In many cases the insurance company representing the at fault defendant may be willing to purchase a “Structure” with the settlement proceeds. This is a highly technical legal device which allows the insurance carrier to purchase an annuity policy for the benefit of the injured party which can be structured in such a way that it can provide: up front capital, a stream of income for a definite period of years, future lump sum payments timed to future critical stages in the injured person’s life, cost of living increases for the income payment, or a combination of all of these.
The structured settlement takes into account these essential factors:
1. The defendant’s insurance company can expect to realize a higher return on its invested funds than the plaintiff can expect to earn if he gets the money up front;
2. The defendant’s insurance company can invest in taxable bonds which pay a higher rate, nevertheless, the payments are TAX FREE income to the plaintiff.
There are advantages to the plaintiff to take a structure:
- No tax on the earnings;
- The management of the fund is done by professionals, and
- There is a valuation-spread between the insurance carrier’s cost and the plaintiff’s benefit
The Federal Income Tax has always not taxed recoveries for personal injury or sickness. However, once a lump-sum tax free amount has been distributed to a plaintiff, his investment of that sum will produce taxable income to the plaintiff. The structured payment arrangement allows for the plaintiff to avoid the payment of taxes until he earns income from his distribution which can be spread over his lifetime, thus minimizing the impact of any after distribution taxes. This arrangement has Internal Revenue approvals.
A surprisingly high percentage of lump sum payments received by plaintiffs are dissipated prematurely or spent frivolously. The financial discipline and sophistication necessary to the retention and proper management of large sums are difficult to come by. In addition to protecting plaintiff from his own gullibility or financial naiveté, a structure provides the very special expertise of professional money managers working to preserve the plaintiff’s funds. These types of arrangements are almost always required in significant settlements involving minors.
Typically, the cost to the insurance company of funding a structured settlement is less than the value of that same settlement to the plaintiff. The spread occurs for a number of reasons:
- The insurance carrier purchases a stream of taxable income which “Converts” to tax free income when paid to the plaintiff. It is cheaper to buy taxable income than it is to buy tax-free income;
- The insurance carrier can use it broad purchasing power and greater market skills to acquire investments paying a higher rate than might be available to the plaintiff investing his own funds;
- The judgments used by the company issuing the annuity for the insurance company to establish the “cost” of the settlement payments may result in a lower out of pocket cost from the insurance carrier than plaintiff would deem necessary to achieve identical results.
* For a more detailed explanation of structured settlements see, Peskin, How To Settle for Top Dollar, The Mitchie Company Charlottesville, VA