Goldman Sachs Defends GE Against Accounting Accusations

Goldman Sachs

GE has taken quite a bit of heat for their alleged accounting irregularities surrounding their managed care insurance divisions. GE denies any wrongdoing, and Goldman Sachs agrees.

General Electric, commonly known as GE, has a very storied history, beginning all the way back in 1892. Among their founders were Thomas Edison and J.P. Morgan. Edison provided the ingenuity and Morgan provided the financing, and together with three other partners, one of the world’s most significant companies of all time was born.

GE is still well known for its use of energy, although it has branched out into a lot of different areas during its lifetime, as is common for a conglomerate of this size. One of these applications is in medical equipment, which eventually led to their offering health insurance as well.

Sometimes you get into a line of business that you come to regret, and there’s no doubt that GE’s insurance divisions have fallen upon hard times. GE lost 22.4 billion in 2018, and $6.2 billion of this came from insurance. GE has stayed the course though and committed a further $15 billion to prop up their two long-term care insurance business, although this really means covering more losses.

With the escalating costs of health care in general, and especially how much the cost of long-term health care has gone up, this is a particularly risky business indeed for insurers, even for a company as large as GE is. The effect this business has had on its bottom line lately speaks well to this.

As is the case with insurance generally, you price the risk involved based upon the best knowledge you have at the time. In the long-term care business, this means needing to predict how prices will change years in advance, because of the lag involved from when the premiums are collected and when the benefits are paid out.

When the cost of something rises this much over inflation, this is going to result in some financial shocks down the road, and when the time frame for the coverage is as long as it is with long-term care coverage, this is not a healthy combination.

GE stock has been well beaten up over the last 3 years, where it has lost 74% of its value. The market can look the other way when new companies lose money, or ones not exactly new but not so old either like Tesla, but when a company who is as big as GE is and has been around for as long as they have does this, this is not taken lightly, nor should it be.

They are at least starting to turn things around in 2019, although they still have a big cash flow problem which came in at negative one billion dollars last quarter. At least they made money though, and they are working hard on shoring up their huge business to earn the confidence of the market once again.

Being Accused of Fraud is Not What GE Needs While This Wounded

Harry MarkopolosReports that accuse them of accounting fraud are the last thing that they need to see now as they seek to rebuild, and this is something with at least the potential to cause a lot of damage to a company if found to be true.

Last Thursday, forensic accountant Harry Markopolos dropped a bomb on GE when he accused them of fraudulent accounting. GE has denied this and has called the whole episode one of “market manipulation, pure and simple.”

The main concern here is that if a company such as GE does not have the wherewithal to meet its future insurance obligations, this may leave many people who have bought insurance from them and expect to receive the benefits of it out in the cold, and people who need long-term medical care are especially not the sort that we want to do that to. Even if they do manage to pay out all the claims, this can do some significant damage to the financial health of a company.

GE is accusing Markopolos of misrepresenting facts in his report, and also are saying that his motive is not to seek truth but to debase GE’s stock value so that the hedge fund that he is partnered in may benefit financially. Hedge funds often will short stock and benefit when its price declines, and a lot of money can be made by questioning the financial viability of a company that you are short.

The motive of Markopolos isn’t relevant though, as if his claims are true, their truth would stand on its own and it wouldn’t matter if he were to gain financially from it. GE’s argument here would therefore not be a valid one and we need to confine ourselves to whether or not GE’s accounting fairly represented their risk or not.

Goldman Sachs has now joined this battle, on the side of GE, and have stated that they find GE’s per-life insurance reserves to be “rational.” GE has also pointed out that their reserves are well above the industry average, which would make them among the most reliable providers out there.

GE has two subsidiaries that offer this type of insurance, and one of them has the third highest per-life reserves in the business, and the other has the highest per-life reserves. GE would be entitled to brag about this, not seek to hide it.

The Calculations May Indeed Be Well-Off, But Not Just GE’s

It very well may be that the means by which we determine what is rational and sufficient as far as what these reserves should be is faulty. If so, the fingers need to be pointed at the entire industry, not just at GE, and in fact, based upon what we know, GE would be at the back of the line when we line up the perpetrators.

The entire industry is struggling with this type of insurance for the very same reasons that GE is, due to years of underpricing this coverage. In the past, what was considered to be sufficient to cover these claims was deemed to be rational at the time, but is not now. Today’s rational may very well become tomorrow’s irrational, so this is an area that we do need to look at closely.

We still can’t be singling out one provider or one company here though, one that is well regulated and follows current accounting practices. Determining whether or not reserves are sufficient is a complicated matter, as many insurance calculations are, and this is especially the case with the long horizons that are involved in long-term care coverage.

The market has punished GE for this news, or at least has done so thus far, although we have at least moved up from the low of $7.65 last Thursday when this news hit the street, to settle in at $8.39 per share at the close on Tuesday. With Goldman Sachs taking GE’s side, the worst may be over here, but this is a stock that was already falling before all this and we may now wonder how long it will take to get back above $10 a share, where they were just three weeks ago.

We’re only off by 64 cents a share from where we were prior to these accusations, and a further $1.63 away from where GE was on July 24. It needs to triple from there to get to where it started 2017 at, which requires optimism of an entirely different scale, and it’s anyone’s guess how many years or even decades that might take.

The biggest lesson for investors here isn’t about how foul reports may cause a stock to drop a little but what can happen if we just close our eyes and hold on tight when a company’s stock goes sour, as those who have held it for the past 3 years can attest to. GE has been touted as a buy around this area, and they may be at some point, but we also need to be careful not to jump on something too soon, when a company’s resurgence is more a matter of rumor than fact.

With or without fraudulent accounting, this stock looks more like the patients that this long-term care is designed to help. While their prospects may be better than someone who is sick and does not have any real hope, GE is plenty sick right now and will require some real nursing to get them on their feet again and even pointed back in the direction of the glory days that have so passed them by now.

Robert

Editor, MarketReview.com

Robert really stands out in the way that he is able to clarify things through the application of simple economic principles which he also makes easy to understand.