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Discounted Cash Flows
The secondary market for a variety of cash products has existed for years. These products range from pension payments, lottery payments, annuity payments, estate settlements, lawsuit settlements, etc. Many of these opportunities trade institutionally among banks, insurance companies, hedge funds and other large entities. Due to recent innovations in the market, discounted income streams, also known as Structured Cash Flows are now available for purchase by individual investors.
What is a Structured Cash Flow?
A structured cash flow represents a fixed income stream, such as an annuity or pension income, sold at a
discount in exchange for a lump sum payment. They can provide higher rates of return than traditional income
products such as annuities, bonds, and CD’s. Structured Cash Flows backed by pension income are paid from
varying entities of credit risk including the federal government, investment grade corporations, and state and
local governments. Buyers may choose the length of the term they will receive monthly payments (between 3
and 10 years), set the amount they will receive each month and decide the credit risk of the payer they prefer.
Some benefits to investing in a Structured Cash Flow?
• Above-average returns when compared to the fixed income portion of your portfolio.
• Income payments are made directly from and are backed by a pension institute. • Corporate pension plans may have additional protection through PBGC funds (www.pbgc.org).
• All income streams are period certain providing predictability of income.
• Money from Non-Qualified funds such as CD's and Money Markets can be used. Also funds currently in IRAs, 401Ks, 403Bs, SEP IRA, Roth IRAs can be transferred to self-directed IRAs, SEPs, etc. and used.
Why are the interest rates higher than those offered by other fixed investments?
Structured Cash Flows are purchased at a discount price from the pension recipient / seller which are then passed through a higher effective yield to the buyer. The interest rate for each Structured Cash Flow is determined by the current market price which is determined by what a seller is prepared to accept as a return for the exchange of their pension income. As with any instrument, anytime a supply and demand market is created, there can be good
opportunities for both sides of the trade. A seller sees an opportunity with a lump sum payment today, where a buyer sees an opportunity with a monthly cash payment. This creates a market that has a low correlation to other traditional equity and income products. Therefore, depending on interest rates, taxes, equity market performance, etc., Structured Cash Flows may produce superior income options on a risk adjusted basis.
Is this opportunity right for me?
If you are looking for monthly income for a number of years, Structured Cash Flows should be considered. As with any opportunity, such an investment should never be the only part of an income strategy, but rather one part of an overall
investment strategy.
What are the advantages of purchasing structured cash flows?
Structured Cash Flows provide a monthly income at a rate of return above other traditional income options such as CD’s, annuities and bonds. Therefore, they allow buyers to create their own personal pension by having payments deposited into their account monthly. While rates of return can and will change, as of November 2011, rates for a 10 year
Structured Cash Flow are at least 8% as compared to a 10 year term certain single premium immediate annuity which currently pays approximately 2.26%.
Who is the payer?
The Payer can be the federal, state, or local government, or any number of corporations or entities. The rate of return will be commensurate with the credit risk of the issuer along with other factors.
What are the risks in buying structured cash flows?
Future income streams from pensions are not risk free investments and every buyer must determine whether such a purchase meets their risk tolerance and objectives. The security of these types of investments is directly related to the health of the company or entity that issues the pension and its ability to pay claims on the terms. These types of investments are not deposits and are not insured by the Federal Deposit Insurance Corporation (FDIC). Income streams from pensions are subject to interest rate risk, market interest rates may rise while the rate of return on the investment of income streams is stagnate and will not increase or decrease in response to any market. Income streams from pensions must be held to term and therefore are not liquid investments. Additional risks include any legal challenge after the purchase of the income stream, breach of contract by the pensioner, bankruptcy initiated by pensioner, contestable periods of life insurance, including fraud and suicide, and future changes to Employment Retirement Income Security Act (ERISA) or any other law governing pensions and retirement income. These specific risks are mitigated through deposit accounts, reserve funds and the purchase of insurance on the life of the seller.
Most pension plan and structured settlement income streams end or continue at reduced payments to the surviving spouse when the original income recipient, the seller, dies. This is commonly referred to as a life contingent income stream. To mitigate the risk associated with a life contingent income stream, the seller is required to maintain and collaterally assign to the buyer of the structured cash flow throughout the payment term either a new or existing life insurance policy. In the event the seller dies before the payment term has ended the buyer would receive a lump sum payment from the life insurance death benefit proceeds equal to the discounted value of remaining payments owed.
What happens at the death of buyer?
In the event that the owner of a structured cash flow dies prior to the end of the contractual term of monthly cash flows being paid, the remaining cash flows per the contractual terms will be payable to the beneficiary(is) under the owners will or trust. If jointly owned, monthly cash flows will continue per the contract to the surviving joint owner.
Matching income requirements with less funds invested
Immediate Annuities are not an exact apple to apples comparison to Structured Cash Flows, but close. Both income streams provide a tax efficient income (assuming non-qualified dollars) by distributing both principal and interest in each payment and in the example below, both are period certain.
The illustration below provides an example of using a top rated fixed immediate annuity (as of 11/1/11) versus an available Structured Cash Flow. In this case the buyer would incur a savings of $36,225 (22% less funds required) to receive the same $1,500 of monthly income paid for 120 months.
Income Solution Total Payments Received Monthly Payment Received Total Income Received Purchase Amount Required Annual Effective Rate Structured Cash Flow 120 monthly payments $1,500 $180,000 $124,703 8.25% Immediate Annuity 120 monthly payments $1,500 $180,000 $160,928 2.33%
Lifetime Income Strategies
Ted and Jane, age 65, have started to see their dream of a comfortable retirement fade, due to the news of a 2% renewal rate on their current CD combined with sky rocketing prices at the gas station and grocery store. Both would like to increase yield within their portfolio without incurring market risk. They decide to invest $100,000 into a federally backed structured cash flow. This income will generate 120 monthly payments of $1,202 providing an 8.25% effective yield.
Ted and Jane also invest additional funds of $119,746 into annuity contracts which provide a guaranteed income withdrawal benefit. Assuming a 7.2% annual step up to the income base and a 6% lifetime guaranteed withdrawal percentage, at age 75 Ted and Jane would receive an income benefit payment of $1,200 per month guaranteed for the remainder of both of their lives.
The above scenarios are hypothetical in nature and are not based on any specific product or available offerings but are generic in form. A guaranteed withdrawal benefit is an insurance rider provided as part of an annuity contract.
Examples of Structured Cash Flow income streams
(Pricing as of 11.22.11)Federal backed Structured Cash Flows
Pension Type Purchase
Price Term Annual Effective Rate Monthly Payment Received Total Payment Received Federal $100,000 36 months 6.00% $3,020 $108,731 Federal $100,000 60 months 6.00% $1,917 $114,994 Federal $100,000 84 months 6.50% $1,468 $123,331 Federal $100,000 120 months 8.25% $1,203 $144,342 Blend: 75% Federal &
25% CCC Program $100,000 120 months 9.18% $1,248 $149,712
State or Corporate backed Structured Cash Flows
Pension Type Purchase
Price Term Annual Effective Rate Monthly Payment Received Total Payment Received
State / Large Corporate $100,000 36 months 6.25% $3,030 $109,093 State / Large Corporate $100,000 60 months 7.00% $1,959 $117,535 State / Large Corporate $100,000 84 months 7.50% $1,513 $127,056 State / Large Corporate $100,000 120 months 8.75% $1,226 $147,220
Blend: 75% State / Large Corporate & 25%
CCC Program
$100,000 120 months 9.56% $1,266 $151,924
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* Structured Cash Flows are exemptfrom registration with the U.S.Securities and Exchange Commission (SEC). * Structured Cash Flows are notdeposits and are notinsured by the FederalDepositInsurance Corporation (FDIC). * Structured Cash Flows are notrisk free.Please referto the section entitled “Whatare the risks?”