The Value of Money Over Time: Structured Settlements and How Other Financial Situations are Impacted by Time


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1 The Value of Money Over Time: Structured Settlements and How Other Financial Situations are Impacted by Time Founded in 1988, Settlement Capital Corporation is credited with establishing the secondary market for structured settlement payments. Since then, we have maintained a leadership position in preserving the rights of individuals to access their structured settlement assets to resolve financial difficulties and to improve their lives. We help people who have money tied up in structured settlements liquidate all or a portion of their payment streams to meet their immediate financial needs such as medical expenses, education cost, home or automobile purchases or new business opportunities. Since structured settlements are rigid and inflexible plans, they often fail their intended purposes, particularly in cases where the individuals receiving the payments are struck with a financial emergency. We structure our transactions based on each clients' specific financial requirement and only acquire the portion of their payment stream that's necessary for them to fulfill those needs. Our transactions are structured similar to the way a bank structures a home loan or the US Government structures a Treasury Bond. Although our transaction is a purchase an not a loan, they both deal with the depreciation of money over time. One of the big misconceptions is the discount rate used to determine the present day value of the future payments. Settlement Capital Corporation will discount the future payments anywhere between 14.5% to no more than 21.5% to the client. The rates will vary due to the independent payment streams, length of term purchased, insurance company, state law, and difficulty involved in the transaction. One of the most difficult concepts of our business is grasping the concept of Time Value of Money. This is not an easy subject at first glance. One of the most common mistakes made is assuming a future payment is going to hold its value over a long period time. In reality, the further out the payment, the less it is worth today. We have created some scenarios of common everyday financial transactions that are similar to the purchase of an annuity policy. These scenarios should provide a clear picture of how money is affected over time. To begin, we will demonstrate the original value of an annuity policy when it is first purchased. Once the insurance company and claimant have agreed to the terms of the settlement, the insurance company will purchase an annuity policy for the claimant. The insurance company will invest a lump sum of money for this policy and earn interest on the money to insure the payout over time. Over the last twenty years, policies have averaged around 6.0% rate of return.
2 The present day value of a $100,000 annuity policy bought last year at 6.0% would pay out to the client 240 monthly payments of $ At the end of the 20 years (240 months), the client will have received $171, As you can see, the present day value of the policy is worth much less than the future value of all the payments. The chart above shows the percentages of the present day value and the interest accrued over time. Now that we know how the annuity policy accrues interest, lets look at a simple home loan that is more commonly used. If someone buys home for $150,000 and you finance the entire amount at a rate of 8.25% for 30 years, your monthly payment will be $1, (this is not including insurance or any other costs associated with the home). After you have made a total of 360 monthly payments of $1,126.90, you will have paid a total of $405,684 for your house that originally only had a present day value of $150,000. Total Amount Paid Breakdown $450, $400, $350, $300, $250, $200, $150, $100, $50, $ $150, Present Day Value of Home $255, Interest Paid $405, Total Future Value of All Payments
3 As you can see, the total future value of all the payments total 2.7 times more than the original present day value of the home. Will the home be worth $405, in thirty years? Probably not, but home owners understand the time value of money attributed to paying for their own home. The US Treasury Bond uses the same principles to calculate the present day value and the future value. A US treasury bond purchased on August 1998 at 6.032% had a present day value of $31,780. The total future value of the US treasury bond will be $100,000 due August 2017.
4 So how is it possible that the US treasury department can turn $31,780 into $100,000? The answer is time. The money earns interest over time and the more time involved the more interest that is accrued. The US treasury bond even accrues interest on its interest. As the Chart above shows, the future value has a significantly higher value than the present day value of the US Treasury Bond. The chart shows how the future value
5 drastically declines in value the closer you get to the present day value. Payments due in the future are just not worth as much today. Finally, we will look at a state funded lottery. Most state lotteries are paid out through the state s lottery commission. Arizona and Colorado are just a couple of examples of states whose lottery is paid out by an annuity. The state lottery commissions actually buys an annuity to pay their winners out over time. Most states now give the winners an upfront cash option. For example in Texas, you have the freedom to choose if you want the money over time (25 years) or if you want the money in a lump sum immediately. Obviously, the money over time will be much greater than the upfront cash option. This is how the Texas Lottery Commission determines how much a client will receive if they choose the money in a lump sum. With Cash Value Option, a player will receive approximately one half of the estimated jackpot. This is the amount that would have been used to purchase a 25year investment if the player had chosen annual payments. That amount will vary with interest rates so there is no fixed percentage that a player will receive. The other half is the interest that would have been earned if the player had chosen to receive the payments over 25 years. Obviously, there is no need to show a chart where the client is getting half the value of the future payments in a lump sum check today. Most state lotteries have the cash value option with their lottery. In fact, of the more than 40 state lotteries, all of them have a cash value option when you purchase the ticket or claim your prize. Plus, if you originally decided to take the money over time, there are 22 states that allow you to sell your lottery payments to companies like Settlement Capital for a lump sum of cash with the courts approval.
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