Officials at the New York State Insurance Department discuss use of separate accounts and credit default swaps (CDS) in a recent life company examination report.

Those topics come up in a department report on a market conduct examination of Genworth Life Insurance Company of New York, a unit of Genworth Financial Inc., Richmond, Va. (NYSE:GNW). The report covers the period from Jan. 1, 2005, through Dec. 31. 2007.

Genworth Life is licensed to do business in a total of 9 states, but it collected 94% of the life premiums, accident and health premiums, annuity considerations, and deposit-type funds it received in 2007 in New York state. The company’s current focus is on the sale of deferred, immediate and variable annuities.

Examiners have included some remarks about advertisements and correspondence in the exam report.

The examiners found that 21 agents distributed 162,900 copies of an advertisement for the New York State Partnership for Long Term Care through the mail. “The advertisement, which was provided to the agents by an outside marketing firm, failed to display the partnership logo, failed to identify the company as the actual insurer, and failed to identify the policy form number associated with the policy that was being offered,” officials say in the report.

But examiners noted “no significant findings” when they reviewed underwriting files for issued and declined cases, and they noted no significant findings when they reviewed a sample of claims, surrenders, changes and lapses.

The New York department also looked at four separate accounts Genworth Life set up for the purpose of issuing four funding agreements.

If a separate account guarantee is equal to or less than the contractholder’s interest in the assets allocated to the account, then a relatively loose investment rule, Section 42040(a)(5)(iii), applies, officials say.

If a separate account guarantee exceeds the contractholder’s interest in the separate account, then New York Insurance Law Section 1409(a) “mini general account” diversification rules apply, and the insurer should invest no more than 10% of the separate account’s assets in any one investment.

Because of a miscommunication between Genworth Life departments, the investments team mistakenly thought Section 4240(a)(5)(iii) applied, when Section 1409(a) actually applied, officials say.

The four Genworth Life funding agreements involved each held $100 million, and each bought senior notes from a separate trust. One trust invested in a guaranteed investment contract and a money market fund, and three invested in the senior tranches of portfolios of credit card receivables.

Each trust entered into a credit default swap (CDS) transaction with Morgan Stanley, New York. Through the swaps, each trust sold protection on a portfolio of corporate loans or corporate and sovereign credits. Each trust is supposed to pay Morgan Stanley if defaults in its portfolio of “reference entities” exceed a specified “attachment point.”

The trusts have not had to make payments to Morgan Stanley, because the portfolio losses have not exceeded the CDS attachment points, but, if the losses at one of the portfolios did exceed the attachment point, and the separate account that provided the CDS protecting the portfolio ran dry, Genworth Life might have to make up for the shortfall by contributing assets from its general account, officials say.

Genworth Life seems to have used the CDS transactions to make each separate account’s more diverse, through synthetic credit exposure to corporate loans, or to corporate and sovereign credits, but the transactions also made the separate account assets more difficult to price, officials say.

Genworth Life appears to have tested one internally generated transaction price estimate by checking to see whether the estimate agreed with an estimate provided by an outside party, officials say. Once Genworth Life found that its estimate for the first transaction agreed with the estimate provided by the outside party, it then relied on its own pricing models to evaluate other transactions, officials say.

“Given the significance of the credit default swaps to the overall value and ratings of the notes, it would have been prudent for the company to seek additional independent valuation of the credit default swaps,” officials say.

Genworth Life says in a response to the exam report that it works closely with insurance regulators and cooperates fully with them during any regulatory examination process.

“After reviewing findings by the New York State Insurance Department concerning separate account investment violations with the appropriate bureaus, we have accepted the violations which were unintended and agreed that we will not engage in similar separate account transactions in the future,” the company says. ” With respect to the long term care advertisement, marketing materials created by an independent agent were never approved for use by us. We believe this to be an isolated incident and have reinforced with independent agents the company requirement that all marketing material be submitted for company review and approval prior to use.”

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