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IFT > SEC Filings for IFT > Form 10-K on 28-Mar-2013All Recent SEC Filings

Show all filings for IMPERIAL HOLDINGS, INC. | Request a Trial to NEW EDGAR Online Pro

Form 10-K for IMPERIAL HOLDINGS, INC.


28-Mar-2013

Annual Report


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 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.

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


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Company earns revenue/income from changes in the fair value of life insurance policies that the Company acquires and receipt of death benefits with respect to matured life insurance policies it owns as well as from interest accruing on outstanding loans and loan origination fees recognized over the life of outstanding loans. In the structured settlement business, the Company purchases structured settlement receivables at a discounted rate and sells these receivables to third parties.

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.

See "Business" in this Annual Report on Form 10-K for additional information regarding our business and operations.

Recent Developments, Uncertainties & Outlook

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 selectively 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 currently focused on raising long-term capital and maintaining and realizing upon its portfolio of life insurance policies. Accordingly, the Company does not currently intend to expend significant resources acquiring policies and expects that earnings in its life finance segment going forward will be driven by maturities in its portfolio of life insurance policies and through unrealized changes in the fair value of its life insurance policies. At December 31, 2012, the Company had approximately $20.3 million of cash and cash equivalents, and marketable securities, with projected premiums of $27.7 million and $26.3 million in 2013 and 2014, respectively. Based on internal projections at December 31, 2012, the Company anticipated a liquidity shortfall in the second quarter of 2013. On March 27, 2013, a subsidiary of the Company borrowed $45 million in aggregate principal amount under an 18-month senior secured bridge facility. The Company believes that the proceeds of this facility will provide the Company with the resources to continue to pay premiums on its portfolio of life insurance policies and fund its operations through December 31, 2013 while the Company continues its efforts to source more permanent capital.

Proposed Settlement of Shareholder Litigation

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

While non-binding and subject to certain contingencies, the terms of the class action settlement include a cash payment of $12.0 million, of which $11.0 million is to be contributed by Imperial's primary and excess D&O Carriers, and the issuance of two million warrants for shares of the Company's stock with an estimated value of $3.1 million at the date of the signing of the Term Sheet. The value of the warrants will be re-assessed at issuance. The warrants will have a five-year term with an exercise price of $10.75 and will be issued when the settlement proceeds are distributed to the claimants. In addition, the underwriters in Imperial's initial public offering are to waive their rights to indemnity and contribution by Imperial. The Company established a reserve related to the proposed settlement of $15.1 million, which is included in other liabilities and a receivable for insurance recoverable from the Company's D&O Carrier of $11.0 million, which is included in prepaid and other assets. The $4.1 million net effect of the settlement is included in legal fees in the statement of operations for the year ended December 31, 2012.


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The derivative would be settled for implementation of certain compliance reforms. The Term Sheet also contemplates payment by Imperial's primary D&O carrier of $1.5 million for legal fees in respect of the derivative actions and the contribution of $500,000 in Imperial stock.

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

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

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

Use of Updated Life Expectancies, Change in Mortality Table & Recent Announcements by Life Expectancy Providers

During the second half of 2012, the Company began receiving updated life expectancy reports on the insureds represented in the Company's portfolio of life insurance policies from both its historical provider of life expectancy reports, AVS Underwriting LLC ("AVS"), and another third party life expectancy provider, 21st Services, LLC ("21st Services"). The procurement of these reports was undertaken in anticipation of a potential financing transaction as the Company believes that potential lenders in any long-term financing will likely require updated life expectancy reports and that such lenders may establish a loan-to-value ratio or borrowing base in any financing based off of a composite mortality factor or "blend" of life expectancy results furnished by these two providers. Additionally, the Company believes that many participants in the secondary and tertiary markets have utilized a blend by these life expectancy providers in pricing life insurance policies and that using a second life expectancy provider mitigates the effects of potential underwriting biases. Having taken these factors into consideration, the Company determined to input a composite mortality factor based off of AVS and 21st Services into its fair value model beginning in the third quarter. See Valuation of Insurance Policies in this Management's Discussion and Analysis of Financial Condition and Results of Operations.

The Company does not expect that it will ever receive updated life expectancy reports on 100% its policies as it anticipates a portion of the insureds represented by its portfolio to be unresponsive to requests for updated medical information. This information is generally required by life expectancy providers to issue new life expectancy reports. The Company believes that insureds who have deteriorated in health are generally less likely to be responsive to requests for updated medical information. As a result, the periodic updating of life expectancy reports may conservatively skew fair value estimates lower as any health deteriorations experienced by unresponsive insureds would not be reflected in the life expectancy inputs that are used to calculate the value of the Company's investment in life settlements.

At December 31, 2012 , the Company had received updated life expectancies on 149 policies, which were blended and inputted in the Company's fair value model at December 31, 2012. In cases where the Company did not receive updated life expectancy reports, the results of original AVS life expectancy reports together with life expectancy reports from 21st Services that were obtained when the original AVS life expectancy reports were obtained have been blended. Additionally and in consultation with third party actuarial consultants, the Company lengthened the life expectancy inputs to its fair value model on 45 policies with life expectancy reports that were more than two years old at December 31, 2012 based on the average lengthening reported on the 149 policies where update life expectancy reports were received. Had the Company not implemented such an adjustment on


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affected policies, the fair value of the Company's portfolio would have increased from the reported amount by $5.8 million. Additionally, the Company replaced its mortality table with a modified version of the 2008 Valuation Basic Table in the third quarter of 2012 as the third party that developed the Company's previously used table has ceased operations. The Company believes that the table utilized in the third quarter is consistent with tables used by other market participants and did not have a material impact on the valuation of the Company's life insurance policies.

On January 22, 2013, 21st Services announced significant revisions to its underwriting methodology. On February 4, 2013, 21st Services then announced that it was correcting errors discovered in its previously announced revised methodology. According to the provider, these revisions have generally been understood to lengthen the average reported life expectancy furnished by 21st Services by 19% and, accordingly, will likely negatively impact the valuation of the Company's portfolio of life insurance policies. However, the Company has not received life expectancy reports from 21st Services that utilize its revised methodology and the fair value of the Company's portfolio of life insurance policies at December 31, 2012 does not take into account changes to life expectancy estimates that may result from 21st Services updated methodology. While the Company is still evaluating the general impact that these revisions might have on the value of its portfolio, the Company may determine to cease utilizing, or adjust the weighting of, 21st Services reports as an input into its fair value model in future periods as market practice responds to the adjusted methodology. Additionally, the Company's other life expectancy provider, AVS Underwriting LLC ("AVS"), filed for federal bankruptcy protection under Chapter 11 on February 12, 2013. The Company cannot, at this time, predict what impact the bankruptcy filing will have on the Company's ability to procure life expectancy reports from AVS in the future, AVS's ability to continue its operations or whether other market participants will continue to use AVS life expectancy reports for valuation purposes going forward. As a result of these developments, the Company may need to adjust the application of life expectancy reports in its fair value methodology or source reports from different life expectancy providers in future periods, which could have a material impact on the Company's fair value calculations and materially and adversely effect our business, financial condition and results of operations.

Principal Revenue and Expense Items

Components of Revenue / Income

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 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 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 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.


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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.

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

Year Ended December 31, 2012 2011 2010 Weighted average per annum interest rate 13.4 % 12.5 % 11.4 %

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.

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 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.

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,
                                                          2012           2011          2010
Origination fees as a percentage of the principal
balance of the loans                                         -  %         25.0 %        41.5 %
Origination fees per annum as a percentage of the
principal balance of the loan                                -  %         24.3 %        22.7 %

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.


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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,
                                                          2012           2011          2010
Agency fees as a percentage of the principal
balance of the loans originated                              -  %         33.0 %        48.8 %

As a result of the voluntary termination of our premium finance business, we did not receive any revenue from agency fees in 2012 and Imperial Life and Annuity Services, LLC has voluntarily surrendered all its insurance agency licenses during the year ended December 31, 2012.

Components of Expenses

Interest Expense

Interest expense is interest accrued monthly on credit facility borrowings that were 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,
                                                          2012        2011        2010
 Weighted average interest rate under credit facilities     0.0 %      15.7 %      17.1 %
 Weighted average interest rate under promissory note       0.0 %       0.0 %      16.5 %
 Total weighted average interest rate                       0.0 %      15.7 %      17.0 %

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 statement of operations.

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


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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, 2012 and 2011, 88 and 131 loans were not repaid at maturity, respectively, all of which were submitted to our lender protection insurer and 95.5% and 100% paid by such 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, 2012 and 2011 was $25.3 million and $49.7 million, respectively. The amount of cash received by us for those loans was $25.6 million and $51.5 million, respectively. This resulted in a gain during the years ended December 31, 2012 and 2011 of $29,000 and $737,000, 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                          Year Ended
                                           December 31, 2012                   December 31, 2011
Number of loans matured                                    89                                 138
Number of loans impaired at
maturity                                                   61                                  52
Loans not repaid at maturity                               88                                 131
Claims submitted to lender
protection insurer                                         88                                 131
Claims paid by lender
protection insurer                                         85                                 131
Amount of claims paid                     $            25,646                 $            51,480
Net carrying value of loans
at payoff                                 $            25,303                 $            49,706
Gain on LPIC payoffs (all
loans)                                                     29                                 737
Gain on LPIC payoffs
(impaired loans)                                          104                                 607
Percent of claims paid by
lender protection insurer                                95.5 %*                              100 %

* Claims have been filed with the LPIC carrier and the Company is pending reimbursement for the remaining 4.5%, a provision for losses on loans receivable of $515,000 was established as collectability of the LPIC claim is uncertain.

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,
                                                          2012          2011          2010
Percentage of total number of loans outstanding with
lender protection insurance                                22.7 %        65.9 %        93.9 %
Percentage of total loans receivable, net balance
covered by lender protection insurance                      3.0 %        70.1 %        94.1 %

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,


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we recorded impairment even though no loans are considered non-performing as no payments are due by the borrower. Loans with insured collateral represented 22.7% and 65.9% of our loans as of December 31, 2012 and 2011, respectively.

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                        Year Ended
                                             December 31, 2012                 December 31, 2011
. . .
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