10/7/2019 1 2019 National Conference on Special Needs Planning and Special Needs Trusts Structured Settlements‐ A Valuable Tool for Settlement Planning Randy Levine| Settlement Consultant Wednesday, October 16, 2019 Randy Levine is a founding partner of ESS Settlement Services, a Sage Settlement Consulting affiliate. He is also a former trial attorney whose extensive experience informs his settlement planning work with personal injury and medical malpractice clients. EVOLUTION OF STRUCTURED SETTLEMENTS • M&P Stores, Inc. v. Taylor, 326 P.2 nd 804 (Okla. 1958) • Plaintiff stepped in a hole in the floor – causing injury. • Jury returned a verdict for the plaintiff – a fixed sum of $36,000 “to be paid $150 per month for 20 years”. • Neither party objected and while the court said the verdict shouldn’t have been paid in the manner it was, but the Court would not sua sponte reform the verdict. • The Thalidomide Cases (Canada) • Plaintiffs were children who suffered extreme birth defects as a result of mothers’ Thalidomide usage. • Richardson‐Merrill (predecessor of Merrill‐Dow) had the license to sell Thalidomide in the U.S. and Canada – but had no insurance. • To settle the claims – agreed to pay over time. • Purchased annuities: Monthly income for life, 2% COLA. Early Experiments with Periodic Payments
Transcript
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2019 National Conference on Special Needs Planning and Special Needs Trusts
Structured Settlements‐ A Valuable Tool for Settlement PlanningRandy Levine| Settlement Consultant
Wednesday, October 16, 2019Randy Levine is a founding partner of ESS Settlement Services, a Sage Settlement Consulting affiliate. He is also a former trial attorney whose extensive experience informs his settlement
planning work with personal injury and medical malpractice clients.
EVOLUTION OF STRUCTURED SETTLEMENTS
• M&P Stores, Inc. v. Taylor, 326 P.2nd 804 (Okla. 1958)• Plaintiff stepped in a hole in the floor – causing injury.• Jury returned a verdict for the plaintiff – a fixed sum of $36,000 “to be paid $150 per month for 20 years”.
• Neither party objected and while the court said the verdict shouldn’t have been paid in the manner it was, but the Court would not sua sponte reform the verdict.
• The Thalidomide Cases (Canada)• Plaintiffs were children who suffered extreme birth defects as a result of mothers’ Thalidomide usage.
• Richardson‐Merrill (predecessor of Merrill‐Dow) had the license to sell Thalidomide in the U.S. and Canada – but had no insurance.
• To settle the claims – agreed to pay over time.• Purchased annuities: Monthly income for life, 2% COLA.
Early Experiments with Periodic Payments
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• IRS Revenue Rulings – 1977‐1979• Provided for tax‐free periodic payments from settlement proceeds as long as:
• The underlying settlement was tax‐free; and• The claimant neither benefitted from nor controlled the funds.
• The Periodic Payment Settlement Act of 1982• Congress codified these revenue rulings• Amended I.R.C. § 104(a)(2) to include the words “whether by suit or agreement… and whether as lump sum or as periodic payments”.
• Created I.R.C. § 130, permitting the assignment of future liabilities for periodic payments created by settlements.
Early Adoption and Favorable Tax Treatment
The 1980’s and 1990’s• During this period the industry began to take root;• The growth was at first focused on the defense side with little growth on the plaintiff side;
• Interest rates on annuities remained good, but little changed in the development of structured settlements.
Workers’ Compensation• Structured settlements were almost exclusively used in personal injury;• Many practitioners wrote about the concept, but lacked the ability to assign the future periodic payments.
A Growing Industry
• I.R.C. 104 modified to include the word “physical”
• Addition of 139F providing tax‐free payments to wrongfully incarcerated individuals
• Tax‐Deferred programs for non‐qualified cases (non‐physical injury settlements)
• Non‐Qualified Assignments
• Secured Creditor Status
• I.R.C. 5891 – Factoring annuity payments
• Special Needs Trusts
• ABLE Accounts
• Medicare Set‐Aside accounts (MSA’s)
Market Changes
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• Personal physical injury or physical sickness (there is no tax imposed on growth if the claimant does not receive funds upfront).
• Defendant/insurer must fund structured settlement directly to avoid “constructive receipt.”
• The Small Job and Protection Act of 1996 amended 104. The major change in the 1996 wording is the addition to the word “physical”. It did not settle all issues surrounding what is or is not taxable; however, it did make clear that punitive damages are taxable.
• The term “personal physical injuries” is not defined in either § 104(a)(2) or the legislative history of the 1996 Act. However, Private Letter Ruling 200041022 states that direct unwanted or uninvited physical contacts resulting in observable bodily harms such as bruises, cuts, swelling, and bleeding are personal physical injuries under § 104(a)(2).
I.R.C. § 104: Cornerstone of the Industry
• August 5, 1997• With the passage of the Taxpayer Relief Act of 1997, Congress permitted the “qualified assignment” of future periodic payments as a result of workers’ compensation settlements;
• The dividing line was injuries post‐August 5, 1997;
The Medicare Secondary Payer Act• Enacted in 1980;• Enforcement began in 2001 – CMS Patel Memorandum;• The requirement to set‐aside funds made sense to utilize structures – discussed in the CMS Memo.
Workers’ Compensation
• The 2000’s and Today• Workers’ Compensation Carriers/defendants adopted the use of structured settlements to settle claims.
• Back‐funding Medicare Set‐Asides with structured settlements has become a rule as opposed to the exception.
• Notably:• The state of Washington (still monopolistic) – structured settlements are the only means of settlement.
• The state of West Virginia – Legacy Old Fund – extensive use of structured settlements.
Structures and Workers’ Compensation
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New Internal Revenue Code § 139(F) allows a wrongfully incarcerated individual an exclusion from gross income for civil damages, restitution, or other monetary awards received as compensation for a wrongful incarceration.
It defines “wrongfully incarcerated individual” as:(1) who was convicted of a covered offense,(2) who served all or part of a sentence of imprisonment relating to that covered offense, and(3)(A) who was pardoned, granted clemency, or granted amnesty for that covered offense because that individual was innocent of that covered offense, or(B)(i) for whom the judgment of conviction for that covered offense was reversed or vacated, and(ii) for whom the indictment, information, or other accusatory instrument for that covered offense was dismissed or who was found not guilty at a new trial after the judgment of conviction for that covered offense was reversed or vacated.
Wrongful Incarceration – I.R.C. 139F
FINANCIAL PROTECTIONS
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Life companies are subjected to regular independent audits and are financially rated entities.
• At a minimum, only deal with companies that have been subject to an independent audit.
• The financial ratings of the company are an important consideration for both the defendant/insurer and the claimant:• For the defendant/insurer, the concern is more of finality and ensuring the claimant doesn’t later attempt to collect against them if the annuity issuer were to fail.
• For the claimant, it seems obvious that they want a financially sound annuity issuer.
Financial Security
• Independent audits assess:• The company’s internal controls and accounting approaches;
• Accuracy of financial statements; and also
• Represents that based on the evidence collected, there is no fraud.
• Independent audits do not assess:• The risk profile of the company’s investment portfolio
• The adequacy of capitalization, or
• The debt/equity ratios.
Independent Audit
Financial Ratings
• It is highly recommended that in addition to annual independent audits, the life company also has a financial rating provided by a reputable ratings provider.
• Financial ratings are opinions of an insurer’s financial strength and ability to meet ongoing obligations.
• Providers generally assess both qualitative and quantitative factors, including:• Financial strength;• Underwriting;• Soundness of investments; and • Management quality.
• Usually range on a letter scale – just like in school, A’s are the best.
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DESIGN
• Claimant name
• Claimant date of birth
• Claimant gender
• Nature of Case
• Physical injuries, if applicable
• Details of case
• Settlement amount
• Net amount to the claimant
• Government Benefits
• Insurance Carrier(s), if available
Information Needed to Start the Structure Process
Insurer
Assigns Future Payments and pays a lump sum
Periodic payments made according to the settlement schedule
Defendant/Insurer
ClaimantAssignment Company
Life Company
The Legal Structure
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Design Elements
Term
Frequency
Contingency
Adjustments
Payment streams are typically designed by considering four key elements:
• Term• The term of the payment is simply the period over which the payment is to be made.• Payments can be made for:
• Period Certain (e.g. over the course of 20 years);• Single lump sum; or• Life: payment will be made for the duration of a measuring life (or lives).
• Frequency• The frequency of payment determines how often it is paid.• For period certain and lifetime payment streams there is a wide range of options for payment frequency:
Design Elements (cont.)
• Weekly• Bi‐weekly• Monthly• Quarterly
• Semi‐annually• Annually• Every x years
• Contingency• Payment streams, whether a one‐off lump sum or a stream of lifetime monthly payments, can be made contingent upon the beneficiary being alive.
• Cost of Living Adjustment (“COLA”)• Payment streams can adjust with inflation (or at some other desired rate) or remain fixed.
• Most cases will not involve a COLA
Design Elements (cont.)
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Reversionary Interest• In situations where a structured settlement may be undesirable because of a likelihood of the claimant passing away and a larger medical lay‐out.
• Reversion pays back funds remaining upon the death of the claimant post‐settlement.
• Accomplished in one of two ways:• Beneficiary designation on the structured settlement
• In the settlement agreement
• Recommended to include in the settlement agreement
Other Attributes
• Temporary Life Provides a payment to the claimant for a set term (e.g., 10 years) but the payment is contingent on the claimant being alive.
Differs from the life only payment because the life only pays for the life of the individual, with no payment to a beneficiary upon the death of the annuitant.
• Lump Sum Payment
• Endowment A life contingent lump sum.
Payment Stream Options
• Period Certain and Life Thereafter A combination of the above, e.g.:
A payment of $1,000 monthly will be made for 20 years’ period certain and life thereafter. This means that the monthly payment will be guaranteed for the first 20 years and switch to life contingent thereafter.
20 Year Guarantee PeriodIf the Claimant dies during this period, the amount remaining of the first 20 years continues to be
paid to the claimant’s beneficiary.
Life Contingent PeriodIf the Claimant dies during this period, payments stop and beneficiaries are
not entitled to anything.
Payment Stream Options (cont.)
Date of settlement
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• Period Certain Pays out for a set period of time.
Payments will be distributed regardless of the claimant being alive – will revert to a set beneficiary.
• Life Only A payment stream that is guaranteed to be paid for the life of the individual.
Contingent upon the claimant being alive (called the measuring life), i.e. there are no payments to beneficiaries.
Payment Stream Options (cont.)
• Catastrophically injured claimants
• Brain injured claimants
• Auto liability
• Medical malpractice
• Birth defects
• Workers’ compensation
• Wrongful incarceration
• Adults
• Minors
• Incompetents
Minimum annuity Premium is $5,000
Good Candidates for Tax‐Free Payments
RATED AGES
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A rated age is an age given based on an individual’s medical impairments and the effect the impairments have on life expectancy.
Example:
• 62 year old male with diabetes
• Normal life expectancy is 21 years
• Decrease in life expectancy due to diabetes is assessed at 4 years
• The decreased expectancy (4 years) is subtracted from the normal life expectancy (21 years)
What is a rated age?
Life Expectancy – Reduction = New Life Expectancy
21 years – 4 years = 17 years
This new life expectancy is then traced to a corresponding age.
To obtain a rated age the structured settlement consultant will need:• The claimant’s most recent medical records (must be within the last two years and no longer than 25 pages).
• For ease of administration, must be typed and not handwritten.
• Usually turn around rated ages in 24 hours (may be rushed in certain circumstances).
Important to look out for:• Psychological conditions (e.g., suicidal ideation, depression, PTSD, etc.)
• Conditions or lifestyle choices not traced to the injury (e.g., smoking, alcohol dependence, asthma, diabetes, etc.)
Determining Factors
• When a structured settlement consultant sends out for rated ages, it’s common to receive a wide range.
• The consultant should look out for outliers:• Too high? Maybe something was weighted too much.
Too low? Maybe something was missed.
• We usually take highest and try to see if we can get others to move toward the higher rated age; especially if the highest has a lower rate of return.
Underwriting: The Settlement Consultant’s Role
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Underwriters at life companies take into consideration various factors:• Date of injury (access progression)
• Current functionality
• Review medical documents for:• Impairments, severity of those impairments, determine current status (control and medications)
• Look into underwriting manuals• Apply ratings to most severe impairments
• Look for co‐morbidities for additional ratings
• Consult Life Tables and apply the ratings
Underwriting: The Life Company’s Role
STRUCTURED SETTLEMENT DOCUMENTS
• Release and Settlement Agreement• Required Annuity Language for tax‐free future periodic payments
• Qualified Assignment Agreement• Qualified Assignment• Qualified Assignment and Release• Qualified Assignment and Release with Pledge (Secured Collector Status)
• Court Order, minors and incompetents
• Trust Agreement, Preservation, Special Needs
• MSA Allocation Report, Medicare compliance
• Premium Check
• Application Information
• Copy of Birth Certificate, minors, lifetime payments
Relevant Documents
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# 1: The Settlement Agreement• Outlines the agreed‐upon settlement;• Provides the defendant/insurer with a complete release of all liability;• Defendant/insurer agrees to pay valuable consideration in exchange for the release;• Specific language is necessary, including:
• Parties stipulate and agree that the settlement will take the form of the specific periodic payments paid by the assignment company;
• An acknowledgement that periodic payments cannot be accelerated, deferred, increased, or decreased;• An acknowledgement that claimant cannot sell, mortgage, encumber, or anticipate the periodic payments,
or any part thereof, by assignment or otherwise;• A beneficiary designation for the annuity• A stipulation that the damages constitute damages under I.R.C § 104(a)(1) and qualify for an I.R.C. § 130
assignment• The claimant acknowledges the assignment, and that the assignment is final, irrevocable, and absolute.• That the insurer through the assignee reserves the right to purchase an annuity to fund the periodic
payments.• Once a structured settlement payment is made to the claimant, the duty to pay that periodic payment is
discharged.
Two Major Documents
# 2: The Assignment (Qualified and Non‐Qualified)• Assigns the Liability to make future payments to the claimant;
• Assignment company accepts the assignment in exchange for a lump sum.
• Three types:1. Standard Uniform Qualified Assignment
2. Uniform Qualified Assignment and Release
3. Uniform Qualified Assignment, Release, and Pledge
Two Major Documents (cont.)
ASSIGNMENTS
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The terms “Qualified” and “Non‐Qualified” reference whether the assignment “qualifies” for special tax treatment under I.R.C. § 130.
Qualified & Non‐Qualified Assignments
How does an assignment work?
Insurer Release for future liability to pay
Transfer of funds to complete the assignment
The Assignment Process
Assignment Company
• 1983 – The Periodic Payment Act Created Internal Revenue Code 130 – Qualified Assignments
• Allows defendant a full release of obligation to make future periodic payments via a transfer of obligation to a third‐party.
• Claimant looks to assignment company if the life company fails to make periodic payments.
• Defendants are more apt to structure because of the transfer of obligation.
• Peace of mind to the claimant knowing the company they sued is not obligated to make their periodic payments.
Qualified Assignments
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• Do not qualify under Internal Revenue Code 130 • To avoid negative tax consequences, assignment companies base themselves in tax‐advantageous countries (primarily Barbados)
• This ensures the assignment company does not have to pay taxes on monies received to purchase an annuity to satisfy the obligation of future periodic payments.
Non‐Qualified Assignments
• Assigns the Liability to make future payments to the claimant.
• Assignment company accepts the assignment in exchange for a lump sum.
• This is a Two‐Party Document:• Agreement between the Assignor (the defendant/insurer) and the Assignee (the Assignment Company).
Standard Uniform Qualified Assignment (UQA)
Provides all of the same attributes of the UQA but this also provides:• An additional agreement, by the claimant to release the defendant/insurer (hence the “release”);
• An acknowledgement by the claimant that they have received independent legal and tax advice; and
• Requires claimant to alert annuity issuer of change of address/bank information.
• Recommended to Defense Insurers
• Downside: an extra document, one rarely understood, for the claimant to sign.
Uniform Qualified Assignment and Release and Pledge (UQA&R)
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• Includes all of the provisions of the UQA&R but grants to the claimant secured creditor status in the assignment company (not the life insurance annuity issuer).
• Three‐party document
• Adds peace of mind; generally sounds better.
• Generally the only assets of the assignment company are the annuity it owns:• Meaning if the assignment company fails – gives the claimant the annuity.• If the life company fails – provides the claimant no greater right to the assets of the life company beyond a standard annuity owner.
Uniform Qualified Assignment, Release and Pledge (UQAR&P)
TAXES
Gross income is “all income from whatever source derived”
26 U.S.C. 61(a)
Three important requirements:1) An “undeniable accession to wealth”;
2) That is “clearly realized”; and
3) “over which the taxpayers have complete control.”
Comm’r. v. Glenshaw Glass Co., 348 U.S. 426 (1955).
So, are proceeds from a workers’ compensation settlement income? Yes. But Congress has the power to carve out or exclude certain monies from taxable income.
Taxability of Workers’ Compensation Settlements
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Workers’ Compensation Settlements are income tax‐free.
I.R.C. 104
a) In general… Gross income does not include –1) Amounts received under workmen’s compensation acts as compensation for personal injuries or
sickness.
• What this means: All benefits received prior to settlement Any lump sum obtained by way of settlement or other agreement (e.g. Schedule Awards) Any monies placed into, and ‐ if done correctly – paid out of a structured settlement annuity
• Are not included in the claimant’s gross income for tax purposes.
I.R.C. 130 Enables a defendant or a defendant’s insurer to assign a future liability without any negative tax
ramifications for the party receiving the funds. Don’t worry about this yet… just know it exists.
Taxability of Workers’ Compensation Settlements (cont.)
#1 Constructive Receipt‐ Think “Control”
#2 Economic Benefit – Think “Set‐aside for”
#3 Cash Equivalency – Think “Can it be converted?”
Tax Doctrines: The Big Three
Constructive Receipt‐ Basically, if the money is available on demand to the person.• This includes:
• Their attorney’s trust account
• A guardian ad litem’s trust account
• Clerk of the court
• “Income is not constructively received if the taxpayer’s control of its receipt is subject to substantial limitations or restrictions.”• Structured settlements include anti‐assignment language (basically what should stop you from “selling” your structured settlement).
• Money to pay for structure never comes into the claimant’s control.
Constructive Receipt Doctrine
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To ensure that the structured settlement does not trigger constructive receipt of the funds:
• The claimant agrees to periodic payments in return for a release of all future claims;
• The defendant/insurer agrees to make periodic payments in exchange for the release;
• The defendant/insurer then assigns the future liability to make payments to a third party (the assignment company) in exchange for a lump sum payment;
• The assignment company accepts the assignment and the lump sum and purchases (and owns) an annuity designed to satisfy the periodic payment settlement agreement.
Constructive Receipt (cont.)
How do structured settlements avoid triggering constructive receipt?
Two ways:1. The appropriate movement of money, and;2. The legal structure of the settlement.
How the settlement money must move:1. Money isn’t paid to claimant.2. Money isn’t paid to claimant’s attorney.3. Money is paid directly to the life company.
Avoiding Constructive Receipt
Economic Benefit• Taxpayer has income when he/she receives the economic benefit of the proceeds.
• Key is when the money is placed beyond the payor’s creditors – seen as being set‐aside for the benefit of the payee.
• Avoiding Economic Benefit• This is handled by the structured settlement company.
• Prior to I.R.C. § 130: Defendant’s insurer would buy the annuity – the annuity was an asset of the insurer and therefore subject to creditors.
• THEREFORE not set‐aside.
Economic Benefit Doctrine
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QUOTES
Understanding a structured settlement quote is essential in order to present it to the claimant.
A structured settlement quote generally will come in
this common format.
Structured Settlement Quotes
Two dates are important to you to keep your eye on:
• Purchase Date• This is the presumed date of funding• If this date is not met, the quote will have to be re‐quoted and the rate will change.
• Common practice is the place this date out a month (sometimes two months out) from the quote date.
• Expiration Date• This is the date the quote will “expire”.• Largely designed to protect the life company.
• Consistently seven days after the quote date.
Reading a Quote: Important Dates
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Benefit DescriptionGives a brief explanation of the benefit, including:• Type of payment stream• Amount• Frequency• Term• Beginning and ending dates• Whether life contingent or guarantees• Any other pertinent information
Guaranteed Benefit, Expected Benefit, and Cost1. Guaranteed Benefit – the amount guaranteed to
be paid, regardless of the claimant being alive;2. Expected Benefit – the amount expected to pay if
claimant survives to life expectancy;3. Cost – What this benefit stream costs – this
amount does not have to be shown.
Reading a Quote: The Benefits Section
Subtotaled Amounts1. Total cash up front2. Annuity Cost3. Assignment Fee – a fee charged by the
assignment company.4. Total Annuity Cost with fees – A subtotal
of Annuity Cost and Assignment Fee.5. Total Annuity with Cash and Fees – This
should be the total settlement amount.
Guaranteed & Expected Benefit and CostThree Columns:1. Guaranteed Benefit – illustrates the
amount guaranteed in this row; subtotaled at the bottom.
2. Expected Benefit – subtotals for the expected benefits should the claimant survive for all benefits.
3. Cost – This column acts as the subtotaling column.
Reading a Quote: The Summary
TRADITIONAL FIXED STRUCTURED SETTLEMENT ANNUITIES, NEW PRODUCTS, AND THE EVOLUTION OF SETTLEMENT PLANNING
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