Prepaid Legal Case Summary

Case Analysis of Prepaid Legal
1. Prepaid Legal is one of the earliest companies in the United States to market and to sell legal expense plans. The company adopts a cost leadership business strategy, providing 5 basic title benefits (Preventive Legal Services, Automobile Legal Protection, Trial Defense, IRS Audit Protection Services, and Preferred Member Discount) with a membership cost ranging from $10 to $25 per month. Moreover, Prepaid selects several market segments, in which it develops specific plans (Commercial Driver Legal Plan, Law Officers Legal Plan, and Business Owners’ Legal Solutions Plan) to compete.
The key elements of PPD’s business strategy include: * Marketing method * Multi-level marketing strategy
Multi-level
marketing encourages individuals to sell memberships and allows individual to recruit and develop their own sales organizations. Furthermore, this marketing strategy promotes face-to-face meetings with prospective purchasers and has the potential of attracting a large number of sales personnel within a short period of time. * Product and Satellite subscription sales
After the merger with TPN, PPD identified approximately 25 core products to be offered to the company’s sales associates.
With a leaner structure, PPD focuses on continuing and increasing the number of digital satellite subscriptions sold, and thereby increases the value of the TPN communication platform. * The company currently markets Memberships on a closed panel basis, according to which the provider attorneys are paid a fixed fee on a per capita basis. Because such fixed fee payments do not vary based on the type and amount of benefits utilized by the members, closed panel memberships provide significant advantages to the Company in managing claims risk. *
Operation * Computerized management information system
The system automates and simplifies daily work by evaluating benefit claims, monitoring member use of attorneys, calculating amount of claims, and monitoring marketing/sales data and financial reporting records. Furthermore, with excessive capacity, the system enables the company to make significant increase in the volume of business with less than commensurate increases in administrative costs. * Quality control (Evaluation and Selection) * Monitor Survey
The company systematically monitors the delivery of services and the performance of its home office personnel on a periodical basis, insuring the quality of its services. * Selection of provider attorney
Each member of the provider attorney firm rendering services must have at least two years of experience as a attorney, unless the Company waives this requirement due to special circumstances such as instances when the attorney demonstrates significant legal experience acquired in an academic, judicial or similar capacity other than as an attorney.
2.
The major problem with the third quarter announcement is the inconsistency resulted from PPD’s increasing revenues and EPS and its decreasing cash flow. Although EPS increased 50% and the company met the expectation of Wall Street, cash flow from operations decreased $379,000, or 7%. Investors may perceive this inconsistency as a signal of manipulation or fraud.
The cause of this problem was PPD’s accounting method for advanced commission, in which commissions are paid to sales associates before premiums are collected from members. When the 134,725 new memberships were sold during the third quarter of 1999, the company paid a great deal of advance commissions to its sales associates. As a result, the free cash held by the company decreased significantly. Also, by classifying these business expenses as assets, it’s possible that PPD’s earning might be overstated. Moreover, another issue worthy of mentioning is the retention rate of sales associates.
3. One alternative method is to expense commission cost as it occurs, rather than capitalize commission as assets. So we cut all the net capitalized commission in assets, and expense the membership commission immediately. Then the earning for the third quarter is estimated as
follows:
Monthly premium: $26
Commission payment for three years (25% of premium): $ 26*12*3*25%=$ 234
In the 3rd quarter, the company added 134,725 new members, thus, commission paid for the third quarter of 1999 is $234*134,725=$ 31,525,650, as a result, earnings before taxes is $15,186,000-31,525,650+9,819,000=$-6,520,650

Another method is to adjust the commission amortization period because it’s not guaranteed that customers will keep the policies for three years. Current amortization period is 3 years, so re-evaluation for this period might be necessary to shorten this period.
4. The computation above is quite conservative, which recognizes expenses immediately as new membership incurs although no revenue is incurred simultaneously. Although this method matches better with the cash flow status, it is a worse indicator for earnings.
5. PPD should take actions to rebuild investors’ confidence. For example, PPD should conduct press release to explain why the 3rd quarter earnings increase while operating cash flow decreases. There is no manipulation of the statements figures. PPD should also emphasize to investors about their focus on sales force, which will boost long-term revenue and growth.
6. We’ll seek information from PPD’s subsequent press release and SEC filings in-depth information about why * How long will the customers keep the contract? What’s the average period premium paid by most customers? * What’s the average retention rate of the sales associates? It’s related to the evaluation of the ‘charge-backs’ if customers cancel the plans within 3 years. * Further information about future stock repurchases. * Explanation about the current accounting method in commission advance, and why they threat certain business expense as assets.