Structured Settlement Annuity Companies’s Business Model

Structured Settlement Annuity Companies Business Model – Unicornomy

Structured Settlement Annuity Companies USA
Structured Settlement Annuity Companies USA

About Structured Settlement Annuity

Something different this time.. Same old, stupid, no money, no honey business model examples bore me a lot.

So I thought why not analyze some business model that is close to my heart – Time Discounting!  This is also called as “Factoring”.

Time / Bill Discounting is a Business model that discounts the value of future cash flows and gives out a lump sump at today’s value of money.

This is a big business model in the US and Japan where you buy out the structured settlement of the plaintiff and give them a lump sum in today’s value.

Let’s look at this in detail.

In USA, when ever some one gets injured because of the acts of a third party either involved directly or indirectly, the injured party called “claimant / plaintiff” sues the third party for compensation.  This is very large industry in the USA. The compensation, if the claimant wins is granted in the way of either a lump sump payment or as a structured settlement.  The sued party called the “Defendant” agrees for a pre-negotiated financial payment scheme between the claimant and themselves and that is knows as structured settlement.

Both agree to resolve a personal injury claim by allotting some part of the settlement in the form of periodic payments with an pre-decided schedule. The increased popularity of the structured settlement was due to rulings by U.S. Internal Revenue Service (IRS) deeming this as tax free, dramatic rise in personal injury case and their awards and higher US interest rates.  The payment to the plaintiff is by way of purchase of regular annuity plan by the defendant through an insurance company which will generate the future structured settlement payments.

How Structured Settlement Annuity Companies Work?

Structured Settlement Annuity Companies : Now please read this carefully – This is the logic behind working of structured settlement annuity companies.

  1. Len Drives a Car and rams into Tara
  2. Tara gets permanent disability, is unable to work
  3. Tara Sues Len
  4. Len pleads guilty
  5. Court grants $10 million to Tara in the form of structured settlement annuity
  6. Many times the plaintiff is not happy with the structured settlement but instead wants lump sum money
  7. She then approaches structured settlement annuity companies to buy out her annuity plan and give her a lump sum
  8. The structured settlement annuity company discounts the future cash flow value to today’s value and offers that as the lump sum to Tara
  9. Tara accepts the lump sum and transfers the right to receive the structured settlement annuities to the discounting company.
  10. The discounting company then makes money in future (with interest based on discounting it by interest rates to Tara).

Read this for Clarity on Financial Business Model : How do Banks Make Money

Structured Settlement Annuity Companies

How Structured Settlement Annuity Companies Work
How Structured Settlement Annuity Companies Work

Image Courtesy  :

The above image gives a very comprehensive over view of how structured settlement buyers work.

How Structured Settlement Annuity Companies Work

Consider this – Every month you deposit 5000$ in bank as a fixed deposit which will earn you interest income and will be paid out at the end of 10 years.  You money will grow every month by way of interest and by way of further funds being infused by you into the account.

Now consider a reverse scenario, you get a loan from a bank for which you are paying 5000$ as EMI every month, what you pay over and above the principal amount is the Interest.

In both the cased since one amount is fixed the $5000 one, the second amount varies, now in the case of structured settlement companies the amount of $5000 is fixed (assuming you get granted that amount in your structured settlement) they reverse calculate as to how much money you would make if you were given out a loan today so as to make an EMI of $5000 for the next tenure of your annuity.

Once they arrive on that figure, they keep some margin for themselves in order to make money and offer you a lump sum.

Different companies offer different rates and different lump sum amounts and you can choose basis the maximum amount that you are getting.

The business model here is keeping the surplus cash generated out of discounting the annuity payment.

Following is an example of reverse calculation, From my understanding they are discounting this by 8.5-9% which is really good in US because bank rates are horrendous.

How Structured Settlement Annuity Companies Work
How Structured Settlement Annuity Companies Work

Structured Settlement Annuity Companies Business Model

The business model of structured settlement annuity companies is primarily dependent upon give a good rate to the structured settlement and getting the future annuities in return.

These companies are primarily large hedge fund companies who have assets under management and they have to generate a decent return for the investors.

Assuming these companies are giving out returns on the basis of 7.5 – 8% means the lump sum investment (that they give to the seller) is yielding at least 9.5% – 10.5% by the insurance company by investing in sovereign bonds of countries like India, China etc.

Read this for Clarity on Financial Business Model : How do Insurance Companies Make Money

Disclaimer : This is just an illustration of how structured settlement annuity companies work.  This is not an offer to buy.

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