Structured Settlements and Annuities

Structured settlements are often a reference point for my friends and relatives who are involved in the legal profession.  Conversations typically involve an acknowledgement of basic annuity awareness as a result of experience with structured settlements in a court of law.

Annuities and structured settlements do share a core similarity: they both can be used to convert a lump sum of money into a series of periodic payments that are disbursed over time.  It is not correct, however, to assume that annuities and structured settlements are one and the same.

Over the past several decades, structured settlements have evolved into a conventional method of financing for tort claims.  In other words, defendants use structured settlements to fund the damages owed to claimants in a personal injury case.  Annuities come into the picture when they are used to fund the legal settlement.

For example, a basic structured settlement scenario might look something like the following:

• Injured person A is awarded $1 million in damages as a result of a personal injury.
• The insurance company that provides liability coverage to the party responsible for the injury of person A is the defendant in the tort suit.
• Instead of paying a lump sum (and in exchange for person A agreeing to dismiss the suit and accept the settlement), the insurance company opts to award damages through a series of periodic payments to person A—the “structured settlement.”
• Assuming that the structured settlement meets certain IRS guidelines, the payments to person A may be excluded from gross income for income tax purposes.
• The insurance company may choose to fund the structured settlement through the purchase an annuity from a life insurance company.
• Alternatively, the insurance company may have interest in removing the structured settlement liability from its balance sheet. In this case, the insurance company may assign the obligation to a third party and then transfer to that third party an amount of money (a “lump sum”) that allows the third party to purchase their own annuity.  

Thus, annuities are used by insurance companies or related third parties as financing vehicles that effectively match asset and liability characteristics of structured settlements.

The structured settlement industry in the United States is large and is estimated to exceed $5 billion per year.  As a result, there is an entire industry that has developed to serve the financing needs of the parties to a structured settlement.