Texas-based Life Partner Holdings Inc., one of the industry leaders in the secondary life insurance market, along with several of its senior executives, is facing charges of improper accounting, disclosure violations, and insider trading in a complaint recently filed by the Securities and Exchange Commission in federal court in Waco, Texas. The SEC alleges that the fraud, dating back to 2006, artificially inflated the company’s revenues and profit margins and misled shareholders about the sustainability of the company’s financials as well as the “consumer demand for the life settlement investments that the Company brokers.”
Life Partners is a publicly traded company listed on the Nasdaq Stock Market and topped Fortune magazine’s 2009 list of fastest-growing small companies in the United States. According to Life Partners’ website, a “life settlement is simply the sale of an existing life insurance policy by a terminally ill or elderly person to another party. The price of the policy is negotiated and sold by the owner at a discount to the face amount. The purchaser then collects the full amount paid out under the policy.” According to the SEC, in a typical life settlement transaction, Life Partners identified “a number of investors who purchase fractional interests in a given policy. Included in the purchase price that investors pay are funds sufficient to cover future premium payments necessary to maintain the policy during the insured’s estimated life expectancy” which is placed into an escrow account. This unique investment market nearly doubled between 2006 and 2007, yet was significantly weakened by the general economic downturn in 2009.
Criticism of Life Partners and the secondary life insurance market is not new. Critics decry the market as effectively “betting on death.” The market is also virtually unregulated, which can lead to the potential for abuse of both policy sellers and buyers. For example, insurance companies have vigorously prosecuted individuals who were alleged to have purchased life insurance policies solely for the purpose of selling them on the secondary market, the third parties who brokered the transactions, and even the good faith third party purchasers, seeking to void those policies. Furthermore, without regulation, elderly or terminally ill policy holders may be pressured into selling their policies for woefully low prices while buyers may be duped into paying too much for policies based upon inflated valuations.
In December 2010, alleged problems with Life Partners’ life-expectancy estimates were explored in a front page article in The Wall Street Journal. In its examination of policies Life Partners brokered in 2002, the Journal found that 95% of the insured people were still living after the life-expectancy period estimated by Life Partners’ physician. As a result, the Journal reported, owners of those policies weren’t likely to enjoy the 10% to 15% annual returns promised by Life Partners.
Similar to the Wall Street Journal exposé, the SEC alleges that Life Partners, and specifically its chairman and CEO, general counsel and chief financial officer “misled shareholders by failing to disclose a significant risk to Life Partners’ business: the company was systematically and materially underestimating the life expectancy estimates it used to price transactions.” Life expectancy estimates are a critical factor in the life settlement transaction and “in determining the purchase price that investors are willing to pay” because the longer an insured’s life expectancy, the more investors will have to pay in premiums to keep the policies in good standing. As the SEC explained in its complaint, investors “will pay more to acquire life settlements that have shorter life expectancies, as they receive their fractional interest in the death benefit sooner, and the anticipated period of time during which they have to make premium payments to maintain the policy is shorter.” As a result, by underestimating life expectancies, Life Partners was able to artificially inflate the prices that investors were willing to pay for the policies.
“Life Partners duped its shareholders by employing an unqualified medical doctor to assign baseless life expectancy estimates to the underlying insurance policies,” said Robert Khuzami, Director of the SEC’s Division of Enforcement. “This deception misled shareholders into thinking that the company’s revenue model was sustainable when in fact it was illusory.”
Life Partners and its officers are emphatically denying the SEC’s allegations. Life Partners’ Chairman, Brian Pardo, who was named in the SEC’s complaint, stated, “It is very disappointing that the SEC has chosen to pursue litigation over issues that we believe have no merit and financial presentation issues that we do not believe are material. We have always done our best to deliver value to our shareholders and to run an honest and transparent company. We intend to vigorously defend ourselves against these meritless claims.”
