Life Partners (LPHI) is a company reporting current success but likely heading towards inevitable failure. Life Partners had a track record of failure from 1991 to 2004, accumulating a loss of $4.9 million as a small, viatical settlement provider. A viatical settlement refers to the purchase of death benefits from the holder of an insurance policy who is terminally ill with a life expectancy of less than 2 years. Life Partners played the role of middleman, purchasing the viatical settlements on behalf of investors for a fee. Life Partners continues to suffer additional losses from the viatical settlements it faciliated prior to 2004, due to lawsuits that continue to be filed against it, and resulting from Life Partners being forced to buy back many of those viaticals.
Life Partners will likely be inevitably forced to report the same results with its life settlements business. As the viatical business dried up, Life Partners entered the life settlement business in 2005. Life settlements are similar to viaticals, except they involve purchasing the death benefits of policyholders who are not terminally ill and are expected to live longer than 2 years. Since entering this business, Life Partners has grown rapidly and has done far more business in the last two years than it has done in all its previous years combined. Life Partners facilitated purchases of policies with face values totaling over $1 billion in the past two year, with $415 million facilitated in 2008 and $693 million in 2009. This is incredible growth over previous years in which Life Partners facilitated purchase of $65 million in 2005, $87 million in 2006, and $151 million in 2007.
However, Life Partners’ growth has not been fueled by investment from the most desirable and expected source, institutional investors, who have both the means and sophistication necessary to purchase life settlements. Institutional investors accounted for a paltry 1% of the purchases in 2009 and even those purchases were made by only 1 institutional investor, who was partially funded by Life Partners. Life Partners did not fare any better with foreign investors, who responsible for only 1% of purchases.
Instead, Life Partners has fueled its growth by luring individual investors, who made 99% of the purchases, through a multi-level marketing scheme of financial investors who misrepresent life settlements as high return/low risk investments and fail to disclose the excessive fees taken by Life Partners and other important information. These individual, retail investors made 99% of the purchases facilitated by Life Partners in 2009. Life Partners pays financial advisors anywhere from approximately 4% to over 6% of the purchase price of a policy for each transaction. Additionally, financial advisors can receive a percentage of the investments obtained by other financial advisors they recruit, down to 5 levels deep. For example, financial advisor 1 can recruit another person, financial advisor 2, to find investors and receive a percentage of financial advisor 2’s transactions. If financial advisor 2 finds another advisor, financial advisor 3, then financial advisor 1 can be paid a percentage of financial advisor 3’s transactions. This occurs 5 levels deep, down to financial advisor 6.
Life Partners Misrepresents Past and Future Returns as High, in the 15% Range and Its Excessive Fees Make Such Returns Appear Impossible
LIfe Partners misrepresents returns as high, in the 15 % range, both historically since 1991 and as estimates of future returns for individual policies it is trying to sell. This is likely a gross exaggeration for numerous reasons. Historically, Life Partners is misrepresenting returns because it is reporting returns for a period of time where most of the policies have not yet matured. Until these policies mature, one cannot know the returns for that time period. Furthermore, the policies that have not yet matured, for which one is having to continue to pay premiums, are likely to provide lower returns, or even substantial losses, which would reduce the represented historical returns substantially. For example, Life Partners is still paying premiums for old viatical settlements which have not yet matured and for which the returns are more likely to be substantial losses than substantial returns.
Regarding estimated future returns for individual policies, Life Partners fees are so excessive that it is likely that the estimated returns are exaggerated and Life Partners appears to be providing unrealistically short life expectancies to provide these exaggerated estimates of returns. In an effort to hide its excessive fees, Life Partners refuses to disclose to investors the fees that it charges. However, these fees can be estimated through calculations made from a combination of data taken from Life Partners’ annual reports and information from a small sampling of approximately 20 individual purchases in 2009. From this sample, Life Partners’ appeared to charge investors an incredible amount in fees, adding up to an average of approximately 136% of the purchase price for these policies. These fees may have increased because Life Partners reported increasing its fees from about 17% of the face value of polices in 2009 to 26% of the face value of policies in the 1st quarter of 2010. These fee is shared with the brokers who are supposed to represent the sellers of the policy and the financial advisors who are supposed to represent the purchasers.
Life Partners appears to misrepresent the estimated future returns by providing unrealistically short estimates of the insureds’ life expectancy. Future returns depend on the purchase price, the amount of the death benefit, and the date the payout will be made, which is when the insured expires. When estimating a future return, Life Partners knows the purchase price and knows the amount the policy will payout but does not know when the insured will die and a payout will occur. Therefore, Life Partners makes an estimate of insureds’ life expectancy. A review of a small sample of policies shows that Life Partners estimated a life expectancy of only about 5 years on average for insureds averaging about 78 years of age with medical records appearing rather ordinary. Compare this to IRS life expectancy charts that give 78 years olds approximately 10 years to live, about twice the time that Life Partners’ estimates. Furthermore, Life Partners makes no adjustment for the chances that there will be no payout for a policy due to a life insurance company challenging its validity or other circumstances.
Without the data, it is very difficult to provide any estimate of the returns to investors with any precision. However, it is difficult to believe that investors will average returns above a couple of percentage points at best. In fact, there is reason to believe that investors may average losses, rather than gains. Generally, some of these reasons include the extraordinarily high fees that Life Partners charges, which reduces the potential return to investors, and the risk insurers will deny payment and challenge the validity of the policies in some cases. This conclusion is supported by the large number of policies that Life Partners has been forced to repurchase an interest in, almost 1000, due to lawsuits and unhappy investors, and the increasing number of lawsuits by insurance companies challenging the validity of the policies. Comparing the number of policies in which Life Partners has repurcashed an interest, 1000, with the total number of policies sold by Life Partners in the past 5 years, 1200, and it is difficult to foresee future success by Life Partners.
Life Partners Misrepresents Life Settlements as Low Risk
LIfe Partners also falsely advertises the life settlements as almost riskless, when they are very risky. The risks range from challenges to the validity of the policy or its transfer that may result in a complete loss for investors to short term fluctuations in price that afflict any asset.
The biggest risk to an investor in a life settlement is that the policy or its purchase is declared invalid and the investor suffers a total loss, including incurring attorneys’ fees for litigation. There are hundreds of lawsuits, and probably thousands, where the policies and/or transfers have been challenged by insurance companies and/or original beneficiaries. These lawsuits have substantially increased in recent years.
Insurance companies have been increasingly denying payment and challenging the validity of stranger oriented policies, known as STOLIs. STOLIs are policies where an elderly person is paid to acquire a life insurance policy just for the purpose of selling the death benefits. States have passed legislation and Court have held that these policies are not valid, concluding that the purchaser lacks the required insurable interest due to the policy being purchased solely for resale and not for actual insurance purposes.
Life Partners may be selling a large number of STOLI policies, as the policies they are selling demonstrate similar characteristics to STOLIs. STOLIs typically are larger policies taken out by elderly people that are resold not much longer than 2 years after being taken out. A small sample of policies sold by Life Partners in 2009 demonstrates these characteristics as most of the policies were taken out recently in 2005 or 2006, were taken out by older people in their 70s and 80s, and are larger policies over $1 million. STOLIs may explain why the average face value of each policy sold by Life Partners has increased greatly in the last few years. Life Partners growth has been due to the increase in the face value of the policies sold, and not to any increase in the number of policies sold.
Another major risk with policies sold by Life Partners is that a total loss will be suffered because the policy expires due to the failure to pay premiums. LIfe Partners sells fractional interests in policies, frequently with more than 40 co-owners of the death benefits. LIfe Partners also collects several years of premiums in advance. However, when the premiums run out, all of the co-owners must pay their portion of the premiums that are due. If any part of the premium is not paid, the life insurance company can cancel the policy. There is a substantial risk that co-owners will not pay their portion of the premiums that come due, resulting in a cancellation of the policy and a total loss.
Another major risk is that the insured lives much longer than estimated, which can result in low returns or even substantial losses. This risk can be increased in 3 ways. First, as discussed above, a life settlements provider may just underestimate life expectancies. Second, medical breakthroughs may unexpectedly increase life expectancies. Imagine if cures for cancer and heart disease are discovered in the near future, it would not bode well for returns from life settlements.
A third factor is the number of policies purchased at one time. The risk is at the highest when a single policy is sold, as the length of time a single person may live can vary greatly from estimates of their life expectancy. By pooling a large number of policies together, a life settlement provider can reduce the risk that the average time lived will vary much from the estimated life expectancy. Industry experts estimate that one should pool a minimum of 300 to 500 policies together to reduce this risk. However, Life Partners sells interests in single policies to individual, retail investors, whereas responsible life settlement providers sell interests in a pool a large number of policies.
Finally, Life Partners also makes the highly misleading representation that life settlements are not subject to market risk. It is doubtful that most investors even understand this ephemeral concept (investors like Warren Buffet and Charlie Munger don’t think the concept even makes any sense) and assume it means that the investment has no risk. Generally, market risk refers to the correlation of movements in the price of an asset with the average price movements in the entire market. There is no reason to think that an investor who attempts to sell a life settlement will not find an offering price subject to swings due to the vicissitudes of the market. Indeed, life settlements have suffered quite a drop in value the last several years. Since life settlements are highly illiquid, they can be subject to large swings in market value and, arguably subject to a greater degree of market risk than many other investments. Indeed, life settlement investors may wish for market risk as life settlements are relatively illiquid and difficult to sell. Recently, an investor was told that he get could only about 80 cents on the dollar to sell his interests and there is reason to believe that this estimate was quite optimistic.
Investors are Not Given Important Information to Evaluate the Investment and are Given Unfavorable Terms in Addition to Excessive Fees
Life Partners does not give investors important information that they need to evaluate the purchase of a life settlement. Investors are not given a copy of the life insurance policy, which should be examined for any additional, unexpected terms that may be unfavorable. Investors are not provided with the medical records of the insured, but only a very short summary of the medical condition provided by Life Partners. Investors are not provided with any analysis of how the life expectancy estimate was arrived at, and only one estimate is given despite most institutional investors requiring two or three estimates as standard practice. Investors are not provided the identity or contact information of the insured, other than a last name.
Life Partners collects from individual investors in advance the money for premiums that are due over the next several years, often collecting in advance 5 years of premiums. The investor loses not only the use of the funds, but also loses the interest that this money collects until it is used to pay the premiums. With little justification, Life Partners includes a provision that it is entitled to receive all of the interest that accumulates on the monies collected from investors in advance for premiums due in the future.
It also appears that when Life Partners collects for premiums, it will frequently collect monies from investors to reimburse itself for premiums that it has paid in the past to keep the policies current. For example, Life Partners might collect for 5 years of premiums from an investor at the time of purchase. However, only money covering three years of premiums will be used to pay future premiums. The money covering the remaining two years will be for premiums that were previously due and paid. There appears to be little basis for having investors pay Life Partners for premiums that have already been paid. This treatment does not occur on every policy, but appears to vary from policy to policy.
Life Partners Will Likely Fold As the Majority of Its Policies, Which It Sold in the Last Two Years, Pass the LIfe Expectancy Estimates Without Payouts and Require Additional Premiums
Life Partners will likely not be able to survive much past 2013 or 2104. The vast majority of transactions facilitated by Life Partners occurred in 2008 and 2009 and it appears that the life expectancies for these policies average about 5 years. Thus, in 2013 and 2014, additional premiums will likely need to be paid by investors as many of the insured will probably exceed the estimated life expectancies. Many of the investors will likely not want to pay the additional premiums need to keep the policies in effect, thereby resulting in a lapse in policies not only for those investors but also for all the other owners of that policy who have a fractional interest. The sums necessary for Life Partners to step in and pay the premiums to keep the policies in effect will likely become impracticably large.
The negative effects for Life Partners will likely snowball. The lawsuits, including class actions, from unhappy investors will likely spiral. Local, state and federal governments will likely become increasingly involved to both assert investors’ rights and to protect them going forward. The sums required for Life Partners to repurchase policies from unhappy investors, which may include attorneys’ fees and interest, will likely be too large for Life Partners to pay. The result is that Life Partners will likely be forced into bankruptcy.
These forces are already at work, subjecting Life Partners to stricter standards and requiring it to disclose its fees and other information, which will result in its fees being reduced substantially and its business deteriorating. States are increasingly passing regulation, such that 45 states now regulate life settlements, up from a small fraction in previous years. At the federal level, the SEC and the General Office of Accounting have recently prepared reports recommending that life settlement be declared securities and calling for increasing the regulation of life settlements. The reports appear to be targeted, in part, directly at Life Partners.
LIfe Partners has already been sued by numerous parties including sellers of policies seeking to rescind the sales; life insurance companies denying payments and seeking to void policies; investors both individually and on behalf of classes seeking damages for fraudulent sales; states such as Texas, Colorado, Utah, California, and Florida; and even the SEC. While Life Partners was initially successful in the SEC lawsuit when the court found the life settlements not to be securities, subsequent lawsuits by states have increasingly found life settlements to be securities, resulting in penalties and bans against Life Partners.
Life Partners has been quieting unhappy investors and resolving lawsuits by repurchasing interests in life settlements from investors. To date, Life Partners has repurchased interests in nearly 1000 settlements. This number is incredibly high, given that Life Partners only facilitated the sale of approximately 1200 life settlements in the past 5 years. In one lawsuit along brought by Colorado, Life Partners was forced to repurchase interests in 542 policies and required to pay attorneys’ fees and interest.
The trend of the maturities of these policies that Life Partners now involuntarily holds on its books is not favorable. Already, 74% of these policies are past the estimated life expectancies, requiring Life Partners to pay the premiums to keep the policies in effect. As times goes by, the number of policies that are past the life expectancies are likely to increase. At the same time, Life Partners will likely continue to have to repurchase interests in policies as a result of unhappy investors and lawsuits against it.
The multi-level marketing scheme of obtaining sales through financial advisors is also not sustainable. These financial advisors have increasingly become the target of lawsuits by states and individuals, as a result of claims that they have breached the duties to investors that they advise. As life expectancies are exceeded, unhappy investors are likely to retaliate against financial advisors for their poor advice with both threats of litigation and actual litigation. Advisors may either be dissuaded from continuing to advise the purchase of life settlements or may be driven out of business.
Even absent these dire consequences, Life Partners business would likely deteriorate due to the reduction of their fees over time. Excessive fees by middleman are never sustainable and are often squeezed to the minimum. An example is the fees for trading stocks, which have continued to be reduced overtime. An exchange that allows trading over the internet, similar to the ones that have been developed for stocks, has recently been created.
Life Partners has probably reached the peak of its performance and will likely deteriorate and disappear over time. LIfe Partners will not be able to continue to take advantage of investors by charging high fees which it refuses to disclose, keeping the interest on monies collected in advance for premiums, keeping information pertinent to evaluating life settlements frm investors, and relying on financial advisors to persuade investors through false advertising. As returns fail to match those advertised and as additional premiums are needed to keep policies in effect, governmental authorities will increasingly step in to both pursue and protect investors’ interests and lawsuits by investors will likely increase both against Life Partners and the financial advisors they paid to lure those investors. As a result, LIfe Partners will be forced to reduce its fees to a reasonable level and will be liable to investors both for failing to comply with securities laws and for fraud and misrepresentations in its advertising. The reduction in fees will cause Life Partners’ net income to reduce and likely go negative. The liabilities will be so substantial that, combined with the adverse impact to Life Partners’ ongoing business, they will cause Life Partners to have difficulty staying out of bankruptcy past 2015.
Disclosure: Short Life Partners