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Structured Settlements: A More In-Depth Look

For nearly 25 years, the federal government has recognized and encouraged the use of structured settlements in personal injury cases. Structured settlements have also attracted strong support from plaintiff attorneys, state attorneys general, legislators, judges, and disability advocates.

Historically, damages paid because of an injury lawsuit came in the form of a single lump sum. This kind of payment, especially in catastrophic injury cases, often placed the injury victim (or family) in a difficult financial position. With the victim focused on adapting to a new lifestyle, there often was not the time to manage large sums of money. That can lead to serious trouble. A person who loses funds intended to cover a lifetime of medical care runs the risk of losing medical care and independence. They also risk winding up on public assistance. That is why, in 1982, a bipartisan coalition of legislators in Congress came together to pass legislation that amended the federal tax code. Their action, the Periodic Payment Settlement Act of 1982 (Public Law 97-473), formally recognized and encouraged the use of structured settlements in physical injury cases.

What is a structured settlement?
Structured settlements are an innovative method of compensating injury victims with the use of annuities. Encouraged by the U.S. Congress since 1982, a structured settlement is a voluntary agreement between the injury victim and the defendant for future periodic payments.

With a structured settlement annuity, the injury victim doesn’t receive compensation for his or her injuries in one lump sum. Rather, he or she receives a stream of tax-free payments tailored to meet future medical expenses and basic living needs.

A structured settlement may be agreed to privately (for example, in a pre-trial settlement) or it may be required by a court order, which often happens in judgments involving minors.

What kind of flexibility do I have in setting up a structured settlement?
Structured settlement annuities are exceptionally flexible and can be designed to meet virtually any set of needs. A relatively simple payment schedule can be set up that provides for equal payments at set intervals - for example, every month for 20 years.

Yet payments need not be in equal amounts. Someone who will need a new wheelchair every three years might elect to receive a larger payment every 36 months to help defray the cost. (This would presumably be in addition to the regular payments.)

The inherent flexibility of structured settlements means that they are well-suited to compensate people for a wide variety of injuries. Your attorney or a Millennium consultant will be able to explain additional details as they apply to your case.

Who determines the amount of payments and the payment schedule?
In any physical injury case, the plaintiff and defendant negotiate issues such as the victim’s medical care and basic living and family needs. Oftentimes, one side (or both) will bring in an expert, such as a structured settlement consultant, who provides calculations on the long-term cost of these needs.

When there is agreement on the amount of damages due the injury victim (which can happen before, during or after a lawsuit), the victim can select a periodic payment plan that meets his or her needs, and the defendant will agree to make the future payments via a structured settlement. The defendant then assigns this obligation to an experienced third party, a life insurance company that funds the damage payments with an annuity.

An annuity has been the preferred way of funding because of its pricing and flexibility. An alternative is a trust fund which invests only in United States Treasuries. However, these trusts are not used very often because they are inflexible and can’t provide lifetime income.

As these issues involve complex calculations, you should always consult your attorney and a structured settlement consultant.

Are structured settlements more likely to be used in certain types of cases?
Structured settlements can be ideally suited for many types of cases, including:

  • Persons with temporary or permanent disabilities;
  • Guardianship cases that may involve minors or persons found to be incompetent;
  • Workers’ compensation cases;
  • Wrongful death cases where the surviving spouse and/or children need monthly or annual income; and
  • Severe injury, especially with long-term needs for medical care, living expenses and support of family.

Independent surveys show that the more serious the injury, the greater the likelihood that a structured settlement will be used.

I’m involved in a lawsuit now. Why should I consider a structured settlement?
The tax-free payments from a structured settlement can:

  • Relieve the financial pressures of medical expenses and living needs;
  • Meet long-term rehabilitation or permanent care facility expenses;
  • Provide for the future costs of college funds, retirement, down payment on a home, or mortgage payment;
  • Provide enhanced protection of the recovery from creditors and predators; and
  • Provide long-term financial security.

What are the advantages of a structured settlement over a lump-sum payment?
A long-term structured settlement has several advantages. First, there is security. A structured settlement provides guaranteed long-term income. That gives the victim or the victim’s family the ability to recover without spending time and resources determining investment strategies. Structured settlement recipients avoid the possibility of a financial loss due to poor investment choices. Structured settlements provide a secure, low-risk source of compensation and the convenience of regular payments tailored to fit the victim’s specific needs.

A second advantage is financial: When Congress amended the federal tax code to encourage structured settlements, it explicitly provided that 100 percent of every structured settlement payment would be exempt from federal and state income taxes.

There are many other benefits as well. The victim avoids the risk of mismanaging his or her settlement proceeds. Insurance industry statistics show that about 25 to 30% of all accident victims completely dissipate their judgments or settlements within two months of recovery, and 90% of them spend it all within five years. (Source: The Rutter Group, Ltd. from Flahavan, Rea, Kelly & Tener, “California Practice Guide: Personal Injury” (TRG 1992) Ch. 4.) Structures can offer rates of return that are competitive with other investments. (See Investment Comparison Chart). Finally, using a structured settlement, a victim can avoid the risk of outliving his or her recovery by transferring the risk to a secure financial institution with experience in this field.

What are the disadvantages of a structured settlement?
There are two main disadvantages:

1. The periodic payments can’t be borrowed against, deferred, accelerated or changed once set up; and

2. Default risk, meaning the life insurance company that is selected becomes unable to make the payments. However, this risk is small due to the well-capitalized life insurance companies that are used for structured settlement annuities. Additionally, there are state insurance guaranty associations for every state that guarantee annuities up to a certain value (this excludes workers’ compensation reinsurance). Finally, settlement proceeds can be spread among several different life insurance companies to lessen default risk.

What are some of the federal tax rules that make structured settlements beneficial?
In the Periodic Payment Settlement Act of 1982 (P.L. No. 97-473), Congress adopted specific tax rules to encourage the use of structured settlements to resolve physical injury cases.

Section 104(a)(2) of the Internal Revenue Code clarifies that the full amount of the structured settlement payments is tax-free to the victim. (By contrast, the investment earnings on a lump sum payment are usually fully taxable.)

What is a “qualified assignment”?
The defendant or its insurer may transfer the obligation to make future payments through a “qualified assignment” to a financially secure and experienced institution – a life insurance company, for example. The assignment provides the injury victim with strong financial security, and the defendant can close its books on the case.

This process relieves the defendant of further responsibility for the payments and transfers the administration and record-keeping responsibilities. The assignment company specializes in these activities and may offer additional financial security to the claimant.

What other federal tax rules govern the use of structured settlements and qualified assignments?
In order to protect the public, Congress specified in Section 130 the requirements to establish a qualified assignment:

  • The assignee assumes the liability from the defendant;
  • Both the victim (and his/her attorney) and the defendant agree that the payment schedule cannot be “accelerated, deferred, increased or decreased”;
  • The payment stream may be excluded from the recipient’s gross income for tax purposes;
  • The injury must be a physical sickness or injury; and
  • A highly secure funding asset (such as an annuity or U.S. Government obligation) must be used to fund the payments.

Conclusion
A structured settlement is a proven, effective solution for the needs of personal injury victims. Personal injury lawyers advocate the use of structured settlements for their clients because they can effectively meet an injured victim’s needs for security, as well as provide more future benefits over time than a single lump sum settlement.

 

  

 

 

  

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