Have you seen the TV commercials about converting your structured settlement to cash? J. G. Wentworth is probably the heaviest advertiser in this business, it certainly is where I live, but it’s not the only company doing it. Peachtree is another, but it’s not the only one either.
If you don’t know what a structured settlement is, you probably don’t have one. So, I’ll explain. Let’s say you’re hurt in a car accident, you sue and an insurance company agrees to pay you money. To quote Doctor Evil, let’s say the amount is “One Million Dollars.” Only, let’s say they get to pay it not in a lump sum, but over an agreed period of time, perhaps 20 years. That arrangement would be similar to the way a top lottery prize is paid, only you have a better chance of being in a car crash than you do of winning Powerball or Mega Millions, so pay attention.
Why would you agree to that and why would the insurance company? Well, you might agree because you’d get more money in the long run. That may or may not be a good thing. We can discuss that farther down the page. You might also agree if it saved you money on taxes. In the first place, some settlements of this kind aren’t taxable and in the second place the calculation is more complicated than you think, so it could appear to save you money on taxes without really doing so. I could discuss that too, but I’m not an actuary and I only want to bore some, not all, of the people who read this. Last, and the reason most individuals would like a structured settlement is because you fear you would squander the money if you got it all at once. Squandering a large sum of money can be fun, but if you got the money and need it to pay for long-term medical treatment, that isn’t the time to do it. In that circumstance, a long-term settlement is probably the best thing for you.
The insurance company likes it because it costs them less money. There are formulae to calculate the present value of a future stream of income, or you can beat it to death with a spreadsheet. But if the insurance company could earn 5 percent on its money and put $1,000,000 aside, it could pay you $50,000 a year for 20 years and at the end of that time, it would still have the million dollars. To pay you that money, again assuming a 5 percent rate of return, it would only have to put aside around $625,000 to pay you over 20 years and have nothing left. But that’s not even how the insurance companies think. If they put aside $625,000 for you and the other $375,000 for themselves, again at a 5 percent rate of return, at the end of 20 years, you would have $50,000 a year for 20 years, there would be nothing left of the $625,000 set aside for generating that income because in addition to the interest, the insurance company would pay the rest of the money to you out of the principal in that account. What about the other $375,000? Thanks for asking. At the end of 20 years, that would be worth almost $948,000! Your mom was wrong about what you should be when you grow up. You should have been an insurance company.
Okay, so how do these companies that convert structured settlements to cash work and how do they make any money? I mean, they’re in business to make money, aren’t they? Yes, they are. And there’s nothing wrong with what they’re doing as long as you understand what you’re doing when you do business with them. In the example I gave above, they buy the $50,000 annual income stream, or what’s left of it, for less than $625,000, or what’s left of that. The difference between what they pay you and what the insurance company put aside to pay them is their gross profit.
If you want a lot of money up front instead of a structured settlement, I suggest you take a lump sum payment instead of an annuity, even if the lump sum appears to be less money. After all, you can invest the money too. But if you’ve already opted for a payout over time, and your circumstances change, your job is to get the highest price you can for that income stream. So, go into this kind of transaction with your eyes open and go in understanding the math, or accompanied by someone who does.