Litigation

Define structured settlement internal rate of return. If you asked the question of different structured settlement consultants would they come up with different answers?

What is structured settlement IRR?

The structured settlement internal rate of return is the result of a mathematical formula that generates an interest rate that is equivalent to the effective compounding rate on invested capital (i.e. the structured settlement funding amount or premium).

How is structured settlement IRR useful?

Once you know the internal rate of return of the structured settlement proposal, you can compare it to after-tax rates that you might earn by opting for other structured settlement plans, or that you might achieve by taking cash and investing in different taxable or tax-exempt financial instruments.

Caveat 1

To calculate the structured settlement IRR you need the following components

• Consideration (amount of initial investment)
• Amount and timing of each cash flow

The results can be very easily misinterpreted and/or misrepresented.

Care should be taken by Plaintiffs and counsel to understand how the IRR is calculated in a structured settlement proposal where lifetime payments are being considered, and there is a plaintiff /annuitant with reduced life expectancy, so an effective comparison can be made.

For example a structured settlement planner quotes an annuity that will pay a 30 year old paraplegic $4,000/month for life with 300 monthly payments certain and tells you that the rate of return is 5.75% tax free. What is wrong and/or missing from the planner's statement?

Answer:
If the structured settlement planner has simply quoted the IRR off the insurance company software, chances are high that the IRR is a number achievable only if the plaintiff lives through normal life expectancy (NLE). If the plaintiff dies before 300 monthly payments are paid, the most that could be paid out is the 300 monthly payments. Therefore when using the IRR to evaluate the "opportunity cost" one should also assess what the IRR would be if the plaintiff dies within the certain period. Because a plaintiff may live longer than normal life expectancy the most useful opportunity cost analysis would include the IRR calculated at various hypothetical "live until" ages.

Caveat 2
When comparing the IRR on alternative investments to a structured settlement IRR, be sure that the IRR on the alternative investment  takes into account all investment charges including, if applicable, surrender charges and commissions on both the acquisition and disposal (buying or selling) of the alternative investment.

On September 20, 2007 published opinion, in response to this authors inquiry, the New York State Insurance Department stated that "although there is no affirmative requirement that an agent or broker substantiate a claimed rate of return, the Insurance Law prohibits the making of misleading statements or misrepresentations regarding life insurance and annuities.

Further Reading

The Internal Rate of Return: Economics Interactive Lecture Samuel L. Baker University of South Carolina  Arnold School of Public Health March 28, 2006