An annuity is a contract between you and an insurance company, under which you make a lump-sum payment or series
of payments. In return, the insurer agrees to make periodic payments to you beginning immediately or at some future date.
Annuities typically offer tax-deferred growth of earnings and may include a death benefit that will pay your beneficiary a
guaranteed minimum amount, such as your total purchase payments.
There are generally two types of annuities—fixed and variable. In a fixed annuity, the insurance company
guarantees that you will earn a minimum rate of interest during the time that your account is growing. The insurance company
also guarantees that the periodic payments will be a guaranteed amount per dollar in your account. These periodic payments
may last for a definite period, such as 20 years, or an indefinite period, such as your lifetime or the lifetime of you and
What is a Structured
Structured Settlements are an innovative method of compensating injury victims. Endorsed by the US Congress since 1982,
a structured settlement is a completely voluntary agreement between the injured victim and the defendant. Under a structured
settlement, an injured victim doesn't receive compensation for his or her injuries in one lump sum. They will receive a stream
of tax-free payments tailored to meet future medical expenses and basic living needs. A structured settlement may be agreed
to privately (for example, in a pre-trial settlement) or it may be required by a court order, which often happens in judgments
involving minors and incapacitated adults.
Structured Settlements in the United States
The United States has enacted structured settlement laws and regulations
at both the federal and state levels. Federal structured settlement laws include sections of the Federal Internal Revenue
Code. State structured settlement laws include structured settlement protection statutes and periodic payment of judgment
statutes. Medicaid and Medicare laws and regulations impact structured settlements. To preserve a claimant’s Medicare
and Medicaid benefits, structured settlement payments may be incorporated into “Medicare Set Aside Arrangements”
the “Special Needs Trusts”.
A personal injury occurs when a person has suffered some form of injury, either physical or psychological, as the result
of an accident.
The most common type
of personal injury claims are road traffic accidents, accidents at work, highway tripping accidents, assault claims, accidents
in the home, and holiday accidents. Indeed, there are a multitude of types of accident and the term personal injury also incorporates
medical and dental accidents (which lead to numerous medical and dental negligence claims every year) and conditions which
are often classified as industrial disease cases. Industrial disease type cases include asbestosis and mesothelioma, chest
diseases (e.g. emphysema, pneumoconiosis, silicosis, chronic bronchitis, asthma, chronic obstructive pulmonary disease, and
chronic obstructive airways disease), vibration white finger, occupational deafness, occupational stress, contact dermititus,
and repetitive strain injury cases.
Where the accident was the fault of someone else, the injured party may be entitled to monetary compensation from the person
whose negligent conduct caused the injury compensation. At least in the United States this system is controversial with critics
calling for various forms of tort reform.
Structured settlements experienced an explosion in use beginning in the 1980s. 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.  Internal Revenue Code § 130 provides, inter alia, substantial tax incentives to insurance
companies that establish “qualified” structured settlements. 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.
However, a substantial downside to structured settlements comes from their inherent inflexibility. 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. 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.
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. 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.
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. 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.
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
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.
Best Interest Standard
Internal Revenue Code
Sec. 5891 and most state laws require that a court find that a proposed settlement factoring transaction be in the best interest
of the seller, taking into account the welfare and support of any dependents.  “Best interest” is generally
not defined, which gives judges flexibility to make a subjective determination on a case-by-case basis. Some state laws may
require that the judge look at factors such as the “purpose of the intended use of the funds,” the payee’s
mental and physical capacity, and the seller’s potential need for future medical treatment.  . One Minnesota
court described the “best interest standard” as a determination involving “a global consideration of the
facts, circumstances, and means of support available to the payee and his or her dependents.” 
Courts have consistently found that the “best
interest standard” is not limited to financial hardship cases.  Hence, a transfer may be in a seller’s best
interest because it allows him to take advantage of an opportunity (i.e., buy a new home, start a business, attend college,
etc.) or to avoid disaster (i.e., pay for a family member’s unexpected medical care, pay off mounting debt, etc.). For
example, a New Jersey court found that a transaction was in a seller’s best interest where the funds were used to “pay
off bills…and to buy a home and get married.” 
Although sometimes criticized for being vague, the best interest standard’s lack of precise definition allows
considerable latitude in judicial review. Courts can consider on a case-by-case basis the totality of the circumstances surrounding
the transfer to determine whether it should be approved.
In the beginning, the factoring industry had some relatively high discount rates due to heavy expenses caused
by costly litigation battles and limited access to traditional investors. However, once state and federal legislation was
enacted, the industry’s interest rates decreased dramatically.
There is much confusion with the terminology
“discount rate” because the term is used in different ways. The discount rate referred to in a factoring transaction
is similar to an interest rate associated with home loans, credit cards and car loans where the interest rate is applied to
the payment stream itself. In a factoring transaction, the factoring company knows the payment stream they are going to purchase
and applies an interest rate to the payment stream itself and solves for the funding amount, as though it was a loan. Discount
rates from factoring companies to consumers can range anywhere between under 9% up to over 18% but usually average somewhere
in the middle. Factoring discount rates can be a bit higher when compared to home loan interest rates, due to the fact the
factoring transactions are more of a boutique product for investors opposed to the mainstream collateralized mortgage transactions.
One common mistake in calculating the discount rate is to use “elementary school math” where you take
the funding/loan amount and divide it by the total price of all the payments being purchased. Because this method disregards
the concept of time (and the time value of money), the resulting percentage is useless. For example, the court in In Re Henderson
Receivables Origination v. Campos noted an annual discount rate of 16.8% where the annuitant received $36,500 for the assignment
of payments totaling $63,364.94 over 84 months (two monthly payments of $672.32 each, beginning September 30, 2006 and ending
on October 31, 2006; eighty-two monthly payments of $692.49 each, increasing 3% every twelve months, beginning on November
30, 2006 and ending on August 31, 2013). However, had the court in Henderson Receivables Origination applied the illogical
formula of discounting from “elementary school math” ($36,500/ $63,364.94), the discount rate would have been
an astronomical (and nonsensical) 61%. 
Discounted Present Value
Another term commonly used in factoring transactions is “discounted present value,” which is defined
in the NCOIL model transfer act as “the present value of future payments determined by discounting such payments to
the present using the most recently published Applicable Federal Rate for determining the present value of an annuity, as
issued by the United States Internal Revenue Service.”  The IRS discount rate, also known as the Applicable Federal
Rate (AFR), is used to determine the charitable deduction for many types of planned gifts, such as charitable remainder trusts
and gift annuities. The rate is the annual rate of return that the IRS assumes the gift assets will earn during the gift term.
The IRS discount rate is published monthly (link to current rate may be found here). In Henderson Receivables Origination
(above), the court calculated the discounted present value of the $63,364.94 to be transferred as $50,933.18 based on the
applicable federal rate of 6.00%.  The “discounted present value” is a measuring stick for determining what
the value of a future payment (i.e., a payment that is due in the year 2057) is today. Hence, the discounted present value
of a payment corrects for inflation and the principle that money available today is worth more than money not accessible for
50 years (or some future time). However, the discounted present value is not the same thing as market value (what someone
is willing to pay). Basically, a calculation that discounts a future payment based on IRS rates is an artificial number since
it has no bearing on the payment’s actual selling price. For example, in Henderson Recievables Origination, it is somewhat
confusing for the court to evaluate future payments totaling $63,364,94 based the discounted present value of $50,933.18 because
that is not the market value of the payments. In other words, the annuitant couldn’t go out and get $50,933.18 for his
future payments because no person or company would be willing to pay that much. Some states will require a quotient to be
listed on the disclosure that is sent to the customer prior to entering into a contract with a factoring company. The quotient
is calculated by dividing the purchase price by the discounted present value. The quotient (like the discounted present value)
provides no relevance in the pricing of a settlement factoring transaction. In Henderson Receivables Origination (above),
the court did consider this quotient which was calculated as 71.70% ($36,500/ $50,933.18). 
 Daniel W. Hindert et al., Structured Settlements and Periodic Payment
Judgments § 1-14–1-17 (Law Journal Press 2000).
 I.R.C. § 130.
Adam F. Scales, Against Settlement Factoring? The Market In Tort Claims Has Arrived, 2002 Wis. L. Rev. 859, 868 (2002).
 Scales, supra note 3, at 869.
 Robert W. Wood, Taxation of Damage Awards
and Settlement Payments 7--16 (Tax Institute 1991).
Hindert, supra note 1, § 1-30.
Adam F. Scales, supra note 3, at 876.
Adam F. Scales, supra note 3, at 899.
Hindert, supra note 1, § 8A-3.
I.R.C. § 5891.
 I.R.C. § 5891; See,
e.g., Model State Structured Settlement Protection Act §4; See also, Tex. Civ. Prac. & Rem. Code §141.
 In re Petition of Settlement Capital
Corp., 774 N.Y.S.2d 635,638-39 (N.Y. Sup. Ct., 2003)
Settlement Capital Corp. v. State Farm Mut. Auto. Ins. Co., 646 N.W.2d 550, 556 (Min. Ct. App. 2002).
 Barr v. Hartford Life Ins. Co., 2004 NY Slip Op 50980U, 3, 4 (N.Y. Sup. Ct. 2004).
 In re Transfer of Structured Settlement Rights by
Joseph Spinelli, 803 A.2d 172, 175 (N.J. Super. Ct. 2002).
 Henderson Receivables Origination, LLC v. Campos, 2006 N.Y. Slip Op. 52430(U) (N.Y. Sup. 2006).
 TX Revised Civil Statute Annotated §
 Henderson Receivables
Origination, LLC v. Campos, 2006 N.Y. Slip Op. 52430(U) (N.Y. Sup. 2006).
The typical structured settlement arises and is structured as follows: An injured party (the claimant) settles
a tort suit with the defendant (or its insurance carrier) pursuant to a settlement agreement that provides that, in exchange
for the claimant's securing the dismissal of the lawsuit, the defendant (or, more commonly, its insurer) agrees to make a
series of periodic payments over time.
The insurer, a property/casualty insurance company, thus finds itself with
a long-term payment obligation to the claimant. To fund this obligation, the property/casualty insurer generally takes one
of two typical approaches: It either purchases an annuity from a life insurance company (an arrangement called a "buy
and hold" case) or it assigns (or, more properly, delegates) its periodic payment obligation to a third party which in
turn purchases an annuity (which arrangement is called an "assigned case").
In an unassigned case, the property/casualty insurer retains the periodic
payment obligation and funds it by purchasing an annuity from a life insurance company, thereby offsetting its obligation
with a matching asset. The payment stream purchased under the annuity matches exactly, in timing and amounts, the periodic
payments agreed to in the settlement agreement.
The property/casualty company owns the annuity and names the claimant
as the payee under the annuity, thereby directing the annuity issuer to send payments directly to the claimant. If any of
the periodic payments are life-contingent (i.e., the obligation to make a payment is contingent on someone continuing to be
alive), then the claimant (or whoever is determined to be the measuring life) is named as the annuitant or measuring life
under the annuity.
In an assigned case,
the property/casualty company does not wish to retain the long-term periodic payment obligation on its books. Accordingly,
the property/casualty insurer transfers the obligation, through a legal device called a qualified assignment, to a third party.
The third party, called an assignment company, will require the property/casualty company to pay it an amount sufficient to
enable it to buy an annuity that will fund its newly accepted periodic payment obligation. If the claimant consents to the
transfer of the periodic payment obligation (either in the settlement agreement or, failing that, in a special form of qualified
assignment known as a qualified assignment and release), the defendant and/or its property/casualty company has no further
liability to make the periodic payments. This method of substituting the obliger is desirable for property/casualty companies
that do not want to retain the periodic payment obligation on their books. Typically, an assignment company is an affiliate
of the life insurance company from which the annuity is purchased.
An assignment is said to be "qualified" if it satisfies the criteria set forth in Internal Revenue
Code Section 130 . Qualification of the assignment is important to assignment companies because without it the amount they
receive to induce them to accept periodic payment obligations would be considered income for federal income tax purposes.
If an assignment qualifies under Section 130, however, the amount received is excluded from the income of the assignment company.
This provision of the tax code was enacted to encourage assigned cases; without it, assignment companies would owe federal
income taxes but would typically have no source from which to make the payments.
A structured settlement factoring transaction describes the selling of future
structured settlement payments (or, more accurately, rights to receive the future structured settlement payments). People
who receive structured settlement payments (for example, the payment of personal injury damages over time instead of in a
lump sum at settlement) may decide at some point that they need more money in the short term than the periodic payment provides
over time. People's reasons are varied but can include unforeseen medical expenses for oneself or a dependent, the need for
improved housing or transportation, education expenses and the like. To meet this need, the structured settlement recipient
can sell (or, less commonly, encumber) all or part of their future periodic payments for a present lump sum.
you would like additional information about structured settlements, please contact Cost Containment Solutions
structured settlement broker. 866.236.4910 x 705