Case Study : Prospect Educational Plan in crisis
Nature and Background of Case:
Educational plans are essentially savings/investment accounts where you put money in, the money is invested in financial and other securities within government guidelines, and your money is supposed to grow over the years and eventually gets paid out to cover a beneficiaries school tuition and expenses. Several years ago, and seemingly out of nowhere, accusations came flying from all directions about pre-need companies. According to the accusations, they were either bankrupt or nothing but a scam, depending on which company you're looking at. And since a large portion of Filipino families relied on these pre-need companies in order to send their children to college, widespread panic ensued the moment these accusations hit the press. Prosepect Educational Plan paid out huge commissions to agents, so that in some cases out of PHP35,000 that a customer paid in, only PHP15,000-20,000 actually went into the “trust fund” that had to grow to pay off the future tuition fees. Prospect Educational Plan sold open-ended educational plans, and that the rise in fees distorted the actuarial assumptions. Holders of this type of plan can go to the most expensive schools but they pay a higher premium. There are two kinds of Prospect Educational Plan educational plan holders: those who are already getting paid for tuition and those who are called “non-availing” mainly because it takes roughly 10 years for them to start getting their benefits from Day One of the plan. Obviously, the availing planholders have the edge. Not so obvious is the fact that every time they get paid, it is to the prejudice of the non-availing. The non-availing outnumber the availing planholders almost 9 to 1. Of the 780,000 planholders of Prospect Educational Plan, only 90,000 are availing. The company claimed that the money that was paid in and invested yielded far lower returns than they had projected, so the double whammy of increased tuition costs, and lower returns, meant they couldn’t meet their promises. This is a very simplified explanation, but the essence of the issue at hand. Forget that the company paid out huge commissions to agents, or to cover administrative expenses, etc. so that in some cases out of PHP35,000 that a customer paid in, maybe only PHP15,000-20,000 actually went into the “trust fund” that had to grow to pay off the future tuition fees. Prospect Educational Plan was brought to its knees when certain government officials of the Philippines, came out of nowhere and publicly declared that Prospect Educational Plan was bankrupt. They questioned the company's use of their trust funds and had the Securities and Exchange Commission or SEC freeze their accounts. Naturally, the families that had subscribed to Prospect Educational Plan at the time were infuriated and began demanding their money back, canceling their subscriptions. This caused further problems for the company, as their reputation was ripped apart in one sudden attack as their potential to sustain their income dwindled. In trying to prove Prospect Educational Plan's bankruptcy, these government officials and the SEC used an accounting principle known as the Actuarial Reserve Liability or ARL to measure PROSPECT EDUCATIONAL PLAN's finances. Under the ARL, Prospect Educational Plan was running at a staggering loss - billions of Pesos in losses, in fact. Using those results, the SEC continued to attack the company - using the numbers he found using the ARL to convince all of Prospect Educational Plan's plan holders to stop their payments. Problem:
Should the ARL be used to regulate pre-need companies? If the ARL had not been used as the formula to calculate PEP's finances, would they still be considered bankrupt? Prospect Educational Plan questioned the SEC for using the ARL on a pre-need firm. The ARL is an accounting principle that determines the immediate liability of a company, normally implemented...
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