Wednesday, August 28, 2019

No. 329: Long-Term Care Insurance—The Markopolos Whistleblower Report on General Electric

On August 15, 2019, Harry M. Markopolos released a 175-page whistleblower report alleging that General Electric Company (GE) is a "bigger fraud than Enron" and is "headed toward bankruptcy." One part of the report relates to GE's accounting for its long-term care (LTC) insurance legacy problem. Another part relates to GE's accounting for a 2017 investment involving a pair of oil and gas businesses. In this post I discuss only the LTC insurance portion of the report.

Harry Markopolos
Markopolos, now aged 62, was born in Erie, Pennsylvania. He received a bachelor's degree in business from Loyola College in Maryland in 1981, and a master's degree in finance from Boston College in 1997. He is a Chartered Financial Analyst and a Certified Fraud Examiner. His name is familiar to those who followed the collapse of the massive Ponzi scheme operated by Bernard Madoff.

Several books have been written about Madoff. One is a 2010 book entitled No One Would Listen: A True Financial Thriller, which is a personal account by Markopolos. David Einhorn, a prominent hedge fund manager and short seller, wrote the December 2009 foreword. In view of recent developments, it is ironic that Einhorn's foreword asks: "How statistically different was Bernie Madoff's track record from General Electric's 100-quarter record of continual earnings growth...?"

Another is a superb 2011 book entitled The Wizard of Lies: Bernie Madoff and the Death of Trust by Diana B. Henriques of The New York Times. She mentions Markopolos prominently because he was one of the first to become suspicious of Madoff. She also describes his several unsuccessful efforts to persuade the Securities and Exchange Commission (SEC) and other regulators to investigate Madoff.

The Markopolos Report
The Markopolos report includes a six-page summary and one page of disclosures. Here is the first paragraph of the summary (the full summary and the page of disclosures are in the complimentary package offered at the end of this post):
This is my accounting fraud team's ninth insurance fraud case in the past nine years and it's the biggest, bigger than Enron and WorldCom combined. In fact, GE's $38 billion in accounting fraud amounts to over 40% of GE's market capitalization, making it far more serious than either the Enron or WorldCom accounting frauds. Enron's CEO Jeff Skilling resigned on August 14, 2001, Enron was downgraded to junk status on November 28, and it filed for bankruptcy protection on December 2. On March 11, 2002, WorldCom received document requests from the SEC related to its accounting and loans to officers. On April 30 CEO Bernie Ebbers resigned regarding his $400 million in personal loans from the company. Then on June 25 CFO Scott Sullivan was fired before WorldCom filed Chapter 11 on July 21. It has been 17 years since WorldCom so we are long overdue for something like GE. As you read our slide deck, you will see that GE utilizes many of the same accounting tricks Enron did, so much so that we have taken to calling this the "GEnron" case.
To obtain the Markopolos report, go to Indicate your name and email address, and confirm you have read the disclosures.

The GE Statements
On August 15, 2019, GE issued a two-page statement entitled "GE Addresses Claims by Harry Markopolos." Here are the first paragraph and the first two sentences of the second paragraph (the full statement is in the complimentary package offered at the end of this post):
The claims made by Mr. Markopolos are meritless. The Company has never met, spoken to or had contact with Mr. Markopolos, and we are extremely disappointed that an individual with no direct knowledge of GE would choose to make such serious and unsubstantiated claims. GE operates at the highest level of integrity and stands behind its financial reporting. We remain focused on running our businesses every day, following the strategic path we have laid out.
Mr. Markopolos openly acknowledges that he is compensated by unnamed hedge funds. Such funds are financially motivated to attempt to generate short selling in a company's stock to create unnecessary volatility.
The statement went on to address the allegations. GE also issued investor updates on August 16 and 19. Here is a paragraph about LTC insurance (underlining in the original) in the August 19 update (the two updates are in the complimentary package offered at the end of this post):
It's important to recognize that there are several characteristics of industry long-term care blocks of business, including coverage and cash benefit options. In addition, GE is a reinsurer that has a variety of contractual relationships and is not responsible for 100% of every claim on every life. And recall how reserves work: the 2017 $15 billion increase to statutory reserves, to be recognized through 2024, was established to cover future claims in addition to claims already incurred.
The Fitch Report
On August 20, 2019, Fitch Ratings, a major rating firm, released a 16-page special report entitled "U.S. Long-Term Care Update: Legacy Exposures Continue to Plague Insurers." The fact that Fitch released the report five days after release of the Markopolos report presumably was a coincidence, but the Fitch report caused more problems for GE. Here is the first paragraph of the executive summary:
Highest Risk Product Exposure. Fitch Ratings ranks legacy individual long-term care (LTC) product exposures among the riskiest products marketed by U.S. life insurers. Our concerns mirror those of insurers that divested this risk or exited the market altogether, including volatile performance, high reserve and statutory capital requirements, as well as heightened exposure to interest rate-related risks. These all have the potential to introduce volatility in companies' capital and earnings generation capabilities for years after policies are issued.
The Fitch report includes a table entitled "Fitch's Individual LTC Observations by Insurer." The table shows, among other things, the "reserve adequacy" of 16 companies that currently offer or have offered LTC insurance. The five companies with "below average" reserve adequacy are Genworth Financial, GE Insurance Operations (including Employers Reassurance Corporation and Union Fidelity Life Insurance Company), UNUM Group, AEGON Americas, and Senior Health Insurance Company of Pennsylvania (SHIP). The seven companies with "above average" reserve adequacy are Manulife Financial, MetLife, Thrivent Financial, CNO Financial Group, Northwestern Mutual, New York Life, and Massachusetts Mutual.

An appendix in the Fitch report provides an update on SHIP. The final paragraph of the update reads:
In 2018 the company also reported reserve strengthening actions of approximately $359 million, driven by revisions in key morbidity, claims cost, lapse and investment yield assumptions. This, along with SHIP's reported asset impairments, led to a reported surplus deficit of about $466.9 million as of December 31, 2018. While we note the company continues to work closely with regulatory bodies, Fitch views SHIP as remaining on-track to becoming the industry's next insolvent LTC writer requiring guaranty fund assessments from the industry.
Regular readers of this blog know I have posted several items about SHIP. The most recent is No. 308 (April 11, 2019) entitled "Long-Term Care Insurance and the Insolvency of Senior Health Insurance Company of Pennsylvania."

Fitch denied my request for permission to include its LTC update in the complimentary package I am offering at the end of this post. However, the firm issued a press release on how to access the report. (The press release is in the complimentary package offered at the end of this post.)

The Litigation
In No. 298 (December 10, 2018), I posted my most recent discussion of the massive legacy problem at GE relating to LTC insurance. I said the then lawsuit, which had been consolidated with other similar lawsuits, was in the hands of U.S. District Judge Jesse M. Burman of the Southern District of New York. On September 20, 2018, GE filed a motion to dismiss the latest consolidated complaint, along with documents in support of the motion. On October 12 the plaintiffs opposed the motion to dismiss the latest consolidated complaint.

On February 27, 2019, new plaintiffs filed a lawsuit against GE, along with a statement that the new case was related to the old case. The next day, the new case was accepted as related to the old case and assigned to Judge Burman. On March 4 the judge ordered the parties in both cases to confer and submit to him a joint letter on how to proceed. On March 13 the parties submitted the joint letter. On March 15 the judge adopted the suggestion that the parties submit another joint letter on how to proceed within two weeks after the judge rules on the pending motion to dismiss the old case. At this writing (late August) the judge has not ruled on the motion to dismiss the old case. (The new case is Touchstone v. GE, U.S. District Court, Southern District of New York, Case No. 1:19-cv-1876.)

General Observations
The Markopolos report is complex, and I do not understand its full implications. Nor am I aware of the status of any investigation of GE by the SEC or any other regulatory agencies. I plan to write again when I learn of any significant developments.

In this post I showed the opening section of GE's August 15 statement about the Markopolos report. In my opinion, the ad hominem attack is unfortunate. It is standard practice for an independent researcher to maintain a distance from the object of the research. An important reason is that to share the research in advance would provide the object of the research with an opportunity to delay and possibly prevent publication in a variety of ways. That is why independent journalists do not share the results of their work in advance with the objects of their news stories.

Available Material
I am offering a complimentary 20-page PDF consisting of the summary and disclosures in the Markopolos report (7 pages), the three GE statements about the Markopolos report (10 pages), and the Fitch press release about the Fitch report (3 pages). Email and ask for the August 2019 package about LTC insurance and the Markopolos report on GE.