Issue #46     July 28, 2008



By John J. Campbell, CELA, MSCC




         A basic understanding of the settlement process is important for any Medicare Set-Aside practitioner.   To properly advise the parties and to be able to craft a cogent analysis of the settlement for a submission of a Medicare Set-Aside Arrangement (MSA) to the Centers for Medicare and Medicaid Services (CMS) for approval, the practitioner needs to know why the parties are settling; what their expectations are from the settlement; and the most advantageous method of payment of the settlement proceeds.


         Just as important is a basic understanding of the use of structured settlements, which have become more and more common in Workers’ Compensation (WC) settlements over the past few years.  Since CMS has certain requirements for the funding of MSAs with structured settlements, practitioners should become familiar with the technical requirements of structured settlements from other perspectives so that the practical and tax advantages of structured settlements are not lost in attempting to comply with CMS requirements.


Why Do Parties Settle?


          If the plaintiff or claimant is successful at a trial or WC hearing, the potential judgment or award can be much higher than what the defendant may be willing to pay to settle the case.  In the context of a WC settlement involving future medical expenses, the settling claimant will be required to give up his or her right under WC laws to receive lifetime medical care for work related injuries or illness at the expense of the employer or WC carrier.  What factors come into play in the decision to settle a case when the result could be a significantly reduced amount in compensation or the absence of guaranteed medical care at no cost?


         One of the first and most common factors leading to a decision to settle a third party liability (TPL) or WC claim is the uncertainty of the outcome of a trial or hearing.  There may be legal issues regarding causation, compensability, liability or damages that could result in a verdict for the defendant, leaving the plaintiff or claimant with no award or judgment at all.  Even a well-tried case is subject to the uncertainties involved whenever someone who is not intimately familiar with the case is given the task of deciding which facts are true and how much, if any, compensation might be due.  There is always a risk of an adverse decision whenever the decision is left up to a third party, such as a judge or jury.  These considerations will come into play when the parties decide upon a compromised settlement amount.


          In the context of WC claims, state WC laws often provide the employer or the WC carrier with considerable authority to determine who the claimant’s doctor will be or what items or services will be approved for payment.  Many claimants find that, over time, the process of dealing with the employer or WC carrier to obtain pre-approval of medical providers or services can become burdensome and even exhausting.  In these cases, claimants will often be willing to receive a discounted settlement amount in return for the freedom to direct their own care.


         Finally, the process of bringing a TPL or WC claim to conclusion through a trial or evidentiary hearing can often take years.  In the mean time, the claimant may be unable to work or find another source of income.  House payments still need to be paid, food still needs to be bought, unexpected expenses will still arise.  Often, a plaintiff or claimant is anxious to settle, simply because he or she is in need of funds for support and other living expenses or obligations.  Rather than wait for a trial or hearing, and risk waiting even longer for the resolution of a potential appeal of the judgment or award, the plaintiff or claimant is willing to settle for a compromised amount now.


The Process


          The process of settlement is fairly simple in theory.  It consists primarily of negotiation and, if negotiation is successful, closure. 


The negotiation phase of the settlement process will always precede final settlement.  Negotiations may be conducted informally between the parties and/or their attorneys.  However, informal negotiations will often stall at some point and a successful conclusion will depend upon the intervention of an outside party, such as a mediator. 


          Mediation used quite often to resolve TPL and WC claims.  Sometimes, the parties will agree voluntarily to undergo mediation in an attempt to reach final and acceptable settlement terms.  Other times, mediation may actually be ordered by a court or WC judge or commissioner, even if neither party requests such an order.   Where mediation is ordered, there will be a deadline for the mediation to occur.  In these situations, MSA practitioners need to be sensitive to these time constraints.


          The services of MSA practitioners are often quite valuable to the parties during the negotiation phase of the settlement process.  The parties want to make well informed decisions regarding the terms of settlement, especially the amount of the settlement.  To arrive at an appropriate settlement amount, the parties may need to know the amounts of any Medicare Secondary Payer claims, Medicaid liens or other government claims or liens.  Where an MSA will be required, the parties will need an accurate estimate of the amount which will be needed to fund the MSA after the settlement is final. 


The parties will also need to know if there are any other issues involving public benefit eligibility that may be affected by the settlement, such as Medicaid or Supplemental Security Income (SSI) benefits.  The parties will look to MSA practitioners to advise them regarding CMS’s requirements regarding the entire MSA process of submission and approval.  Finally, the parties may need some guidance on whether it would be more advantageous to have the settlement paid out in a lump sum, an annuity structure, or some combination of the two. 


Assuming the negotiation phase of the settlement process has yielded an agreement acceptable to the parties, the parties will proceed to the “closure” phase.  Closure will always mean the reduction of the agreed-upon terms of settlement to a written settlement agreement of some sort.  These are typically prepared by counsel for the parties with experience in the proper drafting of these types of documents.  The settlement agreement will constitute a written contract setting out the terms under which the plaintiff or claimant will be compensated and the defendant will be released from further liability.


          In many, but not all, states, WC settlements will need to be approved by the WC judge or commissioner.  This requirement ensures that the settlement is both fair and in the claimant’s best interests.  In states that do require such approval, the settlement will not be final until entry of a final order by the WC judge or commissioner approving the settlement.  This final order will be necessary to obtain final approval for any MSA proposal that may be submitted to CMS.


          Since the final settlement agreement is a contract, the parties to that contract must have legal capacity to create a contract or the settlement will not be valid or binding.  If the plaintiff or claimant has mental capacity issues or if the plaintiff or claimant is a minor, the settlement will always have to be reviewed and approved by a court or WC judge or commissioner.  Usually, the approval of the settlement will be through a court proceeding.  If the parties are settling a TPL claim, the judge of the trial court where the claim is filed will often have the authority to give final approval for a settlement involving an incapacitated plaintiff.  Otherwise, approval of the settlement may need to come from a court with jurisdiction over the incapacitated person, usually a court with probate jurisdiction under the state’s guardianship laws.  Again, where court approval of the settlement is required, a copy of the final court order approving the settlement must be submitted to CMS for final approval of any MSA in connection with the case.


Lump Sum or Structure?


            One of the most common and important issues in the settlement process is how the settlement amount will be paid.  This is especially true where the settlement amount will be large or will need to be available over a long period of time. 


          Traditionally, both TPL and WC settlements were paid in a lump sum amount to the plaintiff or claimant at the time the settlement was final. This is still the case in many, if not most TPL and WC settlements.  However, there are factors that sometimes argue in favor of a different approach. 


When considering the practical issues, the parties may deal with a variety of questions.  Is there a significant risk that the proceeds of a lump sum settlement may be lost or dissipated due to poor money management or investment skills?  Will the settlement funds need to be available over a long period of time to pay for important items, such as support and medical care?  Is it more important to have the funds available on an immediate basis for emergencies or can the funds be placed into long term investments and accessed a little at a time?  Can the plaintiff or claimant accept deferred gratification in favor of immediate gratification from the settlement?  Finally, how can the plaintiff or claimant get the greatest value from the settlement at the least cost to the defendant, so that the parties may be able to reach an acceptable agreement more easily?


In addition to these practical considerations, it is also very important to consider the income tax ramifications involved in deciding whether to pay out the settlement in a lump sum or structure.


          Sections 104(a)(1) & (2) of the Internal Revenue Code (IRC) provide that proceeds of a WC settlement or settlement of a TPL claim involving physical injury or sickness (except for punitive damages) are not taxable.  However, income earned by plaintiffs on lump sum settlements of such claims is taxable.  Settling parties as far back as the 1970's reasoned that if a settlement could be paid out in periodic payments over time, the tax on settlement income could be deferred.


          However, there was a drawback to this idea.  When the parties to a WC or TPL claim agree to a settlement, it is the obligation of the defendant to pay the settlement monies to the plaintiff.  This is true whether the settlement is for a lump sum or for structured, periodic payments.  Until all of the settlement proceeds are paid, the defendant’s obligation continues.  A defendant would not likely be willing to agree to provide periodic payments if it required the defendant to actually make physical payments after the settlement to the plaintiff for 10 or 20 years.  When defendants settle, they want finality, not a continuing obligation.


          In 1983, Congress passed the Periodic Payment Act, amending the IRC to grant statutory authority for the use of periodic payments in personal injury settlements.  The Periodic Payment Act of 1982 created IRC §130, providing that periodic payments of settlement proceeds through a qualified assignment under IRC §130 are tax-free.[1]  Under IRC §130, the income from an annuity that makes periodic payments as part of a settlement of a PI claim for physical injury or sickness is exempt from income tax if there is a qualified assignment of the obligation to make the annuity payments. 


          The assignment of the obligation to make periodic payments constitutes a “qualified assignment” if the following requirements are met:


          (1) assignee must assume liability from a person who is a party to the suit or agreement . . .,  and


(A) such periodic payments are fixed and determinable as to amount and time of payment,

(B) such periodic payments cannot be accelerated, deferred, increased, or decreased by the recipient of such payments,

(C) the assignee's obligation on account of the personal injuries or sickness is no greater than the obligation of the person who assigned the liability, and

(D) the periodic payments must be excludable from the gross income of the recipient under IRC §§104(a)(1) & (2).[2]


          Further, the periodic payments must be funded with a commercial annuity issued by a life insurance company; and the annuity payments cannot be more that the periodic payments under the qualified assignment.  Finally, the annuity must be purchased with settlement proceeds within 60 days before or after the qualified assignment and must be designated specifically to payment of the qualified assignment.


          Once there is a qualified assignment of an annuity funding a structured PI settlement, the plaintiff cannot unilaterally change the terms of the annuity, including the payment amounts or the payee.[3]  The annuity must be purchased directly by a party to the PI suit with liability to the plaintiff to avoid constructive receipt of the settlement funds by the plaintiff.[4]  The plaintiff will also be treated as having constructive receipt of the settlement funds if he or she has the option of receiving a lump sum in lieu of an annuity, or the ability to direct the use of the settlement proceeds to purchase an annuity.[5]  


          Qualified assignments under §130 are available in the settlement of both PI and worker’s compensation claims, but only with regard to settlement proceeds that are exempt from taxation under Sections 104(a)(1) & (2) of the IRC. 




[1] 26 U.S.C. §130

[2] Id.

[3] IRC § 5891 provides for court-approved changes of the payee in situations in which there is a "structured settlement factoring transaction."

[4] Revenue Ruling 79-313 [1979-2 C.B. 75]

[5] Revenue Ruling 65-29 [1965-1 C.B. 59]; Revenue Ruling 76-133 [1976-1 C.B. 34]



         John J. Campbell, the founder and principal attorney of the Law Offices of John J. Campbell, P.C., has practiced law since 1986 and has practiced in the area of Medicare Set-Asides since 1996.  Mr. Campbell is certified as an Elder Law Attorney by the National Elder Law Foundation;* and is a Medicare Set-Aside Consultant Certified (national certification through the Commission on Health Care Certification).*  Mr. Campbell is licensed to practice law in Colorado and is also licensed and on inactive status in Missouri.  He is a member of the Colorado Bar Association (Trust & Estate Section and Elder Law Section), the Arapahoe County Bar Association, the Missouri Bar Association, the National Academy of Elder Law Attorneys, Academy of Special Needs Planners and the National Alliance of Medicare Set-Aside Professionals.  His areas of concentration include elder law; estate, disability and long term care planning; probate; guardianship and conservatorship; Medicare, Medicaid, Medicare Set-Aside Arrangements, and the preservation of public benefits in catastrophic third party liability and worker’s compensation settlements.  Mr. Campbell has published numerous articles and has presented numerous seminars on issues relating to Medicare Set-Aside Arrangements across the country.


*The State of Colorado does not certify attorneys as experts in any field.



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