Beyond Structured Settlements

JCT Structured Settlement Estimate

The Joint Committee on Taxation (JCT) has released its Estimates of Federal Tax Expenditures for Fiscal Years 2010-2014 (JCT Report) and the estimated tax revenue loss for structured settlements may surprise many structured settlement and settlement planning stakeholders.

The first surprise: for what appears to be the first time, the JCT staff actually calculates an estimated tax revenue loss for the "exclusion of investment income from structured settlement arrangements" in its annual JCT Report.

The second surprise: the JCT Report estimates the structured settlement tax revenue loss to be "de minimis" - meaning less that $50 million for Fiscal Years 2010-2014 or less than $12.5 million per year.

The JCT staff prepares its report on tax expenditures annually for the House Ways and Means Committee and the Senate Finance Committee for their use in budget analysis and for determining the relative merits of achieving specific public policy goals through tax benefits or direct outlays. The JCT staff also submits its tax expenditure report to the House and Senate Budget Committees. "Tax expenditures" are defined in the Congressional Budget and Impoundment Control Act of 1974 (the "Budget Act") and include any reductions in income tax liabilities resulting from special tax provisions or regulations that provide tax benefits to specific taxpayers.

Since 1982, IRC section 104(a)(2) has included a tax subsidy for structured settlements and periodic payment judgments. Under IRC section 104(a)(2): gross income does not include "the amount of any damages (other than punitive damages) received (whether by suit or agreement and whether as lump sums or as periodic payments) on account of personal physical injuries or physical sickness". When utilized as settlements, such periodic payment agreements are commonly referred to as "structured settlements".

JCT Reports historically do provide estimates of tax revenue loss resulting generally from the "exclusion of damages on account of personal physical injuries or physical sickness". The current JCT estimate for 2010-2014 is $7.9 billion. Until this year, however, the JCT Report never provided a specific estimate for structured settlements.

The JCT estimate of "de minimus" structured settlement tax revenue loss (under $12.5 million per year) appears especially small compared with statements from structured settlement and some settlement planning consultants aggressively promoting structured settlement tax savings for injury victims.

Compare also the value of the structured settlement tax subsidy as estimated by Jeremy Babener in his 2009 paper titled "Justifying the Structured Settlement Tax Subsidy: The Use of Lump Sum Settlement Monies"- between $360 million and $840 million per year.

Admittedly a "back-of-the-envelope range", Babener generated his tax subsidy estimate based upon input from structured settlement:

• authors - including Law Professor Adam Scales;
• experts - including William Neff, a tax partner at Hogan Lovells; and
• practitioners - including Joseph Tombs, Chairman of the Registry of Settlement Planners.

As documented in footnote 16 of Babener's paper, both Scales and Neff estimated the IRC section 104(a)(2) tax subsidy adds at least 20% to the value of certain structured settlements. Because of low income and/or deductions, however, not all structured settlement recipients benefit from the tax subsidy. Tombs estimated that only 30% of structured settlement recipients actually receive a significant reduction in their future income taxes while Neff believed the majority of structured settlement recipients are net taxpayers.

To calculate his $360 million to $840 million estimate of annual structured settlement tax benefits, Babener assumed:

• $6 billion per year of structured settlement annuity premium;
• A range of 30% to 70% as the likely percentage of structured settlement recipients receiving the tax benefit;
• An average 20% tax benefit for every structured settlement recipient who actually does receive a tax benefit.

Babener additionally pointed out::

• The value of the structured settlement tax subsidy also constitutes lost revenue to the U.S. Treasury;
• The cost of the subsidy to the U.S. Treasury in lost revenue has been largely ignored in structured settlement literature;
• Potential government savings exist that accompany the structured settlement tax loss including a reduction in the number of public benefit dependents.

Currently a NYU Tax LL.M. Candidate, and a former Fellow at the U.S. Treasury's Office of Tax Policy, Babener's writing appears on his website Tax Structuring and is featured on S2KM's structured settlement public policy wiki.

Jeremy Babener Interview

Jeremy Babener , a third year Juris Doctor candidate at New York University has completed a seminal structured settlement paper a copy of which is available for download online in pdf format.

S2KM introduced, summarized and reviewed Jeremy Babener's paper, titled "Justifying the Structured Settlement Tax Subsidy: The Use of Lump Sum Settlements", in two prior S2KM blog posts:

• Dissipation Studies; and
• Jeremy Babener's Dissipation Paper.

This S2KM post features an exclusive interview with Jeremy Babener about his dissipation paper.

S2KM: Jeremy, what are the principle conclusions of your paper?

Jeremy Babener: The structured settlement subsidy, or tax exclusion, is premised upon the belief that claimants prematurely dissipate lump sum settlements. This belief has long been held within the structured settlement industry, and is frequently cited as a proven fact. Anecdotal evidence from industry practitioners, representing a broad cross-section of interests, certainly suggests the belief to be true. However, the article explores the available empirical data. It concludes that the frequency of the dissipating claimant has yet to be proven, and that citations relied upon as evidence lack applicability, or sometimes any substance at all.

S2KM: What surprised you the most about your findings?

Jeremy Babener: The thesis itself is surprising. The use and citation of an unproven statistic by so many in an industry exposes how reliant we are on others’ accurate reporting. It also exemplifies how assertions consistent with one’s previous experiences can bypass criticism.

S2KM: How did you become aware of, and interested in, structured settlements?

Jeremy Babener: I clerked for the U.S. Department of Justice, in the Federal Tort Claims Act Section during the Summer of 2008. As some of the cases moved toward settlement, I was introduced to the concept of the structured settlement. Some commentators call it “a benefit to both sides.” I wanted to learn more.

S2KM: Why did you focus your first structured settlement paper on dissipation studies?

Jeremy Babener: Writing this paper was not planned. In my research for a different article on the single claimant qualified settlement fund issue, I repeatedly read that “90% of lump sum claimants squander their award within five years.” Though I attempted to track down the source of the statistic, I was most surprised to find that I could not. I thought it important for the structured settlement industry to know. Of course, nearly all those I spoke to in the industry believe that most lump sum claimants do prematurely dissipate their settlement, based on personal and anecdotal experience.

S2KM: Did you write the paper for a specific class or seminar?

Jeremy Babener: I wrote the paper during my year in the NYU Journal of Law & Business’ note-writing program, and also for a law course entitled “Tax and Social Policy.”

S2KM: Where and when do you expect to publish your paper and who is your intended audience?

Jeremy Babener: I will be submitting my article to an array of journals and law reviews in August. I wrote the article with those in the structured settlement and factoring industries in mind. However, I think it pertains to many areas where long-term care and financial stability are important, including Medicare.

S2KM: How can interested persons obtain a copy of your paper?

Jeremy Babener: The abstract and draft of the article are available on SSRN. I will also be launching a website with Patrick Hindert. It will provide ongoing posts addressing structured settlement issues, including those introduced by this article.

S2KM: How many dissipation studies did you review as part of this project?

Jeremy Babener: The article reviews twelve studies. Four are American, published between 1936 and 1971. The eight others come from Britain, Canada, Australia, and Scotland, between 1973 and 1994. The article also reviews reports by the Canadian Manitoba Law Commission (1987) and the Law Reform Commission of Ireland (1996).

S2KM: What additional sources did you utilize in your research?

Jeremy Babener: I learned the most about the industry by speaking with those that populate it, including settlement planners, attorneys, and insurance company representatives. The treatises and articles on structured settlements provided an invaluable list of references. I was also fortunate that inquiries to foreign libraries and governments resulted in the requested reports, enabling me to track down nearly every citation I came across.

S2KM: How does the secondary market for structured settlements impact your paper and your view of structured settlement dissipation?

Jeremy Babener: The ability of structured settlement payees to sell their future stream of income for a lump sum amount undermines the purpose of the tax subsidy (i.e. preventing premature dissipation of settlement monies). On the other hand, the flexibility inherent in the ability to factor encourages personal injury claimants to structure their settlements in the first place, which may decrease total settlement dissipation. The factoring industry has produced statistics suggesting that those payees who factor do so responsibly. The sources of such statistics should be analyzed. A modern study on structured settlement factoring may be needed to appreciate the nuances of the issue.

S2KM: What are the earliest and most recent references you located for the statistic that 90% of lump sum injury recipients dissipate their recoveries in 5 years?

Jeremy Babener: The Journal of Commerce reported the 90%-5-year statistic in 1978, quoting T.V. Mangelsdorf, a life insurance underwriter. Today, some commentators, like Paul Lesti, discuss the statistic without reporting it as fact. However, the statistic is cited as proven in articles, on broker websites, and even in Negotiating and Settling Tort Cases, a treatise available on Westlaw.

S2KM: Based upon your research, is the term "squander" an accurate or fair characterization of injury victims?

Jeremy Babener; Where lump sum recipients exhaust their settlement monies in a shorter time than the monies are meant to last, I believe a more accurate characterization would be "premature dissipation". the term "squander" carries a particularly derogatory tone. Though I am not sure I would put it in such strong terms, Washington & Lee School of Law Professor Adam Scales argues quite convincingly, "What is objectionable in the rhetoric of structured settlement enthusiasts is the unsubtle attribution to tort claimants of characteristics, values and habits that are generally held in contempt in American political discourse: a lack of self-control, and the concomitent propensity to wind up om welfare."

S2KM: Did you locate any evidence that injury victims have a greater propensity than other persons to spend money wastefully or foolishly?

Jeremy Babener: The strongest evidence of lump sum recipients’ propensity to prematurely dissipate their settlement comes from anecdotal evidence throughout the industry. A few studies make conclusions that lump sum recipients spend money irresponsibly. However, such studies often have substantial flaws, lack applicability, or provide conclusions based on subjective judgments. For example, some studies criticize the use of lump sum settlement monies on ordinary living expenses.

S2KM: Assuming injury victims do dissipate lump sums, what other explanations, besides a propensity to squander, might explain this occurrence?

Jeremy Babener: The “propensity to squander” addresses the post-settlement decisions of lump sum claimants. However, the settlement amount itself cannot be overlooked. It is important to note the fact that where claimants accept settlements they receive less than the value of their original claim. Once legal and other fees are subtracted, the leftover sum may simply be inadequate. Thus, the money will not last as long as originally intended. For example, a 1984 Australian study of 86 accident claimants found many examples of inadequate settlements, but only seven examples of mismanagement.

S2KM: Did you find any evidence that injury victims manage lump sums responsibly?

Jeremy Babener: Yes, though the studies are either old or foreign. The famed 1971 American “Widows Study,” which some cite to as the source of the 90%-5-year statistic, actually found unwise spending “very much the exception.” Foreign studies also suggest that lump sum recipients can and often do act responsibly, including studies from Scotland (1993), Australia (1992), and Canada (1983). Foreign law commission reports have made similar conclusions.

S2KM: In your opinion, why haven't there been any recent and relevant dissipation studies in the U.S.?

Jeremy Babener: The industry considered performing such a study in the mid-1990s. Then, a few years ago, at least one insurance company was contemplating the idea. Some believe the study would be very difficult to perform; others believe the industry is concerned that the results might not be entirely favorable. I think that there has been little need to prove the contention because so many in the industry, based on personal and anecdotal experience, believe it to be true.

S2KM: Are you planning to write any additional papers related to structured settlements?

Jeremy Babener: I have drafted an article on the use of qualified settlement funds by single party claimants. I will be sharing it with those in the industry prior to submitting it to the NYU Journal of Law and Business this Fall.

Thank you, Jeremy for this interview and for sharing your dissipation paper which has been long overdue in the structured settlement industry. Good luck and future success with your studies, your writing and your professional career.

For related S2KM blog posts, see:

• Dissipation Studies;
• Jeremy Babener Dissipation Paper;
• Structured Settlement 2009 Strategic Analysis;
  
• Structured Settlement Surveys;
• J.G. Wentworth Survey;
• Settlement Consulting;
• Structured Settlement Credo.

Jeremy Babener's Dissipation Paper

Jeremy Babener, a third year Juris Doctor candidate at New York University School of Law, has completed a seminal research paper titled "Justifying the Structured Settlement Tax Subsidy: The Use of Lump Sum Settlements" which identifies and analyzes 12 historical dissipation studies plus two law commission dissipation reports.

This S2KM blog post summarizes and reviews Babener's dissipation paper. A prior S2KM post introduced dissipation studies and "claimant centric" business models as strategically important for structured settlements and settlement planning. A subsequent post will feature an interview with Jeremy Babener about his dissipation paper.

Babener's conclusions about injury victim dissipation studies:

• No existing published dissipation study supports either of two structured settlement industry claims:
  • Injury victims "squander" lump sum awards;
  • Nine out of 10 lump sum injury victim recipients dissipate their awards within five years - the "90% - five year" statistic.
• Dissipation studies exist which reach the opposite conclusion - injury victims have no more propensity to dissipate lump sums than non-injury victims.

Scope: Although Babener's dissipation paper is comprehensive, it focuses on a specific topic - the 90% - five year statistic.

Babener's dissipation paper does not:

• Contend that claimants spend money responsibly. Instead, it "exposes as industry allegory the frequently stated belief that studies have proven [injury victim squandering] to be true." Babener recommends a new United States study to develop "empirical and substantiated" dissipation statistics for injury victims because the United States tax subsidy for structured settlements is premised on this belief.
• Address possible explanations for injury victim dissipation besides "squandering". Other commentators, however, have identified two explanations which deserve greater consideration and analysis:
  • Alternative # 1 - Asset and income qualification requirements for certain government benefits (including Medicaid and SSI) which:
    • Force and re-enforce recipients into poverty; and,
    • For many persons, require asset spend down strategies (dissipation) to qualify.
  • Alternative # 2 - Inadequate funds - where the proposed settlement plans:
    • Don't exist; or
    • Make inaccurate or unrealistic assumptions; or they are:
    • Under-funded; or
    • Improperly implemented; or
    • Badly administered.
• Characterize the secondary market as either proving or disproving claimant dissipation characteristics.

Babener's paper contains six sections - each of which S2KM separately summarizes below.

• Section I - Introduction. Babener focuses on the linkage between the structured settlement tax subsidy and dissipation studies.
• Section II - An Empty Statistic? Babener attempts, but fails, to locate any source supporting the 90%- five year statistic.
• Section III - Other Evidence of Lump Sum Use. Babener reviews other studies casting light on claimants' financial responsibility.
• Section IV - The Informed Conclusions of Others. Babener examines why the unproven 90%-five year assertion endures.
• Section V - Rhetoric of the Dissipating Claimant. Babener addresses the rhetoric of the enduring assertion, calling for a modern American study to answer the question long thought answered.
• Section VI - Conclusion:
  • Appendices (the surveys);
  • The lack of evidence for the 90%-5 year statistic;
  • Other evidence of lump sum dissipation;
  • Evidence of responsible lump sum usage.

Section 1 - Introduction

Babener's paper does not contend that personal injury claimants responsibly expend lump sum settlement monies. Instead, the paper exposes as industry allegory the frequently stated (but unsubstantiated and largely unanalyzed) belief that studies prove injury victims prematurely dissipate lump sums. Babener's paper highlights the federal income tax subsidy for structured settlements and estimates the annual subsidy to total between $360 and $840 million per year assuming $6 billion of annual structured settlement annuity sales. Babener's paper incorporates and builds upon the findings of two other authors who have studied dissipation, Ellen S. Pryor and Adam F. Scales. Babener's paper also reviews and relies upon 12 studies and two law commission reports - most of which are from non-United States countries. Babener also conducted extensive interviews with structured settlement practitioners.

Section 2 - An Empty Statistic?

Babener identifies and traces historic references from 1978 to 2009 citing "insurance studies" which allegedly support the 90% - five year statistic. In every case, Babener finds the reference either lacks any citation or cites to a study that does not support the 90%-5 year statistic. Although articles, treatises and practitioners continue to cite the statistic as proven, Babener's research does not discover any study that supports the 90%-5 year statistic. That statistic, which Professor Scales characterized as "the most consistently repeated 'fact'" in structured settlement law and lore, appears to be a mythical falsehood. Babener does not explore the consequences of this industry myth which extend beyond the scope of his paper.

Section 3 - Other Evidence

Babener summarizes his findings after reviewing 12 dissipation studies plus two law commission reports and references his more detailed analyses of these sources in his paper's Appendices. None of the dissipation studies or reports support the 90% - five year statistic. According to Babener's analysis, seven of these studies, plus two law commission reports support an opposite conclusion: lump sum recipients do not spend their recoveries unwisely.

The law commission reports Babener analyzes are by the Law Reform Commission in Ireland in 1996 and the Canadian Manitoba Law Commission in 1987. The Law Reform Commission of Ireland found "studies recently conducted by the Law Commission and the Disability Management Group of the University of Edinburgh have shown that the risk of dissipation is less than was widely believed and that those awarded very high damages are least likely to fritter away their compensation".

The 12 dissipation studies Babener reviews in his paper are listed here chronologically:

• 1947 U.S. Retirement Railroad Board Compensation study;
• 1959 University of Michigan study;
• 1973 British Personal Injury study;
• 1983 Australian Accident Compensation study;
• 1983 Canadian Auto Accident Compensation study;
• 1984 British Personal Injury study;
• 1984 Australian Traffic Accident study;
• 1987 Canadian Manitoba Law Commission study;
• 1992 Australian Auto Accident study;
• 1993 Scottish PersonaI Injury Compensation study;
• 1994 British Personal Injury Compensation study;
• 1996 Law Reform Commission of Ireland study.

Section 4 - Informed Conclusions of Others

Babener acknowledges that none of the studies he cites and analyzes is directly analogous to 21st century United States injury victims. Babener calls for a modern American study of injury victim dissipation to support the structured settlement tax subsidy.

Section 5 - Rhetoric of the Dissipating Claimant

In discussing and analyzing the continuing rhetoric within the structured settlement industry, especially the pejorative and unproven characterization of injury victims as "squanderers", Babener quotes from Adam Scales' 2002 paper. Scales argues that the image of the dissipating claimant has "intuitive appeal". According to Scales, “What is objectionable in the rhetoric of structured settlement enthusiasts is the unsubtle attribution to tort claimants of characteristics, values, and habits that are generally held in contempt in American political discourse: a lack of self-control, and the concomitant propensity to wind up on welfare." Scales continues, “An essential element of the discussion has been the assumption that successful tort claimants simply cannot be trusted with large sums of money."

Section 6 - Conclusion and Appendices - Babener concludes his paper by calling for a modern American dissipation study. In his paper's Appendices, Babener analyzes existing dissipation studies under three categories:

• Appendix A - frequently cited dissipation studies which do not support the 90%-five year statistic;
• Appendix B - other studies suggesting lump sum settlement recipients dissipate;
• Appendix C - studies offering evidence of responsible money management by injury victims.

For related S2KM blog posts, see:

• Dissipation Studies;
• Jeremy Babener Interview;
• Structured Settlement 2009 Strategic Analysis;
  
• Structured Settlement Surveys;
• J.G. Wentworth Survey;
• Settlement Consulting;
• Structured Settlement Credo.

Dissipation Studies

The United States structured settlement industry has drifted into an era of unprecedented transition and change with stagnant annuity growth and without any articulated industry strategic plan or strategic planning process.

Forces causing structured settlement transition and change:

• Financial service regulatory reform - with consumer protections;
• Tax reform - with reviews of existing subsidies plus potential new tax-subsidized products for disabled persons;
• Health care reform - with expected new rules for Medicaid (special needs trusts) and Medicare (set-aside arrangements);
• Internet-based business models - with improved performance standards and metrics for communication; planning; marketing; learning; product development and work processes;
• Class action lawsuits - exposing bad structured settlement business practices regardless of whether these practices are illegal under current laws;
• Growth of affiliated business markets - special needs planning; lien resolution; the secondary market; Medicare secondary payer practice; life care planning; settlement trusts; and money management of settlement proceeds;
• Retirement and/or death of first generation structured settlement industry leaders.

To recognize strategic change and successfully transition to settlement planning, a larger, more complex business, the structured settlement industry needs new focus, new vision, new leaders, and new "claimant centric" business models.

To better understand and grow their market, the new structured settlement leaders should begin by re-examining industry myths about their customers (injury victims). Where the myths are wrong and misguided, these new industry leaders should reject the historical myths and re-invent structured settlements based upon truth not fiction.

Among structured settlement industry myths, two are especially pernicious, long-standing and related:

• Myth #1: injury victims squander lump sums. Nine out of 10 lump sum recipients dissipate the entire amount within five years.
• Myth #2: structured settlements enable injury victims to live free of reliance on government assistance.

What have been the consequences of these industry myths for the structured settlements?

• Inefficient and anti-claimant business models;
• Product sales instead of settlement solutions;
• Bad business practices - whether or not illegal;
• Lack of market research and product development;
• Selectively incomplete education;
• Defensive and anti-growth political strategies;
• Abandonment of injury victim customers to the secondary market;
• Stagnant structured settlement annuity growth.

What if both myths are false?

Expert commentators have already challenged both myths:

• Adam Scales - When Professor Adam Scales first questioned the myth of squandering injury victims in his remarkable 2002 University of Wisconsin Law Review article titled: "Against Settlement Factoring? The Market in Tort Claims has Arrived", he was reviled by leaders of the primary structured settlement market. Seven years following the publication of Professor Scales' article, structured settlement and settlement planning leaders continue to quote false dissipation statistics and mis-characterize existing dissipation studies to promote a negative and false psychological and financial profile of injury victims.
• David Lillesand - David Lillesand, a leading social security and special needs attorney, has spoken and written about the critical need for serious injury victims to qualify for Medicaid. According to Lillesand, Medicaid is a "life or death" matter for such individuals. Structured settlements do not enable serious injury victims to live free of reliance on government assistance. To the contrary, unless the annuities are paid into a special needs trust, structured settlement annuity payments disqualify injury victims from receiving Medicaid. Even when structured settlement annuities are paid into a special needs trust, the legal rules for structured settlements are either unaddressed by current legislation and regulations and/or uncertain in their application and requirements.

Meet Jeremy Babener , part of a new generation of structured settlement knowledge leaders, and a third year law student at New York University. Babener has accomplished something no one in the structured settlement industry has attempted - a comprehensive review of historic dissipation studies involving injury victims. Babener's new legal research paper, titled "Justifying the Structured Settlement Tax Subsidy: The Use of Lump Sum Settlements," includes extensive Appendices with detailed analysis of 12 dissipation studies relevant to U.S structured settlements.

Babener's paper, which examines and challenges the myth of the squandering injury victim:

• Refutes the existence of any published study supporting the statistic that "90% of lump sum recipients dissipate their recoveries within five years".
• Identifies existing dissipation studies that reach a contradictory conclusion: injury victims have no greater propensity to dissipate money than non-injury victims.
• Incorporates interviews from a cross-section of structured settlement industry practitioners who support the assertion of common lump sum dissipation based on personal and anecdotal experience.
• Calls for a modern study to ground the structured settlement subsidy in proven data.

S2KM begins its public 2009 strategic re-evaluation of structured settlements with a blog series about dissipation studies featuring Jeremy Babener's research. In subsequent posts, S2KM will summarize and review Babener's new dissipation paper and interview Babener about his dissipation research.

For related S2KM blog posts, see:

• Jeremy Babener Dissipation Paper;
• Jeremy Babener Interview;
• Jeremy Babener Responds;
• Settlement Consulting;
• Structured Settlement Credo.