Tuesday, November 25, 2014

No. 74: Life Partners—A New Fund-Raising Scheme that Borders on Extortion

I wrote extensively in The Insurance Forum about Life Partners, Inc. (Waco, TX), an intermediary in the secondary market for life insurance and a subsidiary of Life Partners Holdings, Inc. (NASDAQ:LPHI). I also wrote about LPHI in Nos. 15, 22, 29, 30, 35, 36, 37, and 63. Here I discuss LPHI's new fund-raising scheme that apparently grew out of a desperate need for revenue and that I think borders on extortion.

The Continuing Losses
On October 15, 2014, LPHI timely filed its 10-Q report with the Securities and Exchange Commission for the fiscal quarter ended August 31, 2014, which is the second quarter of LPHI's fiscal year ending February 28, 2015. LPHI reported a net loss of a whopping $7.2 million for the quarter, compared to a net loss of $1.8 million in the corresponding quarter a year earlier. Quarterly losses over the preceding 13 quarters have consistently been under $2 million, with positive net income in only two of those quarters.

On page 11 of the 26-page 10-Q, LPHI gave a detailed discussion of its continuing legal struggle with a German bank that loaned LPHI money in exchange for an interest in some life settlements. The uncertainties associated with the litigation prompted LPHI to record an impairment to the investment value of its interest in those settlements. On page 17 of the 10-Q, LPHI mentioned the impairment in its brief explanation for the large loss in the second fiscal quarter. LPHI said:
The net loss for the Second Quarter of this year was primarily due to the recording of an impairment reserve against the value of the investment in life settlements trust of $6,648,478. Without this reserve, we would have realized a net loss, before taxes, of $838,857 for the Second Quarter of this year.
On top of the continuing losses, LPHI reported an average of slightly fewer than ten new life settlements per quarter during the 14 most recent fiscal quarters. During the most recent five quarters, LPHI reported an average of slightly fewer than four new life settlements per quarter.

Despite the continuing losses and the lack of new life settlements, LPHI has continued paying shareholder dividends. Slightly more than half the dividends go to Brian Pardo, LPHI's chief executive, who beneficially owns slightly more than half the outstanding shares. Prior to 2012, the quarterly dividends were 20 cents per share. LPHI reduced the dividend to 10 cents per share in the next five quarters, and to 5 cents per share since then. At one spot on page 21 of the 10-Q, LPHI said: "We may have to decrease our stock dividends and may make further cuts." At another spot on the same page, LPHI said: "We may reduce or eliminate the dividends for the remainder of fiscal 2015 and for 2016 to conserve working capital until we can realize improved operating results."

The New Fund-Raising Venture
On page 21 of the 10-Q, near the end of a lengthy paragraph explaining how "the operating losses we experienced in fiscal 2014 have eroded the strength of our financial condition," LPHI disclosed a new fund-raising venture. Here is the relevant sentence:
Beginning in the Third Quarter of this year we will bill our life settlement investors for policy monitoring costs in order to recover the expenses of tracking policy premium payments and maturity payouts through the life settlement process.
The First Pardo Letter
On October 14, Pardo sent a one-page letter to clients informing them of the fund-raising venture. Pardo said the company provided important ministerial functions to 23,500 clients without charge for 24 years, but the company can no longer provide those functions without charge. He said a new subsidiary, LPI Financial Services, Inc., will provide those functions "at a very reasonable cost to you."

Pardo said the "cost will be a base charge of $240 per year for each account plus an incremental monthly charge per active life settlement position" of $1.25 for one position, $1.75 for each of two positions, $2 for each of three positions, $2.25 for each of four positions, and $2.50 for each of five positions or more. He said the cost "will be billed in arrears starting with this notice." The word "arrears" means the charge will be for services performed during the past year rather than for services to be performed during the coming year.

An invoice was enclosed with the letter. For example, a client with three positions was asked to remit $312: the base charge of $240 plus a monthly charge of $72 ($2 times 3 positions times 12 months).

The Second Pardo Letter
On October 27, Pardo sent a three-page follow-up letter prompted by what probably was a large number of complaints. He apologized for not providing more details. He said the initial fee charged by Life Partners when the policies "closed" was a fee "for acquisition services." He explained in greater detail than in the first letter the "monumental administrative and technically intense task which requires a small army of full time programmers and IT experts to maintain and manage."

An Unanswered Question
The Pardo letters do not explain what would happen if a client ignores the bill. For example, clients have fractional interests, and it is not clear what would happen if some with interests in a policy pay the bill and some with interests in the same policy do not pay the bill. I asked Life Partners to address the question, but received no reply.

General Observations
The agreements that clients entered into with Life Partners did not provide for ministerial fees. Nonetheless, I think many clients will pay the bills to avoid the possibility of losing everything they invested. I think billing for ministerial fees borders on extortion.

I am offering a five-page complimentary PDF consisting of the one-page first letter, the one-page invoice, and the three-page second letter, with redactions to conceal client identity. Send an e-mail to jmbelth@gmail.com with a request for the Life Partners package.