Compensation and Brain Injury: Life Expectancy, Structured Settlements and the Tort System - Ensuring Adequate Compensation for the Catastrophically Injured.
6th World Congress on Brain Injury
May 6 - 8, 2005
Melbourne Convention Centre
Melbourne, Australia
Presented by R. Brian Webster
Webster & Associates, Vancouver, BC, Canada
Co-authors: Natalie A. Foley, LL.B., Daniel F. Corrin, LL.B.
Presentation Audience
Treating Professionals
Lawyers
Actuaries
Economists
Survivors
Health Care Workers
Introduction
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.
B. Restrictions
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.
D. Advantages/Disadvantages
- 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
Structured judgments
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
(b) if(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 - Subtract
- 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?
4. Options
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.
Your feedback is appreciated.