Sell Structured Settlement Financial Considerations 1 — Questions and Answers
Question 1: What is the 'present value' of a structured settlement payment stream?
- The total dollar amount of all future payments added together
- The current worth of future payments discounted at a given rate (Correct answer)
- The amount the annuity issuer paid to fund the settlement
- The court-appraised value of the payments
Correct answer: The current worth of future payments discounted at a given rate
Present value is the current lump-sum equivalent of future payments, calculated by discounting each payment back to today's value using a specified discount rate.
Question 2: Why does a higher discount rate result in a lower lump-sum offer to the payee?
- Higher rates mean more court fees are charged
- A higher discount rate reduces the calculated present value of future payments more aggressively (Correct answer)
- Higher discount rates increase annuity issuer costs
- Higher rates require larger cash reserves from the factoring company
Correct answer: A higher discount rate reduces the calculated present value of future payments more aggressively
The discount rate is subtracted from future payment values to calculate today's worth — a higher rate means each future payment is discounted more steeply, producing a lower lump sum.
Question 3: What typical discount rate range do factoring companies apply when purchasing structured settlement payments?
- 0–3%
- 3–8%
- 9–18% (Correct answer)
- 25–40%
Correct answer: 9–18%
Factoring companies commonly apply discount rates in the range of 9–18%, though rates can be higher, representing the buyer's profit margin on the transaction.
Question 4: What financial concept explains why receiving money today is considered more valuable than receiving the same amount in the future?
- Compound interest effect only
- Time value of money (Correct answer)
- Inflation risk premium
- Liquidity preference theory
Correct answer: Time value of money
The time value of money principle holds that a dollar today can be invested to earn returns, making it worth more than a dollar received at a future date.
Question 5: If a payee is offered $50,000 today in exchange for payments totaling $100,000 over the next 10 years, what does this imply about the discount rate?
- The discount rate is 0%
- The discount rate is very high, significantly reducing the present value (Correct answer)
- The present value equals the face value
- The factoring company is charging a standard fee only
Correct answer: The discount rate is very high, significantly reducing the present value
Receiving only $50,000 for $100,000 in future payments indicates the discount rate applied is quite high, reducing the present value to half the nominal amount.
Question 6: Which financial metric allows a payee to compare the cost of selling structured settlement payments to taking out a traditional loan?
- Gross discount percentage
- Effective annual interest rate (EIR) (Correct answer)
- Internal rate of return
- Net present value
Correct answer: Effective annual interest rate (EIR)
The effective annual interest rate expresses the transaction cost as an annualized rate, making it directly comparable to loan interest rates.
Sell Structured Settlement Financial Considerations 1
What is the 'present value' of a structured settlement payment stream?