Time Value of Money: Why Lump Sum Payments Cost More

We’ve all played the lottery—bought tickets for a chance at winning the $1.5 billion Powerball. If you flick your eyes to the fine print, you see that if you win you can get the money in an annuity over 30 years.  You can elect to receive a lump sum payment now, bu only if you are willing to accept much less than the amount it said you won on the ticket.

Why is this? Well, it’s tied to the “time value of money.” If the lottery pays you as a part of an annuity, they get to hang on to the rest and invest it—so it will cost less for the state to pay you over time. If the state pays you upfront, it costs the state much more.

Insurance companies know this well! They make most of their money by investing premiums and holding on to that cash as long as possible—thus the long and burdensome claims process.

You may have seen this if you make student loan payments. If you asked to defer your payments until after you graduated from school, you might remember that the election caused your rate to double.

The time value of money principle says that everyone wants to receive money now and pay money later.

Legal funding providers are on the short end of this stick.  They pay now and receive later – often much later.  Could be 6 months or 6 years – or never.  By contrast, loans get monthly payments, which lenders can invest in ways that help alleviate the cost of carrying that debt. Legal funding providers carry risk without getting any payments until the end, costing them much more.

Opponents of legal funding intentionally misrepresent the numbers, and the true cost to legal funders of the time value of money. Don’t let them.