Case let

Making the Decision to Convert Lottery Prize

Winnings:

The Case of the Singer Asset Finance Company

In 1987, Rosalind Setchfield won more than $1.3 million in the Arizona
state lottery. The winnings were to be paid in 20 yearly installments of
$65,276.79. Six years later, in 1995, Mrs. Setchfield received a phone
call from a salesman for the Singer Asset Finance Company of West
Palm Beach, Florida. The Singer company offered to give her $140,000
immediately for one-half of the next nine lottery checks (i.e.,
$140,000 now for $32,638.39 * 9 = $293,745.51 over nine years).
Singer is a prize broker with many employees whose main job is to
track down million-dollar-lottery prizewinners like Mrs. Setchfield.
Singer knows that many people are eager to trade all or part of their
promised winnings for a discounted lump sum immediately. Singer is
part of a growing $700 million prize-broker business. Singer and
Woodbridge Sterling Capital currently account for about 80 percent of
the market for lottery prize conversions. Prize brokers like Singer
resell their rights to receive future payouts (called structured payouts)
to institutional investors such as Sun America, Inc., or the John
Hancock Mutual Life Insurance Co. In the case of Mrs. Setchfield, the
investor was the Enhance Financial Service Group, a New York
municipal bond reinsurer. Singer had arranged to sell its stake in Mrs.
Setchfield’s lottery prize to Enhance for $196,000 and would make a
quick $56,000 profit if she accepted the offer. Mrs. Setchfield accepted
Singer’s offer and the deal were made.

How was Singer able to structure a deal that resulted in a $56,000

profit? The answer is that individuals and institutions have different
inter-temporal consumption preferences. Mrs. Setchfield’s family had
experienced some financial difficulties and was in need of some
immediate cash. She didn’t want to wait nine years for her prize
winnings. On the other hand, the Enhance Group had some excess
cash and was very willing to make a $196,000 investment in order to
receive the rights to obtain half of Mrs. Setchfield’s prize winnings, or
$32,638.39 a year for nine years. The discount rate the Enhance
Group applied to the future payouts was about 8.96 percent (i.e., the
discount rate that equates the present value of $196,000 with Singer’s
right to receive their equal payments of $32,638.39). The discount
rate that Mrs. Setchfield used was 18.1 percent, reflecting her aversion
to deferred cash flows.
SOURCE: Vanessa Williams, “How Major Players Turn Lottery Jackpots
into Guaranteed Bet,” The Wall Street Journal, September 23, 1997.