Annuities and Structured Settlements

An annuity is a contract between a consumer and an insurance company that provides for the repayment of a premium back to its buyer over time. An annuity is a hybrid financial arrangement with characteristics of both an investment and an insurance policy. On the one hand, there is an expectation that the money used to purchase the annuity, which is invested by the insurance company on behalf of its owner, will provide a return that exceeds the original outlay. On the other, it comes with an assurance that there will be a fixed rate or time period of return and sometimes a guarantee against loss of principal.

The concept of annuities dates back to ancient Rome, but the first record of annuities in America comes from the Colonial period. In 1759, a company formed to provide a secure retirement for aging Presbyterian ministers and their families. In 1812, the Pennsylvania Company for Insurance on Lives and Granting Annuities received a charter to sell annuities to the general public.

The current era of annuities began in 1952 when the educators’ retirement fund, TIAA-CREF, first offered a group variable deferred annuity. Annuities today are mostly used as a way to provide for an individual’s retirement, usually on a tax-deferred basis. Americans now own over $1.7 trillion in annuity products.

Structured settlements are linked to annuities because they’re considered an effective way to deliver money to people who need it but also need the disciplined of a monthly or yearly payout. Congress in 1982 passed the Periodic Payment Settlement Tax Act, which established structured settlements as a way to provide long-term financial security to accident victims and their families.

The idea was to replace lump-sum payments awarded to personal injury claimants with periodic payments. The government’s aim was to decrease the number of personal injury award recipients who went through their funds too quickly and were subsequently forced to rely on public assistance. In addition to personal-injury claimants, structured settlements are frequently set up for winners of tobacco lawsuits, for lottery winners and for lawyers and law firms who are owed large sums in fees.

Because annuities can be designed to offer timed payouts, guarantees on principal, as well as investment gains, and were already being offered by insurance companies, they quickly became the preferred vehicle in which to implement structured settlements. To encourage their use, the new law made any interest or capital gains earned on the annuity within a structured settlement tax free.

Why Annuities Are Recommended for Some

The primary reason to own an annuity is security. In addition to ensuring a continuing stream of income, say, during one’s retirement, many annuities are guaranteed for a minimum rate of return, meaning that not only can their principal be protected against loss; their earnings can be, as well. In some cases, by annuitizing the contract, the owner of an annuity can even receive a life-long stream of income, far in excess of his or her original investment.
Annuities also offer predictability. Fixed annuities – ones tied to an unwavering interest rate – are especially attractive to investors who want to know how much money they will have years, or even decades into the future. They generally offer rates superior to money market accounts or certificates of deposit (CDs), and come with similar built-in protections and guarantees.
Conversely, variable annuities – ones tied to rising and falling rates – offer the possibility of returns equal to those achieved via stocks or mutual funds, but with greater flexibility, more protections against loss, and certain tax advantages.

Structured Settlements Utilize Annuities

To fund the financial obligations owed to an injured party, a defendant – or more usually, his or her casualty insurance carrier – will purchase one or more annuities from a life insurance company, or delegate its periodic payment obligations to a third party, which in turn would purchase a qualified funding asset – either an annuity or a government bond.
The payments are then structured, or scheduled. An insurance company agrees to pay the injured individual a predetermined amount of cash for a fixed length of time or for the duration of the life of the claimant, depending upon the particulars of the settlement agreement.
Structured settlements are governed by both federal and state laws and must be closed under court order. The process is highly regulated by the courts. Some states also require the hiring of an attorney as a precondition to acquiring a structured settlement annuity.

Advantages of Structured Settlements

Structured settlements offer advantages to both sides in a personal injury case when damages are awarded. Most important to the plaintiffs is their built-in protection against having settlement funds dissipate too quickly based on bad financial decisions. An injured person who has long-term special needs or loss of income due to an accident will often benefit greatly from having monthly payments to meet daily expenses, as well as periodic lump sum payments with which to purchase medical equipment, modified vehicles, etc.
Minors can benefit from a structured settlement in that their futures can be financially insured to point. Their structured settlements can provide certain payments during childhood, additional disbursements to pay for college, etc.  Defendants enjoy structured settlements because they free them from any future liability claims made by the injured party. Settlements can be purchased at a discount, as the plaintiffs will be earning tax-free gains on the capital used to purchase them.

How to Sell a Structured Settlement

Sometimes those who receive structured settlements wish to claim their cash awards sooner than a payment schedule allows. This typically follows a significant change in someone’s life situation. Financial situations can change, and more money than an incremental monthly income is needed: to pay medical bills, to buy a house, to pay off debts, to fund a college education, etc. In these situations, someone with a structured settlement agreement can negotiate to sell the rights to their future settlement payments. They can sell these rights in whole or in part, although a judge must agree to the terms and the sale before the sale can happen.
Individuals do not negotiate with the owner of the structured settlement (usually an insurance company) but do so with a third party willing to buy all or part of the remaining settlement.  The structured settlement rights holder must provide a legitimate need for the money and calculate the requested payout amount so that the best interests of the seller and any dependents are recognized and upheld.

Bill Fay

Bill Fay is a journalism veteran with a nearly four-decade career in reporting and writing for daily newspapers, magazines and public officials. His focus at Debt.org is on frugal living, veterans' finances, retirement and tax advice. Bill can be reached at bfay@debt.org.

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