SubscribeThe Coming Death of the Insurance Industry
September 17, 2007
This is frank discussion about growing epidemic that is set to become one of this countries biggest scams. It is so monumental that it has the potential of bringing down the entire insurance industry… Seriously. If you scare easily, stop reading now. (Note: Podcast 28 has an amazing interview with Steven Leimberg on this subject, subscribe via iTunes to ensure delivery on Sept 19th)
Never before has the insurance industry faced such a cataclysmic onslaught of potential claims than they will begin to see in only a few decades from now. This is a crisis, which was set in motion by a rather innocent idea and has now turned into a greed-infested scheme. If left alone with no intervention, it will have us all looking back in 20-30 years wondering how and why we could of let this happen.
The financial media is finally picking this up as a front-page concern (Business Week Story) and we are seeing something new just recently with shares of Life Partners Holdings (LPHI) that is beginning to look rather ugly. But why is this coming to their attention just now? It is because for years now, the insurance industry has been systematically pilfered and companies are starting to worry about their future. What started out as a small crack, has now become a major crevasse. Is it will be a wonder if some of the companies will actually survive. No, No, No, not because of a hurricane or tornado. Not even from massive fires or devastating floods or the threat of global warming. Nothing natural can come close to how this is going to affect the industry. This is purely man-made.
It started with an idea from Prudential around 1988. At the time, it was innovative and extremely beneficial to policyholders. You see, back then; AIDS was causing a terrible problem as experimental treatments were very costly. When a patient’s money ran out – they had few alternatives. Prudential devised a way for those who were afflicted to sell their life policies for a substantial amount in return for assigning the death benefit back.
This was the incarnation of what was to become known as Viatical Settlements. The original plan quickly morphed into an investment scheme for many unscrupulous companies who realized that those that were in need of funds would sell their policies for almost any amount. Fair or not. Investors poured in with the promise that within a short time (as AIDS patients had limited life expectancies) they would profit by 15%-25% on their investment. Even as concern was raised about the morals of such a plan, Viatical Settlement companies were popping up in record numbers. It was on later that investors learned that this no-risk plan had many problems and their easy profit wound up turning into ugly losses.
Along the way, the greedy got rich by setting up phony guarantees and investors were fleeced of millions of dollars.
This was just the beginning. These days everyone profits from this (except the insurance industry) and it is finally becoming topic in focus. It can be said that the plan has morphed into a win-win-win-lose scheme.
Now you have a basic background and the genesis of Viatical Settlements - though they are now referred to as Life Settlements amongst the politically-correct. (Think of Stewardess/Flight Attendants and Garbage Men/Sanitation Engineers)
Today, the players are many and the scheme is gaining popularity: It did not stop there; in fact it only gets worse. Presently, the numbers are a lot bigger as the schemes get more and more crafty. These days, seniors are the ones that are selling policies to investor groups – and why not? They too are in for a piece of the profit.
Here is how a typical plan works: First, an insurance agent approaches a senior (usually 75 years old or so) and sees if they are willing to have a life insurance policy bought on their life. Often times, the insured will be required to have a net worth well in excess of $1 million as this plan works much better with higher death benefits. A company, specializing in loans for this investment plan, will advance the annual premiums for 2 years. This is important, as there is no money actually changing hands or expended from the insured to the insurance company. When the policy is issued, the insured usually retains the rights for exactly two years, until the contestable period is over.
Contestable Period Definition - Life insurance policy clause that provides a time limit (usually two years) on the insurer’s right to dispute a policy’s validity based on material misstatements made in the application.
When the loan comes due at the end of the “contestabilty period” the agreement will usually stipulate that the policy will revert ownership to the company (depending on the exact terms of the arrangement) that provided the advance on the premium (premium plus interest of 10% plus annually). This is important, as this is where the profit potential is realized - For the second time! From this point they try to sell the policy to other investors looking to profit from the death of the original insured – the third profit potential.
We could stop there and say that there are several issues that stink to high hell:
- 1) Insureds are induced to do this, as there is BIG MONEY in it for them; assuming all goes well. I have personally seen insureds receive $100,000 PLUS for simply standing in for an insurance exam and signing policy paperwork. I know of several more who received much higher “inducements”.
2) Agents stand to make huge profits as they are usually paid anywhere from 50%-70% of the first years premium on these types of policies.
3) The loans for the premium are charged at a rate significantly above market
4) The higher the death benefit, the better the plan works for all involved
a. Higher Premiums equal higher agent commissions
b. The greater the financial worth of an insured, the higher the death benefit
c. The higher the death benefit, the higher the premium resulting in the more “inducement” the insured will be paid
Here is where it gets tricky. Since there is a significant financial incentive to showing a net worth as high as possible; financial creativity is key. Valuations can be “enhanced” on real estate and businesses rather easily as can the approximated value of other assets. This is a real conflict that should be (but isn’t) taken seriously. Unfortunately, I have also seen several occasions where agents show insureds how to “optimize” these values in order to qualify for a higher death benefit. Just to be clear, this is not just a friendly exaggeration of values that one may do on the golf course. This could be deemed FRAUD.
The risk is weighed against the potential for a nice payday if the plan is approved. The usual decision is no surprise. (Picture the three monkeys with their hands over their eyes, ears and mouth)
Now, here is the reveal of how the life insurance industry is facing potential extinction if nothing is done:
As a practical matter, insurance companies build assumptions as to the percentage of policies written that will lapse into their pricing models. Since policies purchased only to be sold to investors will never lapse, insurance companies will have to pay claims much greater than they paid for. To add insult to injury, rather than paying full premiums, investors usually pay in only the minimum necessary to keep the policy going, thereby depriving the carriers of the capital necessary to invest to pay interest or dividends and cover maturing claims.
As for the insurance industry: “Be careful what you ask for; you might get it….” To be fair, the insurance industry is not without blame. They welcomed the record breaking sales and have turned a blind eye to the potential abuses in pursuit of short term profits. As one described it, “they took a bite of the poison apple; and they liked it….” Now, they’re bailing water as fast as possible to avoid the pending actuarial disaster.
The concept of life insurance was born out of a notion of public trust and common good and special tax incentives were granted as an inducement for bread winners to buy insurance to protect their widows and orphans from becoming wards of the state. While the greedy modern day robber barons will argue that it’s property and you ought to be able to do what your want with it, we can not lose sight of the fact that it’s a very special type of property and different from stocks, bonds, real estate and other commodities.
To purchase life insurance one must have an “insurable interest”- a risk of loss that would occur if the insured dies. Theoretically, one’s life and children are presumed to be better off if their husband or father stays alive. The purpose of the insurance is to replace some or all of the income the insured would have earned had he lived.
In these pre-sold, financial arrangements, it’s exactly the opposite. When outside investors are the beneficiaries, the sooner you die the better their internal rate of return. Life insurance is reduced to no more than a gambling contract which is against public policy.
With ever mounting deficits, it may only be a matter of time until congress strips life insurance of it’s favored tax treatment; thereby making it more costly for “Average Americans” to obtain the coverage they need and upholding a sadly ever-expanding phenomenon of the greedy few destroying an important family financial instrument for the masses.
Many carriers are now fighting back. Some send out investigators to interview insureds as to why they bought the insurance or what they expected would happen so they can rescind contracts. Others simply are refusing to accept collateral assignments and requests for change of ownership. Many have updated their applications to include questions that require disclosure of any financing arrangements, up front incentives or potential sales opportunities.
Even though promoters still tell prospects “not to worry about it” there’s Read more
TDI Podcast 27: The Elephant in the Room
September 15, 2007
Guest: Herb Greenberg, Marketwatch. We review the mistakes investors make and find out where Herb gets his information for researching markets. He explains tools and his methods. Herb is on the money, a great mind to listen and learn from!
What and will the Fed cut…Do We Care? Herb explains that the market is pushing the Fed decision rather than the Fed working as it normal does. He also explains the Fed’s role in the markets. (or what they should be)
Herb also provides tips on what to look for and what to stay away from when getting investment advice. Listener’s questions are answered.
Herb’ s work and writings can be found at: CNBC, Marketwatch.com , his Blog and the Saturday edition of the Wall Street Journal
Stocks Mentioned in Podcast: (FLIR) (CROX) (AAPL) (GE) (HANS) (ZUMZ)
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What do Schwab and Bernanke have in Common?
September 11, 2007
First a Question: What do Mr. Bernanke and Mr. Schwab have in common?
Answer: Both need to clean up a major mess left by their predecessors.
With that in mind, here is something seen earlier today that you do not see too often: “SCHW: $19.15, +0.24, +1.3%; moved up more than 3% to $19.50, making Schwab the biggest gainer among the S&P financial stocks.” Marketwatch had focussed attention on the financial sector/group ahead of the recent volatility into the Bernanke bailout/recession decision. It makes sense that with all of the added volatility we have seen in these markets that there would be a few names that will float to the top. Schwab (SCHW) is one that makes a good deal of investment sense if you think about it.
Sidebar: Whether or not Bernanke rescues the financial market is yet to be seen. What we do know is that he has his hands full. (I was interviewed on Marketwatch/Dow Jones Video today on this exact subject in fact - audio and video are out of synch so close your eyes when you listen). If he decides to act like his predecessor, then it is a sure thing that he will throw gobs of money at the situation in the form of rate cuts and anything else he can get his hands on. This will only exacerbate the problem and leave more of a mess for us to clean up later. If he acts more responsibly, then he will be more careful and restrained. The latter is more his style.
Back to Schwab: Even if you know nothing about the fundamentals for the company or did not have the chance to look at the charts, reports or even the price; the fact remains that you could extrapolate that excessive volatility benefits online brokers. Schwab has a double benefit; 1) they are considered an online broker and 2) one that has managed to steer clear of the mortgage mess. This is in sharp contrast to competitor E-Trade which is knee deep in the mortgage business. Schwab kept their investment philosophy clean, especially since “Chuck” took back the reigns.
In a several posts (going back 2 months), I wrote about the addition of Schwab stock to portfolios and went so far as to “push the idea” as it was clear even as far back as July that there would be a nice move for SCHW as volatility increased within the domestic equity markets. (See Survive Sinkhole and Podcast 22 )
Schwab has a mammoth profit margin of 28.5%, and ROE of 29% and a 5 year growth rate approaching 19%. Not bad, especially when you look at the competition. It is no wonder that E-Trade and Ameritrade are in serious merger discussions.
Ratios are well in-line with a PEG of 1.0 though the current P/E is showing a premium over its competitors. This is primarily because the competitors are so beaten down due their foray into mortgage market investments and investor’s current aversion to any company involved.
Where does it go from here? Schwab (the man) has always had a clear vision for Schwab (the company). His “back to basics” approach after he took back the daily control of the company has shown a leaner and more focussed business. The Post-Pottruck era for Schwab has shown Chuck’s ability to revitalize the brand and keep a sharp pencil on the bottom line. This is in sharp contrast to the poor acquisition record and sector-domination-at-any-cost attitude that was becoming a part of the corporate culture before he came back to head up a general brooming of those in management that had forgotten their roots.
He too has his hands full. Cleaning up the mess included breaking off companies that were not profitable and regaining customer trust. He is doing a great job and the company is on a great path towards continued profitability. We have a 12-month price target of $25 as Schwab should continue to benefit from the fallout over brokers with sub-prime exposure.
Note: Horowitz & Company clients hold LONG positions of SCHW.
Wall Street Journal Interview (Audio)
September 11, 2007
Late last week I was interviewed by Adam Najberg of the Wall Street Journal. He wanted to know what investors, especially affluent investors were thinking during these uncertain times. He was also looking to see what I had been recommending to clients and their portfolios. “When Markets Get Ugly”, Have a listen…
The HTC Touch
September 7, 2007
Over the past several years, there has been a significant move towards the development of the mobile handset. For some companies, it has been a rewarding venture (Apple, Nokia) while for others it has been a struggle (Motorola, Siemens, Sanyo). A few that have been quietly changing the landscape of the handset market rather unnoticed such as HTC. WHO?
HTC is the Taiwanese company that provides cutting edge smart phone technologies. It was founded in 1997 as High Tech Computer Corp. (HTC). According to their own statements: HTC designs, manufactures and markets innovative, features for Smartphone and PDA Phone devices. Since its establishment, HTC has developed strong R&D capabilities, pioneered many new designs and product innovations, and launched state-of-the-art PDA Phones and Smartphones for mobile operators and distributors in Europe, the US, and Asia. These machines are available as HTC devices and as products individually customized for operator and device partners.
Just how are they growing? Well, let’s put it this way, F A S T ! Over the past few years, revenues have accelerated due to the Microsoft partnership. This little known company has been serving up an amazing array of top shelf communication devices.
The latest breed will run the latest Windows Mobile 6, which by most reviews is going to be a major step towards real competition to the RIMM Blackberry device (RIMM) . There has been some recent talk about the potential for Microsoft to purchase RIMM . But the critics of this idea have a great point: The incompatibility of the devices will not make for an accretive transaction, unless one is simply removed from the market. That is a hard thought to believe as the RIMM has become the device of choice/need for government and enterprise businesses.
The HTC Advantage has been said to be the fastest and most powerful Windows Mobile device available. It will provide benefits of a true mobile office along with better push email technologies. (Still not as good as Blackberry Devices though)
The outlook for HTC continues to be bright as the product line up is rather amazing. The TOUCH (yes the touch) is the latest in the touch-screen line ups that has been available in Europe and Asia. The big question is what does this mean to the iPhone and Apple (AAPL)? The obvious question is: Who had the name first? As we all know by now, Apple introduced the iPod Touch this week to muted fanfare. There will surely be a backlash as the argument over name and trademarks will ensue.
In the end, the HTC partnership for Microsoft has been a breath of fresh air as they have been struggling with design issues for several years. One word sums this up: ZUNE. Never the less, with the addition of the latest HTC smartphones and the Windows Mobile 6, Microsoft should be able to maintain a decent share of this market as it is estimated that upwards of 30 new phone models will have
Several sources have estimated:
–Worldwide revenue for mobile phones is expected to total $117.5
billion in 2010, an 18% drop from 2006
– GSM phones made up 45% of worldwide mobile phone revenue in 2006,
smartphones made up 18%, and the remainder was made up by CDMA, W-CDMA, and CDMA2000 phone sales
– Worldwide revenue for the small but fast growing smartphone segment
grew 10% in 1Q07 from 4Q06, driven by the wider availability of 3G, which
unlocks the media application potential of smartphones beyond email
– In 2006, 20% of total mobile phone revenue came from North America,
34% from EMEA, 36% from Asia Pacific, and 10% from CALA
– The number of mobile subscribers grew 26% to 2.5 billion in 2006
The upshot for Microsoft is great, particularly as they gain share in the business market. With Microsoft’s profit Margin of 27.5%, ROE of 52% and a 5 yr EPS growth rate of 11.54%, it is still a company worth owning. Would we buy now? YES! Under $30 is a price that will help to bring over the next few years. Don’t expect for this to be a high-flier, rather a slow steady play.
Click for Windows Mobile - Press Conference
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