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Forensic accountant Harry Markopolos picked at a scab of an old wound for General Electric investors this week when he alleged accounting fraud in the company’s legacy long-term care insurance business.

His 175-page report covered a lot of ground, some of which first came to the fore in 2018. GE CEO Larry Culp dismissed it as “market manipulation—pure and simple.” GE stock (ticker: GE) dropped 11% Thursday following the release of the report, cutting year-to-date gains to about 10%, close to the return of the Dow Jones Industrial Average over the same span.

The stock reacted that way because Markopolos challenged many accounting assumptions for GE. In 2018, the company took an unexpected $6.2 billion charge for mounting losses in its insurance subsidiaries. GE also said it would pay $15 billion over several years to shore up insurance reserves.

After that charge was announced, GE investors—more comfortable analyzing industrial conglomerates—spent more than a year getting comfortable with insurance reserve accounting. GE held an insurance “teach-in” earlier this year to help. That event, along with several announced and completed asset sales over the past 10 months, helped calm investors, sending GE stock higher in 2019.

The Markopolos report contains many detailed claims about several issues. But there’s one investors should focus on above all: Markopolos alleges that GE’s legacy long-term care book of business is getting worse and will require more large cash infusions to pay future insurance claims. A new cash drain would be a big problem for the iconic American manufacturer. That outcome, of course, isn’t certain, and GE characterized his charges as “meritless.”

“GE’s $38 Billion in accounting fraud amounts to over 40% of GE’s market capitalization,” Markopolos wrote, “making it far more serious than either the Enron or WorldCom accounting frauds.”

According to The Wall Street Journal, Markopolos shared the report with an unidentified hedge fund before its release and will share in any profits gained from subsequent stock movement.

Culp responded in an emailed statement: “GE will always take any allegation of financial misconduct seriously. But this is market manipulation—pure and simple. Mr. Markopolos’s report contains false statements of fact, and these claims could have been corrected if he had checked them with GE before publishing the report. The fact that he wrote a 170-page paper but never talked to company officials goes to show that he is not interested in accurate financial analysis, but solely in generating downward volatility in GE stock so that he and his undisclosed hedge fund partner can personally profit.”

Asked about his financial arrangements, Markopolos, who raised alarms about Bernie Madoff’s infamous Ponzi scheme, said: “The SEC pays [whistleblowers] slowly. I want to find financial fraud and I have to have a sponsor for my work.”

Here's what investors need to know about GE’s long-term care insurance book of business, along with some additional history.

What is long-term care insurance?

Long-term care insurance helps policyholders pay for assisted living, nursing homes, or home health care after holders demonstrate they can no longer care for themselves.

The entire U.S. insurance industry struggles with long-term care losses because health care costs grew faster than expected and more policyholders are collecting benefits than was initially expected. What’s more, interest rates have fallen substantially over the past 20 years, meaning insurance companies aren’t earning investment returns they planned for on insurance premiums collected over time.

“Those are the three vectors for loss,” RBC insurance analyst Mark Dwelle said of long-term care insurance history. “It’s fair to say the industry made some bad assumptions,”

“At least [in long-term care insurance] you don’t have surrender risk,” said Jukka Lipponen, president of Independent Insurance Analysts. “There no risk of a run on the bank.” Whole life policies, for instance, can be cashed out at different points. That isn’t the case, however, with long-term care insurance, meaning that GE only needs to worry about the premiums coming in and claims going out.

Which parts of GE does this affect?

The two entities that investors will be hearing more about are ERAC and UFILC. These are life insurance companies owned by General Electric. The companies are regulated by, and file statements with, state insurance authorities.

What’s more, GE’s long-term care business is a reinsurance business. GE’s wholly owned insurance companies, in the past, agreed to indemnify other insurance companies who sold long-term care insurance to groups and individuals. GE receives premiums and pays claims, removing the risk from another insurance company’s books.

Being a reinsurer means GE isn’t the entity asking regulators for premium price increases—the original policy sellers have to, and do, request price increases to stem losses. It also means investors can’t know full details about GE’s long-term care policies because reinsurance agreements are private arrangements, Lipponen said.

How does accounting for this kind of insurance work?

“There are two systems at work,” Dwelle said. Financial statements required by the Securities and Exchange Commission, and widely available to investors, are prepared using “generally accepted accounting principles,” or GAAP.

Insurance regulators have a different set of standards that don’t correspond to GAAP numbers. And insurance filings are difficult for investors to obtain.

How big is the problem Markopolos is alleging?

“GE has overstated net income by $10 billion,” Markopolos told Barron’s in a phone interview.

He alleged that GE has recognized about $30 billion in liabilities on insurance filings, but only $20 billion on its GAAP financial statements. Those numbers should closely approximate one another, according to Markopolos.

“The representations by Mr. Markopolos about GE’s accounting practices are simply not accurate,” said Leslie Seidman, a GE Director and former chairman of the Financial Accounting Standards Board. “The report contains numerous novel interpretations and downright mistakes about the actual accounting requirements, making his conclusions about GE’s reporting questionable at best. In his own words, [Markopolos] stands to personally financially benefit from today’s significant market reaction to his report, and he is selectively front-running widely reported regulatory processes and rigorous investigations without the benefit of any access to GE’s books and records. I urge readers to carefully consider the motivation behind this report as well as the reliability of the analysis underlying his opinions.”

So does GE need more cash to cover liabilities?

That’s something Markopolos alleges—and is the issue investors will likely focus on.

“GE needs an additional $18.5 billion,” Markopolos told Barron’s. That’s his belief after examining state insurance filings. And it’s in addition to the $15 billion GE started contributing to insurance reserves in 2018.

To arrive at that number, Markopolos and his partner John McPherson compared GE state filings to other insurers.

“That’s the difficult part,” Dwelle said, addressing statutory filings generally, not GE specifically. “A nectarine and a peach are close, but they are not the same.”

In other words, anyone looking at statutory filings can’t know all the details of reinsurance agreements.

GE has previously disclosed it expects to complete annual insurance loss recognition testing in accordance with U.S. GAAP during the third quarter. That will be something investors can look to as an update on the condition of the legacy long-term care book of business.

Write to Al Root at allen.root@dowjones.com