History for Structured settlementsStructured settlements experienced an explosion in use beginning in the 1980s.[1] The growth is most likely attributable to the favorable federal income tax treatment such settlements receive as a result of the 1982 amendment of the tax code to add § 130.[2] [3] Internal Revenue Code § 130 provides, inter alia, substantial tax incentives to insurance companies that establish “qualified” structured settlements.[4] There are other advantages for the original tort defendant (or casualty insurer) in settling for payments over time, in that they benefit from the time value of money (most demonstrable in the fact that an annuity can be purchased to fund the payment of future periodic payments, and the cost of such annuity is far less than the sum total of all payments to be made over time). Finally, the tort plaintiff also benefits in several ways from a structured settlement, notably in the ability to receive the periodic payments from an annuity that gains investment value over the life of the payments, and the settling plaintiff receives the total payments, including that “inside build-up” value, tax-free.[5]
However, a substantial downside to structured settlements comes from their inherent inflexibility.[6] To take advantage of the tax benefits allotted to defendants who choose to settle cases using structured settlements, the periodic payments must be set up to meet basic requirements [set forth in IRC 130(c)]. Among other things, the payments must be fixed and determinable, and cannot be accelerated, deferred, increased or decreased by the recipient.[7] For many structured settlement recipients, the periodic payment stream is their only asset. Therefore, over time and as recipients’ personal situations change in ways unpredicted at the settlement table, demand for liquidity options rises. To offset the liquidity issue, most structured settlement recipients, as a part of their total settlement, will receive an immediate sum to be invested to meet the needs not best addressed through the use of a structured settlement. Beginning in the late 1980s, a few small financial institutions started to meet this demand and offer new flexibility for structured settlement payees.[8]
[edit] Process
[edit] Pre-2002
Before the enactment of IRC 5891, which became effective on July 1, 2002, some states regulated the transfer of structured settlement payment rights, while others did not. Most states that regulated transfers at this time followed a general pattern, substantially similar to the present day process which is mandated in IRC 5891 (see below for more details of the post-2002 process). However, the majority of the transfers processed from 1988 to 2002 were not court ordered.[9] After negotiating the terms of the transaction (including the payments to be sold and the price to be paid for those payments), a formal purchase contract was executed, effecting an assignment of the subject payments upon closing. Part of this assignment process also included the grant of a security interest in the structured settlement payments, to secure performance of the seller’s obligations. Filing a public lien based on that security agreement created notice of this assignment and interest. The insurance company issuing the structured settlement annuity checks was typically not given actual notice of the transfer, due to antagonism by the insurance industry against factoring and transfer companies. Many annuity issuers were concerned that factoring transactions, which were not contemplated when Congress enacted IRC 130, might upset the tax treatment of qualified assignments. HR 2884 (discussed below) resolved this question for annuity issuers.
[edit] Federal legislation
In 2001, Congress passed HR 2884, signed into law by the President in 2002 and effective July 1, 2002, codified at Internal Revenue Code § 5891.[10] Through a punitive excise tax penalty, this has created the de facto regulatory paradigm for the factoring industry. In essence, to avoid the excise tax penalty, IRC 5891 requires that all structured settlement factoring transactions be approved by a state court, in accordance with a qualified state statute. Qualified state statues must make certain baseline findings, including that the transfer is in the best interest of the seller, taking into account the welfare and support of any dependents. In response, many states enacted statutes regulating structured settlement transfers in accord with this mandate.
[edit] Post-2002
Today, all transfers are completed through a court order process. As of September 6, 2006, 46 states have transfer laws in place regulating the transfer process. Of these, 41 are based in whole or in part on the model state law enacted by NCOIL, the National Conference of Insurance Legislators (or, in cases when the state law predates the model act, they are substantially similar).
Most state transfer laws contain similar provisions, as follows: (1) pre-contract disclosures to be made to the seller concerning the essentials of the transaction; (2) notice to certain interested parties; (3) an admonition to seek professional advice concerning the proposed transfer; and (4) court approval of the transfer, including a finding that it is in the best interest of seller, taking into account the welfare and support of any dependents.
