The greater the fluctuation in returns brings a greater range of variation in projected values. Thus a projected investment return that employs a static or deterministic approach is bound to be inaccurate because of the failure to recognize the implicit volatility.
In most personal injury settlements, the calculation involves more than a simple lump sum future value or present value; there are multiple cash flows to consider, varying rates of inflation on multiple items, such as cost of medical items, timing of income streams and unknown mortality. If you take two historical periods with the same hypothetical settlement amount, the same distribution amounts and dates and the same returns, but the returns were achieved in a different order there will be a considerable difference in the ending balances.
Monte Carlo analysis or simulation employs what is known as "stochastic" analysis using multiple variables, thus permitting us to account for such factors as health care inflation, general inflation, mortality factors, investment rate of return and others. Armed with a sophisticated program run on a desktop or laptop a simulation of 1,000 to 10,000 trials can be run. The simulation randomly draws values for each factor for each year based on their probability distributions, accounting for an appropriate standard deviation, thus providing a better display of the risk of a 100% cash decision. It shows how long the money will last based on the set of assumptions. The allocation of settlement proceeds in an important decision. For many it's a once in lifetime decision because they have no means to earn back their mistakes. Structured settlements offer guarantees and unique tax advantages not available to other investors.
If you have been solicited to sell your structured settlement payments, beware of the slick "sales pitch" that claims better investment opportunities for the discounted lump sum they want to pay you.
- First, many of the folks promoting this theory may not be properly qualified or licensed to tell you this and you should always check first.
- Second, without a clear understanding of risk your chances for disappointment increase . Monte Carlo analysis, or Monte Carlo simulation can also be applied in this situation and may be very useful. The same concepts apply as they would at the time the structure was created. With Monte Carlo simulation the many variables of your stated needs can be projected and weighed with a statistical sample of hypothetical returns on the discounted "cash now" lump sum, in a statistical trial as described above. Thus you can have a better understanding of the chances of success or failure. You are then in a better position to make an informed decision as to whether the risk is worth the price you pay (the discount).