Pre-Need Scams

SPECIAL REPORT
Pyramid scams thrive in pre-need industry
Daxim L. Lucas and Elizabeth L. Sanchez
Inquirer News Service

(Second of a series)

SENATOR Manuel Roxas II believes that it is almost impossible to distinguish some pre-need firms like College Assurance Plan Philippines Inc. (CAP) from companies engaging in pyramid scams.

Having waged a campaign against pyramiding and "Ponzi" schemes when he was secretary of trade and industry, Roxas knows whence he speaks.

"Some pre-need firms are basically pyramid operations," said the lawmaker, who won public office on a consumer advocacy platform. "The bulk of fees paid by new subscribers are used to pay company obligations that are coming due."

In the case of CAP -- in a scheme mimicked by many industry players -- Roxas said only 10 percent of clients' subscription fees are deposited in trust funds for the first two years of the policy. These funds supposedly are managed by independent trustee banks.

Over the next five years, only 50 percent of clients' payments are deposited with the trustee banks. Everything that is not deposited as trust funds are used for the firm's operating expenses.

"Whatever isn't deposited is used to pay off maturing liabilities of the older policy holders," Roxas said. "This is using OPM [other people's money]. This is really the definition of 'kiting.'"

To remedy this situation, Roxas has filed a bill aimed at better regulating the pre-need industry and defining accounting standards that are all too loosely interpreted by companies to cook their books.

Is accounting really killing the pre-need industry?

CAP seems to think so. It has been the most vocal among pre-need firms about how the new set of rules adopted by the Securities and Exchange Commission (SEC) is hurting its business.

In its petition for rehabilitation filed with the Makati Regional Trial Court, CAP claimed that after operating its business for the past two decades, the industry found itself in a bind after the SEC suddenly changed its regulatory guidelines governing pre-need companies. This was aggravated by a regime of uncontrolled tuition fee increases brought about by government deregulation in the early 1990s.

CAP argued that the tighter accounting policies "came about after serious and manifest attempts" failed to place the pre-need industry under the jurisdiction of the Insurance Commission through legislation.

CAP claimed that what added salt to the wound was the imposition of the Pre-Need Uniform Chart of Accounts (PNUCA) in 2002 as a standard for accounting and reporting of finances and liabilities for pre-need companies.

With the PNUCA in place, pre-need educational and pension plans were no longer treated as investment contracts but as insurance contracts, subject to the Actuarial Reserve Liability (ARL) scheme.

The ARL requires pre-need firms to have reserves as of a present cut-off date to match future liabilities in all existing and lapsed plans.

CAP argued that plans do not mature simultaneously in the immediate future. It added that change of rules -- without proper notice and consultation, it claimed -- in the middle of the game made it nearly impossible for a pre-need firm to meet SEC's requirements.

Worse, CAP's dealer's license and permit to sell were suspended last year due to what it claimed was a "theoretical" trust fund deficiency that was due to the application of the PNUCA.

"It is the insurance companies that largely benefited from the strict impositions of the SEC on pre-need companies like CAP," the company said in its court filing. "Why would a genuine Filipino invention like educational pre-need be allowed to suffer or be extinguished when it has helped fulfill thousands of parents' dreams to send their children to college?"

CAP argued that the SEC should have applied the International Accounting Standards 39, which classifies pre-need education and pension products as investments. PNUCA, it claimed, was patterned after accounting rules for insurance companies.

Much ado over ARL

Much ado has been made over the Actuarial Reserve Liability, a fundamental calculation that takes a snapshot of a pre-need company's liabilities to plan holders at a given point in time.

Some pre-need firms have blamed the ARL for reflecting a supposed weakness in their ability to pay plan holders. CAP, for one, has strongly assailed the calculation, saying it is not a reliable estimate.

The ARL is the present value of projected future liabilities of a pre-need company as determined by an expert called an actuary. The estimate is based on a "discount rate" that must not exceed 80 percent of the interest rate for the longest maturing Philippine government security traded over the previous three months.

The main indicator of a pre-need company's financial health is a comparison of its trust fund versus its ARL. If the ARL is greater than the trust fund assets of a pre-need firm, it means the company does not have enough assets today to answer for the future value of its plan holder liabilities. In theory, the firm is headed toward bankruptcy.

Roberto Manabat, the Securities and Exchange Commission's general accountant, explains that pre-need companies, in their contract with plan holders, promise to pay benefits in the future.

Under present accounting practices, pre-need companies record income as they collect premiums," Manabat said. "For proper matching, the build up of the ARL should be expensed. If no ARL is recognized, the income that may ultimately be issued as dividends to stockholders will be overstated."

While some pre-need firms point out that the ARL is an unreliable estimate, Manabat said, a lot of figures in any company's financial statements are estimates and still provide the best insight to its health.