Frank C. Kilcoyne, CSSC
Volume 20 | November 2007

"Guaranteed" Payments?

Anyone who has been paying attention to these newsletters over the years knows that tax-free and guaranteed payments form the pillars that make structured settlements so appealing.  Yet what exactly does “guaranteed” mean and how far does a “guarantee” go?  I have written about the tax status of structured settlements in previous editions; in this issues I want to discuss exactly what we mean by “guaranteed payment” and how best to enhance that guarantee. 

Crafting a structured settlement plan for an injured claimant requires meticulous consideration of the financial security of that transaction.  Attention to detail here is in the best interests of all parties to the transaction.  Let’s face it: no one wants a problem downstream, so how do we make sure there are none?  First, we use the tried and true method of vetting the companies who may compete for the business.  Given the sensitivity of our cases, we work with only the largest, most highly-rated and financially secure life insurance companies in the industry.  We back structured settlements only with settlement vehicles that have stood the test of time and that have further assets to back them up.  By “backup” I mean funding instruments that have a failsafe system in place to step in should the life insurance company that issued the annuity contract fail to make a payment. 

Even “failsafe” is perhaps too strict a word, as there is no such thing as a “risk free” financial instrument.  Since there is no eliminating risk, handling financial risk is done by managing it.  In this case I say “failsafe” to indicate that another, independent, mechanism stands behind the primary instrument should a problem develop.  I am referring to state insurance guaranty fund associations. 

The prospect of a life insurance company failing to meet its obligations is a frightening thought.  Given how many of us buy life insurance to protect our own families in the event of premature death, let alone what  it could mean to the guardians of an impaired infant who may not have the necessary funds to sustain life.  This is why we make sure our periodic payment plans are underwritten by only the most secure companies and whose contracts are covered by the corresponding state guarantee system.  

Coverage is coordinated on a state-by-state basis, so it is important to understand the levels of guarantee available in the venue in which you’re working.  If you know the levels of guaranty fund "backup” in the state in which you are working, you can design your structured settlement accordingly.    For instance, the Life Insurance Company Guaranty Corporation of New York provides coverage for direct life insurance policies, health insurance policies and annuity contracts. For a policy to be covered, the insurer must be licensed in the State of New York at the time the policy, contract or agreement was issued, or at the time of impairment or insolvency.  The Life Insurance Company Guaranty Corporation of New York will guarantee these contracts up to a present value of $500,000.  The New Jersey Life & Health Insurance Guaranty Association provides similar coverage.

Once you have limited your pool of funding candidates to only highly rated insurers and familiarized yourself with the given state’s guaranty fund protection limits, then you manage your risk in the old fashioned way: you spread it out among those companies, being sure to stay within the applicable limit.  This way, in the unlikely event of trouble with one of the life companies, only a portion of the benefits will be affected and those benefits will be covered by the corresponding state guarantee fund. 

This is not to say that we will ensure or even recommend that every dime of future payments be covered by the applicable guarantee fund.  Pricing differences between companies can mean a reduction in benefits when you diversify between companies.  The security/benefit decision then becomes a value decision, and not one that we can make for the beneficiary or their guardian; they must make it for themselves or their ward.  And every situation is different.  Some people are more security minded while others will want to maximize benefit dollars.  It’s a tradeoff decision that one makes with awareness. 

The cost to diversify and stay under guaranty fund limits can mean a substantial reduction in benefits. For example, in a recent case we put together a structured settlement for the benefit of an impaired female infant named “Sally” (named changed).  Sally’s medical condition is so dire that several annuity issuers provided reduced life expectancy discounts (so-called “rate-ups”) so dramatic that we were able to substantially increase the value of her future payments.  Interestingly, not all the companies agreed on how Sally’s condition would impact her life expectancy and therefore they priced her benefits quite differently.  With in excess of two million dollars available to fund Sally’s future payments; this created a dilemma over how many companies to use to spread the risk versus how much of a reduction in benefits was tolerable. 

Diversifying to keep all payments under the guaranty fund cap would require spreading the payments among four companies and would produce a total of $ 8,359.20 per month for 20 years certain and life increasing by 3.5% per year beginning 1/1/2008.

If however we spread the benefits among the two companies offering the best benefits, only about half of each contract would be covered by the state guarantee fund but Sally would receive an extra $2,002 per month for the same period.  Given Sally’s needs and this significant boost in benefits, it was decided to use just the two most competitive life companies and forego guaranty coverage on approximately half the settlement. 

On any large case involving premium in excess of the state guaranty fund coverage, it’s important to compare the added security to the cost in benefits.  The key is to have enough information to make an informed decision.    Sally’s family, attorney, guardian and the court decided that adding in two additional life companies to gain the guaranty coverage would cost too much in future benefits and would not be in Sally’s best interest.  For what it’s worth, in this case, I agreed. 

 

While splitting benefits between many life companies can be prudent, it is not always done, especially if the reduction in future benefits to the beneficiary is too high.  Want to maximize the future benefits on your next claim settlement?  Call Frank C. Kilcoyne, CSSC at 800-544-5533.  I am here to help.