Beyond Structured Settlements

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.

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.

JCT Structured Settlement Estimate

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

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

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

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

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

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

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

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

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

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

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

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

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

Babener additionally pointed out::

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

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