10-K 1 d419033d10k.htm FORM 10-K Form 10-K
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-K

(Mark One)

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

For the fiscal year ended December 31, 2011

or

 

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

For the transition period from                      to                     

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)

Securities registered pursuant to Section 12(b) of the Act:

 

Title of Each Class

 

Name of Each Exchange on Which Registered

Common Stock, par value $0.01 per share   New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Act:

None

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  þ

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.    Yes  ¨    No  þ

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  ¨    No  þ

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

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   þ  (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  þ

The aggregate market value of the voting and non-voting common stock held by non-affiliates of the registrant on June 30, 2011 was $203,808,387.

The number of shares of the registrant’s common stock outstanding as of September 27, 2012 was 21,206,121.

 

 

 


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IMPERIAL HOLDINGS, INC.

2011 Form 10-K Annual Report

Table of Contents

 

Item

        Page
No.
 
PART I   
1.    Business      1   
1A.    Risk Factors      13   
1B.    Unresolved Staff Comments      27   
2.    Properties      27   
3.    Legal Proceedings      27   
4.    Mine Safety Disclosures      31   
PART II   
5.   

Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Our Equity Securities

     32   
6.    Selected Financial Data      35   
7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations      40   
7A.    Quantitative and Qualitative Disclosures about Market Risk      74   
8.    Financial Statements and Supplementary Data      76   
9.    Changes in and Disagreements with Accountants on Accounting and Financial Disclosure      76   
9A.    Controls and Procedures      77   
9B.    Other Information      77   
PART III   
10.    Directors, Executive Officers and Corporate Governance      78   
11.    Executive Compensation      84   
12.   

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

     96   
13.    Certain Relationships and Related Transactions, and Director Independence      98   
14.    Principal Accountant Fees and Services      102   
PART IV   
15.    Exhibits and Financial Statement Schedules      103   
   Signatures      104   
   Table of Contents to Consolidated Financial Statements and Notes      F-1   
   Exhibit Index      E-1   


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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

This Annual Report on Form 10-K contains forward-looking statements that are subject to risks and uncertainties. All statements other than statements of historical fact included in this Annual Report on Form 10-K 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, expectations may prove to have been materially different from the results expressed or implied by such forward-looking statements. Unless otherwise required by law, the Company also 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.

Forward-looking statements address matters that involve risks and uncertainties. Accordingly, there are or will be important factors that could cause our actual results to differ materially from those indicated in these statements. We believe that these factors 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 investigation, SEC investigation, derivative actions or class action lawsuits or similar matters;

 

   

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

 

   

legal 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;

 

   

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

 

   

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

 

   

changes in mortality rates and inaccurate assumptions about life expectancies;

 

   

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 life insurance policies;

 

   

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

 

   

the effect on our financial condition 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;

 

   

our inability to obtain financing on favorable terms or at all;

 

   

loss of the services of any of our executive officers;


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adverse court decisions interpreting insurable interest or the obligation of a life insurance carrier to 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;

 

   

refusal by our lender protection insurer to pay claims;

 

   

deterioration in the credit worthiness of the life insurance companies that issue the policies serving as collateral for our premium finance loans;

 

   

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 rates and other factors.

See “Risk Factors” for more information. 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. You should evaluate all forward-looking statements made in this Annual Report on Form 10-K 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 Annual Report on Form 10-K 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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PART I

Item 1. Business

Overview

We were founded in December 2006 as a Florida limited liability company and in connection with our initial public offering, on February 3, 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 interest charged on loans, loan origination fees, agency fees from referring agents, 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. In the structured settlement business, the Company purchases structured settlement receivables at a discounted rate and sells these receivables 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.

Recent Developments

On September 27, 2011, a search warrant was executed at the Company’s headquarters and 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 also informed that its chairman and chief executive officer, president and chief operating officer, former general counsel, two vice presidents, three life finance sales executives and a funding manager were also considered “targets” of the USAO Investigation. The USAO Investigation focused on the Company’s premium finance loan business. On September 28, 2011, the Company’s board of directors formed a special committee, comprised of all of the Company’s independent directors, to conduct an independent investigation in connection with the USAO Investigation. In December 2011, the U.S. Attorney’s Office for the District of New Hampshire (the “USAO”) confirmed that Mr. Antony Mitchell, our chief executive officer and then chairman, was no longer a target of the USAO investigation.

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 December 31, 2011, the Company had 13 policies in its portfolio that once served as collateral for premium finance loans derived through the retail non-seminar business.

 

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In connection with the Non-Prosecution Agreement, Imperial voluntarily agreed to terminate its premium finance business, which accounted for approximately 58.2% of our revenues in the year ended December 31, 2011, and terminated certain senior sales staff associated with the premium finance business. As previously disclosed in a Current Report on Form 8-K, filed on April 30, 2012, the Company also accepted the resignation of Jonathan Neuman, the Company’s president and chief operating officer. Additionally, the Company agreed to pay the United States Government $8.0 million, 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, but after two years the Company may petition the USAO to forego the final year of the Non-Prosecution Agreement if we otherwise comply with all of our 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.

As of the filing of this Annual Report, we are also subject to an investigation by the U.S. Securities and Exchange Commission (the “SEC”) and several shareholder class action lawsuits and derivative claims related to the matters surrounding the USAO Investigation. See “Legal Proceedings” and “Risk Factors” for more information regarding these matters.

On August 2, 2012, the Board of Directors of the Company appointed Andrew Dakos, Phillip Goldstein and Gerald Hellerman to serve as directors of the Company in connection with a settlement (the “Settlement”) with Opportunity Partners L.P. (“Opportunity”). The Settlement resulted in Opportunity withdrawing its demand for a special meeting of shareholders, which it had submitted to the Company on May 23, 2012 and agreeing to dismiss its lawsuit to compel an annual meeting of shareholders. In connection with the Settlement, Walter Higgins and A. Penn Wyrough resigned from the Board of Directors. Please see “Legal Proceedings” for more information about this matter.

On August 14, 2012, Antony Mitchell, the Company’s chief executive officer, resigned as chairman of the board (though he continues to serve as a director and the Company’s chief executive officer) and Mr. Goldstein was elected chairman. The committees of the Board of Directors were also reconstituted as further described in Part III of this Annual Report on Form 10-K.

Life Finance Business

Overview

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. In a premium finance transaction, a life insurance policyholder obtains a loan, usually through an irrevocable life insurance trust established by the insured, to pay insurance premiums for a fixed period of time. A premium finance loan allows a policyholder to maintain coverage under the policy without having to make premium payments during the term of the loan and benefits life insurance agents by preventing a life insurance policy from lapsing, which could require the agent to repay a portion of the commission earned in connection with the issuance of the policy. As described above, on April 30, 2012, the Company voluntarily terminated its premium finance business in connection with the Non-Prosecution Agreement with the USAO. We had effectively suspended originating premium finance loans, however, as of the end of the third quarter of 2011.

During the time period in which we were originating premium finance loans, our typical loan was approximately two years in duration and was collateralized by the underlying life insurance policy. Approximately 75.9% of loans originated were insured by lender protection insurance, which every credit facility into which we entered into since December 2007 required us to obtain for each loan originated under such credit facility. This coverage provides insurance on the value of the underlying life insurance policy serving as

 

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collateral underlying the loan should our borrower default. Subject to the terms and conditions of the lender protection insurance policy, in the event of a payment default by the borrower, our lender protection insurer has the right to direct control or take beneficial ownership of the life insurance policy and we are paid an amount equal to the insured value of the life insurance policy serving as collateral underlying the loan. The life insurance policies that served as collateral for our premium finance loans were predominately universal life policies that had an average death benefit of approximately $4.8 million and insured persons over age 75. Generally, the borrower was an irrevocable life insurance trust established by the insured which is both the legal owner and beneficiary of a life insurance policy serving as collateral for a premium finance loan. As used throughout this Annual Report on Form 10-K, references to “borrower” refer to the entity or individual executing the note in a premium finance transaction.

A borrower was not required to make any payment on the premium finance loan until maturity. At the end of the loan term, the borrower either repaid the loan in full (including all interest and fees) or defaulted under the loan. In the event of default, subject to loan terms and conditions, we generally foreclosed on the policy serving as collateral for the loan, and, correspondingly, the borrower typically relinquished control of the policy to us. If we acquired the policy upon a loan default, we either held it for investment, sought to sell the policy, or, if the loan was insured, we were paid an amount equal to the insured value of the policy, which may have been equal to or less than the contractual amount we were owed under the loan. The amounts received in respect of claims were used to repay our lenders from whom, prior to 2011, we borrowed funds to extend premium finance loans to borrowers. As of December 31, 2011, we had 138 premium finance loans outstanding, 65.9% of which had collateral whose value is insured.

We historically retained for investment a number of the policies that we acquired upon foreclosure. Following our initial public offering, we used equity capital to fund premium finance loans. However, in instances where we retained policies that served as collateral for a loan that was insured, in order to retain the policy on our balance sheet, we would typically be required to pay our lender protection insurer in order for the insurer to release its subrogation rights to the policy. When we choose to retain a policy for investment, we are responsible for all future premium payments required to prevent the policy from lapsing. We have developed proprietary systems and processes that we believe, among other things, determine the minimum quarterly premium outlay required to maintain each retained life insurance policy.

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 policyholders with the Company extending a premium finance loan to a borrower. 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 December 31, 2011, the Company had 13 policies in its portfolio that once served as collateral for premium finance loans derived through the retail non-seminar business.

The Company takes title to life insurance policies through two separate channels. First, we acquire life insurance policies when a borrower defaults on a premium finance loan originated by us, and we foreclose on the policy. Second, we acquire life insurance policies through purchases directly from the original policy owners (the secondary market) or from institutional investors (the tertiary market). As of December 31, 2011, the Company had obtained the necessary licenses to purchase life insurance policies directly from original policy owners in 25 states.

Prior to and for a period after our initial public offering, the Company’s focus in our life finance segment was on our premium finance business. Following our initial public offering, however, changing market conditions made the acquisition of life settlements on the secondary and tertiary markets more attractive. Since 2008, the life settlement market has been distressed as a result of the general economic downturn. With the continued decrease of liquidity in the market place, re-selling policies on the tertiary market became significantly

 

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more difficult for investors. While some institutional investors have returned to the market, trading these policies remains challenging for most investors. For institutional investors with the financial capacity to hold these policies to maturity, life settlements remain an attractive, high-yield investment whose returns are non-correlated to the stock and bond markets.

Our strategy is to, in most cases, hold the policies we own to maturity, and thus, we have a long investment horizon. As such, we are attempting to build a portfolio based on principles of portfolio diversification, although these efforts have been hampered since learning of the USAO Investigation. In particular and subject to our cash management needs, we seek to build a portfolio that is diversified with respect to insurance carriers, age of the insured, life expectancy of the insured, geographic location of the insured and amount of death benefit. Diversification within these important attributes should serve to reduce portfolio risk by reducing the risk that one insurance carrier or age group can have a significant negative effect on overall portfolio performance.

As of December 31, 2011, the weighted average discount rate used in valuing the policies in our life settlement portfolio was 24.31% and the fair value of our investment in life insurance policies was approximately $90.9 million. See Note 26, Subsequent Events, to the accompanying consolidated and combined financial statements. The discount rate used in valuing the policies ranged from 16.65% to 32.25%. Our valuation of insurance policies is a critical component of our estimate for the fair value of our investments in life settlements (life insurance policies). We currently use a probabilistic method of valuing life insurance policies, meaning the individual insured’s probability of survival and probability of death are applied to the required premium and net death benefit of the policy to extrapolate the likely cash flows over the life expectancy. These likely cash flows are then discounted using a net present value formula. We believe this to be the preferred valuation method at the present time in the industry. The most significant assumption that our management must make to value a life insurance policy is the appropriate discount rate. Please see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies,” for a more detailed discussion of how we determine the fair value of life settlements.

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 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:

 

Wtd. Agv

Rate

   Rate Adj.     Value      Change in Value  
23.81%      -.50     93,433,348         2,516,098   
24.31%             90,917,250           
24.81%      +.50     88,282,240         (2,635,010

As of December 31, 2011, of the 190 policies in our life settlement portfolio, 125 policies had a nexus to our premium finance business. Only 13 of those life insurance policies were acquired as a result of defaults under premium finance loans originated as part of the retail non-seminar business.

Sources of Revenue/Income

For the years ended December 31, 2011, 2010 and 2009, 71.2% , 87.6% and 95.9%, respectively, of our revenue was generated from our life finance segment. We generated revenue/income from this segment in the form of unrealized change in fair value of life settlements, agency fees, interest income, origination fee income, servicing income and gain on maturities of life settlements with subrogation rights, net that we own as follows:

 

   

Unrealized Change in Fair Value of Life Settlements—The Company acquires certain life insurance policies through purchases in the secondary and tertiary markets and others as a result of certain of the

 

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Company’s borrowers defaulting on premium finance loans and relinquishing the underlying policy to the Company in exchange for being released from further obligations under the loan. 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 unrealized changes in fair value of life settlements in our consolidated and combined statement of operations. The fair value is determined on a discounted cash flow basis that incorporates assumptions about current life expectancy and the expected policy premiums to be paid over the expected life of the insured. The discount rate incorporates, among other factors, 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. As of December 31, 2011, the discount rates utilized to value our investment in life settlements ranged from 16.65% to 32.25% and our weighted average discount rate was 24.31%. During the years ended December 31, 2011 and 2010, the Company earned income of approximately $570,000 and $10.2 million, respectively on the unrealized changes in fair value of life insurance policies it acquired. See “Management’s Discussion and Analysis of Financial Condition and Results of Operation—Critical Accounting Policies – Valuation of Insurance Policies.”

 

   

Agency Fees. For each premium finance loan, Imperial Life and Annuity Services, LLC (“Imperial Life and Annuity”), a licensed insurance agency and our wholly-owned subsidiary, received an agency fee from the referring insurance agent. Agency fees as a percentage of the principal balance of the loans originated during the years ended December 31, 2011, 2010 and 2009 were 33.0% , 48.8% and 50.6%, respectively. During the years ended December 31, 2011, 2010 and 2009, 20.5%, 15.1% and 28.2%, respectively, of our revenue from our life finance segment was from agency fees. As a result of the voluntary termination of our premium finance business, we will not receive any revenue from agency fees in 2012 and beyond, and Imperial Life and Annuity has begun to voluntarily surrender its insurance agency licenses.

 

   

Interest Income. We receive interest income that accrues over the life of the loan and is due upon the date of maturity or upon repayment of the loan. The interest rates are typically floating rates that are calculated at the one-month LIBOR rate plus an applicable margin. In addition, our premium finance loans have a floor interest rate and are capped at 16.0% per annum. For loans with floating rates, each month the interest rate is recalculated to equal one-month LIBOR plus the applicable margin, and then, if necessary, adjusted so as to remain at or above the stated floor rate and at or below the capped rate of 16.0% per annum. The weighted average per annum interest rate for premium finance loans outstanding as of December 31, 2011, 2010 and 2009 were 12.5% , 11.4% and 10.9%, respectively. During the years ended December 31, 2011, 2010 and 2009, 24.6%, 27.2% and 21.9%, respectively, of our revenue from our life finance segment was from interest income. As a result of the voluntary termination of our premium finance business, we will cease earning interest income once our outstanding premium finance loans mature.

 

   

Origination Fees. We charged a loan origination fee on each premium finance loan we funded. The origination fee accrues over the term of the loan and is due upon the date of maturity or upon repayment of the loan. For the years ended December 31, 2011, 2010 and 2009, origination fees as a percentage of the principal balance of the loans originated during such periods were 25.0%, 41.5% and 44.7%, respectively. During the years ended December 31, 2011, 2010 and 2009, the per annum origination fee as a percentage of the principal balance of the loans originated was 24.3%, 22.7% and 19.2%, respectively. During the years ended December 31, 2011, 2010 and 2009, 20.6%, 29.6% and 32.2%, respectively, of our revenue from our life finance segment was from origination fees. As a result of the voluntary termination of our premium finance business, we will cease accruing origination fee income once our outstanding premium finance loans mature.

 

   

Gain on Maturities of Life Settlements with Subrogation Rights, net. When the Company exercised its right to foreclose on collateral for loans insured by the Company’s lender protection insurer, the insurer

 

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had the right to direct control or take beneficial ownership of the life insurance policy, subject to the terms and conditions of the lender protection insurance policy, including notice and timing requirements. Under these circumstances, the insurer maintained its salvage collection and subrogation rights, which provided a remedy by which the insurer could seek to recover the amount of the lender protection claim paid plus premiums paid by it, expenses and interest thereon. In those instances where the Company foreclosed on the collateral, the lender protection insurer has been covering the cost of the ongoing premiums needed to maintain certain of these life insurance policies. However, the lender protection insurer may elect at any time to discontinue the payment of premiums which would result in lapse of the policies if the Company does not otherwise pay the premiums. Because the lender protection insurer controls whether a policy will lapse, and the amount of the lender protection insurer’s salvage collection and subrogation claim rights on any individual life insurance policy could equal or exceed the cash flow received by the Company with respect to any such policy, the Company views these policies as having uncertain value. For these reasons, these policies are considered contingent assets and not included in the amount of life settlements on the accompanying consolidated and combined balance sheet. The Company accounts for the maturities of life settlements with subrogation rights (net of subrogation expenses) as contingent gains in accordance with ASC 450, Contingencies and recognizes the revenue from the maturities of these policies when all contingencies are resolved. During the year ended December 31, 2011, the Company recognized income of approximately $3.2 million, net of subrogation rights in receipt of death benefits with respect to matured life insurance policies.

 

   

Servicing Income. We receive income from servicing life insurance policies controlled by a third party. These services include verifying premiums are paid and correctly applied and updating files for medical history and ongoing premiums. For the year ended December 31, 2011, 2010 and 2009, we earned approximately $1.8 million, $413,000 and $0 in servicing income respectively.

Certain Premium Finance Metrics

The following table shows the method of repayment for loans maturing during the following periods:

 

     Year Ended December 31,  
     2011      2010      2009  

Repaid by the borrower

     —           3         12   

Repaid from death benefit during term of loan

     —           1         2   

Repaid from lender protection insurance claims

     131         419         56   

Lender protection insurance claims in process

     7         3         8   
  

 

 

    

 

 

    

 

 

 
     138         426         78   

Cost of Financing

In our life finance business, we have historically relied heavily on debt financing. However, prior to our initial public offering, debt financing became prohibitively expensive for our business. Every credit facility we entered into since December 2007 for our life finance business required us to obtain lender protection insurance for each loan originated under such credit facility. This coverage provides insurance on the value of the underlying life insurance policy serving as collateral underlying the loan should our borrower default. Subject to the terms and conditions of the lender protection insurance policy, in the event of a payment default by the borrower, our lender protection insurer has the right to direct control or take beneficial ownership of the life insurance policy and we are paid an amount equal to the insured value of the life insurance policy serving as collateral underlying the loan. We also paid a premium to a contingent lender protection insurer for each of our loans originated under our White Oak and Cedar Lane credit facilities. Our cost for contingent lender protection insurance has been included as part of our cost for lender protection insurance. The cost for lender protection insurance has ranged from 8.5% to 11% per annum of the principal balance of the loan. As of December 31, 2011, 65.9% of our outstanding premium finance loans had collateral whose value is insured. By procuring

 

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lender protection insurance, we have been able to borrow at interest rates ranging from 14% to 22%. After December 31, 2010, we ceased originating premium finance loans with lender protection insurance and began funding loans with our own equity. In connection with the Non-Prosecution Agreement, we have since ceased originating premium finance loans altogether.

As of December 31, 2011, in the life finance segment, we had total debt outstanding of $19.3 million borrowed by wholly-owned special purpose entities. This debt is collateralized by life insurance policies underlying premium finance loans that we have assigned, or in which we have sold participation rights, to our special purpose entities. We obtained lender protection insurance for nearly all premium finance loans issued prior to our initial public offering. Debt owned by these special purpose entities is generally non-recourse to us and our other subsidiaries except to the extent of our equity interest in these special purpose entities. One exception is the Cedar Lane facility where we have guaranteed 5% of the applicable special purpose entity’s obligations. Mr. Mitchell, our chief executive officer, and Mr. Neuman, our former chief operating officer, made certain guaranties to lenders for the benefit of the special purpose entities for matters other than financial performance. These guaranties are not unconditional sources of credit support, but are intended to protect the lenders against acts of fraud, willful misconduct or a borrower commencing a bankruptcy filing. To the extent lenders sought recourse against Messrs. Mitchell and Neuman for such non-financial performance reasons, then our indemnification obligations to Messrs. Mitchell and Neuman may require us to indemnify them for losses they may incur under these guaranties.

The following table shows our total outstanding debt in the life finance segment by facility as well as the portion of the outstanding debt that is secured by life insurance policies and for which we have purchased lender protection insurance in dollars and that is non-recourse beyond our special purpose entities (dollars in thousands):

 

     Year Ended December 31,  
         2011             2010      

Credit Facilities

    

Cedar Lane

   $ 19,104      $ 34,209   

White Oak

     173        21,219   

Acorn

     —          3,988   

CTL*

     —          24   
  

 

 

   

 

 

 

Total credit facilities

   $ 19,277      $ 59,440   
  

 

 

   

 

 

 

Promissory Notes

    

IMPEX

     —          2,402   
  

 

 

   

 

 

 

Total promissory notes

   $ —        $ 2,402   
  

 

 

   

 

 

 

Skarbonka debenture payable

       29,767   
  

 

 

   

 

 

 

Total Debt

   $ 19,277      $ 91,609   
  

 

 

   

 

 

 

Amount of Total Debt expected to be repaid with proceeds from lender protection insurance

   $ 19,277      $ 55,452   

% of Total Debt expected to be repaid with proceeds from lender protection insurance

     100.0     60.5

 

* Represents the balance remaining under our $30 million grid promissory note in favor of CTL Holdings.

Underwriting Procedures

We considered and analyzed a variety of factors in evaluating each potential premium financing transaction. Our underwriting procedures required that the policyholder provide supporting documentation of the policyholder’s insurable interest in the life of the insured. Our guidelines generally required that every borrower

 

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have an existing, in-force, life insurance policy and provide proof of at least one prior premium payment from their own funds prior to our funding of a loan and applicants were generally required to sign an unconditional personal guaranty as to various matters related to the funding of the loan, including as to the accuracy of the information provided in the life insurance policy application, as further support for our underwriting procedures, including our assessment of whether the applicant was engaged in a stranger originated life insurance transaction. In the event of a default under the guaranty, the guarantor guaranteed the payment of all outstanding principal and accrued and unpaid interest under the premium finance loan, any early termination fees, costs and expenses payable (including, but not limited to, reasonable attorneys’ fees) as well as any and all costs and expenses to enforce the guaranty (including, but not limited to, reasonable attorneys’ fees). To date, we have never collected on a personal guaranty. Our premium finance legal group reviewed every application and assessed the validity of the applicant’s insurable interest in the life of the insured before a loan was funded.

Servicing

Our servicing department administers all premium payments, loan satisfaction and policy relinquishment processes for policies we own as well as for policies controlled by third parties. They maintain contact with insureds, trustees and referring agents or brokers to obtain current information on policy status. Our servicing department also updates the medical histories of insureds. They periodically request updated medical records from physicians and also contact each insured to obtain updated health information.

With respect to the administration of the policy relinquishment processes, our servicing department sends notices prior to the loan maturity date alerting the borrower that the loan is maturing. In the event of a default, our servicing department will send an agreement to the borrower and its beneficiaries requesting that they agree to relinquish ownership of the policy and all interests therein to us in exchange for a release of the obligation to pay amounts due. If we are unable to come to an agreement with the borrower regarding the relinquishment of the policy, we may enforce our security interests in the beneficial interests in the trust that owns the policy pursuant to which we can exercise control over the trust holding the policy in order to direct disposition of the policy. For the year ended December 31, 2011, we earned $1.8 million in servicing income.

Structured Settlements Business

Overview

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, which provides 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, we purchase a certain number of fixed (life contingent or non life-contingent), scheduled future settlement payments on a discounted basis in exchange for a single lump sum payment, thereby serving the liquidity needs of structured settlement holders.

We use national television marketing and other efforts to generate in-bound telephone and internet inquiries. These efforts have allowed us to build a database generating a strong pipeline of purchasing opportunities.

We train our structured settlements purchasing team to work with a prospective client to review the transaction documentation and to assess a client’s needs. Our underwriting group is responsible for reviewing all proposed purchases and analyzing the associated documentation. We have also developed a nationwide network

 

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of law firms to facilitate the required court approval process for structured settlements. The average cycle time for transactions closing in the year ended December 31, 2011 starting from submission of the paper work to funding the transaction was 67 days. This cycle includes the evaluation and structuring of the transaction, an economic review, pricing and coordination of the court process.

Marketing

Brand awareness is critical to growing market share. We have a primary target market consisting of individuals 18 to 49 years of age with middle class income or lower.

Our primary marketing medium in 2011 was our nationwide direct response television marketing to solicit inbound calls to our call center. Our direct response television campaign consists of nationally placed 15 or 30 second commercials that air during our call center hours on several syndicated and cable networks. Each advertisement campaign is assigned a unique toll free number so we can track the effectiveness of each marketing slot. Typically, we experience a high volume of calls immediately after we air a television advertisement. Therefore, we attempt to space our advertisements to maintain a steady stream of inbound calls that our purchasing team is able to process. In addition to our direct response television campaign, we buy marketing on internet search engines. These advertisements produce leads with contact information that are routed to our purchasing staff for follow-up. We also send letters monthly to most of the leads in our database containing information about us and our services.

We have built a proprietary database of clients and prospective clients. From December 2006 to December 31, 2011, we have purchased a total of 536 structured settlements from existing customers in repeat transactions. The percentage of repeat transactions has grown from 5% in the three months ended May 31, 2008 to 35% in the three months ended December 31, 2011. When our call center staff is not answering inbound calls, they call contacts in the database to generate business. As our database and pool of customers grow, we expect to complete more transactions and our cost of marketing per transaction should decrease.

The following table shows the number of transactions we have completed and our average marketing cost per transaction (dollars in thousands):

 

     Year Ended December 31,  
     2011      2010      2009  

Number of transactions originated

     873         565         396   

Average marketing cost per transaction

   $ 7.0       $ 9.0       $ 11.3   

Average amount paid for settlements purchased

   $ 23.26       $ 23.49       $ 27.64   

We believe this cost per transaction will continue to trend down over time. Additionally, our transactions with repeat customers are generally more profitable than with new customers due to the reduction in transaction costs. As our database grows, it provides more purchasing opportunities. The following table shows the number and percentage of our total structured settlement transactions completed with repeat customers for the three-month periods indicated:

 

    Three Months Ended  
    Dec 31
2008
    Mar 31
2009
    June 30
2009
    Sep 30
2009
    Dec 31
2009
    Mar 31
2010
    June 30
2010
    Sep 30
2010
    Dec 31
2010
    Mar 31
2011
    June 30
2011
    Sep 30
2011
    Dec 31
2011
 

Number of transactions with repeat customers

    12        10        12        10        20        24        25        49        56        48        92        78        89   

Percentage of total transactions

    11     13     13     10     17     22     18     34     31     30     38     37     35

 

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Funding

We believe that we have various funding options for the purchase of structured settlements.

 

   

Origination. We generally originate the purchase of structured settlement receivables and either finance or sell the structured settlements we acquire. In September 2010, we entered into an arrangement to provide us up to $50.0 million to finance the purchase of non-life contingent structured settlements and in December 2011, we entered into a forward purchase and sale agreement to sell up to $40.0 million of life-contingent structured settlement receivables. We also have other parties to whom we have sold non-life contingent structured settlement assets and to whom we believe we can sell such assets in the future.

 

   

Balance sheet. When we purchase structured settlements, we may hold them for investment, servicing the asset and collecting the periodic payments or we may finance or sell such assets through our arrangements described above.

Sources of Revenue

During the years ended December 31, 2011, 2010 and 2009, 27.0%, 12.4% and 4.1%, respectively, of our revenue was generated from our structured settlement segment. Most of our revenue from structured settlements currently is earned from the sale of structured settlements that we originate and mark-to-market adjustments. When we sell assets, the revenue consists of the difference between the sale proceeds and our carrying value. If we retain structured settlements on our balance sheet, we earn interest income over the life of the asset based on the discount rate used to determine the purchase price. During the years ended December 31, 2011, 2010 and 2009, 93.2%, 95.2% and 67.7%, respectively, of our revenue from our structured settlement segment was generated from the sale of structured settlements and mark-to-market adjustments and 4.6%, 3.5% and 30.6%, respectively, was generated from interest income. The following table shows the number of transactions we have originated, the face value of undiscounted future payments purchased, the weighted average purchase discount rate, the number of transactions sold and the weighted average discount rate at which the assets were sold (dollars in thousands):

 

     Year Ended December 31,  
     2011     2010     2009  

Number of transactions originated

     873        565        396   

Face value of undiscounted future payments purchased

   $ 96,628      $ 47,207      $ 28,877   

Weighted average purchase discount rate

     18.2     19.4     16.3

Number of transactions sold

     601        630        439   

Weighted average sale discount rate

     10.5     8.9     11.5

Underwriting Procedures, Transaction Timeline and Process

We review all proposed structured settlement transactions and analyze the transaction documentation. We identify any statutory requirements, as well as any issues that could affect the structured settlement receivables, such as liens, judgments or bankruptcy filings. We also confirm the existence and value of the structured settlement receivables, that the purchase conforms to our established internal or external counterparty credit guidelines and that all applicable statutory requirements are complied with.

Each structured settlement transaction requires a court order approving the transaction. The individual court hearings are administered by a number of outside attorneys with whom we have developed relationships.

As of December 31, 2011, our typical structured settlement transaction was completed in an average of 67 days from the date of initial contact by the client. The following events would occur during such period:

 

   

The individual who has a structured settlement contacts us seeking a lump-sum payment based on the settlement.

 

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After analyzing the settlement structure, we offer to provide a lump-sum amount to the individual in exchange for a set number of payments.

 

   

We complete our underwriting process. Upon satisfactory review, counsel secures a court date and notifies interested parties, including any beneficiaries, owners and issuers of the pending transaction.

 

   

A court hearing is held and the judge approves or denies the motion to sell and assign to us the agreed-upon portion of the individual’s structured settlement.

 

   

Final review of the court-approved transaction takes place and we fund the payment to the individual.

Business Strategy

While we continue to assess our business strategy in light of our exit from the premium finance business and the obligations we have undertaken in the Non-Prosecution Agreement, our primary objective is to maintain and, ultimately, grow shareholder value. Going forward, we intend to pursue the following strategies in order to increase our revenues and generate net profits:

 

   

Effective Cash Management. Our portfolio of life insurance policies requires significant cash outlays in order to pay the premiums necessary to keep policies in force. Until the portfolio begins to generate positive cash flows, we intend to diligently monitor our cash position and proactively seek to manage any impending liquidity shortfall, whether by raising additional debt or equity, selling certain of the life insurance policies that we own, further reducing operating expenses, allowing certain life insurance policies that we own with a lower return profile to lapse or a combination of all of the above. See “Risk Factors” for more information.

 

   

Maintain and selectively grow our portfolio of life insurance policies. Subject to our cash management needs, we plan to continue to maintain our portfolio of life insurance policies and continue to grow our portfolio through borrower defaults and selective purchases on the secondary and tertiary markets. We believe that our ability to value life insurance policies and our licenses to purchase policies directly from insureds positions us well to buy policies at attractive prices. We intend to hold the policies to maturity, though we may occasionally sell policies on the tertiary market as our cash management needs dictate or when the need to re-balance the portfolio or the opportunity for a strategic sale arises.

 

   

Continue to expand structured settlement market presence. We expect to continue to build and enhance our database of structured settlements through a combination of commercial and internet advertising campaigns and targeted marketing efforts. We intend to continue to utilize proprietary training and development methods for our sales force and continue to maintain our specialized and dedicated sales and support infrastructure. In doing so, we will continue to focus on delivering customer service solutions tailored to our customers’ needs and funding payments in a timely manner.

Regulation

Premium Financing Transactions

The making, enforcement and collection of premium finance loans is subject to extensive regulation. These regulations vary widely, but often require that premium finance lenders be licensed by the applicable jurisdiction and that certain disclosures be made to insureds, regulate the amount of late fees and finance charges that may be charged if a borrower is delinquent on its payments, and allow imposition of potentially significant penalties on lenders for violations of that jurisdiction’s insurance premium finance laws. In connection with the Non-Prosecution Agreement, we are terminating our premium finance business and we anticipate that we will no longer be originating loans that are subject to these regulations.

Life Settlements

The sale and solicitation of life insurance is highly regulated by the laws and regulations of individual states and other applicable jurisdictions. The purchase of a policy directly from a policy owner is referred to as a

 

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life settlement and is regulated on a state-by-state basis. At December 31, 2011, we maintained licenses to transact life settlements in 25 of the states that currently require a license and could conduct business in 36 states and the District of Columbia. Our primary regulator is the Florida Office of Insurance Regulation. A majority of the state laws and regulations concerning life settlements are based on the Model Act and Model Regulation adopted by the National Association of Insurance Commissioners (NAIC) and the Model Act adopted by the National Conference of Insurance Legislators (NCOIL). The NAIC and NCOIL models include provisions which relate to: (i) provider and broker licensing requirements; (ii) reporting requirements; (iii) required contract provisions and disclosures; (iv) privacy requirements; (v) fraud prevention measures; (vi) criminal and civil remedies; (vii) marketing requirements; (viii) the time period in which policies cannot be sold in life settlement transactions; and (viii) other rules governing the relationship between policy owners, insured persons, insurer, and others.

In August 2009, the Chairman of the SEC established the Life Settlements Task Force to examine issues raised by the life settlements market and to make recommendations for the improvement of regulation of the market and market practices more generally. In July 2010, the Life Settlements Task Force issued a report suggesting that the SEC recommend that Congress amend the Securities Act of 1933, the Securities Exchange Act of 1934 and the Investment Company Act of 1940 to include life settlements in the definition of “security.” To date, the SEC has not made such a recommendation to Congress. However, if the statutory definitions of “security” were amended to encompass life settlements, we could become subject to additional extensive regulatory requirements under the federal securities laws, including the obligation to register sales and offerings of life settlements with the SEC as public offerings under the Securities Act of 1933 and, potentially, the obligation to register as an “investment company” pursuant to the Investment Company Act of 1940.

Structured Settlements

Each structured settlement transaction requires a court order approving the transaction. These “transfer petitions,” as they are known, are brought pursuant to specific, state structured settlement protection acts (SSPAs). These SSPAs vary somewhat but generally require (i) that the seller receive detailed disclosure statements regarding all key transaction terms; (ii) a three to ten day “cooling-off period” before which the seller cannot sign an agreement to sell their structured settlement payments; and (iii) a requirement that the entire transaction be reviewed and approved by a state court judge. The parties to the transaction must satisfy the court that the proposed transfer is in the best interests of the seller, taking into consideration the welfare and support of his dependents. Generally, a seller does not sell the entire amount of his settlement in one transaction. Once an order approving the sale is issued, the payments from the annuity provider are made directly to the purchaser of the structured settlement pursuant to the terms of the order.

The National Association of Settlement Purchasers and the National Structured Settlements Trade Association are the principal structured settlement trade organizations which have developed and promoted model legislation regarding transfers of settlements, referred to as the Structured Settlement Model Act. While most SSPAs are similar to the Structured Settlement Model Act, any SSPA may place fewer or additional affirmative obligations (such as notice or additional disclosure requirements) on the purchaser, require more extensive or less extensive findings on the part of the court issuing the transfer order, contain additional prohibitions on the actions of the purchaser or the provisions of a settlement purchase agreement, have different effective dates, require shorter or longer notice periods and otherwise vary in substance from the Model Act.

Competition

Life Settlements

Competition in the life settlement space comes through two channels: other life settlement providers and institutional investors. To be a life settlement provider and transact with the original holder of a life insurance policy requires, in most instances, a license on a state-by-state basis. The life settlement business is highly

 

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fragmented and, therefore, competition is diverse. Often, life settlement providers are originating on behalf of institutional investors who do not maintain the necessary licenses to transact in the secondary market for life insurance. These investors may have significantly more resources than the Company and can generally also transact directly in the tertiary market.

Structured Settlements

Competition in the structured settlement market is primarily based upon marketing, referrals and quality of customer service. Based on our industry knowledge, we believe that we are one of the larger acquirers of structured settlements in the United States. Our main competitors are J.G. Wentworth & Company, Inc. and Peachtree Settlement Funding, which recently merged but continue to operate in the marketplace as distinct entities.

Employees

As of December 31, 2011, we had 130 employees. None of our employees is subject to any collective bargaining agreement. We believe that our employee relations are good.

Item 1A. Risk Factors

Risk Factors Relating to Our General Business

The USAO Investigation, the SEC Investigation and the shareholder litigation could materially and adversely affect our business, our financial condition and results of operations.

The defense and investigation of the Company and certain employees in connection with the USAO Investigation, SEC investigation and related shareholder litigation has necessitated the expenditure of significant amounts of the Company’s capital. At December 31, 2011, the Company has expensed an aggregate of $6.0 million in legal costs related to these matters and has continued to expend significant resources through 2012. The capital expended was not originally budgeted for these purposes. As a result, the Company was prevented from acquiring additional life insurance policies for its portfolio that it originally budgeted for purchase and has reduced the Company’s cash on hand for the payments of premiums necessary to maintain the Company’s portfolio.

Additionally and in connection with the Non-Prosecution Agreement, the Company paid an $8.0 million penalty and voluntarily agreed to terminate its premium finance business, which accounted for approximately 58.2% of our revenues in the year ended December 31, 2011. The Company also paid a $1.4 million payment to its former president in connection with his separation from the Company and has ongoing obligations to cover his and other present and former employees’ legal expenses in connection with the USAO Investigation and certain other matters. As of December 31, 2011, we had approximately $75.1 million of cash, cash equivalents, and marketable securities including $691,000 of restricted cash. As of June 30, 2012, we had approximately $51.2 million of cash and cash equivalents, and marketable securities including $1.0 million of restricted cash.

The Company’s director and officer insurance carriers, or D&O carriers, have disputed several of the claims submitted by the Company and reserved their rights, and the Company’s primary D&O carrier filed a declaratory judgment action on June 13, 2012 seeking a judgment that the claims submitted by the Company are precluded under a prior and pending litigation exemption. As of the date of this filing, the Company has not been served in this matter and, while it intends to defend itself vigorously, cannot predict the ultimate outcome which may have a material adverse effect on the Company’s financial position and results of operations.

While the USAO Investigation has been resolved as it pertains to the Company (subject to its ongoing obligations under the Non-Prosecution Agreement), the Company is still being investigated by the SEC and is a

 

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defendant in several shareholder and derivative actions. The Company is unable to predict the outcome of these matters, or to estimate the ranges or amount of possible losses or expenses that could result from them. No provision for losses has been recorded for these exposures and there can be no assurance that the Company will ultimately prevail in its defense of the shareholder actions. Additionally, no assurance can be given that the ultimate outcome of the SEC Investigation will not result in administrative, civil or other proceedings or sanctions against the Company or our employees by the SEC or any other state or federal regulatory agencies. Such proceedings may result in the imposition of fines and penalties, actions against the Company or its employees, modifications to business practices and compliance programs or the imposition of sanctions against the Company. Protracted investigations or litigation could also impose substantial costs and distractions, regardless of its outcome. There can be no assurance that any final resolution of these and similar matters will not have a material and adverse effect on the Company’s financial condition and results of operations.

See “Legal Proceedings,” “Business” and Note 26, Subsequent Events, to the accompanying consolidated and combined financial statements for additional information.

We may require additional funding in the future and may be unable to raise capital when needed, which could result in policy lapses or forced sales of policies. Difficulty accessing the credit and equity markets may adversely affect the maintenance and growth of our business, our financial condition and results of operations.

We estimate that we will need to pay $24.1 million in premiums to keep our current portfolio of life insurance policies in force through 2012 and an additional $24.6 million to keep the portfolio in force through 2013. As of December 31, 2011, we had approximately $75.1 million of cash, cash equivalents, and marketable securities including $691,000 of restricted cash. As of June 30, 2012, we had approximately $51.2 million of cash and cash equivalents, and marketable securities including $1.0 million of restricted cash. Additionally, we have not yet experienced the mortalities of insureds or received the resulting death benefits from our life insurance policies (other than from policies with subrogation rights that are not reported on our balance sheet and that are considered contingent assets). We expect the lack of mortalities of insureds to continue at least through 2012.

We believe that we have sufficient cash and cash equivalents to pay the premiums necessary to keep the life insurance policies that we own in force and our operating expenses through at least 2012 although we will need to proactively manage our cash in advance of any liquidity shortfall. Based on our current internal forecast, we do not anticipate a liquidity shortfall prior to the third quarter of 2013. However, if we do not begin to experience mortalities and collect the related death benefits in a timely manner prior to that time, we will likely need to seek additional capital to pay the premiums, by means of debt or equity financing or the sale of some of the policies that we own. We may also seek to reduce our operating expenses in order to preserve the value of our existing portfolio of policies, and/or, under certain scenarios, lapse or sell certain of our policies or some combination of the above. The lapsing of policies, if any, would create losses as the assets would written down to zero.

Negative press from the USAO Investigation, the SEC Investigation and shareholder litigation or otherwise could have a material adverse effect on our business, financial condition and results of operations.

The negative press resulting from the USAO Investigation, SEC Investigation and shareholder litigation matters have harmed the Company’s reputation and could otherwise result in a loss of future business with our counterparties and business partners. It could also adversely affect the public’s perception of us and lead to reluctance by new parties to do business with us. For example, on October 7, 2011, we were informed that as part of SunTrust Bank’s ongoing review of its business plans and target markets, it conducted a strategic review and decided to end all banking relationships with us. The abrupt termination of our commercial banking relationship resulted in operational difficulties and prevented the Company from transacting with any structured settlement

 

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financing counterparty for most of the fourth quarter of 2011. Other business partners and customers have also curtailed their relationships with us. As a result of these actions, we have experienced higher costs of doing business due to less favorable terms and/or the need to find alternative partners. We cannot assure you that additional business partners and customers will not similarly attempt to end or curtail their relationships with us.

In general, the life finance and structured settlement industries periodically receive negative press from the media and consumer advocacy groups and as a result of litigation involving industry participants. A sustained campaign of negative press resulting from media or consumer advocacy groups, industry litigation or other factors could adversely affect the public’s perception of these industries as a whole, and lead to reluctance to sell assets to us or to provide us with third party financing. We also have received negative press from competitors. Any such negative press could have a material adverse effect on our business, financial condition and results of operations.

The USAO Investigation, the SEC Investigation, the shareholder litigation and other factors may make the market price of our stock highly volatile.

The market price of our common stock could fluctuate substantially in the future. This volatility may subject our stock price to material fluctuations due to the factors discussed in this “Risk Factors” section, and other factors including market reaction to the fair market value of our portfolio; rumors or dissemination of false information; changes in coverage or earnings estimates by analysts; our ability to meet analysts’ or market expectations; and sales of common stock by existing stockholders. For example, after the announcement of the USAO Investigation, our stock price dropped significantly. Currently a number of purported class action lawsuits have been filed against us as well as derivative demands on behalf of certain purchasers of our common stock, which we are prepared to rigorously defend. Litigation of this kind could result in additional substantial litigation costs, a damages award against us and the further diversion of our management’s attention.

The loss of any of our key personnel could have a material adverse effect on our business, financial condition and results of operations.

Our success depends to a significant degree upon the continuing contributions of our key executive officers including Antony Mitchell, our chief executive officer. Mr. Mitchell has significant experience operating businesses in structured settlements and life finance transactions, which are highly regulated industries. Pursuant to a Separation Agreement executed on April 30, 2012, Jonathan Neuman, our former president and chief operating officer, who had years of experience in the specialty finance industry, resigned from the Company. If we should lose Mr. Mitchell as well, such loss could have a material adverse effect on our business, financial condition and results of operations. Moreover, we do not maintain key man life insurance with respect to any of our executives.

Contractions in the market for life insurance policies could make it more difficult for us to opportunistically sell policies that we own.

A potential sale of a life insurance policy owned by us depends significantly on the market for life insurance, which may contract or disappear depending on the impact of potential government regulation, future economic conditions and/or other market variables. The secondary and tertiary markets for life insurance policies incurred a significant slowdown in 2008 which has continued through the present. Historically, many investors who invest in life insurance policies are foreign investors who are attracted by potential investment returns from life insurance policies issued by United States life insurers with high ratings and financial strength as well as by the view that such investments are non-correlated assets—meaning changes in the equity or debt markets should not affect returns on such investments. Changes in the value of the United States dollar and corresponding exchange rates as well as changes to the ratings of United States life insurers can cause foreign investors to suffer a reduction in the value of their United States dollar denominated investments and reduce their demand for such

 

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products. Additionally, we believe increased carrier litigation as well as criminal investigations involving the life settlement market have depleted the investor base. Any of the above factors could result in a further contraction of the market, which could make it more difficult for us to opportunistically sell life insurance policies that we own.

We compete with a number of other finance companies and may encounter additional competition.

There are a number of finance companies that compete with us. Many are significantly larger and possess considerably greater financial, marketing, management and other resources than we do. The life finance business and structured settlement business could also prove attractive to new entrants. As a consequence, competition in these sectors may increase. In addition, existing competitors may increase their market penetration and purchasing activities in one or more of the sectors in which we participate. Increased competition could result in reduced origination volume, increased acquisition costs, changes to discount rates and/or margin compression, each of which could materially adversely affect our revenue, which would have a material adverse effect on our business, financial condition and results of operations.

Disasters, disruptions and other impairment of our information technologies and systems could adversely affect our business.

Our businesses depend upon the use of sophisticated information technologies and systems, including third-party hosted services and data facilities that we do not control. While we have developed certain disaster recovery plans and backup systems, these plans and systems are not fully redundant. A system disruption caused by a natural disaster, cybercrime or other impairment could have a material adverse effect on our results of operations and may cause delays, loss of critical data and reputational harm, and could otherwise prevent us from servicing our portfolio of life insurance policies or managing our structured settlements business.

Failure to maintain the security of personally identifiable and other information, non-compliance with our contractual or other legal obligations regarding such information, or a violation of the Company’s privacy and security policies with respect to such information, could adversely affect us.

In connection with our business, we collect and retain significant volumes of certain types of personally identifiable and other information pertaining to our customers, and counterparties. The legal, regulatory and contractual environment surrounding information security and privacy is constantly evolving. A significant actual or potential theft, loss, fraudulent use or misuse of customer, counterparty, employee or our data by cybercrime or otherwise, non-compliance with our contractual or other legal obligations regarding such data or a violation of our privacy and security policies with respect to such data could adversely impact our reputation and could result in significant costs, fines, litigation or regulatory action.

Changes to statutory, licensing and regulatory regimes governing premium financing, life settlements or structured settlements, including the means by which we conduct such business, could have a material adverse effect on our activities and revenues.

Changes to statutory, licensing and regulatory regimes could result in the enforcement of stricter compliance measures or adoption of additional measures on us or on the insurance companies or annuity providers that stand behind the insurance policies that collateralize our premium finance loans and the structured settlements that we purchase, either of which could have a material adverse impact on our business activities and revenues. Any change to the regulatory regime covering the resale of any of these asset classes, including any change specifically applicable to our activities or to investor eligibility, could restrict our ability to finance, acquire or sell these assets or could lead to significantly increased compliance costs.

In addition, we are subject to various federal and state regulations regarding the solicitation of customers. The Federal Communications Commission and Federal Trade Commission have issued rules that provide for a

 

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national “do not call” registry. Under these rules, companies are prohibited from contacting any individual who requests to have his or her phone number added to the registry, except in certain limited instances. In February 2009, we received a citation for violating these rules. In the event we violate these rules in the future, we could be subject to a significant fine per violation or each day of a continuing violation, which could have a material adverse effect on our business, financial condition and results of operations.

Regulation of life settlement transactions as securities under the federal securities laws could lead to increased compliance costs and could adversely affect our ability to acquire or sell life insurance policies.

The SEC issued a task force report in July 2010 recommending that sales of life insurance policies in life settlement transactions be regulated as securities for purposes of the federal securities laws. To date, the SEC has not made such a recommendation to Congress. However, if the statutory definitions of “security” were amended to encompass life settlements, we could become subject to additional extensive regulatory requirements under the federal securities laws, including the obligation to register sales and offerings of life settlements with the SEC as public offerings under the Securities Act of 1933 and, potentially, the obligation to register as an “investment company” pursuant to the Investment Company Act of 1940.

Any legislation implementing such regulatory change or a change in the transactions that are characterized as life settlement transactions could lead to significantly increased compliance costs, increased liability risk and adversely affect our ability to acquire or sell life insurance policies in the future, which could have a material adverse effect on our business, financial condition and results of operations.

Risk Factors Related to Life Finance Transactions

The life insurance policies that we own or that secure our premium finance loans may be subject to contest, rescission and/or non-cooperation by the issuing life insurance company, which may have a material adverse effect on our business, financial condition and results of operations.

All states require that the initial purchaser of a new life insurance policy insuring the life of an individual have an “insurable interest,” meaning a stake in the insured’s health and wellbeing, rather than the insured’s death, in such individual’s life at the time of original issuance of the policy. Whether an insurable interest exists in the context of the purchase of a life insurance policy is critical because, in the absence of a valid insurable interest, life insurance policies are unenforceable under most states’ laws. Where a life insurance policy has been issued to a policyholder without an insurable interest in the life of the individual who is insured, the life insurance company may be able to void or rescind the policy. Even if the insurance company cannot void or rescind the policy, however, the insurable interest laws of a number of states provide that persons with an insurable interest on the life of the insured may have the right to recover a portion or all of the death benefit payable under a policy from a person who has no insurable interest on the life of the insured. These claims can generally only be brought if the policy was originally issued to a person without an insurable interest in the life of the insured.

Many states have enacted statutes prohibiting stranger-originated life insurance, or STOLI, in which an individual purchases a life insurance policy with the intention of selling it to a third-party investor, who lacks an insurable interest in the insured’s life. Some insurance carriers have contested policies as STOLI arrangements, specifically citing the existence of certain nonrecourse premium financing arrangements as a basis to challenge the validity of the policies used to collateralize the financing. Additionally, if an insurance carrier alleges that there were misrepresentations or fraud in the application process for an insurance policy, they may sue us or others to contest or rescind that policy. If the underlying policy for a premium finance loan we have made or a policy that we own is subject to a successful contestation or rescission, the fair value of the collateral or policy could be reduced to zero and the ability to sell an affected policy could be negatively impaired. Generally, life insurance policies may only be rescinded by the issuing life insurance company within the contestability period, which, in most states is two years. Lack of insurable interest can in some instances, however, form the basis of

 

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loss of right to payment under a life insurance policy for many years beyond the contestability period and insurance carriers have been known to challenge claims for death benefits for over five years from issuance of the policy.

As of December 31, 2011, 8.7%, 53.6%, 76.8%, 85.5%, and 95.7%, respectively, of our premium finance loans outstanding were originated within one month, three months, six months, one year and two years, respectively, of the issuance of the underlying life insurance policy. From time to time, insurance carriers have challenged the validity of a policies owned by us or that once served as the underlying collateral for a premium finance loan made by us. Although, to date, the impact on our business from these challenges has not been significant, the USAO Investigation, the SEC Investigation and the Non-Prosecution Agreement may cause us to experience more challenges to policies by insurers attempting to use such investigations and the Non-Prosecution Agreement as grounds for rescinding or contesting a policy. Any such future challenges to the policies that we own or hold as collateral for our premium finance loans may result in a cloud over title and collectability, increased costs, delays in payment of life insurance proceeds or even the voiding of a policy, and could have a material adverse effect on our business, financial condition and results of operations.

Additionally, if an insurance company successfully rescinds or contests a policy, the insurance company may not be required to refund all or, in some cases, any of the insurance premiums paid for the policy. While defending an action to contest or rescind a policy, premium payments may have to continue to be made to the life insurance company. Additionally, in the case of a policy that serves or served as collateral for a premium finance loan, the issuing insurance company may refuse to cooperate with us by not providing information, processing notices and/or paperwork required to document the transaction. Hence, in the case of a contest or rescission, premiums paid to the carrier (including those paid during the pendency of a contest or rescission action) may not be refunded. If they are not, we may suffer a complete loss with respect to a policy which may adversely affect our business, financial condition and results of operations.

Premium financed life insurance policies are susceptible to a higher risk of fraud and misrepresentation in life insurance applications, which increases the risk of contest, rescission or non-cooperation by issuing life insurance carriers.

While fraud and misrepresentation by applicants and potential insureds in completing life insurance applications (especially with respect to the health and medical history and condition of the potential insured as well as the applicant’s net worth) exist generally in the life insurance industry, such risk of fraud and misrepresentation is heightened in connection with life insurance policies for which the premiums are financed through premium finance loans. In particular, there is a risk that applicants and potential insureds may not answer truthfully or completely to any questions related to whether the life insurance policy premiums will be financed through a premium finance loan or otherwise, the applicants’ purpose for purchasing the policy or the applicants’ intention regarding the future sale or transfer of the life insurance policy. Such risk may be further increased to the extent life insurance agents communicate to applicants and potential insureds regarding potential premium finance arrangements or transfer of life insurance policies through payment defaults under premium finance loans. In the ordinary course of business, our sales team received inquiries from life insurance agents and brokers regarding the availability of premium finance loans for their clients. However, any communication between the life insurance agent and the potential policyholder or insured is beyond our control and we may not know whether a life insurance agent discussed with the potential policyholder or the insured the possibility of a premium finance loan by us or the subsequent transfer of the life insurance policy. Consequently, notwithstanding the representations and certifications we obtain from the policyholders, insureds and the life insurance agents, there is a risk that we may finance premiums for policies subject to contest or rescission by the insurance carrier based on fraud or misrepresentation in any information provided to the life insurance company, including the life insurance application.

Misrepresentations, fraud, omissions or lack of insurable interest can also, in some instances, form the basis of loss of right to payment under a life insurance. Based on statements made in the Non-Prosecution Agreement, there is a risk that policies underlying our outstanding loans or that we own may increasingly be challenged by insurance carriers. Any such future challenges to the policies that we own or hold as collateral for

 

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our premium finance loans may result in increased costs, delays in payment of life insurance proceeds or even the voiding of a policy, a reduction in the fair value of a loan or policy and could have a material adverse effect on our business, financial condition and results of operations.

As of December 31, 2011, of the 190 policies in our life settlement portfolio, 145 policies were previously premium financed. The Company acquired 13 of those life settlements as a result of defaults under premium finance loans originated as part of the retail non-seminar business.

Our success in operating our life finance business is dependent on making accurate assumptions about life expectancies and maintaining adequate cash balances to pay premiums.

If we purchase a life settlement or retain a life insurance policy as a result of a borrower’s default under a premium finance loan, we will be responsible for paying all premiums necessary to keep the policy in force. We estimate that we will need to pay $24.1 million in premiums to keep our current portfolio of life insurance policies in force through 2012 and an additional $24.6 to keep the portfolio in force through 2013. As of December 31, 2011, we had approximately $75.1 million of cash, cash equivalents, and marketable securities including $691,000 of restricted cash. As of June 30, 2012, we had approximately $51.2 million of cash and cash equivalents, and marketable securities including $1.0 million of restricted cash. By using cash reserves to pay premiums for retained life insurance policies, we will have less or no cash available for other business purposes. Therefore, our cash flows and the required amount of our cash reserves to pay premiums will become dependent on our assumptions about life expectancies being accurate.

Life expectancies are estimates of the expected longevity or mortality of an insured and are inherently uncertain. A life expectancy obtained on an insured for a life insurance policy may not be predictive of the future longevity or mortality of the insured. Inaccurate forecasting of an insured’s life expectancy could result from, among other things: (i) advances in medical treatment (e.g., new cancer treatments) resulting in deaths occurring later than forecasted; (ii) inaccurate diagnosis or prognosis; (iii) changes to life style habits or the individual’s ability to fight disease, resulting in improved health; (iv) reliance on outdated or incomplete age or health information about the insured, or on information that is inaccurate (whether or not due to fraud or misrepresentation by the insured); or (v) improper or flawed methodology or assumptions in terms of modeling or crediting of medical conditions. In forecasting estimated life expectancies, we utilize third party medical underwriters to evaluate the medical condition and life expectancy of each insured. The firms that provide health assessments and life expectancy information may depend on, among other things, actuarial tables and model inputs for insureds and third-party information from independent physicians who, in turn, may not have personally performed a physical examination of any of the insureds and may have relied solely on reports provided to them by attending physicians with whom they were authorized to communicate. The accuracy of this information has not been and will not be independently verified by us or our service providers.

If these life expectancy valuations underestimate the longevity of the insureds, the actual maturity date of the life insurance policies may therefore be longer than projected. Consequently, we may not have sufficient cash for payment of insurance premiums and we may allow the policies to lapse or be forced to sell the policies, resulting in a loss of our investment in those policies, or if we continue to fund premium payments, the time period within which we could expect to receive a return of our investment in such life insurance policies may be extended, either of which could have a material adverse effect on our business, financial condition and results of operations. Additionally, if widely used mortality tables are adjusted, as they were in 2008, to generally assume prolonged life expectancies, the fair value of our portfolio of life insurance policies could be adversely affected, which may have a material adverse effect on our business, operations and financial results. Further, updated life expectancy reports may indicate that an insured’s health has improved since the Company last procured a life expectancy report, which would generally result in a decrease in the fair value of the life insurance policy insuring the life of that insured.

Uncertainty in valuing the life insurance policies we own or that collateralize our premium finance loans can affect the fair value of the life insurance policies. If the fair value of the life insurance policies decreases, we will incur losses with respect to the policies we own, and losses with respect to our premium finance loans if the fair value of the collateral is less than the carrying value of the loan.

We evaluate all of our premium finance loans for impairment, on a monthly basis, based on the fair value of the underlying life insurance policies, as the collectability is primarily dependent on the fair value of the policy

 

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serving as collateral. For loans without lender protection insurance, the fair value of the policy is determined using our valuation model, which is a Level 3 fair value measurement. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies—Fair Value Measurement Guidance.” For loans with lender protection insurance, the insured value is also considered when determining the fair value of the life insurance policy. The lender protection insurer limits the amount of coverage to an amount equal to or less than its determination of the value of the life insurance policy underlying our premium finance loan based on the lender protection insurer’s own models and assumptions. For all loans, the amount of impairment, if any, is calculated as the difference in the fair value of the life insurance policy and the carrying value of the loan. A loan impairment valuation is established as losses on our loans are estimated and charged to the provision for losses on loans receivable, and the provision is charged to earnings. Once established, the loan impairment valuation cannot be reversed to earnings.

A large portion of our borrowers may default by not paying off the loan and relinquish ownership of the life insurance policy to us in exchange for our release of the underlying loan. When we obtain ownership of a life insurance policy, either by purchasing the policy on the secondary or tertiary markets or when one of our premium finance borrowers defaults, we record the investment in the policy as an investment in life settlements at fair value as of the date of relinquishment. At the end of each reporting period, we re-value the life insurance policies we own. To the extent that the calculation results in an adjustment to the fair value of the policy, we record this as a unrealized change in fair value of our investment in life insurance policies. This evaluation of the fair value of life insurance policies is inherently subjective as it requires estimates and assumptions that are susceptible to significant revision as more information becomes available. Using our valuation model, we determine the fair value of life insurance policies on a discounted cash flow basis. The most significant assumptions that we estimate are the life expectancy of the insured, expected premium payments and the discount rate. The discount rate is based upon 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 margin an investor in the policy would require. We estimate the life expectancy of an insured by analyzing medical reviews from third-party medical underwriters, who evaluate the health of the insured by examining the insured’s historical and current medical records. We then calculate the probability of mortality by applying the life expectancy estimate provided by a third party to an actuarial mortality table. We use the resulting mortality factor to generate a series of expected cash flows over the insured’s life expectancy and the fair value of the policy. If we are unable to accurately estimate any of these factors, or if the actuarial tables are revised (as they were in 2008), we may have to write down the fair value of our investments in life settlements, which could materially and adversely affect our results of operations and our financial condition.

Insurable interest concerns regarding a life insurance policy can also adversely impact its fair value. A claim or the perceived potential for a claim for rescission or a challenge to insurable interest by an insurance company or by persons with an insurable interest in the insured of a portion of or all of the policy death benefit can negatively impact the fair value of a life insurance policy. If any of the USAO Investigation, SEC Investigation or Non-Prosecution Agreement cause us to experience more challenges to life insurance than we otherwise would, those challenges could negatively impact the fair value of the life insurance policies that we own.

If the calculation of fair value results in a decrease in value, we record this reduction as a loss. As and when loan impairment valuations are established due to the decline in the fair value of the policies collateralizing our loans, our net income will be reduced by the amount of such impairment valuations in the period in which the valuations are established. We increased the discount rate that we apply to our life insurance portfolio in our fair value model, which resulted in a decrease in fair value of the life insurance policies in our portfolio with respect to the year ended December 31, 2011. If we determine that it is appropriate to increase the discount rate further or adjust other inputs to our fair value model further, if we are otherwise unable to accurately estimate the assumptions in our valuation model, or if other factors cause the fair value of our life insurance policies to decrease, the carrying value of our assets may be materially adversely affected.

 

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We have limited operating experience.

Our business operations began in December 2006 and, in connection with the Non-Prosecution Agreement, we terminated our premium finance business, which has been our primary business since our inception. Consequently, we have limited operating history in both of our business segments generally, and our original business plan may no longer be viable, which makes it difficult to evaluate our business and future prospects. We intend to shift our life finance segment towards increased investment in life settlements. However, since our inception, we have had limited experience managing and dealing in life insurance policies owned by us. Therefore, the historical performance of our operations may be of limited relevance in predicting future performance. Furthermore, if we are unable to successfully refocus our life finance segment, our results of operations and financial condition could be materially and adversely affected.

The timing of receipt of expected death benefits from our portfolio of life insurance policies could be volatile, which could have a material adverse effect on our cash flows and liquidity.

Timely receipt of expected cash flows from mortalities is necessary in order for us to service our portfolio of life insurance policies and manage our cash balances. Cash flow volatility generally is inversely correlated to the size of a life settlement portfolio, meaning that the more lives in the portfolio, the less cash flow volatility. We have terminated our premium finance business and also have significantly reduced our purchases of life insurance policies. As a result, our portfolio is smaller than previously anticipated and thus subject to more volatility than we had previously anticipated, which may have a material adverse effect on our business, financial condition and results of operation.

Delays in payment and non-payment of life insurance policy proceeds can occur for many reasons and any such delays may have a material adverse effect on our business, financial condition and results of operations.

A number of arguments may be made by former beneficiaries (including but not limited to spouses, ex-spouses and descendants of the insured) under a life insurance policy, by the beneficiaries of the trust holding the policy, by the estate or legal heirs of the insured or by the insurance company issuing such policy, to deny or delay payment of proceeds following the death of an insured, including arguments related to lack of mental capacity of the insured, contestability or suicide provisions in a policy. In addition, the insurable interest and life settlement laws of certain states may prevent or delay the liquidation of the life insurance policy serving as collateral for a loan. The statements in the Non-Prosecution Agreement may make such delays more likely and may increase carrier challenges to paying out death claims. Furthermore, if the death of an insured cannot be verified and no death certificate can be produced, the related insurance company may not pay the proceeds of the life insurance policy until the passage of a statutory period (usually five to seven years) for the presumption of death without proof. Such delays in payment or non-payment of policy proceeds may have a material adverse effect on our business, financial condition and results of operations.

Our Life Finance segment is highly regulated; changes in regulation, the USAO Investigation and the SEC Investigation could materially adversely affect our ability to conduct our business.

Our Life Finance segment is highly regulated. Generally, as a condition to the issuance of licenses held by the Company’s subsidiaries in the Life Finance segment, we and/or our licensed subsidiaries submit ourselves to potential state regulatory examinations. Currently, our life settlement provider subsidiary is undergoing an examination by the Florida Office of Insurance Regulation, which was initiated after we became aware of the USAO Investigation. To the extent that other state insurance or other regulators initiate their own investigations as a result of the USAO Investigation, the SEC Investigation, or the Florida Office of Insurance Regulation or such other regulators take other action such as imposing fines or rescinding our license in response thereto, our ability to conduct the businesses comprising our life finance segment may be materially adversely affected, which could have a material adverse effect on our business, results of operations and financial condition.

 

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Some life insurance companies are opposed to the financing of life insurance policies.

Some life insurance companies and their trade associations have voiced concerns about the life settlement and premium finance industries generally and the transfer of life insurance policies to investors. These life insurance companies may oppose the transfer of a policy to, or honoring of a life insurance policy held by, third parties unrelated to the original insured/owner, especially when they may believe the premiums for such life insurance policies might have been financed, directly or indirectly, by investors that lacked an insurable interest in the continuing life of the insured. If the life insurance companies seek to contest or rescind life insurance policies acquired by us based on such aversion to the financing of life insurance policies, we may experience a substantial loss with respect to the related premium finance loans and the underlying life insurance policies, which could have a material adverse effect on our business, financial condition and results of operations. These life insurance companies and their trade associations may also seek additional state and federal regulation of the life settlement and premium finance industries. If additional life settlement regulations were adopted, we may experience material adverse effects on our business, financial condition and results of operations.

If a regulator or court decides that trusts that are formed to own many of the life insurance policies that serve as collateral for our premium finance loans do not have an insurable interest in the life of the insured, such determination could have a material adverse effect on our business, financial condition and results of operations.

Generally, there are two forms of insurable interests in the life of an individual, familial and financial. Additionally, an individual is deemed to have an insurable interest in his or her own life. It is also a common practice for an individual, as a grantor or settlor, to form an irrevocable trust to purchase and own a life insurance policy insuring the life of the grantor or settlor, where the beneficiaries of the trust are persons who themselves, by virtue of certain familial relationships with the grantor or settlor, also have an insurable interest in the life of the insured. In the event of a payment default on our premium finance loan, we will generally acquire life insurance policies owned by trusts (or the beneficial interests in the trust itself) that we believe had an insurable interest in the life of the related insureds. However, a state insurance regulatory authority or a court may determine that the trust or policy owner does not have an insurable interest in the life of the insured or that we, as lender, only have a limited insurable interest, which may be less than the amounts due to us. Any such determination could result in our being unable to receive the proceeds of the life insurance policy, which could lead to a total loss of all amounts loaned in the premium finance transaction or a total loss on our investment in life settlements. Any such loss or losses could have a material adverse effect on our business, financial condition and results of operations.

Bankruptcy of the insured, a beneficiary of the trust owning the life insurance policy or the trust itself could prevent a claim under our lender protection insurance policy.

In many instances, individuals establish an irrevocable trust to hold and own their life insurance policy for estate planning reasons. The majority of the premium finance borrowers are trusts owning life insurance policies. A bankruptcy of the insured, a bankruptcy of a beneficiary of a trust owning the life insurance policy or a bankruptcy of the trust itself could prevent us from acquiring the life insurance policy following an event of default under the related premium finance loan unless consent of the applicable bankruptcy court is obtained or it is determined that the automatic stay generally arising following a bankruptcy filing is not applicable.

Our lender protection insurance policies have significant exclusions and limitations.

As of December 31, 2011, we had 91 loans outstanding that were covered by our lender protection insurance. Coverage under our lender protection insurance policies is not comprehensive and each of these policies is subject to significant exclusions, limitations and coverage gaps. In the event that any of the exclusions or limitations to coverage set forth in the lender protection insurance policies are applicable or there is a coverage gap, there will be no coverage for any losses we may suffer, which would have a material adverse effect on our business, financial condition and results of operations. The coverage exclusions include, but are not limited to:

 

   

the lapse of the related life insurance policy due to the failure to pay sufficient premiums during the term of the applicable premium finance loan;

 

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certain losses relating to situations where the life insured has died and there has been a bankruptcy or insolvency of the life insurance company that issued the applicable policy;

 

   

any loss caused by our fraudulent, illegal, criminal, malicious or grossly negligent acts;

 

   

a surrender of the related life insurance policy to the issuing life insurance carrier or the sale of such policy or the beneficial interest therein, in each case without the prior written consent of the lender protection insurer;

 

   

our failure to timely obtain necessary rights, free and clear of any lien or encumbrance, with respect to the applicable life insurance policy as required under the lender protection insurance policy;

 

   

our failure to timely submit a properly completed proof of loss certificate to the lender protection insurance policy insurer;

 

   

our failure to timely notify the lender protection insurance policy insurer of:

 

   

the occurrence of certain prohibited acts, as described in the lender protection insurance policy, or

 

   

material non-compliance of the related loan with applicable laws, in each case after obtaining actual knowledge of such events;

 

   

our making of a claim under the lender protection insurance policy knowing the same to be fraudulent; or

 

   

the related life insurance policy being contested prior to the effective date of the related coverage certificate issued under the lender protection insurance policy and we have actual knowledge of such contest.

While we do not believe the conduct outlined in the Non-Prosecution Agreement resulted in a violation of the terms of any of our lender protection insurance policies, following the announcement of the USAO Investigation and entry into the Non-Prosecution Agreement, our lender protection insurer communicated to the Company that it was reserving its rights under our various lender protection insurance policies.

Failure to perfect a security interest in the underlying life insurance policy or the beneficial interests therein could result in our interest being subordinated to other creditors.

Payment by the related premium finance loan borrower of amounts owed pursuant to each loan is secured by the underlying life insurance policy or by the beneficial interests in a trust established to hold the insurance policy. If we fail to perfect a security interest in such policy or beneficial interests, our interest in such policy or beneficial interests may be subordinated to those of other parties, including, in the event of a bankruptcy or insolvency, a bankruptcy trustee, receiver or conservator.

We are dependent on the creditworthiness of the life insurance companies that issue the policies serving as collateral for our premium finance loans. If a life insurance company defaults on its obligation to pay death benefits on a policy we own, we would experience a loss of our investment, which could have a material adverse effect on our business, financial condition and results of operations.

We are dependent on the creditworthiness of the life insurance companies that issue the policies that we own or that serve as collateral for our premium finance loans. We assume the credit risk associated with life insurance policies issued by various life insurance companies. Furthermore, there is a concentration of life insurance companies that issue the policies that we own or that serve as collateral for our premium finance loans. Approximately 54% of the policies that we owned as of December 31, 2011 were secured by life insurance policies issued by four life insurance companies. The failure or bankruptcy of any such life insurance company or annuity company could have a material adverse impact on our financial condition and results of operation. A life insurance company’s business tends to track general economic and market conditions that are beyond its control,

 

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including extended economic recessions or interest rate changes. Changes in investor perceptions regarding the strength of insurers generally and the policies or annuities they offer can adversely affect our ability to sell or finance our assets. Adverse economic factors and volatility in the financial markets may have a material adverse effect on a life insurance company’s business and credit rating, financial condition and operating results, and an issuing life insurance company may default on its obligation to pay death benefits on the life insurance policies that we own or that serve as collateral for our premium finance loans. In such event, we would experience a loss of our investment in such life insurance policies which could have a material adverse effect on our business, financial condition and results of operations.

If a life insurance company is able to increase the premiums due on life insurance policies that we own or finance, it will adversely affect our returns on such life insurance policies.

To keep the life insurance policies that we own or finance in force, insurance premiums due must be timely paid. If a life insurance company is able to increase the cost of insurance charged for any of the life insurance policies that we own or finance, the amounts required to be paid for insurance premiums due for these life insurance policies may increase, requiring us to incur additional costs for the life insurance policies, which may adversely affect returns on such life insurance policies and consequently reduce the secondary market value of such life insurance policies. Failure to pay premiums on the life insurance policies when due will result in termination or “lapse” of the life insurance policies. The insurer may in a “lapse” situation view reinstatement of a life insurance policy as tantamount to the issuance of a new life insurance policy and may require the current owner to have an insurable interest in the life of the insured as of the date of the reinstatement. In such event, we would experience a loss of our investment in such life insurance policy.

Risk Factors Related to Structured Settlements

We are dependent on third parties to purchase our structured settlements. Any inability to sell structured settlements or, in the alternative, to access additional capital to purchase structured settlements, may have a material adverse effect on our ability to grow our business, our financial condition and results of operations.

We are dependent on third parties to purchase our structured settlements. Our ability to grow our business depends upon our ability to sell our structured settlements at favorable discount rates and to establish alternative financing arrangements.

We may not be able to continue to sell our structured settlements to third parties at favorable discount rates or obtain financing through borrowings or other means on acceptable terms to satisfy our cash requirements. We were unable to obtain such financing through most of the fourth quarter of 2011. Any future inability to obtain financing or the unavailability of third party purchasers could have a material adverse effect on our future ability to grow our business.

Any change in current tax law could have a material adverse effect on our business, financial condition and results of operations.

The use of structured settlements is largely the result of the favorable federal income tax treatment of such transactions. In 1979, the Internal Revenue Service issued revenue rulings that the income tax exclusion of personal injury settlements applied to related periodic payments. Thus, claimants receiving installment payments as compensation for a personal injury were exempt from all federal income taxation, provided certain conditions were met. This ruling, and its subsequent codification into federal tax law in 1982, resulted in the proliferation of structured settlements as a means of settling personal injury lawsuits. Changes to tax policies that eliminate this exemption of structured settlements from federal taxation could have a material adverse effect on our future profitability. If the tax treatment for structured settlements were changed adversely by a statutory change or a change in interpretation, the dollar volume of structured settlements could be reduced significantly which would

 

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also reduce the level of our structured settlement business. In addition, if there were a change in the federal tax code that would result in adverse tax consequences for the assignment or transfer of structured settlements, such change could have a material adverse effect on our business, financial condition and results of operations.

Fluctuations in discount rates or interest rates may decrease our yield on structured settlement transactions.

Our profitability is directly affected by levels of and fluctuations in interest rates. Such profitability is largely determined by the difference between the discount rate at which we purchase the structured settlements and the discount rate at which we can resell these assets or the interest rate at which we can finance those assets. We may not be able to continue to purchase structured settlements at current or historical discount rates. Structured settlements are purchased at effective yields which are fixed, while rates at which structured settlements are sold, with the exception of forward purchase arrangements, are generally a function of the prevailing market rates for short-term borrowings. As a result, decreases in the discount rate at which we purchase structured settlements or increases in prevailing market interest rates after structured settlements are acquired could have a material adverse effect on our yield on structured settlement transactions, which could have a material adverse effect on our business, financial condition and results of operations.

The insolvency of a holder of a structured settlement could have an adverse effect on our business, financial condition and results of operations.

Our rights to scheduled payments in structured settlement transactions will be adversely affected if any holder of a structured settlement, the special purpose vehicle to which an insurance company assigns its obligations to make payments under the settlement (the “Assumption Party”) or the annuity provider becomes insolvent and/or becomes a debtor in a case under the Bankruptcy Code.

If a holder of a structured settlement were to become a debtor in a case under the Bankruptcy Code, a court could hold that the scheduled payments transferred by the holder under the applicable settlement purchase agreement would not constitute property of the estate of the claimant under the Bankruptcy Code. If, however, a trustee in bankruptcy or other receiver were to assert a contrary position, such as by requiring us (or any securitization vehicle) to establish our right to those payments under federal bankruptcy law or by persuading courts to recharacterize the transaction as secured loans, such result could have a material adverse effect on our business. If the rights to receive the scheduled payments are deemed to be property of the bankruptcy estate of the claimant, the trustee may be able to avoid assignment of the receivable to us.

Furthermore, a general creditor or representative of the creditors (such as a trustee in bankruptcy) of an Assumption Party could make the argument that the payments due from the annuity provider are the property of the estate of such Assumption Party (as the named owner thereof). To the extent that a court would accept this argument, the resulting delays or reductions in payments on our receivables could have a material adverse effect on our business, financial condition and results of operations.

If the identities of structured settlement holders become readily available, it could have an adverse effect on our structured settlement business, financial condition and results of operations.

Brand awareness is critical to growing market share. We expect to continue to build and enhance our database of structured settlements through a combination of commercial and internet advertising campaigns and targeted marketing efforts. If the identities of structured settlement holders in our database were to become readily available to our competitors or to the general public, we could face increased competition and the value of our proprietary database would be diminished, which would have a negative effect on our structured settlement business, financial condition and results of operations.

 

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Adverse judicial developments could have an adverse effect on our business, financial condition and results of operation.

 

Adverse judicial developments have occasionally occurred in the structured settlement industry, especially with regard to anti-assignment concerns and issues associated with non-disclosure of material facts and associated misconduct. For example, in the 2008 case of 321 Henderson Receivables, LLC v. Tomahawk, the California County Superior Court (Fresno County, Case No. 08CECG00797—July 2008 Order (unreported)) ruled that (i) certain structured settlement sales were barred by anti-assignment provisions in the settlement documents, (ii) the transfers were loans, not sales, that violated California’s usury laws and (iii) for similar reasons numerous other court-approved structured settlement sales may be void. Although the Tomahawk decision was subsequently reversed by the California Court of Appeal, the Superior Court decision had a negative effect on the structured settlement industry by casting doubt on the ability of a structured settlement recipient to sell portions of the payment streams. Any similar adverse judicial developments calling into doubt such laws and regulations could materially and adversely affect our investments in structured settlements.

Risk Factors Relating to Our Common Stock

Provisions in our executive officers’ employment agreements could impede an attempt to replace or remove our directors or otherwise effect a change of control, which could diminish the price of our common stock.

We have entered into employment agreements with our executive officers as described in the section titled “Executive Compensation—Employment Agreements.” The agreement for our chief executive officer provides for substantial payments upon the occurrence of certain triggering events, including a material diminution of his base salary or responsibilities. These payments are equal to three times the sum of his base salary and the average of the three years’ annual cash bonus, unless the triggering event occurs during the first three years of their respective employment agreements, in which case the payments are equal to six times base salary. These payments may deter any transaction that would result in a change in control, which could diminish the price of our common stock.

Provisions in our articles of incorporation and bylaws could impede an attempt to replace or remove our directors or otherwise effect a change of control, which could diminish the price of our common stock.

 

Our articles of incorporation and bylaws contain provisions that may entrench directors and make it more difficult for shareholders to replace directors even if the shareholders consider it beneficial to do so. In particular, shareholders are required to provide us with advance notice of shareholder nominations and proposals to be brought before any annual meeting of shareholders, which could discourage or deter a third party from conducting a solicitation of proxies to elect its own slate of directors or to introduce a proposal. In addition, our articles of incorporation eliminate our shareholders’ ability to act without a meeting and require the holders of not less than 50% of the voting power of our common stock to call a special meeting of shareholders.

These provisions could delay or prevent a change of control that a shareholder might consider favorable. For example, these provisions may prevent a shareholder from receiving the benefit from any premium over the market price of our common stock offered by a bidder in a potential takeover. Even in the absence of an attempt to effect a change in management or a takeover attempt, these provisions may adversely affect the prevailing market price of our common stock if they are viewed as discouraging changes in management and takeover attempts in the future. Furthermore, our articles of incorporation and our bylaws provide that the number of directors shall be fixed from time to time by our board of directors, provided that the board shall consist of at least three and no more than fifteen members.

Certain laws of the State of Florida could impede a change of control, which could diminish the price of our common stock.

As a Florida corporation, we are subject to the Florida Business Corporation Act, which provides that a person who acquires shares in an “issuing public corporation,” as defined in the statute, in excess of certain

 

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specified thresholds generally will not have any voting rights with respect to such shares unless such voting rights are approved by the holders of a majority of the votes of each class of securities entitled to vote separately, excluding shares held or controlled by the acquiring person. The Florida Business Corporation Act also contains a statute which provides that an affiliated transaction with an interested shareholder generally must be approved by (i) the affirmative vote of the holders of two thirds of our voting shares, other than the shares beneficially owned by the interested shareholder, or (ii) a majority of the disinterested directors.

One of our subsidiaries, Imperial Life Settlements, LLC, a Delaware limited liability company, is licensed as a viatical settlement provider and is regulated by the Florida Office of Insurance Regulation. As a Florida viatical settlement provider, Imperial Life Settlements, LLC is subject to regulation as a specialty insurer under certain provisions of the Florida Insurance Code. Under applicable Florida law, no person can finally acquire, directly or indirectly, 10% or more of the voting securities of a viatical settlement provider or its controlling company without the written approval of the Florida Office of Insurance Regulation. Accordingly, any person who acquires beneficial ownership of 10% or more of our voting securities will be required by law to notify the Florida Office of Insurance Regulation no later than five days after any form of tender offer or exchange offer is proposed, or no later than five days after the acquisition of securities or ownership interest if no tender offer or exchange offer is involved. Such person will also be required to file with the Florida Office of Insurance Regulation an application for approval of the acquisition no later than 30 days after the same date that triggers the 5-day notice requirement.

The Florida Office of Insurance Regulation may disapprove the acquisition of 10% or more of our voting securities by any person who refuses to apply for and obtain regulatory approval of such acquisition. In addition, if the Florida Office of Insurance Regulation determines that any person has acquired 10% or more of our voting securities without obtaining its regulatory approval, it may order that person to cease the acquisition and divest itself of any shares of our voting securities which may have been acquired in violation of the applicable Florida law. Due to the requirement to file an application with and obtain approval from the Florida Office of Insurance Regulation, purchasers of 10% or more of our voting securities may incur additional expenses in connection with preparing, filing and obtaining approval of the application, and the effectiveness of the acquisition will be delayed pending receipt of approval from the Florida Office of Insurance Regulation.

The Florida Office of Insurance Regulation may also take disciplinary action against Imperial Life Settlements, LLC’s license if it finds that an acquisition of our voting securities is made in violation of the applicable Florida law and would render the further transaction of business hazardous to our customers, creditors, shareholders or the public.

Item 1B. Unresolved Staff Comments

None.

Item 2. Properties

Our principal executive offices are located at 701 Park of Commerce Boulevard, Boca Raton, Florida 33487 and consist of approximately 21,000  square feet of leased office space. We consider our facilities to be adequate for our current operations.

Item 3.  Legal Proceedings

Litigation

The USAO Investigation

On September 27, 2011, a search warrant was executed at the Company’s headquarters and the Company was informed that it was being investigated by the USAO. At that time, the Company was also informed that its

 

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chief executive officer and chairman, president and chief operating officer, former general counsel, two vice presidents, three life finance sales executives and a funding manager were also considered “targets” of the USAO Investigation. The USAO Investigation focused on the Company’s premium finance loan business. The Company’s board of directors formed a special committee, comprised of all of the Company’s independent directors, to conduct an independent investigation in connection with the USAO Investigation. In December 2011, the USAO confirmed that Mr. Antony Mitchell, our chief executive officer, was no longer a target of the USAO investigation.

On April 30, 2012, the Company entered into 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 December 31, 2011, the Company had 13 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 accounted for approximately 58.2% of our revenues in the year ended December 31, 2011, and terminated certain senior sales staff associated with the premium finance business. Additionally, the Company agreed to pay the United States Government $8.0 million, 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, but after two years the Company may petition the USAO to forego the final year of the Non-Prosecution Agreement if we otherwise comply with all of our 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 the Company.

The SEC Investigation

As of the filing of this Annual Report, we are also subject to an investigation by the SEC. We received a subpoena issued by the staff of the SEC on February 17, 2012, seeking documents from 2007 through the present that are 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 is cooperating with the SEC regarding this matter. The Company is unable to predict the outcome of the SEC investigation or estimate the amount of any possible sanction, which could include a fine, penalty, or court order prohibiting specific conduct, any of which could be material. No provision for losses has been recorded for this exposure.

 

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The Class Action Litigation

Initially on September 28, 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 which 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, and a decision is pending.

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. The lead plaintiffs have until November 5, 2012 to file an amended complaint.

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. See “Risk Factors” above.

The parties have been attending mediation, most recently on September 7, 2012.

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, 2011 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 defense costs and fees already advanced to the Company under the Policy if it is determined that the Exclusion precludes coverage. As of the filing of this Annual Report on Form 10-K, the Company has not yet been served with the complaint.

The parties have been attending mediation, most recently on September 7, 2012.

 

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The Florida Litigation

On March 14, 2012, Opportunity served the Company with a complaint in the Circuit Court of the 15th Judicial Circuit in and for Palm Beach County, Florida seeking to compel the Company to hold an annual meeting of shareholders as soon as possible and seeking recovery of all costs and expenses, including reasonable attorney’s fees and expenses of experts in connection with the complaint. On March 28, 2012, Opportunity filed a motion to compel an annual meeting of shareholders. The Company filed a motion to dismiss the complaint on April 3, 2012 and an opposition to the motion to compel on May 24, 2012. Following a hearing on June 1, 2012, the Court entered an Order dated June 15, 2012 granting Opportunity motion to compel an annual meeting of shareholders and denying the Company’s motion to dismiss. Pursuant to the Court’s Order, the Company was required to hold its annual meeting of shareholders on or before August 20, 2012. In addition, the Court ordered the Company to seek an exemption from the SEC pursuant to SEC Regulation 17 C.F.R. § 200.30-1(e)(18) on or before June 20, 2012 and to update the Court of any adverse response to its application on or before July 18, 2012.

On August 2, 2012, the Board of Directors of the Company appointed Andrew Dakos, Phillip Goldstein and Gerald Hellerman to serve as directors of the Company in connection with a settlement with Opportunity that resulted in Opportunity withdrawing its demand for a special meeting of shareholders, which it had submitted to the Company on May 23, 2012 and agreeing to dismiss its lawsuit to compel an annual meeting of shareholders. In connection with the Settlement, Walter Higgins and A. Penn Wyrough resigned from the Board of Directors. The Company complied with the Order dated June 15, 2012 prior to the settlement. The Court withdrew the Order dated June 15, 2012 with a subsequent Order dated August 9, 2012, in which the Court also dismissed the case without prejudice.

Derivative Claims

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. The Rothenberg Demand is included in the class action mediation, which has not concluded. 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. The Company has until January 4, 2013 to respond to the complaint.

Counsel for Mr. Rothenberg has been attending mediation with the Company, most recently on September 7, 2012.

Other Matters

As previously disclosed in our prospectus filed with the SEC on February 8, 2011, the Company was involved in a dispute with its former general counsel whom the Company terminated without cause on November 8, 2010. On December 30, 2010, she filed a demand for mediation and arbitration with the American Arbitration Association. On March 11, 2011, the Company entered into a confidential settlement agreement with the plaintiff pursuant to which, among other things, the plaintiff agreed to dismiss all claims in the proceeding in exchange for a settlement payment from the Company. The terms of the settlement agreement did not have a material effect on the Company’s results of operations, financial position or cash flows.

 

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In addition to the proceedings above, we are party to various legal proceedings which arise in the ordinary course of business. From time to time, we also finance the cost of a policyholder’s defense of litigation initiated by a carrier to challenge the policyholder’s life insurance policy. While we cannot predict with certainty the outcome of these proceedings, 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.

Item 4. Mine Safety Disclosures.

Not applicable.

 

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PART II

Item 5. Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities

Shares of our common stock began trading on the New York Stock Exchange, or NYSE, under the symbol “IFT” on February 8, 2011.

The following table shows the high and low sales prices for our common stock for the periods indicated, as reported by the NYSE:

 

     2011  
     High      Low  

1st Quarter

   $ 11.30       $ 10.00   

2nd Quarter

     10.48         9.19   

3rd Quarter

     10.24         1.55   

4th Quarter

     2.77         1.48   

As of September 27, 2012, we had 11 holders of record of our common stock.

 

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Stock Performance Graph

The line graph below compares the cumulative total stockholder return in our common stock between February 8, 2011 (the day shares of our common stock began trading) and December 31, 2011, with cumulative total return on the Russell MicroCap Index and the Nasdaq Financial Index. This graph assumes a $100 investment in each of Imperial Holdings, Inc., the Russell Microcap Index and the Nasdaq Financial Index at the close of trading on February 8, 2011, and also assumes the reinvestment of all dividends. The graph assumes our closing sales price on February 8, 2011 of $10.81 per share as the initial value of our common stock.

The comparisons shown in the graph below are based upon historical data. We caution that the stock price performance shown in the graph below is not necessarily indicative of, nor is it intended to forecast, the potential future performance of our common stock.

 

LOGO

 

    02/8/11     02/28/11     03/31/11     04/30/11     05/31/11     06/30/11     07/31/11     08/31/11     09/30/11     10/31/11     11/30/11     12/31/11  

Imperial Holdings, Inc.

  $ 100.00      $ 101.20      $ 93.89      $ 91.95      $ 93.15      $ 93.99      $ 89.45      $ 68.64      $ 22.20      $ 20.81      $ 17.48      $ 17.39   

Russell Microcap Index

  $ 100.00      $ 101.09      $ 103.72      $ 105.38      $ 103.14      $ 101.11      $ 97.29      $ 87.02      $ 77.33      $ 87.86      $ 86.90      $ 88.09   

Nasdaq Financial Index

  $ 100.00      $ 100.14      $ 98.65      $ 99.27      $ 97.15      $ 94.64      $ 91.80      $ 83.48      $ 76.10      $ 85.85      $ 85.18      $ 86.00   

We selected these indices because they include companies with similar market capitalizations to ours. We believe these are the most appropriate comparisons since we have no comparable publicly traded industry “peer” group operating in the life settlement industry.

The performance graph above is being furnished solely to accompany this Annual Report on Form 10-K pursuant to Item 201(e) of Regulation S-K, is not being filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and is not to be incorporated by reference into any of our filings, whether made before or after the date hereof, regardless of any general incorporation language in such filing.

 

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Dividend Policy

We do not expect to pay any cash dividends on our common stock for the foreseeable future. We currently intend to retain any future earnings to finance our operations. Any future determination to pay cash dividends on our common stock will be at the discretion of our board of directors and will be dependent on our earnings, financial condition, operating results, capital requirements, any contractual, regulatory and other restrictions on the payment of dividends by us or by our subsidiaries to us, and other factors that our board of directors deems relevant.

We are a holding company and have no direct operations. Our ability to pay dividends in the future depends on the ability of our operating subsidiaries to pay dividends to us. Our existing debt facilities restrict the ability of certain of our special purpose subsidiaries to pay dividends. In addition, future debt arrangements may contain certain prohibitions or limitations on the payment of dividends.

Equity Compensation Plans

Prior to our initial public offering, in February 2011, our board of directors and shareholders approved the Imperial Holdings 2010 Omnibus Incentive 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. Prior to our initial public offering, we had no equity compensation plan. See “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters” for more information about the securities authorized for issuance under the Omnibus Plan.

Recent Sales of Unregistered Securities

None.

Purchases of Equity Securities by the Issuer and Affiliated Purchasers

None.

 

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Item 6. Selected Financial Data

The following table sets forth our selected historical consolidated financial and operating data as of such dates and for such periods indicated below. These selected historical consolidated results are not necessarily indicative of results to be expected in any future period. You should read the following financial information together with the other information contained in this Annual Report on Form 10-K, including “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the financial statements and related notes.

 

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The selected historical income statement data for the years ended December 31, 2011, 2010 and 2009 and balance sheet data as of December 31, 2011 and 2010 were derived from our audited consolidated financial statements included elsewhere in this Annual Report on Form 10-K.

 

     Historical  
     Years Ended December 31,  
     2011     2010     2009     2008     2007  
     (in thousands except per share data)        

Income

          

Agency fee income

   $ 6,470      $ 10,149      $ 26,114      $ 48,004      $ 24,515   

Interest income

     8,303        18,660        21,483        11,914        4,888   

Interest and dividends on investment securities available for sale

     640        —          —          —          —     

Origination fee income

     6,480        19,938        29,853        9,399        526   

Realized gain on sale of structured settlements

     5,817        6,595        2,684        443        —     

Realized gain on sale of life settlements

     5        1,951        —          —          —     

Gain on forgiveness of debt

     5,023        7,599        16,410        —          —     

Unrealized change in fair value of life settlements

     570        10,156        —          —          —     

Unrealized change in fair value of structured settlements

     5,302        2,477        —          —          —     

Change in equity investments

     —          (1,284       —          —     

Servicing fee income

     1,814        413        —          —          —     

Gain on maturities of life settlements

          

with subrogation rights, net

     3,188        —          —          —          —     

Other income

     602        242        71        47        2   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total income

     44,214        76,896        96,615        69,807        29,931   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Expenses

          

Interest expense(1)

     8,524        28,155        33,755        12,752        1,343   

Provision for losses on loans receivable

     7,589        4,476        9,830        10,768        2,332   

Loss on loan payoffs and settlements, net

     3,837        4,981        12,058        2,738        (225

Amortization of deferred costs

     6,076        24,465        18,339        7,569        126   

Department of Justice settlement

     8,000        —          —          —          —     

Selling, general and administrative expenses(1)

     49,386        30,516        31,269        41,566        24,335   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total expenses

     83,412        92,593        105,251        75,393        27,911   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

(Loss) Income before income taxes

     (39,198     (15,697     (8,636     (5,586     2,020   

Provision for income taxes

     —          —          —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net (loss) income

   $ (39,198   $ (15,697   $ (8,636   $ (5,586   $ 2,020   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Earnings (loss) per share:

          

Basic(2)

   $ (2.03   $ (4.36   $ (2.40   $ (1.55   $ 0.56   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Diluted(2)

   $ (2.03   $ (4.36   $ (2.40   $ (1.55   $ 0.56   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average shares outstanding:

          

Basic(2)

     19,352,063        3,600,000        3,600,000        3,600,000        3,600,000   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Diluted(2)

     19,352,063        3,600,000        3,600,000        3,600,000        3,600,000   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) Includes amounts for related parties. Refer to our consolidated and combined financial statements for detail.
(2) As of February 3, 2011, the Company had 3,600,000 shares of common stock outstanding. The impact of the Company’s corporate conversion has been applied on a retrospective basis to January 1, 2007 to determine earnings per share for the years ended December 31, 2011, 2010, 2009, 2008 and 2007. As of December 31, 2011, there were 21,202,614 issued and outstanding shares.

 

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    As of December 31,  
    Historical  
    2011     2010     2009     2008     2007  
    (In thousands except share data)  
ASSETS   

Assets

         

Cash and cash equivalents

  $ 16,255      $ 14,224      $ 15,891      $ 7,644      $ 1,495   

Restricted cash

    691        691        —          2,221        1,675   

Certificate of deposit—restricted

    891        880        670        659        562   

Investment securities available for sale, at estimated fair value

    57,242        —          —          —          —     

Agency fees receivable, net of allowance for doubtful accounts

    —          561        2,165        8,871        5,718   

Deferred costs, net

    1,874        10,706        26,323        26,650        672   

Prepaid expenses and other assets

    3,277        1,868        887        4,180        835   

Deposits—other

    761        692        982        476        456   

Interest receivable, net

    5,758        13,140        21,034        8,604        2,972   

Loans receivable, net

    29,376        90,026        189,111        148,744        43,650   

Structured settlement receivables at estimated fair value, net

    12,376        1,446        —          —       

Structured settlement receivables at cost, net

    1,553        1,090        472        1,141        377   

Investment in life settlements, at estimated fair value

    90,917        17,138        4,306        —          —     

Investment in life settlement fund

    —          —          542          1,714   

Fixed assets, net

    585        876        —          —          —     

Other receivable

    1,043        79        1,337        1,850        1,875   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total assets

  $ 222,599      $ 153,417      $ 263,720      $ 211,040      $ 62,001   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
LIABILITIES AND STOCKHOLDERS’/MEMBERS’ EQUITY   

Liabilities

         

Accounts payable and accrued expenses(1)

  $ 16,336      $ 3,425      $ 3,170      $ 5,533      $ 3,437   

Payable for purchase of structured settlements

    —          224        —          —          —     

Other liabilities

    4,279        7,984        —          —          —     

Lender protection insurance claims received in advance

    —          31,154        —          —          —     

Interest payable(1)

    5,505        13,820        12,627        5,563        882   

Notes payable and debenture payable, net of discount(1)

    19,277        91,609        231,064        183,462        35,559   

Income taxes payable

    6,295        —          —          —          —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total liabilities

    51,692        148,216        246,861        194,558        39,878   

Stockholders’/Members’ Equity

         

Member units—preferred (zero and 500,000 authorized in the aggregate as of December 31, 2011, 2010, 2009, 2008 and 2007, respectively):

         

Member units—Series A preferred (zero and 90,796 issued and outstanding as of December 31, 2011, 2010, 2009, 2008 and 2007, respectively)

    —          4,035        4,035        —          —     

Member units—Series B preferred (zero and 25,000 issued and outstanding as of December 31, 2011, 2010, 2009, 2008 and 2007, respectively)

    —          2,500        5,000        —          —     

Member units—Series C preferred (zero and 70,000 issued and outstanding as of December 31, 2011, 2010, 2009, 2008 and 2007, respectively)

    —          7,000        —          —          —     

Member units—Series D preferred (zero and 7,000 issued and outstanding as of December 31, 2011, 2010, 2009, 2008 and 2007, respectively)

    —          700        —          —          —     

Member units—Series E preferred (zero and 73,000 issued and outstanding as of December 31, 2011, 2010, 2009, 2008 and 2007, respectively)

    —          7,300        —          —          —     

Member units—common (zero and 500,000 authorized; zero and 337,500 issued and outstanding as of December 31, 2011, 2010, 2009, 2008 and 2007, respectively)

    —          11,462        19,924        19,945        20,000   

Common stock (par value $0.01 per share 80,000,000 and zero authorized; 21,202,614 and zero issued and outstanding as of December 31, 2011, 2010, 2009, 2008 and 2007, respectively)

    212        —          —          —          —     

Additional paid-in-capital

    237,755        —          —          —          —     

Accumulated other comprehensive loss

    (66     —          —          —          —     

Accumulated deficit

    (66,994     (27,796     (12,100     (3,463     2,123   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total stockholders’/members’ equity

    170,907        5,201        16,859        16,482        22,123   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total liabilities and stockholders’/members’ equity

  $ 222,599      $ 153,417      $ 263,720      $ 211,040      $ 62,001   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) Includes amounts payable to related parties. Refer to our consolidated and combined financial statements for details.

 

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Life Finance Segment—Selected Operating Data (dollars in thousands):

 

     Year Ended December 31,  
     2011     2010     2009  

Period Originations:

      

Number of loans originated (by type):

      

Type 1*

     44        93        194   

Type 2**

     11        4        0   

Principal balance of loans originated

   $ 18,385      $ 20,536      $ 51,573   

Aggregate death benefit of policies underlying loans originated

   $ 311,850      $ 462,350      $ 942,312   

Selling general and administrative expenses

   $ 13,218      $ 10,324      $ 13,742   

Average Per Origination During Period:

      

Age of insured at origination

     75.7        74.0        74.9   

Life expectancy of insured (years)

     14.5        14.1        13.2   

Monthly premium (year of origination)

   $ 11.2      $ 13.7      $ 16.0   

Death benefit of policies underlying loans originated

   $ 5,376.7      $ 4,766.5      $ 4,857.3   

Principal balance of the loan

   $ 334.3      $ 211.7      $ 265.8   

Interest rate charged

     14.0     11.5     11.4

Agency fee

   $ 110.2      $ 103.2      $ 134.6   

Agency fee as % of principal balance

      

Type 1*

     39.0     49.3     50.6

Type 2**

     20.7     30.1     0.0

Origination fee

   $ 79.5      $ 87.9      $ 118.9   

Annualized origination fee as % of principal balance

     24.3     22.8     19.1

End of Period Loan Portfolio

      

Loans receivable, net

   $ 29,376      $ 90,026      $ 189,111   

Number of policies underlying loans receivable

     138        325        692   

Aggregate death benefit of policies underlying loans receivable

   $ 653,493      $ 1,517,161      $ 3,091,099   

Number of loans with insurance protection

     91        304        631   

Loans receivable, net (insured loans only)

   $ 20,785      $ 84,996      $ 177,137   

Average Per Loan:

      

Age of insured in loans receivable

     75.0        75.3        75.4   

Life expectancy of insured (years)

     15.6        15.3        14.5   

Monthly premium

   $ 5.9      $ 7.1      $ 8.5   

Loan receivable, net

   $ 212.8      $ 277.0      $ 273.3   

Interest rate

     12.3     11.4     10.9

Period Acquisitions—Policies Owned

      

Number of policies acquired

     151        33        31   

Average age of insured at acquisition

     78.0        77.5        77.1   

Average life expectancy—Calculated LE (Years)

     10.4        12.8        14.1   

Average death benefit

     4,929        5,176        2,617   

Aggregate purchase price

     56,889        4,010        3,730   

End of Period—Policies Owned

      

Number of policies owned

     190        41        27   

Average Life Expectancy—Calculated LE (Years)

     10.6        13.2        14.1   

Aggregate Death Benefit

     935,466        195,782        75,875   

Aggregate fair value

   $ 90,917      $ 17,138      $ 4,306   

Monthly premium—average per policy

   $ 10.7      $ 6.4      $ 2.8   

 

* We define Type 1 loans as loans that are collateralized by life insurance policies that have been in force less than two years.

 

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** We define Type 2 loans as loans that are collateralized by life insurance policies that have been in force longer than two years.

Structured Settlements Segment—Selected Operating Data (dollars in thousands):

 

     For the Year Ended December 31,  
     2011     2010     2009  

Period Originations:

      

Number of transactions

     873        565        396   

Number of transactions from repeat customers

     307        154        52   

Weighted average purchase discount rate

     18.2     19.4     16.3

Face value of undiscounted future payments purchased

   $ 96,628      $ 47,207      $ 28,877   

Amount paid for settlements purchased

   $ 20,303      $ 12,506      $ 10,947   

Marketing costs

   $ 6,087      $ 5,077      $ 4,460   

Selling, general and administrative (excluding marketing costs)

   $ 15,864      $ 7,888      $ 5,015   

Average Per Origination During Period:

      

Face value of undiscounted future payments purchased

   $ 110.7      $ 83.6      $ 72.9   

Amount paid for settlement purchased

   $ 23.3      $ 22.1      $ 27.6   

Time from funding to maturity (months)

     152.1        133.8        109.7   

Marketing cost per transaction

   $ 7.0      $ 9.0      $ 11.3   

Segment selling, general and administrative (excluding marketing costs) per transaction

   $ 18.2      $ 14.1      $ 12.7   

Period Sales:

      

Number of transactions originated and sold

     601        630        439   

Realized gain on sale of structured settlements

   $ 5,817      $ 6,595      $ 2,684   

Average sale discount rate

     10.5     8.9     11.5

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

You should read the following discussion in conjunction with the consolidated and combined financial statements and accompanying notes and the information contained in other sections of this Annual Report on Form 10-K, particularly under the headings “Risk Factors,” “Selected Financial Data” and “Business.” This discussion and analysis is based on the beliefs of our management, as well as assumptions made by, and information currently available to, our management. The statements in this discussion and analysis concerning expectations regarding our future performance, liquidity and capital resources, as well as other non-historical statements in this discussion and analysis, are forward-looking statements. See “Cautionary Statement Regarding Forward-Looking Statements.” These forward-looking statements are subject to numerous risks and uncertainties, including those described under “Risk Factors.” Our actual results could differ materially from those suggested or implied by any forward-looking statements.

Business 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.

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 charged on loans, loan origination fees, agency fees from referring agents, servicing income, change 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 sold 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.

Recent Developments, Uncertainties & Outlook

In connection with the Non-Prosecution Agreement, which is described in “Legal Proceedings—Litigation—The USAO Investigation,” Imperial voluntarily terminated its premium finance business, which accounted for approximately 58.2% of its revenues for the year ended December 31, 2011. Accordingly, the periods covered in the results of operations below will likely not be comparable to future periods as the Company will no longer recognize any agency fees and, once the Company's remaining premium finance loans mature, the Company will no longer recognize revenue from interest income or origination fees. The only material revenue that the Company expects to recognize from the premium finance business in 2012 is from changes in fair value of life settlements acquired upon default and strategic sales of certain life insurance policies in its portfolio that were acquired upon default of premium finance loans. As a result, we expect our revenue in our Life Finance segment to be materially lower in 2012 than in 2011.

Additionally, the Company’s ability to generate new business in the life finance segment was limited in the fourth quarter of 2011 when the Company originated no premium finance loans and, in order to conserve capital, only purchased 7 policies through life settlement-related acquisitions. This trend has continued into 2012 with the Company only purchasing two policies through life settlement-related acquisitions during the first six months of the year. As a consequence, the Company’s portfolio of life insurance policies is smaller than previously projected, which may result in more volatility and adversely affect the portfolio’s performance.

In the structured settlements segment, during the quarter ended December 31, 2011, the Company did not finance any non-life contingent structured settlements using its dedicated facility for those receivables. However,

 

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the Company continued to originate those receivables using available cash. Likewise, the Company did not finance the acquisition of life-contingent structured settlements into its dedicated facility for those receivables after becoming aware of the USAO Investigation. As a result, on December 31, 2011, the Company terminated its financing arrangements for life-contingent structured settlements and entered into a forward purchase and sale arrangement for these assets. However, this new arrangement compressed the Company’s margins as it required the Company to sell life-contingent structured settlements at a discount rate that was higher than the rate used in the prior facility as a result of the entry into the Non-Prosecution Agreement. As of the filing of this Annual Report on Form 10-K, the discount rate under this forward purchase and sale arrangement is 50 basis points higher than the rate used in the prior facility.

The Company has also expended considerable resources resolving the USAO Investigation, as well as defending itself in the SEC Investigation and related litigation, advancing indemnification costs on behalf of certain employees and in conducting an independent investigation of the facts and circumstances surrounding the USAO Investigation. As of December 31, 2011 and June 30, 2012 (unaudited), the Company’s legal and related fees in respect of these matters was $6.0 million and $16.2 million respectively. Moreover, the Company’s D&O carriers have disputed several of the claims and reserved their rights, and the Company’s primary D&O carrier filed a declaratory judgment action on June 13, 2012 seeking a judgment that the claims submitted by the Company are precluded under a prior and pending litigation exemption.

At the time of the Company’s initial public offering, the Company intended to hold the majority of the life insurance policies it acquired to maturity while strategically trading in and out of certain policies. In light of the USAO Investigation, the SEC Investigation, the related shareholder litigation and the related unbudgeted expenses incurred by the Company, the Company is re-examining its strategy and cash management objectives. We estimate that we will need to pay $24.1 million in premiums to keep our current portfolio of life insurance policies in force through 2012 and an additional $24.6 million to keep the portfolio in force through 2013. As of December 31, 2011, we had approximately $75.1 million of cash, cash equivalents, and marketable securities including $691,000 of restricted cash. As of June 30, 2012, we had approximately $51.2 million of cash and cash equivalents, and marketable securities including $1.0 million of restricted cash. Additionally, we have not yet experienced the mortalities of insureds or received the resulting death benefits from our life insurance policies (other than from policies with subrogation rights that are not reported on our balance sheet and that are considered contingent assets). We expect the lack of mortalities of insureds to continue at least through 2012.

We believe we have sufficient cash and cash equivalents to pay the premiums necessary to keep the life insurance policies that we own in force and our operating expenses through at least 2012, although we will need to proactively manage our cash in advance of any liquidity shortfall. Based on our current internal forecast, we do not anticipate a liquidity shortfall prior to the third quarter of 2013. However, if we do not begin to experience mortalities and collect the related death benefits in a timely manner prior to that time, we will likely need to seek additional capital to pay the premiums, by means of debt or equity financing or the sale of some of the policies that we own. We may also seek to reduce our operating expenses in order to preserve the value of our existing portfolio of policies, and/or, under certain scenarios, lapse or sell certain of our policies or some combination of the above. The lapsing of policies, if any, would create losses as the assets would written down to zero.

Life finance business

In the life finance segment, the Company has historically provided premium finance for individual life insurance policies and purchased life insurance policies in the secondary and tertiary markets. A premium finance transaction is a transaction in which a life insurance policyholder obtains a loan to pay insurance premiums for a fixed period of time, which allows a policyholder to maintain coverage without additional out-of-pocket costs.

Our typical premium finance loan was approximately two years in duration and was collateralized by the underlying life insurance policy. The life insurance policies that served as collateral for our premium finance

 

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loans were predominately universal life policies that had an average death benefit of approximately $4.8 million and insured persons over age 75. Generally, the borrower was an irrevocable life insurance trust established by the insured which was both the legal owner and beneficiary of a life insurance policy serving as collateral for a premium finance loan.

A borrower was not required to make any payment on the premium loan until maturity. At the end of the loan term, the borrower either repaid the loan in full (including all interest and fees) or defaulted under the loan. In the event of default, subject to loan terms and conditions, the borrower typically relinquished control of the policy serving as collateral for the loan to us. If we acquired the policy upon a loan default, we either held it for investment, sought to sell the policy, or, if the loan was insured, we were paid a claim equal to the insured value of the policy, which may have been equal to or less than the amount we are owed under the loan. The amounts received in respect of claims were used to repay our lenders from whom, prior to 2011, we borrowed funds to extend premium finance loans to borrowers. As of December 31, 2011, we had 138 premium finance loans outstanding, 65.9% of which had collateral whose value is insured.

The Company takes title to life insurance policies through two separate channels. First, we acquire life insurance policies when a borrower defaults on a premium finance loan originated by us, and we foreclose on the policy. Historically, a large portion of our borrowers defaulted on their loans and relinquished ownership of their life insurance policies to us. Our loans are secured by the underlying life insurance policy and, although we generally required a personal guarantee from the insured, are usually non-recourse to the borrower. If the borrower defaults on the obligation to repay the loan, we generally have no recourse against the borrower except for the life insurance policy that collateralizes the loan. In instances where we retained policies that served as collateral for a loan that was insured, in order to retain the policy on our balance sheet, we would typically be required to pay our lender protection insurer in order for the insurer to release its subrogation rights to the policy.

Second, we acquire life insurance policies through purchases directly from the original policy owners (the secondary market) and from institutional investors (the tertiary market). At December 31, 2011, we maintained licenses to transact life settlements in 25 of the states that currently require a license and could conduct business in 36 states and the District of Columbia.

Prior to and for a period after our initial public offering, the Company’s focus in our life finance segment was on our premium finance business. Following our initial public offering, however, changing market conditions made the acquisition of life insurance policies on the secondary and tertiary markets more attractive. Since 2008, the life settlement market has been distressed as a result of the general economic downturn. With the continued decrease of liquidity in the market place, re-selling policies on the tertiary market became significantly more difficult for investors. While some institutional investors have returned to the market, trading these policies remains challenging for most investors. For institutional investors with the financial capacity to hold these policies to maturity, life insurance policies remain an attractive, high-yield investment whose returns are non-correlated to the stock and bond markets. The Company suspended originating new premium finance loans and, in an effort to conserve capital, significantly reduced purchases of life insurance policies during the end of the third quarter of 2011.

Structured Settlements

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, which provides 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

 

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court approval. Through such sales, we purchase a certain number of fixed (life-contingent or non life-contingent), scheduled future settlement payments on a discounted basis in exchange for a single lump sum payment, thereby serving the liquidity needs of structured settlement holders.

During the capital markets dislocation in 2008 and 2009, in order to sell portfolios of structured settlements to strategic buyers, we were required to offer discount rates as high as approximately 12.0%. During the year ended December 31, 2011, our weighted average sale discount rate for sales of structured settlements was 10.5%, which includes the sale of both non-life contingent and life-contingent structured settlements. Life-contingent structured settlements are deferred payment streams that terminate upon the death of the structured settlement recipient. Non-life contingent structured settlements terminate on a pre-determined date and do not cease upon the recipient’s death.

We originated 873 transactions during the year ended December 31, 2011 as compared to 565 transactions during the same period in 2010, an increase of 54.5%. We incurred total expenses of $22.0 million during the year ended December 31, 2011 as compared to $13.1 million during the year ended December 31, 2010. The historical operating results of our structured settlement segment reflect our investment in the start-up costs and the initial growth of our structured settlement operations.

Principal Revenue and Expense Items

Components of Revenue

Agency Fee Income

In connection with our premium finance business, we earned agency fees that were paid by the referring life insurance agents. Because agency fees were not paid by the borrower, such fees do not accrue over the term of the loan. Referring insurance agents paid the agency fees to our subsidiary, Imperial Life and Annuity Services, LLC, a licensed insurance agency, for the due diligence performed in underwriting the premium finance transaction. The amount of the agency fee paid by a referring life insurance agent was negotiated with the referring agents based on a number of factors, including the size of the policy and the amount of premiums on the policy. Agency fees as a percentage of the principal balance of loans originated during the periods below are as follows:

 

     Year Ended December 31,  
     2011     2010     2009  

Agency fees as a percentage of the principal balance of the loans originated

     33.0     48.8     50.6

As a result of the voluntary termination of our premium finance business, we will not receive any revenue from agency fees in 2012 and beyond, and Imperial Life and Annuity Services, LLC has begun to voluntarily surrender its insurance agency licenses.

Interest Income

We receive interest income that accrues over the life of the premium finance loan and is due upon the date of maturity or upon repayment of the loan. Substantially all of the interest rates we charged on our premium finance loans are floating rates that were calculated at the one-month LIBOR rate plus an applicable margin. In addition, our premium finance loans have a floor interest rate and are capped at 16.0% per annum. For loans with floating rates, each month the interest rate is recalculated to equal one-month LIBOR plus the applicable margin, and then, if necessary, adjusted so as to remain at or above the stated floor rate and at or below the capped rate of 16.0% per annum. Interest income is recognized using the effective interest method over the life of the loan.

 

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The weighted average per annum interest rate for premium finance loans outstanding as of the dates below is as follows:

 

     Year Ended December 31,  
     2011     2010     2009  

Weighted average per annum interest rate

     12.5     11.4     10.9

Interest income also includes interest earned on structured settlement receivables. Until we sell our structured settlement receivables, the structured settlements are held on our balance sheet. Purchase discounts are accreted into interest income using the effective-interest method. As a result of the voluntary termination of our premium finance business, we will cease earning interest income from premium finance loans once our outstanding premium finance loans mature.

Origination Fee Income

We charged our borrowers an origination fee as part of the premium finance loan origination process. It was a one-time fee that is added to the loan amount and is due upon the date of maturity or upon repayment of the loan. Origination fees are recognized on an effective-interest method over the term of the loan.

Origination fees as a percentage of the principal balance of loans originated during the periods below are as follows:

 

     Year Ended December 31,  
     2011     2010     2009  

Origination fees as a percentage of the principal balance of the loans

     25.0     41.5     44.7

Origination fees per annum as a percentage of the principal balance of the loan

     24.3     22.7     19.2

As a result of the voluntary termination of our premium finance business, we will cease accruing origination fee income once our outstanding premium finance loans mature.

Gain on Sale of Structured Settlements

We purchase a certain number of fixed (life-contingent or non life-contingent), scheduled future settlement payments on a discounted basis in exchange for a single lump sum payment. We negotiate a purchase price that is calculated as the present value of the future payments to be purchased, discounted at a rate equal to our required investment yield. From time to time, we sell portfolios of structured settlements to institutional investors. The sale price is calculated as the present value of the future payments to be sold, discounted at a negotiated yield. We record any amounts of sale proceeds in excess of our carrying value as a gain on sale.

Gain on the Forgiveness of Debt

We entered into a settlement agreement with Acorn Capital Group, or Acorn, as discussed below in “—Losses on Settlements and Loan Payoffs, Net”, whereby our borrowings under the Acorn credit facility were cancelled, resulting in a gain on forgiveness of debt. A gain on forgiveness of debt is recorded at the time at which we are legally released from our borrowing obligations. We do not expect to recognize any material revenue from the Acorn facility in 2012.

Unrealized change in fair value of Life Settlements and Structured Settlement Receivables

We have elected to carry our investments in life settlements at fair value. As of July 1, 2010, we elected to adopt the fair value option, in accordance with ASC 825, Financial Instruments, to record certain newly-acquired

 

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structured settlement receivables at fair value. Any change in fair value upon re-measurement of these investments is recorded through our unrealized change in fair value of life settlements and structured settlement receivables.

Gain on Sale of Life Settlements

Gain on sale of life settlements includes gain from company-owned life settlements and gains from sales on behalf of third parties.

Servicing Income

We receive income from servicing life insurance policies controlled by a third party. These services include verifying premiums are paid and correctly applied and updating files for medical history and ongoing premiums.

Gain on Maturities of Life Settlements with Subrogation Rights, net

The Company accounts for the maturities of life settlements with subrogation rights (net of subrogation expenses) as contingent gains in accordance with ASC 450, Contingencies and recognizes the revenue from the maturities of these policies when all contingencies are resolved.

Components of Expenses

Interest Expense

Interest expense is interest accrued monthly on credit facility borrowings that are used to fund premium finance loans and promissory notes that were used to fund operations and corporate expenses. Interest is generally compounded monthly and payable as the collateralized loans mature.

Our weighted average interest rate for our credit facilities and promissory notes outstanding as of the dates indicated below is as follows:

 

     December 31,  
     2011     2010     2009  

Weighted average interest rate under credit facilities

     15.7     17.1     15.6

Weighted average interest rate under promissory note

     0.0     16.5     16.5

Total weighted average interest rate

     15.7     17.0     15.7

Provision for Losses on Loans Receivable

We specifically evaluate all loans for impairment, on a monthly basis, based on the fair value of the underlying life insurance policies as collectability is primarily collateral dependent. The fair value of the life insurance policy is determined using our valuation model, which is a Level 3 fair value measurement. For loans with lender protection insurance, the insured value is also considered when determining the fair value of the life insurance policy. The insured value is not directly correlated to any portion of the loan, such as principal, accrued interest, accreted origination income, or other fees which may be charged or incurred on these types of loans. The insured value is the amount we would receive in the event that we filed a lender protection insurance claim. The lender protection insurer limits the insured value to an amount equal to or less than its determination of the value of the life insurance policy underlying our premium finance loan based on its own models and assumptions, which may be equal to or less than the carrying value of the loan receivable. For all loans, the amount of loan impairment, if any, is calculated as the difference in the fair value of the life insurance policy and the carrying value of the loan receivable. Loan impairments are charged to the provision for losses on loans receivable in our consolidated and combined statement of operations.

 

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In some instances, we make a loan to an insured whereby we immediately record a loan impairment valuation adjustment against the principal of the loan. Loans that experience an immediate impairment are made when the transaction components that are not included in the loan, such as agency fees, offset or exceed the amount of the impairment.

For loans that matured and were not repaid at maturity, 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 have lender protection insurance, we make a claim against the lender protection insurance policy and, subject to policy terms and conditions, the insurer has the right to direct control or take beneficial ownership of the policy upon payment of our claim.

For loans that had lender protection insurance and matured during the years ended December 31, 2011 and 2010, 131 and 419 loans were not repaid at maturity, respectively, all of which were submitted to our lender protection insurer. The net carrying value of the loans (which includes principal, accrued interest income, and accrued origination fees, net of impairment) at the time of payoff during the years ended December 31, 2011 and December 31, 2010 was $49.7 million and $152.8 million, respectively. The amount of cash received by us for those loans was $51.5 million and $153.3 million, respectively. This resulted in a gain during the years ended December 31, 2011 and December 31, 2010 of $737,000 and $578,000, respectively. This gain was primarily attributable to the insurance amount at the time of payoff exceeding the contractual amounts due under the terms of the loan agreement. Therefore, the amount of claims paid by the lender protection insurer was in excess of 100% of the net carrying value of the loans. The following table provides information on the insured loans that were not repaid at maturity for the periods indicated below (dollars in thousands):

 

     Year Ended
December 31, 2011
    Year Ended
December 31, 2010
 

Number of loans matured

     138        426   

Number of loans impaired at maturity

     52        251   

Loans not repaid at maturity

     131        419   

Claims submitted to lender protection insurer

     131        419   

Claims paid by lender protection insurer

     131        419   

Amount of claims paid

   $ 51,480      $ 153,330   

Net carrying value of loans at payoff

   $ 49,706      $ 152,752   

Gain on LPIC payoffs (all loans)

     737        578   

Gain on LPIC payoffs (impaired loans)

     607        165   

Percent of claims paid by lender protection insurer

     100     100

The following table shows the percentage of the total number of loans outstanding with lender protection insurance and the percentage of our total loans receivable balance covered by lender protection insurance as of the dates indicated below:

 

     December 31,  
     2011     2010     2009  

Percentage of total number of loans outstanding with lender protection insurance

     65.9     93.9     91.2

Percentage of total loans receivable, net balance covered by lender protection insurnace

     70.1     94.1     93.7

We use a method to determine the loan impairment valuation adjustment which assumes the “worst case” scenario for the fair value of the collateral based on the insured coverage amount. At the time of loan origination, we will record impairment even though no loans are considered non-performing as no payments are due by the borrower. Loans with insured collateral represented 65.9% and 93.9% of our loans as of December 31, 2011 and December 31, 2010, respectively.

 

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The following table shows the amount of impairment recorded on loans outstanding with and without lender protection insurance during each period (dollars in thousands):

 

     Year Ended
December 31, 2011
     Year Ended
December 31, 2010
 

Provision for losses on loans receivable with lender protection insurance

   $ 57       $ 2,553   

Provision (recoveries) for losses on loans receivable without lender protection insurance

     7,532         1,923   
  

 

 

    

 

 

 

Total provision for losses on loans receivable

   $ 7,589       $ 4,476   

Loss on Loan Payoffs and Settlements, Net

When a premium finance loan matures, we record the difference between the net carrying value of the loan receivable (which includes the loan principal balance, accrued interest and accreted origination fees, net of any impairment valuation adjustment) and the cash received, or the fair value of the life insurance policy that is obtained if there is a default and the policy is relinquished, as a gain or loss on loan payoffs and settlements, net. This account was significantly impacted by the Acorn settlement, as discussed below, whereby we recorded a loss on loan payoffs and settlements, net, of $4.1 million, $5.5 million and $10.2 million during the years ended December 31, 2011, 2010 and 2009, respectively, under the direct write-off method, as opposed to charging our provision for losses on loan receivables.

Beginning in July 2008, Acorn Capital Group stopped funding under its credit facility with us without any advance notice. Therefore, we did not have access to funds necessary to pay the ongoing premiums on the policies serving as collateral for our borrower’s loans that were financed under the Acorn facility. We did not incur liability with our borrowers because the terms of the Acorn loans provide that we are only required to fund future premiums if our lender provides us with funds. Through December 31, 2011, a total of 119 policies financed under the Acorn facility incurred losses primarily due to non-payment of premiums.

In May 2009, we entered into a settlement agreement with Acorn whereby all obligations under the credit agreement were terminated. Acorn subsequently assigned its rights under the settlement agreement to Asset Based Resource Group, LLC (“ABRG”), an entity that is not related to us. As part of the settlement agreement, we continue to service the original loans and ABRG determines whether or not it will continue to fund the loans. We believe that ABRG will elect to fund the loan only if it believes there is value in the policy serving as collateral for the loan. If ABRG chooses not to continue funding a loan, we have the option to fund the loan or try to sell the loan or related policy to another party. We elect to fund the loan only if we believe there is value in the policy serving as collateral for the loan after considering the costs of keeping the policy in force. Regardless of whether we fund the loan or sell the loan or related policy to another party, our debt under the Acorn facility is forgiven and we record a gain on the forgiveness of debt. If we fund the loan, it remains as an asset on our balance sheet, otherwise it is written off and we record the amount written off as a loss on loan payoffs and settlements, net.

On the notes that were cancelled under the Acorn facility, we had debt forgiven totaling $5.0 million and $7.6 million for the years ended December 31, 2011 and 2010, respectively. We recorded these amounts as gain on forgiveness of debt. Partially offsetting these gains, we had loan losses totaling $4.1 million and $5.5 million during the years ended December 31, 2011, and 2010, respectively. We recorded these amounts as loss on loan payoffs and settlements, net. As of December 31, 2011, there were no loans that remained outstanding from the original 119 loans financed in the Acorn facility.

 

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The following table highlights the number of loans impacted by the Acorn settlement during the periods indicated below (dollars in thousands):

 

     Acorn Credit Facility  
     Year Ended December 31,  
     2011      2010      2009      2008  

Number of loans held at end of period

     —           15         49         112   

Loans receivable, net, balance at end of period

   $ —         $ 4,183       $ 9,601       $ 21,073   

Number of loans impacted during period

     15         48         63         7   

The following table highlights the impact of the Acorn settlement on our financial statements during the periods indicated below (dollars in thousands):

 

     Acorn Credit Facility  
     Year Ended December 31,  
     2011     2010     2009     2008     Total  

Gain on forgiveness of debt

   $ 5,023      $ 7,599      $ 16,410      $ —        $ 29,032   

Loss on loan payoffs and settlements, net

     (4,141     (5,501     (10,182     (1,868   $ (21,692
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Impact on net income (loss)

   $ 882      $ 2,098      $ 6,228      $ (1,868   $ 7,340   

The $7.3 million impact on net income is due to 28 policies on which we decided to continue to fund the premiums after ABRG elected not to continue to fund the premiums. With respect to the associated loans, we received a gain on forgiveness of debt with no offsetting loss on loan payoffs and settlements, net.

Amortization of Deferred Costs

Deferred costs include premium payments made by us to our lender protection insurer. These expenses are deferred and recognized over the life of the note using the effective interest method. Deferred costs also include credit facility closing costs such as legal and professional fees associated with the establishment of our credit facilities, which deferred costs are recognized over the life of the debt. We expect our deferred costs to decline over time as our portfolio of loans with lender protection insurance matures.

Selling, General and Administrative Expenses

Selling, general, and administrative expenses include salaries and benefits, professional and consulting fees, marketing, depreciation and amortization, bad debt expense, and other related expenses to support our ongoing businesses. As a result of the USAO Investigation, the SEC Investigation and related shareholder litigation, we have incurred significant legal expenses, and we expect to continue to incur significant legal expenses pending the resolution of those matters.

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

 

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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. For further information on our critical accounting policies, see the discussion in Note 2 to our audited consolidated and combined financial statements.

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 Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“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 have lender protection insurance, we make a claim against the lender protection insurance policy and, subject to terms and conditions of the lender protection insurance policy, our lender protection insurer has 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 have lender protection insurance, a loan impairment valuation is established if the carrying value of the loan receivable exceeds 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 provision for losses on loans receivable has increased during the year ended December 31, 2011 as a result of the decline in the estimated fair value of the collateral due to the higher discount rate applied in the fair value model. See Notes 10, 15 and 16 to the accompanying consolidated and combined financial statements.

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 and combined 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.

 

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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 and structured settlements 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 which we estimate are the life expectancy of the insured and the discount rate.

In determining the life expectancy estimate, we analyze medical reviews from third-party medical underwriters. Historically, the Company has procured the majority of its life expectancy reports from two life expectancy report providers and uses AVS Underwriting, LLC (“AVS”) life expectancy reports for valuation purposes. The health of the insured is summarized by the medical underwriters into a life assessment

 

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which is based on the review of historical and current medical records. The medical underwriting assesses the characteristics and health risks of the insured in order to quantify the health into a mortality rating that represents their life expectancy.

The probability of mortality for an insured is then calculated by applying the 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 their 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 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 (i.e. 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 mortality rating is used to create a range of possible outcomes for the given life and assign a probability that each of the possible outcomes might occur. 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. An internal rate of return calculation is then used to determine the price 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 price for the policy.

In its fair value methodology and in determining the life expectancy of an insured, the Company applies an actuarial table developed by a third party. In contrast, in pricing trades we believe many market participants generally reference a table developed by the U.S. Society of Actuaries known as the 2008 Valuation Basic Table, or the 2008 VBT. The table used by Imperial to value its life settlements is generally more conservative in that it applies the mortality experience of an insured population that is representative of participants in the life settlement market. Because of the relative greater wealth of the participants in the life settlement market, and thus their access to superior healthcare, these individuals tend to live longer than the general population. The Company believes that applying the 2008 VBT table to its portfolio would not result in a material difference.

As is the case with most market participants, the Company uses life expectancies that are provided by third-party life expectancy 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:

 

LE Mths Adj    Value      Change in
Value
 
+6      74,655,221         (16,262,029
     90,917,250           
-6      108,934,379         18,017,130   

Historically, the Company has used discount rates of 15 - 17.5% in its fair value model for investments in life settlements. At the end of the third quarter of 2011, however, the Company increased its discount rates by 500 basis points for all policies that were previously premium financed and by 75 basis points for all policies that

 

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were not. The Company viewed these adjustments as appropriate in the immediate aftermath of the execution of the search warrant at the Company’s headquarters in connection with the USAO Investigation, the associated negative press, as well as adverse court decisions unrelated to the Company and a generally perceived softening in the market for life insurance policies generally and for premium financed policies specifically.

At December 31, 2011, the Company considered the discount rate based on information that was then available and further adjusted the discount rates, resulting in a weighted average discount rate of 24.31%. In addition to a continuing softening in the market perceived by the Company and corroborated by third party consultants engaged by the Company, the Company viewed a further adjustment to its discount rates as necessary because of the perceived risk premium that an investor would require to transact in a policy associated with the Company. Since the onset of the credit crisis in 2007, capital has generally been limited and credit has generally been costly for the purchase of life insurance policies in the secondary and tertiary markets. At December 31, 2011, in light of the USAO Investigation and publicly available information about the Company and the investigation at that time, 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, the Company believes that an investor would have generally opted to invest in the policy that was not associated with the Company’s premium finance business. In fact, the Company did not attempt to sell any life insurance policies in the fourth quarter of 2011. Since that time, however, market participants have transacted with the Company and the Company believes that investors will require less of a risk premium to transact in policies associated with the Company since our entering into the Non-Prosecution Agreement.

As of December 31, 2011, the Company owned 190 policies with an aggregate investment in life settlements of $90.9 million. Of these 190 policies, 145 were previously premium financed and are valued using discount rates that range from 18.65% – 32.25%. The remaining 45 policies are valued using a discount rate of 16.65%. See Note 26, Subsequent Events, to the accompanying consolidated and combined financial statements.

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 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:

 

Wtd. Agv
Rate

   Rate Adj.     Value      Change in Value  

23.81%

     -.50     93,433,348         2,516,098   

24.31%

            90,917,250           

24.81%

     +.50     88,282,240         (2,635,010

Future changes in the discount rate which we used 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.

Revenue/Income Recognition

Our primary sources of revenue/income are in the form of unrealized change in fair value of life settlements, agency fees, interest income, 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:

 

   

Unrealized Change in Fair Value of Life Settlements—The Company acquires certain life insurance policies through purchases in the secondary and tertiary markets and others as a result of certain of the

 

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Company’s borrowers defaulting on premium finance loans and relinquishing the underlying policy to the Company in exchange for being released from further obligations under the loan. 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 and combined 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. See “—Valuation of Insurance Policies.”

 

   

Agency Fees—Agency fees are paid by the referring life insurance agents based on negotiations between the parties and are recognized at the time a life finance loan is funded. Because agency fees are not paid by the borrower, such fees do not accrue over the term of the loan. A separate origination fee is charged to the borrower which is amortized into income over the life of the loan.

 

   

Interest Income—Interest income on life finance loans is recognized when it is realizable and earned, in accordance with ASC 605, Revenue Recognition. 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 which 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.

 

   

Servicing Income—We receive income from servicing life insurance policies controlled by a third party. These services include verifying premiums are paid and correctly applied and updating files for medical history and ongoing premiums.

 

   

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 which 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 estimate of fair value 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.

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

 

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related loan using the effective interest method and are classified as amortization of deferred costs in the accompanying consolidated and combined 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. This account was significantly impacted by the Acorn settlement, as discussed above, whereby we recorded a loss on loan payoffs and settlements, net, of $4.1 million, $5.5 million and $10.2 million during the years ended December 31, 2011, 2010 and 2009, respectively.

Income Taxes

Prior to our initial public offering, 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.

After the Conversion, we began to 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.

Upon the implementation of ASC 740, we recorded a one-time deferred tax liability of approximately $4.6 million for the federal and state tax effects of cumulative differences between financial and tax reporting which existed at the time of the Conversion. Pursuant to ASC 740 these deferred taxes were recorded in income tax expense, In addition, following the Conversion and prior to the initial public offering, one of our founding members entered into a reorganization that allowed us to assume the corporate shareholder’s tax attributes. These tax attributes include approximately $11.2 million of net operating loss carryovers (“NOLs”). Accordingly, in the second quarter we recorded a one-time deferred tax asset of approximately $4.3 million related to these tax attributes and this amount was recorded as an income tax benefit.

At December 31, 2011, due to the large losses generated in 2011 and the uncertainties that resulted from the USAO Investigation, we recorded a full valuation allowance against our net deferred tax asset of $11.1 million as it is more likely than not that the net deferred tax asset is not realizable. As a result of this increase in the valuation allowance, we recorded no income tax benefit for the current year.

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.

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

 

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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.

Gain on Maturities of Life Settlements with Subrogation Rights, net

Every credit facility entered into by subsidiaries of the Company between December 2007 and December 2010 to finance the premium finance lending business required lender protection insurance for each loan originated under such credit facility. Generally, when the Company exercises its right to foreclose on collateral the Company’s lender protection insurer has the right to direct control or take beneficial ownership of the life insurance policy, subject to the terms and conditions of the lender protection insurance policy, including notice and timing requirements. Otherwise, the lender protection insurer maintains its salvage collection and subrogation rights. The lender protection insurer’s salvage collection and subrogation rights generally provide a remedy by which the insurer can seek to recover the amount of the lender protection claim paid plus premiums paid by it, expenses and interest thereon.

In those instances where the Company has foreclosed on the collateral, the lender protection insurer has maintained its salvage collection and subrogation rights, and has been covering the cost of the ongoing premiums needed to maintain certain of these life insurance policies. However, the lender protection insurer may elect at any time to discontinue the payment of premiums which would result in lapse of the policies if the Company does not otherwise pay the premiums. The Company views these policies as having uncertain value because the lender protection insurer controls what happens to the policy from a payment of premium standpoint, and the amount of the lender protection insurer’s salvage collection and subrogation claim rights on any individual life insurance policy could equal the cash flow received by the Company with respect to any such policy. For these reasons, these policies are considered contingent assets and not included in the amount of life settlements on the accompanying consolidated and combined balance sheet.

The Company accounts for the maturities of life settlements with subrogation rights, net of subrogation expenses as contingent gains in accordance with Accounting Standards Codification (ASC) 450, Contingencies and recognizes the revenue from the maturities of these policies when all contingencies are resolved.

Accounting Changes

Note 2 of the Notes to Consolidated and Combined Financial Statements discusses accounting standards adopted in 2011, as well as accounting standards recently issued but not yet required to be adopted and the

 

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expected impact of these changes in accounting standards. Any material impact of adoption is discussed in Management’s Discussion and Analysis of Financial Condition and Results of Operations and in the Notes to the Consolidated and Combined Financial Statements.

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.

Consolidated Results of Operations (in thousands)

 

     For the Year Ended December 31,  
     2011     2010     2009  

Income

      

Agency fee income

   $ 6,470      $ 10,149      $ 26,114   

Interest income

     8,303        18,660        21,483   

Interest and dividends on investment securities available for sale

     640        —          —     

Origination fee income

     6,480        19,938        29,853   

Realized gain on sale of structured settlements

     5,817        6,595        2,684   

Realized gain on sale of life settlements

     5        1,951        —     

Gain on forgiveness of debt

     5,023        7,599        16,410   

Unrealized change in fair value of life settlements

     570        10,156        —     

Unrealized change in fair value of structured settlements

     5,302        2,477        —     

Change in equity investments

     —          (1,284  

Servicing fee income

     1,814        413        —     

Gain on maturities of life settlements with subrogation rights, net

     3,188        —          —     

Other income

     602        242        71   
  

 

 

   

 

 

   

 

 

 

Total income

     44,214        76,896        96,615   
  

 

 

   

 

 

   

 

 

 

Expenses

      

Interest expense

     8,524        28,155        33,755   

Provision for losses on loans receivable

     7,589        4,476        9,830   

Loss on loan payoffs and settlements, net

     3,837        4,981        12,058   

Amortization of deferred costs

     6,076        24,465        18,339   

Department of Justice settlement

     8,000        —          —     

Selling, general and administrative expenses

     49,386        30,516        31,269   
  

 

 

   

 

 

   

 

 

 

Total expenses

     83,412        92,593        105,251   
  

 

 

   

 

 

   

 

 

 

Income (loss) before income taxes

     (39,198     (15,697     (8,636

Provision for income taxes

   $ —          —          —     
  

 

 

   

 

 

   

 

 

 

Net income (loss)

   $ (39,198   $ (15,697   $ (8,636
  

 

 

   

 

 

   

 

 

 

Life finance Segment Results (in thousands)

 

     For the Year Ended December 31,  
     2011     2010     2009  

Income

   $ 31,499      $ 67,366      $ 92,648   

Expenses

     38,949        68,634        82,435   
  

 

 

   

 

 

   

 

 

 

Segment operating income (loss)

   $ (7,450   $ (1,268   $ 10,213   
  

 

 

   

 

 

   

 

 

 

 

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Structured Settlement Segment Results (in thousands)

 

     For the Year Ended December 31,  
     2011     2010     2009  

Income

   $ 11,933      $ 9,530      $ 3,967   

Expenses

     21,951        13,066        9,475   
  

 

 

   

 

 

   

 

 

 

Segment operating income (loss)

   $ (10,018   $ (3,536   $ (5,508
  

 

 

   

 

 

   

 

 

 

Reconciliation of Segment Results to Consolidated Results (in thousands)

 

     For the Year Ended December 31,  
     2011     2010     2009  

Segment operating income (loss)

   $ (17,468   $ (4,804   $ 4,705   

Other income

     782        0        0   

Unallocated expenses

      

SG&A expenses

     14,215        7,126        8,052   

Department of Justice settlement

     8,000        —          —     

Interest expenses

     297        3,767        5,289   
  

 

 

   

 

 

   

 

 

 
     22,512        10,893        13,341   
  

 

 

   

 

 

   

 

 

 

Income (loss) before income taxes

     (39,198     (15,697     (8,636

Provision for income taxes

     0        —          —     
  

 

 

   

 

 

   

 

 

 

Net income (loss)

   $ (39,198   $ (15,697   $ (8,636
  

 

 

   

 

 

   

 

 

 

2011 Compared to 2010

Net loss for the year ended December 31, 2011 was $39.2 million as compared to a net loss of $15.7 million for the year ended December 31, 2010, a decrease of $23.5 million. Total income was $44.2 million for the year ended December 31, 2011, a 43% decrease over total income of $76.9 million during the year ended in 2010. Total expenses were $83.4 million for the period compared to total expenses of $92.6 million incurred during the year ended December 31, 2010, a reduction of $9.2 million, or 10%.

In our life finance segment which includes our premium finance business, segment operating loss increased by $6.2 million to $7.5 million, primarily driven by decreases in agency fee income, origination income and interest income totaling $30.6 million. Life finance segment expenses were $38.9 million during the year ended December 31, 2011 compared to $68.6 million during the year ended December 31, 2010, a decline of $29.7 million, or 43%. These declines were driven primarily by a $16.2 million reduction in interest expense a decline in amortization of deferred costs of $18.4 million, and a decline of $1.1 million in loss on loan payoffs and settlements, net offset by an increase of $3.1 million in provision for losses on loan receivables and an increase of $2.9 million in selling, general and administrative expenses.

Results of operations in our life finance segment were adversely impacted by the USAO Investigation and related matters. During the year ended December 31, 2011, we originated 55 loans using equity capital, compared to 97 loans originated under the LPIC program during the year ended December 31, 2010. All 55 of these loans were originated during the nine months ended September 30, 2011, after which we suspended origination of premium finance loans. In connection with the Non-Prosecution Agreement, we are voluntarily terminating our premium finance business and we anticipate that we will no longer be originating any premium finance loans.

This decrease in number of loans originated resulted in a reduction in agency fees from $10.1 million during the year ended December 31, 2010 to $6.5 million during the year ended December 31, 2011, a decrease of $3.6 million. As of December 31, 2011, we had loans receivable totaling $29.4 million compared to $90.0 million as

 

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of December 31, 2010, a decrease of $60.6 million, or 67%. Loans outstanding declined from 325 to 138. As a result, origination income and interest income, which accrue over the life of the loan and are therefore a function of the amount of loans outstanding, declined from $19.9 million and $18.7 million, respectively, during the year ended December 31, 2010, to $6.5 million and $7.8 million, respectively, during the year ended December 31, 2011. Offsetting these declines were a reduction of total life finance segment expenses from $68.6 million during the year ended December 31, 2010 to $38.9 million during the year ended December 31, 2011, a decrease of $29.7 million. Interest expense declined to $8.2 million, a reduction of $16.2 million, as notes payable declined from $91.6 million as of December 31, 2010 to $19.3 million as of December 31, 2011. Provision for losses on loans receivable was $7.6 million during the year ended December 31, 2011, compared to $4.5 million during the year ended December 31, 2010. Provision for losses on loans receivable for uninsured loans, however, increased during the year ended December 31, 2011, as a result of the impairment of the collateral based on decreases in the fair value of the collateral underlying those loans. Amortization of deferred costs, which are comprised primarily of upfront premiums previously paid to the LPIC insurer, were $6.1 million during the year ended December 31, 2011 compared to $24.5 million during the year ended December 31, 2010, a decline of $18.4 million. In connection with the Non-Prosecution Agreement, we voluntarily terminated our premium finance business and, as a result, we will no longer be generating agency fees which are tied directly to loan originations. Further, we will no longer generate loan, interest income, or origination income once our remaining loans mature.

As of December 31, 2011, the Company owned 190 policies with an aggregate investment in life settlements of $90.9 million. Of these 190 policies, 145 were previously premium financed and are valued using discount rates that range from 18.65% – 32.25%. The remaining 45 policies are valued using a discount rate of 16.65%. During the year ended December 31, 2011, the Company acquired 151 life insurance policies through purchases in the secondary and tertiary markets and as a result of certain of the Company’s borrowers defaulting on premium finance loans and relinquishing the underlying policy to the Company. Total aggregate death benefit of polices acquired during the year ended December 31, 2011 was $744.3 million.

Unrealized change in fair value of life settlements was an approximately $570,000 gain for the year ended December 31, 2011. This figure was negatively affected by a $14.1 million and $13.5 million reduction in fair value during the three months ended September 30, 2011 and December 31, 2011, respectively, as a result of decreases in the fair value of the Company’s portfolio of life insurance policies, compared to $10.2 million gain for the year ended December 31, 2010. The approximately $570,000 unrealized change in fair value recorded during the year ended December 31, 2011 included $3.0 million attributable to revisions made to the application of our valuation technique and assumptions used in our fair value calculation made in the quarter ended March 31, 2011, as described in Note 2, Principles of Consolidation and Basis of Presentation. These changes impacted the unrealized change in fair value by a gain of $3.0 million on 41 life settlement policies owned as of December 31, 2010.

The Company originated 55 premium finance loans during the year ended December 31, 2011. As a result of the aforementioned changes to the estimated fair value of the loan collateral, the provision for losses on loans receivable for these uninsured loans increased by $7.9 million in the year ended December 31, 2011.

Of the 55 premium finance loans originated during the year ended December 31, 2011, 11 are the Type 2 loans. These loans have an average principal balance of approximately $549,000 compared to approximately $280,000 on Type 1 loans originated during the year ended December 31, 2011. Agency fees as a percent of the principal balance of the loans averaged 39.0% and 20.7% on Type 1 and Type 2 loans, respectively.

In the third quarter of 2011, two individuals covered under policies which were subject to subrogation claims 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. 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 has not collected the $10.0 million death benefit under this policy as of December 31, 2011. The Company accounted for each of these polices as

 

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contingent gains in accordance with ASC 450, Contingencies and recognized $3.2 million in death benefits net of subrogation expense of $312,000 in its consolidated and combined statement of operations during the third quarter of 2011. In accordance with ASC 450, the Company expects to recognize death benefits, net of subrogation expenses on the larger policy in the second quarter of 2012. The Company believes these contingent gains to be unpredictable. No expectations for similar gains in the future should be inferred from the events occurring in the third quarter of 2011.

In our structured settlements segment, total income was $11.9 million for the year ended December 31, 2011 compared to $9.5 million for the year ended December 31, 2010, an increase of $2.4 million. This increase was due to an increase in transactions originated to 873 during the year ended December 31, 2011 compared to 565 transactions originated during the year ended December 31, 2010. Segment SG&A expenses increased by $8.9 million to $22.0 million as we continued to build our infrastructure. This led to a segment operating loss of $10.0 million during the year ended December 31, 2011 an increase of $6.5 million over segment operating loss of $3.5 million recorded during the year ended December 31, 2010.

For the period 2011, the unallocated expenses for the year ended December 31, 2011 were $22.5 million as compared to $10.9 million for the year ended December 31, 2010 an increase of $ 11.6 million. This increase was primarily due to the USAO Investigation whereby the company paid a penalty of $8.0 million coupled with legal fees of $ 6.0 million offset by a decrease in interest expense of $3.5 million.

Upon the implementation of ASC 740 in 2011, we recorded a one-time deferred tax liability of approximately $4.6 million for the federal and state tax effects of cumulative differences between financial and tax reporting which existed at the time of the Conversion. Pursuant to ASC 740 these deferred taxes were recorded in income tax expense, In addition, following the Conversion and prior to the initial public offering, one of our founding members entered into a reorganization that allowed us to assume the corporate shareholder’s tax attributes. These tax attributes include approximately $11.2 million of NOLs. Accordingly, in the second quarter we recorded a one-time deferred tax asset of approximately $4.3 million related to these tax attributes and this amount was recorded as an income tax benefit.

Following the conversion and prior to the initial public offering, one of the founding members entered into a reorganization that allowed the Company to assume the corporate shareholder’s tax attributes. These tax attributes include approximately $11.2 million of NOLs. During the second quarter of 2011, the Company completed an evaluation of this transaction and determined that the Company was entitled to assume the NOLs of this founding member. Accordingly, in the second quarter of 2011, the Company has recorded a one-time deferred tax asset of approximately $4.3 million related to these tax attributes.

Due to the USAO Investigation and the effect that it and related matters have had on our business, the Company determined that it was more likely than not that the net deferred tax asset at December 31, 2011 was not realizable and accordingly, established a 100 percent valuation allowance against it net deferred tax asset. As a consequence, the Company had no income tax provision or benefit for the year ended December 31, 2011.

2010 Compared to 2009

Net loss for the year ended December 31, 2010 was $15.7 million as compared to $8.6 million for the year ended December 31, 2009. Our life finance segment operating income decreased $11.5 million, primarily caused by decreased agency fee income and origination fee income. These declines were directly related to a reduction in the number of otherwise viable premium finance transactions that we could complete as we funded only 97 loans during the year ended December 31, 2010, a 50% decrease compared to the 194 funded during the year ended 2009. This reduction in the number of loans originated was caused by increased financing costs and stricter coverage limitations provided by our lender protection insurer. As a result, we experienced a decrease in agency fee income of $16.0 million, or 61%, and a decrease in origination fee income of $9.9 million, or 33%. These decreases were partially offset by an increase in the unrealized change in fair value of investments of $10.2 million, a decrease in interest expense of $5.6 million and a decrease in SG&A expense of $753,000.

 

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Our results of operations for the year ended December 31, 2010 have been impacted by the execution of a settlement claims agreement, which resulted in a one-time transaction charge of $6.4 million (see below). On September 8, 2010, the lender protection insurance related to our credit facility with Ableco Finance, LLC (“Ableco”) was terminated and settled pursuant to a claims settlement agreement, resulting in our receipt of an insurance claims settlement of approximately $96.9 million. We used approximately $64.0 million of the settlement proceeds to pay off the credit facility with Ableco in full and the remainder was used to pay off almost all of the amounts borrowed under the grid promissory note in favor of CTL Holdings, LLC. As a result of this settlement transaction, our subsidiary, Imperial PFC Financing, LLC, a special purpose entity, agreed to reimburse the lender protection insurer for certain loss payments and related expenses by remitting to the lender protection insurer all amounts received in the future in connection with the related premium finance loans issued through the Ableco credit facility and the life insurance policies collateralizing those loans until such time as the lender protection insurer has been reimbursed in full in respect of its loss payments and related expenses.

Under the lender protection program, we pay lender protection insurance premiums at or about the time the coverage for a particular loan becomes effective. We record this amount as a deferred cost on our balance sheet, and then expense the premiums over the life of the underlying premium finance loans using the effective interest method. As of September 8, 2010, the deferred premium costs associated with the Ableco facility totaled $5.4 million. Since these insurance claims have been prepaid and Ableco has been repaid in full, we have accelerated the expensing of these deferred costs and recorded this $5.4 million expense as Amortization of Deferred Costs. Also in connection with the termination of the Ableco facility, we have accelerated the expensing of approximately $980,000 of deferred costs which resulted from professional fees related to the creation of the Ableco facility. We recorded these charges as Amortized Deferred Costs. In the aggregate, we accelerated the expensing of $6.4 million in deferred costs as a result of this one-time transaction. The insurance claims settlement of $96.9 million was recorded as lender protection insurance claims paid in advance on our consolidated and combined balance sheet. As the premium finance loans mature and in the event of default, the insurance claim is applied against the premium finance loan. As of December 31, 2010, we have approximately $31.2 million remaining of lender protection insurance claims paid in advance related to premium finance loans which have not yet matured. The remaining premium finance loans financed by Ableco will mature by August 5, 2011.

Amortization of deferred costs increased to $24.5 million during the year ended December 31, 2010 as compared to $18.3 million for the year ended December 31, 2009, an increase of $6.2 million, or 34%, due to the settlement claims agreement described above. In total, lender protection insurance related costs accounted for $20.7 million and $16.0 million of total amortization of deferred costs during the years ended December 31, 2010 and 2009, respectively.

Gain on forgiveness of debt decreased to $7.6 million during the year ended December 31, 2010 compared to $16.4 million for the year ended December 31, 2009, a decrease of $8.8 million, or 54%. The reduced gain on forgiveness of debt was offset by a reduction in loss on loan settlement and payoffs, net of $5.5 million as a result of our writing off of fewer loans that were originated under the Acorn facility.

Gain on sale of structured settlements was $6.6 million during the year ended December 31, 2010 compared to $2.7 million for the year ended December 31, 2009. The increase was primarily due to the number of transactions sold. In 2010, we sold 630 structured settlements compared to 439 sales in 2009.

Segment Information

We operate our business through two reportable segments: life finance and structured settlements. Our segment data discussed below may not be indicative of our future operations.

 

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Life Finance Business

Our results of operations for our life segment for the periods indicated are as follows (in thousands):

 

     Year Ended December 31,  
     2011     2010     2009  

Life finance

      

Income

      

Agency fee income

   $ 6,470      $ 10,146      $ 26,114   

Interest income

     7,751        18,326        20,271   

Origination fee income

     6,480        19,938        29,853   

Gain on forgiveness of debt

     5,023        7,599        16,410   

Unrealized change in fair value of life settlements

     570        10,156        0   

Gain on sale of life settlements

     5        1,951        —     

Change in equity investments

       (1,284     —     

Servicing fee income

     1,814        403        —     

Gain on maturities of life settlements with subrogation rights, net

     3,188        —          —     

Other

     198        131        0   
  

 

 

   

 

 

   

 

 

 
     31,499        67,366        92,648   
  

 

 

   

 

 

   

 

 

 

Direct segment expenses

      

Interest expense

     8,229        24,388        28,466   

Provision for losses on loan receivables

     7,589        4,476        9,830   

Loss on loan payoffs and settlements, net

     3,837        4,981        12,058   

Amortization of deferred costs

     6,076        24,465        18,339   

SG&A expense

     13,218        10,324        13,742   
  

 

 

   

 

 

   

 

 

 
     38,949        68,634        82,435   
  

 

 

   

 

 

   

 

 

 

Segment operating (loss) income

   $ (7,450   $ (1,268   $ 10,213   
  

 

 

   

 

 

   

 

 

 

2011 Compared to 2010

Income

Agency Fee Income. Agency fee income was $6.5 million for the year ended December 31, 2011 compared to $10.1 million for the year ended December 31, 2010, a decrease of $3.6 million, or 36%. Agency fee income is earned solely as a function of originating loans. We funded 55 loans during the year ended December 31, 2011, a 43% decrease compared to the 97 loans funded during the year ended December 31, 2010 under credit facilities with lender protection insurance. The Company began originating loans using equity capital instead of debt in late February 2011 after the completion of our initial public offering. As a result of the voluntary termination of our premium finance business, we will not receive any revenue from agency fees in 2012 and beyond, and Imperial Life and Annuity has begun to voluntarily surrender its insurance agency licenses.

Agency fees as a percentage of the principal balance of the loans originated during each period was as follows (dollars in thousands):

 

     Year Ended December 31,  
         2011             2010      

Principal balance of loans originated

   $ 18,385      $ 20,536   

Number of transactions originated

     55        97   

Agency fees

   $ 6,470      $ 10,146   

Agency fees as a percentage of the principal balance of loans originated

     35.2     48.8

 

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Interest Income. Interest income was $7.8 million for the year ended December 31, 2011 compared to $18.3 million for the year ended December 31, 2010, a decrease of $10.5 million, or 57%. During the years ended December 31, 2011 and December 31, 2010, the Company originated 55 and 97 loans respectively. Interest income declined as the balance of loans receivable, net decreased from $90.0 million as of December 31, 2010 to $29.4 million as of December 31, 2011 due to significant loan maturities. There were no significant changes in interest rates. The weighted average per annum interest rate for life finance loans outstanding as of December 31, 2011 and 2010 was 12.3% and 11.4%, respectively. As a result of the voluntary termination of our premium finance business, we will cease earning interest income once our outstanding premium finance loans mature.

Origination Fee Income. Origination fee income was $6.5 million for the year ended December 31, 2011, compared to $19.9 million for the year ended December 31, 2010, a decrease of $13.4 million, or 68%. Origination fee income decreased due to a decline in the average balance of loans receivable, net, as noted above. Also, the Company reduced origination fees charged after ceasing the LPIC program, under which the majority of origination fees were passed along to the LPIC provider. Origination fees as a percentage of the principal balance of the loans originated was 25.0% during the year ended December 31, 2011 compared to 41.5% for the year ended December 31, 2010. As a result of the voluntary termination of our premium finance business, we will cease accruing origination fee income once our outstanding premium finance loans mature.

Gain on Forgiveness of Debt. Gain on forgiveness of debt was $5.0 million for the year ended December 31 2011 compared to $7.6 million for the year ended December 31, 2010, a decrease of $2.6 million, or 34%. These gains arise out of a settlement agreement with Acorn Capital. Zero loans out of 119 loans financed in the Acorn facility remained outstanding as of December 31, 2011. The gains were largely offset by a loss on loan payoffs, net related to Acorn loans of $4.1 million and $5.5 million during the year ended December 31, 2011, and 2010, respectively.

Unrealized Change in Fair Value of Life Settlements. Unrealized change in fair value of life settlements was a gain of approximately $570,000 for the year ended December 31, 2011 compared to $10.2 million for the year ended December 31, 2010. The change in fair value is included in unrealized change in fair value of life settlements in the accompanying consolidated and combined statement of operations. At December 31, 2011, the Company considered the discount rate based on information that was then available and further adjusted discount rates, resulting in a weighted average discount rate of 24.31%.

Servicing Fee Income. Servicing income was $1.8 million for the year ended December 31, 2011 compared to $403,000 for the year ended December 31, 2010. Servicing fee income is earned in providing asset servicing for third parties, which we began providing during the fourth quarter of 2010.

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 passed away. The Company collected the death benefit on one of these policies in the amount of $3.5 million during the third quarter. 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 has not collected the $10.0 million death benefit under this policy as of December 31, 2011. 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 and combined statement of operations during the third quarter of 2011. In 2012, the Company negotiated a settlement in respect of the larger policy and, in accordance with ASC 450, the Company expects to recognize death benefits, net of subrogation expenses on the larger policy in the second quarter of 2012. See Note 26—Subsequent Events. No expectations for similar gains in the future should be inferred from the events occurring in the third quarter of 2011.

Expenses

Interest Expense. Interest expense was $8.2 million for the year ended December 31, 2011 compared to $24.4 million for the year ended December 31, 2010, a decrease of $16.2 million, or 66%. The decrease in interest expense is due to a decline in notes payable from $89.2 million as of December 31, 2010 to $19.3 million as of December 31, 2011, a decrease of $69.9 million, or 78%.

 

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Provision for Losses on Loans Receivable. Provision for losses on loans receivable was $7.6 million for the year ended December 31, 2011 compared to $4.5 million for the year ended December 31, 2010, an increase of $3.1 million. This provision records loan impairments on existing loans in order to adjust the carrying value of the loan receivable to the fair value of the underlying policy. For 2011, the provision for losses on loans receivable increased in the latter half of the year as a result of the decline in the estimated fair value of the collateral due to the higher discount rate we applied in the fair value model. See Notes 10, 15 and 16 to the accompanying consolidated and combined financial statements.

Loss on Loan Payoffs and Settlements, Net. Loss on loan payoffs and settlements, net, was $3.8 million for the year ended December 31, 2011 compared to $5.0 million for the year ended December 31, 2010, a decrease of $1.2 million, or 23%. In the year ended December 31, 2011, we wrote off 15 loans compared to 22 loans written off in the year ended December 31, 2010, all of which were included in the Acorn settlement. Excluding the impact of the Acorn settlements, we had a gain on loan payoffs and settlements, net, of approximately $772,000 and a $500,000 for the years ended December 31, 2011 and 2010, respectively.

Amortization of Deferred Costs. Amortization of deferred costs was $6.1 million during the year ended December 31, 2011 as compared to $24.5 million for the year ended December 31, 2010, a decrease of $18.4 million, or 75%. Lender protection insurance related costs accounted for $4.9 million and $20.7 million of total amortization of deferred costs during the years ended December 31, 2011 and 2010, respectively. As described previously, the lender protection insurance program was terminated as of December 31, 2010 and 91 loans with lender protection insurance remained outstanding as of December 31, 2011. Only $1.1 million of lender protection insurance related costs remain to be amortized.

Selling, General and Administrative Expenses. Selling, general and administrative expenses were $13.2 million for the year ended December 31, 2011 compared to $10.3 million for the year ended December 31, 2010, an increase of $2.9 million or 28%. This increase was due primarily to an increase in personnel expenses of $500,000 due to hiring additional employees throughout 2011, $1.1 million in stock-based compensation and employee bonuses in connection with our IPO in 2011 and expenses related to a work-force reduction at the end of 2011 and an increase in legal fees of $1.1 million.

Adjustments to our allowance for doubtful accounts for past due agency fees are charged to bad debt expense. Our determination of the allowance is based on an evaluation of the agency fee receivable, prior collection history, current economic conditions and other inherent risks. We review agency fees receivable aging on a regular basis to determine if any of the receivables are past due. We write off all uncollectible agency fee receivable balances against our allowance. The aging of our agency fees receivable as of the dates below is as follows (in thousands):

 

     Year Ended
December 31,
 
     2011     2010  

30 days or less from loan funding

   $ —        $ 559   

31 – 60 days from loan funding

     —          —     

61 – 90 days from loan funding

     —          —     

91 – 120 days from loan funding

     —          —     

Over 120 days from loan funding

     260        207   
  

 

 

   

 

 

 

Total

   $ 260      $ 766   

Allowance for doubtful accounts

     (260     (205
  

 

 

   

 

 

 

Agency fees receivable, net

   $ —        $ 561   
  

 

 

   

 

 

 

 

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An analysis of the changes in the allowance for doubtful accounts for past due agency fees during the years ended December 31, 2011 and 2010 is as follows (dollars in thousands):

 

     Year Ended
December 31,
 
     2011     2010  

Balance at beginning of period

   $ 205      $ 120   

Provision for bad debts

     82        85   

Write-offs

     (27     —     
  

 

 

   

 

 

 

Balance at end of period

   $ 260      $ 205   
  

 

 

   

 

 

 

The allowance for doubtful accounts for past due agency fees as of December 31, 2011 was $260,000 as compared to $205,000 as of December 31, 2010. Throughout 2011, we continued to evaluate the collectability of agency fee receivables and recorded approximately $82,000 in bad debt expense during the year ended December 31, 2011.

2010 Compared to 2009

Income

Agency Fee Income. Agency fee income was $10.1 million for the year ended December 31, 2010 compared to $26.1 million for the same period in 2009, a decrease of $16.0 million, or 61%. Agency fee income is earned solely as a function of originating loans. We funded only 97 loans during the year ended December 31, 2010, a 50% decrease compared to the 194 loans funded during the same period of 2009. This reduction in the number of loans originated was caused by increased financing costs and stricter coverage limitations provided by our lender protection insurer.

Agency fees as a percentage of the principal balance of the loans originated during each period was as follows (dollars in thousands):

 

     Year Ended
December 31,
 
     2010     2009  

Principal balance of loans originated

   $ 20,536      $ 51,573   

Number of transactions originated

     97        194   

Agency fees

   $ 10,146      $ 26,114   

Agency fees as a percentage of the principal balance of loans originated

     48.8     50.6

Interest Income. Interest income was $18.3 million for the year ended December 31, 2010 compared to $20.3 million for the year ended December 31 2009, a decrease of $2 million or 10%. Interest income declined as the average balance of loans receivable, net decreased. The balance of loans receivable, net, decreased from $189.1 million to $90.5 million during the year ended December 31, 2010. There were no significant changes in interest rates. The weighted average per annum interest rate for premium finance loans outstanding as of December 31, 2010 and 2009 was 11.9% and 10.9%, respectively.

Origination Fee Income. Origination fee income was $19.9 million for the year ended December 31, 2010 compared to $29.9 million for December 31, 2009, a decrease of $10 million, or 33%. Origination fee income decreased due to a decline in new loans originated in 2010 as well as a decline in the average balance of loans receivable, net, as noted above. Origination fees as a percentage of the principal balance of the loans originated was 41.5% during the year ended December 31, 2010 compared to 44.7% for the year ended December 31, 2009.

 

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Gain on Forgiveness of Debt. Gain on forgiveness of debt was $7.6 million for the year ended December 31, 2010 compared to $16.4 million for December 31, 2009, a decrease of $8.8 million, or 54%. These gains arose out of the Acorn settlement as described previously and include $1.9 million related to loans written off in December 2008, but the corresponding gain on forgiveness of debt was not recognized until 2009 at the time the Acorn settlement was finalized. Only 15 loans out of 119 loans financed in this facility remained outstanding as of December 31, 2010. The gains were substantially offset by a loss on loan payoffs of the associated loans of $5.5 million and $10.2 million during the year ended December 31, 2010, and 2009, respectively.

Unrealized Change in Fair Value of Life Settlements. Unrealized change in fair value of life settlements was $10.2 million for the year ended December 31, 2010 compared to $0 for the year ended December 31, 2009. During the period, we acquired life insurance policies that were relinquished to us upon default of loans secured by such policies. We also acquired life insurance policies directly from third parties. 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. We recorded unrealized change in fair value gains of approximately $10.2 million for the year ended December 31, 2010 due primarily to the evaluation of the fair value of these policies at the end of the reporting period. In several instances there were increases in fair value due to declines in life expectancies of the insured.

Gain on Sale of Life Settlement. Gain on sale of life settlements was $2.0 million for 2010 as compared to $0 for 2009. This relates to gains on sales of life settlements including gains from company-owned life settlements and gains from sales on behalf of third parties. There were no such transactions during 2009.

Change in equity investments. Change in equity investment was a decrease of $1.3 million for 2010 as compared to $0 for 2009. We wrote off our entire investment in life settlement fund as the Company determined that the estimated fair value of the investment was zero and the decline was other than temporary.

Expenses

Interest Expense. Interest expense was $24.4 million for the year ended December 31, 2010 compared to $28.5 million for the year ended December 31, 2009, a decrease of $4.1 million or 14%. The decrease in interest expense is due to a reduction in the amount of loans outstanding, as a result of the repayment of outstanding indebtedness with the proceeds received in connection with the Ableco claims settlement agreement described above.

Provision for Losses on Loans Receivable. Provision for losses on loans receivable was $4.5 million for the year ended December 31, 2010 compared to $9.8 million for the year ended December 31, 2009, a decrease of $5.3 million, or 54%. The decrease in the provision for the year ended December 31, 2010 as compared to the year ended December 31, 2009 was due to less loan impairments recorded on existing loans in order to adjust the carrying value of the loan receivable to the fair value of the underlying policy and a decrease in loan impairment related to new loans originated, as there were fewer new loans originated for the year ended December 31, 2010 as compared to the year ended December 31, 2009.

Loss on Loan Payoffs and Settlements, Net. Loss on loan payoffs and settlements, net, was $5.0 million for the year ended December 31, 2010 compared to $12.1 million for the year ended December 31, 2009, a decrease of $7.1 million, or 59%. The decline in loss on loan payoffs and settlements, net, was due to the reduction of loans written off in the first half of 2010 as a result of the Acorn settlement. In the year ended December 31, 2010, we wrote off only 22 loans compared to 87 loans written off in the year ended December 31, 2009. Excluding the impact of the Acorn settlements, we had a gain on loan payoffs and settlements, net, of $500,000 for the year ended December 31, 2010 and a loss on loan payoffs and settlements, net, of $1.9 million for the year ended December 31, 2009.

Amortization of Deferred Costs. Amortization of deferred costs was $24.5 million for the year ended December 31, 2010 as compared to $18.3 million for the year ended December 31, 2009, an increase of

 

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$6.2 million, or 34%. In connection with the full payoff of the Ableco credit facility, we accelerated the expensing of the remaining $5.4 million of associated deferred lender protection insurance costs. We also accelerated the expensing of approximately $980,000 of deferred costs related to fees incurred in connection with the creation of the Ableco facility. In total, lender protection insurance related costs accounted for $20.7 million and $16.0 million of total amortization of deferred costs for the year ended December 31, 2010 and 2009, respectively.

Selling, General and Administrative Expenses. Selling, general and administrative expenses were $10.3 million for the year ended December 31, 2010 compared to $13.7 million for the year ended December 31, 2009, a decrease of $3.4 million, or 25%. Bad debt decreased by $1.2 million, legal fees decreased by $538,000, life expectancy evaluation expenses decreased by $498,000 and other operating expenses decreased by $1.2 million.

Adjustments to our allowance for doubtful accounts for past due agency fees are charged to bad debt expense. Our determination of the allowance is based on an evaluation of the agency fee receivable, prior collection history, current economic conditions and other inherent risks. We review agency fees receivable aging on a regular basis to determine if any of the receivables are past due. We write off all uncollectible agency fee receivable balances against our allowance. The aging of our agency fees receivable as of the dates below is as follows (in thousands):

 

     Year Ended
December 31,
 
     2010     2009  

30 days or less from loan funding

   $ 559      $ 2,018   

31 – 60 days from loan funding

     —          —     

61 – 90 days from loan funding

     —          32   

91 – 120 days from loan funding

     —          214   

Over 120 days from loan funding

     207        21   
  

 

 

   

 

 

 

Total

   $ 766      $ 2,285   

Allowance for doubtful accounts

     (205     (120
  

 

 

   

 

 

 

Agency fees receivable, net

   $ 561      $ 2,165   

An analysis of the changes in the allowance for doubtful accounts for past due agency fees during the year ended December 31, 2010 and 2009 is as follows (dollars in thousands):

 

     Year Ended
December 31,
 
     2010      2009  

Balance at beginning of period

   $ 120       $ 769   

Bad debt expense

     85         1,290   

Write-offs

     —           (1,939

Recoveries

     —           —     
  

 

 

    

 

 

 

Balance at end of period

   $ 205       $ 120   

The allowance for doubtful accounts for past due agency fees as of December 31, 2010 was $205,000 as compared to $120,000 as of December 31, 2009. Throughout 2010, we continued to evaluate the collectability of agency fee receivables and recorded approximately $85,000 in bad debt expense during the year ended December 31, 2010. We made improvements to our collection process and in our selection of agents with whom we work and our allowance and bad debt expense have returned to what we consider normal levels in 2010.

 

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Structured Settlements

Our results of operations for our structured settlement business segment for the periods indicated are as follows (in thousands):

 

     Year Ended December 31,  
     2011     2010     2009  

Structured settlements

      

Income

      

Realized gain on sale of structured settlements

   $ 5,817      $ 6,595      $ 2,684   

Interest income

     553        334        1,212   

Unrealized change in fair value of structured settlements

     5,302        2,477        —     

Servicing fee income

     —          11        —     

Other income

     261        113        71   
  

 

 

   

 

 

   

 

 

 
     11,933        9,530        3,967   
  

 

 

   

 

 

   

 

 

 

Direct segment expenses

      

SG&A expense

     21,951        13,066        9,475   
  

 

 

   

 

 

   

 

 

 

Segment operating (loss) income

   $ (10,018   $ (3,536   $ (5,508
  

 

 

   

 

 

   

 

 

 

2011 Compared to 2010

Income

Interest Income. Interest income was $553,000 for year ended December 31, 2011 compared to $334,000 for the year ended December 31, 2010, an increase of $219,000.

Realized Gain on Sale of Structured Settlements. Realized gain on sale of structured settlements was $5.8 million for the year ended December 31, 2011 compared to $6.6 million for the year ended December 31, 2010. During the year ended December 31, 2011, we sold 601 of structured settlements for a gain of $5.8 million. During the year ended December 31, 2010, we sold 630 structured settlements for a gain of $6.6 million. Included in these 2010 results was a portfolio purchase and sale of 131 transactions that resulted in a gain of $64,000.

Unrealized Change in Fair Value of Structured Settlement Receivables. Unrealized change in fair value of investments and structured receivables was $5.3 million for the year ended December 31, 2011 compared to $2.5 million for the same period in 2010. At December 31, 2011 we had 288 structured receivables on our balance sheet compared with 84 structured settlement receivables on our balance sheet as of December 30, 2010. The large increase was due to the Company’s inability to finance these receivables in the dedicated financing facility. See “—Liquidity and Capital Resources—Financing Arrangements Summary.” As of July 1, 2010, we elected to adopt the fair value option, in accordance with ASC 825, Financial Instruments, to record certain newly-acquired structured settlements at fair value.

Expenses

Selling, General and Administrative Expenses. Selling, general and administrative expenses $22.0 million for the year ended December 31, 2011 compared to $13.1 million for the year ended December 31, 2010, an increase $8.9 million or 68%. This increase was due in part to an increase in personnel expenses of 5.8 million due to due to hiring additional employees throughout 2011 and stock-based compensation and employee bonuses in connection with our IPO in 2011. In addition, we recorded additional indirect variable expenses associated with the increase in the number of structured settlements originated during the period, including an increase in

 

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advertising of $1.2 million, an increase in legal expenses $804,000, an increase in office supplies, and professional fees in the aggregate amount of approximately $512,000 and a net increase in other expenses of approximately $600,000.

2010 Compared to 2009

Income

Interest Income. Interest income was $334,000 for the year ended December 31, 2010 compared to $1.2 million for the year ended December 31, 2009, a decrease of $877,000, or 72%. The decrease was due to a lower average balance of structured settlements held on our balance sheet during the year ended December 31, 2010, as we were able to sell our structured settlements at a faster rate in 2010 than in 2009.

Gain on Sale of Structured Settlements. Gain on sale of structured settlements was $6.6 million for the year ended December 31, 2010 compared to $2.7 million for the year ended December 31, 2009, an increase of $3.9 million or 144%. During the year ended December 31, 2010, we sold 630 structured settlements for a gain of $6.6 million, a 70% gain as a percentage of the purchase price of $25.8 million as compared to 26% gain as a percentage of the purchase price during the year ended December 31, 2009.

Unrealized change in fair value of Structured Settlement Receivables. Unrealized change in fair value of investments and structured receivables was $2.5 million for the year ended December 31, 2010 compared to $0 for the year ended December 31, 2009. 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. For the six months ended December 31, 2010, changes in the fair value of structured settlements resulted in income of $2.5 million.

Expenses

Selling, General and Administrative Expenses. Selling, general and administrative expenses were $13.1 million for the year ended December 31, 2010 compared to $9.5 million for the year ended December 31, 2009, an increase of $3.6 million, or 38%. This increase was due primarily to increased legal fees of $1.1 million, which are largely attributable to securing a sale arrangement and an increase in transaction expenses resulting from increased originations during the period, which increased to 565 for the year ended December 31, 2010 from 396 during the year ended December 31, 2009. Additionally, payroll increased by $1.0 million due to hiring additional employees and advertising expenses increased by $574,000.

Liquidity and Capital Resources

Historically, we have funded operations primarily from cash flows from operations and various forms of debt financing insured by LPIC. In February 2011, we completed our initial public offering of common stock and received net proceeds of approximately $174.2 million after deducting the underwriting discounts and commissions and our offering expenses. We intended to use approximately $130.0 million of the net proceeds in our life finance segment and up to $20.0 million in our structured settlement activities. We further intended to use the remaining proceeds for general corporate purposes. During the year ended December 31, 2011, the Company invested approximately $128.0 million of the cash proceeds it received from its initial public offering in an investment portfolio consisting of investment grade fixed income securities and short-term marketable securities, pending deployment for purchases of life insurance policies and payments of premium. As of December 31, 2011, the investment portfolio was comprised of approximately $57.2 million fixed income investments. In addition, the Company had approximately $16.3 million of cash and cash equivalents as of December 31, 2011. See Note 26, Subsequent Events to our Audited Consolidated and Combined Financial Statements.

 

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We anticipate that our liquidity needs for years 2012 and 2013 will be in excess of the amounts previously budgeted by the Company as a result of the USAO Investigation, the SEC Investigation and related shareholder litigation. In particular, we believe we will continue to spend significant amounts on legal matters related to the SEC investigation, shareholder litigation and other potential claims over the next year, and possibly beyond. These costs in the aggregate are likely to exceed the limits of our insurance coverage for such matters, which coverage is currently being contested by our primary D&O carrier. We expect to meet our liquidity needs for the next year primarily through cash and other short term cash on hand and, to a lesser extent, through cash flows from sales and financings of structured settlements. We intend to reduce our purchases of life settlements in an effort to conserve capital and may also seek additional debt or equity financing and/or opportunistically sell certain life insurance policies in our portfolio from time to time. In addition, in connection with the Non-Prosecution Agreement, we have ceased originating new premium finance loans. We expect debt maturities to be covered by cash receipts from LPIC claims as discussed further below, and we do not currently have any material planned capital expenditures.

We estimate that we will need to pay $24.1 million in premiums to keep our current portfolio of life insurance policies in force through 2012 and an additional $24.6 million to keep the portfolio in force through 2013. As of December 31, 2011, we had approximately $75.1 million of cash, cash equivalents, and marketable securities including $691,000 of restricted cash. As of June 30, 2012, we had approximately $51.2 million of cash and cash equivalents, and marketable securities including $1.0 million of restricted cash. Additionally, we have not yet experienced the mortalities of insureds or received the resulting death benefits from our life insurance policies (other than from policies with subrogation rights that are not reported on our balance sheet and that are considered contingent assets). We expect the lack of mortalities of insureds to continue at least through 2012. We have sufficient cash and cash equivalents to pay the premiums necessary to keep the life insurance policies that we own in force and our operating expenses through at least 2012 although we will need to proactively manage our cash in advance of any liquidity shortfall. Based on our current internal forecast, we do not anticipate a liquidity shortfall prior to the third quarter of 2013. However, if we do not begin to experience mortalities and collect the related death benefits in a timely manner prior to that time, we will likely need to seek additional capital to pay the premiums, by means of debt or equity financing or the sale of some of the policies that we own. We may also seek to reduce our operating expenses in order to preserve the value of our existing portfolio of policies, and/or, under certain scenarios, lapse or sell certain of our policies or some combination of the above. The lapsing of policies, if any, would create losses as the assets would written down to zero.

Financing Arrangements Summary

We had the following debt outstanding as of December 31, 2011, which includes both the credit facilities used in our life finance segment as well as the promissory notes which are general corporate debt (in thousands):

 

     Outstanding
Principal
     Accrued
Interest
     Total
Principal
and
Interest
 

Credit Facilities:

        

Cedar Lane

     19,104         5,400         24,504   

Other

     173         105         278   
  

 

 

    

 

 

    

 

 

 

Total

   $ 19,277       $ 5,505       $ 24,782   
  

 

 

    

 

 

    

 

 

 

As of December 31, 2011, we had total debt outstanding of $19.3 million. This debt is collateralized by life insurance policies with lender protection insurance underlying premium finance loans that we have assigned, or in which we have sold participations rights, to our special purpose entities. For the Cedar Lane facility, we have guaranteed 5% of the applicable special purpose entity’s obligations. Our chief executive officer and our former chief operating officer made certain guaranties to lenders for the benefit of the special purpose entities for matters other than financial performance. These guaranties are not unconditional sources of credit support, but

 

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are intended to protect the lenders against acts of fraud, willful misconduct or a borrower commencing a bankruptcy filing. To the extent lenders sought recourse against our chief executive officer and our former chief operating officer for such non-financial performance reasons, then our indemnification obligations to our chief executive officer and our former chief operating officer may require us to indemnify them for losses they may incur under these guaranties.

We expect the lender protection insurance, subject to its terms and conditions, to ensure liquidity at the time of loan maturity and, therefore, we do not anticipate significant, if any, additional cash outflows at the time of debt maturities in excess of the amounts to be received by the loan payoffs or lender protection insurance claims.

The following table summarizes the maturities of principal and interest outstanding as of December 31, 2011 for our credit facilities used to fund premium finance loans (dollars in thousands):

 

Credit Facilities:

   Weighted
Average
Interst
Rate
    Year
Ending
12/31/2012
    Year
Ending
12/31/2013
 

Other

     20.1     277        —     

Cedar Lane

     15.6     24,408        96   
    

 

 

   

 

 

 

Totals

     $ 24,685      $ 96   
    

 

 

   

 

 

 

Weighted average interest rate

       15.7     15.6

The material terms of certain of our funding agreements are described below.

Premium Finance Credit Facility

Cedar Lane Capital LLC Facility. On March 12, 2010, Imperial PFC Financing II, LLC, a special purpose entity and wholly-owned subsidiary, entered into an amended and restated financing agreement with Cedar Lane Capital, LLC, to enable Imperial PFC Financing II, LLC to purchase premium finance loans originated by us or participation interests therein. The financing agreement provides for a $15.0 million multi-draw term loan commitment. The term loan commitment is for a 1-year term and the borrowings bear an annual interest rate of 14.0%, 15.0% or 16.0%, depending on the tranche of loans as designated by Cedar Lane Capital, LLC and are compounded monthly. All of the assets of Imperial PFC Financing II, LLC serve as collateral under this credit facility. In addition, the obligations of Imperial PFC Financing II, LLC have been guaranteed by Imperial Premium Finance, LLC; however, except for certain expenses, the obligations are generally non-recourse to us except to the extent of Imperial Premium Finance, LLC’s equity interest in Imperial PFC Financing II, LLC. Our lender protection insurer ceased providing us with lender protection insurance under this credit facility on December 31, 2010. As a result, we ceased borrowing under the Cedar Lane facility after December 31, 2010.

We are subject to several restrictive covenants under the facility. The restrictive covenants include that Imperial PFC Financing II, LLC cannot: (i) create, incur, assume or permit to exist any lien on or with respect to any property, (ii) create, incur, assume, guarantee or permit to exist any additional indebtedness (other than certain types of subordinated indebtedness), (iii) declare or pay any dividend or other distribution on account of any equity interests of Imperial PFC Financing II, LLC, (iv) make any repurchase, redemption, retirement, defeasance, sinking fund or similar payment, or acquisition for value of any equity interests of Imperial PFC Financing II, LLC or its parent (direct or indirect), or (v) issue or sell or enter into any agreement or arrangement for the issuance and sale of any shares of its equity interests, any securities convertible into or exchangeable for its equity interests or any warrants. Imperial Holdings has executed a guaranty of payment for 5.0% of amounts outstanding under the facility.

Structured Settlement Financing Arrangements

8.39% Fixed Rate Asset Backed Variable Funding Notes. We formed Imperial Settlements Funding (“ISF”) as a subsidiary of Washington Square Financial, LLC (“WSF”) to serve as a special purpose financing

 

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entity to allow us to borrow against certain of our structured settlements and assignable annuities, which we refer to as receivables, to provide us liquidity. On September 24, 2010, we entered into an arrangement to provide us up to $50 million in financing. Under this arrangement, a subsidiary of Partner Re, Ltd., or the noteholder, became the initial holder of ISF 2010’s 8.39% Fixed Rate Asset Backed Variable Funding Notes issued under a master trust indenture and related indenture supplement, or the indenture, pursuant to which the noteholder has committed to advance 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 Washington Square 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.

Upon the occurrence of certain events of default under the indenture, all amounts due under the note are automatically accelerated. ISF 2010 is subject to several restrictive covenants under the terms of the indenture. The restrictive covenants include that ISF 2010 cannot: (i) create, incur, assume or permit to exist any lien on or with respect to any assets other than certain permitted liens, (ii) create, incur, assume, guarantee or permit to exist any additional indebtedness, (iii) declare or pay any dividend or other distribution on account of any equity interests of ISF 2010 other than certain permitted distributions from available cash, (iv) make any repurchase or redemption of any equity interests of ISF 2010 other than certain permitted repurchases or redemptions from available cash, (v) enter into any transactions with affiliates other than the transactions contemplated by the indenture, or (vi) liquidate or dissolve.

During the quarter ended 2011, the Company suspended financing under this agreement but resumed financing in 2012.

The Life-contingent Structured Settlement Facility. On April 12, 2011, the Company entered into a financing arrangement for the acquisition of life-contingent structured settlement receivables. The Company’s direct wholly-owned subsidiary, WSF, entered into a purchase agreement to sell up to $40.0 million of structured settlement receivables to its wholly owned special purpose vehicle, Contingent Settlements I, LLC (“CSI”). Through a trust agreement, CSI agreed to sell the life-contingent structured settlement receivables sold to it under the purchase agreement with WSF into a statutory trust that would issue a Class A Note and a residual interest certificate to Beacon Annuity Fund (“Beacon”) and CSI, respectively. Beacon agreed, subject to certain customary funding conditions, to advance up to $40.0 million under its Class A Note, which would entitle Beacon to, among other things, the first 17 years of payments under the life-contingent structured settlement receivables, from the date such receivables are sold into the trust. Beacon committed to purchase the receivables and make advances under the Class A Note for one year absent the occurrence of certain events of default. In the fourth quarter of 2011, the Company ceased financing life-contingent structured settlement receivables under this facility and, on December 30, 2011, entered into an Omnibus Termination Agreement with Beacon and certain other parties to terminate the facility.

On the same day the Omnibus Termination Agreement was executed, December 30, 2011, 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”), an entity managed by Beacon. Subject to predetermined eligibility criteria and on-going funding conditions, Compass committed, in increments of $5.0 million, up to $40.0 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 twenty-four months, subject to Compass maintaining certain purchase commitment levels. Additionally, the Company agreed to guaranty WSF’s obligation to repurchase any ineligible receivables sold under the PSA and certain other related obligations.

 

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Premium Finance Loan Maturities

The following table summarizes the maturities of our premium finance loans outstanding as of December 31, 2011 (dollars in thousands):

 

     Year Ending
12/31/2012
    Year Ending
12/31/2013
    Year Ending
12/31/2014
 

Carrying value (loan principal balance, accreted origination fees, and accrued interest receivable)

   $ 34,696      $ 5,187      $ —     

Weighted average per annum interest rate

     11.9     13.8     0.0

Per annum origination fee as a percentage of the principal balance of the loan at origination

     19.3     12.2     0.0

Cash Flows

The following table summarizes our cash flows from operating, investing and financing activities for the years ended December 31, 2011, and 2010 (in thousands):

 

     Year Ended December 31,  
     2011     2010     2009  

Statement of Cash Flows Data:

      

Total cash provided by (used in):

      

Operating activities

   $ (46,362   $ (27,796   $ (12,631

Investing activities

     (92,542     102,956        (29,316

Financing activities

     140,935        (76,827     50,193   
  

 

 

   

 

 

   

 

 

 

Increase (decrease) in cash and cash equivalents

   $ 2,031      $ (1,667   $ 8,246   
  

 

 

   

 

 

   

 

 

 

Operating Activities

Net cash used in operating activities for the year ended December 31, 2011 was $46.4 million, an increase of $18.6 million from $27.8 million of cash used in operation activities in 2010. The increase was primarily due to a decrease of a $3.1 million in the collection of agency fees, an increase of $3.6 million in payroll and related costs and an $11.9 million increase in legal fees due to the USAO Investigation and other expenses during the period.

Net cash used in operating activities for the year ended December 31, 2010 was $27.8 million, an increase of $15.2 million from $12.6 million of cash used in operation activities in 2009. The increase was primarily due to a $16.0 million decrease in agency fee income and a decrease of $1.0 million in the change in agency fees receivable due to lower collections of receivables during the period.

Net cash used in operating activities in 2009 was $12.6 million, an increase of $10.4 million from $2.2 million of cash used in operating activities in 2008. This increase was primarily due to a $21.9 million decrease in agency fee income due to our origination of fewer premium finance loans, and a $12.3 million increase in cash paid for interest during the period due to an increase in loan maturities during the period. These increases were partially offset by a decrease in selling, general and administrative expenses of $10.3 million due primarily to efforts to reduce operating expenses, and certain changes in assets on our balance sheet due to timing of cash receipts including a decrease in the change in agency fees receivable of $9.6 million and a decrease in the change in structured settlement receivables of $5.4 million.

Investing Activities

Net cash used in investing activities for the year ended December 31, 2011 was $92.5 million, an increase of $195.5 million from $103.0 million of cash provided in investing activities for the year ended December 31, 2010. The increase was primarily due to a $128.0 million increase in purchases of investment securities

 

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available-for-sale, a $77.1 million decrease in cash proceeds from loan payoffs and lender protection insurance claims received in advance, a $49.2 million increase in purchases of life insurance policies, and a $15.6 million increase in premiums paid on investments in life settlements, offset by a $69.5 million increase in proceeds from the sale and repayment of investment securities available-for-sale and a decrease of $6.0 million in originations of loans receivable during the period.

Net cash provided by investing activities for the year ended December 31, 2010 was $103.0 million, an increase of $132.3 million from $29.3 million of cash used in investing activities for the year ended December 31, 2009. The increase was primarily due to a $92.7 million increase in proceeds from loan payoffs and a $39.4 million decrease in cash used to purchase notes receivables.

Net cash used in investing activities in 2009 was $29.3 million, a decrease of $73.5 million from $102.8 million of cash used in investing activities in 2008. The decrease was primarily due to a $43.2 million decrease in cash used for origination of loans receivable and a $32.6 million increase in proceeds from loan payoffs.

Financing Activities

Net cash provided by financing activities for the year ended December 31, 2011 was $140.9 million, an increase of $217.8 million from $76.8 million of cash used in investing activities for the year ended December 31, 2010. The increase was primarily due to an increase of $174.2 million in proceeds from our initial public offering, net of offering costs and a $93.2 million decrease in cash used in the repayment of borrowings from affiliates offset by a $45.7 million decrease in borrowings under credit facilities and from affiliates during the year ended December 31, 2011.

Net cash used in financing activities for the year ended December 31, 2010 was $76.8 million, an increase of $127.0 million from $50.2 million of cash provided by investing activities for the year ended December 31, 2009. The increase was primarily due to an increase of $146.2 million in repayments of borrowings from credit facilities and affiliates, net of additional borrowings, partially offset by an increase of $11.8 million in payment of financing fees and an increase of $10.0 million in proceeds from sale of preferred units.

Net cash provided by financing activities in 2009 was $50.2 million, a decrease of $60.9 million from $111.1 million of cash provided by financing activities in 2008. The decrease was primarily due to a decrease of $73.1 million in borrowing from credit facilities and affiliates, net of repayments, partially offset by a decrease of $5.4 million in payment of financing fees and an increase of $4.7 million in member contributions.

Contractual Obligations

The following table summarizes our contractual obligations as of December 31, 2011 (in thousands):

 

     Total      Due in Less
than 1 Year
     Due
1-3 Years
     Due
3-5 Years
     More than
5  Years
 

Credit facilities(1)

   $ 19,277       $ 3,920       $ 15,357       $ —         $ —     

Expected interest payments(2)

     5,505         1,103         4,402         —           —     

Operating leases

     1,494         528         966         —           —     

Estimated tax payments for uncertain tax positions

     6,295         —           6,295         —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 32,571       $ 5,551       $ 27,020       $ —         $ —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Credit facilities include principal outstanding related to facilities that were used to fund premium finance loans.
(2) Expected interest payments are calculated based on outstanding balances of our credit facilities as of December 31, 2011 and assumes repayment of principal and interest at the maturity date of the related premium finance loan, which may be prior to the final maturity of the credit facility.

 

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Inflation

Our assets and liabilities are, and will be in the future, interest-rate sensitive in nature. As a result, interest rates may influence our performance far more than does inflation. Changes in interest rates do not necessarily correlate with inflation or changes in inflation rates. We do not believe that inflation had any material impact on our results of operations in the periods presented in our financial statements.

Off-Balance Sheet Arrangements

Except as described below in “—Subrogation Rights, Net,” there are no off-balance sheet arrangements between us and any other entity that have, or are reasonably likely to have, a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to stockholders.

Subrogation Rights, Net

As described above in “—Critical Accounting Policies—Gain on Maturities of Life Settlements with Subrogation Rights, Net,” the Company considers policies that it acquired as a result of borrower default as contingent assets and does not include those policies in the amount of life settlement policies on its consolidated and combined balance sheet. In the third quarter of 2011, two individuals covered under policies which were subject to subrogation claims passed away. The Company collected the death benefit on one of these policies in the amount of $3.5 million during the third quarter. 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 had not collected the $10.0 million death benefit under this policy as of December 31, 2011. The Company accounted for the maturities of each of these polices as contingent gains in accordance with ASC 450, Contingencies and recognized the collection of the $3.5 million death benefit net of subrogation expenses of $312,000 in its consolidated and combined statement of operations during the third quarter of 2011. In accordance with ASC 450, the Company will recognize death benefits, net of subrogation expenses on the larger policy in the second quarter of 2012. The Company believes these contingent gains to be unpredictable because the lender protection insurer can discontinue paying the premiums necessary to keep policies subject to subrogation and salvage claims in force at any time and the amount of the lender protection insurer’s subrogation and salvage claim on any individual life insurance policy could equal the cash flow received by the Company with respect to any such policy. No expectations for similar gains in the future should be inferred from the events occurring in the third quarter of 2011.

Item 7A. Quantitative and Qualitative Disclosures about Market Risk

Market risk is the risk of potential economic loss principally arising from adverse changes in the fair value of financial instruments. The major components of market risk are credit risk, interest rate risk and foreign currency risk. We have no exposure in our operations to foreign currency risk.

Credit Risk

In our life finance business segment, with respect to life insurance policies collateralizing our loans or that we acquire upon relinquishment, credit risk consists primarily of the potential loss arising from adverse changes in the financial condition of the issuers of the life insurance policies. We manage our credit risk related to these life insurance policy issuers by generally only funding premium finance loans for policies issued by companies that have a credit rating of at least ““A” by Standard & Poor’s, at least “A2” by Moody’s, at least “A” by A.M. Best Company or at least “A-” by Fitch. At December 31, 2011, all of our loan collateral was for policies issued by companies rated “investment grade” (credit ratings of “A+” to “BBB-”) by Standard & Poor’s, and we owned 7 policies issued by a carrier rated below investment grade.

 

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The following table shows the percentage of the total number of loans outstanding with lender protection insurance and the percentage of our total loans receivable balance covered by lender protection insurance as of the dates indicated below:

 

     December 31,  
     2011     2010     2009  

Percentage of total number of loans outstanding with lender protection insurance

     65.9     93.9     91.2

Percentage of total loans receivable, net balance covered by lender protection insurance

     70.1     94.1     93.7

For the loans that had lender protection insurance and that matured during the years ended December 31, 2011 and December 31, 2010, the lender protection insurance claims paid to us were 94.7 % and 95.5%, respectively, of the contractual amount of the insured loans.

Our premium finance loans are originated with borrowers residing throughout the United States. We do not believe there are any geographic concentrations of loans that would cause them to be similarly impacted by economic or other conditions. However, there is concentration in the life insurance carriers that issued these life insurance policies that serve as our loan collateral. The following table provides information about the life insurance issuer concentrations that exceed 10% of total death benefit of the collateral and 10% of outstanding loan balance as of December 31, 2011:

 

Carrier

   Percentage of
Total Outstanding
Loan Balance
    Percentage of
Total Death
Benefit
    Moody’s
Rating
     S&P
Rating
 

Lincoln National Life Insurance Company

     17.2     13.4     A2         AA-   

ReliaStar Life Insurance Company

     17.1     18.6     A2         A   

Sun Life Assurance Company of Canada

     16.8     23.2     Aa3         AA-   

As of December 31, 2011, our lender protection insurer, Lexington, had a financial strength rating of “A” with a stable outlook by Standard & Poor’s.

The following table provides information about the life insurance issuer concentrations that exceed 10% of total death benefit and 10% of total fair value of our investments in life settlements as of December 31, 2011:

 

Carrier

   Percentage of
Total Fair
Value
    Percentage of
Total Death
Benefit
    Moody’s
Rating
   S&P
Rating

Lincoln National Life Insurance Company

     15.8     14.4   A2    AA-

AXA Equitable Life Insurance Company

     14.6     15.7   Aa3    AA-

In our structured settlements segment, credit risk consists of the potential loss arising principally from adverse changes in the financial condition of the issuers of the annuities that arise from a structured settlement. Although certain purchasers of structured settlements may require higher credit ratings, we manage our credit risk related to the obligors of our structured settlements by generally requiring that they have a credit rating of “A-” or better by Standard & Poor’s. The risk of default in our structured settlement portfolio is mitigated by the relatively short period of time that we hold structured settlements as investments. We have not experienced any credit losses in this segment and we believe such risk is minimal.

Interest Rate Risk

In our life finance segment, most of our credit facilities and promissory notes provide us with fixed-rate financing. Therefore, fluctuations in interest rates currently have minimal impact, if any, on our interest expense under these facilities. However, increases in interest rates may impact the rates at which we are able to obtain financing in the future.

 

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We earn revenue from interest charged on loans, loan origination fees and fees from referring agents. We receive interest income that accrues over the life of the premium finance loan and is due at maturity. Substantially all of the interest rates we charge on our premium finance loans are floating rates that are calculated at the one-month LIBOR rate plus an applicable margin. In addition, our premium finance loans have a floor interest rate and are capped at 16.0% per annum. For loans with floating rates, each month the interest rate is recalculated to equal one-month LIBOR plus the applicable margin, and then, if necessary, adjusted so as to remain at or above the stated floor rate and at or below the capped rate of 16.0% per annum. While the floor and cap interest rates mitigate our exposure to changes in interest rates, our interest income may nonetheless be impacted by changes in interest rates. Origination fees are fixed and are therefore not subject to changes based on movements in interest rates, although we do charge interest on origination fees.

As of December 31, 2011, we owned investments in life settlements in the amount of $90.9 million. A rise in interest rates could potentially have an adverse impact on the sale price if we were to sell some or all of these assets. There are several factors that affect the market value of life insurance policies, including the age and health of the insured, investors’ demand, available liquidity in the marketplace, duration and longevity of the policy, and interest rates. We currently do not view the risk of a decline in the sale price of life insurance policies due to normal changes in interest rates as a material risk.

In our structured settlements segment, our profitability is affected by levels of and fluctuations in interest rates. Such profitability is largely determined by the difference between the discount rate at which we purchase the structured settlements and the discount rate at which we can resell these assets or the interest rate at which we can finance those assets. Structured settlements are purchased at effective yields which are fixed, while rates at which structured settlements are sold, with the exception of forward purchase arrangements, are generally a function of the prevailing market rates for short-term borrowings. As a result, increases in prevailing market interest rates after structured settlements are acquired could have an adverse effect on our yield on structured settlement transactions.

Item 8. Financial Statements and Supplementary Data

The financial statements required by this Item are included in Item 15 of this Annual Report on Form 10-K and are presented beginning on page F-1.

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

Not Applicable.

 

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Item 9A. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our chief executive officer and chief financial officer, conducted an evaluation of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Based on this evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this Annual Report on Form 10-K.

As previously disclosed on the Company’s Forms 12b-25, filed on March 19, 2012, May 14, 2012 and August 13, 2012, the Company has been delayed in filing this Form 10-K for the year ended December 31, 2011 and its Quarterly Reports on Form 10-Q for the quarters ended March 31, 2012 and June 30, 2012 because it was unable to value the premium finance loans on its balance sheet and certain life insurance policies that it owns in light of USAO Investigation. The Company’s management believes that the failure to timely file the required reports stems from the challenge of establishing an appropriate discount rate with which to value the Company’s Level 3 assets in light of the substantial uncertainty generated by the USAO Investigation and related matters, rather than from ineffective disclosure controls and procedures. The Company’s chief executive officer and chief financial officer considered the failure to timely file the Form 10-K and Forms 10-Q when assessing the effectiveness of the Company’s disclosure controls and procedure. Because the delay was not a result of a deficiency in the Company’s disclosure controls and procedures and no material weaknesses in internal controls over financial reporting were reported, the Company’s chief executive officer and chief financial officer concluded that the disclosure controls and procedures were effective notwithstanding the delayed filings.

Management’s Report on Internal Control Over Financial Reporting

Management of Imperial Holdings, Inc. is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rule 13a-15(f) of the Exchange Act. The Company’s management, with the participation of our chief executive officer and chief financial officer, conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission published in 1987. Based on that evaluation, management concluded that our internal control over financial reporting was effective as of December 31, 2011. There were no changes in our internal control over financial reporting during the fourth quarter ended December 31, 2011 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Item 9B. Other Information

None

 

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PART III

Item 10. Directors, Executive Officers and Corporate Governance

The table below provides information about our current directors and executive officers. Each director serves for a one-year term and until their successors are elected and qualified. Executive officers serve at the request of our board of directors.

 

Name

   Age     

Position

Antony Mitchell

     47       Chief Executive Officer and Director

Richard O’Connell, Jr

     54       Chief Financial Officer and Chief Credit Officer

Miriam Martinez

     56       Senior Vice President of Finance and Operations

Michael Altschuler

     35       General Counsel and Secretary

Phillip Goldstein

     67       Chairman of the Board

David A. Buzen

     53       Director

Michael Crow

     50       Director

Robert Rosenberg

     67       Director

Andrew Dakos

     46       Director

Gerald Hellerman

     74       Director

Set forth below is a brief description of the business experience of each of our directors and executive officers, as well as certain specific experiences, qualifications and skills that led to the board of directors’ conclusion that each of the directors set forth below is qualified to serve as a director.

Antony Mitchell

Antony Mitchell has served as our Chief Executive Officer since February of 2007 and prior to August 14, 2012, also served as our chairman He has 17 years of experience in the financial industry. From 2001 to January 2007, Mr. Mitchell was Chief Operating Officer and Executive Director of Peach Holdings, Inc., a holding company which, through its subsidiaries, was a provider of specialty factoring services. Mr. Mitchell was also a co-founder of Singer Asset Finance Company, LLC (a subsidiary of Enhance Financial Services Group Inc.) in 1993, which was involved in acquiring insurance policies, structured settlements and other types of receivables. From June 2009 to November 2009, Mr. Mitchell was the Chair of the Board of Polaris Geothermal, Inc., which focuses on the generation of renewable energy projects. Since 2007, Mr. Mitchell has served as a director (being appointed Executive Chair of the Board of Directors in 2010) of Ram Power, a renewable energy company listed on the Toronto Stock Exchange. Mr. Mitchell’s qualifications to serve on our board include his knowledge of our company and the specialty finance industry and his years of leadership at our company.

Richard O’Connell, Jr.

Richard O’Connell has served as our Chief Financial Officer since April 2010 and Chief Credit Officer since January 2010. From January 2006 through December 2009, Mr. O’Connell was Chief Financial Officer of RapidAdvance, LLC, a specialty finance company. From January 2002 through September 2005 he served as Chief Operating Officer of Insurent Agency Corporation, a provider of tenant rent guaranties to apartment REITs. From March 2000 to December 2001, Mr. O’Connell acted as Securitization Consultant to the Industrial Bank of Japan. From January 1999 to January 2000, Mr. O’Connell served as president of Telomere Capital, LLC, a life settlement company. From December 1988 through 1998 he served in various senior capacities for Enhance Financial Services Group Inc., including as President and Chief Operating Officer of Singer Asset Finance Company from 1995-1998 and Senior Vice President and Treasurer of Enhance Financial Services Group Inc. from 1989 through 1996.

 

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Miriam Martinez

Miriam Martinez, has served as our Senior Vice President of Finance and Operations since September 2010. She primarily oversees the day to day financial, accounting and human resource activities of the company. Ms. Martinez joined Imperial in September 2010 prior to our initial public offering. From the period of 2006 to February 2010, Ms. Martinez served as Regional President and CFO of Qimonda N.A. a US subsidiary of a German Memory chip manufacturer. From 2000 to 2006 Ms. Martinez was CFO Infineon N.A. a US subsidiary of a German—based global semiconductor company. Ms. Martinez has also held executive positions at Siemens and White Oak Semiconductor, a joint venture between Siemens and Motorola. Ms. Martinez has a Bachelor of Accounting from Pace University and a MBA from Nova University. She has also completed the Siemens Executive MBA Program with Duke University.

Michael Altschuler

Michael Altschuler joined Imperial in December of 2010 and was named General Counsel in April of 2011. From 2007-2010, Mr. Altschuler was Director & Counsel at UBS Investment Bank where he had legal responsibility for high-yield originations and bridge lending. Prior to UBS, Mr. Altschuler was associated with the law firm of Latham & Watkins LLP. Mr. Altsch