By Patrick Farber
Verdict (ascdc.org), Volume 2, 2016
When most people think of structured settlements, they think of physically injured individuals, limited or unable to work, who must make their settlement last for years or even a lifetime. While this is true with most structured settlements, there are scenarios where a structured settlement may make sense for non-physically injured individuals – and for the defense. Even when cases do not qualify for tax-exempt status, the tax-deferred and financial planning aspects of the settlements could still make them worthwhile.
Issues to Consider
The regular stream of income produced by a structured settlement comes from annuities created by high-rated insurance companies. Payments are made through an assignment company (typically an affiliate of a life insurance company). The assignee takes over the liability from the defendant in the case, and begins making payments to the plaintiff according to the agreed-upon payment schedule. The defendant and its insurance company are no longer involved in the payment process. This holds true for physically injured (“qualified”) settlements as well as non-injury (“non-qualified”) settlements.
When the structured settlement is devised for a physical injury or workers’ comp claim, the plaintiff receives the income tax-free (thus the qualified status). It does not matter if the injured party receives the income during the first year of the settlement or 10 or 15 years after the settlement. The tax-free status of the payment from the qualified structured settlements for physical injured parties was codified in the Periodic Payment Settlement Act of 1982 (Public Law 97-473).
A structured settlement for non-physical injuries (non-qualified) works in a similar fashion, with the biggest caveat being that these settlements do not enjoy the same tax-free status. These types of annuity products were first introduced in 1981. While interest accumulates tax-free in the structured annuity, it is fully taxable once withdrawn. Although still a small percentage of the over $5 billion in structured annuities written each year, the percent of non-qualified structures versus qualified structures is increasing. According to Melissa Evola-Price, who compiles structured settlements statistics each year, premiums for nonqualified structured settlement annuities increased from $182.3 million in 2014 to $190.3 million in 2015. Non-qualified settlements that are typically considered for structuring include such employment-related instances as wrongful termination, age, gender or race discrimination, harassment and errors and omission-related claims.
For example, a 62-year-old employee at a bank is let go after having a gender change operation. The plaintiff sues and nets $275,000 in the settlement. The plaintiff requests $75,000 in cash upfront. Taxes must be paid on this amount for the current year. The remaining $200,000 is structured into a non-qualified monthly lifetime annuity starting the following year. Payments are $1,000 per month for the plaintiff’s lifetime, guaranteed for 15 years. The plaintiff will receive an IRS 1099 form from the annuity company for tax purposes showing the amount received during a specific year.
Other non-qualifying injuries can also be considered for structured settlements involving construction defect, environmental litigation, malpractice, property disputes, breach of contract and fraud claims.
In another example, a privately held company enters into employment contracts with two investigators. They are terminated before their contracts expire. Each sues the company and receives a $1 million net settlement. They each structure their entire settlement to lessen the tax burden. The first plaintiff is a 59-year-old male who will receive $4,800 a month for life guaranteed for 20 years, while the second plaintiff, a 57-year-old male, will receive $4,700 a month for life, also guaranteed for 20 years. The IRS will send them a 1099 form at the end of each year indicating only the amount of the annuity payments received in that given year, thereby alleviating the tax issue for the year of the settlement.
Cases involving divorce settlements, punitive damages and attorney fees all are suitable for non-qualified structured payments. Recently, a jury awarded $3 million in punitive damages in a wrongful termination case. In lieu of raking the punitive damages amount in cash, the plaintiff elected to receive an annuity that would pay our annually for the next 15 years. By doing so, the plaintiff avoided paying taxes on the entire amount in the year of the judgment and, instead, spread the tax obligation over 15 years.
Timing is Everything
Just as with a qualified structured settlement, a non-qualified structure should be discussed with the plaintiff early in the settlement negotiations. In fact, a good plaintiff’s attorney will talk about structures and familiarize the claimant with the option before beginning settlement discussions with defense counsel. That way, when the parries convene at the negotiating table, the defense can promptly receive the structured settlement proposal for evaluation. If laid our properly, thus can reduce the amount of time and cost needed to settle the case. A structured settlement broker on the defense side can help in this process by reviewing the proposed payment plan and making a recommendation as to the kinds of annuities the individual needs while protecting the defense’s interests.
Measures that safeguard the integrity of the structured settlement annuity enable these settlements to proceed with confidence for both plaintiff and defense. Insurance companies offering non-qualified annuities all have an A or higher rating from A.M. Best, a company that provides rating services to insurance companies.
Going a step further, state and federal solvency standards and regulations provide annuity policy holders with a number of checks and balances to protect their investments. Regulators prevent 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.
In addition, each state insurance department regulates insurance companies headquartered in their state. In California, for example, companies offering structured settlements must first be 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.
Besides the deferred tax liability on income received through a non-qualified structured settlement, the plaintiff, as seen in the examples above, has the ability to select the timing of when payments are received. This could mean using the settlement proceeds to pay for immediate needs, delay payments for future large purchases, retirement or travel, or choose to receive monthly or annual payments – options are limitless. If the claimant decides to fund his or her retirement with the proceeds, the funds will accumulate and grow in the annuity investments tax-free until withdrawn to build up the retirement account over a number of years.
A structured settlement in a non-injury case offers the defense a number of benefits. Like any other settlement, it takes away the inherent risk of going to trial where a jury might render a decision giving the plaintiff a larger award than would have been negotiated in a settlement.
A mutually agreed-upon structured settlement puts an end to ongoing litigation expense. Since the structured settlement payments come from a third parry, nor the defendant or its insurance company, interaction between the defendant and the plaintiff over compensation payments is eliminated.
Finally, because the payment stream to the plaintiff can be customized to meet a variety of his or her needs- for the short or long-term – the plaintiff is more likely to be satisfied with the our come so a messy chapter for both the plaintiff and the defendant can reach closure.
Patrick Farber is a California structured settlements broker with Atlas Settlement Group. Pat works with attorneys throughout the country to create structured settlement annuities or physical and non-physical injury cases. Pat provides support and advice during all phases of the settlement process – at no cost to attorney or client. Reach him at 800-734-3910, firstname.lastname@example.org.