Most everyone has seen some version of a commercial about structured settlements, usually tied into “getting cash now.”
It can be confusing, complex topic, and many companies are not communicating accurate information. It’s actually a simple concept, but the legal documents make it seem much more complicated than it is.
What is a structured settlement?
A structured settlement, strictly defined, is a negotiated agreement in a tort action to provide payments over time. It happens after a court process where one party was hurt and the other party is told to pay. The matter could be personal injury, worker’s compensation for an on-the-job injury, property loss, wrongful termination or a wrongful death claim where a spouse and/or minor children are seeking compensation for lost wages and intangible support, or similar issues. Structured settlements are not usually considered for minor or short-term injuries.
It should be noted that lottery payments are not structured settlements. Those are agreements for periodic payments over time. There are fewer regulations on how to cash-out those payments – turning that revenue stream into a single payment.
Reaching an agreement on a settlement offer can significantly reduce legal fees for both sides of the complaint. Moreover, the injured, or aggrieved party, can get more money over their lifetime than they would in one big check. This can be especially important if an injured person needs long-term medical care, or if minor children will need support over time and through college.
Due to a tax code change in 1982, structured settlement payments are exempt from federal and state income taxes. A structured settlement guarantees funds at defined intervals, such as monthly, for a specified period of time. Depending on the situation, it could be 20 years, or several decades, and in some cases the parties can receive funds beyond the guaranteed settlement term.
Structured Settlement Benefits
Industry data varies, but we’ve all heard stories about people who “hit the jackpot” with a single big payment, only to end up losing it due to mismanagement. The industry calls it “dissipating” those funds. That is cited as the key benefit to staying with a structured settlement payment arrangement.
Registered Settlement Planner John Darer, president of 4structures.com in Stamford, Conn., said that a primary benefit is that structured settlements represent a “stable, guaranteed” cash flow.
“These funds are free of market volatility, which as we’ve recently seen can be quite brutal,” he said. “Injury victims with no incomes or reduced incomes, cannot absorb those losses. Structured settlements also have built in spend-thrift protection.”
Darer calls himself a “centrist” in that he does not predominantly cater to either the plaintiff (injured party) or defendant (insurance company) in structured settlement planning.
The Process
Developing a structured settlement arrangement will involve attorneys and possibly a settlement planner or financial advisor. The injured party is either filing a claim or suing a defendant, either of which may be covered by an insurance company. There will either be a battle in court, or one of the parties may compromise and settle.
If the decision is to negotiate, then it is best to have a specialist to estimate long-term costs. If someone needs long-term medical care or minor children need funding over the long-term, a professional needs to perform interest rate calculations and estimates of whether medical or other expenses may spike at particular times. An attorney can ensure the language protects his or her client.
Angel Viera, a professional with with L.A.-based Structured Financial Settlements, said that people need to understand that, even if offered a lump sum settlement, they have the option to invest in a tax-free annuity from a highly rated insurance company.
“However, keep in mind that the structured settlement has to be worked into the settlement, Viera said “A tax-free structured settlement annuity cannot be funded once the claimant has received the settlement proceeds.”
Issues and Benefits of Cashing-Out
Because of the guaranteed nature of structured settlements, there are those who are adamantly against factoring, or cashing-out, all or part of a settlement. But then there are life’s realities. Sometimes the claimant does need the “cash now.” But it comes at a price, and that is something to examine and consider.
The question is, at what cost? “There is no question that people will typically lose somewhere between 15 percent and 25 percent of the present value of their remaining payments,” according to Mark Wahlstrom, of Scottsdale, Ariz.-based Wahlstrom and Associates,”I am not against factoring, and I will refer people to firms I think are honest and transparent, but that is the reality.”
Wahlstrom is a structured settlement financial advisor who works almost exclusively with the plaintiff, or injured person’s side. Other advisers work almost exclusively on the side of the insurance company that is financially backing the accused party, or defendant,.
Most of those consulted on this story agree that understanding the “present value of future money” is one of the more misunderstood concepts by consumers. A dollar today is not going to be worth as much as a dollar five years from now.
“I think one of the biggest mistakes people make when cashing out a structured settlement is not adequately shopping their options ,” said Andrew Cravenho, principal of Bloomfield, Conn.-Settlement Quotes LLC. “There is industry data that discounts rates used to calculate present value, generally varying from 8 to 18 percent. These rates are essentially the cost of money. Folks often go to one company and that is it. They don’t look around.”
Settlement Quotes LLC specializes in bringing willing sellers to the most generous settlement buyers. Cravenho said that some of the companies that spend the most on advertising offer the most disadvantageous deals to their clients.
“Our firm searches the full range of structured settlement factoring companies as well as private investors,” he said. “We consistently deliver arrangements for our clients from firms that offer discount rates in the 7.5 – 9 percent range. Shopping around can pay huge dividends.”
The difference between 7.5 percent and 18 percent on an average settlement is $125,000 compared to $85,000-a whopping $40,000 difference.
“The policy of some firms is to charge 18 percent on every transaction,” he concluded.
Another way to lose more money in a factoring deal is sometimes referred to as “interest drag.”.This means the present value of future payments is fixed when the seller agrees with the terms and signs the paperwork. After the paperwork is signed, firms can vary significantly in how quickly they execute the deal. The longer it takes for money to be transferred from the buyer to the seller, the more profit the buyer makes, and the more money the settlement seller loses.
To address this, Cravenho said that Settlement Quotes agrees to pay a per diem fee to the seller between the day the terms of the cash-out are contractually set and the day the funds are disbursed. That prevents any interest drag loss to the seller and eliminates any financial incentive to delay the final payment.
Darer, the settlement planner, also recommends that sellers take control by using a structured settlement factoring discount rate calculator found at www.structuredsettlement-quotes.com or the Structured Settlements 4Real blog at www.structuredsettlements.typepad.com . The calculator helps consumers easily discover for themselves what the real, or effective, discount rate is on their planned transaction. They do not have to rely on the buyer.
Factoring deals must also be approved by state courts, using the general standard of whether the factoring arrangement is in the best interest of the person receiving the settlement payments, or any dependent party supported by the payments. Darer points out that 46 states have laws in place regulating this process. Forty-one states are closely modeled on a model law enacted by the NCOIL (National Council of Insurance Legislators). A few states that enacted legislation before NCOIL’s model law was drafted closely resemble it, Darer said. In general, these laws call for the disclosure of the transaction details to the seller, notice to other interested parties, a strong warning to seek professional advice and finally court approval based upon the “best interest” standard referenced above.
For example, North Carolina recently passed restrictions that make it impossible to cash-out a structured settlement. The majority of states, however, are fairly uniform in the way they look at factoring of structured settlements, Cravenho said.
There are reported cases of attorneys taking factoring deals to court with what are more frivolous reasons for cashing out structured settlements, like buying a sports car or other luxury items. Courts will reject such requests. The annuitant is still liable for attorney fees, but is not getting a factored advance on their settlement payments.
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Resources
John Darer, registered settlement planner and president of Stamford, Conn.-based 4structures.com LLC, www.4structures.com.
Angel Viera of Los Angeles-based Structured Financial Settlements, www.structured-settlements.com.
Mark Wahlstrom, a structured settlement financial advisor with Wahlstrom and Associates based in Scottsdale, Ariz. www.wahlstromandassociates.squarespace.com
Andrew Cravenho, principal of Bloomfield, Conn.-based Settlement Quotes LLC. www.structuredsettlement-quotes.com
Settlement Factoring Discount Rate Calculator, www.structuredsettlement-quotes.com or www.structuredsettlements.typepad.com
Washington, D.C.-based National Structured Settlements Trade Association, www.nssta.com
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