EMERGENT CAPITAL, INC. - Annual Report: 2010 (Form 10-K)

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

Form 10-K

 

 

Commission file number: 001-35064

 

IMPERIAL HOLDINGS, INC.

(Exact name of registrant as specified in its charter)

 

 

701 Park of Commerce Boulevard, Suite 301
Boca Raton, Florida 33487
(Address of principal executive offices, including zip code)

 

(561) 995-4200
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:

 

 

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

None

 

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

 

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

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.  Yes o     No þ

 

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

 

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

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ

 

The registrant commenced the initial public offering of its common stock in February 2011. Accordingly, there was no public market for the registrant’s common stock as of the last business day of the registrant’s most recently completed second fiscal quarter.

 

The number of shares of the registrant’s common stock outstanding as of March 25, 2011 was 21,202,614.

 

 

IMPERIAL HOLDINGS, INC.
2010 Form 10-K Annual Report

Table of Contents

 

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

 

This Annual Report on Form 10-K contains forward-looking statements that are subject to risks and uncertainties. All statements other than statements of historical fact included in this Annual Report on Form 10-K are forward-looking statements. Forward-looking statements give our current expectations and projections relating to our financial condition, results of operations, plans, objectives, future performance and business. You can identify forward-looking statements by the fact that they do not relate strictly to historical or current facts. These statements may include words such as “anticipate,” “estimate,” “expect,” “project,” “plan,” “intend,” “believe,” “may,” “will,” “should,” “can have,” “likely” and other words and terms of similar meaning in connection with any discussion of the timing or nature of future operating or financial performance or other events. These forward-looking statements are not historical facts, and are based on current expectations, estimates and projections about the Company’s industry, management’s beliefs and certain assumptions made by management, many of which, by their nature, are inherently uncertain and beyond the Company’s control. Accordingly, readers are cautioned that any such forward-looking statements are not guarantees of future performance and are subject to certain risks, uncertainties and assumptions that are difficult to predict. Although the Company believes that the expectations reflected in such forward-looking statements are reasonable as of the date made, expectations may prove to have been materially different from the results expressed or implied by such forward-looking statements. Unless otherwise required by law, the Company also disclaims any obligation to update its view of any such risks or uncertainties or to announce publicly the result of any revisions to the forward-looking statements made in this report.

 

Forward-looking statements address matters that involve risks and uncertainties. Accordingly, there are or will be important factors that could cause our actual results to differ materially from those indicated in these statements. We believe that these factors include, but are not limited to, the following:

 

 

See “Item 1A. Risk Factors” (Part I, Item 1A). All written and oral forward-looking statements attributable to the Company, or persons acting on its behalf, are expressly qualified in their entirety by these cautionary statements. You should evaluate all forward-looking statements made in this Annual Report on Form 10-K in the context of these risks and uncertainties. The Company cautions you that the important factors referenced above may not contain all of the factors that are important to you.

 

All statements in this Annual Report on Form 10-K to “Imperial,” “Company,” “we,” “us,” or “our” refer to Imperial Holdings, Inc. and its consolidated subsidiaries unless the context suggests otherwise.

 

 

Overview

 

We are a specialty finance company with a focus on providing premium financing for individual life insurance policies issued by insurance companies generally rated “A+” or better by Standard & Poor’s or “A” or better by A.M. Best Company at the time of the financing and purchasing structured settlements backed by annuities issued by insurance companies or their affiliates generally rated “A1” or better by Moody’s Investors Services or “A−” or better by Standard & Poor’s. We were founded in December 2006 as a Florida limited liability company and in connection with our initial public offering, on February 3, 2011, we converted from a Florida limited liability company to a Florida corporation.

 

Premium Finance Business

 

Overview

 

A premium finance transaction is a transaction in which a life insurance policyholder obtains a loan, predominately through an irrevocable life insurance trust established by the insured, to pay insurance premiums for a fixed period of time, allowing a policyholder to maintain coverage under the policy without having to make premium payments during the term of the loan. A premium finance transaction also benefits life insurance agents by preventing a life insurance policy from lapsing, which could require the agent to repay a portion of the commission earned in connection with the issuance of the policy.

 

As of December 31, 2010, the average principal balance of the loans we have originated since inception is approximately $215,000. As used throughout this Annual Report on Form 10-K, references to “principal balance of the loan” refer to the principal amount loaned by us in a premium finance transaction without including origination fees or interest. The life insurance policies that serve as collateral for our premium finance loans are predominately universal life policies that have an average death benefit of approximately $4.4 million and insure persons over age 65. We currently make loans to borrowers in 9 states with the insureds residing in any of the 50 states. As used throughout this Annual Report on Form 10-K, references to “borrower” refer to the entity or individual executing the note in a premium finance transaction. In nearly all instances, the borrower is an irrevocable life insurance trust established for estate planning purposes by the insured which is both the legal owner and beneficiary of a life insurance policy serving as collateral for a premium finance loan.

 

Our typical premium finance loan is approximately two years in duration and is collateralized by the underlying life insurance policy. We generate revenue from our premium finance business in the form of agency fees from referring agents, interest income and origination fees as follows:

 

 

The policyholder is not required to make any payment on the loan until maturity. At the end of the loan term, the policyholder either repays the loan in full (including all interest and fees) or, defaults under the loan. In the event of default, subject to policy terms and conditions, the borrower typically relinquishes to us control of the policy serving as collateral for the loan, after which we may either seek to sell the policy, hold it for investment, or, if the loan is insured, we are paid a claim equal to the insured value of the policy, which may be equal to or less than the amount we are owed under the loan. As of December 31, 2010, 93.9% of our outstanding loans have collateral whose value is insured. With the net proceeds from our recently completed initial public offering, we have the option to retain for investment a number of the policies relinquished to us upon a default. When we choose to retain the policy for investment, we are responsible for all future premium payments needed to keep the policy in effect. We have developed proprietary systems and processes that, among other things, determine the minimum monthly premium outlay required to maintain each retained life insurance policy.

 

Our premium finance borrowers are currently referred to us through independent insurance agents and brokers licensed under state law. Prior to January 2009, we originated some premium finance loans that were sold by life insurance agents that we employed. Once a potential borrower has been referred to us, we assess the borrower’s creditworthiness and the fair value of the life insurance policy to serve as collateral. We further support our loan origination efforts with specialized sales teams that guide agents and brokers through the lending process. Our transaction processing and servicing processes and systems allow us to process a high volume of applications while maintaining the ability to structure complex negotiated transactions and apply our strict underwriting standards. Our existing technology infrastructure allows us to service our current loan volume efficiently, and is designed to permit us to service an increased loan volume.

 

To help protect against fraud and to seek profitable transactions, we perform extensive underwriting before entering into a transaction. We use strict loan underwriting guidelines that, among other things, require:

 

 

We believe that our underwriting guidelines have been effective in mitigating fraud-related risks.

 

We require the borrower to have at least one independent professional trustee to ensure that the trust follows its obligation with respect to administration of the trust’s activities as set forth in the trust instrument as well as the premium finance loan agreement and related documents. If the borrower does not have such a trustee, we require the borrower to amend the trust documentation and appoint an independent professional trustee that will be responsible for ensuring the life insurance premiums are paid to the life insurance company. The professional trustee administers the process of making the premium payments to the life insurance company as they come due from funds the trust holds in escrow for payment of such premiums. We also work with the trustee to monitor the status of the life insurance policy in order to ensure that it remains in force, alert the trustee when premium payments are due and to help ensure that premiums paid are correctly applied by the issuing life insurance company.

 

When we approve a premium finance loan, the borrower executes a loan agreement and other related documents, which contain representations, warranties and guaranties from the insured and representations and warranties from the referring agent or broker in regard to the accuracy of the information provided to us and the issuing life insurance company. The funds required to cover all of the premiums due during the term of a premium finance loan are wired up front directly to the borrower. We do not fund loans that are in excess of the premiums previously paid and future premiums that are scheduled to come due on the policy during the term of the loan. In

order to determine the amount of premiums previously paid by the borrower so as to be certain we are not advancing more then future and past premiums, we require a statement from the issuing life insurance company showing the amount of prior payments.

 

Sources of Revenue

 

For the year ended December 31, 2010 and December 31, 2009, 87.6% and 95.9%, respectively, of our revenue was generated from our premium finance segment. We generate revenue from our premium finance business in the form of agency fees from the referring insurance agent, interest income and origination fees as follows:

 

 

 

 

We are repaid our principal as well as our origination fees and interest income in one of the following three ways:

 

 

With the net proceeds from our recently completed initial public offering, we have the option to retain for investment a number of the policies relinquished to us upon a default. When we retain for investment policies relinquished to us upon default, we will receive the death benefit of the policy upon the death of the insured as long as we continue to pay the premiums required to keep the policy in force and the policy is not contested.

 

Since we were founded in December 2006, nearly all of our loan maturities have occurred during a time of dislocations in the capital markets and, as a result, our historical methods of repayment may not be indicative of future performance. The following table shows the method of repayment for loans maturing during the following periods:

 

 

Cost of Financing

 

In our premium finance business, we have historically relied heavily on debt financing. Debt financing has become prohibitively expensive for our business. Every credit facility we have entered into since December 2007 for our premium finance business has required us to obtain lender protection insurance for each loan originated under such credit facility. This coverage provides insurance on the value of the underlying life insurance policy serving as collateral underlying the loan should our borrower default. Subject to the terms and conditions of the lender protection insurance policy, in the event of a payment default by the borrower, our lender protection insurer has the right to direct control or take beneficial ownership of the life insurance policy and we are paid a claim equal to the insured value of the life insurance policy serving as collateral underlying the loan. We also pay a premium to a contingent lender protection insurer for each of our loans originated under our White Oak and Cedar Lane credit facilities. Our cost for contingent lender protection insurance has been included as part of our cost for lender protection insurance. The cost for lender protection insurance has ranged from 8.5% to 11% per annum of the principal balance of the loan. As of December 31, 2010, 93.9% of our outstanding premium finance loans have collateral whose value is insured. By procuring lender protection insurance, we have been able to borrow at interest rates ranging from 14% to 22%. After December 31, 2010, we ceased originating premium finance loans with lender protection insurance. As a result, we currently have ceased originating new premium finance loans under our credit facilities. With the net proceeds of our recently completed initial public offering, we will fund our new premium finance business with equity financing instead of relying on debt financing and lender protection insurance.

 

The following table shows our total financing cost per annum as a percentage of the principal balance of the loans originated during the following periods (as used throughout this Annual Report on Form 10-K, references to “financing cost” refer to the aggregate cost attributable to credit facility interest, other lender charges and, where applicable, obtaining lender protection insurance on our premium finance loans):

 

 

As of December 31, 2010, we had total debt outstanding of $91.6 million of which $59.4 million, or 64.9%, is owed by our special purpose entities which were established for the purpose of obtaining debt financing to fund premium finance loans. This debt is collateralized by life insurance policies underlying premium finance loans that we have assigned, or in which we have sold participation rights, to our special purpose entities. We have obtained

lender protection insurance for nearly all of these premium finance loans. Debt owned by these special purpose entities is generally non-recourse to us and our other subsidiaries except to the extent of our equity interest in these special purpose entities. One exception is the Cedar Lane facility where we have guaranteed 5% of the applicable special purpose entity’s obligations. Messrs. Mitchell and Neuman (“our CEO and our COO”) made certain guaranties to lenders for the benefit of the special purpose entities for matters other than financial performance. These guaranties are not unconditional sources of credit support but are intended to protect the lenders against acts of fraud, willful misconduct or a borrower commencing a bankruptcy filing. To the extent lenders sought recourse against our CEO and our COO for such non-financial performance reasons, then our indemnification obligations to our CEO and our COO may require us to indemnify them for losses they may incur under these guaranties.

 

As of December 31, 2010, our promissory note had an outstanding principal balance and related interest of approximately $2.4 million and our debenture payable had an outstanding principal balance net of discount of approximately $29.7 million. The promissory note and debenture payable were converted into shares of our common stock upon the closing of our recently completed initial public offering.

 

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

 

 

 

 

Premium Finance Transaction Process

 

A typical premium finance transaction is generally completed in accordance with the steps outlined below:

 

 

Underwriting Procedures

 

We consider and analyze a variety of factors in evaluating each potential premium financing transaction. Our underwriting procedures require that the policyholder provide documentation confirming that the policyholder has a bona fide insurable interest in the life of the insured. We will not finance premiums for a policyholder if we determine that the policyholder has been paid or promised an inducement at any time. Since June 2008, our guidelines have required that every borrower have an existing, in-force, life insurance policy and provide proof of at least one prior premium payment from their own funds prior to our funding of a loan. With respect to our premium finance transactions in which we loan money for premiums previously paid by the policyholder, we do not fund loans with proceeds to the policyholder that are in excess of the premiums previously paid and future premiums due on the policy. Typically, 15-20% of the principal balance of the loan is for premiums already paid by the policyholder and 80-85% is for future premiums. Each applicant is required to sign an unconditional personal guaranty as to various matters related to the funding of the loan, including as to the accuracy of the information provided in the life insurance policy application, as further support for our underwriting procedures, including our assessment of whether the applicant is engaged in a STOLI (“stranger originated life insurance”) transaction. In the event of a default under the guaranty, the guarantor guarantees the payment of all outstanding principal and accrued and unpaid interest under the premium finance loan, any early termination fees, costs and expenses payable (including, but not limited to, reasonable attorneys’ fees) as well as any and all costs and expenses to enforce the guaranty (including, but not limited to, reasonable attorneys’ fees). To date, we have never collected on a personal guaranty. Our premium finance legal group reviews every application and assess the validity of the applicant’s

insurable interest in the life of the insured before a loan is funded. We believe our business practices are designed to minimize the risk of our financing any STOLI policy.

 

Our underwriting procedures require that we use third-party medical underwriters to evaluate the medical condition and life expectancy of each insured. We only enter into transactions which meet certain credit and financial standards, including concentration limits for carrier credit, medical impairment and expected mortality. We use medical reviews from third-party medical underwriters and then we select a conservative view of the insured’s health — the healthiest outlook. These procedures reduce our risk that the insured’s life span is longer than expected.

 

Since our inception in December 2006, we have received over 24,000 life expectancy evaluations. These evaluations have provided us with an extensive exposure to each of the major life expectancy underwriters. Using those evaluations for comparative analysis, we assess which underwriters are generally the most conservative and which are most aggressive, and what biases each underwriter employs in their analysis. In our experience, certain underwriters trend more conservatively for certain sexes, some more for certain ages, and different underwriters have different levels of risk assigned to different medical conditions. We record this data for every underwriting evaluation we receive. We identify not only underwriter biases and sensitivities, strengths and weaknesses but also trends over time, which allows us to better identify the fair value of life insurance policies using our proprietary models.

 

We review potential premium finance transactions for the creditworthiness and ratings of each insurance carrier. In addition to our internal review of the creditworthiness of an insurance carrier, our general guideline for approval of an insurance carrier is a rating of at least “A+” by Standard & Poor’s, at least “A3” by Moody’s, at least “A” by A.M. Best Company or at least “A+” by Fitch. The issuing insurance carrier’s claims paying ability generally must satisfy the applicable ratings of at least two of the foregoing rating agencies as a condition to our funding a premium finance loan. However, based upon our own credit determination, we may provide financing for life insurance policies issued by domestic insurers that are unrated but have a highly-rated parent or affiliate as well as unrated foreign insurers. As of the date of this Annual Report on Form 10-K, we have not experienced any insurer default.

 

Servicing

 

Our servicing department administers all necessary premium payments, loan satisfaction and policy relinquishment processes. They maintain contact with insureds, trustees and referring agents or brokers to obtain current information on policy status. Our servicing department also updates the medical histories of insureds. They request updated medical records from physicians and also contact each insured to obtain updated health information. During the term of a loan, when our servicing department learns of a material health impairment, key personnel in our sales team and management are alerted and our records are updated accordingly.

 

With respect to the administration of the policy relinquishment processes, our servicing department sends notices approximately sixty and thirty days prior to the loan maturity date alerting the borrower that the loan is maturing. In the event of a default, our servicing department will send an agreement to the borrower and its beneficiaries requesting that they agree to relinquish ownership of the policy and all interests therein to us in exchange for a release of the obligation to pay amounts due. If the loan goes into default, we ask the borrower to liquidate the policy. To assist a borrower with its liquidation of a policy, we will introduce the borrower to potential buyers as well as to life settlement brokers. We receive no commission or fee for these introductions or any sale of the policy by the borrower. The liquidation proceeds are used to pay off our loan, including accrued interest and origination fees, and the balance is retained by the borrower. If the liquidation proceeds of a policy are less than the amount to pay off the loan, the borrower seeks our consent in order to liquidate the policy. We may either approve the sale of the policy for less than the amount due on the loan or may decide to take control of the policy. If the loan is covered by lender protection insurance, then the lender protection insurer, rather than us, must consent to the liquidation of the policy if the liquidation proceeds are going to be less than the loan’s insured value. If we are unable to come to an agreement with the borrower regarding the relinquishment of the policy, we may enforce our security interests in the beneficial interests in the trust that owns the policy pursuant to which we can exercise control over the trust holding the policy in order to direct disposition of the policy.

Our Proprietary Systems and Processes

 

We have developed proprietary systems and processes that allow us to, among other things:

 

 

We use a customized application service provider to capture data and manage process flow that is frequently updated by the vendor and avoids the restraints of legacy systems. This system captures all the information necessary to manage, document, report and analyze the sales, underwriting, compliance, funding and servicing components of the premium finance business without the need for a large information technology staff. Compliance reviews have been implemented into our system enabling us to quickly verify the compliance status of every transaction we process.

 

There are numerous insurance companies that meet our ratings guidelines that offer life insurance to high net worth seniors. Each of these companies offers a variety of different life insurance policies with different features and limitations for the insured. New policy types are introduced regularly and existing policy types are modified for new applicants. We have developed proprietary models to assist us in analyzing the fair value of a life insurance policy. In order to determine which policies we believe are the most valuable, we analyze the legal and financial terms of each policy and product type, as well as the health, sex and age of the insured. Based on these and other inputs, we calculate loan balances, policy values and summaries of the cash flows and yields of a potential transaction. Furthermore, we are able to run these models based on life expectancies from a number of different medical underwriters, which allows us to determine the collateral value we believe exists in a policy. Furthermore, the life expectancy evaluations we receive allow us to assess which underwriters are generally the most conservative and which are most aggressive, as well as the biases each underwriter employs in their analysis. These models allow us to evaluate and immediately rank and score the policies based on value and volatility, which, in turn, allows us to determine which premium finance transactions provide us with the best value.

 

Our proprietary models also allow us to enter data to produce the minimum premium schedule that is required to keep the death benefit in force year-over-year until policy maturity. This minimizes the cash outflows required to pay premiums on a policy. Our premium optimizer model takes into account the complex aspects of the individual product structure, such as no-lapse guarantees, policy endorsements, sub-accounts and shadow accounts.

 

Structured Settlements Business

 

Overview

 

Structured settlements refer to a contract between a plaintiff and defendant whereby the plaintiff agrees to settle a lawsuit (usually a personal injury, product liability or medical malpractice claim) in exchange for periodic payments over time. A defendant’s payment obligation with respect to a structured settlement is usually assumed by a casualty insurance company. This payment obligation is then satisfied by the casualty insurer through the purchase of an annuity from a highly rated life insurance company, which provides a high credit quality stream of payments to the plaintiff.

 

Recipients of structured settlements are permitted to sell their deferred payment streams to a structured settlement purchaser pursuant to state statutes that require certain disclosures, notice to the obligors and state court approval. Through such sales, we purchase a certain number of fixed, scheduled future settlement payments on a discounted basis in exchange for a single lump sum payment, thereby serving the liquidity needs of structured settlement holders.

We use national television marketing to generate in-bound telephone and internet inquiries. As of December 31, 2010, we had a database of over 30,000 structured settlement leads. We believe our database provides a strong pipeline of purchasing opportunities. As our database has grown and we have completed more transactions, the average marketing cost per structured settlement transaction, which is one of our key expense metrics, has decreased.

 

Our structured settlements purchasing team is trained to work with a prospective client to review the transaction documentation and to assess a client’s needs. Our underwriting group is responsible for reviewing all proposed purchases and performing a detailed analysis of the associated documentation. We have also developed a cost-effective nationwide network of law firms to represent us in the required court approval process for structured settlements. Historically, the average cycle time starting from submission of the paper work to funding the transaction was 69 days. This cycle includes the evaluation and structuring of the transaction, an economic review, pricing and coordination of the court process. Our underwriting procedures and process timeline for structured settlement transactions are described below.

 

Marketing

 

We do not believe that there are any readily available lists of holders of structured settlements, which makes brand awareness critical to growing market share. We have a primary target market consisting of individuals 18 to 49 years of age with middle class income or lower.

 

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

 

We use our software to efficiently capture all inbound calls. We have built a proprietary database of clients and prospective clients. As of December 31, 2010, we had a database of over 30,000 structured settlement leads. Since inception, we have purchased a total of 229 structured settlements from existing customers in repeat transactions. The percentage of repeat transactions has grown from 5% in the three months ended March 31, 2008 to 31% in the three months ended December 31, 2010. Therefore, we believe our database provides us with a strong pipeline of potential purchasing opportunities with low incremental acquisition cost. When our call center staff is not answering inbound calls, they call contacts in the database to generate business. As our database and pool of customers grow, we expect to complete more transactions and our cost of marketing per transaction should decrease. We have made a significant investment to obtain the information for our database and believe it would be time-consuming and expensive for a competitor to replicate.

 

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

 

 

We believe this cost per transaction will continue to trend down over time. Additionally, our transactions with repeat customers are more profitable than with new customers due to the reduction in transaction costs. As our database grows, it provides more purchasing opportunities. The following table shows the number and percentage

of our total structured settlement transactions completed with repeat customers for the three-month periods indicated:

 

 

As we grow our experienced sales staff, we intend to air more television advertisements to increase our volume of inbound calls. We believe that there are a substantial number of broadcasts viewed by our primary target market, which presents an opportunity to expand our marketing efforts. We also plan to expand our Internet marketing.

 

Funding

 

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

 

 

Sources of Revenue

 

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

 

 

The discount rate at which we acquire structured settlements payment has increased from 2007 to 2010. As our purchasing team gains experience, we are able to improve duration and yield objectives. Furthermore, as we complete more transactions with repeat customers who are familiar with members of our purchasing team, these transactions are driven more by relationship than price.

Underwriting Procedures, Transaction Timeline and Process

 

Our underwriting team is responsible for reviewing all proposed structured settlement transactions and performing a detailed analysis of the transaction documentation. The team identifies any statutory requirements, as well as any issues that could affect the structured settlement receivables, such as liens, judgments or bankruptcy filings. The team confirms the existence and value of the structured settlement receivables, that the purchase conform to our established internal credit guidelines, that all applicable statutory requirements are complied with and confirms that the asset is free from encumbrances. In addition, the underwriting team administers the transaction from the creation of the transaction documentation through the court approval process, and then approves a transaction for funding.

 

Each structured settlement transaction requires a court order approving the transaction. The individual court hearings are administered by a team of outside attorneys that we have selected and developed relationships with. Outside counsel are able to access our origination systems via a secure portal to update records, creating process efficiencies.

 

As of December 31, 2010, our typical structured settlement transaction was completed in an average of 69 days from the date of initial contact by the client. The following events would occur during such 69 day period:

 

 

Our Competitive Strengths

 

We believe our competitive strengths are:

 

 

 

Business Strategy

 

Guided by our experienced management team, with the net proceeds from our recently completed initial public offering, we intend to pursue the following strategies in order to increase our revenues and generate net profits:

 

 

Regulation

 

Premium Financing Transactions

 

The making, enforcement and collection of premium finance loans is subject to extensive regulation. These regulations vary widely, but often:

 

 

Furthermore, the enforcement and collection of premium finance loans may be directly or indirectly affected by the laws and regulations applicable to the life insurance policies that collateralize the premium finance loans. We are also subject to various state and federal regulations governing lending, including usury laws. In addition, our

premium financing programs must comply with insurable interest, usury, life settlement, life finance, rebating, or other insurance and consumer protection laws.

 

The sale and solicitation of life insurance is highly regulated by the laws and regulations of individual states and other applicable jurisdictions. The purchase of a policy directly from a policy owner, which is referred to as a life settlement, is a business we are currently able to conduct in 36 states; however, as of December 31, 2010, we have not engaged in the business of purchasing policies directly from policy owners. Regulation of life settlements (life insurance policies) is done on a state-by-state basis. We currently maintain licenses to transact life settlements (life insurance policies) in 24 of the 38 states that currently require a license. A majority of the state laws and regulations concerning life settlements (life insurance policies) are based on the Model Act and Model Regulation adopted by the National Association of Insurance Commissioners (NAIC) and the Model Act adopted by the National Conference of Insurance Legislators (NCOIL). The NAIC and NCOIL models include provisions which relate to: (i) provider and broker licensing requirements; (ii) reporting requirements; (iii) required contract provisions and disclosures; (iv) privacy requirements; (v) fraud prevention measures such as STOLI; (vi) criminal and civil remedies; (vii) marketing requirements; (viii) the time period in which policies cannot be sold in life settlement transactions; and (viii) other rules governing the relationship between policy owners, insured persons, insurer, and others.

 

Traditionally, the U.S. federal government has not directly regulated the insurance business. Congress recently passed and the President signed into law the Dodd-Frank Act, providing for the enhanced federal supervision of financial institutions, including insurance companies in certain circumstances, and financial activities that represent a systemic risk to financial stability of the U.S. economy. Under the Dodd-Frank Act, the Federal Insurance Office will be established within the U.S. Treasury Department to monitor all aspects of the insurance industry. The director of the Federal Insurance Office will have the ability to recommend that an insurance company or insurance holding company be subject to heightened prudential standards by the Federal Reserve, if it is determined that financial distress at the company could pose a threat to the financial stability of the U.S. economy. Notwithstanding the creation of the Federal Insurance Office, the Dodd-Frank Act provides that state insurance regulators will remain the primary regulatory authority over insurance and expressly withholds from the Federal Insurance Office and the U.S. Treasury Department general supervisory or regulatory authority over the business of insurance.

 

Structured Settlements

 

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

 

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

Competition

 

Premium Finance

 

The market for premium finance is very competitive. A policyholder has a number of ways to pay insurance premiums which include using available cash, borrowing from traditional lenders such as banks, credit unions and finance companies, as well as more specialized premium finance companies like us. Competition among premium finance companies is based upon many factors, including price, valuation of the underlying insurance policy, underwriting practices, marketing and referrals. Our principal competitors within the premium finance industry are CMS, Inc., Insurative Premium Finance Ltd. and Madison One as well as smaller, less well known companies. Life settlement companies that compete with our premium finance business by providing liquidity to policyholders through the sale of life insurance policies include Coventry First LLC, Life Partners Holdings, Inc. and ViaSource Funding Group, LLC, as well as smaller, less well known companies. It is possible that a number of our competitors may be substantially larger and may have greater market share and capital resources than we have.

 

Structured Settlements

 

There are a number of competitors in the structured settlement market. Competition in the structured settlement market is primarily based upon marketing, referrals and quality of customer service. Based on our industry knowledge, we believe that we are one of the larger acquirers of structured settlements in the United States. Our main competitors are J.G. Wentworth & Company, Inc., Peachtree Settlement Funding, Novation Capital LLC (a subsidiary of Encore Financial Services), Settlement Capital and Stone Street Capital.

 

Pre-Settlement Funding Business

 

As a result of our marketing for structured settlements, we receive a number of inquiries from plaintiffs, whose cases have not yet settled or otherwise been disposed of, seeking pre-settlement funding. Pre-settlement funding provides personal injury plaintiffs with a payment in exchange for an assignment of a portion of the proceeds of their pending case. Accident victims often are unable to work for a prolonged period of time and therefore incur high expenses which they find difficult to meet. As a result, accident victims often look to obtain prompt settlements. The pre-settlement funding payment provides a victim and their attorney with the flexibility to continue litigating a case by satisfying the victim’s immediate need for funds.

 

In May 2010, we entered an agreement with Plaintiff Funding Holding, Inc., doing business under the name LawCash. Pursuant to this agreement, we are required to exclusively forward all pre-settlement leads to LawCash, which will screen leads, provide underwriting, funding, servicing and collection services. At funding for a transaction generated from one of our leads, we receive commission of 5% of the actual funded amount. Upon repayment by the plaintiff, we receive 25% of the net profit, which is the difference between (a) the funding advance and LawCash’s costs and (b) the payoff amount, from LawCash. The typical transaction size is approximately $2,500. The agreement with LawCash is terminable by either party for convenience upon 30 days’ prior written notice. To date the Company hasn’t recognized any significant revenue from this agreement.

 

Employees

 

As of December 31, 2010, we had 131 employees. None of our employees is subject to any collective bargaining agreement. We believe that our employee relations are good.

 

 

Risk Factor Relating to Capital Markets

 

Difficult conditions in the credit and equity markets have adversely affected and may continue to adversely affect the growth of our business, our financial condition and results of operations.

 

Beginning in 2007, the United States’ capital markets experienced extensive distress and dislocation due to the global economic downturn and credit crisis. As a result of this dislocation in the capital markets, our borrowing costs increased dramatically in our premium finance business, and we were unable to access traditional sources of

capital to finance the acquisition and sale of structured settlements. At certain points, we were unable to obtain any debt financing. Furthermore, such market conditions forced us to obtain lender protection insurance for our premium finance loans. The cost of this insurance, together with our credit facility interest rate costs, has resulted in total average financing costs of approximately 27.0% per annum of the principal balance of the loans as of December 31, 2010. Our ability to grow depends, in part, on our ability to increase transaction volume in each of our businesses, while successfully managing our growth, and on our ability to access sufficient capital or enter into financing arrangements on favorable terms. With the net proceeds from our recently completed initial public offering, we expect to rely on equity financing and our existing debt financing arrangements to fund our business going forward. However, should additional financing be needed in the future, continued or future dislocations in the capital markets may adversely affect our ability to obtain debt or equity financing. In addition, the future availability of lender protection insurance may affect our ability to obtain debt financing for our premium finance business should additional debt financing be needed. Our provider of lender protection insurance ceased providing us with lender protection insurance on December 31, 2010. This decision by our provider of lender protection insurance only addresses future loans and does not impact our existing premium finance loans. Lender protection insurance on our existing loans will continue for the life of such loans. If we are unable to access sufficient capital or enter into financing arrangements on favorable terms in the future, the growth of our business, our financial condition and results of operations may be materially adversely affected.

 

Risk Factors Related to Premium Finance Transactions

 

Uncertainty in valuing the life insurance policies collateralizing our premium finance loans can affect the fair value of the collateral and if the fair value of the collateral decreases, we will incur losses if the fair value of the collateral is less than the carrying value of the loan.

 

We evaluate all of our premium finance loans for impairment, on a monthly basis, based on the fair value of the underlying life insurance policies, as the collectability is primarily dependent on the fair value of the policy serving as collateral. For loans without lender protection insurance, the fair value of the policy is determined using our valuation model, which is a Level 3 fair value measurement. See “Management’s Discussion and Analysis — Critical Accounting Policies — Fair Value Measurement Guidance.” For loans with lender protection insurance, the insured value is also considered when determining the fair value of the life insurance policy. The lender protection insurer limits the amount of coverage to an amount equal to or less than its determination of the value of the life insurance policy underlying our premium finance loan based on the lender protection insurer’s own models and assumptions. For all loans, the amount of impairment, if any, is calculated as the difference in the fair value of the life insurance policy and the carrying value of the loan. As used throughout this Annual Report on Form 10-K, references to “carrying value of the loan” refer to the loan principal balance, accrued interest and accreted origination fees excluding any impairment valuation adjustment. A loan impairment valuation is established as losses on our loans are estimated and charged to the provision for losses on loans receivable, and the provision is charged to earnings. Once established, the loan impairment valuation cannot be reversed to earnings.

 

In the ordinary course of business, a large portion of our borrowers may default by not paying off the loan and relinquish beneficial ownership of the life insurance policy to us in exchange for our release of the underlying loan. When this occurs, we record the investment in the policy at fair value. At the end of each reporting period, we re-value the life insurance policies we own. If the calculation results in an adjustment to the fair value of the policy, we record this as a change in fair value of our investment in life insurance policies.

 

This evaluation of the fair value of life insurance policies is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. Using our valuation model, we determine the fair value of life insurance policies using a discounted cash flow basis, incorporating current life expectancy assumptions. The discount rate incorporates current information about market interest rates, the credit exposure to the insurance company that issued the life insurance policy and our estimate of the risk margin an investor in the policy would require. To determine the life expectancy of an insured, we utilize medical reviews from third-party medical underwriters. The health of the insured is summarized by the medical underwriters into a life assessment which is based on the review of historical and current medical records. The medical underwriter assesses the characteristics and health risks of the insured in order to quantify the health into a mortality rating that represents

their life expectancy. The probability of mortality for an insured is then calculated by applying the life expectancy estimate to an actuarial table.

 

Insurable interest concerns regarding a life insurance policy can also adversely impact its fair value. A claim or the perceived potential for a claim for rescission by an insurance company or by persons with an insurable interest in the insured of a portion of or all of the policy death benefit can negatively impact the fair value of a life insurance policy.

 

If the calculation of fair value results in a decrease in value, we record this reduction as a loss. As and when loan impairment valuations are established due to the decline in the fair value of the policies collateralizing our loans, our net income will be reduced by the amount of such impairment valuations in the period in which the valuations are established, and as a result our business, financial condition and results of operations may be materially adversely affected.

 

Our success in operating our premium finance business will be dependent upon using equity financing rather than debt financing and lender protection insurance, and making accurate assumptions about life expectancies so that we may maintain adequate cash balances to pay premiums.

 

With the net proceeds of our recently completed initial public offering, we will fund our new premium finance business with equity financing instead of relying on debt financing and lender protection insurance. Without lender protection insurance on our loans, we have the option to retain a number of life insurance policies that we expect borrowers will relinquish to us in the event of default, instead of taking the direction of our lender protection insurer with respect to the disposition of such life insurance policies. If we retain a life insurance policy, we will be responsible for paying all premiums necessary to keep the policy in force. Therefore, our cash flows and the required amount of our cash reserves to pay premiums will become dependent on our assumptions about life expectancies being accurate. By using cash reserves to pay premiums for retained life insurance policies, we will have less cash available for making new premium finance loans as well as less cash available for other business purposes. Adverse changes in fair value of retained life insurance policies will negatively impact our financial statements.

 

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

 

If these life expectancy valuations underestimate the longevity of the insureds, the actual maturity date of the life insurance policies may therefore be longer than projected. Consequently, we may not have sufficient reserves for payment of insurance premiums and we may allow the policies to lapse, resulting in a loss of our investment in those policies, or if we continue to fund premium payments, the time period within which we could expect to receive a return of our investment in such life insurance policies may be extended, either of which could have a material adverse effect on our business, financial condition and results of operation.

The premium finance business is highly regulated; changes in regulation could materially adversely affect our ability to conduct our business.

 

The making, enforcement and collection of premium finance loans is extensively regulated by the laws and regulations of many states and other applicable jurisdictions. These laws and regulations vary widely, but often:

 

 

In addition, our premium finance transactions are subject to state usury laws, which limit the interest rate that can be charged. While we attempt to structure these transactions to avoid being deemed in violation of usury laws, we cannot assure you that we will be successful in doing so. Loans found to be at usurious interest rates may be voided, which would mean the loss of our principal and interest.

 

To the extent that more restrictive regulations or more stringent interpretations of existing regulations are adopted in the future, the future costs of compliance with such changes in regulations could be significant and our ability to conduct our business may be materially adversely affected. There is additional regulatory risk with respect to the acquisition of a life insurance policy in the event of a payment default when we are otherwise unable to sell the policy collateralizing our premium finance loan. For example, if a state insurance regulator were to take the position that our premium finance loans or the acquisition of life insurance policies serving as collateral for such loans should be characterized as life settlement transactions subject to applicable regulations, we could be issued a cease and desist order effectively requiring us to suspend premium finance transactions for an indefinite period, and be subject to fines and other penalties.

 

Our success in our premium finance business depends on maintaining relationships within our referral networks.

 

We rely primarily upon agents and brokers to refer potential premium finance customers to us. These relationships are essential to our operations and we must maintain these relationships to be successful. We do not have fixed contractual arrangements with the referring agents and brokers and they are free to do business with our competitors. Our ability to build and maintain relationships with our agents and brokers depends upon the amount of agency fees we charge and the value of the services we provide. For the year ended December 31, 2010, our top ten agents and brokers referred to us approximately 31.02% and 50.13%, respectively, of our premium finance business, based upon the loan maturity balances of the loans originated during such period. The loss of any of our top-referring agents and brokers could have a material adverse effect on our business, financial condition and results of operations.

 

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

 

All states require that the initial purchaser of a new life insurance policy insuring the life of an individual have an insurable interest in such individual’s life at the time of original issuance of the policy. Whether an insurable interest exists in the context of the purchase of a life insurance policy is critical because, in the absence of a valid insurable interest, life insurance policies are unenforceable under most states’ laws. Where a life insurance policy has been issued to a policyholder without an insurable interest in the life of the individual who is insured, the life insurance company may be able to void or rescind the policy, but must repay to the owner of the policy all premium payments, usually without interest. Even if the insurance company cannot void or rescind the policy, however, the insurable interest laws of a number of states provide that persons with an insurable interest on the life of the insured

may have the right to recover a portion or all of the death benefit payable under a policy from a person who has no insurable interest on the life of the insured. These claims can generally only be brought if the policy was originally issued to a person without an insurable interest in the life of the insured. However, some states may require that this insurable interest not only exist at the time that a life insurance policy was issued, but also at any later time that the policy is transferred.

 

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

 

Premium finance loan originations are susceptible to practices which can invalidate the underlying life insurance policy and subject us to material fines or license suspension or revocation.

 

Many states in which we do business have laws which define and prohibit stranger-originated life insurance (“STOLI”) practices, which in general involve the issuance of life insurance policies as part of or in connection with a practice or plan to initiate life insurance policies for the benefit of a third party investor who, at the time of the policy issuance, lacked a valid insurable interest in the life of the insured. Most of these statutes expressly provide that premium finance loans that only advance life insurance premiums and certain permissible expenses are not STOLI practices or transactions. Under these statutes, a premium finance loan, as well as any life insurance policy collateralizing such loan, must meet certain criteria or such policy can be invalidated, or deemed unenforceable, in its entirety. We cannot control whether a state regulator or borrower will assert that any of our loans should be treated as STOLI transactions or that the loans do not meet the criteria required under the statutes.

 

The legality and merit of “investor-initiated” life insurance products have also been questioned by members of the industry, certain life insurance providers and certain regulators.

 

The premium finance industry has been tainted by lawsuits based on allegations of fraud and misconduct. These lawsuits involve allegations of fraud, breaches of fiduciary duty and other misconduct by industry participants. Some of these cases are brought by life insurance companies attacking the original issuance of the policies on insurable interest and fraud grounds. Notwithstanding the litigation in this industry, there is a lack of judicial certainty in the legal standards used to determine the validity of insurable interest supporting a life insurance policy or the existence of STOLI practices. Lawsuits sometimes focus on transfers of equity interests of the policyholder (e.g., beneficial interests of an irrevocable trust holding a policy) that occur very shortly after or contemporaneously with the issuance of the policy or arrangements whereby the premium finance lender, the life insurance agent and the insured agree to transfer the policy to the premium finance lender or another third party shortly after the policy issuance or the “contestability period.” The “contestability period” is a period of time, usually two years, after which the policy cannot be contested by the issuing life insurance company under the terms of the policy other than for the nonpayment of premiums. Some states have adopted exceptions to such limitation for fraud or other similar malfeasance by the policyholder.

 

While our loan underwriting guidelines are designed to lessen the risks of our participation in STOLI or other business that originates life insurance policies not supported by a valid insurable interest, a regulator’s or carrier’s assertion to the contrary and subsequent successful enforcement could have a material adverse effect on the fair value of the policies collateralizing our premium finance loans and our ability to originate business going forward. In particular, the closer the origination date of a premium finance loan transaction is to the life insurance policy

issuance date, there is increasing risk that a life insurance policy may be subject to contest or rescission on the basis that such policy was issued on the basis of a misrepresentation regarding premium financing, as part of STOLI practices or was not supported by a valid insurable interest. As of December 31, 2010, 11.4%, 57.1%, 82.6%,96.5%, and 99.1%, respectively, of our premium finance loans outstanding were originated within one month, three months, six months, one year and two years, respectively, of the issuance of the underlying life insurance policy. Regulatory, legislative or judicial changes in these areas could materially and adversely affect our ability to participate in the premium finance business and could significantly increase the costs of compliance, resulting in lower revenue or a complete cessation of our premium finance business. In addition, in this arena, regulatory action for statutory or regulatory infractions could involve fines or license suspension or revocation. We may be unable to obtain or maintain the licenses necessary for us to conduct our premium finance business.

 

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

 

Our premium finance loans are secured by the underlying life insurance policy. If the underlying policy is subject to contest or rescission, the fair value of the collateral could be reduced to zero. Life insurance policies may generally be contested or rescinded by the issuing life insurance company within the contestability period and sometimes beyond the contestability period, depending on the grounds for rescission and applicable law. Misrepresentations, fraud, omissions or lack of insurable interest can, in some instances, form the basis of loss of right to payment under a life insurance policy for many years beyond the contestability period. Whether or not there exists a reasonable legal basis for a contest or rescission, it can result in a cloud on the title or collectability of the policy. Contestation can be based upon any material misrepresentation or omission made in the life insurance policy application, even if unintentional. Misleading or incomplete answers by the insured to any questions asked by the insurance carrier regarding the financing of premiums, the policyholder’s net worth or the insured’s health and medical history and condition as well as to any other questions on a life insurance policy application, can lead to claims that a material misrepresentation or omission was made and may give rise to the insurance carrier’s right to void, contest or rescind the policy. Lack of a valid insurable interest of the life insurance policy owner in the insured also may give rise to the insurance carrier’s right to void, contest or rescind the policy. Although we obtain representations and warranties from the insured, policyholders and referring agents, we may not know whether the applicants for any of our policies have made any material misrepresentations or omissions on the policy applications, or whether the policy owner has a valid insurable interest in the insured, and as such, the policies securing our loans are subject to the risk of contestability or rescission. In addition, some insurance carriers have contested policies as STOLI arrangements, specifically citing the existence of certain nonrecourse premium financing arrangements as a basis to challenge the validity of the policies used to collateralize the financing. A policy may be voided or rescinded by the insurance carrier if found to be a STOLI policy where a valid insurable interest did not exist in the insured at policy inception. From time to time, an insurance carrier has challenged the validity of a policy securing one of our premium finance loans, but the impact on our business from these challenges has not been significant to date. Future challenges to the policies that we own or hold as collateral for our premium finance loans may have a material adverse effect on our business, financial condition and results of operations.

 

If the insurance company successfully contests or rescinds a policy, the policy will be declared void, and in such event, the insurance company’s liability would be limited to a refund of all the insurance premiums paid for the policy without any accrued interest. While defending an action to contest or rescind a policy, premium payments may have to continue to be made to the life insurance company. Furthermore, a life insurance company may refuse to refund any of the premiums paid and seek to retain them as an offset to damages it claims to have suffered in connection with the issuance of the life insurance policy. Additionally, the issuing insurance company may refuse to cooperate with us by not providing information, processing notices and/or paperwork required to document the transaction. Hence, in the case of a contest or rescission, premiums paid to the carrier (including those paid during the pendency of a contest or rescission action) may not be refunded. If they are not, we may suffer a complete loss with respect to this portion of the loan amount which may adversely affect our business, financial condition and results of operations.

Premium financed life insurance policies are susceptible to a higher risk of fraud and misrepresentation in life insurance applications.

 

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

 

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

 

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

 

Delays in payment and non-payment of life insurance policy proceeds may have a material adverse effect on our business, financial condition and results of operations.

 

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

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

 

In many instances, individuals establish an irrevocable trust to hold and own their life insurance policy for estate planning reasons. In our premium finance business, the majority of the premium finance borrowers are trusts owning life insurance policies. A bankruptcy of the insured, a bankruptcy of a beneficiary of a trust owning the life insurance policy or a bankruptcy of the trust itself could prevent us from acquiring the life insurance policy following an event of default under the related premium finance loan unless consent of the applicable bankruptcy court is obtained or it is determined that the automatic stay generally arising following a bankruptcy filing is not applicable. A failure to promptly obtain any required bankruptcy court consent within one hundred twenty (120) days following the maturity date of the related premium finance loan could delay or prevent us from making a claim under the lender protection insurance policy for any loss sustained following a default under the premium finance loan. Lender protection insurance insures us against certain risks of loss associated with our premium finance loans, including payment default by the borrower. If a premium finance loan is not repaid, the lender protection insurer, subject to the lender protection insurance policy’s terms and conditions, has the right to direct control or take beneficial ownership of the underlying life insurance policy and we are paid a claim equal to the insured value of the life insurance policy. If we are delayed or otherwise prevented from making a claim under the lender protection insurance policy for any loss sustained following a default under the premium finance loan, additional premium payments will need to be made to keep the life insurance policy in force. As a result, we may be forced to expend additional funds, or borrow funds at unfavorable rates if such financing is even available, in order to fund the premiums or, if we are unable to obtain the necessary funds, we may be forced to allow the policy to lapse, resulting in the loss of the premiums we financed in the transaction. Such events could have a material adverse effect on our business, financial condition and results of operations.

 

Our lender protection insurance policies have significant exclusions and limitations.

 

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

 

 

 

 

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

 

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

 

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

 

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

 

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

 

We are dependent on the creditworthiness of the life insurance companies that issue the policies serving as collateral for our premium finance loans. We assume the credit risk associated with life insurance policies issued by various life insurance companies. Furthermore, there is a concentration of life insurance companies that issue the policies that serve as collateral for our premium finance loans. Over 60% of our premium finance loans outstanding as of December 31, 2010 are secured by life insurance policies issued by four life insurance companies. The failure or bankruptcy of any such life insurance company or annuity company could have a material adverse impact on our ability to achieve our investment objectives. A life insurance company’s business tends to track general economic and market conditions that are beyond its control, including extended economic recessions or interest rate changes. Changes in investor perceptions regarding the strength of insurers generally and the policies or annuities they offer can adversely affect our ability to sell or finance our assets. Adverse economic factors and volatility in the financial markets may have a material adverse effect on a life insurance company’s business and credit rating, financial condition and operating results, and an issuing life insurance company may default on its obligation to pay death benefits on the life insurance policies we acquired following a payment default on our premium finance loans when we are otherwise unable to sell the underlying policy. In such event, we would experience a loss of our investment in such life insurance policies which would have a material adverse effect on our business, financial condition and results of operations.

 

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

 

For any life insurance policies that we own or finance, we will be responsible for paying insurance premiums due. If a life insurance company is able to increase the cost of insurance charged for any of the life insurance policies that we own or finance, the amounts required to be paid for insurance premiums due for these life insurance policies may increase, requiring us to incur additional costs for the life insurance policies, which may adversely affect returns on such life insurance policies and consequently reduce the secondary market value of such life insurance policies. Failure to pay premiums on the life insurance policies when due will result in termination or “lapse” of the

life insurance policies. The insurer may in a “lapse” situation view reinstatement of a life insurance policy as tantamount to the issuance of a new life insurance policy and may require the current owner to have an insurable interest in the life of the insured as of the date of the reinstatement. In such event, we would experience a loss of our investment in such life insurance policy.

 

Failure to protect our premium finance transaction clients’ confidential information and privacy could adversely affect our business.

 

Our premium finance business is subject to privacy regulations and to confidentiality obligations. For example, the collection and use of medical data is subject to national and state legislation, including the Health Insurance Portability and Accountability Act of 1996, or HIPAA. The actions we take to protect such confidential information include, among other things:

 

 

However, if we do not properly comply with privacy regulations and protect confidential information, we could experience adverse consequences, including regulatory sanctions, such as penalties, fines and loss of licenses, as well as loss of reputation and possible litigation.

 

Risk Factors Related to Structured Settlements

 

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

 

We are dependent on third parties to purchase our structured settlements. Our ability to grow our business depends upon our ability to sell our structured settlements at favorable discount rates and to establish alternative financing arrangements. Third party purchasers or other financing may not be available to us in the future on favorable terms or at all. If such other third party purchasers or other financing are not available, then we may be required to seek additional equity financing, if available, which would dilute the interests of shareholders who purchased common stock in our recently completed offering.

 

We may not be able to continue to sell our structured settlements to third parties at favorable discount rates or obtain financing through borrowings or other means on acceptable terms to satisfy our cash requirements, either of which could have a material adverse effect on our ability to grow our business.

 

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

 

The use of structured settlements is largely the result of the favorable federal income tax treatment of such transactions. In 1979, the Internal Revenue Service issued revenue rulings that the income tax exclusion of personal injury settlements applied to related periodic payments. Thus, claimants receiving installment payments as

compensation for a personal injury were exempt from all federal income taxation, provided certain conditions were met. This ruling, and its subsequent codification into federal tax law in 1982, resulted in the proliferation of structured settlements as a means of settling personal injury lawsuits. Changes to tax policies that eliminate this exemption of structured settlements from federal taxation could have a material adverse effect on our future profitability. If the tax treatment for structured settlements were changed adversely by a statutory change or a change in interpretation, the dollar volume of structured settlements could be reduced significantly which would also reduce the level of our structured settlement business. In addition, if there were a change in the federal tax code that would result in adverse tax consequences for the assignment or transfer of structured settlements, such change could have a material adverse effect on our business, financial condition and results of operations.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

We do not believe that there are any readily available lists of holders of structured settlements, which makes brand awareness critical to growing market share. We use national television marketing to generate in-bound telephone and internet inquiries and we have built a proprietary database of clients and prospective clients. As of December 31, 2010, we had a database of over 30,000 structured settlement leads. If the identities of structured settlement holders were to become readily available to our competitors or to the general public, we could face

increased competition and the value of our proprietary database would be diminished, which would have a negative effect on our structured settlement business, financial condition and results of operations.

 

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

 

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

 

Risk Factors Relating to Our General Business

 

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

 

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

 

Traditionally, the U.S. federal government has not directly regulated the insurance business. However, the Dodd-Frank Wall Street Reform and Consumer Protection Act, which we refer to in this Annual Report on Form 10-K as the “Dodd-Frank Act”, provides for the enhanced federal supervision of financial institutions, including insurance companies in certain circumstances, and financial activities that represent a systemic risk to financial stability or the U.S. economy. Under the Dodd-Frank Act, the Federal Insurance Office will be established within the U.S. Treasury Department to monitor all aspects of the insurance industry. Notwithstanding the creation of the Federal Insurance Office, the Dodd-Frank Act provides that state insurance regulators will remain the primary regulatory authority over insurance and expressly withholds from the Federal Insurance Office and the U.S. Treasury Department general supervisory or regulatory authority over the business of insurance. At this time, we cannot assess whether any other proposed legislation or regulatory changes will be adopted, or what impact, if any, the Dodd-Frank Act or any other legislation or changes could have on our results of operations, financial condition or liquidity.

 

In addition, we are subject to various federal and state regulations regarding the solicitation of customers. The Federal Communications Commission and Federal Trade Commission have issued rules that provide for a national “do not call” registry. Under these rules, companies are prohibited from contacting any individual who requests to have his or her phone number added to the registry, except in certain limited instances. We are required to continually review the national “do not call” registry to ensure that we do not contact anyone on that registry. In February 2009, we received a citation for violating these rules. In the event we violate these rules in the future, we could be subject to a fine of up to $16,000 per violation or each day of a continuing violation, which could have a material adverse effect on our business, financial condition and results of operations.

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

 

The Securities and Exchange Commission, or the SEC, recently issued a report recommending that sales of life insurance policies in life settlement transactions be regulated as securities for purposes of the federal securities laws. Although as of December 31, 2010, we have never purchased a policy directly from a policy owner, any legislation implementing such regulatory change or a change in the transactions that are characterized as life settlement transactions could lead to increased compliance costs and adversely affect our ability to acquire or sell life insurance policies in the future, which could have an adverse effect on our business, financial condition and results of operations.

 

Negative press from media or consumer advocacy groups and as a result of litigation involving industry participants could have a material adverse effect on our business, financial condition and results of operations.

 

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

 

We have limited operating experience.

 

Our business operations began in December 2006. Consequently, while certain of our management are very experienced in the premium finance and structured settlement businesses, we have limited operating history in both of our business segments. With the net proceeds of our recently completed initial public offering, we have the option to retain a number of life insurance policies that we expect borrowers will relinquish to us in the event of default, instead of taking the direction of our lender protection insurer with respect to the disposition of such life insurance policies. However, since our inception, we have had limited experience managing and dealing in life insurance policies owned by us. Therefore, the historical performance of our operations may be of limited relevance in predicting future performance.

 

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

 

Our success depends to a significant degree upon the continuing contributions of our key executive officers including Antony Mitchell, our chief executive officer, and Jonathan Neuman, our president and chief operating officer. These officers have significant experience operating businesses in structured settlements and premium finance transactions, which are highly regulated industries. In connection with our recently completed initial public offering, we have entered into employment agreements with each of these executive officers. We do not maintain key man life insurance with respect to any of our executives.

 

Mr. Mitchell is a citizen of the United Kingdom who is working in the United States as a lawful permanent resident on a conditional basis. In order to retain his lawful permanent residency, Mr. Mitchell applied to have the conditions on his permanent resident status removed and pending review of his application, he has been granted an extension of conditional permanent resident status to March 31, 2012. Although Mr. Mitchell has applied to have the conditions on his lawful permanent residency removed, he may not satisfy the requirements to have the conditions removed, or his application to do so may not be approved. The failure to remove the conditions on his permanent residency could result in Mr. Mitchell having to leave the United States or cause him to seek an alternative immigration status in the United States.

 

The loss of Mr. Mitchell or Mr. Neuman or other executive officers or key personnel could have a material adverse effect on our business, financial condition and results of operations.

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

 

There are a number of finance companies that compete with us. Many are significantly larger and possess considerably greater financial, marketing, management and other resources than we do. The premium finance business and structured settlement business could also prove attractive to new entrants. As a consequence, competition in these sectors may increase. In addition, existing competitors may increase their market penetration and purchasing activities in one or more of the sectors in which we participate. The availability of the type of insurance policies that meet our actuarial and underwriting standards for our premium finance transactions is limited and sought by many of our competitors. Also, we rely on life insurance agents and brokers to refer premium finance transactions to us, and our competitors may offer better terms and conditions to such life insurance agents and brokers. Increased competition could result in reduced origination volume, reduced discount rates and/or other fees, each of which could materially adversely affect our revenue, which would have a material adverse effect on our business, financial condition and results of operations.

 

Risk Factors Relating to Our Common Stock

 

If securities or industry analysts publish inaccurate or unfavorable research about our business, our stock price and trading volume could decline.

 

The trading market for our common stock depends in part on the research and reports that securities or industry analysts publish about us or our business. If one or more of the analysts who covers us downgrades our common stock or publishes inaccurate or unfavorable research about our business, our stock price would likely decline. If one or more of these analysts ceases coverage of us or fails to publish reports on us regularly, demand for our common stock could decrease, which could cause our stock price and trading volume to decline.

 

Future sales of our common stock may affect the trading price of our common stock and the future exercise of options may lower the price of our common stock.

 

We cannot predict what effect, if any, future sales of our common stock, or the availability of shares for future sale, will have on the trading price of our common stock. Sales of a substantial number of shares of our common stock in the public market, or the perception that such sales could occur, may adversely affect the trading price of our common stock and may make it more difficult for you to sell your shares at a time and price that you determine appropriate. In connection with our initial public offering, we and our current directors and executive officers, and certain of our shareholders, have entered into 180-day lock-up agreements. An aggregate of 3,600,000 shares of our common stock are subject to these lock-up agreements, plus any shares purchased by such officers, directors, employees and shareholders and their respective affiliates in the directed share program other than shares purchased by Pine Trading, Ltd. and its affiliates.

 

Being a public company will increase our expenses and administrative workload and will expose us to risks relating to evaluation of our internal controls over financial reporting required by Section 404 of the Sarbanes-Oxley Act of 2002.

 

As a public company, we must comply with additional laws and regulations, including the Sarbanes-Oxley Act of 2002, the Dodd-Frank Act, and related rules of the SEC and requirements of the New York Stock Exchange. We were not required to comply with these laws and requirements as a private company. Complying with these laws and regulations will require the time and attention of our board of directors and management and will increase our expenses. Among other things, we will need to: design, establish, evaluate and maintain a system of internal controls over financial reporting in compliance with the requirements of Section 404 of the Sarbanes-Oxley Act and the related rules and regulations of the SEC and the Public Company Accounting Oversight Board; prepare and distribute periodic reports in compliance with our obligations under the federal securities laws; establish new internal policies, principally those relating to disclosure controls and procedures and corporate governance; institute a more comprehensive compliance function; and involve to a greater degree our outside legal counsel and accountants in the above activities.

 

In addition, we expect that being a public company may make it more expensive for us to renew our director and officer liability insurance. We may be required to accept reduced coverage or incur substantially higher costs to

obtain this coverage. These factors could also make it more difficult for us to attract and retain qualified executives and members of our board of directors, particularly directors willing to serve on our audit committee.

 

We are in the process of evaluating our internal control systems to allow management to report on, and our independent registered public accounting firm to assess, our internal controls over financial reporting. We plan to perform the system and process evaluation and testing (and any necessary remediation) required to comply with the management certification and auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act.

 

However, we cannot be certain as to the timing of completion of our evaluation, testing and remediation actions or the impact of the same on our operations. Furthermore, upon completion of this process, we may identify control deficiencies of varying degrees of severity under applicable SEC and Public Company Accounting Oversight Board rules and regulations that remain unremediated.

 

If we fail to implement the requirements of Section 404 in a timely manner, we might be subject to sanctions or investigation by regulatory agencies such as the SEC. In addition, failure to comply with Section 404 or the report by us of a material weakness may cause investors to lose confidence in our financial statements or the trading price of our common stock to decline. If we fail to remediate any material weakness, our financial statements may be inaccurate, our access to the capital markets may be restricted and the trading price of our common stock may decline.

 

As a public company, we are required to report, among other things, control deficiencies that constitute a “material weakness” or changes in internal controls that materially affect, or are reasonably likely to materially affect, internal controls over financial reporting. A “control deficiency” exists when the design or operation of a control does not allow management or employees, in the normal course of performing their assigned functions, to prevent or detect misstatements on a timely basis. A “significant deficiency” is a control deficiency, or combination of control deficiencies, that adversely affects the ability to initiate, authorize, record, process or report financial data reliably in accordance with generally accepted accounting principles that results in more than a remote likelihood that a misstatement of financial statements that is more than inconsequential will not be prevented or detected. A “material weakness” is a significant deficiency, or a combination of significant deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected.

 

Our independent registered public accounting firm has in the past identified certain deficiencies in our internal controls that it considered to be control deficiencies and material weaknesses. If we fail to remediate these internal control deficiencies and material weaknesses and maintain an effective system of internal controls over financial reporting, we may not be able to accurately report our financial results.

 

During their audit of our financial statements for the years ended December 31, 2008 and 2007, Grant Thornton LLP, our independent registered public accounting firm, identified certain deficiencies in our internal controls, including deficiencies that they considered to be significant deficiencies and material weaknesses. Specifically, in their audit of our financial statements for the year ended December 31, 2008, our independent registered public accounting firm identified a material weakness relating to the number of adjustments recorded to reconcile differences and to correct accounts improperly booked relating to the year-end closing and reporting process. In their audit of our financial statements for the year ended December 31, 2007, our independent registered public accounting firm identified material weaknesses relating to (i) the incorrect recordation of agency fees, (ii) a reversal of capital contributions entry due to inaccuracies in the timing of the payments and (iii) inaccuracies in the input of maturity dates of loans. Additionally, the audit identified a significant control deficiency with respect to the number of adjusting journal entries as a result of us having a limited accounting staff.

 

In response, we initiated corrective actions to remediate these control deficiencies and material weaknesses. Although no material weaknesses were identified during the audit of our financial statements for the periods ended December 31, 2009 and 2010. it is possible that we or our independent registered public accounting firm may identify material weaknesses in our internal control over financial reporting in the future. Any failure or difficulties in implementing and maintaining these controls could cause us to fail to meet our periodic reporting obligations or result in material misstatements in our financial statements. The existence of a material weakness could result in errors to our financial statements requiring a restatement of our financial statements, cause us to fail to meet our

reporting obligations and cause investors to lose confidence in our reported financial information, which could lead to a decline in our stock price.

 

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

 

We have entered into employment agreements with our executive officers as described in the section titled “Executive Compensation — Employment Agreements.” The agreements for our Chief Executive Officer and President provide for substantial payments in the event of a material change in the geographic location where such officers perform their duties or upon a material diminution of their base salaries or responsibilities. For Messrs. Mitchell and Neuman, these payments are equal to three times the sum of base salary and the average of the three years’ annual cash bonus, unless the triggering event occurs during the first three years of their respective employment agreements, in which case the payments are equal to six times base salary. These payments may deter any transaction that would result in a change in control, which could diminish the price of our common stock.

 

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

 

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

 

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

 

Certain laws of the State of Florida could impede an attempt to replace or remove our directors or otherwise effect a change of control, which could diminish the price of our common stock.

 

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

 

Additionally, one of our subsidiaries, Imperial Life Settlements, LLC, a Delaware limited liability company, is licensed as a viatical settlement provider and is regulated by the Florida Office of Insurance Regulation. As a Florida viatical settlement provider, Imperial Life Settlements, LLC is subject to regulation as a specialty insurer under certain provisions of the Florida Insurance Code. Under applicable Florida law, no person can finally acquire, directly or indirectly, 10% or more of the voting securities of a viatical settlement provider or its controlling company without the written approval of the Florida Office of Insurance Regulation. Accordingly, any person who

acquires beneficial ownership of 10% or more of our voting securities will be required by law to notify the Florida Office of Insurance Regulation no later than five days after any form of tender offer or exchange offer is proposed, or no later than five days after the acquisition of securities or ownership interest if no tender offer or exchange offer is involved. Such person will also be required to file with the Florida Office of Insurance Regulation an application for approval of the acquisition no later than 30 days after the same date that triggers the 5-day notice requirement.

 

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

 

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

 

 

None.

 

 

Our principal executive offices are located at 701 Park of Commerce Boulevard, Boca Raton, Florida 33487 and consist of approximately 21,000 square feet of leased office space. We also lease office space in Atlanta, Georgia and Chicago, Illinois, which consist of approximately 176 and 150 square feet, respectively. We consider our facilities to be adequate for our current operations.

 

 

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

 

We are otherwise party to various other legal proceedings which arise in the ordinary course of business. We believe that the resolution of these other proceedings will not, based on information currently available to us, have a material adverse effect on our financial position or results of operations.

 

 

 

Shares of our common stock began trading on the New York Stock Exchange, or NYSE, under the symbol “IFT” on February 8, 2011. As of March 25, 2011, we had 7 holders of record of our common stock.

 

Dividend Policy

 

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

 

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

 

Use of Proceeds from Initial Public Offering

 

On February 7, 2011, the Company’s registration statement on Form S-1 (File No. 333-168785) was declared effective for the Company’s initial public offering, pursuant to which the Company registered the offering and sale by the Company of 16,666,667 shares of common stock and the additional sale pursuant to the underwriters’ over-allotment of up to an additional 2,500,000 shares of common stock, at a public offering price of $10.75 per share. FBR Capital Markets & Co. acted as lead bookrunner, JMP Securities LLC acted as joint lead manager and Wunderlich Securities, Inc. acted as co-manager for the offering.

 

In the initial public offering, on February 7, 2011, the Company sold 16,666,667 shares of common stock and pursuant to the underwriters’ over-allotment, on February 15, 2011, the Company sold 935,947 shares of common stock, at a public offering price of $10.75 per share. The offering has since terminated and 1,564,053 of the 2,500,000 shares of common stock included in the underwriters’ over-allotment were not sold. We received net proceeds of approximately $174.4 million after deducting underwriting discounts and commissions and our offering expenses of $14.9 million. None of such payments were direct or indirect payments to any of the Company’s directors or officers or their associates or to persons owning 10 percent or more of the Company’s common stock or direct or indirect payments to others.

 

Since our initial public offering occurred in February 2011, we had not received the net proceeds from the offering as of December 31, 2010. In fiscal year 2011, we intend to use approximately $130.0 million of the net proceeds in our premium financing lending activities and up to $20.0 million in our structured settlement activities. We intend to use the remaining proceeds for general corporate purposes. There has been no material change in the planned use of proceeds from our initial public offering as described in our final prospectus filed with the SEC pursuant to Rule 424(b).

 

Equity Compensation Plans

 

Prior to our initial public offering, in February 2011, our board of directors and shareholders approved the Imperial Holdings 2010 Omnibus Incentive Plan that reserves an aggregate of 1,200,000 shares of common stock for future issuance. Prior to our initial public offering, we had no equity compensation plan.

 

The following table sets forth our selected historical and unaudited pro forma consolidated financial and operating data as of such dates and for such periods indicated below. The selected unaudited pro forma condensed and combined consolidated financial data for the years ended December 31, 2010 and 2009 give pro forma effect to our conversion from a Florida limited liability company into a Florida corporation and conversion of a promissory note and debenture into shares of our common stock in connection with our initial public offering as if they had occurred on the first day of the periods presented. The selected unaudited pro forma financial and operating data set forth below are presented for information purposes only, should not be considered indicative or actual results of operations that would have been achieved had the corporate conversion been consummated on the dates indicated, and do not purport to be indicative of balance sheet data or income statement data as of any future date or future period and does not give effect to our initial public offering. These selected historical and unaudited pro forma consolidated results are not necessarily indicative of results to be expected in any future period. You should read the following financial information together with the other information contained in this Annual Report on Form 10-K, including “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the financial statements and related notes.

 

The selected historical income statement data for the years ended December 31, 2010, 2009, and 2008 and balance sheet data as of December 31, 2010 and 2009 were derived from our audited consolidated financial statements included elsewhere in this Annual Report on Form 10-K. The income statement data for the period from December 15, 2006 through December 31, 2006 and balance sheet data for December 31, 2008, 2007 and 2006 were derived from our audited consolidated financial statements that are not included in this Annual Report on Form 10-K.

 

 

 

 

 

 

 

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

 

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

 

 

 

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

 

Business Overview

 

We are a specialty finance company with a focus on providing premium financing for individual life insurance policies and purchasing structured settlements. We manage these operations through two business segments: premium finance and structured settlements. In our premium finance business we earn revenue from interest charged on loans, loan origination fees and agency fees from referring agents. In our structured settlement business, we purchase structured settlements at a discounted rate and sell such assets to, or finance such assets with, third parties.

 

Beginning in 2007, the United States’ capital markets experienced extensive distress and dislocation due to the global economic downturn and credit crisis. As a result of the dislocation in the capital markets, our borrowing costs increased dramatically in our premium finance business and we were unable to access traditional sources of capital to finance the acquisition and sale of structured settlements. At certain points, we were unable to obtain any debt financing.

In February 2011, we completed an initial public offering of common stock pursuant to which we received net proceeds of approximately $174.4 million, after deduction underwriting discounts and commissions and our offering expenses. We will utilize the net proceeds to finance and grow our premium finance and structured settlement businesses. We will originate new premium finance loans without relying on debt financing and will continue to finance the acquisition and sale of structured settlements.

 

Premium Finance Business

 

A premium finance transaction is a transaction in which a life insurance policyholder obtains a loan to pay insurance premiums for a fixed period of time, which allows a policyholder to maintain coverage without additional out-of-pocket costs. Our typical premium finance loan is approximately two years in duration and is collateralized by the underlying life insurance policy. The life insurance policies that serve as collateral for our premium finance loans are predominately universal life policies that have an average death benefit of approximately $4.4 million and insure persons over age 65.

 

We expect that, in the ordinary course of business, a large portion of our borrowers may default on their loans and relinquish beneficial ownership of their life insurance policy to us. Our loans are secured by the underlying life insurance policy and are usually non-recourse to the borrower. If the borrower defaults on the obligation to repay the loan, we generally have no recourse against any assets except for the life insurance policy that collateralizes the loan.

 

Dislocations in the capital markets have forced us to pay higher interest rates on borrowed capital since the beginning of 2008. Every credit facility we have entered into since December 2007 for our premium finance business has required us to obtain lender protection insurance for each loan originated under such credit facility. This coverage provides insurance on the value of the life insurance policy serving as collateral underlying the loan should our borrower default. After a payment default by the borrower, subject to the terms and conditions of the lender protection insurance policy, our lender protection insurer has the right to direct control or take beneficial ownership of the life insurance policy, and we are paid a claim equal to the insured value of the policy. While lender protection insurance provides us with liquidity, it prevents us from realizing the appreciation, if any, of the underlying policy when a borrower relinquishes ownership of the policy upon default. As of December 31, 2010, 93.9% of our outstanding premium finance loans have collateral whose value is insured. After December 31, 2010, we ceased originating premium finance loans with lender protection insurance. As a result, we currently have ceased originating new premium finance loans under our credit facilities. We will utilize a portion of the net proceeds from our initial public offering to fund new premium finance loans.

 

We have experienced two adverse consequences from our high financing costs: reduced profitability and decreased loan originations. While the use of lender protection insurance allowed us to access debt financing to support our premium finance business, the cost of lender protection insurance substantially reduced the earnings from our premium finance segment. Additionally, coverage limitations related to our use of lender protection insurance reduced the number of otherwise viable premium finance transactions that we could complete. During the year ended December 31, 2010, these coverage limitations became even stricter and further reduced the number of loans we could originate. We believe that the net proceeds from our recently completed initial public offering will allow us to increase the profitability and number of new premium finance loans by eliminating the cost of debt financing and lender protection insurance and the limitations on loan originations that our lender protection insurance imposed.

 

In response to the large increase in our financing costs, in 2008 we implemented a policy to charge origination fees on all premium finance loans and we have since increased the origination fees that we charged.

 

We charge a referring insurance agent an agency fee for services related to premium finance loans. Agency fees and origination fee income have helped us to mitigate the cost of lender protection insurance and our credit facilities. While origination fee income and interest are earned over the life of our premium finance loans, our agency fees are earned at the time of funding. This results in our premium finance business generating significant income during periods of high loan originations but experiencing lower income during periods when there are fewer loan originations.

Despite the use of lender protection insurance, we found it very difficult to secure financing for our premium finance lending business segment during 2008, 2009 and 2010. Traditional capital providers such as commercial banks, investment banks, conduit programs, hedge funds and private equity funds reduced their lending commitments and raised their lending rates. There were periods during 2008 and 2009 when our premium finance segment was unable to originate loans due to our inability to access capital. We were without credit and therefore unable to originate premium finance loans for a total of 9 weeks in 2008 and for a total of 35 weeks in 2009. As a result, we experienced a significant decline in premium finance loan originations from 499 loans originated in 2008 to 194 loans originated in 2009, a decrease of 61%. This also led to a significant reduction in agency fees from $48.0 million in 2008 to $26.1 million in 2009. In 2010, we had adequate access to capital but we nonetheless experienced further declines in premium finance loan originations. Our lender protection insurer’s coverage guidelines were stricter in 2010, which resulted in loan originations declining to 97 loans, a decrease of 50% from 2009. As a result, agency fees declined to $10.1 million in 2010.

 

The amount of losses on loan payoffs and settlements, net, and the amount of gains on the forgiveness of debt that we have recorded since inception within our premium finance business segment have been impacted as a result of financial difficulties experienced by one of our lenders, Acorn Capital Group (“Acorn”). Beginning in July 2008, Acorn stopped funding under its credit facility with us without any advance notice. Therefore, we did not have access to funds necessary to pay the ongoing premiums on the policies serving as collateral for our borrower’s loans that were financed under the Acorn facility. We did not incur liability with our borrowers because the terms of the Acorn loans provide that we are only required to fund future premiums if our lender provides us with funds. Through December 31, 2010, a total of 104 policies financed under the Acorn facility incurred losses primarily due to non-payment of premiums.

 

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

 

On the notes that were cancelled under the Acorn facility, we had debt forgiven totaling $7.6 million and $16.4 million for the year ended December 31, 2010 and 2009, respectively. We recorded these amounts as gain on forgiveness of debt. Partially offsetting these gains, we had loan losses totaling $5.5 million and $10.2 million during the years ended December 31, 2010, and 2009, respectively. We recorded these amounts as loss on loan payoffs and settlements, net. As of December 31, 2010, only 15 loans out of 119 loans originally financed in the Acorn facility remained outstanding.

 

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

 

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

 

 

 

 

Structured Settlements

 

Structured settlements refer to a contract between a plaintiff and defendant whereby the plaintiff agrees to settle a lawsuit (usually a personal injury, product liability or medical malpractice claim) in exchange for periodic payments over time. Recipients of structured settlements are permitted to sell their deferred payment streams pursuant to state statutes that require certain disclosures, notice to the obligors and state court approval. Through such sales, we purchase a certain number of fixed, scheduled future settlement payments on a discounted basis in exchange for a single lump sum payment, thereby serving the liquidity needs of structured settlement holders. During year ended December 31, 2009 and 2010, this purchase discount produced a yield that averaged 16.3% and 19.4%, respectively. We generally sell our structured settlement assets to institutional investors for cash and recognize a gain on the sale.

 

Structured settlements are an attractive asset class for institutional investors for several reasons. The majority of the insurance companies that issue the structured settlements we purchase carry financial strength ratings of “A1” or better by Moody’s Investors Services or “A−” or better by Standard & Poor’s. The periodic payments that make up structured settlements can extend for 20 years or more. This long average life coupled with no risk of prepayment and little credit risk result in a relatively liquid financial asset that can be sold directly to institutional investors such as insurance companies and pension funds.

 

We believe that we have various funding alternatives for the purchase of structured settlements. In addition to available cash, on September 24, 2010, we entered into an arrangement to provide us up to $50 million to finance the purchase of structured settlements. We also have other parties to whom we have sold settlement assets in the past, and to whom we believe we can sell assets in the future. We will continue to evaluate alternative financing arrangements, which could include selling pools of structured settlements to third parties and securing a warehouse line of credit that would allow us to aggregate structured settlements.

 

During the capital markets dislocation in 2008 and 2009, in order to sell portfolios of structured settlements to strategic buyers, we were required to offer discount rates as high as approximately 12.0%. During 2010, the discount rate for our sale of structured settlements decreased. During the year ended December 31, 2010, our weighted average sale discount rate for sales of structured settlements was 8.9%, which includes the sale of both guaranteed (non life-contingent) and life-contingent structured settlements. Life-contingent structured settlements are deferred payment streams that terminate upon the death of the structured settlement recipient. Guaranteed (non life-contingent) structured settlements terminate on a pre-determined date and do not cease upon the recipient’s death.

 

We originated 565 transactions during the year ended December 31, 2010 as compared to 396 transactions during the same period in 2009, an increase of 43%. We incurred total expenses of $13.1 million during the year ended December 31, 2010 as compared to $9.5 million during the year ended December 31, 2009. The historical operating results of our structured settlement segment reflect our investment in the start up costs and the initial growth of our structured settlement operations.

Principal Revenue and Expense Items

 

Components of Revenue

 

Agency Fee Income

 

In connection with our premium finance business, we earn agency fees that are paid by the referring life insurance agents. Because agency fees are not paid by the borrower, such fees do not accrue over the term of the loan. We typically charge and receive agency fees from the referring agent within approximately 46 days of our funding the loan. Referring insurance agents pay 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 is 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:

 

 

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 charge on our premium finance loans are floating rates that are calculated at the one-month LIBOR rate plus an applicable margin. In addition, our premium finance loans have a floor interest rate and are capped at 16.0% per annum. For loans with floating rates, each month the interest rate is recalculated to equal one-month LIBOR plus the applicable margin, and then, if necessary, adjusted so as to remain at or above the stated floor rate and at or below the capped rate of 16.0% per annum. 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:

 

 

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.

 

Origination Fee Income

 

We charge our borrowers an origination fee as part of the premium finance loan origination process. It is 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:

 

Gain on Sale of Structured Settlements

 

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

 

Gain on the Forgiveness of Debt

 

We entered into a settlement agreement with Acorn, as described previously, whereby our borrowings under the Acorn credit facility were cancelled, resulting in a gain on forgiveness of debt. A gain on forgiveness of debt is recorded at the time at which we are legally released from our borrowing obligations.

 

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 change in fair value of life settlement and structured settlement receivables.

 

Gain on Sale of Life Settlements

 

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

 

Components of Expenses

 

Interest Expense

 

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

 

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

 

 

Provision for Losses on Loans Receivable

 

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

impairments are charged to the provision for losses on loans receivable in our consolidated and combined statement of operations.

 

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

 

For loans that matured during the year ended December 31, 2010 and 2009, 99.3% and 85%, respectively, of such loans were not repaid at maturity. In such events of default, the borrower typically relinquishes beneficial 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, 2010 and 2009, 419 and 56 loans were not repaid at maturity, respectively. Of these loans, 419 and 56 were submitted to our lender protection insurer. The net carrying value of the loans (which includes principal, accrued interest income, and accrued origination fees, net of impairment) at the time of payoff during the year ended December 31, 2010 and December 31, 2009 was $152.8 million and $23.8 million, respectively. The amount of cash received by us for those loans was $153.3 million and $24.6 million, respectively. This resulted in a gain during the year ended December 31, 2010 and December 31, 2009 of $578,000 and $741,000, 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):

 

 

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:

 

 

We use a method to determine the loan impairment valuation adjustment which assumes the “worst case” scenario for the fair value of the collateral based on the insured coverage amount. At the time of loan origination, we will record impairment even though no loans are considered non-performing as no payments are due by the borrower. Loans with insured collateral represented 93.9% and 91.2% of our loans as of December 31, 2010 and

December 31, 2009, respectively. We believe that the amount of impairments recorded over the past 18 months is higher than normal due to the state of the credit markets which negatively affected the fair value of the collateral for the loans. During the past 18 months, the insured value of the collateral has often been its highest value. The higher amount of impairment experienced in the latter part of 2009 and during 2010 reflects the realization of less than the contractual amounts due under the terms of the loans receivable. We believe that if the market for life insurance policies improves, our realization rates for the contractual amounts of interest income and origination income should improve as well.

 

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

 

 

Loss on Loan Payoffs and Settlements, Net

 

When a premium finance loan matures, we record the difference between the net carrying value of the loan receivable (which includes the loan principal balance, accrued interest and accreted origination fees, net of any impairment valuation adjustment) and the cash received, or the fair value of the life insurance policy that is obtained if there is a default and the policy is relinquished, as a gain or loss on loan payoffs and settlements, net. This account was significantly impacted by the Acorn settlement, as discussed above, whereby we recorded a loss on loan payoffs and settlements, net, of $5.5 million, $10.2 million and $1.9 million during the years ended December 31, 2010, 2009 and 2008, respectively, under the direct write-off method, as opposed to charging our provision for losses on loan receivables.

 

Amortization of Deferred Costs

 

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

 

Selling, General and Administrative Expenses

 

Selling, general, and administrative expenses include salaries and benefits, professional and consulting fees, marketing, depreciation and amortization, bad debt expense, and other related expenses to support our ongoing businesses.

 

Critical Accounting Policies

 

Critical Accountings Estimates

 

The preparation of the financial statements requires us to make judgments, estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. We base our judgments, estimates and assumptions on historical experience and on various other factors that are believed to be reasonable under the circumstances. Actual results could differ materially from these estimates under different assumptions and conditions. We evaluate our judgments, estimates and assumptions on a regular basis and make changes accordingly. We believe that the judgments, estimates and assumptions involved in the accounting for the loan impairment valuation, allowance for doubtful accounts, and the valuation of investments in life settlements (life insurance policies) have the greatest

potential impact on our financial statements and accordingly believe these to be our critical accounting estimates. Below we discuss the critical accounting policies associated with the estimates as well as selected other critical accounting policies. For further information on our critical accounting policies, see the discussion in Note 2 to our audited consolidated and combined financial statements.

 

Premium Finance Loans Receivable

 

We report loans receivable acquired or originated by us at cost, adjusted for any deferred fees or costs in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 310-20, Receivables — Nonrefundable Fees and Other Costs, discounts, and loan impairment valuation. All loans are collateralized by life insurance policies. Interest income is accrued on the unpaid principal balance on a monthly basis based on the applicable rate of interest on the loans.

 

In accordance with ASC 310, Receivables, we specifically evaluate all loans for impairment based on the fair value of the underlying policies as collectability is primarily collateral dependent. The loans are considered to be collateral dependent as the repayment of the loans is expected to be provided by the underlying insurance policies. In the event of default, the borrower typically relinquishes beneficial ownership of the policy to us in exchange for our release of the debt (or we enforce our security interests in the beneficial interests in the trust that owns the policy). For loans that have lender protection insurance, we make a claim against the lender protection insurance policy and, subject to terms and conditions of the lender protection insurance policy, our lender protection insurer has the right to direct control or take beneficial ownership of the policy upon payment of our claim. For loans without lender protection insurance, we have the option of selling the policy or maintaining it on our balance sheet for investment.

 

We evaluate the loan impairment valuation on a monthly basis based on our periodic review of the estimated value of the underlying collateral. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. The loan impairment valuation is established as losses on loans are estimated and the provision is charged to earnings. Once established, the loan impairment valuation cannot be reversed to earnings.

 

In order to originate premium finance transactions during the recent dislocation in the capital markets, we procured lender protection insurance. This lender protection insurance mitigates our exposure to losses which may be caused by declines in the fair value of the underlying policies. At the end of each reporting period, for loans that have lender protection insurance, a loan impairment valuation is established if the carrying value of the loan receivable exceeds the amount of coverage.

 

Ownership of Life Insurance Policies

 

In the ordinary course of business, a large portion of our borrowers may default by not paying off the loan and relinquish beneficial ownership of the life insurance policy to us in exchange for our release of the obligation to pay amounts due. We account for life insurance policies we acquire upon relinquishment by our borrowers as investments in life settlements (life insurance policies) in accordance with ASC 325-30, Investments in Insurance Contracts, which requires us to use either the investment method or the fair value method. The election is made on an instrument-by-instrument basis and is irrevocable. Thus far, we have elected to account for these life insurance policies as investments using the fair value method.

 

We initially record investments in life settlements at the transaction price. For policies acquired upon relinquishment by our borrowers, we determine the transaction price based on fair value of the acquired policies at the date of relinquishment. The difference between the net carrying value of the loan and the transaction price is recorded as a gain (loss) on loan payoffs and settlement. For policies acquired for cash, the transaction price is the amount paid.

 

The fair value of the investment in insurance policies is evaluated at the end of each reporting period. Changes in the fair value of the investment based on evaluations are recorded as change in fair value of life settlements in our consolidated and combined statement of operations. The fair value is determined on a discounted cash flow basis that incorporates current life expectancy assumptions. The discount rate incorporates current information about

market interest rates, the credit exposure to the insurance company that issued the life insurance policy and our estimate of the risk premium an investor in the policy would require. The discount rate at December 31, 2010 was 15% to 17% and the fair value of our investment in life insurance policies was $17.1 million.

 

Following our recently completed initial public offering, our investment in life settlements (life insurance policies) may increase over time as we begin to make loans without lender protection insurance, as a result of which we have the option to retain a number of the life insurance policies relinquished to us by our borrowers upon default under those loans. Since the term of our premium finance loans is typically 26 months, it will be at least 26 months from the closing of our recently completed initial public offering before we are likely to retain any appreciable number of policies relinquished to us by our borrowers upon default.

 

Valuation of Insurance Policies

 

Our valuation of insurance policies is a critical component of our estimate for the loan impairment valuation and the fair value of our investments in life settlements (life insurance policies). We currently use a probabilistic method of valuing life insurance policies, which we believe to be the preferred valuation method in the industry. The most significant assumptions which we estimate are the life expectancy of the insured and the discount rate.

 

In determining the life expectancy estimate, we analyze medical reviews from third-party medical underwriters. The health of the insured is summarized by the medical underwriters into a life assessment which is based on the review of historical and current medical records. The medical underwriting assesses the characteristics and health risks of the insured in order to quantify the health into a mortality rating that represents their life expectancy.

 

The probability of mortality for an insured is then calculated by applying the life expectancy estimate to a mortality table. The mortality table is created based on the rates of death among groups categorized by gender, age, and smoking status. By measuring how many deaths occur before the start of each year, the table allows for a calculation of the probability of death in a given year for each category of insured people. The probability of mortality for an insured is found by applying their mortality rating from the life expectancy assessment to the probability found in the actuarial table for the insured’s age, sex and smoking status.

 

The resulting mortality factor represents an indication as to the degree to which the given life can be considered more or less impaired than a standard life having similar characteristics (i.e. gender, age, smoking, etc.). For example, a standard insured (the average life for the given mortality table) would carry a mortality rating of 100%. A similar but impaired life bearing a mortality rating of 200% would be considered to have twice the chance of dying earlier than the standard life.

 

The mortality rating is used to create a range of possible outcomes for the given life and assign a probability that each of the possible outcomes might occur. This probability represents a mathematical curve known as a mortality curve. This curve is then used to generate a series of expected cash flows over the remaining expected lifespan of the insured and the corresponding policy. An internal rate of return calculation is then used to determine the price of the policy. If the insured dies earlier than expected, the return will be higher than if the insured dies when expected or later than expected.

 

The calculation allows for the possibility that if the insured dies earlier than expected, the premiums needed to keep the policy in force will not have to be paid. Conversely, the calculation also considers the possibility that if the insured lives longer than expected, more premium payments will be necessary. Based on these considerations, each possible outcome is assigned a probability and the range of possible outcomes is then used to create a price for the policy.

 

At the end of each reporting period we re-value the life insurance policies using our valuation model in order to update our loan impairment valuation for loans receivable and our estimate of fair value for investments in policies held on our balance sheet. This includes reviewing our assumptions for discount rates and life expectancies as well as incorporating current information for premium payments and the passage of time.

Fair Value Measurement Guidance

 

We follow ASC 820, Fair Value Measurements and Disclosures, which defines fair value as an exit price representing the amount that would be received if an asset were sold or that would be paid to transfer a liability in an orderly transaction between market participants at the measurement date. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions the guidance establishes a three-level fair value hierarchy that prioritizes the inputs used to measure fair value. Level 1 relates to quoted prices in active markets for identical assets or liabilities. Level 2 relates to observable inputs other than quoted prices included in Level 1. Level 3 relates to unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Our investments in life insurance policies and structured settlements are considered Level 3 assets as there is currently no active market where we are able to observe quoted prices for identical assets and our valuation model incorporates significant inputs that are not observable. Our impaired loans are measured at fair value on a non-recurring basis, as the carrying value is based on the fair value of the underlying collateral. The method used to estimate the fair value of impaired collateral-dependent loans depends on the nature of the collateral. For collateral that has lender protection insurance coverage, the fair value measurement is considered to be Level 2 as the insured value is an observable input and there are no material unobservable inputs. For collateral that does not have lender protection insurance coverage, the fair value measurement is considered to be Level 3 as the estimated fair value is based on a model whose significant inputs are the life expectancy of the insured and the discount rate, which are not observable. Although collateral without lender protection insurance is a Level 3 asset, we believe that the fair value is predictable based on the fixed contractual terms of the life insurance policy and its premium schedule and death benefit, as well as the ability to predict the insured’s age at the time of loan maturity, which are some of the key factors in determining the fair market value of a life insurance policy.

 

Fair Value Option

 

As of July 1, 2010, we elected to adopt the fair value option, in accordance with ASC 825, Financial Instruments, to record newly-acquired structured settlements at fair value. We have the option to measure eligible financial assets, financial liabilities, and commitments at fair value on an instrument-by-instrument basis. This option is available when we first recognize a financial asset or financial liability or enter into a firm commitment. Subsequent changes in the fair value of assets, liabilities, and commitments where we have elected the fair value option are recorded in our consolidated and combined statement of operations. We have made this election because it is our intention to sell these assets within the next twelve months, and we believe it significantly reduces the disparity that exists between the GAAP carrying value of these structured settlements and our estimate of their economic value.

 

Revenue Recognition

 

Our primary sources of revenue are in the form of agency fees, interest income, origination fee income and gains on sales of structured settlements. Our revenue recognition policies for these sources of revenue are as follows:

 

 

Interest and origination income on impaired loans is recognized when it is realizable and earned in accordance with ASC 605, Revenue Recognition. Persuasive evidence of an arrangement exists through a loan agreement which is signed by a borrower prior to funding and sets forth the agreed upon terms of the interest and origination fees. Interest income and origination income are earned over the term of the loan and are accreted using the effective interest method. The interest and origination fees are fixed and determinable based on the loan agreement. For impaired loans, we do not recognize interest and origination income which we believe is uncollectible. At the end of the reporting period, we review the accrued interest and accrued origination fees in conjunction with our loan impairment analysis to determine our best estimate of uncollectible income that is then reversed. We continually reassess whether the interest and origination income are collectible as the fair value of the collateral typically increases over the term of the loan. Since our loans are due upon maturity, we cannot determine whether a loan is performing or non-performing until maturity. For impaired loans, our estimate of proceeds to be received upon maturity of the loan is generally correlated to our current estimate of fair value of the collateral, but also incorporates expected increases in fair value of the collateral over the term of the loan, trends in the market, sales activity for life insurance policies, and our experience with loans payoffs.

 

Deferred Costs

 

Deferred costs include costs incurred in connection with acquiring and maintaining credit facilities and costs incurred in connection with securing lender protection insurance. These costs are amortized over the life of the related loan using the effective interest method and are classified as amortization of deferred costs in the accompanying consolidated and combined statement of operations.

 

Loss in Loan Payoffs and Settlements, Net

 

When a premium finance loan matures, we record the difference between the net carrying value of the loan and the cash received, or the fair value of the life insurance policy that is obtained in the event of payment default, as a gain or loss on loan payoffs and settlements, net. This account was significantly impacted by the Acorn settlement, as discussed above, whereby we recorded a loss on loan payoffs and settlements, net, of $5.5 million, $10.2 million and $1.9 million during the years ended December 31, 2010, 2009 and 2008, respectively, under the direct write-off method, as opposed to charging our provision for losses on loan receivables.

 

Income Taxes

 

We account for income taxes in accordance with ASC 740, Income Taxes. Prior to the closing of our recently completed initial public offering, we converted from a Florida limited liability company to a Florida corporation. Under ASC 740, deferred income taxes are determined based on the estimated future tax effects of differences between the financial statement and tax basis of assets and liabilities given the provisions of enacted tax laws. Deferred income tax provisions and benefits are based on changes to the assets or liabilities from year to year. In providing for deferred taxes, we consider tax regulations of the jurisdictions in which we operate, estimates of future taxable income and available tax planning strategies. If tax regulations, operating results or the ability to implement tax-planning strategies varies adjustments to the carrying value of the deferred tax assets and liabilities may be required. Valuation allowances are based on the “more likely than not” criteria of ASC 740.

 

The accounting for uncertain tax positions guidance under ASC 740 requires that we recognize the financial statement benefit of a tax position only after determining that the relevant tax authority would more likely than not sustain the position following an audit. For tax positions meeting the more-likely-than-not threshold, the amount recognized in the financial statements is the largest benefit that has a greater than 50 percent likelihood of being realized upon ultimate settlement with the relevant tax authority. We recognize interest and penalties (if any) on uncertain tax positions as a component of income tax expense.

 

Stock-Based Compensation

 

We have adopted ASC 718, Compensation — Stock Compensation. ASC 718 addresses accounting for share-based awards, including stock options, with compensation expense measured using fair value and recorded over the requisite service or performance period of the award. The fair value of equity instruments awarded upon or after the

closing of our recent initial public offering will be determined based on a valuation using an option pricing model which takes into account various assumptions that are subjective. Key assumptions used in the valuation will include the expected term of the equity award taking into account both the contractual term of the award, the effects of expected exercise and post-vesting termination behavior, expected volatility, expected dividends and the risk-free interest rate for the expected term of the award.

 

Accounting Changes

 

Note 2 of the Notes to Consolidated and Combined Financial Statements discusses accounting standards adopted in 2010, as well as accounting standards recently issued but not yet required to be adopted and the expected impact of these changes in accounting standards. Any material impact of adoption is discussed in Management’s Discussion and Analysis and Notes to the Consolidated and Combined Financial Statements.

 

Results of Operations

 

The following is our analysis of the results of operations for the periods indicated below. This analysis should be read in conjunction with our financial statements, including the related notes to the financial statements. Our results of operations are discussed below in two parts: (i) our consolidated results of operations and (ii) our results of operations by segment.

Consolidated Results of Operations (in thousands)