I Was Wrong About Life Partners Holdings

When I first bought shares of Life Partners Holdings (Nasdaq: LPHI  ) , it looked like an almost ideal stock. The company was showing a pristine balance sheet with no long-term debt and more cash than total liabilities. Its business -- life settlements -- combines all the glamour of a funeral parlor with a revulsion factor in line with the modern-day anti-smoking campaigns.

In part because of the negativity surrounding its industry, its valuation looked incredibly attractive, too. With a better than 5% yield at the time, a price-to-earnings ratio around single digits, and a business that looked well-positioned to thrive in a still-shaky economy, it looked like a no-brainer pick.

What's with the industry?
Life settlements is a somewhat macabre business. In a standard case for the industry, a person finds himself or herself insured by a no-longer-needed life-insurance policy. That person can either:

  • Continue to pay on the life insurance.
  • Surrender the insurance for whatever cash value it may have.
  • Sell the policy to someone else for somewhere between the cash value and the death benefit.

It's that third situation where the life-settlements companies like Life Partners Holdings play. They're essentially a matchmaker between investors wanting to buy policies and insured folks wishing to sell.

It may be macabre, but it looked like a potentially lucrative investment -- not to buy the policies, but rather to buy shares in the company that helped facilitate the connections between buyers and sellers. After all, so called "sin stocks" -- broadly defined as stocks of companies in industries that your mother would never approve of your partaking in -- often make strong investments. And what could be more "sinful" than anticipating someone else's passing -- the essence of the life-settlements business?

From no-brainer to zombie apocalypse
Unfortunately, there were some extremely large problems lurking just under the thin veil of the company's apparent success. For one thing, while it's darn near impossible to predict when anyone will pass away, it's a standard actuarial task to project the rate at which large groups pass away. In rating the policies it was selling, Life Partners Holdings was apparently way off the mark, according to a Wall Street Journal article.

Given a large enough sample size and accurate enough actuarial models, you'd expect about half the people in a given population to pass away by their life-expectancy date. In Life Partners Holdings' case, more than 80% of all insured people whose policies Life Partners Holdings sold between 2002 and 2005 lived past their expected death date. I think that's either lousy actuarial estimates or something nefarious. The SEC is investigating and is threatening civil action if it believes there to be funny business going on.

In large part because of its questionable life expectancies, the company is having difficulty accounting for its operations. It delayed several of its earnings filings, just filing both its 10-K annual report for February and its May 10-Q report within the past week, and its overdue August 10-Q finally came out yesterday. As if the delay weren't bad enough on its own, the company's auditors didn't approve of the company's internal controls, citing material weakness in the way it recognized revenue.

Bad accounting. Bad actuarial estimates. And an SEC investigation into the core of its operations. Yuck. The whole experience certainly reinforced the point that it's not enough for a company just to have good reported numbers -- it needs trustworthy management at its helm to assure long-term success.

What to do next?
I was wrong about Life Partners Holdings. It looked almost too good to be true, and it turned out to be a real lemon. I still like the concept of "sin stocks," though, and now (or rather, when Foolish disclosure rules allow) might be the perfect time to trade in my Life Partners Holdings shares for a better-run sin stock.

The sin stocks currently on my watchlist include:

  • Philip Morris International (NYSE: PM  ) , the non-U.S. tobacco business spun off from Altria (NYSE: MO  ) to protect that part of the business from U.S.-centric litigation. Its 4.3% yield looks reasonable, though lower than the 6% of the company that spun it off -- a reasonable tradeoff for shares with less of a legal overhang attached.
  • Diageo (NYSE: DEO  ) , the British purveyor of adult beverages, including my personal favorite -- Guinness. The company currently has a deliciously tempting 4% forward yield and trades below 13 times next year's anticipated earnings.
  • Service Corporation International (NYSE: SCI  ) , the funeral services and cemetery provider. While not generally considered as much of a "sin stock" as the others on this list, it still profits from people's deaths. It certainly has the advantage of a business model that will continue as long as people pass away and that is needed no matter how poor the economy.

Any one of them looks like a potentially more lucrative investment than the overoptimistic marketer of life settlements I currently own. Truth be told, though, I haven't made up my mind on what to do yet, and I'd appreciate your opinion in the poll and comments.

At the time of publication, Fool contributor Chuck Saletta owned shares of Life Partners Holdings. Check out his holdings and a short bio. The Motley Fool owns shares of Diageo, Altria Group, and Philip Morris International. Motley Fool newsletter services have recommended buying shares of Philip Morris International and Diageo. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (6) | Recommend This Article (9)

Comments from our Foolish Readers

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  • Report this Comment On November 29, 2011, at 1:21 PM, antislapp1 wrote:

    There were several Seeking Alpha articles over the past several years detailing the Life Partners debacle, and they were written by people with an analytical background. You really screwed up with this pick since the facts have been out for a long time.

  • Report this Comment On November 29, 2011, at 6:50 PM, TMFBigFrog wrote:

    Hi antislapp1,

    Thanks for reading this article and sending in your comments. You're absolutely right that I was wrong about Life Partners Holdings. Still, I do consider myself very fortunate that from an overall portfolio perspective, following Ben Graham's diversification principles has largely protected us from what could have been a far worse impact from that mistake.

    Regarding the Seeking Alpha analyses, I learned long ago that even well respected analysts get things wrong from time to time, either by getting blindsided or by letting the personal get in the way of the data. For instance, I've tripled the value of my 2003 investment in pipeline giant Kinder Morgan Management. Most of the time I've owned it, Kurt Wulff, the very respected energy analyst at McDepp has been actively writing against it: ( http://www.mcdep.com/2kmr.htm ).

    I respect many of the people over at Seeking Alpha, but back in early 2010 when I first bought my Life Partners Holdings stake, I saw questions being raised but didn't see anything that stood out like a smoking gun, based on publicly available data, delivered by an analyst that I trusted & respected enough at the time to let that analyst drive my decisions for me.

    I don't remember if it was on Seeking Alpha or one of the other sites I frequent, but many of the then timely negative reports I did find on Life Partners Holdings were largely pitches to buy someone's premium research. Regardless, In Life Partners Holdings' case, I'm the one that missed it & missed it with my own money invested.

    Regards,

    -Chuck

    Disclosure: I still own those Life Partners Holdings and Kinder Morgan Management shares.

  • Report this Comment On November 30, 2011, at 6:40 PM, SKEPTIX wrote:

    Not a total lemon. There's still a healthy dividend that the company has continued to pay and increase during the "recent unpleasantness". If you bought the stock as part of an income strategy, it has continued to perform even at the depressed price.

    Was announced today that one of the lawsuits against the company was thrown out as "frivilous". With their new accounting firm getting caught up with their filings, I think it highly likely the SEC's investigation will wrap soon, removing the uncertainty that has made this company so attractive to short.

  • Report this Comment On December 01, 2011, at 7:02 AM, pelican454 wrote:

    LPHI does not guarantee any life expectancies and never has. This year there have been many maturities that have paid an average of over 18% return on investment. An investor has no chance of losing their principle investment. Name any stock that has that possibility.

    With the current world wide economic and the national political situations only Fools continue to buy and gamble on the market and the people selling the market continue to be the biggest con men.

  • Report this Comment On December 01, 2011, at 10:22 AM, johnintexas wrote:

    There are no facts from Seeking Zeta. It is merely part of the longer running attempt to profit from shorting the stock of Life Partners. Just another example of market manipulation by those insiders who have the power to do it and thereby profit from said manipulation.

    But from my perspective it looks like I have dodged the bullets fired by those con artists. I will still make some money.

    The next investigation should be a criminal investigation of the authors of the stories authored by and published on Seeking Alpha.

    The link the to WSJ article should make for interesting prosecution also.

  • Report this Comment On January 04, 2012, at 11:43 AM, john603 wrote:

    Wow. The comments above have been very pro LPHI. But, wait and see SEC press release that blasts the company for fraud! It opens them up to anyone who bought -- to want their deal undone with interest!. I can see a big dividend cut comeing. see

    http://www.sec.gov/news/press/2012/2012-2.htm

    I just went short in my fool acct but I can not go short in my IRA account.

    Good job on the original article.

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