The Elephant in the room is that they have to come up with the lump sum now, meaning they have to pony up a fair amount of cash up front to get those future payments. Not a business you can get into on the cheap, eh?
If the losers of the lawsuit are willing to pay a lump sum, and the winners are willing to accept a lump sum, what would they need JG Wentworth for? If the parties talked to each other, they’d both be better off and leave Wentworth out in the cold.
I can only see two things that Wentworth brings to the transaction.
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Finding people willing to cash in an annuity. Suppose there is someone with a lump sum of cash willing to invest it for the given rate of return. They may be willing to pay Wentworth’s price rather than do all the legwork themselves. (Wouldn’t apply in the lawsuit example, since the parties must already be aware of each other.) I believe that’s the job of the guy in the This American Life program that zagloba linked to, essentially a salesman looking for lottery winners willing to sell.
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Bringing together a group of investors to purchase annuities that none could do individually. I doubt that JG Wentworth is owned by an individual. It’s collective owners are getting a safe return on their investment that none could get on their own.
It actually doesn’t seem terribly expensive, but maybe I’m being naive. If you can get someone to agree to sell you their structured settlement, can’t you use that contract as collateral to secure a favorable loan from a bank? And assuming you acquire the claim as well, you’d be able to settle, pay off the bank loan, and keep your profit. That gives you the capital to start doing more transactions on your own sans the bank. It seems like once you’re in, it’s easy to make money.
No?
The genius of JGW is that they’re getting that cash by selling securities backed by the stream of payments that they purchase, so it’s incredibly cheap.
You have it, Ocardowin. Just replace “bank loan” with “investor capital.”
So, I’m pretty financially unsophisticated, and the concept of a “security” has always eluded me. I’m trying though. Can you explain in as lay terms as possible?
If I have it right, person/company would solicit investors on the basis that their money will be used to purchase SS’s and annuities. Investors invest, person/company purchases the SSs & annuities, and then pays investors back based on the income earned from the assets purchased?
If I purchased a SS for $100k (based on capital raised from 5 different people investing $20k) that had a DPV of $200k, and then settled that claim for $160,000, I could pay each person $25k and pocket $35k in profit, while they’re happy that they got a quick 25% interest without doing much work?
Why wouldn’t investors simply do this on their own? Laziness? Pooling money to buy bigger SSs/As?
How does it work in contexts where there is no one with whom the SS purchaser can settle with and has to keep the structure of the SS?
This seems to assume relatively sophisticated parties. Also, getting cash in two weeks from JGW sounds a lot better than having to go back and negotiate a settlement with the defendant and then get that settlement approved by the court.
A structured settlement has advantages to both parties. The losers in the suit might not be willing to settle for a lump sum. In any case, JGW (or similar) only enters into it if the winning party decides to sell their interest in the settlement later.
Security is just a fancy way of saying a claim to something worth money. In this case, the asset is the stream of payments from the annuity. You have stocks that represent ownership of a money or bonds that represent debt. There are many exotic securities. Even some that no one understand, like the amusingly named dollar BILS.
Anyway, you have the gist of it. You have the events out of order though. JG Wentworth would purchase the payment stream first and then seek investors. It’s easier to sell things to investors when an independent company determines how safe your investment is, which is called a rating (think credit rating). You’ve probably heard the term S&P, which stands for Standard & Poor’s. They’re a company that determines how safe investments are. Fitch and Moody’s are some other big names. They’d examine the stream of payments and tell investors how much risk they should be compensated for. The more risk, the more they need to make. This is why low-risk government bonds pay nothing (.50%!) and high-risk junk bonds can pay 20%+.
Investors are always trying to get the best return for the least amount of risk. The big risk in what JG Wentworth does is called counterparty credit risk. This is the risk that the person will default on their payment obligation. As an individual investor, it is burdensome to minimize this type of risk since it’s a hassle to chase after people for the money they owe you. JG Wentworth is able to mitigate some of this risk by diversifying, which means that they have a lot of people providing them their payment stream, so if a few people don’t pay up it doesn’t matter so much. They’re also able to spread the costs of enforcement over many more transactions than an individual investor is able to.
Generally, the company isn’t interested in getting settlements from the third party. It doesn’t really offer much benefit over the stream of payments, since it’s vulnerable to reinvestment risk. This is the idea that JG Wentworth may not be able to earn the interest at a rate greater than the discount rate of the settlement. To use your numbers, they’d need to turn the 160K into 200K over the life of the security their investors purchased. If they can’t loan out that 160K at a rate good enough to accomplish that, they’re going to be in trouble.
Why someone would want to sell their annuity for CASH NOW is another massive post, probably. I’ll write it in the morning if you care. The gist of it though is remembering the three Cs of lending: creditworthiness, capacity to pay, and collateral. The payments from the annuity are the only way they can hit those.
Yes, but I was trying to answer Ocardowin’s question about JGW buying the settlement from the winner of a lawsuit and then selling it back to the loser. If the losers aren’t willing to settle for a lump sum, then JGW has to find someone else to sell it to (or simply keep it on their own books). If they can find that other buyer, then their profit on the deal can be thought of as an agent’s fee, for bringing together a willing seller and buyer. (And I suppose they take on some risk as well, that they’re buying an asset before knowing for sure that they can sell it.)
There is more I want to ask about this, but I’m in a hurry for now.
So, quickly: Since the investors don’t come in until after you purchase the structured settlement, where does the initial capital to purchase the SS come from? Obviously it can come from personal wealth, but what about for an average Joe Schmo?
In other words, how do you break into this market, because it seems like a fairly lucrative opportunity.
Convince an investor that it makes sense - they give you money in return for convertible, preferred stock, allowing them to collect dividends on earnings until you go public, at which time they convert to common shares and cash out. Failure to pay dividends will usually allows them to take control of the board and decide whether to liquidate, reorganize, change business models, or whatever.
Well, when I said incredibly cheap, I didn’t mean to the point that it was the sort of thing that the wife does out of the spare bedroom to make the family’s vacation money. Launching a security is a serious endeavor, but a small business could handle it.
You’re going to need some junior analysts. You can pay them like $35k/a and then just promise them 150% bonuses if things work out. They’ll figure out how to price the revenue streams so you don’t go bankrupt. You’re going to need some guys (“brokers”) to find the revenue streams. You can probably pay them minimum wage and a commission. The airwaves are already crowded with people trying to capture these revenue streams, so don’t waste time advertising. Just have them hang out around sleazy law offices. Oh, and you’re going to want a lawyer. Spend your money there, since a judge needs to sign off on a lot of these transfers and you need someone with a silver tongue to really make money.
Here’s your big problem though. It’s finding a seed investor. He’s the guy who is going to give you enough money to survive the first year. He’s also going to want around half of everything you’ve built, which sucks. The reality is, you’re probably choosing between owning 100% of a company worth nothing or 51% of a company worth something. Everyone wants their money, so can make those demands. You’re lucky if you can even get their time.
The next problem is finding someone who wants to buy your financial product. The only way to do that if to hit the streets, knock on doors, and buy dinners. You’re going to be selling to portfolio managers who’re looking for ways to further diversify their portfolios. The pitch is something like “Stocks are in turmoil. Bonds don’t provide any return. You need to try something less traditional. Our structured settlement-backed security can offer you returns of 8% with a 0.09 correlation to the S&P500.” And they go, “You’re right!” and you’re now running a sell-side financial services company. Treat yourself to a French cuff shirt and a Hermes tie.