Many investors have been made aware of the opportunities available should they decide to invest in the structured settlement market. If you have been tempted by relatively high rates of return but are unsure about what a structured settlement is, this guide is for you.
What is a structured settlement?
The most common form of structured settlement is one which has been arranged to take care of the present and future needs of a successful plaintiff in a personal injury claim.
Rather than a lump sum payment or a simple annuity, a court may package together a combination of regular and periodic payments in a customized settlement package. These structured settlements are individually tailored to take account of the specific needs of the wronged party.
For example, the assignee may be awarded an initial sum of money to cover immediate medical expenses followed by a series of regular structured settlement payments 20 years later if they are expected to retire early due to their condition. Other structured settlements may provide for several staggered streams of payment or multiple lump sums.
In many cases, the defendant (or, usually, their insurance company) share their exposure by buying an annuity from another insurance company who is then responsible for making the payments to the plaintiff. These insurance companies may also sell their liability on to reinsurers.
There are also less common structured settlements which are bought by lottery winners to enable them to manage their income stream.
How can an investor get involved in the structured settlement market?
Have you come across advertisements from brokers urging people to sell structured settlement deals for cash? These companies offer a discounted lump sum payment in return for the right to benefit from the plaintiff’s future income stream.
This can be an attractive offer for people who find that their financial situation has changed and that the agreed schedule of payments no longer fits their needs. For example, they might have recovered enough to be able to work until their normal retirement age but need urgent funds to cover a child’s college fees.
In such a case, an immediate payment might be better than waiting for 20 years to receive the regular payments originally meant to help them retire early.
Plaintiffs in this situation are not permitted to make that decision alone. The courts need to be involved again to make sure that they will not be adversely by accepting structured settlement cash.
Once the deal has been completed, structured settlement purchasers may then sell them to investors like you. In return for a lump sum payment (with a margin on top) you will then become the assignee of the structured settlement. This means that you will be eligible to receive the remaining payments according to the original agreement. As the structured settlement is not allowed to be altered in any way, you will be tied to the schedule of payments set out at the original court hearing.
Benefits of investing in structured settlements :
As mentioned in the opening paragraph, investing in structured settlements can yield a relatively high rate of return, often in the region of 4 to 7 per cent. The attraction to this type of investment increases when you look at the type of companies who tend to be responsible for selling the annuities created to fund structured settlements. One of the big investment companies in the game are Warren Buffett’s Berkshire Hathaway, currently second in the Fortune 500 list. Other annuity providers are big life insurance companies comfortable with the exposure that long-term payouts present. In fact, settlement companies will only place structured settlements with insurance companies rated A or above.
Providing you do your due diligence in finding out who is responsible for fulfilling the payments, you can ensure that your investment is relatively safe from insolvency risk. It is also worth mentioning that, unlike a life contingent annuity, the agreement outlasts the life of the assignee. Therefore, should you die before receiving any part of the payment schedule, the rights will pass to your estate.
Another benefit of investing in structured settlements is that the future payments are guaranteed by law. They are usually index-linked as well making them practically immune to market risk (although no investment product can ever be 100 per cent watertight).
Investors are also attracted by the tax-free status of most structured settlements drawn up via the correct procedure. This is set down in IRS Code § 104(a)(2) and confers exemption from Federal, State and local tax including any interest accrued. Unlike other investments, you won’t have to pay an annual management fee or any other costs once you have made the initial payment.
Why structured settlements aren’t for all investors :
It is said that there is no such thing as a free dinner and this is as much the case with paying out cash for structured settlement payments as it is for any other investment. The trade-off for your elevated return rate in this case is the illiquidity of your investment. Structured settlements are very flexible in design but once you have bought one, you are tied into the original payment schedule. Regardless of how your personal circumstances change, the payment stream cannot be altered or accelerated.
Although selling structured settlements on is possible, the market isn’t huge and you will, of course, have to discount the value of your future payments.
If you like the thought of earning high rates of return with minimal risk but are not keen on the inflexible payment schedule of structured settlements, you may want to focus your attention on the government bond market instead.
You should now have most of the information you need to make a wise decision about investing in the structured settlement market. To summarize, most structured settlements are tax and fee-free, provide relatively high rates of return and are backed by highly solvent investment firms and insurance companies. However, this needs to be weighed against their highly illiquid structure which can become a chain around the neck should circumstances change.
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Kathy is a financial adviser and blogger. In her blog, she addresses various structured settlement issues including how buying and selling structure settlement payments work, as well as how people should deal with it based on their financial situation. She is associated with Catalina Structured Funding, Inc., a company that provides customers with most cash for their structured settlement or annuity. Send her an email or buzz her on twitter to discuss your situation.