Are factored payments streams legal?
Buying an existing structured settlement annuity, and having the rights to the payments due under the structured settlement annuity policy is legal in all 50 states. The Structured Settlement Protection Act of 2002 paved the way for a court ordered Transfer process, making the purchase and resale of payment rights due under structured settlement annuities a Secondary market.
Why does this industry get such a bad rap?
The issue can be mostly attributed to current marketplace practices and the lack of a true market. Trial lawyers and their advisers (like us here at Milestone) spend an immense amount of time trying to figure out how to protect their clients from life’s harsh challenges when it comes to large lump-sum recoveries. Why did trial lawyers ever recommend structures in the first place?
It’s simple. As a tax incentive for people considering large lumps sum payments, and in an effort to keep as many of these citizens off the welfare rolls, Congress provided the “single largest tax exemption ever” to private citizens with structured settlements. Before the early 2000s, a plaintiff could invest $1,000,000 of his or her net settlement into the form of a structured settlement and over the next 40 years receive $8,000,000 in payments, guaranteed and tax free. That’s a $7 million tax exemption for a single person.
During that time, the best part about a structure was that it could protect absolutely. In order to receive this tax windfall, plaintiffs were required to enter into irrevocable periodic payment obligation, or structured settlement. These contracts provided for their guaranteed payments, as well as the ability to leave the annuity and all of the tax-free payments to an heir through a beneficiary designation. The catch? These arrangements could never be changed. You were unable to sell it, accelerate the payments, encumber them, or take a loan out against the base asset (the annuity policy). The tax-free nature was a trade off in liquidity.
It made sense. Most plaintiffs that became disabled were happy with the prospect of receiving an annual guaranteed income and the quality of life that came with it. The security and dignity that came with the creation of permanent financial security was hard to replicate with traditional markets and investing.
In comparison, stock and bond brokers or financial planners vying to manage these new assets for their own businesses were always hard-pressed to justify their fees, additional taxation, lack of guarantees, and infinite market risk. It rarely made sense to take the money and invest it traditionally. Even in the early 2000’s, interest rates hovered in the high five percent, meaning a taxable portfolio with investment fees would have had to yield nine percent every year just to do what the structure could on a guaranteed basis.
When did the industry start to go wrong?
In 2003, the industry failed to lobby successfully against the passage of the federal Excise Tax bill(IRC 5891), which paved the way for payment stream financiers to market to, prey upon people whose finances were all but exhausted – except for their structure settlement annuity.
The secondary market for structured settlements was born. Unlike stocks – where after an initial public offering, stocks trade on professional exchanges like the New York Stock Exchange, no such professional marketplace exists for an individual who had fallen on hard times and needed access to their only asset. Without a liquidity feature as part of the original structured settlement, plaintiffs had few choices to find people in a bizarre market where their payments streams could be factored for cash. Like payday loans and other caustic consumer finance industries that are unregulated, most plaintiff found themselves between a rock and hard place.
With zero regulatory oversight, the factoring industry (or secondary market industry) flourished by ripping off annuitants and paying pennies on the dollar for what is considered to be a very valuable investment asset. The annuity policies that changed hands were the guaranteed annuity policies from major insurers like New York Life, Metropolitan, Prudential, MassMutual, John Hancock and others.
Why did these major financial institutions stand idly by and allow their policyholders to be fleeced?
They had a choice, but by condoning the transfer of payment rights, as issuers, perhaps they would have been perceived as double dipping? Buying their own paper back at a steep discount would not have been perceived as model behavior for a large corporate citizen.
Still today, $600,000,000 worth of structured settlement paper changes hand per year. The average industry discount rate applied to these transactions is likely 12 to 18 percent. What that means is a 30-year payment stream that was bought yesterday for $1 million should fetch a mere $250,000 in this archaic marketplace.
Berkshire Hathaway appears to be doing something about it. They are running a pilot program in about 10 states where they are providing education and information to the annuitants that hold their paper. This is a good start. They are buying their own paper back at 6.5 percent and 7 percent discount rates. A very good deal for Warren Buffett, and a source of competition for market makers JG Wentworth.
What has the grey market, factoring industry and secondary market for structured settlements done to our nations civil justice system?
I think it has done irreparable generational damage. Notwithstanding current low interest rates that make utilizing structured settlements in personal injury cases a hard sell, trial lawyers have learned that more than likely, as good as the idea was in the 1980s, structured settlements no longer protect their clients. Even worse, they facilitate the rapid dissipation of the settlement through factoring, which was the very risk trial lawyers looked to insurance for in the first place.
Like all small cottage industries that are complex and have no state or federal consumer protection, the story may hold that they are slowly killing the goose that lays the golden eggs.
Trial lawyers working with settlement experts should understand these factoring risks and plan accordingly. When we plan a settlement, we encourage the use of a trust, which puts the payment rights in the hand of a fiduciary, not the individual person. This makes the sale and transfer altogether more challenging, if not practically impossible.
For now, we’ll hope for a world where true or near true liquidity (access to fair market value, like what exists in the Real Estate Industry) exists for existing structured settlement recipients.
About John Bair
John Bair has guided thousands of plaintiffs through the settlement process as co-founder of Milestone Consulting, LLC, a broad-based settlement planning and management firm. Milestone’s approach is comprehensive and future-focused. John’s team has guided thousands of clients by taking the time to understand the complexities of each case. They assess the best outcome and find the path that enables each client to manage their many needs. Read more about Milestone Consulting at http://milestoneseventh.com/.
A West Point graduate where he served as captain and military aviator, John Bair continues his commitment to our country through his efforts within the settlement planning industry. He has represented families of victims lost in the Flight 3407 crash, offered pro bono services to the families of 9/11 victims and drafted the first consumer protection bill for plaintiffs (H.R. 3699).