by John Darer CLU ChFC MSSC CeFT RSP CLTC
A deep dive into just how settlement planners have marketed other people's structured settlement payments as investments, to trial lawyers, their injured clients, conservators, trustees and the Courts, has revealed some pretty scary stuff that should have given judges, lawyers, investors , conservators and guardians ad litem, in my opinion.
California Settlement Planner Declared to the Court That Investing in " In Force" Annuities Would Not Change the Funding Asset
Some settlement planners pitch alternative investments to structured settlements but attempt to characterize them as annuities, perhaps because it is a term familiar to people and the all important judge who must approve a minor's or incompetent's settlement. However this is highly misleading and apes the language used by certain factoring industry predators to peddle such investments.
An internet search uncovered a California settlement planner's Declaration in Support of Petition for Authority to Purchase In-Force Annuities to the Superior Court of the State of California was submitted by a San Francisco law firm representing the Conservator of a disabled person, declared, under penalty of perjury, that "the best alternative I found was not to change the funding asset, but to purchase that asset at a significant discount in the form of '"in-force" annuities". Make no mistake, what the settlement planner declared to the court as annuities are not annuities.
The California settlement planner included a fairly in depth analysis that purports to show, under penalty of perjury, that purportedly "not changing the funding asset" will save money over using a newly issued structured settlement annuities.
Compared to a structured settlement, is "not changing the funding asset" a true statement?
It is notable and significant to observe that the California settlement planner chose to caption the word "in-force" and not annuities in the under penalty of perjury declaration. You will see why that is significant as you read further. The settlement planner repeats this emphasis throughout the settlement planner's under penalty of perjury declaration submitted to the California Superior Court.
The California settlement planner went on to declare, under penalty of perjury:
"In-force" annuities are the byproduct of a structured settlement factoring transaction which is the court ordered transfer of existing future structured settlement payments ( or, more accurately, rights to receive the future periodic structured settlement payments) to a purchaser (or investor). These transactions occur when people who currently receive structured settlement payments find themselves in a position of hardship. The hardship reasons are varied, but include unforeseen medical expenses, the need for improved housing or transportation, and education expenses. The seller must lack viable alternatives to meet these financial needs before a transfer will be authorized by a court.
So the settlement planner undermined the inaccuracy of his under penalty of perjury declaration with the aforementioned follow up statement. There is a change in the funding asset! Let's examine why.
Factored Structured Settlement Payments (Acquired or Assigned Structured Settlement Payment Rights) Are Not Annuities
The California settlement planner was at the time of his declaration, and still is at time of posting, a licensed insurance agent in the State of California. Per California Insurance Code 10509.913 (a) “Annuity” means an annuity that is an insurance product under California law that is individually solicited, regardless of whether or not the product is classified as an individual or group annuity. This definition has been in effect since 2011, preceding the date of the California settlement planner's declaration under penalty of perjury.
Factored structured settlement payment streams are not annuities or insurance products. If you invest in one of these financial instruments, you are not buying an insurance product, you are buying the rights to someone else's structured settlement payments. It's possible that you are out on a limb of an extended branch of a multi-transaction, transaction chain. Regardless of the step, they are often misleadingly marketed to the public as annuities by factoring companies, tertiary market companies and certain settlement planners. On April 6, 2019, the National Association of Insurance Commissioners finalized its Statutory Issue Paper No. 160 which expressly provides that acquired structured settlement income streams are neither annuities or insurance products.
[ Source: NAIC Statutory Issue Paper No. 160 p6 Section 6, footnote which states clearly " This guidance is specific to acquired structured settlement income streams (legal right to receive future payments from a structured settlement) and does not capture accounting and reporting guidance for the acquisition of any insurance product (e.g., life settlement, annuities, etc." ]
Upon information and belief, the California settlement planner often sourced factored structured settlement payment streams from Oregon based Somerset. In November 2016, as part of its announcement suspending sales of the structured settlement derivatives, Somerset said on its website secondarymarketannuties.com:
"When you purchase an SMA that is a Factored Structured Settlement, (FSS) you are purchasing the rights to receive payments from a structured settlement that are funded by an annuity rather than the annuity itself. The entity that issues the annuity (and therefore responsible to make such payments) is usually a highly-rated insurance company. It is important to understand that while the payments are funded by annuities, FSS’s are not annuities" [emphasis added].
The Life and Health Insurance Guaranty Association Model Act introduced in 2018, states unequivocally at Section 3 A (5)(c) This Act shall not provide coverage to a person who acquires rights to receive payments through a structured settlement factoring transaction as defined in IRC 26 USC 5891(c)(3)(A), regardless of whether the transaction occurred before or after such section became effective. The drafting note to the 2018 amendments describes the rationale as follows:
The exclusion from coverage in Section 3A(5)(c) of any person who has purchased from an original structured settlement annuity payee his
or her rights to receive structured settlement annuity benefits and the exclusion of such benefits from covered benefits under Section 3B(2)(n) recognize that the protections afforded by guaranty associations are intended for insurance consumers, such as the original payees of structured settlement annuities. Guaranty association protection does not extend to sophisticated investors who acquire rights to receive structured settlement annuity benefits in the secondary market. These exclusions, however, do not apply to structured settlement annuity benefits that are transferred to children, present or former spouses or other dependents as part of domestic relations settlements or orders, or to other transferees (including donees) who acquire rights to receive structured settlement annuity benefits without providing any monetary consideration. Thus, Section 3A(5)(c) and Section 3B(2)(n) clarify that guaranty association coverage protects structured settlement annuity benefits to which the original payee and his or her family members retain the rights.
And wouldn't it get even more murky if you are acquiring a reassigned structured settlement payment rights down the transaction chain from the originating structured settlement factoring company to another investor, or from an assigned investor to other investors?
"The Only Way to Create a Tax Free Periodic Payment Obligation Funded by "In-force" Annuities is through a 468B Qualified Settlement Fund"
"The only feasible method to create a tax-free periodic payment obligation funded by "in-force" annuities is through the use of a 468B Qualified Settlement Fund (QSF)" declared the California settlement planner under penalty of perjury to the California Superior Court.
(1) The Qualified Funding Asset Question
Critical to the establishment of a structured settlement is a promise to pay future periodic payments in exchange for a release. The future periodic payment obligation is then typically assigned to a qualified assignment company, subject to IRC 130(c) along with funding for the annuity and an assignment fee which are paid to the qualified assignment company. The assignment company takes on the obligations and buys a qualified funding asset, which as set forth in IRC 130(d) can be an annuity or obligations of the United States. Furthermore "qualified funding asset” means any annuity contract issued by a company licensed to do business as an insurance company under the laws of any State
It's seems obvious that a factored structured settlement is not an annuity or a United States Treasury Bond and as a consequence is not a qualified funding asset in the plain reading of IRC 130(d). When structured settlement payment rights are acquired it is only the rights that are transferred not the annuity itself. But it may not seem obvious to the untrained, unwary or those not paying close enough attention if the salesperson is maintaining that it is an annuity, under penalty of perjury. The military have an acronym for it, "SNAFU"
(2) The Qualified Settlement Fund "Shtick"
A qualified settlement fund has been referred to by sales people and others as a "tax-free way station", " a place to "'park' money", by the septic term, " a temporary holding tank", and on a structured settlement annuity company blog "a safe harbor for claimants with unlimited time to resolve their own issues before any form of distribution".
I raise this because in the settlement planner's declaration, that he stated to the California Superior Court that " in order to locate (and purchase) the best " in force" annuities in the most efficient manner possible", he "would recommend that the QSF Administrator be authorized to purchase "in force" annuities...".
The settlement planner's declaration amplified, recommended to the Court that " in order to locate (and purchase) the best " in force" annuities in the most efficient manner possible", he "would recommend that the QSF Administrator be authorized to purchase "in force" annuities that meet certain criteria:
A. The annuities are issued from a life company with a A or better rating from A.M. Best Company
B. The overall annuities are allocated over a minimum of 3 life companies with no more than $1,000,000 per life company;
C. The overall annuities will have a weighted average duration between 10-20 years; and
D. The effective rate of return for the overall purchase of in-force annuities must meet or exceed 4.25%
This part of the settlement planner's declaration conflicts with his statement earlier in the declaration, an admission that what he calls " in force" annuities are a byproduct of a structured settlement factoring transaction.
- Factored structured settlements are not annuities
- Factored structured settlements are not overall annuities
- The settlement planner completely omitted the inherent and sometimes significant transactional risk in the purchase of factored structured settlement payment streams.
- The settlement planner recommends to the court that the QSF Administrator be authorized to buy the factored structured settlement payment streams. How does that impact constructive receipt or economic benefit?
According to the under perjury declaration by the California Settlement Planner, the QSF Administrator was to be authorized to purchase "in force" annuities... which would then be "reinvested" in the claimant's Special Needs Trust at an assumed internal rate of return of 2%.
The qualified settlement fund appears to involve a single disabled individual.
So as articulated in the declaration, the proposed QSF, under this convoluted concept, would act as an intermediary under the auspices of the California Superior Court to buy and hold factored structured settlement payment streams that are labeled annuities but are not annuities? Exactly how would those payments be tax-free as damages?
When a tradition a structured settlement is established in a personal injury settlement, the transaction begins with a promise to pay in a release. This is critical. The promise to pay could be made by the Defendant, the Defendant's Insurer, or in the case of a QSF, the QSF Trustee/Administrator and future periodic payments represent damages that are exempt under IRC 104(a)(2).
Step 2 in establishing a traditional structured settlement would be a qualified assignment, whereby the qualified assignment company assumes the obligation to pay from the defendant, insurer or QSF and purchases a qualified funding asset. Where the damages are taxable, or where they are tax exempt but do not qualify under IRC 130 (such a wrongful imprisonment), a non-qualified assignment is used. Many non-qualified assignment companies are offshore, in Barbados or Ireland. The few that are in the domestic U.S. rely on the use of the immediate annuity exclusion in IRC 72(u), or in two instances, the use of a funding agreement issued by an insurance company, or periodic payment reinsurance where the ceding entity is an insurance company.
Step 3 traditionally involves the purchase of the funding asset by the assignment company to fund its obligation to pay (in this case would be to the Special Needs Trust). Most often the asset is a traditional structured settlement annuity. A real annuity, not a factored payment structured settlement payment stream mislabeled as one.
If there is no assignment, and none is mentioned in the declaration to the Court under penalty of perjury,
- Then is one to presume that the QSF is to stay open until the payment obligation is exhausted? Robert W. Wood, author of the treatise Qualified Settlement Funds and Section 468N opined on June 23, 2014 that (1) QSFs may sometimes be used inappropriately to defer receipt of monies for protracted periods; (2) It seems more likely that the IRS would establish some sort of anti abuse rule addressing the inappropriate use of QSFs to defer income. (3) To be cautious one should try to establish QSFs where there are multiple claimants
- If so, the continued viability of the QSF administrator is and should be an important consideration for the lawyer, judge, guardian or fiduciary.
- Then there is the tax issue related to interest income earned by the QSF while holding the factored structured settlement payment streams. According to 26 § 1.468B-2 Taxation of qualified settlement funds and related administrative requirements, a qualified settlement fund is a United States person and is subject to tax on its modified gross income for any taxable year at a rate equal to the maximum rate in effect for that taxable year under section 1(e).
Why Weren't Transaction Risks of Factored Structured Settlement Payment Streams Mentioned?
The Victims of Terrorism Tax Relief Act of 2001, the now 50 state Structured Settlement Protection Acts and subsequent reforms of those acts were reaction to market conduct. It could be reasonably foreseen that there could be litigation and there has been.
It's a Thing
The California's settlement planner's believed source for factored structured settlement payment streams had investors in the Access Funding lead paint cases where payments were suspended pending the outcome of litigation. Investors in factored payment streams originated by Pinnacle Capital and Sempra Finance face heavy losses in the notorious Barber case where a minor's structured settlement was pillaged starting when he was only 10 year sold. One investor alone may lose in excess of $500,000. In the Wall case, investors lost their entire investment of $153,000 plus legal fees, plus the legal fees of their adversary, Altium Group.
In closing, I recognize that some of the support for the positions taken here post date the date of the California Settlement Planner's declaration, that in of itself is not exculpatory. In 2012, the year the Declaration was submitted to the California Superior Court in the county of San Francisco. In 2012 I wrote "Before recycled structured settlement payment rights become the "Tupperware" of the financial services industry, it is worth making a few points for individual investors" having observed the following recounting by Patrick Hindert from the Evolve QSF Symposium Memphis TN September 27-28 2012.
A Periodic Payment Plan funded with "recycled" structured settlement payment rights, providing promises to pay periodic payments acquired in the secondary market have:
- No tax authority
- No regulatory oversight
- No credit/performance enhancements
- No state ‘guarantee fund’ protection
- No liquidity
- Many risks associated with enforcing and monitoring receivables acquired through structured settlement payment rights ‘transfers’
- An unrated (‘naked’) promise by delegee/obligor (i.e. ‘general unsecured creditor’)
The California settlement planner reads this blog. In January 11, 2012, 4 months before the date of the California settlement planner's declaration, I published Secondary Market for Structured Settlement Payments: Labeling is Questioned.
I encourage lawyers, settlement planners, judges , guardians ad litem and fiduciaries to become fully informed about the risks of investing in factored structured settlement payments streams. Raise a jaundiced eyebrow when you see a salesman in the cloak of a settlement planner try to misdirect you into believing you are investing/buying an annuity. The fact that they are not annuities is very important as is an understanding of the transactional risks. There's clearly more to it than meets the eye. There are probably more than a few plaintiffs who have been sold these instruments and judges who have approved them, without having had complete and full disclosure of all the risks.