The Evolution of Structured Settlements

By Don McNay, CLU, ChFC, MSFS. 

 The 1987 Trial article "The Other Side of Structured Settlements" discussed some of the potential problems of structured settlements. The article said that structured settlements were primarily defense driven vehicles that had serious safety and after tax rate of return concerns.  

Many of the criticisms have been addressed by an evolution in the structured settlement profession. It is a good time to revisit the 1987 article and chart the progress that the structured settlement industry has made.

 Defense Driven

 In 1987, structured settlements were almost exclusively defense driven vehicles. The playing field was often unequal in areas such as knowing the cost of the annuity. The plaintiff who wanted a structured settlement was often at the mercy of claims managers or defense attorneys who saw the structured settlement as a "hard-ball negotiating" tool.

 The structured settlement is still predominantly an instrument of the defense. Some companies with affiliated life insurance carriers aggressively push their in house structured settlements to the exclusion of alternative plans and funding vehicles. However, recent years have seen a movement towards a level playing field based on disclosure of cost and new plaintiff oriented concepts.

 Disclosure of Cost

One of the most dramatic equalization factors is that most structured settlement brokers willingly disclose the cost of what the casualty carrier is paying for the annuity. In the 1980’s, many hid behind the premise that this disclosure could cause a constructive receipt problem for the plaintiff. This gave a tremendous negotiating advantage to the insurer when a plaintiff’s attorney did not get an outside evaluation of the offer. This was particularly true in cases where a plaintiff had a reduced life expectancy and the insurance carrier offered a "rated" annuity. Another problem occurred when the plaintiff’s attorney evaluated a settlement using a present value calculation of the annuity from an accountant or someone not familiar with the nuances of the structured settlement annuity. There have been a number of cases where attorney fees have been challenged because they were based on an improper present value calculation. 

Along with willing disclosure by the defense, an entire industry has been spawned of qualified experts who evaluate structured settlements for the plaintiff and offer alternative programs. The equalization of information has helped to take away any negotiating edge the structured settlement gave the defense.

New Concepts 

Two concepts that have helped put the structured settlement more into the plaintiff’s hands is the 468B trust and the Court Ordered Settlement.

The 468b trust is set up by a government entity. It allows for the claim to be negotiated for cash followed by a schedule of payments and selection of companies to be set up through the trust. Used primarily in mass tort cases, the 468B trust can be used in any case where there are two or more defendants.  

The concept of the Court Ordered Settlement has become increasing popular in guardianship cases.

The full value of a settlement is paid into the Clerk of the Courts in exchange for a full release. The Court then has the discretion to set up a payment schedule best suited to the ward's needs. The Court then enters into a structured settlement. The plaintiff and their representatives can have input into the payment schedule and the selection of a life insurer.

Safety

Like most of the insurance industry, the structured settlement business felt the shock waves of the Executive Life of California insolvency. In fact, the structured settlement industry might have felt a disproportionate impact as Executive Life was a large issuer of structured settlement annuities.  

The 1987 article pointed out that many structure brokers and advocates were oblivious of the safety issues. Unsafe and careless practices manifested themselves as a result. The Executive Life collapse sent a wake up call that has resulted in some dramatic changes in how safety is approached.

Some simple changes reflect the emphasis on safety. One is that most participants are demanding that the annuity be placed with large insurance companies with high ratings. Therefore, smaller companies with poorer ratings are dropping out of the marketplace. A number of large, high rated companies are using their security advantages to come into the business.

Split funding cases above $100,000 in premium is now commonplace. This allows for a large case to be split amongst two or more companies to offer protection in case of one company’s insolvency.

The rise of structured settlements funded by treasury bonds is a direct result of safety concerns. Numerous companies are offering settlements funded by treasury bonds, which offer one of the highest degree of comfort. These treasury bond settlements have some limitations as the return is lower than life insurance annuities and lifetime benefits cannot be offered.

After Tax Rate of Return

The primary motivation for a structured settlement is asset protection. In the case of most victims to quote Will Rogers "Return of my money is more important than return on my money." The reason that structured settlements has maintained their exalted tax status is that they perform a societal benefit by providing a valuable money management tool. Rate of return is a secondary, yet important, concern as to whether or not to enter into a structured settlement.

The inflexibility of a structured settlement is its biggest advantage and disadvantage as it keeps a victim from dissipating their settlement yet cannot be changed in cases of health changes or economic peril. A concern mentioned in the 1987 article is that a structured settlement cannot keep pace with inflation. To answer this concern, at least one annuity carrier has developed a structured settlement where payments will keep pace with the CPI index.

Injury victims have unique financial planning concerns. The May, 1995 article in Best’s Review, "Protect Settlement Pie From Quickly Withering," pointed out some of the social and financial upheavals that an injury victim goes through. Although few studies have been done on dissipation by injury victims, an analogous situation is a Wall Street Journal article that discussed widespread dissipation problems for people who received their retirement plans in a lump sum.

A large lump sum can dramatically change the comfort level for someone in a certain income class. Studies show that people normally have friends whose incomes are within 15% of their own. Many people cannot deal with a sudden change in social status and the fact that their friends might not have their resources.

The Other Side of Structured Settlements touched on the after tax rate of return at a time when tax rates had been dramatically lowered by the 1986 tax reform act. As taxes have increased at the state, local and federal levels, the after tax rate of return matches favorably to alternative investments such as certificates of deposit. A well managed stock portfolio will probably have a higher rate of return than a structured settlement over a long period of time. However, since most injury victims lose their ability to earn large sums of money, many cannot afford the market risk and be subject to the temptation to dissipate a lump sum.

A stream of payments from a structured settlement, combined with a managed portfolio or variable annuity, might offer the best of both worlds to someone who is capable of handling their money.

Structured Settlement rates of returns have benefited greatly from declining interest rates and stable economic conditions. Although concepts such as the CPI indexed annuities were conceived as an answer to high inflation of 15 to 20 years ago, some have the opinion that those conditions were an anomaly.

New Markets

The structured settlement concept has ventured away from its traditional niche in the personal injury field. Special products and concepts have been developed for fields like workers compensation and environmental cleanups. Structured settlement consultants are being trained in areas such as integrating government benefits and financial and estate planning considerations into their structured settlements.

Conclusion

In some countries, structured settlements are a neutral tool available to all parties in a claims situation. This is not the case in the United States, although all factors point to a continuation of more plaintiff control and input. Structured settlements and their favored tax status are predicated on the belief that they are beneficial to the victim and beneficial to society. The dramatic growth in the usage of structured settlements reinforces that many recognize it as a positive tool .

It is obvious that in the years since 1987, the criticisms brought out in The Other Side of Structured Settlements were heard and attempts have been made to deal with them. Removing those roadblocks point to a bright future for the structured settlement concept and its use as a positive economic force.

Don McNay, CLU, ChFC, MSFS, is a structured settlement and financial consultant based in Lexington, Ky. He is the author of the Other Side of Structured Settlements for the May, 1987 edition of Trial. The author would like to thank former ATLA President Peter Perlman and former ATLA Governor E. Andre Busald for their help in writing this article.

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