Beyond Structured Settlements

Stressed-Induced Physical Ailments - 1

In a 2010 Tax Notes article, attorney Robert Wood asks: "is physical sickness the new emotional distress?" Recent Tax Court decisions highlight both the tax issues raised by damages for stress-induced physical ailments resulting from physical sickness and the need for careful tax planning when seeking such damages.

S2KM reviewed federal legislative and regulatory tax history related to emotional distress damages as well as recommendations for related legislative changes in a prior blog post. To summarize:

• As the result of a 1996 amendment, section 104(a)(2) now exempts from federal income tax “damages (other than punitive damages) received … on account of personal physical injuries or physical sickness.”
• Section 104(a) now also provides "emotional distress shall not be treated as a physical injury or physical sickness" for purposes of section 104(a) (2).
• However, damages received on account of emotional distress that are attributable to a physical injury or physical sickness are excludable.
• The related legislative history provides that “emotional distress” includes “physical symptoms (e.g., insomnia, headaches, stomach disorders) which may result from such emotional distress.”
• In a private letter ruling issued in 2000 (“the bruise ruling”), the IRS established “the observable bodily harms” standard in a case involving sexual assault and harassment in an employment context: “we believe that direct unwanted or uninvited physical contacts resulting in observable harms such as bruises, cuts, swelling and bleeding are personal physical injuries under section 104(a)(2).”
• Although the 2012 regulations for IRC section 104(a)(2) confirm that damages for emotional distress attributable to a physical injury or physical sickness are excluded from income under section 104(a)(2), they do not provide any explanation to help define “physical” or “physical sickness”.

Some of the most challenging "emotional distress" cases, from a tax perspective, involve damages for stress-induced physical ailments resulting from physical sickness. The U.S. Tax Court has provided guidance for such cases in three recent and related decisions:

• Domeny v. Commissioner, T.C. Memo 2010-9.
• Parkinson v. Commissioner T.C. Memo 2010-142.
• Blackwood v. Commissioner, T.C. Memo, 2012-190.

In an article published July 19, 2012 titled "Recent U.S. Tax Court Decision Highlights Issues Regarding the Tax Treatment of Damages for Stress-Induced Physical Ailments", attorneys Jeremy Babener and Neil Kimmelfield summarize these cases and offer advice for taxpayers seeking damages for stress-induced ailments.

According to their article, the U.S. Tax Court indicated in Domeny and Parkinson "that damages compensating for stress-induced physical ailments may be tax-free where (1) the taxpayer can demonstrate that the damages were actually received on account of those ailments and (2) the physical nature of the ailments was verified by a physician, preferably based on objective medical evidence rather than the taxpayer’s subjective report of symptoms."

In the more recent Blackwood case, however, (where the taxpayer suffered insomnia, migraines, nausea, and pain in her back, shoulder, and neck) Babener and Kimmelfield state: "the taxpayer did not satisfy this standard, highlighting the difficulty of establishing that damages compensating for stress-induced physical ailments are excludable from income."

Based upon these cases, Babener and Kimmelfield conclude:

• Taxpayers seeking damages for stress-induced physical ailments will have difficulty excluding such damages under IRC section 104(a)(2) unless they " (1) obtain a medical diagnosis during the underlying dispute and (2) emphasize diagnosed physical ailments in communications with the defendant..."
• It remains uncertain whether taxpayers who obtain medical diagnoses will receive receive tax-free treatment for stress-induced physical ailments that are less acute what were present in the Domeny (multiple sclerosis) or Parkinson (heart disease) cases.

In an article titled "Tax-free Physical Sickness Recoveries in 2010 and Beyond", written prior to the Tax Court's Blackwood decision, attorney Robert Wood offered the following additional advice based upon his review of the Domeny and Parkinson cases:

1. "The facts matter and your proof of the facts matter. To exclude a payment on account of physical sickness, you need evidence that you really made the claim and that the payer was aware of it, and at least considered the claims in making the payment.
2. "Proving that you were struck isn’t part of physical sickness, but proving that you had demonstrable sickness is. You’ll need evidence of medical care, and evidence that you were claiming the payer caused your condition or caused it to worsen.
3. "The courts and the IRS shouldn’t be put in the position of trying to figure out which payments were for which claims. Spend the time to nail down as much as you can in the settlement agreement. Very frequently the IRS will accept an explicit allocation and will not go behind it.
4. "Be reasonable. If you are allocating which payments are for which claims, do not go overboard. Don’t allocate $10 to wages in an employment dispute. Don’t allocate 90 percent of a recovery in an intentional infliction of emotional distress case to physical injuries or physical sickness.
5. "When there isn’t much of a record of medical expenses and discovery in the litigation, consider what other documents you can collect at settlement time. A letter from the plaintiff’s attorney saying why the physical sickness claims were strong may help. A letter from a treating physician or an expert physician may help. Declarations may be even more persuasive than letters. Prepare what you can at the time of the settlement, or at the latest, at tax return time. Do as much as you can contemporaneously. Don’t wait for an audit to gather those things."

Taxation of Emotional Distress Damages - 1

Some of the most challenging federal income tax issues for settlement planners and their clients involve damages related to emotional distress and, even more specifically, damages compensating for stress-induced physical ailments.

This blog post summarizes federal legislative and regulatory tax history related to emotional distress damages and highlights recommendations for related legislative changes. In a subsequent blog post, S2KM will review articles by Jeremy Babener and Robert Wood analyzing recent related case law and offering their advice to settlement planning stakeholders.

Before enactment of the Small Business Job Protection Act of 1996, IRC section 104(a)(2) exempted from federal income tax payments received from settlements or judgments resulting from claims for personal injuries or sickness.

As the result of the 1996 amendment, however, Section 104(a)(2) now exempts from federal income tax “damages (other than punitive damages) received … on account of personal physical injuries or physical sickness.” Section 104(a) now also provides "emotional distress shall not be treated as a physical injury or physical sickness" for purposes of subsection (2). However, damages received on account of emotional distress that are attributable to a physical injury or physical sickness are excludable. The related legislative history provides that “emotional distress” includes “physical symptoms (e.g., insomnia, headaches, stomach disorders) which may result from such emotional distress.”

Since 1996, there have been many tax cases and many IRS rulings addressing damages for emotional distress. In a private letter ruling issued in 2000 (“the bruise ruling”), the IRS established “the observable bodily harms” standard in a case involving sexual assault and harassment in an employment context: “we believe that direct unwanted or uninvited physical contacts resulting in observable harms such as bruises, cuts, swelling and bleeding are personal physical injuries under section 104(a)(2).”

The United States Treasury did not issue new regulations for IRC section 104(a)(2), to address the 1996 amendments, until proposed regulations were published in 2009. A public hearing followed on February 23, 2010. On January 20, 2012, Treasury published final regulations for IRC section 104(a)(2) which were essentially the same as the 2009 proposed regulations.

Although the 2012 regulations confirm that damages for emotional distress attributable to a physical injury or physical sickness are excluded from income under section 104(a)(2), they do not provide any explanation to help define “physical” or “physical sickness”.

In addition to the tax rules outlined above, recipients of damages related to emotional distress, and their advisers, should also consider the following:

• IRS Form 1099 - When defendants settle cases involving taxable damages, they are required to complete an IRS Form 1099 and send copies to the claimant and the IRS. Most section 104(a)(2) cases, according to Robert Wood in his article "Tax-Free Physical Sickness Recoveries in 2010 and Beyond", have said a Form 1099 means the defendant/payer thought the damages were taxable. Conversely, Wood states, some courts have noted that the failure to issue a Form 1099 does not make a payment tax free.
• IRC Section 6661 - IRC Section 6661 establishes a 25% penalty for “substantial understatement of income tax.” However, according to case law cited in section 2.03 of “Structured Settlements and Periodic Payment Judgments”, (S2P2J) where a taxpayer reasonably relies on the advice of professionals in claiming a tax exclusion for emotional distress damages, the taxpayer may be able to escape application of an accuracy-related penalty - even though the exclusion was not accepted,
• Medical Care Exception - IRC section 104(a) excludes from gross income “damages not in excess of the amount paid for medical care … attributable to emotional distress.” In his article titled "Maximizing the Medical Care Exception to the Tax on Emotional Distress Damages", Jeremy Babener points out: "...when a client plans to receive damages on account of emotional distress, taking advantage of the medical care exception requires deliberate planning." Babener adds, however, "... while excluding damages based on past medical care expenses is relatively straightforward, excluding damages based on future medical care expenses is anything but."

During and/or concurrent with the February 23, 2010 public Treasury hearing related to the section 104 (a)(2) regulations, multiple persons recommended changes to the "physical" requirement added by the 1996 amendments including:

• The National Taxpayer Advocate - The National Taxpayer Advocate (NTA) addresses taxpayer considerations from inside the IRS. In a 2010 report to Congress, NTA representative Nina Olson recommended that section 104(a)(2) exempt non-physical damages, specifically emotional distress, mental anguish, and pain and suffering. To support her recommendation, Olson offered scientific data (that depression and other psychological illnesses included physical elements) and argued that existing tax law conflicts with public policy (the nondiscrimination requirement in the Mental Health Parity and Addiction Equity Act of 2008).
• John McCulloch - During the Treasury hearing, McCulloch proposed that damages received by victims of prolonged sexual abuse or false imprisonment should always be deemed “physical” for purposes of IRC section 104(a)(2) whether or not evidence is available to demonstrate physical injury.
• David Higgins - In a written submission for the Treasury public hearing, Higgins argued that the IRS’ definition of "physical" is inadequate: “direct unwanted or uninvited physical contacts resulting in observable bodily harm such as bruises, cuts, swelling, and bleeding.” Higgins recommended a broader definition, including damages for:
  • A doctor’s misdiagnosis resulting in death or serious injury from delayed or missing treatment;
  • Child neglect resulting in starvation or illness;
  • Rape committed under threat of bodily harm; and
  • Other situations where traditional physical injury torts occur without unwanted or uninvited physical contact or observable bodily harm.

For more detailed information about taxation of structured settlement payments, including emotional distress damages, see Chapter 2 of "Structured Settlements and Periodic Payment Judgments" (S2P2J).

Settlement Planning Market - 1

Following three 2012 settlement planning conferences, what have we learned, and what do we still need to know, before settlement planning can be recognized and analyzed as a business and professional market?

The settlement planning conferences provided:

• Definitions for Settlement Planning - Joseph Tombs, Director of the Registered Settlement Planner (RSP) certification program, defined settlement planning as "a profession helping recipients of settlement proceeds use those proceeds to achieve post-loss goals and transition successfully to post-settlement financial life. Settlement planners represent a blend of several professionals: part tax lawyer, trial lawyer, special needs lawyer, financial planner, annuity specialist, social worker, and medical case worker."
• Descriptions of an Emergent Profession - Several conference speakers described settlement planning as a larger and more complex successor business and profession for structured settlements. For example, Jack Meligan stated: "SSP and its members have been promoting the practice of Settlement Planning as a more comprehensive solution for the financial issues facing personal injury victims and their families, and the profession of Settlement Planning as the next evolutionary step for members of the financial and legal communities that serve these injured Americans."
• Product Introductions and Descriptions - In addition to structured settlement annuities, conference speakers discussed multiple financial and insurance products in the context of settlement planning including: settlement trusts; blended structures; alternative asset management options; market linked CDs; long term care insurance; life insurance; and reinsurance.
• Government Benefit Updates - Integrating financial and insurance products with available government benefits represents one of the most important settlement planning priorities and requires effective interaction among multiple settlement planning participants. The conferences highlighted settlement planning roles for special needs attorneys as well as financial and insurance professionals. In addition, government benefit developments related to settlement planning were discussed including new requirements for liability Medicare Set-Asides (MSAs) and special needs pooled trusts as well as the Patients Protection and Affordable Care Act.
• Tax Law Updates and Improvements - In addition to integrating tort settlement proceeds with government benefits, settlement planning requires careful tax planning and specialized document drafting. The SSP conference featured Robert Wood and Jeremy Babener, who provided tax law tips and updates for settlement planners, as well as David Higgins, who proposed a potential tax law alternative to expand the use of structured settlement annuities in settlement planning.
• Business Standards and Practices Discussions - The SSP's "Standards of Professional Conduct for Settlement Planners" (SSP Standards) represents a significant accomplishment and valuable industry resource.  Professor Carl Pierce, who helped review and draft the SSP Standards, continued his analysis of related settlement planning issues as part of the Risk Settlement Planning Practicum. Karen Meyers, Director NSSTA's Certified Structured Settlement Consultant (CSSC) program, led a discussion about product suitability during the SSP Annual Meeting.

Unanswered Questions

Despite continuing educational progress, however, certain questions about the settlement planning market still need to be prioritized and addressed before settlement planning becomes a recognized business and profession. Among the most fundamental and important:

• What types of settlements comprise the settlement planning market?
• How large is the settlement planning market?
• Is the settlement planning market increasing or decreasing?
• What informational resources exist to help answer these questions?

Towers Watson Updates

Beginning with the last question, S2KM recommends the Towers Watson updates on "U.S. Tort Cost Trends" as a starting point for discussing the settlement planning market. Since 1985, Towers Watson (and its antecedent Towers Perrin) have published 15 such updates with the most recent 2011 update analyzing U.S. tort costs from 2010. Each study:

• Consists of three components: 1) losses paid to third parties; 2) defense costs; and 3) administrative expenses.
• Calculates tort costs resulting from five insured plus uninsured business lines: 1) commercial multi-peril; 2) medical malpractice; 3) product liability; 4) other liability; and 5) commercial auto;
• Excludes: 1) no-fault auto insurance; 2) property coverages; 3) workers compensation; 4) certain extraordinary (one time) costs - example: tobacco litigation.

Highlights from Towers Watson's "2011 Update on U.S. Tort Cost Trends"

• The tort costs in 2010 ($264.6 billion) were the highest in U.S. history and represent a 5.1% increase from $251.8 billion in 2009. Towers Watson estimates the 2010 U.S. tort system cost approximately $857 per person, versus $820 per person in 2009.
• Towers Watson attributes the increase to the April 2010 Deepwater Horizon drilling rig explosion and resulting oil spill in the Gulf of Mexico. Absent the costs from this event, Towers Watson estimates 2010 tort costs would have decreased 2.4% from 2009.
• Since 1984, tort costs as a ratio of U.S. Gross Domestic Product (GDP) have ranged from a low of 1.70% to a high of 2.30% with relatively rapid increases in the ratio during the mid-1980s and early 2000s offset by intermittent and multi-year declines in the ratio.
• Since 1950, even adjusting for inflation, increases in U.S. tort costs have far exceeded U.S. population growth. However, inflation-adjusted tort costs per capita were 16% lower in 2010 than in the peak year of 2004.
• The weak U.S. economy has had a notable impact on commercial auto insurance claims. 2010 tort costs were the lowest since 2000 and 19% lower than 2004.
• Although medical malpractice costs have increased at an average annual rate of 9.7%, versus 7.5% for all other tort costs, since 1975, growth in medical malpractice costs from 2005 to 2010 averaged only 0.3% per year.
• Looking ahead, Towers Watson:
  • Anticipates employee practices litigation to be significant in the future despite the U.S. Supreme Court's 2011 ruling in favor of Wal-Mart in the sexual discrimination and civil rights class action case Wal-Mart Stores Inc. v. Betty Dukes et al.
  • Identifies "fracking" (a natural gas drilling process that extracts natural gas from shale by using water and chemicals which could result in contaminated drinking water) as a new area of litigation where defense costs are beginning to mount.

Up until its 2002 update of "U.S. Tort Cost Trends", Towers Watson also translated annual tort costs into the following cost categories (with 2001 percentages): 1) administrative costs - 21%; 2) defense costs - 14%; 3) plaintiff attorneys -19%; 4) economic loss - 22%; and 5) non-economic loss - 24%.

Note: Towers Watson discontinued this latter portion of its analysis in 2002, according to Russ Sutter, a Tillinghast principal and actuary who directs the Towers Watson study, "primarily because we lack reliable information from plaintiff attorneys". These percentages therefore represent Towers Watson's "best estimate" in 2002.

S2KM assumptions: lacking alternative estimates of tort cost payment categories and percentages, Towers Watson's "best estimate" in 2002 for 2001 U.S. tort costs continues to represent the most reliable annual analysis of U.S. tort dollars paid to claimants and their attorneys.

Applying Towers Watson's percentages for 2001 to the results of Towers Watson's analysis of 2010 U.S. tort costs ($264.6 billion total), produces the following assumptive results: 1) administrative costs - $55.6 billion; 2) defense costs - $37.0 billion; 3) plaintiff attorneys - $50.3 billion; 4) economic loss - $58.2 billion; and 5) non-economic loss - $63.5 billion.

Utilizing both Towers Watson's 2011 update of its "U.S. Tort Cost Trends" plus S2KM's assumptions based upon Towers Watson's additional 2002 "best estimate" for 2001 produces the following assumptive results for 2010:

• Economic loss of $58.2 billion plus non-economic loss of $63.5 billion (both amounts presumably paid to claimants) equals $121.7 billion of tort-related dollars paid to claimants.
• $121.7 billion plus $50.3 billion paid to plaintiff attorneys equals $172 billion of tort-related dollars paid to plaintiffs and their attorneys.

S2KM will reference and utilize these 2010 annual assumptive "tort cost results" in subsequent blog posts while continuing to discuss the settlement planning market. For additional S2KM reporting about settlement planning, see the structured settlement wiki.

Structured Settlements and Settlement Planning

Selected video presentations from the Risk Settlement Planning Practicum are now posted online including Patrick Hindert's "History of Structured Settlements".  The conference, hosted April 13-14, 2012 by the University of Tulsa College of Law and attended by attorneys and law students, is believed to be the first law school conference about settlement planning.

Additional practicum presenters and topics - with online video links when available:

• Richard Risk - Introduction
• Joseph Tombs - Overview of Settlement Planning
• Professor Carl Pierce - Standards of Professional Conduct
• Jack Meligan - Pitfalls in Settlement Planning
• Jeremy Babener - Taxation in Personal Injury Cases
• Mark Popolizio - How Medicare Impacts Settlement Planning

Hindert, Managing Director of The Settlement Services Group (TSSG), primary author of "Beyond Structured Settlements" and co-author of "Structured Settlements and Periodic Payment Judgments" (S2P2J) provided a 75 minute discussion explaining the historical and evolutionary relationship between structured settlements and settlement planning. The discussion featured  diagrams by Timothy Morbach:

• Traditional Structured Settlement Funding
• Structured Settlement History
• Settlement Planning - with Structured Settlement Funding
• Structured Settlement Transfer

Hindert's discussion:

• Portrayed settlement planning as an emergent system with structured settlements as a core component.
• Highlighted increasing complexity and variations within the structured settlement life cycle.
• Emphasized the concomitant need for compliance and accountability to satisfy changing legislative and regulatory requirements.
• Specifically addressed: qualified settlement funds; special needs trusts; structured settlement transfers; and the ELNY liquidation.

SSP 2012 Annual Meeting - 1

The French author and poet Victor Hugo has been translated and quoted as saying: "There is nothing more powerful than an idea whose time has come."

Has the time come for "settlement planning" to be recognized as a powerful idea deserving professional study and status in the United States? Recent conferences, including the Society of Settlement Planners (SSP) 2012 Annual Meeting, suggest that settlement planning is becoming both an important profession and an alternative business model for the structured settlement industry.

As a foundation for professional status, SSP has previously developed the Registered Settlement Planner (RSP) Program and adopted Standards of Professional Conduct. The 2012 Annual Meeting, held April 30 - May 1 in Las Vegas, featured presentations by leading settlement planning practitioners and subject matters experts. In addition, several product providers introduced insurance and financial products to complement the traditional structured settlement annuity.

What is settlement planning? Joseph Tombs, a former SSP President and co-founder of the RSP program, defines settlement planning as "... a profession helping recipients of settlement proceeds use those proceeds to achieve post-loss goals and transition successfully to post-settlement financial life."

What is a settlement planner? The SSP Standards of Professional Conduct define "settlement planner" as "... a representative who provides advice and other services to a person participating in the design, negotiation or implementation of a settlement or satisfaction of judgment for the benefit of a person claiming a legal entitlement to an award of damages or other compensation."

SSP conference Keynote Speaker Michael Ellsberg, author of "The Power of Eye Contact" and "The Education of Millionaires", discussed how to "Invest in Your Own Human Capital".

Settlement Planning Practitioners and Subject Matter Experts and Topics:

• 2011 SSP President Jack Meligan - SSP Accomplishments
• 2012 SSP President Charles Schell - SSP Goals
• Joseph DiGangi - Reinventing the Settlement Industry
• Douglas Shaw - Medicare Liens
• Robert Wood - Tax Update
• Jeremy Babener - Settlement Agreements and IRS Challenges
• Karen Meyers - Suitability Standards
• Patrick Hindert - Settlement Planning Business Models
• David Higgins - Litigation Rollover Accounts
• Jason Lazurus - Liability MSAs
• Frank Maguire - Overcoming Stalled Markets
• Mark Wahlstrom - Market Trends and Challenges
• Daniel Hindert - The ELNY Liquidation
• Richard Risk - History of Settlement Planning
• Dan Alverez - Lien Resolution
• Joseph Tombs - The RSP Program

Settlement Planning Product Providers

• Wesley Cosgriff - Secured Futures Trust
• John Woolway - Vantage Investment Partners
• Robert Noack - Aequitas Capital Management
• Christi Fried - Continental Trust Services
• Paul Hansen - Morgan Stanley Smith Barney
• Major General James W. Comstock (ret.) - Alternative Design Insurance Services
• Anthony Prieto - Synergy Settlement Services
• James Creel - First Capital Surety & Trust Co.
• Robert Burney - Integrity Financial, Inc.
• Mal Deener - Symetra Life Insurance Company (on behalf of Berkshire Hathaway Life Insurance and National Indemnity)

In subsequent blog posts, S2KM will review selected SSP conference topics. For S2KM reporting of prior SSP meetings, see the structured settlement wiki.

Risk Settlement Planning Practicum

Sheltered from the violent storms that unleashed dozens of tornadoes across Oklahoma and the plains states on April 13-14, 2012, the University of Tulsa College of Law hosted the Richard B. Risk Jr. Settlement Planning Practicum which organizers believe was the first time any law school has sponsored a settlement planning educational conference.

Risk, a national authority on structured settlement law and one of the founders of the Society of Settlement Planners (SSP), endowed the settlement planning practicum which is expected to become an annual event for attorneys and law students. Risk invited and introduced the practicum presenters in the following speaking order: Joseph Tombs, Patrick Hindert, Mark Popolizio, Jeremy Babener, Jack Meligan and Professor Carl Pierce.

Joseph Tombs

Tombs, a lawyer, certified financial planner and former SSP President who, working with Risk, helped organize the Registered Settlement Planner (RSP) certification program, addressed "Common Issues Attorneys Face When Settling Cases". As part of his presentation, Tombs contrasted settlement planning and financial planning. One primary difference, according to Tombs, is the relative importance in settlement planning of "dissipation risk". Other differentiating factors identified by Tombs include the importance of: government benefits, medical forecasting and special needs legal issues. Tombs discussed structured settlements as a core settlement planning tool that combines relatively low investment and dissipation risks.

Tombs emphasized the multi-professional skill sets settlement planning requires and described settlement planning as an evolving profession stating: "The more we study and practice settlement planning, the more we realize its complexity and understand its challenges." He offered the following definition for settlement planning: "a profession helping recipients of settlement proceeds use those proceeds to achieve post-loss goals and transition successfully to post-settlement financial life."

Patrick Hindert

In his presentation titled "The History of Structured Settlements", Hindert (co-author of "Structured Settlements and Periodic Payment Judgments" and author of S2KM's blog) provided a visual analysis featuring schematic diagrams to explain how structured settlement has evolved from a claim management tool into a core component of the larger and more complex settlement planning profession - and how competing business models have restricted the growth of the structured settlement annuity market.

Hindert stated key structured settlement stakeholders have succumbed to "path dependence" by failing to strategically study and analyze continuing industry changes. Structured settlement business models and practices that once made sense and represented "industry standards", according to Hindert, have survived despite the eclipse of their justification, benefit and/or better alternatives.

Hindert described settlement planning as an "emergent system" and quoted John McWhorter, a linguist at Columbia University, to help explain the significance for structured settlements:

"Emergent systems [settlement planning] are ones in which many different elements interact. The pattern of interaction then produces a new element [settlement planning] that is greater than the sum of the parts, which then exercises a top-down influence on the constituent elements [including structured settlements]."

To improve and grow the structured settlement market, Hindert recommended more detailed and comprehensive study of alternative structured settlement payment models and life cycles within the broader context of settlement planning as an important and necessary first step.

Mark Popolizio

A nationally recognized legal authority in Medicare Secondary Payer (MSP) compliance and a current board member of the National Alliance of Medicare Set-Aside Professionals (NAMSAP), Popolizio addressed how Medicare impacts settlement planning. Starting with an introductory Medicare road map, he next discussed CMS' reimbursement rights for conditional Medicare payments - who is at risk; what is Medicare's recovery amount; how to challenge conditional payments; how to obtain information; CMS' most recently announced policies and payment options; and recent case law developments.

Popolizio also discussed Medicare set-aside arrangements (MSAs), in the context of both workers compensation and liability cases, as CMS' recommended method for protecting Medicare's future interests under the MSP Act. For liability cases, he began by emphasizing why the key issue is not: "Are liability MSAs required?" Instead, Popolizio reviewed two recent CMS memoranda providing informal information about how CMS looks at liability MSAs. Finally, Popolizio offered his own recommendations (a three-step process) for approaching the liability MSA issue and also reviewed recent related case law.

Jeremy Babener

Babener, a rising star among structured settlement legal and tax experts, offered a comprehensive overview of "Taxation in Personal Injury Cases". He began by outlining sources for tax authority, the variables for tax liability and the character of income. Next, he discussed the exclusion for personal injury damages and explained the language of IRC 104(a)(2) before addressing other damages in personal injury cases - past and future medical expenses; punitive damages; and pre and post-judgment interest.

Babener explained the importance of documentation, including the complaint and the settlement agreement, to maximize the exclusion for personal injury damages. He highlighted specific facts that frequently create problems with the IRS and conversely how to encourage the IRS to respect the documents so as to obtain the preferred tax result. Babener concluded by addressing these additional settlement tax considerations: legal expenses; structured settlements; qualified settlement funds; and transfers of structured settlement payment rights.

Jack Meligan

Meligan, a founder and current President of the SSP, discussed "Pitfalls in Settlement Planning and How to Avoid Malpractice"; offered reasons why personal injury claimants and their attorneys need settlement planning advice from a qualified professional or team of professionals; and reviewed an example of a settlement plan. In addition, Meligan:

• Summarized three cases (Grillo; Lyons; and Spencer) to demonstrate why structured settlements need to be considered and risks associated with certain business behavior;
• Cited statistics from American Bar Association studies to underscore the frequency and risk of malpractice cases against personal injury attorneys;
• Spotlighted danger areas for plaintiff attorneys: MSP compliance; deductability of attorney fees; and documentation of confidentiality clauses; and
• Cautioned plaintiff attorneys against failing to retain an independent settlement advisor; or to advise their clients about all settlement options (including the pros and cons of structured settlements); or to completely document their files as proof of their best practices.

Professor Carl Pierce

Professor Pierce is the W. Allen Separk Distinguished Professor of Law and Director of the Howard Baker, Jr. Center for Public Policy at the University of Tennessee. Among his professional activities, Professor Pierce has served as Reporter for the Tennessee Bar Association Standing Committee on Ethics and Professionalism and as Associate Reporter for the American Bar Association Special Commission on Evaluation of the Rules of Professional Conduct. During 2007-2008, Professor Pierce served as Consultant to the Society of Settlement Planners (SSP) and helped review and draft the SSP's Standards of Professional Conduct for Settlement Planners (SSP Standards).

Professor Pierce provided a summary comparative analysis of both the National Structured Settlement Trade Association (NSSTA) Statement of Ethics and Professional Responsibility (NSSTA Code of Ethics) and the SSP Standards. Despite substantial experience working with litigators, Professor Pierce acknowledged surprise by the degree of hostility between some plaintiff and defense structured settlement consultants. Professor Pierce:

• Observed that all law school graduates need some exposure to structured settlements and settlement planning;
• Suggested that the business collaboration models among insurance companies, plaintiff attorneys and settlement planners could look very different in the future; and
• Recommended that representatives of NSSTA and SSP meet to discuss and compare their respective statements of ethics and standards.

Congratulations to Richard Risk, the University of Tulsa College of Law and the guest speakers who participated in the Settlement Planning Practicum. S2KM understands that Tulsa College of Law will publish a video compilation of the practicum speaker presentations on YouTube.

Spring 2012 Conferences

During the next four weeks, S2KM will attend and review three professional educational conferences addressing structured settlement and settlement planning issues:

• Richard B. Risk Jr. Settlement Planning Practicum
• National Structured Settlement Trade Association (NSSTA) Annual Meeting
• Society of Settlement Planners (SSP) Annual Meeting

Risk Practicum

A national authority on structured settlement law, Richard Risk has endowed a series of annual settlement planning "practicums" at his law school alma mater, The University of Tulsa College of Law. Risk believes the 2012 practicum, scheduled for April 13-14, will represent the first time any law school in the country has formally recognized settlement planning as a topic of legal education. Speakers: Joseph Tombs; Patrick Hindert; Mark Popolizio; Jeremy Babener; Jack Meligan; Carl Pierce.

NSSTA Annual Meeting

NSSTA's Annual Meeting, scheduled for April 25-27 in Washington, D.C., will feature a mixed agenda of business and political meetings; NSSTA "Takes the Hill" meetings with Members of Congress and senior Congressional Staffers; plus an educational program headlined by Senator Max Baucus, Congressman Richard Neal, NOLHGA Chairman Thomas Ronce and President Peter Gallanis, Mike Montemurro of the IRS, a Congressional Chiefs of Staff panel, plus various NSSTA leaders and property & casualty insurance representatives.

SSP Annual Meeting

SSP will host its Annual Meeting April 29-May 1 in Las Vegas. The SSP educational program will feature 27 speakers discussing strategies to improve and grow the settlement planning market. Some of the SSP presentation categories:

• Revitalizing and reinventing structured settlements
• New NAIC annuity regulations
• Insurance, investment and administrative options
• Tax developments, strategies and legislative proposals
• Medicare (MSA) and Medicaid (SNT) updates
• What ELNY means for settlement planners

In addition to these three 2012 conferences, S2KM previously attended and reviewed the Academy of Special Needs Planners (ASNP) 2012 Annual Meeting. For S2KM's complete reporting about professional associations whose members participate in structured settlements and settlement planning, see the structured settlement wiki.

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 Settlement Metrics - 4

A 2011 National Litigation Management study sponsored by the Council on Litigation Management (CLM):

• Identified structured settlement as the "most penetrated external initiative" among 30 litigation-related service areas analyzed based upon interviews with leading litigation management executives;
• Determined that more than 74 percent of the study's participants rated their available litigation management metrics as "Fair" or worse for measuring the effectiveness of their litigation management programs; and
• Concluded that, to be successful, national litigation management service programs must deliver metrics and analytics that justify the quality, performance, and satisfaction levels litigation management executives are seeking.

S2KM addressed structured settlement "quality" metrics and analytics in a prior blog post and highlighted the historic payout performance of structured settlement annuity providers which has been excellent though not perfect. Fulfilling the promise to pay future periodic payments has represented a primary mission of the United States structured settlement industry for more than 30 years.

This blog post addresses structured settlement "performance" metrics and analytics from the perspective of litigation management executives and focuses upon three issues:

• Structured settlement premium;
• Structured settlement "success ratios"; and
• The cost or cost savings structured settlements generate for defendants and liability insurers.

Structured Settlement Premium

Based upon industry input and sources, S2KM estimates the structured settlement industry has produced approximately $124 billion of annuity premium from 1976 to 2010. For the past five years (2006-2010), the total average annual structured settlement annuity premium has been approximately $5.8 billion per year.

To help evaluate these numbers, compare the Annual Studies of United States Tort Costs published by Towers Watson (formerly Towers Perrin) since 1985. These studies:

• Calculate tort costs resulting from five insured plus uninsured business lines: 1) commercial multi-peril; 2) medical malpractice; 3) product liability; 4) other liability; and 5) commercial auto.
• Exclude: 1) no-fault auto insurance; 2) property coverages; 3) workers compensation; 4) certain extraordinary (one time) costs.
• In 2002, Towers Watson also translated overall tort costs for 2001 into the following categories and percentages: 1) administrative costs (21%); 2) defense costs (14%); plaintiff attorneys (19%); economic loss (22%) and non-economic loss (24%). Towers Perrin discontinued this portion of its analysis in 2002. It was "devilishly difficult" according to Russ Sutter, a Towers Watson principal and actuary who directs their annual tort cost studies, "primarily because we lack reliable information from plaintiff attorneys". These percentages therefore represented Tower Watson's "best estimate" in 2002.

Based upon Towers Watson's most recent 2010 Annual Study and utilizing Tower Watson's 2002 "best estimate" of payout percentages, S2KM estimates, that since 2006, more than $160 billion (65%) of United States tort costs annually have represented payments to injury victims and their attorneys.

Structured Settlement "Success Ratios"

In 2007, the National Structured Settlement Trade Association (NSSTA) reported the results of a survey titled "A Study of the Structured Settlement Process Conducted on behalf of the National Structured Settlement Trade Associations".

• The survey was directed by Robert E. Hoyt, the Dudley L. Moore, Jr. Chairman of Insurance at the Terry College of Business at the University of Georgia.
• It consisted of attorneys involved in structured settlements (43 telephone surveys) and structured settlement recipients (1275 telephone and Internet surveys).
• Among the conclusions and estimates: only 7% of personal injury settlements between $75,000 and $200,000 include structured settlements; and only 30% of personal injury settlements above $1 million include structured settlements.

Another perspective for structured settlement "success ratios" is provided by the 2011 report of the Joint Committee on Taxation (JCT) which the House Ways and Means Committee and the Senate Finance Committee use for determining the relative merits of achieving specific public policy goals through tax benefits or direct outlays. This 2011 report (which represents the first time the JCT has ever provided a specific category for structured settlements) estimated the Federal tax revenue loss resulting from structured settlements was "de minimis" - meaning less that $50 million for Fiscal Years 2010-2014 or less than $12.5 million per year. Compare these numbers with S2KM's estimate of 716,500 structured settlement annuities sold between 1976-2010.

Structured Settlement Costs or Cost Savings

Since structured settlements were first introduced in the late 1970s, proponents have highlighted "claims cost savings" as a primary justification for defendants and liability insurers to promote and fund structured settlements.

In a 2011 research paper, Jeremy Babener did not discover much empirical evidence to support this premise. Babener's research, however, did uncovered plenty of historical anecdotal evidence providing industry estimates of defense structured settlement savings which Babener summarized as follows:

• From between 50% and 75% in 1974;
• To between 20% and 40% in 1978; and
• More recently to between 20% and 25%.

Based upon this historic anecdotal evidence, Babener concluded defendants and their liability insurers have proven themselves capable in the past of utilizing three structured settlement strategies to reduce their personal injury settlement costs:

• Negotiating with nominal terms rather than real value;
• Profiting from the purchase of a structured settlement; and/or
• Negotiating to benefit from the tax subsidy.

A prior S2KM blog post examines these three defense strategies in the context of the Spencer v. Hartford class action settlement and questions whether and how many defendants and liability insurers can actually save money promoting and funding structured settlements with current business models and traditional business practices in today's interest rate environment.

Compare the average yields on 30-year U.S. Treasury bonds for two five year time periods:

• 1980 to 1984 - 12.21%
• 2006 to 2010 - 4.47%

The impact of drastically reduced interest rates completely reverses the advantageous leverage defendants and liability insurers previously obtained from negotiating with structured settlements. Assuming good business practices (full disclosure, informed consent and no misrepresentations), how do litigation management executives:

• Expect to save money promoting and funding structured settlements?
• Justify the added claim costs generated by defense attorneys and claims adjustors reviewing structured settlement proposals prior to claimants agreeing to resolve a case with a structured settlement?

Perhaps it is time for litigation management executives to re-think structured settlements including the metrics and analytics they use to define success and measure performance as well as alternative structured settlement business models.

Structured Settlement Metrics - 2

Why should defendants or liability insurers ever agree to settle a personal injury case using a structured settlement?

Although this question may seem counter intuitive to current structured settlement stakeholders, it represented a fundamental issue when structured settlements were introduced in the late 1970s and early 1980s.

The historic sales rationale for defendants and liability insurers to endorse, promote and fund structured settlements:

• Studies show 9 out of 10 lump sum recipients "squander" their entire settlement within five years.
• Structured settlements enable recipients to live free of public benefits.
• Structured settlements reduce claim costs.
• Structured settlements help defendants settle cases that would otherwise go to trial.
• Structured settlements represent good public policy.

Although still marketed by some sales persons, the first two justifications for defendants and liability insurers to promote and fund structured settlements have been exposed as "myths" by Jeremy Babener and David Lillesand respectively. No studies exist that show 9 of 10 lump sum recipients dissipate their lump sums within five years. Worse, frequent use of the pejorative term "squander" in the context of this dissipation study myth attaches an unfair and unwarranted stigma to injury victims. Even assuming injury victims dissipate lump sums, the reasons could be as varied as payment for justifiable expenses with inadequate settlements (compared with actual lost wages, medical expenses and inflation) or pay down strategies to qualify for Medicaid.

The idea that seriously injured structured settlement recipients can survive without public benefits is nonsense - a Tea Party pipe dream. At least prior to health care reform, no insurance company would offer medical insurance at any price for brain damaged babies, serious burn victims, or quadriplegics. Medicaid represents the only medical insurance available for seriously injured (special needs) claimants whether they settle with a lump sum or a structured settlement. As underscored by Lillesand, "without Medicaid, seriously injured accident victims die" because they cannot gain access to our medical system without an insurance card. Completely contrary to this public benefit myth, how best to integrate structured settlements with Medicaid and Medicare represents an increasingly important focus for personal injury settlement planning.

Based upon the above sales rationale, however, most U.S. liability insurers and self-insured defendants have developed structured settlement programs. According to a 2011 "National Litigation Management study" commissioned by the Council on Litigation Management (Litigation Management Study), structured settlement represents the "most penetrated external initiative" among 30 litigation-related service areas analyzed based upon interviews with leading litigation management executives.

Many structured settlement programs endorsed and promoted by liability insurers and self-insured defendants (defense structured settlement programs) share certain common characteristics including:

• Approved lists of annuity providers (life companies).
• Approved "brokers" who also serve as agents for the approved life companies.
• Proactive case identification of "good candidates" for structured settlements.
• "Early involvement" by the defense structured settlement broker.
• Defense broker attendance and participation at negotiations and mediations.
• Structured settlement funding by defendants or their liability insurers utilizing annuity financing ("buy and hold') or qualified assignments.

Some defense structured settlement programs also feature:

• Defense funding utilizing an affiliated annuity provider;
• Commission sharing by the defense broker with the defendant or liability insurer. Note: such commission sharing generally utilizes a life insurance agency affiliated with the defendant or liability insurer and may or may not be disclosed to injury victims, their attorneys, mediators and/or judges.

The National Litigation Management Study also found that "litigation executives are not happy with the metrics and analytics available to them." When asked "how effective are your metrics in measuring the effectiveness of your litigation program", more than 74 percent of the study's participants rated their available metrics as "Fair" or worse. In the words of Mike Saltman, President of Esquire Corporate Solutions: "to be truly successful, national service programs must be able to deliver the very metrics and analytics that participants said they are seeking: quality, performance, and satisfaction levels. These are the metrics that a national service provider must be able to give to its clients in today's environment."

Many defense structured settlement programs do include performance metrics of which the most common are:

• Annuity premium generated by the structured settlement program; and
• Success ratio - the percentage of targeted structured settlement cases that ultimately settle with a structured settlement.
• Note: some defense structured settlement programs also attempt to measure the cost savings resulting from the use of structured settlements.

Why, when and how should defendants or liability insurers ever agree to settle a personal injury case using a structured settlement?

Bottom line: to answer that question and to evaluate the "quality, performance and satisfaction" of their structured settlement programs, defendants and liability insurers should analyze (and perhaps re-think):

• Program justification
  • Structured settlements reduce claims costs.
  • Structured settlements help defendants settle cases that would otherwise go to trial.
  • Structured settlements represent good public policy.
• Program characteristics
• Program metrics
  • Annuity premium generated by the structured settlement program.
  • Structured settlement success ratio.
  • Cost or cost savings.

S2KM will continue to discuss "structured settlement metrics" in subsequent blog posts which also will be featured on the structured settlement wiki.