Insurance and the Plight of Investors & Policy-Holders: Solid Strategy? Pyramid? Ponzi? Or Bubble? {Devil’s Advocate #6}

Madoff-BernieWhen I began the Ponzi scheme I believed it would end shortly and I would be able to extricate myself and my clients from the scheme. However, this proved difficult, and ultimately impossible, and as the years went by I realized that my arrest and this day would inevitably come. I am painfully aware that I have deeply hurt many, many people, including the members of my family, my closest friends, business associates and the thousands of clients who gave me their money” – Bernie Madoff, March 12th 2009

The Business Guru launches another salvo at an issue which appears to require specific interventions

The Business Guru launches another salvo at an issue which appears to require specific interventions

In today’s discourse I will attempt to determine the nature of a well-known Insurance operation in Barbados and to examine the extent to which it represented prudent management based on best practice.
In order to determine the issues, it is important to establish the various definitions and examine the product or products that precipitated the problem.

Unique Premium Annuity Product

It is instructive to examine the product offerings across a particular industry in various jurisdictions. My research suggests that within the insurance sector, there are two main branches: life or general. Within both these branches of insurance, there is a certain homogeneity across jurisdictions. Home insurance is home insurance wherever you may be on planet earth. Similarly, life insurance offerings around the world have a certain familiarity. Rates may be different based on a particularly country’s demographic and other risk factors.

You would also expect to be able to purchase a product that might have been available in Barbados in other Caribbean countries and indeed anywhere in the developed world. That’s where it gets interesting.
I took to the internet to compare this well-known company’s insurance products with similar product offerings in other markets and generally had no difficulty matching their product offerings to similar products from companies around the world. Then I decided to seek out a definition for an EFPA.
According to a document obtained “The EFPA provides guaranteed annuity rates, where you can invest as little as $5000 up to 5 Years and receive payment either monthly, quarterly , semiannually or annually.”

A visit to another well-known Insurance Company website also showed that their EFPA had very similar qualities.

  • Guaranteed Interest Rates
  • Interest Compounded
  • No Surrender Charges
  • No Expense Charges
  • Flexible Premium Contributions

It was interesting trying to find similar products offered by other life insurance companies in the Caribbean or in the wider global community. It proved impossible to find any other examples of similar products on offer by any other insurance company based on the information on their web-sites. There were several examples of various other types of annuities: with flexible and with inflexible premiums with several companies.

Interestingly, there are also several websites across the world that point to the EFPA as “…a solid investment that… Leading Edge Companies have been using successfully. It is a fixed income instrument (similar to a Cash Deposit) that offers some of the Highest Guaranteed Rates currently available. There are no withholding taxes and both the principal and interest are guaranteed. You reap immediate benefits from your premium investment, there are no expense charges and you have the option to receive interest on a monthly, quarterly, semi-annual or annual basis, or you can leave the interest to be compounded. The investor risk is mitigated as it is backed by a statutory reserve fund which at present stands in excess of $1.4 Billion US. This investment has been in existence for over 12 years with an impressive rate of return. In 2004 and 2005 $600 million US and one (1) billion US were invested respectively …” —

Economic Bubble

An economic bubble is sometimes referred to as a speculative bubble, a price bubble or a financial bubble and can be described as trade in high volumes at prices that are considerably at variance with intrinsic values. Put another way, the trade in products or assets with inflated values.

While some economists deny that bubbles occur, the cause of bubbles remains a challenge to those who are convinced that asset prices often deviate strongly from intrinsic values.

While many explanations have been suggested, it has been recently shown that bubbles appear even without uncertainty or speculation. It has also been suggested that bubbles might ultimately be caused by processes of price coordination or emerging social norms. Because it is often difficult to observe intrinsic values in real-life markets, bubbles are often conclusively identified only in retrospect, when a sudden drop in prices appears. Such a drop is known as a crash or a bubble burst. The 2007 Housing situation which affected several countries around the globe may be the best example of a recent bubble while another example would be the so-called dot com bubble which burst in March 2000.

How would a bubble impact on Insurance? Simple. The various companies in the group needed somewhere to invest the funds collected from insurance, pensions and other products. These investments spanned around the world, in such commodities as methanol, forestry, agriculture, oil and gas, spirits and wines, real estate development, broadcast, medical services and marine services.

The housing bubble also had some impact given the entity’s significant exposure within the Florida Real Estate market. Florida was widely recognised as ground zero in terms of the housing crisis and shared this dubious honour with California.

Outside of that, it is also possible for a company to create its own bubble. Here was a company with Caribbean roots, owned and managed by people who looked like most of us and which to all extents and purposes could be seen as doing extremely well.

Managers appeared to everyone to live solid lifestyle, clothed in expensive suits, they drove the best cars, travelled by private jets, and lived in the most luxurious homes. Meanwhile the company was privately held, so even though we could not examine the financials, many rational Barbadians would have been making decisions based on the evidence before them: visibly successful agents and managers.

This in a sense could have created a situation where rational investors were placing a value on investing with the Company that was higher than the intrinsic value of such investments. This would have led persons to invest their entire life’s savings into their products because the only information that was available suggested that everything was solid,

Indeed these persons would normally have pursued a more diversified investment strategy, but like the dot com bubble, everyone “wanted a piece of the company’s success”. And just like the dot com bubble, they were willing to pay a premium for it. In this case it might have been the price of investing so much money that the company had difficulty getting these funds orderly re-invested and indeed may have been forced to make increasingly complex, risky and longer term investments than might have been the case if investors had a more diversified approach.

Pyramid Scheme

Illegal-Pyramid-SchemeOne of the world’s best documented examples of pyramid schemes and their impact on an economy is one provided by the IMF. This article deals with the collapse of a number of Pyramid schemes in the country of Albania in the 1990’s. It is highly recommended reading.

In a typical pyramid scheme, a fund or company would attract investors by offering them very high returns; these returns would be paid to the first investors out of the funds received from those who invest later. The scheme is insolvent—liabilities exceed assets—from the day it opens for business. However, it flourishes initially, as news about the high returns spreads and more investors are drawn in.

Encouraged by the high returns and by showcase investments and ostentatious spending by the operators, still more people are drawn in, and the scheme grows until the interest and principal due to the early investors exceeds the money paid in by new investors. As a way of attracting new investors, a scheme may increase its interest rates, but the larger interest payments soon force it to raise rates again. Eventually, the high rates begin to arouse suspicion or the scheme finds itself unable to make interest payments. When investors try to get their money out, they discover the truth about the scheme, whose demise is swift.

Some of the Albanian companies met this definition exactly: they were pure pyramid schemes, with no real assets. Other cases are more ambiguous. Some of the largest of the companies—in particular VEFA, Gjallica, and Kamberi—had substantial real investments.

During the 1996 elections, several of the companies made campaign contributions to Albania’s ruling Democratic Party. There were also allegations that many government officials benefited personally from the companies.
It could be argued that in the Albanian situation, some of these companies might not have started as pyramid schemes but at some point, most likely in early 1996 (according to the IMF), these companies too became pyramid schemes. When they collapsed, it was clear that their liabilities massively exceeded their assets.

Also of interest was the fact that two schemes held some US$250 million in the banking system. This was the equivalent of 10% of GDP.

When you look at the local situation we certainly see “showcase investments and ostentatious spending by the operators”. Showcase investments would include the petro-chemical investments, iconic investments like historic hotel complexes, iconic spirit brands and housing projects. The spending would include luxery vehicles and private jets.”

Ponzi Scheme

ponzi-scheme-for-dummies1A Ponzi scheme is a fraudulent investment operation that pays returns to separate investors from their own money or money paid by subsequent investors, rather than from any actual profit earned. The Ponzi scheme usually entices new investors by offering returns other investments cannot guarantee, in the form of short-term returns that are either abnormally high or unusually consistent. The perpetuation of the returns that a Ponzi scheme advertises and pays requires an ever-increasing flow of money from investors to keep the scheme going.

The system is destined to collapse because the earnings, if any, are less than the payments to investors. Usually, the scheme is interrupted by legal authorities before it collapses because a Ponzi scheme is suspected or because the promoter is selling unregistered securities. As more investors become involved, the likelihood of the scheme coming to the attention of authorities increases. While the system eventually will collapse under its own weight, the example of Bernard Madoff demonstrates the ability of a Ponzi scheme to delude both individual and institutional investors as well as securities authorities for long periods: Madoff’s variant of the Ponzi scheme stands as the largest financial investor fraud in history committed by a single person. Prosecutors estimate losses at Madoff’s hand totalling $64.8 billion.

charles-ponzi-tmThe scheme is named after Charles Ponzi who became notorious for using the technique in early 1920. He had emigrated from Italy to the United States in 1903. While Mr. Ponzi did not invent the scheme his operation took in so much money that it was the first to become known throughout the United States.

His original scheme was in theory based on arbitraging international reply coupons for postage stamps, but soon diverted investors’ money to support payments to earlier investors and Ponzi’s personal wealth.

A ponzi scheme will begin to collapse under its own weight as investments slow and the promoter starts having problems paying the promised returns. Indeed, the higher the returns, the greater the chance of the Ponzi scheme collapsing. These liquidity crises often trigger panic, as more people start asking for their money in much the same manner as a bank run.

The other way in which a ponzi scheme unravels is normally due to external market forces. In the Madoff ponzi scheme for example, it was the sharp decline in the economy that caused it to collapse. He had successfully steered his scheme through many business cycles up to that point. When there is an economic decline, the level of new investments slow and investors could be forced to withdraw their investments not because of any actualloss of confidence, but simply due to underlying market fundamentals. In the case of Madoff, the fund could no longer appear normal after investors tried to withdraw $7 billion from the firm in late 2008 as part of the major worldwide market downturn affecting all investments.


There is not enough publically available information to reach a definitive conclusion as to whether recent developments within the local insurance industry were just related to regular business cycles or were the result of an economic bubble or whether there were more factors in operation.

The missing information is the actual financial results of companies which were not regulated by either the supervisor of insurance or the Central Bank of Barbados. There has to be something wrong for a regulated company to make investments with another company whose books the public will never see. It is therefore difficult to judge whether investments were sound or whether the regulated companies were just bankrolling the other activities of the group.
Indeed it is possible by a system of loans and advances from company to company to always present clean balance sheets and income statements for the benefit of the regulator while carrying or hiding heavy losses and troubled investments in the financials of private holdings.

It is therefore in everyone’s best interest if there is nothing more than market forces at work to have an open-book policy regarding the accounts of companies in Barbados. This would be an important way to rebuild public confidence in the sector.. Put another way, a failure to be candid with its investors and potential investors will keep companies in what could be described as the chronic phase of this crisis for a verylong time.

It is also in the best interest of the regulatory agencies involved to carry out whatever investigations they must so that they can assure the public of the sector’s company’s safety.

Finally, Government must act on behalf of the public. It is not fair to regular Barbadians to continue in a state of no information regarding a crisis that is already 15 months in the making. The situation has to be regularised so that the rest of the Barbados economy can settle down because the rest of the Barbados economy is waiting to take the lead from how Government resolves the local insurance matters.

And the longer it takes to resolve, the longer the Barbados economy stays in the doldrums.

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