Earlier this month, General Electric (GE -1.36%) filed its annual report with the SEC. While many investors ignore big SEC filings, due to their length and complexity, they often contain important tidbits -- if you dig far enough. GE's 2021 annual report had two pieces of very good news for shareholders. Let's take a look.
Pension deficit shrinks dramatically
The first piece of encouraging news was a sharp drop in GE's pension deficit. Five years ago, the industrial conglomerate's pension deficit stood near $31 billion. By the end of 2020, GE had whittled that down to $20.6 billion, mainly due to company contributions to the pension plans and freezing pension benefit accruals for many participants.
During 2021, rising interest rates reduced GE's gross pension obligations. Meanwhile, its main pension plan posted a solid 9.7% return last year. As a result, the pension deficit shrank by nearly $10 billion, ending the year at $11.1 billion. That's even better than the estimate of $12 billion that management provided in January.
Most of the remaining pension deficit relates to plans that operate on a pay-as-you-go basis, like GE's supplementary pension plan for higher-level executives. On average, the plans subject to regulatory funding requirements are now over 98% funded under GAAP standards.
In short, whereas GE's pension deficit seemed like a major threat to the company a few years ago, it now seems very manageable. Moreover, interest rates have continued to rise in 2022. If that trend holds through year-end, it could drive further improvement in GE's pension deficit. (Higher interest rates reduce the present value of future payments to retirees.)
GE's insurance operations are looking better
In another good sign for investors, the performance of General Electric's insurance business seems to have stabilized. Four years ago, GE announced that it would take a $6.2 billion charge and contribute nearly $15 billion to its insurance reserves over seven years due to rising losses in its long-term care reinsurance portfolio. Since then, many investors have been on edge, worried that this non-core unit's losses could worsen.
Instead, GE's claims experience has been a little better than projected. As of the company's most recent premium deficiency test (completed in the third quarter of 2021), GE had a positive margin of 11% of its future policy benefit reserves. In effect, that means it now has a little breathing room for things to go wrong without triggering another earnings charge.
Image source: General Electric.
Additionally, the number of covered lives for GE's long-term care reinsurance business has fallen 8% over the past two years, from approximately 328,000 to 301,600. If anything, these declines could accelerate, as the average policyholder age now stands at 78. Thus, the inherent risk of GE's long-term care portfolio is decreasing every year.
Most investors think of the insurance business mainly as a source of risk for GE, but it actually posted profits in 2020 and 2021. In the long run, GE's insurance operations could have significant value to the company, particularly as the less predictable long-term care liabilities run off.
Downside risk is moderating
General Electric certainly has more work ahead of it to finish fixing its less successful business units and split itself into three public companies. Just this week, the company warned that supply chain problems will continue to put pressure on its financial results in the first half of 2022.
However, GE's annual report shows that its biggest sources of balance sheet risk are fading quickly. It now seems highly unlikely that General Electric's pension obligations or insurance liabilities will bring the company down. That means investors can afford to be patient. As the current supply chain constraints ease and management finalizes the separation into three companies over the next few years, GE stock could leap higher.
