Ever heard the expression " All, as they say, that glitters is not gold? " This aphorism is appropriate when speaking about the Structured Settlement Factoring industry. Every company is not the same.
Some are direct purchasers of structured settlement payment rights. Other companies utilize brokers or intermediaries to procure potential sellers. Our only issue with this practice is that often the fees payable to these intermediaries is not transparent in the transaction. And, like all legitimate fees payable to parties that add value to the transaction, the brokers fee is deducted from the transaction.
We believe in practice that this should be fully disclosed to the seller in advance, but often it is not. If a party adds value to the facilitation of the transaction, they are entitled to compensation. The importance of this statement will become evident in due course.
First let's understand that purchasers, factoring companies that is, cannot purchase a Structured Settlements per se.
What a factoring company purchases is the future payment rights of the Structured Settlement. In essence a Structured Settlement factoring company purchases the future payments to be received by the seller for a discounted present value amount.
Structured Settlement payments are discounted to their Present Value (based on the factoring companies criteria) resulting in a lump sum payment that will be less than the sum of the payments over time. Simply put, a dollar is worth more today than it will be tomorrow.
Structured Settlement Factoring companies calculate this cost of money into their calculations when providing you with a quote by using a discount rate. If the Structured Settlement factoring company is using a line of credit for example to purchase future payments, they must pay interest costs on the money they are borrowing. That cost is calculated into the quote they provide the seller. Hypothetically the lower their costs, the better the quote will be for the seller of the structured settlement payments.
According to a 2004 California Attorney Generals report, the average national discount rate is 19.2 percent. Today discount rates range between 9.5% -18%. The average is somewhere in the middle.
Why is this important?
Let's say you have a stream of payments equal to $ 1,000 per month payable for 10 years. That equals a total structured settlement payout over ten years of $ 120,000, ($ 1,000 x 12 months x 10 years).
However, the value of those payments today using a discount rate of 18% is $ 55,498.00. Our example does not include legal fees or other legitimate costs that might be associated with the transaction which impact the final amount paid to the seller.
Keep in mind that advertising costs, broker or intermediary fees and any legal fees will be figured into the final amount payable to the seller.
Factors that contribute to determining the amount of the discounted rate of return include the following:
- Risk: future money carries some risk that it may not be paid.
- Lost investment opportunity: you can't invest and earn a return on money that you're waiting for. You can invest money you have today, which makes it worth more.
- Market finances: as interest rates and inflation climb, the value of tomorrow's dollar gets smaller and smaller. That means you will not get paid as much today if interest rates and inflation are high (or are expected to get higher).
- Often factoring companies add "back-end" fees into the transaction. The initial factoring discount indicated may be low (8% -9%). However, by tacking on extraneous fees to the transaction, the ultimate cash paid to the seller is greatly reduced.
Remember, All, as they say, that glitters is not gold? "