5Cs of choosing a pre-need company

Much talk is made about the complicated math of insurance and pre-need called actuarial math. Back in college when I was pursuing a mathematics degree, I wanted to take up actuarial science as a post-graduate degree. Fortunately, I was lured into the exciting world of journalism. Actuarial Science is concerned with the construction of models and solutions for financial, business and societal problems involving uncertain future events. Actuarial practitioners, also known as actuaries, have been described as financial architects and social mathematicians. They are responsible for assessing and quantifying financial risk. Broadly speaking, actuaries forecast the cost of future risks and improve financial decision making by developing models to evaluate the current financial implications of uncertain future events. Actuarial students learn about advanced mathematical and statistical techniques useful for this purpose, but also study topics in actuarial mathematics, demography, economics, marketing, mathematics of investment and finances, pension mathematics, risk management and insurance, and accounting. Traditionally, most actuaries have been employed in the insurance, employee benefits, and pension and management consulting industries. Many graduates are also finding career opportunities in banks, brokerage houses and software development companies developing programs for their field. I don’t think the actuaries are to be blamed for the catastrophe that has recently hit planholders of CAP and Pacific Plans. You don’t need knowledge in actuarial math to forecast that open-ended educational plans or those that pay the amount of tuition regardless of how much they are are a losing proposition. Only the management of these companies for their lack of prudence and foresight, and whoever decided to deregulate tuition fee hikes in the first place, can be blamed. But as a frustrated actuary and following talks with experts in the pre-need business, we have come up with the 5Cs of choosing a pre-need company in the hope of avoiding similar catastrophies in the future.

After all, not all is lost. The pre-need business can be summed up as follows: Planholders (like me) pay premiums to a pre-need company and (hopefully) get a benefit 10 to 25 years from now. This is nothing more than a planholder making a long-term loan to a pre-need company. So in choosing a pre-need, I as a creditor would use the same criteria used by bankers before they lend money.

Most bankers will tell you that they look at the five Cs – Character, Capacity, Capital, Conditions, and Collateral before extending credit to a prospective borrower. Let us now look at the 5Cs of credit as they apply to the pre-need sector.

Character – Who are the officers and directors of the pre-need company? Are they upright and moral individuals? Do they have an extravagant lifestyles? What are their professional and educational backgrounds? Do they have a reputation for ethics and integrity? In family corporations, ask around if the children are as honorable as their parents or grandparents. Planholders like banks should lend money to people, not just to financial statements.

Capacity – Are they competent in their field? Are the investments of the pre-need company in their field of expertise? If they have life plans, do they invest in memorial parks and memorial chapels? If they have education plans, do they own schools? If they have pension plans, do they have long term government securities or high quality real estate? Bankers want to lend money to people who have proven competence and can perform. Thus, a pre-need firm that invested its money in the transport business or in golf courses would be questionable.

Capital – How much money do they need? Where will they use it? Are they clear about the amount of funds needed and where they intend to spend it? Where will they invest their trust fund? DOSRI loans or loans to directors, officers, shareholders and related interests are a red flag for trouble! What are the trustee banks used by the pre-need companies? You like a bank should never take a risk that doesn‚t make sense.

Conditions – What are the terms of the plan you are buying? The terms should be such that the pre-need company is not stressed to pay your benefits. You should be wary if the promise looks too good to be true. Generally the longer the term, the higher the benefit and interest rate. The asset mix will be affected by the term of the plan. Responsible pre-need companies will have a mix of assets that offset the maturities of their liabilities. Less than one year – Treasury bills, stocks and commercial papers; one to five years – Treasury bills, stocks, real estate (ready to sell); five to 10 years – Treasury bills, real estate in growth areas; 10 years or more – Treasury bills, raw land in growth areas.

Given enough time, land prices will go up since we cannot create more land, but our population is constantly increasing. Who knows? Given 30 to 40 years even the Quezon land holdings of CAP could be worth a huge fortune. Maybe then your grandchildren and great grandchildren can avail. Also, investments that offset or reduce the cost of servicing the plans are good. Thus I thought that the Yuchengcos buying and upgrading Mapua was a move in the right direction, because they could offer planholders the opportunity to study at Mapua Institute of Technology. Mapua recently earned over P400 million. They also have investments in Funeraria Paz and Manila Memorial Park to offset their life plan liabilities.

Collateral — What assets are the pre-need companies using to secure their investment? You want a safe investment for your savings. You are not a venture capitalist. The pre-need company must have enough equity to offset some of its liabilities. Banks generally want 10 to 30 percent down payment to buy a house payable over 15 years. How many pre-need companies have equity from paid up capital or retained earnings equivalent to 10 percent of their actuarial reserve liability (ARL)? The ARL is the amount of money you need to set aside today in order to pay the planholders when their plans mature.

Thus if tuition is rising at 10 percent per annum, today’s P300 per unit will cost P780 per unit 10 years from now. However, if the trust fund is earning 12.75 percent from a 10-year Treasury bill, the pre-need firm only needs P240 to make good its obligation. It can keep the surplus of P65 as operating expenses and profit. For a 15-year plan it can keep P93 and for a 20-year, P117. Collateral security is where the character of the officers and directors is essential. A firm may have a solid asset base, but unless these are encumbered or restricted to the trust fund only, these assets can be moved, sold or assigned somewhere else. Pacific’s planholders are convinced that assets meant to secure their investment were diverted or siphoned off, to Lifetime Plans leaving Pacific Plans as an empty shell without enough assets to answer for its liabilities

With all these, does pre-need make sense? For many beneficiaries of education plans, they are glad that CAP, Pacific and Prudential were able to pay their entire tuition fees in the past. Loyola plans has been advertising its early release of educational benefits made possible by its P300 million Trust Fund Surplus. For many OFWs, pre-need is the forced savings or fund that cannot be touched by relatives.

For life plan holders, the funds for the funeral as well as having a memorial coordinator during some of their lowest moments is priceless. Despite sensationalist claims, the fact is tuition costs have only been rising at about 13 percent per annum since 1984. Philippine treasury "Jobo bills" in 1984 paid 43 percent! A pre-need company could have put its money in T-bills and still make a 30 percent profit. Even today with tuition rising at less than 10 percent, a pre-need company paying 13 percent interest for a 15 year loan is getting cheap money. Many years ago Ambassador Alba of Prudential Plans bought a property along EDSA in a sleepy municipality called Mandaluyong, more famous then for its mental care facility. It is now part of SM Megamall, giving Prudential an astronomical return on investment. Loyola bought a beach property now called Munting Buhangin, which has a one-month waiting list, and is now the object of a P500 million joint venture with Landco and Roxaco. Loyola also recently renovated its chapels and crematories in Guadalupe and Marikina while reducing operation costs 15 percent. Philam Plans and Permanent Plans both of which have trust fund surpluses on the other hand invest in long term government securities which yield in excess of 12 percent while committing to their planholders a return of eight to nine percent, giving their firms a three to four percent profit. Also by being part of a large group, planholders have access to insurance imbedded in their plans that costs 30 percent less than they can get as an individual. Furthermore, the interest rates on their deposits are computed based on the largest bank balances, rather than the one to two percent of savings accounts. My monthly ATM service fee is even higher than the interest I get from my bank. If the business model looks great, what went wrong with other pre-need companies?

According to Sen. Mar Roxas, it is the commission and expense ratio. He cited CAP as one company that paid its directors an override on all collections whether the company or the planholders earned money or not. If some pre-need companies as he mentioned are only investing five percent of the funds collected, that means 95 percent of the payment is going to expense and commissions.

Admittedly, pre-need companies have costs such as insurance for planholders who die before their plans are fully paid, and allowances for people who lapse and don’t fully pay their premiums, advertising, administration costs, salaries and commissions, but these costs should be within reason or their plan becomes nothing more than a Ponzi scheme.

The SEC specifies no more than 10 percent commission and 40 percent for administration costs and insurance in its cost model.

How many pre-need firms comply with this directive?

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