STRUCTURED SETTLEMENT PAYMENT TRANSFERS COMPETITIVE MARKET FORCES

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1 STRUCTURED SETTLEMENT PAYMENT TRANSFERS COMPETITIVE MARKET FORCES By: Andrew S. Hillman, President and CEO of Specialty Asset Advisors, Inc. for Seneca One Finance, LLC May 2015 Scope of this Article This article will discuss certain practices and strategies in the secondary market for structured settlements (secondary market) by some factoring companies of meddling with transactions in the secondary market with a view to winning transactions by offering better terms to a seller (commonly known in the vernacular as poaching ). This article will also discuss some insurance companies (annuity issuers ) forays into, and the impact upon, the secondary market. The Competitive Environment Can t Buy Me Love The secondary market is very competitive. While it is estimated that there are currently about $60 billion worth of payments from structured settlements (primary market), the reality is that only a very small fraction of those are available for purchase (Some estimate this to be in the $5-7 billion range, more than enough to go around one would think). This is due to a variety of factors including, among others, certain statutory restrictions on the sale of these payments (e.g., workers compensation payments, certain payments derived from certain federal lawsuits) and ERISA related payments). In addition, some factoring companies underwriting requirements restrict the purchase of payments to minors, payments to the mentally or physically challenged, payments to persons who have committed felonies, and other types of payments. And, providers of capital, buyers of deals and other investors restrict the purchase of certain payments they deem as too risky (e.g., so- called life- contingent payments or payments to be made too far out in the future). Some annuity issuers have ceased writing structured settlement annuities thereby potentially further decreasing the pool of available structured settlement payments to purchase. While this phenomenon has a lagging impact on availability of structured settlements to factor, it is beginning to have an impact on the secondary market. Additionally, some recipients of structured settlement payments (annuitants, or sellers) typically do not know that they have an outlet to sell their payments or even that the secondary market exists. Factoring companies must reach out to these folks to educate and explain to them that they indeed do have a way to receive money currently by selling their future structured settlement payments. Common methods of this outreach include television advertising, use of internet websites and search engines, direct mail and the increased activity of so- called court scraping where factoring companies manually, either themselves or through professional search services, review court records to determine whether a factoring company intends to or has purchased payments from a seller; and, if so, they can determine 1

2 from the documents filed whether more payments may be available for sale. Court scraping is an arduous, time consuming and expensive process but it can yield a wealth of information about (i) the availability of payments to buy, and their nature (e.g., whether the payments are guaranteed, life- contingent, or subject to other statutory restrictions, such as workers compensation laws or ERISA) and (iii) critical information about the sellers of the payments. Annuitants realize that there are more than a few factoring companies that would like to buy their payments. They increasing shop online where there is a bevy of companies pitching the best price, terms and fastest execution (i.e., getting sellers their money as quickly as possible). It is safe to say that many annuitants are becoming quite knowledgeable and savvy when it comes to selling their future payments for cash. They obtain quotes from more than one factoring company and often play one against another in their search for a better overall deal: i.e., getting the most money, from a reliable buyer, in the shortest period of time. Factoring companies know that competitors are vying for the same deals and that it is very difficult to find and identify those settlements. Of course competition is a healthy thing and should ultimately benefit a consumer in a free marketplace. Indeed, with the advent of (i) more market participants in the secondary market, (ii) readily available and cheaper credit for factoring companies, (iii) a robust tertiary (securitization) market and (iv) the payment certainty that is fostered by so- called transfer laws or SSPAs (discussed later), robust competition has generally lowered discount rates for sellers across the board. Indeed the great majority (up to 80-90%) of these transactions are approved by judges who find that the sales of payments is in the best interests of the sellers and their dependents, the statutory standard that must be met for approval of a sale under the SSPAs. The Rules of the Game Why Can t We Just Get Along? During representatives from the primary and secondary markets agreed upon model legislation (commonly known as the Model Act ) that was intended to provide for statutorily mandated, orderly sales and purchases of structured settlement payments. A concerted lobbying effort then ensued whereby some version of the Model Act (sometimes referred to in this article as Structured Settlement Protection Acts, transfer laws, or SSPAs ) were adopted by the States. SSPAs provide a roadmap to be followed by a purchaser of payments in order to obtain a court order approving the sale of these payments. SSPAs provide for, among other things, disclosures about the financial terms of the transaction, that a judge finds that the transaction is in the best interest of a seller and his or her dependents, and that an annuity issuer receives notice of the proposed transaction and has a right to object to it. The SSPAs were intended to strike a balance between a seller s rights to sell payments on the one hand, and, on the other hand, an annuity issuer s right to be protected when sending to a purchaser the payments. Annuity issuers took a paternalistic approach to their customers and were made comfortable by virtue of their compliance with the SSPAs. Moreover, to further protect consumers from uninformed decisions and to preserve certain federal tax advantages afforded to annuity issuers under the Internal Revenue Code ( IRC ), the IRC was amended to provide that a buyer of payments must receive a qualified order in accordance with an SSPA or, if not, be subject to a 40% excise tax on the transaction. Poaching Hey You, Get Off Of My Cloud 2

3 Factoring companies have developed myriad documents that a seller must sign in order to effect the sale of their payments. The operative document is the purchase and sale agreement ( sales contract ) pursuant to which a seller agrees to sell to a factoring company certain payments in return for a lump sum of cash. These sales contracts provide that certain conditions need to be met under an SSPA for a sale to be consummated. One of these conditions is that a court order must be obtained that approves the sale before the seller receives the purchase price. Sellers of payments are required to affirm that they have not signed any agreements to sell the same payments. Once a sales contract is signed a seller agrees that it will not sign a different agreement with a different buyer to sell those payments even though that seller may be getting a better deal. As was discussed earlier, one way for a factoring company to see whether payments are available for sale is to search court records. Through this mechanism, competitors can see that a request to approve a sale has been filed with a court pursuant to an SSPA. Armed with this information that necessarily includes the identity of the seller, the payments to be purchased as well any remaining payments on the annuity that could be available for purchase, a competitor- factoring company (Factor A) can swoop in and offer the seller a better deal, which usually translates into more money for the seller. But, what about the existence of a sales contract that the seller signed previously with Factor B? Has Factor A interfered with Factor B s deal thereby depriving Factor B of the benefit of its deal with the seller? Assuming that happens, and the seller is getting a better deal from Factor A, is it fair to the seller that it be forced to sell its payments to Factor B and receive less money? While it is beyond the scope of this article to present an extensive legal analysis of the nature of this activity, it is worthwhile to discuss this practice in general terms. In this competitive environment factoring companies aggressively solicit and negotiate with potential sellers of structured settlement payments for the same stream of payments before (and sometimes after) sales contracts are signed. This process is like an auction. During this process it is common practice to better a competitor s offer either through price, execution, or both. So long as this activity has not reached the stage of a signed sales contract; no harm, no foul. However, once a factoring company enters into a sales contract with a seller, reputable factoring companies will back off and not continue to pursue the seller with a purportedly more competitive deal. There are, however, certain outliers in the secondary market that use aggressive, questionable tactics to interfere with competitors contracts. This activity is decried by the secondary market s trade association (the National Association of Settlement Purchasers, or NASP ) and the majority of factoring companies. When this occurs, some factoring companies will sue these bad actors for tortious interference with their contract, in effect, stealing a deal from them. For the most part, the offending company will cease its negotiations with the seller and the initial transaction will proceed unfettered. But, not always. In a recent Texas case, a seller entered into a sales contract with a factoring company. When a competitor factoring company attempted to steal the deal it was sued by that factoring company for interference with its sales contract with the seller. Rather than go quietly and withdraw, and in the face of a signed sales contract, the defendant- factoring company shot back, claiming that the signed sales contract was not really a contract until a judge approved the sale, a requirement of a SSPA and a standard condition in sales contracts. The conclusion that the court drew was that since the sales 3

4 contract contained a condition that court approval was necessary to approve the deal and this had not yet been received, there was no sales contract to interfere with, that the offending factoring company did nothing wrong and that it could continue to pursue the seller s payments. The court agreed with the offending factoring company based upon its reading of the Texas SSPA that in order for a sales contract to be enforceable, a court order had to be obtained. Until that is achieved, held the Court, the sales contract had no legal validity. The holding in the Texas case is an aberration and in this writer s opinion flouts the intent of the SSPAs and the notion of fair play in a competitive marketplace. Taken to its logical extreme, if factoring companies could not be protected from poaching, even where sales contracts are extant, then every contract for the sale of payments that has not yet been court approved could be subject to being poached by other potential buyers. Admittedly, the impact of this case is limited to a specific area in Texas where the lawsuit was filed. That said, since the SSPAs are substantially similar among the states, it will be interesting to see whether this kind of activity will be pursued by factoring companies in other states. It is more than likely that most factoring companies will honor an existing sales contract and not pursue the payments. But, if smaller companies with fewer marketing resources than the larger factoring companies can poach deals in this way, it could theoretically afford them a less expensive marketing advantage over larger companies that rely very heavily on television and the internet as sources for leads. Again, this writer believes the Texas case was aberrational and its holding had little to do with the merits of the winning factoring company s legal arguments. The secondary market in general and NASP members in particular adheres to its Code of Conduct and is quite effective at policing itself. Insurance Company Forays Into the Primary Market A Horse Of A Different Color The Phenomenon of Insurance Company Factoring The financial success of the secondary market has received no little notice (and perhaps some envy) from annuity issuers that have substantial portfolios of structured settlement annuities. Insurance companies have long derided factoring transactions for unwinding transactions by flaunting IRC regulations that were intended to allow personal injury claimants to receive regular payments, receive them tax free, and prevent them from accelerating those payments in order to protect them from dissipating their settlement proceeds. Those same IRC provisions permitted insurance companies to take deductions for purchasing annuities to pay the underlying settlement, absolving them from liability for the settlement. Insurance companies were concerned that these tax benefits could be negatively impacted (with the effect of harming the primary market) if structured settlement transactions were factored. When the Model Act was agreed to, there was adopted a concomitant amendment to the IRC that served to negate these concerns. Thus factoring transactions could go forward (with the reluctant acquiescence of insurance companies), sellers would benefit from protections afforded by SSPAs and insurance companies tax benefits would not be adversely impacted if they obeyed a court order directing them to pay a factoring company directly. 4

5 Some insurance companies that had portfolios of structured settlements wanted to find a way to purchase these payments from their own customer/annuitants: what was good for the goose would be good for the gander! The benefits and advantages of this tact were clear: (i) easy identification of annuitants from their own records; (ii) easy and inexpensive marketing costs; (iii) already developed infrastructure, knowledge and wherewithal to purchase and service payments; and (iv) ability to provide a valued customer service at competitive rates. The combination of earning reasonable spreads on the transactions and, as importantly, retiring their own obligations (i.e., buying out their own annuities), was quite enticing. And, ancillary to that, this could be something with which factoring companies might have difficulty competing. A hurdle that insurance companies had to jump to do this revolved around federal tax issues and whether they could factor these payments without adversely affecting the tax treatment afforded them under the IRC, as previously discussed. The legislative framework that was established by the SSPAs and the amendments to the IRC was intended to level the playing field between the primary and secondary markets. So that if an annuity issuer complied with the SSPAs in their own factoring activities, they could buy these payments without incurring an excise tax. Below are a few examples of the approach a few insurance companies have taken. The Berkshire Hathaway Approach Today, Berkshire Hathaway is one of the largest issuers and owners of structured settlement annuities. As a result, factoring companies very often purchase Berkshire issued annuity payments. In recent years Berkshire has attempted in various states to bootstrap on factoring companies petitions for approval under the SSPAs. In order to purchase those payments, under the SSPAs, factoring companies must provide notice to the owners of the annuities and the annuity issuers of the proposed transfer of annuity payments. It is in this way that Berkshire (and other carriers) discover a factoring transaction is in process. If Berkshire determines that it wants to vie for the payments it does so in a very unorthodox way. Typically, just before or sometimes at the hearing Berkshire will send a letter to the judge and/or file an affidavit with the court offering to buy the payments being sold at a rate that is lower than the rate being offered to the seller. This activity could be characterized as interfering with an existing contract between a seller and a factoring company. And, at least one court in Texas found that to be the case. Interestingly, Berkshire maintains that it does not intend to profit from the transaction. In fact, it maintains that if the factoring company meets or betters Berkshire s offer, that Berkshire will withdraw from the matter. The clear implication of this, according to Berkshire, is that Berkshire s actions are solely to protect the seller of the payments. That may or may not be so, the point being that Berkshire is not following the same rules that factoring companies must follow to transfer payments and that this activity violates the spirit and intent of the SSPAs. There have been a number of reasons for which judges have refused to entertain Berkshire s offers. These include that Berkshire s appearance comes too late for an objection to the transaction and that Berkshire has not followed the other procedural and substantive procedures required under the applicable SSPA (e.g., providing disclosures to the seller, demonstrating best interest, etc.). Yet, there have been occasions where judges have allowed Berkshire to intervene and consummate its deal with a 5

6 seller mostly because factoring companies have withdrawn their offer in the face of expensive litigation with Berkshire over the issue. But the Berkshire approach contains a number of potentially fatal flaws and is fraught with potentially adverse consequences to Berkshire. As was discussed earlier there exists a statutory procedure to obtain court approval of factoring transactions under the SSPAs. This procedure necessarily implicates IRC provisions that were intended to be a safe harbor from potential tax liability for buyers of structured settlement payments. As discussed, the amended IRC provides for the imposition of an excise tax of 40% against a purchaser of structured settlement payments that does not comply with an SSPA. One wonders why Berkshire continues to employ such tactics. It seems apparent that Berkshire is opening itself up to potential tax liability in the form of the excise tax penalty because there is a legitimate question under the IRC whether the activity of Berkshire rises to the level of factoring as opposed to Berkshire s position that it is merely accelerating the payments. This appears to be a distinction without a difference. Lately, however, Berkshire has realized that compliance with an SSPA might be wise to insulate them from any potential excise tax liability. But, they seek to do so after a judge agrees to allow Berkshire to accelerate the payments. Moreover, Berkshire does not assist a seller to obtain court approval and will not pay for any costs (e.g., lawyers fees, filing costs, etc.) associated with that, as factoring companies do. This places a financial burden on a seller that could vitiate any savings it may have by taking the Berkshire offer. Suffice it to say that any insurance carrier that goes down this path does run the risk of the imposition of the excise tax. The IRS has not, to this writer s knowledge, taken up this issue. And, more importantly, until the IRS imposes an excise tax on Berkshire for this activity, it is likely that Berkshire will continue to attempt to ignore the SSPAs in order to obtain a competitive advantage over factoring companies. Interestingly, to date, no other annuity issuers have gone this route. The Symetra Financial Approach Symetra Financial (formerly known as SAFECO) has exited the primary market. Symetra has delved into the secondary market in the appropriate way through a division of Symetra called Clearscape Funding. The model that Symetra uses follows the framework and procedures that factoring companies use when purchasing structured settlement payments. Symetra has found a way to provide their customer/annuitants a service while at the same time complying with SSPAs and the IRC. In contrast to the Berkshire method, Symetra markets by various methods (e.g., mailers, etc.) this cash- out service to its customers. Symetra follows all of the procedures required under the applicable SSPAs, operates on the same playing field as the factoring companies, and competes on price and execution, the same as do the factoring companies. Often times Symetra competes with other factoring companies for the same transactions. It appears that Symetra is now in the business of factoring only its own annuities, thereby emphasizing that this is being offered merely as a service to its annuity customers in that it is not competing in the broader secondary market. The Allstate Life Insurance Company Approach 6

7 In the early 2000s, Allstate introduced its Advanced Funding Exchange Notice which offers an Allstate annuitant an option to cash out a portion of their structured settlement annuity, as long as the applicable SSPA has been complied with. Allstate does this through the use of commutation riders that are sent to their customers in periodic mailings or with their annuity payments. Again, as in the case of Symetra, Allstate is providing its customers with a cash- out service that is limited to its own annuities. And, Allstate purportedly complies with the SSPAs when it customer decides to do this. While, as with Symetra, these programs might limit other factoring companies ability to buy Allstate annuity payments because of potential (but not necessarily) better price and execution, they are transacted on a level playing field and the marketplace (not bad actors nor short cuts) will determine which competing offer wins the transaction. Hardship Conversions In 2014 the IRC determined that insurance companies that write structured settlement annuities are permitted to grant to annuitants Hardship Conversions without either an annuitant or an annuity issuer incurring any adverse tax consequences. These Hardship Conversions allow an annuitant to request that insurance companies covert certain payments due under a structured settlement annuity for specific reasons outlined by the IRS. These reasons include financial hardships due to: medical expenses, expenses related to a terminal illness, home improvement expenses for handicap accessibility, job loss, loss of home and the same types of expenses for an annuitant s dependents. Importantly, in order to transfer payments under a Hardship Conversion, a court order must be obtained in accordance with SSPAs and IRC Section It remains to be seen whether these Hardship Conversions will be implemented by insurance companies and whether these new features that are built into structured settlement annuities will have a deleterious impact on the secondary market. Annuitants may decide to choose this option rather than seek a lump sum payment from a factoring company. But, since the criteria to obtain a hardship conversion is narrower than many best interest reasons, annuitants may find they need to go to a factoring company to receive a lump sum for their payments. There is currently no evidence that any annuity issuers will implement a Hardship Conversion save for one that is apparently currently considering it. Observations As we have seen, there is robust and increasing competition in the secondary market from within and without. Fierce competition among factoring companies for a relative paucity of and difficulty in identifying potential transactions has created poaching both directly by factoring companies themselves, and indirectly by at least one insurance company. Moreover, at least two insurance companies (and there could be more) have determined to provide cash- out services in accordance with the rules of the game with marketing and back office advantages over most factoring companies. Whether insurance companies implement the Hardship Conversion and what impact that might have on the secondary market remains to be seen. It is safe to say that the secondary market is smart and nimble, will weather this competition and continue to provide consumers a much needed ability to receive badly need cash now. 7

8 Andrew S. Hillman, Esq. is President and CEO of Specialty Asset Advisors, Inc. ( a consulting firm that offers a full range of services to the advance funding industry. Seneca One Finance, LLC ( is one of the nation s largest purchasers of structured settlement payments, assignable annuities, lottery winnings and other Specialty Asset Advisors, Inc. All rights reserved. This publication does not purport to give legal or tax advice and may not be used to avoid penalties that may be imposed under the Internal Revenue Code. 8