Beyond Structured Settlements

NASP 2011 Annual Meeting - 2

S2KM has received both positive and negative private feedback about S2KM's coverage of the National Association of Settlement Purchasers (NASP) 2011 Annual Meeting. Although S2KM welcomes any feedback, private or public, negative feedback generally provides greater focus and incentive for afterthoughts.

Among the private criticisms S2KM has received:

• S2KM is biased toward (or has an affinity for) the secondary market at the expense of the primary market.
• S2KM criticizes primary market business conduct without reporting secondary market bad business behavior.
• S2KM should be more of a positive voice for change and not a muckraker.

Bias Toward the Secondary Market

S2KM believes that IRC 5891 and the state protection statutes have radically changed and improved both the structured settlement product and the structured settlement market. To paraphrase NASP President Matt Bracy: structured settlement recipients, in compliance with federal and state laws, now have the right to sell their asset (payment rights) provided a state judge approves the sale in advance as being in the "best interest" of the transferor/payee taking into account the welfare and support of the payee's dependents. Instead of the "grey" secondary structured market that existed from 1986 to 2000, the secondary market is now regulated by state judges and the Internal Revenue Service with substantial penalties for transfer companies who do not comply with federal and state statutes.

Many primary market participants will disagree with portions of the above paragraph. They do not view structured settlements transfers either as a product improvement or as a recipient's "right" however that right may be qualified by statute. In S2KM's opinion, the primary market's general attitude toward and perspective of the secondary market since 2001 represent a serious strategic mistake that has caused considerable harm to the primary structured settlement market. Instead of improving their own products by adding commutation or transfer features, and re-learning how to sell their product in a statutorily re-defined market, the primary market continues to criticize and shun the secondary market.

By comparison, NASP regularly invites and welcomes critics to speak at its educational conferences. These critics have included blogger John Darer, two current co-chairpersons of the NSSTA Legal Committee Peter Vodola and Stephen Harris, and current SSP President Jack Meligan, as well as judges from states where structured settlement transfers are viewed most negatively. Among NASP presentations by S2KM author Patrick Hindert (Hindert), see "How the Primary Market Views Factoring".

Criticizing Business Conduct

Beginning in 2004, S2KM has reported and discussed both primary and secondary structured settlement market business practices and business models. For compilations of S2KM's reporting about secondary market business practices (good and bad), see the Secondary Market page on the structured settlement wiki. For detailed information about pre-2001 secondary market business practices and issues, see section 16.02[2] of "Structured Settlements and Periodic Payment Judgments" (S2P2J) of which Hindert is a co-author.

For S2KM reporting and commentary about primary market business standards and practices, see also the structured settlement wiki:

• Business Standards and Practices .
• Primary Market - includes IRC 468B Qualified Settlement Funds.
• Spencer v. Hartford .

Readers can judge for themselves whether S2KM criticizes primary market business conduct without reporting secondary market bad business behavior.

Positive Voice for Change vs. Muckraker

Wikipedia defines the contemporary use of the term "muckraker" to mean "a journalist who writes in the adversarial or alternative tradition or a non-journalist whose purpose in publication is to advocate reform and change." When S2KM began publishing in 2004, social media (including blogs, wikis and podcasts) represented an "alternative" to traditional print media and educational conferences. Social media provides an opportunity for unpopular or minority ideas and viewpoints to gain an audience not otherwise available. Unfortunately, social media also has a dark side which can include personal attacks and bullying.

In advocating for improved structured settlement business practices and business models, S2KM has attempted (with a few exceptions which S2KM regrets), to follow the lessons taught in "Getting to Yes" which at one time represented a guidebook of sorts for the primary structured settlement market. Perhaps the "Getting to Yes" method can still be useful to help a divided structured settlement industry improve and grow:

• Separate the people from the problem.
• Focus on interests not positions.
• Invent options for mutual gain.
• Insist on using objective criteria.

Without more strategic conversations that include all structured settlement stakeholders and perspectives, the structured settlement industry will never achieve its full potential. To the extent possible, S2KM intends to encourage and to be part of those strategic industry conversations. Some of S2KM's preliminary contributions appear on the following pages of the structured settlement wiki:

• Re-thinking Structured Settlements .
• Growing the Market .

Death and Damages

Jeremy Babener has written a new tax article titled "Death and Damages Can be Taxing" which appears in the April 2011 issue of Trusts & Estates magazine. Written for estate planning professionals, Babener's article addresses both income and estate tax issues involved with lump sum and structured settlements.

Babener's article considers physical and emotional damages resulting from three categories of cases: wrongful death, survivor lawsuits, and pre-death causes of action. In addition to his tax analysis, Babener provides three instructive case examples plus practice tips, a summary table and extensive footnotes.

Babener's article re-affirms, from S2KM's perspective, several important settlement planning lessons:

• The complexity of settlement planning and the importance for many recipients of personal injury and wrongful death settlements to receive timely and related tax advice from tax professionals. Although Babener's audience consists of estate planning professionals who may not always contribute to case-specific pre-settlement planning, they may be called upon post-settlement to address income or estate tax problems created by a poorly planned settlement. Classic "red flag" structured settlement cases include large periodic payouts with long certain periods or large deferred lump sums.
• The importance, when planning settlements, to consider potential future tax changes including estate tax rates and/or the amounts of allowable estate tax exclusions and deductions. Recent estate tax exemptions that shelter extensive sums from any estate tax may not exist when current structured settlement recipients die with still-to-be paid periodic payments.
• The role of allocations in settlement tax planning and tax calculations. As one example, Babener discusses a wrongful death preceded by substantial pain and suffering related to the accident causing the death. Although proceeds from a wrongful death settlement are not subject to estate tax, proceeds related to the pain and suffering will be included in the decedent's estate and will be subject to a potential estate tax. In another example involving co-plaintiffs, Babener suggests naming the more injured party as the primary structured settlement payee and the less-(emotionally) injured plaintiff as contingent structured settlement beneficiary.
• The potential estate planning problems created by structured settlements including valuation of any periodic payments remaining when the primary payee dies and the potential lack of liquidity to pay estate taxes. Babener highlights a current judicial controversy potentially applicable to structured settlements related to Treasury regulations issued in 1995. These regulations provide that a "restricted beneficial interest subject to any contingency, power or other restriction" will be valued for estate tax purposes based on all facts and circumstances rather than by Treasury tables. Whether structured settlement payments are considered to be "restricted beneficial interests" (due to non-assignability clauses) becomes financially significant in calculating estate tax liability. Babener also points out the potential value or need for commutations or factoring transactions to pay estate taxes resulting from structured settlements.
• The risks for claimants and their attorneys in relying on non-tax professionals for settlement planning tax advice. This caveat was highlighted in Adrian v. Mesirow Financial Structured Settlements, a 2010 judicial decision (not mentioned in Babener's article) where a claimant alleged she was mislead by a defense broker about the favorable tax consequences of a structured settlement. In holding that the defense owed no duty to the claimant, the court found that the broker's education, certifications and years of experience related only to her work in life insurance and structured settlements and did not and should not suggest any expertise or special knowledge of tax law.

For additional tax and structured settlement articles by Jeremy Babener, see his Tax Structuring website and S2KM's structured settlement public policy wiki.

For additional information about the taxation of structured settlements, see Chapter 2 of "Structured Settlements and Periodic Payment Judgments" (S2P2J).

Review of "Structured Settlements: Factor vs. Commute?"

Robert W. Wood, an expert tax attorney whose specialties include structured settlements, has written a provocative new article titled "Structured Settlements: Factor vs. Commute?" for the December 25, 2006 edition of "Tax Notes". The article is also accessible on the Wood & Porter website.

Wood's article addresses the strategic question of "whether an insurance company can commute periodic payments due under its own annuity policy (or that of an affiliate) and still comply with the federal income tax law."

Note: quotations and italics are from Wood's article.

Summary of Wood's Conclusions

• There is "no clear answer" - which, in and of itself, Wood characterizes as "unnerving";
• "Factoring someone else's annuity is clearly okay" (meaning in the context of Wood's article, the transaction does not violate section 130's prohibition against acceleration) - provided the parties obtain a court order pursuant to IRC Section 5891 and meet the requirements of the appropriate state structured settlement protection statute.
• But a commutation (see analysis below) "appears to accelerate payments" - in violation of IRC section 130's prohibition against acceleration.
• Wood also differentiates "automatic commutations" (see analysis below) whose features, according to Wood, do not appear (based upon LTR 9812027) to cause an acceleration in violation of IRC section 130;
• Because commutations and third party factoring produce different results for the qualified assignee and annuity issuer, Wood argues they should be treated differently for tax purposes.
• "Issuers risk violating section 130 when they commute their own annuities (with or without a qualified order under section 5891)" and whether directly or using an affiliate company.
• "Given the preponderance of authorities discounting the value of court orders as controlling (or even bearing on) federal income tax consequences, a court order .... cannot prevent (or cure) a violation of section 130."
• Based upon his "serious concerns" about potential adverse and unexpected tax results from commutations used as a substitute for third party factoring, Wood concludes such commutations "should not be recommended by prudent tax practioners."

Summary of Wood's analysis:

• Key terminology
  • Insurance companies - for Wood's article, insurance companies also specifically include "companies that do not actually issue structured settlement annuities but are wholly owned by companies that do. That may include a qualified assignee."
  • Third Party Factoring - For Woods, IRC section 5891 creates a safe harbor for third party factoring. Although commutations and third party factoring produce the same result for the payee (a lump sum), Woods differentiates the results for the qualified assignee and annuity issuer.
  • Commutations
    • One difference between a commutation and third party factoring "is that in a commutation, the payee receives payment from the payer of the periodic payments, not from a third party."
    • A second difference: "in factoring the payments continue (without alteration of amounts or payment frequency) - not so with commutation (which effectively ends the payment stream)"
  • Automatic Commutations -Terminology Wood uses to differentiate commutations meeting the following requirements set forth by the IRS in LTR 9812027 which was issued in 1997:
    • Contemplated in the original structured settlement documents and funding annuity;
    • Caused by events outside the payee's control;
    • The payee has no ability to affect whether a commutation might occur; and
    • The commutation is made to the payee's beneficiaries and not to the payee.
  • Acceleration
    • Both IRC sections 130 and 5891 include prohibitions against acceleration of payments;
    • Acceleration can occur for one party to a structured settlement (payee) and not others (qualified assignee or annuity provider);
      • For the payee, both factoring and commuting represent acceleration;
      • For the annuity issuer and qualified assignee, acceleration only occurs with a commutation. With a factoring transaction, annuity payments continue but to a new person or entity or as part of a new financial security.
• LTR 9812027
  • In which the IRS ruled favorably for a commutation meeting the "automatic commutation" requirements identified above:
    • Structured settlement payments subject to the commutation clause were "fixed and determinable" under IRC section 130(c) (2)(a);
    • The commutation provisions did not cause the assignment to fail to comply with IRC section 130(c);
  • Although a private letter ruling cannot be cited as precedent and LTR 9812027 was issued prior to enactment of IRC section 5891, Wood views LTR 9812027 as important because:
    • No specific IRC section addresses commutations;
    • Besides LTR 9812027, the IRS has not provided any guidance for commutations.
  • Because IRC Section 130(c) prohibits acceleration, Wood characterizes LTR 9812027 as support for his conclusion that automatic commutation features do not cause an acceleration in violation of IRC section 130;
  • As Wood points out, however, in LTR 9812027, the IRS did not expressly address whether an automatic commutation (or any type of commutation) causes an acceleration for 130 purposes.
• Relationship between IRC Sections 130 and 5891:
  • Wood's analysis begins with some fundementals: IRC section 130 provides an exclusion from gross income for the qualified assignee;
  • Without this exclusion, a US-based qualified assignee has a potential tax mismatch - recognizing income immediately, then deducting each periodic payment as paid;
  • If IRC section 130 is satisfied originally, IRC section 5891 provides that any subsequent transfer does not affect the application of IRC section 130 in any year;
  • Third party factoring (pursuant to IRC Section 5891) does not impact the income taxation of any party to the structured settlement including the qualified assignee;
  • IRC section 5891 provides a safe harbor for satisfying the section 130 prohibition against acceleration;
  • There are no statutory pronouncements as to whether a commutation contravenes IRC section 5891;
  • Wood's analysis concludes: whether or not a commutation triggers an IRC section 5891 excise tax, it may still violate IRC section 130's acceleration requirement.
• Significance of a court order
  • To avoid a confiscatory forty (40 per cent) federal income tax, IRC section 5891 requires an acquiring company to obtain a final order, judgment or decree of a state court or responsible administrative authority (court order);
  • Pursuant to IRC section 5891(b)(5), a court order is "dispositive" for avoiding the excise tax;
  • This court order must find that the transfer does not contravene any state or federal statute or the order of any court or responsible administrative authority; accordingly, any such order implicitly states that IRC section 130 (acceleration) is not contravened;
  • Under traditional tax principles, a ruling by a federal or state court is not binding on the IRS or the courts.
  • Therefore, Wood questions why a state court ruling that no statute is violated for IRC Section 5891 purposes should be "dispositive" that the transaction satisfies IRC section 130.
  • Conversely, the state court order required to satisfy IRC section 5891 begs the question: does that proposed transfer violate IRC section 130?

Impact of Wood's Article

• Wood's article represents valuable strategic thinking for three related and overlapping markets: structured settlements; structured settlement transfers (factoring); and personal injury settlement planning.
• His article calls into question the appropriate tax treatment for commutation programs as competitive substitutes for third party factoring.  Wood's analysis should have special interest for companies such as Symetra, All State and National Indemnity who already participate in the secondary market.
• His article helps to explain why most annuity providers have not offered factoring or commutation products and services. 
• Wood's analysis makes it less likely that annuity providers will compete directly with factoring companies - at least until further tax authority or guidance becomes available.
• Nevertheless, Wood's article implicitly challenges structured settlement annuity providers (as well as their distributors and advisors - especially settlement planners) to re-think current structured settlements products, programs and processes in the context of both IRC sections 130 and 5891.
• For astute annuity providers, Wood's analysis offers insights to improve their structured settlement products and simultaneously facilitate the efficient operation of federal and state settlement transfer legislation.
• Wood's article further highlights:
  • The need for additional tax authority and education about factoring and commutations - particularly for state judges; and
  • The important linkage between IRC section 130 and the court orders under state protection statutes required by IRC section 5891.
• Wood's article improves upon and completes Structured Settlements in 2006 - a year in which some of the most important industry developments and some of the best expert commentary have focused on factoring and factoring's impact on structured settlements and personal injury settlement planning.