Around a year ago, I wrote an article on General Electric, the American conglomerate that was once one of the world’s largest and most valuable companies. After slumping revenues and rocketing debts crippled both the company and its share price, the CEO was replaced and the company embarked on an ambitious turnaround plan to pay down debt and restore GE to its former glory.
Since then, things have ticked along largely as you might expect. The C-suite were wheeled out on a semi-regular basis to provide bland “everything is fine” statements to the media. That all changed around two months ago when Harry Markopolos, the man that discovered the Madoff scandal, alleged that the company was running a $38 billion accounting fraud.
The Markopolos Report
Mr Markopolos released an incredibly detailed 175-page report (which you can access here) that made a number of allegations against the company. The report contained extensive referencing which I must confess lost me at several points (I’m not an insurance analyst, so much of it was far beyond my ability to comprehend).
The document made for interesting reading though and I found particular value in the executive summary appended to the front of the report. Broadly speaking, this summary is based around the risk of rising pay-out claims on Long-Term Care contracts (otherwise known as LTCs).
Long Term Care contracts are insurance policies which pay out in the event of long-term care being needed by an individual. If you get cancer, or dementia, or need to go into a care home, these policies will cover the cost. As with other types of insurance policy, the \’trick\’ relies on the company keeping sufficient reserves to pay out future claims, without which, they can require extra funding to cover liabilities.
In his report, Mr Markopolos claimed that GE Financial has kept insufficient reserves for these policies and is basing this claim on two things 1) comparative insurers such as Prudential and 2) the high level of write-downs already incurred by GE on just 15% of their portfolio of policies which began to claim.
He then seems to have taken around 150 pages to detail exactly why this going to bankrupt the company but the argument seems to be that GE as a whole will need to pour more and more operating cash into GE Financial as these policies begin to pay out as existing reserves are insufficient.
The lack of cash on the balance sheet, along with the selling off of business units and on-going costs will bankrupt the company.
Do I agree?
Well, it certainly looks like a compelling argument but I am no insurance expert. GE is facing enormous problems and Mr Markopolos has prior form with uncovering the Madoff Ponzi scheme. His report is highly detailed and makes sense when you read it but is not helped by his hysterical tone (which has been a long-running a long-running problem of his. If you ever get the chance to watch the documentary ‘No One Listened’ you’ll see a very clever, very paranoid and slightly hysterical angle on what the events running up to the Madoff arrest).
In the two months since the report was released, General Electric has issued little statement beyond “this is obviously incorrect”. A number of industry professionals where wheeled out on CNBC and then the world seems to have moved on.
If Mr Markopolos is correct, General Electric will probably by gone by this time next year. Having said that, I’ve seen some truly dire companies stagger on through the most grievous of financial catastrophes (WeWork, anyone?).
In the meantime, the company has also announced that it freezing pensions for around 20,000 employees, gradually moving them from defined-benefits schemes to defined-contribution. It certainly seems like the new CEO, Larry Culp, is doing absolutely everything he can to reduce debts and stem cash flows out of the company as quickly as possible. Whether it remains too little, too late, is yet to be seen.