How the Yuchengcos ended up with a failed company, Pacific Plans.

The saga between the beleaguered pre-need company, Pacific Plans Inc. (PPI) and a feisty group of planholders has finally reached a happy ending.

The Parents Enabling Parents coalition (PEP), a group that had been severely critical of PPI and the Yuchengcos, was supposed to go in for another kill. Last July 21, they were scheduled to file a complaint against the trustee bank of PPI at the Bangko Sentral ng Pilipinas (BSP) for allegedly breaching the required arms-length relationship between the two. PEP had always made known its moves to the Yuchengcos through intermediaries in the hope that the latter would give in to their demands.

Last April 13, PPI submitted to a court a rehabilitation plan which it had unilaterally crafted, sparking fireworks as PEP contested the plan in court, the media, and in hearings at the Senate and Congress.

The night before July 21, Manila Councilor Don Bagatsing arranged a meeting between PEP and Ernesto Garcia, PPI’s president.

Bagatsing earlier promised to broker the talks when the PEP agreed not to pursue a protest rally during last month’s launch of his project—the renaming of a street in Binondo from Nueva Street to Alfonso Yuchengco Street.

Early on, PEP and PPI did not have an open communication line. For the first time on July 20, Garcia said cooler heads prevailed, thus the PEP became “part of the solution, not part of the problem.”

The quandary that the Yuchengcos found themselves in can be traced to this fact: they were not hands-on with PPI. They left the company’s day-to-day operations in the hands of trusted professionals.

On the surface, the professionals—specifically the actuaries and executive officers—had been doing well. PPI was a profitable business. Every year from 1995 to 2001, cash and stock dividends equivalent to anywhere between P3 million and P21 million had been declared.

Not long afterward, problems in some of the Yuchengcos’ businesses started to emerge. Not only were the Yuchengcos trying to nullify its P1.78-billion purchase of Bankard (they found out it had lots of bad assets), the credit-card subsidiary bought from another bank, but issues about PPI began to surface, too.

How did a company such as PPI, owned by one of the wealthiest families and one of the most respected tycoons in the country, end up like this?

For the multibillion-dollar-worth Yuchengco Group of Companies, PPI, a subsidiary engaged in the pre-need business, is a drop in the bucket. PPI’s total resources of about P10 billion is peanuts compared to the conglomerate’s total resources of about P250 billion.

That was the time Helen Yuchengco Dee, the most astute among the Yuchengco siblings, was plucked out of retirement and assigned to handle these problems.

Two NEWSBREAK sources familiar with PPI’s financial problems said Dee was “outraged” when she learned what was wrong with PPI.

The issues on PPI emerged when the Securities and Exchange Commission (SEC), at that time headed by Lilia Bautista, became serious in carrying out reforms in the pre-need industry. Bautista said she knew the industry was a “bomb waiting to explode,” if the previous cozy relationship between the regulator and the industry continued. She recalled that a 1999 study commissioned by the Asian Development Bank had pointed out the ills of the pre-need industry.

But the focus then was on College Assurance Plan (CAP), the industry leader for educational plans with more than 780,000 clients.

CAP was breaking all the rules. For one, it was not remitting enough assets to its trust fund, a kitty fund for a portion of the premium payments of plan holders that should be prudently invested so the pre-need company could meet tuition payments when its plan holders start going to college. In 2002, CAP lacked P2.5 billion in its trust fund deposits. By 2003, this leapfrogged to a whopping P17 billion. The trust fund should already have been P25 billion, but it only had P8 billion.

Also, the trust fund was invested heavily in real estate belonging to CAP’s sister companies. This included golf shares and raw land that still needed additional capital to develop before being sold to the public.

Pre-need companies set aside 51 percent of the premiums paid by its customers to the trust fund, which it should turn over to trustee banks. The trustee banks are given a free hand in determining how the money is to be invested. The remaining 49 percent remains with the pre-need company to cover its operational and marketing expenses, including the fat commissions of its sales agents. In case the trust fund is not sufficient to cover the present value of its current and future obligations, the company can dip into its profits to make up for the deficiency.

However, in the case of CAP, the company itself is bankrupt. As of 2003, it had a capital deficiency of P5.4 billion because its reported assets of P18.5 billion fell short of its P24 billion liabilities.

 
Watch List

PPI was second on SEC’s watch list. Its “sins” pale in comparison to those of CAP’s.

SEC saw that CAP and PPI were pushing down the levels for their Actuarial Reserve Liability (ARL), the amount that the trust funds of pre-need companies should meet, otherwise, they are deemed financially unhealthy. By reporting lower ARLs, a company has less pressure to make more deposits.

(CAP used to question the ARL, but the industry association of accountants had already taken the position that both the ARL and the trust funds, for the sake of prudence, should be reflected in the financial statements. CAP’s arguments stem from the fact that trust fund deficiencies reduce company profits. Actuaries—the professionals who make the complex computation of the ARL based on assumptions like increases in tuition and expected yield in their trust fund investments, among others—are supposed to make judgments independently of their employers.)

PPI’s actuaries seemed to have been acting on their own because their financial assumptions surprised even Dee. One way the actuaries pushed down the ARL amount is by using what is called a “termination approach.” It works this way: pre-need plan holders who voluntarily terminate their plan will be reimbursed a certain percentage of the promised benefit. If the premiums have been fully paid, the plan holder can be reimbursed only up to 50 percent.

According to SEC rules, the actuaries’ computation should use the present value of 100 percent of the expected tuition when the child goes to college, not just half of it. Roberto Manabat, SEC’s general accountant, said using the termination approach is not only a way of dodging what is the prudent amount that should be deposited in the trust fund, but also wrongly assumes that plan holders bought the product with no intention of availing themselves of the benefits.

PPI’s actuaries used the termination approach. Like CAP, PPI assumed yields in their trust fund investments that were way too optimistic. For example, PPI’s actuary used 15 to 18 percent as the expected investment yield. Of this, 3 percent is said to be accounted for by the foreign exchange differential in its dollar-denominated Napocor bonds. Still, the 12 to 15 percent assumed yield of the investment instruments is way above the actual performance of the trust funds, which ranged from 5.5 percent to only 10 percent during the period 1999 to 2002.

All these resulted in a need for PPI to deposit P7 billion to add to its trust funds. In 2002, its trust funds were only P8.6 billion, which the SEC adjusted to about P15 billion.

Dee is reported to have sought a two- to three-year leeway to address the deficiency. The SEC agreed because CAP and other companies were allowed to amortize their deficiencies, too.

Evading Obligation?

Fast forward to April 13, 2005: PPI sought the suspension of payments to creditors and submitted a rehabilitation plan to the court.

The SEC was caught off guard by PPI’s move because days before April 13, it continued to coordinate with PPI to hone its proposed programs that it would purportedly implement to deal with the problematic traditional plans. In its response to the court, SEC called the events that led to PPI’S court filings as a “fraudulent scheme to evade its obligation.”

There has been a lot of brouhaha about PPI’s spinning off its fixed-value plans (educational, pension, and memorial) into a separate company, Lifetime Plans, while leaving behind the problematic traditional educational plans with PPI. Sen. Sergio Osmeña III likened this to the practice of “fraudulent conveyance,” which was popularized by American companies RJ Reynolds and Nabisco. It means the assets of these companies were spun off to shove them away from the grasp of the former’s future claimants.

But the loudest cry of “Fraud!” came from PEP whose members were holding on to traditional plans and are some of the 34,000 remaining plan holders of PPI. The 400,000 plan holders with fixed value plans were transferred to Lifetime.

The whole exercise of dealing with the traditional plans started out well. When Dee approached SEC way back in March 2004 to ask permission to spin off the pension and memorial plans, Bautista told NEWSBREAK they approved it because the proposal made sense. “Separating the products into two companies would allow the chance for the memorial and pension products to be saved [from going down together with the problematic educational plans.]”

The spin-off is actually ideal for all pre-need companies because the lines between one product and the next is clear, and the tendency to mix resources will be minimized, thus making it easier to determine if each product can stand on its own. “Anyway, the proposal then was for Lifetime to be a wholly-owned subsidiary of Pacific, so the earnings of Lifetime would still accrue to Pacific,” Bautista said.

More Scrutiny

But after the March 2004 approval by SEC, Bautista thinks that perhaps PPI eventually saw that the educational plans—both the traditional and fixed value—would both go down if left alone. As an indication, in 2004, the trust funds for the educational plans were insufficient by at least P300 million to meet the ARL level. Thus, the excess in the trust funds of pension and memorial products were used to fill the gap. By December 2004, the shareholders deposited P1.5 billion in PPI’s trust funds, thus the almost P1 billion excess in the trust funds of PPI after the spin-off.

From July 2004 to January 2005, PPI was able to spin off all the fixed value products (pension, memorial, and the fixed-value education) into Lifetime, then conveyed its shares to GPL Holdings, which eventually offloaded the Lifetime shares to Exemplar Holdings, which is partly owned by Memnon Corp. All these companies are owned, one way or another, by the Yuchengcos. In other words, a corporate veil was drawn between Lifetime Plans and PPI, with the plan holders from PPI unable to benefit from the earnings of Lifetime—but GPL Holdings would.

While SEC and the parents’ coalition, after having scrutinized the financials of PPI, both insist that PPI is not illiquid now and was not so in the past, and thus has no justification for going to court, Ernesto Garcia, PPI president, told a Senate hearing that their illiquidity would manifest itself in the coming years. Tuition payments, according to data shown by Garcia, will peak this school year and the next.

However, it seems that PPI’s moves have made things more complicated for the company. For one, it has been in an adversarial relationship with SEC and its clients. And PPI opened itself up to more intense scrutiny.

For example, SEC found out about Lifetime’s failure to submit documentary requirements (such as proof of receivables already collected and titles of cars transferred from PPI to Lifetime) that would complete the registration process of Lifetime. SEC eventually revoked Lifetime’s registration.

 
Sharing the Pain

CAP and PPI provide examples of what roads the other pre-need companies also offering traditional plans will take and adopt. In fact, three months after PPI went to court, another pre-need company, Platinum Plans Inc., went the same way. In the first week of July, it sought and got court intervention to postpone the payment of tuition obligations to its more than 37,000 plan holders. It had a trust fund deficit of about P100 million. 

In a country where the savings rate is low (less than 20 percent) and most of the people are not sophisticated investors, pre-need products have become an essential retail financial instrument designed as forced savings for the long term. In fact, the industry’s total assets are worth more than the assets of life insurance companies, and twice as much as the assets in common trust funds, Roberto de Ocampo, president of Asian Institute of Management, said at a recent forum.

“Despite the credibility issues that are crippling the industry, there should be a sober view,” says Jesus Hofileña, president of Philam Plans, another pre-need company. Only 21 percent of the over five million plan holders have bought traditional educational plans. There are other companies that remain financially healthy. Hofileña cites Philam Plans, which did not offer traditional plans from the start, thus was spared from the burden that CAP, PPI, and Platinum now face.

What to do? Industry players often talk of pain sharing—that the company and the plan holders both take a cut in their profits and benefits, respectively. The experience of PPI is instructive. PPI’s “solution” is to offer to pay seven-percent interest from the time the plan was fully paid until availment. But this was not welcomed by the parents, who insist that PPI must settle the present value of what they are entitled to receive in the future.

The July 20 meeting between the PEP and PPI was a breakthrough since both let go of their defensive stances and moved toward co-authoring a settlement. “We both realized it takes two to tango,” says Garcia.

To share the pain, the two have found a middle ground: to use the current cost of tuition as the basis for computing the benefits of all planholders. PPI has also agreed to consolidate Lifetime’s assets back to PPI.

The work of thresing out the details, especially on what schedule to adopt in converting the Napocor bonds to cash, plus the effort of convincing all the other planholders who are not PEP members to accede to the same formula, will keep both PEP and PPI busy in the next days.

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