I don’t know what it is about structured settlements and structured settlement factoring, but for some reason blatant inaccuracies seem more prevalent than truth in reporting on these topics. Personally I don’t think the facts are all that hard to get right, but maybe I’ve just been around too long.

The latest entry in the bad reporting category to catch my eye was Tim Grant’s piece in the Pittsburgh Post-Gazette, confusingly titled “Structured Settlements Of Money Take Away Risks Of Lump-Sum Payments” (first appearing in the Post-Gazette on June 25, 2008). You can read Mr. Grant’s article here.

Lest anyone should think I am picking on Mr. Grant, you should know that I sent him a personal email on June 25, 2008, which is copied below. Hearing nothing in response, I sent a letter to the editor of the Post-Gazette on June 30, 2008. Again, nothing (and my letter was not, to my knowledge, published). Is this willful blindness or something more sinister at work here?

Although Mr. Grant’s article is replete with error, one whopper stands out:

“Unlike lump sum settlements, payments from structured settlements are income tax free and the benefits are guaranteed for life by insurance companies.”

Many ill-informed commentators get confused about the tax treatment of structured settlement payments and factoring transaction lump sums. Breaking Mr. Grant’s assertion down to a simple form, he says that payments from structured settlements are income tax free (true), while lump sum payments are not (false). Lump sum payments in settlement of personal injury damages are income tax free under Internal Revenue Code 104(a)(2). Further, lump sums received from a factoring transaction are also income tax free, as was clarified over nine years ago by IRS Private Letter Ruling 1999-36030, and more recently by IRC 5891.

Manufactured confusion about taxes has long been used to scare people away from factoring. The bottom line is that income tax is not an issue to be concerned about, whether you are taking a lump sum in settlement of a personal injury claim at settlement, accepting payments over time in a structured settlement, or selling some or all of your future structured settlement payments.

The full text of my letter to Tim Grant:

Mr. Grant:

I read with interest your story about structured settlements. I did, however, find some inaccuracies in the story of which you should be aware.

First, you state that “Unlike lump sum settlements, payments from structured settlements are income tax free and the benefits are guaranteed for life by insurance companies.” This sentence actually contains two inaccurate assertions: (1) that lump sum settlements are not tax free, and (2) the implication that all structured settlements are guaranteed for life. On the first point, under Internal Revenue Code § 104, all personal injury damage payments are excluded from income tax. This is true irrespective of whether the payment is a lump sum or received over time in a structured settlement [see IRC 104(a)(2)]. The second point, that structured settlement payments are guaranteed for life, is true in some circumstances but not all. Sometimes the payments are guaranteed for a time certain (for instance, 20 years), and then for the life of the payee thereafter, but this is not always the case. Many structured settlements are for a certain number of years only.

Finally, your story is replete with statements about the structured settlement payee’s inability to convert all or part of the future payments into either a present lump sum or to take a loan against the future payments. This is simply untrue. Forty-six states (including Pennsylvania) have structured settlement transfer laws which allow people, under some circumstances and with court approval, to sell future structured settlement payments, or to use the payments as collateral for a loan (see, e.g., the Pennsylvania Structured Settlement Protection Act, 40 P.S. 4001 et seq.).

I am general counsel to a company that provides such liquidity options to structured settlement recipients when needed. As your story accurately reports, structured settlements are a very valuable mechanism for settling personal injury lawsuits. In the vast majority of cases, the structured settlement works as planned. Occasionally, however, a life change or other unanticipated event occurs after the settlement and the payee finds that he or she needs more money than the periodic payments provide. In such circumstances, and within the rubrics of the various structured settlement transfer laws, part or all of the payee’s future payments can be sold (or pledged as security for a loan).

If you would like any further information on this topic, please feel free to visit our blog site (http://blog.setcap.com/), read the Wikipedia article on structured settlement transfers or “factoring”

(http://en.wikipedia.org/wiki/Structured_settlement_factoring_transaction), or contact me. Thank you for your attention to this matter, and for writing about this important topic.

Matt Bracy

General Counsel

Settlement Capital Corporation

14755 Preston Rd., Ste. 130

Dallas , Texas 75254 972-450-5864

 

In this third and final installment of my video interview with Jan Schlichtmann, Mr. Schlichtmann concludes his "cross-examination."  As always, I look forward to your comments.  You can reach me at mbracy@setcap.com.   

Click below for part 2 of Jan Schlichtmann's "cross-examination" of me on factoring issues.  As always, I look forward to your comments and questions.  You can reach me directly at mbracy@setcap.com

Late last year renowned plaintiff’s attorney Jan Schlichtmann (of “A Civil Action” fame) presented me with an interesting opportunity. He said he really didn’t like structured settlement factoring and had lots of questions about how it works and problems with the practice. I suggested that he “cross-examine” me, on video tape, with no script or preparation. For almost an hour we let the tape roll and had a very interesting conversation that I think you will find informative and provocative.

The first part of this video interview is available now (below), with the second and third parts to come soon.

This is the first article in a new series on structured settlement factoring basics. These articles will attempt to educate about factoring, open a dialogue on some basic factoring issues, and dispel rumors and misunderstandings. If there is a topic you think should be addressed here, please let me know.

“Servicing” refers to a common practice in structured settlement factoring transactions, where only part of a monthly or lump sum payment is purchased by a factoring company, but the factoring company receives the entire payment. Once received, the factoring company sends the unpurchased portion to the seller/payee. As explained below this is actually a good and necessary practice (contrary to comments by John Darer and Andrew Cravenho, who seem to not fully understand it).

Servicing can best be understood in the context of a typical factoring transaction. Here’s an example: Assume a payee receives $1,000 per month from a structured settlement. The payee has a need for a lump sum for some reason, let’s say it’s to replace an old and not working car.

First Question: How Much?

The payee (now “seller”) contacts a structured settlement factoring company, who first asks the seller how much money they need and why. The new car costs $20,000, and without reliable transportation the seller can’t get to work.

Second Question: How Many?

There are many options available to the seller to reach the desired funding amount, and many factors will go into this analysis. One option would be for the seller to transfer 100% of the monthly payments for a period of time. Under this scenario, the seller would transfer about a couple years worth of payments to generate the desired $20,000.

An obvious problem with this scenario is that it leaves the seller with no monthly income from the structured settlement during those years. Depending on the individual circumstances of the seller, that might be acceptable. For others who rely on some of that monthly income for fixed costs, that would not be the best alternative.

Another option would be to sell just a portion of the monthly payments. For example, the seller could receive $20,000 by transferring $500 per month out of the total $1000. Under this scenario, the seller would need to sell more months of payments, but will be keeping $500 per month throughout. For the remainder of this hypothetical example I will assume that this is the most desirable course for the seller.

Third Question: How’s it done?

Most structured settlement factoring transfers involve only part of the structured settlement payment stream. Sometimes that part is 100% of the payments, but only for a period of time less than the total payment stream (as in the first example above). Sometimes, probably most often, the partial transfer is of a part of the monthly payments or lump sum (as in the latter example above).

There are two ways to accomplish this kind of transfer. First, which is the easiest and preferred method, is for the insurance company that issues the payments to “split” the payments in question, sending the purchased part to the factoring company and rest to the payee/seller. However, in some cases and for a variety of reasons, the issuer will not agree to split the payments. When the payments cannot be split, the only other option is for the entire payment to be sent to the factoring company, who in turn sends the unpurchased portion to the payee/seller. This is called “servicing.”

In circumstances where the annuity issuer will not agree to split payments, servicing is the best alternative for the annuitant. Absent the servicing option, sellers would either not be able to factor payments at all, or would be forced to sell more payments than necessary (or more than is in their best interest to sell). I am not aware of any factoring company that charges a fee for servicing payments in this way. Payees receive their serviced portions promptly and generally experience no significant delay.

Such servicing arrangements should be reflected in the transfer order. Payees/sellers who later elect to sell more payments should be free to do so, and the order approving the subsequent purchase should simply reflect that the prior order is amended as to the servicing and the serviced portion should now go to the new factoring company.

If you have any questions about servicing or factoring in general, please do not hesitate to contact me at mbracy@setcap.com.

***Update 4/23/2008:  Messrs. Darer and Cravenho have both responded to this article on their blogsites.  My response is attached as a comment to Mr. Darer's blog post here.

A structured settlement factoring bill did pass the West Virginia legislature this year, and is at this moment on the Governor’s desk. This bill (HB 4613), which is anticipated will become law shortly, differs drastically from the original proposal that caused such a stir (see our last blog post, “What’s Going On in West Virginia?”). In addition to cleaning up some outdated provisions, the new law confirms that a judge may (not “must”) appoint a guardian ad litem in a transfer case, excuses the judge from being forced to give tax advice to the seller (now the judge is expressly allowed to inquire about tax issues of a guardian ad litem, if appointed, and the factoring company), and requires all attorney’s fees and costs to be paid by the factoring company. This is a very far stretch from the original bill, which would have been disastrous for West Virginians.

For more information on the West Virginia bill and my commentary on some of the political issues surrounding it, listen to my audio interview with Scott Drake of the Legal Broadcast Network by clicking here.

Pat Hindert and John Darer have both written about legislation proposed in West Virginia that would radically alter the current law there, as well as depart from the national model act and standards used in most states. As identified by Hindert, the proposed law, HB 4380, has three essential elements:

• Mandating that a guardian ad litem be appointed for every prospective seller
• Changing the standard for approval from “best interests” to requiring clear and convincing evidence that the transfer is to avoid a financial hardship (and is in the seller’s best interest), and
• Imposing a rate cap for discount rates equal to the average mortgage rate for 20 year mortgages (the average rate is thought to be around 6%, but the state Banking Commissioner has indicated that they do not track that and don’t want to).

Contrary to John Darer’s position, in my opinion none of these would be good for tort victims. In fact, each prong of this proposed new law effectively shuts the courthouse doors on tort victims who will never have their chance to sell structured settlement payments when they need to. They are also just bad public policy. ALL sellers would have to have a guardian ad litem appointed, irrespective of their sophistication or understanding. For the non-lawyers who read this, a guardian ad litem is a court appointed person, usually a lawyer, who is supposed to essentially act as that person’s parent in the matter before the court. (“A guardian ad litem is a special guardian appointed by the court in which a particular litigation is pending to represent an infant, ward or unborn person in that particular litigation…” Black’s Law Dictionary, 6^th Ed.). How insulting to tort victims. Does being a tort victim mean you are not capable of making your own decisions? Or is it because you are a structured settlement recipient? What does that imply about structured settlement recipients? Sure, some tort victims are truly not capable of making financial decisions, and the courts of West Virginia, like courts everywhere, already have the inherent power to appoint guardians ad litem in those cases. But should it be mandatory for all sellers, irrespective of their individual status?

Only sellers needing money to avoid “financial hardship” would be able to sell future payments under the proposal. This is vastly different from the common “best interest” standard, and again would restrict which West Virginians would be able to even make it into the courtroom to tell their story. Is getting a new prosthetic leg “avoiding a financial hardship”? Probably not. How about being able to attend college or a trade school. Again, most likely not. Should structured settlement recipients be able to sell their asset, future payments, to do these things. Maybe. But under the proposed law, they would never get to make that case, under any circumstances.

The “rate cap” is probably the most clear evidence of what this bill is really about. If the rate is capped at 6%, then the structured settlement factoring market in West Virginia is closed. Period. All funding companies in this business must borrow money to use in funding. 6% is far below the rate at which we can borrow, so each transaction would start at a loss, and just get worse. Don’t forget, we would also need to pay the guardian ad litem, and the attorney bringing the action, not to mention covering our overhead, and making a reasonable profit. Under this proposal, we would never get to this level of analysis, because a large “Closed for Business” sign would be hung at the West Virginia border. Customers like “Mr. Smith” (real person, real West Virginian, fake name for this article), a retired Veteran, would not have been able to sell some of his future payments to buy an oxygen machine to help him breathe.

What is this bill really about? Delegate Walters, the key sponsor and a structured settlement broker, has made it very clear that this is really about putting the factoring companies out of business in West Virginia. His bill would do just that. If that is the goal, then let’s debate that issue directly and not dress it up in all this costuming, pretending to be “consumer protection”. But, if the factoring companies are out of business in West Virginia, then West Virginians with structured settlements are out of luck when they experience a life change, not anticipated at the settlement table. They will no longer enjoy the same financial freedom and flexibility as their neighbors in Virginia, Ohio or Pennsylvania.

HB 4380 is bad law and bad policy, and everyone, including the NSSTA and Mr. Darer, should oppose it.