Settlement Capital Corporation was, at the time of this interview, the oldest and largest investor in the structured settlement and annuity industry. Its president, James Lokey, explains what a structured settlement is, how buying the payments works legally, how the company works with brokers, and the ethical issues facing this little-known investment. He was interviewed by W. J. Mencarow.
How structured settlements work
Q: Jim, what is your background, and that of Settlement Capital Corporation?
I graduated in engineering in 1970, then earned a master’s in international management and finance from the University of Texas. Until 1988 I worked in the computer field and in real estate finance. In 1988 I bought a structured settlement annuity as a personal investment, only because I didn’t know enough not to buy it. It’s a long story, but that investment led me to found Settlement Capital. Our purpose was to provide liquidity to a market where none existed.
Q: What is a structured settlement?
“Structured settlement” generally refers to a deferred payment obligation that results from settling a personal injury claim. Most often, the defendant or its insurer guarantees the settlement obligation by buying an annuity and naming the plaintiff or claimant as the payee. Ownership of the annuity stays with the defendant or its insurer, or is assigned to an affiliate of the issuing company. The annuity payments are tax-free to the claimant.
Q: Does Settlement Capital purchase structured settlements exclusively?
We specialize in structured settlements and other annuities, but we will buy most deferred payment corporate obligations rated BBB or better.
Q: Why structured settlements, as opposed to real estate notes or something else?
When we were just getting started and very few people knew about our service, we did our share of notes and mortgages. As awareness of Settlement Capital grew, we dropped any activity that didn’t complement the structured settlement business. Our knowledge and experience gave us a competitive advantage we wanted to build on.
Why the payments can be sold
Q: If someone wants to cash out of their annuity, why doesn’t the insurance company buy it?
If the annuity has been transferred to a third party through a qualified assignment under Internal Revenue Code section 130(c), the assignee is prohibited from accelerating the payments to the annuitant. That isn’t the case with non-assigned annuities, but the obligors have consistently been reluctant to change the terms of a settlement. There are tax issues on all sides of a structured settlement that make the parties want to keep the status quo.
Q: Do you run into assignability problems?
The annuity itself is not assignable, because the individual doesn’t own it. It is typically owned by a subsidiary of the life insurance company that issued it, or by the original defendant’s casualty company. So the annuitant has no right to assign the annuity policy. What they do have is the right to receive the payments under the settlement. That is an absolute right under the settlement agreement, and it is personal property that can be assigned. We are buying their right to receive the payments.
Q: Our firm looked into buying structured settlements several years ago and was told by the insurance company that it wasn’t possible. The company told the annuitant he was prohibited from assigning his payments.
Every insurance company will say that. We believe it comes from a general misunderstanding of IRC 130(c), which prohibits acceleration by the company itself. Careful analysis of the Code shows that it doesn’t apply to the annuitant’s right to assign payments to a third party. We have done our homework in this field and are comfortable with the legal issues.
Please don’t take this to mean there are no legal risks. There are, and they must be properly addressed and priced accordingly.
Finding annuitants and working with brokers
Q: You do a lot of direct advertising to annuitants. Didn’t I see your ad in the Wall Street Journal?
We run ads in about 50 papers across the country every week, everywhere from the Wall Street Journal to the National Enquirer. You never know where you’ll find an annuity.
Q: Do you do a lot of work with individual brokers?
Brokers are our main source of deals, and we welcome new ones. Some of our structured settlement brokers have been with us for over seven years.
Q: What do you expect from a broker?
Integrity and honesty. If they bring that to the table, we will teach them everything they need to know about the structured settlement business. We want the broker to be an active participant, but we don’t expect them to do anything they aren’t trained to do.
Q: Do you do the bulk of the paperwork, or do you expect the broker to provide it?
We do 90% of the paperwork. We ask the broker to send the basic documents for the transaction, such as the policy and the settlement agreement. From those, we do all the legal preparation.
With a new broker, we walk him through the process and handle it so he can see how it works without making mistakes. With our more experienced brokers, we sometimes deal directly with the annuitant because it speeds things up, and brokers who have worked with us for years are comfortable with that.
Pricing to the seller’s needs
Q: How would a broker who has never dealt with structured settlements get the proper education?
The best thing is to introduce us to the person with the annuity or structured settlement who needs financial help, and watch how we do it. We ask a number of questions before we even price an annuity, because we like to know the person’s financial objectives first. We would rather meet the individual’s financial goal than just try to buy all of the payments. By buying only part of the payment stream, we can solve their immediate need and still leave them enough income for the future.
Once we agree, the broker can see how we handle the deal, how we do the paperwork and how it closes.
Q: Do you pay a broker fixed compensation, or quote a price and let the broker earn the spread?
To experienced brokers, we quote a net price and let the broker negotiate his compensation. If a broker needs help or guidance on the spread, we work with him. Because we value structured settlements on many different attributes, we don’t publish a fixed buy price. We are always competitive, though, and when we give a quote, it’s because we can close the deal. That is very comforting to brokers who have seen eye-catching low yields with no follow-through, or last-minute price changes.
Regulation, ethics and the road ahead
Q: What regulatory issues face the structured settlement industry?
When we started, we received both open and quiet acceptance from the structured settlement industry. They even let us join their organization, the National Structured Settlements Trade Association (NSSTA). I think they recognized that some liquidity was probably good for the industry.
More recently, growing competition has brought open criticism of the business. Opponents are mainly concerned about companies that actively solicit individuals to sell their payments, and I am certain that would bring an adverse reaction from the structured settlement industry. I hope the leaders in this business will join in demanding the highest ethical and professional standards from themselves and their brokers.
Q: Do any states require structured settlement dealers or brokers to be licensed or bonded?
At the time of this interview, no. But as happened in the viatical industry, once we get very large or attract a lot of attention, it will probably happen. If licensing were required, it would likely be either an insurance agent’s license or something like the Certified Structured Settlement Consultant (CSSC) designation. I earned that designation through the NSSTA in 1993. It required a home study course, a university class and an exam. Unfortunately, it is not available to the general public.
Q: What do you see for the future of this industry?
I think the industry has a bright future as long as everyone understands its role. We provide a very valuable service to those who need us. For annuitants who don’t need our service, we should recognize that and not pursue them in any way. Educating the public about our service is an essential part of the business, but recognizing need is another part. With over $25 billion of annuities in place at the time of this interview, it shouldn’t be hard for everyone to succeed while building an industry with the highest ethical and professional standards.
