of deferrals

   152   125   27  22%   228   191   37  19%

Amortization of deferred acquisition costs and intangibles

   76   59   17  29%   122   92   30  33%

Interest expense

   2   1   1  100%   4   2   2  100%
                      

Total benefits and expenses

   1,298   1,300   (2) —  %   1,992   1,921   71  4%
                      

Earnings before income taxes

   141   170   (29) (17)%

Income before income taxes

   209   254   (45) (18)%

Provision for income taxes

   49   50   (1) (2)%   69   75   (6) (8)%
                      

Segment net earnings

   92   120   (28) (23)%

Adjustments to segment net earnings:

      

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

   26   —     26  NM(1)

Segment net income

   140   179   (39) (22)%

Adjustments to segment net income:

      

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

   31   —     31  NM(1)
                      

Segment net operating earnings

  $118  $120  $(2) (2)%

Segment net operating income

  $171  $179  $(8) (4)%
                      

(1)Not meaningful

The following table sets forth net operating earningsincome for the products included in our Retirement Income and Investments segment for the sixnine months ended JuneSeptember 30, 2006 and 2005:

 

   Six months ended
June 30,
  Increase (decrease) and
percentage change
 

(Amounts in millions)

    2006      2005        2006 vs. 2005     

Segment net operating earnings:

       

Spread-based retail

  $65  $69  $(4) (6)%

Spread-based institutional

   23   20   3  15%

Fee-based

   30   31   (1) (3)%
              

Total segment net operating earnings

  $118  $120  $(2) (2)%
              

   Nine months ended
September 30,
  Increase (decrease) and
percentage change
 

(Amounts in millions)

      2006          2005              2006 vs. 2005         

Segment net operating income:

       

Spread-based retail

  $88  $108  $(20) (19)%

Spread-based institutional

   32   26   6  23%

Fee-based

   51   45   6  13%
              

Total segment net operating income

  $171  $179  $(8) (4)%
              

Segment net operating earningsincome

Segment net operating income from spread-based retail products decreased $20 million primarily due to income tax favorability that did not recur in the current year, an increase in DAC amortization resulting from higher lapses on fixed annuities, lower net investment income related to bond calls and mortgage prepayments in the current year, unfavorable mortality on life-contingent annuities and lower assets under management from withdrawals outpacing new deposits.

Segment net operating income on fee-based products increased $6 million principally as a result of income tax benefits from dividends received deductions including a change in a prior year estimate and growth in assets under management driven by our distribution expansion, favorable equity markets and continued product introduction and enhancements.

Segment net operating earnings from spread-based retail decreasedinstitutional products increased $6 million primarily due to a lower effective tax rate in the prior year related to favorable tax examination developments. Segment net operating earnings on fee-based decreased from lower expenses in the prior year. Segment net operating earnings on spread-based institutional increased in connection with higher spreads and growth in assets under management related to our FABNs.

Revenues

The decrease in premiums was primarily the result of a $112$141 million reduction in sales of our life-contingent structured settlement annuities. This isannuities due to our continued pricing discipline in the continuing low long-term interest rate environment.environment and our decision in the third quarter of 2006 to discontinue sales of this product. This decrease was partially offset by a $7$59 million increase in sales of our life-contingent single premium immediate annuities.annuities driven by higher sales.

The increase in net investment income was mostlyprincipally due to increased yields on floating rate investments backing spread-based institutional products and higher assets under management. Partially offsetting this increase was lower net investment income related to bond calls and mortgage prepayment of $14 million in the current year.

For a discussion of net investment gains (losses), see the comparison for this line item under “—Results of Operations.”

The increase in policy fees and other income was largelyprimarily attributable to a $36$58 million increase in the fee-based segment as a result of increased sales and growth in assets under management from distribution expansion, favorable equity markets and continued product introduction and enhancements. In addition, surrender fees in our spread-based retail products increased $7 million.

Benefits and expenses

Benefits and other changes in policy reserves decreased $101 million primarily as a result of thea $126 million decrease in the life-contingent structured settlement annuityannuities due to our continued pricing discipline in the continuing low long-

term interest rate environment and our decision in the third quarter of 2006 to discontinue sales which wereof this product. This decrease was partially offset by ana $67 million increase in sales of life-contingent single premium immediate annuities.annuities driven largely by higher sales.

The increase in interest credited was principally due to a $69$97 million increase related to spread-based institutional products as a result of increasedhigher crediting rates on floating rate products and higher assets under management. This increase was partially offset by a $17$33 million decrease in interest credited on fixed annuities associated with crediting rates being reset to current, lower rates as the fixed annuities reach their initial crediting rate guarantee period.

The increase in acquisition and operating expenses, net of deferrals, was primarily from increased expenses of $44 million associated with higher sales and growth in assets under management in fee-based products. Additionally, the prior year included expense favorability that did not recur in the current year.This was partially offset by $5 million of lower expenses associated with our deferred annuities.

The increase in amortization of deferred acquisition costs and intangibles was largely the result of a $15$24 million increase in spread-based retail products primarily due to higher lapses and more favorable gross profit margins. Partially offsetting this increase was an $11Additionally, fee-based products increased by $5 million reduction in amortization expense attributable to investment losses.growth in assets under management.

Provision for income taxes

The effective tax rate increased to 34.8%33.0% for the sixnine months ended JuneSeptember 30, 2006 from 29.4%29.5% for the sixnine months ended JuneSeptember 30, 2005. This increase in the effective tax rate was primarily attributable to a nonrecurring favorable taxIRS examination developmentsdevelopment in 2005.2005, offset by an increase in benefits from dividends received deductions including a change in prior year estimate.

Retirement Income and Investments selected operating performance measures

Spread-based retail products

The following table sets forth selected operating performance measures regarding our spread-based retail products as of or for the three and sixnine months ended JuneSeptember 30, 2006 and 2005:

 

  For the three months
ended June 30,
 Percentage
change
 For the six months
ended June 30,
 Percentage
change
  As of or for the three months
ended September 30,
 Percentage
change
 As of or for the nine months
ended September 30,
 Percentage
change
 

(Amounts in millions)

  2006 2005 2006 vs. 2005 2006 2005 2006 vs. 2005          2006                 2005         2006 vs. 2005         2006                 2005         2006 vs. 2005 

Fixed annuities

             

Account value, net of reinsurance, beginning of period

  $15,241  $15,214  —  % $15,547  $15,113  3% $14,835  $15,540  (5)% $15,547  $15,113  3%

Deposits

   326   699  (53)%  593   984  (40)%  424   530  (20)%  1,017   1,514  (33)%

Interest credited

   139   150  (7)%  284   300  (5)%  137   154  (11)%  421   454  (7)%

Surrenders, benefits and product charges

   (871)  (523) 67%  (1,589)  (857) 85%  (947)  (548) 73%  (2,536)  (1,405) 80%
                             

Account value, net of reinsurance, end of period

  $14,835  $15,540  (5)% $14,835  $15,540  (5)% $14,449  $15,676  (8)% $14,449  $15,676  (8)%
                             

Single premium immediate annuities

             

Account value, net of reinsurance, beginning of period

  $5,772  $5,415  7% $5,680  $5,344  6% $5,888  $5,488  7% $5,680  $5,344  6%

Net earned premiums and deposits

   290   215  35%  540   427  26%  294   230  28%  834   657  27%

Interest credited

   78   80  (3)%  158   157  1%  82   77  7%  240   234  3%

Surrenders, benefits and product charges

   (225)  (222) 1%  (463)  (440) 5%  (200)  (217) (8)%  (690)  (657) 5%
                             

Account value, net of reinsurance, end of period

  $5,915  $5,488  8% $5,915  $5,488  8% $6,064  $5,578  9% $6,064  $5,578  9%
               
              

Structured settlements

             

Account value, net of reinsurance, beginning of period

  $925  $653  42% $871  $533  63% $966  $765  26% $871  $533  63%

Net earned premiums and deposits

   45   116  (61)%  103   240  (57)%  37   69  (46)%  140   309  (55)%

Interest credited

   13   11  18%  25   22  14%  14   11  27%  39   33  18%

Surrenders, benefits and product charges

   (15)  (15) —  %  (31)  (30) 3%  (14)  (14) —  %  (47)  (44) 7%
                             

Account value, net of reinsurance, end of period

  $968  $765  27% $968  $765  27% $1,003  $831  21% $1,003  $831  21%
                             

Total premiums from spread-based retail products

  $200  $241  (17)% $380  $485  (22)% $210  $189  11% $590  $674  (12)%
                             

Total deposits on spread-based retail products

  $461  $789  (42)% $856  $1,166  (27)% $545  $640  (15)% $1,401  $1,806  (22)%
                             

Fixed annuities. The account value, net of reinsurance, decreased primarily due to lapses being greater than deposits in the first half ofthroughout 2006. The attractiveness of certain fixed annuities has declined as a result of continued low long-term interest rates, a relatively flat yield curve and short termcompetitiveness of short-term investment alternatives, such as certificates of deposit. These trends are having an adverse impact on both sales and retention of fixed annuities. In recent quarters, we have experienced improved spreads in fixed annuities primarily due toprincipally from run-off of and crediting rate resets of historically higher crediting rate business. The continued low long-term interest rate environment and a relatively flat yield curve, along with our pricing discipline of selling business that meets our profitability objectives, have adversely affected sales and retention of our fixed annuities. We expect this trend to continue.

Single premium immediate annuities. The account value, net of reinsurance, increased primarily due to the positive net impact of new product sales, lower lapse percentages and lapses along withhigher interest credited on account values in 2005 and 2006.

Structured settlements. We continue to write structured settlements to the extent that we are able to achieve our targeted returns. Our continued pricing discipline in a challenging and competitive long-term interest rate environment was the primary reasoncause for the lower sales of these products during 2006. As a result, and upon completion of a strategic review of our structured settlement annuities, we decided in the first six monthsthird quarter of 2006.2006 to discontinue sales of this product based on relative profitability in this market compared to our other product lines. This exit is not expected to have a material impact on current or future earnings. We will, however, continue to service our current blocks of business.

Spread-based institutional products

The following table sets forth selected operating performance measures regarding our spread-based institutional products as of the three and sixnine months ended JuneSeptember 30, 2006 and 2005:

 

  Three months ended
June 30,
 Percentage
change
 Six months ended
June 30,
 Percentage
change
   As of or for the three
months ended
September 30,
 Percentage
change
 As of or for the nine
months ended
September 30,
 Percentage
change
 

(Amounts in millions)

  2006 2005 2006 vs. 2005 2006 2005 2006 vs. 2005         2006             2005       2006 vs. 2005 2006 2005 2006 vs. 2005 

GICs, funding agreements and FABNs

              

Account value, net of reinsurance, beginning of period

  $9,766  $9,408  4% $9,777  $9,541  2%  $9,886  $9,162  8% $9,777  $9,541  2%

Deposits(1)

   498   871  (43)%  1,478   1,712  (14)%   676   1,402  (52)%  2,154   3,114  (31)%

Interest credited

   123   86  43%  237   168  41%   128   101  27%  365   269  36%

Surrenders and benefits(1)

   (501)  (1,203) (58)%  (1,606)  (2,259) (29)%   (878)  (667) 32%  (2,484)  (2,926) (15)%
                              

Account value, net of reinsurance, end of period

  $9,886  $9,162  8% $9,886  $9,162  8%  $9,812  $9,998  (2)% $9,812  $9,998  (2)%
                              

(1)“Surrenders and benefits” include contracts that have matured but are redeposited with us and are reflected as deposits. In the three months ended JuneSeptember 30, 2006 and 2005, surrenders and deposits included $100$105 million and $725$320 million, respectively, and in the sixnine months ended JuneSeptember 30, 2006 and 2005, surrenders and deposits included $310$415 million and $1,008$1,328 million, respectively, that waswere redeposited and reflected under “Deposits.”

Spread-basedDespite a slight decrease in account values due to GIC maturities, spread-based institutional account values increased mostly due tobenefited from the launch of our registered notes program in the fourth quarter of 2005. This program resulted in an issuance of $300 million of FABNs in the fourth quarter of 2005 and $1,000$1,450 million in the first half ofduring 2006. The increase in interest credited was driven by higher crediting rates on our floating rate products largely due to an increase in the underlying indices. This was partially offset by expected maturities.short-term interest rates.

Fee-based products

The following table sets forth selected operating performance measures regarding our fee-based products as of the sixnine months ended JuneSeptember 30, 2006 and 2005:

 

  For the three months
ended June 30,
 Percentage
change
 For the six months
ended June 30,
 Percentage
change
  As of or for the three
months ended
September 30,
 Percentage
change
 As of or for the nine
months ended
September 30,
 Percentage
change
 

(Amounts in millions)

      2006         2005     2006 vs. 2005     2006         2005     2006 vs. 2005        2006             2005       2006 vs. 2005     2006         2005     2006 vs. 2005 

Income Distribution Series(2)

             

Account value, net of reinsurance, beginning of period

  $1,235  $540  129% $911  $462  97% $1,555  $634  145% $911  $462  97%

Deposits

   350   92  NM(1)  631   177  NM(1)  334   109  NM(1)  965   286  NM(1)

Interest credited and investment performance

   (5)  8  (163)%  54   4  NM(1)  68   13  NM(1)  122   17  NM(1)

Surrenders, benefits and product charges

   (25)  (6) NM(1)  (41)  (9) NM(1)  (28)  (9) NM(1)  (69)  (18) NM(1)
                             

Account value, net of reinsurance, end of period

  $1,555  $634  145% $1,555  $634  145% $1,929  $747  158% $1,929  $747  158%
                             

Traditional variable annuities

             

Account value, net of reinsurance, beginning of period

  $1,360  $747  82% $1,182  $632  87% $1,458  $902  62% $1,182  $632  87%

Deposits

   147   145  1%  279   288  (3)%  105   137  (23)%  384   425  (10)%

Interest credited and investment performance

   (17)  29  (159)%  61   16  NM(1)  54   35  54%  113   51  122%

Surrenders, benefits and product charges

   (30)  (19) 58%  (62)  (34) 82%  (32)  (26) 23%  (94)  (60) 57%
                             

Account value, net of reinsurance, end of period

  $1,460  $902  62% $1,460  $902  62% $1,585  $1,048  51% $1,585  $1,048  51%
               
              

Variable life insurance

             

Account value, beginning of period

  $377  $335  13% $363  $345  5% $367  $347  6% $363  $345  5%

Deposits

   7   11  (36)%  16   19  (16)%  7   7  —  %  23   26  (12)%

Interest credited and investment performance

   (5)  11  (145)%  13   —    NM(1)  10   13  (23)%  23   13  77%

Surrenders, benefits and product charges

   (12)  (10) 20%  (25)  (17) 47%  (13)  (12) 8%  (38)  (29) 31%
                             

Account value, end of period

  $367  $347  6% $367  $347  6% $371  $355  5% $371  $355  5%
                             

Third-party assets

             

Account value, beginning of period

  $5,824  $4,046  44% $5,180  $3,973  30% $6,143  $4,335  42% $5,180  $3,973  30%

Deposits

   643   359  79%  1,225   683  79%  602   429  40%  1,827   1,112  64%

Interest credited and investment performance

   (159)  58  NM(1)  95   (38) NM(1)  154   160  (4)%  249   122  104%

Surrenders, benefits and product charges

   (165)  (128) 29%  (357)  (283) 26%  (133)  (147) (10)%  (490)  (430) 14%
                             

Account value, end of period

  $6,143  $4,335  42% $6,143  $4,335  42% $6,766  $4,777  42% $6,766  $4,777  42%
                             

(1)Not meaningful
(2)The Income Distribution Series offers variable annuity products and four riders that provide the contractholder with a guaranteed minimum income stream that they cannot outlive, along with an opportunity to participate in market appreciation.

Income Distribution Series. We experienced an increase in assets under management attributable to the launch of our guaranteed minimum withdrawal for life benefit rider in the fourth quarter of 2005. Sales of this product remained strong in the first half ofduring 2006, achieving the highest production to date in the secondthird quarter of 2006.

Traditional variable annuities. The increase in assets under management was attributable toprincipally the result of ongoing sales of our core income series variable annuity products and positive investment performancefavorable equity markets for the first sixnine months of 2006. In addition, the introduction of our group variable annuity product in the fourth quarter of 2005 has contributed to the growth in our assets under management.

Third-party assets. Third-party assets include assets managed by our Genworth Financial Asset Management and Genworth Financial Advisor groups. The increase in third-party assets was primarily due to growth in managed money accounts from new and existing clients, as well as positive investment performance during the last three quarters of 2005 and the first quarter of 2006.favorable equity markets. Significant contributors to the growth in deposits waswere the result of expansion of our distribution network, growth in our sales force, and changes in our fee structure. On October 20, 2006, we acquired AssetMark Investment Services, Inc., an investment management and advisor company with more than $9 billion in third-party assets under management.

Mortgage Insurance segment

In the U.S., Canada, Australia, Europe, New Zealand, Mexico and Japan, we offer mortgage insurance products that facilitate homeownership by enabling borrowers to buy homes with low-down-payment mortgages.mortgages and mortgage related services for our financial services customers. These products generally also aid financial institutions in managing their capital efficiently by reducing the capital required for low-down-payment mortgages.

Segment results of operations

Three Months Ended JuneSeptember 30, 2006 Compared to Three Months Ended JuneSeptember 30, 2005

The following table sets forth the results of operations relating to our Mortgage Insurance segment for the three months ended JuneSeptember 30, 2006 and 2005:

 

  Three months ended
June 30,
 Increase (decrease) and
percentage change
 

(Amounts in millions)

     2006          2005               2006 vs. 2005           

Revenues:

    

Premiums

 $267  $220 $47  21%

Net investment income

  85   68  17  25%

Net investment gains (losses)

  1   —    1  NM(1)

Policy fees and other income

  11   12  (1) (8)%
            

Total revenues

  364   300  64  21%
            

Benefits and expenses:

    

Benefits and other changes in policy reserves

  50   39  11  28%

Acquisition and operating expenses, net of deferrals

  76   75  1  1%

Amortization of deferred acquisition costs and intangibles

  13   13  —    —  %
            

Total benefits and expenses

  139   127  12  9%
            

Earnings before income taxes

  225   173  52  30%

Provision for income taxes

  62   52  10  19%
            

Segment net earnings

  163   121  42  35%

Adjustments to segment net earnings:

    

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

  (1)  —    (1) NM(1)
            

Segment net operating earnings

 $162  $121 $41  34%
            

(1)Not meaningful
   Three months ended
September 30,
  Increase (decrease) and
percentage change
 

(Amounts in millions)

      2006          2005              2006 vs. 2005         

Revenues:

       

Premiums

  $262  $218  $44  20%

Net investment income

   86   73   13  18%

Net investment gains (losses)

   —     —     —    —  %

Policy fees and other income

   8   12   (4) (33)%
              

Total revenues

   356   303   53  17%
              

Benefits and expenses:

       

Benefits and other changes in policy reserves

   76   36   40  111%

Acquisition and operating expenses, net of deferrals

   76   81   (5) (6)%

Amortization of deferred acquisition costs and intangibles

   17   18   (1) (6)%
              

Total benefits and expenses

   169   135   34  25%
              

Income before income taxes

   187   168   19  11%

Provision for income taxes

   53   42   11  26%
              

Segment net income

   134   126   8  6%

Adjustments to segment net income:

       

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

   —     —     —    —  %
              

Segment net operating income

  $134  $126  $8  6%
              

The following table sets forth net operating earningsincome for the products included in our Mortgage Insurance segment for the three months ended JuneSeptember 30, 2006 and 2005:

 

  Three months ended
June 30,
  Increase (decrease) and
percentage change
   Three months ended
September 30,
  Increase (decrease) and
percentage change
 

(Amounts in millions)

      2006          2005          2006 vs. 2005           2006          2005              2006 vs. 2005         

Segment net operating earnings:

        

Segment net operating income:

       

U.S. mortgage insurance

  $72  $61  $11  18%  $53  $58  $(5) (9)%

International mortgage insurance

   90   60   30  50%   81   68   13  19%
                      

Total segment net operating earnings

  $162  $121  $41  34%

Total segment net operating income

  $134  $126  $8  6%
                      

Segment net operating earningsincome

Our U.S. mortgage insurance business segment net operating earnings increasedincome remained flat compared to the prior year excluding $5 million, net of tax, of favorable net adjustments to losses, expenses and taxes in the prior year that did not recur. Higher losses and a higher effective tax rate were partially offset by $11 million primarily due to lower administrative costs from productivity gains, higher net investment incomeexpenses, growth in premiums and an increase in earnings from our intra-segment reinsurance and capital maintenance agreements with our international mortgage insurance business. The increase in our

Our international mortgage insurance business segment net operating earningsincome increase includes an increase of $30 million, which included $3$5 million, net of tax, of favorability dueattributable to changes in foreign exchange rates was driven largely byand favorable adjustments to losses of $6 million, net of tax, in the growthprior year that did not recur. Growth of the business and seasoning of our insurance in-force and a decrease in effective tax rate. These increases were partially offset by an increase in losses from portfolio seasoning and higher delinquencieslosses from a limited number of Australian distribution relationships, andas well as continued investments in our global expansion.

Revenues

Our international mortgage insurance premiums increased by $44$37 million, $8 million of which included an increase of $2 million associated withwas attributable to changes in foreign exchange rates, driven by the growth and aging of our international in-force block which resulted in increased earned premiums from prior years new insurance written. This increase in premiums also includes the impact of an $8 million adjustment reducing unearned premium reserves in Australia and a modest increase in international cancellations.business. The increase in our U.S. mortgage insurance business of $3$7 million was primarily driven by increased flow premiums resulting from higher average price per policy, increased reinsurance premiums assumed from our international mortgage insurance business.business and higher bulk premiums.

The increase in net investment income of $13 million, which included ana $3 million increase of $1 million associated withattributable to changes in foreign exchange rates, was largely the result of an increase in invested assets associated with the growth of our international mortgage insurance business and increased yield in the investment portfolio of our U.S. mortgage insurance business.

Policy fees and other income remained relatively flatdecreased by $4 million primarily due to the recent elimination of Canadian application fees in our U.S. and international mortgage insurance businesses.business.

Benefits and Expenses

Our international mortgage insurance benefits and other changes in policy reserves increased $12$23 million, which included an increase ofincluding a $1 million associated withincrease attributable to changes in foreign exchange rates,rates. This increase was primarily driven by higher losses in Australia reflecting thefrom seasoning of more recent in-force blocks of business, and increased delinquencieslosses from a limited number of Australian distribution relationships.relationships and $9 million of favorable adjustments in the prior year that did not recur. The decreaseincrease in our U.S. mortgage insurance business of $1$17 million was largelyprimarily attributable to the result ofincrease in losses associated with a reduction in paid claims due to asmaller decline in our average reserve per delinquency than the number of claims.prior year and a $5 million favorable adjustment to reserves on our prime bulk business in the prior year that did not recur.

Acquisition and operating expenses, net of deferrals decreased in our U.S. mortgage insurance business primarily driven by improved productivity.continued productivity initiatives and other expense reductions, lower contract underwriting volume and $4 million of non-recurring expenses in the prior year quarter. Acquisition and operating expenses, net of deferrals in our international mortgage insurance business increased as a result of continued investment in our existing international mortgage insurance platforms and potential new international platforms.platforms as well as a $2 million increase attributable to changes in foreign exchange rates.

AmortizationOur U.S. mortgage insurance business amortization of deferred acquisition costs and intangibles remained relatively flatdecreased $4 million primarily due to an acceleration of amortization of deferred acquisition costs in the prior year related to low persistency rates. The increase in our U.S. and international mortgage insurance businesses.business amortization of deferred acquisition costs was mainly due to the growth and seasoning of our insurance in-force in our international business.

Provision for income taxes

Provision for income taxes increased $10$11 million, which included anincludes a $2 million increase of $1 million associated withattributable to changes in foreign exchange rates. The effective tax rate decreasedincreased to 27.6%28.3% for the three months ended JuneSeptember 30, 2006 from 30.1%25.0% for the three months ended JuneSeptember 30, 2005. This decreaseincrease in effective tax rate was primarily attributable to nonrecurring favorable IRS examination developments in 2005, offset by the increase in lower taxed foreign earnings and a reduction in excess foreign tax credits. Our Mortgage Insurance segment’s effective tax rate is below the statutory rate primarily as a result of tax-exempt investment income and lower taxed foreign earnings.

SixNine Months Ended JuneSeptember 30, 2006 Compared to SixNine Months Ended JuneSeptember 30, 2005

The following table sets forth the results of operations relating to our Mortgage Insurance segment for the sixnine months ended JuneSeptember 30, 2006 and 2005:

 

  Six months ended
June 30,
  Increase (decrease) and
percentage change
   Nine months ended
September 30,
  Increase (decrease) and
percentage change
 

(Amounts in millions)

      2006         2005              2006 vs. 2005               2006         2005              2006 vs. 2005         

Revenues:

            

Premiums

  $514  $435  $79  18%  $776  $653  $123  19%

Net investment income

   165   137   28  20%   251   210   41  20%

Net investment gains (losses)

   2   —     2  NM(1)   2   —     2  NM(1)

Policy fees and other income

   18   22   (4) (18)%   26   34   (8) (24)%
                      

Total revenues

   699   594   105  18%   1,055   897   158  18%
                      

Benefits and expenses:

            

Benefits and other changes in policy reserves

   96   60   36  60%   172   96   76  79%

Acquisition and operating expenses, net of deferrals

   144   134   10  7%   220   215   5  2%

Amortization of deferred acquisition costs and intangibles

   28   24   4  17%   45   42   3  7%
                      

Total benefits and expenses

   268   218   50  23%   437   353   84  24%
                      

Earnings before income taxes

   431   376   55  15%

Income before income taxes

   618   544   74  14%

Provision for income taxes

   119   114   5  4%   172   156   16  10%
                      

Segment net earnings

   312   262   50  19%

Adjustments to segment net earnings:

      

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

   (1)  —     (1) NM(1)

Segment net income

   446   388   58  15%

Adjustments to segment net income:

      

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

   (1)  —     (1) NM(1)
                      

Segment net operating earnings

  $311  $262  $49  19%

Segment net operating income

  $445  $388  $57  15%
                      

(1)Not meaningful

The following table sets forth net operating earningsincome for the products included in our Mortgage Insurance segment for the sixnine months ended JuneSeptember 30, 2006 and 2005:

 

  Six months ended
June 30,
  Increase (decrease) and
percentage change
   Nine months ended
September 30,
  Increase (decrease) and
percentage change
 

(Amounts in millions)

      2006          2005          2006 vs. 2005           2006          2005              2006 vs. 2005         

Segment net operating earnings:

        

Segment net operating income:

        

U.S. mortgage insurance

  $144  $133  $11  8%  $197  $191  $6  3%

International mortgage insurance

   167   129   38  29%   248   197   51  26%
                      

Total segment net operating earnings

  $311  $262  $49  19%

Total segment net operating income

  $445  $388  $57  15%
                      

Segment net operating earningsincome

Our U.S. mortgage insurance business segment net operating earnings increased by $11 million primarily as a result of higher investment income, lower administrative costs from productivity gains andexpenses, an increase in earnings from our intra-segment reinsurance

and capital maintenance agreements with our international mortgage insurance business. Thebusiness and higher investment income. These were partially offset by an increase in ourlosses and a higher effective tax rate. The current year includes a $2 million, net of tax, favorable adjustment to losses. The prior year includes $5 million, net of tax, favorable net adjustments to losses, expenses and taxes.

Our international mortgage insurance business segment net operating earnings of $38increased by $51 million, which included $4including $9 million, net of tax, of favorableattributable to changes in foreign exchange rates, was driven largely by the growth of the business, seasoning of our insurance in-force and a decrease in effective tax rate. These increases were partially offset by an increase in losses from portfolio seasoning and higher delinquencieslosses from a limited number of Australian distribution relationships, andas well as continued investments in our global expansion. The current year includes $5 million, net of tax, of favorable adjustments to premiums. The prior year includes $12 million, net of tax, of favorable adjustments to premiums and losses.

Revenues

Our international mortgage insurance premiums increased by $71$108 million, which included an increase of $3$11 million associated withattributable to changes in foreign exchange rates, driven by the growth and aging of our international in-force block, which resulted in increased earned premiums from prior-year new insurance written. The year-over-year increase was impacted by thea $10 million release of unearned premium reserves on our single premium product of $10 million in the first quarter of 2005 due to the completion of a European cancellation study and was partially offset by an $8 million favorable adjustment reducingof unearned premium reserves in Australia in the second quarter of 2006 and a modest2006. The increase in international cancellations. The increasepremiums of $15 million in our U.S. mortgage insurance business was primarily driven bydue to increased reinsurance premiums assumed from our international mortgage insurance business.business, increased bulk premiums and increased flow premiums resulting from increased average price.

The increase in net investment income, which included an increase of $2$4 million dueattributable to changes in foreign exchange rates, was largely the result of an increase in invested assets associated with the growth of our international mortgage insurance business and increased yield in the investment portfolio of our U.S. mortgage insurance business.

The decrease in policy fees and other income was primarily driven byfrom lower fees for contract underwriting services and lower other income in our U.S. mortgage insurance business and the recent elimination of Canadian application fees in our international mortgage insurance business.

Benefits and Expenses

Our internationalU.S. mortgage insurance benefits and other changes in policy reserves increased $33$20 million which includedprimarily driven by an increase of $1 millionin losses associated with changes in foreign exchange rates, primarily due to higher losses in Australia reflecting the seasoning of more recent in-force blocks of business and increased delinquencies from a limited number of distribution relationships. Thean increase in our U.S. business of $3 million was principally due to an increase in average reserve per delinquency whichand an

increase of $5 million related to a prime bulk reserve adjustment in the prior year that did not recur. This was partially offset by claims paid favorability and a $3 million decrease in reserves for severely impacted areas associated with Hurricanes Katrina and Rita. Our international mortgage insurance benefits and other changes in policy reserves increased $56 million primarily driven by higher losses in Australia reflecting the seasoning of more recent in-force blocks of business, increased losses from a limited number of distribution relationships in Australia and an increase of $9 million related to loss adjustments in the prior year that did not recur.

The increase in acquisition and operating expenses, net of deferrals, was primarily attributabledue to an increase in costs infrom our existing international platforms and continued investment in potential new international mortgage insurance platforms as well as a $2 million increase attributable to changes in foreign exchange rates. This increase was partially offset by improved productivity in our U.S. mortgage insurance business.business as a result of continued productivity improvements and other expense reductions, lower contract underwriting volume and an increase in indemnity reserves related to our U.S. contract services offerings in the prior year that did not recur.

Amortization of deferred acquisition costs and intangibles increased by $4 million principally due toas a result of the growth and seasoning in our international mortgage insurance business.business which was partially offset by $6 million of accelerated amortization of deferred acquisition costs as a result of low persistency in the prior year that did not recur.

Provision for income taxes

Provision for income taxes increased $16 million, which includes a $5 million which included an increase of $2 million associated withattributable to changes in foreign exchange rates. The effective tax rate decreased to 27.6%27.8% for the sixnine months ended JuneSeptember 30, 2006 from 30.3%28.7% for the sixnine months ended JuneSeptember 30, 2005. This decrease in effective tax rate was primarily attributable to the increase in lower taxed foreign earnings and a reduction in excess foreign tax credits.credits, offset by nonrecurring favorable IRS examination developments in 2005. Our Mortgage Insurance segment’s effective tax rate is below the statutory rate primarily as a result of tax-exempt investment income and lower taxed foreign earnings.

Mortgage Insurance selected operating performance measures

The following tables set forth selected operating performance measures regarding our U.S. and international mortgage businesses as of or for the dates indicated:

 

  For the three months
ended June 30,
  Percentage
change
 For the six months
ended June 30,
  Percentage
change
   Three months
ended September 30,
  Percentage
change
 Nine months
ended September 30,
  Percentage
change
 

(Amounts in millions)

  2006  2005  2006 vs. 2005 2006  2005  2006 vs. 2005   2006  2005  2006 vs. 2005 2006  2005  2006 vs. 2005 

Net premiums written:

                      

U.S. mortgage insurance

  $119  $111  7% $234  $220  6%  $121  $112  8% $355  $332  7%

International mortgage insurance

   244   168  45%  448   305  47%   311   204  52%  759   509  49%
                              

Total net premiums written

  $363  $279  30% $682  $525  30%  $432  $316  37% $1,114  $841  32%
                              

Net premiums earned:

                      

U.S. mortgage insurance

  $116  $113  3% $232  $224  4%  $118  $111  6% $350  $335  4%

International mortgage insurance

   151   107  41%  282   211  34%   144   107  35%  426   318  34%
                              

Total net premium earned

  $267  $220  21% $514  $435  18%  $262  $218  20% $776  $653  19%
                              

New insurance written:

                      

U.S. mortgage insurance

  $8,200  $7,200  14% $15,000  $12,900  16%  $8,200  $7,200  14% $23,200  $20,100  15%

International mortgage insurance

   21,700   21,400  1%  42,100   35,600  18%   28,700   21,000  37%  70,800   56,600  25%
                              

Total new insurance written

  $29,900  $28,600  5% $57,100  $48,500  18%  $36,900  $28,200  31% $94,000  $76,700  23%
                              

Net premiums written

For the three months ended September 30, 2006, the increase in net premiums written was primarily driven by increases in new insurance written in our international mortgage insurance business. The increase in our international mortgage insurance business of $107 million, which included an increase of $17 million attributable to changes in foreign exchange rates, was primarily the result of an increase in flow new insurance written. The increase in net premiums written in our U.S. mortgage insurance business of $9 million was primarily due to higher flow average price per policy, more sales of our single premium product and increased reinsurance premiums assumed from our international mortgage insurance business.

For the nine months ended September 30, 2006, the increase in net premiums written was primarily due to increases in new insurance written in our international mortgage insurance business. The increase in our international business of $250 million, which included an increase of $19 million attributable to changes in foreign exchange rates, was the result of an increase in new insurance written. Included in the international increase was the impact of a catch-up of sales reported to us due to a delay in timing of customer reporting in Australia. The increase in net premiums written in our U.S. mortgage insurance business of $23 million was principally from higher flow average price per policy, higher sales of our single premium product and increased reinsurance premiums assumed from our international mortgage insurance business.

Most of our international mortgage insurance policies provide for single premiums at the time that loan proceeds are advanced. We initially record the single premiums to unearned premium reserves and recognize the premiums earned over time in accordance with the estimated expiration of risk. As of September 30, 2006, our unearned premium reserves in our international mortgage insurance business increased to $2.3 billion from $1.7 billion as of September 30, 2005.

New insurance written

For the three months ended September 30, 2006, the increase in new insurance written was primarily driven by our international mortgage insurance business. International new insurance written increased $7.7 billion, which included an increase of $1.1 billion attributable to changes in foreign exchange rates. The increase in international new insurance written was largely due to growth in international flow and bulk products, which was primarily the result of ongoing expansion of our customer base in Europe and continued account penetration in Canada. U.S. new insurance written increased $1.0 billion associated with an increase in our bulk product writings.

For the nine months ended September 30, 2006, the increase in new insurance written was driven by both our U.S. and international mortgage insurance businesses. International new insurance written increased $14.2 billion, which included an increase of $0.3 billion attributable to changes in foreign exchange rates. The increase in international new insurance written was primarily due to growth in international flow insurance which is the result of the ongoing expansion of our customer base in Europe, continued account penetration in Canada, strong sales by key customers in Australia and a catch-up of sales reported to us caused by a delay in timing of customer reporting in Australia. U.S. new insurance written increased $3.1 billion primarily due to an increase in our bulk product writings and a modest increase in flow new insurance written.

 

  As of the six months
ended June 30,
  Percentage change   As of September 30,  Percentage change 

(Amounts in millions)

  2006  2005  2006 vs. 2005   2006  2005  2006 vs. 2005 

Primary insurance in-force:

            

U.S. mortgage insurance

  $102,000  $104,300  (2)%  $104,000  $101,900  2%

International mortgage insurance

   271,600   210,200  29%   319,600   231,000  38%
                

Total primary insurance in-force

  $373,600  $314,500  19%  $423,600  $332,900  27%
                

Risk in-force:

            

U.S. mortgage insurance

  $22,500  $22,900  (2)%  $23,000  $22,500  2%

International mortgage insurance

   86,600   67,800  28%   102,700   74,500  38%
                

Total risk in-force

  $109,100  $90,700  20%  $125,700  $97,000  30%
                

Primary insurance in-force and risk in-force

The increases in primary insurance in-force and risk in-force were driven primarily by new insurance written in our international mortgage insurance business as we continue to execute our global expansion strategy. Offsetting strong increases in internationalstrategy and higher policy persistency combined with new insurance in-force and risk in-force was a year-over-year declinewritten in our U.S. mortgage insurance business. This decline was driven by policy cancellations which have exceeded new insurance written. Our U.S. flow persistency was 72% and 65%64% for the sixnine months ended JuneSeptember 30, 2006 and JuneSeptember 30, 2005. We believe that sustained higher interest rates and increased persistency will lead to stable to growing levels of insurance in-force. Primary insurance in-force in our U.S. mortgage insurance business increased from $100 billion as of March 31, 2006 to $102 billion as of June 30, 2006 to $104 billion as of September 30, 2006. This increase in primary insurance in-forceinsurance-in-force reflected athe second sequential quarter increase in flow insurance in-force for the first time inafter nearly five years.years of decline.

Our businesses in Australia, New Zealand and Canada currently provide 100% coverage on the majority of the loans we insure in those markets. For the purpose of representing our risk in-force, we have computed an “effective risk in-force” amount, which recognizes that the loss on any particular loan will be reduced by the net proceeds received upon sale of the property. Effective risk in-force has been calculated by applying to insurance

in-force a factor that represents our highest expected average per-claim payment for any one underwriting year over the life of our businesses in Australia, New Zealand and Canada. For the three and sixnine months ending JuneSeptember 30, 2006 and 2005, this factor was 35%.

Net premiums written

For the three months ended June 30, 2006, the increase in net premiums written was driven primarily by increases in new insurance written in our international mortgage insurance business. The increase in our international mortgage insurance business of $76 million, which included an increase of $4 million associated with changes in foreign exchange rates, was the result of an increase in flow new insurance written. The increase in net premiums written in our U.S. mortgage insurance business of $8 million was mostly due to increased reinsurance premiums assumed from our international mortgage insurance business and increased sales of our single premium product.

For the six months ended June 30, 2006, the increase in net premiums written was driven primarily by increases in new insurance written in our international mortgage insurance business. The increase in our international business of $143 million, which included an increase of $2 million associated with changes in foreign exchange rates, was the result of an increase in flow new insurance written. Included in the international increase was the impact of a catch-up of sales reported to us caused by a delay in timing of customer reporting in Australia. The increase in net premiums written in our U.S. mortgage insurance business of $14 million was largely attributable to increased reinsurance premiums assumed from our international mortgage insurance business and increased sales of our single premium product.

Most of our international mortgage insurance policies provide for single premiums at the time that loan proceeds are advanced. We initially record the single premiums to unearned premium reserves and recognize the premiums earned over time in accordance with the estimated expiration of risk. As of June 30, 2006, our unearned premium reserves in our international mortgage insurance business increased to $2.1 billion from $1.6 billion as of June 30, 2005.

New insurance written

For the three months ended June 30, 2006, the increase in new insurance written was driven primarily by our U.S. mortgage insurance business. U.S. new insurance written increased $1.0 billion associated with an increase in our bulk product writings and a modest increase in flow new insurance written. International new insurance written increased $0.3 billion, which included a decrease of $0.2 billion related to changes in foreign exchange rates. The increase in international new insurance written was largely due to growth in international flow which is the result of ongoing expansion of our customer base in Europe, continued account penetration in Canada and strong sales by key customers in Australia. Offsetting this increase was a decline in bulk new insurance written.

For the six months ended June 30, 2006, the increase in new insurance written was driven by both our U.S. and international mortgage insurance businesses. International new insurance written increased $6.5 billion, which included a decrease of $0.8 billion associated with changes in foreign exchange rates. The increase in international new insurance written was largely driven by growth in international flow which is the result of the ongoing expansion of our customer base in Europe, continued account penetration in Canada, strong sales by key customers in Australia and a catch-up of sales reported to us caused by a delay in timing of customer reporting in Australia. Partially offsetting this increase was a decline in bulk new insurance written, associated with strong volume in the prior year, which was not repeated in the current year. U.S. new insurance written increased $2.1 billion driven by an increase in our bulk writings and a modest increase in flow new insurance written.

Loss and expense ratios:

 

 

For the three months

ended June 30,

 Increase (decrease) 

For the six months

ended June 30,

 Increase (decrease)   

Three months

ended September 30,

 Increase (decrease) 

Nine months

ended September 30,

 Increase (decrease) 
 2006 2005 2006 vs. 2005 2006 2005 2006 vs. 2005       2006         2005     2006 vs. 2005     2006         2005     2006 vs. 2005 

Loss ratio:

             

U.S. mortgage insurance

 21% 22% (1)% 19% 18% 1%  37% 24% 13% 25% 20% 5%

International mortgage insurance

 17% 13% 4% 19% 9% 10%  22% 8% 14% 20% 9% 11%

Total loss ratio

 19% 18% 1% 19% 14% 5%  29% 17% 12% 22% 15% 7%

Expense ratio:

             

U.S. mortgage insurance

 33% 42% (9)% 34% 40% (6)%  36% 55% (19)% 35% 45% (10)%

International mortgage insurance

 20% 24% (4)% 21% 23% (2)%  16% 18% (2)% 19% 21% (2)%

Total expense ratio

 25% 32% (7)% 25% 30% (5)%  22% 31% (9)% 24% 31% (7)%

The loss ratio (expressed as a percentage) is the ratio of incurred losses and loss adjustment expense to net premiums earned.

For the three months ended JuneSeptember 30, 2006, theour U.S. loss ratio increased 13 percentage points primarily driven by an increase in loss ratio was driven primarily bylosses associated with a smaller decline in our international business.average reserve per delinquency than the prior year and a $5 million favorable adjustment to prime bulk reserves in the prior year that did not recur. The international loss ratio increased 414 percentage points principally duefrom higher losses as a result of seasoning of more recent in-force blocks of business and increased losses from a limited number of Australian distribution relationships, and an increase of $9 million related to loss adjustments in the prior year that did not recur.

For the nine months ended September 30, 2006, our international loss ratio increased 11 percentage points principally from higher losses in Australia reflecting the seasoning of more recent in-force blocks of business and increased delinquencies from a limited number of distribution relationships. The decrease in our U.S. loss ratio was largely the result of a reduction in paid claims due to a decline in the number of claims.

For the six months ended June 30, 2006, the increase in loss ratio was driven primarily by our international business. The international loss ratio increased 10 percentage points principally due to higher losses in Australia reflecting the seasoning of more recent in-force blocks of business and increased delinquencies from a limited number of distribution relationships. The increase in our U.S. loss ratio was largely the result of an increase in theour average reserve per delinquency.

The expense ratio (expressed as a percentage) is the ratio of general expenses to net premiums written. In our business, general expenses consist of acquisition and operating expenses, net of deferrals, and amortization of deferred acquisition cost and intangibles.

For the three months and sixnine months ended JuneSeptember 30, 2006, the decrease in the expense ratio was primarily driven by improvedcontinued productivity improvements and other expense reductions in our U.S. mortgage

insurance business and strong net premiums written growth in our international mortgage insurance business, partially offset by an increase in costs in our existing international platforms and continued investment in potential new international mortgage insurance platforms.

Corporate and Other segment

The Corporate and Other segment consists primarily of unallocated corporate net investment income and expenses, the results of a small, non-core business that is managed outside our operating segments, and most of our interest expense and other financing costs.

Three Months Ended JuneSeptember 30, 2006 Compared to Three Months Ended JuneSeptember 30, 2005

The following table sets forth the results of operations relating to our Corporate and Other segment for the three months ended JuneSeptember 30, 2006 and 2005:

 

 Three months ended
          June 30,          
 Increase (decrease) and
          percentage change          
   Three months ended
September 30,
 Increase (decrease) and
percentage change
 

(Amounts in millions)

     2006         2005         2006 vs. 2005           2006         2005             2006 vs. 2005         

Revenues:

         

Premiums

 $7  $12  $(5) (42)%  $9  $7  $2  29%

Net investment income

  17   30   (13) (43)%   20   53   (33) (62)%

Net investment gains (losses)

  (3)  —     (3) NM(1)   —     (7)  7  NM(1)

Policy fees and other income

  4   2   2  100%   3   3   —    —  %
                     

Total revenues

  25   44   (19) (43)%   32   56   (24) (43)%
                     

Expenses:

         

Benefits and other changes in policy reserves

  1   1   —    —  %   1   3   (2) (67)%

Acquisition and operating expenses, net of deferrals

  15   30   (15) (50)%   25   27   (2) (7)%

Amortization of deferred acquisition costs and intangibles

  1   2   (1) (50)%   1   3   (2) (67)%

Interest expense

  53   57   (4) (7)%   51   58   (7) (12)%
                     

Total benefits and expenses

  70   90   (20) (22)%   78   91   (13) (14)%
                     

Loss before income taxes

  (45)  (46)  1  (2)%   (46)  (35)  (11) (31)%

Benefit for income taxes

  (13)  (17)  4  (24)%   (14)  (12)  (2) 17%

Cumulative effect of accounting change

   —     —     —    —  %
                     

Segment net loss

  (32)  (29)  (3) 10%   (32)  (23)  (9) (39)%

Adjustments to segment net loss:

         

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

  1   —     1  NM(1)

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

   —     4   (4) NM(1)

Cumulative effect of accounting change

  —     —     —    —  %   —     —     —    —  %
                     

Segment net operating loss

 $(31) $(29) $(2) 7%  $(32) $(19) $(13) (68)%
                     

(1)Not meaningful

Segment net operating loss

The increase in the segment net operating loss iswas primarily attributable to higher interest rates on our corporate debt, offset by operating expenses principally due to lower unallocated overhead expenses in 2006 remaininginvestment income and lower limited partnership distribution income in the Corporatecurrent year. The lower unallocated investment income is the result of our capital management strategy utilizing excess capital for the Continental acquisition and Other segment.for $675 million of stock buybacks in 2006.

Revenues

Premiums decreased largely from continued run-off of certain credit life insurance blocks.

The decrease in net investment income was primarily due tothe result of lower income of $13 million from consolidated securitization entities, which were derecognized in the first quarter of 2006.2006, lower unallocated investment income of $10 million and a $7 million decrease in net investment income from limited partnership distributions

For a discussion of net investment gains (losses), see the comparison for this line item under “—Results of Operations.”

Benefits and expenses

Acquisition and operating expenses, net of deferrals, decreased primarily from lower unallocated overhead expenses remaining in the Corporate and Other segment in 2006 compared to 2005.

Interest expense consists of interest and other financial charges related to our debt that is not allocated for segment reporting purposes. The decrease was primarily associated with the first quarter 2006 derecognition of borrowings related to securitization entities which was partially offset by a higher interest rate environment on corporate debt.

ProvisionBenefit for income taxes

The decreasedincreased tax benefit is driven primarily by higher pretax losses for the three months ended JuneSeptember 30, 2006, was primarily attributable tooffset by an increase in non-deductible expenses.

SixNine Months Ended JuneSeptember 30, 2006 Compared to SixNine Months Ended JuneSeptember 30, 2005

The following table sets forth the results of operations relating to our Corporate and Other segment for the sixnine months ended JuneSeptember 30, 2006 and 2005:

 

 Six months ended
          June 30,          
 

Increase (decrease) and

          percentage change          

   Nine months ended
September 30,
 

Increase (decrease) and

percentage change

 

(Amounts in millions)

     2006         2005         2006 vs. 2005           2006         2005             2006 vs. 2005         

Revenues:

         

Premiums

 $14  $20  $(6) (30)%  $23  $27  $(4) (15)%

Net investment income

  50   64   (14) (22)%   70   117   (47) (40)%

Net investment gains (losses)

  (21)  (6)  (15) NM(1)   (21)  (13)  (8) (62)%

Policy fees and other income

  7   6   1  17%   10   9   1  11%
                     

Total revenues

  50   84   (34) (40)%   82   140   (58) (41)%
                     

Expenses:

         

Benefits and other changes in policy reserves

  2   2   —    —  %   3   5   (2) (40)%

Acquisition and operating expenses, net of deferrals

  20   29   (9) (31)%   45   56   (11) (20)%

Amortization of deferred acquisition costs and intangibles

  2   5   (3) (60)%   3   8   (5) (63)%

Interest expense

  109   120   (11) (9)%   160   178   (18) (10)%
                     

Total benefits and expenses

  133   156   (23) (15)%   211   247   (36) (15)%
                     

Loss before income taxes

  (83)  (72)  (11) 15%   (129)  (107)  (22) (21)%

Benefit for income taxes

  (25)  (25)  —    —  %   (39)  (37)  (2) 5%

Cumulative effect of accounting change, net of taxes

  4   —     4  NM(1)   4   —     4  NM(1)
                     

Segment net loss

  (54)  (47)  (7) 15%   (86)  (70)  (16) (23)%

Adjustments to segment net loss:

         

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

  13   4   9  NM(1)

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

   13   8   5  63%

Cumulative effect of accounting change

  (4)  —     (4) NM(1)   (4)  —     (4) NM(1)
                     

Segment net operating loss

 $(45) $(43) $(2) 5%  $(77) $(62) $(15) (24)%
                     

(1)Not meaningful

Segment net operating loss

The increase in the segment net operating loss iswas primarily attributable to higher interest expense primarily due to higher interest rates on our corporate debt, offset by operating expenses primarily due to lower unallocated overhead expensesnet investment income driven by lower income from consolidated securitization entities, which were derecognized in the first quarter of 2006, lower unallocated investments and higher interest expense. The lower unallocated investment income is the result of our capital management strategy utilizing excess capital for the Continental

acquisition for $675 million for stock buybacks in 2006 remainingand the increase in interest expenses was the Corporateresult of the higher interest rate environment on corporate debt. The lower unallocated investment income was partially offset by a decrease in unallocated acquisition and Other segment.operating expenses, net of deferrals, as a result of increased expense allocation to other business segments.

Revenues

Premiums decreased largely as the result ofmainly from continued run-off of certain credit life insurance blocks.

The decrease in net investment income was primarily the result of lower income from consolidated securitization entities, which were derecognized in the first quarter of 2006 partially offset by an increase in net investment income from limited partnerships.and lower unallocated invested assets.

For a discussion of net investment gains (losses), see the comparison for this line item under “—Results of Operations.”

Benefits and expenses

Acquisition and operating expenses, net of deferrals, decreased primarily fromas a result of lower unallocated overhead expenses remaining in the Corporate and Other segment in 2006 compared to 2005.

Interest expense consists of interest and other financial charges related to our debt that is not allocated for segment reporting purposes. The decrease in interest expense was primarily associated with the first quarter 2006 derecognition of borrowings related to securitization entities which was partially offset by a higher interest rate environment on corporate debt.

Provision for income taxes

The increased tax benefit for additional pretax loss for the sixnine months ended JuneSeptember 30, 2006 wasis offset by an increase in non-deductible expenses.

Investments and Derivative Instruments

Investment results

The following tables set forth information about our investment income, excluding net investment gains (losses), for each component of our investment portfolio for the three and sixnine months ended JuneSeptember 30, 2006 and 2005:

 

 Three months ended
June 30,
 Increase (decrease)   Three months ended
September 30,
   Increase (decrease) 
 2006 2005 2006 vs. 2005   2006   2005   2006 vs. 2005 

(Amounts in millions)

 Yield Amount Yield Amount  Yield   Amount    Yield Amount   Yield Amount   Yield Amount 

Fixed maturities—taxable

 5.8% $731  5.5% $665  0.3% $66   5.8% $735   5.7% $690   0.1% $45 

Fixed maturities—non-taxable

 4.5%  31  4.5%  32  —  %  (1)  4.7%  32   4.5%  31   0.2%  1 

Commercial mortgage loans

 6.9%  138  6.0%  98  0.9%  40   6.1%  126   6.6%  116   (0.5)%  10 

Equity securities

 16.1%  7  8.6%  6  7.5%  1   15.9%  6   0.3%  6   15.6%  —   

Other investments

 6.4%  12  4.6%  10  1.8%  2   4.0%  9   9.9%  25   (5.9)%  (16)

Policy loans

 9.1%  32  8.9%  27  0.2%  5   8.5%  32   8.5%  27   —  %  5 

Restricted investments held by securitization entities

 —  %  —    6.3%  13  (6.3)%  (13)  —  %  —     6.3%  12   (6.3)%  (12)

Cash, cash equivalents and short-term investments

 3.6%  20  1.8%  7  1.8%  13   4.0%  23   3.0%  13   1.0%  10 
                           

Gross investment income before expenses and fees

 5.9%  971  5.5%  858  0.4%  113   5.8%  963   5.8%  920   —  %  43 

Expenses and fees

   (18)   (16)   (2)    (19)    (18)    (1)
                           

Net investment income

 5.8% $953  5.4% $842  0.4% $111   5.7% $944   5.7% $902   —  % $42 
                           

 Six months ended
June 30,
 Increase (decrease)   Nine months ended
September 30,
   Increase (decrease) 
 2006 2005 2006 vs. 2005   2006   2005   2006 vs. 2005 

(Amounts in millions)

 Yield Amount Yield Amount Yield Amount   Yield Amount   Yield Amount   Yield Amount 

Fixed maturities—taxable

 5.8% $1,450  5.5% $1,334  0.3% $116   5.8% $2,185   5.6% $2,013   0.2% $172 

Fixed maturities—non-taxable

 4.5%  62  4.5%  65  —  %  (3)  4.6%  94   4.5%  96   0.1%  (2)

Commercial mortgage loans

 6.6%  259  6.1%  196  0.5%  63   6.4%  385   6.3%  312   0.1%  73 

Equity securities

 13.2%  14  8.7%  12  4.5%  2   13.7%  20   8.5%  18   5.2%  2 

Other investments

 5.7%  23  5.6%  24  0.1%  (1)  4.9%  32   9.1%  61   (4.2)%  (29)

Policy loans

 8.9%  62  8.6%  53  0.3%  9   8.8%  94   8.5%  80   0.3%  14 

Restricted investments held by securitization entities(1)

 6.1%  7  6.6%  27  (0.5)%  (20)  5.4%  7   6.5%  39   (1.1)%  (32)

Cash, cash equivalents and short-term investments

 3.6%  37  1.7%  15  1.9%  22   3.8%  60   2.0%  27   1.8%  33 
                           

Gross investment income before expenses and fees

 5.8%  1,914  5.5%  1,726  0.3%  188   5.8%  2,877   5.6%  2,646   0.2%  231 

Expenses and fees

   (37)   (33)   (4)    (56)    (51)    (5)
                           

Net investment income

 5.7% $1,877  5.4% $1,693  0.3% $184   5.7% $2,821   5.5% $2,595   0.2% $226 
                           

(1)Reflects two months of activity prior to the re-securitization of these assets as further described in note 98 in our “—Notes to Condensed Consolidated Financial Statements.”

Yields for fixed maturities and equity securities are based on amortized cost and cost, respectively. Yields for securities lending activity, which is included in other investments, are calculated net of the corresponding securities lending liability. All other yields are based on average carrying values.

The increase in overall investment yields was primarily attributable to increased yields on floating rate investments backing spread-based institutional products.

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

 

  Three months ended
June 30,
 

Six months ended

June 30,

   Three months ended
September 30,
 

Nine months ended

September 30,

 

(Amounts in millions)

      2006         2005         2006         2005           2006         2005         2006         2005     

Available-for-sale securities

          

Realized gains on sale

  $8  $12  $30  $51   $11  $35  $41  $86 

Realized losses on sale

   (50)  (9)  (76)  (20)   (19)  (10)  (95)  (31)

Loss on derecognition of securitization entities

   —     —     (17)  —      —     —     (17)  —   

Impairments

   (4)  (3)  (5)  (37)   (1)  (32)  (6)  (68)

Net unrealized gains (losses) on trading securities

   (1)  —     (1)  —   

Net unrealized losses on trading securities

   —     —     (1)  —   

Derivative instruments

   (2)  —     (2)  —      2   —     —     —   

Other

   1   —     1   —   
                          

Net investment gains (losses)

  $(49) $—    $(71) $(6)  $(6) $(7) $(77) $(13)
                          

For the three months ended September 30, 2006 and 2005, we recognized impairments of $1 million and $32 million, respectively, and for the nine months ended September 30, 2006 and 2005, we recognized impairments of $6 million and $68 million, respectively. The aggregate fair value of securities sold at a loss during the three months ended September 30, 2006 and 2005, was $919 million and $251 million, respectively, which was approximately 98% and 97% of book value, respectively. The aggregate fair value of securities sold at a loss during the nine months ended September 30, 2006 and 2005, was $2,987 million and $1,409 million, respectively, which was approximately 97% and 98% of book value, respectively.

Derivative instruments primarily consist of changes in fair value on the non-qualifying derivatives, including embedded derivatives, changes in fair value of certain derivatives and related hedged items in fair value hedge relationships and hedge ineffectiveness on qualifying derivative instruments. Effective April 1, 2006, we began classifying changes in fair value of these derivative items as net investment gains (losses). These items were previously included as a component of net investment income, interest credited and benefits and other changes in policy reserves. The amount of these derivative items in prior periods that were included in the aforementioned categories was not material.

For a discussion of the change in net investment gains (losses), see the comparison for this line item under “—Results of Operations.”

Investment portfolio

The following table sets forth our cash, cash equivalents and invested assets as of the dates indicated:

 

  June 30, 2006 December 31, 2005   September 30, 2006 December 31, 2005 

(Amounts in millions)

  Carrying value  % of total Carrying value  % of total   Carrying value  % of total Carrying value  % of total 

Fixed maturities, available-for-sale

              

Public

  $38,652  58% $40,539  59%  $40,024  58% $40,539  59%

Private

   13,664  21   13,398  19    14,256  20   13,398  19 

Commercial mortgage loans

   8,203  12   7,558  11    8,315  12   7,558  11 

Other invested assets

   1,840  3   3,174  5    3,050  5   3,174  5 

Policy loans

   1,485  2   1,350  2    1,498  2   1,350  2 

Restricted investments held by securitization entities

   —    —     685  1    —    —     685  1 

Equity securities, available-for-sale

   187  —     206  —      192  —     206  —   

Cash and cash equivalents

   2,351  4   1,875  3    2,302  3   1,875  3 
                          

Total cash, cash equivalents and invested assets

  $66,382  100% $68,785  100%  $69,637  100% $68,785  100%
                          

The total cash, cash equivalents and invested assets decreased $2.4 billion.investment portfolio increased $852 million. The decreaseincrease was primarily due to cash generated from operating activities, net of cash used for financing activities, which was invested in fixed maturities and commercial mortgage loans. This was partially offset by lower net unrealized gains as a result of a higher interest rate environment, the first quarter 2006 derecognition of restricted investments held by securitization entities from our consolidated statement of financial position a decreaseand decreased participation in the securities lending programprogram.

Included in other invested assets are certain securities that are designated as trading and, a reductionaccordingly, are held at fair value with changes in fair value included in net investment gains (losses) in the condensed consolidated statement of income. As of September 30, 2006 and December 31, 2005, the fair value of the trading portfolio was $31 million and $15 million, respectively.

As of September 30, 2006, the amortized cost or cost, gross unrealized gains (losses), and estimated fair value of our fixed maturities and equity securities classified as available-for-sale were as follows:

(Amounts in millions)

  Amortized
cost or
cost
  Gross
unrealized
gains
  Gross
unrealized
losses
  Estimated
fair value

Fixed maturities:

       

U.S. government, agencies and government sponsored entities

  $697  $24  $(6) $715

Tax exempt

   2,615   107   (2)  2,720

Government—non U.S.

   1,702   73   (4)  1,771

U.S. corporate

   24,785   656   (359)  25,082

Corporate—non U.S.

   10,382   212   (152)  10,442

Mortgage and asset-backed

   13,521   147   (118)  13,550
                

Total fixed maturities

   53,702   1,219   (641)  54,280

Equity securities

   161   33   (2)  192
                

Total available-for-sale securities

  $53,863  $1,252  $(643) $54,472
                

As of December 31, 2005, the amortized cost or cost, gross unrealized gains (losses), and estimated fair value of our fixed maturities and equity securities classified as available-for-sale were as follows:

(Amounts in millions)

  Amortized
cost or
cost
  Gross
unrealized
gains
  Gross
unrealized
losses
  Estimated
fair value

Fixed maturities:

       

U.S. government, agencies and government sponsored entities

  $777  $32  $(4) $805

Tax exempt

   2,797   97   (4)  2,890

Government—non U.S.

   1,736   74   (4)  1,806

U.S. corporate

   25,378   975   (231)  26,122

Corporate—non U.S.

   9,168   306   (84)  9,390

Mortgage and asset-backed

   12,926   140   (142)  12,924
                

Total fixed maturities

   52,782   1,624   (469)  53,937

Equity securities

   173   36   (3)  206
                

Total available-for-sale securities

  $52,955  $1,660  $(472) $54,143
                

Effective March 16, 2005, we began a resultrepurchase program in which we sell a security at a specified price and agree to repurchase that security at another specified price at a later date. Repurchase agreements are treated as collateralized financing transactions and are carried at the amounts at which the securities will be subsequently reacquired, including accrued interest, as specified in the respective agreement. The market value of a higher interest environment, partially offset by cash generated from operating activitiessecurities to be repurchased is monitored and non-recourse funding obligations which wascollateral levels are adjusted where appropriate to protect the counterparty against credit exposure. Cash received is invested in fixed maturitiesmaturities. In the third quarter of 2006 we pledged additional securities of $500 million under our repurchase program. At September 30, 2006, the total fair value of securities pledged under the repurchase program is $833 million and commercial mortgage loans.

Impairmentsthe offsetting repurchase obligation of investment securities

See note 4$798 million is included in our “—Notes toother liabilities on the Condensed Consolidated Financial Statements.”Balance Sheet.

The following table presents the gross unrealized losses and estimated fair values of our investment securities, aggregated by investment type and length of time that individual investment securities have been in a continuous unrealized loss position, as of September 30, 2006:

   Less Than 12 Months  12 Months or more

(Dollar amounts in millions)

  Estimated
fair value
  Gross
unrealized
losses
  # of
securities
  Estimated
fair value
  Gross
unrealized
losses
  # of
securities

Description of Securities

          

Fixed maturities:

          

U.S. government, agencies and government sponsored entities

  $138  $(2) 12  $148  $(4) 29

Tax exempt

   21   —    7   165   (2) 64

Government—non U.S.  

   282   (3) 110   64   (1) 23

U.S. corporate

   5,303   (111) 509   6,320   (248) 676

Corporate—non U.S.  

   3,171   (61) 441   2,392   (91) 251

Mortgage and asset backed

   1,933   (15) 300   4,394   (103) 485
                      

Subtotal, fixed maturities

   10,848   (192) 1,379   13,483   (449) 1,528

Equity securities

   —     —    —     28   (2) 13
                      

Total temporarily impaired securities

  $10,848  $(192) 1,379  $13,511  $(451) 1,541
                      

% Below cost—fixed maturities:

          

<20% Below cost

  $10,824  $(182) 1,374  $13,472  $(443) 1,521

20-50% Below cost

   23   (8) 2   10   (4) 5

>50% Below cost

   1   (2) 3   1   (2) 2
                      

Total fixed maturities

   10,848   (192) 1,379   13,483   (449) 1,528
                      

% Below cost—equity securities:

          

<20% Below cost

   —     —    —     28   (2) 13

20-50% Below cost

   —     —    —     —     —    —  

>50% Below cost

   —     —    —     —     —    —  
                      

Total equity securities

   —     —    —     28   (2) 13
                      

Total temporarily impaired securities

  $10,848  $(192) 1,379  $13,511  $(451) 1,541
                      

Investment grade

  $10,040  $(172) 1,212  $12,782  $(412) 1,416

Below investment grade

   808   (20) 167   714   (38) 117

Not Rated—Fixed maturities

   —     —    —     4   —    1

Not Rated—Equities

   —     —    —     11   (1) 7
                      

Total temporarily impaired securities

  $10,848  $(192) 1,379  $13,511  $(451) 1,541
                      

The investment securities in an unrealized loss position as of September 30, 2006 consisted of 2,920 securities accounting for unrealized losses of $643 million. Of these unrealized losses 91% were investment grade (rated AAA through BBB-) and 98% were less than 20% below cost. The amount of the unrealized loss on these securities was primarily attributable to increases in interest rates.

Of the investment securities in an unrealized loss position for twelve months or more as of September 30, 2006, 7 securities were 20% or more below cost, including 5 securities, which were also below investment grade (rated BB+ and below). These 5 securities accounted for unrealized losses of $3 million. These securities consisted of 3 issuers primarily in the automotive industry and were current on all terms. The unrealized loss on the automotive investments was primarily caused by deteriorating market share and legacy issues. The automotive issuer continues to maintain significant liquidity relative to its maturity and we currently expect to collect full principal and interest.

As of September 30, 2006, we expect these investments to continue to perform in accordance with their original contractual terms and we have the ability and intent to hold these investment securities until the recovery of the fair value up to the cost of the investment, which may be maturity. Accordingly, we do not consider these investments to be other-than-temporarily impaired at September 30, 2006. However, from time to time, we may sell securities in the ordinary course of managing our portfolio to meet diversification, credit quality, yield enhancement, asset-liability management and liquidity requirements.

Derivatives

The fair value of derivative instruments, including financial futures, interest rate and foreign currency swaps and equity index options, are based upon pricing valuation models which utilize independent third party data as inputs. The following table sets forth our positions in derivative instruments and the estimated fair values as of the dates indicated. The fair value of derivative instruments, including financial futures, interest rate and foreign currency swaps, foreign currency forward contracts and equity index options, are based upon quotations obtained from dealers or other reliable sources.indicated:

 

  June 30, 2006  December 31, 2005  September 30, 2006 December 31, 2005

(Amounts in millions)

  Notional
value
  Estimated
fair value
  Notional
value
  Estimated
fair value
  Notional
value
  Estimated
fair value
 Notional
value
  Estimated
fair value

Interest rate swaps

  $11,795  $222  $7,894  $508  $16,763  $503  $7,894  $508

Foreign currency swaps

   533   15   533   4   559   (4)  533   4

Equity index options

   223   20   265   21   281   23   265   21

Financial futures

   9   —     27   —     16   —     27   —  
                        

Total

  $12,560  $257  $8,719  $533  $17,619  $522  $8,719  $533
                        

As of JuneSeptember 30, 2006 and December 31, 2005, the fair value of derivatives in a gain position and recorded in other invested assets was $286$552 million and $559 million, respectively, and the fair value of derivatives in a loss position and recorded in other liabilities was $29$30 million and $26 million, respectively.

ForThe increase in the three months ended June 30, 2006, the Company entered intonotional value of derivatives was primarily due to a forward starting interest rate swapsswap with a notional value totaling approximately $3.4$7.7 billion to hedge the cash flows of forecasted transactions related to our long-term care business within our Protection segment. In addition, for the six months ended June 30, 2006, the Companywe entered into interest rate swaps with notional value of $600 million$0.9 billion to convert fixed rate liabilities into floating rate liabilities to improveconsistent with the overall asset-liability management for our FABN business within our Retirement Income and Investments segment.

Liquidity and Capital Resources

Liquidity and capital resources represent our overall financial strength and our ability to generate strong cash flows from our businesses, borrow funds at competitive rates and raise new capital to meet our operating and growth needs.

Genworth Financial and Subsidiaries

The following table sets forth our condensed consolidated cash flows for the sixnine months ended JuneSeptember 30:

 

(Amounts in millions)

  2006 2005   2006 2005 

Net cash from operating activities

  $1,997  $1,363   $3,350  $2,424 

Net cash from investing activities

   (752)  (1,039)   (1,554)  (2,855)

Net cash from financing activities

   (760)  (708)   (1,351)  339 
       

Net increase (decrease) in cash less foreign exchange effect

  $445  $(92)
       

Cash flows from operating activities are affected by the timing of premiums received, fees received, investment income and expenses paid. Principal sources of cash include sales of our products and services. The increase in cash flows from operating activities for the sixnine months ended JuneSeptember 30, 2006 was primarily the result of increases in our long-term care insurance reserves due to normal aging of the in-force block, growth of our international mortgage insurance unearned premium reserves and tax payments made in 2005 that did not recur in 2006.

As an insurance business, we typically generate positive cash flows from operating activities, as premiums and deposits collected from our insurance and investment products exceed policy acquisition costs, benefits paid and redemptions. These positive cash flows are then invested to support the obligations of our insurance and investment products and required capital supporting these products. Accordingly, in analyzing our cash flow we focus on the change in the amount of cash available and used in investing activities.

The increase in net cash from investing activities for the sixnine months ended JuneSeptember 30, 2006, compared to JuneSeptember 30, 2005, was primarily the result of an increased level of proceeds from fixed maturities and sale of investments offset by purchases caused primarily by cash from the issuances of non-recourse funding obligations and commercial paper borrowings. The cash provided by these issuances was partially offset by investment proceeds used to provide for the net redemptions of our investment contracts.

Changes in cash from financing activities primarily relate to the issuance and repayment of borrowings, dividends to our stockholders and other capital transactions, as well as the issuance of, and redemptions and benefit payments on, investment contracts. During the sixnine months ended JuneSeptember 30, 2006, cash from financing activities included net redemptions on investment contracts of $1,053$1,811 million and cash used for the acquisition of treasury stock of $553$675 million, partially offset by an issuance of $750 million in non-recourse funding obligations, and $143 million ofprovided by commercial paper borrowings.

Total assets were $103.6$107.8 billion as of JuneSeptember 30, 2006, compared to $105.7 billion as of December 31, 2005. The decreaseincrease in total assets was driven primarily by a decrease in other invested assets due to a reduction in the participation in our securities lending program anddeferred acquisition costs, fixed maturity securities, attributable to lower fair values in the current interest rate environment. These increases were offset by increased balances in commercial mortgage loans and cash and cash equivalents driven primarily by normal business growth. Total liabilities were $91.4$94.5 billion as of JuneSeptember 30, 2006, compared to $92.3 billion as of December 31, 2005. The decreaseincrease in total liabilities was primarily driven by a decrease in other liabilities primarily due to a reduction in the participation in our securities lending program and a decrease in future annuity and contract benefits due to net redemptions of our investment contracts, partially offset by an increase in our long-term care insurance fromreserves due to normal aging of the in-force block. These decreases are partially offset by an increase inblock, growth of our international mortgage insurance and issuances of non-recourse funding obligationsobligations.

Effective March 16, 2005, we began a repurchase program in which we sell a security at a specified price and short-term borrowings.agree to repurchase that security at another specified price at a later date. Repurchase agreements are treated as collaterized financing transactions and are carried at the amounts at which the securities will be subsequently reacquired, including accrued interest, as specified in the respective agreement. The market value of securities to be repurchased is monitored and collateral levels are adjusted where appropriate to protect the counterparty against credit exposure. Cash received is invested in fixed maturities. In the third quarter of 2006 we pledged additional securities under our repurchase program. At September 30, 2006, the fair value of securities pledged under the repurchase program totaled $833 million and the offsetting repurchase obligation of $798 million is included in other liabilities on the Condensed Consolidated Balance Sheet.

Genworth Financial, Inc.—holding company

We conduct all our operations through our operating subsidiaries. Dividends from our subsidiaries and permitted payments to us under our tax sharing arrangements with our subsidiaries are our principal sources of cash to pay stockholder dividends and to meet our holding company obligations, including payments of principal and interest on our outstanding indebtedness.

Our primary uses of funds at our holding company level include payment of general operating expenses, payment of principal, interest and other expenses related to holding company debt, payment of dividends on our common and preferred stock, amounts we owe to GE under the Tax Matters Agreement, contract adjustment payments on our Equity Units, contributions to subsidiaries, and, potentially, acquisitions.

Our holding company had $142$223 million and $332 million of cash and cash equivalents as of JuneSeptember 30, 2006 and December 31, 2005, respectively.

In the first quarterand second quarters of 2006, we declared common stock dividends of $34 million and $35 million, respectively, which were paid in the second quarterand third quarters of 2006.2006, respectively. During the secondthird quarter of 2006, we raised the quarterly dividend by 20% to $0.09 a share from $0.075 a share. In addition, we declared dividends on our common stock of $35$40 million, which will be paid during the thirdfourth quarter of 2006. The declaration and payment of future dividends to holders of our common stock will be at the discretion of our board of directors and will depend on many factors including our receipt of dividends from our insurance and other operating subsidiaries, financial condition, earnings,net income, capital requirements of our subsidiaries, legal requirements, regulatory constraints and other factors as the board of directors deems relevant. In addition, our Series A Preferred Stock bears dividends at an annual rate of 5.25% of the liquidation value of $50 per share. We also pay quarterly contract adjustment payments with respect to our Equity Units at an annual rate of 2.16% of the stated amount of $25 per Equity Unit.

During the quarter, we repurchased 2.23.6 million shares at a weighted average price of $33.24.$34.43. Under the share repurchase program approved by our board of directors in December 2005, we havehad the authority to repurchase an additional $197$75 million. Additionally, on October 26, 2006, our Board of Directors increased the size of the stock repurchase program to $1.0 billion, an increase of $250 million, which is expectedraising our remaining repurchase capacity to be completed by year-end.$325 million.

Insurance companies domiciled in the United States are restricted by various state insurance laws as to the amount of dividends that may be paid within any twelve consecutive month period without regulatory consent. Dividend restriction laws in Virginia and North Carolina, states in which Genworth has domiciled regulated insurance entities, changed effective July 1, 2006 and December 31, 2006, respectively. In both states, the insurance laws changed to “greater of” from “lesser of” provisions, wherein the maximum amount that can be paid within a twelve-month period without prior approval by the Insurance Commissioner of the state is limited to the greater of (a) 10% of the insurance company’s capital and surplus as of the prior December 31 or (b) net gains from operations (for life insurance companies) or net income, excluding realized investment gains (for property and casualty insurance companies) for the twelve-month period ending on the prior December 31. We believe these changes will enhance holding company liquidity. During the sixnine months ended JuneSeptember 30, 2006, we received dividends from our insurance subsidiaries of $383 million.$247 million, of which $243 million was received from our principal domestic mortgage insurance subsidiary during the third quarter of 2006.

In addition to dividends from our insurance subsidiaries, our other sources of funds include service fees we receive from GE, payments from our subsidiaries pursuant to tax sharing arrangements, proceeds from any additional issuances of commercial paper and borrowings pursuant to our revolving credit facilities.

Regulated insurance subsidiaries

The liquidity requirements of our regulated insurance subsidiaries principally relate to the liabilities associated with their various insurance and investment products, operating costs and expenses, the payment of dividends to us, contributions to their subsidiaries, payment of principal and interest on their outstanding debt obligations and income taxes. Liabilities arising from insurance and investment products include the payment of benefits, as well as cash payments in connection with policy surrenders and withdrawals, policy loans and obligations to redeem funding agreements under applicable put option provisions.

Historically, our insurance subsidiaries have used cash flow from operations and sales of investment securities to fund their liquidity requirements. Our insurance subsidiaries’ principal cash inflows from operating activities derive from premiums, annuity deposits and policy and contract fees and other income, including commissions, cost of insurance, mortality, expense and surrender charges, contract underwriting fees, investment management fees, and dividends and distributions from their subsidiaries. The principal cash inflows from investment activities result from repayments of principal, sales of invested assets and investment income.

As of JuneSeptember 30, 2006, we had approximately $2.7 billion of renewable floating rate funding agreements, which are deposit-type products that generally credit interest on deposits at a floating rate tied to an external market index. Purchasers of renewable funding agreements include money market funds, bank common trust funds and other short-term investors. Some of our funding agreements contain “put” provisions, through which the contractholder has an option to terminate the funding agreement for any reason after giving notice within the

contract’s specified notice period, which is generally 90 days or 180 days. Of the $2.7 billion aggregate amount outstanding as of JuneSeptember 30, 2006, $875 million had put option features including $425 million with put options features of 90 days and $450 million with put options of 180 days.

Our insurance subsidiaries maintain investment strategies intended to provide adequate funds to pay benefits without forced sales of investments. Products having liabilities with longer durations, such as certain life insurance and long-term care insurance policies, are matched with investments having similar estimated lives such as long-term fixed maturities and commercial mortgage loans. Shorter-term liabilities are matched with fixed maturities that have short- and medium-term fixed maturities. In addition, our insurance subsidiaries hold highly liquid, high-quality short-term investment securities and other liquid investment-grade fixed maturities to fund anticipated operating expenses, surrenders, and withdrawals. As of JuneSeptember 30, 2006, our total cash and invested assets was $66.4$69.6 billion. Our investments in privately placed fixed maturities, commercial mortgage loans, policy loans and limited partnership interests are relatively illiquid. These asset classes represented approximately 35% of the carrying value of our total cash and invested assets as of JuneSeptember 30, 2006.

During 2005, certain of our domestic life insurance subsidiaries transferred primarily foreign-issued investment securities to an affiliated special purpose entity (“SPE”) which is a subsidiary in our Mortgage Insurance segment and consolidated in our financial statements and whose sole purpose is to securitize these investment securities and issue secured notes to various affiliated insurance companies. The securitized investments are owned in their entirety butby the SPE and are not available to satisfy the claims of our creditors. These securitized investments provide collateral to the notes issued by the SPE to the insurance companies. The value of those securities as of JuneSeptember 30, 2006 was $1.5 billion.

Capital resources and financing activities

On May 25, 2006 we entered into a $1.0 billion five-year revolving credit facility, which matures in May 2011, replacing our $1.0 billion five-year revolving credit facility, which was scheduled to mature in May 2009. We also have a $1.0 billion revolving credit facility that matures in April 2010. These facilities bear variable interest rates based on a one-month LIBOR plus margin. As of JuneSeptember 30, 2006, we utilized $170$171 million of the commitment under these facilities for the issuance of a letter of credit for the benefit of one of our Mortgage Insurance subsidiaries.

On January 20, 2006, River Lake Insurance Company III (“River Lake III”), a special purpose financial captive insurance company wholly owned by First Colony Life Insurance Company (“First Colony”), itself anour indirect wholly owned subsidiary of Genworth, issued $750 million in aggregate principal amount of floating rate surplus notes due 2036 (the “Notes”“RL III Notes”). River Lake III has received regulatory approval to issue additional series of its floating rate surplus notes up to an aggregate amount of $1.2 billion (including the RL III Notes), but is under no obligation to do so.

On September 22, 2006, River Lake Insurance Company (“River Lake I”), a special purpose captive insurance company wholly owned by First Colony, our indirect wholly owned subsidiary of the Company, issued $300 million in aggregate principal amount of floating rate surplus notes due 2033 (the “RL I Notes”). River Lake I previously received approval from the Director of Insurance of the State of South Carolina (the “Director”) on July 23, 2003 to issue up to an aggregate amount of $1.2 billion of its floating rate surplus notes and has issued an aggregate of $1.1 billion to date (including the RL I Notes). Despite having additional capacity, River Lake I does not expect to issue any additional notes.

On October 24, 2006, Rivermont Life Insurance Company I (“Rivermont I”), a special purpose financial captive insurance company wholly owned by First Colony, itself an indirect wholly-owned subsidiary of the Company, issued $315 million in aggregate principal amount of floating rate surplus notes due 2050 (the “Rivermont I Notes”). Rivermont I has received regulatory approval to issue additional series of its floating rate surplus notes up to an aggregate principal amount of $475 million (including the Rivermont I Notes), but is under no obligation to do so. The Rivermont I Notes are direct financial obligations of River Lake IIIRivermont I and are not guaranteed by First Colony or Genworth.

The Rivermont I Notes were issued by River Lake IIIRivermont I to fund statutory reserves required by thefor policies subject to Valuation of Life Insurance Policies Regulation. River Lake IIIRegulation (more commonly known as “Regulation XXX”), as clarified by Actuarial Guideline 38 (more commonly known as “AXXX”) and its predecessor regulations. Rivermont I has reinsured on a coinsurance basis from First Colony, on a combination coinsurance and modified coinsurance basis, certain termuniversal life insurance policies having guaranteed level premiums. with secondary guarantees written or reinsured by First Colony. Genworth has agreed to provide a limited guaranty to Rivermont I to mitigate certain interest rate risks associated with this reinsurance. First Colony has also agreed to indemnify Rivermont I for certain limited costs.

The Notes have been sold to a third-party for deposit into certain Delaware trusts (the “Trusts”) that will issue money market or term securities. The principal and interest payments due on the money market and term securities will be insured by a third party insurance company.(the “Securities”). The holders of the Rivermont I Notes cannot require repayment from Genworth or any of its subsidiaries, other than River Lake III,Rivermont I, the direct issuer of the Rivermont I Notes. First ColonyGenworth has also agreed, under certain circumstances, to indemnify River Lake III andprovide to the third party insurer forTrusts a certain limited costs. River Lake IIIamount of liquidity in the event that the Trusts do not have sufficient funds available to fully redeem the Securities at the stated maturity date.

Rivermont I will pay interest on the principal amount of the Rivermont I Notes on a monthly basis, subject to regulatory approval. Any payment of principal of, including by redemption, or interest on the Rivermont I Notes may only be made with the prior approval of the Director of Insurance of the State of South Carolina in accordance with the terms of its licensing order and in accordance with applicable law. The holders of the Rivermont I Notes have no rights to accelerate payment of principal of the Rivermont I Notes under any circumstances, including without limitation, for nonpayment or breach of any covenant. River Lake IIIRivermont I reserves the right to repay the Rivermont I Notes at any time, subject to the terms of the Rivermont I Notes and prior regulatory approval. In addition, we continue to

work towards the the execution of a capital management strategy for our universal life business which could result in the issuance of additional non-recourse funding obligations.

On December 21, 2005, our Board of Directors approved a stock repurchase program, authorizing Genworth to repurchase up to $750 million of our common stock over the succeeding 18 months. Additionally, on October 26, 2006, our Board of Directors increased the size of the stock repurchase program to $1.0 billion, an increase of $250 million. We expect the purchases to be made from time to time in the open market or in privately negotiated transactions, and will be funded from cash and/or the proceeds from issuance of debt securities.

Concurrently with GE’s secondary offering of our Class A Common Stock completed in March 2006, we repurchased 15 million shares of our Class B Common Stock directly from GE, which were automatically converted to Class A Common Stock upon the transfer of these shares to us, for an aggregate price of $479 million. We financed the stock repurchase with $250 million cash available at the holding company and the proceeds of the issuance of $229 million in commercial paper under our existing commercial paper program.

During the second quarter of 2006, we repurchased 2.2 million shares of our Class A Common Stock at an average market price of $33.26$33.24 per share for an aggregate price of $74 million. During the third quarter of 2006,

we repurchased 3.6 million shares of our Class A Common Stock at an average market price of $34.43 per share for an aggregate price of approximately $122 million. We financed these repurchases with cash available at the holding company.

We believe our cash flows from operation, further issuances under our commercial paper program and revolving credit facilities will provide us with sufficient liquidity to meet our operating requirements for the foreseeable future.

Contractual obligations and commercial commitments

We enter into obligations to third-parties in the ordinary course of our operations. However, we do not believe that our cash flow requirements can be assessed based upon an analysis of these obligations. The most significant factor affecting our future cash flows is our ability to earn and collect cash from our customers. Future cash outflows, whether they are contractual obligations or not, also will vary based upon our future needs. Although some outflows are fixed, others depend on future events. Examples of fixed obligations include our obligations to pay principal and interest on fixed-rate borrowings. Examples of obligations that will vary include obligations to pay interest on variable-rate borrowings and insurance liabilities that depend on future interest rates and market performance. Many of our obligations are linked to cash-generating contracts. These obligations include payments to contractholders that assume those contractholders will continue to make deposits in accordance with the terms of their contracts. In addition, our operations involve significant expenditures that are not based upon “commitments.” These include expenditures for income taxes and payroll.

During the second quarter of 2006, we agreed to acquire Vero LMI and AssetMark, as further described in note 54 in our “—Notes to Condensed Consolidated Financial Statements.”

During 2006, we issued $750 million$1.05 billion in non-recourse funding obligations, and $229 million of commercial paper borrowings as further described in note 87 in our “—Notes to Condensed Consolidated Financial Statements.”

There have been no other material additions or changes to our contractual obligations and commercial commitments as set forth in our 2005 Annual Report on Form 10-K.

Securitization Entities

During the first quarter of 2006, we derecognized securitization entity balances of $685 million, $44 million, $660 million and $15 million of restricted investments held by securitization entities, other assets, borrowings related to securitization entities and other liabilities, respectively. We continue to hold a retained interest in the form of interest-only strips. We recognized a loss on sale of $11 million, net of tax, from this re-securitization transaction. See note 98 in our “—Notes to Condensed Consolidated Financial Statements.”

New Accounting Standards

RecentlyFor a discussion of recently adopted

On January 1, 2006, we and not yet adopted Financial Accounting Standards Board (“FASB”) Statement of Financial Accounting Standards (“SFAS”) No. 123R,Share-Based Payment, an amendment of SFAS No. 123,Accounting for Stock-Based Compensation. We adopted SFAS No. 123R under the modified prospective transition method. The statement requires companies to recognize the grant-date fair value of options and other equity-based awards within the income statement over the respective vesting period of the awards. We adopted SFAS No. 123 effective January 1, 2002 and, as permitted, we determined a grant date fair value using a Black-Scholes model and recognized the related compensation expense through the income statement for all equity awards issued subsequent to January 1, 2002. As a result of the adoption of SFAS No. 123R, we will continue to recognize the remaining portion of the requisite service under previously granted unvested awards including those awards granted prior to January 1, 2002. Prior to the adoption of SFAS No. 123R, we adjusted compensation cost related to forfeiture of awards when the actual forfeiture occurred. SFAS No. 123R requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates and requires companies which previously accounted for forfeitures on an occurrence basis to include in income of the period of adoption a cumulative effect of a change in accounting principle for the adjustment to reflect estimated forfeitures for prior periods. On January 1, 2006, we recognized an increase to net earnings of $4 million related to the cumulative effect of a change in accounting principle for the adoption of SFAS No. 123R. Seestandards, see note 62 in our “—Notes to Condensed Consolidated Financial Statements.”

As of January 1, 2006, we adopted SFAS No. 155,Accounting for Certain Hybrid Financial Instruments. SFAS No. 155 amends SFAS No. 133,Accounting for Derivative Instruments and Hedging Activities, and SFAS No. 140,Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. SFAS No. 155 allows financial instruments that have embedded derivatives to be accounted for as a whole, eliminating the need to bifurcate the derivative from its host, if the holder elects to account for the whole instrument on a fair value basis. In addition, among other changes, SFAS No. 155 (i) clarifies which interest-only strips and principal-only strips are not subject to the requirements of SFAS No. 133; (ii) establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation; (iii) clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives; and (iv) eliminates the prohibition on a qualifying special-purpose entity (“QSPE”) from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial interest. Adoption of SFAS No. 155 did not have a material impact on our condensed consolidated financial statements.

Not yet adopted

In September 2005, the American Institute of Certified Public Accountants issued Statement of Position (“SOP”) 05-1,Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection With Modifications or Exchanges of Insurance Contracts.This statement provides guidance on accounting for deferred acquisition costs and other deferred balances on an internal replacement, defined broadly as a modification in product benefits, features, rights, or coverages that occurs by the exchange of an existing contract for a new contract, or by amendment, endorsement, or rider to an existing contract, or by the election of a benefit, feature, right, or coverage within an existing contract. Depending on the type of modification, the period over which these deferred balances will be recognized could be accelerated. SOP 05-1 is effective for internal replacements occurring in fiscal years beginning after December 15, 2006. We are currently evaluating the impact that SOP 05-1 will have on our consolidated results of operations and financial position.

In July 2006, FASB Interpretation (“FIN”) No. 48,Accounting for Uncertainty in Income Taxes was issued. This guidance clarifies what criteria must be met prior to recognition of the financial statement benefit of a position taken in a tax return. Additionally, it applies to the recognition and measurement of income tax uncertainties resulting from a purchase business combination. This guidance is effective for fiscal years beginning after December 15, 2006. We are currently evaluating the impact FIN No. 48 will have on our consolidated results of operations and financial position.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Market risk is the risk of the loss of fair value resulting from adverse changes in market rates and prices, such as interest rates, foreign currency exchange rates and equity prices. Market risk is directly influenced by the volatility and liquidity in the markets in which the related underlying financial instruments are traded. There were no material changes in these risks since December 31, 2005.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

As of JuneSeptember 30, 2006, an evaluation was carried out under the supervision and with the participation of Genworth’s management, including our Chief Executive Officer and Acting Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934). Based upon that evaluation, the Chief Executive Officer and the Acting Chief Financial Officer concluded that the design and operation of these disclosure controls and procedures were effective.

Changes in Internal Control Over Financial Reporting During the Quarter Ended JuneSeptember 30, 2006

There were no changes in our internal control over financial reporting that occurred during the quarter ended JuneSeptember 30, 2006 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II—OTHER INFORMATION

Item 1. Legal Proceedings

We face a significant risk of litigation and regulatory investigations and actions in the ordinary course of operating our businesses, including the risk of class action lawsuits. Our pending legal and regulatory actions include proceedings specific to us and others generally applicable to business practices in the industries in which we operate. In our insurance operations, we are, have been, or may become subject to class actions and individual suits alleging, among other things, issues relating to sales or underwriting practices, payment of contingent or other sales commissions, claims payments and procedures, product design, product disclosure, administration, additional premium charges for premiums paid on a periodic basis, denial or delay of benefits, charging excessive or impermissible fees on products, recommending unsuitable products to customers, that our pricing structures and business practices in our mortgage insurance business, such as captive reinsurance arrangements with lenders and contract underwriting services, violate RESPA or related state anti-inducement laws, and breaching fiduciary or other duties to customers. Plaintiffs in class action and other lawsuits against us may seek very large or indeterminate amounts, including punitive and treble damages, which may remain unknown for substantial periods of time. In our investment-related operations, we are subject to litigation involving commercial disputes with counterparties. We are also subject to litigation arising out of our general business activities such as our contractual and employment relationships. We are also subject to various regulatory inquiries, such as information requests, subpoenas and books and record examinations, from state, federal and international regulators and other authorities. A substantial legal liability or a significant regulatory action against us could have an adverse effect on our business, financial condition and results of operations. Moreover, even if we ultimately prevail in the litigation, regulatory action or investigation, we could suffer significant reputational harm, which could have an adverse effect on our business, financial condition and results of operations.

Except as described below, there were no material developments during the quarter in any of the legal proceedings identified in Part 1, Item 3 of our 2005 Annual Report on Form 10-K, as updated in Part II, Item 1 of our Quarterly Report on Form 10-Q for the quarterly periodperiods ended March 31, 2006 and June 30, 2006. In addition, there were no new material legal proceedings during the quarter.

As previously identified, the U.K. antitrust authorities are conducting a review of the payment protection insurance sector in the United Kingdom. The review is in response to a complaint lodged under U.K. anti-trust law by a consumer activist group (the Citizens Advice Bureau). In October 2006, the antitrust authorities published their provisional findings which concluded that there are features of the payment protection insurance market which may be adversely affecting competition. Accordingly, the U.K. antitrust authorities are recommending that a more detailed review of the payment protection insurance market can be carried out. The U.K. antitrust authorities are currently consulting with industry participants on their provisional findings and are expected to issue their final report in the first quarter of 2007. We are participating in the consultation process.

Also as previously identified, the Financial Services Authority in the U.K. conducted an industry-wide review of payment protection insurance products in 2005. The Financial Services Authority has recently completed a further review of payment protection insurance products. Although the Financial Services Authority concluded that there have been improvements since 2005, the Financial Services Authority identified a number of areas of concern, in particular relating to sales practices. During 2007, the Financial Services Authority intends to examine whether additional regulation of payment protection insurance products is required.

In additional, as previously identified, in January 2006, as part of an industry-wide review, our U.S. mortgage insurance subsidiary received an administrative subpoena from the Minnesota Department of Commerce with respect to our reinsurance arrangements, including captive reinsurance transactions. During the third quarter of 2006, we received a follow-up industry-wide request from Minnesota for additional information, and we have responded.

We cannot assure that the above, or previously identified investigations and proceedings will not have a material adverse effect on our business, financial condition or results of operations. In addition, it is possible that

related investigations and proceedings may be commenced in the future, and we could become subject to further investigations and have lawsuits filed against us. In addition, increased regulatory scrutiny and any resulting investigations or proceedings could result in new legal precedents and industry-wide regulations or practices that could adversely affect our business, financial condition and results of operation.

As previously identified, one of our mortgage insurance subsidiaries is named as a defendant in two lawsuits filed in the U.S. District Court for the Northern District of Illinois, William Portis et al. v. GE Mortgage Insurance Corp. and Karwo v. Citimortgage, Inc. and General Electric Mortgage Insurance Corporation. The Portis complaint was filed on January 15, 2004, and the Karwo complaint was filed on March 15, 2004. Each action seeks certification of a nationwide class of consumers who allegedly were required to pay for our private mortgage insurance at a rate higher than our “best available rate,” based upon credit information we obtained. Each action alleges that the Fair Credit Reporting Act (“FCRA”) requires notice to such borrowers and that we violated the FCRA by failing to give such notice. The plaintiffs in Portis allege in the complaint that they are entitled to “actual damages” and “damages within the Court’s discretion of not more than $1,000 for each separate violation” of the FCRA. The plaintiffs in Karwo allege that they are entitled to “appropriate actual, punitive and statutory damages” and “such other or further relief as the Court deems proper.” Similar cases were filed against six other mortgage insurers. We have vigorously denied liability with respect to plaintiffs’ allegations. Nevertheless, to avoid the risks and costs associated with protracted litigation and to resolve our differences with consumers, our mortgage insurance subsidiary reached an agreement to settle the cases on a nationwide class action basis. The settlement documents have been finalized, and were submitted toAt a hearing on October 16, 2006, the Court for preliminary approval on July 14, 2006. At an April 25, 2006 conference, the Court was advised of the general

terms of the settlement and set September 25, 2006 as the tentative date for a hearing to determine whether to givegave final approval to the settlement. We now anticipate that the final approval hearing will take place in October 2006. In the fourth quarter of 2005, upon reaching an initial agreement in principle with respect to the settlement, an accrual was established representing our best estimate of the cost of the settlement. The precise amount of payments in this matter cannot be estimated because they are dependent upon Court approval of the class and related settlement, the number of individuals who ultimately will seek relief in the claim form process of any approvedthe class settlement, the identity of such claimants and whether they are entitled to relief under the settlement terms.

As previously identified, one of our mortgage insurance subsidiaries is named asinvolved in an arbitration regarding our delegated underwriting practices. A mortgage lender that underwrote loan applications for mortgage insurance under our delegated underwriting program commenced the arbitration against us in 2003 after we rescinded policy coverage for a defendantnumber of mortgage loans underwritten by that lender. We rescinded coverage because we believe those loans were not underwritten in a lawsuit,Wilma Juanita Kern, et al. v. General Electric Capital Assurance Company,filed on February 16,compliance with applicable program standards and underwriting guidelines. However, the lender claims that we improperly rescinded coverage. In addition to seeking reinstatement of coverage, attorney’s fees and punitive damages are sought. The first phase of the arbitration covering 30 loans was held in January 2005 in the Circuit Court for the Third Judicial Circuit in Madison County, Illinois. The plaintiffs seek to proceed on the basis of a class action, brought on behalf of Illinois purchasers of long-term care insurance. Plaintiffs allege the improper refusal to provide long-term care benefits to long-term care insureds who were cared for in unlicensed facilities in Illinois, and the improper sale of policies requiring insureds to reside in licensed assisted care facilities during a time period when no licensed facilities, or too few licensed facilities were available in Illinois. Plaintiffs seek unspecified damages for breach of contract, violationpanel ordered that 28 of the Illinois Consumer Fraud Actloans be reinstated. The second phase covering 33 loans was held in July 2005 and unjust enrichment.the arbitration panel ordered reinstatement of coverage on 5 of the 33 loans. We agreed to a recess of the third phase of arbitration to determine if any settlement could be effected. In MayMarch 2006, an agreement in principle to settle this case on an individual basismatter was reached, and wereached. The settlement was finalized in a written settlement agreement dated July 31, 2006. Previously established reserves are inadequate to cover the process of documenting a proposedexpected settlement agreement.costs.

Item 1A. Risk Factors

The discussion of our business and operations should be read together with the risk factors contained in Item 1A of our 2005 Annual Report on Form 10-K, filed with the Securities and Exchange Commission, which describe various risks and uncertainties to which we are or may become subject. These risks and uncertainties have the potential to affect our business, financial condition, results of operations, cash flows, strategies or prospects in a material and adverse manner. As of JuneSeptember 30, 2006, there have been no material changes to the risk factors set forth in our 2005 Annual Report on Form 10-K.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Issuer Purchases of Equity Securities

 

Period

  Total number of
shares (or
units) purchased
  Average price
paid per share
(or unit)
  Total number of
shares (or units)
purchased
as part of publicly
announced plans
or programs
  Maximum
number (or
approximate
dollar value) of
shares (or units)
that may yet be
purchased under
the plans or
programs(1)

April 1, 2006 through April 30, 2006

  —    $—    —    $271,000,000

May 1, 2006 through May 31, 2006

  1,048,500  $33.16  1,048,500   236,203,268

June 1, 2006 through June 30, 2006

  1,164,000  $33.30  1,164,000   197,405,914
            

Total

  2,212,500  $33.24  2,212,500  $197,405,914
            

Period

  Total number of
shares (or
units) purchased
  Average price
paid per share
(or unit)
  Total number of
shares (or units)
purchased
as part of publicly
announced plans
or programs
  Maximum
number (or
approximate
dollar value) of
shares (or units)
that may yet be
purchased under
the plans or
programs(1)

July 1, 2006 through July 31, 2006

  —    $—    —    $197,405,914

August 1, 2006 through August 31, 2006

  2,916,500  $34.26  2,916,500   97,413,684

September 1, 2006 through September 30, 2006

  634,625  $35.26  634,625   75,016,524
            

Total

  3,551,125  $34.43  3,551,125  $75,016,524
            

(1)On December 21, 2005, our Board of Directors approved a stock repurchase program, authorizing Genworth to repurchase up to $750 million of our common stock over the succeeding 18 months. Additionally, on October 26, 2006, our Board of Directors increased the size of the stock repurchase program to $1.0 billion, an increase of $250 million.

Item 4. Submission of Matters to a Vote of Security Holders

The annual meeting of stockholders of Genworth Financial, Inc. was held on May 17, 2006. Stockholders elected for the ensuing year all of the director nominees and ratified the selection of KPMG LLP as our independent registered public accounting firm for 2006.

The voting results were as follows:

   Votes cast  

Abstain

   For  Against  

Management Proposal

      

Ratification of the selection of KPMG LLP as the independent registered public accounting firm for 2006.

  402,135,208  1,428,868  1,734,729

Election of Directors

   Votes
received
  Votes
withheld

Frank J. Borelli

  402,877,748  2,421,057

Michael D. Fraizer

  400,754,993  4,543,812

Nancy J. Karch

  402,910,140  2,388,665

J. Robert “Bob” Kerrey

  403,209,494  2,089,311

Saiyid T. Naqvi

  403,219,914  2,078,891

James A. Parke

  403,210,926  2,087,879

James S. Riepe

  403,222,623  2,076,182

Thomas B. Wheeler

  402,894,384  2,404,421

Item 6. Exhibits

 

10.52.7Sub-Plan under the 2004 Genworth Financial, Inc. Omnibus Incentive Plan: Genworth Financial U.K. Share Incentive Plan
12  Statement of Ratio of EarningsIncome to Fixed Charges
31.1  Certification of Michael D. Fraizer
31.2  Certification of Richard P. McKenneyVictor C. Moses
32.1  Certification Pursuant to Section 1350 of Chapter 63 of Title 18 of the United States Code—Michael D. Fraizer
32.2  Certification Pursuant to Section 1350 of Chapter 63 of Title 18 of the United States Code—Richard P. McKenneyVictor C. Moses

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

.  

GENWORTH FINANCIAL, INC.

(Registrant)

Date: July 28,October 27, 2006  
  By: /s/    SCOTT R. LINDQUIST        
    

Scott R. Lindquist

Vice President and Controller

(Duly Authorized Officer and

Principal Accounting OfficerOfficer)

 

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