by John Darer CLU ChFC MSSC CeFT RSP CLTC
A structured settlement is an important financial planning tool for tort victims, if properly used
Its contractual guarantees and tax advantages, have their place as a financial foundation or insurance. But, in my opinion, an aggressive approach employed by some settlement planners, that involves emphasizing the factorability of a structure "as a settlement planning tool", to convince your client that he or she should take a bigger structured settlement is trouble. Attorneys must be be aware that some bamboozled brokers tarnish the settlement planning process by doing just that.
For those that use this tactic I see a huge potential malpractice issue. It's not the question of factoring per se, it's the question of suitability by encouraging the placement of that "nth amount more" of a financial product at the expense of an allocation to a more suitable alternative when you know that there is a substantial risk of factoring. Practitioners who also hold themselves out as "settlement planners" need to be held to a higher suitability standard
What worth is a settlement planning approach that has your client losing money in mind?
"Becky Gomez" is at a mediation and accepts a structured settlement that includes a $50,000.00 lump sum on October 15, 2012, using an A+XV rated New York domiciled life insurer. The cost of this element of Becky's recovery is $42,572.50 with an August 15, 2008 purchase. That amounts to a 3.93% income tax-free internal rate of return assuming nothing is factored in the interim.
If Becky then tries to factor the payment almost immediately, and assuming the Court would approve the transaction, using the factoring effective discount rate* calculator we learn that
- With a 8.85% effective discount rate Becky would get approximately $35,000 today which amounts to 82.21% of this element of recovery
- With a 11.2 % effective discount rate Becky would get approximately $32,000 today which amounts to 75.16% of this element of recovery
- With a 13.37% effective discount rate Becky would get approximately $29,500 today which amounts to 69.29% of this element of recovery
- With an 18.01% effective discount rate Becky would get approximately $24,930 today which amounts to 58.56% of this element of recovery
Factoring a Structured Settlement Always Results in a Financial Loss
Regardless of the effective discount rate used in the above example, IF the annuitant factors, there is a BIG LOSS on the original $42,572.50 investment. How do these losses of the recovery in such a short period of time compare with the stock market? An 18 % effective discount rate would result in a loss of capital to the plaintiff which EXCEEDS the losses in virtually every bear market in the S&P 500 in the last 35 years!
To quote a friend "If this is Kansas, how come I don't see Dorothy and Toto?"
Ironically, the settlement planners pushing the factorability "crack" or "crock" are the same ones who say you should take a structure because it's free of market volatility. While the estimates bandied about these days say that only about 5% of structures are actually factored, how many of your clients need to take advice from a trojan horse?
If a settlement planner or structured settlement broker has taken fees for advice that leads to the above, it is nothing short of scandalous. In the structured settlement industry there is currently a story circulating of a broker who took a massive fee on a factoring deal within one year of structured settlement creation. One factoring company operative markets (intended as a source of "comfort") that she is the "only former structured settlement broker in the factoring business" and employs a "settlement planning approach".
In the example case wouldn't the settlement planner be more responsible and the plaintiff be better off in the first place by addressing liquidity needs through placing a portion of the recovery in a Settlement Preservation Trust, 130X or recovery management trust where liquidity is not an issue?
* effective discount rate is the factoring discount rate including all charges, commissions and fees.