Structured Settlement is a unique form of settlement between two parties – the claimant who files a lawsuit against the other party, the defendant, for an injury claim or the workers compensation etc. It has also become a popular settlement option in the insurance sector where the insured can claim the insurance money, in a structured way of receiving it in installments rather than as a lump sum amount. These installments can be variable depending on the agreement between the two parties like – a smaller annual amount for next 20 years or a larger amount per year for next 10 years etc. The amount for initial few years could vary from the installment amount for years thereafter to the extent that the claimant can also choose to have no payments for few initial years and fixed annual installments thereafter to fund retirement needs.
Because of its popularity and uniqueness, it is important to analyze these settlements by having a careful look at its pros and cons.
The Merits of Structured Settlements
There are certain explicit and obvious advantages to the claimant by using the mode of receipt of payments through structured settlements. They are as follows:
- Guaranteed income stream – The claimant gets the right to receive ensured and regular payments according to the Periodic Payment Settlement Act of 1982. All such agreements have legal backing and the consent of the court.
- Avoids huge losses – The claimant may end up splurging if he gets a large lump-sum amount. This risk can be avoided through structured settlement wherein payment in annual installments and not altogether at once avoids any risk of windfall losses which may occur in case of the claimant making bad financial decisions.
- Tax-free payments – The Internal Revenue Service Code Section 104(a)(2) states that all the settlement payments received by the claimant and the interest on this amount are tax-free.
- Flexible in design – The structured settlements are agreed upon by planning and negotiation and the claimant can involve himself along with his attorney into the drafting of such an agreement to suit his financial requirements.
- No costs – The terms of structured settlement can be agreed upon even outside the courtroom without a trial if the parties agree on the terms of the settlement mutually. This can even save upon the legal and other miscellaneous costs.
- No effect of external volatile financial environment – There is not any effect of volatility in the stock market or of fluctuations in interest rates on settlement amount. In addition to this, the claimant’s right to receive the settlement amount is not affected in any way even if he already receives a government funded financial assistance in the form of unemployment benefits or other social security benefits.
- Compensation not affected even after the defendant’s death – In case the original defendant party dies, the periodic payments to the claimant will not be affected. The claimant will continue to receive his periodic payments for as long as decided in the agreement.
- Choice to sell the structured settlement to get lump-sum amount – The claimant has no compulsion to adhere to the settlement terms for the rest of his life. He can do away with the periodic payments terms to get a larger lump-sum by selling his structured settlement right to receiving money in installments to another financial entity that deals in structured settlements in return for the huge lump sum amount.
- Security of payments – Only highly rated insurance companies back the periodic payments settlements so structured settlements have very low risk of default. This makes these structured settlements safe.
- Built-in Inflation Factor – A structured settlement annuity offers the additional option to the claimants to receive the money as long as he lives and with an in-built inflation factor to guard him against rising prices with absolutely no additional costs or charges.
The Demerits of Structured Settlements
Like two sides of the same coin, there are certain demerits against the various merits for the claimant by using the mode of receipt of payments through structured settlements which are listed below:
- Periodic Payments may trap the claimant – The Periodic Payment Settlement Act of 1982, ensures that the claimant receives a guaranteed income stream by the consent of the court of law with adequate legal backing. But, the claimant might feel trapped by the periodic payments after a point of time especially when the claimant has urgent financial needs to cater to. In such a case the smaller amounts received periodically may restrict the freedom of the claimant.
- Completely inflexible once the terms have been decided – The structured settlements offer flexibility of payments schedule while drafting of the agreement . But after the terms have been decided and formally approved by the court, they cannot be changed in any case. This makes the structured settlements highly inflexible after the official authentication if the payments schedule by the court.
- No Compensation after claimant’s death – The Law guarantees that if the original defendant party dies, the income to the claimant will not be hampered. It will continue like any other normal payments from the agreement. But, in case of the claimant, if the claimant dies suddenly before the completion of receipt of all due periodic payments, then there are no further payments henceforth. Thus it is usually suggested that the claimant must agree upon a shorter period of time rather than for longer duration.
- Legal expenditure involved – Legal costs and expenses are explicitly involved in the process of settling claims through structured settlements. The parties involved have to go through the proper trial by hiring a lawyer, preparing necessary legal documents etc. which all come with certain costs. Although the terms can be agreed upon between parties even outside the courtroom mutually, yet, people seldom get into such a method and it is advised to follow all the protocols so as to maintain legal authenticity of the whole procedure.
- Lower returns because investment is not in lump-sum – The claimant is at a loss when he decides to invest his settlement receipts periodically by himself because then he foregoes higher rates of return on investment he could have made with a larger lump sum instead of accepting a structured settlement.
- Different Settlement Agreements by different drafting companies – The structured settlement agreement could differ according to different companies who are drafting the settlement agreement on behalf of the defendant party. Thus, if that turns out to be a company with some regulations regarding drafting of such an agreement for claims settlement, the claimant might end up with a different agreement as compared to other claimants with the same case against the defendant party.
- The claimant is not the owner! – The whole process of structured settlement is done legally where the claimant is a mere receiver of the settlement payments and thus, according to the tax code, the claimant does not own anything except the claim to the payment. In fact the claimant cannot be the owner of the policy otherwise the tax-free arrangement would not be applicable. Going by the actual process, the defendant passes on the money and right to make payments to an insurance company who in turn, pays the money periodically to the claimant. Thus, the insurance company holds the right of ownership of the settlement policy, not the claimant.
The demerits clearly show where the claimant might feel duped of his settlement money in case he fails to carefully understand the whole process of agreeing upon the structured settlement. But, on the other hand, the benefits prove that structured settlement contract, if drafted keeping into account everyone’s best interests, can be very beneficial as well if the limitations are sought to be eliminated by careful analyses and information sharing between both parties. Thus, structured settlements can truly serve the financial needs of the claimant by providing him a guaranteed and risk-free income stream while also easing the financial burden of lump-sum payments on the defendant since he would now have to make periodic payments of smaller amounts.