Structured Settlement is the gift of a legal arrangement in 1983 which makes it sort of an innovation in the financial and insurance arena. It 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. It is truly beneficial to both parties but before analyzing the scope of structured settlement, it is important to briefly understand what Structured Settlement means and how it originated.
Understanding Structured Settlement
Structured Settlement is the special form of compensation amount payable for any form of damage done to a party (like injury by medical negligence, accident, etc.) by another party against whom the victim files a lawsuit. The unique feature of this settlement amount is that it consists of one part of the amount paid to the claimant initially and the remaining is paid out to that party through installments instead of paying the whole compensation as a lump sum. 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 understand it, consider an example. For instance, a claimant may wish to be given $10,000 yearly for first 5 years and $15,000 for remaining 10 years (given the total compensation amount is $2,00,000). The claimant can also choose to have no payments for few initial years and fixed annual installments thereafter to fund retirement needs.
Origin of Structured Settlement
Structured Settlements were first brought to the financial scene as a mode of claims settlement when in 1960s, a drug sold widely to treat morning sickness in pregnant ladies, called Thalidomide, caused huge deformities and birth defects in small children. This was for the first time in Canada that structured settlement was used to pay off the claims of a large number of the affected people since the drug manufacturer did not have enough money to settle all claims at once in lump sum amount.
On a similar account, structured settlements are becoming popular with the settlement of claims for children who have suffered in injury in an accident or due to medical negligence. Structured settlements not only assure that the child receives the benefits of the settlement amount but also receives a continuous flow of non-taxable income to support his needs. There are no costs for the child and the settlements are backed by top-rated highly credible insurance companies.
There have been many amendments in the law of settlements of claims to make it tax-free and flexible regarding payment schedules to suit the needs of the claimant and the capability of the defendant. According to the NSSTA (National Structured Settlement Trade Association), in order to make this form of compensatory mechanism more widespread, the Congress (United States) in 1982 laid down specific tax rules called the Periodic Payment Settlement Tax Act and the Section 104 (a) (2) of Internal Revenue Code stated that the whole amount of structured settlement would be tax-free to the claimant.
Structured Settlements are a viable option for people due to various reasons, of which a few could be the involvement of a child in the personal injury loss, if the total amount of loss is greater than $10,000 and the same could be carried forward to the succeeding years in installments, need for a stable and guaranteed constant flow of income for some time etc.
Key Features and Benefits of Structured Settlement
Having understood how this unique form of compensatory settlement came about, there are certain salient features as well as benefits to this form of settlement. Following are the merits of the structured settlement amount received in annual installments:
- The whole of the compensation or the settlement amount is tax-free. Moreover, the interest payable on the settlement amount is also tax-free.
- There is no effect of volatility in the stock market health or of fluctuations in interest rates on settlement amount.
- There is no risk of default generally, or this method of settlement would not have been agreed upon by the court if the defendant were not credible in the first place.
- Structured Settlement is a source of a guaranteed income stream with the freedom to spend the money as per the claimant’s desires.
- There are no overhead costs or hidden expenses involved in the process of settling claims through structured settlements. The parties involved are all benefitted because such settlement can be agreed upon even outside the courtroom without a trial if the parties agree on the terms of the settlement devised. This can even save upon the legal costs.
- For someone who has never handled too large an amount at once, chances are that the person might lose that lump-sum money due to his poor financial knowledge and bad financial choices. The claimant can avoid this risk by agreeing upon settlement of his claims through structured settlement wherein payment in annual installments ensures a continuous flow of income and avoids any risk of windfall losses due to a bad financial choice.
- The claimant does not need to be forever stuck with the agreed upon mode of receiving payments. He has the option of selling his structured settlement right to receiving money in installments to another insurance company or some cooperation that deals in structured settlements in return for the huge lump sum amount, slightly discounted, to suit his urgent financial needs.
Words of Caution while dealing with Structured Settlements
Now, having understood the concept, characteristics and benefits of Structured Settlements, there are certain precautions one must keep in mind while dealing with Structured Settlements:
- The structured settlement agreement would depend largely upon the defendant entity company who is drafting it. Thus, in case it is a company with some regulations regarding drafting of such an agreement for claims settlement, the claimant must have complete information of any such rules and regulations of the company.
- Depending on the state or country where this form of structured settlement is being held in operation to settle claims, the rules and laws may differ or may be changed over time slightly. The person must acquire complete knowledge of these settlements before striking a deal with the defendant party or before agreeing to any compensatory amount.
- These forms of tailored settlements are agreed upon by planning and negotiation thus the claimant must involve himself along with his attorney into the drafting of such an agreement to suit his financial requirements.
- It is very important for the parties involved to understand that once agreed upon, the terms of structured settlement cannot be changed. This hold true for the claimant as well as the defendant. Thus, if they find that at any point of time they could do away with the payment in installments, as agreed upon earlier, they have the option of selling away their structured settlements to some insurance company at a discount.
Legal Aspects related to Structured Settlements
There are certain legal arrangements to make structured settlements function the way they work. They are as follows:
- The Periodic Payment Settlement Act of 1982, ensures that the claimant receives a guaranteed income stream over the period of settlement agreed upon by the parties. Any such agreement is entered into in the presence of the court of law and has thus, all the legal backing required.
- The Internal Revenue Service Code Section 104(a)(2)assures that the settlement payments received by the claimant from the contract are tax-free and even the interest rate received on this amount are free of all taxes.
- The insurance company backing this stream of annuities is generally highly rated by the credit rating agencies so agreeing to a structured settlement obviously has a negligible risk.
- Even 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!
The whole process of structured settlement payments is done through the approval of the court. 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. Actually the claimant cannot be the owner of the policy otherwise the tax-free arrangement would not be applicable. 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 bottom line is, this form of payments through structured settlement has the potential to benefit all the parties, given that the contract is drafted keeping into account everyone’s best interests. Thus a fair and fine contact can attend to the financial needs of all parties and can provide a guaranteed and risk-free income stream to the claimant.