Life Partners Position Holder Trust

Life Partners IRA Holder Partnership, LLC

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See accompanying notes to financial statements

 

See accompanying notes to financial statements

 

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LIFE PARTNERS POSITION HOLDER TRUST

NOTES TO FINANCIAL STATEMENTS

Operations

Units represent beneficial interests in the Trust, and all holders of Units are entitled to receive cash distributions from the Trust in accordance with their respective Pro Rata Shares. A Trust beneficiary’s respective “Pro Rata Share” means the ratio, expressed as a percentage, of (i) the number of Units which such Trust beneficiary is the registered owner, to (ii) the total number of Units outstanding as of the measurement date, subject to modification for purposes of distributing any recovered assets.

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Summary of Significant Accounting Policies

Basis of Presentation

Investments in Life Insurance Policies

Fair Value of Life Insurance Policies

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. The Trust’s investments in life insurance policies are considered to be Level 3 as there is currently no active market where the Trust is able to observe quoted prices for identical assets and the Trust’s valuation model incorporates significant inputs that are not observable.

 

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The Trust’s investments in life insurance policies are its primary source of income. Gain or loss is recognized from ongoing changes in the portfolio’s estimated fair value, including any gains or losses at maturity. Gains or losses from maturities are recognized on receipt of an insured party’s death notice or verified obituary and determined based on the difference between the death benefit and the policy’s estimated fair value at maturity.

The Trust assumed the Debtors’ receivables related to life insurance policy premiums and service fees that were paid by the Debtors on behalf of fractional interest holders prior to the Trust’s effective date. After December 9, 2016, the policy premiums allocable to continuing fractional interest holders are those persons' obligations and not the Trust’s. If a continuing fractional interest holder defaults on future premium obligations, such position is deemed contributed to the Trust in exchange for the number of Units provided by the Plan.

The Trust maintains an allowance for doubtful accounts for estimated losses resulting from the inability to collect premiums and service fees receivable. Such estimates are based on the position holder’s payment history and other indications of potential uncollectability. After all attempts to collect a receivable have failed, receivables are written off against the allowance. The Trust may recover any outstanding receivable balances pursuant to the Trustee’s set-off rights under the Plan.

 

Maturities receivable consist of the Trust’s portion of life insurance policy maturities that occurred, but payment was not yet received as of the end of the reporting period.

Income Taxes

No provision for state or federal income taxes from operations has been made as the liability for such taxes is attributable to the Unit holders rather than the Trust. The Trust is a grantor trust with taxable income or loss passing through to the Unit holders. In certain instances, however, the Trust may be required under applicable state laws to withhold amounts otherwise due to Unit holders and remit them directly to state or federal tax authorities. Such payments on behalf of the Unit holders are deemed distributions to them.

 

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Accounts Payable and Accrued Expenses

 

Accounts payable and accrued expenses primarily include professional services, legal fees and expected litigation settlements, some of which are Debtors’ obligations assumed at inception by the Trust pursuant to the Plan. The Trust also accrues liabilities for state taxes payable and other miscellaneous accruals. The Trust accrues liabilities when costs are incurred, and such costs can be reasonably estimated.

Premium liabilities are funds in escrow on behalf of continuing fractional holders for future payment of their premium obligations. If such funds are not used for such continuing fractional holder’s premium payments, they are refunded to the respective continuing fractional holder.

 

Maturity Liability

Use of Estimates

 

The preparation of these financial statements, in conformity with GAAP, requires the Trust to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of income and expenses during the reporting periods. Actual results could differ from these estimates and such differences could be material. The estimates related to the valuation of the life insurance policies represent significant estimates made by the Trust.

 

Risks and Uncertainties

 

The Trust encounters economic, legal, and longevity risk. The main components of economic risk potentially impacting the Trust are market risk, concentration of credit risk, and the increasing cost of insurance risk. The Trust’s market risks include interest rate risk and the risk of declines in valuation of the Trust’s life insurance policies, including declines caused by the selection of increased discount rates associated with the Trust’s fair value model. It is reasonably possible that future changes to estimates involved in valuing life insurance policies could change and materially affect future financial statements. Concentration of credit risk is the risk that an insurance carrier who has issued life insurance policies held by the Trust, does not remit the amount due under those policies due to the carrier’s deteriorating financial condition or otherwise. Another credit risk potentially impacting the Trust is the risk continuing fractional holders may default on their future premium obligations, increasing the Trust’s premium obligations.  The increasing cost of insurance risk includes the carriers’ attempts to change a policy’s cost of insurance.  While some cost of insurance increases are anticipated and taken into consideration in the Trusts forecasts; other cost of insurance increases are unilaterally imposed by the carrier.  In 2018, one carrier increased the cost of insurance associated with its policies held by the Trust, representing about $188 million in face value, by approximately 45% over the prior cost of insurance. The Trust, through ATLES is a class plaintiff in three class actions against carriers over their cost of insurance increases.

 

Longevity risk refers to the reasonable possibility that actual mortalities of insureds in the Trust’s portfolio extend over longer periods than are anticipated, resulting in the Trust paying more in premiums and delaying its collection of death benefits.   Further, increased longevity may encourage additional continuing fraction holders to default on their premium obligations, increasing the Trust’s positions and its premium payment burden.

 

The Trust maintains the majority of its cash in several accounts with a commercial bank. Balances on deposit are insured by the Federal Deposit Insurance Corporation (“FDIC”). However, from time to time the Trust's balances may exceed the FDIC insurable amounts.

 

Litigation

 

In accordance with applicable accounting guidance, the Trust establishes an accrued liability for litigation and regulatory matters when those matters present loss contingencies that are both probable and estimable. In such cases, there may be an exposure to loss in excess of any amounts accrued. When a loss contingency is not both probable and estimable, the Trust does not establish an accrued liability. As a litigation or regulatory matter develops, the Trust, in conjunction with any outside counsel handling the matter, evaluates on an ongoing basis whether such matter presents a loss contingency that is probable and estimable. If, at the time of evaluation, the loss contingency related to a litigation or regulatory matter is not both probable and estimable, the matter will continue to be monitored for further developments that would make such loss contingency both probable and estimable. When a loss contingency related to a litigation or regulatory matter is deemed to be both probable and estimable, the Trust will establish an accrued liability with respect to such loss contingency and record a corresponding amount of litigation-related expense. The Trust will then continue to monitor the matter for further developments that could affect the amount of any such accrued liability. There have been no material changes to any litigation matters during the three and six months ended June 30, 2018.

 

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As of December 31, 2017, the Trust owned an interest in 3,140 policies of which 600 are life settlement policies and 2,540 are viaticals. The PHT Portfolio’s aggregate face value is approximately $1.3 billion as of December 31, 2017 of which $1.1 billion is attributable to life settlements and $179.1 million is attributable to viaticals. The PHT Portfolio’s aggregate fair value was estimated at $272.1 million as of December 31, 2017 of which $270.6 million was attributable to life settlements and $1.5 million is attributable to viaticals.

Life expectancy reflects the probable number of years remaining in the life of a class of persons determined statistically, affected by such factors as heredity, physical condition, nutrition, and occupation. It is not an estimate or an indication of the actual expected maturity date or indication of the timing of expected cash flows from death benefits. During the three months ended June 30, 2018, the Trust discontinued the use of life expectancies originally inherited from the Debtors based on management’s determination that such life expectancies had become outdated. Management now utilizes default mortality multipliers to determine the estimated longevity of its insureds. See: Note 6 – Fair Value Measurement, below for a more detailed discussion of this change in estimating the insureds’ longevity. The following tables (i) illustrate the immediate impact on near term longevity estimates; and (ii) summarize the Trust's life insurance policies grouped by remaining life expectancy as of June 30, 2018 and December 31, 2017:

 

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As of December 31, 2017:

 

Estimated premiums to be paid by the Trust for its portfolio during each of the five succeeding fiscal years and thereafter as of June 30, 2018, are as follows:

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There was a $30 million increase in the PHT portfolio’s face value amount from December 31, 2017 to June 30, 2018. This is due primarily to: (i) the fact that positions were allocated to the claimants who are on litigation hold despite such position not actually being issued to them because of restrictions in the Plan; (ii) other positions were deemed contributed into the PHT because the corresponding continuing fractions holder failed to pay premiums when due; and (iii) recognition of increases in certain policies’ face value.

 

The Trust’s estimated total future premium payable are $499.2 million as of June 30, 2018. This is an increase of $90.8 million from the total estimated future premiums of $408.4 million as of December 31, 2017. The increase in estimated premiums payable is due to: (i) increases in estimated life expectancies resulting from the use of standard mortality multipliers compared to previously used life expectancy estimates; and (ii) increases in the cost of insurance imposed by certain life insurance companies.

 

The Trust anticipates funding the estimated premium payments from maturities of life insurance policies. It also maintains premium reserves and access to lines of credit.

 

 

On December 9, 2016, the Trust obtained a term loan from Vida Opportunity Fund, LP, an affiliate of Vida Capital, Inc., for $55.0 million. Interest accrues at 11% of outstanding balance per annum and is paid quarterly. Principal is due in full on December 9, 2018 but is not subject to a prepayment penalty. Substantially all of the Trust’s assets collateralize the loan. As of June 30, 2018, and December 31, 2017, the outstanding balances were $22.5 million and $35.0 million, respectively.

 

On December 9, 2016, the Trust entered into a revolving line of credit with Vida Longevity Fund, LP, an affiliate of Vida Capital, Inc., for $25.0 million. Interest accrues at 11% of outstanding balance and is paid quarterly. The line of credit matures on December 9, 2018, at which point any amount outstanding is due in full. As of June 30, 2018, and December 31, 2017, no amounts have been drawn on the line of credit.

 

In accordance with the Plan, the Trust issued notes totaling approximately $36.5 million in exchange for claims against the Debtor’s estate and the interests in life insurance policies held by the exchanging claimants. The proceeds from those interests collateralize the Trust’s obligations under the notes. Interest accrues at 3% of the outstanding balance and is paid annually in December. Principal is due in full on December 9, 2031. In accordance with the note, beginning in December 2017, the Trust is required to make annual payments to a sinking fund to reserve for the current year’s interest payment and 1/15 of the notes’ original principal amount. Such fund is included in restricted cash on the accompanying balance sheets. As of June 30, 2018, and December 31, 2017, the outstanding balance of the notes was $36.5 million. The sinking fund associated with these notes has a balance of $2.4 million at June 30, 2018 and December 31, 2017.

 

On March 28, 2017, the Trust was ordered to pay the Chapter 11 trustee’s fees totaling $5.5 million. The first payment of $2.8 million was paid in 2017. The remaining balance is in the form of a note payable in the amount of $2.8 million and is due in three equal annual payments on January 1 beginning in 2019. The note does not bear interest as ordered by the Court, thus the note has been discounted by $0.2 million, based on an implied interest rate of 3% as of December 31, 2017. As of June 30, 2018, and December 31, 2017, the outstanding balance was $2.6 million.

 

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Note 6 - Fair Value Measurements

 

The Trust carries its life insurance policies at fair value. 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.

 

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.

 

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Quantitative Information about Level 3 Fair Value Measurements

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The life insurance policies’ fair value estimates were reduced significantly in the second quarter of 2018. The primary cause of the change was the use of standard mortality multipliers for all policies as opposed to using previous life expectancy estimates that were previously determined by the Debtor for certain policies. A secondary cause was the increase in the cost of insurance imposed by certain life insurance companies on a number of policies.

In assessing and determining the PHT Portfolio’s valuation, the Position Holder Trust retained Lewis & Ellis, Inc. as its principal actuaries.

Following is a summary of the methodology used to estimate the assets’ fair value measured on a recurring basis and within the above fair value hierarchy. The overall methodology did not change from first quarter 2018 to the second quarter 2018; however, the method for estimating longevity was modified during the second quarter of 2018.For the prior year and the first quarter of 2018, the PHT Portfolio’s fair value was estimated using an actuarially based approach incorporating net cash flows and life expectancies as provided by third-party life expectancy providers when they were available. If a policy did not have a LE, or the LE became aged, a default mortality multiplier was used, based on the 2015 VBT.

 

This approach applied a monthly mortality scale as generated by the specific life expectancy (“LE”) and/or a default mortality multiplier of each insured which is used to project the PHT Portfolio’s present value of net cash flows (death benefits less premium payments and servicing company compensation). The mortality scale was actuarially rolled forward from the LE underwriting date to the valuation date.

The LEs that the Trust holds were issued by life expectancy providers to the Debtor during the course of the bankruptcy. The LEs were approaching, and in some cases exceeding, two years since issuance. As LEs age, they become less reliable because they are based on increasingly out of date medical information. After two years, many industry participants obtain new medical information from insureds and purchase new LEs. The Trust does not have to do so because of the significant time and financial burden that would be required to obtain new medical releases from the insureds and collect their medical records from various doctors, clinics and hospitals.

Because it had a number of LEs that were becoming aged and, thus, less reliable, the Trust began to incrementally phase out the LEs in favor of a mortality multiplier based on the 2015 Valuation Basic Table produced by the U.S. Society of Actuaries (“2015 VBT”) beginning in December 31, 2017.  Accordingly, as the LE’s aged, less weight would be applied to them and more weight would be placed with the default mortality multiplier. A 25% discount would be applied quarterly starting 21 months past the underwriting date until the aged LE date was fully discounted and replaced by the default mortality multiplier. A LE that is 24 to 26 months old would have a 50% discount, an LE that is 27 to 29 months old will have a 75% discount, and an LE greater than or equal to 30 months would only use the default mortality multiplier, as described below. The Trust anticipated eliminating reliance on most of its LEs in favor of the mortality multiplier by the end of calendar year 2018.

As a result of its planned comparison of actual to expected mortalities during the second quarter of 2018, the Trust noticed a growing divergence between actual and expected maturities. After further analysis, the Trust determined that the LEs in its possession were less reliable than previously understood and that the mortality multipliers were providing more accurate longevity projections across the portfolio. Accordingly, the Trust’s management decided to accelerate its migration towards the mortality multipliers and stop using the LEs.

Beginning in the second quarter 2018, the PHT Portfolio’s fair value was estimated using an actuarially based approach incorporating net cash flows and life expectancies as determined by a default mortality multiplier, based on the 2015 VBT. A default mortality multiplier for each insured was used to project the PHT Portfolio’s present value of net cash flows (death benefits less premium payments and servicing company compensation).

The default mortality multipliers have not changed since the inception of the Trust. The multipliers used are 100% for the Life Settlement males, 100% for the Life Settlement females, and 350% for the viaticals regardless of gender. On a quarterly basis, the Trust compares actual mortalities to expected mortalities to refine its analysis.

The exclusive use of the mortality multipliers has had the effect of extending anticipated longevity of the insureds in the PHT Portfolio. As a result, the amount of premiums that the Trust anticipates paying increased as did the anticipated length of time before the receipt of the death benefit. These factors were major contributors to the 2018 reduction in the estimated fair value of the PHT Portfolio.

The Trust will continue to monitor historical deaths on a quarterly basis. We will compare actual to expected mortalities to refine our mortality multipliers; such that they reasonably “validate” based on our analysis of trends.  An in-depth review of the historical death experience to the mortality tables will be conducted on our third quarter results as an annual process to ensure the Trust information is current for the most accurate estimating process of valuing the investment portfolio.

 

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The monthly net cash flows with interest and survivorship were discounted to arrive at the PHT Portfolio’s estimated value as of June 30, 2018 and December 31, 2017. Future changes in the longevity estimates and estimated cash flows could have a material effect on the PHT Portfolio’s fair value, and the Trust’s financial condition and results of operations.

 

 

The table below reflects the effect on the PHT Portfolio’s fair value if the actual life expectancy experienced is 5% less or 5% more than is currently estimated. If the life expectancy estimate increases by 5% or decreases by 5%, the change in estimated fair value of the life insurance policies as of June 30, 2018 and December 31, 2017 would be as follows:

Cost of Insurance

Discount rate

The discount rate is another significant input in the fair value determination. The Trust’s estimate incorporates market factors, the size of the portfolio, and various policy specific quantitative and qualitative factors including known information about the underlying insurance policy, its economics, the insured and the insurer.

 

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Credit Exposure to Insurance Companies

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See accompanying notes to financial statements

 

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See accompanying notes to financial statements

 

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See accompanying notes to financial statements

 

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See accompanying notes to financial statements

 

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Critical Accounting Policies

Investments in Life Insurance Policies

Fair Value of Life Insurance Policies

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. The Trust’s investments in life insurance policies are considered to be Level 3 as there is currently no active market where the Trust is able to observe quoted prices for identical assets and the Trust’s valuation model incorporates significant inputs that are not observable.

The Trust’s valuation of life insurance policies is a critical estimate within the financial statements. The Trust currently uses a probabilistic method of valuing life insurance policies, which the Trust believes to be the preferred valuation method in its industry. The Trust calculates the assets’ fair value using a present value technique to estimate the fair value of the projected future cash flows. The most significant assumptions in estimating the fair value are the Trust’s estimate of the insureds’ longevity, anticipated future premium obligations and the discount rate. See Note 6, “Fair Value Measurements in the accompanying financial statements.”

Income Recognition

 

The Trust’s investments in life insurance policies are its primary source of income. Gain or loss is recognized from ongoing changes in the portfolio’s estimated fair value, including any gains or losses at maturity. Gains or losses from maturities are recognized at receipt of a death notice or verified obituary for an insured party and determined based on the difference between the death benefit and the estimated fair value of the policy at maturity.

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The Trust assumed the Debtors’ receivables related to life insurance policy premiums and service fees that were paid by the Debtors on behalf of fractional interest holders prior to the Trust’s effective date. After December 9, 2016, the policy premiums allocable to continuing fractional interest holders are those persons' obligations and not the Trust. If a continuing fractional interest holder defaults on future premium obligations, such position is deemed contributed to the Trust in exchange for the number of Units provided by the Plan.

The Trust maintains an allowance for doubtful accounts for estimated losses resulting from the inability to collect premiums and service fees receivable. Such estimates are based on the position holder’s payment history and other indications of potential uncollectability. After all attempts to collect a receivable have failed, receivables are written off against the allowance. At June 30, 2018 and December 31, 2017, the allowance for doubtful accounts was $5.0 million, all of which was for receivables assumed from the Debtors on the effective date. Outstanding receivable balances may be recoverable pursuant to the Trustee’s set-off rights under the Plan.

Maturities receivable consist of the Trust’s portion of life insurance policy maturities that occurred, but payment was not yet received as of the reporting period.

Income Taxes

No provision for state or federal income taxes has been made as the liability for such taxes is attributable to the Unit holders rather than the Trust. The Trust is a grantor trust with taxable income or loss passing through to the Unit holders. In certain instances, however, the Trust may be required under applicable state laws to remit directly to state tax authorities amounts otherwise due to Unit holders. Such payments on behalf of the Unit holders are deemed distributions to them.

 

The Financial Accounting Standards Board (the “FASB”) has provided guidance for how uncertain tax positions should be recognized, measured, disclosed, and presented in the financial statements. This requires the evaluation of tax positions taken or expected to be taken in the course of preparing the Trust’s tax returns to determine whether the tax positions are more-likely-than-not of being sustained when challenged or when examined by the applicable taxing authority. The Trust has no material uncertain income tax positions as of June 30, 2018 or December 31, 2017.

 

The Trust also assumed income tax liabilities of the Debtors at its inception which total approximately $2.0 million and $2.0 million as of June 30, 2018 and December 31, 2017, respectively, related to taxes, penalties, and interest from the Debtors’ 2008, 2009 and 2010 income tax returns. These obligations bear interest at 4% annually and is payable in equal annual installments in 2017, 2018 and 2019.

 

Accounts Payable and Accrued Expenses

Accounts payable and accrued expenses primarily include professional services, legal fees and expected litigation settlements, some of which are obligations assumed by the Trust that were incurred prior to the effective date of the Trust. The Trust also accrues liabilities for state taxes payable and other miscellaneous accruals. The Trust accrues liabilities when costs are incurred, and such costs can be reasonably estimated.

As of June 30, 2018, and December 31, 2017, the Trust holds $25.2 million and $30.2 million, respectively, in escrow for future payment of premium obligations. To the extent advanced premiums received from continuing fractional holders are not used for premium payments, they are refunded to the respective continuing fractional holder.

 

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Maturity Liability

The Trust encounters economic, legal, and longevity risk. The main components of economic risk potentially impacting the Trust are market risk, concentration of credit risk, and the increasing cost of insurance risk. The Trust’s market risks include interest rate risk and the risk of declines in valuation of the Trust’s life insurance policies, including declines caused by the selection of increased discount rates associated with the Trust’s fair value model. It is reasonably possible that future changes to estimates involved in valuing life insurance policies could change and materially affect future financial statements. Concentration of credit risk is the risk that an insurance carrier who has issued life insurance policies held by the Trust, does not remit the amount due under those policies due to the carrier’s deteriorating financial condition or otherwise. Another credit risk potentially impacting the Trust is the risk continuing fractional holders may default on their future premium obligations, increasing the Trust’s premium obligations.  The increasing cost of insurance risk includes the carriers’ attempts to change a policy’s cost of insurance.  While some cost of insurance increases are anticipated and taken into consideration in the Trusts forecasts; other cost of insurance increases are unilaterally imposed by the carrier. In 2018, one carrier increased the cost of insurance associated with its policies held by the Trust, representing about $188 million in face value, by approximately 45% over the prior cost of insurance. The Trust, through ATLES is a class plaintiff in three class actions against carriers over their cost of insurance increases.

 

Longevity risk refers to the reasonable possibility that actual mortalities of insureds in the Trust’s portfolio extend over longer periods than are anticipated, resulting in the Trust paying more in premiums and delaying its collection of death benefits.   Further, increased longevity may encourage additional continuing fraction holders to default on their premium obligations, increasing the Trust’s positions and its premium payment burden.

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As of June 30, 2018, the Trust owns an interest in 3,082 policies of which 567 are life settlement policies and 2,515 are viaticals. The PHT Portfolio’s aggregate face value is approximately $1.3 billion as of June 30, 2018 of which $1.1 billion is attributable to life settlements and $203.0 million is attributable to viaticals. The PHT Portfolio’s aggregate fair value is $190.3 million as of June 30, 2018 of which $188.0 million is attributable to life settlements and $2.3 million is attributable to viaticals.

 

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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 and interest rate risk.  As of June 30, 2018, we did not hold a material amount of financial instruments for trading purposes.

Credit Risk

Credit risk consists primarily of the potential loss arising from adverse changes in the financial condition of the issuers of the life insurance policies that we own.

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 life settlements as of June 30, 2018.

 

Interest Rate Risk

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