A structured settlement is a proven, effective solution for the needs of personal injury claimants. For years, they have been widely used in the tort area to compensate severely injured, often profoundly disabled, tort victims. In a structured settlement, the parties reach a voluntary agreement, under which the injured person receives damages in the form of a stream of periodic payments.
These payments come from a well-capitalized, financially experienced institution and are tailored to meet the victim’s future medical expenses and basic living needs. These payments may be scheduled for any length of time — even as long as the claimant’s lifetime — and are structured to meet the financial needs of the claimant. Payments can be in equal amounts or can vary. They may include future lump sums.
A structured settlement arrangement may be agreed to privately, as in a pre-trial settlement, or it may be required by a court order, as in a settlement or judgment involving a minor. Claims professionals, plaintiff attorneys, judges and defense attorneys advocate the use of structured settlements because they can effectively meet a claimant’s needs for security, and provide more benefits over time than a single, lump-sum settlement because of applicable tax rates.
Why is a structured settlement necessary?
Historically, damages paid because of a personal injury lawsuit came in the form of a lump sum at the time of settlement or judgment. This kind of payment, especially in large catastrophic injury cases, places the claimant (or the family) in the position of managing a large sum of money, which is intended to provide for a lifetime of medical and other needs.
Since most people are not experienced in handling large sums, there is always the danger that the money will be spent quickly or invested unwisely, leaving little or nothing to cover future needs of a seriously injured person. Indeed, evidence suggests that many claimants who receive lump sum awards dissipate their assets and are left with unmet needs within a relatively short period of time.
Thus, structured settlements were developed to create a more stable financial basis for the claimant.
How does it work?
The defendant agrees with the victim on a stream of periodic damage payments tailored to the victim’s particular medical care and basic living and family needs. The defendant then assigns its periodic payment obligation to a life insurance company, which funds the victim’s damage payments with an annuity. In some instances, the defendant retains the periodic payment liability and purchases an annuity to fund the payments to the victim.
Annuity contracts have been the preferred way of funding because of their pricing and flexibility for settlement design. An alternative is a trust fund, which invests only in United States Treasury obligations. These trusts add the safety of investment in obligations issued by the U.S. Government.
What are the benefits of a structured settlement?
There are some important benefits to the claimant in structuring the settlement:
- The claimant receives compensation when it is needed. Instead of receiving a lump sum that has to be invested at risk and managed for a fee, the recovery is paid out over time. This better correlates the settlement with the actual need for funds.
- The full amount of the damage payments is tax-free. A lump sum received for physical injury also would be tax-free, but the investment earnings earned over the years or decades on that lump sum would be taxable. By structuring the settlement, the claimant avoids this taxation.
- The claimant receives payment from two of the safest types of funding assets available: life insurance annuities or U.S. Treasuries.
When should someone consider a structured settlement?
- Temporarily or permanently disabled plaintiffs or claimants.
- Guardianship cases, including minors or incompetents.
- Wrongful death cases where the surviving spouse and/or children need monthly or annual income.
- Severe injury, especially with long-term needs for medical care, living expenses and support of family.
- Workers’ compensation claims where issues of future income or medicals needs must be met.
Are you able to use a structured settlement in workers’ compensation claims?
Yes. An injured worker can tailor a structured settlement to fit his or her needs whether it be to supplement income, fulfill long-term medical needs, assist with family needs or to reduce the out-of-pocket costs for Medicare set asides.
Why should plaintiffs consider structured settlements?
- Structured settlements in physical injury cases provide an assured payment stream that is fully tax-free. (Check with your tax advisor for details and confirmation.)
- Claimants/plaintiffs avoid the risk of mismanagement. Insurance industry statistics show that about 25 to 30% of all accident victims completely dissipate their judgments or settlements within two months of recovery, and 90% of them spend it all within five years. (Source: The Rutter Group, Ltd. from Flahavan, Rea, Kelly & Tener, “California Practice Guide: Personal Injury” (TRG 1992) Ch. 4.)
- Recipients avoid unnecessary financial strain. Structured settlements provide a secure, low-risk source of compensation and the convenience of regular payments tailored to the plaintiff’s specific needs.
- The claimant can receive more compensation over time than through a lump-sum settlement.
- Structures can offer rates of return that are competitive with other financial vehicles.
- Structures provide an efficient means of resolving claims and avoiding the expense and delay of a trial.
- Under a structure, a victim can avoid the risk of outliving his or her recovery by transferring the risk to a secure financial institution with experience in this field.
What are the advantages to the defendant/insurer?
- Earlier and more creative settlements, including assistance by structured settlement brokers with negotiations, life care planning, and settlement documents.
- Reduced litigation costs.
- Avoidance of the risk and expense of a jury trial.
- The ability to assign future liability through a qualified assignment.
What is the role of a secured creditor?
Under a structured settlement where the defendant retains the periodic payment liability, the federal tax code allows the claimant to have no more than a general creditor’s interest in the assets of the defendant, to the extent of the future payments. If the liability to make the payments is assigned to a third party, however, the tax code permits the claimant to have a greater interest — that of a “secured creditor.”
This interest is secured by the annuity or U.S. government obligation purchased by the assignment company to fund its future obligations to the claimant. Should the assignment company fail to pay, the claimant, as a secured creditor, can become the owner of the assets funding his/her payments. This ensures that the assignee’s other creditors cannot use the assets to satisfy their claims against the company. Note that this secured interest applies to the assignment company, not to the life insurance company issuing the annuity contract.
Are there other uses for periodic payments?
- Wrongful Termination
- Sexual Harassment
- Mental Anguish
- Contract Disputes
- Divorce settlements
- Construction Defect
- Punitive Damages
- Property Loss Claims
- Environmental Claims and Pollution Liability
- Qualified cases in which the funds have already been paid to the claimant or his/her attorney (constructive receipt)
NOTE:The tax treatment of these alternative uses of structures is not the same as that of physical injury cases. A qualified tax expert should be consulted before any decisions or annuity purchases are made.