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Federal law

Model state legislation

The following article by KG Funding owner Mike Schaul appeared in the Summer, 2000, issue of the Campbell Law Observer, which is published by students at the Norman Adrian Wiggins School of Law, Campbell University, Buies Creek, NC. The intended audience was NC lawyers, but it should be instructive to anyone interested in the sale of structured settlements. I added occasional addenda on the situation at the end of the article, and there is an addendum in which I tried to explain anything technical.

I wrote a new article which appeared in the Campbell Law Observer in April, 2005. At present, I am still working with the NC General Assembly to fix the problems discussed in these articles.

In July, 1999, I read in the (Raleigh, NC) News and Observer that the North Carolina General Assembly was considering legislation to regulate the sale of payments under structured settlements. As a broker experienced in such transactions whose office is 10 minutes from downtown Raleigh, I quickly got involved.

It appeared that some very well-intentioned legislators were trying to create legislation to protect payment sellers from "unscrupulous" funders. The N&O reported that a man had sold a $15,000 payment due five years out for $5,000 to J. G. Wentworth, a New Jersey company that advertises heavily on late night cable. The insurance company had refused to make the $15,000 payment, and Wentworth, having no standing to enforce payment, sued the annuitant for the entire $15,000. Going after a man for whom only $5,000 had been important a few years earlier was certainly an example of astoundingly poor judgment.

($5,000 for a $15,000 may seem like a huge discount, but at 15%, the present value was $7118.51. Whether there was a broker or not, $2,118.51 is probably less than the costs of the transaction, so the $5,000 paid to the seller, while seeming outrageous at first glance, actually is pretty reasonable. The 15% is reasonable, given Wentworth's cost of funds for a high-risk investment.)

The legislators wanted to be sure incidents like this wouldn't happen again. By the time I got involved, the House was already marking up a bill that had been passed by the Senate. This bill followed the views of the insurance industry lobbyists, who were certainly much better known to the legislators, and mostly ignored the lobbyists of the National Association of Settlement Purchasers (NASP), a trade organization made up of ethical funders whose objective is to provide an important service.

Provisions of SB 746

The bill added Article 44B to the General Statutes (1-543.10-15 except as noted) on July 19,1999, and went into effect October 1. The main provisions are:

  1. The annuitant must convince a superior court judge (1-394.1) that he had received "independent professional advice" and that the sale of the payments is in his best interest (there is no guidance to the judge).
  2. The obligor and the attorney general must be given 30 days notice of the hearing so they may contest it, if they desire.
  3. The discount rate is capped at prime + 5%.
  4. Broker's fees were lumped together with "service charges, application fees, processing fees, closing costs, administrative fees, notary fees and other commissions, fees, costs, expenses and charges payable by the payee or deductible from the gross amount" under a 2% cap.
  5. There is no cap on legal fees.
  6. The judge is instructed to "order the obligor to execute an acknowledgment of assignment letter on behalf of the transferee for the amount of the structured settlement payment rights to be transferred."
  7. The funder is required to provide various disclosures, such as discount rate and fees, to the annuitant.
  8. For settlements entered into in North Carolina, the court where the action was pending has exclusive jurisdiction.

A Recent Episode

In April, I had a call from an attorney whose client was a 27-year-old woman. She was the recipient of four more payments over the next 14 years for the wrongful death of her mother when she 13. The amounts were such that she clearly could not have been dependent on them for normal living expenses. The woman was about to get married and wanted cash for a down payment on a house.

Before SB 746 was passed, she would probably have received $18-20,000 for her settlement. It would have taken 4-6 weeks and been easy and routine. There are only a few actual funders in the country (as opposed to brokers, who are everywhere), so I contacted the ones most likely to be interested and give her a good price. One faxed back, "We are not purchasing payments under NC law." A second called from Florida and told me about some complex mechanism they use that involves bringing the annuitant to Florida and somehow doing the deal under Florida law. She would have received $9,125, minus a commission to me (which wouldn't be restricted under Florida law) and whatever she might pay her attorney. Executives of two other funders called. Our lengthy discussions formed the nucleus of this article.

This woman was typical of young adults who had settlements created when they were children and who wanted to start their lives using their assets according to what they saw as their best interests. Examples of transactions I've done for similar amounts include a man who wanted to start a business and a skilled tradesman who had just moved to North Carolina and needed to pay off maternity debts. The latter had a large enough income stream so that he was able to go back to the funder twice within the next few months for money to develop his business and buy a house.

The real value of a structured settlement.

The simple reality is that no matter how carefully an attorney structures a settlement to be in the best interests of the client, the client's perception of his interests changes over time, and clients should be able to get cash if they want it. No one in the settlement purchase industry knows exactly why the insurance companies are so adamantly against such conversions, especially since the IRS, in a private opinion last year, eliminated much of the tax issue the insurers raise. The insurance industry refused to participate in a wider reaching inquiry to the IRS for fear their entire argument would be wiped out. Some suspect that the purchasers are making them look bad. There have been many cases of plaintiffs who have called purchasers to find out whether the structured payout is worth as much as a current lump sum. The result is usually that it isn't.

Under NC law, insurers may determine future value using 6%, but SB 746 allows purchases for prime + 5%. For example, the client is offered $20,000 now. An equivalent structured offer could be $13,400 in five years plus $17,900 in ten. If prime is 9.5%, the legal limit is 14.5%, and the present value of these payments, if sold per SB 746, is $6,518 + 4,235 = $10,753! If the insurance company is able to invest at 12%, its actual investment isn't the $10,000 + 10,000 = $20,000 the law prescribes, but $7,376 + 5,224 = $12,600.

In my mind, the client has been offered a settlement worth between $10,753 and $12,600 under the guise of being offered $20,000. Suppose the client is offered $15,000 and $20,000 payments (about 12% more) to sweeten the deal; then it costs the insurer about $14,100, and the payments can be sold for $12,000. Is this exposure why the insurance companies don't like settlement purchasers?

Analysis of the provisions of SB 746

The most important fact is that the industry has been totally shut down in North Carolina. Companies that used to quote aggressively don't return my calls. One of the executives I discussed the situation with told me that his company had seen 162 possible deals from NC since SB 746 went into effect and had passed (not bid) on 162. He explained that his cost of funds is much higher than prime and too high to fit his expenses under the prime + 5% limit.

Because of tax considerations, the policies are written making the payments unassignable. Purchasers usually establish joint accounts with the annuitants and use irrevocable powers of attorney to get paid. The authors of SB 746 included the requirement that the judge "order the obligor to execute an acknowledgment of assignment letter on behalf of the transferee for the amount of the structured settlement payment rights to be transferred" in the believe that they were solving the assignability issue, but they didn't. Under the statute, the judge doesn't order assignment of the payments to the purchaser, nor does it instruct, or even permit, the Commissioner of Insurance to enforce the order. The result is that the insurers routinely put the full weight of their legal resources into avoiding paying the purchasers.

Settlement purchasers pay a premium for their funds because they are making a risky investment. The first risk is that insurers will either refuse to pay them or engage in extensive legal obfuscation to increase the costs. The second risk is that the client goes into bankruptcy. Because the payments aren't assigned, purchasers have legal expenses to enforce their claims. They usually succeed, but at possibly high cost. Since the average purchase is for $20,000 or less, the costs may be large compared to the amounts being protected.

Other results of SB 746, if there were any sales taking place, would be:

  1. Disclosures to the annuitant by the purchaser. NASP had already developed a code of ethics for its members that included such disclosures. Purchasers don't object to reasonable disclosures, although my experience is that most annuitants are only interested in the bottom line.
  2. Going to court and giving 30 days notice will add weeks if not months to funding times, causing hardship to the annuitant.
  3. Giving obligors carte blanche to object has resulted in lengthy, obfuscatory briefs in other states, increasing the legal costs to either the client or the purchaser (i.e., the client).
  4. The professional advice requirement adds an expense prior to going to court of several hundred dollars.
  5. A person who has moved within NC, even hundreds of miles, must return to the original jurisdiction, again at considerable cost.
  6. After all these costs are incurred, the plaintiff has no assurance that the judge will agree, especially since it's entirely up to the judge's own judgment whether the sale is in the plaintiff's "best interest". I was told that at least one judge in another state who has had to make such determinations is a former insurance company lawyer who has brought his bias against all such sales to the bench.
  7. Broker's fees are included with several other fees, which are collectively capped at 2% of the funded amount. That means that for a typical $15,000-$20,000 payout, the broker gets less than $300-400. If there were a competitive market, no broker could afford to pursue this business and provide the guidance that in the past produced higher payouts to annuitants. I've had cases where a potential seller told me the deal he'd been offered by a major funder (after calling their 800 number), where I was able to get them better deals while still earning myself a fair fee. Deals through brokers cost funders less than deals brought in via cable advertising, and their rate structures reflect that fact.

Summary

In 1998, the US House had a bill (HR 4314) to regulate this industry. I met with a cosponsor from Maryland. He believed that due to the tax-advantaged status of a settlement that the government had a public policy interest in controlling the industry. In a follow-up e-mail to his chief of staff, I explained that structured settlements had the same status as a lump sum settlement. His other concerns disappeared, and he wasn't a sponsor when the bill was reintroduced in 1999.

North Carolina's legislators were clearly well-intentioned when they passed SB 746, but their understanding of the facts was incomplete. In the last few days' rush to adjournment, some laws are passed without the scrutiny they should get. I would only be speculating on the reasons, but the legislators considered it important to pass something. The House committee chair responded during the hearing I attended that "if we don't get it right this time, we can go back and fix it later." We have a law intended to protect a very small percentage of a very small number of people that instead prevents all of them from controlling their own financial destinies. It should be fixed.

Addendum that didn't appear in the Campbell Law Observer

The present value of a future payment is the amount that would have to be invested today to reach that future payment. For example, if I want to have $200 at some future time, and I can double my money in that time, the present value, the amount I have to invest now, is $100. Future value is the opposite, i.e., the amount I will have in the future for my investment today. The calculation is based on the amount of time and the interest rate (or earnings in the case of an investment).

Suppose an insurance company offers you a choice of cash settlement of $20,000 now, or four payments of $10,000, to be paid 5,10,15,and 20 years from now. If the insurance company can make 12% on their investments, they only have to invest $5,504.50 for the first payment in 5 years, and as little as $918.06 for the one in 20 years. Their total investment for the four payments would only be $11,120.34! Four payments of $10,000 may look like more than $20,000, but it's only $11,120.34 to the insurance company. You can see that if they "generously" offered three payments of $10,000, and a $50,000 payment after the 20 years, the total present value to them would be $14,792.57.

Now you can see how lucrative the settlement industry actually is, how it misleads people, and why it doesn't want us telling you what your settlement is really worth.

Updates since the article appeared in the Campbell Law Observer

This addendum updated 10/20/2000.

I received a letter from a CLO reader who told me that he had arranged the sale of a structured settlement under NC's new law for about $300,000. Based on that, I concluded that if the deal is large enough, the transaction costs could be buried within NC's limits. When I was recently offered a large settlement in NC, I found only one funder willing to look at NC at any price. This deal is in progress and will net the seller over $100,000.

Other states have entered the court order brigade. A client in MI assured me in early October that his attorney said no court order was required. Unfortunately, it was effective October 1, so I gave him the citation so the attorney could check it out. Even if the client receives as much as he would have before the law was effective, the court order will cost him both money and time delay. A client in OH is up against the same situation. With the laws so new in both states, they may turn out to be guinea pigs.

The saddest case I've had was a soldier who called from Ft. Bragg, NC. He has a $30,000 payment coming to him next August, but he is about to lose his house and car in the wake of a divorce. For our purposes, he could be a resident of CA or NC. CA allows a greater discount than NC, but even so, the legal discount can't cover the transaction costs. He's willing to accept a discount greater than these "protective" laws allow. Before they existed, he could have gotten something in the low 20s and kept his life together. So, to the patriots in the NC and CA legislatures, you've just done in a soldier by preventing him from saving his tangible property by disposing of his own intangible property at a price that would have been acceptable to him. Feeling patriotic?

This addendum updated 6/20/2001.

The National Association of Insurance Commissioners negotiated compromise model legislation that is supposed to be supported in each state by both NSSTA (National Structured Settlement Trade Association, the insurers) and NASP (National Association of Settlement Purchasers, the buyers). Federal legisaltion incorporating the same principles is expected, as well. Some state legislatures have gone forward; NC has not; I don't know about your state, but I can find out. In general, the model legislation requires court orders (which the insurers will have to abide by) and doesn't set yields.

By the way, statutory yield maximums can have unintended consequences. We started working with a NC woman whose transaction was large enough last fall (2000) to cover expenses despite the NC yield cap of prime+5%. We had a lot of delays, and the prime rate has dropped 2.5%. Unfortunately, the buyer's cost of funds was tied to treasuries, which hardly changed. That made the deal impossible. Fortunately, the client was planning to move to a state without yield limits, so we can still do it for her. The irony of all this NC "consumer protection" is that she will receive $11,000 more under the new state's law, and I'll get a commission that isn't constrained by NC's law.

This addendum updated 7/15/2002.

Federal legislation is in effect. The Victims of Terrorism Tax Relief Act of 2001, H.R.2884, which the President signed in January, 2002, contains a chapter setting uniform procedures for the sale of structured settlement payments. Before and since, at least 34 states have passed legislation similar or identical to the model act. Of those which have not, NC is the only one which has totally shut the industry down, because NC has an unrealistic cap on yields and fees.

This addendum updated 3/3/2005.

It's time for North Carolina. There are now 37 states which have adopted the model legislation. I'm working on getting it adopted in North Carolina. When there is a bill number, I'll post it here. I encourage my readers to contact their legislators to support it. I have made arrangements that will allow me to offer special pricing for any transactions submitted before the change goes into effect. You will, of course, receive my usual professional service.

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