Structured Settlements: Protect Clients and Yourself

5/8/2006

Negotiating and finalizing a structured settlement for the first time can be a daunting task. Even if you have experience with structured settlements, there are considerations that are not contained in the rules. No matter what your experience level, reviewing the following tips on structured settlements could further protect your clients and yourself.

In order to effectively utilize structured settlements, it is important to have your own structured settlement consultant who can advise you and your client, be involved in settlement negotiations and be present at mediation. In many settlement situations, the defense is providing their own structure consultant. But do not underestimate the benefit of having your own advisor. Not only can these consultants "co-broker" these deals with defense consultants, but they can help you avoid any pitfalls. Your consultant will also typically have more payment options and can offer competitive pricing. These advisors also do a lot of the work for you, such as drafting the release and working with the insurance companies to have the annuity funded.

In speaking with structured settlement consultant Michelle Madich, M.B.A., CSSC of Capital Planning, Inc. (mmadich@capitalplanning.com or 952-541-9464), getting advisors like her involved early on allows them to be more creative, to better evaluate your case and to suggest more structure options.

Attorneys often suggest structured settlements because the client is a minor, the client has both immediate and long-term needs or there is a need to protect the client’s settlement funds from themselves or others. Clients of all ages often choose structures because the payments are tax-free¹ and there is a myriad of periodic/lump sum payment options offered. Do not forget that structured payments are guaranteed income and usually have good solid returns. As an additional benefit, these returns are also tax-free, as opposed to cash settlement funds your client could invest in the market. Further, your client has the ability to designate a beneficiary who will then step into their shoes and receive the future guaranteed payments tax-free.² If your client receives government benefits, structured settlements can also provide for the payment of the periodic funds into a special or supplemental needs trust to protect those benefits.

When negotiating a settlement, the tax-free aspects of the structured settlement may help to close any gap which exists between parties discussing regular lump sum settlement amounts. But avoid letting the defense lawyer use their structured settlement numbers to detract from your client’s actual case value. In other words, negotiate your case for its value, not what a structured settlement could net for your client in the future. For example, if your client’s case is worth $300,000, avoid the defense argument that a $150,000 settlement could net $300,000 in future total benefits. Instead, tell the defense lawyer that you will negotiate apples to apples and hold open the willingness to structure all or a portion of the settlement until later. Also, when determining the cost of the structure, make sure you have accounted for your attorneys’ fees (and costs) based on the present value of the settlement. If your client structures the whole settlement, you will not get paid.

You should be aware that on large structures, there may be an issue of risk on the qualified assignment. Typically, the liability carrier assigns, to a third party assignee, its obligation to make the future payments to your client, and those payments are then commonly funded through the purchase of an annuity from a life company. There are four levels of guarantee for your client’s payments. Both the life company and the assignment company guarantee your client’s future guaranteed payments at the first and second level. At the third level, all life companies offer a back-up guarantee, if levels one and two fail. But, in the unusual case that both the life company and the assignment company go bankrupt or are liquidated, and the back-up guarantee fails, the Minnesota Guaranty Fund (or whatever state fund you are dealing with) will indemnify only up to $100,000 (present value)/$300,000 (future payments) per annuity contract. Thus, in order to dissipate the risk of failed or insufficient guarantees on large structure settlements, you should consider purchasing separate guarantee(s) with a stand alone assignment company or splitting up the structured settlement into more than one annuity.

One easily overlooked factor of structured settlements is constructive receipt. In order to maintain the tax-free nature of structured settlements, neither the client nor the attorney can "constructively receive" settlements funds necessary to "fund" the structure. The "constructive receipt" doctrine provides that "income is not constructively received if the taxpayer's control of its receipt is subject to substantial limitations or restrictions."³ Because the obligation to make the future payments is asssigned to an assignment company, the assignment company is the actual owner of the annuity, not your client. Thus the settlement funds must be transferred directly from the defendant insurance company to the assignment company. Be aware that if you obtain a jury verdict for your client, this is considered constructive receipt. While other types of funding agreements may be available for jury verdict awards, a tax-free structured settlement is not.

Your client must be thoroughly advised that a structured settlement is essentially illiquid. Once your client enters into a structured settlement, the terms of the annuity are unchangeable and payments cannot be accelerated, increased or decreased. The policy cannot be reassigned to anyone else. While there are several companies out there that will buy your client’s future structured settlement benefits, these companies take deep discounts, leaving your client with just a fraction of what the periodic payments are worth and depriving your client of future tax benefits. Moreover, the language of the settlement agreement itself or state law may limit,⁴ or even prohibit, your client’s sale or transfer of their future periodic payments.

Further, a few companies such as Allstate offer "funding exchange programs" allowing a lump sum payment (without deep discounts) in exchange for your client’s future benefits. But, these programs are conditional and your client cannot rely on them. These programs are only allowed under certain conditions and usually require a court order of hardship and an order that the annuity be cashed out.

One way to document that your client is aware of the illiquid nature of the structure is to send the client a letter describing the illiquid nature in detail and attaching a fact sheet that you can obtain from your structured settlement consultant. You may also suggest to your client that they seek out an independent consultation with a financial advisor, to ease any worries they may have.

1. Section 104(a)(2) of I.R.C.; Section 130 of I.R.C.

2. Rev. Rul.79-220.

3. Treas. Reg. S1.451-2(a).

4. See Minn. Stat. § 549.30-34.

The above article was authored by Kate Westad and appeared in the Spring 2006 Minnesota Trial Lawyer Magazine. You can contact Kate Westad at kate@lommen.com, 612-336-9322 or 800-752-4297.