Law360, New York (May 19, 2015, 5:07 PM ET) --
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| Joseph Barnet |
Understanding the importance of their clients’ need for future financial security, these attorneys advise their clients to consider a structured settlement annuity — because of the simplicity, long-term financial security, and peace of mind it provides.
Structured settlements consist of one or more streams of scheduled payments that, with the help of a licensed structured settlement consultant who specializes in creating these settlement plans, are designed specific to a claimant’s personal situation and ongoing financial needs. The payments received from a properly designed structured settlement are income tax-free, while the investment income earned from a lump sum settlement can be fully taxable. As a result, over time a structured settlement has the potential of resulting in a greater overall net return than a lump sum payment. Structured settlements also provide protection against reductions caused by interest rate or economic changes.
In the U.S., structured settlements have been helping physical injury victims and their families experience financial security for more than 30 years. They have been endorsed by legislators, disability advocates, judges and attorneys, and the federal government has introduced tax incentives that make “qualified” structured settlements particularly effective. (Qualified structured settlements are those meeting the requirements of paragraphs (1) or (2) of section 104(a) of the Internal Revenue Code.)
Structured settlements can also be used in situations that don’t involve a physical injury or wrongful death claim. Nonqualified structured settlements — or those that don’t qualify for tax-free status because they aren’t associated with an injury, sickness or death — can be used for structuring attorney fees, divorce settlements, employment dispute compensation, property damage claims, discrimination case payouts, and more.
Understanding How Structured Settlements Work
Often made in conjunction with an immediate lump sum payment, structured settlements can be helpful to both claimants and defendants. They can be agreed to privately — as in a pretrial settlement — or they can be ordered by a court, which often happens in cases involving minors and incompetent adults.
Engaging a structured settlement consultant early in settlement negotiations to assist in designing a plan that meets the claimant’s specific requirements is critical. Based on the claimant’s input and circumstances, the structured settlement consultant can tailor the payment plan to meet the claimant’s unique needs. Anticipated needs, such as medical costs, the purchase of modified vehicles, and educational expenses can be included as future periodic payments.
In most cases, structured settlements are funded by annuities from life insurance companies that have strong credit ratings and are regulated by state insurance departments. The ongoing payments are supported by these companies’ general accounts. This is particularly attractive as managing large sums of money can be difficult for some people, especially those coping with a physical injury, disability or the loss of a loved one. In this way, structured settlements help safeguard claimants against dissipation; that is, the potential for exhausting settlement funds intended to help claimants meet their future financial needs.
Exhibit 1 is a hypothetical example of structured settlement designed specifically for a 45-year-old married man with one child. In this scenario, the claimant was seriously injured in an accident, and was forced to take time off from his job at a manufacturing company. When his physical injury case settled, this individual was faced with an important decision: whether to take a lump sum payment or a structured settlement.
With the help of a structured settlement consultant, this man determined that a structured settlement was a better choice for his family, because:
- All the payments he receives are tax free;
- There are no trust expenses or ongoing management fees; and
- He receives full payments even though he has returned to work.
The structured settlement also enables him to customize future payments to help with his family’s expected monthly expenses and educational costs.
Exhibit 1: Structuring a Settlement
Influencing the Structured Settlement Marketplace
From $150 million in premium in 1979, the structured settlement marketplace grew steadily to more than $4 billion in premium two decades later.[1] And the new millennium brought an ongoing flow of structured settlement annuity transactions. Between 2000 and 2008, sales progressively rose to a peak of $6.4 billion.[2]
Like many industries, however, the structured settlement marketplace declined during the economic downturn of 2008 to 2012. But with the subsequent economic recovery came an increase in transactions (see Exhibit 2). Nonetheless, an overall lack of understanding continues to restrict growth in the structured settlement arena, and prevents many claimants from experiencing the benefits of a structured settlement.
Exhibit 2: Sales in Billions
Because most claimants have little or no knowledge of available settlement options, they turn to their attorneys for guidance. According to a 2013 survey, attorneys have a significant influence on the decision making that occurs in physical injury and wrongful death litigation. The survey showed that over two-thirds of claimants who selected structured settlements learned about them from their attorneys, and 58 percent said their legal representative had the most influence on their decision to choose a structured settlement.[3]
A prior survey also supports the notion that a lack of understanding is inhibiting the adoption of structured settlements. In that study, individuals with no connection to an actual case were shown two theoretical personal injury scenarios. Without being informed of the differences between lump sums and structured settlements, 65 percent selected a lump sum. After becoming more educated on the differences, however, 73 percent of respondents said they would have chosen a structured settlement, while only 27 percent would have picked a lump sum.[4]
With heightened awareness, understanding and education from the legal community, more physical injury, wrongful death and workers’ compensation claimants might experience the many benefits structured settlements have to offer.
Vetting Structured Settlement Providers
When counseling claimants on potential structured settlement providers, attorneys and consultants should assess the annuity firm’s financial strength and stability, as well as several other qualities, such as its:
- History of life insurance expertise
- Long-term commitment to the marketplace
- Dedication to service and quality
- Conservative, fixed-income asset management approach
- Product features and underwriting guidelines
Cost-effective pricing and brand recognition should also be considered, and the chosen annuity provider should be among the strongest life insurance firms in the industry, with strong credit ratings from the major independent rating agencies. The following state-mandated safeguards help enhance insurers’ ability to pay claims and protect policyholders:
- Statutory reserves. Insurance companies must hold these reserves, either as cash or marketable investments, as they represent the estimated amount needed to fund future policyholder benefits.
- Cash flow testing. This process evaluates an insurer’s ability to meet its contractual obligations under a variety of market environments.
- Minimum risk-based capital. These are assets in excess of the amount required to fund all liabilities, and ensure stakeholders will receive payments in the event of insolvency.
Many insurance companies also hold excess capital and surplus to provide another layer of financial protection against economic volatility. The chosen structured settlement provider should possess all of these attributes.
Looking to the Future
Legal professionals are key influencers of the decisions made by claimants in physical injury and wrongful death cases. Expanding the knowledge and appreciation that attorneys, judges, mediators and legislators have of structured settlements is critical to the industry’s future success — and to claimants’ long-term financial security.
Proven to be a secure method of providing future income, structured settlements are likely to remain attractive to claimants, defendants and financial professionals. Structured settlements have demonstrated time and again to be an effective means for compensating physical injury and wrongful death claimants.
For more information about these important solutions, read Prudential’s informative white paper, “Structured Settlements: An Effective Solution for Meeting the Ongoing Financial Needs of Physical Injury Victims.”
—By Joseph Barnet, Prudential Structured Settlements
Joseph Barnet is vice president and head of Prudential Structured Settlements.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
[1] Sources: 1975-1998, Quarterly Summary of the United States Provider Premium, Melissa Evola Price, February 2014; 1999-2013, LIMRA Quarterly U.S. Individual Annuity Reports.
[2] LIMRA Quarterly U.S. Individual Annuity Reports.
[3] Source: 2013 Prudential Structured Settlements Claimant Survey.
[4] American General Life Companies Structured Settlements Survey Report, 2012.