If you’re a seasoned broker of structured settlements, you already know the most important part of a successful deal: understanding the seller’s motivations and fears.
The situation is often the same. The seller is in a financial crisis and can’t get traditional credit. He has a structured settlement with guaranteed future payments, but he has no credit or poor credit and the bank has already turned him down. He may have called his insurance company and been told that selling his payments is not only “illegal” but the ultimate tax sin. So when he answers your ad, he’s already inclined to doubt you.
These are answers to the questions I was asked most often by brokers over the years I spent buying settlements.
Start with the seller’s circumstances
The sooner you understand the seller’s situation, the better for everyone. No funder will buy payments under the wrong circumstances, which include payments to minors or their guardians, payments meant for medical necessities, and payments to people who can’t work and depend on the structure as their only income.
If you’re uncomfortable negotiating with the seller, you can agree on a fee with your funder and let it handle the whole transaction.
What structured settlements are and why they can be sold
Q: What are structured settlements?
Simply put, they are agreements to make payments over time in exchange for a release of liability. They’re usually tied to the settlement of personal injury claims.
Q: The seller asks how we can buy his payments when he’s been told it can’t be done. What do we say?
Under the settlement agreement, the plaintiff (the person receiving the structured settlement) is granted only the right to receive certain future payments in return for releasing the defendant from liability. To make those payments, the defendant or its insurer buys an annuity and either keeps ownership or assigns it to another company. So the annuitant doesn’t own the policy and can’t sell it. He does, however, own the right to receive the payments, which is personal property and can be assigned.
The non-assignment language in the settlement agreement and the annuity is generally unenforceable under the Uniform Commercial Code. Some states, including Texas and Illinois, have statutes that restrict assignment of structured settlements, but an assignment of the right to receive payments is legal and binding.
Q: What is the purpose of structured settlements?
They help resolve thousands of personal injury claims. At the time of settlement, the tax benefits to the defendant, the insurer and the claimant make the structure good for everyone, and it usually keeps serving everyone’s interests. But circumstances change, and the original plan may stop serving the plaintiff.
Q: If structured settlements are so good for everyone, why do so many people want to sell them?
In life, the only constant is change. Structured settlements are rigid, inflexible plans, so they often fail in their intended purpose. The basic flaw in the rules behind the industry is the assumption that the original structure will serve the annuitant and his beneficiaries for its whole life. How often beneficiaries turn to the secondary market shows that their needs are often very different from the original claimant’s.
Q: Are all structured settlements designed to meet the plaintiff’s future financial needs?
The insurers’ reaction to our business rests on the idea that every structure is written perfectly from the start. That’s ludicrous, since no one is clairvoyant. They never predict divorce, early death, medical emergencies or changes in finances. They never predict, though it’s often the case, that the injury award is too small, leading to more or earlier medical bills than expected. Most structures are written simply to resolve a legal dispute, not to meet the plaintiff’s long-term needs.
Why insurers resist and why discount rates are high
Q: Why are the insurance companies and their industry association so opposed to the secondary market?
Mostly fear of the unknown. Some insurers believe these third-party transactions will bring them bad tax consequences, though nothing in tax history supports that fear. The agents who sell structures also hear objections from plaintiffs’ attorneys, who worry that clients will sell their benefits for less than the premium needed to buy the annuity. Why not just settle for that premium now and avoid a loss later? That threat of lost business drives the agents’ opposition.
Q: Since the payments are virtually guaranteed, why are the discount rates so high?
No one argues about the safety of the payments. The rates reflect uncertainty elsewhere. The insurers’ lack of cooperation, and sometimes their open opposition, means deals take longer and cost more, and fixing problems is expensive. And although non-assignment language is unnecessary and generally unenforceable, its presence creates a perceived legal risk for investors. Even so, at the time of writing (1998) rates had dropped sharply in recent years and were lower than credit card rates.
Finding sellers and pricing deals
Q: Who are the sellers?
Usually people with a financial emergency and no access to traditional credit. Sometimes their money problems come from the very event that led to the settlement. Because funders look only at the annuity and not at the seller’s credit, they can provide money no one else will.
Q: How do you find them?
Anywhere you already advertise. Structured settlement annuitants are as varied as the population. Their most common traits are poor credit and a financial emergency.
Q: How much will I have to spend on advertising?
If you advertise only for structured settlements, it can cost up to $250 in direct advertising just to make the phone ring. Expect to talk to seven or more people before you find a qualified seller. So you may spend somewhere around $1,500 in direct costs to close one structured settlement. Spreading your ad dollars across other products improves the return.
Q: Should I specialize in this area?
I wouldn’t recommend specializing in structures to the exclusion of everything else. Learn enough to be useful to anyone who needs the service. Never try to “wing it” through a deal. If you’re new, you’ll close more deals by letting your funder or a master broker carry the ball.
Q: How can I price with confidence?
Learn the funders’ underwriting criteria and their rates for different deals. One funder won’t buy final lump-sum payments, while others will at higher rates. Some won’t buy payments from companies rated below A, while others will, for smaller amounts and higher discount rates. No funder will buy all the payments of a disabled person who can’t work, or payments needed for medical necessities. Every deal requires knowing the seller’s needs, their situation and the funders’ criteria. Never rely on published rates to price your deals.
Q: How can I compete with funders who advertise directly for the same deals?
Wholesale rates to brokers let brokers produce about half of all settlements purchased. Most funders need some deals at retail rates to balance their portfolios. Your wholesale rates let you compete directly with a funder and still win the deal.
Serving the seller well
Q: What do sellers usually want?
They’ll often say as much cash as possible. Sometimes it’s just enough to buy a car so they can get to work, or to make a down payment on a home. Whatever the reason, it’s up to you to understand their financial goals so you can serve their needs.
Q: What if they want to sell their entire settlement?
Tell them that while it may be possible to buy all their payments, it’s unlikely to be in their best interest. Make several offers with a more conservative approach that still meets their specific needs.
Taxes and regulation at the time of writing (1998)
Q: Why are the payments tax-free to the annuitant?
Through the Internal Revenue Code and certain Revenue Rulings, Congress and the IRS treat a personal injury settlement as returning, or trying to return, the injured person to where they were before the injury. Since there’s no gain, only a return to “normal,” there’s nothing to tax.
Q: What are the seller’s tax consequences of an assignment?
At the time of writing, the IRS had not ruled on this, and although most insurers said the sale was taxable, they simply didn’t know. Some accountants advised that the sale proceeds take on the character of the payments sold, meaning tax-free. Others said there’s no taxable event without a gain, and the sale actually produces an effective capital loss. (The original premium for the annuity, which the plaintiff could have taken as a tax-free lump sum, was larger than the premium needed for an annuity paying up to the date of sale plus the amount received for the future payments.)
As a broker, you can’t and shouldn’t give tax advice. Tell sellers to see their own tax advisers.
Q: Is federal or state regulation of the industry coming?
I expected regulation to wait until the tax questions were answered. It seemed likely the official reading of the tax code would not prohibit the transaction. It might say the seller has a tax liability, but it was very unlikely to say a third-party sale affects the insurer’s tax liability. Even so, insurers would still be barred from accelerating payments themselves because of their obligations under IRC 130(c). As this article first went to press, a bill was introduced in Congress that could severely affect the industry.
Q: What form of regulation do you foresee?
Disclosure of all rates, fees and expenses; education or licensing requirements for brokers and funders; perhaps ranges of discount rates for certain deals; and legal representation and court approval for most transactions.
Q: What would life be like in a regulated environment?
Deals would be slower and more expensive. Small deals would either have to be exempt from court approval or would stop making economic sense. That would be a disservice, since small deals often give sellers the most relief.
