Dreams Down the Drain
PhilippineBusiness.com.ph
Volume 12 No. 6 – Industry
Uncovering the roots of the pre-need industry mess
By Shiela F. Camingue
 |
| Scores of students face the prospect of having to discontinue their schooling after several pre-need firms filed for rehabilitation or liquidation |
Some one million planholders of financially distressed pre-need firms are in danger of not being able to continue their schooling in the future due to delays or nonpayment of their tuition fees. Since last year, at least three firms have filed for rehabilitation or liquidation and nine others have been placed on the Security and Exchange Commission’s watch list of likely troubled firms.
Ever since the problems of the first pre-need firm to file for rehabilitation became public, the industry’s performance has been on a downtrend. The succeeding series of pre-need failures has sent the entire industry and planholders into a panic, causing sales to drop by almost 50% in the first four months of 2005. Enraged planholders are blaming the distressed companies and asking them to pay their contractual obligations, but the management and officers of cash-strapped pre-need firms are claiming their collapse was due to forces beyond their control. The SEC, the industry’s watchdog, is being widely criticized for failing to see the impending crisis, and proposals have already been made to transfer the supervision of pre-need firms to the Insurance Commission. Legislators have vowed to formulate reforms that will regulate the pre-need industry and assist victims of pre-need company failures and collapses, but to date, no concrete action has been finalized to aid the affected planholders.
|
||||||||||||||||||||||||||||||||||||||||
How did the pre-need industry end up in such a sorry state?
“It’s Not Us”
Planholders of troubled pre-need companies are crying mismanagement, accusing the firms of misappropriating funds. The companies, in turn, are pointing their fingers to a host of financial and legal factors as the real culprits. They claim certain aspects of the business were beyond their control, causing their financial obligations to grow out of proportion.
Pacific Plans, for instance, traces its problems to runaway tuition that was the result of the partial deregulation of tuition fee increases in 1990. It said that when full deregulation came in 1994, schools responded right away and raised fees by as much as 36% in schoolyear 1995–96 alone. This put tremendous pressure on the firm’s traditional or open-ended plans and its trust fund. Since it could not pass on the addi-tional cost to its planholders, Pacific Plans opted to file for company rehabilitation. College Assurance Plan, on the other hand, blames stringent SEC circulars as the cause of its trust fund deficiency. CAP argues that the SEC is requiring companies to maintain high reserves and follow new actuarial rules that do not apply to the pre-need industry.
Ailing firms also attribute the mess they are in to the financial crisis in 1997, which affected currencies, stock markets, and other asset prices of several Asian countries, and to a host of other financial and economic factors that affected company sales and revenues. Many people believe, however, that the root of the problem is the nature of the plan itself.
Runaway Tuition
Pacific Plans started selling open-ended educational plans in 1986. At that time, the government capped tuition fee increases by no more than 10% per year, allowing all pre-need companies to predict precisely how much they needed each year to meet obligations. In 1990, educational markets were deregu-lated and the cap on college and high-school tuition fees was removed on the condition that parents and students were informed. In 1993, elementary schools followed. By 1994, the government removed the last remaining restriction and the laissez-faire approach to education was in effect. Since then, tuition fees have increased steadily. Every year, more and more colleges, mostly private higher educational institutions, apply for tuition hikes. In recent years, state universities and colleges have also begun increasing tuition and other fees as huge budget cutbacks constrained them from increasing capital and administrative expenses.
Accurate Reserves
Pre-need companies, like insurance firms and other similar financial entities, promise a future payment in exchange for premiums paid to it by its customers today. These premiums are to be invested in such a way as to cover these future obligations. Like any other business, they operate under conditions of risk and uncertainty. As such, these features need to be accurately estimated, especially on their potential impact on investments and the viability of the business as a whole.
The key indicator to measure is the actuarial reserve liability (ARL), which represents the net present value of a pre-need company’s future contractual obligations to its planholders. Since it represents the pre-need’s ability to pay the benefits expected by every planholder, the assumptions must be realistic and conservative. Typically, a company is able to do this by using assumptions on interest rate, inflation rate, proportion of lapsed plans, and tuition fee increases, in the case of educational plans. Ideally, the ARL’s ratio to the trust fund must be 1:1 for a company to be considered healthy.
To help prevent ARL miscalculations, the SEC issued Memorandum Circulars 6, 7, and 8 on 27 June 2002. These circulars set the standards for the valuation of actuarial reserves for pre-need plans, information requirements to accompany the ARL report, and the responsibilities of actuaries. The regulations were aimed at ensuring that future actuarial reserve valuations were done properly and that manipulated assumptions were not included to boost income and minimize required deposits to the trust fund.
Unfortunately, the industry did not welcome the circulars and preferred to wait for an earlier set of rules issued on 16 August 2001 to take effect first. At a June 2005 conference on the pre-need industry at the Asian Institute of Management, Juan Miguel Vazquez, president of the Philippine Federation of Pre-Need Plan Companies, said the circulars were not widely received by member companies because of “inconsistencies” with the previous rules, which took effect only on 30 April 2002. The new circulars resulted in confusion and volatile swings in actuarial reserves computations.
CAP’s 2002 financial statements submitted to the SEC, for instance, were revalued a number of times. In its first submission, CAP’s ARL had a balance of only P15.5 billion based on a modified valuation method wherein plan termination values were used in estimating the ARL. Following a study made by independent actuarial consultants, however, the commission rejected the valuation method used and asked CAP to revalue the ARL using the 2002 SEC valuation guidelines. CAP complied, but due to changes in methodology, actuarial assumptions, and the number of fully paid plans used in the computation of the ARL, its revised ARL as of end-2002 rose to P24.7 billion. Despite applications for regulatory leeway and prior-period adjustments on key accounts, CAP’s recognized trust fund deficiency for 2002 still stood at P16.0 billion. This increased further to P17.2 billion in 2003 as CAP’s ARL rose to P25.6 billion.
Mismatch
CAP’s experience demonstrates Vazquez’s point that the ARL circulars created confusion. Had there been a better transition, the maturity schedules of each company could have been determined and matched against their liquid funds. The SEC could have used these schedules in estimating the compliance period and provided pre-need firms with ample time to accurately estimate their ARLs. Since the ARL directly relates to the trust fund, no unnecessary variance would have been created.
If the ARL is less than the trust fund, there is a surplus. If the ARL is greater than the trust fund, there is a variance or a trust fund deficiency. However, since the variance is treated as an expense, this creates unnecessary reductions to the company’s capital. What complicates the issue is the “prospective” nature of the ARL. It is only a net present value computation or a forecast, hence, a company’s financial obligations is bloated by something that does not exist yet. “It is this perception of great instability from bloated capital deficiencies that created the crisis,” Vazquez states. However, whatever CAP’s problems were, other companies were able to comply without much confusion.
The pre-need industry controversy is not only due to bloated or high ARLs. In fact, some companies that have been reported to be in trouble had more than enough funds to cover for their long-term obligations. Pacific Plans, for instance, had a trust fund excess of P586.3 million when it applied for rehabilitation. Prudential Life Plans and PET Plans, despite having been short-listed by the SEC as likely troubled firms, had trust fund surpluses of P1.2 billion and P5.5 million, respectively, based on their latest reports submitted to the SEC.
|
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Investing it Right
Where these trust funds are invested is also another source of controversy. Industry officials believe that pre-need companies used the trust fund for investments other than those outlined by the SEC. The commission specifically mandated companies to invest in fixed-income instruments, mutual funds, equities, and real-estate assets that will guarantee sufficient growth of the fund. Also, a pre-need firm’s investments in real-estate assets, for instance, must not exceed 25% of its total trust fund and must include properties located in strategic areas of cities and first-class municipalities. Investments in equities are likewise limited only to actively traded stocks issued by financially stable companies with a good track record and that have declared dividends for the past three years. The amount for this purpose shall also not exceed 25% of the total trust fund equity.
Trust fund withdrawals, on the other hand, must only be confined to payments of tuition fees of scholars or nominees; costs related to the administration, preservation, maintenance, and protection of the trust fund; cash surrender or termination values to planholders; and duly justified investing activities. Theoretically, a company must have liquid assets and readily convertible investments to meet sudden financial problems.
In Pacific Plan’s case, almost 98% of the trust fund as of end-2004 were in government-guaranteed National Power Corporation bonds worth US$89.1 million that will mature in July 2010. On the other hand, CAP’s trust fund investments as of 2003 were mostly in Metro Rail Transit bonds, real estate, and investments in affiliates. But the MRT bonds worth US$50.7 million acquired in 2002 from an affiliate had maturity dates starting only in 2013 to 2025. Investments in affiliates were also questioned. CAP planholders accused the pre-need firm of breaching their fiduciary obligations by using the funds to bankroll directly and indirectly the operations of affiliate companies owned by some members of the CAP board. Some of these companies include Fil-Estate Corporation, Fil-Estate Development Corporation, Camp John Hay Golf Club, Fil-Estate Properties, Fil-Estate Management, CAP Realty, CAP General Insurance, Manila Southwoods, Southwoods Ecocentrum, Sherwood Hills Golf and Country Club, and Global Business Systems.
Industry observers also believe that the 1997 Asian financial crisis was also a factor in the collapse of some pre-need firms today. The crisis exposed financial and corporate sectors to foreign-exchange risks. These risks and the collapse of the real-estate bubble affected the financial profiles of firms, especially companies that relied too much on real-estate investments. The peso fell significantly. As a result, the fluctuations in interest rates associated with the devaluation of the peso caused pre-need companies’ investment yields to decline and financial liabilities to increase.
Looking Forward
While it is important to understand the roots of the pre-need mess, it is also imperative that all stakeholders—planholders, pre-need firms, and the government—now move forward and start working on the necessary reforms that will save the industry from its present predicament. So many parents have seen their dreams for their children go down the drain. If confidence in the pre-need industry continues to erode, the future viability of the industry’s business model will be in peril.
SEC, lobby group hit for collapse of preneeds
Manila Standard Today
Oct. 13, 2005
A CONTROVERSIAL United States lobby firm, Senator Mar Roxas and the Securities and Exchange Commission are to blame for the collapse of the preneed industry.
This was the testimony given by former SEC chairman Perfecto Yasay Jr. during the hearing of the House committee on oversight, chaired by Quezon Rep. Danilo Suarez.
Yasay testified that during her term as SEC chief, the lobby group Accelerating Growth for Investment Liberalization and Equity (AGILE) recommended that all preneed firms should use the actuarial reserve limit (ARL) rule to protect the policyholders.
“I rejected that because I believe the preneed industry will go bankrupt and the policyholders would be on the losing end,” Yasay told the panel.
House Senior Deputy Minority Leader Rolex Suplico explained that ARL refers to a reserve fund, which the SEC will make sure that every preneed company must have at any given time.
The ARL rule was implemented by his successor, SEC Chief Lilia Bautista, in 2002 upon the orders of then Department of Trade and Industry secretary-turned-senator Roxas.
“It was quite anomalous that Roxas ordered the SEC chief and the SEC chief followed the order to implement the AGILE-proposed ARL when SEC is not under the DTI but under the Department of Finance,” Yasay said.
Yasay said the collapse of the preneed industry began when the companies could no longer touch their funds because of the rule.
He cited the case of College Assurance Plan (CAP), which was compelled by SEC to have an ARL exposure of P2.5 billion in 2002.
In 2003, CAP’s exposure more than doubled from P7.5 billion and yet grew by P15 billion in 2004 because of the rule.
Meanwhile, Pacific Plans failed to send a representative to the hearing after House Speaker Jose de Venecia refused to sign the invitation for former ambassador Alfonso Yuchengco to testify before Suarez’ committee.
The family of Yuchengco, a member of the newly formed Constitutional Commission, owns Pacific Plans.
CAP officials who were present said the company has yet to recover from the financial mess it is in and could not promise to issue checks for the next semester’s enrollment of its beneficiaries. Christine F. Herrera
What We Need to Know About Pre-Need Companies
Newsbreak Online
Monday, 15 August 2005
The situation as of December 2004:
■ The pre-need industry has sold almost 2.5 million plans. Of these, more than 70 percent, or 1.6 billion plans, are educational plans. Pension and memorial (or life) plans account for the remainder. This means Filipinos put a premium on education, and would rather invest in it than in products that are for retirement or burial purposes.
■ At any one time, about 10 percent of students enrolled in private schools are beneficiaries of educational plans. Most of them are enrolled in non-exclusive schools.
■ The problems besetting the pre-need industry—prompted by the brouhaha over the financial problems of College Assurance Plan, Pacific Plans, and lately, Platinum Plans—are just the beginning. There are about half a million plans that have been fully paid but not yet being availed of. About 400,000 plans are still actively being paid.
■ Almost 100,000 plans have lapsed, or those with premiums which have not been paid on time and have not been reinstated.
■ More than P100 billion worth of plans have been sold. Most of these were sold during the latter half of the 1990s when pre-need companies added educational plans in their product portfolios, or when new pre-need companies started offering educational plans.
■ A pre-need company is generally considered financially sound when its trust fund (or 51 percent of the total premiums paid by plan holders, invested to grow and meet future tuition payments) is sufficient to cover its computed Actuarial Reserve Liability (an approximation of all present and future tuition payments).
■ From the table, some companies, even the big ones, had incurred a trust fund deficit as of December 2004. In the case of Philamlife and Manulife, they regularized it by depositing additional assets to their trust funds by January. The Securities and Exchange Commission allows this in consideration of the delay in the computation of the final ARL for a certain period. (Usually the ARL for December is computed in January, so only then would companies know if they have deficits.) Himlayang Pilipino, Provident Plans, and Transnational Plans were able to fund their trust fund deficits only after the January deadline.
■ Some companies, which offer pension and/or memorial plans together with their education plans, incur trust fund surplus in one product and deficits in another. This is the case with both Loyola Plans and Grayline Plans. Both had surpluses in their trust funds for educational plans, but incurred deficits in their pension and life plans. Companies have to ask permission from SEC before they are allowed to use their surplus funds to subsidize the others.
Sources: Documents submitted to the SEC, various interviews, Senate hearings
When Good Plans Go Bad
Newsbreak
Written by Lala Rimando
Monday, 23 May 2005
As Pacific Plans grapples with liquidity problems, holders of pre-need educational plans feel they’re left holding the bag.
To Luzvimina Hipolito of Quezon City, the problem involving her and the company that sold her an educational plan is basic: she who makes a living running a carinderia never missed a single payment of her premiums, even during the times “that I had nothing left to pay for house rent.” If the company is in dire straits now, she asks, “Should I let my children stop schooling?” The answer, to her, is as clear as a summer day: “Raising the money should not be my problem; it should be the Yuchengcos’.”
The Yuchengco family, one of the country’s most venerable names, is embroiled in the latest scandal to hit the pre-need industry because it owns the Pacific Plans Inc. (PPI) that is in default in its payments to 34,000 planholders.
Pre-need companies like PPI had offered traditional educational plans that guaranteed to cover 100 percent of the tuition of the planholders’ child. (These were apart from the fixed-value educational plans, which had limited value coverage.) In 1990, the government lifted the 10-percent ceiling on tuition increases. With deregulation, tuition charged by schools soared. Because of the unlimited guarantee offered by the traditional educational plan, a holder may have paid only P40,000 in total premiums but could reap more than P300,000 in benefits.
PPI, a 38-year-old company, stopped selling the traditional plans in 1992 but continued to service existing ones until last school year. Last April 13, the company won a Makati court ruling that allowed it to suspend payment to planholders.
On the surface, this appeared to be PPI’s effort to stop the company from hemorrhaging. But questions have been raised about its motive.
In December last year, the company thought that its trust fund—the pool of premium payments from planholders that had been invested—was healthy. It had reached P3.2 billion, more than enough to cover the P2.7 billion Actuarial Reserve Liability (ARL), or the amount that PPI should target to ensure enough funds to cover current and future tuition payments.
But to service all tuition requirements of the planholders for the coming school year in June, the company had to raise about P600 million. The trust fund had P341 million worth of cashable assets, and PPI president Ernesto Garcia said they had hoped to augment the balance with the sale of US$51.8 million in zero-coupon Napocor bonds where part of the trust was invested.
The bonds had been bought at a discount. Their US$51.8-million face value and seven percent coupon rate will be realized when they mature in 2010, although they are traded in the bond market. However, the Napocor bonds were affected by the credit downgrades of international credit rating agencies in the first quarter, Garcia said. The company had two options: to cash in the Napocor bonds so it could fully pay planholders this year—which would mean absorbing losses of up to P550 million—or suspending payment to planholders.
PPI chose the latter, explaining that to cash in the Napocor bonds would further endanger the trust fund and might prevent the company from servicing tuition requirements of 19,000 planholders who would enroll in the future.
In the rehabilitation plan, which PPI submitted to the court and could still be contested by planholders, the proposed solution was to hold on to the bonds until maturity in 2010. PPI would disburse the P341 million to cover a portion of the planholders’ first-semester tuition requirements, but for the second semester and succeeding school years, planholders were being asked to wait for five years.
In essence, the planholders would shoulder the company’s liquidity problem. They were left holding the bag. In the past, Garcia said, the profits generated from the more than 400,000 fixed-value contracts—the safer and more viable pre-need product because the tuition and other benefits are predetermined—were used to meet the planholders’ tuition needs. But since the fixed-value contracts had been spun off to another company, the PPI was left only with the traditional planholders’ investments.
Premeditated
About 3,000 parents who had bought the plan have formed the Parents Enabling Parents (PEP) Coalition to protest this arrangement. They’re not buying the official line that the spin-off and the court plea were part of a corporate strategy to protect all the 34,000 planholders’ interest in the long term.
Philip Piccio, PEP spokesperson, told NEWSBREAK, “The move to shield themselves [the Yuchengcos] through the court was premeditated. Therefore, there is malice and probably fraud.”
The coalition questions the August 2004 spin-off of the assets and trust funds of the 400,000 fixed-value planholders to a new company, Lifetime Plans Inc. The stake of PPI in Lifetime was subsequently sold to GPL Holdings, another Yuchengco company. “The [corporate restructuring] was to ensure that our share in Lifetime’s profits would be out of reach,” said Picco.
The spin-off is a business approach that isolates the good assets from the bad. The bad assets are either sold to another investor at big discounts, or nursed back to profitability. This strategy has been implemented in the case of the United Coconut Planters Bank (UCPB) and the Philippine National Bank (PNB). Both banks created separate departments to isolate their soured loans from the rest of the earning assets. PNB turned in modest profits because of this, while UCPB is recuperating.
In PPI’s case, the “good assets” were spun off to Lifetime Plans while the “bad assets” were left with PPI. Garcia said they had equitably apportioned the assets, liabilities, and trust funds between PPI and Lifetime. “We asked ourselves if we wanted to wait until [another pre-need] would go belly up,” Garcia said. “We could just ride the tide and not to put too much focus on ourselves. But our decision was to immediately protect the interests of the greater good. And we thought it was the most prudent thing to do.”
But even the Securities and Exchange Commission (SEC), the pre-need industry’s regulator, was caught off-guard when PPI sought relief from the court. Fe Barin, the SEC chairperson for the past eight months, said, “They pulled one over us.” Filing for suspension of payment is a strategy that companies use to overtake their creditors, suppliers, and other stakeholders who might go after the companies’ assets once they smell financial trouble.
In hindsight, the SEC could have seen this situation coming, especially after it approved the spin-off in August 2004. But Barin explained that the circumstances then were different. The SEC allowed the Lifetime spin-off because the apparent game plan at that time was for the company to find an investor and not go to court.
Since 2002, PPI, the College Assurance Plan (CAP) and 10 other pre-need companies that offered traditional educational plans have been on the SEC watch list. Reforms followed more than 10 years of lax regulation of the pre-need industry, thus the belated order to stop the sale of traditional plans only in 2002.
A source said PPI was one of those with faulty computations of their ARL, or the present value of all current and future tuition availments. The ARL is based on inflation, interest rates, and expected tuition fee increases, among others. A measure of how healthy a pre-need company is whether its trust fund is equal to or exceeds the ARL. The company’s ARL in 2002 was only P8.9 billion. The correct figure, the source said, should be about P15 billion. In other words, PPI’s trust fund was short by almost P7 billion then because it only had P8.6 billion. The Yuchengcos reportedly sought a two-to-three-year leeway to address the deficiency. The SEC agreed because CAP and the other pre-need companies were also allowed to amortize their deficiencies.
Of all the pre-need companies on SEC’s watch list, CAP was the big bang; it had 780,000 planholders. Its trust fund deficiency was climbing every year and reached P17 billion in 2004. The public gauged the SEC’s capability as regulator by the way it handled CAP. Did SEC fail to anticipate PPI’s moves because it was lax with CAP and others? Or did PPI take advantage of the situation, hoping it would be treated with the same kid gloves as CAP?
Garcia said that PPI had made earnest efforts since 2003 to contain its exposure to traditional plans. Proposals to schools were made wherein PPI would advance the entire four- or five-year college tuition of planholders. The proposal included a cap of 10 percent on yearly tuition increases. None of the schools agreed. PPI said they tried to buy back the plans, but most of its planholders declined. The company also decided against negotiating directly with each planholder because it was time-consuming.
Obviously learning from CAP’s experience, PPI isolated the profits earned by its 400,000 fixed-value planholders to protect these profits from being used to subsidize the withdrawals of traditional planholders. CAP, meanwhile, continues to deplete its trust funds to meet current tuition requirements.
Sentiments are mixed. Parents say CAP’s strategy continues to give hope, while PPI doused it. Others say CAP is leaving them in the dark, while PPI is more forthcoming about what planholders should expect.
Damage Control
Last April, PPI planholders received individual letters detailing the amounts due them based on the proposed rehabilitation plan. They were told they could sell back their plans if they decide not to wait for the Napocor bonds to mature in July 2010. Or they could let their money remain in the trust fund, earning seven percent from the year they finished paying the premiums until the bond matures.
The planholders were not pleased. Piccio stressed that they bought PPI educational plans on the assurance that PPI was backed by the financial muscle of the Yuchengco Group of Companies. The group includes major players like Rizal Commercial Banking Corp., Malayan Group of Insurance and Great Pacific Life Assurance Corp., and House of Investments. Other sister companies include Bankard, Mapua Institute of Technology, Honda Cars Manila, Manila Memorial Park, and Nippon Life Philippines.
PEP is also getting inspiration from CAP, which recently filed a class suit. For their part, PEP members are preparing documentary evidence of fraud and pooling their financial resources for the cases they plan to file soon.
Garcia admitted they underestimated the intensity of the backlash from planholders, especially against the person of the patriarch, former Ambassador Alfonso Yuchengco. The initial plan was to dissociate the family and the conglomerate’s other companies from PPI, but, in the end, the Yuchengcos found themselves committing bulk of the P2 billion funds to meet the withdrawals before 2010—a decision that could have saved them all the brouhaha in the first place.
An insurance executive summed up the entire affair with this comment: “Financial services are fiduciary businesses. We should always remember that we are handling other people’s money.”—With reports from Dwight Agulan
Your Say on the Matter….
Lyra on SEC seizes evidence vs. p… Krystel on SEC seizes evidence vs. p… Raul Durias on Pacific Plans owner offers to… edward mortise on Pacific Plans buyer assures pl… edward mortise on Pacific Plans owner offers to… edward mortise on Parents group to sue ex-Pacifi… -
-
This site is a public service for PEP Coalition planholders as well as for the public who may be looking for information on the pre-need industry and the PEP Coalition's quest for justice in the courts. We also scour the internet for past and present articles on the industry and specific pre-need companies in an effort to provide ready access to everything written about the pre-need industry in a central area (our site). Each news article contains the source, publish date, and where available, a link back to the actual news site. If you have a reaction to a specific article posted, you may click on Comments link found at the bottom of each post.
PEP Coalition 