Most attorneys are familiar with the term "present value" because jury instructions often require that any award for future lost wages, income, etc. be reduced to its "present value" (the lump-sum amount of cash invested today that will replace the lost future income). This "present value" of future damages usually disregards mortality, the tax-free nature of future payments, changes in future interest rates, etc. In addition, at the end of the payout period, all of the cash used to fund the present value must be consumed (i.e., zero dollars in the bank account). This is the classic, totally theoretical, "present value".
The application of the "present value method" in determining the current worth of a structured settlement is also another hypothetical and theoretical calculation. Subjective judgments must be made regarding future interest rate (discount rate) change and mortality issues that will have a profound impact on the theoretical"present value". For example, a difference of one percent in the interest rate, in a $1,000 per month payment over the life a ten-year-old child, will result in a change in the "present value" of a structured settlement by over $100,000. The impact of mortality issues on "present value" can be illustrated when doctors differ on the life expectancy of a profoundly injured ten-year-old child, by approximately 20 years. This 20-year difference in life expectancy translates into a $70,000+ change in the "present value" of a structured settlement. In contrast to the classic present value approach, this method of funding a structured settlement does not require that all the cash used to fund the settlement be consumed.
Thus the "present value" method of determining the value of a structured settlement is purely a hypothetical calculation, subject to significant manipulation. Most attorneys’ fees are based on a percent of the "true" value of the structured settlement. Using a hypothetical "present value" method of calculating the value of a structured settlement is a sure-fire way to invite a fee dispute. Consequently, the "present value" method of determining the true value of a structured settlement should be avoided.
The "cost" of a structured settlement, on the other hand, is the actual (non-theoretical) amount of cash that a structured settlement annuity company requires today to guarantee a specific series of future payments, irrespective of future changes in interest rates and mortality. The annuity companies use their own internal rates of return (including stocks, bonds, real estate, etc. and profit) to determine what they will charge (the cost) to commit to make the payments in the structured settlement.
The "cost" method of determining the value of a structured settlement is the most objective and simplest method of establishing the true, current (in today’s dollars) cash value of a structured settlement. The "cost" method of determining the "true" value of a structured settlement is the purchase price (i.e., the "cost") that an insurance company charges for a specific future payout schedule. While the "cost" to purchase a structured settlement may vary from insurance company to insurance company, the "cost" is still an actual number, not a theoretical number. A structured settlement broker who has access to insurance company annuity rates can quote you the "cost" of a structured settlement.
The cost method is recognized in the vast majority of jurisdictions (for example the Sixth Circuit, Michigan, New Jersey, New York, Pennsylvania, etc.) that have considered this matter. The cost method is codified in at least two states (Florida and New Jersey) and is a part of the Uniform Periodic Payment of Judgements Act. In addition, the cost method is mandated as part of the ethical and disciplinary standards in at least three states (Florida, Tennessee and New Jersey).
The "present value" method of valuing structured settlement has been traditionally used by the defense structured settlement broker. The defense brokers used this method to persuade the plaintiff attorney that the value of the structured settlement is greater than what the defense is paying for it. The cost method is the only correct way to determine the "true" cash value of a structured settlement.