How To Invest In Structured Settlements
The return is good, but the risks are hidden
Structured settlements are generally associated with the compensation of injured plaintiffs following a legal hearing. They are more than just a compensation package. One of their main characteristics is that they cover all medical expenses that the injured claimant may be carrying in connection with the injuries sustained.
Another characteristic is that if the plaintiff is no longer able to engage in gainful employment because of the injuries suffered, the relatives need another source of income on which they can rely. Therefore, structured settlements are usefully compared to some form of early retirement benefits. Disbursements after legal disputes, however, are not the only types of compensation associated with structured settlements.
Lottery winners often require the services of a structured settlement specialist. In general, a good number of lottery winners will be poorer after a few years than before receiving the considerably large payment.
According to studies, about 80% of lottery winners after five years are in a worse financial position than before winning. Therefore, it would be better for them to sell the lump sum in exchange to a third party for annuity payments over a specified period. As a result, there are more opportunities for investors to participate in the structured payments market, but the main route is to settle litigation.
How do you invest in structured settlements?
In a lawsuit, the plaintiff usually receives the compensation awarded by the judge and, as mentioned, these payments can be made over a longer period. In fact, some of them are lifelong payments, which means that the defendant’s insurance service provider takes the risk.
To guarantee these payments, the insurance company finds an investor willing to reinsure the insurance against structured pension payments. This means that the risk is transferred or shared with a third party, which in this case becomes an investor.
Buffett likes structured annuities
This was achieved by Warren Buffett trading portfolio in 2013 with Berkshire Hathaway when it became Cigna Corp. (NYSE: CI) has guaranteed minimum death benefits and guaranteed minimum income benefits, up to $4 billion.
In return, Cigna paid Berkshire Hathaway $2.2 billion. For Berkshire Hathaway, Cigna was just another addition to a list of reinsurance deals the company has signed since 2010, including American International Group (NYSE: AIG), Lloyds (NYSE: LYG), and Swiss Swiss (XSWX: SREN) Other.
In 2012, Berkshire Hathaway reportedly was one of the largest reinsurers of structured settlements, controlling at least 15% of the market through its insurance company.
This has led many to wonder why one of the brightest investors would choose to invest in something that could easily lead to catastrophic losses following the events of the 2008-2009 financial crisis. If there is a financial crisis, insurance companies tend to suffer. For example, consider the case of AIG.
What are the risks?
The responsibility of paying specific amounts to certain policyholders regardless of market conditions can be catastrophic. This is also the reason why the insurance company reinsures guaranteed benefits to reduce the risk.
Therefore, it is clear that structured settlements have a high-risk exposure, time. This opens the door to more risks regarding liquidity, bankruptcy, and economic crises. The longer the period, the higher the risk of a possible financial crisis. But again, financial crises occur in cycles. This means that if you do not try to take on positions that guarantee death benefit payments, you can identify the best possible time to invest in structured settlements.
And just like Buffett Berkshire Hathaway, a few years after a financial crisis sounds like a good time. Structured settlements are illiquid, meaning that it is difficult to recover those funds if your funds are tied to the product for the entire period unless there are agreed pension payments along the way. The other option is to find a buyer, which is not easy in an illiquid market.
As long as the insurance company remains financially sound, structured settlements are low-risk, fixed income products that tend to deliver unusually high returns compared to their counterparts. Any pension payments are likely to be irregular, and the amounts will vary as well.
Conclusion: Should you invest in structured settlements?
In summary, while structured settlements are widely considered to be low-risk, investing only in fixed income investments, liquidity is a major concern, especially for indefinite-term investments.
Therefore, it would be better for investors only to replenish a small portion of their portfolio to offset their investments in risky assets.