• Filing Date: 2018-08-20
  • Form Type: 10-Q
  • Description: Quarterly report
v3.10.0.1
Fair Value Measurements
6 Months Ended
Jun. 30, 2018
Fair Value Disclosures [Abstract]  
Fair Value Measurements
Fair Value Measurements

The Company carries life settlements and debt under the Revolving Credit Facility at fair value as shown in the consolidated balance sheets. Fair value is defined as an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. As such, fair value is a market based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. Fair value measurements are classified based on the following fair value hierarchy:

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

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

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

Assets and liabilities measured at fair value on a recurring basis

The balances of the Company’s assets measured at fair value on a recurring basis as of June 30, 2018, are as follows (in thousands):
 
Level 1
 
Level 2
 
Level 3
 
Total
Fair Value
Assets:
 
 
 
 
 
 
 
Investment in life settlements
$

 
$

 
$
569,373

 
$
569,373

 
$

 
$

 
$
569,373

 
$
569,373


The balances of the Company’s liabilities measured at fair value on a recurring basis as of June 30, 2018 are as follows (in thousands):
 
Level 1
 
Level 2
 
Level 3
 
Total
Fair Value
Liabilities:
 
 
 
 
 
 
 
White Eagle Revolving Credit Facility
$

 
$

 
$
353,387

 
$
353,387

 
$

 
$

 
$
353,387

 
$
353,387


The balances of the Company’s assets measured at fair value on a recurring basis as of December 31, 2017, are as follows (in thousands):
 
Level 1
 
Level 2
 
Level 3
 
Total Fair
Value
Assets:
 
 
 
 
 
 
 
Investment in life settlements
$

 
$

 
$
567,492

 
$
567,492

 
$

 
$

 
$
567,492

 
$
567,492


The balances of the Company’s liabilities measured at fair value on a recurring basis as of December 31, 2017, are as follows (in thousands):
 
Level 1
 
Level 2
 
Level 3
 
Total Fair
Value
Liabilities:
 
 
 
 
 
 
 
White Eagle Revolving Credit Facility
$

 
$

 
$
329,240

 
$
329,240

 
$

 
$

 
$
329,240

 
$
329,240



The Company categorizes its investment in life settlement portfolio in two classes, non-premium financed and premium financed. In considering the categories, historically, it has generally believed that market participants would require a lower risk premium for policies that were non-premium financed, while a higher risk premium would be required for policies that were premium financed; the Company believes that this risk premium has been declining.
($ in thousands)
Quantitative Information about Level 3 Fair Value Measurements
 
 
Fair Value
at 6/30/18
 
Aggregate
death benefit
at 6/30/18
 
Valuation Technique
 
Unobservable Input 
 
Range
(Weighted Average)
Non-premium financed
$
99,349

 
$
299,719

 
Discounted cash flow
 
Discount rate
 
11.50%
-
17.50%
 
 
 
 
 
 
 
Life expectancy evaluation
 
(5.2 years)
Premium financed
$
470,024

 
$
2,527,144

 
Discounted cash flow
 
Discount rate
 
15.50%
-
21.50%
 
 
 
 
 
 
 
Life expectancy evaluation
 
(8.3 years)
Total Life settlements
$
569,373

 
$
2,826,863

 
Discounted cash flow
 
Discount rate
 
15.93%
 
 
 
 
 
 
 
Life expectancy evaluation
 
(8.0 years)
White Eagle Revolving Credit Facility
$
353,387

 
$
2,814,863

 
Discounted cash flow
 
Discount rate
 
19.07%
 
 
 
 
 
 
 
Life expectancy evaluation
 
(8.0 years)


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

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

The Company provides medical records for each insured to LE providers. Each LE provider reviews and analyzes the medical records and identifies all medical conditions it feels are relevant to the life expectancy determination of the insured. Debits and credits are assigned by each LE provider to the individual’s health based on identified medical conditions which are derived from the experience of mortality attributed to relevant conditions in the portfolio of lives that the LE provider monitors. The health of the insured is summarized by the LE provider into a life assessment of the individual’s life expectancy expressed both in terms of months and in mortality factor. The mortality factor represents the degree to which the given life can be considered more or less impaired than a life having similar characteristics (e.g. gender, age, smoking, etc.). For example, a standard insured (the average life for the given mortality table) would carry a mortality rating of 100%. A similar but impaired life bearing a mortality rating of 200% would be considered to have twice the chance of dying earlier than the standard life relative to the LE provider’s population. Since each provider’s mortality factor is based on its own mortality table, the Company calculates its own factors to apply to the table selected by the Company.

The Company calculates mortality factors so that when applied to the mortality table selected by the Company, the resulting LE equals the LE provided by each LE provider. The resulting mortality factors are then blended to determine a factor for each insured.

A mortality curve is then generated based on the calculated mortality factors and the rates from the Company selected mortality table to generate the best estimated probabilistic cash flow stream. The net present value of the cash flows is then calculated to determine the policy value.

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.

The Company uses the 2015 Valuation Basic tables, smoker distinct ("2015 VBT"), mortality tables developed by the U.S. Society of Actuaries (the "SOA"). The mortality tables are created based on the expected rates of death among different groups categorized by factors such as age and gender. The 2015 VBT is based on a large dataset of insured lives, face amount of policies and more current information and its dataset includes 266 million policies. The experience data in the 2015 VBT dataset includes 2.55 million claims on policies from 51 insurance carriers. Life experiences implied by the 2015 VBT are generally longer for male and female nonsmokers between the ages of 65 and 80, while smokers and insureds of both genders over the age of 85 have significantly lower life expectancies. The table shows lower mortality rates in the earlier select periods at most ages, so while the Company continues to fit the life expectancies from the LE providers to the 2015 VBT, the change in the mortality curve changes the timing of the Company’s expected cash flow streams.

Future changes in the life expectancies could have a material adverse effect on the fair value of the Company’s life settlements, which could have a material adverse effect on its business, financial condition and results of operations.

Life expectancy sensitivity analysis

If all of the insured lives in the Company’s life settlement portfolio lived six months shorter or longer than the life expectancies provided by these third parties, the change in estimated fair value would be as follows (dollars in thousands):

Life Expectancy Months Adjustment
Value
 
Change in Value
+6
$
479,154

 
$
(90,219
)
-
$
569,373

 
$

-6
$
665,721

 
$
96,348



Discount rate

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

The Company re-evaluates its discount rates at the end of every reporting period in order to reflect the estimated discount rates that could reasonably be used in a market transaction involving the Company’s portfolio of life settlements. In doing so, consideration is given to the various factors influencing the rates, including risk tolerance and market activity. The Company relies on management insight, engages third party consultants to corroborate its assessment, engages in discussions with other market participants and extrapolates the discount rate underlying actual sales of policies. In considering these factors, at June 30, 2018, the Company determined that the weighted average discount rate calculated based on death benefit was 15.93% compared to 15.95% at December 31, 2017.

Credit exposure of insurance company

The Company considers the financial standing of the issuer of each life insurance policy. Typically, we seek to hold policies issued by insurance companies that are rated investment grade by the top three credit rating agencies. At June 30, 2018, the Company had 19 life insurance policies issued by three carriers that were rated non-investment grade as of that date. In order to compensate a market participant for the perceived credit and challenge risks associated with these policies, the Company applied an additional 300 basis point risk premium.

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 the Company’s life settlements as of June 30, 2018:
Carrier
Percentage of
Total
Fair Value
 
Percentage of
Total Death
Benefit
 
Moody's
Rating
 
S&P
Rating
Transamerica Life Insurance Company
18.5
%
 
21.1
%
 
A1
 
AA-
Lincoln National Life Insurance Company
23.4
%
 
19.8
%
 
A1
 
AA-


Estimated risk premium

As of June 30, 2018, the Company owned 596 policies with an estimated fair value of $569.4 million. Of these 596 policies, 520 were previously premium financed and are valued using discount rates that range from 15.50% to 21.50%. The remaining 76 policies, which are non-premium financed, are valued using discount rates that range from 11.50% to 17.50%. As of June 30, 2018, the weighted average discount rate calculated based on death benefit used in valuing the policies in the Company’s life settlement portfolio was 15.93%.

Market interest rate sensitivity analysis

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

Weighted Average Rate Calculated Based on
 
 
 
 
 
Death Benefit
Rate Adjustment
 
Value
 
Change in Value
15.43%
-0.50%

 
$
583,330

 
$
13,957

15.93%

 
$
569,373

 
$

16.43%
+0.50%

 
$
555,990

 
$
(13,383
)


Future changes in the discount rates we use to value life insurance policies could have a material effect on the Company's 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 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.

White Eagle Revolving Credit Facility— As of June 30, 2018, 594 policies are pledged by White Eagle to serve as collateral for its obligations under the White Eagle Revolving Credit Facility. Absent an event of default under the White Eagle Revolving Credit Facility, ongoing borrowings will be used to pay the premiums on these policies and certain approved third party expenses. As more fully described in Note 9, "White Eagle Revolving Credit Facility," proceeds from the maturity of the policies pledged as collateral under the White Eagle Revolving Credit Facility are distributed pursuant to a waterfall. After premium payments, fees to service providers and payments of interest, a percentage of the collections from policy proceeds are to be paid to the Company, which will vary depending on the then LTV ratio.

The Company elected to account for the debt under the White Eagle Revolving Credit Facility in accordance with ASC 820, which includes the 45% interest in policy proceeds payable to the lender, using the fair value method. The fair value of the debt is the amount the Company would have to pay to transfer the debt to a market participant in an orderly transaction. We calculated the fair value of the debt using a discounted cash flow model taking into account the stated interest rate of the White Eagle Revolving Credit Facility and probabilistic cash flows from the pledged policies. Accordingly, our estimates are not necessarily indicative of the amounts that we, or holders of the instruments, could realize in a current market exchange. The most significant assumptions are the estimates of life expectancy of the insured and the discount rate. The use of different assumptions and/or estimation methodologies could have a material effect on the estimated fair values.

Life expectancy sensitivity analysis of the White Eagle Revolving Credit Facility

A considerable portion of the fair value of the White Eagle Revolving Credit Facility is determined by the timing of receipt of future policy proceeds. Should life expectancies lengthen such that policy proceeds are collected further into the future, the fair value of this debt will decline. Conversely, should life expectancies shorten, the fair value of this debt will increase. Considerable judgment is required in interpreting market data to develop the estimates of fair value.

If all of the insured lives in the life settlement portfolio pledged under the White Eagle Revolving Credit Facility live six months shorter or longer than the life expectancies used to calculate the estimated fair value of the White Eagle Revolving Credit Facility debt, the change in estimated fair value would be as follows (dollars in thousands):
Life Expectancy Months Adjustment
Fair Value of White Eagle
Revolving Credit
Facility
 
Change in Value
+6
$
304,605

 
$
(48,782
)
 
$
353,387

 
$

-6
$
401,459

 
$
48,072



Future changes in the life expectancies could have a material effect on the fair value of the White Eagle Revolving Credit Facility, which could have a material adverse effect on its business, financial condition and results of operations.

Discount rate of the White Eagle Revolving Credit Facility

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

Market interest rate sensitivity analysis of the White Eagle Revolving Credit Facility

The extent to which the fair value of the White Eagle Revolving Credit Facility could vary in the near term has been quantified by evaluating the effect of changes in the weighted average discount. 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 estimated fair value of the White Eagle Revolving Credit Facility as of June 30, 2018 would be as follows (dollars in thousands):
Discount Rate
Rate Adjustment
 
Fair Value of White Eagle
Revolving Credit
Facility
 
Change in Value
18.57%
-0.50
 %
 
$
360,651

 
$
7,264

19.07%

 
$
353,387

 
$

19.57%
+0.50
 %
 
$
346,375

 
$
(7,012
)


Future changes in the discount rates could have a material effect on the fair value of the White Eagle Revolving Credit Facility, which could have a material adverse effect on its business, financial condition and results of its operations.

At June 30, 2018, the fair value of the debt was $353.4 million and the outstanding principal was approximately $355.6 million.

Changes in Fair Value

The following table provides a roll-forward in the changes in fair value for the six months ended June 30, 2018, for all life settlement assets for which the Company determines fair value using a material level of unobservable (Level 3) inputs, which consists solely of life settlements (in thousands):
Life Settlements:
 
Balance, January 1, 2018
$
567,492

Purchase of policies

Change in fair value
10,920

Matured/lapsed/sold policies
(53,935
)
Premiums paid
44,896

Transfers into level 3

Transfer out of level 3

Balance, June 30, 2018
$
569,373

Changes in fair value included in earnings for the period relating to assets held at June 30, 2018
$
(20,728
)



The following table provides a roll-forward in the changes in fair value for the six months ended June 30, 2018, for the White Eagle Revolving Credit Facility for which the Company determines fair value using a material level of unobservable (Level 3) inputs (in thousands):
White Eagle Revolving Credit Facility:
 
Balance, January 1, 2018
$
329,240

Draws under the White Eagle Revolving Credit Facility
46,067

Payments on White Eagle Revolving Credit Facility
(19,543
)
Unrealized change in fair value
(2,377
)
Transfers into level 3

Transfer out of level 3

Balance, June 30, 2018
$
353,387

Changes in fair value included in earnings for period relating to liabilities held at June 30, 2018
$
(2,377
)

The following table provides a roll-forward in the changes in fair value for the six months ended June 30, 2017, for all assets for which the Company determines fair value using a material level of unobservable (Level 3) inputs, which consists solely of life settlements (in thousands):
Life Settlements:
 
Balance, January 1, 2017
$
498,400

Purchase of policies

Change in fair value
28,922

Matured/sold policies
(43,073
)
Premiums paid
42,033

Transfers into level 3

Transfers out of level 3

Balance, June 30, 2017
$
526,282

Changes in fair value included in earnings for the period relating to assets held at June 30, 2017
$
9,730



The following table provides a roll-forward in the changes in fair value for the six months ended June 30, 2017, for the White Eagle Revolving Credit Facility for which the Company determines fair value using a material level of unobservable (Level 3) inputs (in thousands):
White Eagle Revolving Credit Facility:
 
Balance, January 1, 2017
$
257,085

Draws under the White Eagle Revolving Credit Facility
43,399

Payments on White Eagle Revolving Credit Facility
(5,656
)
Unrealized change in fair value
10,046

Transfers into level 3

Transfer out of level 3

Balance, June 30, 2017
$
304,874

Changes in fair value included in earnings for the period relating to liabilities at June 30, 2017
$
10,046

There were no transfers of financial assets or liabilities between levels of the fair value hierarchy during the six months ended June 30, 2018 and 2017.

Other Fair Value Considerations - Carrying value of certificate of deposits, prepaid expenses and other assets, receivable for maturity of life settlements, investment in affiliates, 8.5% Senior Secured Notes, 8.5% Senior Unsecured Convertible Notes, 5.0% Senior Unsecured Convertible Notes, accounts payable and accrued expenses approximate fair value due to their short-term maturities and/or low credit risk.