Structured Settlements Secondary Market and Factoring 1 — Questions and Answers
Question 1: What is the 'discount rate' in a structured settlement factoring transaction?
- The Federal Reserve's benchmark interest rate
- The annual interest rate used by the factoring company to calculate the present value it will pay for future payment rights (Correct answer)
- The life insurer's internal rate of return on the annuity
- The IRS-mandated rate for valuing structured settlements
Correct answer: The annual interest rate used by the factoring company to calculate the present value it will pay for future payment rights
The discount rate is the annualized rate the factoring company applies to convert future payment rights into a present-value lump sum, directly determining how much the payee receives.
Question 2: What is 'present value' as used by factoring companies when pricing a purchase of structured settlement payments?
- The total of all future payments being purchased
- The lump sum a factoring company will pay today, which equals the future payments discounted back at the factoring company's required rate of return (Correct answer)
- The original cost of the annuity to the defendant
- The IRS-approved value of the payment stream
Correct answer: The lump sum a factoring company will pay today, which equals the future payments discounted back at the factoring company's required rate of return
The factoring company calculates the present value of the payment stream at its own discount rate (profit margin included) to arrive at the purchase price it will offer the payee.
Question 3: Under IRC §5891, to avoid the 40% excise tax, a factoring company must obtain what?
- IRS pre-approval of the discount rate used
- A qualified order — a court order approving the transfer that meets all applicable state SSPA requirements (Correct answer)
- Approval from the original defendant's insurer
- A waiver from the annuity issuer
Correct answer: A qualified order — a court order approving the transfer that meets all applicable state SSPA requirements
IRC §5891 requires a 'qualified order' — defined as a final court order approving the transfer that satisfies state SSPA requirements — to avoid the 40% excise tax on the discount amount.
Question 4: What is 'double-dipping' in the context of structured settlement factoring?
- A claimant selling the same payments to two different factoring companies (Correct answer)
- A practice where a factoring company applies the discount to the gross rather than net payments, inflating the effective rate
- Applying for court approval in two states simultaneously
- A claimant receiving both a lump sum and continued periodic payments
Correct answer: A claimant selling the same payments to two different factoring companies
Double-dipping refers to a claimant (fraudulently) selling the same future payment rights to more than one factoring company, which is why title searches of prior transfers are conducted.
Question 5: What information must a factoring company typically disclose to a structured settlement payee before the payee signs a transfer agreement?
- Only the lump sum being offered
- The gross advance amount, the present value of payments sold (at a standard rate), the net amount payable, and the effective annual discount rate (Correct answer)
- Only the annuity issuer's name
- Only the court in which approval will be sought
Correct answer: The gross advance amount, the present value of payments sold (at a standard rate), the net amount payable, and the effective annual discount rate
State SSPAs mandate comprehensive disclosure so the payee can evaluate the true economic cost of the transaction, including all fees and the effective annual percentage rate.
Question 6: What is a 'best interest' finding in the context of structured settlement factoring?
- The factoring company's determination that the transaction is profitable
- A court's finding that the transfer of payment rights is in the best interest of the payee, considering financial needs and dependent welfare (Correct answer)
- The IRS's determination that the transaction is tax-compliant
- The annuity issuer's consent to the transfer
Correct answer: A court's finding that the transfer of payment rights is in the best interest of the payee, considering financial needs and dependent welfare
State SSPAs require the approving court to make an affirmative finding that the transfer serves the payee's best interest, acting as a safeguard against exploitative transactions.
Structured Settlements Secondary Market and Factoring 1
What is the 'discount rate' in a structured settlement factoring transaction?