Basic Principles of Structured Settlements
The first basic thing to do is to find the “players” in the structured settlement game. Briefly below I will list each of these people and what their function is.
Initially, it must be understood that when the plaintiff signs a release to accept a structured settlement, it initially represents a promise by the defendant or his liability insurance company to make periodic payments to the plaintiff in the future. The liability company then goes out and purchases an annuity which it will own and which it may then use to fund its obligation to the plaintiff. Thus, the liability carrier is generally the Obligor (since it owes the money to the plaintiff) and it is the Owner of the annuity policy which is purchased from the Annuity Company or the Life Company.
While the obligation to pay the plaintiff initially is that of the liability carrier, they typically make an Assignment of that obligation to a separate company, the Assignee. The liability company does this in order to get the obligation to the plaintiff off its balance sheet. Many times, the Assignee is a sister corporation of the liability company. The Assignee then becomes obligated to make the periodic payments to the plaintiff, and in order to fund that obligation, they go out and purchase an annuity from the life company.
Whether or not there is an assignment of the obligation or it stays with the original liability carrier, the point to remember is that the plaintiff is, in the first instance, looking to the obligor (either the liability company or the assignee) to make the monthly payments. As such, his first concern is that the obligor not become insolvent. If that happens, plaintiff has problems because he probably is a general creditor of the insolvent company. That means that the annuity payments received by the insolvent company from the Life Company are perceived as simply general assets of the insolvent company which must be distributed among all their creditors; the annuity payments are not seen as segregated assets which were “earmarked” for the plaintiff.
It should be understood that there is now an IRS regulation which permits a plaintiff to gain some protection in this situation and become more than a general creditor, i.e., a secured creditor. If the plaintiff is a secured creditor and the Obligor becomes insolvent, then the plaintiff can make a direct claim on the annuity even though the Obligor remains the owner of it. The problem, however, is it is not yet clear how you go about getting a security interest in an annuity. That varies from state to state.
If the plaintiff cannot become a secured creditor, probably the best thing that he can insist on is that the obligation be assigned to a “shell” company or sister corporation whose only activity is to funnel annuity payments to plaintiffs. In other words, the corporation’s only assets are annuity payments received on various cases, and its liabilities are the payouts due the individual plaintiffs. In that fashion, there is a perfect balance between assets and liabilities. If the shell corporation engages in no other business except funneling structured settlement payments, then there is little risk of it going bankrupt, unless of course an employee or other person would embezzle the funds.
All of this points out once again that the plaintiff is initially concerned with the financial solvency of the Obligor, be that the original liability company or an assignee. Technically, if the plaintiff becomes a secured creditor of the Obligor, he is not so concerned about financial stability because he’s going to have a direct claim on the annuity. But certainly if he is not a secured creditor, it would seem that at a minimum, he wants a very secure company which deals in nothing but funneling structured settlement payments.
The only other thing the plaintiff can do to protect against the insolvency of the Obligor is to get a separate company to Bond the Obligor, i.e., Guarantee that it will step in and make the payments to the plaintiff if the Obligor becomes insolvent.
Sometimes, in place of a Bonding Company, or in addition to a Bonding Company, the plaintiff may insist that the original defendant or original liability carrier guarantee the performance of the Assignee. Often times, however, an original defendant or liability company is unwilling to do that.
As far as the financial stability of the Life Company is concerned, plaintiff wants to make sure that is a secure company for this reason. If the Life Company goes under, the plaintiff still has a direct obligation owing from the Obligor, but that Obligor is depending on receiving money from the Life Company to fund its obligation. Therefore, if the Life Company goes under, now the Obligor is scrambling around to get funds to make its payment to the plaintiff. Thus, the plaintiff has an interest in seeing that a very secure Life Company is utilized so that the Obligor will always have funds available to pay the plaintiff.
Cost v. Present Value
The term cost refers to what the liability company or the Assignee has to pay in order to purchase the annuity from the Life Company.
Present Value, on the other hand, refers to the overall worth of the future stream of income to the plaintiff.
It used to be that insurance companies would not tell plaintiff’s attorney what the actual cost of the annuity is. Some still will not do that. However, the IRS in a private letter ruling 83-33035 has stated that knowledge of the cost by the plaintiff does not constitute constructive receipt.
“The Service has consistently taken the position that knowledge is not determinative in deciding the question of constructive receipt, but the unqualified availability of the funds is decisive.”
Thus, the first way to find out cost is to simply ask the company what the cost is. If they won’t tell you, then the only other way to do it is to try to calculate it based on what rate of return you think the Assignee is getting. In other words, use a figure that represents a good market rate for a pre-tax investment (say 8.5%) and then discount the future payments by that amount. That should give you a rough idea of what the Assignee is paying for the annuity.
Calculating present value to the plaintiff requires one to take into consideration the fact that the monthly annuity payments are received tax-free by the plaintiff. Therefore, in calculating this amount, one should use a competitive market rate on good quality available municipal bonds (say 7%) since they are tax-free instruments. You can then discount the future stream of income by 7% to arrive at the present value of the package to the plaintiff.
One would think that the cost of an annuity should generally be less than the present value since the former is a pre-tax calculation, whereas the latter is an after-tax calculation.
The difference between cost and present value is important not only in trying to “size up” how the structure offer stacks up against a potential lump-sum verdict, but it is also important in calculating an attorney’s fee. One could make the argument that it would be legitimate to base a fee on either the cost or the present value. However, I think if the plaintiff’s lawyer is to be conservative, it is probably always safer to base it on the lower figure of cost. That method of calculating a fee is endorsed in Johnson v. Sears Roebuck, 436 A.2d 675 (1981).