Not often that a change in actuarial tables helps drive a $100 million fraud, but that’s the allegation in a lawsuit filed last month in Manhattan.
The plaintiff: Concord Management Fund, which lost millions in a quirky plan to sell life insurance policies to wealthy people. The quirk: Policyholders could turn a profit without making an initial investment.
When that plan didn’t work, Concord alleges, Fifth Third Bank, Bank of America, and Ira Brody – a prominent Tennessee politician who almost became state treasurer – conspired to hide the truth in what the plaintiffs call a “shocking scheme involving fraud, forgery and bribery in which a renegade group of executives in Concord . . . looted the assets of Concord.”
It’s a complex case that really has two parts. The first part is a dubious but legal scheme to make money by lending wealthy people money to turn a profit in life settlements, an insurance-related transaction I’ll describe in a bit. The second part is really just garden variety large-scale fraud, at least according to Concord’s accusations.
Before going further, though, there are three important finance terms that you have to know:
- Face value is the amount a life policy will pay upon death. If you take out a policy today with $100,000 face value and die tomorrow, your heirs get $100,000.
- Cash value is the amount an insurance company will pay you if you decide to turn in your policy before you die. For the classic term policy, this amount is zero. But for whole life insurance, for example, you pay a higher premium, and the extra money gets invested. If you turn in the policy, that extra money, plus interest gets returned to you. The extra money plus interest is the cash value.
- Market value is the amount you could get for a policy in the open market, an actuarial present value, if you will. There are companies that will buy your policy from you. When you die, they collect.
Now sometimes you can get more selling your policy on the open market than you could collect from the insurance company in cash value. Suppose you have a $100,000 policy and the cash value is $10,000. Further suppose there’s a 50% chance you’ll die tomorrow. That policy has a market value of a little less than $50,000. Instead of turning your policy in, you would be about $40,000 better off selling your policy on the open market.
The buyer of your policy would be a life settlement company. A company could buy your policy and similar policies from 99 people like you, and pay something less than $5 million. When 50 of the 100 die, the company will collect $100,000 for each of those people. It will pocket $5 million. The difference between what it paid and what it collected is profit.
Life settlement companies have been around since early in the age of AIDS. Gay single men were dying with insurance policies but without heirs. Worse, they were going broke because the cocktail of effective drugs was really expensive. These companies would buy the policies, which helped pay for the drugs, which prolonged the victim’s life. The life settlement company would profit in the way I just described.
They are legitimate businesses; they even hire actuaries to help ensure they are valuing policies properly.
The fraud involves two banks, a tangle of investment companies and Concord. Concord is a premium finance company. These companies lend money to people who want to buy insurance. As collateral, the borrower pledges the cash value of the policy. If that’s not enough to cover the loan (it rarely is), the borrower obtains a letter of credit for the difference and assigns it to the premium finance company.
Notice that it’s the cash value of the policy that acts as collateral, not the market value. And that’s where – finally! – we can begin our first part of the story. (Don’t worry – from here it’s pretty easy to follow.)
In 2007, Concord and Fifth Third Bank concocted a product called Unity, targeted at the rich. The idea was a customer could turn a profit on a couple of insurance transactions without investing a cent. Here’s how:
- A customer borrowed cash from Fifth Third to buy an insurance policy. No payments were due on the loan for several years. Concord handled the paperwork.
- Instead of accepting the cash value of the policy as collateral, Concord accepted the market value of the policy. The market value would have to exceed the entire amount of the loan. Then the customer wouldn’t need a letter of credit.
- When the loan came due, the customer sold the policy on the open market. With the proceeds, he paid off the loan. What was left was the customer’s profit.
Behind this was a complex series of transactions. Here’s what you need to know about them:
- Concord and Fifth Third made money off fees. (The lawsuit maintains Concord’s fees were funneled to ‘renegade’ executives.)
- Bank of America supervised trusts needed to complete the transaction. It was responsible for preventing fraud and ensuring that underwriting standards were met.
- Fifth Third made the loan, but Concord guaranteed it. So Concord – not the bank – took on the loan risk.
In all, it’s not a terrible idea. You have to be able to find customers who don’t have long to live – the product sought people with future life expectancy between 2½ and 12 years. Longer than that, and the market value of the policy would be less than the loan.
The product launched in September 2007, but it didn’t sell.
After five months only 10 loans were made, and seven of those were refinancing of existing policies.The lawsuit says the product was larded down with fees, fees so high that no one selling the product seemed to care whether the loan got paid off.
One loan was for $1.86 million. $140,000 covered the premium and $1.7 went to fees.
So the target customer – a rich person likely in the last decade of life – wouldn’t buy this newfangled product. He preferred traditionally structured life insurance. So brokers only steered less desirable customers to the Concord product.
Then, in words you probably thought you’d never read, the actuarial tables dealt a stinging blow.
In March, the Society of Actuaries released a new set of life tables, VBT 2008. [VBT stands for Valuation Basic Table.] These tables had lower mortality rates at most ages – they implied that people would live longer.
This was bad news for the Concord product. It depended on the market value of a life insurance policy, but if people are going to live longer than previously thought, that means the average death benefit would be paid later. And the longer you have to wait for the money, the less the policy is worth in the open market.
So a product that didn’t have much of a following made even less sense.
At this point, the lawsuit alleges, a group of Concord insiders turned to fraud. Allegations include:
- Concord abandoned its underwriting standards. In December 2008, for example, the company approved 21 loans, with underwriting standards waived on all 21. Standards for minimum net worth, life expectancy requirement and the minimum age were waived. In all, $80 million in fraudulent loans were approved, according to court documents.
- The policies themselves were overvalued. Sometimes discount rates were too low. Other times the valuation would use the old 2001 actuarial table. Some policies were valued several times by different companies, and Concord management cherry-picked the best quote in its support for the loan.
- The company’s top management forged documents to keep the flow of loans going, photoshopping insureds’ signatures onto new documents.
- Management misappropriated company assests to pay for private school tuition, trips to Disney land, limousines, sports tickets and jewelry.
- People who got wise were paid off spa retreats, vacations to Miami and Vegas, electronics and sports equipment.
The scam unraveled, according to the lawsuit, in late 2008. One of the supposed ringleaders, Ira Brody, resigned to pursue an appointment to be treasurer of the state of Tennessee. (He didn’t get it.)
Shortly thereafter, he requested $2 million in bogus fees, according to the lawsuit. Bank of America, as trustee, got suspicious (finally, the lawsuit seems to imply) and turned the request over to Concord’s legal team, which apparently did not know of the scam.
The plaintiffs, outside investors in Concord, seek $70 million in damages from Brody and Fifth Third Bank for perpetrating the fraud, and from Bank of America for failing its fiduciary responsibility to ferret out the fraud. $250 million in damages are also sought.