Dispelling Industry Myths
Because of the large amount of misinformation, speculation and general ill-will surrounding the secondary market, I feel that it is necessary to respond to a few common misconceptions about the factoring of structured settlement annuities:
Myth: I don’t recommend structured settlements since the claimant will just factor it anyway.
$6.2 billion settlement dollars are put into structured settlements each year and that less than $300 million is factored each year
Reality: Only a small percentage of payments from structured settlements are ever factored. There are few reliable statistics to clarify that point, but consider the fact that $6.2 billion settlement dollars are put into structured settlements each year and that less than $300 million is factored each year. It has been estimated by industry insiders that some of the payments are factored in about 7% of structured settlements. That means that the vast majority of structured settlement annuities are paid as designed to the injury victim. Compare the chances of someone factoring their payments to the chances of someone dissipating cash received from a settlement. When cash is received, one study found that 95% of claimants have exhausted their settlement within five years. From my experience a structure that provides funds to an individual upon reaching age of majority is an effective means of preventing that young adult from squandering the settlement proceeds. Keep in mind, that with IRC5891, all annuitants who would like to cash out their structured settlement must receive court approval to do so. This approval process takes into account the financial needs of the annuitant and is an effective way to ensure that the funds will not be utilized for unnecessary purchases.
Myth: The parents will try to cash out a minor’s structured settlement.
Reality: With the enactment of IRC 5891, this scenario is highly unlikely as the courts are not keen on approving such transfers. A minor’s guardian must demonstrate that there exists some extreme need on behalf of the minor along with evidence of such need. Additionally, many states insist upon a court appointed independent Guardian Ad Litem to protect the interests of the minor. I can recall only two such cases that were extreme enough for the courts to allow a transfer in the time that I have been working in the secondary market.
Myth: The annuitant will lose 50 percent by factoring.
Reality: In this case, many compare the cumulative future payments with the present value lump sum payment offered by the factoring company, failing to take into consideration the discount to account for the time value of money. For instance, if an annuitant has 200 payments of $1,000, the cumulative payments would be $200,000. In this case, a factoring transaction might net the annuitant approximately $100,000 or 50% of the cumulative total. This may equate to a discount rate of approximately 10%. However, in this scenario, the factoring company has to wait almost 17 years to collect all these monthly payments, during which the equivalent present value of these payments is continually diminishing. A dollar will not have the same purchasing power in 17 years as it has today.
Myth: Factoring discount rates are outrageous.
Reality: Up until the recent onset of the credit crisis, discount rates had been driven down considerably by the enactment of IRC 5891 and the accompanying increased level of competition. The current credit environment has made access to capital more expensive and more difficult to locate than it was a year ago. However, even in the midst of the current crisis, my effective rates which include legal fees and costs are most often lower than credit card interest rates. An annuitant who is drowning in credit card debt may be better off paying their creditors from a factoring transaction. For example, I have worked with annuitants who are paying 19% or more on bank credit cards and have found that judges are usually sympathetic to their plight and willing to approve a factoring transaction that will clear the debt. However, since structured settlement annuity payments are generally exempt from creditor’s claims, selling the payments to pay down credit cards may not be appropriate for your situation.