6th World Congress on Brain Injury
May 6 – 8, 2005
Compensation and Brain Injury: Life Expectancy, Structured Settlements and the Tort System
Presented by Brian Webster
Webster & Associates, Vancouver, BC, Canada
Co-authors: Natalie A. Foley, LL.B., Daniel F. Corrin, LL.B.
- Treating Professionals
- Health Care Workers
The ultimate purpose of damage awards in personal injury cases is to provide fair and adequate compensation, most importantly for the care of seriously injured plaintiffs. Traditionally damages are assessed and paid as a “lump sum” award “once and for all.” The purchase of annuities by or on behalf of defendants for periodic payment of the plaintiff’s award called “structured settlements” has a history in the UK (1989), US (1970s), Canada (1970s) and Australia (1990s). The tax free status of these structured annuities enjoyed elsewhere has recently been legislated in Australia in 2001 with the passing of income tax amendment legislation. Providing rather strict criteria are met, the income portion of such annuities is tax free in all jurisdictions.
The structured settlement option, its advantages and disadvantages, has been debated in tort jurisdictions in Canada, the US and the UK. (See “Structured Settlements in Australia www.structuredsettlement.com.au, Copyright Structured Settlements Australia Pty Ltd.) These countries now have tax rules intended to make the purchase of a structured settlement annuity more attractive. Recently, there has also been movement in the direction of giving courts more authority to order these annuities and in some cases the legislative provisions are mandatory.
The method used to calculate the sum used to purchase the structured settlement annuity is critical to this discussion because the financial implications for the injured party and the defendant or his underwriter are significant. These implications have an enormous impact upon the financial security and quality of life of the injured party.
This paper recommends consideration of structured settlements in traumatic brain injury cases where the structured settlement is able to provide proper compensation to the survivor and will actually meet their needs over the long run.
1. The Traditional Approach – Lump Sum Calculation
Traditionally, the tort systems in the above common law jurisdictions contemplated calculation of a lump sum award. A lump sum is defined as: total calculation of damages, past and present and future, pecuniary and non-pecuniary, representing the plaintiff’s loss resulting from the compensable injury. The payment of a lump sum to the plaintiff represents a final settlement (or judgment) between the parties. The payment of the lump sum ends the defendant’s obligations to the plaintiff. The lump sum is intended to provide compensation for care and other damages, past and future, suffered by the plaintiff for the plaintiff’s life time. This sum, when calculated, may be reduced by a percentage, for example, by the degree of the plaintiff’s contributory negligence.
2. The Structured Settlement Approach
A “structured settlement” is actually a premium paid by the defendant to a life insurance company to purchase an annuity payable to the plaintiff, usually monthly, over a life time. It may not be assigned or commuted (except in some parts of the USA). It may not be varied. When purchased, changes such as balloon payments or annual increases to ameliorate the effects of inflation may be built in.
Two Methods: (Traditional Lump Sum Method, Periodic Payment Assurance Method)
There are essentially two alternative methods which have been considered by the courts to calculate the amount of funds (the “premium”) available for purchase of a structured settlement annuity. One calculation utilizes the same present value calculation which is used to award the traditional lump sum value (ie. the same amount as a traditional judgment). This method utilizes a legislated discount rate and deemed life expectancy. Various quotes are then sought to purchase an annuity to pay monthly or annual amounts as desired with the available (lump sum) premium. While the format of payment may change (i.e. rate of increase, balloon payment or end date), the amounts are determined by the rates and the premium available.
Alternatively, a structured settlement annuity premium can be calculated without reference to the traditional lump-sum method. It can simply be the premium required to purchase the monthly payment agreed upon or ordered by the court. In this method, the traditional lump-sum present value calculation is not required. It is only the periodic payments and their rate of change that matters. The monthly amount required will determine the cost of the premium which will be purchased in the market place.
Example A – Structure the Lump Sum (from The Institute of Structured Settlement Task Force)
This example is based on a seriously -injured person with a life expectancy of 44 years, and assessed expenses of $5,000 per week for the rest of life:
Applying the High Court’s 3% discount rate gives an award for future care of $6,422,500. Investing the entire lump sum in fixed interest investments yielding 5.5% and drawing $5,000 a week results in the lump sum running out after about 30 years, well short of the assumed life expectancy of 44 years.
Example B – Structure the Monthly Amount:
Use the weekly or monthly sum deemed necessary, say $20,000 a month for “life” ($5,000 week), without deemed life expectancy indexed to CPI. Depending on the assumptions made, and particularly in a climate of low interest rates, the cost of purchasing an annuity to provide the same $20,000 per month for life will exceed a lump sum. The estimated premium may be $8,600,000 ($430,000 per $1000 per month income). In this illustration, the cost is 30% more than by the lump sum method.
A. History of Structured Settlements
See “Structured Settlements in Australia” www.structuredsettlement.com.au, Copyright Structured Settlements Australia Pty Ltd.
In most jurisdictions which allow “tax free” structured settlements, these annuities must be: purchased by the defendant from a licensed life insurance company, payable to the plaintiff, not commutable, assignable or variable. They are relatively secure, but inflexible.
C. Tax Advantages
No tax paid on the income portion of the payments. There may be taxes payable if the lump sum were invested in securities.
- Advantages (compared with lump sum)
- Transfer of funding to a mutually accepted third party
- Tax exemption on income earned
- Tailoring of the annuity payments to known needs
- Low risk of losing invested funds
- Certainty, peace of mind, for the injured party
- Prevents dissipation
- Disadvantages (compared with lump sum)
- If there is a variation in future needs, the injured party may either be under-compensated or have extra money which will be difficult to invest or save.
- If long term interest rates are low at the time of purchase, the plaintiff may be under-compensated if the traditional lump sum method is used to calculate the premium for the annuity does not equate with the real cost to purchase actual care.
- Capital expenditures are difficult to plan for.
- Exclusion of future social welfare benefits which are means tested.
- Insurance agents charge 3-5 % or more taken from the gross premium but paid by the insurance company.
- Deficient insurance laws and disclosure rules in many jurisdictions mean injured consumers do not know if they are getting the best deal (hidden commissions).
- In low interest economic climates, there may be a lack of competition among underwriters given unprofitable market conditions. Conversely, if high rates of interest prevail, life insurance companies may demand a discount to be profitable.
- Insolvency risk if the company responsible for making payments fails.
3. Optional and Mandatory Structured Settlements
Structured settlement annuities are optional in Australia. There is some mandatory legislation in the United States, Canada and proposed mandatory provision in the UK.
A. Mandatory Structured Settlements
Mandatory structured settlement legislation allows the court to order payment of periodic payments even if one or more of the parties do not agree.
B. British Columbia (an example)
The Insurance (Motor Vehicle) Act, RSBC 1996 c. 231
55 (1) The court must order that an award for pecuniary damages in a motor vehicle action be paid periodically, on the terms the court considers just,
(a) if the award for pecuniary damages is, after section 25 has been applied, at least $100 000 and the court considers it to be in the best interests of the plaintiff, or
(i) the plaintiff requests that an amount be included in the award to compensate for income tax payable on income from investment of the award, and
(ii) the court considers that the order, that the award be paid periodically, is not contrary to the best interests of the plaintiff.
(2) Despite subsection (1), the court must not make an order under this section
(a) if one or more of the parties in respect of whom the order would be made satisfies the court that those parties do not have sufficient means to fund the order, or
(b) if the court is satisfied that an order to pay the award periodically would have the effect of preventing the plaintiff or another person from obtaining full recovery for damages arising out of the accident.
(3) If the court does not make an order for periodic payments under this section, it may make an award for damages that includes an amount to offset liability for income tax on income from investment of the award.
(The issue of “tax gross-up” is outside the scope of this paper but is the increasing of a traditional lump sum award to ensure it is not depleted due to future income taxes payable.)
C. Methodology (Ontario)
Section 116 of the Courts of Justice Act, R.S.O 1990, c. 43 and
Wilson v. Martinello (1995), 125 D.L.R. (4th) 240 (Ont. CA)
- Determine amount of care
- Apply Life Expectancy and Discount Factor
i. Define Life Expectancy
ii. Define Discount Factor
= lump sum
- Up front expenses and legal fees
- Buy an annuity
This method uses the traditional lump sum to calculate a premium which the plaintiff takes into the market place.
The United States
Various jurisdictions in the United States have structured judgment legislation in one form or another. American courts have seen various constitutional challenges brought by plaintiffs. Some of these challenges have concerned the apparent discrepancy between structures being imposed in certain types of personal injury cases (eg. medical malpractice) and not others. The courts in California and Arizona have found that the plaintiff has no vested right in a particular form of remedy, i.e. a lump sum award. (See American Bank & Trustco v. Community Hospital of Los Gatos-Saritoga Inc., 683 P.2d670 (Cal. 1984) and Smith v. Superior Court, 831 P. 2d1279 (Ariz. APP. Div. 1 1991).
Depending on the economic climate, the balance of lump sum may be inadequate to purchase the original amount of care awarded or alternatively generates an excess. If so, who bears the cost/loss of who receives the excess?
The presumption is that the paramount consideration is the proper care for the injured person.
a) If the original lump sum in inadequate, then add an additional lump sum, a “structured settlement gross-up” or
b) Pay originally contemplated monthly payments for the care and purchase the annuity necessary to secure these payments.
In other words, it will be unlikely, currently, that the sum produced using the traditional method is the correct premium for a structured settlement annuity. Structured settlement annuities cannot be assumed to be “cost-neutral”. (Hardman, infra).
The United Kingdom example
The UK has recently proposed legislation that will provide the Court the power to order payment of certain future losses by way of periodic payments. (The Courts Act of 2003 received Royal Assent on November 20, 2003). This is opposed to the use of a lump sum method to fund those payments.
The amendments to the UK new Court Rules have attempted to address some of the shortcomings of structured annuities by contemplating variation of future payments. However, “variation” of a final award in a personal injury case is not acceptable to private insurers or injured plaintiffs. It is seen as desirable only to government backed payers.
See: “Periodical Payments: A look at the new Rules” by David Marshall, Anthony Gold Solicitors, November 2004; and, “Periodical Payments: A Defendant’s Lawyer’s Perspective” by Michael Hardman of Berrymans Lace Mawer, Liverpool, both presented at the March 7 2005 Damages Working Party Conference “From Lump Sum Periodic Payments and Beyond” for further commentary
5. Currently structured settlements are not cost neutral; they cost more.
Cost neutrality will only be possible when economic assumptions behind annuities are the same as those made by the court in predicting care needs and arriving at a lump sum. Currently (May 2005), it is estimated that direct funding of periodic payments through structured settlements requires 25-30% increase in premiums over the traditional lump sum. This puts pressure on injured plaintiffs to accept a reduced amount if the premium calculated using a traditional lump sum method. Hardman, supra.
6. Beware of Biases in this Debate
Assuming the paramount consideration is fair and adequate compensation for care of the plaintiff, we are concerned that any court ruling or legislation making structured settlements mandatory not be permitted to come at the cost to the proper care of the traumatic brain injury survivor. A structured settlement annuity should be an option for an injured plaintiff, NOT mandatory.
7. Important factors when considering a structured settlement annuity
- Contact and retain an INDEPENDENT, FEE ONLY structured settlement annuity consultant. Most jurisdictions have special accreditation for structured settlement annuity brokers over and above annuity brokers generally.
- Do not accept resolution if the payments do not meet the survivor’s needs.
- Ensure that payments are indexed for inflation (CPI).
- Structured settlements may be a useful tool for the care of traumatic brain injury survivors but must be carefully examined by knowledgeable unbiased experts.
- Structured settlements should remain an option and not be mandatory.