With all the negative news surrounding AIG, many attorneys may be wondering whether the structured settlement insurance annuities they arranged for an injured party or for themselves (to pay attorney fees) may be in fiscal danger. Fortunately, unlike other financial entities, insurance companies must adhere to some of the most rigorous regulations found in any industry.
Structured settlements as we know them today came about in 1982 when the U.S. Congress passed The Periodic Payment Settlement Act of 1982 (Public Law 97-473). The act enables injury victims to obtain customized structured cash payments plans through insurance annuities that assure them guaranteed, tax-free income over time. Previously, most settlements were doled out in lump sum cash payments with any money earned from the settlement subject to taxation. Injured parties, usually unaccustomed to receiving large sums of money, typically burned through their settlement proceeds and were soon left with nothing.
Today, judges actively encourage structured settlements by court order, usually in the pre-trial phase, in not only personal injury cases, but in workers’ comp, employment and discrimination, molestation, Medicare, environmental, property and property loss cases. The types of cases in which structured settlements are allowed have grown substantially over the last five years.
Structured Settlement Fundamentals
During settlement negotiations, plaintiff and defendant attorneys determine the injured party’s ongoing medical care, living and family needs (i.e., possible future medical treatment, in-home nursing expenses, college tuition for dependent children, adjustments to living quarters). Once the injured party’s needs are determined and a dollar amount assigned, the defendant (or its insurance company) agrees to the settlement and funds the obligation by purchasing an annuity from a high-rated insurance company. This insurance carrier or “assignee” then takes over the liability from the defendant and begins making periodic payments to the injured party.
For injured parties, structured settlements provide a tax-free income stream, possibly for life, without fear of money mismanagement, market fluctuations or unscrupulous con artists waiting to milk them out of their money. Typically, future income and upfront cash for attorney fees, medical expenses and related liens are included in the package. In the event of the injured party’s death, a guaranteed portion of the settlement may be made to the estate or a named beneficiary such as a spouse or child.
For defendants, structured settlements allow payment guarantees and obligations to shift from the defendant to the assignee life insurance company issuing the annuity. Defendants are no longer required to produce a lump sum payment upfront.
Structured Settlement Safety
The system has worked smoothly for more than 25 years without too much worry about the financial strength of the underlying insurance company. That all changed with AIG’s dramatic fall in September 2008. AIG’s American General Life Insurance Company is a market leader in writing structured settlement annuities. Should there be concern? American General Life Insurance Company is a relatively new subsidiary of AIG, with AIG purchasing the company in 2001. AIG life companies, and there are 71 U.S.-based companies, are separate from AIG’ corporate and its other subsidiaries including AIG Financial Products–the company that has caused so much economic grief.
The National Association of Insurance Commissioners (NAIC), whose members regulate insurance companies, responded to insurance stability questions and saw it as an opportunity to assure individuals receiving structured settlement income that insurance companies, including AIG’s American General Life Insurance Company, were sound.
In a statement, the NAIC explained:
“As a holding company, AIG is a separate, federally regulated legal entity that is distinct and apart from its subsidiary insurers. The subsidiary insurers are governed by state laws designed to protect the interest of policyholders. State insurance regulators are committed to protecting the interest of policyholders and will work closely with AIG management and other regulators to fulfill this commitment. The No. 1 job of state insurance regulators is to make sureinsurance companies operate on a financially sound basis.” In other words, parent companies cannot raid the coffers of their profitable, well-capitalized life insurance company subsidiaries, thus keeping the likes of AIG Financial Products from taking assets from American General Life Insurance Company. A wall exists between entities. The statement went on to say, “It is a state insurance regulator’s responsibility to protect policyholders and ensure a healthy, competitive market for insurance products. Strict solvency standards and keen financial oversight – based on conservative investment and accounting rules – continue to be the bedrock of state-based insurance regulation.”
American General Life Insurance Company is one of many insurance companies, including New York Life, John Hancock Life, Hartford Life, Pacific Life, MetLife, New York Life and The Prudential, which write structured settlement annuity policies. All have an A or higher rating from A.M. Best, a company that provides rating services to insurance companies
State and federal solvency standards and regulations provide annuity policyholders with a number of checks and balances to protect their investments. Regulators’ conservative accounting and investment rules keep insurers from investing heavily in risky investments. Investments are typically investment-grade fixed-income securities including government-backed securities. When factoring in their tax-free status, structured settlement annuity returns are favorable to taxable returns in traditional investment portfolios.
Each state insurance department regulates insurance companies headquartered in their state. In California, for example, companies offering structured settlements must be first approved by the California Department of Insurance. The department evaluates the insurance carrier’s solvency and whether the carrier complies with California regulations. Carriers are also subject to mandatory annual audits and other financial compliance requirements. These procedures are almost similar in other states.
State insurance commissioners have developed these regulations to preserve the solvency of general accounts in which assets are held so that contractual obligations to policyholders are met. These general accounts support only the obligations of the insurance companies–and not the obligations of a parent company or other subsidiaries.
Attorney Legal Fees
Attorneys began using the structured settlement option for payment of legal fees involving physical injury or sickness cases after the decision in Childs vs. Commissioner, 103 T.C. 634 (1994), affirmed 898 F3d 856 (June 11, 1996). The Tax Court held that attorney fees from these cases could be received in periodic payments.
While a structured settlement for attorneys’ fees does not enjoy the tax-free status of income received in an injured party’s settlement, the income generated from the fee settlement is 100 percent tax deferred when an attorney’s personal tax rate may be lower. The arrangement provides a stable income stream with investments in low-risk vehicles that are not influenced by market fluctuations. Attorneys can use structured settlement for their fees regardless of whether their clients receive a lump sum settlement or a structured settlement.
Given the investment alternatives in today’s financial markets, structured settlements still offer the safety and stability needed for both individuals who require temporary or ongoing financial support and their attorneys who are looking to reduce taxes and desire a regular income stream.
Patrick C. Farber is a Structured Settlement Broker with Ringler Associates in Southern California. He specializes in settling medical malpractice, personal injury, product liability, workers’ compensation, mass torts and construction defect cases with structured settlements in court hearings, arbitrations and settlement conferences. Find out more about Patrick Farber at www.patrickfarber.com.