Thursday, April 7, 2016

No. 154: Genworth's Long-Term Care Insurance and the Company's Destacking Plan

In No. 144 (posted February 16, 2016), I discussed a news release issued by Genworth Financial, Inc. (NYSE:GNW) that mentioned a "strategic update." The release, filed as an exhibit to an 8-K (material event) report filed with the Securities and Exchange Commission (SEC) on February 4, said the company's planned actions are "aimed at separating and isolating its LTC [long-term care insurance] business."

The announcement triggered significant reductions in the financial strength ratings of Genworth's life insurance subsidiaries, mostly into the vulnerable (or below-investment-grade) range. The announcement also caused a sharp decline in the company's share prices. Here I discuss the "destacking" plan at the heart of the company's strategic update.

The Current Situation
Genworth's life insurance business consists of three operating subsidiaries: Genworth Life Insurance Company (GLIC), domiciled in Delaware; Genworth Life and Annuity Insurance Company (GLAIC), domiciled in Virginia; and Genworth Life Insurance Company of New York (GLICNY), domiciled in New York. The two subsidiaries most affected by the destacking plan are GLIC, primarily a long-term care insurance company; and GLAIC, primarily a life insurance and annuity company.

The long-term care insurance business of GLIC is financially troubled, while the life insurance and annuity business of GLAIC is financially sound. At present, Genworth, GLIC, and GLAIC are "stacked." That means Genworth is the parent of GLIC, and GLIC is the parent of GLAIC. Thus GLAIC is an asset of GLIC.

As of December 31, 2015, the statutory net worth of GLAIC is $1.7 billion, and the statutory net worth of GLIC is $2.7 billion. Because GLAIC represents more than 60 percent of GLIC's net worth ($1.7 divided by $2.7), GLAIC provides significant value and protection to GLIC and its long-term care insurance policyholders.

The Destacking Plan
Under the proposed "destacking" plan, GLAIC would be moved from GLIC to Genworth. In other words, GLIC and GLAIC would become sister subsidiaries of Genworth, and GLAIC, with its $1.7 billion of net worth, would no longer be an asset of GLIC. Under the proposed plan, Genworth would contribute $200 million to the net worth of GLIC. A major question is whether that amount is adequate compensation for GLIC and its long-term care insurance policyholders for the loss of GLAIC's $1.7 billion of net worth.

Genworth says the proposed destacking plan is subject to the approval of various state insurance regulators. An important question is whether the insurance commissioner in Delaware, where GLIC is domiciled, will approve the removal of a $1.7 billion asset from GLIC in exchange for a contribution of $200 million.

Genworth has not yet formally submitted the destacking plan to Delaware for approval. It remains to be seen whether the proposal will be available to the public when Genworth submits it, and whether the commissioner will conduct a public hearing on it.

The Note Indentures
Another dimension of the destacking plan relates to Genworth's eight issues of outstanding notes with principal amounts totaling $3.8 billion. The maturity dates of the notes range from 2018 to 2066. The note indentures provide that the "disposition" of a "significant subsidiary" might constitute an "event of default," thereby causing the notes to become due and payable immediately.

On March 4, Genworth asked the noteholders to consent to changes in the indentures to eliminate certain subsidiaries, including GLIC, from the definition of "significant subsidiary." To compensate noteholders for consenting to the changes in the indentures, Genworth offered consent fees ranging from $6.25 per $1,000 of principal amount for the short duration notes to $15 per $1,000 of principal amount for the long duration notes. The aggregate amount of the consent fees was $44 million, provided all the noteholders consented.

On March 22, Genworth announced it had received the required number of consents in order to effectuate the changes in the note indentures. The changes mean that the "disposition" of GLIC, through a sale or even an insolvency, would not be an "event of default" under the note indentures. The changes in the indentures remove a major potential obstacle to the implementation of the destacking plan.

The Reinsurance Repatriation
Brookfield Life and Annuity Insurance Company Limited (BLAIC) is Genworth's primary Bermuda domiciled captive reinsurance subsidiary. Half of GLIC's long-term care insurance business, involving about $1 billion of reserve liabilities, has been ceded to BLAIC. As part of the strategic update, and subject to regulatory approvals, Genworth plans to "repatriate" ("unwind") all the reinsurance its insurance subsidiaries have ceded to BLAIC. After the repatriation, which is expected to occur in 2016, Genworth plans to dissolve BLAIC.

Genworth's 2015 10-K report discloses that the company has been using various accounting practices that are permitted by Delaware and Vermont insurance regulators but that deviate from accounting practices permitted by the National Association of Insurance Commissioners. For more on such practices, see No. 153 (posted March 31, 2016).

General Observations
My initial reaction to the destacking plan was that Genworth might be considering the sale of GLIC. However, the questions that naturally follow such a reaction are "To whom?" and "At what price?" I think no reputable company would want to take over GLIC's large and troubled block of long-term care insurance policies at any price.

GLIC has been asking state insurance regulators to approve substantial premium increases on long-term care insurance policies. The company calls them "actuarially justified" premium increases, but the words "actuarially justified" are not necessary. I think GLIC or any other reputable company would refrain from seeking premium increases that are not actuarially justified.

The requests for premium increases create a dilemma for state insurance regulators. Disapproving the requests might force GLIC into insolvency. Approving the requests, on the other hand, increases the financial burdens faced by elderly long-term care insurance policyholders. Although policyholders may be offered the opportunity to avoid the premium increases by accepting reduced benefits, or to pay no further premiums by accepting even lower "paid-up" benefits, the financial burdens on those vulnerable policyholders remain.

I think the survival of GLIC is open to question. In the event of its insolvency, the changes in the note indentures protect Genworth's noteholders, Genworth's shareholders, and Genworth itself. However, the changes do not protect GLIC's long-term care insurance policyholders. Nor do they protect state guaranty associations or insurance companies that would be subjected to assessments. The Delaware commissioner and the other regulators who will be asked to approve the destacking plan are the only ones who can protect policyholders, state guaranty associations, and insurance companies that would be assessed.

Available Material
I am making available a complimentary 16-page PDF ("April 2016 Genworth package") consisting of selected pages from Genworth's filings with the SEC about the strategic update, the destacking plan, the consent solicitation, the results of the consent solicitation, and the repatriation of the Bermuda reinsurance. Also, the complimentary 31-page PDF ("February 2016 Genworth package") offered in No. 144 remains available. Email and ask for the April 2016 Genworth package and/or the February 2016 Genworth package.