Structured Settlements: Learn It Here

Our focus [...] was to encourage and govern the use of structured settlements in order to provide long-term financial security to seriously-injured victims and their families and to insulate them from pressures to squander their awards.Senator Baucus, 1998.

Each year, $6 billion worth of structured settlements deals are done in the United States. A structured settlement might be the financial tool you need right now in your life, but before proceeding, you need to be aware of its rules and practices.

Structured settlements, are, unfortunately, complicated and awfully scary for some. But they cannot remain so, especially for the recently injured. Fortunately, it turns out that with the useful information gathered in one unique place, you will be able to take into account structured settlement’s main components and make your mind about it.

This article is thus an introduction to the structured settlement industry, with emphasis on its loopholes and problems, so the person considering a structured settlement may become aware of the mechanisms involved and common practices of its players.

Summary

1. Structured Settlement Definition [Jump]
2. Overview of the Structured Settlement System [Jump]
3. Structured Settlement Terminology [Jump]
4. The Myth Of The Squandering Plaintiff [Jump]
5. Structured Settlements: How We Got Here [Jump]
6. The Benefits of Periodic Payments v. Lump-Sums [Jump]
7. The Benefits of Structured Settlement Annuities [Jump]
8. Factors To Consider When Negotiating A Structured Settlement [Jump]
9. Structured Settlement Abuses [Jump]

What is a structured settlement ? Structured Settlement Definition

An agreement by which a structured settlement company pays a tax-free stream of income over a period of time to a plaintiff1A “plaintiff” is a person who brings a case to Court. A “claimant” is a person who claims a specific right from someone (an amount of money from an insurer, for instance). This article will use the term “plaintiff”. in compensation of damages is called a “structured settlement.”

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Overview of the Structured Settlement System

When a harm or illness is caused by accident, parties want to reach a satisfactory settlement. Under U.S tort law, this settlement usually takes the form of a financial compensation, even if it might not be plaintiff’s main objective2Jeremy Babener, “Structured Settlements and Single-Claimant Qualified Settlement Funds: Regulating in Accordance with Structured Settlement History.” New York University Journal of Legislation and Public Policy, (2010): 59, stating that claimants often seek non-monetary compensation: an apology, public vindication, the opportunity to state one’s point of view. Accessed March 2016. Available at: N.Y.U Journal Of Legislation And Public Policy (pdf). [Hereinafter Babener, Single-Claimant QSF].. This compensation can be made through a lump-sum or by a structured settlement, among others3Idem, page 11: a trust is another possibility..

In one hand, if they agree on a lump-sum payment, the plaintiff would be taxed on these earnings if invested4Robert W. Wood, “Unqualifying Qualified Structured Settlements?” Woodcraft Tax Notes, (2010): 581: “[…] In contrast, if the same case is settled for cash, the lump sum would be tax free, but the subsequent earnings on that sum would be taxed.” Accessed May 2016. Available at Wood LLP Attorneys At Law (pdf). [Hereinafter Robert Wood, Unqualifying UQSS]. and the defendant would be directly liable towards the plaintiff. Therefore, it’s not the ideal choice.

In the other hand, they can choose a structured settlement and thus avoid a costly trial. Both parties would benefit from the deal: the defendant by paying less over the long-term and transferring his liability to a third-party company, and the plaintiff by earning more over the long-term and having a 100% tax-free steady revenue.

structured-settlement

structured-settlement

A classic structured settlement would follow these steps:

1. Parties agree to settle the case through a structured settlement.

2. After negotiating the terms of the contract, there is usually an immediate lump-sum to provide for plaintiff’s urgent needs: medical bills, out-of-pocket expenses5McKellar Structured Settlements, Inc., “Structured Settlements 101”, page 1. Accessed May 2016. Available at McKellar Structured Settlements., or “a stipend to augment or replace lost wage income6Danninger, Brent B., Robert W. Johnson, and Paul J. Lesti. “Negotiating a Structured Settlement”. American Bar Association Journal, (1984) 70(5): 67–70. Accessed April 2016. Available at JSTOR.org. [Hereinafter Danninger, Negotiating].. This lump-sum is usually half of the defendant’s payment7Babener, Single-Claimant QSF, page 10..

3. The defendant, or more often, his liability insurance company, pays a premium (a lump-sum payment) to the qualified assignee (or “assignment company”8Robert Wood, Unqualifying UQSS, page 581.), i.e., a structured settlement company, to take defendant’s liability towards the plaintiff (through novation). This transfer of liability is called a qualified assignment. According to the IRC 130(a), this payment is tax-free as long as it does not exceed the qualified funding asset. However, the defendant can only deduct the present value of the payment and not the aggregated output9Babener, Single-Claimant QSF, page 13.

4. With the premium from the defendant, the structured settlement company buys the qualified funding asset, i.e., the annuity contract, from a life-insurance company. For example, if the premium is 100k, the structured settlement company takes 3k as fees and uses the rest to buy the qualified funding asset. Thanks to IRC Section 130(a), the structured settlement company only pays taxes on the 3k. Were a lump-sum to be invested as annuities, it would have been taxed following IRC Section 72 according to the tax bracket of the person.

5. The life-insurance company invests the premium and then pays plaintiff’s periodic payments with its earnings. “The exemption for these payments continues even upon plaintiff’s death.10Idem, page 14, quoting a professional: “Life Insurance Company gets to sell their annuity policies at very competitive rates. In turn, they put that money to work on investments earning large returns for themselves which far exceed the rate at which the annuities were placed. . . . It is not difficult to see the large profits the Life Insurance Companies enjoy . . . .”).”. According to IRC Section 104(a)(2), these periodic payments will not be taxed.

Structured settlements are tax-free under section 104(a)(2) as long as it involves physical injuries or sickness11Robert Wood, Unqualifying UQSS, page 581.. There is a mechanism called “unqualified structured settlement” used for non-injury cases. An unqualified settlement is taxed at every payment and by its nature, it does not involve a qualified assignment12Ibidem..

Examples of fully-taxable litigation:13Ibidem. employment; discrimination; false arrest; breach of contract; sexual harassment; punitive damages; property damages; fraud; some estate distributions; environmental claims; psychological/emotional distress; coverage buyouts; property disputes; and E&O/D&O claims.

You may check this traditional procedure below:

structured-settlement2

Why is a qualified assignee necessary, you may ask? The answer lies in the justification of the tax-exemption for periodic payments: the constructive receipt and economic benefit tax doctrines.

A taxpayer acquires constructive receipt of monies, […], once the monies have been set aside for his or her exclusive use and can be drawn upon at any time.”14Babener, Single-Claimant QSF, page 3. […] “A taxpayer acquires the economic benefit of monies when they are unconditionally and irrevocably transferred to him or her, though not necessarily accessible.”15Ibidem.

“To qualify, the assignment company must receive the obligation from a person who is a party to the suit, and the plaintiff-payee must not have rights to the periodic payments that would result in constructive receipt or economic benefit.16See IRC Section 130(c).

The problem when a plaintiff has control over his settlement funds, is that he may squander it all “within 5 years” and become dependent upon the state. With the qualified assignment, the plaintiff is a mere beneficiary but not the owner, which is the structured settlement company (qualified assignee). Thus, Congress created the monetary incentive, the tax-subsidy, in order to avoid the squandering effect.

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Structured Settlements Terminology

Annuitant The beneficiary of the Annuity Contract (former Plaintiff)
Annuity Contract The agreement between the Annuitant and the insurance company
Beneficiary (in this industry) The heir to Plaintiff’s remaining periodic payments

See “commutation rider” below.

Constructive Receipt (doctrine) Gross income under the taxpayer’s control must be included in gross income
Defendant The tortfeasor
Economic Benefit (doctrine) A taxpayer is taxable on all compensations for personal services
Plaintiff The person who initiates the lawsuit
Qualified Assignee The third-party company who takes the responsibility to makes future payments to the Annuitant
Qualified Assignment The transfer of liability from the defendant to the Qualified Assignee
Qualified Funding Asset The Annuity Contract
Rated Age A medical condition resulting in a lower life expectancy
Settlement Agreement An agreement by which the Plaintiff releases the Defendant of further obligations in exchange of periodic payments.
Special Needs Trust A tool used to preserve eligibility to SSI and Medicaid.

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The Myth of the Squandering Plaintiff

Since its beginnings in the 60’s, structured settlement companies, brokers, articles, books, ads, have put forward the fact that “within five years, 95% of plaintiffs dissipate their lump-sum settlement” as an argument in favor of structured settlements (and against factoring operations). However, this argument is not funded.

Indeed, in a paper17Jeremy Babener, “Justifying the Structured Settlement Tax Subsidy: The Use of Lump Sum Settlement Monies”, 6, New York University Journal of Law & Business, 127 (2009). Accessed May 17, 2016. Available at N.Y.U Journal of Law And Business (pdf). [Hereinafter Babener, Tax Subsidy]. which relied “on twelve studies and two law commission reports concerning lump sum dissipation” among others sources, the author argues that this affirmation is nothing more than a myth and indeed, “the risk of dissipation is less than was widely believed and that those awarded very high damages are less likely to fritter away their compensation” 18Babener quoting Richard Lewis, The Merits of a Structured Settlement: The Plaintiff’s Perspective”, Oxford University Press 1993, Oxford Journal of Legal Studies Vol.13, Iss.4 : 598. [Hereinafter Lewis, Merits].

He quotes a 1988 treatise19Robert L. Conason, “7 Damages in Tort Actions”, Matthew Bender & Co., 1988., whose author says:

We often hear or have seen written in articles, the apparent statistic that 95% or [sic] the plaintiffs who receive sizable settlements have no money within five years. I have asked the authors of these articles the source for this statistic. Two have pointed me to a particular broker whom they quoted. I have asked that broker for his source of the statistic and he has promised to provide me with the study. This was over a year ago. In the meantime, we have paid for searches of the available literature and have been able to turn up nothing on the subject. I doubt that 90% of [sic] 95% of the plaintiffs who receive large awards completely squander their money in 5 or 10 years, and I am almost sure that no study exists to indicate such a contention.”

Therefore, the Squandering Plaintiff is nothing more than “oft-repeated urban myth of unsubstantiated origin.”20Babener, Tax Subsidy, page 149. […] that to “this day, articles, treatises, and practitioners continue to cite the statistic as proven.21Idem, page 141. This is not to say that plaintiffs do not dissipate their lump-sums quickly, but only that this affirmation is not funded, and probably exaggerated due to commercial reasons. Indeed, there is a consensus among structured settlement professionals that plaintiffs do dissipate their settlement prematurely, particularly after factoring,22Idem, page 146. often due to a lack of mental ability, financial knowledge or simply to show off to friends and family (See the “pools-win syndrome” here).

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Structured Settlements: How We Got Here

Structured settlements have changed the landscape of monetary compensation in the tort industry since its beginnings in the late 60’s. It is estimated that since 1975, insurance companies have committed between $35023Terrence McCoy, “How companies make millions of lead-poisoned, poor blacks”, The Washington Post, August 25, 2015. Accessed February 2016. Available at The Washington Post (article). and $40024Babener, Single-Claimant QSF, page 6. billion to structured settlements, handing payments to over 500k25Idem, page 20. beneficiaries. As of 2005, it was estimated that $100 billion were being paid of past structured settlement deals in the US26Ibidem., with 6 billion being purchased each year27Idem, page 7..

Structured settlements are born in the late 60’s28Daniel W. Hindert, Joseph Julnes Dehner and Patrick J. Hindert, “Structured Settlements and Periodic Payment Judgments”, Law Journal Press, 2015. and became wide spread thanks to the thalidomide cases in Canada29Babener, Single-Claimant QSF, page 16., among others30Idem, page 18., when a pharmaceutical company used “structured settlements” to settle the cases31Ibidem.. The United States saw in structured settlements a tool that would prevent beneficiaries of damages from quickly dissipating their awards and thus becoming dependent upon the State.

In 197932Richard B. Risk Jr., “Structured Settlements: The Ongoing Evolution from a Liability Insurer’s Ploy to an Injury Victim’s Boon”, Tulsa Law Review, Vol.36, Iss.4, Art.9., Revenue Rulings 79-313, which allowed a plaintiff to exclude from gross income increased payments, and Revenue Ruling 79-220, which allowed a plaintiff to exclude from gross income the nominal value of periodic payments, contributed to the industry’s growth33Babener, Single-Claimant QSF, page 18..

In 198234The Joint Committee on Taxation, “The Periodic Payment Settlement Act of 1982”, Congress of the United States, 1982. Accessed May 2016. Available at The Joint Committee on Taxation. was enacted the Periodic Payments Settlement Tax Act which “ amends the Internal Revenue Code to allow an income tax exclusion for damages for personal injuries or sickness whether the damages are paid as lump sums or as periodic payments.”35Congress of the United States, “An act to amend the Internal Revenue Code of 1954 with respect to the tax treatment of periodic payments for damages received on account of personal injury or sickness, and for other purposes.” Accessed May 2016. Available at Congress.gov. It created Section 130. Some actors of the industry say that structured settlement’s success is largely due to this act36Babener, Single-Claimant QSF, page 19..

Another mechanism came to life in the mid-80’s37Jason D. Lazarus, Esq., “Qualified Settlement Funds: A Quick Guide for Trial Lawyers”, Settlement Law Firm¸ 2010.: the Qualified Settlement Fund (or Designated Settlement Fund38Ibidem.), which aim was to give power back to plaintiffs, due to some abuses in the industry39Babener, Single-Claimant QSF, page 60. (see here). At the same time, a secondary industry came to life: the structured settlement factoring industry, in which beneficiaries of structured settlements (annuitants) sell their remaining stream of income in exchange of a lump-sum payment40Internal Revenue Code, “Structured Settlement Factoring Audit Technique Guide (ATG)”, September 2015. Accessed May 2016. Available at IRS.gov (pdf). [Hereinafter, IRC, Audit]., which is worth less than the remaining periodic payments.

In 199341United States Government Publishing Office, “Omnibus Budget Reconciliation Act of 1993”. Accessed May 2016. Available at United States Government Publishing Office (pdf). was enacted the Omnibus Budget Reconciliation Act (“OBRA 93”), which created the Special Needs Trust (also called “Supplemental Care Trust42Roger M. Bernstein and Margrit S. Bernstein, “The Use of Special Needs Trusts in the Settlement of Personal Injury Cases”, Marquette Elder’s Advisor: Vol.1: Iss.1, Article 13, 1999. Accessed May 2016. Available at Marquette Elder’s Advisor., “Supplemental Needs Trust43Ibidem., “Qualified Disability Trust44Ibidem. and variants), a mechanism by which a plaintiff keeps his eligibility to programs like Medicaid, while receiving periodic payments.

In 199745Congress of the United States, “Taxpayer Relief Act of 1997”. Accessed May 2016. Available at Congress.gov., Congress enacted the Taxpayer Relief Act, which enabled qualified assignments for workers’ compensation cases46Haines, Susan G. and Campbell, John J, “Protecting the Disabled Individual Through the Use of a Medicare Set-Aside Trust,” Marquette Elder’s Advisor: Vol. 1: Iss. 4 (2000), Article 10. Accessed March 2016. Available at: Marquette Elder’s Advisor. [Hereinafter Haines, Trust]..

The last major change in the industry came in 2002 with the Structured Settlement Protection Act, which aim is to set minimum requirements for structured settlement factoring companies to comply with in order to protect the beneficiary’s “best interests”47IRC, Audit., but also set basics rules for negotiations in the primary industry48Ibidem..

In its beginnings, structured settlements faced opposition from the plaintiff’s attorney side49Babener, Single-Claimant QSF, page 8., but it did not endure: very soon both sides recognized structured settlement’s benefits.50Ibidem. Today, one third of injured plaintiffs are offered a structured settlement. Cases have been reported of malpractice lawsuits when lawyers do not mention structured settlement as an option in a tort case.51Ann J. Conner, “Is Plaintiffs’ Lawyer Liable for Not Offering Structured Settlement?” Lawyers Weekly USA, 2001. Accessed May 2016. Available at Lawyers Weekly USA (pdf).

Structured Settlement Facts

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The Benefits of Periodic Payments Against Lump-Sums

The typical structured settlement is agreed to after a lawsuit has been filed, but before substantial involvement by a judge.52Babener, Single-Claimant QSF, page 9. Indeed, one of the advantages of a structured settlement is that it can encourage the early, private, settlement of a case and therefore avoid disputes and the trauma which a litigation may cause. Therefore it has a “therapeutic effect.”53Lewis, Merits, page 598. However, in cases involving minors or incompetent adults, the structured settlement might be ordered by a court.54Joseph Barnet, “Attorneys Play Vital Role in Structured Settlement Annuities”, available at Law360.

As noted above, brokers have noticed first-hand cases where lump-sum beneficiaries dissipate their awards quickly. This is firstly due to the emotional trauma caused by the accident, and secondly, beneficiaries of lump-sum may fall into self-indulgence and fecklessness:

He may be over-generous in rewarding his relations or in compensation others to whom he feels obliged”. Or feel the need to “buy friendship” and experience what has been described as the “pools-win syndrome”.55Ibidem.[…] “And be subject to the depredations of spend-thrift friends and unscrupulous financial advisers.”56Idem, page 545.2

For a larger example of the pools-win syndrome, read this article from the Washington Post.

The payment of a substantial lump sum often does not mitigate those economic losses in the long run, even if the amounts are theoretically adequate, because few people are capable of investing a large lump sum to assure security, liquidity, and an appropriate rate of return for their future needs. They often are ill-advised by friends, relatives, and even professional managers, and some are natural spend-thrifts in any event.”57Babener, Single-Claimant QSF, page 26 : Interview with Stan Schultz, CEO, IBAR Settlement Co., Inc. (Apr. 8, 2009).

The lack of financial support, discipline and knowledge is yet another reason:

I suspect that there are many counsel and judges who… do not appreciate the need for reinvestment of the part of the income from the lump sum in the early years. How can we expect a much higher degree of sophistication among tort victims? The lump sum award demands both an unreasonable high level of sophistication and a most exception amount of discipline on the part of the average tort victim. Without both this level of sophistication and discipline, the lump sum will prove itself to be a poor and inadequate substitute for the lost income stream.”58Bale, “Encouraging the Hearse Horse No To Snicker”, in F. Steel and S. Rogers-Magnet (eds), Issues in Tort Law (1983) 98.

Nevertheless, structured settlements also require a new set of abilities and financial discipline. The person must learn how to live within his new budget and to plan and think over the long-term, even if this is easier due to the very nature of structured settlements. A structured settlement therefore is said to bring a “positive focus” to the family59Lewis, Merits, page 357..

However, a structured settlement may affect the claimant’s perception of his condition: some plaintiffs receiving monthly payment may mistakenly perceive themselves as beneficiaries of a welfare program.60Ibidem. In the absence of a lump-sum, the person may think that his conditions were underestimated and thus suffer from psychological stress61Ibidem.. In the contrary, by taking a step back and looking at all his due payments, he may mistakenly believe himself as a millionaire and fall into the pools-win syndrome. Therefore advice and support from both the family and professionals is crucial.

The other main appeal of a structured settlement is its tax advantage. The income is tax-free to the extent that it does not exceed the qualified funding asset: it can be annuities or US Government bonds or a mixture of both. This article will only talk about annuities, since it is the common choice.

For a more detailed article, read Structured Settlement vs Lump Sum Payment

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The Benefits of Structured Settlement Annuities

An annuity is a series of payments at defined intervals. In the structured settlement industry, it is called the “qualified funding asset”. This qualified funding asset is tax exempt to the extent that it covers the cost of the annuity premium. For example, a defendant pays $100k to the structured settlement company. The structured settlement company takes a $3k as fees. Following IRC Section 72 regarding annuities, the structured settlement company only has to pay taxes on these $3k.

The payments generated by a structure could be less than the returns from the investment of a conventional lump sum. This depends upon current investment conditions and the projections made concerning the future performance of the economy, including the expected inflation rate.”

Indeed, annuities might be reduced with the revision of the inflation rate but not by falls in the stock exchange62Ibidem.: “the yield from annuities are linked to investments in long-dated government securities [which] are not subject to the dramatic fluctuations experienced by the equity market.”63Ibidem. Therefore, annuities provide a security that cannot be matched by a lump-sum: “the security provided by the lifetime payments generated by a structure cannot by matched by the investment of a lump-sum.64Ibidem. Moreover, “[…] one study found the internal rates of structured settlements to historically outperform Treasury bill rates 78.52% of the time.”65Babener, Single-Claimant QSF, page 26.

And this statement can be proven by the following table66Structured Settlement Market Information, Tools and Charts, “Taxable Equivalent Yield”. Accessed June 2016. Available at 4Structures.:

After-Tax Structured Settlement Investment VS Lump-Sum Investment
Structured settlement Lump-Sum
Tax-Free Rate 15% Bracket 18% Bracket 28% Bracket
2.0% 2.35% 2.44% 2.78%
3.0% 3.53% 3.66% 4.17%
4.0% 4.71% 4.88% 5.56%
5.0% 5.88% 6.10% 6.94%
5.5% 6.47% 6.71% 7.64%
6.0% 7.06% 7.32% 8.33%
6.5% 7.65% 7.93% 9.03%

As you can see, a person on the 28% tax bracket would have to invest at a rate-of-return of 9.03% in order to obtain the same earnings as a structured settlement annuity recipient at a 6.5% rate.

While determining one’s periodic payments, one must take into account one’s future needs. Increasing cost of living, future medical needs, purchase of modified vehicles and inflation are one of the factors that may reduce the yield of one’s payments.

Cost of Living Adjustments (or COLA) “may be built into a structured settlement design to provide for annual cost of living increases, such as 2%, 3%, or 4%.”67Robin Young & Company, Structured Settlements, “The Benefits of a Structured Settlement.” The COLA is based on increases of cost of living, based on the Consumer Price Index. There is others riders, like Pacific’s Life ILAPA, which is linked to S&P 500® Index.

Structured Settlement Annuity Payments Growth : COLA vs ILAPA
COLA ILAPA
Year Annual Increase Monthly Payments S&P Annual Return Annual Return Monthly Payments Annual Variance
1985 $1,165.18 $1,166.22 $12.48
1986 2.27% $1,191.63 21.92% 5.00% $1,224.53 $394.80
1987 2.27% $1,218,68 27.48% 5.00% 1,285.76% $804.97
1988 2.27% $1,246.34 -5.06% 0.00% $1,285.76 $473.00
1989 2.27% $1,274.64 12.62% 5.00% $1,350.05 $904.97
1990 2.27% $1,303.57 18.72% 5.00% $1,417.55 $1,367.76
1991 2.27% $1,333.16 –6.91% 0.00% $1,417.55 $1,012.67
1992 2.27% $1,363.42 34.12% 5.00% $1,488.43 $1,500.08
1993 2.27% $1,394.37 3.89% 3.89% $1,546.37 $1,823.96
1994 2.27% $1,426.03 8.64% 5.00% $1,623.69 $2,371.97

The main difference between the projected rates of return from an annuity-backed structure as opposed to a lump-sum is that the former depends upon the secure returns from long dated gilts, whereas the latter is primarily linked to less certain performance equities. The certainty gained by investment in an annuity is obtained at a price: the rates are generally lower than the return on equities, especially if the annuity is index-linked.”

Another way to protect your monthly payments from inflation is to combine a monthly payment that grows each year by a set percentage with lump-sums. For example, a settlement could pay $1,500 per month, growing at 3% per year, with an additional lump-sum of $15,000 in five years, another of the same value in ten years and a last of $30,000 in fifteen years. If the plaintiff spends all of the lump-sum payments, he would still be protected against an inflation rate at 3%. If the inflation rate is higher, he can invest the lump-sums.

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Annuity Company Bankruptcy

Even if it has never occurred, it is not impossible to the annuity company (the insurer making the payments) to go bankrupt. If this occurs, you structured settlement payments might end. In order to avoid such situation, all parties involved in a structured settlement must:

1. Make sure the company has at least a Class XIII financial rating from the A.M Best Company.

2. You may check Understanding Best’s Financial Strength Ratings.

3. The company’s obligations are backed by a government fund. For example, the Life Insurance Company Guaranty Corporation of New York which “protect policyholders of life insurance companies [of the State of New York] in the event of an insurance company insolvency.”68Life Insurance Company Guaranty Corporation of New York, “About us”, Life Insurance Company Guaranty Corporation of New York.

4. A performance (or surety) bond can be purchased on the structured settlement. A performance bond “guarantees to the obligee that the principal will carry out their performance and payment obligations according to agreement.”

As for the insurers, they protect themselves and therefore plaintiff’s periodic payments by:

1. Maintaining assets above a certain reserve ratio. The reserve is usually higher.

2. State regulators may help restructuring the companies during crisis.

3. If a company stops making payments, a state insurance guaranty may continue it, for example, the Federal Deposit Insurance Corporation (“each depositor insured to at least $250,000 per insured bank”).

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Factors To Consider When Negotiating A Structured Settlement

Structured settlements are flexibles tools prior to the agreement; it usually can’t be changed thereafter. Therefore one have to, with the broker’s help, consider every aspect of one’s life in order to determine the debut, length, and the ending of the structured settlement. Clauses of non-assignment (which forbids an annuitant of selling his structured settlement payments to structured settlement factoring companies) have been reported but some courts choose not to enforce them69Babener, Single-Claimant QSF, page 10..

The crucial point of the structured settlement contract is the value of the structured settlement. “The price of each annuity is calculated using a multitude of variables including but, not limited to, current yield rates, profit margin, mortality rates (if life contingent), fixed percentage for the parent company and commission”.70Christi Fried, from Continental Trust, commentary on the broker’s commission. Available at 4Real.

Defendants can profit by negotiating in future terms: “Due to inflation, one dollar in ten years is worth far less than one dollar today. If invested prudently, one dollar today will increase in value faster than inflation. Thus, a defendant who can promise plaintiff $100,000 spread out in monthly payments over ten years is far better off doing so than paying plaintiff $100,000 in cash today.”71Babener, Single-Claimant QSF, page 52.

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Rated Ages

If a plaintiff has a “rated age”, “the injured person is treated as older than he actually is for the purpose of determining the cost of the annuity”. In other words, “If a person receives a rated age it means that the life-insurance company had decided that the person’s life expectancy is less than normal.”72Jason D. Lazarus, J.D., CSSC, “Structured Settlements: The Impact of Substandard Age Ratings”. Available at Special Needs Firm (pdf).

As a result the cost of providing a given level of benefit is reduced. Therefore, “a higher income can be secured from the annuity because the life office expects it to be in payment for a shorter time”, whether or not the factor(s) of such lower expectancy is related to the claim.

Life insurance companies often use The National Vital Statistics Report as landmark for life expectancy in the United States. “The shortened life-expectancy results in a lower structured settlement cost for the same benefit stream when compared to the cost for a person with a normal life expectancy.” Therefore the monthly benefits would be greater and the premium smaller.

For example, the settlement of $1,000 per month for life for a 25-year old male with a 47.5-year life expectancy has an expected payout of $570,000 and a cost of $129,178. The addition of a 3% growth rate increases the total cash payout by $658,825 to $1,228,825, while increasing the cost of the annuity only $51,201 to $180,379.”

The rated age is obtained after the broker sends the plaintiff’s medical records to the life insurance company: discharge summaries from hospitals, prescription records, past medical records, social and family history of the patient, etc.

Usually the life insurance company’s physician reviews the records and determines the rated age (if there is one), but not always : “Just because a doctor does not comment on reduced life expectancy or states there is no reduced life expectancy does not mean there will be not rated age.” The final decision belongs to the life insurance company which looks for certain medical conditions.

Some of these conditions lowering the life expectancy of plaintiffs include: heart conditions, hypertension, liver disease, cancer, HIV, brain trauma, obesity, amputations, genetic disorders, strokes, electrocution, diabetes, narcotic use, smoking, alcoholism, multiple sclerosis, muscular dystrophy, cerebral palsy, hepatitis, lung disease, among others.

When rated ages apply, the lawyer’s role is to protect his client interests. Plaintiff’s attorney need to take into account the plaintiff’s present health problems and foresee future health problems and make sure his future stream of income and, if agreed, lump-sum payments, will cover his future health and other needs.

Rated ages only work with life-contingent payments. A life-contingent payment ends with plaintiff’s life. Guaranteed payments can be passed on if the structured settlement outlives the plaintiff. In this case, the plaintiff’s heirs would benefit from the structured settlement. However, some payments are guaranteed between one-third and one-half over the beneficiary’s life-expectancy.73Danninger, Negotiating, page 69.Guarantees are particularly useful when the plaintiff is the family bread-winner. In these cases the structured settlement should be guaranteed at least until the youngest child is expected to leave home.”74Ibidem.

Moreover, often the guaranteed payment is not as much higher as expected.75Ibidem. If the structured settlement is not for life, “stress, social isolation and concern over the continued provision of such assistance if or when they would no longer be able to provide it.” Therefore, “the plaintiff and his immediate family can be impaired because of the need to assume such burdens.”

Sources diverge on the average amount of the total payout of a structured settlement involving a major disease or accident. The structured settlement selling industry talks about two-thirds of them averaging a total payout of $400k76Babener, Single-Claimant QSF, page 9., whereas the structured settlement factoring industry says that half of the premiums are valued at below $50k and that only 13% exceeds $250k77Ibidem.. As for the minimum, “values as low as $5,000 and $2,700 have been reported.”78Ibidem.When life-contingent payments does not apply, the average span of a structured settlement is 20 years79Ibidem..

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Choosing the right structured settlement broker

After agreeing on paying the injury awards through a structured settlement, parties have to choose a structured settlement broker. A structured settlement broker is a person who will help both parties, and under each party’s attorney’s surveillance, to create the contract that will fit their needs. The broker is hired by the defendant.80Marjorie Suisman, “Qualified Settlement Trusts: A Useful Tool in Multi-Party Litigation”, Davis Malm & D’Agostine P.C: 3, 2005. Accessed April 2016. Available at Davis Malm & d’Agostine, attorneys at law.. [Hereinafter Suisman, QST].

The choice of the structured settlement broker is highly important. For this reason, you have to make sure the structured settlement broker has all the licenses they need, particularly the license from the life-insurance company he works for: “The broker must have a current license or appointment issued by at least one life insurance company to sell its structured settlement annuity contracts or to act as a structured settlement consultant or broker for the company.”81Annuity Brokers Minimum Qualification, law.cornell.edu/cfr/text/28/50.24. The Department of Justice has issued a list of approved brokers that meets the minimum requirements82U.S. Department of Justice, “Update of the 2015 Calendar-Year Annuity Brokers List”. Available at Justice.gov [last visited March 2015]..

If you choose a Qualified Settlement Fund to operate your structured settlement, “it gives the plaintiffs the opportunity to hire their own settlement broker who can approach a variety of annuity companies to obtain the most competitive payout from the highest rated carriers.”83Suisman, QST, page 4

The broker commission is usually between 2%84Babener, Single-Claimant QSF, page 10. and 4%*85Ibidem.. It is derived from the premium used to purchase the qualified funding asset (the annuity contract) and will be paid by the insurance company. It’s worth noticing that in cases where there’s multiples agents, which is often the case86Ibidem., the 4% will be shared among them87Idem, page 10., which may induce a conflict of interest88Ibidem., not always mentioned to the recipient(s)89Ibidem..

Usually the insurance company pays the commission in advance to the broker and hopes to get sufficient margins to cover the costs thereafter:90John Darer, “How Does Structured Settlement Broker Get Paid? Who Pays It?”, Structured Settlements. Available at 4Real [Last visited June 2016]. it is called Deferred Acquisition Costs91You may check the definition of a “Deferred Acquisition Cost” at Investopedia: http://www.investopedia.com/terms/d/dac.asp.. Nevertheless, this tactic is not wide-spread92Christi Fried, from Continental Trust (http://continental-trust.com), disagrees with John Darer’s comments and states that the broker’s commission is taken into account when negotiating the cost of the structured settlement. and has been challenged93Ibidem.. The lack of margins to cover the costs will not change the value of the structured settlement thereafter94John Darer quoting a friend of his from the structured settlement industry: “Out of its own funds, the annuity company will advance this 4 percent commission to the broker(s) handling the structured settlement and hope that the company’s investment margins are sufficient to recover the commission advances. Even if the annuity company’s margins are less than anticipated, your structured settlement payments will remain the same”.. One other tactic consist of the liability insurer working exclusively with a given broker and the latter sharing his commission from the purchase of the structured settlement with the former95Babener, Single-Claimant QSF, 56: “A liability insurer might almost exclusively hire those particular brokers, refusing to structure a settlement unless their broker is used. In exchange for this business, it has been reported that brokers will often share their commission on annuity purchases for structured settlements with the liability insurer.”.

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Hiring the right attorney

Plaintiff and defendant attorneys play an essential role in the negotiation process. They must clearly state to all parties the payments amount and due dates, if there’s a planned increase, it must clearly state by how much and when it will increase. It also may state any amount deducible from the periodic payments; if the plaintiff is allowed or not to transfer his rights to a structured settlement factory company.

Each party has a lawyer to defend his interests, to make clarifications about the process and to create the specific terms of the contract. “In representing a client, a lawyer shall exercise independent professional judgement and render candid advice. In rendering advice, a lawyer may refer not only to law but to other considerations such as moral, economic, social, psychological, and political factors that may be relevant to the client’s situation.”

Therefore an excellent attorney would ask question as these:

1. How does the plaintiff attorney know whether the defense broker “shopped” the market for the most competitive quotes (within the range of acceptable life companies)?96Ibidem.

2. Has defense broker adequately spread the annuity risk?97Ibidem.

3. Has defense broker maximized the statutory protection afford annuities?98Ibidem.

And the plaintiff would ask:

1.Is the language clear, as to when the payments will begin? And when they will end? Are actual dates used?

2. Is there any ambiguity as to whether or not the payments will continue over the lifetime of the claimant?

3. Are all payment streams consistently stated throughout all of the documents?

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Structured settlement attorney cost

The cost of the attorney’s fees is based on the cost of the settlement99Danninger, Negotiating, page 70.. Some attorneys ought to be paid at the settlement. “Counsel should state in their contingent fee agreements that fees will be calculated on a structured settlement’s cost and may be paid at settlement or structured separately. […] Otherwise, an agreement based on ‘any money received’ may be interpreted as entitling the attorney to a percentage of each payment when it is received.”100Ibidem.

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Structuring attorney’s fees

Regardless of the fact that the plaintiff chooses to receive his payments from the defendant in a structured way, attorneys can structure their own payments. He, or his company will, receive his payments over a period of time, instead of a large and taxable lump-sum payment. The benefit to the attorney being that he will be taxed at each periodic payment instead of being taxed on the lump-sum payment.

1. The attorney can choose to delay his first payment sometimes up to twenty years (until his retirement age, for example),
2. it can be indexed to COLA in order to protect it from inflation,
3. or other cost-of-living adjustment (for example Pacific Life’s Index-Linked Annuity Payment Adjustment rider, “ILAPA”), etc. He can also choose to receive lump-sum payments at certain dates.

These aspects (timing, amount, etc.) ought to be negotiated before the final judgement in order to avoid constructive receipt, otherwise the attorney will be taxed now and not later. It is usually used by lawyers exercising on contingency-fee basis, i.e., the lawyer is paid only if he handles the case successfully.

By structuring his fees, the attorney will secure himself a steady revenue. Structuring fees is not suited for any attorney. It depends on the attorney’s tax bracket, health, needs, etc. Contrary to plaintiff’s structured payment, a commutation rider is usually not available.

Example of attorney’s structured fees vs lump-sum101John J. McCulloch, “Attorney Fee Structured Settlements”, EPS Settlements Group.:

Lump-sum Structured
Contingency fee $2,000,000 $2,000,000
Federal Income Tax $700,00 $0
35% Bracket $65,000 $0
Employment Taxes $170,000 $0
State Income Tax (8.5%) $0 $0
Total after taxes $1,065,000 $2,000,000

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Commutation riders

The death commutation rider is a mechanism by which, at plaintiff’s death, a lump-sum payment, sometimes covering from 5% to all of the remaining periodic settlements, will be made to plaintiff’s beneficiary. Therefore commutation riders is used with life-contingency payments.

It could also be used when the death of the plaintiff excludes the need of further periodic payments. Commutation riders have to be made at the settlement negotiation and usually can’t be renegotiated. A commutation rider is especially suitable for persons in a Special Need Trust.

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Structuring workers’ compensation

Workers’ compensation involving Medicare Set-asides benefit much by the use of structured settlements if the sum is consequent102Denise Johnson, “Workers’ Comp Structured Settlements Beneficial in Medicare Set Asides”, Claims Journal, (2012). Accessed March 2016. Available at: Claims Journal..

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Special Needs Trust

The receipt of income from a structured settlement can hurt a person if he already receives government help. Therefore, the use of a structured settlement with a Special Needs Trust may be the way to go. Nevertheless, unlike structured settlements, special needs trust are taxable, even if, due to the very nature of Special Needs Trusts, the tax rate will be very low.

With a Special Needs Trust, a disabled person transfers excess assets to a trust without losing government’s benefits, like Medicaid or Supplemental Security Income (SSI) and receives professional advice if certain conditions are met. Therefore the purpose of such trusts is to “pay for expenses not paid for by public benefits.” The person therefore can use the money for other expenses without losing the help needed to his health.

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The Short-Changing scheme and other tactics

It is argued that structured settlements were specially designed for defendants103Babener, Single-Claimant QSF, page 50.. Often represented by they insurers at the negotiations104Ibidem., defendants have enjoyed the advantages of experience for being “repeat players”.105Ibidem. Plaintiffs’ attorneys often allow defendant’s insurer to control the structuring: “Many plaintiff attorneys who rightly were concerned over their own exposure to a legal malpractice […] simply had their clients take the cash.”106Ibidem.

However, as plaintiffs gained experience, defense-side savings have decreased.107Ibidem.During the early development of structured settlements, defendants maintained an information and resource advantage over plaintiffs, a condition that dissipated in the 1990’s.”108Ibidem.

The National Structured Settlement Trade Association worked hard to prevent plaintiffs from gaining power at the negotiations. For example, it “worked to defeat proposed legislation that would have allowed structured settlement plaintiffs to select their broker.”109Ibidem.

Another tactic used by defendants and their insurers consist of hiding the true value of the structured settlement. They stated that if the plaintiff knew of the actual price, it would constitute constructive receipt. Later they argued that if the plaintiff broker is involved in the negotiations, it would cause the same effect. These allegations are of course false.110Ibidem. This tactic is called the “short-changing scheme.”

For example, one case regarded the representation by the Medial Malpractice Insurance Association to plaintiffs that a structured settlement package, including annuity providing for payments of $3,000 per month to life to an infant, carried a present value of $940,180. In fact, the package’s true present value was $410,000.”111Idem, page 53.

Today, only a very naïve attorney would not insist on knowing the cost of the proposed settlement on behalf of a client.”112Ibidem. That is why unrepresented plaintiffs are more at risk of falling into this scheme.

How did the defendant increased the value of the structure?

1. By negotiating on nominal value (rather than real).

Due to inflation, one dollar in ten years is worth far less than one dollar today. If invested prudently, one dollar today will increase in value faster than inflation. Thus, a defendant who can promise plaintiff $100,000 spread out in monthly payments over ten years is far better off doing so than paying plaintiff $100,000 in cash today.”113Ibidem.

2. Profiting through the purchase of the structured settlement annuity.

Defendants may profit more from structured settlements by buying the annuity contract from a life insurance company114whose parent is the casualty insurer. Some insurers only work with their affiliates companies.

3. Negotiating the benefit from the tax subsidy.

Defendants may indirectly benefit from structured settlements by asking for a decreased settlement payment.115Ibidem.

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Qualified Settlement Fund (or Designated Settlement Fund)

A qualified settlement fund’s main purpose is to give the control of the structured settlement to the plaintiff. It is created by section 468B of the Internal Revenue Code.

Today it is unclear if plaintiffs would lose the tax subsidy if they agree on a qualified settlement fund, that’s one of the reasons that it is not widely used by plaintiffs.116Idem, page 4. Therefore, a qualified settlement is used in cases of mass-tort settlements.

A QSF is used in connection with the establishment of a Special Needs Trust. It ensures that an otherwise eligible injured plaintiff is not disqualified from receiving government benefits.”117Ibidem. The Qualified Settlement Fund can be a party to a qualified assignment. This “gives the plaintiff greater flexibility and superior bargaining power in negotiating a structured settlement.”118Ibidem.

1. First, defendants make a deductible lump-sum payment to the fund, which will be paid out to plaintiffs. The Fund takes on defendant’s liability towards the plaintiff, as the usual structured settlement company. “The funds can remain in the QSF, earning interest for the plaintiffs, until all claims are settled.119Ibidem.

2.  With a qualified settlement fund, the defendant deposits the premium into a trust, which thus becomes the assignee. 120Suisman, QST.

3. The defendant is thereafter released of his liability towards the plaintiff,121Ibidem. and is entitled to a deduction from income tax for the amount paid to the trust. With a qualified settlement fund, the defendant does not have to wait until the plaintiffs receives the money to be deductible.122Ibidem.

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Bonus: Structured settlement and structured settlement factoring industry lobbies:

Lobby group National Structured Settlement Trade Association

nsstalogo200x500

National Association of Settlement Purchasers

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Year founded 1985 1996
Role To defend structured settlement companies’ interests. To defend structured settlement factoring companies’ interests.
Notable achievement Lobbied for the tax-exclusion upon which the whole industry is dependent. Lobbied for the legitimacy of factoring transactions.
How much they spent in 2015? $48 000123 OpenSecrets.org, “National Structured Settlement Trade Association”, Opensecrets.org. $10 000124OpenSecrets.org, “National Association of Settlement Purchasers”, Opensecrets.org.
Are they enemies? Yes125Babener, Single-Claimant QSF, 36: “the two sides criticized each other publicly.”
But where do they agree? They found a compromise on the 40% tax for factoring transactions.

What do you think of structured settlements? Write below.

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