DFW investors learn the unspoken risks of betting on death [Fort Worth Star-Telegram, Texas]

Feb. 11--Half-jokingly, Brian Pardo was introduced as long-winded at an alternative-investment forum in downtown Fort Worth last month. No misrepresentation there.

The 69-year-old CEO plodded through a detailed history of his company, Waco-based Life Partners, which has acted since 1991 as a specialized broker, buying and selling life insurance policies of old, often ailing people who were predicted to survive only a few years.

The secondary life insurance market, once the preserve of big institutional investors, has been broadened by companies like Life Partners by selling to ordinary -- and critics would say, unsophisticated -- investors who sometimes rolled over their retirement savings.

The down-to-earth CEO, whose mismatched brown sport coat, thickly knotted tie and red shirt gave him an everyman look, offered little indication at the sales meeting that Life Partners was facing potent challenges.

News that profits in the latest quarter had dropped 18 percent was followed Jan. 5 with a lawsuit filed by the Securities and Exchange Commission, accusing the company and its top officers of duping investors.

"Every time they put out a press release," Pardo said of the SEC, "we get $2 million, $3 million in new business."

The SEC alleges that a Nevada oncologist with no actuarial training rapidly dispensed life expectancy estimates that proved uncommonly off the mark -- wrong more than 80 percent of the time. It said Dr. Ron Cassidy's average prediction from 2000 to 2010 were life predictions of 3.9 years when they "should have been at least 9 years longer," the commission asserted.

Last summer, after a two-year investigation, the Texas State Securities Board sued the Waco company, alleging that it hadn't responded to subpoenas.

And investors have also brought lawsuits.

Jose Gallo, a 62-year-old police officer, has been approached to join a class-action suit against Life Partners. He hasn't seen a dime in returns in six years and has had to shell out thousands on premiums to keep his death benefit portfolio from collapsing.

"It appeals to your greed," Gallo said, referring to sales pitches that emphasize the age and poor health of the insured. "At no time was the risk indicated."

In a quarterly filing Jan. 6, Life Partners Holdings denied the SEC allegations, said it will vigorously defend itself and insisted that the suit has "no effect on any of Life Partners Inc.'s life settlements or its life settlement clients." It acknowledged that the SEC investigation has hurt its operating results and business relationships.

In June 2011, Ernst & Young resigned as the independent auditor of Life Partners Holdings after it said Pardo "threatened" the firm for refusing to sign off on financial statements. The same month, apparently prompted by Ernst & Young's action, the EideBailey accounting firm disavowed the Waco company's 2009 figures.

None of this has helped Life Partners Holdings stock (ticker: LPHI), traded on the Nasdaq exchange and now fetching slightly more than half its 52-week high.

The sales pitch

Pardo, who flew a helicopter gunship in Vietnam, is no stranger to adversity and clearly doesn't scare easily.

Repeatedly, he assured the Omni Fort Worth Hotel audience that Life Partners had taken an earlier SEC lawsuit all the way to the U.S. Supreme Court and had never lost in court against regulators.

"It's a battle," Pardo told the estimated 200 prospective investors, saying the insurance industry was conniving with the SEC to put him out of business. "We will fight to the conclusion ... and will prevail."

He didn't mention losing cases to Utah and Colorado securities officials since 2006. Nor did he bring up his earlier venture, Waco-based American Solar King, later ASK Corp., which closed down in a 1989 bankruptcy without admitting wrongdoing after the SEC alleged fraud the year before.

There was no way to determine how convincing Pardo and other speakers proved that winter night at the Omni after guests were served finger food and slices of Virginia ham.

Clearly, the 2{-hour presentation was complicated and exhausting. A speaker warned that only half the listeners would grasp a data-heavy video presentation on why the stock market was doomed, and predicted that the rest of the audience would nod off. He was right. Chins hit chests and snoring was audible on some rows.

Accompanied by a thick folder, the spiels emphasized the rewards of investing through Life Partners and gave only brief cautionary references to a possible downside. They also denounced The Wall Street Journal's 2011 expose on the company.

The listeners included at least one doctor and many elderly couples as well as people who already had bought life settlements, or viaticals. They were told that stocks were headed for collapse, that the housing crisis proved that real estate was a hopeless investment and that bank certificates of deposit gave little return.

As for life settlements, they could return 5 to 12 percent a year, the audience was told. One speaker called out to a colleague who shouted back that a particular portfolio had paid back more than 20 percent. A worst-case scenario was about 2.5 percent paid annually over 18 years. Not great, but better than holding shares during a stock market crash, the pitchman said.

In the audience were couples who had invested more than $100,000.

Now, years beyond the policies' three- or four-year life expectancy predictions, no policies had paid out for some investors. This meant they were obliged to pay premiums to keep their portfolios alive.

One Flower Mound couple is facing 2012 payments totaling $18,000 to safeguard a $300,000 investment.

When they approached a speaker, he advised them to sell one of their five policies but warned that they wouldn't get back their full investment.

According to the SEC lawsuit, Life Partners takes a thick slice for itself worth hundreds of thousands. One policy, sold to investors for $3 million, paid off $360,000 in sales commissions, or 12 percent, the agency said.

Cassidy, the doctor who made the life expectancy estimates, did OK too. He was paid $500 per review, totaling more than $1 million from 2000 to 2010, plus $15,000 a month since February 2008, according to the suit. Cassidy's answering service said he doesn't talk to the news media.

Cassidy, a 1974 graduate of the University of Texas Medical Branch at Galveston, initially approached Life Partners executives at the funeral of another Reno doctor who had been providing life expectancies. Jack Kelly, a part-owner of the Waco company, "died unexpectedly" in 1999, the SEC said.

The sickest and oldest

Linda and Ron Mitchell, a semiretired couple from Midlothian, said they went to an investment advisory firm, Woods Financial Group of Fort Worth, to buy two annuities -- a conservative investment that pays a guaranteed annual return.

Instead, a salesman steered them to life settlements from Life Partners, saying they were a far better choice.

The Mitchells were completely sold.

"We said, 'Give us the oldest ones in the worst health.' We thought that would be the best strategy,'" recalled Linda Mitchell, 65. She and her husband sunk $52,189.19 -- a quarter of their retirement savings -- into fractions of six policies six years ago.

Despite the couple's choosing the sickest and oldest people insured, none of the death benefits have "matured," meaning the insured party hasn't died, and the Mitchells have been forced to pay premiums.

When the policies are purchased, the price Life Partners charges investors like the Mitchells includes premiums to cover the life expectancy period as predicted by Cassidy. If done to industry standards, half of such policies are expected to mature by the life expectancy date, half later.

But Cassidy relied on census tables rather than the standard actuarial practice of using data tailored to insured populations, the SEC says. Although Pardo and other executives knew this as far back as 2003, they permitted the doctor to continue his flawed methodology, the suit alleges. His calculations were stunningly inaccurate -- the insured outlived his estimates 88 to 91 percent of the time from 2006 through 2010, it said.

The Mitchells were lucky. After some badgering, Woods found them a buyer for one policy at the price they had paid.

"I was the squeaky wheel," Linda said of her effort to get assistance. That $10,000 is now used to pay premiums. The salesman who originally dealt with them no longer works for Woods, she said.

"We didn't get all the information upfront that we needed," she said. "We got it after the fact -- after we purchased them."

Woods Financial Group did not respond to requests for comment.

The feds' new tactic

At the Omni, Pardo exuded confidence that his company will triumph over the SEC as it did in 2007. Life Partners had successfully argued that it dealt in life insurance policies, not securities.

But the feds are using a different legal strategy this time.

Instead of arguing that Pardo is not licensed to be trading securities, it is zeroing in on insider trading allegations and Cassidy's methodology, alleging that his generally short estimates artificially inflated Life Partners revenue, on which shareholders based their investment decisions.

The SEC cited a 2010 transaction for which Cassidy figured a life expectancy of four years. But if the insured happened to live just two years longer, the suit said, the deal would be unprofitable -- not snaring the $859,000 in net revenue that Life Partners had recorded in its books. And life settlement investors haven't fared well, either, because Cassidy's allegedly wayward calculations overvalued the fractions of policies they bought.

If accurate life expectancy estimates had been used on 2,260 life settlements sold from 2000 to 2010, the average projected return to investors would have been 0.4 percent, the SEC says. But because they were promised returns of 10 percent or more, investors overpaid Life Partners$555 million in that period, the agency says.

Amid this mess, Pardo, who owns slightly more than 50 percent of voting stock, has done quite well for himself.

In fiscal 2011, he earned $1.1 million, including a $468,560 bonus. In addition, Life Partners paid him $189,653 last year for leasing his airplane at what it said was "below fair rental value," provided hangar space worth $29,000 and directly paid him $187,626 for renting his Florida-moored yacht, which is used for sales promotions.

His Cessna Citation X, which is the fastest civilian aircraft available and costs $22 million new, hit the news last fall when The New York Times reported that Gov. Rick Perry's presidential campaign admitted underpaying Pardo $23,000 for nine trips on it.

Pardo's family also benefits. The company paid $180,000 last year to ESP Communications, a company owned by his wife, Elizabeth, that telephones caregivers to learn the health status of the insured and then files death claims. It operates out of Life Partners'Waco offices.

Six years, no payouts

Gallo, the suburban police officer who describes himself as a novice investor, rolled over his entire 401(k) retirement account -- $150,000 -- into a Life Partners portfolio on the advice of his certified public accountant, Ron Harrison of Carrollton.

He said Harrison assured him it was a safe investment and never mentioned that premiums might need to be paid at some point. The CPA stressed, Gallo recalled, that one or two policies would surely pay off early, the rest later.

Six years later, none has. And Gallo says he'll be financially stretched to find $3,000 to cover so-called depleted premiums this year. He has already paid $6,000. Gallo was informed that he might lose 20 percent of his investment on a policy if he sells it on the secondary market to cover the premiums.

"Ron Harrison told me it was a very good investment," he said. "Now he won't return my calls."

Harrison told the Star-Telegram that he wouldn't sell Gallo the same Life Partners investment today.

"What was suitable five years ago is not suitable today. And I feel bad for Jose," said Harrison, a licensed insurance agent. He said he no longer believes that the life expectancy estimates cited on the more than 40 policies he sold to 11 clients were objectively made. "I believe they are biased. But I don't have proof."

Harrison said he is working to help clients sell some of their fractional policies to cover premiums.

"If the investment performed the way they said it would, it would have delivered double-digit returns," he said. "It all comes down to life expectancy."

Only three of the 40 policies he sold -- less than 10 percent -- have matured, he said. But they still held value, he insisted.

"They weren't investing in Life Partners," he said. "They were investing in A-rated insurance policies taken out by the beneficiaries. No matter what Life Partners has done, the policies will eventually pay."

Harrison, who has stopped selling death benefits, said he himself was not given a full picture of how Life Partners operated. But he made clear that the sales could be lucrative, in line with commissions paid on annuity investments.

Moreover, if a salesperson enlisted others to market Life Partner investments, he or she received 1 percent of their override sales, and another 1 percent for the sales of others who were in turn brought in.

"It was MLM -- multilevel marketing -- which is not unusual," Harrison explained. "But they recruited hairdressers and car mechanics to sell. You didn't need to be insurance licensed; I believe I was the exception to the rule."

He said Life Partners affiliates recruited by saying: "This is the best way to make a side income. Your wife won't need to work."

Selling was not a big challenge.

"Someone could go to a Tupperware party or a church group and soon everyone's rolling over their husband's IRA," Harrison said. "It's a good concept. A lot of Southwest pilots came in. Pilots and lawyers love the logic of this: You know people are going to die. You just don't know when."

Barry Shlachter,

817-390-7718

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