A structured settlement factoring transaction means a transfer of structured settlement payment rights (including portions of structured settlement payments) made for consideration by means of sale, assignment, pledge, or other form of encumbrance or alienation for consideration.Subparagraph (A) of paragraph 3 of subsection (c) of . In order for such transfer to be approved, the transfer must comply with Internal Revenue Code section 5891 and any applicable state structured settlement protection law.
Purpose of a structured settlement factoring transaction A structured settlement factoring transaction is a means to raise liquidity where there is no other viable means, via the transfer of structured settlement payment rights, for items such as unforeseen medical expenses, the need for improved housing or transportation, education expenses and the like, or in a situation where the individual has simply spent all his or her cash. To meet this need, the structured settlement recipient may involve the sale (or, less commonly, the encumbrance) of all or part of certain future periodic payments for a lump sum. Generally such lump sums are discounted. If a person sells the structured settlement payment rights, he or she will never receive the full amount of the payments originally contracted for when the individual settled his or her case and the structured settlement was established. A judge must review the submission and determine that the structured settlement transfer is in the best interest of the payee and any applicable dependents.
History Structured settlements experienced an explosion in use beginning in the 1980s. § 1-14–1-17 Growth in the United States was most likely attributable to the favorable federal income tax treatment for such settlements receive as a result of the 1982 amendment of the Internal Revenue Code to add 26 USC § 130.
Beginning in the late 1980s, a few small financial institutions started to meet this demand and offer new flexibility for structured settlement payees. Financial commentators and lawyers suggest caution in the sale of structured settlements. Sale of a structured settlement "is tempting, but it's typically not smart."
Controversy Concerning "Servicing" of Structured Settlement Payments by Factoring Companies Servicing of structured settlement payments occurs when a structured settlement payee sells only a portion of their future structured settlement payment rights, yet concurrent with the transfer, the factoring company also enters into an agreement to "service" the structured settlement payments that have not been sold.
In "servicing" practice, one check is made payable to the factoring company instead of one to the factoring company and one to the payee. The factoring company receives the entire structured settlement payment, when due from the annuity issuer, takes what is owed to it and "passes through" the balance to the payee. This involves issuing a separate check to the payee issued off the factoring company account.
It has been alleged that annuity issuers will not address questions of payees whose payments are subject to a servicing agreement. Some factoring industry commentators suggest the reason for this phenomenon is that some structured annuity issuers will not "split" annuity payments (i.e. make payments to more than one place)ostensibly to save administrative cost. Others say that the practice is driven by the factoring companies simply as a means to secure new business. Several industry commentators have expressed concerns questioned whether such servicing agreements are in the structured settlement payee's "best interest".
What they say needs to be addressed is what effect the bankruptcy of a factoring company "servicing company" would have on the payee, with respect to the payments being serviced. Until this issue is decided, payees who are considering partial structured settlement transfers should be wary about participating in "servicing agreements". One possible solution has been suggested-that there be a requirement that servicing companies post a bond.
Factoring Terminology
Discount Rate In the beginning, the factoring industry had some relatively high discount rates due to heavy expenses caused by costly litigation battles and limited access to traditional investors. However, once state and federal legislation was enacted, the industry's interest rates decreased dramatically.
There is much confusion with the terminology “discount rate” because the term is used in different ways. The discount rate referred to in a factoring transaction is similar to an interest rate associated with home loans, credit cards and car loans where the interest rate is applied to the payment stream itself. In a factoring transaction, the factoring company knows the payment stream they are going to purchase and applies an interest rate to the payment stream itself and solves for the funding amount, as though it was a loan. Discount rates from factoring companies to consumers can range anywhere between 8% up to over 18% but usually average somewhere in the middle. Factoring discount rates can be a bit higher when compared to home loan interest rates, due to the fact the factoring transactions are more of a boutique product for investors opposed to the mainstream collateralized mortgage transactions.
One common mistake in calculating the discount rate is to use “elementary school math” where you take the funding/loan amount and divide it by the total price of all the payments being purchased. Because this method disregards the concept of time (and the time value of money), the resulting percentage is useless. For example, the court in In Re Henderson Receivables Origination v. Campos noted an annual discount rate of 16.8% where the annuitant received $36,500 for the assignment of payments totaling $63,364.94 over 84 months (two monthly payments of $672.32 each, beginning September 30, 2006 and ending on October 31, 2006; eighty-two monthly payments of $692.49 each, increasing 3% every twelve months, beginning on November 30, 2006 and ending on August 31, 2013). However, had the court in Henderson Receivables Origination applied the illogical formula of discounting from “elementary school math” ($36,500/ $63,364.94), the discount rate would have been an astronomical (and nonsensical) 61%.Henderson Receivables Origination, LLC v. Campos, 2006 N.Y. Slip Op. 52430(U) (N.Y. Sup. 2006).
Discounted Present Value Another term commonly used in factoring transactions is “discounted present value,” which is defined in the National Conference of Insurance Legislators's model transfer act as “the present value of future payments determined by discounting such payments to the present using the most recently published Applicable Federal Rate for determining the present value of an annuity, as issued by the United States Internal Revenue Service.”Texas Revised Civil Statute Annotated § 141.002(4).
The discount rate, also known as the Applicable Federal Rate (AFR), is used to determine the charitable deduction for many types of planned gifts, such as charitable remainder trusts and gift annuities. The rate is the annual rate of return that the IRS assumes the gift assets will earn during the gift term. The IRS discount rate is published monthly. Present tax rates. In Henderson Receivables Origination, the court calculated the discounted present value of the $63,364.94 to be transferred as $50,933.18 based on the applicable federal rate of 6.00%.
The “discounted present value” is a measuring stick for determining what the value of a future payment (i.e., a payment that is due in the year 2057) is today. Hence, the discounted present value of a payment corrects for inflation and the principle that money available today is worth more than money not accessible for 50 years (or some future time). However, the discounted present value is not the same thing as market value (what someone is willing to pay). Basically, a calculation that discounts a future payment based on IRS rates is an artificial number since it has no bearing on the payment's actual selling price. For example, in Henderson Receivables Origination, it is somewhat confusing for the court to evaluate future payments totaling $63,364,94 based the discounted present value of $50,933.18 because that is not the market value of the payments. In other words, the annuitant couldn't go out and get $50,933.18 for his future payments because no person or company would be willing to pay that much. Some states will require a quotient to be listed on the disclosure that is sent to the customer prior to entering into a contract with a factoring company. The quotient is calculated by dividing the purchase price by the discounted present value. The quotient (like the discounted present value) provides no relevance in the pricing of a settlement factoring transaction. In Henderson Receivables Origination, the court did consider this quotient which was calculated as 71.70% ($36,500/ $50,933.18).
United States
Consumer Financial Protection Bureau warning
The Consumer Financial Protection Bureau (CFPB) hs issued a warning to consumers that consumers could receive much less cash than their settlement is worth. Dealing with companies that offer lump sum payments for their disability, personal injury or structured settlement payments can be risky. Some companies target people with disabilities who have structured settlements. If an individual receives a flyer or solicitation promising fast cash or a lump sum payment for monthly payments, the individual should use caution. The CFPB cautions that individuals should consider all options, including talking to trusted people or to a lawyer or financial counselor, before trading future payments for instant cash.
The CFPB warning follows several high-profile news stories and lawsuits over the alleged abusive business practices by companies that purchase structured settlement payments. Several states have implemented structured settlement protection reforms in order to minimize abuses.
Process
Pre-2002 Congress enacted law to provide special tax breaks for payments received by tort victims in structured settlements, and for the companies that funded them. The payments were tax free, whereas if the tort victim had been given a lump sum and invested it themselves, the payments from those investments would be taxable.
Companies liked structured settlements because it allowed them to avoid taxes to a certain extent, and plaintiffs liked them because it allowed them to receive tax-free payments of what became, over time, a much larger amount of money than the original amount paid out by the settling party. Such settlements were also considered an especially good idea for minors, as they held the money safe for adulthood and ensured that youth would not find the money wasted or ill-spent. “Despite the best intentions of plaintiffs, lump sum settlement awards are often quickly dissipated because of excessive spending, poor financial management, or a combination of both. Statistics showed that twenty-five to thirty percent of all cash awards are exhausted within two months, and ninety percent are exhausted within five years.”Andrada, “Structured Settlements – The Assignability Problem,” 9 S. Cal. Interdis. L.J. 465, 468 (Spring 2000).
An explanation of Internal Revenue Code section 130 was given during discussions of possible taxation of companies that bought future payments under those structured settlements. “By enacting the PPSA, Congress expressed its support of structured settlements, and sought to shield victims and their families from pressures to prematurely dissipate their recoveries.”145 Cong. Rec. S52281-01 (daily ed. May 13, 1999) (statement of Sen. Chaffee).