Why are structures important?
An American life insurance industry study found that after receiving a large sum of money from a lump-sum settlement or judgment, a lottery windfall, or an inheritance, 25% of recipients had nothing left within two months. At the end of one year 50% had nothing left. After two years 70% had nothing left; and, within 5 years 90% had nothing left. (R.Somers, The Structured Settlement – A Better Way, The Journal of Insurance, March/April 1979).
Fiscal imprudence is human nature. It’s hard to control spending.
Injured victims who receive large lump sum awards need the money for good reason.Structures were created to prevent accident victims from becoming victims again by squandering their lump sums and becoming a burden on family or society.
What is a structured settlement?
A structured settlement is an alternative to a conventional lump-sum settlement. It is a method of settling a claim for damages in respect of personal injuries or wrongful death by the payment of periodic sums for designated periods of time. The defendant’s liability for payment of the periodic sums is funded through the purchase of an annuity contract from a life insurance company.
A structured settlement is a tax-free financial package paid out over time and tailored to meet the specific needs and preferences of individual plaintiffs.
The structure is a type of annuity underwritten by a life insurance company, andguaranteed by the defendant’s casualty insurance company (like ICBC).
The annuity payments may be scheduled for any length of time – even as long as the plaintiff’s lifetime – and may consist of regular installment payments and/or future lump sums. Payments can be in fixed amounts or they can vary.
Thus, a structure may provide regular monthly payments for a fixed term, or for theplaintiff’s life. These regular periodic payments can be combined with lump sumpayments made at fixed intervals in the future (e.g., every five years).
In our business we refer to structured settlements as Structures. Structured settlements are also referred to as Structured Annuities, Annuity Policies, Annuity Contracts, or simply Annuities.
Payment terms are most often referred to as:
- Single Life
- Single Life, guaranteed for X years
- Term Certain
- Periodic Lump sums
An acronym for a structured settlement agreement is “SSA”.
When is a structured settlement appropriate?
These are examples of cases appropriate for a structured settlement:
- In cases involving the following types of injuries: serious head injuries; wrongful death; spinal cord injuries, serious burns; loss of limbs; multiple fractures; moderate permanent injury; injuries that require ongoing medical care.
- The plaintiff will have an expensive cost of future care.
- The plaintiff will need supplementary income streams (in addition to the regular monthly income benefits) for such things as: housing and support staff; support services; respite (break); rehabilitation maintenance intervention; case manager; counselor/social worker; psychologist; speech language pathologist; transportation; medical expenses; vocational services.
- The plaintiff has poor or limited financial management skills or needs professional investment advice.
- The plaintiff has a history of addiction to gambling, drugs, or alcohol.
- To avoid influence from family or friends regarding the use of settlement funds.
- To avoid squandering a lump sum award.
- The plaintiff is a minor.
- The plaintiff has a diminished earning capacity and needs to replace or supplement an income stream.
- The plaintiff’s life expectancy is in doubt.
- A fatality has left a surviving spouse or dependents in need of a guaranteed income stream.
- Children need deferred payments to cover educational or other expenses.
- The plaintiff has no immediate need for large amounts of money.
- The plaintiff wishes to defer commencement of payments to a future date (such as retirement) allowing the fund to grow tax-free in the meanwhile.
- The plaintiff’s health will deteriorate giving rise to the need for periodic lump sums to fund equipment purchases.
- Elderly plaintiffs who want to plan the distribution of their estates.
- Elderly plaintiffs with a keen interest in lifetime payments (to cover nursing home costs for an indefinite period).
- Where damages exceed policy limits and each dollar counts.
What is a lump sum settlement?
Before 1979 in Canada a plaintiff was compensated for personal injuries with a one-time lump-sum payment representing the sum of all damages suffered by the plaintiff. Whether awarded by a court, or paid as a settlement by the defendant’s insurer, a plaintiff received one lump sum.
It would then be up to the plaintiff to spend the money wisely.
In 1978 the Supreme Court of Canada in the case of Andrews v. Grand & Toy Alta. Ltd., [1978] 2 S.C.R. 229, Dickson J. stated (at 236):
The subject of damages for personal injury is an area of the law which cries out for legislative reform…When it is determined that compensation is to be made, it is highly irrational to be tied to a lump sum and once-and-for-all award.
The lump sum award presents problems of great importance. It is subject to inflation, it is subject to fluctuation on investment, income from it is subject to tax… yet our law of damages knows nothing of periodic payments.
Why are structured settlements tax-free?
In Canada, compensation for personal injuries is tax-free whether the award or settlement is made by a lump sum or by periodic payments.
The Canadian Customs and Revenue Agency (CCRA) published on May 8, 1987 an Interpretation Bulletin regarding structured settlements. This bulletin is reproduced below, or link here
http://www.ccra-adrc.gc.ca/E/pub/tp/it365r2/it365r2-e.html.
Do I have to structure my entire settlement?
No you don’t. You can structure all or part of the settlement award.
Typically negotiations involving structures will provide for an immediate cash paymentplus future periodic payments (e.g., monthly) plus specific lump sum payments at future intervals (e.g., every five years).
The immediate cash component can be used for purposes such as:
- Payment of legal fees
- Buying equipment
- Modifying a house
- Paying tuition
Can I take a lump sum and create my own structure?
No you cannot.
Canada Customs and Revenue Agency (CCRA) requires the casualty insurer to be the owner/annuitant of the structure. Payments under the structure are irrevocably directed to the plaintiff. The money to purchase the structure must be paid directly from the casualty company to the life insurance company (or their lawyers). If the plaintiff or plaintiff’s counsel receives the funds first, Canada Customs and Revenue (CCRA) will disallow the tax-free status of the structure.
An excerpt from the CCRA Interpretation Bulletin:
To create such a structured settlement the following conditions must be complied with: (a) a claim for damages must have been made in respect of personal injury or death, (b) the claimant and the casualty insurer must have reached an agreement under which the latter is committed to make at least periodic payments to the claimant for either a fixed term or the life of the claimant, (c) the casualty insurer must (i) purchase a single premium annuity contract which must be non-assignable, non-commutable, non-transferable and designed to produce payments equal to the amounts, and at the times, specified in the agreement referred to in (b), (ii) make an irrevocable direction to the issuer of the annuity contract to make all payments thereunder directly to the claimant, and (iii) remain liable to make the payments as required by the settlement agreement (i.e., the annuity contract payout). As a consequence of compliance with the foregoing conditions, the casualty insurer is the owner of, and annuitant (beneficiary) under, the annuity contract…”
Is there a minimum amount that can be structured?
There is no minimum, but common sense plays a role in determining whether it is worth structuring a settlement.
What is our role as a structure broker?
- Consulting with plaintiff counsel and/or the defendant casualty insurer.
- Collecting medical information for use by the life insurance companies in performing an age rate-up (life impairment rating).
- Assisting with the design (structuring) of the payment schedule.
- Demonstrating a variety of easy-to-understand payment schedules on printouts using exclusive commissioned computer software.
- After the structure is designed, we obtain quotes from each of four federally regulated Canadian life insurance companies.
- We arrange to finalize the transaction between the casualty insurer and the life insurance company.
- We provide a detailed payment schedule showing the dates and amounts of each payment to be made under the structured annuity contract.
- At no charge for the life of the annuity we provide administrative services to the client for address or banking changes, and we’ll provide necessary interaction with the underwriting life insurance company.
Why does a casualty insurer allow structures?
The income stream from a structured annuity is tax-free. The income stream from investment of a conventional lump sum is not tax-free. Therefore, in order to produce the same after-tax income stream in the plaintiff’s hands a casualty insurer must pay out a higher conventional lump sum. It is called a tax gross up on the award, and the casualty insurer saves this amount when purchasing a structured annuity.
These savings are significant when multiplied by any number of similar claims made against an insurer.
How is the price of a structure established?
It depends on a number of factors:
- The desired level of monthly income
- The number and amount of intermittent lump sum payments
- The prevailing interest rates
- The life expectancy of the plaintiff.
What interest rate is used in a structure?
Structures are based on current long-term interest rates.
To learn more about interest rates in Canada link to the Bank of Canada website:
www.bankofcanada.ca/en/backgrounders/bg-p6.htm.
Standard Life also has charts showing the history of 30-year interest rates at:
http://www.sli.ca/eng/reviews/pdf/4283f-3.pdf.
How do you protect a structured settlement against inflation?
When you design the payment schedule, you can build in an annual increase in the monthly payments. The increase can be a fixed percentage amount (called flat indexing) or it can be linked to the Consumer Price Index (CPI-indexing).
Periodic lump sum payments can also be an effective guard against inflation.
How safe is the stream of payments?
Canada Customs and Revenue Agency (CCRA) requires structured annuity payments to be fully guaranteed by:
- A federally regulated life insurance company and
- The defendant’s casualty insurance company or assignee.
This provides maximum security for the structure fund and the payment stream.
Can the structure be taken away from me?
No. You cannot sell, assign, give away, mortgage, pledge, or cash in
(commute) a structured annuity. Payments are irrevocably directed to the
plaintiff from the casualty insurer (the legal owner of the annuity) to
ensure that if the casualty company goes bankrupt the plaintiff’s payment
stream is not subject to an attack by creditors of the casualty insurer.
Also, since the casualty insurer is the legal owner of the annuity, this
arrangement prevents the annuity itself from being garnisheed or seized by a
creditor of the plaintiff.
Why is the plaintiff’s life expectancy critical to the cost of a structure?
Structured settlement payments are often made for the life of the plaintiff, with or without a guarantee period.
In these cases the life insurance company sets the price of the structure after examining the plaintiff’s medical records and the insurance industry’s mortality tables to determine how long the plaintiff is expected to live.
A shorter life means a life insurance company will pay out less money over time. Thus, for a given level of “investment” (i.e., the purchase price of the annuity) a shorter life expectancy translates into higher monthly benefits for the plaintiff.
Even when the plaintiff lives longer than expected the life insurance company will continue paying benefits for the rest of the plaintiff’s life. The life insurance company assumes the risk of a plaintiff living longer than expected, and it sets the price of the structure accordingly.
What role does life expectancy play in non-structured conventional Lump sum awards?
With non-structured conventional lump-sum awards the plaintiff assumes the risk of living longer than expected. In other words, a plaintiff who lives longer than expected might run out of money.
Why? Because in non-structured cases the future income award is calculated as the present value of the expected future income stream, which is based on the expected lifespan of the plaintiff. A conventional award is paid as a one-time lump-sum payment, and if the plaintiff lives longer than they were expected to live at the time the award was paid, the award might prove to be too low. In the result, the plaintiff in a non-structuredcase may exhaust their funds and run out of money.
With a structured settlement, income benefits can be paid for life regardless of how long the plaintiff lives. A structure transfers the risk of outliving one’s income to the life insurance company.
What is an impairment rating or age rating?
As noted above, where an accident or a health condition lowers the plaintiff’s life expectancy the life insurance company underwriting the structure will expect to pay benefits for a shorter period of time than is called for by mortality tables.
The process of determining how long the plaintiff is expected to live is called animpairment rating, or an age rating.
For example, a life insurer paying $1,000 monthly will charge less for a structured annuity if the plaintiff is expected to live only 15 years longer instead of 30 years longer. Thus a 45-year old might be treated like a 60-year old for the purposes of establishing the price of the structure.
What is a guarantee period?
A beneficiary designated in a will continue receiving payments after the plaintiff’s death. The structured annuity might be set up for life, guaranteed for a suitable period of time, to provide for the plaintiff’s dependents.
What is a measuring life?
The purchase price of a structure is directly related to the life expectancy of a plaintiff. The measuring life is almost always that of the plaintiff.
However, it is possible to base the structure on the joint life expectancies of two people (e.g., husband and wife).
What happens upon death of the plaintiff/claimant/annuitant?
Four scenarios are possible depending on how the structure is designed: :
- If the plaintiff dies before the end of a guarantee period all remaining paymentsrequired to be made under the annuity contract can be made to such beneficiary or beneficiaries as the plaintiff names in a Will, or in accordance with a court order under the Estate Administration Act RSBC c.122.
- If the plaintiff dies after the end of the guarantee period the payments cease.
- If there is no guarantee period then the payments will cease upon the plaintiff’s death.
- If the structured annuity is for a fixed term then the payments are made only for that term and the death of a plaintiff has no effect on the structure payments.
What is a reversionary interest?
A reversionary clause may be appropriate if the plaintiff has no dependants to support. If a reversionary clause is built into the annuity and the plaintiff dies before the end of a guarantee period the remaining annuity payments revert (are returned) to the casualty company.
Since the casualty insurer does not need to receive the payments on the same schedule as the plaintiff, the casualty insurer is allowed to commute (cash in) the annuity and take back a lump sum, which is just like taking back a portion of the purchase price. Accountants can calculate the commuted value of an annuity to the penny based on discounting formulas.
Sometimes a casualty company will insist on a reversionary clause as a condition of agreeing to the structure; this is especially the case when the plaintiff’s benefits are used to pay expenses associated with the their day-to-day care (e.g., 24-hour nursing, medication etc.).