(Bloomberg) — Maureen Gidding paid $25,000 for part of a life insurance policy on a man she didn’t know.
What she did know, however, was the company that sold it to her predicted he’d be dead in 18 months. Life Partners Holdings Inc. promised that when he expired, she would get a $30,000 share of the policy’s payout — a 20 percent return.
That was 2001. Fourteen years later, the man is still alive, Life Partners is bankrupt and Gidding is deep in the red. The 63-year-old has already paid more than she can hope to recoup when the $8,000 she has spent on premiums and fees is factored in.
The collapse of Life Partners, which sold shares in policies on the elderly and the ill, doesn’t fit neatly under bankruptcy law, which requires a judge distribute assets equally among creditor classes. How 90,000 investors and clients get compensated when many of those assets are being held in escrow by the grim reaper is an open question.
“How can someone wrap things up and bring it to a conclusion if there are still scores of policies outstanding because insureds have not passed away?” said Christopher Bebel, a former Securities and Exchange Commission attorney.
The investment vehicles, blandly labeled life settlements but known more bluntly as death bonds, first appeared in the late 1980s, when they were called viaticals. They became popular among AIDS patients who needed cash for medical expenses and elderly clients seeking money for end-of-life care.
Life Partners, founded in 1991, sold stakes in policies with a face value of $2.4 billion. Its clients were individuals, but the $35 billion market has also attracted asset managers like Fortress Investment Group LLC and insurers such as American International Group Inc.
Life Partners relied on an expert to estimate life expectancies, a key factor in the price investors would pay. The identity of the insured, or any other fractional investors in the policy, would usually remain secret. A Texas jury found the company had low-balled mortality estimates in a lawsuit filed by the Securities and Exchange Commission. Unwilling to pay a $46 million judgment, the Waco-based company filed for bankruptcy Jan. 20.
In the past, life settlement companies have mostly been unwound in receivership, in which a trustee pooled the remaining assets, using the returns on policies where the insured died to pay premiums to maintain the policies on those who yet lived.
But since investors own their stakes in life insurance policies, and not the company, a bankruptcy judge doesn’t have the power to pool those assets absent “extraordinary circumstances,” said Raniero D’Aversa, a lawyer who worked on the bankruptcy of Ritchie Capital Management Ltd.’s lifesettlement funds.
“This is the first time a large life settlements fraud has been unwound in bankruptcy rather than a receivership,” said Dennis Roossien Jr., a lawyer for Life Partners’ official creditor committee. “The implications to the bankruptcy code are a blank slate.”
The trustee appointed to unwind Life Partners, H. Thomas Moran, announced May 20 that he wants to largely pool the policies, borrowing excess cash that has accumulated in some to pay premiums on others whose investors can’t meet premium payments, to keep them from lapsing.
Moran said that otherwise, 850 policies with death benefits of $140 million could lapse in the next 90 days, and 1,800 policies worth $800 million could lapse in the next 12 months.