Saturday, August 17, 2019

One more brief comment on the Markopolis GE paper

The absolute core of the Harry Markopolis paper is that GE is dramatically under-reserved for long term care insurance.

And it clearly has been. It took a charge (ie recognised future losses) in 2017 and 2018. In accounting parlance they RECOGNISED huge losses in 2017 and 2018 for payments they will have to make in the future.

And Markopolis points to these charges as the evidence that GE has the worst long term care business in insurance.

Here is a slide that had my jaw dropping:

GE's Employer Re subsidiary (one of the two places it has long term care policies) it seems has a 527 percent loss ratio.

Yes, it does, in the year they take the huge reserve hit.

Markopolis is arguing the provisions they have already taken is proof that the book is bad. And he doesn't recognise current payments are way way below these provisions.

The Employers Re cash flow statement

So here is another way of looking at it. This is the operating part of the cash flow statement of Employers Re taken from the statutory statements. You can find the original here.

Yes, you see this right. The company had 500 million of premiums collected and 597 million of investment income. It paid out 893 million in benefit loss related payments. After all the sundry expenses Employers Re was still operating cash flow positive by more than 80 million.

The main source of the massive cash draw central to the Markopolis thesis is still cash flow positive. The 527 percent loss reserve above isn't a current payment by Employers Re - it is an estimate of their future payments. Current payments are completely manageable.

Union Fidelity Life - the other GE insurance company - the one with a mere 280 percent combined ratio - is actually cash flow negative. And the combined is marginally cash flow negative.

But that is not the point. Current cash flows are not the issue. And the combined ratio that Markopolis trumpets are not indicative of current cash flow. They are the provisions that GE is making for future cash flows.

Future cash flows at the insurance companies

Alas the Employers Re will not stay cash flow positive. Not close. Several things are going to happen to make it worse. These things will also happen at Union Life and both companies will become deeply cash flow negative.

First investment income is going to go down. This is inevitable. These policies were written 15 years ago or more and some of the bonds that back these policies were also purchased 15 years ago. As investment income goes down the cash-flow of the book will deteriorate.

Further as time goes on the insured get older. And as they pass through their 80s they will be more likely to wind up in nursing homes. Claims will increase.

Finally, for better or for worse some of the insured will stop making payments. The main reason this happens is that they die. The average age of insured here is in the late 70s.

When everyone has stopped making payments of course the business has run-off. Any cash left in the holding company can finally be distributed to the holding company (that is ultimately the GE parent company).

So how did this impact GE holding company cash flow so negatively?

GE has an agreement with the insurance commissioner to maintain a 300 percent risk based capital ratio at these subsidiaries. When the subsidiaries take additional provisions for future claims it can cause a cash draw on the parent company even if the actual insurance companies are cash flow positive.

At year end last year the two companies had a capital adequacy ratio of 365 and 426 percent. They can take small hits from here without any cash charge to the parent company. But that is only after they took accounts of massive capital contributions by the GE parent company.

How does this run off?

After the capital contributions there are tens of billions of excess at the insurance companies. Alas this cannot be accessed for decades because of the promise to maintain 300 percent capital adequacy ratios. My guess - and at this point it is only an educated guess - that the company will still be under-reserved and further losses will be booked. But those losses will be insufficient to absorb the excess capital at the insurance companies. Over the next thirty years these insurance companies will be both a source of losses (provisioning) and a source of parent company cash (as the excess reserves get released).

This is so far from the Markopolis view as to be comical.

Scoping it

The average cost of a month in a nursing home is about $7000.

There are about 270 thousand policies outstanding. That number falls all the time because there are a lot of ninety year olds in the book and they die.

The statutory reserves per policy outstanding is about $75000. [You can multiply this out. It is a lot.]

In other words give-or-take there is about 11 months in a nursing home provisioned per policy holder.

The average length of stay in a nursing home seems to be about 29 months as per this.

According to this a senior citizen has about a one in four chance of winding up in a nursing home at some point.

So this looks fine. If the claim rate winds up being one in four and there is 11 months provisioned per policy holder it looks like there is 44 months provisioned per claimant. And the average claim is only 29 months.

But it is not so simple. People who are insured are more likely to wind up in a nursing home because either it is already paid for or at least it is already partially paid for.

If you know the claims rate (by age and sex) on their book and the age and sex distribution of insured you could work out whether the book was under-reserved for or not.

I suspect the provisioning is line-ball accurate here now. They haven't written a new policy in over a decade so the way the book runs off should be utterly obvious to GE now.

But I do not have the claim curves.

I guess this was the sort of information I was hoping for from Harry.

But I didn't get it.


Thursday, August 15, 2019

The flat-out silly Markopolos GE report

GE is a deeply problematic company. It might not make it. And Harry Markopolos - the Madoff whistleblower - has put out a report on GE.

The report is I highly negative and I believe utterly misleading.

This report focuses on the Long Term Care business.

That business is

a) both having reserving problems and 
b) is for good reason the best performed Long Term Care business in the world.

Long Term Care - the business of insuring people against the need to go into a nursing home - has hurt everyone who touched it.

GE used to own Genworth - and when they spun it out they reinsured Genworth's policies. Those reinsurance contracts have bitten GE pretty hard. But they were - by the standard of Long Term Care policies really well underwritten.

I wrote a blog post a few years ago about how those policies were written. Read it and the ask yourself how valid is Markopolos's comparison with other companies.

Strangely and just to prove poor Harry's incompetence one of the companies he compares GE's business to is Genworth. This is bizarre. GE reinsured Genworth. They are the same policies.


But outside Long Term Care is where the report gets really silly. Here is a slide comparing GE's industrial margins to Madoff returns:

He states GE Industrial Margin of 14.7 percent is "too good to be true".

Let's give him some comparisons:

United Technologies13.3%
Emerson Electric16.4%
Illinois Toolworks24.3%
Roper Technologies27.4%
Rockwell Automation20.4%

I guess all of these are "too good to be true" too. Indeed the entire high-end of US manufacturing is worse than Madoff if you believe Mr Markopolis.


I think the alternative is more likely. Say what you will, GE remains the unequivocal leader in medical imaging technology and the unequivocal leader in jet engines. In both these there are very few competitors and it would be near impossible to eat into GE's lead.

My guess - and it is a guess - that over time GE's industrial margin goes back towards the upper-end of the above-mentioned comparables.

Harry's report is silly. The market should ignore it.


For disclosure: we are long a little bit of GE with the emphasis on "small". GE is a problematic company and a zero is a possibility. However the Markopolis report is not an accurate guide to GE's problems.

Friday, August 2, 2019

The latest Ken Henry blow-up

Warren Buffett - quite regularly at his annual meetings - observes that almost 400 thousand people work at Berkshire - in other words a medium sized city.

In those 400 thousand people (as in any medium sized city) there are almost certainly people doing things that they should not and things that you would not want to see on the front page of the local paper. They are selling products that rip off customers, they are doing things that threaten the reputation of Berkshire.

It is unreasonable in any large company to expect that there is no corporate mischief, no customers that are being misled, no staff doing things that are wrong.

But you can expect the management to monitor staff behaviour and to create incentives to do the right thing and to appropriately deal with staff that do the wrong thing. You should also expect them to compensate customers who fall victim and that compensation should be expensive.

Warren Buffett will also endlessly talk about the things he is doing to ensure that integrity is what is rewarded at Berkshire.

The Sydney Morning Herald today led with a headline that in leaked letters to consultants Dr Ken Henry (then Chair of National Australia Bank) had said that bad things were being done - even as they spoke - at National Australia Bank. To quote:

[Dr Henry is] confident that there are products currently being sold now that they will need to remediate in the future ([and he] highlighted an example of SMSF borrowing to invest in managed funds).
This looks pretty like the thing that Warren Buffett said about Berkshire. And it was said - as the context makes clear - to have the consultants who were hired to help in remediating the matter. In other words the admission is what is required to fix the problem.

A while ago I went to look at the lending practices of the Australian banks and I am confident that all four big banks had bad processes, and ripped off customers. As I have stated elsewhere I think that National Australia was the least bad of a bad lot. But it clearly had things to fix.

I still think NAB has things to fix. So does Westpac, CBA and ANZ [in that order I believe]. Stating it and acting on it is a necessary part of the process.

That Ken Henry actually stated it and presumably to a consultant he had hired to help reflects well, not poorly on him.


PS. I also think alas that Dr Henry is right. The mis-selling scandals cost British banks billions of pounds. PPI mis-selling alone was above 20 billion pounds. There has been so much mischief at Australian banks that this issue is certain to bite them in the future. Dr Henry clearly identified the issue and wanted to do something about it. He should be applauded.

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