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Item 2.06
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Material Impairments.
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The fair value of the
portfolio of life insurance policies owned by GWG Holdings, Inc. (the “Company”) is determined as the net present value
of the life insurance portfolio’s future expected cash flows (net of policy benefits received and required premium payments).
The net present value of the future expected cash flows incorporate life expectancy estimates and current discount rate assumptions.
The life expectancy estimates used by the Company for acquiring and valuing life insurance policies has in the past been typically
based upon the average of two life expectancy reports received from independent third-party medical actuarial underwriting firms
(“Life Expectancy Providers”). After the acquisition of a life insurance policy, the Company has sought to update these
life expectancy reports on a periodic basis.
In October and November
2018, two of the primary Life Expectancy Providers used by the Company - ITM TwentyFirst, LLC (“TwentyFirst”) and AVS,
LLC (“AVS”) - released updates to their respective mortality tables and medical underwriting methodologies. As disclosed
in the Company’s Form 10-Q filed with the Securities and Exchange Commission on November 19, 2018 the majority of the Company’s
life insurance policies were valued using life expectancy reports provided by TwentyFirst and/or AVS. The updates from TwentyFirst
and AVS suggest a lengthening of prior life expectancy estimates and relate to revised estimates of the originally issued life
expectancy reports. These updates do not encompass any change to the insured’s age and health condition since the report
was originally issued.
The Company, along
with other major secondary market participants, have noted the frequent changes in methodologies made by the Life Expectancy Providers
over the years that, short of purchasing revised life expectancy reports at a substantial cost, have lacked detailed information
about the impact of these changes on individual policy values. Moreover, our experience is these methodology changes have not resulted
in a narrowing of consensus in the life expectancy estimates issued for individual insureds. Finally, as the Company’s portfolio
has grown in size and diversity, our ability to model with greater certainty and predictability through the incorporation of historical
portfolio experience in conjunction with the use of life expectancy reports has improved significantly.
As a result, the Company
undertook a comprehensive study to determine a more accurate, transparent and cost-effective method of pricing, valuing, and modeling
the performance of our portfolio of life insurance policies. The Company’s goal was to incorporate life expectancy estimates
from Life Expectancy Providers, the historical experience of the portfolio, the diversification and mortality factors of the portfolio,
and relevant market-based observations and inputs.
The Company believes it
has succeeded in creating and validating such an approach which is referred to as the “Longest Life Expectancy” method.
The Longest Life Expectancy methodology adopted by the Company is built from the following pillars:
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The
utilization of life expectancy reports from independent Life Expectancy Providers for
the pricing of all life insurance policies;
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The application of a stable valuation
methodology driven by the experience of the life insurance portfolio which is re-evaluated if experience deviates by a specified
margin; and
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The use of relevant market observations
that can be validated and mapped to the discount rate used to value the life insurance portfolio.
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The Company has resolved
to use the Longest Life Expectancy methodology going forward based upon using the longest life expectancy report received from
the Life Expectancy Providers used for pricing at the time a life insurance policy is purchased (the “Longest Life Expectancy”).
The Company’s
portfolio modelling and predicted future cash flows are based upon the central limit theorem which establishes that, in certain
situations, random events become normalized and predictable around the mean as the number of observations grow in size. We believe
the Company’s portfolio of life insurance policies has grown sufficiently large in size and diversity to establish that
while individual mortality experience is inherently unpredictable, the actual mortality experience of the portfolio should be
expected to approach the mean modelled prediction. As of December 31, 2018, the Company’s portfolio, stratified by age of
insured in the table below, stood at $2.047B in face value of policy benefits and 1,154 policies:
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Percentage of Total
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Min Age
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Max Age
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Number of
Policies
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Policy
Benefits
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Number of Policies
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Policy
Benefits
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95
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100
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|
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16
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$
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23,483,000
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|
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1.4
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%
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|
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1.1
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%
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90
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|
94
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|
|
129
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|
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257,877,000
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|
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11.2
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%
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|
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12.6
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%
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85
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|
89
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|
|
232
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|
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519,107,000
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|
|
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20.1
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%
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|
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25.3
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%
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80
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|
84
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|
|
243
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|
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458,529,000
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|
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21.1
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%
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|
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22.4
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%
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75
|
|
79
|
|
|
230
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|
|
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407,087,000
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|
|
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19.9
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%
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|
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19.9
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%
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70
|
|
74
|
|
|
213
|
|
|
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275,933,000
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|
|
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18.4
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%
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|
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13.5
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%
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60
|
|
69
|
|
|
91
|
|
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105,976,000
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7.9
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%
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|
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5.2
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%
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Total
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1,154
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$
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2,047,992,000
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|
|
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100.0
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%
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|
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100.0
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%
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After extensive research and modelling,
the Company found that the Longest Life Expectancy methodology was highly predictive of the actual experience of our portfolio
of life insurance policies as compared to our historical methodology that applied the average of two life expectancy reports received
from Life Expectancy Providers (the “Average Life Expectancy”).
The tables below
compare the actual-to-expected mortality cash flow experience of our life insurance portfolio using Average Life Expectancy and
Longest Life Expectancy. By using the Longest Life Expectancy methodology, we increased our actual-to-expected mortality cash flow
experience accuracy from 78% to 95%.
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(1)
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Quarterly cash flow weighted average
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We believe that a Longest
Life Expectancy methodology which incorporates the actual mortality experience of our portfolio and the use of third-party estimates
is superior to our historical methodology. We believe this methodology should minimize future fluctuations of valuation, decrease
our reliance on Life Expectancy Providers for updated reports, and improve our ability to finance and forecast future revenues
and earnings.
We expect the implementation
of the Longest Life Expectancy methodology will require the Company to take a non-cash charge to revenue of $84 million,
reflecting a decrease in the fair value of its portfolio of life insurance at December 31, 2018. This non-cash charge represents
approximately 10% of the fair market value of the portfolio prior to adjustment.
Further information regarding
the new methodology and this change will be included in the Company’s 2018 10-K filing.
Forward-Looking Statements
This Current Report
on Form 8-K contains statements that are forward-looking statements within the meaning of Section 27A of the Securities Act
of 1933, as amended and Section 21E of the Securities Exchange Act of 1934, as amended. The Company intends these
forward-looking statements to be covered by the safe harbor provisions for such statements. All statements that do not
concern historical facts are forward-looking statements. The words “believe,” “could,”
“possibly,” “probably,” “anticipate,” “estimate,” “project,”
“expect,” “may,” “will,” “should,” “seek,” “intend,”
“plan,” “expect,” or “consider” and similar expressions are intended to identify
forward-looking statements but are not the exclusive means of identifying such statements. Forward-looking statements are
subject to risks and uncertainties, which could cause actual results to differ materially from such statements, including,
but not limited to the risks that the Company may recognize additional valuation adjustments or impairments related to its
assets, as well as the other risks set forth in the Company’s filings with the U.S. Securities and Exchange Commission.
These forward-looking statements should be considered in light of these risks and uncertainties. The Company bases its
forward-looking statements on information currently available to it at the time of this report and undertakes no obligation
to update or revise any forward-looking statements, whether as a result of changes in underlying circumstances, new
information, future events or otherwise.