GWG's Decade-Long Fraud Started Well Before Beneficient Joined In

By Craig McCann and Regina Meng.

Three Wall Street Journal stories describe alleged diversion of assets at GWG/Beneficient in 2019 and later to entities controlled by its CEO.[1] The WSJ stories mention an SEC investigation into accounting practices at GWG/Beneficient focused on the treatment of intra-company transactions and the calculation of comical "goodwill" Beneficient put on its books as it combined with GWG. In addition to these post 2018 issues, GWG's use of demonstrably unreliable ad hoc mortality studies to fraudulently inflated its revenues and assets from 2013 through 2018 and beyond is worth some scrutiny.

GWG Hides, then Partially Discloses, $179 Million in Fraudulent Revenue and Assets

GWG's December 31, 2018 Form 10-K, filed late on July 7, 2019 after Beneficient executives effectively took control, includes an $87 million reduction in the value of GWG's portfolio of life insurance contracts resulting from a change in methodology for estimating life expectancies.[2] Several places in the Form 10-K, GWG says it is writing down its insurance contracts $87 million and in parens says "net of impact of a change in discount rate". For example, at page 46 of the 2018 Form 10-K, GWG writes:

The implementation of the Longest Life Expectancy methodology required us to take a non-cash charge (net of the impact of a change in discount rate) to revenue of $87.1 million, reflecting a decrease in the fair value of its portfolio of life insurance policies at December 31, 2018. This non-cash charge represents approximately 10% of fair market value of the portfolio prior to adjustment.

GWG includes the $87.1 million negative revenue item as it compares results in 2018 to 2017 in a Table partially reproduced in Figure 1.

For many years, this table included the "Change in life expectancy evaluation" item but GWG inserted the "Change in life expectancy valuation methodology" item for the first time in its December 31, 2018 Form 10-K. These two line items refer to exactly the same issue and were separated solely to facilitate a dramatic understatement of the true impact of GWG partially correcting its prior misrepresented assets and revenues.

These items in the December 31, 2018 Form 10-K should be combined and simply read "Change in life expectancy evaluation": ($91,990,000)



Making this correction would still leave GWG's Form 10-K misleading as it combines the impact of a sharp reduction in the discount rate GWG used to increase revenues with a partial correction of its mortality assumptions.

As we can see in Figure 1, GWG recognized revenues of $14,931,000 in 2017 resulting from changes in discount rates it made in 2017. This $14,931,000 in revenue resulted from reductions of 0.15%, 0.27% and 0.09% in the discount rate GWG used to value its portfolio of insurance contracts and was reported on GWG's June 30, 2018 Form 10-Q, September 30, 2018 10-Q and December 31, 2017 Form 10-K.[3]



In fact, prior the December 31, 2018 Form 10-K GWG filed in July 2019, GWG appears to have always disclosed the impact of changes in the discount rate it used to value its portfolio of insurance contracts on its revenues and assets.

We can estimate the "revenue" GWG created but did not disclose by lowering the discount rate on December 31, 2018 from 10.45% to 8.25% from GWG's September 30, 2018 Form 10-Q at page 16 excerpted in Figure 2 or from its December 31, 2018 Form 10-K at F-20 excerpted in Figure 3.





According to GWG's September 30, 2018 Form 10-Q, a 2% drop in the discount rate adds $78,624,000 in asset value and revenue. GWG's 2.2% drop thus adds $86,486,000 in asset value and revenues.

GWG's December 31, 2018 Form 10-K reports a virtually identical sensitivity to an increase of 2% in the discount rate from 8.25% as its prior Form 10-Q reported for a 2% drop in the discount rate from 10.45%; a 2% increase in the discount rate reduces GWG's asset value and thus its revenue by $78,615,000. GWG's 2.2% drop then adds $86,476,500 in asset value and revenues.

Averaging these two nearly identical estimates we conclude GWG without disclosure added $86,481,250 in asset value and revenues in the 4th Quarter of 2018 by reducing the discount rate it applied to value its portfolio of insurance contracts from 10.45% to 8.25%.

If GWG had not for the first time combined the change in the reported value of its portfolio of insurance contracts in 2019, it would have reported $178,471,250 ($91,990,000 + $86,481,250) in negative revenue and write-down of its asset values due to a change in life expectancy estimates and a $86,481,250 gain due to its 2.20% reduction in discount rate.[4]

We can check this astonishing result by applying the GWG's reported sensitivities to changes in remaining life expectancy in Figure 1 and Figure 2 tables to the change in life expectancies GWG reported with the December 31, 2018 Form 10-K.

GWG's September 30, 2018 Form 10-Q at p. 14 reports a weighted average age of 82.1 years and weighted average life expectancy of 79.9 months.

GWG's December 31, 2018 Form 10-K at F-19 reports the same weighted average age of 82.1 years but a weighted average life expectancy of 93.2 months - the same average age as the Form 10-Q but 13.3 months longer life expectancy.

Returning to GWG's reported sensitivities in Figure 2 and Figure 3, the September 2018 Form 10-Q reports that an increase of 8 months in average life expectancy would reduce GWG's asset value by $102,195,000. Thus, 13.3/8.0 * $102,195,000 = $169,899,188 is a good estimate of the asset and revenue impact of increasing the weighted average life expectancy from 79.9 months to 93.2 months.

GWG's December 31, 2018 Form 10-K reports that a decrease of 8 months in average life expectancy would cause an increase in asset value and positive revenues of $113,410,000. Thus, 13.3/8.0 * $113,410,000 = $188,544,125 is a good estimate of the asset and revenue impact of reducing the life expectancy from 93.2 months to 79.9 months using the Form 10-K sensitivities.

The average of these two estimates is $179,221,656 - just about exactly the $178,471,250 estimated impact of change in mortality derived above using GWG's reported sensitivities and reported change in discount rates.

Table 2 partially corrects GWG's "Results of Operations - 2018 Compared to 2017", December 31, 2018 Form 10-K, p. 51 excerpted in Figure 1.



GWG's undisclosed $179 million write down caused by increasing the average life expectancy GWG used in valuing its portfolio of insurance contracts partially reversed asset value and revenues it had fraudulently accumulated over the previous ten years. GWG created these phantom revenues and asset values over time by applying ever more aggressive mortality assumptions instead of using standard mortality tables.

GWG's Justifications for its Misrepresentations Are Further Misrepresentations.

Without disclosing the $179,221,656 write-down due to correcting its life expectancy assumptions or the offsetting $87,231,656 gain resulting from its 2.2% reduction in discount rate, GWG falsely justifies combining these two items for the first time in the December 31, 2018 Form 10-K with an astonishing word salad.

GWG falsely claims that its dramatic reduction in discount rate from 10.45% to 8.25% was part and parcel of a new life expectancy methodology - the Longest Life Expectancy methodology. The correct way to estimate life expectancy is entirely independent of how cash flows tied to mortality should be discounted.

Moreover, GWG had gradually lowered its discount rate nearly 5% over the prior 6 years to generate ever more revenues and asset value growth. GWG repeatedly described the discount rates and changes as follows.

The discount rate we apply incorporates current information about discount rate applied by other reporting companies owning portfolios of life insurance policies, the discount rates observed in the life insurance secondary market, market interest rates, the credit exposure to the insurance companies that issued the life insurance policies and management's estimate of the risk premium a purchaser would require to receive the future cash flows derived from our portfolio as a whole.[5]

GWG correctly did not mention life expectancy methodology in these discount rate descriptions.

GWG claims the dramatic increase in average life expectancy was due to a new methodology not to a change in "life expectancy evaluation." This new methodology uses the same consulting reports estimating mortality risk of the insured parties as the old methodology but instead of averaging the resulting two life expectancies, takes the longer of the two life expectancies for each contract holder. Same data, slight change in 5th grade arithmetic, results in different assumed life expectancy. GWG is simply changing its life expectancy evaluation. There is no connection between this revision which brings GWG's weighted average life expectancies closer to what would be derived from standard mortality models and the correct discount rate for future cash flows from life insurance contracts.

More to follow

GWG's $179,221,656 devaluation of its portfolio of loan contracts resulted from increasing the weighted average remaining life expectancy from 79.9 months to 93.2 months in one quarter was necessary because GWG's assumed mortality risk was becoming untenably high and life expectancy untenably low. GWG's unrealistic assumptions might have continued to generate phantom asset value growth and revenues except that its realized death benefits were far less than implied by its mortality assumptions. Eventually, GWG's false model-based revenues had to run up against reality as they did in 2019.

Rather than be candid about the $179,221,656 write-off, GWG slipped back in $87,231,656 by dramatically reducing the discount rate without, for the first time, disclosing the impact of this reduction.

We will explain the details of GWG's life expectancy misstatements from 2013 to 2018 which led to the need for the misrepresentations in GWG's December 31, 2018 Form 10-K filed in July 2019 in a subsequent post.

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[1] Alexander Gladstone, "An Asset-Management Merger Ended in Bankruptcy, While Its Architect Got $174 Million", Wall Street Journal, July 29, 2022 at wsj.com/articles/an-asset-management-merger-ended-in-bankruptcy-while-its-architect-got-174-million-11659103557, Alexander Gladstone, "Financial Firm Beneficient Pushed Boundaries Before Bond Program's Collapse", Wall Street Journal, December 23, 2022 at wsj.com/articles/financial-firm-beneficient-pushed-boundaries-before-bond-programs-collapse-11671757459 and Alexander Gladstone, "$2 Billion Default Followed Warnings to Everyone but Investors", Wall Street Journal, July 28, 2023 at wsj.com/articles/2-billion-default-followed-warnings-to-everyone-but-investors-fbf13873.

[2] www.sec.gov/Archives/edgar/data/1522690/000121390019012331/f10k2018_gwgholdings.htm

[3] Found at www.sec.gov/Archives/edgar/data/1522690/000121390017008423/f10q0617_gwgholdings.htm at page 8, www.sec.gov/Archives/edgar/data/1522690/000121390017011623/f10q0917_gwgholdings.htm at page 8 and www.sec.gov/Archives/edgar/data/1522690/000121390018003608/f10k2017_gwgholdings.htm at F-11 respectively. GWG's prior years' Form 10-Qs and Form 10-Ks similarly report revenue resulting from changes in discount rates.

[4] The largest drop in the prior 5 years had been 0.28%.

[5] This representative text comes from GWG's December 31, 2016 Form 10-K at page F-8.