10-Q 1 d542804d10q.htm FORM 10-Q Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-Q

 

 

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2013

or

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number: 001-35064

 

 

IMPERIAL HOLDINGS, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Florida   30-0663473

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

701 Park of Commerce Boulevard—Suite 301

Boca Raton, Florida 33487

(Address of principal executive offices, including zip code)

(561) 995-4200

(Registrant’s telephone number, including area code)

 

 

Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer   ¨    Accelerated filer   ¨
Non-accelerated filer   x  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

As of August 13, 2013, the Registrant had 21,237,166 shares of common stock outstanding.

 

 

 


Table of Contents

IMPERIAL HOLDINGS, INC.

FORM 10-Q REPORT FOR THE QUARTER ENDED JUNE 30, 2013

TABLE OF CONTENTS

 

     Page No.  
PART I — FINANCIAL INFORMATION   

Item 1. Financial Statements (Unaudited)

     5  

Consolidated Balance Sheets as of June 30, 2013 and December 31, 2012

     5  

Consolidated Statements of Operations for the three months and six months ended June  30, 2013 and 2012

     6  

Consolidated Statement of Comprehensive Income (Loss) for the three months and six months ended June 30, 2013 and 2012

     7  

Consolidated Statement of Stockholders’ Equity for the six months ended June 30, 2013

     8  

Consolidated Statements of Cash Flows for the six months ended June 30, 2013 and 2012

     9  

Notes to Consolidated Financial Statements

     10  

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

     38  

Item 3. Quantitative and Qualitative Disclosures About Market Risk

     61  

Item 4. Controls and Procedures

     63  
PART II — OTHER INFORMATION   

Item 1. Legal Proceedings

     63  

Item 1A. Risk Factors

     65  

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

     66  

Item 3. Defaults Upon Senior Securities

     66  

Item 4. Mine Safety Disclosures

     66  

Item 5. Other Information

     66  

Item 6. Exhibits

     66  

 

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Table of Contents

“Forward Looking” Statements

This Quarterly Report on Form 10-Q contains forward-looking statements that are subject to risks and uncertainties. All statements other than statements of historical fact included in this Quarterly Report on Form 10-Q are forward-looking statements. Forward-looking statements give our current expectations and projections relating to our financial condition, results of operations, plans, objectives, future performance and business. You can identify forward-looking statements by the fact that they do not relate strictly to historical or current facts. These statements may include words such as “anticipate,” “estimate,” “expect,” “project,” “plan,” “intend,” “believe,” “may,” “will,” “should,” “can have,” “likely” and other words and terms of similar meaning in connection with any discussion of the timing or nature of future operating or financial performance or other events. These forward-looking statements are not historical facts, and are based on current expectations, estimates and projections about the Company’s industry, management’s beliefs and certain assumptions made by management, many of which, by their nature, are inherently uncertain and beyond the Company’s control. Accordingly, readers are cautioned that any such forward-looking statements are not guarantees of future performance and are subject to certain risks, uncertainties and assumptions that are difficult to predict. Although the Company believes that the expectations reflected in such forward-looking statements are reasonable as of the date made, results may prove to be materially different. Unless otherwise required by law, the Company disclaims any obligation to update its view of any such risks or uncertainties or to announce publicly the result of any revisions to the forward-looking statements made in this report.

Factors that could cause our actual results to differ materially from those indicated in our forward-looking statements include, but are not limited to, the following:

 

   

our results of operations;

 

   

continuing costs associated with the USAO investigation, SEC investigation, derivative actions, the class action lawsuits and similar matters;

 

   

adverse developments, including financial ones, associated with the USAO and SEC investigations, derivative actions or class action lawsuits, other litigation and judicial actions or similar matters;

 

   

our ability to continue to comply with the covenants and other obligations, including the conditions precedent for additional fundings, under our revolving credit facility;

 

   

our inability to obtain financing on favorable terms or at all for life insurance policies that have not been pledged as collateral under our revolving credit facility;

 

   

our ability to continue to make premium payments on the life insurance policies that we own;

 

   

obligations, including payments that may be undertaken by the Company to settle derivative actions or class action lawsuits;

 

   

loss of business due to negative press from the USAO investigation, SEC investigation, Non-Prosecution Agreement, class action lawsuits or otherwise;

 

   

failure to obtain court approval of the settlement agreements for the class action and derivative action lawsuits or appeals of the settlements;

 

   

costs in excess of our directors’ & officers’ insurance coverage;

 

   

refusal by our directors’ and officers’ insurance carriers to reimburse us for claims submitted;

 

   

loss of revenue associated with the termination of our premium finance business;

 

   

increases to the discount rates used to value the life insurance policies that we own;

 

   

inaccurate estimates regarding the likelihood and magnitude of death benefits related to life insurance policies that we own;

 

   

changes in mortality rates and inaccurate assumptions about life expectancies;

 

   

changes in life expectancy calculation methodologies by third party medical underwriters;

 

   

changes to actuarial life expectancy tables;

 

   

lack of mortalities of insureds of the life insurance policies that we own;

 

   

increased carrier challenges to the validity of our owned life insurance policies;

 

   

delays in the receipt of death benefits from our portfolio of life insurance policies;

 

   

costs related to obtaining death benefits from our portfolio of life insurance policies;

 

   

the effect on our financial condition as a result of any lapse of life insurance policies;

 

   

deterioration of the market for life insurance policies and life settlements;

 

   

our inability to re-sell the life insurance policies we own at favorable prices, if at all;

 

   

adverse developments associated with uncooperative co-trustees;

 

   

loss of the services of any of our executive officers;

 

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adverse court decisions interpreting insurable interest and the obligation of a life insurance carrier to pay death benefits or return premiums upon a successful rescission or contest;

 

   

our inability to continue to grow our businesses;

 

   

changes in laws and regulations applicable to premium finance transactions, life settlements or structured settlements;

 

   

increased competition for the acquisition of structured settlements;

 

   

adverse developments in capital markets;

 

   

disruption of our information technology systems;

 

   

our failure to maintain the security of personally identifiable information pertaining to our customers and counterparties;

 

   

regulation of life settlement transactions as securities;

 

   

our limited operating experience;

 

   

deterioration in the credit worthiness of the life insurance companies that issue the policies included in our portfolio;

 

   

increases in premiums on life insurance policies that we own or finance;

 

   

changes in current tax law regarding the treatment of structured settlements;

 

   

our ability to grow our database of structured settlement holders;

 

   

the effects of United States involvement in hostilities with other countries and large-scale acts of terrorism, or the threat of hostilities or terrorist acts; and

 

   

changes in general economic conditions, including inflation, changes in interest or tax rates and other factors.

All written and oral forward-looking statements attributable to the Company, or persons acting on its behalf, are expressly qualified in their entirety by these cautionary statements. See “Risk Factors” below and in our Annual Report on Form 10-K for the year ended December 31, 2012 filed with the U.S. Securities and Exchange Commission on March 28, 2013. You should evaluate all forward-looking statements made in this Form 10-Q in the context of these risks and uncertainties. The Company cautions you that the important factors referenced above may not contain all of the factors that are important to you.

All statements in this Form 10-Q to “Imperial,” “Company,” “we,” “us,” or “our” refer to Imperial Holdings, Inc. and its consolidated subsidiaries unless the context suggests otherwise.

 

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Table of Contents
Item 1 Financial Statements.

Imperial Holdings, Inc. and Subsidiaries

CONSOLIDATED BALANCE SHEETS

 

     June 30,
2013
    December 31,
2012*
 
     (Unaudited)        
     (In thousands except share data)  
ASSETS   

Assets

    

Cash and cash equivalents

   $ 21,283      $ 7,001   

Cash and cash equivalents (VIE restricted, Note 5)

     2,280        —     

Restricted cash

     —          1,162   

Investment securities available for sale, at estimated fair value

     —          12,147   

Deferred costs, net

     —          7   

Prepaid expenses and other assets

     14,690        14,165   

Deposits - other

     1,603        2,855   

Interest receivable, net

     42        822   

Loans receivable, net

     206        3,044   

Structured settlement receivables, at estimated fair value

     1,393        1,680   

Structured settlement receivables at cost, net

     1,584        1,574   

Investment in life settlements, at estimated fair value

     47,645        113,441   

Investment in life settlements, at estimated fair value (VIE restricted, Note 5)

     218,128        —     

Fixed assets, net

     140        232   

Investment in affiliates

     2,315        2,212   
  

 

 

   

 

 

 

Total assets

   $ 311,309      $ 160,342   
  

 

 

   

 

 

 
LIABILITIES AND STOCKHOLDERS’ EQUITY   

Liabilities

    

Accounts payable and accrued expenses

   $ 7,573      $ 6,606   

Accounts payable and accrued expenses (VIE restricted, Note 5)

     1,452        —     

Other liabilities

     23,123        20,796   

Note payable, at estimated fair value (VIE restricted, Note 5)

     101,775        —     

Income taxes payable

     6,295        6,295   
  

 

 

   

 

 

 

Total liabilities

     140,218        33,697   

Commitments and Contingencies (Note 17)

    

Stockholders’ Equity

    

Common stock (80,000,000 authorized; 21,237,166 and 21,206,121 issued and outstanding as of June 30, 2013 and December 31, 2012, respectively)

     212        212   

Additional paid-in-capital

     239,118        238,064   

Accumulated other comprehensive loss

     —          (3

Accumulated deficit

     (68,239     (111,628
  

 

 

   

 

 

 

Total stockholders’ equity

     171,091        126,645   
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 311,309      $ 160,342   
  

 

 

   

 

 

 

 

* Derived from audited consolidated financial statements.

The accompanying notes are an integral part of these financial statements.

 

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Imperial Holdings, Inc. and Subsidiaries

CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

 

     For the Three Months Ended
June 30,
    For the Six Months Ended
June 30,
 
     2013     2012     2013     2012  
     (in thousands, except share and per share data)  

Income

  

Interest income

   $ 75      $ 698      $ 162      $ 1,604   

Interest and dividends on investment securities available for sale

     —          132        14        260   

Origination fee income

     —          188        —          438   

Realized gain on sale of structured settlements

     3,128        3,134        6,670        5,609   

(Loss) gain on life settlements, net

     (1,247     55        (1,247     291   

Change in fair value of life settlements (Notes 13 & 15)

     64,846        4,874        66,686        9,129   

Unrealized change in fair value of structured settlements

     236        569        781        1,178   

Servicing fee income

     76        327        310        684   

Gain on maturities of life settlements with subrogation rights, net

     —          6,090        —          6,090   

Other income

     2,000        116        2,090        866   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total income

     69,114        16,183        75,466        26,149   
  

 

 

   

 

 

   

 

 

   

 

 

 

Expenses

        

Interest expense

     10,759        304        10,861        1,078   

Change in fair value of note payable

     (5,361     —          (5,361     —     

Loss on extinguishment of debt

     3,991        —          3,991        —     

Provision for losses on loans receivable

     —          441        —          441   

(Gain) loss on loan payoffs and settlements, net

     (65     162        (65     153   

Amortization of deferred costs

     —          516        7        1,497   

Personnel costs

     3,653        5,033        6,984        8,722   

Marketing costs

     617        1,286        1,428        3,447   

Legal fees

     4,665        5,699        8,744        13,590   

Professional fees

     1,619        1,795        2,720        3,713   

Insurance

     479        617        998        1,086   

Other selling, general and administrative expenses

     1,036        955        1,730        1,959   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total expenses

     21,393        16,808        32,037        35,686   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before income taxes

     47,721        (625     43,429        (9,537

(Provision) benefit for income taxes

     —          —          (40     41   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

   $ 47,721      $ (625   $ 43,389      $ (9,496
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) per share:

        
  

 

 

   

 

 

   

 

 

   

 

 

 

Basic

   $ 2.25      $ (0.03   $ 2.05      $ (0.45
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

   $ 2.25      $ (0.03   $ 2.04      $ (0.45
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average shares outstanding:

        
  

 

 

   

 

 

   

 

 

   

 

 

 

Basic

     21,219,880        21,206,121        21,213,039        21,205,370   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

     21,237,166        21,206,121        21,230,325        21,205,370   
  

 

 

   

 

 

   

 

 

   

 

 

 

The accompanying notes are an integral part of these financial statements.

 

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Imperial Holdings, Inc. and Subsidiaries

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (UNAUDITED)

 

     For the Three Months Ended
June 30,
    For the Six Months  Ended
June 30,
 
     2013      2012     2013      2012  
     (In thousands)     (In thousands)  

Net income (loss)

   $ 47,721       $ (625   $ 43,389       $ (9,496

Other comprehensive income (loss), net of tax:

          

Unrealized (loss) gains on investment securities available for sale

     —           (2     —           64   

Reclassification adjustment for gains included in net income

     —           —          3         —     
  

 

 

    

 

 

   

 

 

    

 

 

 

Comprehensive income (loss)

   $ 47,721       $ (627   $ 43,392       $ (9,432
  

 

 

    

 

 

   

 

 

    

 

 

 

The accompanying notes are an integral part of these financial statements.

 

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Imperial Holdings, Inc.

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY (UNAUDITED)

For the Six Months Ended June 30, 2013

 

     Common Stock      Additional
Paid-in Capital
     (Accumulated Deficit)     Accumulated
Other Comprehensive
Income (Loss)
    Total  
     Shares      Amount                            
     (in thousands, except share data)  

Balance, December 31, 2012

     21,206,121         212         238,064         (111,628     (3   $ 126,645   

Comprehensive income

     —           —           —           43,389        3        43,392   

Stock-based compensation

     —           —           988         —          —          988   

Issuance of common stock

     13,759         —           57         —          —          57   

Issuance of restricted stock

     17,286         —           9         —          —          9   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Balance, June 30, 2013

     21,237,166         212       $ 239,118       $ (68,239   $ —        $ 171,091   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

The accompanying notes are an integral part of these financial statements.

 

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Imperial Holdings, Inc. and Subsidiaries

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

 

     For the Six Months Ended
June 30,
 
     2013     2012  
     (In thousands)  

Cash flows from operating activities

       —     

Net income (loss)

   $ 43,389      $ (9,496

Adjustments to reconcile net loss to net cash used in operating activities:

    

Depreciation and amortization

     100        236   

Loan origination cost

     10,340        —     

Amortization of premiums and accretion of discounts on available for sale securities

     21        611   

Provisions for losses on loans receivable

     —          441   

Stock-based compensation

     1,054        100   

(Gain) loss on loan payoffs and settlements, net

     (65     153   

Origination fee income

     —          (438

Change in fair value of life settlements

     (66,686     (9,129

Unrealized change in fair value of structured settlements

     (781     (1,178

Change in fair value of note payable

     (5,361     —     

Loss (gain) on life settlements

     1,247        (291

Interest income on loans

     (162     (1,604

Amortization of deferred costs

     7        1,497   

Loss on extinguishment of debt

     3,991        —     

Gain on sale and prepayment of investment securities available for sale

     (22     (39

Change in assets and liabilities:

    

Certificate of deposit - restricted

     —          895   

Deposits - other

     1,252        (846

Investment in affiliates

     (105     (907

Structured settlement receivables

     1,190        11,020   

Prepaid expenses and other assets

     (531     (931

Accounts payable and accrued expenses

     2,419        (3,918

Other liabilities

     2,327        (2,375

Interest receivable

     95        166   

Interest payable

     —          (4,294

Deferred income tax

     40        (41
  

 

 

   

 

 

 

Net cash used in operating activities

     (6,241     (20,368
  

 

 

   

 

 

 

Cash flows from investing activities

    

Purchase of fixed assets, net of disposals

     2        (17

Purchase of investment securities available for sale

     —          (35,492

Purchase of investments in life settlements

     (7,000     (130

Proceeds from sale and prepayments of investment securities available for sale

     12,111        51,676   

Proceeds from maturity of investment in life settlements

     6,039        —     

Premiums paid on investments in life settlements

     (35,556     (13,118

Proceeds from surrender of investments in life settlements

     1,050        —     

Proceeds from sale of investments in life settlements

     —          5,626   

Proceeds from loan payoffs and lender protection insurance claims received in advance

     691        20,680   
  

 

 

   

 

 

 

Net cash (used in) provided by investing activities

     (22,663     29,225   
  

 

 

   

 

 

 

Cash flows from financing activities

    

Repayment of borrowings under bridge facility

     (45,000     (15,161

Restricted cash

     1,162        (332

Borrowings from bridge facility

     41,400        —     

Loan origination cost

     (6,731     —     

Borrowings from revolving credit facility

     54,635        —     
  

 

 

   

 

 

 

Net cash provided by (used in) financing activities

     45,466        (15,493
  

 

 

   

 

 

 

Net increase (decrease) in cash and cash equivalents

     16,562        (6,636

Cash and cash equivalents, at beginning of the period

     7,001        16,255   
  

 

 

   

 

 

 

Cash and cash equivalents, at end of the period

   $ 23,563      $ 9,619   
  

 

 

   

 

 

 

Supplemental disclosures of cash flow information:

    

Cash paid for interest during the period

   $ 510      $ 5,361   
  

 

 

   

 

 

 

Supplemental disclosures of non-cash investing activities:

    

Investment in life settlements acquired in foreclosure

   $ 2,924      $ 2,650   
  

 

 

   

 

 

 

Supplemental disclosures of non-cash financing activities

    
  

 

 

   

 

 

 

Credit facility origination costs paid to lender

   $ 4,000      $ —     
  

 

 

   

 

 

 

Purchase of policies through release of subrogation claim paid by lender

   $ 48,500      $ —     
  

 

 

   

 

 

 

The accompanying notes are an integral part of these financial statements.

 

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Imperial Holdings, Inc. and Subsidiaries

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

June 30, 2013

(1) Description of Business

Imperial Holdings, Inc. (“Imperial,” the “Company,” “we” or “us”) was formed initially as a Florida limited liability Company pursuant to an operating agreement dated December 15, 2006 between IFS Holdings, Inc., IMEX Settlement Corporation, Premium Funding, Inc. and Red Oak Finance, LLC. In connection with the Company’s initial public offering on February 3, 2011, the Company succeeded to the business, assets and liabilities of the limited liability Company.

The Company, operating through its subsidiaries, is a specialty finance company with its corporate office in Boca Raton, Florida. The Company operates in two reportable business segments: life finance (formerly referred to as premium finance) and structured settlements. In the life finance business, the Company earns revenue/income from interest accruing on outstanding loans and loan origination fees over the life of the outstanding loans, servicing income, changes in the fair value of life settlements the Company acquires and receipt of death benefits with respect to matured life insurance policies it owns. In the structured settlement business, the Company purchases structured settlements at a discounted rate and sells such assets to third parties.

In February 2011, the Company completed the sale of 17,602,614 shares of common stock in its initial public offering at a price of $10.75 per share. The Company received net proceeds of approximately $174.2 million after deducting the underwriting discounts and commissions and its offering expenses.

On September 27, 2011, the Company was informed that it was being investigated by the U.S. Attorney’s Office for the District of New Hampshire (the “USAO Investigation”). At that time, the Company was informed that, among other individuals, its former president and chief operating officer, former general counsel, three former life finance sales executives, two vice presidents and a funding manager were considered “targets” of the USAO Investigation. The USAO Investigation focused on the Company’s premium finance loan business.

On February 17, 2012, the Company received a subpoena issued by the staff of the U.S. Securities and Exchange Commission (the “SEC”) seeking documents from 2007 through the present, generally related to the Company’s premium finance business and corresponding financial reporting. The SEC is investigating whether any violations of federal securities laws have occurred and the Company has been cooperating with the SEC regarding this matter. The Company is unable to predict what action, if any, might be taken in the future by the SEC or its staff as a result of the matters that are the subject of the subpoena or what impact, if any, the cost of responding to the subpoena might have on the Company’s financial position, results of operations, or cash flows. The Company has not established any provision for losses in respect of this matter.

On April 30, 2012, the Company entered into a Non-Prosecution Agreement (the “Non-Prosecution Agreement”) with the USAO, which agreed not to prosecute the Company for its involvement in the making of misrepresentations on life insurance applications in connection with its premium finance business or any potential securities fraud claims related to its premium finance business. In the Non-Prosecution Agreement, the USAO and the Company agreed among other things, that the following facts are true and correct: (i) at all relevant times (x) certain insurance companies required that the prospective insured applying for a life insurance policy, and sometimes the agent, disclose information relating to premium financing on applications for life insurance policies, and (y) the questions typically required the prospective insured to disclose if he or she intended to seek premium financing in connection with the policy and sometimes required the agent to disclose if he or she was aware of any such intent on the part of the applicant; (ii) in connection with a portion of the Company’s retail operation known as “retail non-seminar” that began in December 2006 and was discontinued in January 2009, Imperial had a practice of disclosing on applications that the prospective insured was seeking premium financing when the life insurance company allowed premium financing from Imperial; however, in certain circumstances, Imperial internal life agents facilitated and/or made misrepresentations on applications that the prospective insured was not seeking premium financing when the insurance carrier was likely to deny the policy on the basis of premium financing; and (iii) to the extent that external agents, brokers and insureds caused other misrepresentations to be made in life insurance applications in connection with the retail non-seminar business, Imperial failed to appropriately tailor controls to prevent potential fraudulent practices in that business. As of June 30, 2013, the Company had 41 policies in its portfolio that once served as collateral for premium finance loans derived through the retail non-seminar business.

In connection with the Non-Prosecution Agreement, Imperial voluntarily agreed to terminate its premium finance business, which historically accounted for the majority of the Company’s revenues and terminated certain senior sales staff associated with the premium finance business. Additionally, the Company paid the United States Government $8.0 million, and agreed to cooperate fully with the USAO’s ongoing investigation and to refrain from and self-report any criminal conduct. The Non-Prosecution Agreement has a term of three years until April 30, 2015, but after April 30, 2014 the Company may petition the USAO to forego the final year of the Non-Prosecution Agreement, if the Company otherwise complies with all of its obligations under the Non-Prosecution Agreement. Should the USAO conclude that Imperial has not abided by its obligations under the Non-Prosecution Agreement, the USAO could choose to terminate the Non-Prosecution Agreement, resume its investigation of the Company, or bring charges against Imperial. While the Non-Prosecution Agreement effectively resolved the USAO Investigation as it pertains to the Company (subject to the Company’s continuing compliance with its terms), the USAO is continuing to investigate certain individuals formerly employed by the Company; the Company is continuing to incur expenses regarding its indemnification obligations with respect to such individuals.

 

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As previously reported in earlier periodic reports filed with the SEC, the Company anticipated a liquidity shortfall in the second quarter of 2013. Accordingly, to avoid lapsing policies in its portfolio, the Company sought additional capital and, on March 27, 2013, Greenwood Asset Portfolio, LLC (“Greenwood”), a subsidiary of the Company, borrowed $45.0 million in aggregate principal amount under the terms of an eighteen-month bridge facility (the “Bridge Facility”), funded by entities associated with certain of the Company’s shareholders (including entities associated with two of the Company’s directors) and secured by substantially all of the Company’s portfolio of life insurance policies.

Revolving Credit Facility and Related Transactions

Effective April 29, 2013, White Eagle Asset Portfolio, LLC (“White Eagle”), an indirect subsidiary of the Company, entered into a 15-year revolving credit agreement (the “Revolving Credit Facility”) with LNV Corporation, as initial lender, Imperial Finance & Trading, LLC, as servicer and portfolio manager and CLMG Corp., as administrative agent, providing for up to $300.0 million in borrowings. Proceeds from the initial advance under the facility were used, in part, to retire the Bridge Facility and to fund the Release Payment described below. Ongoing draws under the Revolving Credit Facility may be used, among other things, to pay premiums on the life insurance policies that have been pledged as collateral under the Revolving Credit Facility. Proceeds from the policies pledged as collateral will be distributed pursuant to a waterfall. After premium payments and fees to service providers, 100% of the remaining proceeds will be directed to pay outstanding principal and interest on the loan. Generally, after payment of principal and interest, collections from policy proceeds are to be paid to White Eagle up to $76.1 million, then 50% of the remaining proceeds are to be directed to the lenders with the remainder paid to White Eagle. As of June 30, 2013, 459 life insurance policies owned by White Eagle with an aggregate death benefit of approximately $2.3 billion and an estimated fair value of approximately $218.1 million at June 30, 2013 have been pledged as collateral under the Revolving Credit Facility.

On April 30, 2013, the Company and certain of its subsidiaries (together, the “Imperial Parties”) entered into a Master Termination Agreement and Release (the “Termination Agreement”) with CTL Holdings, LLC (“CTL” and together with the Imperial Parties, the “LPIC Parties”) and Lexington Insurance Company (the “LPIC Provider”). Under the Termination Agreement, the LPIC Parties made a payment of $48.5 million to the LPIC Provider (the “Release Payment”) and the LPIC Provider and the LPIC Parties provided full releases to each other in respect of the lender protection insurance coverage issued by the LPIC Provider and the claims paid by the LPIC Provider in respect of that coverage. With the effectiveness of the Termination Agreement, the LPIC Provider released any and all subrogation claims and related salvage rights in 323 life insurance policies with an aggregate death benefit of approximately $1.6 billion that have been kept off-balance sheet as contingent assets for financial reporting purposes in prior periods and that have historically been characterized as “Life Settlements with Subrogation rights, net.” 267 of the 323 life insurance policies were pledged by White Eagle as collateral under the Revolving Credit Facility at June 30, 2013.

On April 30, 2013, OLIPP III, LLC, a subsidiary of the Company purchased all of the membership interests in CTL from Monte Carlo Securities, Ltd. in exchange for $7.0 million and for assuming the amount of the Release Payment allocated to CTL. Prior to this acquisition, the LPIC Provider maintained subrogation rights in the 93 life insurance policies owned by CTL with an aggregate death benefit of approximately $340.0 million. Those rights were terminated pursuant to the Termination Agreement. The acquisition of CTL was treated as a related party transaction as the Company’s chief executive officer was the manager of CTL at the time of the acquisition and was recused from participating in the Company’s Board of Directors’ consideration and approval of the acquisition.

At June 30, 2013, the Company or its subsidiaries owned 402 policies that were either acquired through the acquisition of CTL or that were considered contingent assets prior to the effectiveness of the Termination Agreement, with an aggregate death benefit of $1.9 billion and an estimated fair value of approximately $139.7 million. The Company believes that it was uniquely positioned to transact with both the LPIC Provider and CTL and that the transaction prices were, accordingly, not indicative of what an exit price would be for these 402 policies in a negotiated market transfer. The addition of these policies resulted in a $65.8 million unrealized gain in investments in life settlements during the quarter ended June 30, 2013 and policy acquisitions similar in scale and in transaction price to those made during the quarter should not be anticipated in future periods.

Due to these policy additions, the application of fair value accounting to amounts owing under the Revolving Credit Facility and the elimination of servicing fee income through intercompany consolidation, the results of prior periods may not be comparable to the Company’s results at June 30, 2013 or in future periods.

The Company collected death benefits of $5.0 million and $1.0 million, respectively, plus interest from two policies in the second quarter of 2013 that matured in the first quarter of 2013. In addition, the Company collected $1.0 million from the surrender of two policies that it acquired as part of the acquisition of policies during the second quarter of 2013.

At June 30, 2013, the Company’s portfolio of life insurance policies consisted of 627 life settlements with an aggregate death benefit of approximately $3.0 billion. 168 of these policies with an aggregate death benefit of approximately $730.9 million have not been pledged under the Revolving Credit Facility.

Life Finance

Our life finance segment is comprised of our premium finance loan and life settlements businesses. The Company historically provided premium finance loans for individual life insurance policies and, commencing in 2011, began using its life settlement provider licenses to purchase life insurance policies. As described above, the Company voluntarily terminated its premium finance business in connection with the Non-Prosecution Agreement with the USAO.

Structured Settlements

Washington Square Financial, LLC, a wholly-owned subsidiary of the Company, purchases structured settlements from individuals. Structured settlements refer to a contract between a plaintiff and defendant, whereby the plaintiff agrees to settle a lawsuit (usually a personal injury, product liability or medical malpractice claim) in exchange for periodic payments over time. A defendant’s payment obligation with respect to a structured settlement is usually assumed by a casualty insurance company. This payment obligation is then satisfied by the casualty insurer through the purchase of an annuity from a highly rated life insurance company, thereby providing a high credit quality stream of payments to the plaintiff.

Recipients of structured settlements are permitted to sell their deferred payment streams to a structured settlement purchaser pursuant to state statutes that require certain disclosures, notice to the obligors and state court approval. Through such sales, the Company purchases a certain number of fixed, scheduled future settlement payments on a discounted basis in exchange for a single lump sum payment.

 

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(2) Principles of Consolidation and Basis of Presentation

The accompanying unaudited consolidated financial statements include the accounts of the Company, all of its wholly-owned subsidiaries and its special purpose entities, with the exception of Imperial Settlements Financing 2010, LLC (“ISF 2010”), an unconsolidated special purpose entity (see Note 12). The special purpose entity has been created to fulfill specific objectives. All significant intercompany balances and transactions have been eliminated in consolidation, including revenue from servicing policies pledged as collateral under the Revolving Credit Facility. Notwithstanding consolidation, White Eagle is the owner of 459 policies, with an aggregate death benefit of approximately $2.3 billion and an estimated fair value of approximately $218.1 million at June 30, 2013.

The unaudited consolidated financial statements have been prepared in conformity with the rules and regulations of the SEC for Form 10-Q and therefore do not include certain information, accounting policies, and footnote disclosures information or footnotes necessary for a complete presentation of financial position, results of operations and cash flows in conformity with generally accepted accounting principles. However, all adjustments (consisting of normal recurring accruals), which, in the opinion of management, are necessary for a fair presentation of the financial statements, have been included. Operating results for the six months ended June 30, 2013 are not necessarily indicative of the results that may be expected for the year ending December 31, 2013. These interim financial statements should be read in conjunction with the Consolidated Financial Statements and Notes thereto included in Imperial’s Annual Report on Form 10-K for the fiscal year ended December 31, 2012.

Use of Estimates

The preparation of these consolidated financial statements, in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from these estimates and such differences could be material. Significant estimates made by management include the loan impairment valuation, income taxes, valuation of securities available for sale, valuation of structured settlement receivables, the valuation of investments in life settlements and the valuation of its note payable owing under the Revolving Credit Facility.

(3) Recent Accounting Pronouncements

In February 2013, the Financial Accounting Standards Board (“FASB”) issued ASU 2013-02, Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income. ASU 2013-02 requires entities to report, either on the face of the income statement or in the notes, the effect of significant reclassifications out of accumulated other comprehensive income (“AOCI”) on the respective line items in net income if the amount being reclassified is required under GAAP to be reclassified in its entirety to net income. For other amounts that are not required under GAAP to be reclassified in their entirety from AOCI to net income in the same reporting period, an entity is required to cross-reference other disclosures required under GAAP that provide additional detail about those amounts. See Note 4, Changes in Accumulated Other Comprehensive Loss, Net of Tax, for the required disclosures. ASU 2013-02 is effective as of January 1, 2013 for Imperial and did not have a significant impact on our financial statements, other than presentation.

In March 2013, the FASB issued ASU No. 2013-05, Foreign Currency Matters (Topic 830): Parent’s Accounting for the Cumulative Translation Adjustment upon Derecognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or of an Investment in a Foreign Entity (“ASU 2013-05”). ASU 2013-05 clarifies the applicable guidance applied for the release of cumulative translation adjustments into net income when a reporting entity either sells a part or all of its investment in a foreign entity or ceases to have a controlling financial interest in a subsidiary or group of assets that constitute a business within a foreign entity. ASU 2013-05 is effective prospectively for reporting periods beginning after December 15, 2013, with early adoption permitted. ASU 2013-05. The Company does not anticipate the adoption of this amendment will have a material impact on its financial statements.

In July 2013, the FASB issued ASU No. 2013-11, Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists (“ASU 2013-11”). ASU 2013-11 requires, unless certain conditions exists, an unrecognized tax benefit, or a portion of an unrecognized tax benefit, to be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, similar tax loss, or a tax credit carryforward. ASU 2013-11 is effective prospectively for reporting periods beginning after December 15, 2013, with early adoption permitted. Retrospective application is permitted. The Company does not anticipate the adoption of this amendment will have a material impact on its financial statements.

 

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(4) Changes in Accumulated Other Comprehensive Loss, Net of Tax

The following table presents changes in accumulated other comprehensive loss, net of tax, by component for the six months ended June 30, 2013 (in thousands):

 

     Unrealized
Gains and
Losses on
Available-for-

Sale Securities
 

Balance as of December 31, 2012

   $ (3

Amounts reclassified from accumulated other comprehensive income

     3   
  

 

 

 

Balance as of June 30, 2013

   $ —     
  

 

 

 

Reclassifications out of accumulated other comprehensive loss, net of tax, for the six months ended June 30, 2013 are as follows (in thousands):

 

     Amount Reclassified
from Accumulated
Other Comprehensive
Loss
    Affected Line in
the  Consolidated

Statement of
Operations

Loss on available for sale securities

   $ (22   Other Expenses

Tax effect

     25      Provision for Income Tax
  

 

 

   

Total amount reclassified from accumulated other comprehensive loss for the six months ended June 30, 2013

   $ 3     
  

 

 

   

(5) Consolidation of Variable Interest Entities

The Company evaluates its interests in variable interest entities (“VIEs”) on an ongoing basis and consolidates those VIEs in which it has a controlling financial interest and is thus deemed to be the primary beneficiary. A controlling financial interest has both of the following characteristics: (i) the power to direct the activities of the VIE that most significantly impact its economic performance; and (ii) the obligation to absorb losses of the VIE that could potentially be significant to it or the right to receive benefits from the VIE that could be significant to the VIE.

The following table presents the consolidated assets and consolidated liabilities of VIEs for which the Company has concluded that it is the primary beneficiary and which are consolidated in the Company’s consolidated financial statements as of June 30, 2013, as well as non-consolidated VIEs for which the Company has determined it is not the primary beneficiary (in thousands):

 

     Primary Beneficiary      Not Primary
Beneficiary
 
     Consolidated VIEs      Non-consolodiated VIEs  
     Assets      Liabilities      Total
Assets
     Maximum Exposure
To Loss
 

June 30, 2013

   $ 220,408       $ 103,227       $ 2,315       $ 2,315   

December 31, 2012

   $ —         $ —         $ 2,212       $ 2,212   

On December 21, 2012, Greenwood opened a securities intermediary account which provides for a securities intermediary to hold Greenwood’s life insurance policies on its behalf. As of December 31, 2012, OLIPP IV, LLC, a wholly-owned subsidiary of the Company, contributed 191 life settlements with an estimated fair value of approximately $104.6 million to Greenwood. On March 27, 2013, as part of the Bridge Facility, Greenwood, as issuer, and the Company and OLIPP IV, LLC, as guarantors, entered into an indenture with Wilmington Trust Company, as indenture trustee, under which an aggregate principal amount of $45.0 million of 12% increasing rate senior secured bridge notes were issued to certain entities associated with certain of the Company’s shareholders, including to entities associated with two of the Company’s directors. Interest under the Bridge Facility accrued at 12% per annum for the first nine months from the issue date, and increases of 600 basis points thereafter to 18% per annum were scheduled. Up to 25% of the net proceeds from the Bridge Facility after transaction expenses could have been used by the Company for general corporate purposes, including for premium payments on life insurance policies not owned by Greenwood, with the balance used to pay fees and expenses associated with the Bridge Facility and for premiums on life insurance policies owned by Greenwood. The Bridge Facility was guaranteed by the Company and secured by the cash on account at Greenwood and its portfolio of life insurance policies. The Bridge Facility was also secured by pledges of the equity interests of Greenwood’s direct parent and each subsidiary of the Company, other than its licensed life settlement provider, that held life insurance policies that were not subject to the subrogation rights of the Company’s lender protection insurance carrier.

Effective April 29, 2013, White Eagle entered into the Revolving Credit Facility and a portion of the proceeds from the initial borrowings were used to repay all outstanding amounts under the Bridge Facility. Ongoing draws under the Revolving Credit Facility may be used, among

 

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other things, to pay premiums on the life insurance policies that have been pledged as collateral under the Revolving Credit Facility. As of June 30, 2013, 459 life insurance policies owned by White Eagle with an aggregate death benefit of approximately $2.3 billion and an estimated fair value of approximately $218.1 million at June 30, 2013 were pledged as collateral under the Revolving Credit Facility. A Company subsidiary acts as portfolio manager and servicer for life insurance policies owned by White Eagle and the Company was determined to be the primary beneficiary of White Eagle as it has a controlling financial interest and the power to direct the activities that most significantly impacted White Eagle’s economic performance and the obligation to absorb economic gains and losses. In accordance with Accounting Standards Codification (“ASC”) 810, Consolidation, the Company consolidated White Eagle in its financial statements beginning in the three months ended June 30, 2013.

Imperial Settlements Financing 2010, LLC (“ISF 2010”), is an unconsolidated special purpose entity formed to allow the Company to sell structured settlements and assignable annuities, and to borrow against certain of its receivables to provide ISF 2010 liquidity. In determining whether the Company is the primary beneficiary, the Company concluded that it does not control the servicing, which is the activity that most significantly impacts the VIE’s performance. An independent third party is the master servicer and they can only be replaced by the control party, which is the entity that holds the majority of the outstanding notes. A Company subsidiary is a back-up servicer and is insignificant to ISF 2010’s performance. The Company’s maximum exposure related to ISF 2010 is limited to 5% of the dollar value of the ISF 2010 transactions, which is held back by ISF 2010 at the time of sale, and is designed to absorb potential losses in collecting the receivables. The obligations of ISF 2010 are non-recourse to the Company. The total funds held back by ISF 2010 as of June 30, 2013 and December 31, 2012 were approximately $2.3 million and $2.2 million, respectively and are included in investment in affiliate in the accompanying consolidated balance sheet.

(6) Gain on Maturities of Life Settlements with Subrogation Rights, net

In the third quarter of 2011, two individuals covered under policies, which were subject to subrogation claims of the LPIC Provider unexpectedly passed away. The Company collected the death benefit on one of these policies in the amount of $3.5 million during the third quarter of 2011. The other was the result of an accidental death and the $10.0 million face value of the policy was larger than average.

The Company accounted for the maturities of each of these polices as contingent gains in accordance with ASC 450, Contingencies and recognized $3.2 million in death benefits net of subrogation expenses of $312,000 in its consolidated statement of operations during the third quarter of 2011. In the second quarter of 2012, the Company negotiated a settlement in respect of the larger policy and collected approximately $6.1 million, net of subrogation expenses and reported a gain in accordance with ASC 450, Contingencies in its consolidated statement of operations for the second quarter of 2012 when all contingencies were resolved.

Historically, the Company believed these contingent gains to be unpredictable because the LPIC Provider could discontinue paying the premiums necessary to keep a policy subject to subrogation and salvage claims in force at any time. Further, the amount of the LPIC Provider’s subrogation and salvage claim on any individual life insurance policy could have equaled the cash flow received by the Company with respect to any such policy. Upon the execution of the Termination Agreement, the LPIC Provider released any and all subrogation claims and related salvage rights in the life insurance policies that had been characterized as “Life Settlements with Subrogation rights, net.” As a result of the Termination Agreement, the Company will no longer have any gains on maturities of life settlements with subrogation rights, net.

(7) Earnings Per Share

Basic net income per share is computed by dividing the net earnings attributable to common shareholders by the weighted average number of common shares outstanding during the period.

Diluted earnings per share is computed by dividing net income attributable to common shareholders by the weighted average number of common shares outstanding, increased to include the number of additional common shares that would have been outstanding if the dilutive potential common shares had been issued. Conversion or exercise of the potential common shares is not reflected in diluted earnings per share, unless the effect is dilutive. The dilutive effect, if any, of outstanding common share equivalents is reflected in diluted earnings per share by application of the treasury stock method, as applicable. In determining whether outstanding stock options, restricted stock, and common stock warrants should be considered for their dilutive effect, the average market price of the common stock for the period has to exceed the exercise price of the outstanding common share equivalent.

 

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The following tables reconcile actual basic and diluted earnings per share for the three months and six months ended June 30, 2013 and 2012 (in thousands except share and per share data).

 

     For the Three  Months
Ended June 30,
    For the Six Months
Ended June 30,
 
     2013      2012     2013      2012  

Basic income (loss) per share:

          

Numerator:

          

Net income (loss) available to common stockholders

   $ 47,721       $ (625   $ 43,389       $ (9,496
  

 

 

    

 

 

   

 

 

    

 

 

 

Denominator:

          

Weighted average common shares outstanding

     21,219,880         21,206,121        21,213,039         21,205,370   
  

 

 

    

 

 

   

 

 

    

 

 

 

Basic income (loss) per share

   $ 2.25       $ (0.03   $ 2.05       $ (0.45
  

 

 

    

 

 

   

 

 

    

 

 

 

Diluted income (loss) per share:

          

Numerator:

          

Net income (loss) available to common stockholders

   $ 47,721       $ (625   $ 43,389       $ (9,496
  

 

 

    

 

 

   

 

 

    

 

 

 

Denominator:

          

Weighted average common shares outstanding

     21,219,880         21,206,121        21,213,039         21,205,370   

Add: Restricted Stock

     17,286         —          17,286         —     

Diluted weighted average shares outstanding

     21,237,166         21,206,121        21,230,325         21,205,370   
  

 

 

    

 

 

   

 

 

    

 

 

 

Diluted income (loss) per share(1)(2)

   $ 2.25       $ (0.03   $ 2.04       $ (0.45
  

 

 

    

 

 

   

 

 

    

 

 

 

 

(1) The computation of diluted EPS did not include 488,632 outstanding options and 4,240,521 outstanding warrants for the three months and six months ended June 30, 2012, as the effect of their inclusion would have been anti-dilutive.
(2) The computation of diluted EPS did not include 933,969 outstanding options and 4,240,521 outstanding warrants for the three months and six months ended June 30, 2013, as the effect of their inclusion would have been anti-dilutive.

(8) Investment Securities Available for Sale

The Company had no securities available for sale at June 30, 2013. The Company liquidated its entire portfolio of investment securities available for sale during the first quarter of 2013. Proceeds from sale and prepayment of investment securities available for sale during the six months ended June 30, 2013 and 2012 amounted to approximately $12.1 million and $51.6 million, respectively, resulting in gross realized gains of approximately $22,000 and $39,000, respectively.

The amortized cost and estimated fair values of securities available for sale at December 31, 2012 are as follows (in thousands):

 

     December 31, 2012  

Description of Securities

   Amortized
Cost
     Gross  Unrealized
Gains
     Gross  Unrealized
Losses
    Estimated
Fair Value
 

Corporate bonds

   $ 8,275         25       $ (67   $ 8,233   

Government bonds

     3,524         76         —         3,600   

Other bonds

     310         4         —         314   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total available for sale securities

   $ 12,109       $ 105       $ (67   $ 12,147   
  

 

 

    

 

 

    

 

 

   

 

 

 

The scheduled maturities of securities at December 31, 2012, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties (in thousands).

 

     December 31, 2012  
     Amortized Cost      Estimated Fair Value  

Due in one year or less

   $ 6,172       $ 6,197   

Due after one year but less than five years

     2,413         2,350   

Due after five years but less than ten years

     3,524         3,600   
  

 

 

    

 

 

 

Total available for sale securities

   $ 12,109       $ 12,147   
  

 

 

    

 

 

 

Information pertaining to securities with gross unrealized losses at December 31, 2012, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position is as follows (in thousands):

 

     December 31, 2012  
     Less than 12 Months     12 Months or More      Total  

Description of Securities

   Estimated
Fair  Value
     Unrealized
Loss
    Estimated
Fair  Value
     Unrealized
Loss
     Estimated
Fair  Value
     Unrealized
Loss
 

Corporate bonds

     1,932         (67     —          —          1,932         (67

Government bonds

     —          —         —          —          —          —    

Other bonds

     —          —         —          —          —          —    
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

Total available for sale securities

   $ 1,932       $ (67   $ —        $ —        $ 1,932       $ (67
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

 

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The Company monitors its investment securities available for sale for other-than-temporary impairment, or OTTI, on an individual security basis considering numerous factors, including the Company’s intent to sell securities in an unrealized loss position, the likelihood that the Company will be required to sell these securities before an anticipated recovery in value, the length of time and extent to which fair value has been less than amortized cost, the historical and implied volatility of the fair value of the security, failure of the issuer of the security to make scheduled interest or principal payments, any changes to the rating of the security by a rating agency and recoveries or additional declines in fair value subsequent to the balance sheet date. The relative significance of each of these factors varies depending on the circumstances related to each security.

(9) Loans Receivable

A summary of loans receivables at June 30, 2013 and December 31, 2012 is as follows (in thousands):

 

     June 30,
2013
    December 31,
2012
 

Loan principal balance

   $ 364      $ 5,255   

Loan origination fees, net

     90        1,157   

Loan impairment valuation

     (248     (3,368
  

 

 

   

 

 

 

Loans receivable, net

   $ 206      $ 3,044   
  

 

 

   

 

 

 

The Company also had interest receivable, net which consisted of approximately $42,000 and $727,000 in accrued and unpaid interest at June 30, 2013 and December 31, 2012, respectively, and a related impairment valuation of approximately $90,000 and $947,000, respectively.

An analysis of the changes in loans receivable principal balance during the three months and six months ended June 30, 2013 and 2012 is as follows (in thousands):

 

     For the Three Months Ended
June 30,
    For the Six Months Ended
June 30,
 
     2013     2012     2013     2012  

Loan principal balance, beginning

   $ 3,356      $ 21,080      $ 5,255      $ 31,264   

Loan payoffs

     (652     (6,631     (652     (13,325

Loans transferred to investments in life settlements

     (2,340     (1,514     (4,239     (5,004
  

 

 

   

 

 

   

 

 

   

 

 

 

Loan principal balance, ending

   $ 364      $ 12,935      $ 364      $ 12,935   
  

 

 

   

 

 

   

 

 

   

 

 

 

Loan origination fees include fees that are payable to the Company on the date the loan matures. The loan origination fees are reduced by any direct costs that are directly related to the creation of the loan receivable in accordance with ASC 310-20, Receivables — Nonrefundable Fees and Other Costs, and the net balance is accreted over the life of the loan using the effective interest method. Discounts include purchase discounts, net of accretion, which are attributable to loans that were acquired from affiliated companies under common ownership and control.

In accordance with ASC 310, Receivables, the Company specifically evaluates all loans for impairment based on the fair value of the underlying policies as foreclosure is considered probable. The loans are considered to be collateral dependent as the repayment of the loans is expected to be provided by the underlying policies. See Note 15.

 

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An analysis of the loan impairment valuation for the three months ended June 30, 2013 is as follows (in thousands):

 

     Loans
Receivable
    Interest
Receivable
    Total  

Balance at beginning of period

   $ 2,401      $ 711      $ 3,112   

Charge-offs

     (2,153     (621     (2,774
  

 

 

   

 

 

   

 

 

 

Balance at end of period

   $ 248      $ 90      $ 338   
  

 

 

   

 

 

   

 

 

 

An analysis of the loan impairment valuation for the three months ended June 30, 2012 is as follows (in thousands):

 

     Loans
Receivable
    Interest
Receivable
    Total  

Balance at beginning of period

   $ 7,488      $ 1,668      $ 9,156   

Provision for losses

     360        81        441   

Charge-offs

     (2,331     (440     (2,771
  

 

 

   

 

 

   

 

 

 

Balance at end of period

   $ 5,517      $ 1,309      $ 6,826   
  

 

 

   

 

 

   

 

 

 

An analysis of the loan impairment valuation for the six months ended June 30, 2013 is as follows (in thousands):

 

     Loans
Receivable
    Interest
Receivable
    Total  

Balance at beginning of period

   $ 3,368      $ 947      $ 4,315   

Charge-offs

     (3,120     (857     (3,977
  

 

 

   

 

 

   

 

 

 

Balance at end of period

   $ 248      $ 90      $ 338   
  

 

 

   

 

 

   

 

 

 

An analysis of the loan impairment valuation for the six months ended June 30, 2012 is as follows (in thousands):

 

     Loans
Receivable
    Interest
Receivable
    Total  

Balance at beginning of period

   $ 10,195      $ 1,920      $ 12,115   

Provision for losses

     360        81        441   

Charge-offs

     (5,038     (692     (5,730
  

 

 

   

 

 

   

 

 

 

Balance at end of period

   $ 5,517      $ 1,309      $ 6,826   
  

 

 

   

 

 

   

 

 

 

An analysis of the allowance for loan losses and recorded investment by loan type for the six months ended June 30, 2013 is as follows (in thousands):

 

     Uninsured
Loans
    Insured
Loans(1)
    Total  

Loan impairment valuation

      

Balance at beginning of period

   $ 2,692      $ 676      $ 3,368   

Charge-offs

     (2,444     (676     (3,120
  

 

 

   

 

 

   

 

 

 

Ending balance

   $ 248      $ —        $ 248   
  

 

 

   

 

 

   

 

 

 

Ending balance: individually evaluated for impairment

   $ 248      $ —        $ 248   
  

 

 

   

 

 

   

 

 

 

 

(1) As a result of the entry into the Termination Agreement on April 30, 2013, the LPIC Provider is no longer obligated to pay claims on loans that were insured.

 

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An analysis of the allowance for loan losses and recorded investment in loans by loan type for the six months ended June 30, 2012 is as follows (in thousands

 

     Uninsured
Loans
    Insured
Loans
    Total  

Loan impairment valuation

      

Balance at beginning of period

   $ 7,103      $ 3,092      $ 10,195   

Provision for loan losses

     —          360        360   

Charge-offs

     (2,825     (2,213     (5,038
  

 

 

   

 

 

   

 

 

 

Ending balance

   $ 4,278      $ 1,239      $ 5,517   
  

 

 

   

 

 

   

 

 

 

Ending balance: individually evaluated for impairment

   $ 4,278      $ 1,239      $ 5,517   
  

 

 

   

 

 

   

 

 

 

All loans were individually evaluated for impairment as of June 30, 2013 and 2012. There were no loans collectively evaluated for impairment and there were no loans acquired with deteriorated credit quality. See Note 15.

An analysis of the credit quality for loans outstanding at June 30, 2013 is presented in the following table (dollars in thousands):

 

     Uninsured     Insured(1)  
S&P Designation    Unpaid
Principal
Balance
     Percent     Unpaid
Principal
Balance
     Percent  

AAA

   $ —           0.00   $ —           0.00

AA+

     —           0.00     —           0.00

AA

     —           0.00     —           0.00

AA-

     —           0.00     —           0.00

A+

     299         82.23     —           0.00

A1

     —           0.00     —           0.00

A

     —           0.00     —           0.00

A-

     65         17.77     —           0.00
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 364         100   $ —           0.00
  

 

 

    

 

 

   

 

 

    

 

 

 

 

(1) As a result of the entry into the Termination Agreement on April 30, 2013, the LPIC Provider is no longer obligated to pay claims on loans that were insured.

An analysis of the credit quality indicators by loan type at December 31, 2012 is presented in the following table (dollars in thousands):

 

     Uninsured     Insured(1)  
S&P Designation    Unpaid
Principal
Balance
     Percent     Unpaid
Principal
Balance
     Percent  

AAA

   $ —          0.00   $ —          0.00

AA+

     —          0.00     —          0.00

AA

     —          0.00     —          0.00

AA-

     2,072         43.58     408         81.44

A+

     2,548         53.97     93         18.56

A1

     —          0.00     —          0.00

A

     —          0.00     —          0.00

BB-

     134         2.45     —          0.00
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 4,754         100   $ 501         100
  

 

 

    

 

 

   

 

 

    

 

 

 

 

(1) All of the Company’s insured loans had lender protection coverage with Lexington Insurance Company. As of December 31, 2012, Lexington had a financial strength rating of “A” with a stable outlook by Standard & Poors (S&P). As a result of the entry into the Termination Agreement on April 30, 2013, the LPIC Provider is no longer obligated to pay claims on loans that were insured.

 

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Table of Contents

A summary of our investment in impaired loans at June 30, 2013 and December 31, 2012 is as follows (in thousands):

 

     June 30.
2013
     December 31,
2012
 

Loan receivable, net

   $ 206       $ 3,011   

Interest receivable, net

     42         724   
  

 

 

    

 

 

 

Investment in impaired loans

   $ 248       $ 3,735   
  

 

 

    

 

 

 

An analysis of impaired loans with and without a related allowance at June 30, 2013 is presented in the following table by loan type (in thousands):

 

     Recorded
Investment
     Unpaid
Principal
Balance
     Related
Allowance
     Average
Recorded
Investment
     Interest
Income
Recognized
 

With no related allowance recorded:

              

Uninsured Loans

   $ —         $ —         $ —         $ —         $ —     

Insured Loans(1)

     —           —           —           —           —     

With an allowance recorded:

              

Uninsured Loans

     248         364         338         1,934         132   

Insured Loans(1)

     —           —           —           
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total Impaired Loans

   $ 248       $ 364       $ 338       $ 1,934       $ 132   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) As a result of the entry into the Termination Agreement on April 30, 2013, the LPIC Provider is no longer obligated to pay claims on loans that were insured.

An analysis of impaired loans with and without a related allowance at December 31, 2012 is presented in the following table by loan type (in thousands):

 

     Recorded
Investment
     Unpaid
Principal
Balance
     Related
Allowance
     Average
Recorded
Investment
     Interest
Income
Recognized
 

With no related allowance recorded:

              

Uninsured Loans

   $ —        $ —        $ —        $ —        $ —    

Insured Loans

     —          —          —          —          —    

With an allowance recorded:

              

Uninsured Loans

     3,623         4,735         3,413         6,887         1,444   

Insured Loans

     112         501         902         7,091         227   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total Impaired Loans

   $ 3,735       $ 5,236       $ 4,315       $ 13,978       $ 1,671   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The amount of the investment in impaired loans that had an allowance as of June 30, 2013 and of December 31, 2012 was $248,000, and $3.7 million, respectively. The amount of the investment in impaired loans that did not have an allowance was zero as of June 30, 2013 and December 31, 2012. The average investment in impaired loans for the six months ended June 30, 2013 and year-ended December 31, 2012 was approximately $1.9 million and $14.0 million, respectively. The interest recognized on the impaired loans was approximately $27,000 and $214,000 for the six months ended June 30, 2013 and 2012, respectively.

The Company had no past due loans at June 30, 2013. An analysis of past due loans at December 31, 2012 is presented in the following table by loan type (in thousands):

 

     30-59 Days
Past Due
     60-89 Days
Past Due
     Greater Than
90 Days
Past Due
     Total
Past Due
 

Uninsured Loans

   $ —        $ —        $ 599       $ 599   

Insured Loans

     —          —          315         315   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ —        $ —        $ 914       $ 914   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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During the six months ended June 30, 2013 and the year ended December 31, 2012, the Company did not originate any loans. Loan interest receivable at June 30, 2013 and December 31, 2012 was approximately $42,000, and $727,000 net of impairment of approximately $90,000, and $947,000, respectively. As of June 30, 2013, there were a total of two loans outstanding with the average loan balance of approximately $182,000.

The allowance for interest receivable represents interest that is not expected to be collected. At the time the interest income was recognized and at the end of the reporting period in which the interest income was recognized, the interest income was believed to be collectible. The Company continually reassesses whether interest income is collectible in conjunction with its loan impairment analysis. The allowance for interest receivable represents interest that was determined to be uncollectible during a reporting period subsequent to the initial recognition of the interest income. As of June 30, 2013, the loan portfolio consisted of loans with original maturities of 2 years and variable interest rates at an average interest rate of 14.00%. During the six months ended June 30, 2013 and 2012, 1 and 67 loans were paid off with proceeds of lender protection insurance totaling approximately $117,000 and $21.0 million respectively, of which approximately $93,000, and $13.3 million was for principal of the loans, and approximately $40,000, and $5.2 million was for accrued interest, respectively, and accreted origination fees of approximately $39,000, and $5.6 million, respectively. The Company had an impairment associated with these loans of approximately $56,000, and $3.6 million, respectively. We recognized a gain of zero and $7,200 on these transactions, respectively. Also during the three months ended on June 30, 2013, 1 loan was repaid totaling approximately $574,000 of which $560,000 was for the principal of the loan and approximately $196,000 was for accrued interest. Prior to this repayment, impairment associated with this loan was approximately $250,000, resulting in a gain of approximately $65,000 on this transaction.

Our premium finance borrowers were generally referred to us through independent insurance agents and brokers although, prior to January 2009, we originated some premium finance loans that were sold by life insurance agents that we employed. In certain of these instances, the life insurance agents employed by the Company worked with external brokers and agents to obtain insurance for individuals with the Company extending a premium finance loan to a borrower with the policy as collateral. We refer to these instances as the “retail non-seminar business,” which began in December 2006 and was discontinued in January 2009. In total, the Company originated 114 premium finance loans as part of the retail non-seminar business. As of June 30, 2013, the Company had 41 policies as a result of its retail non-seminar business.

(10) Origination Fees

A summary of the balances of origination fees that are included in loans receivable in the consolidated balance sheet as of June 30, 2013 and December 31, 2012 is as follows (in thousands):

 

     June 30,
2013
    December 31,
2012
 

Loan origination fees gross

   $ 91      $ 1,334   

Un-accreted origination fees

     (4     (190

Amortized loan originations costs

     3        13   
  

 

 

   

 

 

 
   $ 90      $ 1,157   
  

 

 

   

 

 

 

Loan origination fees are fees payable to the Company on the date of loan maturity or repayment. Loan origination costs are deferred costs that are directly related to the creation of the loan receivable.

(11) Stock-Based Compensation

In connection with the Company’s initial public offering, the Company established the Imperial Holdings 2011 Omnibus Incentive Plan (the “Omnibus Plan”). The purpose of the Omnibus Plan is to attract, retain and motivate participating employees and to attract and retain well-qualified individuals to serve as members of the board of directors, consultants and advisors through the use of incentives based upon the value of our common stock. Awards under the Omnibus Plan may consist of incentive awards, stock options, stock appreciation rights, performance shares, performance units, and shares of common stock, restricted stock, restricted stock units or other stock-based awards as determined by the compensation committee. The Omnibus Plan provides that an aggregate of 1,200,000 shares of common stock are reserved for issuance under the Omnibus Plan, subject to adjustment as provided in the Omnibus Plan. During the quarter ended June 30, 2013 the Company issued 545,000 options to employees at a strike price of $6.94. The Company recognized approximately $798,000 and $84,000 in stock-based compensation expense relating to stock options it granted under the Omnibus Plan during the three months ended June 30, 2013 and 2012, respectively and $988,000 and $96,000 during the six months ended June 30, 2013 and 2012, respectively. The Company incurred additional stock-based compensation expense of approximately $9,000 and zero relating restricted stock granted to its board of directors during the three months ended June 30, 2013 and 2012, respectively, and $9,000 and $4,000 during the six months ended June 30, 2013 and 2012, respectively. On April 1, 2013, the Company granted 14,828 shares of unrestricted common stock to its outside directors with an aggregate grant date fair value of approximately $57,000 computed in accordance with ASC 718, Compensation-Stock Compensation.

 

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Table of Contents

Options

As of June 30, 2013 options to purchase 933,969 shares of common stock were outstanding and unexercised under the Omnibus Plan at a weighted average exercise price of $8.52 per share. The outstanding options issued in 2011 expire seven years after the date of grant and were granted with a strike price of $10.75 which was the offering price of our initial public offering or fair market value (closing price) of the stock on the date of grant and vest over three years. The outstanding options issued during the quarter ended June 30, 2013, will expire seven years after the date of grant and were granted with strike price of $6.94 which was the fair market value (closing price) of the stock on the day preceding the date of grant and one-third vested immediately and the remaining two-third vest ratably over two years.

The Company has used the Black-Scholes model to calculate fair values of options awarded. This model requires assumptions as to expected volatility, dividends, terms, and risk free rates. Assumptions used for the periods covered herein, are outlined in the table below:

 

     Six Months Ended
June 30, 2013

Expected Volatility

   65.47

Expected Dividend

   0%

Expected Term in Years

   4.25

Risk Free Rate

   0.48% - 1.01%

The Company commenced its initial public offering of common stock in February 2011. Accordingly, there was no public market for the Company’s common stock prior to this date. Therefore, the Company identified comparable public entities and blended the average volatility of those entities with the Company’s volatility from the date of its initial public offering through June 30, 2013, to reasonably estimate its expected volatility. The Company does not expect to pay dividends on its common stock for the foreseeable future. Expected term is the period of time over which the options granted are expected to remain outstanding and is based on the simplified method as outlined in the SEC Staff Accounting Bulletin 110. The Company will continue to estimate expected lives based on the simplified method until reliable historical data becomes available. The risk free rate is based on the U.S Treasury yield curve in effect at the time of grant for the appropriate life of each option.

The following table presents the activity of the Company’s outstanding stock options for the six months ended June 30, 2013:

 

Common Stock Options

   Number of
Shares
    Weighted
Average Price
per Share
     Weighted
Average
Remaining
Contractual
Term
 

Options outstanding, December 31, 2012

     487,314      $ 10.75         —     

Options granted

     545,000      $ 6.94         6.93   

Options exercised

     —        $ —           —     

Options forfeited

     (1,081   $ 10.75         —     

Options expired

     (97,264   $ 10.75         —     
  

 

 

      

Options outstanding June 30, 2013

     933,969      $ 8.52         5.97   
  

 

 

      

Exercisable at June 30, 2013

     471,907      $ 9.28         5.51   
  

 

 

      

Unvested at June 30, 2013

     462,062      $ 7.75         6.44   
  

 

 

      

As of June 30, 2013, all outstanding stock options had an exercise price above the market value of the common stock on that date.

The remaining unamortized amounts of approximately $513,000, $673,000, and $267,000 will be expensed during 2013, 2014, and 2015, respectively.

Restricted Stock

As of June 30, 2013, an aggregate of 17,286 shares of restricted stock granted to our directors under the Omnibus Plan was outstanding subject to one year vesting schedule commencing on the date of grant. The fair value of the unvested restricted stock was valued at $120,138 based on the closing price of the Company’s shares on the grant date.

 

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Table of Contents

The following table presents the activity of the Company’s unvested restricted stock common shares for the six months ended June 30, 2013:

 

Common Unvested Shares

   Number of
Shares
 

Outstanding December 31, 2012

     —     

Granted

     17,286   

Vested

     —     

Forfeited

     —     
  

 

 

 

Outstanding June 30, 2013

     17,286   
  

 

 

 

The aggregate intrinsic value of these awards is approximately $118,000 and the remaining weighted average life of these awards is .93 years as of June 30, 2013. The remaining unamortized amounts of approximately $60,000 and $52,000 will be expensed during 2013 and 2014, respectively.

(12) Structured Settlements

The balances of the Company’s structured settlements are as follows (in thousands):

 

     June 30,
2013
     December 31,
2012
 

Structured settlements - at cost

   $ 1,584       $ 1,574   

Structured settlements - at fair value

     1,393         1,680   
  

 

 

    

 

 

 

Structured settlements receivable, net

   $ 2,977       $ 3,254   
  

 

 

    

 

 

 

All structured settlements that were acquired subsequent to July 1, 2010 were marked to fair value. Structured settlements that were acquired prior to July 1, 2010 were recorded at cost. During 2011, the Company reacquired certain structured settlements that were originally acquired prior to July 1, 2010 and the Company continued to carry those structured settlements at cost upon reacquisition.

Certain financing arrangements for the Company’s structured settlements are described below:

Life-Contingent Structured Settlement Facility

On December 30, 2011, Washington Square Financial, LLC (“WSF”) entered into a forward purchase and sale agreement (“PSA”) to sell up to $40.0 million of life contingent structured settlement receivables to Compass Settlements LLC (“Compass”). On May 21, 2013 WSF and Compass executed an Amended and Restated Purchase and Sale Agreement. Subject to predetermined eligibility criteria and on-going funding conditions, Compass committed, in increments of $10.0 million, up to $45.0 million to purchase life-contingent structured settlement receivables from WSF. The PSA obligates WSF to sell the life-contingent structured settlement receivables it originates to Compass on an exclusive basis for twelve months following the amendment date, subject to Compass maintaining certain purchase commitment levels. Additionally, the Company has agreed to guarantee WSF’s obligation to repurchase any ineligible receivables sold under the PSA and certain other related obligations.

For the six months ended June 30, 2013 and 2012, respectively, the Company sold 80 and 225 structured settlements under this facility, respectively, 5 and 107 of which were originated in 2012 and 2011, respectively, generating income of approximately $72,000 and $1.1 million, respectively, which was recorded as an unrealized change in fair value of structured settlements in 2012 and 2011, respectively. The Company originated and sold 75 and 118 structured settlement transactions under this facility generating income of approximately $1.1 million and $1.0 million, respectively, recorded as gain on sale of structured settlements during the six months ended June 30, 2013 and 2012, respectively.

The Company also realized income of approximately $218,000 and $283,000 that was recorded as an unrealized change in fair value during the six months ended June 30, 2013 and 2012, respectively, on structured settlements that are intended for sale to Compass. As of June 30, 2013, the Company had available commitments under this facility of $8.2 million.

8.39% Fixed Rate Asset Backed Variable Funding Notes

Imperial Settlements Financing 2010, LLC (“ISF 2010”) was formed as an affiliate of the Company to serve as a special purpose financing entity to allow the Company to sell structured settlements and assignable annuities, which are referred to as receivables, to ISF 2010 and ISF 2010 to borrow against certain of its receivables to provide ISF 2010 liquidity. ISF 2010 is a non-consolidated special purpose financing entity. On September 24, 2010, ISF 2010 entered into an arrangement to obtain up to $50 million in financing. Under this arrangement, a subsidiary of Partner Re, Ltd. (the “noteholder”) became the initial holder of ISF 2010’s 8.39% Fixed Rate Asset Backed Variable Funding Note issued under a master trust indenture and related indenture supplement (collectively, the “Indenture”) pursuant to which the noteholder committed to advance ISF 2010 up to $50 million upon the terms and conditions set forth in the Indenture. The note is secured by the receivables that ISF 2010 acquires from the Company from time to time. The note is due and payable on or before January 1, 2057, but principal and interest must be repaid pursuant to a schedule of fixed payments from the receivables that secure the notes. The arrangement generally has a concentration limit of 15% for the providers of the receivables that secure the notes. Wilmington Trust is the collateral trustee. As of June 30, 2013 and December 31, 2012, the balance of the notes outstanding on the special purpose financing entity’s books was $45.2 million and $43.2 million, respectively.

 

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Table of Contents

Upon the occurrence of certain events of default under the Indenture, all amounts due under the note are automatically accelerated. The Company’s maximum exposure related to ISF 2010 is limited to 5% of the dollar value of the ISF 2010 transactions, which is held back by ISF 2010 at the time of sale, and is designed to absorb potential losses in collecting the receivables. The obligations of ISF 2010 are non-recourse to the Company. The total funds held back by ISF 2010 as of June 30, 2013 and December 31, 2012 were approximately $2.3 million and $2.2 million and are included in investment in affiliate in the accompanying consolidated balance sheet.

During the six months ended June 30, 2013 and 2012, the Company sold 57 and 430 term certain structured settlements, respectively. Of the 57 structured settlements sold during the six months ending June 30, 2013, 2 were originated in 2012 and 1 was originated in 2011 generating income of $11,000 and $2,500, respectively, which was recorded as an unrealized change in fair value of structured settlements in 2012 and 2011, respectively. Of the 430 structured settlements sold during the six months ended June 30, 2012, 181 were originated in 2011 generating income of approximately $3.2 million, which was recorded as an unrealized change in fair value of structured settlements in 2011. The Company originated and sold 54 and 249 non-life-contingent settlement transactions under this facility generating income of approximately $601,000 and $3.6 million, respectively, which was recorded as a realized gain on sale of structured settlements during the six months ended June 30, 2013 and 2012, respectively. The Company also realized income of approximately $135,000 and $473,000 that was recorded as an unrealized change in fair value during the six months ended June 30, 2013 and 2012, respectively, on structured settlements that are intended for sale to ISF 2010. The Company receives 95% of the purchase price in cash from ISF 2010. Of the remaining 5%, which represents the Company’s interest in ISF 2010, 1% is required to be contributed to a cash reserve account held by Wilmington Trust.

When the transfer of the receivables occurs, the Company records the transaction as a sale and derecognizes the asset from its balance sheet. In determining whether the Company is the primary beneficiary of the trust, the Company concluded that it does not control the servicing, which is the activity that most significantly impacts the trust performance. An independent third party is the master servicer and they can only be replaced by the control partner, which is the entity that holds the majority of the outstanding notes. The Company is a back-up servicer, which is insignificant to ISF 2010 performance.

3rd Party Sales

For the six months ended June 30, 2013 and 2012, respectively, in addition to its intended sales to Compass and ISF 2010, the Company also sold 176 and 73 structured settlement deals to unrelated third parties for $8.6 million and $1.0 million, respectively, generating income of $5.0 million and $939,000, respectively, recorded as a gain on sale of structured settlements and $158,000 that was previously recorded as an unrealized change in fair value in 2012.

For the six months ended June 30, 2013 and 2012, respectively, the Company recorded income of approximately $388,000 and $134,000, respectively, that was recorded as unrealized change in fair value on structured settlements that are intended for sale to other parties.

Total income recognized through accretion of interest income on structured settlement transactions for the six months ended June 30, 2013 and 2012, respectively, was approximately $171,000 and $171,000, respectively. For the six months ended June 30, 2013, $132,000 of accretion income, related to structured settlement receivables held at cost, was recognized in interest income and $39,000 related to structured settlement receivables held at fair value, was recognized as unrealized change in fair value in the accompanying consolidated statement of operations.

The receivables at June 30, 2013 and December 31, 2012 were approximately $3.0 million and $3.3 million, respectively, net of a discount of approximately $5.0 million and $4.6 million, respectively.

(13) Investment in Life Settlements (Life Insurance Policies)

The Company accounts for policies it acquires using the fair value method in accordance with ASC 325-30-50 Investments — Other — Investment in Insurance Contracts. Under the fair value method, the Company recognizes the initial investment at the purchase price. For policies that were relinquished in satisfaction of premium finance loans at maturity, the initial investment is the loan carrying value and for policies purchased in the secondary or tertiary markets, the initial investment is the amount of cash outlay at the time of purchase. At each reporting period, the Company re-measures the investment at fair value in its entirety and recognizes changes in fair value in earnings in the period in which the changes occur. See Note 15.

As of June 30, 2013 and December 31, 2012, the Company owned 627 and 214 policies, respectively, with an aggregate estimated fair value of investments in life settlements of $265.8 million and $113.4 million, respectively.

 

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The weighted average life expectancy calculated based on death benefit of insureds in the policies owned by the Company at June 30, 2013 was 11.9 years. The following table describes the Company’s investments in life settlements as of June 30, 2013 (dollars in thousands):

 

     Number of                
     Life Settlement      Fair      Face  

Remaining Life Expectancy (In Years)

   Contracts      Value      Value  

0 - 1

     1       $ 1,744       $ 2,100   

1 - 2

     —           —           —     

2 - 3

     5         6,326         13,750   

3 - 4

     4         5,229         11,200   

4 - 5

     11         14,497         46,450   

Thereafter

     606         237,977         2,941,640   
  

 

 

    

 

 

    

 

 

 

Total

     627       $ 265,773       $ 3,015,140   
  

 

 

    

 

 

    

 

 

 

The weighted average life expectancy calculated based on death benefit of insureds in the policies owned by the Company at December 31, 2012 was 10.6 years. The following table describes the Company’s investment in life settlements as of December 31, 2012 (dollars in thousands):

 

     Number of                
     Life Settlement      Fair      Face  

Remaining Life Expectancy (In Years)

   Contracts      Value      Value  

0 - 1

     —         $ —         $ —     

1 - 2

     —           —           —     

2 - 3

     1         1,222         2,500   

3 - 4

     4         3,319         11,450   

4 - 5

     7         11,375         30,950   

Thereafter

     202         97,525         1,028,256   
  

 

 

    

 

 

    

 

 

 

Total

     214       $ 113,441       $ 1,073,156   
  

 

 

    

 

 

    

 

 

 

Premiums to be paid during each of the five succeeding fiscal years and thereafter to keep the life insurance policies in force as of June 30, 2013, are as follows (in thousands):

 

Remainder of 2013

   $ 33,831   

2014

     54,796   

2015

     53,279   

2016

     56,206   

2017

     62,684   

Thereafter

     1,203,143   
  

 

 

 
   $ 1,463,939   
  

 

 

 

The $1.46 billion noted above represents the estimated total future premium payments required to keep the life insurance policies in force during the life expectancies of all the underlying insured lives and does not give effect to projected receipt of death benefits. The estimated total future premium payments could increase or decrease significantly to the extent that actual mortalities of insureds differs from the estimated life expectancies.

(14) Note Payable

Revolving Credit Facility

Effective April 29, 2013, White Eagle entered into a 15-year revolving credit agreement (the “Revolving Credit Facility”) with LNV Corporation, as initial lender, Imperial Finance & Trading, LLC, as servicer and portfolio manager and CLMG Corp., as administrative agent (the “Agent”).

General & Security. The Revolving Credit Facility provides for an asset-based revolving credit facility backed by White Eagle’s portfolio of life insurance policies with an initial aggregate lender commitment of up to $300.0 million, subject to borrowing base availability. Upon the closing of the Revolving Credit Facility, White Eagle owned a portfolio of 459 life insurance policies with an aggregate death benefit of approximately $2.3 billion and an estimated fair value of approximately $218.1 million at June 30, 2013, which has been pledged as collateral under the Revolving Credit Facility. In addition, the Company’s equity interests in White Eagle have been pledged under the Revolving Credit Facility.

 

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Borrowing Base. Borrowing availability under the Revolving Credit Facility is subject to a borrowing base, which at any time is equal to the lesser of (A) the sum of all of the following amounts that have been funded or are to be funded through the next distribution date (i) the initial advance and all additional advances to acquire additional pledged policies or that are not for ongoing maintenance advances, plus (ii) 100% of the sum of the ongoing maintenance costs, plus (iii) 100% of accrued and unpaid interest on borrowings (excluding the rate floor portion described below), plus (iv) 100% of any other fees and expenses funded and to be funded as approved by the required lenders, less (v) any required payments of principal and interest previously distributed and to be distributed through the next distribution date; (B) 75% of the valuation of the policies pledged as collateral as determined by the lenders; (C) 50% of the aggregate face amount of the policies pledged as collateral (excluding certain specified life insurance policies); and (D) the then applicable facility limit.

Amortization & Distributions. Proceeds from the policies pledged as collateral under the Revolving Credit Facility will be distributed pursuant to a waterfall. Absent an event of default, after premium payments and fees to service providers, 100% of the remaining proceeds will be directed to pay outstanding interest and principal on the loan, unless the lenders determine otherwise. Generally, after payment of interest and principal, collections from policy proceeds are to be paid to White Eagle up to $76.1 million, then 50% of the remaining proceeds are to be directed to the lenders with the remainder paid to White Eagle and for any unpaid fees to service providers. With respect to approximately 25% of the face amount of policies pledged as collateral under the Revolving Credit Facility, White Eagle has agreed that if policy proceeds that are otherwise due are not paid by an insurance carrier, the foregoing distributions will be altered such that the lenders will receive any “catch-up” payments in respect of amounts that they would have received in the waterfall prior to distributions being made to White Eagle. During the continuance of events of default or unmatured events of default, the amounts from collections of policy proceeds that might otherwise be paid to White Eagle will instead be held in a designated account controlled by the lenders and may be applied to fund operating and third party expenses, interest and principal, “catch-up” payments or percentage payments that would go to the lenders as described above.

Use of Proceeds. Generally, ongoing advances may be made for paying premiums on the life insurance policies pledged as collateral, to pay debt service (other than a “rate floor” component equal to the greater of LIBOR (or the applicable base rate) and 1.5%), and to pay the fees of service providers. Subsequent advances in respect of newly pledged policies are at the discretion of the lenders and the use of proceeds from those advances are at the discretion of the lenders.

Interest. Borrowings under the Revolving Credit Facility bear interest at a rate equal to LIBOR or, if LIBOR is unavailable, the base rate, in each case plus an applicable margin of 4.00% and subject to the rate floor described above. The base rate under the Revolving Credit Facility equals the sum of (i) the weighted average of the interest rates on overnight federal funds transactions or, if unavailable, the average of three federal funds quotations received by the Agent plus 0.75% and (ii) 0.5%. The effective rate at June 30, 2013 is 5.5%.

Maturity. The term of the Revolving Credit Facility expires April 28, 2028, which is also the scheduled commitment termination date (though the lenders’ commitments to fund borrowings may terminate earlier in an event of default). The lenders’ interests in and rights to a portion of the proceeds of the policies does not terminate with the repayment of the principal borrowed and interest accrued thereon, the termination of the Revolving Credit Facility or expiration of the lenders’ commitments.

Covenants/Events of Defaults. The Revolving Credit Facility contains covenants and events of default that are customary for asset-based credit agreements of this type, but also include cross defaults under the servicing, account control, contribution and pledge agreements entered into in connection with the Revolving Credit Facility (including in relation to breached by third parties thereunder), changes in control of or insolvency or bankruptcy of the Company and relevant subsidiaries and performance of certain obligations by certain relevant subsidiaries, White Eagle and third parties. The Revolving Credit Facility does not contain any financial covenants, but does contain certain tests relating to asset maintenance, performance and valuation the satisfaction of which will be determined by the lenders with a high degree of discretion.

Remedies. The Revolving Credit Facility and ancillary transaction documents afford the lenders a high degree of discretion in their selection of and implementation of remedies in relation to any event of default, including a high degree of discretion in determining whether to foreclose upon and liquidate all or any pledged policies, the Company’s interests in White Eagle, and the manner of any such liquidation. White Eagle has limited ability to cure events of default through the sale of policies or the procurement of replacement financing.

We have elected to account for this note payable, which includes the 50% interest in policy proceeds to the lender, using the fair value method. The fair value of the debt is the amount the Company would have to pay to transfer the debt to a market participant in an orderly transaction. We calculated the fair value of the debt using a discounted cash flow model taking into account the stated interest rate of the credit facility and probabilistic cash flows from the pledged policies. Considerable judgment is required in interpreting market data to develop the estimates of fair value. Accordingly, our estimates are not necessarily indicative of the amounts that we, or holders of the instruments, could realize in a current market exchange. The most significant assumptions are the estimates of life expectancy of the insured and the discount rate. The use of different assumptions and/or estimation methodologies could have a material effect on the estimated fair values.

At June 30, 2013 the fair value of the debt is $101.8 million. See Note 15 — Fair Value Measurements. As of June 30, 2013, the borrowing base was approximately $107.7 million including $107.1 million in outstanding principal.

There are no scheduled repayments of principal and interest. Payments are due upon receipt of death benefits and distributed pursuant to the waterfall as described above.

 

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(15) Fair Value Measurements

We carry investments in life settlements, structured settlements, and our note payable at fair value in the consolidated balance sheets. Fair value is defined as an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. As such, fair value is a market based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. Fair value measurements are classified based on the following fair value hierarchy:

Level 1 — Valuation is based on unadjusted quoted prices in active markets for identical assets and liabilities that are accessible at the reporting date. Since valuations are based on quoted prices that are readily and regularly available in an active market, valuation of these products does not entail a significant degree of judgment.

Level 2 — Valuation is determined from pricing inputs that are other than quoted prices in active markets that are either directly or indirectly observable as of the reporting date. Observable inputs include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, and interest rates and yield curves that are observable at commonly quoted intervals.

Level 3 — Valuation is based on inputs that are both significant to the fair value measurement and unobservable. Level 3 inputs include situations where there is little, if any, market activity for the financial instrument. The inputs into the determination of fair value generally require significant management judgment or estimation.

Assets and liabilities measured at fair value on a recurring basis

The balances of the Company’s assets measured at fair value on a recurring basis as of June 30, 2013, are as follows (in thousands):

 

                          Total  
     Level 1      Level 2      Level 3      Fair Value  

Assets:

           

Investment in life settlements

   $ —         $ —         $ 265,773       $ 265,773   

Structured settlement receivables

     —           —           1,393         1,393   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ —         $ —         $ 267,166       $ 267,166   
  

 

 

    

 

 

    

 

 

    

 

 

 

The balances of the Company’s liabilities measured at fair value on a recurring basis as of June 30, 2013, are as follows (in thousands):

 

                          Total  
     Level 1      Level 2      Level 3      Fair Value  

Liabilities:

           

Note Payable

   $ —         $ —         $ 101,775       $ 101,775   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ —         $ —         $ 101,775       $ 101,775   
  

 

 

    

 

 

    

 

 

    

 

 

 

The balances of the Company’s assets measured at fair value on a recurring basis as of December 31, 2012, are as follows (in thousands):

 

     Level 1      Level 2      Level 3      Fair Value  

Assets:

           

Investment in life settlements

   $ —        $ —        $ 113,441      $ 113,441  

Structured settlement receivables

     —          —          1,680        1,680  

Investment securities available for sale

     —          12,147        —          12,147  
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ —        $ 12,147      $ 115,121      $ 127,268  
  

 

 

    

 

 

    

 

 

    

 

 

 

The Company values its investment in life settlement portfolio in two classes, non-premium financed and premium financed. In considering the categories, it is generally believed that market participants would require a lower risk premium for policies that were non-premium financed, while a higher risk premium would be required for policies that were premium financed.

 

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($ in thousands)    Quantitative Information about Level 3 Fair Value Measurements
     Fair Value
at 6/30/13
     Aggregate
death benefit
6/30/2013
    

Valuation Technique(s)

  

Unobservable Input

   Range
(Weighted Average)

Non-premium financed

   $ 35,561       $ 206,450       Discounted cash flow    Discount rate    14.59% - 21.59%
            Life expectancy evaluation    (9.3 years)

Premium financed

   $ 230,212       $ 2,808,690       Discounted cash flow    Discount rate    16.59% - 29.59%
  

 

 

    

 

 

          
            Life expectancy evaluation    (12.1 years)

Investment in life settlements

   $ 265,773       $ 3,015,140       Discounted cash flow    Discount rate    (20.61%)
            Life expectancy evaluation    (11.9 years)
  

 

 

    

 

 

    

 

  

 

  

 

Structured settlements receivables

   $ 1,393         N/A       Discounted cash flow    Facility sales discount rates    6.73% - 12.80%
  

 

 

    

 

 

    

 

  

 

  

 

            Discount rate    23.50%*

Note payable

   $ 101,775         N/A       Discounted cash flow    Life expectancy evaluation    (11.4 years)
  

 

 

    

 

 

    

 

  

 

  

 

 

* Actual

Following is a description of the methodologies used to estimate the fair values of assets and liabilities measured at fair value on a recurring basis and within the fair value hierarchy.

Investment in life settlements — The Company has elected to account for the life settlement policies it acquires using the fair value method. Due to the inactive market for life settlements, the Company uses a present value technique to estimate the fair value of our investments in life settlements, which is a Level 3 fair value measurement as the significant inputs are unobservable and require significant management judgment or estimation. The Company currently uses a probabilistic method of valuing life insurance policies, which we believe to be the preferred valuation method in the industry. The most significant assumptions are the estimates of life expectancy of the insured and the discount rate.

In determining the life expectancy estimate, we analyze medical reviews from independent secondary market life expectancy providers (each a “LE provider”). An LE provider reviews the medical records and identifies all medical conditions it feels are relevant to the life expectancy of the insured. Debits and credits are then assigned by each LE provider to the individual’s health based on identified medical conditions. The debit or credit that an LE provider assigns to a medical condition is derived from the experience of mortality attributed to this condition in the portfolio of lives that the LE provider monitors. The health of the insured is summarized by the LE provider into a life assessment of the individual’s life expectancy expressed both in terms of months and in mortality factor.

The resulting mortality factor represents an indication as to the degree to which the given life can be considered more or less impaired than a standard life having similar characteristics (e.g. gender, age, smoking, etc.). For example, a standard insured (the average life for the given mortality table) would carry a mortality rating of 100%. A similar but impaired life bearing a mortality rating of 200% would be considered to have twice the chance of dying earlier than the standard life. The probability of mortality for an insured is then calculated by applying the blended life expectancy estimate to a mortality table. The mortality table is created based on the rates of death among groups categorized by gender, age, and smoking status. By measuring how many deaths occur during each year, the table allows for a calculation of the probability of death in a given year for each category of insured people. The probability of mortality for an insured is found by applying the mortality rating from the life expectancy assessment to the probability found in the actuarial table for the insured’s age, sex and smoking status. The Company has historically applied an actuarial table developed by a third party. However, beginning in the quarter ended September 30, 2012, the Company transitioned to a table developed by the U.S. Society of Actuaries known as the 2008 Valuation Basic Table, or the 2008 VBT. However, because the 2008 VBT table does not account for anticipated improvements in mortality in the insured population, the table was modified by outside consultants to reflect these expected mortality improvements. The Company believes that the change in mortality table does not materially impact the valuation of its life insurance policies and that its adoption of a modified 2008 VBT table is consistent with modified tables used by market participants and third party medical underwriters.

The mortality rating is used to create a series of best estimate probabilistic cash flows. This probability represents a mathematical curve known as a mortality curve. This curve is then used to generate a series of expected cash flows over the remaining expected lifespan of the insured and the corresponding policy. A discounted present value calculation is then used to determine the value of the policy. If the insured dies earlier than expected, the return will be higher than if the insured dies when expected or later than expected.

The calculation allows for the possibility that if the insured dies earlier than expected, the premiums needed to keep the policy in force will not have to be paid. Conversely, the calculation also considers the possibility that if the insured lives longer than expected, more premium payments will be necessary. Based on these considerations, each possible outcome is assigned a probability and the range of possible outcomes is then used to create a value for the policy.

Historically, the Company has procured the majority of its life expectancy reports from two life expectancy report providers and only used AVS Underwriting LLC (“AVS”) life expectancy reports for valuation purposes. Beginning in the quarter ended September 30, 2012, the Company began utilizing life expectancy reports from 21st Services, LLC (“21st Services”) for valuation purposes and began averaging or “blending,” the results of the two life expectancy reports to establish a composite mortality factor.

On January 22, 2013, 21st Services announced revisions to its underwriting methodology and on February 4, 2013, announced that it was correcting errors discovered in its previously announced revised methodology. According to the 21st Services, these revisions have generally

 

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been understood to lengthen the average reported life expectancy furnished by this life expectancy provider by 19%. At March 31, 2013, the Company had not received any life expectancy reports from 21st Services utilizing its revised methodology and, to account for the impact of the revisions and based off of market responses to the methodology change, the Company lengthened the life expectancies furnished by 21st Services by 13% prior to blending them with the life expectancy reports furnished by AVS.

As of June 30, 2013, the Company received 98 updated life expectancy reports from 21st Services that utilize its revised methodology. These life expectancies reported an average lengthening of life expectancies of 15.8% and, based on this sample, for the six months ended June 30, 2013, the Company increased the life expectancies furnished by 21st Services by 15.8% on the rest of its portfolio of life settlements prior to blending them with the life expectancy reports furnished by AVS. The Company expects to continue to lengthen life expectancies furnished by 21st Services that have not been re-underwritten using their updated methodology. Since the Revolving Credit Facility necessitates that the Company procure updated life expectancies on a periodic basis, the amount of policies that are lengthened by the Company in this manner will decrease over time and the fair value calculations in future periods will, accordingly, reflect the actual impact of the revised 21st Services methodology on a policy by policy basis as updated life expectancy reports are procured. At June 30, 2013, had the Company not applied a 15.8% increase to the 21st Services life expectancy reports, the portfolio would have increased from the reported amount of $265.8 million by $5.3 million.

Prior to the quarter ended June 30, 2013, when blending AVS and 21st Services’ life expectancy reports to derive a composite mortality factor, the Company would cap the higher mortality factor at an amount that was 150% above the lower mortality factor. This was done so as to reduce variances between life expectancies furnished by these two life expectancy providers. For the period ending June 30, 2013, the Company terminated its use of such a cap. The Company believes that the elimination of this cap is consistent with valuation methodologies employed by other market participants in connection with 21st Services’ revised methodology.

Life expectancy sensitivity analysis

As is the case with most market participants, the Company used a blend of life expectancies that are provided by two third-party LE providers. These are estimates of an insured’s remaining years. If all of the insured lives in the Company’s life settlement portfolio live six months shorter or longer than the life expectancies provided by these third parties, the change in fair market value as of June 30, 2013 would be as follows (dollars in thousands):

 

Life Expectancy Months Adjustment

   Fair Value      Change in Value  

+6

   $ 219,364       $ (46,409

-

   $ 265,773         —     

-6

   $ 316,408       $ 50,635   

Discount rate

The discount rate incorporates current information about market interest rates, the credit exposure to the insurance company that issued the life insurance policy and our estimate of the risk premium an investor in the policy would require.

The Company believes that investors in esoteric assets such as life insurance policies typically target yields averaging between 12% — 17% for investments of more than a 5 year duration, and had historically used a 15% — 17% range of discount rates to value its life insurance policies. In the third quarter of 2011 and in the immediate aftermath of becoming aware of the USAO investigation, the Company substantially increased the discount rates utilized in its fair value model as it believed that the USAO Investigation along with certain unfavorable court decisions unrelated to the Company contributed to a contraction in the marketplace that has continued to reverberate. Since that time, the Company has been re-evaluating its discount rates at the end of every reporting period in order to reflect the estimated discount rates that could reasonably be used in a market transaction involving the Company’s portfolio of life insurance policies. In doing so, the Company relies on management insight, engages third party consultants to corroborate its assessment, engages in discussions with other market participants and potential financing sources and extrapolates the discount rate underlying actual sales of policies.

Although the Company believes that its entry into the Non-Prosecution Agreement had a positive effect on the market generally and for premium financed life insurance policies specifically, the Company believes that, when given the choice to invest in a policy that was associated with the Company’s premium finance business and a similar policy without such an association, all else being equal, an investor would have generally opted to invest in the policy that was not associated with the Company’s premium finance business. However, since entering into the Non-Prosecution Agreement, investors have required less of a risk premium to transact in these policies and the Company expects that, in time, investors will continue to require less of a risk premium to transact in policies associated with its premium finance business.

Credit exposure of insurance company

The company considers the financial standing of the issuer of each life insurance policy. Typically, we seek to hold policies issued by insurance companies with investment-grade ratings of at least single-A. At June 30 2013, the Company had six life insurance policies issued by one carrier that was rated non-investment grade by S&P s of that date. In order to compensate a market participant for the perceived credit and challenge risks associated with these policies, the Company applied an additional 300 basis point risk premium.

 

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Table of Contents

Estimated risk premium

As of June 30, 2013, the Company owned 627 policies with an aggregate investment in life settlements of $265.8 million. Of these 627 policies, 584 were previously premium financed and valued using discount rates that range from 16.59% to 29.59%. The remaining 43 policies were valued using discount rates that range from 14.59% to 21.59%. The weighted average discount rate calculated based on death benefit used in valuing the policies in our life settlement portfolio was 20.61% at June 30, 2013 and 24.01% at December 31, 2012.

Market interest rate sensitivity analysis

The discount rate incorporates current information about market interest rates, the credit exposure to the insurance company that issued the life insurance policy and our estimate of the risk premium an investor in the policy would require. The extent to which the fair value could vary in the near term has been quantified by evaluating the effect of changes in the weighted average discount rate on the death benefit used to estimate the fair value. If the weighted average discount rate were increased or decreased by 1/2 of 1% and the other assumptions used to estimate fair value remained the same, the change in fair market value as of June 30, 2013 would be as follows (dollars in thousands):

 

Weighted Average Rate Calculated Based on Death Benefit

   Rate Adjustment     Value      Change in Value  

20.11%

     -0.50   $ 273,967       $ 8,194   

20.61%

     —        $ 265,773       $ —     

21.11%

     0.50   $ 257,950       $ (7,823

Future changes in the discount rates we use to value life insurance policies could have a material effect on our yield on life settlement transactions, which could have a material adverse effect on our business, financial condition and results of our operations.

At the end of each reporting period we re-value the life insurance policies using our valuation model in order to update our loan impairment valuation for loans receivable and our estimate of fair value of investments in policies held on our balance sheet. This includes reviewing our assumptions for discount rates and life expectancies, as well as incorporating current information for premium payments and the passage of time.

Structured settlement receivables — All structured settlements that were acquired subsequent to July 1, 2010 were marked to fair value. Structured settlements that were acquired prior to July 1, 2010 were recorded at cost. We make this election because it is our intention to sell these assets within the next twelve months. Structured settlements are purchased at effective yields, which are fixed. Purchase discounts are accreted into interest income using the effective-interest method for those structured settlements marked to fair value. As of June 30, 2013, the Company had 39 structured settlements with an estimated fair value of $1.4 million and an average sales discount rate of 8.96%.

Note payable — Effective April 29, 2013, White Eagle, a subsidiary of the Company, entered into a 15-year Revolving Credit Facility with LNV Corporation, as initial lender, Imperial Finance & Trading, LLC, as servicer and portfolio manager and CLMG Corp., as administrative agent. In connection with the Revolving Credit Facility, White Eagle pledged 459 policies to serve as collateral for its obligations under the facility. Absent an event of default under the Revolving Credit Facility, ongoing borrowings will be used to pay the premiums on these policies and certain approved third party expenses. Proceeds from the policies pledged as collateral will be distributed pursuant to a waterfall. After premium payments and fees to service providers, 100% of the remaining proceeds will be directed to pay outstanding principal and interest on the loan. Generally, after payment of principal and interest, collections from policy proceeds are to be paid to White Eagle up to $76.1 million, then 50% of the remaining proceeds are to be directed to the lenders with the remainder paid to White Eagle. We have elected to account for this note payable, which includes the lender’s interest in policy proceeds, using the fair value method. The fair value of the debt is the amount the Company would have to pay to transfer the debt to a market participant in an orderly transaction. We calculated the fair value of the debt using a discounted cash flow model taking into account the stated interest rate of the Revolving Credit Facility and probabilistic cash flows from the pledged policies. Accordingly, our estimates are not necessarily indicative of the amounts that we, or holders of the instruments, could realize in a current market exchange. The most significant assumptions are the estimates of life expectancy of the insured and the discount rate. The use of different assumptions and/or estimation methodologies could have a material effect on the estimated fair values.

Life expectancy sensitivity analysis of note payable

A considerable portion of the fair value of the Company’s note payable derives from the timing of receipt of future policy proceeds. Should life expectancies lengthen such that policy proceeds are collected further into the future, the fair value of this debt will decline. Conversely, should life expectancies shorten, the fair value of this debt will increase. Considerable judgment is required in interpreting market data to develop the estimates of fair value.

 

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As is the case with most market participants, the Company used a blend of life expectancies that are provided by two third-party LE providers. These are estimates of an insured’s remaining years. If all of the insured lives in the Company’s life settlement portfolio live six months shorter or longer than the life expectancies provided by these third parties, the change in fair market value would be as follows (dollars in thousands):

 

     Fair Value of         

Life Expectancy Months Adjustment

   Note Payable      Change in Value  

+6

   $ 86,552       $ (15,223

-

   $ 101,775         —     

-6

   $ 119,953       $ 18,178   

Discount rate of note payable

The discount rate incorporates current information about market interest rates, credit exposure to insurance companies and our estimate of the return a lender lending against the policies would require.

Market interest rate sensitivity analysis of note payable

 

           Fair Value of         

Discount Rate

   Rate Adjustment     Note Payable      Change in Value  

23.00%

     -0.50   $ 104,328       $ 2,553   

23.50%

     —        $ 101,775       $ —     

24.00%

     0.50   $ 99,316       $ (2,459

Future changes in the discount rates could have a material effect on the fair value our note payable, which could have a material adverse effect on our business, financial condition and results of our operations.

At June 30, 2013 the fair value of the debt is $101.8 million. The outstanding principal is approximately $107.1 million as of June 30, 2013.

Changes in Fair Value

The following tables provide a roll-forward in the changes in fair value for the six months ended June 30, 2013, for all assets for which the Company determines fair value using a material level of unobservable (Level 3) inputs (in thousands):

 

Life Settlements:

  

Balance, December 31, 2012

   $ 113,441   

Purchase of policies

   $ 55,500   

Acquired in foreclosure

     2,924   

Unrealized change in fair value

     61,808   

Matured/lapsed/sold policies

     (3,456

Premiums paid

     35,556   

Transfers into level 3

     —     

Transfer out of level 3

     —     
  

 

 

 

Balance, June 30, 2013

   $ 265,773   
  

 

 

 

Changes in fair value included in earnings for the period relating to assets held at June 30, 2013

   $ 61,438   
  

 

 

 

The Company recorded unrealized change in fair value gains of approximately $64.8 million and $4.9 million during the three months ended June 30, 2013 and 2012, respectively, and a change in fair value of life settlements of approximately $66.7 million and $9.1 million for the six months ended June 30, 2013 and 2012, respectively.

 

Structured Settlements:

  

Balance, December 31, 2012

   $ 1,680   

Purchase of contracts

     10,611   

Unrealized change in fair value

     781   

Sale of contracts

     (11,636

Collections

     (43

Transfers into level 3

     —     

Transfer out of level 3

     —     
  

 

 

 

Balance, June 30, 2013

   $ 1,393   
  

 

 

 

Changes in fair value included in earnings for the period relating to assets held at June 30, 2013

   $ 254   
  

 

 

 

 

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The following tables provide a roll-forward in the changes in fair value for the six months ended June 30, 2013, for all liabilities for which the Company determines fair value using a material level of unobservable (Level 3) inputs (in thousands):

 

Note payable:

  

Balance, December 31, 2012

   $ —     

Initial Advance under the revolving credit facility

     83,020   

Subsequent Draws under the revolving credit facility

     24,116   

Unrealized change in fair value

     (5,361

Transfers into level 3

     —     

Transfer out of level 3

     —     

Balance, June 30, 2013

     101,775   
  

 

 

 

Changes in fair value included in earnings for the period relating to assets held at June 30, 2013

   $ (5,361
  

 

 

 

The following tables provide a roll-forward in the changes in fair value for the six months ended June 30, 2012, for all assets for which the Company determines fair value using a material level of unobservable (Level 3) inputs (in thousands).

 

Life Settlements:

  

Balance, December 31, 2011

   $ 90,917   

Purchase of policies

     130   

Acquired in foreclosure

     2,650   

Unrealized change in fair value

     9,129   

Sale of policies

     (5,334

Premiums paid

     13,118   

Transfers into level 3

     —     

Transfer out of level 3

     —     
  

 

 

 

Balance, June 30, 2012

   $ 110,610   
  

 

 

 

Changes in fair value included in earnings for the period relating to assets held at June 30, 2012

   $ 8,945   
  

 

 

 

Structured Settlements:

  

Balance, December 31, 2011

   $ 12,376   

Purchase of contracts

     11,674   

Unrealized change in fair value

     1,178   

Sale of contracts

     (22,467

Collections

     (168

Transfers into level 3

     —     

Transfer out of level 3

     —     
  

 

 

 

Balance, June 30, 2012

   $ 2,593   
  

 

 

 

Changes in fair value included in earnings for the period relating to assets held at June 30, 2012

   $ 589   
  

 

 

 

There were no transfers of financial assets between levels of the fair value hierarchy during the six months ended June 30, 2013 and 2012.

Assets and liabilities measured at fair value on a non-recurring basis

Following is a description of the methodologies used to estimate the fair values of assets and liabilities measured at fair value on a non-recurring basis, and the level within the fair value hierarchy in which those measurements are typically classified.

The Company’s impaired loans are measured at fair value on a non-recurring basis, as the carrying value is based on the fair value of the underlying collateral. The method used to estimate the fair value of impaired collateral-dependent loans depends on the nature of the collateral. For collateral that has lender protection insurance coverage, the fair value measurement is considered to be Level 2 as the insured value is an observable input and there are no material unobservable inputs. For collateral that does not have lender protection insurance coverage, the fair value measurement is considered to be Level 3 as the estimated fair value is based on a model whose significant inputs are the life expectancy of the insured and the discount rate, which are not observable inputs. As of June 30, 2013 and December 31, 2012, the Company had insured impaired loans with a net carrying value, which includes principal, accrued interest, and accreted origination fees, net of impairment, of

 

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approximately zero and $112,000, respectively. As of June 30, 2013 and December 31, 2012, the Company had uninsured impaired loans (Level 3) with a net carrying value of approximately $206,000 and $3.6 million, respectively. The provision for losses on loans receivable related to impaired loans was zero for both of the six months ended June 30, 2013 and 2012. See Notes 9 and 15.

(16) Segment Information

The Company operates in two segments: life finance and structured settlements. Prior to the fourth quarter of 2011, the life finance segment provided financing in the form of loans to trusts and individuals for the payment of premiums of life insurance policies. Beginning in 2011, in this segment, the Company also acquired life insurance policies through purchases in the secondary and tertiary markets. The structured settlements segment purchases structured settlements from individuals.

Recipients of structured settlements are permitted to sell their deferred payment streams to a structured settlement purchaser pursuant to state statutes that require certain disclosures, notice to the obligors and state court approval. Through such sales, the Company purchases a certain number of fixed, scheduled future settlement payments on a discounted basis in exchange for a single lump sum payment.

The performance of the segments is evaluated by members of the Company’s senior management team. Cash and income taxes generally are managed centrally. Performance of the segments is based on revenue and cost control.

 

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Segment results and reconciliation to consolidated net income were as follows (in thousands):

 

     For the Three Months Ended     For the Six Months Ended  
     June 30,     June 30,  
     2013     2012     2013     2012  
     (Unaudited)     (Unaudited)  

Life finance

        

Income

        

Interest income

   $ 9      $ 588      $ 29      $ 1,433   

Origination income

     —          188        —          438   

Change in fair value of life settlements

     64,846        4,874        66,686        9,129   

(Loss) gain on sale of life settlements, net

     (1,247     55        (1,247     291   

Servicing fee income

     76        327        310        684   

Gain on maturities of life settlements with subrogation rights, net

     —          6,090        —          6,090   

Other

     1,952        133        1,997        159   
  

 

 

   

 

 

   

 

 

   

 

 

 
     65,636        12,255        67,775        18,224   
  

 

 

   

 

 

   

 

 

   

 

 

 

Direct segment expenses

        

Interest expense

     10,755        304        10,855        1,075   

Change in fair value of note payable

     (5,361     —          (5,361     —     

Loss on extinguishment of debt

     3,991        —          3,991     

Provision for losses on loan receivables

     —          441        —          441   

(Gain) loss on loans payoffs and settlements, net

     (65     162        (65     153   

Amortization of deferred costs

     —          516        7        1,497   

Personnel costs

     1,232        2,255        2,679        3,564   

Legal fees

     1,458        498        1,359        1,506   

Professional fees

     790        432        968        865   

Insurance

     101        282        313        493   

Other selling, general and administrative expenses

     535        328        798        762   
  

 

 

   

 

 

   

 

 

   

 

 

 
     13,436        5,218        15,544        10,356   
  

 

 

   

 

 

   

 

 

   

 

 

 

Segment operating income

   $ 52,200      $ 7,037      $ 52,231      $ 7,868   
  

 

 

   

 

 

   

 

 

   

 

 

 

Structured settlements

        

Income

        

Realized gain on sale of structured settlements

   $ 3,128      $ 3,134      $ 6,669      $ 5,609   

Interest income

     64        110        131        171   

Unrealized change in fair value of structured settlements

     236        569        781        1,178   

Other income

     48        155        87        253   
  

 

 

   

 

 

   

 

 

   

 

 

 
     3,476        3,968        7,668        7,211   
  

 

 

   

 

 

   

 

 

   

 

 

 

Direct segment expenses

        

Personnel costs

     1,893        2,436        3,660        4,590   

Marketing costs

     617        1,286        1,428        3,447   

Legal fees

     539        554        967        1,144   

Professional fees

     360        499        679        912   

Insurance

     94        274        306        486   

Other selling, general and administrative expenses

     453        475        865        1,034   
  

 

 

   

 

 

   

 

 

   

 

 

 
     3,956        5,524        7,905        11,613   
  

 

 

   

 

 

   

 

 

   

 

 

 

Segment operating loss

   $ (480   $ (1,556   $ (237   $ (4,402
  

 

 

   

 

 

   

 

 

   

 

 

 

Consolidated

        

Segment operating income

     51,720        5,481        51,994        3,466   

Unallocated income

        

Interest and dividends on investment securities available for sale

     2        132        16        260   

Other income

     —          7        8        631   
  

 

 

   

 

 

   

 

 

   

 

 

 
     2        139        24        891   
  

 

 

   

 

 

   

 

 

   

 

 

 

Unallocated expenses

        

Interest expense

     4        —          7        3   

Personnel costs

     529        342        646        568   

Legal fees

     2,668        4,647        6,415        10,940   

Professional fees

     469        864        1,073        1,936   

Insurance

     283        61        378        107   

Other selling, general and administrative expenses

     48        331        70        340   
  

 

 

   

 

 

   

 

 

   

 

 

 
     4,001        6,245        8,589        13,894   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before income taxes

     47,721        (625     43,429        (9,537

(Provision) benefit for income taxes

     —          —          (40     41   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

   $ 47,721      $ (625   $ 43,389      $ (9,496
  

 

 

   

 

 

   

 

 

   

 

 

 

 

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Segment assets and reconciliation to consolidated total assets were as follows (in thousands):

 

     June 30,      December 31,  
     2013      2012  

Direct segment assets

     

Life finance

   $ 270,685       $ 123,581   

Structured settlements

     8,161         6,862   
  

 

 

    

 

 

 
     278,846         130,443   

Other unallocated assets

     32,463         29,899   
  

 

 

    

 

 

 
   $ 311,309       $ 160,342   
  

 

 

    

 

 

 

Amounts are attributed to the segment that holds the assets. There are no intercompany sales and all intercompany account balances are eliminated in segment reporting.

(17) Commitments and Contingencies

In accordance with applicable accounting guidance, the Company establishes an accrued liability for litigation and regulatory matters when those matters present loss contingencies that are both probable and estimable. In such cases, there may be an exposure to loss in excess of any amounts accrued. When a loss contingency is not both probable and estimable, the Company does not establish an accrued liability. As a litigation or regulatory matter develops, the Company, in conjunction with any outside counsel handling the matter, evaluates on an ongoing basis whether such matter presents a loss contingency that is probable and estimable. If, at the time of evaluation, the loss contingency related to a litigation or regulatory matter is not both probable and estimable, the matter will continue to be monitored for further developments that would make such loss contingency both probable and estimable. Once the loss contingency related to a litigation or regulatory matter is deemed to be both probable and estimable, the Company will establish an accrued liability with respect to such loss contingency and record a corresponding amount of litigation-related expense. The Company continues to monitor the matter for further developments that could affect the amount of the accrued liability that has been previously established. Excluding expenses of external legal service providers, USAO litigation-related fees of $3.0 million and $10.1 million were recognized for the six months ended June 30, 2013 and 2012, respectively.

Employment Agreements

In connection with our initial public offering, we entered into employment agreements with certain of our executive officers. The agreement for our chief executive officer provides for substantial payments in the event that the executive terminates his employment with us due to a material change in the geographic location where such officer performs his duties or upon a material diminution of his base salary or responsibilities, with or without cause. For our chief executive officer, payments are equal to three times the sum of base salary and the average of the three years’ annual cash bonus, unless the triggering event occurs during the first three years of his employment agreement, in which case the payments are equal to six times base salary. For our chief executive officer, the agreement provides for bonus incentives based on pre-tax income thresholds.

On April 26, 2012, the Company entered into a Separation Agreement and General Release of Claims (the “Separation Agreement”) with its former chief operating officer, Jonathan Neuman. As part of the Separation Agreement, Mr. Neuman resigned as a member of the Company’s board of directors and as an employee of Company. Pursuant to the Separation Agreement, the Company paid Mr. Neuman a separation payment of $1.4 million. The Separation Agreement does not include a covenant by Mr. Neuman to refrain from competing with Imperial, but does contain customary non-disparagement and non-solicitation provisions. The Separation Agreement provides releases by each party and also obligates the Company to continue to indemnify Mr. Neuman for his legal expenses substantially in the same manner contemplated by his employment agreement with the Company.

On February 15, 2012, the Company entered into a retention arrangement with its Chief Financial Officer and Chief Credit Officer, Richard O’Connell, Jr. The arrangement provides that, in the event Mr. O’Connell’s employment is terminated without cause or Mr. O’Connell terminates his employment with the Company for good reason, in each case, prior to December 31, 2013, Mr. O’Connell will be entitled to 24 months’ base salary in addition to any accrued benefits. Additionally, unless Mr. O’Connell’s employment is terminated for cause, Mr. O’Connell will be entitled to a minimum bonus of $250,000 for each of 2012 and 2013, subject to the Company’s Board of Directors’ right to terminate the bonus payment in respect of 2013 prior to January 1, 2013. Except for the provisions relating to severance and other termination benefits, the terms of Mr. O’Connell’s Employment and Severance Agreement entered into with the Company as of November 4, 2010 remain in effect during the term of the retention arrangement and the provisions of the employment agreement relating to severance and other termination benefits will again be in effect following any termination of the retention arrangement if Mr. O’Connell is then employed by the Company.

During the first quarter of 2012, the Company also entered into severance and retention award agreements with certain of its executive officers (other than the CEO and CFO). The agreements generally provide for a minimum guaranteed bonus in each of 2012 and 2013 as well as severance payments equal to two years base salary in the event of termination by the Company without Cause (as defined in the respective agreement) provided the executive executes a general release of claims against the Company.

 

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We do not have any general policies regarding the use of employment agreements, but may, from time to time, enter into such a written agreement to reflect the terms and conditions of employment of a particular named executive officer, whether at the time of hire or thereafter.

Repurchase Obligations

The subsidiaries of the Company that conveyed policies to White Eagle have undertaken in their contribution agreements to repurchase policies in relation to material breaches of their representations, warranties and covenants concerning such policies. Any such repurchase will be at a price that the lenders under the Revolving Credit Facility determine is the greater of the fair market value thereof or the aggregate amount of maintenance costs and other borrowed amounts allocated to such policy by the lenders with interest on such borrowed amounts at 12% per annum.

Class Action Litigation, Derivative Demands and the Insurance Coverage Declaratory Relief Complaint

The Class Action Litigation

Initially on September 29, 2011, the Company, and certain of its officers and directors were named as defendants in a putative securities class action filed in the Circuit Court of the 15th Judicial Circuit in and for Palm Beach County, Florida, entitled Martin J. Fuller v. Imperial Holdings, Inc. et al. Also named as defendants were the underwriters of the Company’s initial public offering. That complaint asserted claims under Sections 11, 12 and 15 of the Securities Act of 1933, as amended, alleging that the Company should have, but failed to disclose in the registration statement for its initial public offering purported wrongful conduct relating to its life finance business that gave rise to the USAO Investigation. On October 21, 2011, an amended complaint was filed that asserts claims under Sections 11, 12 and 15 of the Securities Act of 1933, based on similar allegations. On October 25, 2011, defendants removed the case to the United States District Court for the Southern District of Florida.

On October 31, 2011, another putative class action case was filed in the Circuit Court of the 15th Judicial Circuit in and for Palm Beach County, Florida, entitled City of Roseville Employees Retirement System v. Imperial Holdings, et al, naming the same defendants and also bringing claims under Sections 11, 12 and 15 of the Securities Act based on similar allegations. On November 28, 2011, defendants removed the case to the United States District Court for the Southern District of Florida. The plaintiffs in the Fuller and City of Roseville cases moved to remand their cases back to state court. Those motions were fully briefed and argued.

On November 18, 2011, a putative class action case was filed in the United States District Court for the Southern District of Florida, entitled Sauer v. Imperial Holdings, Inc., et al, naming the same defendants and bringing claims under Sections 11 and 15 of the Securities Act of 1933 based on similar allegations.

On December 14, 2011, another putative class action case filed in United States District Court for the Southern District of Florida, entitled Pondick v. Imperial Holdings, Inc., et al., naming the same defendants and bringing claims under Sections 11, 12, and 15 of the Securities Act of 1933 based on similar allegations.

On February 24, 2012, the four putative class actions were consolidated and designated: Fuller v. Imperial Holdings et al. in the United States District Court for the Southern District of Florida, and lead plaintiffs were appointed.

In addition, the underwriters of the Company’s initial public offering have asserted that the Company is required by its Underwriting Agreement to indemnify the underwriters’ expenses and potential liabilities in connection with the litigation.

The Insurance Coverage Declaratory Relief Complaint

On June 13, 2012, Catlin Insurance Company (UK) Ltd. (“Catlin”) filed a declaratory relief action against the Company in the United States District Court for the Southern District of Florida. The complaint seeks a determination that there is no coverage under Catlin’s primary Directors, Officers and Company Liability Policy (the “Policy”) issued to the Company for the period February 3, 2012 to February 3, 2012, based on a prior and pending litigation exclusion (the “Exclusion”). Catlin also seeks a determination that it is entitled to reimbursement of the approximately $800,000 in defense costs and fees advanced to the Company in the first quarter of 2012 under the Policy if it is determined that the Exclusion precludes coverage. As of the filing of this Quarterly Report on Form 10-Q, the Company has not yet been served with the complaint.

Derivative Demands

On November 16, 2011, the Company’s Board of Directors received a shareholder derivative demand from Harry Rothenberg (the “Rothenberg Demand”), which was referred to the special committee for a thorough investigation of the issues, occurrences and facts relating to, connected to, and arising from the USAO Investigation referenced in the Rothenberg Demand. On May 8, 2012, the Company’s Board of Directors received a derivative demand made by another shareholder, Robert Andrzejczyk (the “Andrzejczyk Demand”). The Andrzejczyk Demand, like the Rothenberg Demand was referred to the special committee, which determined that it did not contain any allegations that differed materially from those alleged in the Rothenberg Demand. On July 20, 2012, the Company (as nominal defendant) and certain of the Company’s officers, directors, and a former director were named as defendants in a shareholder derivative action filed in the Circuit Court of the 15th Judicial Circuit in and for Palm Beach County, Florida, entitled Robert Andrzejczyk v. Imperial Holdings, Inc. et al. The complaint alleges, among other things, that the Special Committee’s refusal of the Andrzejczyk Demand was improper.

 

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The Settlement

On December 18, 2012, attorneys for the Company signed a Term Sheet for Global Settlement Regarding Imperial Holdings, Inc. Matters (the “Term Sheet”) setting forth the terms upon which each of the parties to the matters described in “Class Action Litigation, Derivative Demands and the Insurance Coverage Declaratory Relief Complaint” would be willing to settle the class action litigation and derivative actions as well as the declaratory relief action filed by Catlin, respectively. In addition to the Company’s attorneys, the Term Sheet was signed by attorneys representing the plaintiffs in the class action lawsuits and derivative actions instituted against the Company, as well attorneys for the Company’s director and officer liability insurance carriers (“D&O Carriers”), certain individual defendants named in the class actions and the underwriters in the Company’s initial public offering.

The terms of the class action settlement include a cash payment of $12.0 million, of which $11.0 million is to be contributed by the Company’s primary and excess D&O Carriers and the issuance of two million warrants for shares of the Company’s stock with an estimated fair value of $3.1 million at the date of the signing of the Term Sheet. The value of the warrants were reassessed during the six months ended June 30, 2013 and resulted in an increase in fair value of $3.3 million. The estimated fair value at June 30, 2013 was $6.4 million. The warrants will have a five-year term with an exercise price of $10.75 and will be issued when the settlement proceeds are distributed to the claimants. In addition, the underwriters in the Company’s initial public offering are to waive their rights to indemnity and contribution by the Company. The Company recorded a reserve at June 30, 2013 related to the proposed settlement of $17.4 million, which is included in other liabilities and a receivable for insurance recoverable from the Company’s D&O Carrier of $11.0 million, which is included in prepaid and other assets. $4.1 million net effect of the proposed settlement is included in legal fees in the statement of operations for the year ended December 31, 2012 and an additional $3.3 million is included in the six month period ended June 30, 2013.

The derivative action settlement requires implementation of certain compliance reforms and contemplates payment by the Company’s primary D&O carrier of $1.5 million for legal fees in respect of the derivative actions and the contribution of $500,000 in the Company’s stock.

In addition, the settlements contemplate that the Company will contribute $500,000 to a trust to cover certain claims under its director and officer liability insurance policies.

The Company established a reserve to the proposed derivative settlement and insurance trust of $2.5 million, which is included in other liabilities and a receivable for insurance recoverable from the Company’s D&O Carrier of $1.5 million, which is included in prepaid and other assets. The net effect of the settlement of $1.0 million is included in legal fees in the settlement of operations for the year ended December 31, 2012.

The settlements also require the Company to advance legal fees to and indemnify certain individuals covered under the policies. The obligation to advance and indemnify on behalf of these individuals, while currently unquantifiable, may be substantial and could have a material adverse effect on the Company’s financial position and results of operations. See Note 20 — Subsequent Events.

SEC Investigation

On February 17, 2012, the Company received a subpoena issued by the staff of the SEC seeking documents from 2007 through the date of the subpoena, generally related to the Company’s premium finance business and corresponding financial reporting. The SEC is investigating whether any violations of federal securities laws have occurred and the Company has been cooperating with the SEC regarding this matter. The Company is unable to predict what action, if any, might be taken in the future by the SEC or its staff as a result of the matters that are the subject of the subpoena or what impact, if any, the cost of responding to the subpoena might have on the Company’s financial position, results of operations, or cash flows. The Company has not established any provision for losses in respect of this matter.

Sun Life

On April 18, 2013, Sun Life Assurance Company of Canada (“Sun Life”) filed a complaint against the Company and several of its affiliates in the United States District Court for the Southern District of Florida, entitled Sun Life Assurance Company of Canada v. Imperial Holdings, Inc., et al. The complaint seeks to contest the validity of at least twenty-nine (29) policies issued by Sun Life. The complaint also asserts the following claims: (1) violations of the federal Racketeer Influenced and Corrupt Organizations Act, (2) common law fraud, (3) civil conspiracy, (4) tortious interference with contractual obligations, and (5) an equitable accounting. In response to a motion to dismiss filed by the Company, Sun Life filed an amended complaint on June 13, 2013. The Company believes that the amended complaint is without merit and filed another motion to dismiss on July 8, 2013. The Company intends to defend itself vigorously. No reserve has been established for this litigation. See Note 20 — Subsequent Events.

Sanctions Order

On April 27, 2012, after the conclusion of a jury trial in the matter styled Steven A. Sciaretta, as Trustee of the Barton Cotton Irrevocable Trust a/k/a the Amended and Restated Barton Cotton Irrevocable Trust v. The Lincoln National Life Insurance Company (“Lincoln”) , the defendant, Lincoln, filed a motion seeking sanctions against the Company’s subsidiary, Imperial Premium Finance (“IPF”), a non-party to the litigation, relating to its corporate representative deposition and trial testimony. On May 6, 2013, the Court issued an order sanctioning IPF and ordering it to pay $850,000.00. On June 4, 2013, IPF filed a Notice of Appeal of the order to the Eleventh Circuit Court of Appeals. The Company recorded a reserve of $850,000 that is included in legal fees for the six months ended June 30, 2013.

 

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Litigation

We are party to various other legal proceedings that arise in the ordinary course of business. We believe that the resolution of these other proceedings will not, based on information currently available to us, have a material adverse effect on our financial position or results of operations.

(18) Stockholders’ Equity

On February 3, 2011, the Company converted from a Florida limited liability company to a Florida corporation (the “Conversion”) at which time the members of Imperial Holdings, LLC became shareholders of Imperial Holdings, Inc. As a limited liability company, the Company was treated as a partnership for United States federal and state income tax purposes and, as such, the Company was not subject to taxation. For all periods subsequent to such conversion, the Company will be subject to corporate-level United States federal and state income taxes.

On February 11, 2011, the Company closed its initial public offering of 16,666,667 shares of common stock at $10.75 per share. On February 15, 2011 Imperial Holdings, Inc. sold an additional 935,947 shares of common stock. The sale was in connection with the over-allotment option Imperial Holdings, Inc. granted to its underwriters in connection with Imperial’s initial public offering. As a result, the total initial public offering size was 17,602,614 shares. All shares were sold to the public at a price of $10.75. The Company received net proceeds of approximately $174.2 million after deducting the underwriting discounts and commissions and our offering expenses.

(19) Income Taxes

Our provision for income taxes is estimated to result in an annual effective tax rate of 0.0% in 2013, except as noted below. The 0.0% effective tax rate is a result of our recording of a valuation allowance for those deferred tax assets that are not expected to be recovered in the future. Due to significant cumulative losses since the Conversion, the uncertainties that resulted from the USAO Investigation, SEC investigation, Non-Prosecution Agreement and the class action lawsuits and expectation of taxable losses in the foreseeable future, we may not have sufficient taxable income of the appropriate character in the future to realize any portion of the net deferred tax asset.

Generally, the amount of tax expense or benefit allocated to continuing operations is determined without regard to the tax effects of other categories of income or loss, such as other comprehensive income. However, an exception to the general rule is provided when, in the presence of a valuation allowance against deferred tax assets, there is a pretax loss from continuing operations and pretax income from other categories. In such instances, income from other categories must offset the current loss from operations, the tax benefit of such offset being reflected in continuing operations. For the six months ended June 30, 2012 we reduced the deferred tax valuation allowance from continuing operations by $41,000 to reflect the future taxable income associated with unrealized gains in accumulated other comprehensive income. As the Company sold all of its remaining investment securities in the first quarter of 2013, this allocation between continuing operations and other comprehensive income was reversed.

On February 3, 2011, we converted from a Florida limited liability company to a Florida corporation (the “Conversion”). Prior to the Conversion we were treated as a partnership for federal and state income tax purposes. As a partnership our taxable income and losses were attributed to our members, and accordingly, no provision or liability for income taxes was reflected in the accompanying consolidated financial statements for periods prior to the Conversion.

In February of 2013 the Company was notified by the Internal Revenue Service of its intention to examine the Company’s partnership return for the year ended December 31, 2010. In April of 2013, the Internal Revenue Service notified the Company that it had decided not to proceed with the examination.

The Company and its subsidiaries are subject to U.S. federal income tax as well as to income tax in Florida and other states in which it operates.

At June 30, 2013, income taxes payable includes an estimated liability for unrecognized tax benefits of $6.3 million that relate to the Conversion and was charged to paid-in-capital in the first quarter of 2011.

(20) Subsequent Events

Revolving Credit Facility

The Revolving Credit Facility was amended on August 9, 2013 to provide until August 31, 2013 for the delivery of certain post-closing items by White Eagle and the servicer.

Sun Life

On July 29, 2013, the Company filed a complaint against Sun Life in United States District Court for the Southern District of Florida, entitled Imperial Premium Finance, LLC v. Sun Life Assurance Company of Canada. The complaint asserts claims against Sun Life for breach of contract, breach of the covenant of good faith and fair dealing, and fraud, and seeks a judgment declaring that Sun Life is obligated to comply with the promises made by it in certain insurance policies. The complaint also seeks compensatory damages of no less than $30 million in addition to an award of punitive damages.

 

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Class Action Litigation, Derivative Demands and the Insurance Coverage Declaratory Relief Complaint

On July 29, 2013, the parties to the Term Sheet executed definitive settlement agreements in respect of the class action litigation, derivative action and insurance coverage declaratory relief complaint. The class action litigation and derivative action settlements are subject to court approval and all of the settlements are contingent on effectiveness of the other settlements. On August 6, 2013, the federal court entered an order preliminarily approving the class action settlements and setting a settlement hearing for December 16, 2013. On August 13, 2013, the state court entered an order preliminarily approving the derivative action settlement and setting a final fairness hearing for December 17, 2013. Final court approval of the Securities Class Action and Derivative Action settlements could be delayed by appeals or other proceedings.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion summarizes the significant factors affecting the consolidated operating results, financial condition, liquidity, and cash flows of our Company as of and for the periods presented below and should be read in conjunction with the financial statements and accompanying notes included with this Quarterly Report on Form 10-Q. This discussion contains forward-looking statements that are based on the beliefs of our management, as well as assumptions made by, and information currently available to, our management. Actual results could differ materially from those discussed in or implied by forward-looking statements as a result of various factors. See “Forward-Looking Statements.”

Overview

We were founded in December 2006 as a Florida limited liability company and in connection with our initial public offering, in February 2011, Imperial Holdings, Inc. succeeded to the business of Imperial Holdings, LLC and its assets and liabilities.

Imperial Holdings, Inc. (the “Company” or “Imperial”) operates in two reportable business segments: life finance (formerly referred to as premium finance) and structured settlements. In the life finance business, the Company earns revenue/income from changes in the fair value of life insurance policies that the Company acquires and receipt of death benefits with respect to matured life insurance policies it owns as well as from interest accruing on outstanding loans and loan origination fees recognized over the life of outstanding loans. In the structured settlement business, the Company purchases structured settlement receivables at a discounted rate and sells these receivables to third parties. Our Annual Report on Form 10-K for the fiscal year ended December 31, 2012 provides additional information about our business, operations and financial condition.

New Revolving Credit Facility, Retirement of Bridge Facility, Portfolio Growth and Change in Accounting Estimate

In anticipation of a liquidity shortfall in the second quarter of 2013, on March 27, 2013, a subsidiary of the Company borrowed $45.0 million in aggregate principal amount under an 18-month senior secured bridge facility (the “Bridge Facility”) while the Company continued in its efforts to source longer-term capital.

On April 29, 2013, White Eagle Asset Portfolio, LLC, a subsidiary of the Company entered into a 15-year revolving credit facility providing for up to $300.0 million in borrowings (the “Revolving Credit Facility”) to pay premiums on the policies pledged as collateral under the facility, debt service and for the fees and expenses of certain service providers. The initial advance under the Revolving Credit Facility was approximately $83.0 million, with a portion of such borrowings used to retire the debt outstanding under the Bridge Facility. In addition, proceeds of the initial advance were used to pay transaction fees and expenses, a distribution to the Company and to fund a $48.5 million release payment under a termination agreement (the “Termination Agreement”) to the Company’s lender protection insurance coverage provider (the “LPIC Provider”) who released all of its salvage and subrogation rights in 323 policies that the Company has historically treated as contingent assets and described as “Life Settlements with Subrogation rights, net” as well as in 93 policies that were owned by CTL Holdings, LLC (“CTL”). On April 30, 2013, the Company acquired CTL and its 93 policies. At June 30, 2013 the Company’s portfolio consists of 627 policies, with an aggregate death benefit of $3.0 billion compared to 220 policies, with an aggregate death benefit of $1.1 billion at March 31, 2013.

459 policies owned by White Eagle, with an aggregate death benefit of $2.3 billion, and an estimated fair value of approximately $218.1 million at June 30, 2013 have been pledged as collateral under the Revolving Credit Facility and the Company can use subsequent draws to pay premiums on these policies. The Company is presently evaluating the 168 policies that have not been pledged as collateral, the majority of which had historically been maintained by the LPIC Provider, and may pledge certain of these policies in the future. It may also determine to sell or lapse certain of these policies as its portfolio strategy and liquidity needs dictate. Should it choose maintain all of the policies that have not been pledged as collateral under the Revolving Credit Facility, the Company estimates that it will need to pay approximately $6.5 million to maintain these 168 policies in force through 2013 and may seek to raise additional capital to maintain some or all of these policies.

        The procurement of the $300.0 million 15-year Revolving Credit Facility and the retirement of the $45.0 million Bridge Facility served to effectively recapitalize the Company and significantly mitigate liquidity risk. While the Revolving Credit Facility provides the lender with a significant interest in the policies pledged as collateral, the initial borrowings under the facility allowed the Company to opportunistically triple the size of its portfolio through the extinguishment of subrogation rights in policies that were historically considered contingent assets and through the acquisition of the CTL policies.

At June 30, 2013, the Company or its subsidiaries owned 402 policies that were either acquired through the acquisition of CTL or that were considered contingent assets prior to the effectiveness of the Termination Agreement, with an aggregate death benefit of $1.9 billion and an estimated fair value of approximately $139.7 million. The Company believes that it was uniquely positioned to transact with both the LPIC Provider and CTL and that the transaction prices were, accordingly, not indicative of what an exit price would be for these 402 policies in a negotiated market transfer. The addition of these policies resulted in a $65.8 million unrealized gain in investments in life settlements during the quarter ended June 30, 2013 and policy acquisitions similar in scale and in transaction price to those made during the quarter should not be anticipated in future periods.

Due to these policy additions, the application of fair value accounting to amounts owing under the Revolving Credit Facility and the elimination of servicing fee income through intercompany consolidation, the results of prior periods may not be comparable to the Company’s results at June 30, 2013 or in future periods.

 

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The Company collected death benefits of $5.0 million and $1.0 million plus interest, respectively, in the second quarter of 2013 in respect of two policies that matured in the first quarter of 2013 and collected an additional $1.0 million from the surrender of two policies that were acquired during the second quarter of 2013.

Settlement of Shareholder Litigation

On December 18, 2012, attorneys for Imperial signed a Term Sheet for Global Settlement Regarding Imperial Holdings, Inc. Matters (the “Term Sheet”). Also signing the Term Sheet were attorneys representing the plaintiffs in the previously disclosed class action lawsuits and derivative actions instituted against the Company as well attorneys for Imperial’s director and officer liability insurance carriers (“D&O Carriers”), certain individual defendants named in the class actions and the underwriters in Imperial’s initial public offering. The Term Sheet provides the terms upon which each of the parties represented by the signatories would be willing to settle the class action litigation and derivative actions as well as the declaratory relief action filed by Catlin, Imperial’s primary D&O Carrier.

On July 29, 2013, the parties to the Term Sheet executed definitive settlement agreements in respect of the class action litigation, derivative action and insurance coverage declaratory relief complaint. The class action litigation and derivative action settlements are subject to court approval and all of the settlements are contingent on effectiveness of the other settlements. On August 6, 2013, the federal court entered an order preliminarily approving the class action settlements and setting a settlement hearing for December 16, 2013. On August 13, 2013, the state court entered an order preliminarily approving the derivative action settlement and setting a final fairness hearing for December 17, 2013. Final court approval of the class action and derivative action settlements could be delayed by appeals or other proceedings

The terms of the class action settlement include a cash payment of $12.0 million, of which $11.0 million is to be contributed by Imperial’s primary and excess D&O Carriers, and the issuance of two million warrants for shares of the Company’s stock with an estimated fair value of $3.1 million at the date of the signing of the Term Sheet. The value of the warrants were reassessed during the six months ended June 30, 2013 and resulted in an increase in fair value of $3.3 million. The estimated fair value at June 30, 2013 was $6.4 million. The fair value of the warrants will be re-assessed at issuance. The warrants will have a five-year term with an exercise price of $10.75 and will be issued when the settlement proceeds are distributed to the claimants. In addition, the underwriters in Imperial’s initial public offering are to waive their rights to indemnity and contribution by Imperial. The Company recorded a reserve at June 30, 2013 related to the proposed settlement of $18.4 million, which is included in other liabilities and a receivable for insurance recoverable from the Company’s D&O Carrier of $11.0 million, which is included in prepaid and other assets. $4.1 million net effect of the settlement was included in legal fees in the statement of operations for the year ended December 31, 2012.

The derivative action settlement requires implementation of certain compliance reforms and contemplates payment by Imperial’s primary D&O carrier of $1.5 million for legal fees in respect of the derivative actions and the contribution of $500,000 in Imperial stock.

In addition, the settlements contemplate that Imperial will contribute $500,000 to a trust to cover certain claims under its director and officer liability insurance policies.

The Company established a reserve related to the proposed derivative settlement and insurance trust of $2.5 million, which is included in other liabilities and a receivable for insurance recoverable from the Company’s D&O Carrier of $1.5 million, which is included in prepaid and other assets. The net effect of the settlement of $1.0 million was included in legal fees in the statement of operations for the year ended December 31, 2012.

The settlements also require Imperial to advance legal fees to and indemnify certain individuals covered under the policies. The obligation to advance and indemnify on behalf of these individuals, while currently unquantifiable, may be substantial and could have a material adverse effect on the Company’s financial position and results of operations.

Use of Updated Life Expectancies & Recent Announcements by Life Expectancy Providers

To calculate the fair value of its life insurance policies, beginning with the quarter ended September 30, 2012 and consistent with the practice of many participants in the secondary and tertiary markets, the Company utilizes a “blend” of the life expectancy reports furnished by AVS Underwriting LLC (“AVS”) and 21st Services, LLC (“21st Services”) to establish a composite mortality factor input into its fair value model.

On January 22, 2013, 21st Services announced revisions to its underwriting methodology and on February 4, 2013, announced that it was correcting errors discovered in its previously announced revised methodology. According to the 21st Services, these revisions have generally been understood to lengthen the average reported life expectancy furnished by this life expectancy provider by 19%. At March 31, 2013, the Company had not received any life expectancy reports from 21st Services utilizing its revised methodology and, to account for the impact of the revisions and based off of market responses to the methodology change, the Company lengthened the life expectancies furnished by 21st Services by 13% prior to blending them with the life expectancy reports furnished by AVS.

As of June 30, 2013, the Company received 98 updated life expectancy reports from 21st Services that utilize its revised methodology. These life expectancies reported an average lengthening of life expectancies of 15.8% and, based on this sample, for the six months ended June 30, 2013, the Company increased the life expectancies furnished by 21st Services by 15.8% on the rest of its portfolio of life settlements prior to blending them with the life expectancy reports furnished by AVS. The Company expects to continue to lengthen life expectancies furnished

 

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by 21st Services that have not been re-underwritten using their updated methodology. Since the Revolving Credit Facility necessitates that the Company procure updated life expectancies on a periodic basis, the amount of policies that are lengthened by the Company in this manner will decrease over time and the fair value calculations in future periods will, accordingly, reflect the actual impact of the revised 21st Services methodology on a policy by policy basis as updated life expectancy reports are procured. At June 30, 2013, had the Company not applied the 15.8% increase to the 21st Services life expectancy reports, the portfolio would have increased from the reported amount of $265.8 million by $5.3 million.

Prior to the quarter ended June 30, 2013, when blending AVS and 21st Services’ life expectancy reports to derive a composite mortality factor, the Company would cap the higher mortality factor at an amount that was 150% above the lower mortality factor. This was done so as to reduce variances between life expectancies furnished by these two life expectancy providers. For the period ending June 30, 2013, the Company terminated its use of such a cap. The Company believes that the elimination of this cap is consistent with valuation methodologies employed by other market participants in connection with 21st Services’ revised methodology.

One of the Company’s life expectancy providers, AVS, filed for federal bankruptcy protection under Chapter 11 on February 12, 2013. The Company cannot, at this time, predict what impact the bankruptcy filing will have on the Company’s ability to procure life expectancy reports from AVS in the future, AVS’s ability to continue its operations or whether other market participants will continue to use AVS life expectancy reports for valuation purposes going forward. The Company will continue to monitor the market response to these developments and may elect to adjust the application of life expectancy reports in its fair value methodology or source reports from different life expectancy providers in future periods.

Critical Accounting Policies

Critical Accounting Estimates

The preparation of the financial statements requires us to make judgments, estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. We base our judgments, estimates and assumptions on historical experience and on various other factors that are believed to be reasonable under the circumstances. Actual results could differ materially from these estimates under different assumptions and conditions. We evaluate our judgments, estimates and assumptions on a regular basis and make changes accordingly. We believe that the judgments, estimates and assumptions involved in the accounting for the loan impairment valuation, allowance for doubtful accounts, income taxes, valuation of structured settlements and the valuation of investments in life settlements have the greatest potential impact on our financial statements and accordingly believe these to be our critical accounting estimates. Below we discuss the critical accounting policies associated with the estimates as well as selected other critical accounting policies.

Life Finance Loans Receivable

We report loans receivable acquired or originated by us at cost, adjusted for any deferred fees or costs in accordance with ASC 310-20, Receivables — Nonrefundable Fees and Other Costs, discounts, and loan impairment valuation. All loans are collateralized by life insurance policies. Interest income is accrued on the unpaid principal balance on a monthly basis based on the applicable rate of interest on the loans.

In accordance with ASC 310, Receivables, we specifically evaluate all loans for impairment based on the fair value of the underlying policies as collectability is primarily collateral dependent. The loans are considered to be collateral dependent as the repayment of the loans is expected to be provided by the underlying insurance policies. In the event of default, the borrower typically relinquishes ownership of the policy to us in exchange for our release of the debt (or we enforce our security interests in the beneficial interests in the trust that owns the policy). For loans that had lender protection insurance, we made a claim against the lender protection insurance policy and, subject to terms and conditions of the lender protection insurance policy, our lender protection insurer had the right to direct control or take beneficial ownership of the policy upon payment of our claim. For loans without lender protection insurance, we have the option of selling the policy or maintaining it on our balance sheet for investment.

We evaluate the loan impairment valuation on a monthly basis based on our periodic review of the estimated value of the underlying collateral. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. The loan impairment valuation is established as losses on loans are estimated and the provision is charged to earnings. Once established, the loan impairment valuation cannot be reversed to earnings.

In order to originate premium finance transactions our lenders required that we procure lender protection insurance. This lender protection insurance mitigates our exposure to losses, which may be caused by declines in the fair value of the underlying policies. At the end of each reporting period, for loans that had lender protection insurance, a loan impairment valuation was established if the carrying value of the loan receivable exceeded the amount of coverage. The lender protection insurance program was terminated as of December 31, 2010, and all loans originated after December 31, 2010, do not carry lender protection insurance coverage. Thus, for all loans originated in 2011 and beyond, a loan impairment valuation is established if the carrying value of a loan receivable exceeds the fair value of the underlying collateral. The Company ceased originating loans in the fourth quarter of 2011. The Termination Agreement entered into on April 30, 2013 between the Company and its lender protection insurer eliminated lender protection insurance coverage for all loans that previously had such coverage.

 

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Fair Value Option

As of July 1, 2010, we elected to adopt the fair value option, in accordance with ASC 825, Financial Instruments, to record newly-acquired structured settlements at fair value. We have the option to measure eligible financial assets, financial liabilities, and commitments at fair value on an instrument-by-instrument basis. This option is available when we first recognize a financial asset or financial liability or enter into a firm commitment. Subsequent changes in the fair value of assets, liabilities, and commitments where we have elected the fair value option are recorded in our consolidated statement of operations. We have made this election for our structured settlement assets because it is our intention to sell these assets within the next twelve months, and we believe it significantly reduces the disparity that exists between the GAAP carrying value of these structured settlements and our estimate of their economic value.

We have elected to account for the note payable under the Revolving Credit Facility with LNV Corporation, which includes the 50% interest in policy proceeds to the lender, using the fair value method. The fair value of the debt is the amount the Company would have to pay to transfer the debt to a market participant in an orderly transaction. We calculated the fair value of the debt using a discounted cash flow model taking into account the stated interest rate of the credit facility and probabilistic cash flows from the pledged policies. Considerable judgment is required in interpreting market data to develop the estimates of fair value. Accordingly, our estimates are not necessarily indicative of the amounts that we, or holders of the instruments, could realize in a current market exchange. The most significant assumptions are the estimates of life expectancy of the insured and the discount rate. The use of different assumptions and/or estimation methodologies could have a material effect on the estimated fair values.

Fair Value Measurement Guidance

We follow ASC 820, Fair Value Measurements and Disclosures, which defines fair value as an exit price representing the amount that would be received if an asset were sold or that would be paid to transfer a liability in an orderly transaction between market participants at the measurement date. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions the guidance establishes a three-level fair value hierarchy that prioritizes the inputs used to measure fair value. Level 1 relates to quoted prices in active markets for identical assets or liabilities. Level 2 relates to observable inputs other than quoted prices included in Level 1. Level 3 relates to unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Our investments in life insurance policies, structured settlements and note payable are considered Level 3 assets as there is currently no active market where we are able to observe quoted prices for identical assets and our valuation model incorporates significant inputs that are not observable. Our impaired loans are measured at fair value on a non-recurring basis, as the carrying value is based on the fair value of the underlying collateral. The method used to estimate the fair value of impaired collateral-dependent loans depends on the nature of the collateral. For collateral that has lender protection insurance coverage, the fair value measurement is considered to be Level 3 as the insured value is an observable input to the Company, but not observable to market participants. For collateral that does not have lender protection insurance coverage, the fair value measurement is considered to be Level 3 as the estimated fair value is based on a model whose significant inputs are the life expectancy of the insured and the discount rate, which are not observable.

Ownership of Life Insurance Policies

In the ordinary course of business, a large portion of our borrowers default by not paying off the loan and relinquish ownership of the life insurance policy to us in exchange for our release of the obligation to pay amounts due. We also buy life insurance policies in the secondary and tertiary markets. We account for life insurance policies that we own as investments in life settlements (life insurance policies) in accordance with ASC 325-30, Investments in Insurance Contracts, which requires us to use either the investment method or the fair value method. The election is made on an instrument-by-instrument basis and is irrevocable. We have elected to account for these life insurance policies as investments using the fair value method.

We initially record investments in life settlements at the transaction price. For policies acquired upon relinquishment by our borrowers, we determine the transaction price based on fair value of the acquired policies at the date of relinquishment. The difference between the net carrying value of the loan and the transaction price is recorded as a gain (loss) on loan payoffs and settlement. For policies acquired for cash, the transaction price is the amount paid.

Valuation of Insurance Policies

Our valuation of insurance policies is a critical component of our estimate for the loan impairment valuation and the fair value of our investments in life settlements (life insurance policies). We currently use a probabilistic method of valuing life insurance policies, which we believe to be the preferred valuation method in the industry. The most significant assumptions are the Company’s estimate of the life expectancy of the insured and the discount rate.

In determining the life expectancy estimate, we analyze medical reviews from independent secondary market life expectancy providers (each a “LE provider”). An LE provider reviews the medical records and identifies all medical conditions it feels are relevant to the life expectancy of the insured. Debits and credits are then assigned by each LE provider to the individual’s health based on these medical conditions. The debit or credit that an LE provider assigns to a medical condition is derived from the experience of mortality attributed to this condition in the portfolio of lives that it monitors. The health of the insured is summarized by the LE provider into a life assessment of the individual’s life expectancy expressed both in terms of months and in mortality factor.

The resulting mortality factor represents an indication as to the degree to which the given life can be considered more or less impaired than a standard life having similar characteristics (e.g. gender, age, smoking, etc.). For example, a standard insured (the average life for the

 

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given mortality table) would carry a mortality rating of 100%. A similar but impaired life bearing a mortality rating of 200% would be considered to have twice the chance of dying earlier than the standard life. Historically, the Company has procured the majority of its life expectancy reports from two life expectancy report providers and only used AVS life expectancy reports for valuation purposes. Beginning in the quarter ended September 30, 2012, the Company began utilizing life expectancy reports from 21st Services for valuation purposes and began averaging or “blending,” the results of the two life expectancy reports to establish a composite mortality factor.

The probability of mortality for an insured is then calculated by applying the blended life expectancy estimate to a mortality table. The mortality table is created based on the rates of death among groups categorized by gender, age, and smoking status. By measuring how many deaths occur before the start of each year, the table allows for a calculation of the probability of death in a given year for each category of insured people. The probability of mortality for an insured is found by applying the mortality rating from the life expectancy assessment to the probability found in the actuarial table for the insured’s age, sex and smoking status. The Company has historically applied an actuarial table developed by a third party. However, beginning in the quarter ended September 30, 2012, the Company transitioned to a table developed by the U.S. Society of Actuaries known as the 2008 Valuation Basic Table, or the 2008 VBT. However, because the 2008 VBT table does not account for anticipated improvements in mortality in the insured population, the table was modified in conjunction with outside consultants to reflect these expected mortality improvements. The Company believes that the change in mortality table does not materially impact the valuation of its life insurance policies and that its adoption of a modified 2008 VBT table is consistent with modified tables used by market participants and third party medical underwriters.

The mortality rating is used to create a series of best estimate probabilistic cash flows. This probability represents a mathematical curve known as a mortality curve. This curve is then used to generate a series of expected cash flows over the remaining expected lifespan of the insured and the corresponding policy. A discounted present value calculation is then used to determine the value of the policy. If the insured dies earlier than expected, the return will be higher than if the insured dies when expected or later than expected.

The calculation allows for the possibility that if the insured dies earlier than expected, the premiums needed to keep the policy in force will not have to be paid. Conversely, the calculation also considers the possibility that if the insured lives longer than expected, more premium payments will be necessary. Based on these considerations, each possible outcome is assigned a probability and the range of possible outcomes is then used to create a fair value for the policy.

As is the case with most market participants, the Company used a blend of life expectancies that are provided by two third-party LE providers. These are estimates of an insured’s remaining years. If all of the insured lives in the Company’s life settlement portfolio live six months shorter or longer than the life expectancies provided by these third parties, the change in fair market value at June 30, 2013 would be as follows (dollars in thousands):

 

Life Expectancy Months Adjustment

   Fair Value      Change in Value  

+6

   $ 219,364       $ (46,409

-

   $ 265,773         —     

-6

   $ 316,408       $ 50,635   

Prior to the second quarter of 2013, the Company would adjust its average, or blend, of the two life expectancy reports when the difference in the probability of mortality between the reports was greater than 150%. In those instances and as reflected in the fair market value at December 31, 2012 and March 31, 2013, the Company would cap the higher mortality factor at amount that was 150% above the lower mortality factor, which ultimately reduced the mortality factor inputted into the Company’s fair value model. As discussed above under Use of Updated Life Expectancies and Change in Mortality Table in this Management’s Discussion and Analysis of Financial Condition and Results of Operations, the Company ceased applying a cap as part of the valuation adjustments implemented in connection with 21st Services’ revised underwriting methodology. Additionally, the Company increased the life expectancies furnished by 21st Services by 15.8% at June 30, 2013 prior to blending them with the life expectancy reports furnished by AVS. Had the Company not implemented such an adjustment, the fair value of the Company’s portfolio would have increased from the reported amount of $265.8 million by $5.3 million.

The Company believes that investors in esoteric assets, such as life insurance policies, typically target yields averaging between 12% — 17% for investments of more than a 5 year duration, and had historically used a 15% — 17% range of discount rates to value its life insurance policies. In the third quarter of 2011 and in the immediate aftermath of becoming aware of the USAO investigation, the Company substantially increased the discount rates inputted into its fair value model as it believed that USAO Investigation along with certain unfavorable court decisions unrelated to the Company contributed to a contraction in the marketplace that has continued to reverberate. Since that time, the Company has been re-evaluating its discount rates at the end of every reporting period in order to reflect the estimated discount rates that could reasonably be used in a market transaction involving the Company’s portfolio of life insurance policies. In doing so, the Company relies on management insight, engages third party consultants to corroborate its assessment, engages in discussions with other market participants and potential financing sources and extrapolates the discount rate underlying actual sales of policies.

Although the Company believes that its entry into the Non-Prosecution Agreement had a positive effect on the market generally and for premium financed life insurance policies specifically, the Company believes that, when given the choice to invest in a policy that was

 

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associated with the Company’s premium finance business and a similar policy without such an association, all else being equal, an investor would have generally opted to invest in the policy that was not associated with the Company’s premium finance business. However, since entering into the Non-Prosecution Agreement, investors have required less of a risk premium to transact in these policies and the Company expects that, in time, investors will continue to require less of a risk premium to transact in policies associated with its premium finance business.

As of June 30, 2013, the Company owned 627 policies with an aggregate investment in life settlements of $265.8 million. Of these 627 policies, 584 were previously premium financed and are valued using discount rates that range from 16.59% to 29.59%. The remaining 43 policies are valued using discount rates that range from 14.59% to 21.59%.

The discount rate incorporates current information about market interest rates, the credit exposure to the insurance company that issued the life insurance policy and our estimate of the risk premium an investor in the policy would require. The extent to which the fair value could vary in the near term has been quantified by evaluating the effect of changes in the weighted average discount rate on the death benefit used to estimate the fair value. If the weighted average discount rate were increased or decreased by 1/2 of 1% and the other assumptions used to estimate fair value remained the same, the change in fair market value would be as follows (dollars in thousands):

 

Weighted Average Rate Calculated Based on Death Benefit

   Rate Adjustment     Value      Change in Value  

20.11%

     -0.50   $ 273,967       $ 8,194   

20.61%

     —        $ 265,773       $ —     

21.11%

     0.50   $ 257,950       $ (7,823

Future changes in the discount rates we use to value life insurance policies could have a material effect on our yield on life settlement transactions, which could have a material adverse effect on our business, financial condition and results of our operations.

At the end of each reporting period we re-value the life insurance policies using our valuation model in order to update our loan impairment valuation for loans receivable and our estimate of fair value for investments in policies held on our balance sheet. This includes reviewing our assumptions for discount rates and life expectancies as well as incorporating current information for premium payments and the passage of time.

Valuation of Note payable

We have elected to account for this note payable, which includes the lender’s interest in policy proceeds, using the fair value method. The fair value of the debt is the amount the Company would have to pay to transfer the debt to a market participant in an orderly transaction. We calculated the fair value of the debt using a discounted cash flow model taking into account the stated interest rate of the Revolving Credit Facility and probabilistic cash flows from the pledged policies. Accordingly, our estimates are not necessarily indicative of the amounts that we, or holders of the instruments, could realize in a current market exchange. The most significant assumptions are the estimates of life expectancy of the insured and the discount rate. The use of different assumptions and/or estimation methodologies could have a material effect on the estimated fair values.

Life expectancy sensitivity analysis of note payable

A considerable portion of the fair value of the Company’s note payable derives from the timing of receipt of future policy proceeds. Should life expectancies lengthen such that policy proceeds are collected further into the future, the fair value of this debt will decline. Conversely, should life expectancies shorten, the fair value of this debt will increase. Considerable judgment is required in interpreting market data to develop the estimates of fair value.

As is the case with most market participants, the Company used a blend of life expectancies that are provided by two third-party LE providers. These are estimates of an insured’s remaining years. If all of the insured lives in the Company’s life settlement portfolio live six months shorter or longer than the life expectancies provided by these third parties, the change in fair market value at June 30, 2013 would be as follows (dollars in thousands):

 

Life Expectancy Months Adjustment

   Fair Value of
Note Payable
     Change in Value  

+6

   $ 86,552       $ (15,223

-

   $ 101,775         —     

-6

   $ 119,953       $ 18,178   

Discount rate of note payable

The discount rate incorporates current information about market interest rates, credit exposure to insurance companies and our estimate of the return a lender lending against the policies would require.

 

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Market interest rate sensitivity analysis of note payable

 

Discount Rate

   Rate Adjustment     Fair Value of
Note Payable
     Change in Value  

23.00%

     -0.50   $ 104,328       $ 2,553   

23.50%

     —        $ 101,775       $ —     

24.00%

     0.50   $ 99,316       $ (2,459

Future changes in the discount rates could have a material effect on the fair value of our note payable, which could have a material adverse effect on our business, financial condition and results of our operations.

At June 30, 2013 the fair value of the debt is $101.8 million. See Note 15 — Fair Value Measurements. The outstanding principal is approximately $107.1 million as of June 30, 2013.

Revenue/Income Recognition

Our primary sources of revenue/income are in the form of unrealized change in fair value of life settlements, interest income, and origination fee income, servicing income and realized gains on sales of structured settlements. Our revenue/income recognition policies for these sources of revenue/income are as follows:

 

   

Change in Fair Value of Life Settlements — When the Company acquires certain life insurance policies we initially record these investments at the transaction price, which is the fair value of the policy for those acquired upon relinquishment or the amount paid for policies acquired for cash. The fair value of the investment in insurance policies is evaluated at the end of each reporting period. Changes in the fair value of the investment based on evaluations are recorded as changes in fair value of life settlements in our consolidated statement of operations. The fair value is determined on a discounted cash flow basis that incorporates current life expectancy assumptions. The discount rate incorporates current information about market interest rates, the credit exposure to the insurance company that issued the life insurance policy and our estimate of the risk premium an investor in the policy would require. Changes in the fair value of the investment is also recognized upon the receipt of death notice or verified obituary of insured.

 

   

Gains on Life Settlement, Net — The Company recognizes gains from life settlement contracts that the Company owns upon the signed sale agreement and/or filing of ownership forms and funds transferred to escrow.

 

   

Interest Income — Interest income on premium finance loans is recognized when it is realizable and earned, in accordance with ASC 605, Revenue Recognition. Once the premium finance loans on our balance sheet mature, we will no longer have any revenue generated from interest income from premium finance loans. Discounts on structured settlement receivables are accreted over the life of the settlement using the effective interest method.

 

   

Origination Fee Income — Loans often include origination fees that are fees payable to us on the date the loan matures. The fees are negotiated at the inception of the loan on a transaction by transaction basis. The fees are accreted into income over the term of the loan using the effective interest method. Once the premium finance loans on our balance sheet mature, we will no longer have any revenue generated from origination income.

 

   

Servicing Income — We historically received income from servicing life insurance policies controlled by a third party. These services included verifying premiums are paid and correctly applied and updating files for medical history and ongoing premiums. Upon the effectiveness of the Termination Agreement, the Company ceased receiving servicing income from LPIC Provider.

 

   

Realized Gains on Sales of Structured Settlements — Realized gains on sales of structured settlements are recorded when the structured settlements have been transferred to a third party and we no longer have continuing involvement, in accordance with ASC 860, Transfers and Servicing.

 

   

Interest and origination income on impaired loans is recognized when it is realizable and earned in accordance with ASC 605, Revenue Recognition. Persuasive evidence of an arrangement exists through a loan agreement which is signed by a borrower prior to funding and sets forth the agreed upon terms of the interest and origination fees. Interest income and origination income are earned over the term of the loan and are accreted using the effective interest method. The interest and origination fees are fixed and determinable based on the loan agreement. For impaired loans, we do not recognize interest and origination income that we believe is uncollectible. At the end of the reporting period, we review the accrued interest and accrued origination fees in conjunction with our loan impairment analysis to determine our best estimate of uncollectible income that is then reversed. We continually reassess whether the interest and origination income are collectible as the fair value of the collateral typically increases over the term of the loan. Since our loans are due upon maturity, we cannot determine whether a loan is performing or non-performing until maturity. For impaired loans, our estimate of proceeds to be received upon maturity of the loan is generally correlated to our current fair value estimate of the collateral, but also incorporates expected increases in fair value of the collateral over the term of the loan, trends in the market, sales activity for life insurance policies and our experience with loans payoffs.

 

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Deferred Costs

Deferred costs include costs incurred in connection with acquiring and maintaining credit facilities and costs incurred in connection with securing lender protection insurance. These costs are amortized over the life of the related loan using the effective interest method and are classified as amortization of deferred costs in the accompanying consolidated statement of operations.

Loss in Loan Payoffs and Settlements, Net

When a premium finance loan matures, we record the difference between the net carrying value of the loan and the cash received, or the fair value of the life insurance policy that is obtained in the event of payment default, as a gain or loss on loan payoffs and settlements, net.

Income Taxes

Prior to our initial public offering in 2011, we converted from a Florida limited liability company to a Florida corporation (the “Conversion”). Prior to the Conversion we were treated as a partnership for federal and state income tax purposes. As a partnership our taxable income and losses were attributed to our members, and accordingly, no provision or liability for income taxes was reflected in the accompanying consolidated financial statements for periods prior to the Conversion.

We account for income taxes in accordance with ASC 740, Income Taxes. Under ASC 740, deferred income taxes are determined based on the estimated future tax effects of differences between the financial statement and tax basis of assets and liabilities given the provisions of enacted tax laws. Deferred income tax provisions and benefits are based on changes to the assets or liabilities from year to year. In providing for deferred taxes, we consider tax regulations of the jurisdictions in which we operate, estimates of future taxable income and available tax planning strategies. If tax regulations, operating results or the ability to implement tax-planning strategies varies adjustments to the carrying value of the deferred tax assets and liabilities may be required. Valuation allowances are based on the “more likely than not” criteria of ASC 740.

At June 30, 2013 and 2012, due to the significant cumulative losses since the Conversion and the uncertainties that resulted from the USAO Investigation, SEC investigation, Non-Prosecution Agreement and class action lawsuits, we recorded a full valuation allowance against our net deferred tax asset as it is more likely than not that the net deferred tax asset is not realizable. As a result of these increases in the valuation allowance, we recorded no income tax provision or benefit for the period ended June 30, 2013 and 2012.

The accounting for uncertain tax positions guidance under ASC 740 requires that we recognize the financial statement benefit of a tax position only after determining that the relevant tax authority would more likely than not sustain the position following an audit. For tax positions meeting the more-likely-than-not threshold, the amount recognized in the financial statements is the largest benefit that has a greater than 50 percent likelihood of being realized upon ultimate settlement with the relevant tax authority. We recognize interest and penalties (if any) on uncertain tax positions as a component of income tax expense.

In February of 2013 the Company was notified by the Internal Revenue Service of its intention to examine the Company’s partnership return for the year ended December 31, 2010. In April of 2013, the Internal Revenue Service notified the Company that it had decided not to proceed with the examination.

Stock-Based Compensation

We have adopted ASC 718, Compensation — Stock Compensation. ASC 718 addresses accounting for share-based awards, including stock options, with compensation expense measured using fair value and recorded over the requisite service or performance period of the award. The fair value of equity instruments awarded upon or after the closing of our initial public offering will be determined based on a valuation using an option pricing model which takes into account various assumptions that are subjective. Key assumptions used in the valuation will include the expected term of the equity award taking into account both the contractual term of the award, the effects of expected exercise and post-vesting termination behavior, expected volatility, expected dividends and the risk-free interest rate for the expected term of the award.

Investment Securities Available for Sale

Investment securities available for sale are carried at fair value, inclusive of unrealized gains and losses, and net of discount accretion and premium amortization computed using the level yield method. Net unrealized gains and losses are included in other comprehensive income (loss) net of applicable income taxes. Gains or losses on sales of investment securities available for sale are recognized on the specific identification basis.

Management evaluates securities for other than-temporary-impairment on a quarterly basis. Impairment is evaluated considering numerous factors, and their relative significance varies depending on the situation. Factors considered include the Company’s intent to hold the security until maturity or for a period of time sufficient for a recovery in value, whether it is more likely than not that the Company will be required to sell the security prior to recovery of its amortized cost basis, the length of time and extent to which fair value has been less than amortized cost, the historical and implied volatility of the fair value of the security, failure of the issuer of the security to make scheduled interest or principal payments, any changes to the rating of the security by a rating agency and recoveries or additional declines in fair value subsequent to the balance sheet date. The Company liquidated its entire portfolio of investment securities available for sale during the first quarter of 2013.

 

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Recent Accounting Pronouncements

Note 2 of the Notes to Consolidated Financial Statements discusses accounting standards adopted during the six months ended June 30, 2013. The adoption of these standards has not had an impact on the Company’s financial position or results of operations.

Results of Operations

The following is our analysis of the results of operations for the periods indicated below. This analysis should be read in conjunction with our financial statements, including the related notes to the financial statements. Our results of operations are discussed below in two parts: (i) our consolidated results of operations and (ii) our results of operations by segment.

 

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Imperial Holdings, Inc. and Subsidiaries

CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

 

     For the Three Months Ended
June 30,
    For the Six Months Ended
June 30,
 
     2013     2012     2013     2012  
     (in thousands, except share and per share data)  

Income

  

Interest income

   $ 75      $ 698      $ 162      $ 1,604   

Interest and dividends on investment securities available for sale

     —          132        14        260   

Origination fee income

     —          188        —          438   

Realized gain on sale of structured settlements

     3,128        3,134        6,670        5,609   

(Loss) gain on life settlements, net

     (1,247     55        (1,247     291   

Change in fair value of life settlements (Notes 13 & 15)

     64,846        4,874        66,686        9,129   

Unrealized change in fair value of structured settlements

     236        569        781        1,178   

Servicing fee income

     76        327        310        684   

Gain on maturities of life settlements with subrogation rights, net

     —          6,090        —          6,090   

Other income

     2,000        116        2,090        866   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total income

     69,114        16,183        75,466        26,149   
  

 

 

   

 

 

   

 

 

   

 

 

 

Expenses

        

Interest expense

     10,759        304        10,861        1,078   

Change in fair value of note payable

     (5,361     —          (5,361     —     

Loss on extinguishment of Bridge Facility

     3,991        —          3,991        —     

Provision for losses on loans receivable

     —          441        —          441   

(Gain) loss on loan payoffs and settlements, net

     (65     162        (65     153   

Amortization of deferred costs

     —          516        7        1,497   

Personnel costs

     3,653        5,033        6,984        8,722   

Marketing costs

     617        1,286        1,428        3,447   

Legal fees

     4,665        5,699        8,744        13,590   

Professional fees

     1,619        1,795        2,720        3,713   

Insurance

     479        617        998        1,086   

Other selling, general and administrative expenses

     1,036        955        1,730        1,959   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total expenses

     21,393        16,808        32,037        35,686   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before income taxes

     47,721        (625     43,429        (9,537

(Provision) benefit for income taxes

     —          —          (40     41   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net Income (loss)

   $ 47,721      $ (625   $ 43,389      $ (9,496
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) per share:

        
  

 

 

   

 

 

   

 

 

   

 

 

 

Basic

   $ 2.25      $ (0.03   $ 2.05      $ (0.45
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

   $ 2.25      $ (0.03   $ 2.04      $ (0.45
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average shares outstanding:

        
  

 

 

   

 

 

   

 

 

   

 

 

 

Basic

     21,219,880        21,206,121        21,213,039        21,205,370   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

     21,237,166        21,206,121        21,230,325        21,205,370   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

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Life Finance Segment Results (in thousands)

 

     For the Three Months Ended
June 30,
     For the Six Months Ended
June 30,
 
     2013      2012      2013      2012  
     (Unaudited)      (Unaudited)  

Income

   $ 65,636      $ 12,255       $ 67,775       $ 18,224   

Expenses

     13,436         5,218         15,544         10,356   
  

 

 

    

 

 

    

 

 

    

 

 

 

Segment operating income

   $ 52,200       $ 7,037       $ 52,231       $ 7,868   
  

 

 

    

 

 

    

 

 

    

 

 

 

Structured Settlements Segment Results (in thousands)

 

     For the Three Months Ended
June 30,
    For the Six Months Ended
June 30,
 
     2013     2012