What’s in the name? An oxymoron and a dangerous deception
Some settlement planners believe they’ve found a way for injured plaintiffs to receive the tax-free status of a structured settlement while also participating in market-based investments. Settlement planners are now encouraging personal injury victims and their attorneys to invest in new, market-based financial products loosely referred to as “market-based structured settlements.” However, since these products lack all the critical features of a structured settlement, the misnomer is dangerously misleading.
WHAT IS A STRUCTURED SETTLEMENT?
Between Internal Revenue Code Section 104(a)(2) and the Periodic Payment Settlement Act of 1982, the IRS and Congress created their greatest gift of all time for personal injury victims: the structured settlement.
With a structured settlement, personal injury victims receive tax-free, guaranteed future periodic payments funded via a fixed-annuity contract. These transactions are backed by a select group of blue-chip, highly rated life insurance companies and regulated by insurance commissioners in all 50 states.
To qualify for tax-free treatment by the IRS, the Federal government says these payments must be “fixed and determinable” and the plaintiff cannot have constructive or actual receipt of the funds. When injured individuals opt for a structured settlement, they know the exact amount of their payments and the exact date their payments will be made. They never need to worry about the stock market or the performance of their investments.
Structured settlements have been widely accepted as the most financially secure, tax-advantaged investment option for injured plaintiffs for the past 40 years.
WHAT ARE THESE “MARKET-BASED” INSTRUMENTS?
Through a broad interpretation of Internal Revenue Code Section 130 that governs structured settlements, some settlement planners believe they can offer a non-fixed annuity funding vehicle which attempts to follow a framework similar to that of a structured settlement, including the tax benefits. These market-based vehicles are funded by an investment portfolio—not a fixed-annuity contract. They are touted as providing injured plaintiffs with the ability to achieve the tax-free status of a structured settlement while also participating in market-based investments through a non-qualified assignment, an offshore assignment company and a series of private-letter rulings from the IRS.
They skirt the “fixed and determinable” requirement of IRC Section 130 by asserting that fixed payments and fixed percentage distributions are the same thing. However, the exact future payment amounts are not guaranteed, fixed, or determinable because future payments are linked to investment performance. What is fixed is merely the formula by which each payout will be calculated if funds are available. Most importantly, the IRS has not expressly adopted these products under IRC Section 130 as true, tax-exempt structured settlements.
WHY DOES IT MATTER FOR THE INJURED PLAINTIFF?
Most injured individuals who settle a claim face unique challenges as investors. Chasing return or risking their principal in a volatile and fluctuating market should be avoided at all costs, especially when funds are needed for the security of day-to-day living and medical expenses. Plaintiffs who invest in these market-based programs have no protection from early dissipation. They can lose principal and they have no guarantee of minimum payments. They may also be subject to investment and/or management fees.
These market-based programs are everything a structured settlement is not: money sent to offshore companies with unknown financial strength, added investment fees and market volatility, risk of losing tax-exempt status. In fact, the very idea of a “market-based structured settlement” re-introduces all the risk Congress and the IRS intended to protect injured individuals from when they passed the landmark legislation that created structured settlements. Furthermore, if one assumes their “market-based structured settlement” is a tax-free benefit, who will pay for back taxes, interest, fines, fees and representation if this loose interpretation of IRC Section 130 turns out to be wrong?
Plaintiffs with discretionary income, investment knowledge and the risk tolerance to participate in the market, would be better served by using a proven investment vehicle alongside a structured settlement. If you want to invest in the market, find a financial advisor who has experience working with personal injury recipients and invest in the market! Structured settlements provide guaranteed, tax-exempt income for the essentials. “Market-based” portfolios are for discretionary income and long-term investment. Mix the two for a balanced portfolio but don’t confuse them.
WHY DOES IT MATTER FOR THE INSURANCE CARRIER?
Now that settlement planners have chosen to claim these new market-based vehicles are structured settlements, insurance carriers are being asked to fund them on behalf of plaintiffs to avoid constructive receipt (the same way they would fund a typical structured settlement). The problem is, these vehicles are not structured settlements. Most insurance carriers have created protocols to ensure compliance with the Federal guidelines and IRS codes that govern structured settlements. However, since these market-based programs fall outside the terms of IRC Section 130, are not guaranteed or regulated and require a non-qualified assignment with funding through an offshore assignment company, the insurance industry has widely refused to recognize them as legitimate structured settlements.
You might see settlement planners aggressively marketing and selling these products to personal injury victims and their attorneys with the expectation that insurance carriers will somehow agree to fund them under their current structured settlement guidelines. Insurance carriers with loosely based structured settlement programs or no program at all are especially easy targets. Most of these transactions are either disguised as a traditional structured settlement or justified as a “one-off.” Other transactions are hidden within Qualified Settlement Funds (QSF) to bypass defense collaboration and review.
Chronovo believes every insurance carrier, self-insured corporation, and/or third-party administrator should have a formal structured settlement program. Protocols, standards, required language, national scope, training and vetted structured settlement consultants are critical in all structured settlement matters, not to mention avoiding any unexpected but accepted liability should these “market-based structured settlements” create litigation.
In short, nothing compares to a traditional structured settlement when it comes to protecting personal injury victims. Nothing else should share its title. Just because a sash might look a bit like a seat belt, it will not keep you safe.