Structured Settlement Basis

A structured settlement for workers’ compensation or physical injury tort claims is a special provision under the United States Internal Revenue Code [Sec. 104(a)(1) and (2), respectively] that exempts all payments from current year income taxation, whether received as a lump sum or over a period of time. If the entire settlement is taken as a cash lump sum, that amount is excluded from current year taxable income, but the first dollar earned on the award becomes a taxable event. The structured payments must be determined at the time of settlement and incorporated into the settlement agreement and release, not afterwards when it is too late. Once the cash is either actually or constructively received by the claimant, the benefit of tax free growth is lost forever.

Conversely, if the total settlement amount is taken as a cash lump sum, the growth from an investment will be subject to federal and state income taxes, which reduces the net performance of the investment by the marginal tax rates, which can approach 50%.

Dissipation Risk with Large Lump Sum Payments

Despite best intentions, lump sum payments are dissipated within a short time after the money is received by the claimant. It is believed that 90 percent of cash settlements are gone within five years. Tragically, when the money is intended to replace lost income for a disability or to care for a seriously injured or ill individual for a lifetime, that person may be left without the means of self-support or to receive appropriate care.

Origin-of-the-Claim Test Determines if Damages Are Nontaxable

When the federal tax code [IRC § 104(a)2)] was amended in 1996 (Small Business Job Protection Act), Congress preserved the right of family members to make derivative claims based on the physical injury or physical illness of another person, even though the claimant personally may not have suffered the injury or illness. All sums received (except for punitive damages) are excluded from the claimant’s gross income. This is known as the origin-of-the-claim test.

Claims on Behalf of Minors

For minors, structured programs have significant advantages over cash settlements. First, with a cash settlement, a minor may have immediate access to the funds upon reaching age 18. This could mean handing a very large check to an 18 year old. Next, the investment of the settlement proceeds may be governed by the probate court. The allowable investments may include annuities, bank CDs, U.S. Treasury obligations and municipal bonds. Currently, the structured program pays a higher after-tax rate of return than any of the allowable investments governed by the probate court, and there are no trust fees. Finally, with a cash settlement, tax returns must be filed, creating a paperwork nightmare every year between settlement and the minor reaching age 18. Additionally, if the taxes are paid out of settlement proceeds, an annual trip to the probate court will be necessary.

Rated Age Based on Health History of Payee

For individuals with serious health problems facing them, structured settlements have significant advantages over cash settlements. People with serious health problems, as a group, statistically will live shorter lives than the population as a whole. This fact allows the life carrier underwriting the structure to provide a greater monthly benefit to the person with health problems for a given premium payment than would be given to a person with a standard life expectancy. This is called mortality risk, and life insurance companies are in the business of assuming mortality risk. To prevent the life insurance company from reaping a windfall in the event the annuitant dies soon after payments begin, we generally recommend placing a minimum number of guaranteed payments in the structured settlement. In these instances we recommend and would be willing to submit medical records to the underwriters of several companies with the purpose of obtaining a rated age. This might result in higher benefit payments for the same cost.

Planning for Estate Taxes

The receipt of settlement proceeds, either by a lump sum or through periodic payments, when combined with the claimant’s other assets, can create an estate in excess of $1,000,000 which would be subject to estate taxes at the death of the claimant. Estate tax rates range from 37 to 55 percent of amounts above $1,000,000, and payment generally is due in cash in nine months after the death. With proper planning, the impact of potential estate taxes can be minimized.

Payment Schedule Can Be Matched With Needs

The more we can understand about how the settlement proceeds can most benefit them, the better job we can do in designing the program best suited for the claimant(s).

Based on our understanding of the needs of the claimant(s), we will prepare structured settlement illustrations concentrating on the following:

+ Sufficient tax-free cash at the time of settlement to cover costs, expenses, medical liens, attorney fees and to provide initial liquidity.
+ Tax-free periodic payments

Annuity Quotes Are Time-Sensitive and Have Expiration Dates

Annuity illustrations assume funding by a certain date. Additionally, they are subject to rate changes, based on the performance of the economy, and may expire without notice. Usually, the illustrations are valid for a minimum number of days (5 to 14), according to the policy of the individual company. An expired quote will need to be rerun based on the new rates, if the case has not settled.

Available Payment Options

Settlement proposals are merely illustrations based on a hypothetical amount set aside from the settlement proceeds to fund future benefits, unless the attorney for the claimant(s) has confirmed a settlement offer and has provided us with specific amounts to use as the cost of the future benefits. The illustrations are a true reflection of the cost of providing future benefits, using the software quotation system of the company being illustrated. Please consider the illustrations as conceptual. We are prepared to work with the claimant, using any amount agreed to by the defense, in developing additional illustrations that might more closely meet the needs. Various payment options can be combined to match the specific future needs of the claimant(s). Some of the payment options that may be offered by an annuity issuer are:

- Period Certain—Regularly repeating payments of a specified amount. The payment amount may be level or increasing regularly (usually annually) by a percentage (i.e., 3% compounded) or in fixed steps to help keep pace with inflation. Payment intervals can be weekly, monthly, quarterly, semiannually, annually, or longer.

- Lump Sum—A single payment of a specific amount on a specified amount.

- Life (With or Without Period Certain)—Annuity payments are made for as long as the annuitant lives or for the “Period Certain,” whichever is longer. Payments may be level or increasing regularly.

- Temporary (Life Contingent)—Annuity payments are made for specific fixed period or for as long as the annuitant is alive, whichever is shorter.

- Endowment (Life Contingent)—A “Lump Sum” payment which will be paid only if the measuring life (annuitant) is living on the date the payment is due.

- Joint (With or Without Period Certain)—Annuity payments are made for as long as at least one of the annuitants is living on the date the payment is scheduled to be made. This contract will terminate upon either the date of the last surviving annuitant’s death or the date the last guaranteed payment is made, whichever is longer. Some companies offer a different percentage of the benefit (i.e., 50%, 200%, etc.) to be paid to the survivor after the first death.

- Installment Refund—Annuity payments are made for as long as the annuitant lives. Payments terminate when the annuitant dies, unless total benefits paid at that time are less than the cost of the annuity. In that event, annuity payments will be made until the total benefits equal the cost of the annuity.

- Cash Refund—Annuity payments are made for as long as the annuitant lives. Payments terminate when the annuitant dies, unless total benefits paid at that time are less than the cost of the annuity. In that event, a lump sum will be made for the difference between the total benefits paid to date and the original cost. (Some companies might use a different method of calculating the cash refund amount.) This option provides for estate liquidity.

How to Assess Strength of the Annuity Issuer

The annuity company selected in most cases should be from among the strongest life insurance companies in the industry, with very high ratings by the independent analysts. Under the model Uniform Payment of Judgments Act of 1990, to become a qualified insurer, an insurance company must be an admitted insurer in the state and must request designation by the insurance commissioner. The insurer must have a minimum of $100,000,000 of capital and surplus, exclusive of any mandatory security valuation reserve, and must have at least the following minimum ratings from two nationally recognized rating organizations: A.M. Best, A+; Moody’s, Aa3; Standard & Poor’s, AA-; Fitch (formerly Duff & Phelps), AA-. Some assignment companies or guarantors are not life insurance companies and, thus, do not have the ratings normally assigned by the independent analysts to life insurance companies. In such case, we can provide other ratings by independent analysts and financial information about the non-insurance company guarantor. We generally seek a company that will accommodate the needs of the claimant and that offers a competitive rate. If the claimant prefers a particular company or, conversely, wishes to eliminate a particular company from consideration for any reason, that will be done, as we can write with virtually any company in the structured settlement marketplace.

Large Cases Warrant Diversification of Funding Assets

For very large cases, we recommend consideration of splitting between two or more annuity companies to diversify for greater protection. This may not always mean the best rate. But, the companies may be selected from among those offering the top rates.

No Legal or Accounting Advice Being Rendered

This presentation has been prepared with the understanding that Structured Settlement Services LLC is not engaged in rendering legal or accounting advice. Structured Settlement Services LLC does not engage in the practice of law, accounting or the sale of securities. The tax laws and precedents are presented to the best of our understanding. However, the claimant should consider retaining independent tax counsel before reliance on this presentation. Also, it should be noted that tax laws might change at any time.