Beyond Structured Settlements

Treasury Publishes New IRC 104(a)(2) Regs

The United States Treasury has published new regulations for IRC section 104(a)(2) relating to the exclusion from gross income for amounts received on account of personal physical injuries or physical sickness.

Published January 20, 2012, the new section 104(a)(2) regulations make two primary changes to the current regulations. First, they incorporate amendments to 104(a)(2) made in Small Business Job Protection Act of 1996 (1996 Act). Second, they eliminate the previous regulatory requirement that damages must be based upon “tort or tort type rights” to qualify for the tax exclusion.

The 1996 Act included two legislative amendments narrowing the applicability of the 104(a)(2) exclusion. The first amendment prevents any punitive damages from qualifying for the tax exclusion in the personal injury context. The second amendment requires that injury or sickness damages must result from “physical” origins to be excluded. Although emotional distress is not considered a physical injury or physical illness, the new regulations confirm that damages for emotional distress attributable to a physical injury or physical sickness are excluded from income under section 104(a)(2).

The new section 104(a)(2) regulations also eliminate the previous regulatory requirement that damages must be “based on tort or tort type rights” to qualify for exclusion. In a 1995 case (Commissioner v. Schleier), the United States Supreme Court interpreted this requirement to disallow the exclusion of damages where the relevant law (a "no-fault" statute) provided a contractual remedy even though the claimant suffered a personal physical injury or physical sickness as a result of a breach of contract. The new regulations eliminate this prior requirement and allow the tax exclusion to apply even when the physical injury or sickness does not constitute a tort under state or common law.

The new, final regulations for section 104(a)(2) are essentially the same as the proposed regulations the United States Treasury issued in 2009 and which were the subject of a public hearing on February 23, 2010. The final regulations did not adopt any of the recommendations offered by commentators at the public hearing. These recommendations included:

•  Requests by Richard Risk and Jack Meligan that the final regulations address whether a claimant has constructive receipt or the current economic benefit of a damage award that is set aside for the claimant’s benefit in a section 468B qualified settlement fund;

• Requests by John McCulloch and David Higgins that the final regulations confirm several specific types of damages are "physical" and therefore tax-exempt.

For background information about the new section 104(a)(2) regulations and their application to structured settlements, including commentary and analysis by Jeremy Babener, see these prior S2KM blog posts:

• Treasury Hearing on IRC 104(a)(2) Regs
• A Common Cause at the Treasury Regulation Hearing
• Treasury Hearing Commentary
• Voices at the Treasury Hearing
• Speaker Comments at the Treasury Hearing
• Legislation to Expand the Structured Settlement Industry
• Babener Proposes Expanded S2 Tax Subsidy

For a copy of the new section 104(a)(2) regulations, see the structured settlement wiki.

Structured Settlements in 2011 - 3

Prior S2KM 2011 year-end structured settlement blog posts have highlighted the historic significance of the ELNY liquidation and provided a strategic 2011 industry retrospective . This blog post summarizes additional important 2011 structured settlement developments and information.

Taxation

• IRS Audit Guides - The Internal Revenue Service published an Audit Guide in 2011 to assist its examiners in determining the tax treatment of proceeds from lawsuits, settlements and awards received after August 21, 1996. That date marked the enactment of the Small Business Job Protection Act of 1996 which added a "physical" requirement to IRC § 104(a)(2). The IRS had previously published an Audit Guide to assist its examiners in determining whether the IRC §5891 excise tax applies to specific structured settlement factoring transactions.
• JTC Structured Settlement Estimate - The Joint Committee on Taxation (JCT) in 2011 released its Estimates of Federal Tax Expenditures for Fiscal Years 2010-2014 (JCT Report). For the first time, the JCT Report calculated an estimated tax revenue loss for the "exclusion of investment income from structured settlement arrangements". The JCT estimate projected 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.

Government Benefits

• Medicare Secondary Payer Protocol - Although no statutory or regulatory authority requires Medicare set-aside arrangements (MSAs) in third party liability settlements, confusion continues as to whether and when MSAs are necessary and/or appropriate for such cases. On May 6, 2011, the United States Attorney's Office for the Western District of New York (USAOWDNY) released a one page "Medicare Secondary Payer Protocol" (MSP Protocol) establishing a voluntary process by which that U.S. Attorney's Office will review MSA proposals for liability cases provided certain conditions are met.

• U.S. v. Stricker - In this case involving periodic payments and the MSP Act, a U.S. District Court in Alabama denied a motion by the U.S. Government to reconsider the court's earlier dismissal based upon its finding that the applicable statutes of limitations barred the Government's complaint. The Government had argued on appeal that the court erred in granting its motions to dismiss without considering the Government's theory of continuing accrual argument.

• WCMSA portal - The Centers for Medicare and Medicaid Services (CMS) announced the creation of an Internet portal for submission of workers compensation MSA (WCMSA) proposals. The new web-based application:
  • Enables WCMSA proposals to be submitted electronically for CMS review;
  • Accepts submission documents and supplemental information CMS may request;
  • Provides online status updates for MSA applications;
  • Generates email alerts when approval letters are issued.
• Conditional payment guidelines - CMS released guidelines during 2011 to provide certainty and finality for conditional Medicare payments. This "self-calculated final conditional payment amount" option, will be initiated in February 2012 for claims with a total settlement value of $25,000 or less allowing attorneys and/or claimants to receive a final amount owed number from CMS prior to settlements. For additional information see the Medicare Secondary Payer Recovery Contractor (MSPRC) website.

Minors Settlements - Whether a structured settlement annuity that extends beyond the age of majority is "suitable" for, or in the "best interests" of, a minor (especially a minor without a debilitating injury) represents an important industry issue. In his 2009 presentation to the Society of Settlement Planners (SSP) titled "What Judges Look for When Approving a Minor's Settlement", Texas attorney Phillip McCrury surveyed state minors' statutes and concluded many states require judges to consider the "best interest" of a minor even though very few states directly address structured settlement annuities. Two 2011 cases (only one involving a structured settlement) highlight the potential for conflicting judicial interpretations when annuities are part of a proposed minor's settlement.

• Hancock v. Share - A Florida Appellate Court reversed a Florida Trial Court ruling that denied approval of a proposed structured settlement for a minor. Although the trial court had found that the proposed structured settlement was in the "best interests" of the minor, it refused to approve the structured settlement citing a Florida statute that prohibits a guardian "to bind the assets" of a minor beyond the age of majority.
• In the Matter of Sandra McDuffie - A New York trial court ruled against an estate administrator who proposed to purchase an annuity for a minor child of the decedent stating "the Court cannot authorize the administrator to restrict funds due to an infant after the infant has reached the age of [majority]".

Executive Life Insurance Company of California - In a legal dispute (Aurora S.A. v. Poizner) which it characterized as "another aspect of the dizzyingly complex and heavily litigated failure of the Executive Life Insurance Company", a California Court of Appeals on August 8, 2011 upheld a trial court decision that California's Insurance Commissioner correctly declined to approve the proposed sale of Aurora National Life Assurance Company (Aurora) by Aurora S.A. to Reassure America Life Insurance Company (REALIC), a Swiss Reinsurance subsidiary.

Structured Settlement Annuity Sales - S2KM acknowledges and appreciates receiving market recap reports highlighting quarterly structured settlement annuity sales (Melissa Evola) and weekly financial market data (Richard Nahill).

• Annuity sales - Evola's most recent quarterly compilation of 2011 structured settlement annuity sales (thru September 30) indicates 21,846 cases have been structured for a total premium of $3,633,489,474. These numbers represent a significant decrease from 2010 (also thru September 30) of 23,578 cases and $4,140,704,642 of premium.
• Interest rates - Nahill's most recent 2011 financial market recap (for week ending December 16) shows interest rates of 1.86 percent for 10-year U.S. Treasury bonds compared with 3.30 percent as of December 31, 2010.

For prior S2KM annual reports summaring structured settlement industry developments, see the structured settlement wiki.

Executive Life Timeline

The following Executive Life timeline also appears on the structured settlement wiki where it will be edited and updated.

1935 - Executive Life Insurance Company of New York (ELNY) is incorporated and subsequently (in 1937) licensed as a stock life insurer company in the state of New York.

1961 - Executive Life Insurance Company of California (ELIC) is founded as a subsidiary of First Executive Corporation (FEC). FEC subsequently: 1) becomes a public company and 2) borrows $14.6 million from what is now Citibank to purchase ELNY.

1974 - Fred Carr joins FEC which then has $77 million of assets (355th among U.S. life insurers) of which $22 million represents policy loans. FEC's investment portfolio is $20 million under water. FEC is in default on its $14.6 million Citibank loan. Both the IRS and the New York Insurance Department are investigating ELNY. Touche Ross, FEC's auditors, refuses to express an opinion on its financial statements.

1986 - FEC's zenith. Shareholders' equity is more than $1.5 billion with no debt and total assets of $16.4 billion. The Ivan Boesky scandal erupts and junk bond prices begin to fall.

1987 - The New York Insurance Department disallows a number of reserve credits for ELNY resulting from questionable reinsurance treaties. ELNY admits to violating eight sections of the New York insurance code and agrees to pay a $250,000 fine. ELIC provides ELNY with a $151 million capital infusion requiring FEC to raise additional capital. Joseph Belth, an Indiana University professor and publisher of "Insurance Forum", begins writing negative reports about Executive Life. The mainstream financial press eventually echoes Belth's negative analysis questioning FEC's concentration of junk bonds. FEC and Executive Life complete over $40 billion in junk bond trades with Michael Milken and Drexel Burnam Lambert between 1982 and 1987. Executive Life's competitors promote these negative press reports to convince Executive Life policyholders to surrender their SPDA contracts.

1988 - Carr negotiates a $275 million loan for FEC from a consortium of Japanese banks.

1989 - FEC announces the sale of ELNY. With the Japanese bank loan nearing default, FEC completes a complex rights offering which raises $284 million.

1990 - The ELNY sale falls apart. FEC investors initiate a lawsuit alleging fraud. ELIC and ELNY announce a write down that eventually totals $776 million. A.M. Best's lowers ELIC's and ELNY's ratings from A+ to A. FEC becomes the most shorted stock in the United States during 1990. From July 1989 to the end of 1990, FEC's stock falls from $16 per share to 16 cents per share as its net worth declines to a negative $3 billion.

1991 - FEC loses $1 billion of its investment portfolio. Michael Milken is jailed for securities fraud. Newly elected California Insurance Commissioner John Garamendi obtains a court order seizing control of ELIC. New York's Insurance Commissioner Salvatore Curiale follows with ELNY on April 16. Both companies enter rehabilitation a status which ELNY retains to the present day. FEC files for Chapter 11 bankruptcy. The combined companies strand more than 500,000 policyholders, annuitants, investors, employees and agents. The annuitants include 13,500 structured settlement recipients. Commissioner Garamendi enters into a two-part sales agreement with New California Life Holdings, Inc. (New California) and Altus Finance (Altus), an affiliate of the French Bank Credit Lyonnais, in connection with the ELIC rehabilitation.

1992 - Gary Schulte publishes his book titled "The Fall of First Executive".

1993 - The 1991 ELIC sales agreement and the ELIC rehabilitation plan are modified and then approved by the Los Angeles Superior Court. Under this agreement, Altus pays $3.25 billion and acquires ELIC's $6.4 billion junk bond portfolio. The Altus purchase price includes $300 million of capital for a newly formed company, Aurora National Life Assurance Company, Inc. (Aurora) which assumes ELIC's remaining assets and liabilities including its structured settlement obligations.

1994 - ELIC's former policyholders and structured settlement recipients are given the opportunity to either opt out of the rehabilitation plan and receive the liquidation value of their existing ELIC contracts or opt in to a new restructured contract with Aurora.

1998 - An anonymous whistle-blower alleges that Crédit Lyonnais was the real buyer of ELIC and controls it through secret agreements. Because banks were prohibited from owning U.S. insurance companies in 1993, the California Insurance Department sues Credit Lyonnais and other parties alleging violations of the federal Bank Holding Company Act, the California Insurance Code and other California statutes.

2003 - Credit Lyonnais and some of the other defendants settle with the California Insurance Department for $730.5 million of which $211 million will be distributed to opt out policyholders and payees and $403 million to Aurora to supplement payments for opt in policyholders and payees.

2005 - The California Insurance Department case against the remaining defendants results in a substantial verdict including $700 million of punitive damages.

2007 - New York Governor Eliot Spitzer announces an "agreement in principle" for ELNY designed to continue paying all ELNY annuitants 100% of their benefits. The plan is intended to protect approximately 11,000 ELNY annuity recipients including approximately 8000 structured settlement recipients. The announced plan requires and anticipates future approval by the New York Nassau County State Supreme Court. The announced plan, however, whereby various insurers and guarantee associations apparently agreed to pay $650 to $750 million to fund approximately $2 billion of future ELNY payments, never materializes.

2008 - The U. S. Court of Appeals for the Ninth Circuit reviews the 2005 trial court verdict in the California Insurance Department ELIC case and remands the case for a new trial on the issue of damages. A new trial court date has not yet been set.

2009 - Audited financial statements indicate ELNY has total admitted assets of $984,021,594 compared with total liabilities of $2,516,254,541 as of December 31, 2009.

2010 - A New York State Supreme Court Judge orders the Superintendent of the New York State Insurance Department to present the Court with a proposed order and plan of liquidation for ELNY on or before July 1, 2011 after the Superintendent confers with the Life Insurance Company Guaranty Corporation of New York and other interested parties. The plan is supposed to establish a briefing schedule and provide for notice to all ELNY creditors. Audited financial statements (as of December 31. 2010) show ELNY has assets of $905,945,200 compared with liabilities of $2,474,317,342 resulting in a negative surplus of $1,568,372,142. The California Insurance Commissioners distributes funds received from the 2003 Credit Lyonnais settlement to approximately 27,300 former ELIC policyholders including former ELIC structured settlement recipients (opt outs) who elected to terminate their policies.

2011 - The Superintendent of the New York Insurance Department files a motion to postpone the deadline for filing a proposed order and plan of liquidation for ELNY with the New York State Supreme Court of Nassau County from July 1, 2011 to August 10, 2011 "in order to present a comprehensive and consensual proposed Plan of Liquidation that maximizes the potential benefits for ELNY's structured settlement and other annuitants."

Bing Appointed NYLB Superintendent

New York Governor Andrew Cuomo's recent appointment of Jonathan Bing to serve as Special Deputy Superintendent of the New York Liquidation Bureau (NYLB) could prove a positive development for structured settlement stakeholders in the anticipated liquidation of Executive Life of New York (ELNY).

Bing, who was serving his fifth term in the New York State Assembly, assumed his new position just prior to the June 23, 2011 motion by the Superintendent of the New York Insurance Department to postpone the deadline for filing a proposed order and plan of liquidation for ELNY with the New York State Supreme Court of Nassau County from July 1, 2011 to August 10, 2011 "in order to present a comprehensive and consensual proposed Plan of Liquidation that maximizes the potential benefits for ELNY's structured settlement and other annuitants."

Created in 1909 by the New York State Legislature, the NYLB "carries out the responsibilities of the Superintendent of Insurance as Receiver, and acts on his behalf in the discharging of his statutorily defined duties to protect the interests of the policyholders and creditors of insurance companies that have been declared impaired or insolvent."

Prior to the collapse of First Executive Corporation in 1991, at which time ELNY entered rehabilitation under the supervision of the NYLB, ELNY sold an estimated 8,000 structured settlement annuities. To date, all related ELNY structured settlement payments have been paid in full. However, the most recent financial statements for ELNY (as of December 31. 2010) show assets of $905,945,200 compared with liabilities of $2,474,317,342 resulting in a negative surplus of $1,568,372,142. The 2007 announcement of "an agreement in principle", whereby various insurers and guarantee associations apparently had agreed to pay $650 to $750 million to fund future ELNY payments, has never materialized.

As the NYLB's Special Deputy Superintendent, Bing can be expected to play an important role in any ELNY liquidation. What are Bing's attitudes toward structured settlement recipients and persons with disabilities?

Bing's strong support for, and favorable attitude toward, persons with disabilities (and also therefore, at least potentially, structured settlement victims) are apparent from his responses to a 2008 Questionnaire when he was running for re-election to the New York State Assembly. The questionnaire was compiled and published by the 504 Democratic Club, "The First Democratic Club in the Country Focusing on Disabled Rights". Here are some of Bing's responses:

• "While in office, I have introduced legislation sponsored by 41 colleagues to expand the Disabled Rent Increase Exemption ... for rent regulated tenants and worked closely with the disability community on this issue."
• "This year [2008], I authored legislation ... to create licensing for vision rehabilitation therapists and orientation and mobility specialists."
• "I co-sponsored the law that phased in an increase to $29,000 in the income eligibility for the real property tax exemption for disabled property owners."
• "I have also sponsored legislation to create a New York State housing registry containing up-to-date information regarding accessible housing statewide for people with disabilities, and supported the law which created the Access to Home program to provide financial and technical resources to assist renters and property owners to make dwelling units accessible for low and moderate income persons with disabilities."
• "I was also a co-sponsor of "Timothy's Law," [designed to end health insurance discrimination by enacting parity in coverage for people with biologically-based psychiatric disabilities] which was a significant step to end our health insurance system's second-class treatment of individuals requiring mental health care."
• "In [my] capacity [as the New York Coordinator for the Federal Emergency Management Agency's Disaster Legal Services Program after 9/11], I supervised attorneys responding to disabled New Yorkers with questions concerning housing, employment, health and environment, and a host of other issues."
• "During the two-year process of writing [a substantial 1996 law journal article on the subject of the mentally retarded and capital punishment], I learned much about the plight of mentally retarded defendants in the criminal justice system."
• "In December 1990, I was hospitalized for emergency surgery to repair a detached retina in my left eye....The experience taught me to appreciate the difficulties that people with visual impairments or blindness must face."
• "The first person I hired in my political career was Micah Kellner, a person with a disability who was elected to the Assembly in 2007."
• "With regard to the DRIE legislation discussed above, I have brought together a coalition of advocates for the disabled - including the Coalition for the Homeless, Multiple Sclerosis Society, and the Center for the Independence of the Disabled -- to work to advance this measure as well as prevent bills that would cause harm to the disability community from moving forward in the Assembly."
• "I have supported legislation ... which has passed the Assembly on several occasions that would waive sovereign immunity for New York State for [Americans with Disabilities] violations."
• "Yes" in response to: "Would you oppose proposals which would negatively affect eligibility, benefits, coverage, and/or access to services for Medicaid beneficiaries and eliminate the systemic bias that leads to unwanted placement in nursing homes and other institutions?"
• I am a sponsor of ... legislation that would require the inclusion of [Post Traumatic Stress Disorder] among the list of biologically based mental illnesses that would be covered under Timothy`s Law. I was a sponsor of the 2006 law which ensured that treatment of autism was covered by health insurance."
• "Yes" in response to: "Do you support Medicaid Presumptive Eligibility legislation which would eliminate the standard 45 days coverage gap that blocks access to treatment?"
• "I am a sponsor of ... legislation that would add low-income disabled persons to the list of those eligible for [Elderly Pharmaceutical Insurance Coverage] ."
• "I have also sponsored legislation ... that has passed the Assembly to create a statewide registry of accessible housing for people with disabilities."
• "Yes" in response to: "Do you favor incorporating [provisions Section 504 of the Rehabilitation Act of 1973 requiring housing developers to set aside a certain percentage of accessible units for persons with disabilities when federal funds are used for construction] into State law so that the Department of Housing and Community Renewal can be empowered to enforce these provisions?"
• "I support many efforts to ensure that those with disabilities have access to the voting booth. I am a sponsor of ... legislation which passed the Assembly that would require each New York State polling place to be accessible to physically disabled voters. I have also voted for [legislation] which would require that polling places, whenever practicable, be on a public transportation route, and ... which would provide that ballots be made available in Braille."
• "Yes" in response to: "Will you support a fully funded office of disability services on each SUNY and CUNY campus to assist students with disabilities in securing accommodations?"
• "I will work with schools in my District to ensure that students with disabilities have access to a quality education. I am a sponsor of A. 3496, the "Dignity for All Students Act," that would authorize the State Education Department to establish policies and procedures for affording all public school students an environment free of harassment and discrimination based on their disability."
• "I convinced the New York City Department of Transportation to build a driveway in front of a senior facility in the heart of the Second Avenue Subway construction zone in the East 90s so that the residents would have access to wheelchair-accessible transportation. I have also supported [legislation] to ensure that persons with disabilities have access to gasoline at service stations."
• "Yes" in response to: "Will you support Assembly Member Kellner's proposed bill requiring NYC to transition to a 100% accessible taxi fleet?"
• "Yes" in response to:"Do you support legislation requiring car services, and all shuttle services to purchase wheelchair accessible vehicles or otherwise ensure that they have the capacity to serve persons with disabilities?"

For complete and continuing S2KM reporting about Executive Life of New York, see S2KM's structured settlement wiki.

"The Fall of First Executive"

Twenty years after entering rehabilitation, Executive Life of New York (ELNY) appears on the brink of liquidation with potential future losses resulting to structured settlement stakeholders including defendants and liability insurers who purchased structured settlement annuities as well as structured settlement recipients.

The most recent financial statements for ELNY (as of December 31. 2010) show assets of $905,945,200 compared with liabilities of $2,474,317,342 resulting in a negative surplus of $1,568,372,142.

On December 17, 2010, a New York State Supreme Court Judge ordered the Superintendent of the New York State Insurance Department to present the Court with a proposed order and plan of liquidation for ELNY on or before July 1, 2011. On June 23, 2011, the Superintendent moved to postpone the deadline from July 1 to August 10 "in order to present a comprehensive and consensual proposed Plan of Liquidation that maximizes the potential benefits for ELNY's structured settlement and other annuitants."

Because of the 20 year time lapse since ELNY sold the last of its nearly 8,000 structured settlement annuities many current structured settlement stakeholders have either forgotten or never directly experienced the meteoric rise and fall of First Executive Corporation (FEC) and its two life insurance subsidiaries, Executive Life of California (ELIC) and ELNY (also referred to herein together as "Executive Life")

For persons interested in the background story of the rise and fall of FEC, "The Fall of First Executive", written by Gary Schulte and published in 1992, provides a fascinating and educational history of the events that led to the largest insurance failure in history. Schulte, who served as Marketing Director for Executive Life, provides an insider's account in the immediate aftermath of the FEC and Executive Life debacle.

Schulte's story inevitably features FEC CEO Fred Carr, who first gained a national reputation as a financial "gunslinger" during the 1960 mutual fund "Go-Go" years when his company, the Enterprise Fund, first outperformed the mutual fund industry then tanked in 1968. Carr's subsequent experience with FEC and Executive Life had many parallels to his mutual fund career.

ELIC was founded in 1961 and subsequently borrowed $14.6 million from what is now Citibank to purchase ELNY. Because the New York insurance code is more restrictive than other states, many life insurance companies own separate New York affiliates.

When Carr first joined FEC in 1974, the company was already publicly traded and "a financial mess". FEC had $77 million of assets (355th among U.S. life insurers) of which $22 million represented policy loans. FEC's investment portfolio was $20 million under water. FEC was in default on its $14.6 million Citibank loan. Both the IRS and the New York Insurance Department were investigating ELNY. Touche Ross, FEC's auditors, refused to express an opinion on its financial statements.

At its zenith, under Carr's leadership in 1986-87, FEC had shareholders' equity of more than $1.5 billion, no debt, and total assets of $16.4 billion. The combined assets of the two Executive Life subsidiaries ranked 15th among U.S. life insurers. Both Executive Life companies held ratings of AAA and A+ from Standard & Poor's and A.M. Best's respectively. Executive Life was ranked #1 in employee productivity and sold the highest average per case premium in the life insurance industry.

FEC's stock price reached its all time high in June 1986 at $23 per share. FEC counted among its major shareholders some of the most respected investors in the United States including John Templeton of Templeton Funds (7.3%) and Peter Lynch of Fidelity Securities (11.4%). Here is what analysts had to say during 1986-87:

• "Executive Life's capital structure and, hence, operating leverage are substantially more conservative than virtually all its "AAA" rated counterparts" - Standard & Poor's November 3, 1986;
• "I'd rather have Fred Carr running my company than the people who run General Motors" - Peter Lynch, Magellan Fund, in Barron's, February 2, 1987;
• "First Executive Corportation is one of the strongest life insurers in the United States ... The company's strong financial position is a counter to potential criticisms of investment policy." Johnson, Lane Equity Research Report, February 23, 1987.

By the time it collapsed in 1991, however, FEC had lost $1 billion of its investment portfolio; its market value had declined 99% from $1.5 billion to $15 million; and its net worth had sunk from almost $2 billion to a negative $3 billion.

So what happened to explain this roller coaster ride? On the upside, Schulte attributes FEC's early success to the convergence of four crucial components:

• Superior investment performance - Fred Carr was an early advocate for and investor in "high yield securities" (junk bonds). He formed a strategic relationship with "junk bond king" Michael Milken. By 1987, FEC and Executive Life had accumulated the largest junk bond portfolio in the world. Unlike its competitors, Executive Life initially did not have old investment portfolios or many existing policyholders to service. FEC offered new money rates at a time when interest rates reached historic highs and new money was hot.
• Profitable, competitive, innovative products - FEC specialized in interest sensitive and single premium products. Unlike structured settlements, most of FEC's products, including single premium deferred annuities (SPDA) and guaranteed investment contracts (GICs) were transferable. Offering higher rates than its competitors, Executive Life initially benefited from product transfers (disintermediation) from more conservative life companies.
• National distribution system - Fred Carr entered the life insurance industry when the traditional and expensive captive agency system (agents representing one company) was morphing into an independent agency system (agents representing multiple companies). With virtually no development costs, FEC was able to cherry pick the best agents who had been trained by and had previously represented other companies. The Executive Life companies also sold their products through stockbrokers and offered top producers participation in an agent owned reinsurance company.
• Unlimited capital to fund growth - As one informal quid pro quo for purchasing junk bonds from Milken and his company Drexel Burnham Lambert, Fred Carr had a reciprocal outlet for selling FEC stock. In addition, FEC implemented a series of "innovative" surplus relief reinsurance agreements which initially accelerated FEC's growth.

To explain the downfall of FEC and Executive Life, Schulte highlights both specific developments and more fundamental problems. The specific developments:

• In 1986, the Ivan Boesky scandal erupted and junk bond prices began to fall. Also in 1986:
  • Michael Milken's problems began to surface as junk bonds increasingly were utilized to finance leveraged buyouts, many of which were underfunded. Although Milken, in 1986, was still considered by many "the most influential man in American finance since J.P. Morgan", the "junk bond king" eventually was jailed for securities fraud in 1991.
  • Financial analysts first noted that municipalities were not legally responsible for the performance of GIC-backed bonds. In a matter of months, Executive Life's extensive GIC market dried up.
  • The Tax Reform Act of 1986 restricted the flexibility of withdrawls from two additionally important Executive Life products: SPDAs and interest sensitive whole life insurance.
• In 1987, the New York Insurance Department disallowed a number of reserve credits for ELNY resulting from questionable reinsurance treaties. ELNY admitted to violating eight sections of the New York insurance code and agreed to pay a $250,000 fine. ELIC subsequently provided ELNY with a $151 million capital infusion requiring FEC to raise additional capital.
• Also in 1987, Joseph Belth, an Indiana University professor and publisher of "Insurance Forum", began writing negative reports about Executive Life. The mainstream financial press eventually echoed Belth's negative analysis questioning FEC's concentration of junk bonds. Executive Life's competitors promoted these negative press reports to convince Executive Life policyholders to surrender their SPDA contracts.
• To pay for contract surrenders, FEC was forced to sell junk bonds before their maturity at a loss in a plummeting and thinly traded market. During the first half of 1990 alone, Executive Life experienced $2 billion of SPDA surrenders which Schulte equates to a "run on the bank".
• Although Fred Carr invested in companies that were heavily indebted, he disliked debt and avoided using debt financing for FEC. Nevertheless, as financial pressures increased in 1988, Carr negotiated a $275 million loan for FEC from a consortium of Japanese banks.
• To raise capital in 1989, FEC announced the sale of ELNY but the sale fell apart in January of 1990. With the Japanese bank loan nearing default, FEC did complete a complex rights offering which raised $284 million in 1989 but also resulted in a 1990 investor lawsuit alleging fraud.
• In January 1990, Executive Life announced a write down that eventually totaled $776 million and A.M. Best's lowered Executive Life's ratings from A+ to A. Peter Lynch liquidated Fidelity's investment in FEC the same month after stating to Fred Carr: "Fred, I've been listening to you for an hour and you sound to me like someone who's shorting the FEC stock". In fact, FEC was the most shorted stock in the United States during 1990. From July 1989 to the end of 1990, FEC's stock fell from $16 per share to 16 cents per share as its net worth declined to a negative $3 billion.
• On April 11, 1991, newly elected California Insurance Commissioner John Garamendi obtained a court order seizing control of ELIC. New York's Insurance Commissioner Salvatore Curiale followed with ELNY on April 16. FEC filed for Chapter 11 bankruptcy on May 13. As Schulte points out: FEC was bankrupt when Fred Carr took it over in 1974, and it was bankrupt when he left seventeen years later.

More fundamental problems attributed by Schulte to Fred Carr, FEC and Executive Life:

• In mid-1980s, Executive Life was known for three things and two were bad: competitive, innovative products; junk bonds; and the poorest service to agents and policyholders in the industry.
• FEC and Executive Life overdosed on junk bonds. In a properly constructed portfolio, higher risk of default for high yield bonds may be compensated for by higher returns. Fred Carr, however, never said "no" to Michael Milken. He "bought in" on every Drexel Burnham Lambert junk bond deal. FEC did over $40 billion in trades with Drexel Burnam between 1982 and 1987 and accumulated the largest portfolio of junk bonds in world. Fred Carr underestimated the risks associated with the yields.
• Executive Life was also very aggressive with mortality assumptions reaching too far and promising more than it could deliver. Fred Carr took a short-term period during which exceptional yields were available and extrapolated those yields to long-term products.
• The lack of good operating systems caused serious servicing problems. Schulte characterizes FEC as a "Fortune 500 sole proprietorship". There was no budgeting or internal controls; no pension or profit sharing plan. FEC had an "addictive reliance" on outside consultants. Officers never attended Board meetings. Employee morale was always low. FEC and Executive Life hired young, single, poorly qualified, immigrants. In 1986, turnover in operations at FEC was 106 percent.
• Schulte also highlights how FEC and Carr greatly underestimated the "psychomedia risk". Once Executive Life was caught in the media cross-hairs, a crisis in confidence occurred creating an avalanche of policy surrenders. Of the $19 billion of assets Executive Life held on January 1, 1990, $11 billion were subject to surrender by policy holders.

When FEC and Executive Life collapsed in 1991, the combined companies stranded more than 500,000 policyholders, annuitants, investors, employees and agents. The annuitants included 13,500 structured settlement recipients. Despite payment delays, almost all of the ELIC structured settlement payees eventually received, and continue to receive, their payments in full. ELNY, operating under the control of the New York Liquidation Bureau since 1991, has met all of its structured settlement payment obligations to date despite its deteriorating financial condition.

The ultimate fate of ELNY's structured settlement payees and purchasers remains uncertain pending the results of its anticipated liquidation. As Schulte concludes in his 1992 book: "the proverbial fat lady in the First Executive Opera has yet to sing. Her song could put a different complexion on [the Executive Life story]."

For additional and continuing reporting and analysis about Executive Life, see:

• S2KM's structured settlement wiki;
• Sections 3.05 and 5.04 of "Structured Settlements and Periodic Payment Judgments" (S2P2J).

Joseph Dehner Interview

Joseph Dehner is a partner in the Frost Brown Todd law firm and co-author of "Structured Settlements and Periodic Payment Judgments" (S2P2J). He has been studying and writing about structured settlements since 1977 and agreed to be interviewed for this S2KM blog post.

S2KM: Your Frost Brown Todd biography highlights your expertise in multinational securities and business disputes. How do structured settlements fit into your legal practice?

Dehner: Through some of my clients, I was part of the birth of the structured settlement industry many years ago. It is great to see the structured settlement industry evolve into a robust part of the U.S. economy. I continue to advise attorneys and firms on structured settlement and periodic payment judgment issues. One example was the honor of serving as the U.S. Government’s expert witness in the criminal trial of James Gibson, who besmirched the good names of structured settlements and US Government bond trusts, and is now serving a long prison term.

S2KM: William T. Robinson lll, your Frost Brown Todd partner and President-Elect of the American Bar Association (ABA), was be a featured speaker at the NSSTA 2011 Annual Meeting. In addition to Robinson and yourself, does Frost Brown Todd have other attorneys with structured settlement expertise?

Dehner: We have a large litigation department, but I am the primary person specializing in structured settlement matters within our firm.

S2KM: You and your co-authors have been writing and updating S2P2J since 1986. Who is your target audience and how to you track new developments?

Dehner: Our target audience includes attorneys, as well as structured settlement consultants, judges and funding providers. We review on a monthly basis all reported cases and news reports about structured settlements and periodic payment judgments, and follow information as it flows about case and other developments.

S2KM: Having recently completed S2P2J Release 49, what important legal issues and developments do you see emerging?

Dehner: There is a growing experience of post-settlement issues emerging from a variety of directions – including fights among beneficiaries of holders of structured settlement rights, factoring company fights and disputes arising from Protection Act hearings, tax rulings (e.g., wrongly incarcerated persons can receive tax-free payments, despite prior uncertainty whether they suffered a “physical” injury), rights in bankruptcy, whether structured settlement rights are marital property, and many other issues that are being resolved over time by individual case rulings. The growing use of structured settlements outside the “tax-free” arena represents recognition that settlement is a time to put into place good financial planning.

S2KM: How do structured settlements in the United States differ from structured settlements in other countries?

Dehner: Many countries have more of a safety net philosophy and less of a litigation-driven means of addressing the needs of injured persons. But for common law countries, many have moved well ahead of the USA in insisting that compensation meet needs – meaning that payments should correspond over time to the actual needs of injured persons. So, in the UK, Ireland and elsewhere, we are seeing a conversion from the ancient lump-sum one-time system to what we in the USA would find normal in the workers compensation context. This is a real sea shift in thinking.

S2KM: Are there any lessons or ideas the United States structured settlement industry can gain from other countries?

Dehner: Sure – read Chapter 1 of our book about other country experiences and approaches.

S2KM: How do you view the secondary market? Are structured settlement transfers good or bad for the industry generally - and more specifically for structured settlement recipients?

Dehner: It’s not a question of bad or good. It’s a question of how individuals react in the real world. People who hold structured settlement rights chose to take money over time at one point, and then decide for various reasons to get cash now in exchange for giving up future rights that have greater value overall. But that’s their choice. The reality is that high-pressure tactics, coupled with what would have been viewed as usury and heresy in the Middle Ages, robbed those individuals of a truly fair and efficient secondary market when the factoring industry arose. Protection Acts now exist in 47 states. When you review the reported decisions about transfers of structured settlement rights, virtually every case where a judge wrote an opinion rejects the transfer and recites in pointed language why discount rates and other factors compel denial of a transfer application. Most transfers go through anyway because of no real contest and no real focus by the court on the underlying issues. I would hope that the impact of factoring over time does not dissuade Congress from maintaining favorable government support for structured settlements through a continuation of 104(a)(2) treatment.

S2KM: What factors, in your opinion, have contributed to the recent decline in growth of the structured settlement annuity premium?

Dehner: It’s pretty simple really. Interest rates are so low for so long that structured settlements have not stood out as bargains compared to receiving a lump sum and investing it for potentially greater returns (though the performance of the US equity markets should cause a reasonable observer to think twice).

S2KM: Do you have any thoughts or ideas about how to improve and/or grow the structured settlement industry?

Dehner: Greater focus on its basic point is where to start. Regardless of tax treatment, putting into place a compensation plan that actually aims to match needs with resources makes sense. Although there is no solid statistical evidence to support the concept that recipients of windfalls have nothing left after five years, we all know the realities that confront anyone who obtains a large sum as a first time experience with wealth. Charities, friends and relatives want a piece. It’s easy to spend money sitting in the bank. And then at some point there is nothing left to deal with what in some cases is a lifetime of needs. My favorite structured settlement example was an elderly fellow I represented who was pushed over in a grocery store, broke his hip and ended up in a nursing home that at the time cost about $1100/month. He would have run out of money from his savings in about two years. Instead of getting a small lump sum settlement for what happened, the insurer provided a structured settlement that paid $1400/month for the rest of his life. The cost was minimal, given his age and the magic of actuarial science. He died 15 years later, but never had to worry about his nursing home bills. Keep the focus on this example and what it represents, and the structured settlement industry merits a bright and expanding future.

S2KM: What lessons, if any, do the Spencer v. Hartford and Macomber v. Travelers class action settlements provide for the structured settlement industry?

Dehner: Transparency. As long as underlying economic realities are known and disclosed to those involved, I don’t see an issue. One can argue about Spence and Macomber should ultimately have been decided, but there is an easy solution to the issues that underlay both cases – being up front and clear in documentation and negotiation as to what was going on. When we wrote "Structured Settlements and Periodic Payment Judgments" in 1986 (since updated 49 times), our negotiation chapter talked about how a good structured settlement negotiation should be about how much a claimant would receive when over time. It was not about negotiating an amount first, and then finding out what it would buy. Focusing on what payments will be received when (and the reliability of the financing mechanism) and disclosure of who does what and receives what are consistent with best practices, and should not be subject to later court challenges about what participants earned how much in the process.

S2KM: What impact, if any, would the expanded use of 468B funds in single event tort cases have on structured settlements?

Dehner: It would simplify matters for a defendant, of course, but would require clear IRS or statutory guidance that is missing now. It would give greater leverage to the claimant than exists now, so the defense side understandably is reluctant to embrace the tool generally, and absent clear guidance on the efficacy of single-claimant 468B funds, there is no point in the rhetorical debate that rages about this issue.

S2KM: Assuming federal malpractice reform legislation is enacted, should periodic payment of judgments be included?

Dehner: Of course. Read the recent paper of the Irish judiciary, or the UK Government’s papers that led to widespread use of periodic payment judgments there as a matter of course. Or just think about what the law really accomplishes at its best – matching compensation with actual need. This is not about favoring the defense or plaintiff side of the bar. And it is not about who wins and loses. This is about trying to make sure as well as possible that injured persons receive compensation that meets their needs. If it lowers cost, fine. If it increases cost, fine. I would argue that this is unknowable, but it is obvious to a rational individual that trying to match compensation against need is better than the equivalent of a lottery, where some people lose completely, others win it big, and many get a lump sum that does not last enough to get them through their lifetimes.

S2KM: Are there any opportunities for the structured settlement industry to benefit from proposed changes (including budget decreases) for Medicare, Medicaid and/or Social Security?

Dehner: Yes, and one can expect both further pressures for Medicare and Medicaid reimbursement at settlement time, as well as increasingly sophisticated settlement planning. Our book tries to keep abreast of these rapidly changing areas and how attorneys and other participants in the structured settlement industry can do a good job for their clients (and not make serious mistakes in the process).

S2KM: From an historic legal perspective, what impact have structured settlements and periodic payment judgments had on the U.S. tort system?

Dehner: The rule thought to be enunciated first in England in Fetter v. Beale that an injury should be compensated with a single one-time payment – the lump-sum system – has been met with deviation when it matters most – in workers compensation systems, in vaccine cases, in other applications. And even in England, the lump sum award system is slowly disappearing based on statutory changes. Structured settlements in the US have continued to chip away at lump sum thinking in America. History should show that structured settlements and periodic payment judgments will prove to be a far better alternative to the jackpot theory of litigation. Do we really want injured people to go to courthouse casinos for justice?

SSP and NSSTA 2011 Annual Meetings - 7

Fulfilling the promise to pay future periodic payments has been the primary mission, and a cornerstone for success, of the United States structured settlement industry for more than 30 years.

With the exception of Executive Life Insurance Company of California, which collapsed in 1991 and resulted in some individuals receiving somewhat less than 100% of their payments, all structured settlement recipients, or the factoring companies and/or investors who purchased their payment rights, have to this date received their promised future periodic payments in full.

What happens if and when a structured settlement annuity provider is financially unable to meet its periodic payment obligations?

In the United States, the regulation of insurance and insurer insolvency is governed by state law. Insurance companies are expressly excluded as debtors under the Federal Bankruptcy Code. For structured settlements, however, the Federal Bankruptcy Code could apply if a non-insurance qualified assignee entered bankruptcy.

Most state insurance laws provide for the Commissioner of Insurance of the state where an insurance company is domiciled to:

• Determine that an insurer should be placed in liquidation.
• Petition a state court to enter an order of liquidation.
• Serve as receiver or liquidator when an insurer is placed in liquidation.
• The liquidator's role is to wind up the insurer's business under court supervision.
• In New York, the New York Liquidation Bureau (NYLB) manages insurance company liquidations as well as conservatorships and rehabilitations.

Since 1971, when the National Association of Insurance Commissioners first promulgated the Life and Health Insurance Guaranty Association Model Act (Model Act), state life and health guaranty associations have provided a safety net to protect consumers from some of the risks resulting from the insolvency of a life or health insurance company.

Every state, plus the District of Columbia and Puerto Rico, currently has a life and health guaranty association. All of these guaranty associations are members of the National Organization of Life & Health Insurance Guaranty Associations (NOLHGA).

NOLHGA was founded in 1983 and operates as a not-for-profit corporation. The primary mission of NOLGA and its members, who are separate from but work closely with state insurance regulators, is to ensure that consumers receive (at a minimum) a level of financial protection as prescribed by state statute when a life or health insurance company fails.

Perhaps anticipating the possible insolvency of Executive Life Insurance Company of New York (ELNY), the National Structured Settlement Trade Association (NSSTA) provided a timely and valuable educational discussion about state life and health guaranty associations featuring Thomas Ronce and Craig Ulman during its 2011 Annual Meeting.

In his NSSTA presentation, Ronce explained how the state life and health guaranty structure differs from FDIC protection because of the non-uniform state-based provisions, lack of pre-funding, and the nature of the guaranty itself. Ronce reviewed the history of the guaranty associations and also discussed:

• Guaranty association coverage issues.
• Powers and duties of guaranty associations.
• How assessments are calculated.
• Collections and tax offsets.
• NOLHGA's role generally and in multi-state insolvencies.
• NOLHGA's Insolvency Task Forces.

Ulman focused his discussion of guaranty association coverage on "Issues, Pitfalls and Developments Affecting Structured Settlements". Among the issues:

• Guaranty association coverage limits - with more than half the states providing $250,000 or less.
• Owner-based coverage vs. payee based coverage - with most states providing the later.
• The NAIC Model Act subrogation provisions (enacted in 27 states) which specifically address and impact structured settlements.

As potential pitfalls for structured settlements, Ulman highlighted general and state-specific coverage exclusions as well as timing issues which could determine whether and when a state guaranty statute applies to a structured settlement recipient.

As significant, related developments, Ulman identified several enacted or proposed amendments to state guaranty statutes:

• Replacing owner-based coverage with payee-based coverage.
• Increasing coverage limits from $100,000 to $250,000.
• Adopting subrogation provisions based on § 8.K.(3) of the NAIC Model Act.
• Relaxing or eliminating the prohibition on advertising the availability of Guaranty Association coverage.
• Reducing or eliminating state tax offsets for Guaranty Association assessments.

For additional information about structured settlement annuity company insolvencies and state insurance guaranty associations, see sections 3.05 and 5.04 of "Structured Settlements and Periodic Payment Judgments" (S2P2J).

For S2KM's complete reporting about the SSP and NSSTA 2011 Annual Meetings, see the structured settlement wiki.

SSP and NSSTA 2011 Annual Meetings - 5

One of three fundamental transitions reshaping the structured settlement industry is the change from a singular, illiquid and non-assignable product to multiple products with greater flexibility to address changing needs and circumstances of injury victims. This transition includes the potential of greater product liquidity for traditional structured settlements provided by IRC section 5891 and the state protection statutes.

During their 2011 annual meetings and educational conferences, both the Society of Settlement Planners (SSP) and the National Structured Settlement Trade Association (NSSTA) addressed this structured settlement industry transition.

NSSTA's Legal Committee organized two educational programs featuring secondary market structured settlement issues:

• Peter Vodola, Katherine Scanlon and Amy Ravitz - "Legal Committee Update on Developments in the Law"; and
• Judge Edward Burke and Judge Steven Denton (moderated by Vodola) - "Judicial Perspective" (on structured settlements).

The Legal Committee Update approached "factoring" from the perspective of "what is it and why should we [NSSTA] care?" Their "what is it" segment:

• Introduced NSSTA members to IRC section 5891;
• Highlighted the "best interest" test and disclosure requirements of state protection statutes; and
• Summarized the Ceron v. Henderson case which S2KM previously reported as part of S2KM's "business standards and practices" series.

NSSTA's "why should we care" (about factoring) comments focused upon:

• How factoring companies are "adversely defining" the term "structured settlement" with aggressive television and internet advertising;
• How structured settlement factoring cases have inundated many state court dockets; and
• How NSSTA members should respond to plaintiff attorneys and judges who resist structured settlements because of proliferating factoring transactions.

The theme of NSSTA's "Judicial Perspective", as stated by participating Judge Denton, might have been: "don't presume that judges understand structured settlements". Previously a plaintiff attorney, Judge Denton claimed a familiarity with structured settlements but acknowledged he had never been asked to approve a structured settlement transfer application. Conversely, Judge Burke stated that his structured settlement experience was limited to reviewing and approving transfer applications.

Among his NSSTA comments, Judge Burke identified his "heroes" to include the superior court judges involved in the California Fresno County factoring cases. Judge Burke's judicial praise is both noteworthy and difficult to understand. In Henderson v. Scieteco (one of the Fresno County factoring cases) , a California appellate court subsequently reversed the entire consolidated order from the Fresno County Superior Court because of "multiple prejudicial errors in making its factual findings and in reaching legal conclusions" (emphasis added).

Also in Henderson v. Scieteco, the California appellate court held that public policy supports state court approved structured factoring transactions (emphasis added). NSSTA's Legal Committee representatives failed to mention this case when they discussed "public policy" and factoring during their structured settlement legal update.

Some judges not only understand structured settlements, but also have experience with both primary and secondary market structured settlement cases and publish local court rules for structured settlements. See, for example, Rule 68.2 and Rule 68.3 of the Local Rules for the Hamilton County, Ohio Probate Court.

SSP offered three presentations about non-traditional structured settlement products as part of its educational program segment titled "Practice Improvement: Marketing and New Products",

• Anthony Prieto and Tim Denehy - "The Use of Structured Settlement Annuity Payment Rights";
• Brian Michaels - "Expanded Use of Non-Qualified Assignments"; and
• Rick Miller - "Equity Indexed Annuities and Settlement Planning".

Prieto and Denehy introduced a product called "The Settlement Asset Management Trust (SAM trust) with Enhanced Structured Income (ESI)" which is essentially an irrevocable spendthrift trust generating level monthly income payments for durations of 10-30 years plus access to discretionary distributions.

The ESI component, according to Prieto and Denehy, consists of payment rights previously sold (i.e., transferred or factored) by a structured settlement recipient to a third party purchaser (factoring company) with an approved court order pursuant to a state protection statute. The SAM trust product managers purchase the payment rights from one or more factoring companies and transfer the payment rights to the SAM trust.

According to Prieto and Denehy, the resulting SAM trust can produce a taxable interest rate that is "typically three (3%) percent higher than comparable fixed products with similar guarantees and safety." Their explanation for the enhanced interest rate: the ESI does not have the same high internal costs as a typical annuity during the first few years of the annuity policy.

Although the flow of structured settlement payment rights purchased from various factoring companies is typically uneven, Prieto and Denehy maintain the SAM trustee can consolidate selected payment rights to create an even payment flow to the SAM trust beneficiary who might be an injury victim or a plaintiff attorney.

In addition to an interest rate risk, Prieto and Denehy acknowledge the ESI has an insurance company insolvency risk similar to a traditional structured settlement. According to Prieto and Denehy, however, a typical SAM trust will include between two and ten separate payment rights purchases thereby diversifying the insolvency risk.

Although some secondary market brokers and factoring companies have previously sold "re-cycled" structured settlement payment rights to individuals, Prieto and Denehy believe their product is different because the SAM trust integrates multiple streams of separate payment rights and also includes a cash allocation permitting discretionary distributions.

For additional S2KM reporting about the SSP and NSSTA 2011 Annual Meetings, see the structured settlement wiki.

See "Structured Settlements and Periodic Payment Judgments" (S2P2J) for additional information about:

• Non-qualified (under IRC section 130) assignments and products - Section 3.08A; and
• Judicial review of transfer applications - Section 16.05

SSP and NSSTA 2011 Annual Meetings - 4

One of the notable features of the 2011 educational conferences sponsored by the Society of Settlement Planners (SSP) and the National Structured Settlement Trade Association (NSSTA) was how relatively few speakers focused on traditional structured settlement issues.

Of those who did, some offered external perspectives on structured settlements (attorneys, judges, financial planners, unions). In addition, NSSTA's Legal Committee provided an update on structured settlement legal issues.

Most of the other SSP and NSSTA 2011 educational speakers addressed structured settlements in the context of either:

• Peripheral topics such as: strength of life companies; state guaranty associations; Executive Life of New York (ELNY); internet marketing; certification programs; and the sale of structured settlement payment rights; or
• Settlement planning topics such as: Medicare set-asides (MSAs); special needs trusts (SNTs); 468B qualified settlement funds (QSFs); taxation (income and estate) of damages; lien resolution; non-qualified products; and allocation of medical expenses.

Two SSP presentations were also noteworthy for providing both a general understanding of settlement planning and the role of structured settlements as a core component of settlement planning:

• Kevin Urbatsch and Michele Fuller - "Working with a Special Needs Attorney";
• Jack Meligan - "Dissecting a Settlement Plan".

Urbatsch and Fuller, special needs attorneys and members of the Academy of Special Needs Planners (ASNP), addressed a variety of settlement planning topics:

• What is a settlement plan?
• What types of injury victims require settlement planning?
• What professionals should comprise a settlement planning team?
• What special needs issues should a settlement plan address?
• In addition to Medicare, Medicaid and Social Security, what government programs should a settlement plan consider?
• What benefits do these various government programs provide?
• Why are damage allocations important for settlement planning?
• Who is, and who is not, qualified to make damage allocations?
• What are the disadvantages of, and alternatives to, special needs trusts (SNTs)?
• How does health care reform impact settlement planning, Medicaid and SNTs?
• Why are 468B Qualified Settlement Funds (QSFs) important for settlement planning?

Meligan's discussion focused on a case-specific settlement plan. Meligan's recommended planning considerations included: "better quality of life"; new care facility; medications and therapy; estate planning; whether an SNT is appropriate; and whether a Medicare set-aside (MSA) is necessary. His proposed settlement plan recommended specific products and product and service providers for:

• A structured settlement payable into a SNT.
• An MSA funded in part with a structured settlement.
• Resolution of Medicaid and Medicare liens.
• A Treasury bill money market account.
• A "laddered" certificate of deposit portfolio.
• Investment in silver coins to address inflation.
• A will plus consideration of estate taxes.
• Prescription medications.
• Family evaluation to assist with life style changes.

S2KM comments about structured settlements and settlement planning:

• The future of structured settlements depends upon whether, how, when and by whom structured settlements are integrated into settlement planning.
• Settlement planning requires and deserves greater educational attention - by SSP and NSSTA as well as by special needs attorney associations.
• The SSP discussions led by Urbatsch, Fuller and Meligan provided a good introduction to many settlement planning issues.
• If NSSTA continues to study settlement planning (or settlement consulting), it might be valuable to review and compare:
  • SSP's "Standards of Professional Conduct for Settlement Planners" with NSSTA's "Code of Ethics";
  • SSP's "Registered Settlement Planner" (RSP) certification program with NSSTA's "Certified Structured Settlement Consultant" (CSSC) program;
  • SSP's 2011 educational agenda with NSSTA's 2011 educational agenda.
• New settlement planning standards need to be identified and established. For example: definitions and vocabulary; knowledge requirements; professional planning team composition; roles and responsibilities; individual and integrated work product; product recommendation criteria; licensing and certification; business practices including compensation disclosure, conflicts of interest and informed consent; documentation; and financing products and mechanisms.
• QSFs and structured settlements can improve settlement planning and therefore should be considered in every complex personal injury case.

S2KM comments about Meligan's sample settlement plan:

• At least until someone else presents a personal injury settlement plan featuring structured settlements in an educational forum, Meligan's plan represents the industry standard.
• It would be valuable to study and compare settlement plans developed by different professionals (trustees, special needs attorneys, and financial planners) for the same case example.
• Every settlement plan recommending a structured settlement should:
  • Justify why structured settlements are appropriate (product suitability) and more appropriate than comparable alternatives products - for example: SPIAs and indexed annuities.
  • Include some tax analysis to determine whether "tax-free" products are needed or justified.
  • Justify recommended amounts allocated to purchase structured settlements. Among the most frequent and severe settlement planning criticisms of structured settlements:
    • Single product structured settlement agents have an inherent conflict of interest that should disqualify them from allocating settlement proceeds;
    • Structured settlement agents invariably over-structure cases which limits planning options and increases the likelihood of future factoring transactions.
  • Disclose compensation (including shared compensation) from all recommended products subject to the recipient's informed consent.
  • Reference IRC section 5891 and the applicable state structured settlement protection statute(s).
  • Include a comparison of projected revenues from all sources and projected expenses.

For additional S2KM reporting about:

• SSP and NSSTA 2011 Annual Meetings - see the structured settlement wiki;
• Structured Settlements and Settlement Planning - see this earlier S2KM blog post.

 

SSP and NSSTA 2011 Annual Meetings - 3

Whether and when personal injury settlements are taxable to their recipients represents one of the most important structured settlement legal issues. Both the Society of Settlement Planners (SSP) and the National Structured Settlement Trade Association (NSSTA) featured multiple tax presentations during their 2011 educational conferences.

At the SSP conference, Robert Wood and Jeremy Babener each separately addressed multiple settlement tax issues. Wood discussed: "468B Qualified Settlement Funds" (QSFs) and "Common Settlement Tax Mistakes and How to Fix Them". Babener's SSP presentation addressed three topics:

• Maximizing the medical expense deduction;
• Emotional distress and the medical care exception; and
• Inheritance of personal injury proceeds.

The NSSTA conference also featured a QSF presentation by Martin Jacobson titled "The Ins and Outs of 468B Funds". In addition, NSSTA's Legal Committee Update included a summary of a 2011 tax case, Espinoza v. Commissioner, plus an introduction to IRC Section 5891 as part of a discussion about the secondary structured settlement market.

Wood, who has written both a textbook and a Tax Management portfolio about QSFs, utilized case examples to explain several QSF issues: when is a QSF available; formation of a QSF; who should serve as QSF administrator; what are the QSF administrator's responsibilities; determining QSF income and deductions; information reporting responsibilities; amounts to report and forms to use; reporting of structured settlements; and terminating a QSF.

In his presentation about identifying and fixing settlement tax mistakes, Wood highlighted several issues: the need for professional tax computations; interest is always taxable; punitive damages; attorney fees; tax allocations; miscellaneous itemized deductions; above-the-line deductions; the unclear scope of section 104; sex abuse and wrongful imprisonment cases; the Murphy case; constructive receipt; employment disputes; Form 1099; as well as qualified and non-qualified structured settlements. For related writing by Wood, see the Wood & Porter website as well as S2KM's structured settlement public policy wiki.

Like Wood, Babener is both a prolific writer about settlement tax issues, as evidenced by Babener's website and related commentary appearing on S2KM's structured settlement public policy wiki, and a frequent speaker at educational conferences sponsored by SSP and the National Association of Settlement Purchasers (NASP). Also similar to Wood, Babener's SSP presentation and handouts utilized case examples (as well as tables) to help communicate his analysis. Equally appropriate for their audience, both Wood and Babener emphasized settlement tax planning and incorporated structured settlements into their discussions.

Jacobson's QSF discussion at the NSSTA conference specifically addressed the single claimant issue. Jacobson focused his analysis on the statutory language of IRC 468B, related Treasury Regulation 1.468B-1(c) and related Revenue Procedure 93-34.

• Treasury Regulation 1.468B-1(c) requires and permits a QSF to be "established to resolve or satisfy one or more contested or uncontested claims that have resulted or may result from an event (or related series of events) that has occurred and that has given rise to at least one claim asserting liability ..." (emphasis added).
• Revenue Procedure 93-34 sets forth the rules under which a QSF will be considered a "party to the suit or agreement" for purposes of Section 130 and includes a stipulation that all Section 130 requirements still apply (emphasis added).

Jacobson highlighted the issue of whether Revenue Procedure 93-34 means that constructive receipt and economic benefit apply to single claimant QSF-funded Section 130 Qualified Assignments. For purposes of the single claimant QSF issue, Jacobson identified what he termed "the real questions":

• Does a single claimant have economic benefit of the funds placed in the QSF?
• Does the single claimant have "unqualified availability" of those funds?
• Has IRC Section 130(c) been satisfied?
• Is there going to be an IRS ruling applicable to single claimant QSFs?
• In the continuing absence of such an IRS ruling, Jacobson quoted Robert Wood's recommendation to "avoid the single claimant controversy" by establishing QSFs with multiple claimants.

With deference to Martin Jacobson for his valuable presentation and gratitude that NSSTA's educational programs have begun to address important and controversial industry issues, S2KM suggests these additional "real questions" concerning single claimant QSFs:

• Why haven't any NSSTA or SSP members applied for one or more IRS rulings applicable to single claimant QSFs?
• For example, what constitutes "multiple claimants" for purposes of QSFs - multiple family members as claimants? government liens? a plaintiff attorney's compensation claim?
• Does public policy favor or not favor single claimant QSFs? If not, why not?
• As Jeremy Babener addresses in his important QSF paper, how far has existing federal legislation eroded the applicability of the constructive receipt and economic benefit tax doctrines to structured settlements:
  • Technical and Miscellaneous Revenue Act of 1988 - allowing "secured creditor status"; and
  • Victims of Terrorism Tax Relief Act of 2001 - allowing transfers of payment rights ("factoring") pursuant to state protection statutes.

For additional information about:

• Structured settlement tax issues - see Chapter 2 of "Structured Settlements and Periodic Payment Judgments" (S2P2J);
• Single claimant 468B QSFs - see S2KM's blog post "Single Claimant QSF Update"
• SSP and NSSTA 2011 Annual Meetings - see S2KM's structured settlement wiki.