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By Jason D. Lazarus, J.D., LL.M., MSCC, CSSC

In a recent Washington Post article, an egregious story of embezzlement was detailed involving personal injury settlements for children whose parents had died due to medical malpractice.  The settlements stemmed from cases against the federal government who in turn had hired the Pension Company, a structured settlement firm, to purchase annuities for the settlements.  These annuities, called structured settlements, were set up to make future periodic payments to the minor children for their damages.  The problem was that it was a fraudulent scheme by the Chief Executive of the Pension Company to take the money and convert it to his own use instead of purchasing structured settlement annuities for the minor children.  To further complicate things, Pension Company, was one of the country’s largest structured settlement firms and was a trusted provider for the government until this story was uncovered.  This is a sad situation that could have easily been prevented had there been a plaintiff-based settlement planner engaged to protect the plaintiff’s interests.  It is often overlooked, but the importance of making sure the plaintiff has adequate protections when it comes to a structured settlement transaction is highlighted by this case.  Before discussing how a plaintiff based-settlement planner can help, first it is important to understand the basics about structured settlements.

Understanding Structured Settlements

When any physical injury victim recovers money either by settlement or by verdict, the question of the tax treatment of said recovery arises.  As long as it is compensation for personal physical injuries, it is tax-free under Section 104(a)(2) of the Internal Revenue Code.[1]  Section 104(a)(2) of the Internal Revenue Code states that “gross income does not include . . . the amount of any damages received (whether by suit or agreement and whether as lump sums or as periodic payments) on account of personal injuries or sickness.”[2]  Section 104(a)(2) gives the personal injury victim two different financial options for their recovery: lump sum or periodic payments.[3]  The second option, receiving “periodic payments,” is known as a structured settlement[4].   A structured settlement’s investment gains are never taxed.[5] Using a structured settlement offers spendthrift protection[6] and the money has enhanced protection against creditor claims as well as judgments.[7]

Structured settlements utilizing life insurance annuities as their funding mechanism have been around for four decades.  Over half a million injury victims receive benefits from structured settlement annuities.  Each year, life insurance companies that provide structured settlements receive more than $6 billion to fund new structured settlement arrangements and an estimated $156 billion has been paid in total to fund structured settlements in force since the seventies.[8]  Since 1976, in excess of 880,000 cases were settled using a structured settlement for all or part of the settlement with an average annuity premium of just over $177,000.00.[9]

Structured settlements are utilized in the settlement of tort claims because of the advantages they offer like income tax-free payments,[10] fixed low-risk competitive returns, guaranteed lifetime income, no-cost financial management, spendthrift protection, creditor protection and avoidance of guardianship requirements in certain cases.  Structured settlements offer the unsophisticated investor the ability to make a one-time, simple investment decision that will provide competitive returns with no market risk and no taxation.[11]  Similarly, sophisticated investors can use the annuity as a funding mechanism for other investments using a dollar cost averaging approach.[12]  For the injury victim, a low-risk, fixed and income tax-free vehicle that can provide guaranteed income is very attractive and appropriate.  In addition, a structured settlement can be a tool to pass wealth on to the next generation avoiding income tax on any of the income generated.[13]

Legal Protections of Structured Settlements

There are a variety of legal protections offered by structured settlements.  A particularly important set of legal protections will be explored in the following paragraphs.  First, annuities in general have significant protections against loss due to insolvency of the life insurance company (the only way to lose money with a fixed annuity).  There are several layers of protection against insolvency or in case of insolvency.  The first layer of protection is that annuity providers are overseen by state insurance commissions.  The second layer of protection is that state law imposes reserve and surplus requirements on life insurance companies.  The third layer of protection is that every state has a state guaranty association which guarantees annuities.  The final layer of protection is careful selection of the highest quality annuity providers to provide structured settlements.

Oftentimes the protection that structured settlement annuities are afforded under the law in terms of judgments and creditor claims is overlooked when analyzing whether to implement one; however, this feature is very important for injury victims who need to protect their recovery.  Injury victims only get one opportunity to recover compensation for their injuries.  If someone who recovers compensation for their injuries is subsequently involved in an accident where they injure someone else or someone is injured on their property, bank accounts and most investments are exposed to claims.  In addition, if an injury victim gets into debt and has creditors making claims, their assets could be exposed to these claims.

However, many states have either common law or statutes that protect annuities from legal process.  For example, in Florida there is a statute[14] that completely exempts annuities from creditors and judgments.  This statute gives injury victims an option to completely protect their settlement proceeds from judgments or creditor claims by entering into a structured settlement annuity as part of their settlement.  That statute has been interpreted by Florida courts[15] to defeat judgment creditor claims against structured settlement annuities.

In addition, structured settlements offer enhanced protection under the law in case of divorce or bankruptcy.  Structured settlements are not owned by the injury victim.  Instead, the injury victim is the payee and the life insurance company’s assignment company owns the annuity.  When a structured settlement is created as part of a settlement, an assignment occurs.  The assignment is done to transfer ownership of the annuity from the purchaser (the defendant) to the life company assignment corporation.  The assignment corporation takes on the obligation to make the future periodic payments and purchases an annuity from the annuity issuer.  Because of this legal arrangement, structured settlement annuities are not an asset owned by an injury victim.  Consequently, it is not an asset that can generally be divided in the case of divorce.[16]  The income that it produces can be considered in determining alimony, but the asset itself usually is not divided.[17]  Similarly, a structured settlement annuity is not an asset generally reachable in cases of bankruptcy.[18]

Gargan & Woodyard Embezzlement:  Don’t throw the baby out with the bathwater

As detailed above, there are many great reasons to enter into structured settlements.  They are a powerful planning tool for injury victims.  Obviously care and thought should be given to how to construct a structured settlement plan for an injury victim.  Diversification and creating overlapping income streams with different companies may be advisable depending on the circumstances.  Careful analysis regarding the financial strength of the life insurance companies proposed for an injury victim is also of paramount importance.  Developing a sound settlement plan based upon the client’s future financial needs is also critical.  All of this needs to be done by someone independent of the defendant.  This brings me back to the Loudon man, Joseph Gargan.  Mr. Gargan was retained by the defendant, the government, as a “defense structure broker” to put together structured settlements for injury victims.  Had the plaintiffs had their own settlement planner in place to develop a plan and address the financial strength of the life insurance companies, this would never had occurred.  This is so because the plaintiff’s planner would have gotten a copy of not only the payment of the premium to the life company to purchase the annuity but also gotten a copy of the contract directly from them to document the annuity policy was put into place.   Without those protections, this type of situation can happen.

This is not the first time a scheme like this has unfolded.  Back in 2016, a Ringler structured settlement broker was indicted in Dallas for a scheme to defraud Ace European Insurance Company out of more than $4.6 million dollars over the period from 2002 through 2013 related to failing to send premium to purchase structured settlement annuities.  In the lawsuit, it is alleged that a broker for Ringler Associates, Michael Woodyard of Texas, stole structured settlement premiums from insurers and converted them to his own use.  Upon investigation, it was discovered that annuities in certain cases had never been purchased.  Instead, Woodyard allegedly converted those funds to his own private use.  Woodyard had, according to the complaint, set up a typical Ponzi scheme where he had been, for a period, making annuity payments to injury victims from his own funds until the scheme collapsed.  He had even issued fraudulent annuity certificates to his clients to hide the fraud and made “lulling” payments to cover up.  He was ultimately sentenced to 87 months in federal prison and ordered to pay $3.9 million in restitution.  This type of scheme was so easily preventable had the plaintiff employed their own planner in these transactions.  When a planner is involved in these transactions, they get a copy of the premium check issued by the insurer to fund the structured settlement and have direct contact with the life insurance company issuing the annuity contract.  Therefore, it would have been easily discovered that in fact no annuities were purchased had a plaintiff settlement planner been engaged by the personal injury attorneys whose clients had structured settlements “placed” by Ringler and Mr. Woodyard.

Why you need a plaintiff-based settlement planner

Protecting the plaintiff is not the goal or responsibility of the defense broker, their allegiance is to their client, the defendant insurance company.  In the course of discovery regarding the Woodyard/Ringler matter, Ringler denied in a court filing that it “owed plaintiffs a duty to exercise reasonable care.”  Since a “defense structure broker” has no duty to the plaintiff, it is critical to engage your own plaintiff-based settlement planner.  It is a must to have a credentialed expert assisting with what will be the most important financial transaction of the injury victim’s life.  A settlement is meant to last the remainder of that person’s life.  Making sure all options are explored is critical.  Additionally, making sure that client is properly protected in any transaction involving the insurance company and a structured settlement is imperative.  Equally as important, protecting yourself from liability in these transactions is necessary as they are complex and highly specialized.  Having an experienced plaintiff-based planner to guide you through the issues and make sure you do not have malpractice exposure is critical.

Conclusion

The question of how to best to manage the net proceeds presents an important question that must not be overlooked.  Should the settlement be structured?  Should a trust be utilized?  Are there public benefit preservation issues that will determine what type of trust needs to be created?  Frequently these questions are overlooked because the defendant comes to mediation with a “structured settlement broker” who offers the solution to all of these issues, a structured settlement annuity.  Structured settlement annuities are the cornerstone of a strong settlement plan but there are many issues that need to be explored.  An experienced settlement planner can help with these issues and protect your client from fraud as well as protect your law firm from liability with these complicated transactions.

Contact us today to see how Synergy’s settlement planning team can protect the recovery, improve client satisfaction and give you a trusted partner to provide holistic solutions including structured settlements, public benefit preservation solutions and trusts.  We are your expert settlement advocates that will drive a better outcome in every case with a guarantee that the plaintiff is ALWAYS better off as a result of our involvement.

[1] I.R.C. § 104(a)(2) (2007).

[2] Id.

[3] Id.

[4] A structured settlement is a single premium fixed annuity used to provide future periodic payments to personal physical injury victims.  The interest earned is not taxable under Section 104(a)(2) and a series of revenue rulings that provide the basis for structured settlements.

[5] See I.R.C. § 104(a)(2) (2007).  See also Rev. Rul. 79-220 (1979) (holding recipient may exclude the full amount of the single premium annuity payments received as part of a personal injury settlement from gross income under section 104(a)(2) of the code).

[6] Structured settlements cannot be accelerated, deferred, anticipated or encumbered.  The payments are made pursuant to the terms of the contract with the life insurance company.  Thus, a personal injury victim is protected from spending the money too quickly.  However, there are “factoring” companies that will purchase structured settlement annuities and provide a lump sum payment.  These transactions are now regulated by IRC 5891 and many states have enacted provisions to protect structured settlement recipients from unfair transactions.  IRC 5891 requires a finding that the sale is in the best interest of the annuitant and requires judicial approval.  IRC 5891

[7] Many states offer protection by statute for annuities.  For example, in Florida, annuities have immunity from legal process as long as they are not set up to defraud creditors.  See generally Fla. Stat. § 222.14 (2007).

[8] Daniel W. Hindert & Craig H. Ulman, Transfers of Structured Settlement Payment Rights:  What Judges Should Know About Structured Settlement Protection Acts, 44 NO. 2 Judges’ J. 19 (2005); see also https://s2kmblog.typepad.com/rethinking_structured_set/2017/02/structured-settlement-2016-annuity-sales.html

[9] https://s2kmblog.typepad.com/rethinking_structured_set/2017/02/structured-settlement-2016-annuity-sales.html

[10] See I.R.C. §104(a) (2008).  See also Rev. Rul. 79-220 (July 1979) (payments are income tax-free to injury victim and all subsequent payees)

[11] Richard B. Risk, Jr., Structured Settlements: The Ongoing Evolution from a Liability Insurer’s Ploy to an Injury Victim’s Boon, 36 Tulsa L. J. 865 (2001).

[12] Id.

[13] While structured settlements are income tax-free even to subsequent payees, they are not estate tax-free.  The present value of the remaining guaranteed payments is includable in the injury victim’s gross estate.

[14] “The cash surrender values of life insurance policies issued upon the lives of citizens or residents of the state and the proceeds of annuity contracts issued to citizens or residents of the state, upon whatever form, shall not in any case be liable to attachment, garnishment or legal process in favor of any creditor of the person whose life is so insured or of any creditor of the person who is the beneficiary of such annuity contract, unless the insurance policy or annuity contract was effected for the benefit of such creditor.” Fla. Stat. § 222.14 (2008).

[15] See Windsor-Thomas Group Inc. v. Parker, 782 So.2d 478 (Fla. 2d DCA 2001).  Judgment creditor brought an action to garnish an annuity that funded structured settlement of a tort case in favor of the judgment debtor. The issuer moved to quash the writ based on the statutory prohibition that annuity contracts are not liable to attachment, garnishment, or legal process in favor of any creditor. The Circuit Court dissolved the writ. Creditor appealed. The District Court of Appeal held that the issuer had standing to raise the statutory prohibition against garnishment.

[16] See generally Krebs v. Krebs, 435 N.W.2d 240 (Wis. 1989)

[17] See generally Ihlenfeldt v. Ihlenfeldt, 549 N.W.2d 791 (Wis. App. 1996)

[18] See In re McCollam, 612 So.2d 572 (Fla. 1993).  Annuity was exempt under Florida Statute 222.14 from creditor claims in bankruptcy action.  See also In re Orso, 283 F.3d 686 (5th Cir. 2002) (holding structured settlement “annuity contracts under which payments were owed came within scope of Louisiana statute exempting such contracts from the claims of creditors”); In re Belue, 238 B.R. 218  (S.D. Fla. 1999) (holding “debtor who was named, as payee and intended beneficiary, under annuity purchased by insurance company to fund its obligations under structured settlement agreement was entitled to claim annuity payments as exempt under special Florida exemption for proceeds of any annuity contracts issued to citizens or residents of state . . . .”); In re Alexander, 227 B.R. 658 (N.D. TX 1998) (holding structured settlement annuity paid to debtors following the death of their children in automobile accident was entitled to exemption as an annuity under Texas law).

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