I’m guessing JP Wentworth creates a loan for the lump sum of the settlement, and makes money from collecting on the interest. Their commercials are getting pretty lavish, so I guess they’re enjoying some measure of success in these hard times.
So are there really that many lawsuit and lottery winners? Or are there other means of getting “structured settlements” that I don’t know about, and how can I get one?
they offer you a percent of the value and keep the difference
For a string of payments in the future, you can calculate what’s called the “present value.” I’m not going to go into all the details (this wiki article gives an overview). But, basically, you can come up with a value today that equals the value of all these future payments.
What these companies do, then, is pay you something less then the present value of all the future payments. That’s how they make their profit.
It’s definitely profitable, since the company has no reason to enter into the transaction unless it will be profitable. They will only give some percentage of the present value, and they decide the percentage.
Your question seemed to be more about the size of the market–who else might use this service besides lottery and lawsuit winners. I wonder if pensions, divorce settlements, or child support qualify as structured settlements for this purpose, if they are in the form of a series of payments?
Ok, I see I didn’t answer this part of your question. There’s all sorts of ways you can get structured payments in the future. For example, some people are the beneficiaries of trusts or annuities (sometimes set up by rich relatives). Sometimes, people get structured buyouts to get them to leave a job. Or, sometimes people make loans to other people.
I’d say your best bets are to win the lottery or get a rich uncle.
Theoretically, I suppose. But you’d want to include the risk of default in determining what percentage of present value to pay out. For a lottery winner, the risk of default is pretty non-existent, since most states do some sort of Federal bond investment for the payouts. But for a divorce settlement (except for rich people), the risk of default is pretty high. I can’t imagine that it’s typically done (except for rich people).
I’m being pedantic here, but this is GQ, it’s what we do. This post acts like there is a single present value for a stream of payments. But that’s not the case. Rather, the present value must be calculated using a “discount rate,” which is the same thing (but the opposite, if you get my drift) of an interest rate. For example, if I loan you $100 and you must pay me 10% interest plus enough principal so the loan is paid off in 10 years, then I will receive a stream of payments, and the present value of the stream at a 10% discount rate is $100.
So, JG Wentworth and the like don’t technically pay customers less than the present value, they just pay people a present value calculated at a low discount rate.
Yes, you’re correct. I was trying to keep the explanation simple (and the wiki article I linked to covers this).
Couldn’t that be the same thing? There’s the actual discount rate that the absolute best estimate would come up with. And there’s the one JG Wentworth screw the client with.
Well since we’re being pedantic, JG Wentworth pays the present value calculated a a HIGH discount rate so the present value they pay is low.
OK, so say for example, I’ve been awarded $100K, and I will be given $10K a year for 10 years. JG Wentworth offers to pay me the whole $100K today (because I need money NOW!), which means they will get the settlement instead of me, and they put it in an account that accumulates interest. So would this be considered an annuity?
Judging from a quick google search, it looks like annuity rates are currently at about 3%. So according to the Wiki article, the PV is 100K/.03 x (1 - 1/1.03[sup]10[/sup]) = $853K. Did I calculate this right? I know inflation is inevitable, but would it really suck away a potential profit of $750K?
I get the feeling I didn’t set up the situation correctly. Finances was never my strong point, explaining why my dinner last night was made by Alpo. So can the pedants enlighten me?
Here is a previous thread on this topic: Payout for Structured Settlements - that big of market?? - Factual Questions - Straight Dope Message Board
For starters, I’m betting they won’t be paying you $100K today. It’ll probably be more like $50K or $60K, just at a guess.
No, you did not calculate that correctly. There is no way you’re going to have $850k after 10 years at 3% per year.
What’s the right way then?
You can discount a cash flow (a finite stream of payments) to find the net present value using the format: Payment/(1+r)[sup]Number of times compounded[/sup]. I’m making a couple of simplifying assumptions, namely that there’s yearly compounding (the method for doing monthly or daily compounding simply involves finding the periodic rate of return and adjusting the number of times compounded) and that you’re getting your payment at the beginning of the compounding period (the first payment isn’t discounted). With your 3% rate of interest, that would (roughly) be
10000/1 + 10000/1.03 + 10000/1.03*1.03 + […] + 10000/1.03[sup]9[/sup]
So the present value using that rate of return is about 10,000 + 9708.74 + 9425.96 + 9151.41 + 8884.87 + 8626.09 + 8374.84 + 8130.92 + 7894.09 + 7440.94, for a net present value of somewhere in the neighborhood of 87637.86.
A 5% rate of interest, on the same cash flow, would sum up to about $81078.22.
For a perpetual (infinite payments) annuity, you can approximate the value by dividing the payment by the rate of interest, so at 3% rate of return 10,000/.03 equals about $333,333.33, and a 5% rate would have a net present value of about $200,000, but those aren’t really what are at issue here.
Investing a lump of $100,000 at 3% yearly would net you 100,000*1.03[sup]10[/sup] or about $134,000, but that’s neither here nor there.
The gist of all of this is that J.G. Wentworth is paying less than a dollar now for a dollar later, because what you want is sort of an impatience premium. You want to have the money to spend now. If you’re impatient, having the money in hand will be worth taking somewhat less than you’d get if you waited it out; if you’re patient, you can take the periodic payments.
A golden age of the lump sum game was before state lotteries started offering a lump sum option, but only offered payouts over a number of years. The state lottery’s lump sum payouts are reasonably close to a fair present value of the payment stream.
The Wentworths* of the world play on the financial desparation and lack of sophistication of the people whose payment streams they’re buying. It’s common for a lottery winner to think he’s rich and proceed to go into debt by spending faster than the payments come in. Or there’s a health or other financial emergency. Plus your typical lottery winner likely doesn’t know how to calculate a fair present value of his lottery payments, and the Wentworth dude isn’t going to give him an unbiased education.
For some insight into what actually happens in the purchase of such income streams, I recommend Act Two of this episode of This American Life.
*JG Wentworth may be completely fair and above board in their dealings. I’m just using their name as a stand in for the industry.
This is because the lump sum payout for these lotteries is how much in government bonds (usually long term Treasuries IIRC) they’d have to go out and purchase in order to guarantee full payment of the prize over the payment period.
Apologies for bumping a very old thread, but I had a question on this topic…
So when JG Wentworth purchases an SS or an annuity, do they just sit on the yearly stream of payments, or do they try to convert it into a lump sum?
For example, if they purchase someone’s structured settlement & claim from a lawsuit for 50% of the discounted present value, do they then settle the claim with the payer for, say, 80% of the discounted present value, giving them a 30% profit immediately?
How do they do this in the lotto context, or in non-lawsuit contexts?
Edit:
Also wanted to ask…is it as easy at it sounds? It seriously sounds like a gold mine with fairly low stress and low overhead. Where’s the elephant in the room?
I heard that they turn a profit because at some point they steal your underpants.