For about a dozen years now, late-night TV has frequently had advertisements from a financial firm known as J.G. Wentworth. On June 1st 2009, that firm, formally known as JGW Holdco LLC, and two of its subsidiaries, J.G. Wentworth LLC and J.G. Wentworth Inc., entered Chapter 11 bankruptcy protection after the company allegedly "encountered liquidity problems amid a tightening credit market".

This relatively-small financial firm repeatedly pitched the concept that one could sell insurance contracts known as structured settlements "to raise cash now". Rather than receive a stream of payments in future years as specified in an annuity insurance contract that is part and parcel to a structured settlement, the beneficiary of that structured settlement could receive a sum of cash from J.G. Wentworth "now". In exchange, the beneficiary would give up all future claims to the annuity cash flows and the funder, J.G. Wentworth, would receive them instead.

Many individuals and firms have long avoided the structured settlement sector of the financial markets, particularly on the purchase side of the transactions. Most sellers of structured settlements are what one would call "retail" customers. Frequently, these customers are less sophisticated in one way or another. Often the customer is at least middle-aged, if not older; is in a diminished physical state; and has encountered some type of financial stress that is leading to the consideration of the sale of the structured settlement annuity contract.

In such a condition, it often is not clear to a seller whether a proposed transaction price is fair or not, especially when potentially pressured by an aggressive broker who promises to get the seller cash now. As with all retail-oriented businesses, the "downsides" (risks) of entering into the transaction are rarely well-explained. Further the total fees to be paid to the broker and/or principal are often concealed or less than completely disclosed.

Frequently, structured settlements result from the settlement of some type of property, casualty or health insurance contract. For example, consider the hypothetical example of a forty-five year old man who is left unable to work again as a result of a botched surgery procedure. In all likelihood, there would be some litigation that would attempt to apportion blame for the accident among various possible parties. Assuming that it truly was a botched procedure, one or more professionals would be held responsible for the accident and their insurance P&C carrier(s) would be on the hook for the mal-practice coverage.

A theoretical P&C insurance company in this example would likely be ordered by the courts (if the litigation ever were to go all the way to trial) to compensate the victim for his pain and suffering as well as his lost earning potential. Exactly how that amount is calculated includes many assumptions like inflation rate(s), effective working life of the individual, retirement costs, etc. Frequently, rather than wait for a court to order the payment of damages according to some schedule, the two parties to the litigation will attempt to reach some type of mutually agreeable settlement.

One type of settlement sometimes ordered by the courts involves a single lump-sum payment. More often, the two parties negotiate a schedule that includes either fixed or variable payment amounts over some number of years. Typically, the P&C insurance company then will purchase an annuity contract from a relatively highly-rated annuity (life) insurance company that will exactly cover the agreed-upon payments with the injured party. Generally, it is more economic for the P&C company to purchase such an annuity contract since it either by regulation is prevented from issuing annuity contracts or the capital requirements (if it were to do so) are too onerous, especially relative to its relatively short-tail P&C insurance lines.

It is these relatively high-grade, life-insurance carrier, "guaranteed" cash flows that the J.G. Wentworth's of the world were purchasing from retail beneficiaries. Many of these annuity contracts stretched out for more than ten years and most called for unique payment schedules, sometimes with a bit of optionality. The method of pricing these contracts typically involved a discounted cash-flow ("DCF") methodology that included a risk adjustment for the perceived financial health of the life insurance carrier.

Say the fair market value of the above hypothetical policy (using their proprietary DCF pricing model) was two million dollars and change. The brokers in the structured settlement market often would suggest transaction prices that were less than their undisclosed DCF number, sometimes far less. There generally also would be limited disclosure of what yield their proposed price might equate to. Further, since each structured settlement contract was likely unique, it was very unlikely that a retail seller might find another party who on a timely-basis might supply a competing price. The subsequent inclusion of brokerage and other fees would further reduce the proceeds from the sale of the annuity contract yet further raising the effective yield at which the transaction was conducted.

At one time, J.G. Wentworth was the largest buyer of structured settlement contracts. Frequently, they then would sell a portfolio of individually purchased policies into a special-purpose vehicle which would issue securitization debt that was secured by the life insurance company cash flow payments. J.G. Wentworth (or an affiliate) would take out the "arbitrage" profits of purchasing the contracts from retail sellers at say X and then reselling those same cash flows to institutional investors at say X + some amount. They typically would bear the costs of setting up the trust, but would take out an additional on-going fee for "servicing" the transaction.

Toomre Capital Markets LLC ("TCM") had the opportunity to work with J.G. Wentworth some number years ago as one of their providers of "professional services." After performing some due diligence, that opportunity was declined. One might fairly say that TCM is not surprised to learn of this bankruptcy filing.

In this era of reduced credit availability, reputation and the value of whether one's actions consistently match one's words are highly prized. Such qualities are likely to become even more so as the capital markets credit crunch continues. Hence, TCM wonders whether and in what form J.G. Wentworth might emerge from bankruptcy protection.