Mike Green, an attorney based out of Philadelphia who represents several structured settlement factoring companies published an informative article on the Settlement Capital blog late last week. There are a couple of points that were mentioned in the article that I would like to discuss.
In the article published by Mr. Green, he explained the concept of an annuity's present value. I would like to provide a few examples on the concept.
"In order to place a present value on an annuity’s payments, a discount rate must be applied to account for the decreased value of those future dollars.The higher the rate, the lower the present value.The lower the rate, the higher the present value."
Example A: Discount Rate= 20% and Present Value= $40,000
Example B: Discount Rate= 10% and Present Value= $100,000
As you can see, the higher the rate, the lower the present value, thus the lower the rate, the higher the present value of the annuity. Feel free to use our present value calculator to calculate the present value of your annuity.
IRS Discount Rate
The IRS discount rate is present in documents received by the annuitant when transferring the rights to their structured settlement payments. This rate is artificially low and confuses the annuitant because the annuitant compares the IRS rate to the rate offered by the structured settlement factoring company purchasing the rights to the payments.
Every structured settlement factoring company "borrows" money in order to purchase the rights to an annuity. There is no way for any company to borrow money at a 4% rate to match the rate listed by the IRS. When an annuitant views the effective discount rate associated with the transaction and then views the IRS rate, many annuitants question the overall validity of the transaction.
The IRS's rate of 4.2% is artificially low to increase the present value, which in turn will increase taxable revenue. With this said, what is the rate to be used by a state's Guarantee Association to calculate the present value of an annuity if an insurance company defaults? Currently there is no listed rate by any Guarantee Association.
High Discount Rates
There are certain transactions where the discount rate of a transfer can exceed 20%. This does not necessarily mean that the annuitant is receiving a "bad" deal. The circumstances that create a discount rate which exceed 20% are usually caused by one of two reasons:
- The payments being transferred are in the very near future, usually within a year or two.
- The present value of the annuity is near or under $10,000.
Transactions that exceed the 20% threshold will become more prevalent in the near future due to the increase in inflation caused by the downturn in the economy. I believe that if a judge thinks an annuitant can receive a better deal by going elsewhere, the judge has an obligation to require the annuitant to obtain quotes from other companies before approving the transaction. It should not be a judge's responsibility to know the overhead of a company when approving a transaction. If a different company can complete the transaction at a cheaper rate, then they should have the opportunity to provide the annuitant with the increased funds.