GNW has historically been one of the largest players in the LTC market and following the exit of some prominent players such as UNM and MET, it remains the largest player in what we view as the most structurally challenged lines in the low rate environment.
Despite pressure from low rates and the exit of other players GNW has reported operating profits in the segment in US GAAP. On a GAAP basis, GNW’s LTC book has produced steady profits, including a $99mm gain in 2011, $132mm in 2010 and $163mm in 2009. However, on a statutory basis, even with the aid of captive reinsurance, the company has printed pretax losses in long term care of $225mm, a loss of $39mm and a gain of $11mm
in 2011, 2010 and 2009, respectively. The company has asked for and received price increases on 70% of its LTC book across 43 states. The fact that the company is asking for rate increases implies that the book is mispriced and that they are in loss positions In FAS 60 accounting, new business is amortized at a set pace as long as there is profit margin in the book. We suspect GNW is writing new business that is profitable (maybe in
the 5-10% ROE range) that has kept it from taking a GAAP DAC and reserve hit.
However, should new sales slow this dynamic could change, resulting in charges similar to what happened to others once they substantially slowed or stopped writing LTC. The abrupt resignation of CEO Frazier signals to us that there could be issues with this business going forward.
Prior to the end of 2011, Brookfield Life Assurance Co. reinsured long-term care business from GNW’s main operating subsidiary, Genworth Life Insurance Co. (GLIC). Prior to late
2011, Brookfield owned the portion of GNW’s Canadian MI business not pledged to support the US MI (note GNW injected $375mm of shares into the US MI as capital in 2Q11), the Australian MI business and the International Protection business. It was to this entity that GNW ceded its LTC book.
We suspect that the use of the captive reinsurance entity helps delay loss recognition as it uses a modified GAAP accounting framework that is less onerous relative to Statutory Accounting Principles when it comes to discount rate, morbidity and mortality assumptions. GLIC received reinsurance reserve relief from Brookfield Life Assurance of $6.3B in 2010, $5.6B in 2009, $5B in 2008, $3.6B in 2007 and $3.2B in 2006. In 2011 GNW created Brookfield Life and Annuity Insurance Co. (BLAIC), which novated Brookfield Life Assurance Co of its reinsurance with GLIC and therefore now provides support in the form of reserve relief for GLIC’s LTC business. BLAIC provided reserve
credit of $6.9B in 2011.
Brookfield Life Assurance Co. still owns the Canadian and Australian MI stakes but no longer reinsures the LTC book, and the company indicates that both of these assets in BLAC are unencumbered. However, BLAIC still has ownership of the International Protection business, which we suspect in effect helps capitalize the LTC reinsurance program. While it is our understanding that Canadian and Australian MI assets are
unencumbered, it is unclear what other assets were pledged to BLAIC in order to support the reinsurance of the LTC liabilities.
Interesting read. One odd thing about this report is the use of the terms "imply" and "suspect" to describe publicly disclosed stuff. For example, regarding the statement:
"The fact that the company is asking for rate increases implies that the book is mispriced and that they are in loss positions" - in the Feb. 2011 shareholders, the company disclosed that the ROE on the blocks for which price increases were sought was -7%. No need to imply this information.
"We suspect GNW is writing new business that is profitable (maybe in
the 5-10% ROE range) that has kept it from taking a GAAP DAC and reserve hit" - they disclosed in the same presentation that the ROE for new LTC business was 17% to date, and estimated 15% long-term (i think this may be a high estimate).
Did the authors look at all of the publicly available info before drafting this report?
I looked through the annual statutory statements for 2011 and didn't see the BLAIC reinsurance treaty referenced, though i have no reason to believe it doesn't exist, as the entity was created last year. However, capitalizing an entity via monatizing derivatives (e.g. capital gains) is not suspicious. The replacement swaps could turn south, but with Bernanke pledging low interest through 2014, the odds are in GNW's favor.
On the other hand, the use of the European LPI as capital support for a BLAIC reinsurance treaty would encumber the sale of LPI - i figure this may have been done to free up the AU division for the IPO, judging from the org chart.
Regarding the statement that "the abrupt resignation of CEO Frazier signals to us that there could be issues with this (LT) business going forward" - if this is the only reason they can point to for Fraizer's departure, they aren't trying too hard.
So the thesis is that if LTC sales slow down, they'll have to take a DAC and statutory reserve hit on this old business due to the low interest rate environment. And if BM adopts new statutory reserve standards, they'll take a statutory hit. Maybe, but isn't the point of the two rounds of price increases to address the very problems raised? And, it seems like a discount of .19 to BV takes a DAC hit into account.
Informative, but doesn't change my feelings that this company is undervalued, unless AU and CA MI fall off a cliff.
p.s. if you want to see another reason why this thing trades at .2 of book, look at the org chart and the reinsurance treaty info in the statutory filings. it is truly a tangled web, and untangling it will take some time.
There is also a reason a stock drops 10% a day. The people who lost the biggest are the ones who fall in love with a stock when it keeps going down. Back in 2008 when the market crashed, people who lost the biggest are the ones when GNW dropped 10 dollars in a day he thought the market will bounce back tomorrow, and then it dropped another 10 points the next day , and he still think market will bounce back in the next two days, then GNW dropped another $8 in the next two days. Finally when the market settled, GNW settled at $0.7, and the fool ride all the way down from $25 to $0.7. Why not cut your loss when your loss is minum and save your capital and buy back at a much lower price with much more shares. The ones who average down are the most foolish investors , and those guys never make big money, and the best they can get is make even when the market rebound.
Right On man. Put him on Iggy...GNW will end up like Sears (SHLD), similar situation specially if they spin off Canada or others just like Sears
One way it appears GNW has capitalized BLAIC is through the monetization of derivative assets. Specifically, in 2011, GNW monetized forward starting swaps, which the company indicated helped improve its statutory unassigned surplus position. However, of the $1.3B gain, it appears that ~$700mm to $1B of the gain was allocated to BLAIC to, in our view, help capitalize the entity.
Business that has been ceded to BLAIC has been deteriorating, with incurred loss ratios to net premiums written increasing over the past five years. We would note that reinsured
incurred loss ratios have been increasing over the last three years, coming in at 87% of ceded earned premiums in 2011.
Despite this, it is unclear if and when GNW will have to take the pain on LTC on a statutory basis. As BLAIC is in Bermuda, the potential of regulators there adopting a Solvency II
accounting framework could result in GNW to realize some losses on a statutory basis, but we would note that there is limited visibility on GNW’s ability to change domicile of the
entity or novate the reinsurance to another entity outside of Bermuda.