Monday, November 20, 2017

No. 242: Long-Term Care Insurance—The Closed Block at Kanawha Hits the News

KMG America Corporation is a holding company formed in 2004, incorporated in Virginia, and based in Minnesota. In 2004 KMG acquired Kanawha Insurance Company, which is domiciled in South Carolina. Kanawha, which began business in 1958, had been selling, among other things, long-term care (LTC) insurance. Kanawha stopped selling LTC insurance in 2005, and continued to administer the policies in runoff as a closed block. In 2007 Humana Inc. (NYSE:HUM), a large health insurance company, acquired KMG, including Kanawha's LTC block.

On November 6, 2017, Humana announced it had entered into a definitive agreement to sell KMG, including Kanawha and its LTC block, to Continental General Insurance Company, a Texas company owned by HC2 Holdings, Inc. (NYSE:HCHC). The parties anticipate the transaction will close in the third quarter of 2018, subject to various approvals, including approval by the South Carolina Department of Insurance. Here I discuss the transaction and its implications for those in the LTC block.

The Acquirer
Philip Alan Falcone (CRD#1442413) is chairman, president, and chief executive officer of HC2 Holdings. On November 6, 2017, HC2 issued a press release about the agreement with Humana. The press release quotes Falcone as saying:
We closed our initial acquisitions of American Financial Group's long-term care insurance businesses almost two years ago as the first step towards building a platform focused on acquiring LTC businesses. Since then, we've steadily built our insurance platform infrastructure in Austin, Texas and looked at numerous potential acquisitions in the space. We are extremely pleased to have reached this mutually beneficial agreement with Humana as it represents another key stepping stone for our platform. In addition, we believe this transaction is further validation of our platform and our strategy and represents industry recognition as the counterparty of choice for future LTC transactions. We look forward to leveraging this platform to generate meaningful growth.
Falcone is the founder of Harbinger Capital Partners, a New York hedge fund. On August 19, 2013, the Securities and Exchange Commission (SEC) issued a press release entitled "Philip Falcone and Harbinger Capital Agree to Settlement." The press release provides a link to a June 2012 SEC press release that in turn provides links to four other SEC documents. The first paragraph of the August 2013 press release reads:
The Securities and Exchange Commission today announced that New York-based hedge fund adviser Philip A. Falcone and his advisory firm Harbinger Capital Partners have agreed to a settlement in which they must pay more than $18 million and admit wrongdoing. Falcone also agreed to be barred from the securities industry for at least five years. [Blogger's note: The words "and admit wrongdoing" are important. This was one of the first SEC settlements requiring an admission of wrongdoing. Also, although the agreement barred Falcone from the securities industry for at least five years, he was not barred from serving as an officer of a publicly-owned company.]
Rating Actions
Kanawha has financial strength ratings issued by Standard & Poor's (S&P) and A. M. Best. Both issued announcements about their financial strength ratings of Kanawha promptly after Humana and HC2 announced the tentative agreement. Continental General is not rated by any of the major rating firms, and HC2 has an S&P debt rating of B– (Weak).

On November 8, 2017, S&P said it has placed its BB+ (Marginal) rating of Kanawha on CreditWatch with negative implications. BB+ is the highest rating in S&P's below-investment-grade (junk) range. Upon closing of the sale, S&P said it could lower the rating to HC2's rating of B– (Weak), which would place Kanawha's rating deep in the junk range.

On November 9, 2017, Best said it has placed its B++ (Good) rating of Kanawha under review with negative implications. B++ is low in Best's investment-grade range, and a downgrade of two or more levels would place Kanawha's rating in Best's junk range. Best said that a downgrade could occur on closing of the sale, but that Best would need discussions with Continental General and HC2.

Humana's Public Filings
To get a feel for Humana's experience with Kanawha's LTC closed block, I reviewed Humana's public filings with the SEC from the 2007 acquisition of KMG to the present. On November 30, 2007, Humana announced its purchase of KMG in an 8-K (significant event) report and a press release. The announcements did not mention the LTC block. In its 10-K report for the year ended December 31, 2007, Humana mentioned its acquisition of KMG but did not mention the LTC block. In its 10-K report for 2008, Humana mentioned the LTC block and said:
Long-term care policies provide for long-term duration coverage and, therefore, our actual claims experience will emerge many years after assumptions have been established. The risk of a deviation of the actual morbidity and mortality rates from those assumed in our reserves are particularly significant to our closed block of long-term care policies. We monitor the loss experience of these long-term care policies, and, when necessary, apply for premium rate increases through a regulatory filing and approval process in the jurisdictions in which such products were sold. We expect to file premium rate increases in 2009. To the extent premium rate increases or loss experience vary from our acquisition date assumptions, future adjustments to reserves could be required. Failure to adequately price our products or estimate sufficient benefits payable or future policy benefits payable may result in a material adverse effect on our results of operations, financial position, and cash flows.
In its 10-K report for 2008, Humana also said there were about 37,000 policyholders in the LTC block. In subsequent reports, the company provided figures that show the pace at which the number of policyholders in the LTC block has been declining:
12/31/08       37,000
12/31/09       36,000
12/31/10       36,000
12/31/11       Not shown
12/31/12       34,000
12/31/13       33,300
12/31/14       32,700
12/31/15       31,800
12/31/16       30,800
9/30/17         30,100
In its reports for 2009 and thereafter, Humana mentioned increases in reserves, increases in future benefits, and premium increase requests. The company also mentioned capital contributions it made to KMG to support the LTC block.

General Observations
Readers of this blog and The Insurance Forum are aware I have written extensively about transfers of blocks of policies from one insurance company to another. For example, see No. 220 (posted June 1, 2017). I wrote numerous articles on the subject in the Forum beginning in 1989, and I devoted a chapter to the subject in my 2015 book entitled The Insurance Forum: A Memoir.

I have said a transfer of a block of policies from one insurance company to another requires the consent of each affected policyholder. However, no such requirement applies when an entire insurance company is acquired by another insurance company, as is the case with Kanawha's LTC block.

I did not learn of the transfer of Kanawha's LTC block to Humana in 2007. If I had, I would not have been particularly concerned because Humana was (and is) a major company with fairly high financial strength ratings. Now, however, I am deeply concerned about the fate of the 30,000 policyholders remaining in the LTC block. The parties plan to move the LTC block to an unrated insurance company whose parent has a junk debt rating. Moreover, the acquiring insurance company and its parent are controlled by an individual now barred from the securities industry.

I hope the South Carolina Department will take a close look at the situation before approving the transfer of the LTC block from Humana to Continental General and HC2. I asked the Department what documents will be provided, which will be public and which will be confidential, whether there will be a hearing, and, if so, whether the hearing will be public or closed. A Department spokeswoman replied promptly. She said the matter will be handled in accordance with South Carolina statutes (Sections 38-21-60 and 38-21-70) and a regulation (69-14). My impression is that the process will generate little public information, but I plan to follow developments as closely as possible.

Available Material
I am offering a complimentary 11-page PDF consisting of Humana's November 2007 press release (2 pages), Humana's November 2017 press release (4 pages), HC2's November 2017 press release (3 pages), and the SEC's August 2013 press release (2 pages). Email and ask for the November 2017 package about Kanawha's closed block of LTC insurance policies.