Tax Issues
Unlike structured settlements, where principal and interest are tax-free, re-factored annuities are essentially cash investments, just like stocks or corporate bonds. This means they are subject to any applicable federal, state or local taxes. They fall into the category of an after-settlement investment–without the unique tax benefits of a structured annuity or even lump sum payment negotiated during a settlement or mediation hearing.

Injured parties who opt for a re-factored annuity as part of settlement will owe taxes on each periodic payment received. Clients may be enticed by the higher rates of return often offered by a re-factored annuity (typically the main draw for these investments), but when determining the real rate of return after taxes, actual income can be similar to a traditional structure depending on the injured party’s tax bracket.

Safety Concerns
In general, life companies are not allowed to re-direct annuity payments from the factoring company that purchases the annuity to an investor. This means, injured parties who choose a re-factored annuity are receiving their income stream from the factoring company, not the life company (although the life company is still obligated to make the original payments).

Whether the injured party continues to receive the promised payments from a re-factored annuity depends on the factoring company’s financial stability. If the factory company fails, legal questions have arisen as to what happens to the stream of payments to the injured party. Although unlikely, if a life company fails, the injured party may not have protection rights under state guaranty laws. Whereas a structured settlement has multiple layers of protection, re-factored annuities have no safety net and are exposed to the same investment risks as any other market-driven investment.

What’s more, when the original owner of the structured settlement dies, the annuity may be challenged by creditors, ex-spouses, beneficiaries of the annuitant and others. Finally, state insurance regulators are pushing for legislation that would permit life companies to terminate benefits in the event of a change in ownership or assignment. If this legislation is successful, this would eliminate re-factored annuities altogether.

Comparing traditional structured settlements with re-factored annuities is like comparing apples to oranges. Tax obligations, safety worries and legal uncertainties that come with re-factored annuities are typically not what injured parties want or need when seeking long-term financial security for themselves and their families. Pooled re-factored annuity investments should be evaluated thoroughly and vigilantly with full disclosure of their pros and cons to an injured client.

The New York case, In The Matter Of The Petition Of J.G. Wentworth Originations, LLC and Allia Rahman, No. 216362011 (N.Y. Sup. Ct. Dec. 14, 2011), involved factoring company J.G. Wentworth and its attempt to transfer payments due to be paid to Allia Rahman. J.G. Wentworth was proposing an annual discount rate of 17.78 percent as part of the transaction. The aggregate amount of the transferred payments came to $89,237.77. Using the annual discount rate of 17.78 percent, Rahman would have received only $12,500, about 20 percent of what she would have received if she did not transfer the annuity payments to the factoring company.

Justice David J. Elliot ruled that J.G. Wentworth failed to demonstrate that the transfer was in Rahman’s best interest or that the transfer was fair and reasonable, in part, because of the high discount rate. He pointed to the New York lottery’s 10 percent transfer law as a possible guideline for structured settlement discount rates.

Currently, the California State Structured Settlement Protection Act does not set a cap on discount rates. While California judges have the discretion to deny a transfer if they deem it not in the best interest of the injured party, having a cap could help ensure the payee receives a larger percentage of the settlement proceeds.

Thank you Peter Vodola, partner with Seiger Gfeller Laurie LLP in West Hartford, Connecticut, for bringing this case and issue to my attention. For more analysis, go to Pete’s blog.

For a copy of the opinion: Click Here.

Feel free to email me with any structured settlement questions at p...@patrickfarber.com or call 800-734-3910.

That’s demonstrated by the judicial opinions in which courts take a closer look at proposed transfers of structured settlement payment rights and inquire into the details of the payee’s financial situation.

In a recent example, Whitney v. LM Property & Casualty Ins. Co., (N.Y. Sup. Ct. June 24, 2011), the court denied a request by the plaintiff, Charlotte Whitney, to transfer a portion of her structured settlement payments to a factoring company, Settlement Funding of New York (also a plaintiff). Whitney had already sold approximately $252,000 of her structured settlement payments to Settlement Funding in three previous transfers over three years. In return, she received approximately $92,000 from the factoring company (an affiliate of Peachtree Settlement Funding). Whitney wanted to sell an additional 156 monthly payments of $500 each and two future lump sum payments of $10,000. The total amount of the payments that would be transferred in the latest deal would be $98,000 and in exchange, Whitney would receive $12,409.47 from Settlement Funding

The court refused to allow the latest transfer because it was not convinced that the transfer would be in the payee’s best interest. The court noted that previous transfers did not fulfill the stated goals of helping Whitney purchase a home, secure transportation and pay off loans. Instead, the court said she has continued to amass debts. The court also held that the Peachtree affiliate did not properly serve its hearing notice on Whitney.

Without the important safeguard of court review, structured settlement payees like Whitney would continue to sell off settlement payments designed to provide a steady, reliable income stream at a fraction of what they are worth. And, as seen in the above example, factoring companies would be only too happy to accommodate them.

For a copy of the ruling, go to Whitney Opinion.

Thanks to Peter J. Vodola, a partner in the West Hartford, CT law firm of Seiger Gfeller Lauriee LLP, who brought the ruling to my attention and who recently analyzed the opinion (opinion analysis).

Pete often represents insurers in matters involving structured settlements, and has won dispositive rulings for his clients under several state structured settlement protection statutes. He also counsels insurers and brokers on business and litigation matters involving structured settlement annuities and other insurance products. To contact Pete directly, go to 860-760-8419 or pvod...@sgllawgroup.com.

- Patrick Farber

Image: basketman / FreeDigitalPhotos.net

Pat Farber’s Structured Settlements Alert : August 25, 2010

A Wall Street Journal article recently shed light on a relatively new way factoring companies are earning income from structured settlement annuities.  In settlements involving personal injuries and some non-personal injuries, the injured party often agrees to an annuity that pays out settlement funds over time instead of in a single lump sum.  The annuity income is tax-free.  In addition, structured settlements enable injured parties to better plan their financial future.  However, when an unforeseen financial emergency arises and money is needed fast, injured parties can sell their annuities for cash to factoring companies at deeply discounted rates.

According to the Wall Street Journal, factoring companies are now selling the purchased annuity streams of income on the secondary market, often promoting these financial vehicles as “guaranteed” with high rates of returns.  In reality, the secondary market for these investments can be fraught with risk.

Click here to read the full article.

Patrick C. Farber Structured Settlements Broker with more than 30 years experience, Pat has placed over $1.75 billion in annuity premiums and U.S. Government notes. He specializes in settlements involving medical malpractice, physical injury, non-physical injury, product liability, workers’ compensation, mass torts, punitive damages, employment, construction defect cases and attorney fees in court hearings, arbitrations and settlement conferences–all at no cost to clients. E-mail Pat personally at p...@patrickfarber.com or call 800-734-3910.