Monday, March 19, 2018

No. 258: Long-Term Care Insurance—The Kansas Insurance Department's Bailout of General Electric

In No. 257 (posted March 12, 2018) I reported on shareholder litigation against General Electric Company (GE) relating to a huge charge taken by GE in connection with an old run-off block of long-term care (LTC) insurance policies. A reader immediately informed me of another dimension of the subject, which I discuss in this follow-up.

The Huge Charge
It was not widely known until recently that GE had retained financial responsibility for a run-off block of LTC insurance policies sold more than a decade ago, prior to the creation of Genworth Financial, Inc. In July 2017 GE disclosed problems in its old LTC block. In November GE disclosed that its old LTC block had been largely reinsured, that the company was reviewing the reserve liabilities for its old LTC block, and that the charge was expected to be more than $3 billion.

On January 16, 2018, GE shocked the insurance world by disclosing that it will contribute about $15 billion of capital to the reinsurer over the next seven years, consisting of about $3 billion in the first quarter of 2018 and about $2 billion per year in each of the six following years. On January 24 GE disclosed the existence of an investigation by the Securities and Exchange Commission (SEC). GE said the SEC is "investigating [GE's] process leading to the insurance reserve increase and the fourth-quarter charge as well as GE's revenue recognition and controls for long-term service agreements."

The Reinsurer
In its January 16 disclosure, which was in an 8-K (significant event) report filed with the SEC, GE alluded to accounting rules of the Kansas Insurance Department and identified the reinsurer as "North American Life and Health (NALH)." I learned recently that the reinsurer for which GE used a Kansas "permitted accounting practice" was Employers Reassurance Corporation (ERAC), a Kansas-domiciled GE subsidiary. Later I discuss that error in GE's January 16 filing.

In ERAC's statutory annual statement for 2017, as filed March 1, 2018, the first note under "Notes to Financial Statements," on page 19.1 of the statement, discusses the old LTC block. The note says an accounting practice permitted in Kansas, but not permitted under the statutory accounting principles promulgated by the National Association of Insurance Commissioners (NAIC), allowed ERAC to add almost $11 billion (the figure is $10,983,500,000) to its surplus. Here is my edited version of a portion of the note (the full note is in the complimentary package offered at the end of this post):
During December 2017, ERAC requested and subsequently received approval from the Kansas Insurance Department for a permitted accounting practice to spread and delay the full recognition of the indicated increase in additional actuarial reserves (AAR) that would otherwise be required under the NAIC's statutory accounting principles over the years 2017 through 2023. The increase in AAR is predominantly related to the changes in ERAC's asset adequacy (cash flow testing) assumptions for long-term care business. The effects of the permitted practice are included in ERAC's calculation of its risk-based capital (RBC). Absent the permitted practice, ERAC would have required an additional capital contribution from GE under the terms of the existing Capital Management Agreement in place. The amount of AAR recognized in ERAC's 2018-2023 statutory financial statements will be computed by taking a percentage of the difference between the total estimated AAR adjustment as determined by the respective year's cash flow testing and the year-end 2016 AAR, and then subtracting the amount of change in AAR recognized in each of the preceding years starting in 2017.
ERAC's RBC Ratios
From ERAC's statutory financial statement for 2017, I calculated the RBC ratios (as percentages) at the end of each of the last five years, where the denominators of the ratios are company action level RBC. The ratios were 310 in 2013, 202 in 2014, 173 in 2015, 224 in 2016, and 187 in 2017. Without the Kansas permitted accounting practice, ERAC would be deeply insolvent and far below mandatory control level RBC.

My Public Records Request to the Kansas Department
On March 13 I asked the Kansas department, pursuant to the Kansas Open Records Act (KORA), for a copy of ERAC's request for the permitted accounting practice and a copy of the department's approval of the request. On March 14 Elizabeth J. Hickert Fike, an attorney in the legal division of the department, said:
The documents you are requesting are not subject to public disclosure. We consider that material to be included in our financial analysis workpapers. Please see 40-222(k)(7) for confidentiality of financial examination, including ongoing analysis.
Ms. Fike provided me with the text of that subsection of the Kansas Statutes (45-215 referred to below is the KORA). It reads:
All working papers, recorded information, documents and copies thereof produced by, obtained by or disclosed to the commissioner or any other person in the course of an examination made under this act including analysis by the commissioner pertaining to either the financial condition or the market regulation of a company must be given confidential treatment and are not subject to subpoena and may not be made public by the commissioner or any other person, except to the extent otherwise specifically provided in K.S.A. 45-215 et seq., and amendments thereto. Access may also be granted to the national association of insurance commissioners [sic] and its affiliates. Such parties must agree in writing prior to receiving the information to provide to it the same confidential treatment as required by this section, unless the prior written consent of the company to which it pertains has been obtained.
My Other Request to the Kansas Department
On March 13 I also asked the Kansas department some questions about the "permitted accounting practice to spread and delay additional actuarial reserves." On March 15 Tish M. Becker, chief financial analyst in the department, responded in detail. She said ERAC requested the department's approval of the permitted accounting practice on December 29, 2017. She said the department notified all the states where ERAC is licensed (the District of Columbia and all states except New York) and received no objections. Any objecting state can require the company to file a statement in that state not reflecting the permitted accounting practice, but such a statement would be rarely seen because it would not be the official statement circulated by the NAIC. I do not know how many states formally approved the permitted accounting practice, and how many tacitly approved it by not commenting on it.

Ms. Becker said the department reviewed ERAC's request "utilizing various actuarial and financial experts" and approved the request on January 11, 2018. She also said that, if the department had not granted the request, the Capital Management Agreement would have resulted in GE contributing the full amount. Ms. Becker made this general comment:
Please recognize there is a difference between what is booked on a statutory accounting basis for the insurance legal entity, versus what is booked on a GAAP [Generally Accepted Accounting Principles] basis on a group's consolidated financials.
In response to my inquiry about GE's erroneous identification of the reinsurer, Ms. Becker pointed out that GE has two life-health insurance subsidiaries, ERAC and Union Fidelity Life Insurance Company (UFLIC), both of which are domiciled in Kansas. She said "North American Life and Health (NALH)" is a term used by GE to discuss the results of its run-off insurance operations including both ERAC and UFLIC. She explained that, while UFLIC also identified an increase in additional actuarial reserves as of December 31, 2017, the increase was fully funded. Thus the department did not approve a permitted accounting practice for UFLIC.

I am not satisfied with that explanation. I can conceive of only two possible explanations for GE's error. A charitable explanation is that GE first requested the permitted accounting practice from an outside company, which declined to get involved, and GE then turned to ERAC. A less charitable explanation is that GE used a phony name for the reinsurer to avoid calling attention to the details of the permitted accounting practice shown in the note in ERAC's statutory statement.

My Writings about Permitted Accounting Practices
I have written extensively about permitted accounting practices in state regulation of insurance. My most important articles on the subject were in the February 2009, April 2009, May 2009, and August 2009 issues of The Insurance Forum. It is no coincidence that the articles appeared during the Great Recession. The articles are in the complimentary package offered at the end of this post.

General Observations
For a single state insurance regulator to approve—in violation of the NAIC's statutory accounting principles, and with the approval (or lack of disapproval) of the other state insurance regulators—the bailout of GE to the tune of almost $11 billion is an outrage. This case illustrates that any deviation, no matter how large, from acceptable accounting practices can be deemed acceptable by state insurance regulators.

Uniformity among the states was the basic reason for the creation of the NAIC's predecessor almost 150 years ago. In the wake of the unacceptable accounting practice described here, it will be interesting to see what rating actions, if any, are taken by the major firms that assign financial strength ratings to insurance companies.

Available Material
I am offering a 16-page complimentary package consisting of the note in ERAC's 2017 statutory financial statement (1 page) and the four 2009 Forum articles (15 pages). Email and ask for the March 2018 follow-up about GE's old LTC insurance block.