A structured settlement is a financial or insurance arrangement, including periodic payments, that a claimant accepts to resolve a personal injury tort claim or to compromise a statutory periodic payment obligation. Structured settlements were first utilized in Canada and the United States during the 1970s as an alternative to lump sum settlements. Structured settlements are now part of the statutory tort law of several common law countries including: Australia, Canada, England and the United States. Although some uniformity exists, each of these countries has its own definitions, rules and standards for structured settlement. Structured settlements may include income tax and spendthrift requirements as well as benefits. Structured settlement payments are sometimes called “periodic payments”. A structured settlement incorporated into a trial judgment is called a “periodic payment judgment”.
Structured Settlements in the United States
The United States has enacted structured settlement laws and regulations at both the federal and state levels. Federal structured settlement laws include sections of the Federal Internal Revenue Code. State structured settlement laws include structured settlement protection statutes and periodic payment of judgment statutes. Medicaid and Medicare laws and regulations impact structured settlements. To preserve a claimant’s Medicare and Medicaid benefits, structured settlement payments may be incorporated into “Medicare Set Aside Arrangements” the “Special Needs Trusts”.
Injury victims should know that structured settlements are endorsed by many of the nation's largest disability rights organizations, including the American Association of People with Disabilities [1] and the National Organization on Disability [2].
Definitions
The United States definition of “structured settlement” for Federal income taxation purposes, found in Internal Revenue Code Section 5891(c)(1), is an "arrangement" that meets the following requirements:
A structured settlement must be established by:
A suit or agreement for periodic payment of damages excludable from gross income under Internal Revenue Code Section 104(a)(2); or
An agreement for the periodic payment of compensation under any workers’ compensation law excludable under Internal Revenue Code Section 104(a)(1); and
The periodic payments must be of the character described in subparagraphs (A) and (B) of Internal Revenue Code Section 130(c)(2) and must be payable by a person who:
Is a party to the suit or agreement or to a workers' compensation claim; or
By a person who has assumed the liability for such periodic payments under a Qualified Assignment in accordance with Internal Revenue Code Section 130.
Legal Structure
The typical structured settlement arises and is structured as follows: An injured party (the claimant) settles a tort suit with the defendant (or its insurance carrier) pursuant to a settlement agreement that provides that, in exchange for the claimant's securing the dismissal of the lawsuit, the defendant (or, more commonly, its insurer) agrees to make a series of periodic payments over time. The insurer, a property/casualty insurance company, thus finds itself with a long-term payment obligation to the claimant. To fund this obligation, the property/casualty insurer generally takes one of two typical approaches: It either purchases an annuity from a life insurance company (an arrangement called a "buy and hold" case) or it assigns (or, more properly, delegates) its periodic payment obligation to a third party which in turn purchases an annuity (which arrangement is called an "assigned case").
In an unassigned case, the property/casualty insurer retains the periodic payment obligation and funds it by purchasing an annuity from a life insurance company, thereby offsetting its obligation with a matching asset. The payment stream purchased under the annuity matches exactly, in timing and amounts, the periodic payments agreed to in the settlement agreement. The property/casualty company owns the annuity and names the claimant as the payee under the annuity, thereby directing the annuity issuer to send payments directly to the claimant. If any of the periodic payments are life-contingent (i.e., the obligation to make a payment is contingent on someone continuing to be alive), then the claimant (or whoever is determined to be the measuring life) is named as the annuitant or measuring life under the annuity.
In an assigned case, the property/casualty company does not wish to retain the long-term periodic payment obligation on its books. Accordingly, the property/casualty insurer transfers the obligation, through a legal device called a qualified assignment, to a third party. The third party, called an assignment company, will require the property/casualty company to pay it an amount sufficient to enable it to buy an annuity that will fund its newly accepted periodic payment obligation. If the claimant consents to the transfer of the periodic payment obligation (either in the settlement agreement or, failing that, in a special form of qualified assignment known as a qualified assignment and release), the defendant and/or its property/casualty company has no further liability to make the periodic payments. This method of substituting the obliger is desirable for property/casualty companies that do not want to retain the periodic payment obligation on their books. Typically, an assignment company is an affiliate of the life insurance company from which the annuity is purchased.
An assignment is said to be "qualified" if it satisfies the criteria set forth in Internal Revenue Code Section 130 [3]. Qualification of the assignment is important to assignment companies because without it the amount they receive to induce them to accept periodic payment obligations would be considered income for federal income tax purposes. If an assignment qualifies under Section 130, however, the amount received is excluded from the income of the assignment company. This provision of the tax code was enacted to encourage assigned cases; without it, assignment companies would owe federal income taxes but would typically have no source from which to make the payments
Wednesday, February 6, 2008
Structured settlement factoring transaction
Structured settlement factoring transaction
A structured settlement factoring transaction describes the selling of future structured settlement payments (or, more accurately, rights to receive the future structured settlement payments). People who receive structured settlement payments (for example, the payment of personal injury damages over time instead of in a lump sum at settlement) may decide at some point that they need more money in the short term than the periodic payment provides over time. People's reasons are varied but can include unforeseen medical expenses for oneself or a dependent, the need for improved housing or transportation, education expenses and the like. To meet this need, the structured settlement recipient can sell (or, less commonly, encumber) all or part of their future periodic payments for a present lump sum.
History
Structured settlements experienced an explosion in use beginning in the 1980s.[1] The growth is most likely attributable to the favorable federal income tax treatment such settlements receive as a result of the 1982 amendment of the tax code to add § 130.[2] [3] Internal Revenue Code § 130 provides, inter alia, substantial tax incentives to insurance companies that establish “qualified” structured settlements.[4] There are other advantages for the original tort defendant (or casualty insurer) in settling for payments over time, in that they benefit from the time value of money (most demonstrable in the fact that an annuity can be purchased to fund the payment of future periodic payments, and the cost of such annuity is far less than the sum total of all payments to be made over time). Finally, the tort plaintiff also benefits in several ways from a structured settlement, notably in the ability to receive the periodic payments from an annuity that gains investment value over the life of the payments, and the settling plaintiff receives the total payments, including that “inside build-up” value, tax-free.[5]
However, a substantial downside to structured settlements comes from their inherent inflexibility.[6] To take advantage of the tax benefits allotted to defendants who choose to settle cases using structured settlements, the periodic payments must be set up to meet basic requirements [set forth in IRC 130(c)]. Among other things, the payments must be fixed and determinable, and cannot be accelerated, deferred, increased or decreased by the recipient.[7] For many structured settlement recipients, the periodic payment stream is their only asset. Therefore, over time and as recipients’ personal situations change in ways unpredicted at the settlement table, demand for liquidity options rises. To offset the liquidity issue, most structured settlement recipients, as a part of their total settlement, will receive an immediate sum to be invested to meet the needs not best addressed through the use of a structured settlement. Beginning in the late 1980s, a few small financial institutions started to meet this demand and offer new flexibility for structured settlement payees.[8]
Process
Pre-2002
Before the enactment of IRC 5891, which became effective on July 1, 2002, some states regulated the transfer of structured settlement payment rights, while others did not. Most states that regulated transfers at this time followed a general pattern, substantially similar to the present day process which is mandated in IRC 5891 (see below for more details of the post-2002 process). However, the majority of the transfers processed from 1988 to 2002 were not court ordered.[9] After negotiating the terms of the transaction (including the payments to be sold and the price to be paid for those payments), a formal purchase contract was executed, effecting an assignment of the subject payments upon closing. Part of this assignment process also included the grant of a security interest in the structured settlement payments, to secure performance of the seller’s obligations. Filing a public lien based on that security agreement created notice of this assignment and interest. The insurance company issuing the structured settlement annuity checks was typically not given actual notice of the transfer, due to antagonism by the insurance industry against factoring and transfer companies. Many annuity issuers were concerned that factoring transactions, which were not contemplated when Congress enacted IRC 130, might upset the tax treatment of qualified assignments. HR 2884 (discussed below) resolved this question for annuity issuers.
Federal legislation
In 2001, Congress passed HR 2884, signed into law by the President in 2002 and effective July 1, 2002, codified at Internal Revenue Code § 5891.[10] Through a punitive excise tax penalty, this has created the de facto regulatory paradigm for the factoring industry. In essence, to avoid the excise tax penalty, IRC 5891 requires that all structured settlement factoring transactions be approved by a state court, in accordance with a qualified state statute. Qualified state statues must make certain baseline findings, including that the transfer is in the best interest of the seller, taking into account the welfare and support of any dependents. In response, many states enacted statutes regulating structured settlement transfers in accord with this mandate.
Post-2002
Today, all transfers are completed through a court order process. As of September 6, 2006, 46 states have transfer laws in place regulating the transfer process. Of these, 41 are based in whole or in part on the model state law enacted by NCOIL, the National Conference of Insurance Legislators (or, in cases when the state law predates the model act, they are substantially similar).
Most state transfer laws contain similar provisions, as follows: (1) pre-contract disclosures to be made to the seller concerning the essentials of the transaction; (2) notice to certain interested parties; (3) an admonition to seek professional advice concerning the proposed transfer; and (4) court approval of the transfer, including a finding that it is in the best interest of seller, taking into account the welfare and support of any dependents.
States with Transfer Laws in Place
Factoring Terminology
Best Interest Standard
Internal Revenue Code Sec. 5891 and most state laws require that a court find that a proposed settlement factoring transaction be in the best interest of the seller, taking into account the welfare and support of any dependents. [11] “Best interest” is generally not defined, which gives judges flexibility to make a subjective determination on a case-by-case basis. Some state laws may require that the judge look at factors such as the “purpose of the intended use of the funds,” the payee’s mental and physical capacity, and the seller’s potential need for future medical treatment. [12] [13]. One Minnesota court described the “best interest standard” as a determination involving “a global consideration of the facts, circumstances, and means of support available to the payee and his or her dependents.” [14]
Courts have consistently found that the “best interest standard” is not limited to financial hardship cases. [15] Hence, a transfer may be in a seller’s best interest because it allows him to take advantage of an opportunity (i.e., buy a new home, start a business, attend college, etc.) or to avoid disaster (i.e., pay for a family member’s unexpected medical care, pay off mounting debt, etc.). For example, a New Jersey court found that a transaction was in a seller’s best interest where the funds were used to “pay off bills…and to buy a home and get married.” [16]
Although sometimes criticized for being vague, the best interest standard’s lack of precise definition allows considerable latitude in judicial review. Courts can consider on a case-by-case basis the totality of the circumstances surrounding the transfer to determine whether it should be approved.
Discount Rate
In the beginning, the factoring industry had some relatively high discount rates due to heavy expenses caused by costly litigation battles and limited access to traditional investors. However, once state and federal legislation was enacted, the industry’s interest rates decreased dramatically. There is much confusion with the terminology “discount rate” because the term is used in different ways. The discount rate referred to in a factoring transaction is similar to an interest rate associated with home loans, credit cards and car loans where the interest rate is applied to the payment stream itself. In a factoring transaction, the factoring company knows the payment stream they are going to purchase and applies an interest rate to the payment stream itself and solves for the funding amount, as though it was a loan. Discount rates from factoring companies to consumers can range anywhere between under 9% up to over 18% but usually average somewhere in the middle. Factoring discount rates can be a bit higher when compared to home loan interest rates, due to the fact the factoring transactions are more of a boutique product for investors opposed to the mainstream collateralized mortgage transactions. One common mistake in calculating the discount rate is to use “elementary school math” where you take the funding/loan amount and divide it by the total price of all the payments being purchased. Because this method disregards the concept of time (and the time value of money), the resulting percentage is useless. For example, the court in In Re Henderson Receivables Origination v. Campos noted an annual discount rate of 16.8% where the annuitant received $36,500 for the assignment of payments totaling $63,364.94 over 84 months (two monthly payments of $672.32 each, beginning September 30, 2006 and ending on October 31, 2006; eighty-two monthly payments of $692.49 each, increasing 3% every twelve months, beginning on November 30, 2006 and ending on August 31, 2013). However, had the court in Henderson Receivables Origination applied the illogical formula of discounting from “elementary school math” ($36,500/ $63,364.94), the discount rate would have been an astronomical (and nonsensical) 61%. [17]
Discounted Present Value
Another term commonly used in factoring transactions is “discounted present value,” which is defined in the NCOIL model transfer act as “the present value of future payments determined by discounting such payments to the present using the most recently published Applicable Federal Rate for determining the present value of an annuity, as issued by the United States Internal Revenue Service.” [18] The IRS discount rate, also known as the Applicable Federal Rate (AFR), is used to determine the charitable deduction for many types of planned gifts, such as charitable remainder trusts and gift annuities. The rate is the annual rate of return that the IRS assumes the gift assets will earn during the gift term. The IRS discount rate is published monthly (link to current rate may be found here). In Henderson Receivables Origination (above), the court calculated the discounted present value of the $63,364.94 to be transferred as $50,933.18 based on the applicable federal rate of 6.00%. [18] The “discounted present value” is a measuring stick for determining what the value of a future payment (i.e., a payment that is due in the year 2057) is today. Hence, the discounted present value of a payment corrects for inflation and the principle that money available today is worth more than money not accessible for 50 years (or some future time). However, the discounted present value is not the same thing as market value (what someone is willing to pay). Basically, a calculation that discounts a future payment based on IRS rates is an artificial number since it has no bearing on the payment’s actual selling price. For example, in Henderson Receivables Origination, it is somewhat confusing for the court to evaluate future payments totaling $63,364,94 based the discounted present value of $50,933.18 because that is not the market value of the payments. In other words, the annuitant couldn’t go out and get $50,933.18 for his future payments because no person or company would be willing to pay that much. Some states will require a quotient to be listed on the disclosure that is sent to the customer prior to entering into a contract with a factoring company. The quotient is calculated by dividing the purchase price by the discounted present value. The quotient (like the discounted present value) provides no relevance in the pricing of a settlement factoring transaction. In Henderson Receivables Origination (above), the court did consider this quotient which was calculated as 71.70% ($36,500/ $50,933.18). [19]
A structured settlement factoring transaction describes the selling of future structured settlement payments (or, more accurately, rights to receive the future structured settlement payments). People who receive structured settlement payments (for example, the payment of personal injury damages over time instead of in a lump sum at settlement) may decide at some point that they need more money in the short term than the periodic payment provides over time. People's reasons are varied but can include unforeseen medical expenses for oneself or a dependent, the need for improved housing or transportation, education expenses and the like. To meet this need, the structured settlement recipient can sell (or, less commonly, encumber) all or part of their future periodic payments for a present lump sum.
History
Structured settlements experienced an explosion in use beginning in the 1980s.[1] The growth is most likely attributable to the favorable federal income tax treatment such settlements receive as a result of the 1982 amendment of the tax code to add § 130.[2] [3] Internal Revenue Code § 130 provides, inter alia, substantial tax incentives to insurance companies that establish “qualified” structured settlements.[4] There are other advantages for the original tort defendant (or casualty insurer) in settling for payments over time, in that they benefit from the time value of money (most demonstrable in the fact that an annuity can be purchased to fund the payment of future periodic payments, and the cost of such annuity is far less than the sum total of all payments to be made over time). Finally, the tort plaintiff also benefits in several ways from a structured settlement, notably in the ability to receive the periodic payments from an annuity that gains investment value over the life of the payments, and the settling plaintiff receives the total payments, including that “inside build-up” value, tax-free.[5]
However, a substantial downside to structured settlements comes from their inherent inflexibility.[6] To take advantage of the tax benefits allotted to defendants who choose to settle cases using structured settlements, the periodic payments must be set up to meet basic requirements [set forth in IRC 130(c)]. Among other things, the payments must be fixed and determinable, and cannot be accelerated, deferred, increased or decreased by the recipient.[7] For many structured settlement recipients, the periodic payment stream is their only asset. Therefore, over time and as recipients’ personal situations change in ways unpredicted at the settlement table, demand for liquidity options rises. To offset the liquidity issue, most structured settlement recipients, as a part of their total settlement, will receive an immediate sum to be invested to meet the needs not best addressed through the use of a structured settlement. Beginning in the late 1980s, a few small financial institutions started to meet this demand and offer new flexibility for structured settlement payees.[8]
Process
Pre-2002
Before the enactment of IRC 5891, which became effective on July 1, 2002, some states regulated the transfer of structured settlement payment rights, while others did not. Most states that regulated transfers at this time followed a general pattern, substantially similar to the present day process which is mandated in IRC 5891 (see below for more details of the post-2002 process). However, the majority of the transfers processed from 1988 to 2002 were not court ordered.[9] After negotiating the terms of the transaction (including the payments to be sold and the price to be paid for those payments), a formal purchase contract was executed, effecting an assignment of the subject payments upon closing. Part of this assignment process also included the grant of a security interest in the structured settlement payments, to secure performance of the seller’s obligations. Filing a public lien based on that security agreement created notice of this assignment and interest. The insurance company issuing the structured settlement annuity checks was typically not given actual notice of the transfer, due to antagonism by the insurance industry against factoring and transfer companies. Many annuity issuers were concerned that factoring transactions, which were not contemplated when Congress enacted IRC 130, might upset the tax treatment of qualified assignments. HR 2884 (discussed below) resolved this question for annuity issuers.
Federal legislation
In 2001, Congress passed HR 2884, signed into law by the President in 2002 and effective July 1, 2002, codified at Internal Revenue Code § 5891.[10] Through a punitive excise tax penalty, this has created the de facto regulatory paradigm for the factoring industry. In essence, to avoid the excise tax penalty, IRC 5891 requires that all structured settlement factoring transactions be approved by a state court, in accordance with a qualified state statute. Qualified state statues must make certain baseline findings, including that the transfer is in the best interest of the seller, taking into account the welfare and support of any dependents. In response, many states enacted statutes regulating structured settlement transfers in accord with this mandate.
Post-2002
Today, all transfers are completed through a court order process. As of September 6, 2006, 46 states have transfer laws in place regulating the transfer process. Of these, 41 are based in whole or in part on the model state law enacted by NCOIL, the National Conference of Insurance Legislators (or, in cases when the state law predates the model act, they are substantially similar).
Most state transfer laws contain similar provisions, as follows: (1) pre-contract disclosures to be made to the seller concerning the essentials of the transaction; (2) notice to certain interested parties; (3) an admonition to seek professional advice concerning the proposed transfer; and (4) court approval of the transfer, including a finding that it is in the best interest of seller, taking into account the welfare and support of any dependents.
States with Transfer Laws in Place
Factoring Terminology
Best Interest Standard
Internal Revenue Code Sec. 5891 and most state laws require that a court find that a proposed settlement factoring transaction be in the best interest of the seller, taking into account the welfare and support of any dependents. [11] “Best interest” is generally not defined, which gives judges flexibility to make a subjective determination on a case-by-case basis. Some state laws may require that the judge look at factors such as the “purpose of the intended use of the funds,” the payee’s mental and physical capacity, and the seller’s potential need for future medical treatment. [12] [13]. One Minnesota court described the “best interest standard” as a determination involving “a global consideration of the facts, circumstances, and means of support available to the payee and his or her dependents.” [14]
Courts have consistently found that the “best interest standard” is not limited to financial hardship cases. [15] Hence, a transfer may be in a seller’s best interest because it allows him to take advantage of an opportunity (i.e., buy a new home, start a business, attend college, etc.) or to avoid disaster (i.e., pay for a family member’s unexpected medical care, pay off mounting debt, etc.). For example, a New Jersey court found that a transaction was in a seller’s best interest where the funds were used to “pay off bills…and to buy a home and get married.” [16]
Although sometimes criticized for being vague, the best interest standard’s lack of precise definition allows considerable latitude in judicial review. Courts can consider on a case-by-case basis the totality of the circumstances surrounding the transfer to determine whether it should be approved.
Discount Rate
In the beginning, the factoring industry had some relatively high discount rates due to heavy expenses caused by costly litigation battles and limited access to traditional investors. However, once state and federal legislation was enacted, the industry’s interest rates decreased dramatically. There is much confusion with the terminology “discount rate” because the term is used in different ways. The discount rate referred to in a factoring transaction is similar to an interest rate associated with home loans, credit cards and car loans where the interest rate is applied to the payment stream itself. In a factoring transaction, the factoring company knows the payment stream they are going to purchase and applies an interest rate to the payment stream itself and solves for the funding amount, as though it was a loan. Discount rates from factoring companies to consumers can range anywhere between under 9% up to over 18% but usually average somewhere in the middle. Factoring discount rates can be a bit higher when compared to home loan interest rates, due to the fact the factoring transactions are more of a boutique product for investors opposed to the mainstream collateralized mortgage transactions. One common mistake in calculating the discount rate is to use “elementary school math” where you take the funding/loan amount and divide it by the total price of all the payments being purchased. Because this method disregards the concept of time (and the time value of money), the resulting percentage is useless. For example, the court in In Re Henderson Receivables Origination v. Campos noted an annual discount rate of 16.8% where the annuitant received $36,500 for the assignment of payments totaling $63,364.94 over 84 months (two monthly payments of $672.32 each, beginning September 30, 2006 and ending on October 31, 2006; eighty-two monthly payments of $692.49 each, increasing 3% every twelve months, beginning on November 30, 2006 and ending on August 31, 2013). However, had the court in Henderson Receivables Origination applied the illogical formula of discounting from “elementary school math” ($36,500/ $63,364.94), the discount rate would have been an astronomical (and nonsensical) 61%. [17]
Discounted Present Value
Another term commonly used in factoring transactions is “discounted present value,” which is defined in the NCOIL model transfer act as “the present value of future payments determined by discounting such payments to the present using the most recently published Applicable Federal Rate for determining the present value of an annuity, as issued by the United States Internal Revenue Service.” [18] The IRS discount rate, also known as the Applicable Federal Rate (AFR), is used to determine the charitable deduction for many types of planned gifts, such as charitable remainder trusts and gift annuities. The rate is the annual rate of return that the IRS assumes the gift assets will earn during the gift term. The IRS discount rate is published monthly (link to current rate may be found here). In Henderson Receivables Origination (above), the court calculated the discounted present value of the $63,364.94 to be transferred as $50,933.18 based on the applicable federal rate of 6.00%. [18] The “discounted present value” is a measuring stick for determining what the value of a future payment (i.e., a payment that is due in the year 2057) is today. Hence, the discounted present value of a payment corrects for inflation and the principle that money available today is worth more than money not accessible for 50 years (or some future time). However, the discounted present value is not the same thing as market value (what someone is willing to pay). Basically, a calculation that discounts a future payment based on IRS rates is an artificial number since it has no bearing on the payment’s actual selling price. For example, in Henderson Receivables Origination, it is somewhat confusing for the court to evaluate future payments totaling $63,364,94 based the discounted present value of $50,933.18 because that is not the market value of the payments. In other words, the annuitant couldn’t go out and get $50,933.18 for his future payments because no person or company would be willing to pay that much. Some states will require a quotient to be listed on the disclosure that is sent to the customer prior to entering into a contract with a factoring company. The quotient is calculated by dividing the purchase price by the discounted present value. The quotient (like the discounted present value) provides no relevance in the pricing of a settlement factoring transaction. In Henderson Receivables Origination (above), the court did consider this quotient which was calculated as 71.70% ($36,500/ $50,933.18). [19]
Settlement (structural)
Settlement (structural)
For settlement of the ground, see subsidence.
Timber frame building showing considerable, but tolerable settlement
Timber frame building showing considerable, but tolerable settlement
Settlement in a structure refers to the distortion or disruption of parts of a building due to either; unequal compression of its foundations, shrinkage such as that which occurs in timber framed buildings as the frame adjusts its moisture content, or by undue loads being applied to the building after its initial construction.[1] Settlement should not be confused with subsidence which results from the load bearing ground upon which a building sits reducing in level, for instance in areas of mine workings where shafts collapse underground.
Some settlement is quite normal after construction has been completed, but unequal settlement may cause significant problems for buildings. Traditional green oak framed buildings are designed to settle with time as the oak seasons and warps, lime mortar rather than Portland cement is used for its elastic properties and glazing will often employ small leaded lights which can accept movement more readily than larger panes.
For settlement of the ground, see subsidence.
Timber frame building showing considerable, but tolerable settlement
Timber frame building showing considerable, but tolerable settlement
Settlement in a structure refers to the distortion or disruption of parts of a building due to either; unequal compression of its foundations, shrinkage such as that which occurs in timber framed buildings as the frame adjusts its moisture content, or by undue loads being applied to the building after its initial construction.[1] Settlement should not be confused with subsidence which results from the load bearing ground upon which a building sits reducing in level, for instance in areas of mine workings where shafts collapse underground.
Some settlement is quite normal after construction has been completed, but unequal settlement may cause significant problems for buildings. Traditional green oak framed buildings are designed to settle with time as the oak seasons and warps, lime mortar rather than Portland cement is used for its elastic properties and glazing will often employ small leaded lights which can accept movement more readily than larger panes.
structured sale
A structured sale is a special type of installment sale pursuant to the Internal Revenue Code.[1] Installment sales permit sellers to defer recognition of gains on the sale of a business or real estate to the tax year in which the related sale proceeds are received. Structured sales allow the seller of an asset to pay taxes over time while having the payments guaranteed by a high credit quality alternate obligor, who accepts assignment of the buyers periodic payment obligation. Transactions can currently be done as small as $100,000.
In a structured sale, rather than the buyer paying the installments, the buyer pays cash, some of which is used as consideration for a third party assignment company to accept the payment obligation. The assignment company then purchases an annuity from a life insurance company with high financial ratings from A. M. Best. Case law and administrative precedents supporting substitution of obligors.[2] In addition, a properly handled transaction will avoid issues with constructive receipt and economic benefit.
While negotiating the installment payments, the seller is free to design payment streams with a great deal of flexibility. The seller recognizes capital gain in each year an installment payment is received. Interest is imputed and taxed annually, even in years d-ring the contract where no installment payments are received. Taxation is the same as if the buyer were making installment payments directly.
Structured sales are an alternative to a section 1031 exchange, which defers recognition of capital gain, but forces the seller to continue holding some form of property. Structured sales work well for sellers who want to create a continuing stream of income without management worries. Retiring business owners and downsizing homeowners are examples of sellers who can benefit.
The structured sale must be documented, and money must be handled in such a way that the ultimate recipient is not treated as having constructive received the payment prior to the time it is act-ally paid. For the buyer, there is no difference from a traditional cash-and-title-now deal, except for additional paperwork. Because of tax advantages to the seller, structuring the sale might, however, make the buyer's offer more attractive. Because the buyer has paid in full, the buyer gets full title at time of closing.
There are no direct fees to the b-yer or seller to employ the structured sale strategy. The structured settlement specialist who implements the transaction is paid directly by the life insurance company that writes the annuity.
The internal rate of return is comparable to long term high quality debt instruments.
Allstate Life was the originator of the structured sale concept and until recently was the only structured settlement annuity company whose product was available for the structured sale transaction. Prudential has begun to use its non-qualified assignment product on a limited basis. By mid 2007, Aviva Life may be in the market as well.
In a structured sale, rather than the buyer paying the installments, the buyer pays cash, some of which is used as consideration for a third party assignment company to accept the payment obligation. The assignment company then purchases an annuity from a life insurance company with high financial ratings from A. M. Best. Case law and administrative precedents supporting substitution of obligors.[2] In addition, a properly handled transaction will avoid issues with constructive receipt and economic benefit.
While negotiating the installment payments, the seller is free to design payment streams with a great deal of flexibility. The seller recognizes capital gain in each year an installment payment is received. Interest is imputed and taxed annually, even in years d-ring the contract where no installment payments are received. Taxation is the same as if the buyer were making installment payments directly.
Structured sales are an alternative to a section 1031 exchange, which defers recognition of capital gain, but forces the seller to continue holding some form of property. Structured sales work well for sellers who want to create a continuing stream of income without management worries. Retiring business owners and downsizing homeowners are examples of sellers who can benefit.
The structured sale must be documented, and money must be handled in such a way that the ultimate recipient is not treated as having constructive received the payment prior to the time it is act-ally paid. For the buyer, there is no difference from a traditional cash-and-title-now deal, except for additional paperwork. Because of tax advantages to the seller, structuring the sale might, however, make the buyer's offer more attractive. Because the buyer has paid in full, the buyer gets full title at time of closing.
There are no direct fees to the b-yer or seller to employ the structured sale strategy. The structured settlement specialist who implements the transaction is paid directly by the life insurance company that writes the annuity.
The internal rate of return is comparable to long term high quality debt instruments.
Allstate Life was the originator of the structured sale concept and until recently was the only structured settlement annuity company whose product was available for the structured sale transaction. Prudential has begun to use its non-qualified assignment product on a limited basis. By mid 2007, Aviva Life may be in the market as well.
Reverse convertibles securities
Reverse convertibles securities
What are Reverse Convertible Securities?
* Short-term coupon bearing notes, structured to provide enhanced yield while participating in certain equity-like risks.
* Investment value is derived from underlying equity exposure, which is paid in the form of fixed coupons.
* Investors receive full principal back at maturity if the Knock-in Level is not breached (which is typically 70-80% of the initial reference price).
* The underlying stock, index or basket of equities is defined as Reference Shares. However, in most cases, Reverse convertibles are linked to a single stock.
Reference Shares
* Underlying stocks or basket of equities can include names such as:
o Dell Computers
o Wal Mart
o Exxon Mobil
o Cisco
o Best Buy
o Corning
* Broad market indices may include names such as:
o Nasdaq-100 Index
How do Reverse Convertibles work?
* Short-term investments, typically with one year maturity.
* At maturity, investors receive either 100% of their original investment or a predetermined number of shares of the underlying stock, in addition to the stated coupon payment.
* The investors’ earning potential is limited to the security’s stated coupon, because investors receive coupon payments regardless of the performance of the underlying reference shares.
* Coupon payments are the obligation of the Issuer and are paid quarterly.
* Sold by prospectus or offering circular and pricing term sheet.
* General rule of thumb:
The higher your coupon payment, the greater likelihood of receiving stock at maturity.
* NOTE: Whether or not the Knock-in Level is breached, the investor will receive fixed periodic coupons through the term of the notes.
Delivery at Maturity
At maturity, there are 2 possible outcomes:
* Cash Delivery
o Stock closes at or above the Initial Share Price upon valuation date, regardless of whether the stock closed below the Knock-in Level during the holding period. OR stock closes below the Initial Share Price, but has never closed below the Knock-in Level.
* Physical Delivery
o Underlying shares closed below the Knock-in Level at any time during the holding period and does not trade back up above the Initial Share Price on valuation date (4 days prior to maturity).
Physical Delivery
* Initial Share Price is determined on Trade Date.
* The final valuation of the shares is based on the closing price of the Reference Shares determined 4 days prior to maturity.
* If the investor is delivered physical shares, their value will be less than the Initial Share Price, however, investors are not required to sell their shares at prevailing market prices.
Secenario 1 - Cash Delivery
Cash Delivery
Reference share closing price is above the Initial Share Price of the note on Valuation Date (4 days prior to maturity), regardless of whether the stock closed below the Knock-in Level. Investor receives Cash Delivery Amount (Par), at maturity.
Secenario 2 - Cash Delivery
Cash Delivery
Reference share closing price is below the Initial Share Price of the note on Valuation Date (4 days prior to maturity), but never closed below the Knock-in Level. Investor receives Cash Delivery Amount (Par) at maturity.
What are Reverse Convertible Securities?
* Short-term coupon bearing notes, structured to provide enhanced yield while participating in certain equity-like risks.
* Investment value is derived from underlying equity exposure, which is paid in the form of fixed coupons.
* Investors receive full principal back at maturity if the Knock-in Level is not breached (which is typically 70-80% of the initial reference price).
* The underlying stock, index or basket of equities is defined as Reference Shares. However, in most cases, Reverse convertibles are linked to a single stock.
Reference Shares
* Underlying stocks or basket of equities can include names such as:
o Dell Computers
o Wal Mart
o Exxon Mobil
o Cisco
o Best Buy
o Corning
* Broad market indices may include names such as:
o Nasdaq-100 Index
How do Reverse Convertibles work?
* Short-term investments, typically with one year maturity.
* At maturity, investors receive either 100% of their original investment or a predetermined number of shares of the underlying stock, in addition to the stated coupon payment.
* The investors’ earning potential is limited to the security’s stated coupon, because investors receive coupon payments regardless of the performance of the underlying reference shares.
* Coupon payments are the obligation of the Issuer and are paid quarterly.
* Sold by prospectus or offering circular and pricing term sheet.
* General rule of thumb:
The higher your coupon payment, the greater likelihood of receiving stock at maturity.
* NOTE: Whether or not the Knock-in Level is breached, the investor will receive fixed periodic coupons through the term of the notes.
Delivery at Maturity
At maturity, there are 2 possible outcomes:
* Cash Delivery
o Stock closes at or above the Initial Share Price upon valuation date, regardless of whether the stock closed below the Knock-in Level during the holding period. OR stock closes below the Initial Share Price, but has never closed below the Knock-in Level.
* Physical Delivery
o Underlying shares closed below the Knock-in Level at any time during the holding period and does not trade back up above the Initial Share Price on valuation date (4 days prior to maturity).
Physical Delivery
* Initial Share Price is determined on Trade Date.
* The final valuation of the shares is based on the closing price of the Reference Shares determined 4 days prior to maturity.
* If the investor is delivered physical shares, their value will be less than the Initial Share Price, however, investors are not required to sell their shares at prevailing market prices.
Secenario 1 - Cash Delivery
Cash Delivery
Reference share closing price is above the Initial Share Price of the note on Valuation Date (4 days prior to maturity), regardless of whether the stock closed below the Knock-in Level. Investor receives Cash Delivery Amount (Par), at maturity.
Secenario 2 - Cash Delivery
Cash Delivery
Reference share closing price is below the Initial Share Price of the note on Valuation Date (4 days prior to maturity), but never closed below the Knock-in Level. Investor receives Cash Delivery Amount (Par) at maturity.
Secenario 3 - Physical Delivery
Secenario 3 - Physical Delivery
Physical Delivery
Reference share closing price is below the initial price of the note at valuation date (4 days prior to maturity), and has closed below the downside Knock-in Level during the holding period. Investors receive Physical Delivery Amount, or shares of stock, at maturity. Predetermined number of shares delivered to the investor if closing price of reference shares below initial price.
Physical Delivery Amount = (Original Investment Amount / Initial Price of Underlying Asset),
Liquidity
* Generally created as a buy and hold investment.
* Issuers typically provide liquidity in the secondary market.
* The secondary market price may not immediately reflect changes in the underlying security.
* Liquidations prior to maturity may be less than the initial principal amount invested.
Trading
* Trade flat and accrue on a 30/360 basis.
* End of day pricing posted on Bloomberg and/or the internet.
* Pricing will fluctuate intraday.
* Reverse Convertibles are notes that are registered with the SEC
Ratings
* These are an unsecured debt obligation of the issuer, not the reference company thus it carries the rating of the issuer.
* The creditworthiness of the issuer does not affect or enhance the likely performance of the investment other than the ability of the issuer to meet its obligations.
Taxes
* For tax purposes Reverse Convertibles Notes are considered to have two components:
o A debt portion.
o A put option.
* At maturity, the option component is taxed as a short-term capital gain if the investor receives the cash settlement. In the case of physical delivery, the option component will reduce the tax basis of the Reference Shares delivered to their accounts.
* Investors should consult their own tax advisor prior to investing. Refer to the Note’s prospectus for more detailed information.
Investor Benefits
* Enhanced yield.
* Current income
* Downside protection, typically up to 10-30% on most Reverse Convertible offerings.
* The bid-ask spread is typically 1%.
* $1,000 minimum investment.
Risk to Consider
* Owners of the Reverse Convertible Notes may be exposed to the risk of the decline in the price of the reference shares during the term of the note.
* Investments in equity-linked notes may not be suitable for all investors.
* Investors selling notes prior to maturity may receive a market price which is at a premium or a discount to par and may not necessarily reflect any increase or decrease in the market price of the underlying equity to the date of such sale.
* Reverse Convertibles do NOT guarantee return of principal at maturity.
* In addition, Reverse Convertibles do not have the same price appreciation potential as the reference shares because at maturity the value of the note may not appreciate above the initial principal amount.
* The market price of the Reverse Convertibles may be influenced by unpredictable market factors.
Investor Suitability Profile
* High net worth clients seeking current income.
* Traditional Equity Customers.
o Trust accounts
o Money managers
o Qualified accounts
o Non-profit organizations
* Investors that believe the markets will be relatively flat.
* Current equity linked notes investors.
* Investors who own the underlying stock.
* Notes purchased at original issue will not subject to wash sale rules on the underlying stock
Physical Delivery
Reference share closing price is below the initial price of the note at valuation date (4 days prior to maturity), and has closed below the downside Knock-in Level during the holding period. Investors receive Physical Delivery Amount, or shares of stock, at maturity. Predetermined number of shares delivered to the investor if closing price of reference shares below initial price.
Physical Delivery Amount = (Original Investment Amount / Initial Price of Underlying Asset),
Liquidity
* Generally created as a buy and hold investment.
* Issuers typically provide liquidity in the secondary market.
* The secondary market price may not immediately reflect changes in the underlying security.
* Liquidations prior to maturity may be less than the initial principal amount invested.
Trading
* Trade flat and accrue on a 30/360 basis.
* End of day pricing posted on Bloomberg and/or the internet.
* Pricing will fluctuate intraday.
* Reverse Convertibles are notes that are registered with the SEC
Ratings
* These are an unsecured debt obligation of the issuer, not the reference company thus it carries the rating of the issuer.
* The creditworthiness of the issuer does not affect or enhance the likely performance of the investment other than the ability of the issuer to meet its obligations.
Taxes
* For tax purposes Reverse Convertibles Notes are considered to have two components:
o A debt portion.
o A put option.
* At maturity, the option component is taxed as a short-term capital gain if the investor receives the cash settlement. In the case of physical delivery, the option component will reduce the tax basis of the Reference Shares delivered to their accounts.
* Investors should consult their own tax advisor prior to investing. Refer to the Note’s prospectus for more detailed information.
Investor Benefits
* Enhanced yield.
* Current income
* Downside protection, typically up to 10-30% on most Reverse Convertible offerings.
* The bid-ask spread is typically 1%.
* $1,000 minimum investment.
Risk to Consider
* Owners of the Reverse Convertible Notes may be exposed to the risk of the decline in the price of the reference shares during the term of the note.
* Investments in equity-linked notes may not be suitable for all investors.
* Investors selling notes prior to maturity may receive a market price which is at a premium or a discount to par and may not necessarily reflect any increase or decrease in the market price of the underlying equity to the date of such sale.
* Reverse Convertibles do NOT guarantee return of principal at maturity.
* In addition, Reverse Convertibles do not have the same price appreciation potential as the reference shares because at maturity the value of the note may not appreciate above the initial principal amount.
* The market price of the Reverse Convertibles may be influenced by unpredictable market factors.
Investor Suitability Profile
* High net worth clients seeking current income.
* Traditional Equity Customers.
o Trust accounts
o Money managers
o Qualified accounts
o Non-profit organizations
* Investors that believe the markets will be relatively flat.
* Current equity linked notes investors.
* Investors who own the underlying stock.
* Notes purchased at original issue will not subject to wash sale rules on the underlying stock
Life settlement
Life settlement
A life settlement is a financial transaction in which a policyowner possessing an unneeded or unwanted life insurance policy sells the policy to a third party for more than the cash value offered by the life insurance company. The purchaser becomes the new beneficiary of the policy at maturation and is responsible for all subsequent premium payments.
Life settlements are an important development in that they have opened a secondary market for life insurance in which policyowners can access fair market value for their policies, rather than accepting the lower cash surrender value from the issuing life insurance company.
Generally speaking, life settlements are an option for high-net-worth policyowners age 65 or older. Independent estimates report that among this group, 20% of policies have a market value that exceeds the cash value offered by the carrier. And while many policyowners are unfamiliar with life settlements until a financial professional mentions the option to them, the concept has gained attention from high-profile proponents such as Warren Buffett, former U.S. Representative Bill Gradison, and numerous media sources including The Wall Street Journal, Time Magazine, Business Week and The Economist. A growing number of experts now believe that informing clients about offering life settlements should fall under the fiduciary duty of a financial advisor.
How It Works
In a life settlement transaction, there is a chain leading from the seller of the policy to the end buyer of the policy (known as a life settlement provider). Each link in the chain has a different responsibility in facilitating the transaction and ensuring that it runs smoothly, while outside vendors typically assist the provider with specialized functions.
Policy Sellers
Candidates for life settlements are policyowners over the age of 65 who no longer want or need a particular life insurance policy. Life settlement candidates generally have a life expectancy between 2 and 20 years. There are certain restrictions for their policies as well - policies must be valued at $50,000 or more, and depending on the life expectancy determination of the seller, any and all types of policies can be sold, ie; universal life, whole life, or convertible term contracts.
A life settlement is a financial transaction in which a policyowner possessing an unneeded or unwanted life insurance policy sells the policy to a third party for more than the cash value offered by the life insurance company. The purchaser becomes the new beneficiary of the policy at maturation and is responsible for all subsequent premium payments.
Life settlements are an important development in that they have opened a secondary market for life insurance in which policyowners can access fair market value for their policies, rather than accepting the lower cash surrender value from the issuing life insurance company.
Generally speaking, life settlements are an option for high-net-worth policyowners age 65 or older. Independent estimates report that among this group, 20% of policies have a market value that exceeds the cash value offered by the carrier. And while many policyowners are unfamiliar with life settlements until a financial professional mentions the option to them, the concept has gained attention from high-profile proponents such as Warren Buffett, former U.S. Representative Bill Gradison, and numerous media sources including The Wall Street Journal, Time Magazine, Business Week and The Economist. A growing number of experts now believe that informing clients about offering life settlements should fall under the fiduciary duty of a financial advisor.
How It Works
In a life settlement transaction, there is a chain leading from the seller of the policy to the end buyer of the policy (known as a life settlement provider). Each link in the chain has a different responsibility in facilitating the transaction and ensuring that it runs smoothly, while outside vendors typically assist the provider with specialized functions.
Policy Sellers
Candidates for life settlements are policyowners over the age of 65 who no longer want or need a particular life insurance policy. Life settlement candidates generally have a life expectancy between 2 and 20 years. There are certain restrictions for their policies as well - policies must be valued at $50,000 or more, and depending on the life expectancy determination of the seller, any and all types of policies can be sold, ie; universal life, whole life, or convertible term contracts.
Financial Advisors
Life settlements are complex financial transactions that are generally conducted on behalf of clients by experienced professional advisors. Some examples of advisors that are becoming increasingly involved in the life settlement arena are:
* Accountants/CPAs
* Attorneys
* Financial Planners/CFPs/ChFCs/CFCs
* Insurance Advisors
* Estate Planners/CEPs
* Certified Senior Advisors/CSAs
* Charitable Trust Officers
Providers
Life settlement providers serve as the purchaser in a life settlement transaction and are responsible for paying the client a cash sum greater than the policy's cash surrender value. The top providers in the industry fund many transactions each year and hold the seller's policy as a confidential portfolio asset. They are experienced in the analysis and valuation of large-face-amount policies and work directly with advisors to develop transactions that are customized to a client's particular situation. They have in-house compliance departments to carefully review transactions and, most importantly, they are backed by institutional funds.
Life Settlement providers must be licensed in the state where the policy owner resides. Approximately 41 states have regulations in place regarding the sale of life insurance policies to third parties.
Brokers
Financial advisors who choose not to submit cases directly to a settlement provider may opt to work through a life settlement broker. Life settlement brokers are intermediaries who bring together policyowners who wish to sell a policy and providers seeking to purchase them. Brokers, in exchange for a fee, will shop a policy to multiple providers, much as a real estate broker solicits multiple offers for one’s home. While it is the broker's duty to collect bids, it is still incumbent on the advisor to help the client evaluate the offers against a number of criteria including offer price, stability of funding, privacy provisions, net yield after commissions, and more. Compensation arrangements vary significantly and should be fully disclosed and understood to determine if engaging a broker will benefit the client. In many states, brokers must be licensed to do business in that state.
* Accountants/CPAs
* Attorneys
* Financial Planners/CFPs/ChFCs/CFCs
* Insurance Advisors
* Estate Planners/CEPs
* Certified Senior Advisors/CSAs
* Charitable Trust Officers
Providers
Life settlement providers serve as the purchaser in a life settlement transaction and are responsible for paying the client a cash sum greater than the policy's cash surrender value. The top providers in the industry fund many transactions each year and hold the seller's policy as a confidential portfolio asset. They are experienced in the analysis and valuation of large-face-amount policies and work directly with advisors to develop transactions that are customized to a client's particular situation. They have in-house compliance departments to carefully review transactions and, most importantly, they are backed by institutional funds.
Life Settlement providers must be licensed in the state where the policy owner resides. Approximately 41 states have regulations in place regarding the sale of life insurance policies to third parties.
Brokers
Financial advisors who choose not to submit cases directly to a settlement provider may opt to work through a life settlement broker. Life settlement brokers are intermediaries who bring together policyowners who wish to sell a policy and providers seeking to purchase them. Brokers, in exchange for a fee, will shop a policy to multiple providers, much as a real estate broker solicits multiple offers for one’s home. While it is the broker's duty to collect bids, it is still incumbent on the advisor to help the client evaluate the offers against a number of criteria including offer price, stability of funding, privacy provisions, net yield after commissions, and more. Compensation arrangements vary significantly and should be fully disclosed and understood to determine if engaging a broker will benefit the client. In many states, brokers must be licensed to do business in that state.
Investors / Risk takers
Investors / Risk takers
Life settlement investors are known as financing entities because they are providing the capital or financing for life settlement transactions (the purchase of a life insurance policy). Life settlement investors may use their own capital to purchase the policies or may raise the capital from a wide range of investors through a variety of structures. The life settlement provider is the entity that enters into the transaction with the policyowner and pays the policyowner when the life settlement transaction closes. In most cases, the life settlement provider has a written agreement with the life settlement investor to provide the life settlement provider with the funds needed to acquire the policy. In this scenario, the life settlement investor is effectively the ultimate funder of the secondary market transaction. However, in some life settlement transactions, the life settlement provider is also the investor; the provider uses its own capital to purchase the policy for its own portfolio.
Life settlement investments are not typically suitable for individual investors. Risks are associated with life settlement investments that individual investors may not recognize and that unscrupulous promoters may misrepresent or fail to disclose. For example, funds invested in life settlement investments are usually not accessible on the demand of the investor, as are investments in many other types of securities, such as mutual funds. These factors and others render this type of investment unsuitable for the financial needs and interests of the average individual investor. For this reason, the norm today, especially among reputable life settlement providers, is to obtain capital only from life settlement investors who are established and credible institutional sources of capital rather than individual sources of capital.
In most cases, a life settlement investor must be a qualified institutional buyer as defined in the federal Securities Act of 1933. A qualified institutional buyer (QIB) is defined under Regulation D, Rule 144A as an entity owning and investing large amounts of securities, with the threshold ranging from $10 million to $100 million of securities not affiliated with the entity and dependent on the type of entity. QIBs are eligible to participate in a restricted investment market known as the "Rule 144A market" that is not available to the public because the issuer of the securities has chosen not to make the required public disclosures or to register the securities. The purpose of the qualified institutional buyer requirement in life settlements is to prevent unsophisticated or undercapitalized investors from participating in—and potentially being harmed by—complicated life settlement transactions.
Financial institutions meet the qualified institutional buyer test and are therefore suitable life settlement purchasers. In addition, institutions have teams of experienced investment analysts and are experts at managing investment risk; they can impose a “corporate governance” discipline on the life settlement transaction process intended to minimize questionable market practices; and institutional funding provides a high degree of consumer protection with regard to privacy and confidentiality (a policyowner’s or insured’s personal information should never be in the hands of an individual investor.)
Other Involved Parties
Underwriters/Life Expectancy Providers - Provide life expectancy estimates on the insured for pricing purposes. There are four major life expectancy providers, namely 21st Services, AVS, Fasano, and ISC Services.
Some underwriters provide unreasonably short life expectancies by using base tables that are 5 years out of date, ignoring future mortality improvements & current treatments Eg Statins and basing life expectancies on life manuals which are conservative for mortality and not longevity risk. Others apply actuarial analysis to the most recent available data as well as their own experience to develop their base tables and underwriting manuals.
Providers who do not provide short life expectancies are shunned by originators whom are primarily remunerated for volume. Providing more reasonable life expectancies does not inflate the apparent value in these insurance policies. This results in fewer cases being written and less support from originators.
There are no experience studies publically available which support the accuracy of any of the major life settlements underwriters.
Steps in a Transaction
1. Policyowner consults with an advisor, decides to sell his or her policy.
2. Policy owner and advisor decide whether to work with broker or to go directly to providers.
3. Client & advisor submit policy for valuation. Client releases medical information.
4. If policy meets criteria for a life settlement, providers send offers directly or through a broker.
5. Client and advisor review offers and client accepts his preferred offer.
6. Client and advisor complete the provider's closing package, and return essential documents.
7. Provider places cash payment in escrow and submits change of ownership forms to the insurance carrier.
8. Paperwork is verified and funds are transferred to the policy seller.
Life settlement investors are known as financing entities because they are providing the capital or financing for life settlement transactions (the purchase of a life insurance policy). Life settlement investors may use their own capital to purchase the policies or may raise the capital from a wide range of investors through a variety of structures. The life settlement provider is the entity that enters into the transaction with the policyowner and pays the policyowner when the life settlement transaction closes. In most cases, the life settlement provider has a written agreement with the life settlement investor to provide the life settlement provider with the funds needed to acquire the policy. In this scenario, the life settlement investor is effectively the ultimate funder of the secondary market transaction. However, in some life settlement transactions, the life settlement provider is also the investor; the provider uses its own capital to purchase the policy for its own portfolio.
Life settlement investments are not typically suitable for individual investors. Risks are associated with life settlement investments that individual investors may not recognize and that unscrupulous promoters may misrepresent or fail to disclose. For example, funds invested in life settlement investments are usually not accessible on the demand of the investor, as are investments in many other types of securities, such as mutual funds. These factors and others render this type of investment unsuitable for the financial needs and interests of the average individual investor. For this reason, the norm today, especially among reputable life settlement providers, is to obtain capital only from life settlement investors who are established and credible institutional sources of capital rather than individual sources of capital.
In most cases, a life settlement investor must be a qualified institutional buyer as defined in the federal Securities Act of 1933. A qualified institutional buyer (QIB) is defined under Regulation D, Rule 144A as an entity owning and investing large amounts of securities, with the threshold ranging from $10 million to $100 million of securities not affiliated with the entity and dependent on the type of entity. QIBs are eligible to participate in a restricted investment market known as the "Rule 144A market" that is not available to the public because the issuer of the securities has chosen not to make the required public disclosures or to register the securities. The purpose of the qualified institutional buyer requirement in life settlements is to prevent unsophisticated or undercapitalized investors from participating in—and potentially being harmed by—complicated life settlement transactions.
Financial institutions meet the qualified institutional buyer test and are therefore suitable life settlement purchasers. In addition, institutions have teams of experienced investment analysts and are experts at managing investment risk; they can impose a “corporate governance” discipline on the life settlement transaction process intended to minimize questionable market practices; and institutional funding provides a high degree of consumer protection with regard to privacy and confidentiality (a policyowner’s or insured’s personal information should never be in the hands of an individual investor.)
Other Involved Parties
Underwriters/Life Expectancy Providers - Provide life expectancy estimates on the insured for pricing purposes. There are four major life expectancy providers, namely 21st Services, AVS, Fasano, and ISC Services.
Some underwriters provide unreasonably short life expectancies by using base tables that are 5 years out of date, ignoring future mortality improvements & current treatments Eg Statins and basing life expectancies on life manuals which are conservative for mortality and not longevity risk. Others apply actuarial analysis to the most recent available data as well as their own experience to develop their base tables and underwriting manuals.
Providers who do not provide short life expectancies are shunned by originators whom are primarily remunerated for volume. Providing more reasonable life expectancies does not inflate the apparent value in these insurance policies. This results in fewer cases being written and less support from originators.
There are no experience studies publically available which support the accuracy of any of the major life settlements underwriters.
Steps in a Transaction
1. Policyowner consults with an advisor, decides to sell his or her policy.
2. Policy owner and advisor decide whether to work with broker or to go directly to providers.
3. Client & advisor submit policy for valuation. Client releases medical information.
4. If policy meets criteria for a life settlement, providers send offers directly or through a broker.
5. Client and advisor review offers and client accepts his preferred offer.
6. Client and advisor complete the provider's closing package, and return essential documents.
7. Provider places cash payment in escrow and submits change of ownership forms to the insurance carrier.
8. Paperwork is verified and funds are transferred to the policy seller.
Life Settlement History
Life Settlement History
Although the secondary market for life insurance is relatively new, the market was more the 100 years in the making. The life settlement market would not have originated without a number of events, judicial rulings, and key individuals.
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The Policy as Transferable Property
The Supreme Court case of Grigsby v. Russell (1911) established the policyowner’s right to transfer an insurance policy. Justice Oliver Wendell Holmes noted in his opinion that life insurance possessed all the ordinary characteristics of property, and therefore represented an asset that a policyowner could transfer without limitation. Wrote Holmes, “Life insurance has become in our days one of the best recognized forms of investment and self-compelled saving.” This opinion placed the ownership rights in a life insurance policy on the same legal footing as more traditional investment property such as stocks and bonds. As with these other types of property, a life insurance policy could be transferred to another person at the discretion of the policyowner.
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This decision established a life insurance policy as transferable property that contains specific legal rights, including the right to:
* Name the policy beneficiary
* Change the beneficiary designation (unless subject to restrictions)
* Assign the policy as collateral for a loan
* Borrow against the policy
* Sell the policy to another party
A second milestone occurred in 2001 when The National Association of Insurance Commissioners (NAIC) took a crucial step by releasing the Viatical Settlements Model Act defining guidelines for avoiding fraud and ensuring sound business practices. Around this time, many of the life settlement providers that are prominent today began purchasing policies for their investment portfolio using institutional capital. The arrival of well-funded corporate entities transformed the settlement concept into a regulated wealth management tool for high-net-worth policyowners who no longer needed a given policy. Strong demand for life settlements policies is driving a rapid market expansion that continues today.
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Major Study Findings
One major study that showed some of the potential of the life settlement market was conducted by the University of Pennsylvania business school, the Wharton School. The research papers, credited to Neil Doherty and Hal Singer, were released under the title "The Benefits of a Secondary Market For Life Insurance." ([1]) This study found, among other things, that life settlement providers paid approximately $340 million to consumers for their underperforming life insurance policies, an opportunity that was not available to them just a few years before.
"We estimate that life settlements, alone, generate surplus benefits in excess of $240 million annually for life insurance policyholders who have exercised their option to sell their policies at a competitive rate." - Wharton Study, pg 6
Another study, perhaps even more influential, was the Conning & Co. Research study "Life Settlements: Additional Pressure on Life Profits." This study found that senior citizens owned approximately $500 billion worth of life insurance in 2003, of which $100 billion was owned by seniors eligible for life settlements. Since 2003, more and more of these eligible senior clients have sold their policies and helped the market increase.
Other Life Settlement Fast Fent Providers - 34
o Estimated Amount of life policies to be purchased by providers in 2005 - $10-15 billion
- From the Maple Life Financial Industry Outlook 2005
Although the secondary market for life insurance is relatively new, the market was more the 100 years in the making. The life settlement market would not have originated without a number of events, judicial rulings, and key individuals.
The Policy as Transferable Property
The Supreme Court case of Grigsby v. Russell (1911) established the policyowner’s right to transfer an insurance policy. Justice Oliver Wendell Holmes noted in his opinion that life insurance possessed all the ordinary characteristics of property, and therefore represented an asset that a policyowner could transfer without limitation. Wrote Holmes, “Life insurance has become in our days one of the best recognized forms of investment and self-compelled saving.” This opinion placed the ownership rights in a life insurance policy on the same legal footing as more traditional investment property such as stocks and bonds. As with these other types of property, a life insurance policy could be transferred to another person at the discretion of the policyowner.
This decision established a life insurance policy as transferable property that contains specific legal rights, including the right to:
* Name the policy beneficiary
* Change the beneficiary designation (unless subject to restrictions)
* Assign the policy as collateral for a loan
* Borrow against the policy
* Sell the policy to another party
A second milestone occurred in 2001 when The National Association of Insurance Commissioners (NAIC) took a crucial step by releasing the Viatical Settlements Model Act defining guidelines for avoiding fraud and ensuring sound business practices. Around this time, many of the life settlement providers that are prominent today began purchasing policies for their investment portfolio using institutional capital. The arrival of well-funded corporate entities transformed the settlement concept into a regulated wealth management tool for high-net-worth policyowners who no longer needed a given policy. Strong demand for life settlements policies is driving a rapid market expansion that continues today.
alt="Dj-Mails.com">Major Study Findings
One major study that showed some of the potential of the life settlement market was conducted by the University of Pennsylvania business school, the Wharton School. The research papers, credited to Neil Doherty and Hal Singer, were released under the title "The Benefits of a Secondary Market For Life Insurance." ([1]) This study found, among other things, that life settlement providers paid approximately $340 million to consumers for their underperforming life insurance policies, an opportunity that was not available to them just a few years before.
"We estimate that life settlements, alone, generate surplus benefits in excess of $240 million annually for life insurance policyholders who have exercised their option to sell their policies at a competitive rate." - Wharton Study, pg 6
Another study, perhaps even more influential, was the Conning & Co. Research study "Life Settlements: Additional Pressure on Life Profits." This study found that senior citizens owned approximately $500 billion worth of life insurance in 2003, of which $100 billion was owned by seniors eligible for life settlements. Since 2003, more and more of these eligible senior clients have sold their policies and helped the market increase.
Other Life Settlement Fast Fent Providers - 34
o Estimated Amount of life policies to be purchased by providers in 2005 - $10-15 billion
- From the Maple Life Financial Industry Outlook 2005
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