The selected historical statement of operations data for the years ended December 31, 2014, 2013, 2012, 2011, and 2010, and balance sheet data as of December 31, 2014, 2013, 2012, 2011, and 2010 were derived from our audited consolidated financial statements and reflect the retroactive revision to reflect the classification of our structured settlement business as discontinued operations.
We were founded in December 2006 as a Florida limited liability company and in connection with our initial public offering, in February 2011, Imperial Holdings, Inc. succeeded to the business of Imperial Holdings, LLC and its assets and liabilities. Incorporated in Florida, Imperial owns a portfolio of 607 life insurance policies, also referred to as life settlements, with a fair value of $388.9 million and an aggregate death benefit of approximately $2.9 billion at December 31, 2014. The Company primarily earns income on these policies from changes in their fair value and through death benefits.
Our indirect subsidiary, White Eagle Asset Portfolio, LP, (“White Eagle”), is the owner of 450 of these life insurance policies with an aggregate death benefit of approximately $2.3 billion and an estimated fair value of approximately $306.3 million at December 31, 2014. White Eagle pledged its policies as collateral to secure borrowings made under a $300.0 million 15-year revolving credit agreement (the “Revolving Credit Facility”), which is used, among other things, to pay premiums on the life insurance policies owned by White Eagle. The majority of our other assets, including the 157 policies that were not pledged as collateral under the Revolving Credit Facility, with an aggregate death benefit of approximately $679.2 million and an estimated fair value of approximately $82.6 million at December 31, 2014 are pledged as collateral for the payment of the Secured Notes.
In August 2014, the U.S. Society of Actuaries released draft tables for the 2014 Valuation Basic Table (“2014 VBT”), which show a lengthening of average life expectancies. We currently use a modified version of the 2008 Valuation Basic Table (“2008 VBT”), the predecessor to the 2014 VBT, as one input to the estimation of fair value of our life settlements. The 2014 VBT is expected to be released some time in 2015 and we will continue to monitor the market reaction to the draft tables and to the 2014 VBT once it is released. Future changes in mortality tables could have a material adverse effect on the fair value of our investment in life settlements, which could have a material adverse effect on our business, financial condition and results of operations.
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 income 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 income taxes, the valuation of investments in life settlements, the valuation of the debt owing under the Revolving Credit Facility and the valuation of our conversion derivative liability formerly embedded within the Convertible Notes have the greatest potential impact on our financial statements and accordingly believe these to be our critical accounting estimates.
The Company determined that an embedded conversion option existed in the Convertible Notes, prior to June 5, 2014, that was required to be separately accounted for as a derivative under Accounting Standards Codification (“ASC”) 815, Derivatives and Hedging. On June 5, 2014, the Company obtained shareholder approval to issue shares of common stock upon conversion of the Convertible Notes in an amount that exceeded the New York Stock Exchange limits for issuances without shareholder approval. In accordance with ASC 815, the Company reclassified the conversion derivative liability to stockholders’ equity along with unamortized transaction costs proportionate to the allocation of the initial debt discount and the principal amount of the Convertible Notes. In subsequent reporting periods, the Convertible Notes will continue to be recorded at accreted value up to the par value of the Convertible Notes at maturity. The debt discount will be amortized into interest expense using the interest method, in an aggregate amount equal to the amount of the conversion derivative liability reclassified into equity along with any unamortized transaction costs. See Note 11, “8.50% Senior Unsecured Convertible Notes.”
Deferred debt costs include costs incurred in connection with acquiring and maintaining debt arrangements. These costs are amortized over the life of the related loan using the effective interest method and are classified as interest expense in the accompanying consolidated statement of operations. These deferred costs are related to the Company’s Notes. The Company did not recognize any deferred debt costs on its Revolving Credit Facility given all costs were expensed due to electing the fair value option in valuing the Revolving Credit Facility.
Our provision for income taxes results in an annual effective tax rate of -2.5% in 2014, except as noted below. For periods prior to 2014 our provision for income taxes resulted in an annual effective tax rate of 0.0%. At December 31, 2013, due to the large losses and the uncertainties that resulted from the USAO Investigation, SEC investigation, Non-Prosecution Agreement and class action lawsuits, we recorded a full valuation allowance against our net deferred tax asset as it was more likely than not that the net deferred tax asset is not realizable. As a result of these increases in the valuation allowance, we recorded no income tax benefit for 2013.
The Company owns certain foreign subsidiaries formed under the laws of Ireland and Bermuda. These foreign subsidiaries utilize the U.S. dollar as their functional currency. The foreign subsidiaries’ financial statements are denominated in U.S. dollars and therefore, there are no translation gains and losses resulting from
Our net loss for the year ended December 31, 2014 includes income tax expense of approximately $3.7 million, which resulted from the adoption of ASU No. 2013-11. See Note 19 “Income Taxes,” to the accompanying consolidated financial statements.
Of these 607 policies owned as of December 31, 2014, 553 were premium financed and are valued using discount rates that range from 16.05% - 25.80%. The remaining 54 policies are valued using discount rates that range from 14.80% - 20.80%. See Note 13, “Fair Value Measurements,” to the accompanying consolidated financial statements.
Servicing Fee Income. Servicing income was zero for the year ended December 31, 2014 compared to $310,000 in 2013. Servicing fee income was earned in providing asset servicing for third parties, which we began providing during 2010. This decrease was due to the Company ceasing to service assets for unaffiliated third parties on April 30, 2013.
Of the interest expense of $16.2 million, approximately $8.0 million represents interest paid on the Revolving Credit Facility. Interest expense on the Convertible Notes totaled $7.5 million including $5.2 million, $2.0 million and $332,000 representing interest, amortization of debt discount and issuance costs, respectively. The Company recorded $694,000 of interest expense on the Secured Notes, including $592,000, $36,000, and $66,000 from interest, amortizing debt discounts and issuance costs, respectively, during the year ended December 31, 2014. Of the interest expense of $13.7 million for 2013, $2.8 million represents interest paid and approximately $10.3 million represents loan origination cost incurred under the Revolving Credit Facility, which was not capitalized as a result of electing the fair value option for valuing the Revolving Credit Facility. The Company borrowed $45.0 million under a bridge facility in March 2013 and fully prepaid this facility in the subsequent quarter ended June 30, 2013. Interest expense of $550,000 is associated with this facility for the year ended December 31, 2013. See Note 10 Revolving Credit Facility, Note 11, 8.50% Senior Unsecured Convertible Notes and Note 12, 12.857% Senior Secured Notes to the accompanying consolidated financial statements.
gain of approximately $9.4 million for the year ended December 31, 2013. This change is associated with the lengthening of life expectancy estimates for the policies pledged under the Revolving Credit Facility offset by a reduction in the discount rate. The Revolving Credit Facility is valued at December 31, 2014 using a discount rate of 23.89%. See Note 13, “Fair Value Measurements,” to the accompanying consolidated financial statements.
Legal expenses for the year ended December 31, 2014 were $13.6 million compared to $11.7 million for 2013. Of the legal expense, approximately $5.0 million is mainly associated with the USAO Investigation for 2014, compared to $4.5 million for the year ended December 31, 2013. Legal expense also includes approximately $2.3 million associated with the warrants for the class action litigation for the year ended December 31, 2013. See Note 15, “Commitments and Contingencies,” to the accompanying consolidated financial statements.
During the year ended December 31, 2013, four life insurance policies with face amounts totaling $14.1 million matured. The net gain of these maturities was $9.2 million and is recorded as a change in fair value of life settlements in the consolidated statement of operations for the year ended December 31, 2013. Proceeds from these maturities totaling $12.0 million were received during the year ended December 31, 2013 with $2.1 million receivable for maturity of life settlements at December 31, 2013. Of the total maturities, two policies with a face value of $6.0 and $2.1 million served as collateral under the White Eagle Credit Facility and the proceeds of $6.0 million were utilized to repay borrowings under the facility in January 2014.
As of December 31, 2013, the Company owned 612 policies with an estimated fair value of $303.0 million compared to $113.4 million at December 31, 2012, an increase of $189.6 million or 167%. Of the 612 policies, 457 policies were pledged to the Revolving Credit Facility and 155 policies were not pledged. During the year ended December 31, 2013, the Company acquired 432 life insurance policies compared to 31 policies during the same period in 2012. Of the 432 policies acquired during 2013, 16 were as a result of certain of the Company’s borrowers defaulting on premium finance loans and relinquishing the underlying policy to the Company, compared to 29 policies acquired in the same manner for 2012. Of the remaining 416 policies, 323 policies were acquired upon the effectiveness of a termination agreement with the lender protection insurance coverage provider and were previously held off balance sheet as contingent assets for financial reporting purposes in the prior period, with the remaining 93 acquired through the Company’s acquisition of CTL Holdings, LLC, for a total purchase price of $55.5 million. As of December 31, 2013, the aggregate death benefit of the Company’s investment in life settlements was $3.0 billion.
Servicing Fee Income. Servicing income was $310,000 for the year ended December 31, 2013 compared to $1.2 million in 2012, a decrease of $873,000 or 74%. Servicing fee income is earned in providing asset servicing for third parties, which we began providing during the fourth quarter of 2010. This decrease was primarily due to a reduction in the number of policies serviced and at April 30, 2013 the Company stopped servicing assets for unaffiliated third parties as a result of the Termination Agreement.
Gain on maturities of life settlements with subrogation rights, net. In the third quarter of 2011, two individuals covered under policies, which were subject to subrogation claims unexpectedly passed away. The Company collected the death benefit on one of these policies in the amount of $3.2 million net of subrogation expense during the third quarter of 2011. In the year ended December 31, 2012, the Company negotiated a settlement in respect of the larger policy and collected approximately $6.1 million, net of subrogation expenses, and reported a gain in accordance with ASC 450, Contingencies in its consolidated statement of operations for the year ended December 31, 2012 as all contingencies were resolved. There were no such gains for the year ended December 31, 2013. As a result of the Termination Agreement, the Company no longer holds life settlements with subrogation rights.
Change in fair value of Revolving Credit Facility debt. Change in fair value of Revolving Credit Facility debt was approximately $9.4 million for the year ended December 31, 2013 compared to zero for the year ended December 31, 2012. This change is associated with the adoption of the fair value option in accounting for the Revolving Credit Facility debt and the lengthening of life expectancy estimates for the policies in the Revolving Credit Facility. The Revolving Credit Facility is valued at December 31, 2013 using a discount rate of 24.04%. See Note 13, “Fair Value Measurements,” to the accompanying consolidated financial statements.
Net loss from our discontinued structured settlement operations for the year ended December 31, 2014 was $369,000 as compared to income of $13.5 million for the year ended December 31, 2013. Total income from our discontinued structured settlement operations was $192,000 for the year ended December 31, 2014 compared to $22.6 million in 2013. This reduction is mainly associated with the sale of the structured settlement operations in October 2013. During the year ended December 31, 2014, our discontinued structured settlement operations sold 8 structured settlements for a gain of $18,000, compared to the sale of 529 structured settlements for a gain of $9.6 million. Unrealized change in fair value of structured settlements receivable was $32,000 for the year ended December 31, 2014 compared to $1.2 million for the year ended December 31, 2013.
As of December 31, 2014, the Company’s cumulative legal and related fees in respect of the USAO Investigation (including indemnification obligations), the SEC Investigation, the IRS Investigation and related matters were $40.4 million, including $5.7 million, $4.5 million and $16.3 million incurred during the year ended December 31, 2014, 2013 and 2012, respectively. We believe we may continue to spend significant amounts on these matters as well as for general litigation and judicial proceedings over the next year, and possibly beyond. In addition, as part of the framework for the settlements of certain litigation arising from the USAO Investigation, the Company has undertaken to advance legal fees and indemnify certain individuals covered under the director and officer liability insurance policies. The remaining obligation to advance and indemnify on behalf of these individuals, while currently unquantifiable, may be substantial and could have an adverse effect on the Company’s financial position and results of operations. See Item 1A - Risk Factors - Risks Related to Our Business - “Indemnification, advancement and cooperation obligations related to the USAO Investigation could have a material adverse effect on our business, financial condition and results of operations” and - “Investigations by the SEC and IRS could materially and adversely affect our business, financial condition and results of operations.”
Accordingly, the Company must proactively manage its cash in order to effectively run its businesses, service its debt and opportunistically grow its assets. To do so, the Company may in the future determine to sell or, under certain circumstances, lapse certain of its policies as its portfolio management strategy and liquidity needs dictate. The lapsing of policies, if any, could result in events of default under certain of our debt arrangements and would create losses as such assets would be written down to zero.
LLC, as the initial servicer, the initial portfolio manager and guarantor, Lamington Road Bermuda Ltd., as portfolio manager, LNV Corporation, as initial lender, the other financial institutions party thereto as lenders, and CLMG Corp., as administrative agent for the lenders.
In February 2014, we issued $70.7 million in aggregate principal amount of 8.50% senior unsecured convertible notes due 2019. For a description of the Convertible Notes see Note 11, “8.50% Senior Unsecured Convertible Notes,” of the notes to Consolidated Financial Statements.
The following table summarizes our cash flows, which includes both continuing and discontinued operations, from operating, investing and financing activities for the years ended December 31, 2014, 2013 and 2012 (in thousands):
Net cash used in operating activities for the year ended December 31, 2013 was $24.4 million. Our net income of $65.3 million was adjusted for; Revolving Credit Facility origination costs of $10.3 million which were incurred to obtain the facility and expensed during 2013; non-cash Revolving Credit Facility financing costs of $2.0 million, which represent interest expense associated with the Revolving Credit Facility, the amount is a non-cash item and was withheld by the lender and added to the outstanding loan balance; loss on extinguishment of $4.0 million on a bridge facility for deferred financing costs recognized because the Bridge Facility was repaid before the maturity date; change in fair value of life settlement gains of $88.7 million which is mainly attributable to the significant purchase of a portion of our portfolio during the second quarter of 2013; change in fair value of credit facility gains of $9.4 million that resulted from the Company adopting the fair value option for the Revolving Credit Facility; gain from business disposition of $11.3 million which resulted from the sale of the structured settlement operations; and, a net positive change in the components of operating assets and liabilities of $1.2 million. This $1.2 million change in operating assets and liabilities is partially attributable to a $12.8 million decrease in prepaid expenses due to collections of insurance recoveries from our D&O Carriers associated with class action litigation and derivative settlement and a $13.5 million increase in restricted cash which holds the amount collected from the D&O Carriers.
The following table summarizes our contractual obligations as of December 31, 2014 (in thousands):
(1) Proceeds from policy maturities pledged under the Revolving Credit Facility will generally be used to pay down the Revolving Credit Facility debt. Please see Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources-Financing Arrangement Summary-Revolving Credit Facility-Amortization & Distributions.
(2) Includes $1.9 million related to outstanding interest due for the Revolving Credit Facility.