STRUCTURED SETTLEMENTS

By Anthony F. Prieto, Jr., CFP(R)

At Synergy, we spend a lot of time in mediations helping attorneys and their seriously injured clients to plan for their post settlement future.  We try to create holistic settlement plans that meet our client’s needs while taking the least possible amount of risk.  The majority of financial products in the settlement industry are fixed income or fixed interest products.  To keep it simple, I will only be discussing fixed rate products below.

A commonly asked question about fixed interest products, such as a structured settlement annuity, is what is the rate?  That is hard to explain because it’s not always comparing apples to apples when you look at investment returns among different products.  I took the most commonly used terms in the financial industry and went to www.investopedia.com for definitions.  Below are the simple form definitions from that site:

Yield:

The income return on an investment. This refers to the interest or dividends received from a security and is usually expressed annually as a percentage based on the investment’s cost, its current market value or its face value.

Nominal Rate of Return:

The amount of money generated by an investment before expenses such as compounding periods, taxes, investment fees and inflation are factored in.

Effective Rate of Return:

An investment’s annual rate of interest when compounding occurs more often than once a year.

Internal Rate of Return (IRR):

The discount rate often used in capital budgeting that makes the net present value of all cash flows from a particular project equal to zero.

Tax Equivalent Yield (TEY):

The equivalent yield on a taxable investment when an investor’s tax rate is considered.  (The higher your tax bracket the more this will impact your rate.)

Pretty simple right?  To make matters worse, structured settlement annuities typically have both guaranteed and expected returns listed on the proposals.  The Internal Rate of Return (IRR) which is shown on the proposal is based on life expectancy.  Different life companies use different life tables to determine life expectancy.  As a result, the exact same proposal from two different life companies could show two different internal rates of return.  It is important to know that the IRR shown on a structured settlement quote is a composite rate.  It takes into consideration that short payments receive less interest than the longer payments.

What should you do?  First, recognize that the rate is not necessarily as important as creating a plan that meets your needs.  Second, find an expert that will take the time to thoroughly explain these issues and assist you in arriving at an educated decision.  There are many options in terms of managing monies recovered as a result of a personal physical injury.  Knowing the options and focusing on solutions rather than rates will result in a plan that ultimately meets the primary objective of having a good investment solution which also meets critical life needs post settlement.

Synergy provides comprehensive settlement planning/consulting services.  We offer unique solutions to meet the needs of our clients.  Find out more today about how Synergy can make a difference.  Visit our consulting site at www.synergysettlementconsulting.com

By Matt Bracy[1] and Jason Lazarus[2]

Every investment vehicle has inherent risks.  This is the tradeoff for the chance to make higher returns.  However, “factored” structured settlements present investors with a unique low risk/high yield opportunity.  “Factored” structured settlements are periodic payments due to a personal injury claimant, paid through a fixed annuity, that have been sold at a discount to a “factoring” company.  Once a factoring company purchases these structured settlement payments, they either bundle the payment streams together in securitized transactions for institutional investors or sell those streams of income to individual investors.  When individual streams of income are sold, they are typically offered by a financial professional to individual investors.  The latter practice is the subject of a recent Investor Bulletin issued by the SEC and FINRA.

On May 13, 2013 the US Securities and Exchange Commission, Office of Investor Education and Advocacy, issued an Investor Bulletin entitled, “Pension or Settlement Income Streams: What you need to know before buying or selling them.” It is the opinion of the authors that this bulletin is misleading and in some cases inaccurate concerning the sale of structured settlement payment streams and factored structured settlements as an investment vehicle.

The bedrock of securities laws, Rule 10b-5, recognizes that partial information and misinformation can be as detrimental to investors as outright falsehoods. In part, the rule makes it unlawful:

To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading (emphasis added)

The SEC bulletin muddles together two distinctly different businesses, pension purchasing and structured settlement factoring.  To make matters worse, the bulletin further muddles the distinctions between the process of purchasing payments from the structured settlement recipient and selling purchased payment streams to investors. What could have been an informative and educational memo for investors to help understand these transactions and investment opportunities instead became a confusing and misleading series of partial truths mixed with some outright misstatements.

The purpose of this article is to add clarity to these issues, at least as it pertains to structured settlement factoring and the use of these payment streams as investments.

Background

Structured settlements and related annuities have been used since the 1970s as a tool to settle personal injury and workers’ compensation claims. Structured settlements are agreements to settle physical personal injury claims through payments over time, using fixed annuities offered by highly rated life insurance companies.  The novelty of structured settlements, and one of their greatest attributes, is that they allow for payment of compensatory damages over time – ideally, payments matched to monthly medical or income replacement needs. The primary advantage of structured settlements is that the payments are completely federal income tax-free to the injury victim.  .

For the vast majority of structured settlement recipients (some estimate as many as 95%), these periodic payments work very well and continue to meet their needs year after year.However, an estimated 5% of structured settlement recipients at some time find that they need liquidity. Structured settlements inherently lack liquidity or the ability to adapt to changed circumstances, since the payments are “set in stone” when the structure is created, and cannot be “increased, decreased, accelerated or deferred”[3]. Considering the difficulty in predicting needs going out 20 years or more, which is common for structured settlements, this low percentage of people needing a change is truly remarkable.

Due to unforeseen changes in life circumstances, such as medical needs, oppressive debt, or positive life-changing opportunities, the structured settlement’s periodic payments may no longer suffice. Beginning in the late 1980s, finance companies began buying part or all of a structured settlement recipient’s rights to receive future payments in exchange for a lump sum payment. By 2002, this process was formalized through state and federal laws, requiring local court approval for all such transfers upon a finding that the transfer is in the best interest of the seller, taking into account the welfare and support of any dependents, among other things.

Prior to the financial crisis of 2008/2009, many finance companies purchasing future structured settlement payment rights were backed by large financial institutions and international banks. Since 2009, with credit tightening, investors began buying structured settlement payment rights from factoring company originators providing necessary capital to the factoring companies.  Many private investors and financial advisors have become attracted to factored structured settlement payment rights due to their relatively high yields and low risk of default. Universal court approval of transfers and good due diligence regarding each transaction have led many to consider this a viable alternative to more traditional investments offering low returns.

Instead of focusing on the real risks, the SEC and FINRA bulletins have combined concerns over factoring structured settlements, pensions and investment in structured settlement payment rights after a factoring company has purchased them.  The bulletin specifically recognizes the attractiveness of these high yields and points out, correctly, that there are commissions associated with the sale of the payment streams.  This is so with almost any financial product sold to investors.  The bulletin also correctly points out that the income streams are illiquid.  Where the bulletin confuses the issues is when it begins to talk about the lack of reliable information about factored structured settlement annuities as investments and its discussion of legal enforceability of a transfer of future structured settlements.

Clearing up the Muddle

Some features of structured settlement factoring that should be clarified:

Always Court Ordered

Contrary to the SEC bulletin’s statement that “the secondary sale of a structured settlement often must be approved by a court, in keeping with the Uniform Periodic Payment of Judgments Act”, the truth is that since 2002 all structured settlement transfers must be court approved. This is so because of the intersection of federal tax law (IRC 5891), providing a punitive excise tax to structured settlement transfers unless approved by a state court, and state laws now in place in nearly all states[4] (and none of them have anything to do with the Uniform Periodic Payment of Judgments Act).

One of the reasons investors may be so attracted to structured settlement payment streams is that the court order clearly approves the transfer and orders the annuity issuer to make the designated payments to a specified transferee.[5]  Accordingly, the bulletin is not completely accurate when it suggests that there could be legal challenges to the purchase of future payments of a structured settlement by an investor.  If a structured settlement factoring transaction complies with federal and state structured settlement transfer laws, the risk of a challenge is relatively small.  While there is some risk, having an independent legal evaluation of the transaction to make sure all laws were properly complied with lessens this risk greatly.  In addition, the legal evaluation provides the necessary background information regarding the structured settlement annuity and the issuer so that an investor knows exactly what he or she is getting.  The information is reliable and readily available as part of the closing process of the sale of a factored structured settlement to an investor.

No Negative Tax Consequences to the Seller

The payee of a structured settlement is the personal injury claimant, or his/her heir or estate. Clearly, they receive the payments federal income tax free.[6] What about when these payments are sold?

Because the SEC bulletin combines so many divergent topics, it is not clear who or what situation they are addressing when they write, “The lump sum payment you collect may be taxable.” The IRS long ago clarified[7] that the seller of structured settlement payment rights does not suffer any adverse tax consequences from the sale, but rather receives the lump sum purchase price federal income tax free, just as they received the payments being sold. Investors who subsequently purchase future periodic payments from a factored structured settlement annuity will have gain and should consult a tax professional about proper reporting of taxable income.  However, that is normal recognition of taxable income as one would have with any other taxable investment vehicle.

Investors’ Rights

There is no better example of the muddling confusion of this bulletin than this statement:

Your “rights” to the income stream you purchased could face legal challenges. It may not be legal to purchase someone’s pension. And it may be difficult to legally force the original owner of a pension or structured settlement to forward or assign their income to a factoring company or investor.

Again, this article is focused on the structured settlement world, and we leave the nuances of the pension purchasing process to those more knowledgeable of it. Our focus is on the second sentence above, and the impressions that it creates. First, no one involved in structured settlements or structured settlement factoring are interested in “forcing” anyone to assign their payments. Willing sellers of such payments, motivated by whatever pressing financial need is in their lives, decide to sell this valuable asset in return for a lump sum. Once the terms are agreed upon, a judge decides whether or not the sale is in their best interests, and whether the transfer laws have been complied with (written disclosures about the terms of the transaction are delivered prior to the contract being signed, the seller is advised to seek independent professional advice, etc.).

Significantly, once the order is signed, the annuity issuer is now bound to send the payments to the factoring company or investor as directed in the court order. Legal enforcement of a court order is relatively straightforward, should it be needed. If the court order designates the factoring company as the payment recipient, and the payment rights are subsequently assigned to an investor, enforcement of that assignment is also relatively straightforward.

The Real World

Despite the inaccuracies and misleading information, the SEC bulletin makes a few good points — not unique to structured settlement payment rights, but good points nonetheless: Investors should learn about what they are buying, investigate the company they are doing business with, and hire professionals for help and guidance. Structured settlement payment rights have become popular with many investors because they realize the relative stability of this asset and opportunity for making a good return. As the bulletin’s garbled message makes clear however, it is not always easy to understand how this works and the process is somewhat complicated. Education about this product becomes more difficult however when partial information, or misinformation, are spread.

Ultimately, an investor must work with professionals who do the proper due diligence as it relates to the factored structured settlement investment opportunities.  Having an independent legal evaluation of each transaction is critical to the process of making sure the investment vehicle is “clean”.  The independent legal evaluation will answer most of the questions identified in the SEC bulletin as being critical for the investor to analyze.  In the end, each investor will have to decide based upon the real facts whether this is an appropriate vehicle or not.  However, a low risk high yield investment opportunity shouldn’t be avoided or discredited without complete and accurate information.  Hopefully this article has provided some clarity to the cloudy picture painted by the SEC’s bulletin.

By Jason D. Lazarus, J.D., LL.M., MSCC, CSSC

In November, the MSPRC announced a fixed percentage option for resolving conditional payments where the settlement is $5,000 or less.  In those cases, the injury victim can resolve Medicare’s recovery claim by paying Medicare 25% of the total liability settlement instead of using the traditional recovery process.  There are certain requirements that must be met in order to utilize this option which I will outline below.  Importantly, when exercising this option the injury victim gives up the right to appeal the fixed payment amount or request a waiver of the recovery.

The option is now available.  In order to elect this option, the following criteria must be met:

1. The liability insurance (including self-insurance) settlement is for a physical trauma based injury. (This means that it does not relate to ingestion, exposure, or medical implant), and
2. The total liability settlement, judgment, award, or other payment is $5000 or less, and
3. The beneficiary elects the option within the required timeframe and Medicare has not issued a demand letter or other request for reimbursement related to the incident, and
4. The beneficiary has not received and does not expect to receive any other settlements, judgments, awards, or other payments related to the incident.

When should the request be made to utilize this option?  According to CMS, the fixed percentage option request must be submitted before or at the same time notice of settlement documentation is submitted (i.e., when requesting a final demand).  If the request is made in response to a conditional payment notice (CPN), it must be received by the response due date referenced in the CPN.  There is a “fixed percentage option election document” located in the attorney toolkit on the MSPRC’s website.   The document must be completely filled out and mailed to the following address:

MSPRC-Fixed Percentage
P.O. Box 13880
Oklahoma City, OK 73113

A request for the fixed percentage option may be denied if the case does not meet all of the required criteria discussed above.  If the request is denied, the beneficiary will receive an explanation of why the request was denied.  A regular demand letter is then issued separately.  If the request is approved, the beneficiary will receive a bill for repayment of 25% of the total settlement, which must be paid in the timeframe specified on the bill.

While this option is only limited to settlements of $5,000 or less, it is helpful to have this “streamlined” resolution process in those smaller settlements.  It is important to keep in mind that once this option is elected; there is no appeal or waiver of the recovery.

By Jason D. Lazarus, J.D., LL.M., MSCC

Traci Hancock, as mother and natural guardian of Marisa Hancock appealed an order entered by Judge Smith approving, in part, a proposed settlement agreement.  The grounds of the appeal was that the trial court erred in refusing to approve a structured settlement that paid out past age of majority.  The 5^th DCA in Florida reversed the Judge’s decision.

In Hancock, Traci Hancock was appointed guardian over the property of an injured minor, Marisa Hancock.  The property of the guardianship was proceeds from a personal injury lawsuit.  Traci Hancock as guardian filed a petition seeking approval of a settlement agreement on behalf of the minor.  The proposed settlement agreement provided for payment to Traci Hancock for services as guardian, to Marisa’s counsel for their services in the personal injury lawsuit and the guardian ship proceedings and to Marisa for her tort damages.  The petition stated that it was in Marisa’s best interest that the lawsuit be settled and that Marisa’s proceeds would be used to purchase “annuity for the benefit of the minor child.”  The proposed structured settlement annuity paid out over a 27 year period.

At the hearing to approve, Judge Smith asked counsel for Marisa whether she would be able to “get her cash out of the annuity when she turns 18” and counsel replied no.  Judge Smith entered an order approving the settlement of the lawsuit but refusing to authorize the purchase of a structured settlement annuity.  The court’s grounds for denying the structured settlement were that the “Guardian of the property has no authority to bind the assets of the ward beyond the age of majority pursuant to Florida Statute 744.441(19).”  Traci Hancock alleged that Judge Smith “erred, as a matter of law, in denying her request to approve the structured port of the settlement agreement.”  The 5^th DCA agreed.

In its decision, the 5^th DCA found that Judge Smith erred in his conclusion that 744.361(6)(c) required the court to ensure that upon reaching age 18 the ward’s proceeds of her lawsuit would be available to her.  The 5^th DCA also found error with Judge Smith’s reliance upon Guardianship of Bernstein v. Miller.  Bernstein involved the creation of irrevocable trusts that didn’t pay out until age 30 for two minor children to manage inheritance from their deceased father.  The 4^th DCA struck down the trial court’s creation of the irrevocable trusts because it violated section 744.441(19) of the Florida Statutes which authorizes the creation of irrevocable trusts which extend beyond the disability of the ward only if the trust is created in connection with tax planning.  The 5^th DCA in Hancock indicated that since this matter didn’t involve any trust documents, the limitation set forth in 744.441(19) wasn’t an issue.

The 5^th DCA found that a trial court is authorized to approve a proposed annuity contract under 744.441(21) provided there is a finding that it is “appropriate for, and in the best interest of, the ward.”  In the instant case, all of the parties and even Judge Smith agreed that the proposed annuity contract was in Marisa’s best interest.   Accordingly, the 5^th DCA held it was error by the court to refuse to approve the structured settlement.  While this has always been the common practice, court’s approving structured settlements for minors where the money was paid out post age of majority, some court’s questioned whether there was a legal basis to do so.  Judge Smith in Volusia count was one of those judges and now the 5^th DCA has answered the question and put it to bed.

To view the opinion click HERE