Oklahoma Bar Journal
Protecting the Settlement Recovery: Planning Options for Settlement Recipients and Their Attorneys
By John M. Wylie, Joseph W. Tombs and Greg Maxwell
Personal injury attorneys often feel a desire to focus on their next case once the present case settles, but the financial decisions arising at the end of a case can affect the client for years into the future and are generally too much for the client to handle alone. Additionally, missing the opportunity to help with the financial, lien resolution and government entitlement (Medicaid, SSI, Medicare and SSDI) issues arising in personal injury settlements can result in unsatisfied clients, malpractice claims and ethics violations.1 These risks are not merely academic. In State ex rel. Oklahoma Bar Assn. v. Friesen, an Oklahoma attorney was disbarred for mishandling and failing to properly establish a structured settlement on behalf of a client.2
Most personal injury settlement recipients want to be responsible with their settlement funds but do not necessarily have the skills for the task. When a client is asked, “What is the most important thing you’d like to accomplish with this settlement money?” the answer is almost always sensible and responsible. It may be to pay back loans, replace lost future income, fund future medical expenses, upgrade living conditions or ensure their family’s medical and future educational needs are paid. Given the opportunity, most personal injury victims will create a plan to use their funds to better their lives. Unfortunately, some are not given that opportunity and consequently squander their tort recoveries.3
A few simple steps to educate a client taken shortly before and after settlement will ensure the client is equipped to make informed decisions and protected from predators. If a settlement involves a significant amount of money and the attorney does not know what to do, it may be preferable for the plaintiff’s attorney to refer this process to competent outside counsel.
For most settlement recipients, dissipation is the greatest risk to their future financial security. In this context, “dissipation” means the net settlement recovery does not last as long as it should. Most clients are financial novices. A financial novice who suddenly has more money on hand than at any other time in life can easily dissipate those funds through a combination of impulsive spending, poor investment choices and well-intentioned gifts and loans to family and friends.
Dissipation risk can be mitigated but not without effort. Many personal injury victims need constraints placed on their access to settlement funds to avoid dissipation. These constraints should last until the recipients are ready to manage the funds themselves. It may be in the client’s best interest to make settlement funds less easy to access immediately. The decision to place some, or all, of a settlement into a situation that is more secure but relatively inaccessible should be made with a client’s input and not unilaterally for them by the attorney.
The world is a dangerous place for an injury victim with a settlement, and not all “predators” are acting from ill will. It may be difficult for associates of the client to understand that the client’s settlement is meant to last for a lifetime of expenses. Even well-meaning family and friends may ask for loans, propose speculative business ventures or offer commission-loaded investments. Financially unsophisticated settlement holders may be lured into casinos, shopping malls and car lots carefully designed to induce wanton and frivolous spending. Money earmarked for replacing future income or paying future medical costs all too often gets wasted in these ways.
For clients who choose to structure a portion of their settlement, perhaps the most dangerous predators are the annuity factoring companies. These companies offer to purchase future payments from an annuity or structured settlements at a heavily discounted rate. They advertise incessantly in an effort to tempt structured settlement recipients with the allure of “cash now.” In some unique circumstances, a factoring transaction truly may be needed. However, many injury victims who desperately need the guaranteed future payments succumb to the endless solicitation and are left destitute.
Section 5891 was added to the Internal Revenue Code in an effort to protect structured settlement recipients from these companies.4 This code provision requires a judge to approve proposed factoring transactions after considering the best interests of the annuity payee and the payee’s dependents.5 Oklahoma’s procedure for approval of a proposed factoring transaction of structured settlement payments are found in the Structured Settlement Protection Act of 2001.6 The IRS penalty for unapproved factoring transactions is a 40 percent federal tax imposed on the factoring company.7 This legislation is a very positive development, but it does not solve the underlying problem. If an annuity payee is intent on factoring future payments, a way can usually be found to do it. Even though the procedure requires a finding that the sale is in the best interests of the client/seller, most judges have little reason to find otherwise in the face of crowded dockets, an earnest seller and an even more anxious buyer.
ALLOCATING THE SETTLEMENT – LIQUID VERSUS SECURED
Proper allocation of settlement proceeds is critical for the client. A client’s recovery may take several forms including cash, managed investment accounts, structured future payments, settlement trusts or some blend of each. Each of these options has distinct advantages and disadvantages, and since no case and client are the same, no single settlement solution is right in all circumstances. Each case requires planning to fit the abilities, needs, goals and special circumstances of each client. In addition, attorneys must keep in mind that in many cases the settlement allocation chosen will need to pass muster with a judge who is often asked to approve the terms of a settlement for minors or adults whose ability to make decisions may be impaired.
Ranked from most to least liquid (and therefore least to most secure), the four options are cash, managed investment accounts, settlements trusts and structured settlement annuities.
Cash is the most widely used settlement option for most clients for obvious reasons – cash spends. Cash is extremely liquid and is ideal for meeting an immediate need or goal of the client. It is often used to pay down debt, purchase new cars or homes and meet the immediate needs many injury victims face upon settling a personal injury case. This liquidity is the biggest advantage of cash, but it is also its greatest disadvantage. Cash in the hands of many injured clients will most likely be dissipated quickly because it can be spent on a client’s whim, often leaving the family without future income or money to pay ongoing medical expenses.
Managed Investment Accounts
A managed investment account is only slightly less liquid than cash and only slightly more secure. Therefore, the dissipation risk is essentially the same. The client can request the funds at any time. It only takes a phone call to the investment advisor to turn the account into cash. This requirement may be enough to help a financially savvy client curb the trend toward dissipation but will do little to protect a financial novice. However, an investment advisor may be a helpful educator and coach who may be able to curtail some potentially poor decisions.
Settlement trusts allow clients some flexibility and liquidity while also providing a level of dissipation protection. Settlement trusts can be drafted to allow payments to be made for education expenses, medical expenses and provide the client with monthly income. They can also allow for some percentage of the trust corpus to be used for discretionary spending. This gives clients some freedom and flexibility without allowing them to dissipate the entire principal amount. A settlement trust may allow the beneficiary time to gain financial discipline and establish a budget, while still allowing for some flexibility and future contingencies to be paid.
Trusts are not a silver bullet for all clients, however. Trust principal is not guaranteed because the funds are placed in an investment portfolio that fluctuates and can lose value. Corporate trustees often have hefty trustee fees and management expenses that will decrease the net return of the trust portfolio. Additionally, most trust departments at major banks have little experience dealing with the unique needs of injury victims.
It is often the case that a client will have ongoing medical expenses. Government programs such as Medicare and SSI require means testing that often considers income and assets. If care is not exercised in establishing the trust, a client may be required to expend most, or all, of their settlement proceeds before becoming eligible for services under those programs. An attorney should strive to preserve both the client’s settlement principal and the client’s ability to take advantage of any applicable government programs
in crafting a settlement trust.
Structured Settlement Annuities
Structured settlement annuities provide injured clients with guaranteed, tax-exempt future payments. At the outset, the payment structure is extremely flexible and can be designed to fund future goals (i.e. college or retirement) or can be used to provide lifelong income. Seriously injured clients seeking a lifetime payment can also benefit from a “rated age,” which serves to increase the payout per premium dollar. For many clients, structured settlement annuities provide much needed dissipation protection, guaranteed income and financial stability.
However, they are not without their drawbacks. While structured settlement annuities are flexible in design, they are impossible to change once established. A structured settlement may have a value of hundreds of thousands of dollars, but the client will only be able to access the scheduled disbursements. A client with a large amount of inaccessible money can easily become frustrated. This can increase the risk that a client will feel a need to sell future payments, usually at a dramatically discounted return for the client.
Also, annuity payments are guaranteed by the annuity companies that offer them, and thus are only as solid as the company backing them. While the risk of annuity company insolvency is usually small, it is not zero. Most annuity companies in the structured settlement market are rated A+ or better with AM Best. An attorney should verify the financial security of the company servicing any proffered structured settlement annuity.
A skilled settlement-planning attorney may be helpful in creating custom solutions that merge some of the benefits of one or more of the four options. For example, a structured settlement annuity can pay directly into a trust, allowing settlement money to grow tax-free inside the annuity while taking advantage of the liquidity of a trust. Structuring into a trust also makes it impossible for the client to factor the future payments because the trust, not the injured client, is the payee of the annuity.
PROPER SETTLEMENT PLANNING AND EDUCATION
Some attorneys try to meet their professional obligation for securing competent financial advice to clients by simply offering them a chance to use a structured settlement. While a structured settlement can be an ideal tool in some situations, it is not a panacea, nor is it the only option available. Allocating the settlement may involve the use of a structured settlement, but real settlement planning involves a more
Recent lawsuits against plaintiff attorneys reveal that a plaintiff’s attorney should inform their client of the option to structure their recovery.8 Also, a plaintiff’s attorney should not rely on defense attorneys to control the structured settlement process.9 An attorney may attempt to argue by retaining a structured settlement broker and documenting the client was informed of a structured settlement option that they have done all that is required of them, but this approach likely falls short of meeting the attorney’s professional duty to be an advisor.10
To know the right mix of cash, future payments and trusts for each client, it is imperative your client is educated about the pros and cons of each option before settlement. It is also important that you understand your client’s unique situation and circumstances. Presettlement planning allows clients to consider their unique post-settlement needs and goals before the stresses and pressures of mediation. In addition, a presettlement financial plan allows the client to have meaningful input regarding the form the settlement ultimately takes. Proper presettlement planning creates client ownership or “buy-in” in the result. This can greatly reduce the risk that a client will prematurely dissipate their settlement recovery because liquidity issues – future cash needs and contingency plans have been discussed and preplanned.11
Early in the settlement process, before mediation or arbitration, the client needs to be educated – ideally by an independent settlement planner or attorney.12 This presettlement meeting separates the planning from the stress of mediation, resulting in better decisions. It is in everyone’s best interest if the client has only one decision to make at mediation – should the case be settled for the amount offered? However, clients are ill-equipped to make this decision without the answer to the primary question on their mind – “After this is all over, how many of my basic goals will this cover?”
Clients often do not know what to expect at each step of the litigation process and thus feel disempowered. They do not fully understand the time it will take to get court approval, settle liens or wrangle with the defense over the wording of the settlement agreement. At some point in mediation, many clients get angry at the defendant and its insurers, at the system, the process and often at their own attorneys. It can become difficult to convince angry clients to accept reasonable offers and even harder for them to be pleased with your representation or their own decisions made in that environment.
On the other hand, a client who is prepared for what to expect at mediation and who knows the costs of meeting his goals feels empowered to make an informed settlement decision. This client is more likely to follow the advice of counsel and to be more content with the settlement.
The transition into post-settlement financial life can be difficult. Left to their own devices, settlement recipients often seek advice from sources unfamiliar with the complexities associated with the financial aspects of handling a settlement recovery and fall prey to the all-too-familiar predators. Post-settlement financial education for injury victims and their families has traditionally been glaringly absent. Post-settlement financial education should be more comprehensive than just investing the proceeds and should also include credit repair, budgeting, insurance review, estate planning and tax planning.
JUST A SETTLEMENT OR A REMEDY?
A client’s transition from litigation and final settlement to post-settlement life is not an easy one. Every client’s financial knowledge and education is different. Each client needs specific attention to help bridge the gap from pre-injury life to post-settlement normalcy.
Plaintiff’s attorneys are all too aware that they cannot turn back time and reverse the wrongs done to their clients. All they can do is seek financial compensation for the injuries suffered. If money is the primary balm an attorney has to offer to an injured client, it stands to reason the attorney should not only maximize the settlement received by the client, but also put a remedial plan in place that will continue to address the client’s needs into the future. Some attorneys may feel comfortable providing their clients this type of financial education themselves while others prefer to bring in an independent settlement planning specialist.13 In either case, it is the plaintiff’s attorney who holds the key to helping the client create and implement a comprehensive plan that will increase their client’s quality of life and long-term financial security.
Author’s Note: Portions of this article previously appeared in a 2010 article of the Utah Trial Lawyer’s Journal titled “Protecting the Settlement Recovery: Planning Options for Settlement Recipients and their Attorneys”.
ABOUT THE AUTHORS
John Wylie is of counsel with Tombs Maxwell LLP, a multi-state law firm that deals with the legal and financial issues that arise at the time of settlement. Mr. Wylie is a member the OU College of Law class of 1997. He lives and practices in Norman.
Joseph Tombs serves as a settlement-planning attorney in Lubbock, Texas. Mr. Tombs has a focus in financial and tax planning for recipients of tort settlements. He is a founding member of Amicus Settlement Planners LLC, Amicus Financial Advisors LLC and Tombs Maxwell LLP.
Greg Maxwell of Tombs Maxwell LLP focuses his practice on settlement planning and special-needs planning for injury victims and provides consulting services to law firms regarding Medicare secondary payer compliance. Mr. Maxwell is a certified financial planner and founded Amicus Settlement Planners LLC, a plaintiff-loyal structured settlement planning firm, in 2004.
1. See, Oklahoma Rules of Professional Conduct, Rule 2.1, Comments 4 and 5.
2. State ex rel. Oklahoma Bar Association v. Friesen, 2016 OK 109, 384 P.3d 1129.
3. Cordell, D.M. and J.W. Tombs, “Planning Considerations for Personal Injury Settlement Recipients,” Journal of Financial Planning, January 2005, pp. 26-28.
4. I.R.C. §5891 (2002).
5. I.R.C. §5891(b)(2)(A)(ii) (2002).
6. 12 O.S. §3238 et seq.
7. I.R.C. §5891(a) (2002).
8. E.g., Grillo v. Henry, 96th Dist. Ct, Tarrant Co. (Tex.) and Grillo v. Pettiette, et al., 96th Dist. Ct. Tarrant Co.
9. E.g., Lyons v. Medical Malpractice Insurance Association, 730 N.Y.S.2d 345, 286 A.D.2d 711 (N.Y. App. Div. 2001) and Macomber v. Travelers Property and Casualty Corporation, 260 Conn. 620, 804 A.2d 180 (Sept. 3, 2002).
10. Oklahoma Rules of Professional Conduct, Rule 2.1, Comments 4 and 5.
11. Additionally, in negotiating any settlement, a plaintiff’s attorney should be mindful that most insurance companies will want to service any resulting structured settlement or annuity themselves, or through some subsidiary of the insurance company. Annuities are financial investments that are regularly sold to the public, and which are offered on a basis that makes money for the annuity provider. In negotiations, the attorney should be aware that the “face value” of an annuity may represent the “retail” cost of the annuity, where the settlement payor may be purchasing it at “cost” from itself or its wholly-owned subsidiary.
12. Most personal injury attorneys do not have errors and omissions liability coverage for financial and tax advice. Referring clients to independent financial and/or tax professionals helps ensure that the client is educated, and the personal injury attorney is protected from potential liability regarding the financial and tax aspects of the settlement.
13. Make sure that any professional you introduce has experience with injury victims and the proper credentials and education. The Certified Financial Planner (CFP®) designation and membership in the Society of Settlement Planners are good indications of competence and experience in the field. The Society of Settlement Planners is a national group of attorneys and settlement planners dedicated to protecting Plaintiff’s rights and interests in financial matters.
Originally published in the Oklahoma Bar Journal -- OBJ 89 pg. 38 (November 2018)