photo by James Lourens
If you grew up in America when I did, you remember General Electric as the company that made everything from clock radios to jet engines, en route to becoming the most valuable company in the world.
In GE’s heyday near the end of the 20th century, then-CEO Jack Welch insisted that his company be number one or, at worst, number two in every line of business where it participated. GE divested many businesses under Welch – 117 in his first four years, according to an account in Harvard Business Review – but as it did so, it pushed into new frontiers too, including health care technology and financial services.
Welch is long gone, and those glory days came to a screeching halt a decade ago when the financial crisis hit. Welch’s successor, Jeffrey Immelt, labored beneath Welch’s long shadow; now Immelt’s successor, John Flannery, must at least consider the prospect of breaking up GE entirely.
The Wall Street Journal recently reported that Flannery told investors GE is considering breaking its major divisions into separately traded entities, a more extreme evolution of his stated plan to focus on the company’s core units of aviation, power and health care. Should GE move forward with its plans to divide and, if not conquer, at least survive, the first moves will likely arrive by this spring.
If the end comes for GE as we knew it, the coup de grace may be delivered by a product far removed from the company’s industrial roots. The pathogen that is making GE sick is, ironically, long-term care insurance – a financial vehicle that was supposed to care for customers amid the infirmities of old age.
GE told investors that it would have to set aside $15 billion over the next seven years to shore up insurance reserves at its GE Capital unit, and LTC insurance is the main culprit. Though GE has not covered new LTC insurance policies since 2006, it kept billions of dollars of coverage on the books after the 2008 financial crisis. The company has now realized and acknowledged that its continuing involvement in LTC insurance is deeply unprofitable.
A few of us in the financial industry have always said LTC insurance is a product that would never work, because it cannot work. Every time we said so, jeering hecklers in the insurance industry and its allies in government and consumer groups emerged to criticize both our intelligence and our good faith. It was true nearly a decade ago, and it remains true today. A recent commentary by my colleague Melinda Kibler continues to draw such naysayers, even though LTC insurance’s flaws are now so blatantly evident that most of the companies that once sold it are either gone or have left the market, and those that remain are imposing massive rate hikes to stem their losses.
Insurance only works when a rare but costly risk can be spread among a large, relatively homogeneous population that is exposed to that risk. LTC insurance is, essentially, insurance against the physical and mental decline that comes with old age. Most people reach old age, especially those with the financial resources to consider LTC insurance in the first place. So most of those covered by these policies were inevitably going to collect, meaning there was nowhere to spread the risk. As it turned out, people are collecting even earlier and living even longer than the actuaries predicted, so the losses are showing up sooner and bigger than even we skeptics expected.
A day after reporting on GE’s woes, The Wall Street Journal noted the general problems with LTC insurance, with particular focus on Genworth Financial – the company GE spun off in 2006. To make the spinoff work, GE had to retain some of the exposure on its own books, resulting in the massive charges the company announced this week. But Genworth itself is financially beset, to the point that its CEO ludicrously told the Journal that “We never should have done it [sold LTC insurance at unrealistically low rates], and the regulators never should have allowed it” – as though it were regulators’ job to ensure that insurance companies priced their own products sustainably.
My Palisades Hudson colleagues and I never sold LTC insurance – in sharp contrast to many of those who attack us for our views – and we never recommended it. The product was designed to solve a very real problem, which is that the services infirm people need are very expensive. But insurance does not make those services less expensive; to the extent it stimulates demand, it makes them more costly. The real answers to the costs of growing old are, first, for individuals to save for those costs, but second and more important, for society to find ways to make growing old less costly, such as by providing more services at home so elderly and incapacitated people don’t need to be housed in expensive institutional settings.
LTC insurance was supposed to be a magic bullet. Unfortunately, magic is not real.
An “I told you so” isn’t very satisfying, however, when we consider that magical thinking surrounds so many other aspects of financial planning for the elderly. Social Security, Medicare and a vast array of public and private pension plans are all seriously underfunded. They are just as incapable of fulfilling their promises at their stated costs as was LTC insurance, and they are destined for a similar outcome. Promises that cannot be kept will not be kept. The fate of LTC insurance is just one of the first of what I suspect will be many iterations of the same story.