Structured settlement annuities provide customized payment solutions for injured plaintiffs to cover future medical expenses, lost income, and other costs related to their injuries or claims. Unlike lump sum payments, structured settlement proceeds with regular tax-free income over 5, 10, 20 years, or even a lifetime to provide financial security.
Structured settlements are carefully designed around individual needs during settlement negotiations. You work with financial advisors and legal counsel to project future costs and craft an optimal schedule of tax-free payments over time. These payments can include almost any custom configuration – monthly, annually, lump sums, or stepped payouts timed around specific needs or milestones.
Once a structured settlement annuity schedule is mutually agreed upon and signed off by all parties, the payments are guaranteed and fixed. The structure is funded by annuities and/or bonds which provide a rate of return to generate the income streams. The insurer or bond issuer is then responsible for making the scheduled payments.
These conservative investments allow for predictable returns to fund long-term payment schedules. However, economic changes can impact structured settlements in a few ways discussed below.
How Inflation Impacts Structured Settlements
One major economic factor that can affect structured settlements is the rate of inflation over time. Inflation causes the prices of goods and services to increase across an economy. This reduces your purchasing power – essentially the amount of real goods your money can buy. This can pose challenges for structured settlements that specify fixed periodic payments over many years.
For example, let’s say you have a structured settlement funded by an annuity scheduled to pay you $2,000 per month over the next 20 years for a disabling injury. This income stream made sense to cover your rent, healthcare bills, transportation, and other monthly costs of living.
However, historically inflation has averaged around 3% per year. Over 20 years compounded, that inflates prices by 80%! This means something that costs $100 today will cost $180 in 20 years. As goods, services, and living expenses become more expensive over time, the fixed $2,000 monthly payment loses purchasing power and covers less and less relative costs.
To illustrate, if we assume 3% average annual inflation over 20 years, that $2,000 monthly payment would need to be over $3,500 in 20 years just to equal the same purchasing power as when it started.
This demonstrates how uncontrolled inflation poses a severe risk to fixed payment structured settlements over long time horizons. It is difficult to predict inflation accurately over 5, 10 or 20 years – it may remain mild or could spike unexpectedly. Either way, uncontrolled inflation erosion poses a threat to the plaintiffs’ long-term financial security.
So how can this risk be addressed or minimized when negotiating structured settlements?
Protecting Your Money Against Inflation Risk
The most direct way to hedge inflation risk is to opt for Treasury Inflation-Protected Securities (TIPS) rather than regular annuities. TIPS adjusts payments based on the Consumer Price Index so they increase to match actual inflation. TIPS prevent uncontrolled inflation erosion to purchasing power.
One downside to picking TIPS over fixed payments is that initial periodic payments start lower to account for expected inflation adjustments over time. So plaintiffs face a trade-off – either higher initial monthly income that is fixed and may lose ground to inflation or slightly lower variable payments directly tied and protected from inflation. Based on individual situations, needs, and priorities over short- vs long-term, TIPS may make more sense for some than others.
Beyond TIPS, there are a few other options that aim to balance both steady income with some protection against excessive inflation:
- Fairfield Funding offers Indexed annuities that base yearly payment increases on market performance. The increases are uncapped so payments can rise to match significant inflation. Of course, the starting payments are lowered to allow for future increases.
- In some structured settlements, plaintiffs have access to a diversified pool of assets through a market-based structure rather than just fixed annuities. These may include stocks, bonds, alternatives, and inflation hedges. The market-based structure allows for the potential to achieve returns that can outpace inflation over the long run. Professional investing advice helps to align the investments with financial goals.
There is no perfect inflationary hedge that provides guaranteed growth as high as needed while retaining high initial baseline payments. As with many financial decisions, plaintiffs need to weigh their priorities for the immediate monthly income they require now versus retaining future purchasing power over 5, 10, or 20 years.
Everyone needs to assess their unique circumstances, future earnings ability, financial risks and personal inflation expectations before deciding which structured settlement approach best aligns with their priorities.
How Interest Rates Impact Structured Settlements
Interest rates impact structured settlements in a couple of key ways. First, annuity yields offered by insurance companies correspond closely with prevailing government Treasury bond rates when settlements take effect. Insurance companies generate much higher returns on their underlying investments than they credit annuity yields. When interest rates decline, their investment margins increase.
In today’s historically low rate environment with Fed funds at 3%, 10-year Treasury yields around 4%, and short-term rates at 2%, annuity yields don’t look particularly exciting for new settlements. Safe fixed annuities seldom yield over 4% currently.
However, unlike bonds and the stock market, the yields locked in don’t fluctuate after your settlement money has been signed and funded. Existing structured settlement recipients continue earning the same pre-set rates regardless of where interest rates move in the future.
So even though low-interest rates reduce potential yields on new structures today, previously settled cases continue receiving the original periodic payments funded at whatever locked-in rate. This prevents market volatility and is a major benefit of structured settlements versus choosing lump sums to individually invest.
For example, someone who settled a large injury claim in 1990 likely locked in an 8%+ fixed annuity rate and receives significantly higher monthly income versus an identical case settled today earning 4% yields. So in effect, past higher rate environments created some windfalls, while current low rates temporarily hamper new cases until inflation normalizes yield curves.
Looking ahead, when interest rates eventually rise back closer to historical norms, higher annuity rates will follow. Newly settled cases will lock in better yields. Of course, no one can predict reliably when rate increases might accelerate. But odds favor some reversion to mean over 5-10 years.
Major positive rate shocks also incentivize settlement purchasers. When fixed rates spike well above recent ranges, it draws more third-party investors looking to buy existing structured settlement payment streams as annuity yield alternatives in order to deploy their capital. More buyers and better fund availability allow settlement recipients to tap funds earlier if desired. While not an everyday occurrence, this dynamic illustrates the ongoing interrelationship between market interest rates and structured settlement rates of return.
Recession Impacts on Structured Settlements
Global recessions, such as the 2008 Financial Crisis or the 2020 COVID-fueled contraction have the potential to impact structured settlements in a few nuanced ways.
First and most simply, economic declines increase unemployment risk. This influences some settlement recipients’ preference for larger upfront lump sums to provide greater financial flexibility in case regular income sources are disrupted. Someone who feels confident in their job security may opt for reliable steady payments over decades. However, recipients with higher perceived income volatility risks may choose more cash upfront rather than locking into long-term payment schedules.
In this sense recessions indirectly shift preferences and structured settlement decisions. However, the payments themselves are protected contractual obligations between the annuity issuer and recipient.
In fact, structured settlements provide highly valuable income continuity to cover expenses if employment income temporarily ceases. These steady settlement funds security is a major benefit versus choosing larger lump sums that later run dry. Having structured settlement payments avoids tapping principal assets when markets decline.
For these reasons, some legal advisors argue that recession fears make structured settlements more appealing for injured plaintiffs lacking earning power. The counterargument says getting maximum funds while available makes sense against very long-term uncertainties. There are good cases to be made on both sides depending on personal situations.
Looking at annuity companies themselves, major highly-rated insurance firms fund structured settlements that are generally well protected from market gyrations, with over $100 billion in diversified assets. Yet in severe financial crises, the bankruptcy risk of one or more weak insurers can arise.
If an annuity company ever becomes financially distressed, state insurance guarantee programs provide backup coverage for structured settlement payments. This safety net protects recipients in case an insurer can’t meet its obligations. Guarantee benefits typically cover up to $250,000 per person. So structured settlements have reliable safeguards in place.
Structured settlements provide customized tax-free income designed to cover future expenses related to injury claims. Specified periodic payments are determined during settlement processes based on individual needs.
Once the structured settlement schedule has been mutually agreed upon by all parties and annuities or bonds are purchased to fund it, recipients receive the payments as contracted. They cannot be changed or canceled (except in certain legal cases of demonstrated hardship where courts may approve early payouts to settlement purchasers).
However, external economic factors like inflation, interest rates, and recessions do impact structured settlements in notable ways:
- Inflation poses the largest risk to structured settlements. Over many years, high inflation can seriously reduce the real value of future fixed payments. Special inflation-adjusted payments or indexed increases are solutions to consider.
- Interest rates influence the returns structured settlements can offer at the time of settlement. However, after being set up, existing structured settlements are unaffected if rates go up or down.
- During recessions, some people may prefer larger lump sum payments in case of job loss. But structured settlements provide steady reliable income that continues no matter the economy. A few recipients facing unique hardship may qualify to sell some payments. Overall structured settlements deliver income stability even in shaky times.
The main point is that external economic changes rarely alter guaranteed structured settlement payments directly. But factors like inflation can erode the real value of fixed payments over decades. Understanding one’s own priorities and options to accommodate different economic scenarios leads to the best outcome.