Citron Updates Life Partners, Inc. (NASDAQ:LPHI)


The SEC Has Spoken — It’s Time for Investors to Listen

The stock of Life Partners has been under pressure lately- and for good reason.

Over the years, Citron Research has presented several stories alerting readers to anticipated government regulation or intervention into a “too good to be true” business model. Last year, we accurately warned of a government crackdown on the exaggerated marketing abuses of for-profit education at Apollo Group and Medicare reimbursement abuse at Amedisys. Both stocks are down close to 50% since our initial reports.

Yet, in Citron Research’s 9 years of publishing, we have never seen a company so clearly pinned in the crosshairs of a government launched laser-guided smart bomb – at both state and federal levels.

For those of you who missed the first couple episodes here is a brief bullet point refresher:

  • The brokered spreads between prices paid and received for their life settlement policies is enormous, far beyond industry norms.
  • Disclosure is inadequate and transparency is poor to both parties in its brokered transactions.
  • It has for years operated under a Federal safe-harbor legal ruling that Life Settlements transactions are NOT securities sales.
  • It is restricted from operating in states that hold Life Settlements legally to be securities, and facing increasing scrutiny in others.
  • To settle a fraud suit brought by the State of Colorado, Life Partners bought back all the life settlements it sold in that state.
  • The company lost a legal challenge in Florida to its claim that Life Settlements are not securities.
  • Management has a tainted past: at the CEO’s last company he was cited by the SEC for overstating revenues and profits.
  • Currently the CEO maintains his stock in a trust domiciled in the secretive tax haven nation of Gibraltar.

At that time, our opinion was that regulation of the life settlements industry would destroy the business of Life Partners. In the opinion of Citron, that day has come.

In the SEC’s own words:

Last week the SEC released a 90-page report explicating the securitization of the Life Settlement markets, and headlining its strong recommendation that Congress bring Life Settlements under the umbrella of securities regulation. This report has many references to Life Partners and appears to be a direct assault on their operations.

The report starts by stating how Life Partners has attempted to skirt regulation, quoting from their 10-K:

“Some states and the Securities and Exchange Commission have attempted to treat life settlements as securities under federal or state securities laws. We have structured our settlement transactions to reduce the risk that they would be treated as securities under state or Federal securities law, and the Federal Circuit Court for the District of Columbia has ruled that our settlement transactions are not securities under the Federal securities laws.”

An Outsourced, Unregistered Investment Sales Network that Recruits Unqualified Investors

The SEC goes on to state the importance of protecting the investor and uses Life Partners as their poster child. As it states in the report,

“Another large participant acts as a purchasing agent of life insurance policies. This participant’s customers are primarily retail investors 37 who generally buy fractional interests in one or more policies.38

The SEC points this out explicitly, in contrast to much of LPHI’s official rhetoric, which states disingenuously that the company services “institutional investors”.

LPHI’s filings with the SEC indicated that their business model was based upon sourcing capital from both retail investors and institutional investors. 2009’s 10-K indicated that approximately 10% of its business came from institutional investors. This year’s 10-K, however, reveals that the only institutional investor over the past 3 years has been a fund in which LPHI itself has made a $6.5 million investment. Thus, the company’s prior SEC filings failed to identify the conflict of interest and disclosure deficiency that existed during fiscal 2008 and 2009. Further, it failed to disclose that the related fund paid LPHI fees approximating 2.0% of face value, compared to the 10.5% of face value it charged to its less sophisticated retail investors… but that is merely a sideshow of the larger issues.

The SEC’s report was recently covered by Business Week, which reiterated the need to do away with the informal sales networks that generate retail investors for the Life Settlement business.

With a quick 10 minute Google search, Citron was able to find no less than 5 Life Partners sales agents who are all making fraudulent statements that misrepresent the risks/returns of investment in their life settlement policies. If we could do that in 10 minutes, how many will the SEC be able to uncover with subpoena power?

The Disturbing Case of SEC vs Mutual Benefits

The most compelling part of the SEC report is on page 30, wherein Life Partners is compared to Mutual Benefits. Mutual Benefits was to date the largest Life Settlement scam; 30,000 investors lost $1 billion, before the SEC brought charges.

Note that Citron is not claiming that LPHI pulled money out of escrow to pay for investor withdrawals — the classic Ponzi Scheme  gambit.  Neverless, some of the comparisons are haunting.   As stated in the SEC report:

“The SEC brought an emergency action against Mutual Benefits, charging that it promised investors fixed returns ranging from 12% to 72%, while falsely representing life expectancy figures as having been verified by an independent physician. In reality, more than 90% of Mutual Benefits’ policies had surpassed their life expectancies. In order to deal with shortfall resulting from these maturing policies, Mutual Benefits effectuated a premium payment scheme, similar to a traditional Ponzi scheme, paying premium obligations of specific investors with monies escrowed for future obligations of other investors. The SEC also charged that at least $26 million in funds collected by Mutual Benefits was misappropriated by company insiders and their relatives.”

OK, lets break that paragraph down from the SEC that refers to Mutual Benefits and lets see how it describes Life Partners.

“charging that it promised investors fixed returns ranging from 12% to 72%”

Life Partners licensees also make outrageous claims. The Colorado lawsuit noted that LPHI’s largely unregistered licensees (its representatives that solicit funds from retail investors) promised, via radio advertisements, “a 14 year average annual return of more than 16% with low risk to principal… while falsely representing life expectancy figures as having been verified by an independent physician.”

Just like Mutual Benefits, Life Partners also does not use an independent party to prepare life expectancies. The in-house LE is not common practice in the industry and nowhere have we seen this disclosed in any of LPHI marketing material.

“In reality, more than 90% of Mutual Benefits’ policies had surpassed their life expectancies”

Statistics on LPHI’s policies indicate that 76% of insureds are living longer than the company’s recorded Life Expectancy.

“In order to deal with shortfall resulting from these maturing policies, Mutual Benefits effectuated a premium payment scheme … paying premium obligations of specific investors with monies escrowed for future obligations of other investors”

According to the LPHI 10-K: “We make advances on policy premiums to maintain certain policies.” They have also gotten into the business of buying some of the policies. Imagine if Countrywide had funded defaulted mortgages out of profits just to make its disclosed default rates look healthier.

LPHI Chart

This chart shows that that LPHI has originated over 75% of all its life settlements in the past four years. Most of the current premium advances appear to be servicing policies that were sold to investors prior to 1998.

The Story in the Numbers:

Last year Life Partners reached an agreement with the State of Colorado to settle fraud charges. As part of the settlement, they agreed to buy back all of the policies written to Colorado investors. These policies can now be analyzed for performance, revealing a dirty little secret about Life Partners’ track record.

For those of you who are number junkies, here is a brief analysis of what we now know of Life Partners current financial health and trends that we finally can analyze in the “post Colorado” settlement. The numbers are staggering and speak for themselves. We welcome you to do your own homework.

Analysis of LHIP Fee Structure from Financial Filings Data

Fiscal 2007 Fiscal 2008 Fiscal 2009 Fiscal 2010 Q1 2011
Number of Settlements 220 200 196 201 38
Face Value of Policies 151,397,000 415,293,000 693,715,000 590,189,000 99,544,266
Average Revenue Per Settlement 135,433 363,046 528,645 562,171 703,060
Net Revenues Derived 12,231,000 36,822,734 54,420,577 62,019,160 15,047,257

Per Settlement Statistics (Calculated from Above)

Fiscal 2007 Fiscal 2008 Fiscal 2009 Fiscal 2010 Q1 2011
Average Face Value Per Settlement 688,168 2,076,465 3,539,362 2,936,264 2,619,586
Total Fees 135,433 363,046 528,645 562,171 703,060
Percentage of Total Face Value 19.7% 17.5% 14.9% 19.1% 26.8%
Fee Split Breakout
55,595 184,114 277,656 308,553 395,980
Percentage of Total Face Value (LPHI)
8.1% 8.9% 7.8% 10.5% 15.1%
Others (Selling Broker, LPHI Licensees)
79,838 178,932 250,989 253,618 307,080
Percentage of Total Face Value (Others)
11.6% 8.6% 7.1% 8.6% 11.7%

Life Partners’ business model only worked in an unregulated world, where they could freely match unsophisticated buyers with policy sellers purposely left in the dark about price transparency. This is precisely why markets are regulated – efficient markets need a level playing field and a fair referee to prevent brokers from gouging the transacting parties. Its main tools are to enforce transparency of price discovery and competitive fees.

Now, in the sunsetting phase of its business model, as the number of unregulated transaction candidates dries up, its financial statements reveal that LPHI is being forced to close fewer transactions, of larger face value, and carve out for itself an ever larger share of the transaction fees. These fees are now nearly equivalent to the value paid to the seller of the policies – an absurdly high value.

Meanwhile, it must “pay the piper” — out of current profits — for its mounting legacy of overly-optimistic life expectancy estimates on its portfolio holdings policies.

We credit Life Partners for being an early mover in the Life Settlement business. For years they have been able to take advantage of a non-regulated market and set the rules for their own advantage.

However, that advantage, cashiered at the expense of their customers, has not created a sustainable business model or a fungible asset base in a regulated market. Once regulation forces full disclosure for investors, unsophisticated retail investors are excluded and sellers get a fair market, and margins will collapse as investment banking firms enter the market. Citron believes LPHI’s cash flow is doomed.

All good things must come to an end. It is now apparent more than ever that the epitaph will be written with SEC letterhead.