Definition and Historical Background
Structured settlements are uniquely capable of satisfying many of the hard to quantify fundamental human concerns of the catastrophically injured. As such, they can be an integral part of a post-settlement portfolio that helps an injured person to regain financial control of his or her life.
By definition, a structured settlement describes compensation for a personal injury claim where at least part of the settlement is paid over time, rather than with a single lump sum. In lieu of receiving all monies up front, the claimant receives instead a promise from some entity to make future payments according to an agreed upon schedule. These future payments may be scheduled for varying lengths of time—even for the balance of the claimant's lifetime. Further, payments may occur in equal installments and/or in deferred lump sums. The amount of the periodic payment can be fixed or it can vary. Payout schedules may be personalized to accommodate the needs and concerns of a particular claimant.
A structured settlement is not an actual financial product; rather, it is a specific agreement. The defendant may retain the obligation to make the future payments, or, more commonly, it may transfer the obligation to make the future payments by purchasing an annuity contract from a life insurance company. Due to their flexibility for custom-tailoring settlements as well as their pricing, annuity contracts have been the preferred vehicle for financing these future payments.
Historically, settlements and judgments have been paid in one lump sum. The concept of the structured settlement is a rather recent phenomenon. M & P Stores, Inc. v. Taylor is the 1958 case that is commonly identified as establishing the precedent for compensating plaintiffs for damages with a future stream of payments. In that case, the jury awarded periodic payments instead of a single lump sum. It was not until the 1960's, however, that the concept enjoyed a more auspicious debut when substantial claims were filed on behalf of birth defect victims of the drug Thalidomide. The drug company Richardson Merrill, which did not have insurance for the claims, settled cases by agreeing to make a stream of lifetime payments to the victims rather than one up- front lump sum. Merrill secured their obligation to make these future payments with annuities.
The concept did not experience widespread use, however, until the Internal Revenue Service issued a series of revenue rulings in the 1970's. These rulings established that a personal injury claimant could receive a future stream of payments and appreciate the same tax-exempt status afforded lump sum settlements of personal injury claims under Section 104(a)(2) of the Internal Revenue Code, provided certain criteria were met. That is, structured settlement payments are received free from Federal income taxation. In contrast, even though a lump sum settlement is received income tax fee, when invested, it generally would produce taxable income.
The Periodic Payment Act of 1982 provided statutory certainty to these administrative rulings. Furthermore, even in the current outcry for tort reform, the cornerstone of the structured settlement concept remains firmly entrenched in the minds of our legislators. In an Act signed by the President in August of 1996, which codified the "Origin of the Claim Test," Congress made clear its intent to continue to afford this favorable tax treatment to personal injury claimants.
As the concept has continued to prove its mettle as a means of meeting fundamental human concerns of the catastrophically injured, and as the necessary rules and laws have continued to be codified, the structured settlement industry has grown—but it has not even come close to capturing its potential.
It is important to consider that the settlement annuity is only part (albeit a significant part) of a well-considered settlement portfolio that provides future income as well as capital growth, security, and liquidity.