A safe alternative to structured settlements.

The evolution of financial settlement options for tort victims has been intriguing. In the beginning, there were cash settlements. Life was simple then. Plaintiffs' trial lawyers were not required to have financial expertise and had no responsibility for advising clients about what to do with settlement proceeds. Then the structured settlement was born and began to evolve.

The structured settlement concept flourished in the 1970s and 1980s, growing into a multibillion-dollar-a-year industry. In the 1990s, however, two factors have combined to significantly curtail the use of structured settlements.

First, top-rated life insurance companies, such as Executive Life Co., were placed in receivership by state regulators. The fear of insurance-company failure ran over the plaintiffs' bar like a tidal wave, leaving in its wake the need for a safe alternative to annuity-based structured settlements.

Lawyers began to question what their responsibility would be should they recommend an annuity-based structured settlement to a client and find many years later--perhaps even after they had retired and stopped buying malpractice coverage--that the annuity carrier had failed. This well-founded fear led to the declining use of annuities sponsored by insurance companies and the rising popularity of Treasury bond structured settlement trusts. These are entirely safe vehicles into which government obligations can be placed.

Just as Treasury bond structured settlements became increasingly popular, a second development shook the structured settlement industry: Interest rates declined sharply. Attorneys became fearful of locking up their clients' money for prolonged periods of time at the prevailing low interest rates.

The crucial problem facing plaintiffs' attorneys today is their unhappiness with the available options. Most are concerned about the financial stability and longterm viability of annuity-based structured settlements offered by insurance companies. While fears of bankruptcy do not apply to Treasury bond structured settlement trusts, lawyers have significant fear of rising future interest rates. Attorneys are left in the uncomfortable and frustrating position of knowing that they have to make a recommendation to their clients but not knowing exactly what the best approach might be.

There are a number of traditional alternatives. Plaintiffs are often approached by stockbrokers, life insurance agents, and other investment salespeople presenting deals that look too good to be true.

Plaintiffs wish to handle their money responsibly but may lack the experience and financial acumen to differentiate between appropriate and inappropriate between appropriate and inappropriate investments. They may risk their money in inappropriate and ill-timed investments, where the risk far exceeds what a tort victim can tolerate. Such investments include high-yield junk bonds, speculative stocks, real estate syndications, horse-racing syndications, high-risk financing of doomed real estate projects, precious metals, and collectibles. Plaintiffs often fall victim to investment salespeople who are motivated more by the prospect of earning a commission than by a desire to give good advice.

Life insurance salespeople usually offer tort victims various types of insuranceindustry-driven financial vehicles, such as universal life, variable life, deferred annuities, and variable annuities. Since the largest, most stable life insurance companies compete in the marketplace based on their stability and size, the smaller, less stable life insurance companies try to sell their products by offering promises of higher yields. All to often, they fail to deliver on these promises. In difficult economic times like those we are experiencing today, too many salespeople choose to sell the most competitive product as opposed to the safest one, and tort victims invariably wind up holding inappropriate and risky assets.

Financial planners and bank trust officers receive fees for the advice they give. They are a far better bet for tort victims than commission-based product salespeople. However, financial planning for tort victims is significantly different from financial planning for people who have accumulated assets through inheritance or earnings. If the financial planner or trust officer does not have a long track record of successful experience working with tort victims, the planner or officer invariably falls back on generic money management methods. Unfortunately, these are usually inappropriate as a foundation for planning for tort victims.

For example, financial planners and bank trust officers generally are determined to achieve portfolio diversification. This is a sound economic principle for most people, but it exposes tort victims to unacceptably high risk levels. Does it make sense to invest a substantial portion of a plaintiff's recovery in stocks at a time when the Dow Jones Industrial Average is at or near an all-time high?

A New Alternative

In response to these problems and the concerns of the plaintiffs' bar, the settlement fund management trust has emerged. The trust is intended to manage a plaintiff's tax-free recovery from a tort action.

The trustee typically invests the funds in a portfolio of U.S. government securities, U.S. government guaranteed securities, and investment-grade municipal bonds. The objective of the trust is to have income-producing instruments constantly maturing so that the maturity value can be reinvested at various times in the future to garner the then-current interest rates, creating a form of dollar-cost averaging of interest rates. The overall performance of the portfolio will follow future interest rate trends without exposing the plaintiff to any unnecessary risk. This ability to hedge future interest rates is critical when rates are as low as they are currently.

The trust provides plaintiffs with a financial management vehicle designed to take into account their particular requirements, administered by a trustee with significant expertise in dealing with tort victims. Critical financial decisions are made with an eye toward the special circumstances of tort victims as opposed to more traditional general investment principles. The trust provides plaintiffs' attorneys with a settlement option custom-designed to the needs of their clients. At the same time, it offers the ability to respond to future interest rate changes and provides a safe alternative to the risks inherent in insurance company annuities.

The settlement fund management trust is a grantor trust with the plaintiff (or the guardian for the estate of the plaintiff, as the case may be) serving as the grantor. The trustee receives and invests the plaintiff's net recovery (or a portion thereof), pays out the desired income stream to the plaintiff, and reinvests the balance. Trust provisions may be included to permit use of the principal for special needs, such as medical emergencies, education, and life care. The trust includes spendthrift provisions so that the assets are protected against any imprudent acts of the grantor, as in a structured settlement.

Investments are made by the trustee in financial vehicles chosen to best meet the plaintiff's future needs. Because these plaintiffs have very low risk-tolerance levels, the trustee will only consider financial vehicles that fall into the safest categories. Depending on the plaintiff's tax position, the trustee may choose tax-exempt vehicles or government-backed taxable vehicles to provide the most suitable net yield for the plaintiff without sacrificing safety.

The trust may be drawn on a revocable basis (for a competent adult) or on an irrevocable basis (for a competent adult in appropriate cases or for an infant or incompetent adult). In some situations it may be desirable to have the trust drawn on a revocable basis so that it may be amended or canceled in the future. There may also be special circumstances in which the right to amend or revoke should not be left in the hands of the grantor. In such cases, these trust powers may be made subject to the order of a court of competent jurisdiction.

When setting up a trust for an infant who is fully expected to become a competent adult, the trust may be made irrevocable until the age of majority. At that point, the beneficiary of the trust becomes the successor grantor, with the trust possibly changing from irrevocable to revocable status.

The applicable law for the trust is the grantor's state of domicile. Should the grantor move from one state to another, the law governing the trust would automatically change to the new state of domicile.

In the majority of trusts prepared for competent adults, the power of amendment is unfettered. Schedule B of the trust contains the grantor's investment directions, developed with the recommendations of the trustee. The grantor may change these investment directions at will in the future. The trustee will recommend changes as the economic climate changes.

The payout directions in the trust are contained in Schedule C. Should the grantor wish to change the payment stream to meet changing needs, this can be accomplished by merely executing a new Schedule C and forwarding it to the trustee.

The Result

The settlement fund management trust gives the plaintiff an overall financial plan that takes advantage of safety and stability, coupled with the flexible financial management aspects of a grantor trust. It is managed by a trustee who specializes in dealing with tort victims.

This approach eliminates the risk of commercial failure of the funding mechanisms, reduces interest rate risk, diminishes the possible estate tax problem of conventional structured settlements, allows for emergency invasions of principal, permits the redesign of the income stream to meet changing needs, and maintains spendthrift protection while leaving open the possibility of future tax-free income. The result is that the plaintiff receives solid guarantees of investment safety coupled with flexibility and professional money management in an anti-spendthrift vehicle.

Trial lawyers recognize the need to achieve a full and fair recovery for the personal injury victim. Isn't it just as important to protect the recovery once it is obtained? Attorneys must give the victim's recovery the same level of attention they gave the underlying litigation. In the end, they must help their clients do something safe, prudent, and secure with the cash.