Structured Settlements typically originate in voluntary settlements of tort claims. It is not always the case that structured settlements are the result of court orders or are court mandated as a form ‘spendthrift trust.’ Rather, they are convenient, cost effective, and reasonably settle claims, especially personal injury claims. Insurance companies like using structured settlements as they can move a liability for future claims off their books and close a case, while ensuring long term compensation and reducing their exposure.
Structured settlements offer plaintiffs a mechanism to receive both compensation and investment and income, in one package, and receive it all tax free. And, annuity issuers are also allowed to book the premium from a settlement invested into an annuity in a qualified manner as well, rather than as income. In most cases, structured settlements allow the parties to close a claim, exchange money, buy an annuity, have the annuity issuer earn a return on that annuity premium, and pay out significantly higher future guaranteed payments to the plaintiff, and do it tax free to all parties.
Problems with Structured Settlements:
One common complaint about Structured Settlements is that they are largely inflexible. The payee receives a set fixed payment, rather than an asset they control or can modify, and reality is that people’s circumstances and needs change.
Therefore, in the 1990’s a secondary market for these payments evolved and flourished to provide liquidity to payment recipients seeking lumps sums well after their settlements were finalized.
Legal Framework For Transferring Payment Rights:
In many structured settlements, there is boilerplate language relating to the non-transferability of the payments. Because a structured settlement is not taxable to the original payee, it was mistakenly included in many cases as protection against a claim of ‘constructive relief’. This overly cautious approach was cleared up unequivocally in 2002 with the adoption of IRS Regulations Section 5891 which clarified that a sale of structured settlement payment rights would not alter the tax treatment applicable to the annuitant, or to the annuity issuer.
This clarification of procedure was widely backed in the factoring industry as it gave clarity and spurred nearly all states to adopt a relatively uniform transfer procedure. While each state has nuances, they all follow the same general guideline and provide legal certainty for participants. In general, IRC 5891 indicated that transfers of payment rights would not incur an excise tax on the parties provided they followed a state statute procedure and were in the best interest of the annuitant.
The state specific transfer procedures call for numerous consumer protections, including notifications, rights and obligations to seek independent counsel, and clearly defined disclosure of the discount rate of the transaction.
It’s interesting to note that while most structured settlements arise from voluntary (IE non-court ordered) agreements, the court inserts itself when one of these private parties decides to sell. While the original settlement may not have been under a given court’s jurisdiction, state statutes makes it the Courts business later on, which is cumbersome to say the least for many sellers.
Regardless, USC 5891 provides clarity and liquidity, and gives rise to Secondary Market Annuities – a term we use to describe payment rights from various sources, including those stemming from structured settlements.