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Rooms 316-318

TUESDAY, JUNE 14TUESDAY, JUNE 14TUESDAY, JUNE 14

What Every Litigator Should Know About Strucuted Settlments Structured Settlements 101

3:20 p.m. - 3:50 p.m.

Presented by Scott Brown

Summit Structured Settlements 755 SE Frontier Avenue, Suite 101

Waukee, IA 50262 Phone: 515-987-6888

Steven Lawyer Steven Lawyer & Associates

4944 Pleasant St West Des Moines, IA 50266

Phone: 515-282-2080

Sponsored by the Iowa Association of Justice

Structured Settlements 101

Most everyone has heard or read about former professional athletes who are penniless within a

year or two of retiring from their multi-million dollar salaries. Unfortunately, a similar situation

often befalls upon those receiving large lump sums of money in lawsuits, regardless of whether

the amount received was $100,000 or $1,100,000. Many people are simply unable to handle

large sums of money in such a way as to adequately protect their future needs.

This isn’t a new phenomenon. In 1980, the ABA Journal published a study that looked at persons

who had received lump sum payments in excess of $100,000, including recipients of personal

injury verdicts and settlements. The study revealed that after just five years, 90 percent of the test

group had nothing left of their lump sum payment. This included the personal injury settlement

recipients who no longer had the money, but still had their disabilities.

The recipient of a personal injury settlement who squanders a recovery may be unable to meet

his or her economic or medical needs, and may need to be supported by government programs

for the rest of their life. In 1983, recognizing that many plaintiffs needed to be protected from

themselves (and that taxpayers needed protection from having to support those who are likely to

squander their lawsuit recoveries), Congress passed the Periodic Payment Settlement Act in

which the federal government formally endorsed structured settlements in personal injury and

wrongful death cases, and codified the special tax treatment that encourages their use. In 1997,

the law was changed to include workers’ compensation settlements. By 2006 over $100 billion in

personal injury, wrongful death, and workers’ compensation recoveries had been placed into

structured settlements.

What is a Structured Settlement?

Structured settlements have been a useful tool in helping to resolve legal disputes for more than

three decades. Structured settlements deliver fixed streams of tax-free payments that can often

better address the needs of those bringing physical injury, wrongful death, and workers’

compensation claims, while relieving those individuals of the responsibilities and challenges of

managing large sums of money. By providing these benefits, claims often become easier to

settle, which reduces litigation costs for both sides of legal disputes.

In its simplest terms, a structured settlement is like putting the plaintiff (or workers’

compensation claimant) on an allowance. Or, perhaps more accurately it is like giving them an

allowance (that can’t be taken away from them), funded out of their lawsuit recovery, which is

earning a guaranteed rate of return, without having to incur any ongoing asset management fees,

and without having to worry about any downturns in the stock or bond markets.

In a structured settlement, the defendant or their liability insurance carrier pays funds to a life

insurance company for the purchase of a structured settlement annuity which will then produce

periodic payments made according to a predetermined payment schedule. Payments can be

scheduled at the times and amounts necessary to help with buying a house, or putting kids

through college. Others recipients prefer to receive regular monthly payments for a number of

years. Some prefer lifetime payments (that will continue being paid month after month no matter

how many years that they live past their normal life expectancy).

In order to close their books on the lawsuit and immediately deduct the entire settlement cost, the

defendant or their liability insurance carrier will almost certainly assign their duty to make

periodic payments and their ownership of the structured settlement annuity to an “assignment

company” that is affiliated with the life insurance carrier that is administering the structured

settlement.

It should be pointed out that neither the plaintiff nor the defense incurs any out-of-pocket costs

when structuring a settlement. As such, there is rarely any downside to exploring whether a

structured settlement would be helpful in resolving a legal dispute.

So, how do the life insurers and the structured settlement consultants (also known as structured

settlement brokers) get paid? At the time of settlement, the life insurer administering the

structured settlement receives the structure funding from the defendant or their liability insurer,

then immediately puts that money to work. The life insurance carrier uses that money in such a

way that it expects to earn a rate of return a little bit higher than the rate of return guaranteed to

the plaintiff (or workers’ compensation claimant) in their structured settlement. The difference in

the rates of return (that is, “the spread”) is where the life insurer earns its profit. All of the life

insurer’s expenses, including any commissions paid to structured settlement consultants working

for the plaintiff and for the defense, are also paid out of the spread.

Evolution of Structures

To better understand the structured settlement process, it can be helpful to know a little bit about

how structured settlements first came into existence and how the law that governs structured

settlements has evolved over time. 1

The first known structured settlements were used in the Thalidomide claims in the 1960s.

Expectant mothers took Thalidomide to ease the symptoms of morning sickness. Unfortunately,

Thalidomide often deformed the fetus. Consequently, various suits begged for a financial product

that would provide benefits for the lifetime of these children (70 to 80 years), who were expected

to outlive their parents.

A simple annuity contract was introduced to the process. An annuity is merely a contract issued

by a life insurance company that guarantees a certain future payout in exchange for an immediate

premium. It is also one of the few mechanisms that can guarantee a payment stream for a

lifetime.

The structured settlements set up in the Thalidomide claims established the obligation to make

the future periodic payments in the settlement agreement. The defendant/insurer then purchased

and continued to own an annuity that guaranteed the same payments required by the settlement

agreement. For convenience, the defendant/insurer instructed the annuity provider to make the

payments directly to the claimant, thus providing instant and direct payment administration of

the obligation.

There were no guidelines for structured settlements in those days. The closest arrangement to

structured settlements were deferred compensation agreements, where the benefits were tax

deferred as long as the recipient had neither actual nor constructive receipt of the funding asset.

Consequently, the Thalidomide claims were set up in a manner analogous to deferred

compensation arrangements. For this reason, everything was established by the

defendant/insurer. The claimant had no hand in setting up the arrangement except to accept the

benefits.

The parties to the Thalidomide settlements were hoping that these settlements would be treated

as tax free and not tax deferred, since at that time2 the Internal Revenue Code (I.R.C.) §104(a)(2)

excluded from income "the amount of any damages received (whether by suit or agreement) on

account of personal injuries or sickness." However, the I.R.C. was silent as to "payments over

time," which would later be called "structured settlements" or "periodic payments." The

Thalidomide litigants felt that their best chance of receiving tax free status would be to avoid

constructive or actual receipt of the annuity by the claimant.

After a few years had passed, in 1979 the IRS issued two Revenue Rulings: 79-220 and 79-313.

These rulings put forward the following requirements for a structured settlement to be tax free

under §104(a)(2):

1. The claimant is a mere recipient of the benefits.

2. The annuity is purchased at the convenience of the obligor/defendant.

3. The claimant has neither actual nor constructive receipt of the annuity or the

economic benefit of the lump sum amount that was invested to yield the future

payments (i.e., the premium).

4. The claimant does not have the right to accelerate any payment or increase or

decrease the amount of the payments.

The Revenue Rulings settled the tax issue for the claimant, but left the defendant/insurer on the

hook for the duration of the obligation as owner of the annuity. Defendant/insurers are

accustomed to a complete release once they pay their money, but this result was unattainable in

the 1970s.

The defendant/insurer’s problem was solved with the passage of the Periodic Payment

Settlement Act of 1982. First, Congress added to I.R.C. §104 (a)(2) the following italicized

words "whether by suit or agreement and whether as lump sums or as periodic payments." The

Conference Committee reports made it clear that Congress intended to codify the Revenue

Rulings, rather than change them, and reaffirmed the prohibition against actual or constructive

receipt.

Additionally, this legislation enacted a new I.R.C. §130, which paved the way for the assignment

of the periodic payment obligation to a third-party assignee, thus allowing the original

defendant/insurer to be completely released at the time of settlement. The assignee would take

over the obligation and own the annuity instead of the original defendant/insurer. An assignment

under §130 is referred to as a qualified assignment. Some of the requirements of §130 are as

follows:

1. Originally, only liability claims that qualified under §104 (a)(2) could be assigned.

This was amended in 1997 to include workers’ compensation claims under §104

(a)(1) filed after August 5, 1997.

2. The only assets that qualify to fund a qualified assignment are (a) annuity contracts,

or (b) any obligation of the United States.

3. The periodic payments must be fixed and determinable as to the amount and time of

payment.

4. Although not in the original act, §130 was amended in 1988 to allow the recipient to

be a secured creditor of the funding asset.

So, in summary, the law governing structured settlements has evolved to where:

1. Today it is clear that both lump sum recoveries and structured settlements can be tax

free where there has been a personal physical injury or physical sickness (or a

workers’ compensation injury).

2. The original structured settlement concept was borrowed from deferred compensation

agreements (which prohibited taking actual or constructive receipt of the funding

asset). Structured settlements have continued to retain the prohibition against taking

actual or constructive receipt of the funding asset. If the plaintiff (or workers’

compensation claimant) or their attorney should take actual or constructive receipt of

the recovery, a tax-free structured settlement is no longer possible.

3. So that the defendant/insurer can be released at the time of settlement and close their

books on the case at hand, the defendant/insurer will almost certainly assign their

liability to make future structured settlement payments to an assignment company

(typically an affiliate of the life insurance company providing the structured

settlement).

Qualified (and Non-Qualified) Assignments

In the vast majority of structured settlements, the defendant/insurer will enter into a qualified

assignment of the periodic payment obligation pursuant to I.R.C. §130. The assignment is

considered “qualified” because the settlement proceeds (both the money used to initially fund the

structured settlement AND the amount earned over the life of the structure) qualify to be

excluded from income taxes under paragraph (1) or (2) of I.R.C. §104.

In a qualified assignment, the defendant/insurer transfers, or “assigns,” the liability and

responsibility for making periodic payments to a third-party assignment company. The

assignment company—typically an affiliate of the life insurer providing the structured settlement

annuity—requires that the defendant/insurer pay an amount sufficient to purchase an annuity,

which funds the periodic payment obligation. Once the assignment is executed, the

defendant/insurer has no further liability to make the periodic payments. The assignment

company purchases the annuity from a life insurance company to fund its obligation to make the

periodic payments and directs the annuity issuer where to send the payments.

Structured settlements are also possible in taxable damage cases, such as discrimination lawsuits.

These are called “non-qualified” structured settlements, because the structured settlement

payments do not qualify for exclusion from taxes. Non-qualified structured settlements do

include a guaranteed rate of return and perhaps even more importantly offer the ability to defer

(and spread) the payment of taxes over a period of several years, so that those taxes can be paid

using lower tax rates. For instance, a plaintiff receiving $400,000 in a discrimination settlement,

would ordinarily be taxed on that entire amount, at the highest possible tax rate, during the year

the money was received. By structuring the settlement over 5 or 10 years, they would save a

large amount of money by being able to pay taxes on their recovery at a much lower tax rate. In

fact, the tax savings are often so large that a plaintiff’s attorney who fails to consider structuring

a taxable damage case may be carelessly costing his client tens of thousands of dollars (or more).

Structuring Contingent Fees

In addition to qualified structured settlements and non-qualified structured settlements, there is

one other common type of structured settlement. Plaintiff (and claimant’s workers’

compensation) attorneys are afforded the option to structure their contingent fees. Such attorneys

can structure their contingent fees even in cases where their clients don’t structure their

settlement.

The structured payments are not taxable to the attorney until the year in which they are received.

Contingent fee attorneys may choose to structure a large fee in order to defer taxes (perhaps until

after retirement) in order to lessen the tax bite. It should be noted that same prohibition against

taking actual or constructive receipt of the settlement funds also applies to the structuring of

attorney fees. In order to avoid having the contingent fee become taxable at the time of

settlement, the contingent fee attorney cannot take actual or constructive control of the money.

Rather, the money funding the attorney fee structure needs to be sent directly by the

defendant/insurer to the life insurance company that will be providing the attorney fee structure.

In addition to the potential tax savings, other reasons that attorneys may choose to structure their

fee might be to pay for their children’s or grandchildren’s college expenses, or to fund their

retirement. If an attorney chooses to receive lifetime payments during retirement, it is like

purchasing “longevity insurance” as the payments will continue to be made no matter how long

the attorney lives, so that the attorney cannot outlive their money.

Common Situations for Structured Settlements

For the defense, a structured settlement is a tool for helping to settle cases sooner and without the

risk and expense of going to trial. For instance, a plaintiff that might have reservations about

settling a case for $100,000, may be much more willing to settle if they can see on paper how

that $100,000 settlement can grow into guaranteed, tax-free payments totaling $200,000 over a

period of years.

For the plaintiff (or workers’ compensation claimant’s) attorney, whenever a structured

settlement might be of benefit to a client, the exploration of a structured settlement is something

that should be discussed with the client. In such instances, the attorney might even have an

ethical duty to have this discussion with their client.

What follows are several questions and answers that should run through the plaintiff (or workers’

compensation claimant’s) attorney’s mind in nearly every case. These questions address some of

the more common situations where a structuring a settlement might be particularly beneficial to a

plaintiff or workers’ compensation claimant.

Are settlement proceeds of $25,000 or more going to be paid to a minor? If so, the choice is

whether to establish and maintain an ongoing conservatorship with its attendant procedural

requirements and expenses, or to consider a structured settlement. With a structured settlement

the conservatorship can be terminated immediately after the claim is settled. Ongoing bonding

and reporting requirements and expenses can be easily avoided. As such, a structured settlement

is an option that should be considered when a minor is involved.

Is my client going to need to spend his or her entire settlement within the next 3 or 4 years? If

the answer is yes, then a structured settlement may not be appropriate. If the answer is no, then

you need to dig a bit deeper. While not an exhaustive list of considerations, several additional

questions need to be answered:

1) Does my client have the capability to both intelligently invest and responsibly manage the

settlement money he or she will be receiving? Most people are not good at managing large

amounts of money suddenly received. Many attorneys have had former clients who have

quickly blown through their settlement dollars. Studies bear out that the majority of accident

victims who receive their money in a lump sum spend every penny within a few short years.

Would the client benefit from being put an allowance? If the client has no investment

experience and isn’t sophisticated with money, a structured settlement is an option that

should be considered.

2) Is my client thinking about putting some or all of their settlement into a conservative, fixed-

income investment? Looking for financial security and peace of mind, many Americans put

some or all of their investable assets into conservative, fixed-income investments such as

bonds. Some want to avoid market risk and reduce the possibility of losing money. Others,

particularly as they age, want to make sure they have a dependable source of income locked

in before their mental faculties start to decline. The tax-free return on a structured settlement

is typically better than the return on bond portfolios. As such, if your client is thinking about,

or will benefit from, putting some or all of their settlement dollars into a conservative, fixed-

income investment, then a structured settlement is an alternative that should be considered.

3) Does my client have worries about outliving their money? Outliving your money is the

number one financial fear of many Americans—living too long and completely exhausting

one’s savings. Depending upon your client’s circumstances, it may be possible to obtain a

structured settlement that will provide them with monthly income payments for as long as

they live, even if they live past 100. If your client has worries about “living too long,” then a

structured settlement is an option that should be considered.

4) Is my client receiving government benefits that may be affected by a settlement recovery?

The last thing you want to do is to get a $100,000 settlement on behalf of your client, which

ends up costing them $100,000 worth of government benefits. Your structured settlement

consultant should be able to work with you to craft a structured settlement plan that will

greatly reduce the likelihood of losing government benefits. For example, in a workers’

compensation compromise settlement a carefully crafted structured settlement can often help

avoid social security disability offset issues.

5) Speaking of workers’ compensation. . . . Death (or remarriage) may put an abrupt end to the

weekly workers’ compensation benefit payments that are supporting a family. A structured

settlement can be a tool to ensure that payments will continue to support the family after

remarriage or death.

6) In a case where there is no physical injury, is your client going to be receiving a large,

taxable settlement? Where there is no physical injury involved, such as in a discrimination

case, large settlements can lead to large tax bills. Your clients might suddenly find

themselves in the highest possible tax bracket. By structuring taxable settlements, where the

income is received (and thus the taxes are deferred) over a period of several years, the

highest tax brackets can easily be avoided. In many instances, this could save your clients

tens of thousands of dollars.

Isn’t This Structured Settlement Thing Just Extra Work?

Do I Really Have To Discuss This With My Clients?

In the most cases where a structured settlement is being considered, both the plaintiff side and

the defense side will have their own structured settlement consultant. Regardless if you are a

plaintiff attorney or a defense attorney the job of your structured settlement consultant is to be

your partner or coach, and he or she will “hold your hand” every step of the way to make the

process as simple and seamless as possible. For instance, your structured settlement person will

provide you with the numbers and will draft the structured settlement language that will need to

be included in the release. After you have done a structured settlement or two, you will find the

process pretty straightforward.

There is a proper path that needs to be followed to put a structured settlement into place. It isn’t

terribly hard to stay on that path, but things can get complicated or difficult if an attorney has

gotten off the proper path before bringing in their structured settlement consultant. You should

be contacting your structured settlement consultant before any mediation or settlement

discussions are held.

Does a trial lawyer ever have an ethical duty to discuss the possibility of a structured settlement

with a client? Of course, both the plaintiff and defense attorneys, in working through legal

disputes, are to strive for the best possible outcome for their clients. For the plaintiff attorney in

particular, the question arises, “Does this mean that I have any sort of ethical duty to discuss

structured settlements with a client?”

The answer appears to be that such a duty exists when a structured settlement might be in the

client’s best interest. Quoting from section 2.1 of the 2002 ABA publication Ethical Guidelines

for Settlement Negotiations, “During settlement negotiations and in concluding a settlement, a

lawyer is the client’s representative and fiduciary, and should act in the client’s best interest and

in furtherance of the client’s lawful goals.” In most instances, one of your client’s “lawful goals”

will be to end up in the best possible financial situation at the conclusion of their lawsuit.

At the heart of the attorney-client relationship, an attorney must comply with Iowa Rule of

Professional Conduct 32:1:4(b), “A lawyer shall explain a matter to the extent reasonably

necessary to permit the client to make informed decisions regarding the representation.” This

would seem to involve communication not only of all settlement offers, but also of all settlement

options that would best serve the client, including the option to receive part or all of the

settlement recovery in the form of a structured settlement.

It appears that there are times when not only should a structured settlement be discussed, but

when a structured settlement consultant should be brought in to be a part of that discussion. Iowa

Rule of Professional Conduct 32:2:1 states, “In representing a client, a lawyer shall exercise

independent professional judgment and render candid advice. In rendering advice, a lawyer may

refer not only to law but to other considerations such as . . . economic . . . factors, that may be

relevant to the client’s situation." In addition, Comment 4 to the Rule says in part, “Matters that

go beyond strictly legal questions may also be in the domain of another profession. . . . Where

consultation with a professional in another field is itself something a competent lawyer would

recommend, the lawyer should make such a recommendation.”

Many trial lawyers are unaware that they can even be sued for failing to discuss the possibility of

a structured settlement with a client. As such, it may be wise to have some familiarity with the

well-known legal malpractice case, Grillo v. Pettiete. (Josephine Grillo, as guardian and as next

friend for Christina Grillo, a minor v. Tom L. Pettiette, T. E. Swate, and Hardy Milutin & Johns,

96th District Court, Tarrant Count, TX, Cause 96-145090-92.)

Christina Grillo suffered quadriplegia, blindness, and seizures resulting from medical

malpractice at birth. Her family sued and received a $2.5 million medical malpractice settlement.

The family was never informed about the option to structure the settlement, and the entire $2.5

million settlement was completely exhausted within just a few short years, largely to cover the

cost of Christina’s ongoing care.

The Grillo family later learned that if Christina’s settlement had been structured properly, not

only would they have received far more (guaranteed and tax free) income over Christina’s

lifetime, but they would have also preserved their eligibility for government benefits and that

much of Christina’s care would have been paid for by Medicaid. The Grillo family then brought

a legal malpractice claim against Christina’s attorney and the guardian ad litem, who eventually

settled for an amount in excess of $4.1 million. (And, yes, a sizeable portion of that amount was

put into a structured settlement.)

There are clearly times when a structured settlement could be of benefit to a plaintiff. Just as

clearly, at those times it would appear that a plaintiff attorney has a duty to help his or her clients

explore all of their settlement options. It is my belief that we are talking about two sides of the

same coin. When a structured settlement might be of benefit to your clients, it is an option that

you should be discussing with them.

Quoting from the Journal of the Virginia Trial Lawyers Association (Summer 2004, page 36),

“A structured settlement under IRC 104 represents a substantial economic value available to

claimants in the resolution of their claim and plaintiff’s attorneys who fail to consider this option

leave themselves openly exposed to Grillo-type claims. Rather than debate whether trial counsel

has a duty to alert a client to the benefits of a structured settlement, the safer response is to

assume that such a duty exists, analyze its implications, and adjust your practices accordingly.”

The Bottom Line

For the defense, a structured settlement is an important tool for helping to settle cases sooner and

without the risk and expense of going to trial. For the plaintiff (or workers’ compensation

claimant’s) attorney, a structured settlement is an important tool for improving the financial

future of his or her clients. Whether you are the defense attorney or the plaintiff’s attorney, there

are structured settlement consultants available without charge to you or your clients to answer all

of your questions and hold your hand through the entire structured settlement process. A

structured settlement is not appropriate in every case, but you owe it to your clients to understand

the process, and to explore the use of a structured settlement when such a settlement might be

beneficial.

1 Parts of the seminar paper that you are reading today are “borrowed” from other papers. Much of the section “Evolution of Structures” comes from an article that appeared in the July/August 1999 edition of the ABA’s General Practice, Solo & Small Firm Division Magazine. That article was written by Wayne Wagner, a Certified Structured Settlement Consultant who has worked for Ringler Associates in New Orleans, Louisiana since 1984. The sections “Common Situations for Structured Settlements” and “Do I Really Have to Discuss This With My Clients” come from articles that I have written for the Iowa Trial Lawyer magazine, a publication of the Iowa Association for Justice. 2 It is important to note that there have been a couple of amendments over the years to the tax laws that allow for structured settlements. In 1996, the word “physical” was dropped into the phrase “personal physical injuries or physical sickness” that appears in I.R.C. §104(a)(2). In order to for there to be a tax-free (or qualified) structured settlement, the lawsuit needs to allege that a physical (as opposed to a merely emotional) injury was involved. Then in 1997, I.R.C. §130 was amended to allow for the use of qualified assignments in workers’ compensation claims filed after August 5, 1997.