Workers' Compensation Newsletter
Allowable Sale of the Proceeds of Structured Settlements
Many people enter into a “structured settlement” as a result of recovery on a legal claim, such as personal injury, medical malpractice, or workers’ compensation. A “structured settlement” takes a lump-sum award and turns it into a series of payments that may last for a specified period of time. This is usually accomplished by the purchase of an “annuity contract.”
Annuity contracts are commonly sold by certain insurance companies. A lump-sum “premium” is paid for a guaranteed stream of future payments. However, the recipient’s circumstances can change, prompting some recipients to sell the rights to the periodic payments for immediate cash.
Sale of the Rights to Structured Settlement Payments
There are numerous entities willing to purchase a stream of payments, whether from a structured settlement or other source, such as lottery winnings. The process usually begins with calculation by the purchaser of the “net present value” of the settlement payments (NPV). NPV is basically the current value of a future payment. For example, if a recipient is entitled to receive $100 ten years from now, that right is worth less than $100 right now, due to inflation and other factors. By applying an accepted “discount” percentage rate, NPV can be calculated.
Purchase options may include:
- Full purchase – the purchaser commonly calculates NPV of the payments and offers a lump sum, usually substantially less than the total initial amount or even the NPV
- Purchase of a specific number of payments – only a specific number of the future payments are purchased at a discounted NPV rate
- Purchase of a portion of each payment – the purchaser acquires only a right to a certain percentage of each payment, with the balance to the original recipient
Legal Procedures Necessary for Sale
Most states have laws that regulate the purchase of the right to structured settlement payments. These laws commonly require, among other things, specific, written disclosures regarding the transaction, such as fees, commissions, and discount rates, and also require court approval prior to the actual sale.
Federal Regulation of Structured Settlements Purchases
As part of the “Victims of Terrorism Relief Act of 2001,” the United States Congress enacted a law applicable to the sale of structured settlements (the Act). The Act requires that all sales, assignments, transfers, or encumbrances (i.e., borrowing money secured by the settlement payments) of structured settlements be approved by a state court. The Act does not mandate the procedure, but requires states to evaluate whether the sale is in the best interests of the seller, taking into account the welfare and support of the seller’s dependents, and violates no federal or state law or court order.
Once the court has determined that the sale qualifies, it must issue a “qualified order” approving the transfer or sale. – In addition, a “model act” intended to regulate such sales, has been adopted by most states.
Effect of Failure to Comply With the Act
If the parties fail to obtain a “qualified order,” the Act imposes on “any person who acquires directly or indirectly structured settlement payment rights in a structured settlement factoring transaction a tax equal to 40 percent of the factoring discount.” The “factoring discount” is an amount equal to the difference between:
- The gross total, undiscounted sum of the payments purchased minus
- The total amount actually paid by the purchaser
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