Creation and Sale
A structured settlement is an agreement between parties which generally results in an insurance entity committing to make tax-free payments to an individual for an agreed upon period of time or for the life of the individual. Structured Settlements are based on a financial plan for immediate cash and future tax-exempt payments which take into consideration the future needs of the injured party. Structured Settlements are also designed by the plaintiff in order to maximize their settlement by receiving secure and tax-free payments.
Upon reaching a settlement which includes the requirement of future periodic payments, the Plaintiff often requires the Defendant to transfer its obligation to make these periodic payments to a subsidiary or affiliate of an insurance company (often referred to as an assignment company). The Defendant or its liability insurance carrier pays the assignment company an agreed amount of money in a lump sum in exchange for its agreement to assume this periodic payment obligation. The assignment company uses this lump sum to purchase an annuity from an insurance company which is often affiliated with, or a parent of, the assignment company. After the assignment, the assignment company or the insurer will make all of the periodic payments directly to the Plaintiff.
Each insurance company is regulated through state insurance commissions, who mandate the repayment of these annuities as claims paying obligations. In addition, each state has a specific limited guarantee or fund for repayment in the event that an insurance company is unable to meet their obligations. Physical, personal injury settlement payments are generally received tax-free by an injured person by reason of Section 104 Internal Revenue Code. With a qualifying structured settlement, the individual receives a tax-free accrual of interest for the life, or term, of the annuity. In this manner, the injured person becomes the payee of a Structured Settlement, which generates payments at a fixed rate, for a fixed term.
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In some instances, the individual annuitant who is receiving periodic payments under a Structured Settlement desires to sell some or all of their future payments for a lump sum of money. The cash flows are sold at a discount in exchange for the lump sum payment, and this discounted Structured Settlement is available for sale to the Purchaser. This manner of securing the payment streams at a discount directly from the seller is how the Purchaser secures such favorable yields. Financial brokers normally facilitate this transaction on behalf of the seller (or annuitant) and the purchaser.
The payment rights to the future cash flow can only be transferred from the Annuitant to the Purchaser pursuant to a court order process, mandated by state law. Financial brokers typically engage a legal counsel to meet the requirements of each state. Part of this court order process requires confirmation from the judge that the transaction is in the best interests of the Annuitant. A broker facilitates this process by working directly with the annuitants and local legal counsel. The local councel arranges for all the appropriate contracts and agreements between the seller and purchaser, ensures that all state and federal requirements are being met, and ensures that the insurance company or assignment company acknowledges or stipulates that the purchased payments are being redirected from the Seller to the Purchaser. Also, the broker arranges for the retention of independent legal counsel, who will be engaged to secure a court order approving the sale of the Structured Settlement payment rights from the Seller directly to the Purchaser. The court order will specify that all of the purchased payments are to be paid directly to the Purchaser from the insurance entity.
It typically takes 2 or more months to complete a purchase and sale transaction from the time that the broker reaches an agreement with an individual to purchase his or her Structured Settlement payment rights and when a final court order is obtained approving the purchase and sale transaction.
These transactions vary in size from approximately $10k to well over $1M in principal invested. There is also a wide variety of “start dates” and “end dates”, providing a wide range of cash flow durations. These cash flows are NOT volatile, and can be expected to be received as agreed to. Purchasers can choose which Structured Settlements meet their specific objectives. A Purchaser can purchase assets backed by different insurance entities, of different sizes, with different durations. Fixed Income Annuities can also be purchased for an individual investment portfolio through Self Directed Retirement Accounts. The Purchaser can choose an asset that has a specific start date, ensuring income in retirement.
In each state, there have been thousands of approved transactions where Plaintiffs have sold their lump sum payment. The market is established, and processes exist in each state to successfully complete these transactions.
The Internal Revenue Code, which exempts from tax the Structured Settlement payments being made to an injured person pursuant to a settlement, is not applicable to secondary market purchasers. Hence, the receipt of Structured Settlement payments is generally taxable to a secondary market purchaser. Investors should consult their own tax advisor as to the tax considerations that would be applicable prior to purchasing any Structured Settlements.