The $15 Billion Money Pit Dragging GE Down
(Bloomberg) -- Jack Welch built it, Jeff Immelt milked it and John Flannery failed to fix it.
Now Larry Culp must figure out what to do with the troubled remnants of GE Capital, the finance arm that nearly sank General Electric Co. a decade ago.
With anxiety over GE running high on Wall Street, Culp, the new chief executive officer, has a lot of work to do. So far GE -- once the quintessential American conglomerate -- just keeps stumbling from bad to worse.
But perhaps Culp’s most formidable challenge is the gaping hole inside the financial unit. A big part of the trouble has to do with GE’s book of long-term care insurance, a vestige of GE Capital that backs policies which pay for things like home health aides and nursing-home stays. Once little more than an afterthought, the portfolio has turned into a money pit that threatens to complicate efforts to turn around GE as worries grow over a funding shortage.
While GE has tried all year to offload the liabilities and Culp said no issue at the finance arm gets more attention, few see any easy answers. The problem is twofold. As medical costs soar and Americans live longer, GE’s assumptions about what it will have to pay out are proving to be too rosy. This year, the firm said it will need an extra $15 billion to cover future claims.
But unloading them on a would-be buyer will likely come at a very steep price. Past deals have suggested transactions of this type are often “prohibitively expensive,” analysts at Evercore Inc. have said.
Insurers including Athene Holding Ltd., backed by private equity firm Apollo Global Management LLC, have expressed interest in GE’s insurance assets, but talks have since cooled under Culp, according to people familiar with the matter. GE has also held talks with Warren Buffett’s Berkshire Hathaway Inc. about absorbing its insurance liabilities, two people said.
“It’s very difficult to sell” these types of policies, said GB Taglioni, North American leader of Boston Consulting’s insurance practice. He declined to talk about GE’s situation specifically. “There have been a lot of sellers and there have been, up until now, very few buyers.”
A GE spokeswoman declined to comment beyond recent filings and public comments, while Athene and Apollo also declined to comment. A Berkshire representative didn’t respond to requests for comment.
The situation has become all the more pressing as worries about GE’s finances deepen. In the past year, the company’s woes have wiped out more than $90 billion from its stock market value, called into question the sustainability of its debt burden and cost Flannery his job. Under Flannery, the industrial giant tried in vain to appease Wall Street by selling various businesses, like its energy finance and industrial gas-engine units, to shore up its balance sheet.
The insurance business itself came to the fore in spectacular fashion earlier this year after GE disclosed a $6.2 billion charge for the fourth quarter of 2017. It led to an ongoing regulatory investigation of GE’s accounting practices and shined a light on how precarious GE Capital’s situation had become.
And just this week, Gordon Haskett analyst John Inch flagged a potential trouble spot within one of the more profitable parts of the finance unit -- GE’s aircraft leasing arm. The division, which Inch sees as vulnerable to a pullback in the energy industry following a rival’s bankruptcy, has been the subject of intensifying deal speculation. In August, Singapore’s sovereign wealth fund expressed interest in buying some or all of GE Capital Aviation Services, people familiar with the matter said.
While GE is hardly alone when it comes to the headaches caused by long-term care policies, it stands out because of the sheer size of its reserve deficit. Complicating matters is the fact that, as a reinsurer of roughly 300,000 long-term care policies, GE is on the hook for payouts tied to those policies but has no power to increase rates itself and must rely on the primary insurers to raise them. (Some are held by Genworth Financial, a GE unit spun off in 2004.)
GE has a plan to plug the deficit. It will set aside the $15 billion it needs over seven years and has already contributed $3.5 billion of that this year. A sustained jump in interest rates could reduce GE’s deficit. Blackstone Group LP and Guggenheim Partners have expressed interest in managing its insurance assets, people familiar with the matter said, which could also help GE narrow its shortfall if they can produce higher returns. The firms declined to comment.
But the worry is that the liabilities will just keep growing as America’s health-care costs outpace those of every other developed nation. GE has warned there’s a risk the amount of its contributions could change. The open-ended nature of the obligations could ultimately stand in the way of a potential deal. Industry insiders say they expect GE will need to cover a substantial part of its hole before buyers entertain any serious offers over price.
“Long-term care is hard to ring-fence,” UBS analyst Steven Winoker wrote in a report to clients last month.
How GE will come up with the money is another issue. While it has more than $20 billion in cash and $40 billion in credit lines, worries about the company’s finances continue to grow. In the first nine months of the year alone, GE’s cash balance fell by $17 billion. It also has $18 billion in debt coming due in 2020, data compiled by Bloomberg show. As funding costs rise, analysts are watching closely to see whether GE will need to tap its credit lines and put some of its more attractive assets on the block.
Recent long-term care deals show just how difficult -- and costly -- it might be for GE. In August, CNO Financial agreed to pay $825 million to Canada Pension Plan Investment Board’s Wilton Re to get some of its long-term care policies off its books. The commission was equal to 30 percent of the $2.7 billion in reserves that CNO set aside for those policies, which Evercore said were among the “safest” in the industry. By comparison, the money GE needs just to cover its shortfall is more than five times CNO’s reserves.
“The problem is there’s still just a very significant amount of uncertainty over the correct assumptions that should be used to properly value the reserve,” according to Ryan Krueger at Keefe Bruyette & Woods.
Accounting changes could also have a material impact on GE. Starting in 2021, more stringent requirements will obligate firms to update liability assumptions and disclose their effect on earnings each year. Current rules often let them kick the can before disclosing one big charge all at once. Another tweak involves changing the rate that firms use to determine how much they need to cover future liabilities -- from a self-reported assumption to a market rate.
The insurance business is “a liability that is difficult to get one’s arms around,” S&P Global Ratings’ Matt Carroll said.
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