For catastrophically injured clients, cash requirements which are immediate as well as those in the future need to be considered when devising the settlement plan. This is so because without taking it into account, many settlement plans are devised with insufficient liquid assets to properly address the needs without significant market losses. Investopedia defines liquidity as the degree to which an asset or security can be quickly bought or sold in the market without affecting the assets price. Cash is usually considered the most liquid asset. In the settlement context, liquid assets are necessary to meet ongoing and emergency needs without needing to liquidate variable investments to pay for them. A checking account would be the most liquid of assets (aside from cash), to meet these needs. On the other hand, a stock market based investment account is not as liquid. If you were to use it to pay for immediate cash needs after settlement or ongoing expenses you could potentially take a loss on your investments each time you made a withdrawal. The withdrawal requires a conversion to cash.
In the normal family situation, monthly liquidity to pay bills is generated from paychecks. The funds come in and go out each month to pay expenses. They will usually maintain an emergency fund or have access to credit for larger cost or unforeseen items that do not occur regularly. They create current and ongoing liquidity with their paycheck. In the settlement planning context, it is more common for the plaintiff to have a variety of items that need to come out of their settlement proceeds immediately or within the first 24 months. They typically do not have sufficient income to create liquidity. Because of this fact, the settlement plan must be built to address liquidity.
As part of any settlement plan, it is important to review the one time and ongoing expenses that will happen in the first two years and allocate those funds to liquid asset classes within the plan. In addition, our settlement consulting team typically recommends a second layer of liquidity be allocated as an emergency account. This is usually between 5 & 10% of the net settlement. Ongoing liquidity would need to consider the future monthly needs of the plaintiff.
Guardians, Trustees and Investment Advisors need to plan around the future liquidity needs. It is easy to do the analysis at the beginning of the plan. You can set the funds aside that will be needed for the first few years. How do you invest the funds that need to be liquid in years 3 and beyond to maximize your rate with minimal risk? You can:
- Stagger CDs that mature in years three through ten.
- Stagger Bond Portfolios to mature in years three through ten.
- Utilize an annual payment from a structured settlement.
- Rebalance Investment Portfolios with the inclusion of liquid assets and a floor. This allows an automatic replenishment of liquid assets when they market is up.
Why is this so important for your client? They only receive one settlement and have one chance to get the balance right! All the assets need to be working hard to earn as much as possible. For every 100k, an additional 1% of interest earns them $1,000 more of spendable dollars each year. If they do not have liquid assets to pay for a need, they may have to sell something at a loss. This has an inverse relation to earning more interest. Selling at a 1% loss takes away $1,000 of spendable income each year.
So how do you make sure your client is protected and is sufficiently liquid? Engage experienced settlement planners to craft a solid strategy for the recovery. This is accomplished by taking steps to limit liquidity risks. Creating recurring liquidity with different investment vehicles is very important. Planning ahead for major expenses for durable medical equipment needs or medical procedures as well as other major purchases is critical. Preparing an annual budget that is reviewed annually and adjusted will help to stretch the liquid dollars. Then reallocating and rebalancing the portfolio when necessary will be the best defense to becoming illiquid.
Jason D. Lazarus is the managing partner and founder of the Special Needs Law Firm; a Florida law firm that provides legal services related to public benefit preservation, liens and Medicare Secondary Payer compliance. He is also the founder and Chief Executive Officer of Synergy Settlement Services, which offers healthcare lien resolution, Medicare secondary payer compliance services, public benefit preservation and complex settlement consulting.