While some trial lawyers automatically reject the guarantees and unique tax advantages inherent in a structured settlement when interest rates are low or there is the perception that they (their clients) can do better in the stock or bond markets. But consider that even those who are not going through a major life transition event may have a loss aversion and a natural emotional reaction to extreme market declines leading them to sell out during periods of extreme market declines to seek the safety in cash. See Market Timing is Not Easy in our section Structured Settlements vs Other Investment Alternatives
Some assume that the client would not be interested in a structure because they are not a minor, unsophisticated, incompetent, needy for income or dependent on complex medical support. The decision to go with 100% cash by a Plaintiff may be borne from the reasons above or other reasons such as fear of the unknown, misperceptions about flexibility; sometimes simply the perception to get rich or even the dignity of wealth.
Decisions made solely made on the basis of achieving said returns on a straight-line basis could prove to be flawed. An average rate of return of 7% does not mean that 7% was achieved in each and every year in between, or will be in the future. 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, also known as Monte Carlo 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.
“Monte Carlo Simulation, also known as the Monte Carlo Method or a multiple probability simulation, is a mathematical technique, which is used to estimate the possible outcomes of an uncertain event. The Monte Carlo Method was invented by John von Neumann and Stanislaw Ulam during World War II to improve decision making under uncertain conditions. It was named after the well-known casino town, in Monaco, since the element of chance is core to the modeling approach, similar to a game of roulette. Since its introduction, Monte Carlo Simulations have assessed the impact of risk in many real-life scenarios, such as in artificial intelligence , stock prices, sales forecasting, project management, and pricing”. Source: IBM
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.
Last update February 19, 2023
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