Brokers who work with structured settlements need to understand how the settlement documents are put together, because a small drafting mistake can put the claimant’s tax benefits at risk. Here is what happens when an assigned structured settlement is made, and where the paperwork commonly goes wrong.
The two documents in an assigned settlement
An assigned structured settlement rests on two documents:
- Settlement Agreement and Release. It extinguishes the tort liability while creating a new liability of the defendant or insurer to make future payments to the claimant or plaintiff.
- Qualified Assignment. It transfers the liability to make the future payments from the original party (defendant or insurer) to a third party, usually an assignment company affiliated with the life insurance company that will issue the annuity as the funding asset. The annuity is owned by the assignee, not by the defendant or insurer, and certainly not by the plaintiff.
A qualified assignment may also release the original party in case the assignee defaults on the future payments. It may also contain a pledge that lets the claimant secure ownership of the annuity contract if the assignee defaults.
Where to show the consideration
The settlement agreement should list the cash component and the future payments as the consideration for extinguishing the tort claim. It should not list the annuity premium and assignment fee paid to the third-party assignee for assuming the future payment liability.
It is permissible to show that consideration in another section of the settlement agreement, as long as it is clear the money is not being paid directly to the claimant or plaintiff. Usually the agreement contains language permitting the assignment and naming the entity that will assume the future payment liability. Putting the amount paid as consideration in that section should make clear that the money is not going to the claimant or plaintiff.
Often the casualty insurer insists that the total it is spending on the settlement appear in the documents. Sometimes the plaintiff’s counsel wants the amount recorded, since the attorney’s contingency fee is usually based on the total the defense spends, at the time of settlement, for the plaintiff’s benefit.
Whatever the reason, it is acceptable to mention the consideration paid for future benefits, or to name the annuity issuer. But it must be done very carefully, so the essential character of the promise of future payments to the plaintiff is properly described.
Keep the court order consistent
The court order approving the settlement should also treat the present and future payments as the consideration to the minor or incompetent injury victim. Sometimes the order doesn’t list the settlement terms at all, but simply incorporates the settlement agreement by reference and attaches it.
The qualified assignment, which covers only the future payments, is often attached to the order as well. However, it usually isn’t signed by all the parties at the time of settlement, because it must first go to the assignee for acceptance of the future payment liability.
A journal entry of judgment, listing the total amount paid by the defense, is often prepared as a settlement document. That is acceptable as long as it is clear the total is being paid for the benefit of the claimant or plaintiff, and not necessarily all to the plaintiff.
Avoid a second general release
A very common error happens when defense counsel isn’t satisfied with the Settlement Agreement and Release, drafted by a settlement broker from specimen documents long used in the structured settlement industry, and wants the parties to also sign a General Release of All Claims (or a document with a similar title). That document isn’t meant to go to the assignment company, but defense counsel feels it’s needed to protect the casualty insurer.
Unfortunately, such documents usually list the full amount the casualty insurer is paying for the claimant’s benefit as the consideration. That must be avoided if the tax benefits are to be preserved.
A second release causes another problem. Both the Settlement Agreement and Release and the General Release of All Claims usually state that the document represents the entire agreement between the parties. Both can’t be the entire agreement, and that ambiguity clouds the settlement terms.
(This article does not purport to give legal or tax advice.)
