Frank C. Kilcoyne, CSSC

Structures with Upside

One of the things our claimants like best about their structured settlements is the fact that by structuring, they can assure themselves a guaranteed base of income which will last as long as they do – or longer.  That the payments are also tax-free is often just icing on the cake. As much as they like the guaranteed aspect of these payments, some wish they could also have a little upside in good markets.

Well, thanks to the creative folks at Pacific Life Insurance Company, it looks like our claimants can now have just such a thing - and the payments are still guaranteed and still tax-free.

Before launching into “annuity speak”, let’s discuss how this works in plain English: in effect, Pacific Life has created a “ratchet” mechanism which ties future payments to the performance of an investment index. If over a year’s time that index goes up, the following year’s payments are increased, to a maximum of 5%. If the index goes higher than 5%, tough luck: the payment increase tops out at 5%. However, once increased, the payments will never be reduced. I think I know some people who would be interested in an arrangement like this.

Technically, this is offered in the form of a “rider” (optional insurance policy feature) to their standard fixed settlement annuity which creates the “up” mechanism. It does not disturb the rock-solid underpinnings to which our markets have grown accustomed: real guarantees from real American life insurance companies. They call it an “Index-Linked Annuity” and it is tied to positive movements of the S&P 500 stock index.

The “Index-Linked Annuity Payment Adjustment Rider” is not a security and does not participate directly in the stock market or any indexed investment fund. It is not an investment; it is an insurance product designed to offer a wider range of choice to injured claimants crafting a traditional qualified structured settlement plan.

Increases are measured based on time segments called “Index Measurement Periods” which essentially represent one-year periods from the date of original issuance. If the S&P 500 index increases over the Index Measurement Period, payments are increased. If the index decreases or remains flat over the measuring period, annuity payments will remain the same. Again, if the index decreases, there is no corresponding decrease in payments.

The following example helps demonstrate how the rider works. Assume the following:

• Prospective annual returns for the S&P 500 index are 3%, -4%, 8% and 5%. These returns are strictly hypothetical and used for demonstration purposes only.
• The rider was added when the annuity was purchased.
• The initial structured settlement monthly annuity payment amount was $1,500 for the first year.
• The annual maximum annuity payment adjustment is 5%.

At the end of year 1 the S&P 500 index returned 3% for the year, so the payment amount would increase by 3%. In this example that means an additional $45 per month, bringing the monthly annuity payment to $1,545.00 from $1.500.00.

At the end of year 2, however, the S&P 500 index experienced a negative 4% return for the period. The monthly payment amount remains even at $ 1,545.00.

At the end of year 3, the S&P 500 index returned 8% for the year, causing payments to increase up to the maximum 5%, which means an additional $77.25 per month. The monthly annuity payment increases to $1,622.25 from $1,545.00.

At the end of year 4, the S&P 500 index returns 5% for the year, so the payment increases by 5%, an additional $81.11. The monthly annuity payment amount now rises to $1,703.36.

As you can see from this example, the potential for increased payments is real. It also clearly capitates the amount of return a claimant can earn in a given year, meaning that they will never match the full long-term return of the S&P500 index itself (which is often greatly helped by a few truly spectacular years).

This feature is clearly not for everyone, but it does offer a nice middle ground for claimants who like the income security of a traditional structured settlement. Many will just feel personally happier with some upside potential. Claimants who have suffered a personal physical injury qualify for one of the most valuable tax breaks in the entire Internal Revenue Code: a Section 104 periodic payment settlement. With this feature, they now have new flexibility in how they schedule future payments.

I have no idea where the stock market is headed and can’t assure any claimant that they would be better off with this option than the traditional fixed immediate settlement annuity. However, I like the simplicity of the ratchet design and think it may offer a nice value proposition to many settling claimants.

Like an occasional pay raise, unexpected increases in income simply feel good and they do indeed help us manage the inevitable increases in our costs of everyday living.

Are you dealing with a claimant who would benefit from income security but be happier with a little “upside”? Call Frank C. Kilcoyne, CSSC at 800-544-5533. I am here to help.


(1) The S&P 500® is widely regarded as the best single gauge of large cap U.S. equities. There is over USD 5.14 trillion benchmarked to the index, with index assets comprising approximately USD 1.6 trillion of this total. The index includes 500 leading companies and captures approximately 80% coverage of available market capitalization. Source: http://us.spindices.com/indices/equity/sp-500