Source: gefraud.com

Two weeks ago a 175 page report was released by Harry Markopolos and his team that works with him, detailing allegations that GE is hiding massive future losses in their reinsurance business as well as having used accounting cover ups and fraud to hide other massive losses, like one in its Baker Hughes subsidiary.

I initially wanted to write in detail about this report because it’s available for free in the link above and quite extensive. The mainstream media assumes (wrongly in my opinion) that there isn’t a market for in depth analysis of allegations like these and have mostly reported the figures of an alleged $38 billion in potential losses as well as the dismissive denial from GE. I wanted to take the time to read the report and I didn’t want to do readers an injustice by simply skimming through it and regurgitating a few points. So I will do my best to touch on what I feel we’re the most important highlights.

Before I get into the details of what I feel was the meat of the report though, I want to step back and think about the motivations behind this report because it has been noted in the media that an advanced copy of the report was given to a hedge fund in return for a percentage gain of any profits made from shorting the stock. This is disclosed in the report and GE spokespeople seized on this as evidence that Markopolos is just out to manipulate the market and make money. To understand why I think that is false and GE may have a real problem, consider the following.

• Markopolos is an experienced financial professional most famous for alerting the SEC about Bernie Madoff before it was known to anyone that he was running a ponzi scheme. He did this through statistical analysis of the reported returns and determined there was no combination of securities in any market that could have produced the same returns with the same volatility. Markopolos quit his job as a CIO to investigate fraud full time in 2004. This is not just money for him, it is clearly a passion that is driven by a sense of duty to right the wrongs of people who are defrauding investors. As I have talked about in some of my motivational posts on this site, when someone is motivated by more than money, when they are driven by their passion, you are seeing work above and beyond what a casual worker will produce, you are seeing their legacy at work. This gives him and his team a stronger sense of legitimacy in their claim in my eyes.
• Markopolos is a Chartered Financial Analyst and Certified Fraud Examiner. As a member of these societies he takes an oath to uphold ethical standards beyond what many in the financial industry need to abide by. He is bound by a fiduciary duty not to deceive investors.
• In his analysis, Markopolos discloses that some details were left out and have been provided solely to the SEC and FBI for their analysis. This tells me that he has what he believes is actionable evidence of fraud beyond what he has publicly disclosed which may tip off GE were they to find out what it was.
• He has a strong track record. Besides Madoff he has exposed 9 different companies defrauding investors one of which led to heavy fines for trust banks which were found to have defrauded investors out of millions. in addition he hired accounting and insurance industry experts to assist him in his analysis, strengthening his argument and the expertise of his team.

GE also has an incentive to dismiss his claims. There are thousands of jobs at risk, billions in investor money, reputations and big egos that are driving them to keep the company from tilting into bankruptcy as Markopolos claims they will go.

What the Report Claims

Now that you have the background on the legitimacy of the report, I want to give you some of the highlights I gathered from it.

In 2017 and 2018, GE had $53.5 billion in negative surprises. Most of these were related to Long Term Care (LTC) agreements in its reinsurance unit.

Source: gefraud.com

Long term care insurance is that insurance bought by younger people who make monthly payments into a policy with the understanding that when they are older and they need nursing home or skilled nursing care, the policy will kick in and foot the bill.

This kind of policy requires esoteric actuarial assumptions on how long patients will live the care they will need and the expected interest rates to arrive at an estimation of the future costs and in turn what should be charged currently to the buyer.

What we know now is that the market in the 90’s and early 2000’s was not well developed and many of the actuarial assumption in terms of life expectancy, care costs and interest rates were way off. The companies like GE that guarantee these policies are on the hook to pick up these costs down the road and they cannot be modified. It was a great ploy in the mid 2000’s, the payout was a long way off but GE could recognize the premiums as income right then.

The losses we have already seen were mostly due to higher reserves for covering those losses which directly impacts profitability. Markopolos claims however, those reserves are woefully inadequate and there are bigger losses to come.

Source: gefraud.com

BGHE above stands for Baker Hughes. This is a subsidiary majority owned by GE for which it has already claimed $2 billion in losses and is in the process of divesting. It is likely to recognize a big loss when it does go through but Markopolos argues that loss should have been recognized in 2018 and needs to be restated. I don’t want to focus on this part since it is the smaller part of the $38 billion and because there is a much stronger explanation backing up the potential LTC losses.

As a publicly traded entity, GE has a reporting requirement on reserves for its policies under Generally Accepted Accounting Principals or GAAP. However it also has a reporting requirement for those reserves as a state regulated entity under what the author calls Standard Accounting Practice or SAP rules which are completely different.

Markopolos went through the painstaking task of finding these filings with the state and analyzing them as well as comparing GE to its peers in the same market.

Source: gefraud.com

• When comparing reserves to its peers, Markopolos argues they are woefully underfunded and they need to have higher reserves right now.
• In addition, he also claims that GE has the worst performing portfolio in the market i.e. the most toxic assets out there.
• He also gives a timeline of Q1 2021 when the two systems will be aligned to correct the accounting discrepancy and GE will have to recognize a $10.5 billion loss.

Source: gefraud.com

Essentially this has not been recognized as of yet because the buyers are still aging but they are about to hit the most common period for when claims start, mainly when they reach ages 80-90, 86.2% of claims are yet to be filed.

Source: gefraud.com

Markopolos then gives a number of examples across the industry of smaller companies that have held these policies and taken huge losses he also goes into detail as to why the policies were written so poorly and why insurance companies have moved out of this market due to the high losses.

In addition, there were past examples of accounting fraud, claims that inexperienced managers were running insurance units and other claims of a culture run amuck when it came to compliance and reporting. He even took the time to read Jack Welch’s book and tease out some relevant quotes.

GE’s Response

The response from GE was tepid at best. They simply claimed that they stand behind their figures and continued to bad mouth Markopolos and his team. Yet there are very detailed accusations in this report, likely the reason it was a length of 175 pages: to offer overwhelming evidence of fraud. There was no mention of whether they will need to recognize that accounting change in 2021 or why their loss ratios are so much higher compared to that of the wider industry.

Knowing how things work at a large company, the investor relations department at GE would likely have little to offer in any response anyway. It’s usually very senior managers that are aware of fraud like this and unfortunately, investor relations, who speak to the media and research analysts, only act as their mouthpiece or share what management wants people to hear.

Losses like those that Markopolos and his team describe would not just cause the company to lose money, they could trigger violations of debt covenants, creating a chain of defaults that may force GE to file for bankruptcy. Markopolos even offered definitive timelines like Q1 2021 of when write-downs will have to occur.

Given that a lot of finance has to do with faith and credit, will we watch a slow death for GE it will it implode suddenly? Is Markopolos completely wrong and will the company limp along and miraculously turn itself around? Feel free to share your comments on what you think.

The information provided by www.cashchronicles.com is for informational purposes only. It should not be considered legal or financial advice. You should consult with an attorney or other professional to determine what may be best for your individual needs. www.cashchronicles.com does not make any guarantee or other promise as to any results that may be obtained from using our content. No one should make any tax or investment decision without first consulting his or her own financial advisor or accountant and conducting his or her own research and due diligence. To the maximum extent permitted by law, www.cashchronicles.com disclaims any and all liability in the event any information, commentary, analysis, opinions, advice and/or recommendations prove to be inaccurate, incomplete or unreliable, or result in any investment or other losses. Content contained on or made available through the website is not intended to and does not constitute legal advice or investment advice and no attorney-client relationship is formed. Your use of the information on the website or materials linked from the Web is at your own risk.