The Position Holder Trust expects that fulfilling its liquidating purpose will require a significant amount of time. As such, the Trust will have significant ongoing operations during that period due to the nature of its assets and its plan to maximize the proceeds to its beneficiaries by maintaining the majority of its Policies until maturity. As a result, the Trust has concluded that its liquidation is not imminent, in accordance with the definitions under accounting principles generally accepted in the United States and has not applied the liquidation basis of accounting in presenting its financial statements. The Trust will continue to evaluate its operations to determine when its liquidation becomes imminent and the liquidation basis of accounting is required.
The following table provides a roll-forward in the changes in fair value for the year ended December 31, 2017, for the PHT Portfolio:
As of December 31, 2017, the Portfolio held 3,140 Policies with an estimated fair value of $471.6 million compared to 3,252 Policies with a fair value of $470.7 million at December 31, 2016, an increase of $0.9 million. Of the Portfolio value, $272.1 million is attributable to the PHT Portfolio and $199.5 million to the Continuing Fractional Holders. As of December 31, 2017, the Policies’ aggregate death benefit was approximately $2.1 billion, which was comprised of $1.8 billion in life settlement contracts and $252.0 million in viatical contracts.
The Policies were valued using a base or foundational discount rate of 15%, with further valuation adjustments based upon the size of the insured pool, life expectancy data, distinctions between life settlement and viatical policies and whether the Policies are whole life, convertible term or non-convertible term policies and with a post-adjustment weighted average discount rate of 25.45% for Life Settlements and 31.82% for Viaticals. See, Note 6, Fair Value Measurements to the accompanying consolidated financial statements.
The following table provides a roll-forward in the changes in fair value for the period ended December 31, 2016, for the Trust’s Policies:
The Position Holder Trust paid of $19.9 million of its outstanding notes payable during the year ended December 31, 2017. The Trust received $207.1 million of contributed cash at creation on December 9, 2016. In addition, Vida Opportunity Fund, LP, an affiliate of Vida Capital, Inc. provided the $55 million Exit Loan Facility necessary to provide for consummation of the reorganization transactions contemplated by the Plan. The Maturity Funds Facility of $27.2 million was repaid during 2016.
At December 31, 2017, the Position Holder Trust had $78.1 million of cash primarily consisting of $5.7 million held to pay Policy premiums, $30.2 million was held to pay for premiums collected and due on behalf of the Continuing Fractional Holders, $23.6 million was held to pay pre and post effective date maturities collected and owed to Continuing Fractional Holders, $16.6 million was held as collateral deposits on debt, and $1.8 million was available to pay for operating expenses of the Trust. The primary need for working capital is to pay premiums on Policies and expenses relating to administration of the Trust and its assets. 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.
The Trust’s total outstanding liabilities decreased by $47.6 million from $178.4 million at December 31, 2016, to $130.8 million at December 31, 2017. The decrease was mainly attributable to the expenditure of cash to pay outstanding liabilities associated with the payout of pre and post effective date maturities of $23.7 million, notes payable of $19.9 million, Creditors’ Trust funding of $10.0 million, and certain other obligations associated with the bankruptcy and organization of the Trust and IRA Partnership, including interest, offset by increase in liabilities for premiums payable of $4.4 million.
Pursuant to the Servicing Agreement, fees for servicing the Policies will be paid out of the death benefits paid on Policies in an amount equal to 2.65% of the death benefits paid. In addition, the Trust is required by the Plan to contribute $12 million to the Creditors’ Trust over the three-year period following the Effective Date. An initial $2 million was contributed to the Creditors’ Trust on December 9, 2016, and an additional $5 million was contributed in both January and December 2017.
The Debtors’ estate included 1,177 security holders who held their positions through their individual retirement accounts, which are prohibited investments for an IRA. As a result, the Plan included a mechanism to resolve the IRA investors’ claims by establishing the IRA Partnership and authorizing the issuance of the New IRA Notes.
The Position Holder Trust is authorized to issue New IRA Notes in a principal amount of $63.7 million bearing interest at 3.00% per annum, due 2031. As of December 31, 2017, there were $36.5 million of New IRA Notes outstanding, with accrued interest of $109 thousand through December 31, 2017. Interest is payable annually. The first payment of $1.1 million was made in December 2017. As of December 31, 2016, the outstanding amount of the New IRA Notes was $36.5 million, with accrued interest of $81 thousand as of December 31, 2016.
As a basis for considering such assumptions, the guidance establishes a three-level fair value hierarchy that prioritizes the inputs used to measure fair value. Level 1 relates to quoted prices in active markets for identical assets or liabilities. Level 2 relates to observable inputs other than quoted prices included in Level 1. Level 3 relates to unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. The Trust’s investments in life insurance policies are considered to be Level 3 as there is currently no active market where the Trust is able to observe quoted prices for identical assets and the Trust’s valuation model incorporates significant inputs that are not observable.
The Trust’s valuation of life insurance policies is a critical estimate within the financial statements. The Trust currently uses a probabilistic method of valuing life insurance policies, which the Trust believes to be the preferred valuation method in the industry. The Trust calculates the assets’ fair value using a present value technique to estimate the fair value of the projected future cash flows. The most significant assumptions in estimating the fair value are the Trust’s estimate of the insureds’ life expectancy and the discount rate. See Note 6, “Fair Value Measurements”.
The Trust assumed the Debtors’ receivables related to life insurance policy premiums and service fees that were paid by the Debtors on behalf of fractional interest holders prior to the Trust’s effective date. After December 9, 2016, the policy premiums allocable to continuing fractional interest holders are those persons’ obligations and not the Trust’s. If a continuing fractional interest holder defaults on future premium obligations, such position is deemed contributed to the Trust in exchange for the number of Units provided by the Plan.
The Trust maintains an allowance for doubtful accounts for estimated losses resulting from the inability to collect premiums and service fees receivable. Such estimates are based on the position holder’s payment history and other indications of potential uncollectability. After all attempts to collect a receivable have failed, receivables are written off against the allowance. At December 31, 2017 and 2016, the allowance for doubtful accounts totals $5.0 million, all of which was for receivables assumed from the Debtors on the effective date. Outstanding receivable balances may be recoverable pursuant to the Trustee’s set-off rights under the Plan.
The Financial Accounting Standards Board (“FASB”) has provided guidance for how uncertain tax positions should be recognized, measured, disclosed, and presented in the financial statements. This requires the evaluation of tax positions taken or expected to be taken in the course of preparing the Trust’s tax returns to determine whether the tax positions are more-likely-than-not of being sustained when challenged or when examined by the applicable taxing authority. The Trust has no material uncertain income tax positions as of December 31, 2017 and 2016.
The Trust also assumed income tax liabilities of the Debtors at its inception which total approximately $2.0 million as of December 31, 2017 related to taxes, penalties, and interest from the Debtors’ 2008, 2009 and 2010 income tax returns. These obligations bear interest at 4% annually and are due in full by January 2020.
The Trust encounters economic, legal, and longevity risk. The two main components of economic risk potentially impacting the Trust are market risk and concentration of credit risk. The Trust’s market risks include interest rate risk and the risk of declines in valuation of the Trust’s life insurance policies, including declines caused by the selection of increased discount rates associated with the Trust’s fair value model. It is reasonably possible that future changes to estimates involved in valuing life insurance policies could change and result in material effects to the future financial statements. Concentration of credit risk is the risk that an insurance carrier who has issued life insurance policies held by the Trust, does not remit the amount due under those policies due to the deteriorating financial condition of the carrier or otherwise. Another credit risk potentially impacting the Trust is the risk continuing fractional holders may default on their future premium obligations, increasing the Trust’s premium liability.
On December 9, 2016, the Trust received funds related to maturities that occurred prior to the formation of the Trust. These funds are recognized as a liability on the accompanying balance sheet as pre-effective maturity liabilities owed to the fractional interest holders. Additionally, the Trust has recorded a receivable for maturities that occurred prior to December 9, 2016 where proceeds were not received as of that date. This receivable is $9.0 million as of December 31, 2016 and is included in maturity liabilities on the accompanying balance sheet.
The Trust accounts for its interests in life insurance policies at fair value in accordance with ASC 325-30, Investments in Insurance Contracts. The Trust initially recognized the life insurance policies transferred at its inception at their fair market value on December 9, 2016 and the Trust will estimate the fair value of its life insurance policies and recognize changes therein at each subsequent reporting period.
The Trust’s valuation of life insurance policies is a critical estimate within the financial statements. The Trust currently uses a probabilistic method of valuing life insurance policies, which the Trust believes to be the preferred valuation method in its industry. The Trust calculates the assets’ fair value using a present value technique to estimate the fair value of the projected future cash flows. The most significant assumptions in estimating the fair value are the Trust’s estimate of the insureds’ life expectancy and the discount rate. See Note 6, “Fair Value Measurements”.
The Trust assumed the Debtors’ receivables related to life insurance policy premiums and service fees that were paid by the Debtors on behalf of fractional interest holders prior to the Trust’s effective date. After December 9, 2016, the policy premiums allocable to continuing fractional interest holders are those persons' obligations and not the Trust. If a continuing fractional interest holder defaults on future premium obligations, such position is deemed contributed to the Trust in exchange for the number of Units provided by the Plan, as recently modified by the Bankruptcy Court.
Estimated premiums to be paid by the Trust for its portfolio during each of the five succeeding fiscal years and thereafter as of December 31, 2017, are as follows:
The amount of $408.4 million represents the estimated total future premiums payable by the Trust. The Trust is required to pay its portion to keep the life insurance policies in force during the life expectancies of all the underlying insured lives. The estimated total future premium payments could increase or decrease significantly to the extent that insurance carriers increase the cost of insurance on their issued policies or that actual mortalities of insureds differs from the estimated life expectancies. If the continuing fractional holders default on their future premium obligations, the Trust’s premium liability may increase.
In accordance with the Plan, the Trust issued New IRA notes of $36.5 million in exchange for claims against the Debtor’s estate and the incidental interests in life insurance policies. Those policies collateralize the Trust’s obligations under the notes. Interest accrues at 3% of outstanding balance and is paid annually in December. Principal is due in full on December 9, 2031. In accordance with the notes, beginning in December 2017, the Trust is required to make annual payments to a sinking fund for the principal payment due at maturity. Such fund is included in restricted cash on the accompanying balance sheet.
Following is a description of the methodologies used to estimate the assets’ fair value measured on a recurring basis and within the above fair value hierarchy.
The following table provides a roll-forward in the changes in fair value for the Trust’s life insurance policies:
The Partnership accounts for its investment in the PHT using the equity method of accounting in accordance with Accounting Standards Codification (ASC) 323, Investments - Equity Method and Joint Ventures. The Partnership and the Trust are closely connected, with a common trustee and common management. As a result of this common oversight and control, as well as the Partnership’s position as the majority holder of the Trust’s beneficial interest units, the Partnership is considered to have significant influence under the provisions of ASC 323, resulting in the application by the Partnership of the equity method of accounting.