General Electric (GE) stock reached a new low of $16.02 on January 19, 2018, continuing the 2017 downtrend into 2018.
GE’s stock slide followed an announcement that the company has completed a comprehensive review of its insurance portfolio. The review was initiated in mid-2017 and involved re-evaluation of actuarial assumptions behind the long-term care legacy reinsurance business. Following the completion of this review, GE has taken an after-tax charge of $6.2 billion.
Here is an excerpt from the conference call transcript:
[W]e’ve been performing a comprehensive review of our insurance portfolio. We finished that work late last week and reviewed it with our regulator, and we’re going to share those results of that review with you today. We’ve taken an after-tax GAAP charge of $6.2 billion, which is $7.5 billion at a 21% tax rate. And you will see that reflected in our fourth quarter financials. GE Capital will make a $3 billion statutory cash contribution to its insurance subsidiary in the first quarter of 2018 and approximately $2 billion annually from 2019 to 2024, for a total of approximately $15 billion.
Long-term care insurance is a small legacy part of GE’s portfolio, and no new business was originated after the year 2006. Overall, GE holds only 4% of the long-term care reinsurance market.
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.
Increasing claims trends (along with low interest rates that reduce returns on investments) have, for years, presented challenges for both insurers and reinsurers in the long-term care sector, so changes in the actuarial assumptions should not be that uncommon.
The GE charge prompted us to take a closer look at other companies that disclosed changes in the long-term care reserves. One of the awesome features for Watchdog Reports is to quickly compare reports for companies in the same industry. From an accounting standpoint, changes in claim reserves are often disclosed prospectively as changes in accounting estimates. The disclosure rule applies only to material adjustments – disclosure of routine immaterial changes is not required.
We identified 30 insurance companies and 60 changes in accounting estimates related to the modifications of the loss reserves filed since 2004. We looked at the entire insurance industry, so naturally many of the adjustments are likely to be related to products other than the long-term care market (e.g., worker compensation claims). Yet, we found a few interesting examples.
On November 11, 2014, Genworth Financial Inc (GNW), which GE spun off in 2004, provided the following disclosure:
Long Term Care Insurance
As of September 30, 2014, the liability for policy and contract claims, before insurance, of our long-term care insurance business increased to $6,011 million from $4,999 million as of December 31, 2013 largely as a result of a $604 million increase primarily related to the completion of a comprehensive review of our long-term care insurance claim reserves conducted over the past few months. This review was commenced as a result of adverse claims experienced during the second quarter of 2014 and in connection with our regular review of our claims reserve assumptions during the third quarter of each year. As a result of this review, we made changes to our assumptions and methodologies primarily impacting claim terminations, most significantly in later-duration claims, and benefit utilization that claimants are staying on claim longer and utilizing more of their available benefits in aggregate than had previously been assumed in our reserve calculations.
In lay terms, the periodic reviews of claim reserves are common, and charges are expected. Since 2004, Genworth Financial disclosed seven similar changes in estimates, totaling $3.8 billion.
Let’s look at another company, China Life Insurance Co Ltd (LFC):
II. Details of the Changes in Accounting Estimates and the Impact on the Company
The Company determined actuarial assumptions which include, among others, discount rates, mortality rates, morbidity rates, expenses assumptions, lapse rates and policy dividends assumptions based on current information available as at the date on the balance sheet. These assumptions were used to calculate the liabilities of insurance contracts as at the date of the balance sheet. On 30 Jun 2016, the Company reviewed the above assumptions based on current information. The changes in liabilities of insurance contracts arising from the changes in the assumptions were recognized in the statement of profit or loss, which in aggregate reduced profit before tax by RMB10,731 million for the six months ended 30 June 2016. As at 30 June 2016, the changes in the assumptions above resulted in an increase in liabilities of life insurance contracts by RMB88,847 million and an increase in liabilities of long-term health insurance contracts by RMB81,884 million.
The Company adopted prospective application method to deal with the changes in accounting estimates, and no retroactive adjustment is required.
In this example, as in the previous one, we see a periodic review of the underlying assumptions which resulted in a prospective adjustment to the recorded liabilities. As we can see from the table above, China Life Insurance recorded six changes in estimates that in total exceeded $5 billion.
So why then, did some companies disclose reserve-related changes in estimates over the last decade, and others did not? Changes in actuarial models (such as mortality rates and discount rates) that result in material changes need to be disclosed. For routine, immaterial quarterly updates we may not find any disclosure.
Also, it is worth noting that a company may seem to interpret a change in estimate as the output of an estimating model, e.g., we may see a year over year difference without a change in the model. That could also be material, if say the company’s claims payout increased dramatically after increase in the number of policies sold. And sometimes companies whose financial reporting depends hugely on estimates will make disclosures about just the simple change in the output. We generally don’t view those as legitimate changes in accounting estimates. The issue with GE’s charge, of course, is not only the magnitude, but also the need to reserve $15 billion to increase the statutory capital reserves. The contribution may put some liquidity pressure on the company and limit funds available for other purposes.
In a sense, issues with the insurance subsidiary are just another confirmation to our previous argument: if a company needs four distinct EPS to describe its business, the business is too complex to fully understand. Impairments and one time charges rarely go alone. When such a complex conglomerate is breaking up, re-evaluating every segment and every line of business is likely to surface additional surprise findings.
Corporate Watchdog readers can access the latest copy of the GE Watchdog summary report or full PDF at CWDReports.com. We’ve also made the interactive GE report available for free to all Watchdog Readers. Just go to CWDReports.com, scroll down the page and add your email to the blue box to see the full GE report.