Important Legal Information and Risk Factors
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EEA Fund Management (Guernsey) Limited is licensed by the Guernsey Financial Services Commission to carry on the restricted activities of promotion, subscription, dealing, management and administration in connection with Category 1 Collective Investment Schemes and Category 2 General Securities and Derivatives under The Protection of Investors (Bailiwick of Guernsey) Law, 1987 as amended.
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The risks which may impact on the performance of the Fund are set out in the Fund’s prospectus and are summarised below.
In this section:-
“Cell” means a cell created by the Company for the purpose of segregating and protecting cellular assets;
“Company” means EEA Life Settlements Fund PCC Limited;
“EEA Inc.” means EEA Life Settlements Inc, a corporation formed under the laws of Delaware;
“Fund” means any one or more of the Company, its Cells, the Master Subsidiary, the Master Sub II and EEA Inc.;
“Investment Adviser” means ViaSource Funding Group LLC; and
“Master Subsidiary” means EEA Life Settlements Master Fund Limited;
“Master Sub II” means EEA Life Settlements Master Fund II Limited; and
“Manager” means EEA Fund Management (Guernsey) Limited.
All other defined terms used have the meanings given to them in the Fund’s prospectus.
Investment in the Fund should be regarded as a medium to long term investment.
Investment risk: The price of the shares in the Company and the income from them (if any) can go down as well as up and, on the redemption of shares, investors may not receive the amount that they originally invested. The return on the investments will be dependent in large part upon the ability and expertise of the Investment Adviser to source and price the investments. The pricing of a settlement is dependent upon the life expectancy of the insured and premiums payable to maintain the policy. The investment in a policy may result in a loss if the medical diagnosis of the insured’s condition is incorrect, the insured lives longer than the life expectancy estimate and, as a result, a higher premium has to be paid for the remainder of the term.
Valuation overstatement or understatement risk: The valuation of the policies is based on the projected cashflows which depend upon the unknown length of time for which the insured will live. If the Investment Adviser underestimates how long an insured may live, it may pay more for a life policy than the policy is worth either on a discounted or a present value basis and be required to pay out more premiums than anticipated. Either of these circumstances could have a significant adverse effect on the returns on the investments. Inaccurate forecasting of an insured’s life expectancy could result from, among other things: advances in medical treatment resulting in deaths occurring later than forecast; inaccurate diagnosis or prognosis; changes to life style habits or the individual's ability to fight disease resulting in improved health; fraud or misrepresentation by the insured. Although two qualified physicians’ estimates are used, such valuations will ultimately be a matter of informed judgement and there is no guarantee they will not be overstated or understated.
Insured fraud risk: Although the Investment Adviser will conduct certain diligence in advance of investing in a policy, there is a risk that EEA Inc will be defrauded. Among other types of fraud that may exist, an insured may misrepresent the status of his illness, may fail to disclose all beneficiaries or may sell a policy to more than one purchaser. If EEA Inc is subject to such fraud, returns on the investments may be adversely affected.
Availability risk: The continuity of operation of a Cell is dependent on the Fund’s ongoing ability to purchase life insurance policies and the availability of leverage, where required, to meet the investment objectives of the Cell. A change in the availability of life insurance policies or leverage (if appropriate) could adversely affect the Manager’s ability to execute its investment strategy leading to the potential failure of the Cell to meet its investment objective. Changes in the economy and other changed circumstances may result in a reduced ability to purchase life insurance policies Such changes could result from, among other things: (i) improvement in the economy, generating higher investment returns to insureds from their investment portfolios; (ii) improvements in health insurance coverage, limiting the need of insureds to obtain funds to pay the cost of their medical treatment; (iii) a change in law requiring the Fund to apply more stringent credit standards in purchasing life settlements; (iv) the entry into the market of less reputable third party brokers who submit inaccurate or false life settlement information to the Investment Adviser on behalf of insureds; (v) the establishment of new licensing requirements for the market participants and a delay in complying or an inability to comply with such new requirements; or (vi) refusal of the insurance company that issued the policy to consent to its transfer. A change in the availability of life insurance policies or leverage (where appropriate) could adversely affect the ability of the Investment Adviser to execute its investment strategy and meet its investment objective. Initially the Investment Adviser will be licensed in a number of states in the United States of America and will only be able to purchase life settlements in the states in which it is licensed or in which licensing is not required. EEA Inc will therefore be dependent on its ability to find an adequate supply of policies in the states in which the Investment Adviser is licensed or in which licensing is not required.
Policy Pricing Risks: The life settlements market has witnessed an inflow of funding. Most of these investment groups have elected to use either the life expectancy at the lower confidence level, or they have used some variations of the mortality curves provided by life expectancy firms. This practice of purchasing policies with shorter life expectancies derived from a lower confidence level has created an extremely competitive pricing arena. This increase in the competitiveness in pricing may make it more difficult for EEA Inc to purchase policies in an expedient manner and result in lower margins on the investments.
Liquidity risk: EEA Inc intends to purchase a substantial pool of life settlements. There is minimal or no return on such purchases until maturity. Proceeds derived from maturing policies will be reinvested and will not be readily available to satisfy redemption requests. Such an investment is essentially illiquid. Therefore, EEA Inc may not have access to liquid assets to make any payment to shareholders until the life insurance policies mature or unless it realises the assets through the secondary market. The secondary market of these settlements is not highly regulated or developed and there is no certainty the market will be active. Accordingly delays may occur in redemption payments. In order to increase EEA Inc's liquidity, the Manager shall seek to match redemptions with subscriptions and source available credit facilities with the pledging of the life insurance policies.
Missing Insureds: There is a risk that an insured with whom EEA Inc has entered into a contract may go missing, or that there may be a delay in ascertaining that an insured has died or in obtaining required documentation needed to claim the insured’s death benefit. EEA Inc could incur substantial unplanned expenses in locating missing insureds and could experience substantial delays in collecting death benefits. In some states, the regulator may limit the frequency of contacts that the Investment Adviser through its tracking firms could make to the insured or obtaining his or her medical records by the tracking firms.
Counterparty risk: There is a counterparty risk in respect of the solvency of the insurance company during the period a policy is held to maturity. There is no guarantee that the insurance companies will meet their obligations to make payment on maturity. The Manager manages counterparty risk by limiting the exposure to any single insurance company obligor and by only buying policies written by insurers that meet its rating requirements. EEA Inc relies on the Investment Adviser to locate and evaluate policies to be purchased, to administer the policies in the books and to process claims. If, as a result of insolvency or liquidation or otherwise, the Investment Adviser were to cease servicing the life settlements, it may be difficult to find a suitable successor adviser. Any successor adviser may have less experience and be less capable in evaluating policies, processing claims and managing collection systems.
Hedging risk: The use of hedging instruments involves certain special risks including dependence on the Cell’s ability to predict movements in interest rates, the price of investment assets and cash instruments being hedged, imperfect correlation between the hedging instruments and the investment assets, cash instruments and interest rates being hedged, and the fact that the skills needed to use hedging instruments are different from those needed to select the Cells’ investment assets, cash instruments and leverage. Whilst such techniques can improve the return on invested capital, their use also increases the costs and the risk of losses to the Company and the Cells.
Concentration Risk: All of the Cells are ultimately exposed to the same underlying risk. In each case the Cell will participate indirectly in a pro rata share of the investment assets. Accordingly no diversity or spread of risk will be achieved by investing in more than one Cell, save in respect of any differences in performance related to such factors as the expenses, and the currency in which that Cell is denominated. The distributions to Shareholders are paid out of the distributions from the Master Subsidiary and the Master Sub II, which in turn are derived from distributions or repayment of loans notes from EEA Inc. Such distributions or repayments could be paid out of the unrealised profits of EEA Inc. The unrealised profits, which are not determined on a marked to market basis, may not be crystallised in the event of early realisation or delayed maturity of the underlying investment in life policies. As a result, the total performance of EEA Inc and thus the Cells, the Master Subsidiary and the Master Sub II may be adversely affected.
Leverage risk: Where the Cell uses leverage to increase potential investment returns a significant risk exists should the cost of borrowing exceed the rate of return of the investment assets. The Cell’s exposure to capital risks is increased by the degree of leverage employed.
Custody risk: Cells which borrow for the purpose of leverage may be required to provide security. Where security is required, assets will be deposited with the lender and will cease to be within the Custodian’s exclusive control. Accordingly, the Cell may be exposed to acts, omissions or insolvency risk of the lender. If pledging of security is required, the Manager will source reliable financial institutions with good credit ratings to minimise such risk.
Redemption Charges risk: Shares may be subject to redemption charges and/or a dilution levy. Such charges will decrease the redemption value of shares.
Currency fluctuation risk: The underlying investments of a Cell may be denominated in currencies other than the base currency. Any fluctuation in the value of these other currencies against the base currency will affect the profitability of a Cell when the investments are converted into its base currency. The Manager may use hedging instruments including forward exchange contracts, futures and options to minimise such currency risk. There is no guarantee that any Cell will at all times have access to adequate hedging facilities to be able to hedge the Cell’s foreign currency exposure comprehensively. There is a risk that part or all of a Cell’s foreign currency exposure may remain unhedged or overhedged from time to time.
Cell Risks: The Company is registered as a protected cell company. Under Part XXVII of the Companies Law, the assets of a Cell will not be available to meet the liabilities of another Cell. Although subject to limited judicial scrutiny, the principal advantage of a protected cell company is that, although it is still a single legal entity, it protects the assets of one Cell in the Company from the liabilities of other Cells in the Company. However, the concept of a protected cell company is relatively new and has been subject to limited judicial scrutiny. Accordingly, where the assets of the Company are outside Guernsey and the action is brought against the Company or the assets in that jurisdiction it is not known how the foreign courts will react to Part XXVII of the Companies Law. Furthermore, if a liability is imposed on the Company, it is not known how the courts will react in allocating that liability to one or more of the various Cells.
Changes in taxation: Any change in the Fund's tax status, or in taxation legislation or practice in either Guernsey or any jurisdiction in which the Fund invests, could affect the value of the investments held by the Fund or the Fund's ability to achieve its investment objectives or alter the after-tax returns to Shareholders.
US Federal and State Tax Risks: The IRS could raise a number of issues regarding the US federal income taxation of the Fund which, unless successfully challenged in court, could substantially increase the amount of US federal income tax that the Fund would be required to pay. For example, the IRS could assert that (i) some or all of the interest expense paid by EEA Inc does not reduce the income of EEA Inc for US federal income tax purposes, (ii) the interest paid by EEA Inc is subject to US federal income tax (in which case such tax would be imposed at a rate of 30 per cent.), or (iii) the gain recognised by the Master Subsidiary when it transferred the policies to Master Sub II was subject to US federal income tax on a net basis. Other potential grounds for increased US federal income tax liability also exist. Additionally, the States of New Jersey or other states could assert successfully that EEA Inc was engaged in business or otherwise connected to those states. If such contention were accepted, some or all of the income of EEA Inc could be subject to the income tax of one or more states.