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A primer on structured settlements

|Written By Julius Melnitzer

Structured settlements are still a minefield for personal injury lawyers not familiar with them. Fortunately, two of Canada''s leading brokers, McKellar Group of Guelph, Ont., and Henderson Struct-ured Settlements Inc., based in Ancaster, Ont., have provided some easy-to-read guidelines. Just a click on the Henderson web site (www.henderson.ca) will ensure prompt and free-of-charge arrival of The User's Guide to Structured Settlements at your doorstep in a few days. The nice thing about the Henderson document is that you can give it to your clients, and they'll probably understand it.

"Clearly, there is a need for literature that is written from the perspective and in the language of the consumer," the guide states. "This guide is intended to service this need."

While the whole guide is a worthwhile read, lawyers will find Chapter 5: How do you negotiate structured settlements? particularly useful. It provides a step-by-step procedural guide to negotiation involving a structure.

The first step, according to the guide, is the identification of the appropriate claim and claimant types. A quick referral back to the third chapter reveals a list of claim types amenable to structured settlements, which include claims involving:

?    more than $50,000;

?    serious bodily injury;

?    fatal injury and dependency;

?    future care costs;

?    future lost income;

?    excess limits;

?    multiple parties;

?    questionable liability or quantum;

?    punitive damages; and

?    first-party claims (accident benefits).

Claimant types amenable to structured settlements include:

?    infants;

?    financially unsophisticated plaintiffs;

?    claimants with reduced life expectancies;

?    plaintiffs at risk for "compensation neurosis"; and

?    claimants with a high marginal rate of income taxation.

Once the claim and the claimant type have been identified, it is important to get in touch with a structure consultant at the earliest opportunity.

"Whether for evaluative or illustrative purposes, early contact allows the consultant to take the necessary preparatory measure," the guide states. "For example, the submission of medical documentation for life impairment ratings."

The third step is determining a point of comparison, which is almost always the lump-sum claim potential. This involves calculating the present value of the future heads of damages being claimed.

Next is the preparation and exchange of offers. This can be approached using either a "top-down" or "ground-up" approach.

A top-down structure offer begins with the present value of the claimant's full lump-sum loss broken down in terms of what will be paid up front and what will be invested in the structure. Plaintiffs generally discount the latter in recognition of the fact that the casualty insurer has no obligation to agree to a structured settlement and should therefore share in the tax benefit that the claimant receives.

"The discount employed, conventionally, has been in the range of 10 to 15 per cent," Henderson says.

A ground-up structure is based on the loss assessed on a periodic basis, rather than on a lump sum. This involves calculating how much needs to be invested in a structure to replace a claimant's periodic loss such as his or her future lost income.

"If this amount is not increased by some percentage factor, the claimant gets merely what he has lost, on a net basis, and the casualty insurer enjoys the full benefit of the tax savings through a significantly lower (relative to a present value calculation) loss payment," the guide states.

"There is no convention associated with the percentage increase that may be applied to this 'ground-up' figure; this is a matter of negotiation."

The fifth step in the process is legal fees, usually addressed with an up-front payment. "While always negotiable, the amount paid usually approximates what would have been paid had the loss been settled by a lump sum," Henderson states.

Things get a little more complicated in Statutory Accident Benefits Schedule cases.

"These cases present unique negotiating challenges with respect to finding agreement on the method of valuation, securing or giving up appropriate discounts, and retaining or relinquishing reversionary interests," McKellar says in a web-posted article called, "The role of structured settlements in SABS claims."

McKellar lists 11 factors that bear on the results of SABS negotiations. These are:

?    valuation method;

?    mortality;

?    reversionary interests;

?    settlement discounts;

?    estate protection for claimants;

?    taxation;

?    administrative expenses;

?    reserving;

?    reinsurance;

?    elimination of risk; and

?    negotiations.

There are two basic methods of valuing SABS claims. The first involves an actuarial calculation to estimate the present value (APV) of future SABS obligations under the policy. The other method is to use structure costs to value future SABS obligations.

APV calculations usually cost a few thousand dollars in actuarial fees, but structure valuation is cost-free. A structure cost also generally produces a lower figure than an APV, partly because life expectancy reductions (impairment ratings) obtained from life insurers are invariably more aggressive than the mortality assumptions used in actuarial

calculation.

"In fact," McKellar says, "many actuarial calculations assume normal life expectancy, notwithstanding that brokers are able to obtain annuity impairment ratings from the life companies."

Generally, SABS benefits cease with the death of the insured. In some first-party settlements, however, an insurer may retain a reversionary interest. If a claimant wishes to extend security to his or her estate, the insurer generally extracts a reduction in the settlement amount. A reversion cannot be created, however, unless the structure provides for some period of guaranteed payments.

SABS payments are tax-free. But if the claimant settles for cash and invests that cash, the income generated will be taxable. A settlement based on a structure, however, allows claimants to receive payments tax-free.

Lawyers negotiating with claimants should keep in mind the advantages an insurer achieves in settling.

To begin with, the insurer avoids the considerable administrative expenses involved in the ongoing administration of SABS claims. "These claims can be particularly labour-intensive, continuing for many years, with some coverages providing payments for as long as a claimant is alive," McKellar says.

Reserves can also be problematic for insurers, especially where benefits are indexed to inflation. With future rates of inflation unknown, setting accurate reserves can be difficult. Under-reserving or over-reserving can have adverse financial implications for insurers.

"Settling the claim whether for cash or a structure crystallizes the casualty insurer's exposure or obligation," McKellar states.

As well, reinsurers can cause difficulties for smaller casualty insurers where SABS claims are not settled. "For example, once the primary insurer's retention is exhausted on a claim, the reinsurer will be anxious to have it resolved, to crystallize its loss," McKellar states.

"If the claim is not settled and the reinsurance commutation clause is triggered, the primary insurer may be responsible for future adverse developments on that claim."

In other words, settlement eliminates risks ? for both sides.

What is frequently overlooked, however, in any type of claim where a structure ensues, is the importance of the settlement documentation.

Generally speaking, settlement documentation includes a combination of the following:

?    minutes of settlement;

?    release;

?    consent judgment;

?    partial satisfaction piece; and

?    certified copy of the annuity contract.

The McKellar Group, however, notes that there are some critical items that must be addressed at the time of settlement to avoid last-minute complications.

McKellar's leaflet, "Tips for negotiating structures" (available at www.mckellar.com), emphasizes the need for mutual agreement between plaintiff and defence about the details of structuring before the settlement is concluded.

"The settlement agreement should clearly include the right of the plaintiff to structure, and specify the amount to be structured," the authors write. "If the amount is not yet known, specify the right to structure 'all or any portion of the settlement funds.'"

McKellar's advice also contains the following caveats:

?    The insurer's consent must be extended as part of any settlement that establishes a structure;

?    It is too late to structure after a plaintiff has received settlement funds, but monies can be held in trust for the plaintiff without jeopardizing the potential for structuring;

?    The life insurer issuing the structure should be mutually acceptable to the plaintiff and the casualty insurer, both of whom seek guaranteed security for the investment;

?    Assignment of the structure, if required, should be clearly delineated. Absolute assignment is available to casualty insurers, offshore insurers, and self-insured who do not want the ongoing liability associated with structures;

?    The defendant's casualty insurer must consent to the assignment;

?    The settlement agreement should stipulate whether the plaintiff or the casualty insurer is responsible for the cost of assignment, usually about $2,000;

?    The requirement of assignment may restrict brokerage options and may result in lower payments or higher costs; and

?    The settlement agreement should be specific about reversion to avoid subsequent disputes. The parties should consider such issues as whether the reversion is full or partial, whether a minimum/maximum structured amount has been specified and whether the casualty insurer must approve the final form of the structure.

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