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How structured settlement buyout offers work

Know 'discount rate' before trading payment stream for a lump sum

By Brad Allen

How to evaluate structured settlements"It's my money and I need it now!"

That cable-TV declaration, which has spawned dozens of YouTube parodies, invites owners of financial instruments called "structured settlements" to cash in their guaranteed streams of future income for upfront lump sums.  

But cash "now!" means settling for fewer dollars today than the total stream of payments would add up to. When is that trade the right decision?

What structured settlements are
Structured settlements are a stream of payments that a consumer can win after an accident, workers compensation claim or legal judgment. Whoever has to pay out a structured settlement will buy an annuity contract from an insurance company. Settlement payments are guaranteed over the life of the contract. They're certain, predictable.

But circumstances can change. Perhaps you want to buy a house, start a business, get married -- whatever life serves up that makes your pockets feel empty.

Sell your settlement? Yes
Ken Murray, CEO of J.G. Wentworth, the firm behind many of those TV commercials, argues that selling structured settlement payments can be a better alternative to taking out a loan, because it doesn't require any credit checks and you're not left with debt. "Selling structured settlement payments is the safest financial transaction a consumer can enter into," he says.

Murray points out that most states have laws that govern how a settlement can be sold, and they require a judge to look over the deal to review its fairness.

But he cautions that it's "not a good idea if the consumer does not have a legitimate need" for a lump sum, or if the payments are required for living expenses.

Sell your settlement? Maybe
Selling a structured settlement should be "a 'go slow' decision rather than reactive or impulsive," advises Henry L. Strong, president of JMW Settlements Inc., a national settlement planning firm. A beneficiary should "recognize the true value of what they have and make all their decisions based on good information," he adds.

David Kaufman, CEO of Voyant Advisors LLC, whose firm provides modeling and investment management tools to financial planners, suggests anyone thinking of trading future income for a lump sum should ask two key questions: "Can I be financially disciplined? Does it make sense in terms of my financial strategy and long-term goals?"

He suggests modeling out different scenarios, with a financial planner or on your own, to "get a sense of the true value of the settlement ... make it part of your plan and go for it."

Sell your settlement? No
Margot Saunders, counsel at the National Consumer Law Center, is definitive: "My advice is not to sell." She emphasizes that consumers who need cash "should get a standard loan from a bank at standard interest rates, and pay it back with the proceeds" from the settlement. She says structured settlements are established with their recipients' future financial interests in mind. To sell one "is undermining all those goals at a very high cost."

Time value of money
Lump-sum settlement firms such as Wentworth offer less than the sum of the stream of payments. For consumers, the question they need to examine is: How much less?

When evaluating whether a lump sum is fair, the math can be complex, but the underlying concept is simple: You would rather have a dollar today than a dollar in the future. So you'll take a discount on money now, compared to money later. The trick is in the details.

  • Would you rather have $1,000 today or $1,001 a year from now? Most folks would take the $1,000 now. It's not worth it to wait a year for just $1.
  • Would you rather have $1,000 today or $2,000 tomorrow? Whoa! Now that's different. Most folks would wait -- it's worth it to wait a day for $1,000.

You have just learned a key financial concept -- there is a time value of money.

A mortgage in reverse
Think about the lump sum buyout as if it were a mortgage in reverse. Those who have mortgages know that you borrow a sum upfront, and then pay it off with a stream of payments over many years. The sum of those payments is far greater than the amount originally borrowed. For example, someone who borrows $100,000 on a 30-year mortgage at 5 percent will pay a total of $193,256 -- nearly double the borrowed amount.

With a buyout of a structured settlement, it works in reverse. You receive an upfront sum and surrender the stream of payments. And instead of paying at a certain interest rate, you surrender those payments at what is called a discount rate.

The buyer of your stream of payments will want that discount rate to be as high as possible. You want it to be as low as possible. 

The company offering a lump sum for your structured settlement has overhead expenses (those TV ads aren't free) and a profit margin to maintain, so the firm will offer as low a sum as it can. Discount rates have ranged anywhere from 8 percent to nearly 22 percent in recent years, according to a review of several websites and examples of buyout offers.

HOW MUCH IS YOUR
STRUCTURED SETTLEMENT WORTH?
When you surrender a structured settlement, you surrender a stream of payments for a single, upfront sum. Whether it's a good deal for you or not depends on the discount rate. The lower the rate, the better it is for you.
Sum of payments for a 10-year, $1,000-per-month annuity Discount rate
Upfront settlement
$120,000 5% $94,600
$120,000 10% $76,200
$120,000 15% $62,590
$120,000 20% $52,500
Source: Structuredsettlement-quote.com calculator  

 

For example, giving up a lifetime total of $120,000 in future income by selling a $1,000 a month, 10-year annuity might bring you between  $48,308.02 and $82,421.48. It pays to shop around.

The process
The whole process could take 45 to 60 days, even if everything goes smoothly, so this is not really "now!" money. For sure, it will require a court hearing. Expect to make the case why the settlement no longer meets your financial needs. The broker involved will have to explain the discount factor. If the judge determines that the sale is not in your best interests, the transfer can be stopped. But the definition of "best interest" is vague, so that rarely happens.

A little upfront investment can save you a lot of headaches and regrets. Here are some things to watch for:

1. Shop around. Get competing quotes from several firms. If you've sold part of your settlement in the past and are in the market again, get competitive bids again. Know how many days you have to cancel with no penalty.

2. Get all the information and disclosures upfront. Disclosure requirements vary by state, but you should ask about commitments on timing, fees (the broker should pay the fees) and a guarantee on the payout dollar amount.

3. Know who you're dealing with. Check with the Better Business Bureau. Make sure the company you are dealing with has been in business for a few years and can do business across the United States. How financially sound are they? If you sell only a portion of your settlement, does the company "service" the payout, taking all the annuity proceeds then paying out your share? That could limit your flexibility on the rest of your settlement.

4. Consult an attorney and a financial planner. Be aware of restrictions that may exist on selling your settlement. Know the tax consequences. Know what the impact of selling will be on your future financial situation. Have a plan and stick to it.

See related: What to ask before getting a lawsuit settlement loan

Published: June 29, 2010


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