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Fair Value Definition and Hierarchy

9 Months Ended

Sep. 30, 2020

ASC 820, Fair Value Measurements and Disclosures (“ASC 820”), establishes a hierarchical disclosure framework that prioritizes and ranks the level of market price observability used in measuring assets and liabilities at fair value. Market price observability is affected by a number of factors, including the type of investment, the characteristics specific to the investment and the state of the marketplace, including the existence and transparency of transactions between market participants. Assets and liabilities with readily available and actively quoted prices, or for which fair value can be measured from actively quoted prices in an orderly market, generally will have a higher degree of market price observability and a lesser degree of judgment used in measuring fair value.

ASC 820 maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring the use of observable inputs whenever available. Observable inputs are inputs that market participants would use in pricing the asset or liability developed based on market data obtained from third-party sources. Unobservable inputs are inputs that reflect assumptions about how market participants price an asset or liability based on the best available information. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (i.e., the “exit price”) in an orderly transaction between market participants at the measurement date (a non-distressed transaction in which neither seller nor buyer is compelled to engage in the transaction).

The fair value hierarchy prioritizes the inputs into three levels based on the observability of inputs as follows:

Level 1 — Valuations based on quoted prices in active markets for identical assets or liabilities that the Company has the ability to access as of the measurement date. Valuations are based on quoted prices that are readily and regularly available in an active market.

Level 2 — Valuations based quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable market data.

Level 3 — Valuations based on inputs that are unobservable, are derived from other valuation methodologies, including option pricing models, discounted cash flow models and similar techniques, and are not based on market exchange, dealer, or broker traded transactions. Level 3 valuations incorporate certain assumptions and projections in determining the fair value assigned to such instruments.

A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.

The availability of observable inputs can vary by types of assets and liabilities and is affected by a wide variety of factors, including, for example, whether an instrument is established in the marketplace, the liquidity of markets and other characteristics particular to the transaction. To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment. Accordingly, the degree of judgment exercised by management in determining fair value is greatest for assets and liabilities categorized in Level 3.

Financial instruments measured at fair value on a recurring basis

The Company’s financial assets and liabilities carried at fair value on a recurring basis, including the level in the fair value hierarchy, on September 30, 2020 and December 31, 2019 are presented below (in thousands).


	As of September 30, 2020
	Level 1		Level 2		Level 3		Total
Assets:
Investments in put options	$	11,584	$	—	$	—	$	11,584
Investments in life insurance policies	—		—		787,260		787,260

	As of December 31, 2019
	Level 1		Level 2		Level 3		Total
Assets:
Investments in life insurance policies	$	—	$	—	$	796,039	$	796,039

The following is a description of the valuation methodologies used for financial instruments measured at fair value on a recurring basis:

Investment in put options

On July 17, 2020, Beneficient, through its subsidiary CT Risk Management, L.L.C., made aggregate payments of $14.8 million to purchase put options against a decrease in the S&P 500 Index. The options have an aggregate notional amount of $300.0 million and are designed to protect the net asset value of the interests in alternative assets that collateralize Beneficient’s loan portfolio against market risk. One-half of the put options expire in July 2022 with the remaining put options expiring in July 2023. Changes in the fair value of the options are recognized directly in earnings. The fair value of the options is recorded in the other assets line item of the condensed consolidated balance sheets, and changes in the fair value of the options are recognized directly in earnings in the other income (loss) line item of the condensed consolidated statements of operations.

Investments in life insurance policies

The estimated fair value of our portfolio of life insurance policies is determined on a quarterly basis by management taking into consideration a number of factors, including changes in discount rate assumptions, estimated premium payments and life expectancy estimate assumptions, as well as any changes in economic and other relevant conditions. The discount rate incorporates information about discount rates observed in the life insurance secondary market through competitive bidding observations (which have declined recently as a result of our decreased purchase activity) and other means, fixed income market interest rates, the estimated credit exposure to the insurance company that issued the life insurance policy and management’s estimate of the operational risk yield premium a purchaser would require to receive the future cash flows derived from our portfolio as a whole. Management has significant discretion regarding the combination of these and other factors when determining the discount rate.

Under our Longest Life Expectancy portfolio valuation methodology, we: i) utilize life expectancy reports from third-party life expectancy providers for the pricing of all life insurance policies; ii) apply a stable valuation methodology driven by the experience of our life insurance portfolio, which is re-evaluated if experience deviates by a specified margin; and iii) use relevant market observations that can be validated and mapped to the discount rate used to value the life insurance portfolio.

These inputs are then used to estimate the discounted cash flows from the portfolio using the ClariNet LS probabilistic and stochastic portfolio pricing model from ClearLife Limited, which estimates the expected cash flows using various mortality probabilities and scenarios. The valuation process includes a review by senior management as of each quarterly valuation date. We also engage ClearLife Limited to prepare a net present value calculation of our life insurance portfolio using the inputs we provide on a quarterly basis.

The following table reconciles the beginning and ending fair value of our Level 3 investments in our portfolio of life insurance policies (in thousands):


	Three Months Ended September 30,				Nine Months Ended September 30,
	2020		2019		2020		2019
Beginning balance	$	794,706	$	799,266	$	796,039	$	747,922
Total gain in earnings(1)	6,021		14,181		23,476		48,031
Purchases	—		711		—		32,250
Settlements(2)	(13,467)		(6,640)		(32,255)		(20,685)
Transfers into Level 3	—		—		—		—
Transfers out of Level 3	—		—		—		—
Ending balance	$	787,260	$	807,518	$	787,260	$	807,518

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(1)Net change in fair value

(2)Policy maturities at initial cost basis

The net activity in the table above is reported in gain on life insurance policies, net, in the condensed consolidated statements of operations.

There have been no transfers between levels for any assets or liabilities recorded at fair value on a recurring basis or any changes in the valuation techniques used for measuring the fair value as of September 30, 2020 and December 31, 2019. The following table provides quantitative information about the significant unobservable inputs used in the fair value measurement of the Company’s Level 3 fair value assets:


	As of September 30, 2020			As of December 31, 2019
Weighted-average age of insured, years*	82.9			82.4
Age of insured range, years	63-100			62-101
Weighted-average life expectancy, months*	82.8			86.2
Life expectancy range, months	0-240			0-240
Average face amount per policy (in thousands)	$	1,777		$	1,756
Discount rate	8.25		%	8.25		%

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(*)Weighted-average by face amount of policy benefits

Life expectancy estimates and market discount rates for a portfolio of life insurance policies are inherently uncertain and the effect of changes in estimates may be significant. For example, if the life expectancy estimates were increased or decreased by four and eight months on each outstanding policy, and the discount rates were increased or decreased by 1% and 2%, with all other variables held constant, the fair value of our investment in life insurance policies would increase or decrease as summarized below (in thousands):


	Change in Life Expectancy Estimates
	Minus 8 months		Minus 4 months		Plus 4 months		Plus 8 months
September 30, 2020	$	98,909	$	46,028	$	(62,483)	$	(115,452)
December 31, 2019	$	113,812	$	57,753	$	(55,905)	$	(111,340)
	Change in Discount Rate
	Minus 2%		Minus 1%		Plus 1%		Plus 2%
September 30, 2020	$	84,613	$	40,314	$	(36,802)	$	(70,497)
December 31, 2019	$	91,890	$	43,713	$	(39,790)	$	(76,118)

Financial instruments measured at fair value on a non-recurring basis

There were no assets or liabilities measured at fair value on a non-recurring basis as of September 30, 2020. As of December 31, 2019, Beneficient’s assets and liabilities were recorded at fair value in the consolidated balance sheet due to the application of purchase accounting in accordance with ASC 805 as described in Note 4.

Carrying amounts and estimated fair values

The Company is required to disclose the estimated fair value of financial instruments, whether or not recognized in the condensed consolidated balance sheets, for which it is practicable to estimate those values. These fair value estimates are determined based on relevant market information and information about the financial instruments. Fair value estimates are intended to represent the price at which an asset could be sold or the price at which a liability could be settled. However, given there is no active market or observable market transactions for many of the Company’s financial instruments, estimates of fair values are subjective in nature, involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimated values. Nonfinancial instruments are excluded from disclosure requirements.

The carrying amounts and estimated fair values of the Company’s financial instruments not recorded at fair value were as noted in the tables below (in thousands).


	As of September 30, 2020
	Level in Fair Value Hierarchy	Carrying Amount		Estimated Fair Value
Financial assets:
Cash, cash equivalents and restricted cash	1	$	109,756	$	109,756
Life insurance policy benefits receivable, net	1	36,418		36,418
Loans receivable, net of allowance for loan losses and discount	3	227,047		257,764
Fees receivable	1	31,571		31,571
Financial liabilities:
Senior credit facility	2	$	203,907	$	213,117
L Bonds and Seller Trust L bonds	2	1,521,411		1,638,227
Other borrowings	2	100,178		101,368
Other liabilities	1	57,056		57,056


	As of December 31, 2019
	Level in Fair Value Hierarchy	Carrying Amount		Estimated Fair Value
Financial assets:
Cash, cash equivalents and restricted cash	1	$	99,331	$	99,331
Life insurance policy benefits receivable, net	1	23,031		23,031
Loans receivable, net of allowance for loan losses and discount	3	232,344		232,344
Fees receivable	1	29,168		29,168
Financing receivables from affiliates	2	67,153		59,608
Financial liabilities:
Senior credit facility with LNV Corporation	2	$	174,390	$	184,587
L Bonds and Seller Trust L Bonds	2	1,293,530		1,390,288
Other borrowings	2	153,086		153,086
Other liabilities	1	44,352		44,352

Other liabilities is comprised of the interest and dividends payable and accounts payable and accrued expenses line items on the condensed consolidated balance sheets as of September 30, 2020 and December 31, 2019.

- Definition

The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial assets and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the entity is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risks are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.

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