* See our Consolidated Statements of Operations in Part II, Item 8. Financial Statements and Supplemental Data for detail of selling general and administrative expenses.
Imperial Holdings, Inc. (the “Company” or “Imperial”) operates in two reportable business segments: life finance (formerly referred to as premium finance) and structured settlements. In the life finance business, the
At the time of the Company’s initial public offering, the Company intended to hold the majority of the life insurance policies it acquired to maturity while selectively trading in and out of certain policies. In light of the USAO Investigation, the SEC Investigation, the related shareholder litigation and the related unbudgeted expenses incurred by the Company, the Company is currently focused on raising long-term capital and maintaining and realizing upon its portfolio of life insurance policies. Accordingly, the Company does not currently intend to expend significant resources acquiring policies and expects that earnings in its life finance segment going forward will be driven by maturities in its portfolio of life insurance policies and through unrealized changes in the fair value of its life insurance policies. At December 31, 2012, the Company had approximately $20.3 million of cash and cash equivalents, and marketable securities, with projected premiums of $27.7 million and $26.3 million in 2013 and 2014, respectively. Based on internal projections at December 31, 2012, the Company anticipated a liquidity shortfall in the second quarter of 2013. On March 27, 2013, a subsidiary of the Company borrowed $45 million in aggregate principal amount under an 18-month senior secured bridge facility. The Company believes that the proceeds of this facility will provide the Company with the resources to continue to pay premiums on its portfolio of life insurance policies and fund its operations through December 31, 2013 while the Company continues its efforts to source more permanent capital.
While non-binding and subject to certain contingencies, the terms of the class action settlement include a cash payment of $12.0 million, of which $11.0 million is to be contributed by Imperial’s primary and excess D&O Carriers, and the issuance of two million warrants for shares of the Company’s stock with an estimated value of $3.1 million at the date of the signing of the Term Sheet. The value of the warrants will be re-assessed at issuance. The warrants will have a five-year term with an exercise price of $10.75 and will be issued when the settlement proceeds are distributed to the claimants. In addition, the underwriters in Imperial’s initial public offering are to waive their rights to indemnity and contribution by Imperial. The Company established a reserve related to the proposed settlement of $15.1 million, which is included in other liabilities and a receivable for insurance recoverable from the Company’s D&O Carrier of $11.0 million, which is included in prepaid and other assets. The $4.1 million net effect of the settlement is included in legal fees in the statement of operations for the year ended December 31, 2012.
The derivative would be settled for implementation of certain compliance reforms. The Term Sheet also contemplates payment by Imperial’s primary D&O carrier of $1.5 million for legal fees in respect of the derivative actions and the contribution of $500,000 in Imperial stock.
The Company does not expect that it will ever receive updated life expectancy reports on 100% its policies as it anticipates a portion of the insureds represented by its portfolio to be unresponsive to requests for updated medical information. This information is generally required by life expectancy providers to issue new life expectancy reports. The Company believes that insureds who have deteriorated in health are generally less likely to be responsive to requests for updated medical information. As a result, the periodic updating of life expectancy reports may conservatively skew fair value estimates lower as any health deteriorations experienced by unresponsive insureds would not be reflected in the life expectancy inputs that are used to calculate the value of the Company’s investment in life settlements.
The Company accounts for the maturities of life settlements with subrogation rights (net of subrogation expenses) as contingent gains in accordance with ASC 450, Contingencies and recognizes the revenue from the maturities of these policies when all contingencies are resolved.
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 charged on our premium finance loans are floating rates that were 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.
Gain on sale of life settlements includes gain from company-owned life settlements and gains from sales on behalf of third parties.
In connection with our premium finance business, we earned agency fees that were paid by the referring life insurance agents. Because agency fees were not paid by the borrower, such fees do not accrue over the term of the loan. Referring insurance agents paid 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 was 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:
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
For loans that had lender protection insurance and matured during the years ended December 31, 2012 and 2011, 88 and 131 loans were not repaid at maturity, respectively, all of which were submitted to our lender protection insurer and 95.5% and 100% paid by such 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 years ended December 31, 2012 and 2011 was $25.3 million and $49.7 million, respectively. The amount of cash received by us for those loans was $25.6 million and $51.5 million, respectively. This resulted in a gain during the years ended December 31, 2012 and 2011 of $29,000 and $737,000, 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):
* Claims have been filed with the LPIC carrier and the Company is pending reimbursement for the remaining 4.5%, a provision for losses on loans receivable of $515,000 was established as collectability of the LPIC claim is uncertain.
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 below, whereby we recorded a loss on loan payoffs and settlements, net, of zero, $4.1 million and $5.5 million during the years ended December 31, 2012, 2011 and 2010, respectively, under the direct write-off method, as opposed to charging our provision for losses on loan receivables.
The $7.3 million impact on net income is due to 28 policies that we decided to continue to fund the premiums after ABRG elected not to continue to fund the premiums. With respect to the associated loans, we received a gain on forgiveness of debt with no offsetting loss on loan payoffs and settlements, net.
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 include salaries and benefits, professional and consulting fees, marketing, depreciation and amortization, bad debt expense, and other related expenses to support our ongoing businesses. As a result of the USAO Investigation, the SEC Investigation and related shareholder litigation, we have incurred significant legal expenses, and we expect to continue to incur significant legal expenses pending the resolution of those matters.
valuation of investments in life settlements 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 financial statements.
In determining the life expectancy estimate, we analyze medical reviews from independent secondary market life expectancy providers (each a “LE provider”). An LE provider reviews the medical records and identifies all medical conditions it feels are relevant to the life expectancy of the insured. Debits and credits are then assigned by each LE provider to the individual’s health based on these medical conditions. The debit or credit that an LE provider assigns to a medical condition is derived from the experience of mortality attributed to this condition in the portfolio of lives that it monitors. The health of the insured is summarized by the LE provider into a life assessment of the individual’s life expectancy expressed both in terms of months and in mortality factor.
The 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 (e.g. gender, age, smoking, etc.). For example, a standard insured (the average life for the given mortality table) would carry a mortality rating of 100%. A similar but impaired life bearing a mortality rating of 200% would be considered to have twice the chance of dying earlier than the standard life. Historically, the Company has procured the majority of its life expectancy reports from two life expectancy report providers and only used AVS life expectancy reports for valuation purposes. Beginning in the quarter ended September 30, 2012, the Company began utilizing life expectancy reports from 21st Services for valuation purposes and began averaging or “blending,” the results of the two life expectancy reports to establish a composite mortality factor. However, when “blending” the AVS and 21st Services life expectancy reports, if the difference in the probability of mortality between the reports is greater than 150%, the Company will reduce the higher mortality factor until the difference is 150%.
The probability of mortality for an insured is then calculated by applying the blended 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 the mortality rating from the life expectancy assessment to the probability found in the actuarial table for the insured’s age, sex and smoking status. As discussed above in Use of Updated Life Expectancies and Change in Mortality Table in Management’s Discussion and Analysis of Financial Condition and Results of Operations, the Company has historically applied an actuarial table developed by a third party. However, beginning in the quarter ended September 30, 2012, the Company transitioned to a table developed by the U.S. Society of Actuaries known as the 2008 Valuation Basic Table, or the 2008 VBT. However, because the 2008 VBT table does not account for anticipated improvements in mortality in the insured population, the table was modified in conjunction with outside consultants to reflect these expected mortality improvements. The Company believes that the change in mortality table does not materially impact the valuation of its life insurance policies and that its adoption of a modified 2008 VBT table is consistent with modified tables used by market participants and third party medical underwriters.
As noted above, the Company takes an average, or blend, of the two life expectancy reports to derive a composite mortality factor, unless the difference in the probability of mortality between the reports is greater than 150%. In such instances and as reflected in the fair market value at December 31, 2012, the Company will cap the higher mortality factor at amount that is 150% above the lower mortality factor, which ultimately reduces the mortality factor inputted into the Company’s fair value model. At December 31, 2012, had the Company not implemented such a cap on affected policies, the fair value of the Company’s portfolio would have increased from the reported amount by $9.5 million. Additionally, the Company lengthened the life expectancy inputs to its fair value model on 45 policies with life expectancy reports that were more than two years old at December 31, 2012 based on the average lengthening reported on the 149 policies where update life expectancy reports were received. Had the Company not implemented such an adjustment on affected policies, the fair value of the Company’s portfolio would have increased from the reported amount by $5.8 million.
The Company believes that investors in esoteric assets, such as life insurance policies, typically target yields averaging between 12%-17% for investments of more than a 5 year duration, and had historically used a 15%-17% range of discount rates to value its life insurance policies. In the third quarter of 2011 and in the immediate aftermath of becoming aware of the USAO investigation, the Company substantially increased the discount rates inputted into its fair value model as it believed that USAO Investigation along with certain unfavorable court decisions unrelated to the Company contributed to a contraction in the marketplace that has continued to reverberate. Since that time, the Company has been re-evaluating its discount rates at the end of every reporting period in order to reflect the estimated discount rates that could reasonably be used in a market transaction involving the Company’s portfolio of life insurance policies. In doing so, the Company relies on management insight, engages third party consultants to corroborate its assessment, engages in discussions with other market participants and potential financing sources and extrapolates the discount rate underlying actual sales of policies.
The discount rate incorporates current information about market interest rates, the credit exposure to the insurance company that issued the life insurance policy and our estimate of the risk premium an investor in the policy would require. The extent to which the fair value could vary in the near term has been quantified by evaluating the effect of changes in the weighted average discount rate on the death benefit used to estimate the fair value. If the weighted average discount rate were increased or decreased by 1/2 of 1% and the other assumptions used to estimate fair value remained the same, the change in fair market value would be as follows (dollars in thousands):
Our primary sources of revenue/income are in the form of unrealized change in fair value of life settlements, agency fees, interest income, and origination fee income, servicing income and realized gains on sales of structured settlements. Our revenue/income recognition policies for these sources of revenue/income are as follows:
Servicing Income-We receive income from servicing life insurance policies controlled by a third party. These services include verifying premiums are paid and correctly applied and updating files for medical history and ongoing premiums.
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 $0 million, $4.1 million and $5.5 million during the years ended December 31, 2012, 2011 and 2010, respectively.
After the Conversion, we began to account for income taxes in accordance with ASC 740, Income Taxes. 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.
At December 31, 2012 and 2011, 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 of $27.8 million and $11.1 million, respectively, as it is 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 2012 and 2011.
In most instances where the Company has foreclosed on the collateral, the lender protection insurer has maintained its salvage collection and subrogation rights, and also covers the cost of the ongoing premiums needed to maintain certain of these life insurance policies. However, the lender protection insurer may elect at
As of December 31, 2012, we had loans receivable totaling $3.0 million compared to $29.4 million as of December 31, 2011, a decrease of $26.4 million, or 90%. Loans outstanding declined from 138 to 22. As a result, origination income and interest income, which accrue over the life of the loan and are therefore a function of the amount of loans outstanding, declined from $6.5 million and $7.8 million, respectively, during the year ended December 31, 2011, to $500,000 and $1.7 million, respectively, a reduction of $6.0 million and $6.1 million or 92% and 78% respectively, during the same period in 2012.
During 2011, two individuals covered under policies that 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. For 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. A gain from the settlement was recorded in accordance with ASC 450, Contingencies in its consolidated statement of operations for the year ended December 31, 2012 as all contingencies were resolved.
Interest expense declined to $1.3 million compared to $8.2 million, a reduction of $6.9 million or 84%, as notes payable declined from $19.3 million as of December 31, 2011 to zero as of December 31, 2012. These notes payable, the majority of which were guaranteed under LPIC which was discontinued as of December 2010, declined as premium finance loans serving as collateral for these notes matured during the year ended December 31, 2012.
Amortization of deferred costs, which are comprised primarily of upfront premiums previously paid to the LPIC insurer, was $1.9 million during the year ended December 31, 2012 as compared to $6.1 million for 2011, a decrease of $4.2 million, or 69%. Lender protection insurance related costs accounted for $1.5 million and $4.9 million of total amortization of deferred costs during the years ended December 31, 2012 and 2011, respectively. As described previously, the lender protection insurance program was terminated as of December 31, 2010 and 5 loans with lender protection insurance remained outstanding as of December 31, 2012. Only $7,000 of lender protection insurance related costs remains to be amortized.
As of December 31, 2012, the Company owned 214 policies with a fair market value of $113.4 million compared to $90.9 million at December 31, 2011, an increase of $22.5 million or 25%. During the year ended December 31, 2012, the Company acquired 31 life insurance policies compared to 151 policies during the year ended December 31, 2011. Total aggregate death benefit of polices acquired was $166.0 million and $774.3 million for the year ended December 31, 2012 and December 31, 2011, respectively. Of the 31 policies acquired during 2012, 29 were as a result of certain of the Company’s borrowers defaulting on premium finance loans and
Unrealized change in fair value of life settlements was a loss of approximately $5.7 million for the year ended December 31, 2012 compared to a gain of $570,000 for the year ended December 31, 2011, a decrease of $6.3 million. This loss was primarily driven by increased life expectancy inputs to the Company’s fair value model reflected in the updated life expectancy reports procured by the Company in respect of 149 insured lives. These reports showed that, in the aggregate, there was less health impairment and thus longer life expectancies relative to the original life expectancy reports inputted into the Company’s fair value model. The $570,000 unrealized changed in fair value recorded during the year ended December 31, 2011 included $3.0 million attributable to revisions made to the application of our valuation technique and assumptions used in our fair value calculation made in the quarter ended March 31, 2011, as described in Note 2, Principles of Consolidation and Basis of Presentation. During the year ended December 31, 2012, the 29 policies which were acquired as a result of certain of the Company’s borrowers defaulting on premium finance loans and relinquishing the underlying policy to the Company resulted in a decrease in unrealized change in fair value of $264,000 and 6 polices were sold that resulted in a gain of $291,000.
Two updated life expectancy reports show discrepancies with the previously reviewed and relied upon medical records of two insureds, resulting in significant extensions to the insureds’ life expectancies. Unrealized change in fair value of life settlements for these two policies accounted for approximately $3.3 million of the $5.7 million loss for the year ended December 31, 2012.
In our structured settlements segment, total income was $14.0 million for the year ended December 31, 2012 compared to $11.9 million in December 31, 2011, an increase of $2.1 million or 18%. This was due to an increase in transactions sold. During the year ended December 31, 2012, 1,235 structured settlements that were sold that resulted in a gain of $11.5 million compared to 979 structured settlements that were sold that resulted in a gain of $5.8 million during the year ended December 31, 2011. Unrealized change in fair value of structured settlements receivable was $1.8 million for the year ended December 31, 2012 compared to $5.3 million in 2011.
This segment continues to be characterized by high growth in lead generation and sales as well as high operating costs. This led to a segment operating loss of $7.5 million during the year ended December 31, 2012, a decrease of $2.5 million over the segment operating loss of $10.0 million recorded during 2011.
Non-direct segment expense was $24.5 million compared to $22.5 million for the year ended December 31, 2012, an increase of $1.5 million or 7%. This is primarily driven by increases in legal fees of $4.8 million or 32%, offset by a reduction in personnel cost of $2.2 million, which is mainly due to a redistribution of costs directly to Company segments and a reduction in SG&A of $892,000. Total legal expenses for 2012 were $20.0 million and included $14.3 million associated with the USAO Investigation, compared $6.0 million for 2011. This figure includes $5.1 million associated with the proposed settlement of the class action litigation and derivative action. During 2011, expense totaling $8.0 million of the $22.5 million was associated with the settlement of the USAO Investigation.
In our life finance segment which includes our premium finance business, its operating loss increased by $6.2 million to $7.5 million, primarily driven by decreases in agency fee income, origination income and interest income totaling $30.6 million. Life finance segment expenses were $38.9 million in 2011 compared to $68.6 million during 2010, a decline of $29.7 million, or 43%. These declines were driven primarily by a $16.2 million reduction in interest expense, a decline in amortization of deferred costs of $18.4 million, and a decline of $1.1 million in loss on loan payoffs and settlements, net offset by an increase of $3.1 million in provision for losses on loan receivables and an increase of $2.9 million in selling, general and administrative expenses.
Results of operations in our life finance segment were adversely impacted by the USAO Investigation and related matters. During 2011, we originated 55 loans using equity capital, compared to 97 loans originated under the LPIC program during the year ended December 31, 2010. All 55 of these loans were originated during the nine months ended September 30, 2011, after which we suspended origination of premium finance loans. In connection with the Non-Prosecution Agreement, we voluntarily terminated our premium finance business and we anticipate that we will no longer be originating any premium finance loans.
This decrease in the number of loans originated resulted in a reduction in agency fees from $10.1 million during 2010 to $6.5 million during 2011, a decrease of $3.6 million. As of December 31, 2011, we had loans receivable totaling $29.4 million compared to $90.0 million as of December 31, 2010, a decrease of $60.6 million, or 67%. Loans outstanding declined from 325 to 138. As a result, origination income and interest income, which accrue over the life of the loan and are therefore a function of the amount of loans outstanding, declined from $19.9 million and $18.7 million, respectively, during the year ended December 31, 2010, to $6.5 million and $7.8 million, respectively, during the year ended December 31, 2011. Offsetting these declines were a reduction of total life finance segment expenses from $68.6 million during the year ended December 31, 2010 to $38.9 million during the year ended December 31, 2011, a decrease of $29.7 million. Interest expense declined to $8.2 million, a reduction of $16.2 million, as notes payable declined from $91.6 million in 2010 to $19.3 million in 2011. Provision for losses on loans receivable was $7.6 million during 2011, compared to $4.5 million during the year ended December 31, 2010. Provision for losses on loans receivable for uninsured loans increased during the year ended December 31, 2011, as a result of the impairment of the collateral based on decreases in the fair value of the collateral underlying those loans. Amortization of deferred costs, which are comprised primarily of upfront premiums previously paid to the LPIC insurer, were $6.1 million during the year ended December 31, 2011 compared to $24.5 million during the year ended December 31, 2010, a decline of $18.4 million. In connection with the Non-Prosecution Agreement, we voluntarily terminated our premium finance business and, as a result, we will no longer be generating agency fees that are tied directly to loan originations. Further, we will no longer generate loan, interest income, or origination income once our remaining loans mature.
16.65%. During the year ended December 31, 2011, the Company acquired 151 life insurance policies through purchases in the secondary and tertiary markets and as a result of certain of the Company’s borrowers defaulting on premium finance loans and relinquishing the underlying policy to the Company. Total aggregate death benefit of polices acquired during the year ended December 31, 2011 was $744.3 million.
Unrealized change in fair value of life settlements was an approximately $570,000 gain for the year ended December 31, 2011. This figure was negatively affected by a $14.1 million and $13.5 million reduction in fair value during the three months ended September 30, 2011 and December 31, 2011, respectively, as a result of decreases in the fair value of the Company’s portfolio of life insurance policies, compared to $10.2 million gain for the year ended December 31, 2010. The approximately $570,000 unrealized change in fair value recorded during the year ended December 31, 2011 included $3.0 million attributable to revisions made to the application of our valuation technique and assumptions used in our fair value calculation made in the quarter ended March 31, 2011, as described in Note 2, Principles of Consolidation and Basis of Presentation. These changes impacted the unrealized change in fair value by a gain of $3.0 million on 41 life settlement policies owned as of December 31, 2010.
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 $3.5 million during the third quarter. The other was the result of an accidental death and the $10.0 million face value of the policy was larger than average. The Company did not collect the $10.0 million death benefit under this policy as of December 31, 2011. The Company accounted for each of these polices as contingent gains in accordance with ASC 450, Contingencies and recognized $3.2 million in death benefits net of subrogation expense of $312,000 in its consolidated statement of operations during the third quarter of 2011. In accordance with ASC 450, the Company expected to recognize death benefits, net of subrogation expenses on the larger policy in the second quarter of 2012. The Company believes these contingent gains to be unpredictable. No expectations for similar gains in the future should be inferred from the events occurring in the third quarter of 2011.
In our structured settlements segment, total income was $11.9 million for the year ended December 31, 2011 compared to $9.5 million in 2010, an increase of $2.4 million. This increase was due to an increase in transactions originated to 873 during the year ended December 31, 2011 compared to 565 transactions originated during the year ended December 31, 2010. Segment SG&A expenses increased by $8.9 million to $22.0 million as we continued to build our infrastructure. This led to a segment operating loss of $10.0 million during 2011 an increase of $6.5 million over segment operating loss of $3.5 million recorded during 2010.
recorded in income tax expense, In addition, following the Conversion and prior to the initial public offering, one of our founding members entered into a reorganization that allowed us to assume the corporate shareholder’s tax attributes. These tax attributes include approximately $11.2 million of NOLs. Accordingly, in the second quarter we recorded a one-time deferred tax asset of approximately $4.3 million related to these tax attributes and this amount was recorded as an income tax benefit.
Following the conversion and prior to the initial public offering, one of the founding members entered into a reorganization that allowed the Company to assume the corporate shareholder’s tax attributes. These tax attributes include approximately $11.2 million of NOLs. During the second quarter of 2011, the Company completed an evaluation of this transaction and determined that the Company was entitled to assume the NOLs of this founding member. Accordingly, in the second quarter of 2011, the Company recorded a one-time deferred tax asset of approximately $4.3 million related to these tax attributes.
Agency Fee Income. Agency fee income was zero for the year ended December 31, 2012 compared to $6.5 million for 2011, a decrease of $6.5 million. Agency fee income is earned solely as a function of originating loans. We did not fund any loans during the year ended December 31, 2012, compared to the 55 loans funded during 2011. As a result of the voluntary termination of our premium finance business, we did not receive any revenue from agency fees in 2012 and will not in the future.
Interest Income. Interest income was $1.7 million for the year ended December 31, 2012 compared to $7.8 million for 2011, a decrease of $6.1 million, or 78%. During the years ended December 31, 2012 and December 31, 2011, the Company originated zero and 55 loans respectively. Interest income declined as the balance of loans receivable, net decreased from $29.4 million as of December 31, 2011 to $3.0 million as of December 31, 2012 due to significant loan maturities. There were no significant changes in interest rates. The
Origination Fee Income. Origination fee income was $500,000 for the year ended December 31, 2012, compared to $6.5 million for 2011, a decrease of $6.0 million, or 92%. Origination fee income decreased due to a decline in the average balance of loans receivable, net, as noted above. Also, the Company reduced origination fees charged after ceasing the LPIC program, under which the majority of origination fees were passed along to the LPIC provider. Origination fees as a percentage of the principal balance of the loans originated was 25.0% during 2011. As a result of the voluntary termination of our premium finance business, we did not originate any loans or origination fees during 2012. We will cease accruing origination fee income once our outstanding premium finance loans mature.
Gain on Forgiveness of Debt. Gain on forgiveness of debt was zero for the year ended December 31 2012 compared to $5.0 million in 2011, a decrease of $5.0 million. These gains arise out of a settlement agreement with Acorn Capital in 2011. Zero loans out of 119 loans financed in the Acorn facility remained outstanding as of December 31, 2012. The gains were largely offset by a loss on loan payoffs, net related to Acorn loans of $4.1 million during 2011.
Unrealized Change in Fair Value of Life Settlements. Unrealized change in fair value of life settlements was a loss of approximately $5.7 million for the year ended December 31, 2012 compared to a gain of $570,000 in 2011, a decrease of $6.3 million. This loss was primarily driven by increased life expectancy inputs to the Company’s fair value model reflected in the updated life expectancy reports procured by the Company in respect of 149 insured lives. These reports showed that, in the aggregate, there was less health impairment and thus longer life expectancies relative to the original life expectancy reports inputted into the Company’s fair value model. The $570,000 unrealized changed in fair value recorded during the year ended December 31, 2011 included $3.0 million attributable to revisions made to the application of our valuation technique and assumptions used in our fair value calculation made in the quarter ended March 31, 2011, as described in Note 2, Principles of Consolidation and Basis of Presentation. During the year ended December 31, 2012, the 29 policies which were acquired as a result of certain of the Company’s borrowers defaulting on premium finance loans and relinquishing the underlying policy to the Company, resulted in a decrease in unrealized change in fair value of $264,000 and 6 polices were sold resulting in a gain of $291,000.
The discount rates used in the fair value calculation for the year ended December 31, 2012 ranged from 14.80% to 33.80% an increase from the range 16.65% to 32.25% rates used during 2011. See Note 14 to the accompanying consolidated financial statements.
Gain on Maturities of Life Settlements with Subrogation Rights, net. During 2011, two individuals covered under policies that were subject to subrogation claims unexpectedly passed away. The Company collected the death benefit on one of these polices in the amount of $3.2 million, net of subrogation expenses. In 2012 the Company negotiated a settlement in respect to the larger policy and collected approximately $6.1 million, net of subrogation expenses. A gain was reported in accordance with ASC 450, contingencies in its consolidated statement of operations for the year ended December 31, 2012 as all contingencies were resolved.
Provision for Losses on Loans Receivable. Provision for losses on loans receivable was $515,000 during the year ended December 31, 2012, compared to $7.6 million during 2011, a decrease of $7.1 million or 93%. This provision records impairments on existing loans in order to adjust the carrying value of the loan receivable to the fair value of the underlying policy or when collectability of the LPIC claim payment is uncertain. See Notes 9, 13 and 14 to the accompanying consolidated financial statements.
Loss on Loan Payoffs and Settlements, Net. Loss on loan payoffs and settlements, net, was $125,000 for the year ended December 31, 2012 compared to $3.8 million in 2011, a decrease of $3.7 million, or 97%. In the year ended December 31, 2012, we wrote off zero loans compared to 15 loans written off in 2011, all of which were included in the Acorn settlement. Excluding the impact of the Acorn settlements, we had a loss of $125,000 and a gain of $772,000 on loan payoffs and settlements, net, for the years ended December 31, 2012 and 2011, respectively.
Amortization of Deferred Costs. Amortization of deferred costs was $1.9 million during the year ended December 31, 2012 as compared to $6.1 million for 2011, a decrease of $4.2 million, or 69%. Lender protection insurance related costs accounted for $1.5 million and $4.9 million of total amortization of deferred costs during the years ended December 31, 2012 and 2011, respectively. As described previously, the lender protection insurance program was terminated as of December 31, 2010 and 5 loans with lender protection insurance remained outstanding as of December 31, 2012. Only $7,000 of lender protection insurance related costs remains to be amortized.
Adjustments to our allowance for doubtful accounts for past due agency fees are charged to bad debt expense during 2011. There was no charge to bad debt expense for agency fee receivable for the year ended December 31, 2012. Our determination of the allowance is based on an evaluation of the agency fee receivable, prior collection history, current economic conditions and other inherent risks. The allowance for doubtful accounts for past due agency fees as was $260,000 as of December 31, 2012 and 2011.
Origination Fee Income. Origination fee income was $6.5 million for the year ended December 31, 2011, compared to $19.9 million in 2010, a decrease of $13.4 million, or 68%. Origination fee income decreased due to a decline in the average balance of loans receivable, net, as noted above. Also, the Company reduced origination fees charged after ceasing the LPIC program, under which the majority of origination fees were passed along to the LPIC provider. Origination fees as a percentage of the principal balance of the loans originated was 25.0% during 2011 compared to 41.5% in 2010. As a result of the voluntary termination of our premium finance business, we will cease accruing origination fee income once our outstanding premium finance loans mature.
Gain on Forgiveness of Debt. Gain on forgiveness of debt was $5.0 million for the year ended December 31 2011 compared to $7.6 million in 2010, a decrease of $2.6 million, or 34%. These gains arise out of a settlement agreement with Acorn Capital. Zero loans out of 119 loans financed in the Acorn facility remained outstanding as of December 31, 2011. The gains were largely offset by a loss on loan payoffs, net related to Acorn loans of $4.1 million and $5.5 million during the year ended December 31, 2011, and 2010, respectively.
Interest Expense. Interest expense was $8.2 million for the year ended December 31, 2011 compared to $24.4 million in 2010, a decrease of $16.2 million, or 66%. The decrease in interest expense was due to a decline in notes payable from $89.2 million as of December 31, 2010 to $19.3 million as of December 31, 2011, a decrease of $69.9 million, or 78%.
Interest Income. Interest income was $329,000 for year ended December 31, 2012 compared to $553,000 for 2011, a decrease of $224,000 or 41% as a result of a reduction of the asset held during the year ended December 31, 2011. Interest income is accretion during the period on the structured settlement assets held on our balance sheet.
Interest Income. Interest income was $553,000 for year ended December 31, 2011 compared to $334,000 for 2010, an increase of $219,000.
Unrealized Change in Fair Value of Structured Settlement Receivables. Unrealized change in fair value of investments and structured receivables was $5.3 million for the year ended December 31, 2011 compared to $2.5 million for the same period in 2010. At December 31, 2011 we had 288 structured receivables on our balance sheet compared with 84 structured settlement receivables on our balance sheet as of December 30, 2010. The large increase was due to the Company’s inability to finance these receivables in the dedicated financing facility
We anticipate that our liquidity needs for 2013 and for 2014 will be in excess of the amounts of cash and cash equivalents held by the Company as of December 31, 2012, as a result of matters associated with the USAO and SEC Investigations and related shareholder litigation. The Company has expended considerable resources resolving the USAO Investigation, as well as responding to the SEC investigation and related litigation, advancing indemnification costs on behalf of certain employees and in conducting an independent investigation of the facts and circumstances surrounding the USAO Investigation. As of December 31, 2012, the Company’s cumulative legal and related fees in respect of these matters were $29.1 million, including $22.3 million paid during the year ended December 31, 2012.
We believe we will continue to spend significant amounts on legal matters related to the USAO and SEC investigations, shareholder litigation and other potential claims over the next year, and possibly beyond. We expect to meet our liquidity needs for the next year primarily through our cash resources and, to a lesser extent, through cash flows from sales and financings of structured settlements. We have only purchased 2 life insurance policies during the 12 months ended December 31, 2012 in an effort to conserve capital, are seeking capital and may also sell certain life insurance policies in our portfolio. We may also seek to reduce our operating expenses in order to preserve the value of our existing portfolio of policies, and/or, under certain scenarios, lapse or sell certain of our policies or some combination of the above. The lapsing of policies, if any, would create losses as such assets would be written down to zero. In connection with the Non-Prosecution Agreement, we have ceased originating new premium finance loans. We expect debt maturities to be covered by cash receipts from LPIC claims as discussed further below, and we do not currently have any material planned capital expenditures.
Interest under the Bridge Facility accrues at 12% per annum for the first nine months from the issue date, and increases by 600 basis points thereafter to 18% per annum. Up to 25% of the net proceeds from the Bridge Facility after transaction expenses may be used by the Company for general corporate purposes, including for premium payments on life insurance policies not owned by Greenwood, with the balance used to pay fees and expenses associated with the Bridge Facility and for premiums on life insurance policies owned by Greenwood. The Bridge Facility is guaranteed by the Company and secured by the cash on account at Greenwood and its portfolio of life insurance policies. The Bridge Facility is also secured by pledges of the equity interests of Greenwood’s direct parent and each subsidiary of the Company, other than its licensed life settlement provider, that holds life insurance policies that are not subject to the subrogation rights of the Company’s lender protection insurance carrier.
8.39% Fixed Rate Asset Backed Variable Funding Notes. We formed Imperial Settlements Funding (“ISF”) as a subsidiary of Washington Square Financial, LLC (“WSF”) to serve as a special purpose financing entity to allow us to borrow against certain of our structured settlements and assignable annuities, which we refer to as receivables, to provide us liquidity. On September 24, 2011, we entered into an arrangement to provide financing up to $50 million in financing. Under this arrangement, a subsidiary of Partner Re, Ltd., or the noteholder, became the initial holder of ISF 2011’s 8.39% Fixed Rate Asset Backed Variable Funding Notes issued under a master trust indenture and related indenture supplement, or the indenture, pursuant to which the noteholder has committed to advance up to $50 million upon the terms and conditions set forth in the indenture. The note is secured by the receivables that ISF 2011 acquires from Washington Square from time to time. The note is due and payable on or before January 1, 2057, but principal and interest must be repaid pursuant to a schedule of fixed payments from the receivables that secure the notes. The arrangement generally has a concentration limit of 15% for the providers of the receivables that secure the notes. Wilmington Trust is the collateral trustee.
During the third quarter of 2011, the Company suspended financing under this agreement, but resumed financing on January 12, 2012 pursuant to an acknowledgement that provided for WSF to make a $258,000 payment in respect of, the transfer of the ownership of certain lock-box accounts associated with the facility. As of December 31, 2012, the Company had available commitments under this facility of $6.8 million. We also have other parties to whom we have sold term-certain structured settlement assets and to whom we believe we can sell such assets in the future.
The Life-contingent Structured Settlement Facility. On December 30, 2011, WSF entered into a forward purchase and sale agreement (“PSA”) to sell up to $40.0 million of life-contingent structured settlement receivables to Compass Settlements, LLC (“Compass”). Subject to predetermined eligibility criteria and on-going funding conditions, Compass committed, in increments of $5.0 million, up to $40.0 million to purchase life-contingent structured settlement receivables from WSF. The PSA obligates WSF to sell the eligible life-contingent structured settlement receivables it originates to Compass on an exclusive basis for twenty-four months, subject to Compass maintaining certain purchase commitment levels. Additionally, the Company agreed to guaranty WSF’s obligation to repurchase any ineligible receivables sold under the PSA and certain other related obligations. As of December 31, 2012, the Company had available commitments under this facility of $6.6 million.
The following table summarizes our cash flows from operating, investing and financing activities for the years ended December 31, 2012, 2011 and 2010 (in thousands):
Net cash used in operating activities for the year ended December 31, 2012 was $38.1 million, a decrease of $8.3 million from $46.4 million of cash used in operation activities in 2011. The decrease was mainly due to a reduction in accounts payable and accrued expenses of $19.1 million and interest payable of $1.3 million as a result of paying down loans outstanding. These were offset by increased structured settlement receivables of $18.4 million, other liabilities of $20.1 million, which is mainly attributable to liabilities associated with the class action and derivative action proposed settlement, prepaid expenses and other assets of $8.8 million that are mainly associated with insurance coverage for Directors and Officers, insurance recoverable related to the class action and derivative proposed settlement and deposits of $2.0 million.
Net cash provided by financing activities for the year ended December 31, 2011 was $140.9 million, an increase of $217.8 million from $76.8 million of cash used in investing activities in 2010. The increase was primarily due to an increase of $174.2 million in proceeds from our initial public offering, net of offering costs and a $93.2 million decrease in cash used in the repayment of borrowings from affiliates offset by a $45.7 million decrease in borrowings under credit facilities and from affiliates during the year ended December 31, 2011.
Except as described below in “-Subrogation Rights, Net,” there are no off-balance sheet arrangements between us and any other entity that have, or are reasonably likely to have, a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to stockholders.