The Law and Economics of the Secondary Market in Structured Settlements

I saw a television ad while working out a bit ago in the fitness room at the New York Hilton, and it must be the influence of all the legal scholars around me, but even though I’ve seen it a zillion times, it now struck me as something that ought to be somebody’s research topic.

The ad is for J.G. Wentworth, which buys structured settlements. There’s a pitchman who ought to be every law firm’s managing partner (gray hair, jut jaw, gravelly voice) and the tag line “It’s Your Money; Use It When You Want It.” Structured settlements are appealing to insurance companies and tort defendants because of the gap between the absolute value of the settlement to the recipient and the present value to the payor. It’s effective to close out a negotiation where, say, the plaintiff is at $800,000 and the defendant is at $500,000 by structuring a settlement that is closer to $800,000 in total dollars paid over the life of the settlement but closer to $500,000 in present value.

Let’s take my hypothetical numbers as an example. The plaintiff gives up $300,000 in present value to get a settlement. I suspect there is risk averseness at play there in two respects – the certainty of settlement versus trial, and the greater value of the current money to the later money. I don’t know how much of the discount is due to litigation risk and how much is time value of money, but there’s no doubt some of each.

So the plaintiff gets the structured settlement, decides she needs the money now, and goes to J.G. Wentworth, which factors it for her. That means J.G. Wentworth is going to take an additional [?] discount [?] to give the plaintiff a lump sum now and collect in the plaintiff’s name over the balance of the structured settlement. This is speculation, but I suspect plaintiff now collects less than the $500,000 the defendant/insurer was willing to pay in present value originally. Would Wentworth’s discount rate, if you applied it to the original $800,000, tell us how much of the $300,000 haircut was due to litigation risk and how much due to time value? I don’t know and I’m quickly getting in over my head here.

I’d be the last person in the world (perhaps) to suggest that there ought to be a governmentally imposed restriction on the right of anybody to sell a financial instrument. I’d also be skeptical of attempts to regulate the practice by cognitive means like disclosures and warnings. But this strikes me a weird market, and if an SSRN key word search and a Westlaw search of the form [(structured /2 settlement) /p (secondary /2 market)] are any indication, nobody has written on it.

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10 Responses

  1. Stephen Aslett says:

    It’s been written on. You just need to broaden your Westlaw queries. Here’s a sampling (all discuss J.G. Wentworth):

    Laura J. Koenig, Note, Lies, Damned Lies, and Statistics? Structured Settlements, Factoring, and the Federal Government, 82 Ind. L.J. 809 (2007).

    Adam F. Scales, Against Settlement Factoring? The Market in Tort Claims Has Arrived, 2002 Wis. L. Rev. 859 (2002).

    Julie Gannon Shoop, Selling Structured Settlements: Boon or Boondoggle for Injury Victims?, Trial, July 1999, at 12.

  2. John Darer says:

    I share your distaste for JGW commercials.

    I have written over 150 posts on the subject of factoring and its impact on tort victims at Structured Settlements 4Real located at http://structuredsettlements.typepad.com. There is far more to this than meets the eye, particularly structured settlement consultants,s ettlement planners and (if one factoring company’s advertising is to be believed) even personal injury lawyers, who are on the “structured settelment factoring vig” You have only scratched the surface. I’ve had the scuba gear on for a while now and you and your readers may find posts of interest.

    Former Indiana law school student’s Laura Koenig piece is poorly researched, hardly seminal and is overly reliant on material from Adam Scales which is also very poorly done. I did a 3 part review of it that points out the inaccuracies.

    Other sources of information:

    Beyond Structured Settlements

    http://s2kmblog.typepad.com and

    The Settlement Channel

    http://settlementchannel.squarespace.com

    If you need a resource consider me a volunteer

  3. John Darer says:

    I share your distaste for JGW commercials.

    I have written over 150 posts on the subject of factoring and its impact on tort victims at Structured Settlements 4Real located at http://structuredsettlements.typepad.com. There is far more to this than meets the eye, particularly structured settlement consultants,s ettlement planners and (if one factoring company’s advertising is to be believed) even personal injury lawyers, who are on the “structured settelment factoring vig” You have only scratched the surface. I’ve had the scuba gear on for a while now and you and your readers may find posts of interest.

    Former Indiana law school student’s Laura Koenig piece is poorly researched, hardly seminal and is overly reliant on material from Adam Scales which is also very poorly done. I did a 3 part review of it that points out the inaccuracies.

    Other sources of information:

    Beyond Structured Settlements

    http://s2kmblog.typepad.com and

    The Settlement Channel

    http://settlementchannel.squarespace.com

    If you need a resource consider me a volunteer

  4. On a side note, structured settlements are often used when a minor is injured – courts often want to see a third part trustee handling the investment and payouts to a minor instead of the parent, who might squander the lump some in a way that is not to the minor’s benefit.

  5. yclipse says:

    By definition, Wentworth would not be doing this if there weren’t a profit to made from it, and the profit has to come from the annuitant.

    I write only to point out that there is one more advantage to using structured settlements. Providing funds as a stream of income means that the recipient will not be able to blow it all within a couple of years of reaching the settlement, as many recipients of a lump sum have done.

  6. John Darer says:

    As a practical matter if a structured settlement is incorporated as a piece of a well formed settlement plan the need to factor should be mitigated. The attorney and settlement planner should be aware of all sources of income and expenses. Unless the plaintiff has sufficient liquidity independent of the settlement some cash should be set aside.

    In addition to structured settlements, for non Medicaid dependent minor plaintiffs, settlement management trusts can be used to provide spendthrift protection and provided Court approval is obtained, greater flexibility than a blocked account.

  7. I hate those commercials! I have watched a lot of TV the past few months with the baby (mostly TNT and USA for Law & Order reruns), and JGW is obviously targeting tort victims who are home during the day. I was mentioning these commercials to a colleague, who told me that when tort victims sell their structured settlement, the proceeds are taxable, even if the award was not.

  8. John Darer says:

    Christine, as much as I share your and your colleagues distaste for the commercials, provided the so-called “structured settlement factoring transaction” follows the guidelines of IRC 5891 and applicable state law there is a tax exclusion. If there is no “qualified order” then an excise tax of 40% is levied on the purchaser who presumably must pass on the expense to the seller in one form or another.

  9. Jeffrey,

    Many people feel the same way about those JGW commercials, not to mention that they are false advertising by saying “Get your money now”. The fact remains that this type of transaction needs to be approved by a local court system in order for the structured settlement factoring transaction to be completed.

    A judge has to make sure the transaction is in the best interest of the annuitant. This would include such things as employment, reason for selling, and discount rate of the transaction.

    As far as the discount rate of a transaction, this all depends upon how the settlement was structured. In your example you mentioned that the present value at settlement was $500k. In order to figure out how much the annuitant would receive if they decided to sell their structured settlement, one would need to know the insurance company and how the annuity was paid out.

    I created a structured settlement factoring discount rate calculator and present value calculator to help in these types of cases.

    Here is the link to the present value calc: http://www.structuredsettlement-quotes.com/fun/pv/

    Discount rates range from 8-12%.

    If you have any questions on the topic, please let me know.