Structured settlements have become part of the statutory tort law of several common law countries including Australia, Canada, England and the United States. Structured settlements may include income tax and spendthrift requirements as well as benefits and are considered to be an asset-backed security. Often the periodic payment will be created through the purchase of one or more annuities, which guarantee the future payments. Structured settlement payments are sometimes called periodic payments and when incorporated into a trial judgment is called a ?periodic payment judgment."
A purchaser of a structured settlement is an individual or company who buys a pre-existing structured settlement. These settlements can include lottery winnings, annuities, etc. An example: There's a court ordered structured settlement which pays five thousand dollars a year, to individual A, for twenty years. Individual A doesn't want to wait for twenty years to receive their money so they approach purchaser A, a SS purchaser. Purchaser A offers them fifty thousand dollars for their SS. In this case Individual A receives less money than they would if they waited twenty years, however they get more money immediately, which they might need.
Things become more complicated if individual A only wants to sell some of their SS, or if the purchaser A buys this SS and then sells it to purchaser B and keeps a percentage. This could extrapolate to an unlimited number of individuals and purchasers. While the purchasing of SS has been around for a while, it has become a larger industry in recent years, probably because of the risk-free incentive. These purchasers are essentially buying loans which are guaranteed to be paid off. Because of the growing market and the growing complexities, SS purchasers are finding it more and more difficult to track their settlements(loans).[original research?] Because of this, there is a growing market of loan servicing software being used by SS purchasers to keep track.
Purchase Structured Settlements
Why would a company want to purchase a structured settlement from a person receiving regular installments in compensation for a personal injury? The answer is clear: the company is guaranteed a steady, safe cash flow that is generally not taxable in return for a lump sum of money of about half the value of the full-term settlement. When companies buy a structured settlement they are always getting the better end of the deal, no matter how appealing the quick cash may seem to the seller. These companies are generally not out to make life better for injured persons, but instead are seeking to profit from those persons' pressing financial needs or eagerness to be free from what may seem to many like an allowance. This is why persons wishing to sell settlements need to be very, very careful about who they sell those settlements to.
First of all, exactly what are structured settlements and how do such arrangements work? When a person wins a lawsuit based on worker's compensation, personal injury, or medical malpractice, often the court will rule that compensation be paid in installments, either in small, regular amounts or a few lump sums over the years. Often, these payment plans will cease upon the death of the payee, whether or not there are dependents involved. Before accepting a compromise, injured persons need to work closely with lawyers to ensure that the settlement is going to benefit them to the fullest possible extent in order to prevent future financial distress and the loss of well-deserved compensation. This careful planning will prevent the undesirable necessity of finding a company to purchase a structured settlement from its possessor when he finds that waiting for a monthly check isn't a tolerable system.?
If, however, a person has already settled a legal case and finds that the periodic payment plan is not working for him or decides that larger amounts of money are needed immediately in order to purchase medical equipment, a customized vehicle or home to accommodate injuries, or similar items, or does not expect to live long enough to benefit from long-term compensation, may want to consult various companies that offer to buy a structured settlement. Such companies will allow him to sign over annuities in exchange for immediately accessible cash. Persons considering this option should know that while their annuities are not subject to taxation, the lump sum received from a third party may very well be, causing them to lose even more well-deserved money. This is a decision that requires long, hard thought and should not be entered in to hastily or lightly, as its consequences can be disappointing at best and catastrophic at worst. If a person is confident in his investing and money-handling skills, he might be able to pull off the sale of his annuities aptly, but this is not always the case.
In general, this option is a very bad investment decision, as it is possible to lose up to half of one's settlement money in the process. Plus, persons on a periodic payment are often unable to work and need the regular installments to meet their daily needs; if these payments cease and the person is unable to support himself by working due to injuries, his financial need will be much greater than before a company agreed to purchase a structured settlement from him. A Biblical proverb sums up this situation very well: "The simple inherit folly, but the prudent are crowned with knowledge" (Proverbs 14:18). This is a financial decision that could end in folly, especially if rushed into without sufficient forethought and good legal advice.
If a person is absolutely sure that finding a company to buy a structured settlement from him is the most viable option, there are a few ways to ensure that the owner receives the very best deal. First, he should compare quotes at different settlement companies to see which is going to give him the highest payoff with the fewest risks; many online companies allow customers to get a free quote over the Internet. Next, he should be sure that the chosen company has a good reputation for paying its customers in-full and on time and that it is well-funded, licensed, and insured so that it doesn't go bankrupt and leave him with nothing. After selecting a trustworthy company, the person should consult a lawyer to ensure that proceedings are in his favor and that the sum received in return for annuities is reasonable and fair; he may choose to sell the entire settlement or only a part of it--the latter, of course, is the best choice. By following these steps, selling one's settlement may be a safe, prudent, and beneficial option for a person in financial distress.
It is important to know that selling one's annuities is not always a possibility. About one-third of states have laws that do not allow businesses to purchase a structured settlement, and some insurance companies are not willing to transfer annuities to another entity. In this case, a person will have to find another solution for their financial needs besides selling. Persons who are unsure whether their state of residence restricts such sales should consult a lawyer for advice. For the other two-thirds of the country, however, finding a company to buy a structured settlement is a feasible, if not advisable, option--a last resort for the financially stressed, sure to offer immediately accessible funds in a very short time frame.
When investors purchase structured settlements they are required to follow protocol enacted by Congress in 2002. Structured settlements are often used to provide long-term financial compensation to individuals who sustained injuries caused by neglect, or to payout lottery jackpot winnings. To sell future payments requires court authorization.
The process required to purchase structured settlements involves analyzing client contracts, presenting offers, contacting lawyers, obtaining court approval, and providing lump sum payment in exchange for future payments.
There are several reasons Annuitants need to sell future annuity payments. Some of the more common include paying off high-interest debts, making home improvements, purchasing investment products, buying real estate, or starting or expanding a business.
Prior to seeking out investment companies to purchase structured settlements, Annuitants need to first determine if the sale is allowed in their state of residence. More than 30 states prohibit the sale or transfer of future annuity payments.
Another consideration is tax consequences of obtaining lump sum cash in exchange for future payments. Annuity payments provided as injury compensation are tax-free, while those provided for lottery winnings may be subjected to taxation at both state and federal levels. Funds provided in exchange for future payments may also be subjected to taxation at both levels.
Companies that buy structured settlements do not provide full face value. Instead, they charge fees for orchestrating the transaction and offer less because they must wait for payments to be distributed.
If the state of residence allows the sale of future payments, Annuitants must appear in court to present their case as to how the sale will improve their life. Structured settlements are used to ensure injured parties have sufficient income to cover normal living expenses and required medical care. Judges will not allow Annuitants to obtain upfront cash for frivolous purposes.
In states that permit the sale of structured settlements, Annuitants can elect to sell future payments in whole or part. Courts normally do not allow Annuitants to sell litigation settlements in whole, but may authorize if payments are structured for lottery winnings.
Annuitants must obtain transfer of payment rights from the insurance company that guarantees payments. Insurance companies are not required to permit the sale of payments or agree to payment rights transfers.
Lastly, Annuitants should shop around and consult with multiple annuity buyers to ensure they obtain the best price. A trusted source for locating reputable buyers is National Structured Settlements Trade Association at NSSTA.com.
Obtaining legal counsel is the only way to ensure structured settlement sales are properly conducted and adhere to state laws. Lawyers can advise of tax ramifications, assist with negotiations, and help Annuitants ensure they receive fair offers from companies that purchase structured settlements.
Is Structured Settlement Annuity Investing A Good Deal? Yes, but...
As interest rates remain low, investors - especially retirees - struggle to find yield wherever they can. Unfortunately, though, the necessity of earning a required return to fund financial goals becomes the mother of invention for a wide range of investment strategies, both legitimate and fraudulent. A recent offering of rising popularity is structured settlement annuity investing, often offering "no risk" rates of return in the 4% to 7% range. In general, the opportunity for "high yield" (at least relative to today's interest rates) and "no risk" is a red flag warning. But the reality is that with structured settlement annuity investing, the higher returns are legitimately low risk; the appealing return relative to other low-risk fixed income investments is not due to increased risk, but instead due to very poor liquidity. Which means such investment offerings can potentially be a way to generate higher returns, not through a risk premium, but a liquidity premium. But the caveat, however, is that the investments are so illiquid and the cash flows so irregular, they probably should at best only ever be considered for a very small portion of a client's portfolio anyway.
The inspiration for today's blog post has been a series of inquiries I've received from other planners over the past month, whose clients are being solicited to invest in structured settlement annuities, but have been understandably wary of the purported "high fixed return with low risk" offering. After all, most returns that seem "too good to be true" for their risk are in fact too good to be true, and entail higher risk than what is first apparent. Yet due to the unique way that structured settlement annuities work, the reality is that higher yields are not actually a high risk premium, but a low-risk low liquidity premium.
To understand why, it may be helpful to review exactly what a structured settlement is. A structured settlement arises most commonly when a plaintiff wins a lawsuit - for instance, due to injury as a result of medical malpractice - and the payment for damages is awarded as a series of payments over a period of time. This is often done to coincide with certain key ages - for instance, the structured settlement for an injured child might be timed to have the bulk of the payments made after the child turns 21, while the structured settlement of an injured 45-year-old adult might include annual payments for the next 20 years and then a lump sum at age 65. Each situation is unique. However, to avoid the financial risks involved by having the plaintiff waiting on the defendent to make payments over the span of many years or decades, the defendent (or the defendent's professional liability insurance company) often purchases an annuity from a quality insurance company to make the obligatory payments to the plaintiff, allowing the defendent to resolve his/her end of the settlement with a single lump sum payment.
So where does structured settlement investing come into play? The opportunity arises when the plaintiff who is receiving the structured settlement annuity payments finds a want or need for more liquidity. Or as the infamous J.G. Wentworth (a company that buys structured settlements) commercials put it, "If you have a structured settlement but need cash now, call J.G. Wentworth, 877-CASH-NOW"! So the individual receiving payments contacts the company to explore selling the structured settlement income stream.
In practice, though, most such companies that buy structured settlements do not keep them in their own investment portfolio; they then re-sell the structured settlement annuity payments to an investor, pocket a small slice or charge a markup as a commission, and seek out another structured settlement annuity to buy and repeat the process. Which means ultimately, the company needs to find both an ongoing stream of people who have structured settlement annuities to sell (not surprisingly, easier to find in these difficult economic times), and investors who are willing to buy the seller's unique annuity stream of payments.
So what does this look like from the investor's perspective? Because each structured settlement was arranged for the winning plaintiff's particular circumstances, no two structured settlement annuity investment options are the same. One might offer $2,000/month for the next 18 years; another might provide for a single lump sum payment of $200,000 in 10 years and another $100,000 5 years after that, with no intervening payments; another might provide for a series of $1,000/month payments for 10 years, then a $100,000 lump sum at the end of 10 years.?
How does the return work with such irregular payments? From the investor's perspective, this is similar to buying an original issue discount bond that matures at par value. For instance, if the structured settlement provides $200,000 in 10 years and another $100,000 payment 5 years thereafter, then the lump sum required for the investor might be $170,884; if you do the math (it's a standard IRR/NPV calculation for any financial calculator or spreadsheet), "investing" $170,884 today for $200,000 received in 10 years and another $100,000 received in 15 years equates to a 5% internal rate of return. However, it's important to note that you don't receive any kind of ongoing 5%/year payments (unless that happens to be what the annuity offers); your 5% return is solely attributable to the fact that that's how much money would have grown for the future value the investor gets from the annuity payments to equal the lump sum the investor paid today to get them. So the return is legitimate, but it's not comparable at all to the ongoing cash flows from a 5% coupon bond.
So why are the returns as high as they are? It's not due to risk; as noted earlier, the annuity payments are generally backed by highly rated insurance companies that are anticipated to have virtually no risk of outright annuity payment default (after all, that's what the original structured settlement payment recipient was counting on for those payments in the first place, and the court wouldn't have approved it if the annuity provider wasn't sound!). And the payments are generally guaranteed and fixed to the dates that are assigned; unlike lifetime annuitization that planners may be more familiar with, the payments from structured settlements generally are not life contingent (i.e., the payments will continue, even if the original annuity dies). Instead, the returns are due to sheer illiquidity. After all, how many people out there really want to buy an arbitrary structured settlement payment of $200,000 in 10 years and another $100,000 to arrive 5 years later, with no intervening cash flows? The answer is, not many. Yet in many cases, the structured settlement recipient really needs the liquidity for some reason, and can't wait long. The end result: the structured settlement recipient becomes willing to give up a healthy discount rate to get that lump sum of cash now.
So where does this fit for the financial planning client? The internal rate of return on many structured settlement payments are pretty appealing in today's marketplace; rates of 4%+ are pretty common (although notably, that's not a huge spread relative to the yield on comparable long term bonds). But most clients are unlikely to find a structured settlement that actually provides cash flows that line up with exactly when the client may need them, and there are only so many to choose from at any given time (for instance, here's a sample rate sheet from one provider) - which means at best, this should only be done with a small enough portion of the portfolio that it won't create a liquidity problem for the client investor. Otherwise, the client could themselves become the seller, and be forced to go through the same discounting process - bearing in mind that the structured settlement broker needs a cut too, so if the "cost" to generate a 5% return is $170,884 in the earlier example, the seller is going to get something less than that amount. This means that a buyer who becomes a seller will likely experience a loss of their own, as they essentially absorb both sides of what is a very wide bid-ask spread. Which means to say the least, this is for "long-term money" only! And of course, basic due diligence on the broker arranging the structured settlement and affirming the rating on the underlying insurance company is important, as always.
It's worth noting as well that structured settlement annuity investing is not just something that clients are being solicited for. Some of the structured settlement brokers involved are now reaching out to work with financial advisors directly as well (as a way to get access to more investment dollars), and in some cases advisors can actually be compensated and share in the commissions for helping to arrange such investments (not unlike how registered representatives are paid for many forms of annuity investing). However, this requires the broker/dealer to review and approve the offering (so that the registered representative doesn't get in trouble for selling away).
And in practice, it seems that broker/dealers themselves are mixed on these offerings. At least one company I know of doesn't want to allow their representatives to do structured settlement annuity business not because they're unsound or risky, but because the broker/dealer is afraid that if more investor dollars flow into this space, it will encourage structured settlement annuity firms to be more aggressive and potentially even predatory in trying to persuade structured settlement recipients to part with their guaranteed payments in exchange for quick and easy cash now (as typical structured settlement annuity recipients are unlikely to "do the math" on the internal rate of return being used to discount their payments!). On the other hand, part of the reason for the high returns in structured settlement annuity investing is because there are so few investors involved that the market is highly illiquid and inefficient; in theory, if there were multiple companies competing for a structured settlement recipient's payments, there would be more competition, resulting in a higher price that both delivers more money to the seller and provides lower ("more competitive"?) yields for the investor.
In the end, structured settlement annuity investing can only go so far. There are just only so many structured settlement annuitants receiving payments out there, although in recent years this "industry" has expanded to also buy the annuity payments from lottery winners, and even some annuity payments from individuals who simply bought a commercial immediate annuity product and now want to liquidate it. Nonetheless, there is clearly some capacity constraint in how much this particular investment strategy can grow. But for the time being, the yields would suggest that the seller demand exceeds the buyer interest, which creates an opportunity for the client investor who can tolerate the illiquidity and has otherwise done the due diligence.
So what do you think? Have your clients been approached regarding structured settlement annuity investing? Did you counsel them to invest, or not? Have you considered getting involved with the brokers that offer such investments? Would you consider it to be a good right for the right client situation?
Source: http://www.koplak.co.uk/2013/08/purchase-structured-settlements.html
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