Executive Summary
As interest rates remain low, investors - especially retirees - struggle to find yield wherever they can. Unfortunately, though, the necessity of earning a required return to fund financial goals becomes the mother of invention for a wide range of investment strategies, both legitimate and fraudulent.
A recent offering of rising popularity is investing into structured settlement annuity contracts, which often claim to offer "no risk" rates of return in the 4% to 7% range. In general, the opportunity for "high yield" (at least relative to today's interest rates) and "no risk" is a red flag warning. But the reality is that with structured settlement annuity investing, the higher returns can legitimately be lower risk; the appealing return relative to other low-risk fixed income investments is not due to increased risk, but instead due to very poor liquidity. Which means such investment offerings can potentially be a way to generate higher returns, not through a risk premium, but a liquidity premium.
The caveat to structured settlement annuities, however, is that the investments can be so illiquid and the cash flows so irregular, they probably should at best only ever be considered for a very small portion of a client's portfolio anyway!
Investing Into A Structured Settlement Annuity
The inspiration for today's blog post has been a series of inquiries I've received from other planners over the past month, whose clients are being solicited to invest in structured settlement annuities, but have been understandably wary of the purported "high fixed return with low risk" offering. After all, most returns that seem "too good to be true" for their risk are in fact too good to be true, and entail higher risk than what is first apparent. Yet due to the unique way that structured settlement annuities work, the reality is that higher yields are not actually a high risk premium, but a low-risk low liquidity premium.
To understand why, it may be helpful to review exactly what a structured settlement is. A structured settlement arises most commonly when a plaintiff wins a lawsuit - for instance, due to injury as a result of medical malpractice - and the payment for damages is awarded as a series of payments over a period of time. This is often done to coincide with certain key ages - for instance, the structured settlement for an injured child might be timed to have the bulk of the payments made after the child turns 21, while the structured settlement of an injured 45-year-old adult might include annual payments for the next 20 years and then a lump sum at age 65. Each situation is unique. However, to avoid the financial risks involved by having the plaintiff waiting on the defendent to make payments over the span of many years or decades, the defendent (or the defendent's professional liability insurance company) often purchases an annuity from a quality insurance company to make the obligatory payments to the plaintiff, allowing the defendent to resolve his/her end of the settlement with a single lump sum payment.
So where does structured settlement annuity investing come into play? The opportunity arises when the plaintiff who is receiving the structured settlement annuity payments finds a want or need for more liquidity. Or as the infamous J.G. Wentworth (a company that buys structured settlements) commercials put it, "If you have a structured settlement but need cash now, call J.G. Wentworth, 877-CASH-NOW"! So the individual receiving payments contacts the company to explore selling the structured settlement income stream.
In practice, though, most such companies that buy structured settlements do not keep them in their own investment portfolio; they then re-sell the structured settlement annuity payments to an investor, pocket a small slice or charge a markup as a commission, and seek out another structured settlement annuity to buy and repeat the process. Which means ultimately, the company needs to find both an ongoing stream of people who have structured settlement annuities to sell (not surprisingly, easier to find in these difficult economic times), and investors who are willing to buy the seller's unique annuity stream of payments.
Typical Terms Of Structured Settlement Annuities - Costs And Cash Flow Returns
So what does this look like from the investor's perspective? Because each structured settlement was arranged for the winning plaintiff's particular circumstances, no two structured settlement annuity investment options are the same. One might offer $2,000/month for the next 18 years; another might provide for a single lump sum payment of $200,000 in 10 years and another $100,000 5 years after that, with no intervening payments; another might provide for a series of $1,000/month payments for 10 years, then a $100,000 lump sum at the end of 10 years.
How does the return work with such irregular payments? From the investor's perspective, this is similar to buying an original issue discount bond that matures at par value. For instance, if the structured settlement provides $200,000 in 10 years and another $100,000 payment 5 years thereafter, then the lump sum required for the investor might be $170,884; if you do the math (it's a standard IRR/NPV calculation for any financial calculator or spreadsheet), "investing" $170,884 today for $200,000 received in 10 years and another $100,000 received in 15 years equates to a 5% internal rate of return. However, it's important to note that you don't receive any kind of ongoing 5%/year payments (unless that happens to be what the annuity offers); your 5% return is solely attributable to the fact that that's how much money would have grown for the future value the investor gets from the annuity payments to equal the lump sum the investor paid today to get them. So the return is legitimate, but it's not comparable at all to the ongoing cash flows from a 5% coupon bond.
The Illiquidity Risk Premium Of Investing In Structured Settlements
So why are the returns as high as they are? It's not due to risk; as noted earlier, the annuity payments are generally backed by highly rated insurance companies that are anticipated to have virtually no risk of outright annuity payment default (after all, that's what the original structured settlement payment recipient was counting on for those payments in the first place, and the court wouldn't have approved it if the annuity provider wasn't sound!). And the payments are generally guaranteed and fixed to the dates that are assigned; unlike lifetime annuitization that planners may be more familiar with, the payments from structured settlements generally are not life contingent (i.e., the payments will continue, even if the original annuity dies). Instead, the returns are due to sheer illiquidity. After all, how many people out there really want to buy an arbitrary structured settlement payment of $200,000 in 10 years and another $100,000 to arrive 5 years later, with no intervening cash flows? The answer is, not many. Yet in many cases, the structured settlement recipient really needs the liquidity for some reason, and can't wait long. The end result: the structured settlement recipient becomes willing to give up a healthy discount rate to get that lump sum of cash now.
So where does this fit for the financial planning client? The internal rate of return on many structured settlement payments are pretty appealing in today's marketplace; rates of 4%+ are pretty common (although notably, that's not a huge spread relative to the yield on comparable long term bonds). But most clients are unlikely to find a structured settlement that actually provides cash flows that line up with exactly when the client may need them, and there are only so many to choose from at any given time (for instance, here's a sample rate sheet from one provider) - which means at best, this should only be done with a small enough portion of the portfolio that it won't create a liquidity problem for the client investor. Otherwise, the client could themselves become the seller, and be forced to go through the same discounting process - bearing in mind that the structured settlement broker needs a cut too, so if the "cost" to generate a 5% return is $170,884 in the earlier example, the seller is going to get something less than that amount. This means that a buyer who becomes a seller will likely experience a loss of their own, as they essentially absorb both sides of what is a very wide bid-ask spread. Which means to say the least, this is for "long-term money" only! And of course, basic due diligence on the broker arranging the structured settlement and affirming the rating on the underlying insurance company is important, as always.
It's worth noting as well that structured settlement annuity investing is not just something that clients are being solicited for. Some of the structured settlement brokers involved are now reaching out to work with financial advisors directly as well (as a way to get access to more investment dollars), and in some cases advisors can actually be compensated and share in the commissions for helping to arrange such investments (not unlike how registered representatives are paid for many forms of annuity investing). However, this requires the broker/dealer to review and approve the offering (so that the registered representative doesn't get in trouble for selling away). And in practice, it seems that broker/dealers themselves are mixed on these offerings. At least one company I know of doesn't want to allow their representatives to do structured settlement annuity business not because they're unsound or risky, but because the broker/dealer is afraid that if more investor dollars flow into this space, it will encourage structured settlement annuity firms to be more aggressive and potentially even predatory in trying to persuade structured settlement recipients to part with their guaranteed payments in exchange for quick and easy cash now (as typical structured settlement annuity recipients are unlikely to "do the math" on the internal rate of return being used to discount their payments!). On the other hand, part of the reason for the high returns in structured settlement annuity investing is because there are so few investors involved that the market is highly illiquid and inefficient; in theory, if there were multiple companies competing for a structured settlement recipient's payments, there would be more competition, resulting in a higher price that both delivers more money to the seller and provides lower ("more competitive"?) yields for the investor.
In the end, structured settlement annuity investing can only go so far. There are just only so many structured settlement annuitants receiving payments out there, although in recent years this "industry" has expanded to also buy the annuity payments from lottery winners, and even some annuity payments from individuals who simply bought a commercial immediate annuity product and now want to liquidate it. Nonetheless, there is clearly some capacity constraint in how much this particular investment strategy can grow. But for the time being, the yields would suggest that the seller demand exceeds the buyer interest, which creates an opportunity for the client investor who can tolerate the illiquidity and has otherwise done the due diligence.
So what do you think? Have your clients been approached regarding structured settlement annuity investing? Did you counsel them to invest, or not? Have you considered getting involved with the brokers that offer such investments? Would you consider it to be a good right for the right client situation?
(Editor's Note: This post was included in SenseToSave's Carnival of Personal Finance #352.)
I’m perplexed.
The defendant wants to make a single payment. The plaintiff wants to receive a single payment. So who agreed to the stream of payments in the first place, and why?
One set of middlemen (including possibly a financial planner) are being paid a hefty spread to collapse a payment stream that was telescoped by another middleman (the annuity provider). Meanwhile, the injured party loses in both transactions.
Am I the only one who smells something peculiar (if not downright rotten) here?
Structured Settlements were brought upon in 1982 by United States Congress so that instead of the Plaintiff receiving a lump sum, they are awarded a specific payment stream that would cover medical expenses and means of living costs over a period of time specific to their claim. This is why so many different payment streams are available to investors. For example: A settlement is awarded to a middle aged man who owns a plumbing company because he was injured in a car accident. He is still capable of working but requires physical therapy and visits with his primary care doctor so that he can continue being recommended for therapy. But, in 10 years, it’s probable that his injury will incopasitate him and he will no longer be able to conting running his company. His Structured Settlement would likely be immediate income of a determined dollar amount that would cover his monthly medical expenses and then a lump sum to start being paid out annually in 10 years that would compensate him for no longer being able to work. The Defendent purchases an annuity on behalf of the Plaintiff in full because otherwise, not only would they have to make payments to the Plaintiff as determined, the Plaintiff most likely won’t settle based on the Defendent’s “promise to pay”. I have dealt with hundreds of Structured Settlement Transfers on the investor’s end and on average I have about 50 pending cases to maintain daily. If this kind of investment is one that fits in to a person’s financial future, they should consider themselves lucky!
Please note that I did not give a link to the small firm I work for or mention its name. My intention in posting a response here is only to educate!
Okay, Michael, suppose I buy the $170,884 settlement you mentioned above and put it in a $2mm portfolio. I take an immediate hit and then I have to explain for 10 years why the total return is lagging. No thank you.
Sincerely,
Joe.
Joe,
I’m not sure I follow. Where’s the “immediate hit”?
This would be equivalent to buying a AAA-rated 5% zero coupon bond that the client can commit to holding to maturity. Obviously, the client would need to be able to manage the illiquidity, but in exchange for that liquidity (NOT risk) premium, the client is getting a high-quality-rated fixed income 5% yield that legitimately is not high risk.
In point of fact, David Swensen at Yale has written extensively about investors generating better returns not by investing for risk premiums (which is obviously a risky way to higher returns) but for liquidity premiums (which increase returns without increasing risk, but by reducing liquidity). Clearly, that requires proper liquidity management itself, but we’re only talking about doing this with a very small piece of a portfolio anyway.
Granted, advisors that run an AUM model probably won’t find this appealing anyway, especially because the size of the typical deals mean clients would have to be investing on a one-off basis anyway.
The primary purpose of this post was to explain the situation and the lay of the land for advisors whose clients are being solicited to buy these and are trying to figure out whether they are legitimate or not. As it turns out, notwithstanding all the scams out there, these (when properly done) are actually a legitimate way to capture higher returns without higher risk (but with much lower liquidity).
Respectfully,
– Michael
We are considering this as a fixed income play, no future lump sums, no break in payments. We would be purchasing a stream of fixed payments, for a fixed period…paying a rate of return of X. Could be a proxy for part of the intermediate bond asset class in a portfolio.
Bryan,
Indeed, if you were able to find a particular annuity payment stream for sale that happened to have ongoing payments of an appropriate dollar amount relative to the client’s overall portfolio, that would certainly work as well!
Just saw this one today on offering sheet:
Metropolitan Life Insurance Company “A+” rating (936903)
One hundred and one (101) monthly payments as follows: $740.34 from March 30th, 2012 till July 20th, 2020.
Investment: $60,885.13 to yield 5.25%
I’m listening to all your conversations about how structured annuity guaranteed payments lifetime contingent well gentleman here we have a 62 year old lady whose husband died 3 years ago she’s disabled and she got her annuity to her father’s wrongful death from a nursing home she was guaranteed 20 years 1000 dollars a month and also had annual 3172 dollars in Decemberactual 20 year guaranteed at this time her husband passed away she had to come live with me because of lack of income and she’s disable she only want to sell 400 dollars in payments for 20 years guaranteed but what JG Wentworth did was taking advantage of the elderly and mental disabled is there employees cook advantage of this womaposn st her a grievance of her husband’s death and her 2 children as I speak today she is now girl lose a property she’s broke she has an lifetime contingent but that only comes back to her and 2021 this so called pos rushed this poor lady that by the way they rushed her telling her the truth or date this coming up and to just sign it they had hey notary there quicker than lightning can strike in December of 2011 she realized she had no 1 new Woody from Allstate coming to her bank we then gold 20 Wentworth his comment was you should read the contract he no longer works there but we are striving to find an attorney to represent her and we will , call fraud department, abuse of the elderly, she lives in the state of Florida would you JG Wentworth is not licensed but will get them she is broke losing her home mentally and physically disabled how could a human being do this to somebody take their lives justice will prevail and that intended for you Jay G Wentworth. if anyone would like to reply please do
One thing that the regulators are cracking down on is suitability of annuities. These products have a place in many portfolios but there has been many advisors/brokers who have hammered people with unsuitable investments.
I am in the process of purchasing a annnuity from someone at a rate of %%%, the deal should be going down today, 3 lawyers are revieing it and it has already been to court, I will get a monnthly income for 20 years starting in 7 yrs. Are they more risk in this than a CD if it does not exceed the amount that the state insurance commision garenties
I think people need to FORGET about state insurance guarantees. These are meaningless. In the middle of writing this post, I randomly selected a state so I could copy and paste language from their statute authorizing the guarantee association. While you want to check any state with which you deal, my guess is that they are quite similar. I went to the site for the Pennsyvania association and here is some verbiage from their act:
–the beneficiaries, payees or assignees of insured persons are protected as
well, even if they live in another state [so if you have the annuity assigned to you, you are protected]
–If a member company becomes insolvent, money to continue coverage and
pay claims is obtained through assessments of the guaranty association’s
other member insurance companies writing the same line or lines of
insurance as the insolvent company. All 50 states, the District of
Columbia, and Puerto Rico have life and health insurance guaranty
associations. [so the guaranty association is just a consortium of the solvent insurance companies and should not be thought of as some “pot of money”]
A friend went to jg Wentworth and was offered 50k for a 72k lump sum payment (over a wrongful death suit) that would pay out in 24 months. Because he needed money quicker than the 4 week downtime that he was required to wait…he looked around. I ended up offering 52k. When it matures in 10 more months I will have made just over 22%. Now Im wanting to find more of these SS’s!!!! No tax on gains too…is a huge part.
Tom,
The gain on your investment would still be taxable. It functions just like purchasing a discounted bond that matures at full value, where the gain is fully taxable.
– Michael
My research indicates the following issues. I would like your opinion please…..
The original payee of the structured settlement does have an annuity contract from an insurance company and has a degree of protection via the State guaranty associations.
When another person buys that structured settlement it is purchased from the original payee through a “broker” or factor, not from the insurance company or even through that insurance companies licensed agent. Therefore the relationship between the purchaser of the structured settlement and the issuing insurance company is not exactly the same as a relationship between an insurance company and an original owner /purchaser of the annuity.
I suspect that the insurance companies legal obligation to the buyer of the secondary annuity may be substantially less than to the original owner. This is not a bond trading as a security and under sec rules.
Also if the insurance company failed I have doubts that the state guarantee association would be obligated (and if so in what state?)
Where can I find the definitive answers?
Stephan,
Generally the sale of a structured annuity results in the transfer of the actual annuity contract. As a result, the new owner would have all the same rights and protections of any annuity owner.
I’m sure somewhere out there some deals are arranged differently, so I can’t quite characterize that as universal, but this isn’t like buying some electronics equipment and wondering about the transferability of the limited warranty. There is no “void if transferred” attached to state guaranty funds; they exist to back annuities, not annuity owners per se, and it’s still an annuity.
If you’re concerned about a particular structured annuity transaction, then you would need to investigate the details of whether/how that particular deal with transfer to the contract to you as the new owner.
I hope that helps a little!
– Michael
There is another opportunity which is simply annuitants selling their income stream. These are not structured settlements but may be annuities received as an early retirement offer or non-qualified annuities in the annuitization phase for which the owner now wants a lump sum. I would guess this market dwarfs the structure settlement offerings and provide the same set of benefits to the buyer. I think BDs are reluctant to allow their reps into this market as the yields will undermine sales of “fresh” annuities from insurers. For an investor not to consider secondary market annuities is frankly, foolish, as the yields are higher by 50% r more and the credit risk identical as one can get these secondary annuities with payments guaranteed by the same companies that issue primary annuities, eg. Metlife, NYLife, Pru, etc. When seeking to build my retirement portfolio, I purchased secondary annuity with a FAT yield and could not be happier.
Where would one buy these secondary annuities from a reliable source?
EZ Secondary Market Annuities – Tommy (844) 397-2837
People while investing in any commodity will surely have various opinions and various views about the same. Although in case of annuity and structure settlement the possibility is a little less but people do have their second opinion as if the investment is really safe or not. While going through the above post I come to know that annuity and structure settlement are of no harm and can be considered as a good deal. There exist some negative aspects as well, but if done with all the anxiety and care then one should go for it for sure.
Check out Pacific Structured Assets for plenty of these offerings at higher yields then you will find elsewhere
If you are thinking about buying one of these annuities first and foremost investigate the tax consequences. 40% excise tax. So these 5-7% returns promised will get wiped out.
http://www.irs.gov/irb/2004-30_IRB/ar09.html
http://www.irs.gov/uac/Form-8876,-Excise-Tax-on-Structured-Settlement-Factoring-Transactions
Michael, thanks for explaining the concept to everyone. It is very complicated and no matter how hard you try to simplify it, it is still difficult to understand sometimes. At RSL Funding, we attempt to explain the benefits of structured settlement annuities, sometimes to no avail so don’t be alarmed if some readers do not pick up on the concept…
I am still trying to understand how these settlements are taxed after buying one. I have not heard of any 40% excise tax, don’t think that’s accurate as stated here in another blog..
If there is a qualified court order, then no tax. All of our deals go to court. We have inventory for you to purchase structured settlements. Secondary Market Annuities are great for higher yields and safe income.
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AskMrAnnuity.com is a great source for secondary market annuities. We have a great deal of inventory for those interested in purchase structured settlements.
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Hi Steve,
I am an attorney with a client looking to sell her various annuities. I am seeking a buyer for her. I am attaching here a screen shot of the annuity payments by year. They are actually made more frequently. If anyone is interested in making about 6% safe money, please shoot me an email [email protected]. This is a real deal. I am a licensed attorney. The payments and contracts are fully documented and available for inspection for serious buyers.
Projecting a life expectancy of somebody is not an exact science. There are a lot of factors involved. Face it, it is not as secure as many other investments out there, but the returns would make up to it for a long time to come. Risk needs to be calculated and not avoided. Anyway, a more competitive market means a higher value policy thus more income for life insurance policy holder. See? the market is balancing itself. There are no, high profit, no risk. There might be for a while. But this hot market will be known by everybody especially investors and brokers. A competitive market means a shared profit for everybody involves. And that is a good thing.
I totally agree with you david. Risks are applicable on all investment systems as well. structured settlement is though not a bad option of investment
structured settlement for cash
y2b.io/eUIEX
First, the idea that there are more sellers than buyers is incorrect. Most structured settlements sold on the secondary market are sold to institutional investors—like insurance companies, banks, pension and hedge funds—before they even hit the individual investor market. Good ones go quickly.
One company has a deal with a international bank, which buys them all…
Secondary structured settlements are all now backed by court orders, and are not subject to a 40% excise tax as some people think; that is a holdover from there were done with court orders. Income from these that is in excess of the cost basis is taxable as ordinary interest income and is largely self-reported.
I think there a few reasons financial advisors usually discourage this—First, they don’t sell them and thus don’t profit from them. They may work for insurance companies and investment firms that don’t want to lose money on their primary products. For example, do you think Insurance Company A, which has to pay out the structured settlement at, say, 7%, really wants this to compete with the primary annuities they are currently selling at 3-4%? Of course not.
The secondary SS business used to be dirty, but now, throughout the country there are federal and state laws that regulate them, including a court proceeding that is supposed to rely on selling the settlement being in the best interest of the original owner. How often this is ruled the case, and how often it really is the case, varies a lot between states. Some states, like CA and NY, are very careful and refuse to allow a sale if they hold it is NOT in the seller’s best interest. Other states, like FL and TX, have more lax rules due to the political leanings of the state that someone should be able to do what they want with their money, even if it isn’t a “good” idea. Still, after a court order establishes that selling some or all of a settlement is “in the best interests” of the seller, it really doesn’t matter who buys it. Someone is going to, and if it doesn’t go to a small group of individual buyers, another insurance company or institutional investment company or bank buys them….Usually someone has arranged to tentatively buy it before the court order is even approved. There’s no shortage of buyers just a shortage of understanding.
I have bought several structures settlements in the last 5 years. They use to pay much more and some were even for just a couple of years, paying 6.25% These days, I have found that I am lucky to find one that pays even 4% with a time period of 5 years. Most of them go out very far If you are young enough, and time is one your side, it would really pay to go out 20 years or more. Still, I like them, in general. And sometimes you can even get them with only putting $25,000 into one. Many of them pay a set amount every month, put directly into your account. I like those a lot, as I am semi retired.
Michael-
Thanks for this good summary article. Structured settlements are a good alternative fixed income and you are right, the yield premium is primarily due to liquidity limitations. That said, just as the original recipients defined a need and filled it with a guaranteed payment stream, many investors do the same thing and find peace of mind in a guaranteed and period certain income stream or lump sum. To your point in the article about those lumps sums, the closest comparable is a zero coupon bond. Many investors with qualified funds, for example, seek safe appreciation, and don’t need cash flow until their RMD’s kick in. In those situations lump sums make great sense.
These payments are offered as Secondary Market Annuities and investors can learn more and see current available inventory http://www.secondarymarketannuity.net
If you get into structured settlements, be sure due diligence has been done to make sure the seller hasn’t already sold the asset to someone else. I had one where the seller promised the funds as collateral for a loan and I had to fight with the lending bank to get my money. I got it in the end, thanks to a broker who went to court and absorbed all fees related to the case.
We purchased a secondary market annuity from Somerset Wealth Strategy (11/22/13) purchased price $149,253 (AGI (annuity issuer) interest rate 4.75% with 2% COLA. Payments are supposed to start Jan. 2018 for 10 years. Six months ago we received a letter from INF Settlement Trust (who received $90K) from our proceeds that they had been informed by one or more of the insurance companies’ legal counsel involved that, they consider this a competing claim. For this reason they have decided to withhold payments until the issue is resolved in court. However, in order to continue processing & forwarding our payments INF Settlement Trust requires that each assignee execute the accompanying Release & Hold Harmless Agreement. INCREDIBLE!! We did our due diligent research in choosing Somerset Wealth Strategies. The sales was sign off in a court in Maryland. Now I have been reading via internet that the Attorney General Brian E. Frosh has filed suit against Access Funding, LLC (a structured settlement transferee, for violations of the Maryland Consumer Protection Act. The suit, which is currently pending in the Circuit Court for Baltimore City, alleges that Access Funding mislead & induced approximately 100 injured & cognitively impaired Marylanders to transfer more than $27 million in future structured settlement payments and in exchange, provided about $6 million in cash to those Marylanders. At least 70% of Access Funding’s Maryland customers had been plaintiffs in lead paint poisoning lawsuits. ost were young people between the ages of 19 & 26 residing in Baltimore city. What I would like to know is where do I go to find an attorney to protect my interest. Haven’t had any luck so far. HELP!!
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I am an attorney with a client looking to sell her various annuities. I am seeking a buyer for her. I am attaching here a screen shot of the annuity payments by year. They are actually made more frequently. If anyone is interested in making about 6% safe money, please shoot me an email [email protected]. This is a real deal. I am a licensed attorney. The payments and contracts are fully documented and available for inspection for serious buyers.