Highly rated insurance companies - Annuity settlements
So why are the returns as high as they are? It's not due to risk; as noted earlier, the annuity payments are generally backed by highly rated insurance companies that are anticipated to have virtually no risk of outright annuity payment default (after all, that's what the original structured settlement payment recipient was counting on for those payments in the first place, and the court wouldn't have approved it if the annuity provider wasn't sound!). And the payments are generally guaranteed and fixed to the dates that are assigned; unlike lifetime annuitization that planners may be more familiar with, the payments from structured settlements generally are not life contingent (i.e., the payments will continue, even if the original annuity dies). Instead, the returns are due to sheer illiquidity. After all, how many people out there really want to buy an arbitrary structured settlement payment of $200,000 in 10 years and another $100,000 to arrive 5 years later, with no intervening cash flows? The answer is, not many. Yet in many cases, the structured settlement recipient really needs the liquidity for some reason, and can't wait long. The end result: the structured settlement recipient becomes willing to give up a healthy discount rate to get that lump sum of cash now.
So where does this fit for the financial planning client? The internal rate of return on many structured settlement payments are pretty appealing in today's marketplace; rates of 4%+ are pretty common (although notably, that's not a huge spread relative to the yield on comparable long term bonds). But most clients are unlikely to find a structured settlement that actually provides cash flows that line up with exactly when the client may need them, and there are only so many to choose from at any given time (for instance, here's a sample rate sheet from one provider) - which means at best, this should only be done with a small enough portion of the portfolio that it won't create a liquidity problem for the client investor. Otherwise, the client could themselves become the seller, and be forced to go through the same discounting process - bearing in mind that the structured settlement broker needs a cut too, so if the "cost" to generate a 5% return is $170,884 in the earlier example, the seller is going to get something less than that amount. This means that a buyer who becomes a seller will likely experience a loss of their own, as they essentially absorb both sides of what is a very wide bid-ask spread. Which means to say the least, this is for "long-term money" only! And of course, basic due diligence on the broker arranging the structured settlement and affirming the rating on the underlying insurance company is important, as always.
So why are the returns as high as they are? It's not due to risk; as noted earlier, the annuity payments are generally backed by highly rated insurance companies that are anticipated to have virtually no risk of outright annuity payment default (after all, that's what the original structured settlement payment recipient was counting on for those payments in the first place, and the court wouldn't have approved it if the annuity provider wasn't sound!). And the payments are generally guaranteed and fixed to the dates that are assigned; unlike lifetime annuitization that planners may be more familiar with, the payments from structured settlements generally are not life contingent (i.e., the payments will continue, even if the original annuity dies). Instead, the returns are due to sheer illiquidity. After all, how many people out there really want to buy an arbitrary structured settlement payment of $200,000 in 10 years and another $100,000 to arrive 5 years later, with no intervening cash flows? The answer is, not many. Yet in many cases, the structured settlement recipient really needs the liquidity for some reason, and can't wait long. The end result: the structured settlement recipient becomes willing to give up a healthy discount rate to get that lump sum of cash now.
So where does this fit for the financial planning client? The internal rate of return on many structured settlement payments are pretty appealing in today's marketplace; rates of 4%+ are pretty common (although notably, that's not a huge spread relative to the yield on comparable long term bonds). But most clients are unlikely to find a structured settlement that actually provides cash flows that line up with exactly when the client may need them, and there are only so many to choose from at any given time (for instance, here's a sample rate sheet from one provider) - which means at best, this should only be done with a small enough portion of the portfolio that it won't create a liquidity problem for the client investor. Otherwise, the client could themselves become the seller, and be forced to go through the same discounting process - bearing in mind that the structured settlement broker needs a cut too, so if the "cost" to generate a 5% return is $170,884 in the earlier example, the seller is going to get something less than that amount. This means that a buyer who becomes a seller will likely experience a loss of their own, as they essentially absorb both sides of what is a very wide bid-ask spread. Which means to say the least, this is for "long-term money" only! And of course, basic due diligence on the broker arranging the structured settlement and affirming the rating on the underlying insurance company is important, as always.
