Equity Funding Scandal

THE EQUITY FUNDING Corporation of America was a life insurance company capitalized in 1960 with a few thousand dollars, which by 1973 claimed assets of $1 billion making it the first white-collar crime to break the billion-dollar mark. The Equity scandal illustrated there is almost no limit to the dollar amounts that can be fraudulently obtained and can go undetected for over a decade.

Equity fabricated non-existing assets and sold them. To understand how the scheme worked requires noting certain practices in the insurance industry. Insurance companies buy and sell policies they issue to other companies, which is called reinsurance. This spreads risk evenly over all companies so, in the event of multiple claims, they do not fall too heavily on one insurer. For example, consider that one company wrote all of the homeowner policies in Florida and a hurricane caused billions of dollars in claims. It would endanger the company's financial stability to pay them all. But if many companies share the risk, each pays a portion of the large number of claims. The same practice applies to life insurance.

Knowing there is a ready market for life insurance policies among other insurance companies, the founders of Equity Funding forged policies by writing insurance on nonexisting people or “fence posts.” Secretaries made up fake names, ages, medical histories, addresses, and premiums on forged applications. When several thousand applications were forged, they were assigned policy numbers and entered into the company computer. These policies were sold to other insurance companies in routine reinsurance transactions for large sums of money. The company buying the policies could expect to collect premiums on some policies for decades.

Of course, in a month the first month's premiums are due and will have to be forwarded to the company that bought the policies from Equity. In the meantime, more fake policies were issued and sold to another company, and the first month's premium due to the first was paid from funds received from the second. Money from the sale of the fake policies went into Equity's account. Since the price paid by other insurance companies was so much higher than the premiums due on earlier policies, Equity's cash assets skyrocketed.

With massive revenue flowing in and only a few employees needed to carry on the fraud, Equity began to legitimize operations by hiring real agents. With the ever-increasing flow of money from forged policies, Equity could offer insurance products that no other company could match. Offers included[Page 294] life insurance with a cash-value so high, the insured paid virtually no premium for coverage. Sales volume naturally increased giving Equity an ever-expanded market share, causing its stock price to go up on average 166 percent annually. Such a well-performing stock attracts investors. Labor unions invested pension funds and colleges and universities added Equity stock to their endowments. Tens of thousands of private investors made substantial investments.

As Equity sales and stock prices advanced, other companies became worried. They had more agents than Equity, yet they could not write that much insurance. Some reasoned that if given a chance, Equity policyholders would also buy their products. Taking names and addresses from policies that they purchased in reinsurance deals, the companies mailed literature offering Equity policyholders their products. When all offers came back from the post office marked “address unknown,” the fraud was exposed.

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