A fixed rate structured settlement annuity is often created in connection with the settlement of a personal injury lawsuit. In a typical transaction, the defendant and plaintiff reach a settlement which provides for the plaintiff to receive periodic payments over a period of time.
The use of structured settlements has risen dramatically in the past twenty years. Previously, claimants were presented with the option of an immediate cash settlement, which created significant tax related burdens, and did not always address the long term needs of the plaintiff. Structured settlement growth is most attributable to the favorable federal income tax treatment that such settlements received as a result of the 1982 amendment of the Internal Revenue Code. These amendments approved a structure under which personal injury tort claimants could receive periodic payments over a term of years in settlement of their claim from insurance companies and assignment companies. These amendments confirmed that the personal injury tort plaintiff could receive the periodic payments under a structured settlement on a tax-free basis, including the ability to receive the “inside build-up” value or gain in investment value over the life of the payments. The Internal Revenue Code was also amended by adding new Section 130, which provided substantial tax clarity to insurance companies that establish “qualified” structured settlements and led to the creation of assignment companies that were affiliated with the insurance companies that issued the annuities.
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The most significant downside for a plaintiff with a structured settlement comes from its inherent inflexibility. In ways unforeseen at the settlement table, the plaintiff’s financial needs often change over time resulting in a demand for liquidity options. Beginning in the late 1980s, a few small specialty finance companies started meeting post settlement liquidity demands by offering new flexibility for structured settlement payees through a lump sum cash payment to the plaintiff in return for some or all of the rights to the plaintiff’s structured settlement payments. During the late 1980s and early 1990s, certain legal and tax issues surrounding settlement transactions limited the growth of the assigned structured settlement market.
Federal legislation
In 2001, Congress passed H.R. 2884, which was promptly signed into law by the President. This legislation enacted Internal Revenue Code Section 5891 effective July 1, 2002 which largely eliminated the remaining material tax issues associated with the purchase and sale of Structured Settlements. Through a punitive excise tax penalty imposed on the Structured Settlement purchaser, Code Section 5891 created the de facto regulatory paradigm for the industry. To avoid the excise tax penalty, a state court, in accordance with a qualified state statute, must approve all structured settlement transactions. Qualified state statutes call for certain baseline findings, including a requirement that the transfer is in the best interest of the seller taking into account the welfare and support of any dependents. In response, many states enacted statutes regulating structured settlement transfers in accordance with this mandate.
Post-2002
Today, virtually all transfers are completed through a court order process. As of January 15, 2009, 46 states have transfer laws in place regulating the transfer process. Of these states, 41 are based in whole or in part on the model state law (“Model Act”) enacted by the National Conference of Insurance Legislators. In cases when the state law predates the Model Act, they are substantially similar. Most state transfer laws contain the following similar provisions:
- Pre-contract disclosures to be made to the seller concerning the essentials of the transaction.
- Notices to be issued to certain interested parties.
- An admonition to the seller to seek professional advice concerning the proposed transfer.
- A court approval of the transfer, including a finding that it is in the best interest of seller, taking into account the welfare and support of any dependents.
