It’s Lifemark…But Not As Expected
Posted by robin in Financial Articles Thursday March 18, 2010 11:24 am
This is intriguing…
Keydata is a drama with a second act.
Perhaps it will be more captivating than the first.
Act I saw Keydata Investment Services (KIS), a UK-based creator of structured investment products, closed down by the FSA in June 2009.
Keydata investors were among those ripped off when their Luxembourg-based fund was mysteriously liquidated in the mayhem of the financial crisis.
This was no mean feat as the assets in question are not renowned for their liquidity. It’s not everyone who wants to buy a second-hand American life insurance policy and the few that do tend to take their time over the purchase.
As such, £280m went walkies, £100m odd belonging to British Keydata savers.
After some deliberation, the British investor’s safety net – the Financial Services Compensation Scheme – defused a brewing uproar, with outraged from the Daily Mail leading the charge, and agreed to foot the bill.
The finger of blame pointed to a fugitive British businessman, David Elias, holed up in the offshore tax haven of Labuan, Malaysia. Elias is since reported dead - timely, if controversial to the end. A single manservant bore witness to his demise reported the Guardian.
Subsequent reports suggest the missing loot may have found its way to Brazil and bagged 400,000 acres of Amazonian rainforest.
While Elias was the villain of the piece, Keydata’s image was shattered along the way. Botched ISA listings, product errors and marketing literature that was somewhat economical with the actualite all came to light as its business entrails were dragged into public view. It was a sorry end to a business, which a decade ago, once attracted FTSE 100 private equity company 3i Group plc. as a significant investor.
In due course, Keydata’s appointed administrators, PwC, sorted out the mess.
Or, so we thought…
The intermission was rudely brief.
Only six days after Act I ended, the curtain rose on Act II.
On 13 November, the FSCS announced a bail out. HMRC chimed in it would not chase unpaid tax and investors had not lost their ISA allowance.
On 19 November, 2009 the Luxembourg regulator, the Commission de Surveillance du Secteur Financier (CSSF), announced it was placing Lifemark in ‘provisional administration’ for an initial period of three months and appointed KPMG’s Eric Collard to find out what was going on.
So what is Lifemark?
Lifemark is the up and coming star of Act II…and for British savers, its regulator and compensation scheme a much bigger deal.
Act I - featured a £280m fund with £100m odd of British investors’ money.
Act II - features a fund of an estimated £350m, 95% of which is British investors’ money. It also has four times the number of investors, some 23,000.
As of the end of 2008, Lifemark had assets of €461m (£419m) – including €262m life policies plus €100m cash – but subsequently would have received the proceeds of two more tranches in the first half of 2009: Defined Income Plans 7 and 8, which closed on 30 January and 17 April respectively prior to the plug being pulled in June.
At this point it is worth noting the difference between the value of the fund today and what it should one day be worth. The £350m fund owns life insurance policies that should eventually stump up $1.35bn (around £900,000 currently) when the last American life finally pegs out. Therein, it is hoped, lies the investor’s final profit.
Publicity on the subject seems sporadic. Perhaps this is less newsworthy. In Act I the fund assets were stolen and the villain was identified and outed - an easy to understand story with beginning, middle and end.
Act II is less straightforward. The assets exist. It’s just now they evidently aren’t as safe as PwC once pronounced.
Getting into the fund business…
Keydata’s raft of structured product launches backed by life settlements were all invested in Luxembourg domiciled funds, a fact hard to detect in their early marketing literature.
Initially, for the first three Secure Income Bond launches SLS Capital SA, was entrusted with the money. Ultimately a bum choice as we know now.
By the time Secure Income Bond 4 was rolled out, KIS had established its own Luxembourg fund operation to do the job, hence the creation of Lifemark SA in January 2006.
Its purpose was as a special purpose vehicle to issue publicly-listed corporate bonds, which is what investors bought. These in turn would be invested in American life insurance policies. The shareholders are listed as Dutch foundations and KIS CEO Stewart Ford was both a director and understood to control the company.
Against the initial three tranches of money invested via SLS Capital. Lifemark was the recipient of 35 tranches. According to PwC:
Secure Income Bond 4
Secure Income Plans 1-12 and 14
Defined Income Plans 1-8
Income Plans 1-12 and 14
More tranches, more dough.
So it’s a bigger fund. So what? The assets are safe. PwC said so.
They did. But they were left scrambling for answers on 19 November 2009 following an announcement from the CSSF, the Luxembourg regulator. Lifemark was put into ‘provisional administration’. PwC administrator Dan Schwarzmann commented in a press release issued on 20 November 2009, the day after the news broke:
“…I am endeavouring to talk to Lifemark at the earliest opportunity so that I can provide investors with as much clarity as possible.”
Skipped Lifemark income payments also had Shwarzmann guessing 10 days later:
“Over the last few weeks, Lifemark has not been making the income payments due to investors. We have been repeatedly assured by Lifemark that this is due to administrative issues and have advised investors accordingly.”
Given PwC were also auditors to the Lifemark fund, it seems curious to the observer they have been so consistently behind the curve. Does Lux not speak with London?
Subsequently, in 2010, the CSSF suspended the listings of Lifemark securities from 1 February and extended KPMG’s involvement for a further six months, taking us to mid-August 2010.
By 2 March, 2010 the game was up. Lifemark declared default and announced it was working on a restructuring. The new deal is not an income plan but a zero income plan and with no secondary market in which to offload, investors will likely be bound to stay the course. Notices are coming through in batches according to when each issue hits its default date, but, in effect, all Keydata savers counting on income have been left high and dry.
The £350m question
What is the fund worth today?
The answer is of acute interest to legions of investors and will determine what they can expect to get back from this investment and when.
Rachel Irving, FSA enforcement officer, offered an insight when she warned of a problem brewing in a witness statement connected to a legal challenge from Ford over the regulator’s seizure of a computer server belonging to another of his businesses, Fieldglen Ltd. According to a Citywire report Irving noted:
A “predicted liquidity gap and Lifemark’s proposal for dealing with it indicate a real risk of problems at Lifemark.”
The article continued:
“Although Lifemark’s $1.3 billion of life settlement assets are ultimately thought to be sufficient to meet its obligations, the 23,000 investors with £350 million in Lifemark could face delays in payouts in 2012-13.”
The first bonds were due to pay out this spring, and as at the end of 2008, the fund was due to repay €461m to investors between 2011 and 2014.
A report in the Mail later in the month, February 27, was gloomier. They claimed they had learnt a “severe shortfall” is predicted in the fund. Their sources proved credible just three days after predicting investors’ income was expected to stop during the month, it did just that when Lifemark announced default.
In doing so Lifemark revealed it was necessary to “apply the remaining cash available to payments of insurance premium under the existing policies in the portfolio rather than using the cash available to make interest payments under the bonds”.
Marketed with a popular high yield income option, in the cold light of day, the investment logic to these life settlement-backed bonds looks somewhat perverse.
Typical vanilla income funds buy assets that yield some form of income such as dividends, coupons, rent and interest, from which to pay investors. This fund turned that notion on its head. It offered bumper income yields on fund assets that not only yield zippo by way of income they actually cede it ie you have to pay out to keep them viable. Anyone who’s ever bought a life insurance policy knows what happens if premiums go unpaid.
And the expense ratio is..?
Such a promise relies heavily on the sums being right, otherwise expenses drain fund liquidity and solvency issues arise. One estimate has it the fund was shelling out over £5m ($8m) a month in expenses – principally premium payments, policyholder income and commission to intermediaries (subsequently redirected to pay PwC).
Excuse the blizzard of numbers that follows but the point it gets to is a significant one.
Lifemark, reporting in euro, paid out €28m in interest expenses in 2008 and €21m in 2007.
In addition to premium payments, there are other costs. This fund was not short of them. Operating expenses in 2007 and 2008 weighed in at €27.5m and €22.8m respectively. 2008 cost is split between €15m “other operating expenses” and €12.5m “amortization prepaid expenses”, relating to the initial issuance cost of the bonds.
“Expenses had a massive detrimental impact on this fund” says one close to the action who adds a condemnation of the “outrageous” distribution agreements in place.
This then presumably includes the supporting cast, amongst them: investment manager Meditron Asset Management, premium payment administrators, Montage Investment Group, accountants Deloittes, as well as advisers to the fund, Luxembourg registered Tandem Partners SARL. The latter causing the FSA, not to mention investors, further dismay when it found out Stewart Ford had been paid £4.2m via Tandem between 2007 and 2009, and not the £904,500 it had thought.
Then reflect a moment on the currency complexities such a fund presents. Sterling investors buy into a euro denominated fund which invests into dollar assets. Eventual wind up reverses the process. In addition to these , currency deals were done in Canadian dollars, Swiss francs and Swedish krona.
As such, currency fluctuations pose a significant risk to promised investor returns, so you need a hedging operation to neutralise the impact. This is a further cost and, in itself can be risky. (A point made in the 2008 management report along with notice of other risks. This extensive notice did not appear in 2006/2007.) Lifemark included Societe Europeenne de Banque, a Luxembourg-based private bank, in the task.
As at the end of 2008, they had booked an “unrealised” forex loss of €79m on pretty chunky sterling and dollar contracts weighing in at £318.5m and $572m. The position is open ended and remains open. The loss is understood to have narrowed somewhat since though remains significantly in the red. It is weighted towards a recovery in sterling.
Another item of note was a mishap in 2006 when €7.7 million was reported lost in “transferable securities”.
This writer is no accountant but the accounting “equalisation provisions” are baffling to the layperson and, in the circumstances, raise further enquiry.
They are explained as losses in various forms (sales, default, lower market values or loss) which may cause a reduction in the value of the bonds. “Such short falls will be born by the bondholder in inverse order of the priority of payments,” it warns. This sounds like a cost but curiously appears as Income of €43m on the 2008 P&L.
It is glaring now is that investors have no idea what this fund costs. Operating costs at £25m (€27.5m) in 2008 on the projected final value at that time of $964m (approx £641m presently) suggests a fund with annual expenses approaching 4%. Pricey and when more legitimately set against the present £350m fund value…well, ruinous.
Add in your interest payments and soured forex and securities trades and we start to see where the Mail gets its “severe shortfall” from.
Would a UK investor know this? No. Expense ratios routinely available on vanilla collective funds – unit trusts, OEICs etc - go undisclosed when they come wrapped up in the mystique packaging of a ‘structured product’.
Taking Defined Income Plan 5 as our sample, the product brochure provides little detail under the ‘Charges’ section in the small print. The plans are designed to be held for the full term it says, early encashment will prompt a one-off £150 + VAT and crucially “all charges are reflected in the terms offered”. Ie they’re not telling. It also warns its charges may rise for any cost inducing regulatory changes. Er, transparency anyone?
The main problem
In a nutshell, they have got their sums wrong…
Keydata developed a model and it hasn’t worked out.
“Policyholders are not dying fast enough,” was the blunt assessment from FSA enforcement officer, Rachel Irving.
Keydata investors own a bunch of second-hand American life insurance policies. This is a relative novel, fashionable but not uncontroversial “asset class” which has been touted for its virtues in providing investment returns that are non-correlated to conventional financial market investments.
A life settlement fund collects a return on its investment when the Americans on whom they own insurance policies, die. It’s not for everyone: “ghoulish” snorted Private Eye in its recent censure.
The principle risk is the one that has materialised. Your lives assured don’t die fast enough. That costs the fund more premium money and has a detrimental knock-on effect for investor returns. Private Eye warns:
“Americans are living longer than actuarial tables say they should… Just as with toxic sub-prime derivatives, “death bonds” are reliant on computer models reliant on the past when the future may be a very different place. Some see ‘death bonds’ as the next securitisation time bomb.”
In the Lifemark fund at the end of 2008, there were 305 policies with a total life assurance value (ie benefit on death) of $963m and 10 people had died yielding $35m in life assurance proceeds. One close to the scene says the sums were done on the assumption of 30 deaths a year and have only been averaging around 10.
At the end of 2008, that was what was recorded, just 10 deaths, and the payout on one was lingering following a legal challenge from the spouse of the deceased. However, the average age in the portfolio is 82 and unconfirmed reports claim as of November 2009, the number of deaths had increased to 40. It may yet work out, given time.
Investment Manager – Walter Gerasimowicz of Meditron Asset Management – wrote in his 2008 year-end report:
“Investors should be pleased with the performance of the portfolio to date, as the Lifemark portfolio has achieved positive returns in each of the past 30 months.”
Exactly what is meant exactly by “positive returns” is hard to fathom in hindsight given the death rate was lagging badly and threatened future positive returns. It also makes an observer wonder at how management could make the claim of superior performance in the 2008 accounts:
“Lifemark’s approach has lead to the development of proprietary models and protocol which has allowed us to outperform other participants in the industry consistently…”
Particularly, given a paragraph later the management report goes on to inform that steps are being taken to arrange credit for possible liquidity issues as €461m owed to Keydata investors, falls due:
“Lifemark views the expected income from the life settlement portfolio as sufficient to meet all expected obligations. Expected drawdowns of a credit facility may be necessary in years 2011-2014 as a temporary solution while the Lifemark Portfolio seasons. We view those periods where cash is needed to temporarily fund liabilities, as manageable.”
As euphemisms go, “seasons” takes some beating.
Ragin’ regulator
The FSA appear hopping mad and reports indicate any relationship with Stewart Ford has broken down following accusations he tried to mislead investigators. They were left distinctly underwhelmed also by management proposals to plug liquidity shortfalls with new money from investors. Their fury is stoked by impotence and embarrassment - KPMG and HSBC first served warning in 2005 and KIS management have effectively run rings around their jurisdiction.
The FSA’s failure here was acknowledged in a recent speech from departing CEO, Hector Sants. He gave notice that, in future, the regulator will no longer behave like some bored fire officer playing pool in the station canteen while awaiting a call out for the next house blaze. It will instead actively promote fire prevention:
“We will now seek to proactively intervene earlier in the product chain to anticipate consumer detriment and choke it off before it occurs.”
A good thing too, as the KIS operation effectively sucked offshore more than half a billion quid from British savers. KIS administration and marketing operations were the only activities carried out in its jurisdiction. Everything else is out of the regulators reach.
Money went to Luxembourg, then on to America to buy life insurance policies. The controller of SLS Capital was based in Labuan, Malaysia. The KIS chief executive relocated to Switzerland. Lifemark itself is owned by Dutch foundations and KIS had another operation in the Isle of Man, domiciled in Caymans. One time sales director and polo enthusiast, Mark Owen is reported to be abroad.
The only thing in the FSA’s lap now is 23,000 aggrieved investors, not to mention their advisers, wanting answers. No wonder they’re stroppy.
Meanwhile, life goes on. Advisers are looking at £440 a head to pay for the Act I losses with possibly more to come. PwC are out of pocket millions in fees. In January 2010, Credit Suisse lent KIS UK £3.2m to maintain a pulse after the Lifemark commission tap was switched off. In February, the managing director of their Life Finance Group, that handles life settlement business, left for another firm.
Ex-employees of KIS UK, have regrouped at Arbuthnot Latham and since opened up shop in the structured product market as Gilliat Financial Solutions. The Keydata Income Property Bond is comprehensively bust and the Isle of Man operation, set up in April 2009, is now likely to wind up following reports the £6m fund bought a £3m of worthless SLS Capital units.
Note, if you have investments in Luxembourg, the compensation limit is a modest €20,000. In sterling, that’s around £18,200 at time of writing, against £50,000 in the UK.
As for investors in Keydata’s Lifemark-issued bonds they nervously await clarification from KPMG’s imminent re-structuring plan. Given a fair few are in their senior years themselves, it’s a touch ironic they may now effectively in a mortality race with the very individuals on whom their investment depends.
The last ones standing, win. Ghoulish indeed.
PS
The Lifemark 2008 annual report can be accessed here.
For a small fee, earlier years can be accessed here here.
The real reason Keydata failed..?
Posted by robin in Financial Articles Monday June 29, 2009 2:00 pm
Satirical magazine and admirable scourge of the rich and powerful, Private Eye, invariably refers to the Financial Services Authority (FSA) derisively as the Fundamentally Supine Authority.
Post credit crunch, this perception may have passed its sell by date as the chastened UK regulator is reorganised and reinvigorated under the new leadership of Lord Turner.
The recent case of Keydata Investment Services Ltd gives cause to wonder. This regulated investment firm was forced into administration by the FSA on June 8, 2009.
A history of success
On the face of it this seems a highly successful business with a canny knack for giving consumers what they want. The 30-40 suitors vying to buy the business adds credence to this view.
So why didn’t the FSA like this business? And what went wrong?
Well, let’s start with a little history…
Keydata was started in 1997 by Stewart Ford to provide investment information to IFAs. The business really took off in 2001 when Keydata Investment Services (KIS) was established. This business for the most part created and administered structured products for retail investors. Between 75-80% was on behalf of third parties such as RBS, HSBC, Skandia, Blue Sky Asset Management and Morgan Stanley and the balance was their own products.
Structured products have been popular sellers with cautious retail investors as they offer both a return and capital security (up to a point) over a fixed term, typically 5-7 years. A backdrop of bank failures, economic upheaval, and interest rates at a three hundred year low, has prompted nervy investors to pile in. Even after many lost money following the Lehmans failure, where the investment bank acted as market counterparty for a range of structured products.
Such favourable conditions helped KIS increase turnover over 50% in the past two years to £15.7m. Staff numbers increased too to help administer it from 60 in 2006 to 95 in 2008. By the time PwC was appointed it boasted 85,000 investors and £3bn under management with the directors expressing “confidence” in the future outlook for the business.
In spite of this expansion the company had managed to pay off £2.9m long-term debt in the preceding two years. In October 2006 it paid £1.2m of a £1.85m debt to 3i Plc. The £650,000 balance was waived as an inducement to early repayment by the FTSE venture capital firm.
More recently it paid off a final £400,000 to leave the company debt free, not bad in the teeth of a severe recession and at a time when financial services businesses generally are suffering.
As at its latest accounts to 30 September, 2009, prepared by BDO Stoy Hayward, the company had £3.4m cash and current assets exceeded current liabilities by some margin.
FSA pounce on tax trouble
So how does a debt free company with cash in the bank get brought down?
Well, it turns out the FSA was conducting an ongoing investigation into the company and when it discovered it had a tax problem with HMRC, it stepped in.
What triggered their probe and how long it had been going on prior to their taking action is a mystery. It had managed to avoid the obvious banana skin of having used Lehmans as a market counterparty unlike competitors such as NDF and Arc, so was not tainted by its failure.
The tax problem was caused by KIS’s own in-house products. Some appeared to fall foul of the ISA rules reported the FT on June 9. They had not been properly listed on the Luxembourg stock exchange, a core requirement, so did not qualify as tax exempt. SLS Capital, was hired by KIS to arrange this for them. Who screwed up here is unclear but the ultimate HMRC bill lay at KIS’s door.
The total investment sum caught in the debacle has been estimated at £200m. Though Dan Schwarzmann of PwC, the appointed administrator, chose his words carefully when he told the FT Secure Income Bonds 1-3 did not qualify for ISA status, and other plans which “may be impacted” include the Defined Income Plans 1-8, and Secure Income Plan 1-12 and 14.
A Keydata source disputes the total putting it at about between £80-100m and maintains only “a couple of products weren’t listed”. In addition, the tax bill they say was a good deal less than £5m. The company had agreed a “simplified voiding”, whereby bonds are back-listed, and a tax take between £700,000-£2.5m had been agreed.
Given the strong financial position of the company, it would appear to have been able to meet this cost with room to spare. In addition, the directors had allegedly built up an external contingency fund with up to £6m available.
Not good enough said the FSA and it was declared “insolvent”.
“…a product development issue…”
If this doesn’t quite seem to add up, what else might have been the problem?
Well, a good number of KIS’s own structured products were invested in a relatively novel and not uncontroversial asset, a portfolio of American traded life policies aka life settlements. Is the FSA uneasy with these investments for structured products sold often to relatively unsophisticated investors? A comment from the CEO of one of Keydata’s client asset management companies, Blue Sky, in Money Marketing offers an insight:
‘Blue Sky chief executive Chris Taylor said: “This is not a structured products event. This is a product development issue about life settlements. Life settlements never were and aren’t a structured product even when they’re issued by a structured product provider.”’
If Mr Taylor is right, Catalyst Investment Group Ltd is likely to be reviewing their future structured product plans. They too have offered similar life settlement structured products with their Arm Assured Growth and Income Plans.
Suspect sales strategy
A further report on June 18 from Money Marketing disclosed the FSA has long been worried about structured products and that Keydata’s sales relationships with IFAs was ‘at arm’s length and not close enough’.
This was of particular concern in relation to outbound telephone sales practice on complex structured plans linked to traded life policies. The concern was whether customers would really understand what they were buying if they were not sitting down in front of someone.
KIS had evidently aware of this concern and made moves to address it by deploying regional sales staff last October.
“Fat Cat” greed..?
Another question mark surrounds the directors. Comments such as “loss of faith” and “lack of confidence” have surfaced. Although turnover had been going up profits had slumped from £2.4m in 2006 to £988,000 in 2007 and just £1,414 in 2008 and directors’ remuneration had skyrocketed. The three directors paid themselves £7.8m in the past two years, with the highest paid pocketing almost £2m. A Citywire report exploited the City fat cat image with the headline ‘Keydata director’s salary increased eight fold in three years’.
In their defence, it is worth remembering the business was growing, had paid off all its long-term debt, written down a dud £1m loan to Fundworks Ltd to nil and still had £3.4m in the bank. It had created a further 35 jobs in the past two years. Furthermore, the directors had built up this private business from nothing paying themselves much lower salaries in earlier years.
Some of the more recent and much higher remuneration is alleged to have gone into the contingency fund. Also, the running of the business appears to have been sound given a mere day after going into administration, PwC judged the business “fit and proper” to service its £3bn in assets. The assets themselves appear to be safe having been successfully ring-fenced against such an eventuality.
Not too shabby in the teeth of the worst downturn most can remember.
A further cause for eyebrow-raising may have been the fact that founder director and majority shareholder has become a Swiss resident. Stewart Ford owned 53.4% of Keydata UK Ltd, the holding company for KIS. Did the combination of rapidly inflated remuneration and tax haven residency raise hackles with the authorities?
Whether FTSE venture capitalists 3i saw these risks coming down the track we don’t know. They appear to have exited some time prior to its demise, having been repaid their money (albeit at a 35% discount) and hold no shares in the holding company, Keydata UK ltd, although they are listed on the register.
Would a discreet deal have been better?
FSA spokeswoman Abi Jones told FT Adviser on June 11: “We would not make the decision to put a regulated firm into administration if that was not to secure the best possible outcome for investors.”
Here’s hoping but it seems a lot of distress for the investors concerned.
Wouldn’t a sale on the quiet have been the best possible outcome? After all, this “insolvent” business has seen no shortage of suitors vying for its talents with the likes of Morgan Stanley expressing interest alongside smaller investment boutiques such as Premier Asset Management, Meteor Asset Management and Jubilee Financial Products. A deal is said to be imminent.
Why further disillusion investors attracted to what they believed to be “lowish risk” investments? A quiet sale engineered by the FSA could have ensured continuity and avoided further damaging public confidence in savings products, surely never at a lower point.
The real problem…
The FT’s Matthew Vincent suspects a new macho culture and reported the FSA “even use the language of The Sweeney”, a hard hitting ‘70s TV cop show, these days. The Feds nailed Al Capone on taxes and that’s what the FSA has done with Keydata, he concludes.
That may be what nailed them but the real reason for their demise looks like something else.
It looks like serious regulatory concern at a perceived mismatch: a mismatch of inadequately selling complex investment products, backed by exotic assets, to predominantly unsophisticated investors.
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