The statements in this discussion and analysis concerning expectations regarding the Position Holder Trust’s and the IRA Partnership's future performance, liquidity and capital resources, as well as other non-historical statements are forward-looking statements that involve substantial risks and uncertainties. Words such as “anticipates,” “expects,” “intends,” “plans,” “believes,” “seeks,” “estimates,” “would,” “should,” “targets,” “projects” and variations of these words and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements include these words. These statements are not guarantees of future performance and are subject to risks, uncertainties, and other factors, some of which are beyond our control and are difficult to predict, that could cause actual results to differ materially from those expressed or forecasted in the forward- looking statements, including the factors set forth below and elsewhere in this report:
risks relating to the validity and enforceability of the life insurance policies in our portfolio.
The Bankruptcy Court organized the Trust and IRA Partnership in order to liquidate the assets of the Debtors in a manner calculated to conserve, protect and maximize the value of the assets, and to distribute the proceeds thereof in accordance with the Plan. The Trust and IRA Partnership have no other business interests nor operations and will not acquire any additional life insurance policies. The IRA Partnership’s sole assets are beneficial interest units in the Trust.
In second quarter of 2020, the Trustee of the Life Partners Position Holder Trust, acting on behalf of the Trust, entered into a five-year agreement, which shall be effective beginning November 1, 2020, to replace Magna Servicing as the servicer for the insurance policies owned by the Trust. The new servicer, NorthStar Life Services, LLC, maintains offices in Atlanta, GA, Irvine, CA and Waco, TX.
NorthStar Life Services, LLC is a well-known and experienced servicer that has been providing servicing of life insurance policies since 2009. NorthStar Life Services, LLC is owned and operated by John McFarland and is comprised of a highly skilled group of life settlement professionals with an executive team that has more than 80 years of combined life settlement experience. Additionally, NorthStar will be focused on enhancing the IT infrastructure and applications necessary for both portfolio servicing and client relations to ensure the long-term operational efficiency of the Trust. McFarland an industry expert with 15 years of experience in the industry and is also the owner and current CEO of NorthStar Capital Management, LLC, and a Director of the Life Insurance Settlement Association (LISA). McFarland was previously Chief Operating Officer of AVS Underwriting, LLC, the largest and oldest life expectancy provider in the market. The Trustee is confident that the contributions of NorthStar Life Services, LLC, guided by Mr. McFarland, will enhance the value of the portfolio and streamline operations of the Trust.
The novel coronavirus (COVID-19) pandemic has not had a material adverse effect on the Trust’s operations during the year ending December 31, 2020. The extent to which the Trust will be impacted by the outbreak will largely depend on future developments, which are highly uncertain and cannot be accurately predicted, including new information which may emerge concerning the severity of the outbreak and actions by government authorities to contain the outbreak or treat its impact, among other things.
Net increase in net assets for the year ended December 31, 2020 was $58.8 million as compared to a net increase in net assets of $63.4 million for the same period last year. The following are the components of net change in net assets resulting from operations for the years ended December 31, 2020 and 2019:
On August 3, 2020 the Partnership made a distribution of $17.6 million based on its share of the distribution from the Trust, net of the amount owed by the Partnership to the Trust.
The Position Holder Trust paid $9.7 and $16.5 million of its outstanding notes payable during the years ended December 31, 2020 and 2019, respectively.
As of December 31, 2020, and 2019, the Position Holder Trust and IRA Partnership had no off-balance sheet arrangements.
The primary needs for working capital are to pay premiums on Policies and expenses relating to the administration of the Trust and its assets. The Trust is authorized for the use of collected death benefits, called the “Maturity Funds Facility,” from which the Trustee may borrow on a short-term revolving basis to fund its premium reserves. The Trust is also entitled to access the cash surrender value included in the beneficial ownership registered in its name to use for any purpose permitted by the Position Holder Trust Agreement, including to satisfy its share of the premium obligations relating to the Policies. If any such use results in a decrease in the death benefit payable under the related Policy, the decrease will be taken out of the Position Holder Trust’s share of the maturity proceeds of the Policy or, if the Trust’s share is insufficient, the Trust must make up the difference. The Trust believes that these financial resources, in addition to proceeds from maturities, line of credit, and Maturity Funds Facility, are sufficient for it to continue its operations and to issue funds, as necessary, throughout the twelve months after the date of this report.
As of December 31, 2020, and December 31, 2019, the outstanding balances of the New IRA notes was $16.1 million and $24.9 million, respectively. The sinking fund associated with these notes had balances of $0.3 million and $0.1 million at December 31, 2020 and December 31, 2019, respectively.
On March 28, 2017, the Trust, was ordered to pay the Chapter 11 trustee’s fees totaling $5.5 million. The first payment of $2.8 million was paid in 2018. The remaining balance was in the form of a note payable in the amount of $2.8 million and was due in three equal annual payments on January 1 beginning in 2019. The note did not bear interest as ordered by the Court, thus the note was originally discounted by $0.2 million, based on an implied interest rate of 3%. Installments were paid in January 2019, December 2019, and January 2020 resulting in the note being completely satisfied.
At December 31, 2020, the Position Holder Trust had $100.4 million of cash primarily consisting of $61.2 million held to pay policy premiums on behalf of Trust and the continuing fractional holders, $6.3 million held to pay continuing fractional holders for maturities collected, $31.9 million held as collateral deposits on debt, policy premiums, and future distributions, and $1.0 million was available to pay for operating expenses of the Trust.
At December 31, 2019, the Position Holder Trust had $80.8 million of cash primarily consisting of $56.2 million held to pay policy premiums on behalf of the Trust and the continuing fractional holders, $8.9 million held to pay continuing fractional holders for maturities collected, $14.9 million held as collateral deposits on debt, and $0.8 million was available to pay for operating expenses of the Trust.
In June 2016, the FASB issued new guidance (ASU 2016-13, Financial Instruments - Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments), effective for fiscal years beginning after December 15, 2022 and interim periods within those fiscal years. Notable amendments in this update will change the accounting for impairment of most financial assets and certain other instruments in the following ways:
The amendments in this ASU may be early adopted during any interim or annual period beginning after December 15, 2018. The Trust is currently evaluating the impact of this new accounting guidance on its financial statements and does not plan to early adopt.
Earnings attributable to the Partnership’s interests in the Trust and recognized under the equity method represented approximately $34.0 million at December 31, 2020 and $38.4 million at December 31, 2019.
The Partnership, due to the nature of its assets and operations, is subject to significant risks and uncertainties affecting the Trust which encounters economic risk. The two main components of economic risk potentially impacting the Partnership's interest in the Trust are market risk and concentration of credit risk. Market risks include interest rate risk and the risk of declines in valuation of the Trust’s life insurance policies, including declines caused by the selection of increased discount rates associated with the Trust’s fair value model. Concentration of credit risk is the risk that an insurance carrier who has issued life insurance policies held by the Trust, does not remit the amount due under those policies due to the deteriorating financial condition of the carrier or otherwise. It is reasonably possible that future changes to estimates involved in valuing the Trust’s life insurance policies could change and result in material effects on the Partnership’s financial position and results of operation.
The Trust's management is responsible for these financial statements. Our responsibility is to express an opinion on the Trust’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Trust in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We identified the Trust's valuation of life insurance policies as a critical audit matter. The principal considerations for our determination include the judgments required in the selection of a discount rate and mortality assumptions, both unobservable inputs, and the application of the valuation model used by the Trust to estimate the fair value. This matter required a higher degree of auditor judgment and specialized knowledge to audit the estimated fair value of the life insurance policies.
Our audit procedures related to this critical audit matter included the following, among others:
We also evaluated the adequacy of the Trust’s disclosures in Note 6 in relation to the valuation of life insurance policies.
The Trust’s investments in life insurance policies are its primary source of income. Gain or loss is recognized from ongoing changes in the portfolio’s estimated fair value, including any gains or losses at maturity. Gains or losses from maturities are recognized at receipt of a death notice or verified obituary for an insured party and determined based on the difference between the death benefit and the estimated fair value of the policy at maturity.
As of December 31, 2020, the Trust owns an interest in 2,739 policies of which 407 are life settlement policies and 2,332 are viaticals. As of December 31, 2019, the Trust owned an interest in 2,896 policies of which 483 are life settlement policies and 2,413 are viaticals (the “PHT Portfolio”). The PHT Portfolio’s aggregate face value is $1.0 billion as of December 31, 2020 of which $0.8 billion is attributable to life settlements and $0.2 billion is attributable to viaticals. The PHT Portfolio’s aggregate face value is $1.1 billion as of December 31, 2019 of which $0.9 billion is attributable to life settlements and $0.2 billion is attributable to viaticals. The PHT Portfolio’s aggregate fair value is $159.2 million as of December 31, 2020 of which $153.7 million is attributable to life settlements and $5.5 million is attributable to viaticals. The PHT Portfolio’s aggregate fair value was $172.2 million as of December 31, 2019 of which $168.7 million was attributable to life settlements and $3.5 million was attributable to viaticals.
In year ending December 31, 2019 the Trust did two partial redemptions of all remaining notes totaling 4/15th of the outstanding balance of those notes and the Trust redeemed in full all New IRA Notes having an outstanding balance of $7,500 or less. The amount paid in connection with the redemption was $11.6 million and only funds set aside in a sinking fund established pursuant to the Bankruptcy Plan for that purpose were used. Accrued interest on all New IRA Notes through the redemption dates was paid as well.
In 2019 there was a conversion of notes payable to IRA Partnership and Trust units of $0.3 million based on changes to elections for certain unit holders which were in dispute and resolved through settlement, mediation or court order.
Level 2 - Valuation is determined from pricing inputs that are other than quoted prices in active markets that are either directly or indirectly observable as of the reporting date. Observable inputs include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, and interest rates and yield curves that are observable at commonly quoted intervals.
As of December 31, 2020, the default mortality multipliers used are 100% for the life settlement males, 90% for the life settlement females, and 350% for the viaticals regardless of gender. As of December 31, 2019, the default mortality multipliers used are 110% for the life settlement males, 90% for the life settlement females, and 350% for the viaticals regardless of gender. On a quarterly basis, the Trust compares actual mortalities to expected mortalities to refine its analysis. The Trust compares actual to expected mortalities to evaluate and refine the mortality multipliers; such that they reasonably “validate” based on the Trust’s analysis of trends.
In second quarter of 2020, the Trust changed its methodology for accounting for the servicing fee in valuing the Trust's portfolio. Historically, the Trust reduced its expected future cash flow from maturities to account for the servicing fees which were expected to be paid upon maturity of a policy. Under the new model the Trust no longer decreases the future cash flow for the expected servicing fee, instead the Trust incorporates the fee structure through the discount rate. This change was made (i) to bring Trust's practices more in line with industry norms, and (ii) due to the change in servicer, which requires the Trust to now pay the fees periodically, rather than being deferred and paid as a percentage of proceeds upon policy maturity. This change increased the discount rate for the Trust's portfolio by 2%, however it did not have a significant impact to the value of the Trust's portfolio.
Future changes in the discount rates used by the Trust to value life insurance policies could have a material effect on the fair value of the Portfolio, which could have a material adverse effect on the Trust’s financial condition and results of operations.
The Bankruptcy Court organized the Trust and the Partnership in order to liquidate the assets of the Debtors in a manner calculated to conserve, protect and maximize the value of the assets, and to distribute the proceeds thereof to the Trust’s securities holders in accordance with the Plan. The Trust and IRA Partnership have no other business interests nor operations and will not acquire any additional life insurance policies in the future. The Trust’s beginning assets and liabilities were contributed pursuant to the Plan as of December 9, 2016.
On August 3, 2020, the Trust made a distribution of $30.0 million of which approximately $17.6 million was paid to the IRA Partnership, net of amounts owed by the Partnership to the Trust. The distribution was based on the number of Units held and deducting any holder obligations for unpaid premiums. After receiving the distributions on August 3, 2020, the Partnership immediately distributed its share of the distributions to the Partnership interest holders based on the number of Member Interests held and deducting any holder obligations for unpaid premiums. In 2019, the Trust distributed $20.0 million of which approximately $12.1 million was paid to the IRA Partnership, net of amounts owed by the Partnership to the Trust.