Structured Cash Flows

Discounted Structured Cash Flows

  Structured Cash Flows

The secondary market for a variety of discounted structured cash flows has existed for over 30 years and represents a billion dollar a year industry.

Examples include secondary market pension and lottery payments, annuity payments and structured and lawsuit settlements.

Video-Structured Cash Flows

Most of these products are purchased directly by institutions such as banks and hedge funds but have recently expanded to include qualified individuals.

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What are structured cash flows? 

Structured cash flows represent a fixed income stream such as a qualified annuity payment, retirement benefit or pension income sold at a discount in exchange for a lump sum payment. These future income streams can provide for higher rates of return than available through traditional fixed or income products.

Structured cash flows represent predictable income that is paid by institutions such as the federal government, investment-grade corporations and state and local governments.

What are the benefits of purchasing structured cash flows? 

Structured cash flows often provide monthly income at a discount rate above other traditional income options such as certificates of deposit, annuities and bonds. This allows a buyer to receive a predictable cash flow deposited into their account on a monthly basis.

You can select from available terms such as 5 or 10 years, the amount of monthly income desired and the credit risk preferred. While discount rates can and will change, currently the effective rate available for a 5 year structured cash flow is 7% as compared to a 5 year term certain single premium immediate annuity offering an internal rate of return of 1.25% for the same term. 

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Why are the rates higher than those offered by other fixed options?

Structured cash flows are purchased at a discounted value from the seller. The discount rate for each structured cash flow is determined by the current market price for what a seller is prepared to accept as a lump sum in return for parting with their pension income for a set period of time.

As with any instrument: any time a supply and demand market is created, there can be good opportunities for both the buyer and seller. In this case a seller has a need for a lump sum payment today while a buyer sees an opportunity to receive a dependable monthly payment.

For the buyer this creates an opportunity to participate in an alternative income solution that has a low correlation to other traditional income and Equity products. Therefore, depending on effective rates, taxes and equity market performance a structured cash flow may offer a superior income option on a risk-adjusted basis.

What are the Risks and Protections available?

Lack of Liquidity 

Structured Cash Flows must be held to term and therefore are not liquid. The interest rate and payment amount are set and will not increase or decrease in response to market changes. As a result longer terms are subject to potential interest rate risk.

Institutional Risks 

Pension benefits represent dependable monthly income paid to a seller by an institution to include federal, state and local government and corporate defined benefit plans.  Federal government plans may have taxing authority and constitutional safeguards which protect vested benefits. Corporate plans may offer backing through the Pension Benefit Guarantee Corporation fund. www.pbgc.gov

A reserve account is available for pension benefits paid by cities, counties and some corporate pension plans to help protect against default risks related to the paying institution. This reserve account shall replace any lost payments due to the credit default of the pension benefit for as long as there are remaining funds in the reserve account, or until a replacement of purchased payments has been obtained.

Contract Risks 

Contractual risks are those risks which are uniquely related to the purchase of a structured cash flow and can result in a missed or reduced payment. Examples of contract risk include attempted breach by the seller for any reason including bankruptcy or death.

What protections are in place to safeguard against contract risks?

  1. Underwriting Requirements 

 

Any interested sellers must first meet certain financial underwriting requirements which include the ability for a seller to maintain their financial commitment after receiving and spending a lump sum payment.

Underwriting standards include: 

 Credit Report and History

 Marital Status and State Ownership Laws

 Sources of Income and Debt to Income Ratio

 Use of Funds and Future Financial Stability

 Bankruptcy and Likelihood to File Bankruptcy in the Future

 Payment History (Tax Liens and Insurance Premium)

 Character Evaluation & Personal History

  1. Shortfall Account and Reserve Account 

 

A shortfall account and a reserve account to protect against contractual risks related to a pension seller. Contractual risks are those risks which are uniquely related to the purchase of a structured cash flow and can result in a missed or reduced payment.

Examples of contract risk include attempted breach by the seller for reasons including bankruptcy or death. The shortfall and reserve accounts are funded by the company and represent a portion of the buyers purchase price.

  1. Reducing Obligation and Contract Replacement 

 

The cash flow obligation owed from a seller reduces with every monthly payment. Therefore the risks associated with the default of a particular cash flow also decrease. In addition, if a contract is considered an official breach, and funds are available within the shortfall and reserve account, the company will attempt to replace the cash flow with a cash flow of similar characteristics. It is likely that the company will be able to replace the cash flow at a lower cost which will reduce exposure to the shortfall and reserve accounts.

  1. Experience in Debt Collection 

 

Management has prior experience specific to debt collection. Assuming a contract breach while funds are available within the reserve account, the company will acquire the breached contract which will allow them to pursue a resolution of payment directly from the seller.

  1. Diversification 

 

On purchases over $25,000 there is often more than one seller’s cash flow included in a single transaction. This transaction is not a pooled transaction but instead individual cash flow transactions completed with multiple sellers.

Important Disclosure 

Although the resources mentioned above are in place to protect the buyer and the cash flow obligation promised, historical precedence for this type of purchase is limited. Therefore these steps act as tools for risk mitigation but do not serve to provide a guarantee of payment.

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