Many injury victims find it very difficult to manage a lump sum settlement on their own. In fact ninety percent of injury victims have nothing left of their settlements within five years of settlement. Implementing a sound financial plan with the right combination of investments can prevent this from happening. However, most financial products have costs associated with them and even though a physical injury recovery is tax-free, once invested the gains are taxable. Nevertheless, there are many good options for managing your physical injury recovery and we can assist you developing a plan that is right for you. Certain financial products have less risk and can offer guarantees of principal to limit downside risk since you only get one opportunity to preserve your physical injury recovery. Our job is to give you sound advice about the options to let you make the best possible decision.
You may want to consider mutual funds, managed accounts, annuities, life insurance, college plans and long term care insurance. All of these products can be wrapped up inside trusts to protect you and your loved ones. It is important to explore the many options available and that is where we come in.
Why You Need a Settlement Planner
The intersection of settlement planning, settlement taxation, public benefit preservation and liens complicates settlements today. These matters are a fertile area for malpractice claims against personal injury attorneys. Without an expert’s guidance, keeping up to date on the changing facets of the law and ethical responsibilities in these areas is difficult at best. You should not underestimate the importance of hiring an expert settlement planner on your next case who can help guide you and your client through these complexities.
The use of structured settlements and trusts as a way to fund future needs for injury victims has become common place in today’s settlement landscape. Frequently, these solutions are proposed by the defendant as a way to settle the case.
Structured Settlements
A structured settlement is simply a future periodic payment arrangement that is made a part of a personal injury settlement. Under Section 104(a)(2) of the Internal Revenue Code, all of the future periodic payments are completely tax-free to the injury victim even though the payments include interest they earn. The structured settlement is spendthrift as it can’t be accelerated, invaded or sold. Fixed annuities are used as the funding mechanism for a structured settlement. These annuities are offered by large well capitalized life insurance companies. Annuities are used because of their flexibility and because many different payments options are available for the injury victim to meet their needs.
While the transaction and the concept might seem very simple, there are many issues that trial lawyers should be aware of as well as concerned about. If you review the sections in this part of the site it will give you a good idea of the issues and also why it is important to have your own settlement planner looking out for these issues.
Understanding the Transaction
In order to have a tax-free structured settlement in a personal injury settlement, a release with the required language for a structured settlement must be executed, a uniform qualified assignment must be executed and the structured settlement annuity must be funded by the defendant with a check made payable to the assignment company. The premium which goes from the defendant to the assignment company is used to purchase the qualified funding asset (the annuity contract) from the annuity issuer. The assignment company is the obligor (owes the payments to the injury victim) and the annuity issuer (the life insurance company) guarantees the payments. The release must set forth the obligation of the defendant to make the future periodic payments and then that obligation is assigned to the assignment company relieving the defendant of any future liability or obligation. The qualified assignment is the document that transfers the future periodic payment obligation from the defendant to the assignment company and is a required document in the transaction.
Qualified Settlement Funds
Qualified Settlement Funds grew out of Internal Revenue Code Section 468B. 468B was passed by Congress in 1986 and created Designated Settlement Funds (“DSF”). The DSF was fairly limited in the way it could be utilized and in 1994 passed regulations creating a new type of fund, Qualified Settlement Funds (“QSF”). The DSF and QSF were created for use in mass tort litigation enabling a defendant to settle a claim by depositing money into a central fund that could then settle with each individual plaintiff. The defendant could walk away from the fund after its creation and funding taking a deduction for the entire settlement amount in the year it was deposited into the fund. However, the QSF is not limited to situations involving mass torts. A Qualified Settlement Fund can be used to settle cases of any value involving multiple plaintiffs including cases involving the personal injury victim with a derivatively injured spouse, child or parent. It can arguably be used in single plaintiff cases based upon the plain language of the Treasury Regulations.
Using a 468B Qualified Settlement Fund settlement proceeds can be placed into a QSF trust preserving the right to do a structured settlement and protecting public benefit eligibility temporarily. While the money is in the QSF, a financial settlement plan can be designed and liens can be negotiated. Additionally, if the settlement recipient is on public benefits the QSF avoids issues with constructive receipt of the settlement, which could trigger a loss of public benefits. While the funds are in the QSF, there is time to create a public benefit preservation trusts for the settlement recipient. The structured settlement or other financial products can then be set up to work in concert with a special needs trust or Medicare Set Aside so that the injured victim does not lose their public benefits.
IRS Code § 468B and Income Tax Regulations found at § 1.468B control the use of a QSF. These provisions provide that a defendant can make a qualifying payment to the QSF and economic performance would be accomplished, crucial for tax reasons to the defendant. Thus the QSF trustee can receive settlement proceeds allowing the defendant a current year deduction releasing them from the case. The QSF trustee can, after receiving the settlement proceeds, agree to pay a plaintiff future periodic payments, assign that obligation to a third party, and allow the plaintiff to receive tax-free payments under IRC § 104(a)(2) (the provision excluding from gross income periodic payments from a structure). The transaction works exactly the same as it normally would when you have the defendant involved in the structured settlement transaction.
There are only three requirements under 468B to establish a QSF trust. First, the fund must be established pursuant to an order of a court and is subject to the continuing jurisdiction of the court. Second, it must be established to resolve one or more contested claims arising out of a tort. Third, the fund, account, or trust must be a trust under applicable state law. One restriction is that it can’t be used in a Workers’ Compensation case.
Mechanically, it is easy to establish a QSF. First, the court having jurisdiction over the litigation must be petitioned to establish the fund. The court is provided with the fund document and an order to establish the fund. Once the order is signed, the defendant is instructed to make a check payable to the QSF and the defendant is given a cash release in return for the payment. The QSF then can fund a structured settlement, pay liens and fund a special needs trust. Once all funds have been distributed, the fund dissolves.
There are several advantages to utilizing a QSF. First, funding the QSF removes the defendant and defense counsel from the settlement process. It is very much like an all cash settlement in the eyes of the defendant. Once the Trustee receives the settlement money, economic performance has occurred and the defendant is out of the case. Second, the attorney’s fees and other expenses can be paid immediately from the 468B fund. Third, the 468B trust removes the defendant from process of allocating the settlement amounts between the various plaintiffs. Fourth, the plaintiffs receive the interest income from the settlement fund. The plaintiffs can take their time, carefully considering the various financial decisions they must make and addressing public benefit preservation issues. Finally and probably most importantly, the time crunch is alleviated with regards to the lien negotiations, allocations, and probate proceedings.
The end of a personal injury case is typically one big time crunch which I call the “settlement time crunch”. There is enormous pressure to wrap up the case quickly to get the client paid and yourself paid. However, in the rush to finalize the settlement you may overlook or miss important settlement planning issues. Instead, a Qualified Settlement Fund can be created to receive the settlement proceeds thereby giving everyone the time necessary to carefully plan for the future. You can get your fees and costs quickly. The funds are obtained from the defendant, they are released and the client’s settlement dollars can begin to earn interest for them. The liens can be negotiated, allocation decisions can be made, public benefit preservation trusts can be implemented and structured settlements can be considered. Your option to structure your attorney fees is also preserved. The QSF is an important tool for trial lawyers to consider using.
Reducing Default Risk
The only major risk an injury victim takes when entering into a structured settlement is the solvency of the company selected to provide the future periodic payments. However, this is a relatively small risk given the financial size of the major life insurance companies that provide structured settlement annuities. Nevertheless, when a “substantial” structured settlement is done one must always consider split funding the structured settlement with multiple companies to spread out the risk. The premium can be spread out amongst as many different companies as the client would like. However, if the case involves a rated age it may be detrimental to the client to split fund. This issue must be examined on a case by case basis.
In addition, when a structured settlement is done secured creditor status can be requested. This is accomplished by doing a special kind of assignment document called a Uniform Qualified Assignment Release and Pledge Agreement. This gives the injury victim secured creditor status which means in the event of the insolvency of a life insurance company they would stand in line only behind the government as a creditor. It moves them to the front of the line.
Substandard Age Ratings
You may have heard of “Substandard Age Ratings” or “Rated Ages” if you have had a case where the plaintiff had a reduced life expectancy and a structured settlement was offered to settle the claim. A “rated age” is a life expectancy adjusted age used to calculate the cost of a structured settlement. If a person receives a rated age it means that the life insurance company has decided that the person’s life expectancy is less than normal. 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. For example, a case we consulted on involved a two year old brain injured girl who had a rated age of sixty-four. Therefore, a life annuity, the most common funding vehicle for a structured settlement, is priced as if the plaintiff is chronologically age sixty-four. This results in a significant cost savings on the price of the life annuity.
A structured settlement consultant obtains rated ages by sending the plaintiff’s medical records to the life insurance companies that are in the structured settlement market. Usually, a consultant will send out at the most fifteen to twenty pages of records indicating any pertinent diagnosis and current medical conditions. A life company physician or medical underwriter determines the rated age after reviewing the records provided to them. I have heard many times from attorneys that none of the plaintiff’s physicians say she has a reduced life expectancy so don’t bother getting rated ages. 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 no rated age. While what the doctors say carries weight, the ultimate decision on whether to issue a rated age rests with the life insurance company. In most cases, the life insurance company will issue a rated age if certain medical conditions are present.
Physicians’ and Medical Underwriters’ rated age assessments can vary greatly among life insurance companies since they are based upon an examiner’s opinion and opinions among examiners will differ. For example, in the case mentioned above involving the two year old brain injured girl, we obtained rated ages with the highest being sixty-four and the lowest being twelve. The fifty-two year difference in the rated age makes a tremendous difference in the ultimate benefits to the victim. Even the thirteen year difference between the highest rated age of sixty-four and the second highest rated age of fifty-one makes a significant difference. In the case involving the brain injured minor, Pacific Life had the highest rated age and New York Life had the second highest rated age. A.M. Best rates both Pacific Life and New York Life A++ so they were both highly rated life insurance companies. The structured settlement consultant working for the defendant was not approved to represent Pacific Life. If we had not been involved in the case the defense consultant would have quoted New York Life and would not have gotten a rated age from Pacific Life. If the victim did not know about Pacific Life she would have lost a substantial amount of money.
How much would she have lost? If the rated age of fifty-one is used the plaintiff has lost $514,938 over the guarantee period and $2,439,987 over the expected period. As you can see even a relatively small variation in rated ages, such as thirteen years, can have a profound impact on a case. To add another layer of complexity, you must then compare all of the rated ages with each particular life insurance company’s rates to determine the best possible deal. It is very important that you have all of the facts when a rated age is involved.
Annuity Rates
The two main determinants of the price of a structured settlement annuity are rated ages and annuity rates (pricing). To figure out the best possible solution using a structured settlement you must compare the rated ages with the annuity rates. Annuity rates vary depending on how aggressively a life insurance company is going after business and on market conditions. Most life insurance companies offer what is called daily rates (special pricing) if the premium is $250,000.00 or more.
As an example, take the case of Ed. His highest rated age was from Allstate at fifty-three and $1,000 per month for life with a twenty year guarantee had a cost of $183,812. The second highest rated age at 38 was from Prudential and the same benefits had a cost of $202,374. Mass Mutual had the third highest at 35 and the same benefits had a cost of $212,358. Interestingly though the fourth best price was from Met which had one of the lowest age ratings at 14 but a cost of $216,314 which was lower than quite a few companies that had better age ratings. In some cases the highest age rating may not yield the lowest price as it normally does thus a complete market survey must be done to get the best possible deal for the injury victim.
Explanation of State Insurance Guaranty Associations
Understand first, that though state guaranty fund laws are based on an original model act, over the years, each act has been modified such that they are all somewhat different. At its core, each state has a guaranty association composed of all of the companies who write life and health insurance in that state. If any carrier becomes insolvent, the guaranty association assesses its members against a predetermined formula to make up the shortfall. The variables in each state include:
- The coverage limit: Most states use a $100,000 limit though some offer $300,000 or $500,000 for annuities, including structured settlement annuities (Florida’s is $300,000 – see attached statute). The limit refers to the present value of the remaining future stream of payments at the time of the insolvency.
- The triggering mechanism: Most states trigger the coverage with insolvency. Some few use a somewhat lower standard.
- Definition of who is covered: Most states cover the annuity owner, in the case of a structured settlement, the assignment company. Some states cover the annuitant or the measuring life.
In practical terms, the guaranty associations fund the transfer of obligation from an insolvent insurer to a solvent insurer. The classic case was the Canadian company, Confederation Life. When Confederation was taken into conservation by the Canadian government, the US regulators separated the US business from the parent company. Each block of business was grouped and assigned a pro rata share of the assets. The block of assets and liabilities in each line of business was then sold at auction to the highest bidder (which is to say, the company willing to take the least assets in order to guaranty 100% payments to all policyholders in that line of business. The prize business, life insurance and investment products, is sold first. Since those contracts represent an ongoing stream of premiums or payments, companies are willing to take less assets in order to secure the business. The excess assets are then poured over the other lines of business. The single premium business is sold last, by which time it is covered by the maximum amount of assets. If there is any shortfall, the guaranty funds step in to fill the gap. It is relatively rare for guaranty funds to have to do more than finance the process and recoup their investment once all policyholders have been guaranteed 100% payments. In the case of the kind of highly rated companies associated with structured settlements it is rarer still.
Only once in the history of the guaranty funds has a shortfall continued to exist at the end of the above process. That was the case of Executive Life of California which fell victim to the junk bond craze of the mid-1980′s. First Executive Corp, ELIC’s parent was holding some 13,000 structured settlements when it was taken into conservation. Of those, 8,000 were covered 100% by ELIC’s assets. Of the remaining 5,000, 3,500 were covered by a combination of ELIC’s assets and the guaranty fund coverage. Another 1,100 policies were made whole by a combination of the above and shortfall payments made by property casualty insurers. The remaining 300 annuitants recovered an average of 92 cents on the dollar.
That is the only case in which anybody suffered any loss with a structure. Given that there are more than 500,000 structures in force around the world, an 8% on 300 policies is an infinitesimally small loss ratio. Moreover, with the improvements in state regulation systems, including risk-based capital measures, far fewer insolvencies are expected to occur, and fewer still, if any, among the companies who write structures who represent the top 2% of all life and annuity companies in the country.