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.[1] 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.[2] 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.[3][4]
Beginning in the late 1980s, a few small financial institutions started to meet this demand and offer new flexibility for structured settlement payees.[4] Financial commentators and lawyers suggest caution in the sale of structured settlements.[5][6]
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. [citation needed] 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%.[7]
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[8] 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.”[9]
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.[10] In Henderson Receivables Origination,[7] 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%.[9]
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,[7] 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.[11]
The CFPB warning follows several high-profile news stories and lawsuits over the alleged abusive business practices by companies that purchase structured settlement payments.[12][13] 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.”[14]
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.”[15]
Congress was willing to afford such tax advantages based on the belief that the loss in income taxes would be more than made up by lower expenditures on public assistance programs for those who suffered significant injuries. A strict requirement for a structured settlement to qualify for this tax break was that the tort victim was barred from accessing their periodic payments before they came due. It was for this reason that the annuity had to be owned by another who had control over it. The tort victim could not be seen to have “constructive receipt” of the annuity funds prior to their periodic payments. If the tort victim could cash in the annuity at any time, it was possible that the IRS might find constructive receipt.
According to Joseph M. Mikrut, “Congress conditioned the favorable rules on a requirement that the periodic payments cannot be accelerated, deferred, increased or decreased by the injured person. Both the House Ways and Means and Senate Finance Committee Reports stated that the periodic payments as personal injury damages are still excludable from income only if the recipient is not in constructive receipt of or does not have the current economic benefit of the sum required to produce the periodic payments.”[16] “These factoring transactions directly undermine the policy objective underlying the structured settlement tax regime, that of protecting the long term financial needs of injured persons . . . “[16]
Mikrut was testifying in favor of imposing a punitive tax on factoring companies that engaged in pursuit of structured settlement payments. Despite the use of non-assignment clauses in annuity contracts to secure the tax advantages for tort victims, companies cropped up that tried to take advantage of these individuals in ”factoring” transactions, purchasing their periodic payments in return for a deeply discounted lump sump payment. Congress felt that factoring company purchases of structured settlement payments “so directly subvert the Congressional policy underlying structured settlements and raise such serious concerns for the injured victims,” that bills were proposed in both the Senate and the House to penalize companies which engage in such transactions.[16]
Before the enactment of IRC 5891, which became effective on July 1, 2002, some states regulated the transfer of structured settlement payment rights, while others did not. Most states that regulated transfers at this time followed a general pattern, substantially similar to the present day process which is mandated in IRC 5891 (see below for more details of the post-2002 process). However, the majority of the transfers processed from 1988 to 2002 were not court ordered.[17] After negotiating the terms of the transaction (including the payments to be sold and the price to be paid for those payments), a formal purchase contract was executed, effecting an assignment of the subject payments upon closing. Part of this assignment process also included the grant of a security interest in the structured settlement payments, to secure performance of the seller's obligations. Filing a public lien based on that security agreement created notice of this assignment and interest. The insurance company issuing the structured settlement annuity checks was typically not given actual notice of the transfer, due to antagonism by the insurance industry against factoring and transfer companies. Many annuity issuers were concerned that factoring transactions, which were not contemplated when Congress enacted section 130, might upset the tax treatment of qualified assignments. House of Representatives Bill 2884 (discussed below) resolved this question for annuity issuers.
Federal legislation
In 2001, Congress passed HR 2884Archived 2008-10-06 at the Wayback Machine , signed into law by the President in 2002 and effective July 1, 2002, codified at Internal Revenue Code § 5891.[18] Through a punitive excise tax penalty, this has created the de facto regulatory paradigm for the factoring industry. In essence, to avoid the excise tax penalty, IRC 5891 requires that all structured settlement factoring transactions be approved by a state court, in accordance with a qualified state statute. Qualified state statutes must make certain baseline findings, including that the transfer is in the best interest of the seller, taking into account the welfare and support of any dependents. In response, many states enacted statutes regulating structured settlement transfers in accord with this mandate.
Post-2002
Today, all transfers are completed through a court order process. As of January 1, 2013, 47 states have transfer laws in place regulating the transfer process. Of these, 37 of the laws are based in whole or in part on the model state law enacted by NCOIL, the National Conference of Insurance Legislators (or, in cases when the state law predates the model act, they are substantially similar).
Most state transfer laws contain similar provisions, as follows: (1) pre-contract disclosures to be made to the seller concerning the essentials of the transaction; (2) notice to certain interested parties; (3) an admonition to seek professional advice concerning the proposed transfer; and (4) court approval of the transfer, including a finding that it is in the best interest of seller, taking into account the welfare and support of any dependents.
In 2005, the ABA Journal, a publication of the American Bar Association, published Transfers of Structured Settlement Payment Rights: What Judges Should Know about Structured Settlement Protection Acts.[19] The article cites the "unusual combination of state law requirements and federal tax law sanctions" and "explains the SSPAs and their relationship to the IRC and discusses some of the key questions that courts need to address in ruling on SSPA applications."
Federal tax law
Internal Revenue Code section 130 provides substantial tax incentives to insurance companies that establish “qualified” structured settlements.[3][20] There are other advantages for the original tort defendant (or casualty insurer) in settling for payments over time, in that they benefit from the time value of money (most demonstrable in the fact that an annuity can be purchased to fund the payment of future periodic payments, and the cost of such annuity is far less than the sum total of all payments to be made over time). Finally, the tort plaintiff also benefits in several ways from a structured settlement, notably in the ability to receive the periodic payments from an annuity that gains investment value over the life of the payments, and the settling plaintiff receives the total payments, including that “inside build-up” value, tax-free.[21]
However, a substantial downside to structured settlements comes from their inherent inflexibility.[22] To take advantage of the tax benefits allotted to defendants who choose to settle cases using structured settlements, the periodic payments must be set up to meet basic requirements set forth in Internal Revenue Code section 130(c). Among other things, the payments must be fixed and determinable, and cannot be accelerated, deferred, increased or decreased by the recipient.[23] For many structured settlement recipients, the periodic payment stream is their only asset. Therefore, over time and as recipients’ personal situations change in ways unpredicted at the settlement table, demand for liquidity options rises. To offset the liquidity issue, most structured settlement recipients, as a part of their total settlement, will receive an immediate sum to be invested to meet the needs not best addressed through the use of a structured settlement.
Best Interest Standard
Internal Revenue Code Sec. 5891 and most state laws require that a court find that a proposed settlement factoring transaction be in the best interest of the seller, taking into account the welfare and support of any dependents.[24] “Best interest” is generally not defined, which gives judges flexibility to make a subjective determination on a case-by-case basis. Some state laws may require that the judge look at factors such as the “purpose of the intended use of the funds,” the payee's mental and physical capacity, and the seller's potential need for future medical treatment.[25][26] One Minnesota court described the “best interest standard” as a determination involving “a global consideration of the facts, circumstances, and means of support available to the payee and his or her dependents.”[26]
Courts have consistently found that the “best interest standard” is not limited to financial hardship cases.[27] Hence, a transfer may be in a seller's best interest because it allows him to take advantage of an opportunity (i.e., buy a new home, start a business, attend college, etc.) or to avoid disaster (i.e., pay for a family member's unexpected medical care, pay off mounting debt, etc.). For example, a New Jersey court found that a transaction was in a seller's best interest where the funds were used to “pay off bills…and to buy a home and get married.”[28]
Although sometimes criticized for being vague, the best interest standard's lack of precise definition allows considerable latitude in judicial review. Courts can consider on a case-by-case basis the totality of the circumstances surrounding the transfer to determine whether it should be approved.
↑ Orman, Suze (April 2009). "The Smart Way to Pay Off Debt". Oprah.com. Retrieved 13 June 2017. Sale of a structured settlement "is tempting, but it's typically not smart."
↑ Larson, Aaron. "What is a Structured Settlement". ExpertLaw.com. Retrieved 13 June 2017. "Any person entering into a structured settlement should be on guard for potential exploitation in relation to the settlement".
In finance, a bond is an instrument of indebtedness of the bond issuer to the holders. The most common types of bonds include municipal bonds and corporate bonds. Bonds can be in mutual funds or can be in private investing where a person would give a loan to a company or the government.
In economics and finance, present value (PV), also known as present discounted value, is the value of an expected income stream determined as of the date of valuation. The present value is usually less than the future value because money has interest-earning potential, a characteristic referred to as the time value of money, except during times of zero- or negative interest rates, when the present value will be equal or more than the future value. Time value can be described with the simplified phrase, "A dollar today is worth more than a dollar tomorrow". Here, 'worth more' means that its value is greater. A dollar today is worth more than a dollar tomorrow because the dollar can be invested and earn a day's worth of interest, making the total accumulate to a value more than a dollar by tomorrow. Interest can be compared to rent. Just as rent is paid to a landlord by a tenant without the ownership of the asset being transferred, interest is paid to a lender by a borrower who gains access to the money for a time before paying it back. By letting the borrower have access to the money, the lender has sacrificed the exchange value of this money, and is compensated for it in the form of interest. The initial amount of the borrowed funds is less than the total amount of money paid to the lender.
A zero coupon bond is a bond in which the face value is repaid at the time of maturity. That definition assumes a positive time value of money. It does not make periodic interest payments or have so-called coupons, hence the term zero coupon bond. When the bond reaches maturity, its investor receives its par value. Examples of zero-coupon bonds include US Treasury bills, US savings bonds, long-term zero-coupon bonds, and any type of coupon bond that has been stripped of its coupons. Zero coupon and deep discount bonds are terms that are used interchangeably.
The time value of money is the widely accepted conjecture that there is greater benefit to receiving a sum of money now rather than an identical sum later. It may be seen as an implication of the later-developed concept of time preference.
Factoring is a financial transaction and a type of debtor finance in which a business sells its accounts receivable to a third party at a discount. A business will sometimes factor its receivable assets to meet its present and immediate cash needs. Forfaiting is a factoring arrangement used in international trade finance by exporters who wish to sell their receivables to a forfaiter. Factoring is commonly referred to as accounts receivable factoring, invoice factoring, and sometimes accounts receivable financing. Accounts receivable financing is a term more accurately used to describe a form of asset based lending against accounts receivable. The Commercial Finance Association is the leading trade association of the asset-based lending and factoring industries.
An invoice, bill or tab is a commercial document issued by a seller to a buyer, relating to a sale transaction and indicating the products, quantities, and agreed prices for products or services the seller had provided the buyer.
A structured settlement is a negotiated financial or insurance arrangement through which a claimant agrees to resolve a personal injury tort claim by receiving part or all of a settlement in the form of periodic payments on an agreed schedule, rather than as a lump sum. As part of the negotiations, a structured settlement may be offered by the defendant or requested by the plaintiff. Ultimately both parties must agree on the terms of settlement. A settlement may allow the parties to a lawsuit to reduce legal and other costs by avoiding trial. Structured settlements are most widely used in the United States, but are also utilized in Canada, England and Australia.
Prior to 2006, a private annuity trust (PAT) was an arrangement to enable the value of highly appreciated assets, such as real estate, collectables or an investment portfolio, to be realized without directly selling them and incurring substantial taxes from their sale.
A lump sum is a single payment of money, as opposed to a series of payments made over time.
A payment is the voluntary tender of money or its equivalent or of things of value by one party to another in exchange for goods, or services provided by them, or to fulfill a legal obligation. The party making a payment is commonly called the payer, while the payee is the party receiving the payment.
In the United States, an annuity is a structured (insurance) product that each state approves and regulates. It is designed using a mortality table and mainly guaranteed by a life insurer. There are many different varieties of annuities sold by carriers. In a typical scenario, an investor will make a single cash premium to own an annuity. After the policy is issued the owner may elect to annuitize the contract for a chosen period of time. This process is called annuitization and can also provide a predictable, guaranteed stream of future income during retirement until the death of the annuitant. Alternatively, an investor can defer annuitizing their contract to get larger payments later, hedge long-term care cost increases, or maximize a lump sum death benefit for a named beneficiary.
A structured sale or structured installment sale, is a special type of installment sale pursuant to the Internal Revenue Code. In an installment sale, the seller defers recognition of gain on the sale of a business or real estate to the tax year in which the related sale proceeds are received. In a structured sale, the seller is able to pay U.S. Federal income tax over time while having the seller's right to receive those payments guaranteed by a high credit quality alternate obligor. This obligor assumes the buyer's periodic payment obligation. Transactions can be arranged for amounts as small as $100,000.
Tax deduction at source (TDS) in India is a means of collecting tax on income, dividends, or asset sales by requiring the payer to deduct tax due before paying the balance to the payee.
A mortgage loan or simply mortgage is a loan used either by purchasers of real property to raise funds to buy real estate, or alternatively by existing property owners to raise funds for any purpose while putting a lien on the property being mortgaged. The loan is "secured" on the borrower's property through a process known as mortgage origination. This means that a legal mechanism is put into place which allows the lender to take possession and sell the secured property to pay off the loan in the event the borrower defaults on the loan or otherwise fails to abide by its terms. The word mortgage is derived from a Law French term used in Britain in the Middle Ages meaning "death pledge" and refers to the pledge ending (dying) when either the obligation is fulfilled or the property is taken through foreclosure. A mortgage can also be described as "a borrower giving consideration in the form of a collateral for a benefit (loan)".
A life annuity is an annuity, or series of payments at fixed intervals, paid while the purchaser is alive. A life annuity is an insurance product typically sold or issued by life insurance companies.
Rede known as Redecard is a Brazilian multi-brand acquirer with 25 brands in its portfolio, for credit, debit and benefit cards. Its activities include merchant acquiring, capturing, transmission, processing and settlement of credit and debit card transactions, prepayment of receivables to merchants, rental of POS terminals, check verification through POS terminals, credit card machine and the capture and transmission of transactions using benefit-voucher, private-label cards and loyalty programs such as Multiplus. The company is the first largest in its sector. The company was traded in BM&F Bovespa and disclosed in 2012, 24, September.
Securitization is the financial practice of pooling various types of contractual debt such as residential mortgages, commercial mortgages, auto loans or credit card debt obligations and selling their related cash flows to third party investors as securities, which may be described as bonds, pass-through securities, or collateralized debt obligations (CDOs). Investors are repaid from the principal and interest cash flows collected from the underlying debt and redistributed through the capital structure of the new financing. Securities backed by mortgage receivables are called mortgage-backed securities (MBS), while those backed by other types of receivables are asset-backed securities (ABS).
Taxation may involve payments to a minimum of two different levels of government: central government through SARS or to local government. Prior to 2001 the South African tax system was "source-based", wherein income is taxed in the country where it originates. Since January 2001, the tax system was changed to "residence-based" wherein taxpayers residing in South Africa are taxed on their income irrespective of its source. Non residents are only subject to domestic taxes.
An annuity is a series of payments made at equal intervals. Examples of annuities are regular deposits to a savings account, monthly home mortgage payments, monthly insurance payments and pension payments. Annuities can be classified by the frequency of payment dates. The payments (deposits) may be made weekly, monthly, quarterly, yearly, or at any other regular interval of time. Annuities may be calculated by mathematical functions known as "annuity functions".
The term secondary market annuity is a term that certain salespeople use to describe an investment in factored structured settlement payment rights. The use of the term secondary market annuity is a misnomer. The National Association of Insurance Commissioners, an association of state regulators of insurance issued its Statutory Issue Paper No. 160 which makes clear that the acquisition of structured settlement payment rights is a not an annuity or an insurance product. The term “structured settlement payment rights” means rights to receive payments under a structured settlement. When the ownership of structured settlement payment rights is transferred by a Qualified Order, the ownership of the actual insurance product, the structured settlement annuity, does not change hands. The ownership of the annuity stays the same, as it was when the structured settlement was established. It is in most cases owned by a qualified assignment company, a subsidiary of the annuity issuer. The structured settlement derivatives being marketed to investors as "secondary market annuities" do not have the same statutory protections as legitimate annuities. 15 states expressly exclude factored structured settlement payment streams from their state guaranty association insolvency schemes.
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