GE says shock multibillion-dollar insurance charge is 'a special case'
General Electric made what seemed like a smart move last week, giving investors several days to digest some bad news ahead of announcing its fourth-quarter results on Wednesday.
GE still had to talk about the after-tax charge of $6.2 billion and additional cash funding of $15 billion in statutory capital contributions to its insurance subsidiary on its earnings call on Wednesday, but the surprise charge and reported loss was mitigated by talk of a better future. GE
shares rallied as the company reported its results.
But there was more bad news to come, when GE was forced to acknowledge a Securities and Exchange Commission investigation into the process leading to the sudden multibillion-dollar charge, and an additional review of revenue recognition and controls over its long-term contracts.
The market immediately reversed the gains.
When GE first announced the charge on January 16, which related to the remnants of its long-term care reinsurance portfolio, CEO John Flannery told analysts he had “underappreciated the risk in this book.”
So what happened?
GE’s North America Life & Health subsidiary is a reinsurance portfolio the company held on to after mostly exiting the business between 2004 and 2006. A reinsurer buys the right to receive premiums from the primary insurers that deal directly with consumers in exchange for eventually shouldering any potential losses. Those primary insurers underwrite and administer the policies and process claims when they come in.
The majority of GE Capital’s remaining insurance business, 60%, is related to long-term care insurance. At the time, Flannery told analysts, GE believed that a gradual runoff of existing claims—no new business has been added since 2006—would be more profitable than selling the whole business. Unfortunately, Flannery said this week, GE didn’t anticipate the low interest rate environment, low policy lapse rates, and higher claims cost that it is seeing now.
As part of the IPO of the Genworth business and sale of ERC to reinsurer Swiss Re, GE “derisked” its balance sheet by approximately $130 billion of risky insurance assets and was paid approximately $13 billion in cash. However, what GE held on to was a book of business that was nowhere near ripe and is only recently showing its true colors.
GE warned analysts as long ago as the second-quarter of 2017 that a review of its claims experience and reserves was under way, and any charge would happen in the fourth quarter.
In its 2017 second quarter filing with the Securities and Exchange Commission, GE wrote: “We have recently experienced elevated claim experience for a portion of our long-term care insurance products, which may result in a deficiency in reserves plus future premiums compared to future benefit payments. Should such a deficiency exist, we would record a charge to earnings in the second half of 2017 upon completion of this review.”
And in its third quarter 2017 filing with the SEC, GE warned about the potential charge again but with more details.
“We have recently experienced elevated claim experience for a portion of our long-term care insurance contracts and are conducting a comprehensive review of premium deficiency assumptions across all insurance contracts, including a reassessment of future claim projections for long-term care contracts that will be incorporated within our annual test of future policy benefit reserves for premium deficiencies in the fourth quarter of 2017. We would record a charge to earnings for any premium deficiencies in the fourth quarter of 2017 upon completion of this review.”
Accounting experts were expecting the review to result in some financial charge, but not on this scale.
“The review of business always carries the risk of unexpected findings, yet the magnitude of the $6.2 billion charge is far more staggering than the $3 billion that the market anticipated,” research firm Audit Analytics wrote in a note to subscribers.
At its annual meeting last November, chief financial officer Jamie Miller told shareholders that GE was likely to take a charge of more than $3 billion.
Changes in insurance claim reserves typically are disclosed in advance as changes in accounting estimates related to long-term care reserves. Companies are only required to disclose adjustments that are material. In its note Audit Analytics wrote it looked at 30 insurance companies and found 60 changes in accounting estimates filed with the SEC for adjustment to the long-term care loss reserves filed since 2004.
According to Audit Analytics, the top five are:
|Company||Ticker||Auditor||Aggregate impact on pretax income (in millions)||Number of changes in estimates|
|China Life Insurance Co Ltd||LFC, +1.79%
|Genworth Financial Inc.||GNW, -0.94%
|Travelers Companies, Inc.||TRV, +0.64%
|Humana Inc.||HUM, +0.83%
|Prudential Financial Inc||PRU, +1.30%
Source: Audit Analytics
the reinsurance business GE spun off in 2004, disclosed in a routine SEC filing that year that periodic reviews of claim reserves are common and charges are to be expected. Since 2004, Genworth Financial has disclosed nine changes in estimates related to its long-term care portfolio, totaling $3.8 billion.
A spokeswoman for Genworth Financial declined to comment on its relationship to GE or its reinsurance portfolio.
The last time GE disclosed any changes in reserves even partly attributable to the long-term care reinsurance portfolio, according to Audit Analytics, was in its 2004 annual report, the same year it spun off the Genworth business. The company wrote that liabilities, reserves and annuity benefits were $4.5 billion higher than in 2003, and “attributable to growth in annuities, long-term care insurance, structured settlements, the effects of the weaker U.S. dollar, increases in loss reserves for policies written in prior years and 2004 U.S. hurricane-related losses.”
On the call last week when the charge was first announced, Chief Risk Officer Ryan Zanin told analysts that a large percentage of the policyholders in their book of business were sold the policies at a very early age and are only now reaching the prime claim paying period—ages 80 and up. Therefore, approximately 40% of inception-to-date claims have occurred in the last two years.
A GE spokeswoman told MarketWatch: “GE has tested the adequacy of its policy reserves for the runoff insurance business every year through premium deficiency testing.”
“In all prior years,” Zanin said on the call last week, “these tests resulted in a positive margin, which, under GAAP, requires that original assumptions above the book remain locked.”
Also on the call last week, JP Morgan analyst Stephen Tusa asked GE Chief Financial Officer Jamie Miller if the company was happy with its auditor. “If these guys reviewed this stuff every year for the last several years and this is kind of a result of that, doesn’t that kind of raise questions?” he asked.
Flannery said that he was not planning an auditor change.
KPMG, the GE auditor for more than 100 years, is also the external auditor for Genworth Financial.
A spokesman for KPMG emailed MarketWatch to say this.
“We are confident that our audits and reviews were appropriately performed in accordance with applicable professional standards, and we stand behind our work. Our client confidentiality obligations prohibit us from commenting further.”
GE shares were down 1.1% Friday, and have lost 47% in the last 12 months, while the Dow Jones Industrial Average
has gained 32% and the S&P 500
has gained 24%.