Estimating the Income of an Aboriginal Plaintiff: Recent Evidence

Posted on December 1, 2013April 18, 2017 By economica

One of the more difficult problems facing the courts in personal injury actions is determining the future earning capacity of aboriginal plaintiffs ¹ . In this article, I report on data concerning aboriginal earnings that Statistics Canada has made available from the 2011 census – now known as the National Household Survey.

Note that the discussion below examines statistics for those individuals who fall within the “aboriginal identity” classification, as defined by Statistics Canada. That is, this is a general discussion and care should be taken, on a case-by-case basis, to ensure that the adjustments applied are relevant to the specific aboriginal identity and situation of the plaintiff.

1. Aboriginal incomes

The “all workers” figures outlined in Table 1 (which consist of full-time and part-time workers, as well as individuals who were unemployed for part of the census year) indicate that aboriginals earned annual incomes that were equal, on average, to 79 percent of those of non-aboriginals. The difference is larger for males (at 77 percent) than for females (at 82 percent). When hours of work and unemployment are accounted for, the difference between aboriginal and non-aboriginal incomes becomes smaller, with aboriginal income equal (on average) to approximately 85 percent of non-aboriginal income. Again, the difference is slightly larger for males (at 84 percent) than for females (at 88 percent).

Four factors appear to explain most of the differences between aboriginal and non-aboriginal incomes:

educational attainment,
unemployment rates,
labour force participation rates, and
whether the individual lived on or off of a reserve.

I discuss each of these factors in the sections below.

2. Educational attainment

As shown in Table 1, the difference between aboriginal and non-aboriginal incomes varies by level of education. Education affects this differential in two ways.

First, as shown in Table 1, aboriginals earn less than non-aboriginals at each level of education. Second, as shown in Table 2, aboriginals (on average) have less education than do non-aboriginals.

The data in Table 2 indicate that, on average, aboriginal individuals are much more likely to be non-high school graduates than are non-aboriginals. This is significant given that the average income of a worker with a high school level of education is approximately 28 percent higher than the income of a worker without a high school education. Further, aboriginals are much less likely to complete an education at the bachelor’s degree level than non-aboriginals. Again, this is important given that the average income of a worker with a post-secondary education is approximately 81 percent higher than that for a worker without high school.

3. Rate of unemployment

In addition to differences in educational attainment, aboriginals were more likely to be unemployed than non-aboriginals.

In Table 3, I outline the unemployment rate of aboriginal and non-aboriginal Canadians at each level of education.

As shown in Table 3, the unemployment rate experienced by aboriginal Canadians is significantly higher (at about twice the rate) than for non-aboriginals.

Educational attainment mitigates some of this effect, with aboriginal and non-aboriginal Canadians at the bachelor’s degree level or higher experiencing similar rates of unemployment. However, an unemployment rate for aboriginals that is approximately twice that of non-aboriginals appears to hold for levels of education below that of a bachelor’s degree.

4. Participation rate

In addition to difference in the unemployment rate and educational attainment of aboriginals, participation in the labour force is lower for aboriginals than for non-aboriginals. In Table 4, I outline the participation rate of aboriginal and non-aboriginal Canadians, at each level of education.

As shown in Table 4, approximately 74 percent of non-aboriginal males (with no high school education) participate in the labour force, while only 61 percent of aboriginal males at this level of education participate. This decreases to 52 and 44 percent for non-aboriginal and aboriginal females respectively.

5. Living on or off a reserve

The discrepancies in education, unemployment and participation rates discussed above become even more pronounced when comparing aboriginals living on reserve with aboriginals living off reserve.

Interestingly, the difference between the participation rates of aboriginal and non-aboriginal Canadians decreases as education level increases.

For example, for men with a bachelor’s degree or higher, the participation rates are about the same for aboriginals and non-aboriginals. For women with a bachelor’s degree or higher, aboriginal women actually have a higher participation rate than non-aboriginal women.

First, as shown in Table 5, the level of education is lower for aboriginals living on reserve than for those living off reserve. Again, a lower level of educational attainment will, on average, lead to a lower level of income, all else being equal.

Second, the unemployment rate experienced by aboriginals living on reserve is significantly higher than the rate of those living off reserve.

As shown in Table 6, males living on reserve experienced an unemployment rate that was approximately twice that of aboriginal males living off reserve, and this holds true regardless of education level.

Women living on reserve fared slightly better than males, experiencing an unemployment rate that was higher than, but not twice as high, as those living off reserve. Educational attainment mitigated this effect to some extent, at least for the level of bachelor’s degree or above.

Third, participation rates decreased for aboriginals living on reserve, when compared to the rates for aboriginals living off reserve.

As can be seen in Table 7, participation in the labour force is higher for individuals living off reserve than for those living on reserve. However, educational attainment is a significant mitigating factor, with the difference in participation rates on and off reserve becoming smaller as the level of education increases.

6. Conclusions

In large part, these figures explain why the ratio of the earnings of aboriginals and non-aboriginals was much lower for “all workers”, 79 percent, than for “full-time” workers, 85 percent. And, when education level and work behavior are controlled for, aboriginal earnings are actually similar to non-aboriginal earnings. For example, at the high school level, the aboriginal income was equal to 94 percent of the non-aboriginal income for males, and 96 percent for females.

For example, male aboriginals with no high school diploma, living on reserve, had a participation rate that was 14 percent lower than those living off reserve, while the participation rate of males on reserve with a bachelor’s degree was only four percent lower than those living off reserve.

Notably, at the non-high school level, aboriginal females working full-time earned slightly more than non-aboriginal females (with aboriginal income equal to approximately 101 percent of the non-aboriginal income).

I believe that the conclusions outlined below can be drawn from the information discussed in this article.

If nothing was known about a plaintiff except that he or she was aboriginal – for example, if the plaintiff was a child – it would be appropriate to assume that they would earn approximately 77 percent as much as a non-aboriginal for males, and approximately 82 percent as much as a non-aboriginal for females.
If the education level of the plaintiff is known (or has been predicted), but the individual had not yet established a work history, then it would be appropriate to reduce the full-time figures for males by six percent for non-high school and high school, and by 14 percent for post-secondary. For females, there would be no adjustment necessary at the non-high school level, a four percent reduction at the high school level, and an 11 percent reduction at the post-secondary level.
Further, in the above case, the unemployment rate would have to be adjusted upwards to equal twice that of an average worker for each education level except bachelor’s degree and above (as these levels of education do not require an adjustment).
The adjustments described above would likely double for a plaintiff living on a reserve. That is, the unemployment rate of an aboriginal person living on reserve is approximately twice that of an aboriginal person living off reserve. Further, participation rates decrease significantly when a person lives on reserve, and educational attainment is much lower on reserve than off reserve.
If the plaintiff had completed his/her education and had established a consistent work history, however, that history should form the primary determinant of the forecast of future earnings. The forecast would not require the application of adjustments related to the average aboriginal Canadian, as it would be based on the plaintiff’s demonstrated (i.e., actual) work history.

Footnotes:

Aboriginal identity is defined by Statistics Canada as including “persons who reported being an Aboriginal person, that is, First Nations (North American Indian), Métis or Inuk (Inuit) and/or those who reported Registered or Treaty Indian status, who is registered under the Indian Act of Canada, and/or those who reported membership in a First Nation or Indian band. Aboriginal peoples of Canada are defined in the Constitution Act, 1982, section 35 (2) as including the Indian, Inuit and Métis peoples of Canada” (see Statistics Canada’s website, www.statcan.gc.ca).

[back to text of article]

Laura Weir is a consultant with Economica and has a Bachelor of Arts in economics (with a minor in actuarial science) and a Master of Arts degree from the University of Calgary.

Implied Rates of Return on Structured Settlements

Posted on December 1, 2012April 18, 2017 By economica

by Derek Aldridge & Christopher Bruce

The purpose of a lump sum award in a personal injury or fatal accident case is to provide a fund that, when invested, will generate a stream of benefits equal to the plaintiff’s future stream of losses. One method of generating such a stream would be to purchase a life annuity. This, for example, is what is anticipated by Section 19.1 of the Judicature Act (RSA 2000) when it provides that:

(2) On application by any party to a proceeding, the Court may order that damages awarded be paid in whole or in part by periodic payments…

This type of periodic payment has come to be known as a structured settlement annuity. Such annuities are sold by insurance companies. When calculating the price it is going to charge for an annuity, the insurer determines how much it would have to invest, at current interest rates, in order to generate a stream of income at least equal to the required periodic payments. For example, if it had promised to pay $10,000 per year indefinitely , and the rate of interest that it thought it could earn was 10 percent, it would charge at least $100,000 – as $100,000, invested at 10 percent per year, would generate a stream of income of $10,000 per year.

Conversely, therefore, if we observe the lump sum that an insurance company charges for an annuity that promises a specified stream of payments, we can calculate the rate of interest that the insurance company expects to obtain on the investment of that sum. For example, if it was observed that the company had charged $100,000 for a periodic payment of $10,000 per year (indefinitely)¹, we would be able to calculate that the rate of return it expected to obtain on investment of that $100,000 was at least 10 percent.

We have used this principle to calculate the rate of return that insurers expect to obtain on a series of standard structured settlements. By contrasting these rates of return with the rates that Economica has been using, we can check whether Economica’s rates are consistent with those that sophisticated investors – insurance companies – expect to earn on low-risk investments.

With the assistance of Heber Smith, of Smith Structured Settlements (www.structuredsettlements.ca), in August 2011 we obtained quotes on an annuity that provided payments of $1,000 per month to a male plaintiff. These quotes were for

three different ages of plaintiffs: 20, 35, and 50;
two different termination dates: the plaintiff’s age 60 and his age of death; and
two different assumptions concerning inflation indexation: one in which the insurer increased the annual payment each year by the rate of consumer price inflation and one in which the payment was increased each year by a fixed 2 percent.

We report the quotes that we obtained for twelve different scenarios in columns 6 and 8 of the table below. As an example of how to read this table, the $127,064 figure in column 6 of the first row in the table, indicates that we were quoted a price of $127,064 to purchase an annuity that paid $1,000 per month, increasing at the rate of consumer price inflation, from the plaintiff’s age 50 to his age 60. Similarly, it is seen from column 8 of the first row that that annuity would have cost $121,255 if the payments had been adjusted by 2 percent per year instead of by the prevailing rate of inflation. (If we assume that insurers believe that inflation will be 2 percent on average, the difference be $5,809 difference between columns 6 and 8 in the first row is a “premium” the insurer charges to compensate it for taking the risk that inflation might prove to be higher than 2 percent.)

The comparable figures in columns 6 and 8 of the third row of the table report the cost of an annuity that extends to the end of the plaintiff’s life, instead of to age 60 (as in the first row). The figures in the third row would be relevant if an annuity was being purchased to pay for costs of care, instead of for loss of earnings (first row). The remaining rows in the table report the costs of annuities paying $12,000 per year to a 20-year old and a 35-year old.

Given the quotes reported in columns 6 and 8, we were able to calculate the real rate of interest (interest rate net of a two percent expected rate of inflation) the insurance company was expecting to receive from investment of each annuity. These rates are reported in columns 7 and 9, with the figures in column 7 referring to the quotes in column 6 and the figures in column 9 referring to the quotes in column 8. As an example, the figure of -0.95% in column 9 of the first row indicates that the insurance company anticipated that it would receive a nominal interest rate of approximately 1.05% (i.e. 1.05% nominal interest – 2.00% inflation = -0.95% real rate of interest, or discount rate).

Of the twelve discount rates reported in the table, only one – the 2.10 percent rate of return in column 9 of the second row – exceeds the lowest rate used by Economica, as reported in Table 2 of the first article in this newsletter – 1.80 percent on investments of less than four years; and most of the remaining discount rates are significantly lower than the rates that we recommend.

The result is that the present discounted values quoted by insurance companies for the purchase of structured settlements are considerably higher than the comparable values that would have been calculated by Economica. The latter values are reported in column 4 of the table. It is seen in column 4 of row four, for example, that whereas Economica would have calculated that a plaintiff would need $277,538 to replace $12,000 per year from age 20 to age 60; the quote we received for a structured settlement was $506,890 – 82.6 percent more.

The differentials are even greater if we use the discount rate that some other expert economists have recommended – 3.50 percent. In the fourth row of column 5, for example, we report that the present value of $12,000 from age 20 to age 60 would be $252,895 if 3.50 percent is used – less than half of the $506,890 that we were quoted for a structured settlement.

To conclude: in every case, the present values that we would estimate using our discount rate assumptions are considerably lower than the actual cost that a plaintiff would incur if he were to buy an annuity to fund his future losses. This is very strong evidence in support of the claims that we have made over the last several years that our discount rate approach is a conservative one. Based on the costs to purchase structured settlement annuities, and the plaintiff’s ability to demand that his/her loss be funded using this “periodic payment” approach (given Section 19.1 of the Judicature Act), it follows that any reasonable change to our discount rate approach would be to use lower rates, not higher (as some other experts have argued).

Acknowledgment

As noted above, Heber Smith, of Smith Structured Settlements generously provided us with quotes on various annuities which we used in the creation of this article. On previous cases, we have worked together with Mr. Smith when the plaintiff’s lawyer chose to argue that damages should be satisfied by periodic payments (in accordance with Section 19.1 of the Judicature Amendments Act), rather than a conventional present value. An advantage of having future losses assessed in this manner is that it removes the subjective nature of opinions concerning the discount rate. Instead of relying on opinion concerning the rate of return that a plaintiff will earn on his or her investments, we can determine precisely how much it will cost the plaintiff to purchase annuities to fund the future losses.

Smith Structured Settlements serves the personal injury community as an annuity brokerage specializing in the preparation of fee-based Section 19.1 damages reports. Should you wish to investigate such an option they may be reached at www.structuredsettlements.ca.

Footnote:

Of course, structured settlements never continue indefinitely. We use this example because of its mathematical simplicity. [back to text of article]

Timing, Turning Bad into Good

Posted on September 1, 1998March 24, 2017 By economica

by Heber G. Smith

This article was originally published in the autumn 1998 issue of the Expert Witness.

In the past, my financial advisors were quick to remind me how splendidly they were handling my finances. More recently, however, they are somewhat sheepish discussing the more than modest shrinkage in my meager retirement assets, referring to such world events such as the Asian Crisis and the Russian meltdown as possible causes.

Upon closer scrutiny, I discovered what may have been long apparent to investors more skilled than I — that portfolio performance isn’t always a function of management but of timing. During a bull market, most equity positions increase in value but during bear markets, the converse is usually true. To make matters worse, an investor who is dependent on a market-based portfolio for needed income, will find that the concept of dollar cost averaging works against him/her when withdrawing regular fixed dollar sums from equity portfolios during a bear market. The timing of such sells to satisfy fixed income requirements dictates that, on average, more assets are sold low than are sold high. In order, therefore, to enable a personal injury client to reap the income required for the settlement duration, we suggest that an action settled during the early stages of a bull market is best. Consider the following chart (below left), which illustrates regular withdrawals of $1,200 per month adjusted for a 25% tax rate when $250,000 is invested in the TSE 300 in the fall of 1992. The result is an increasing portfolio value.

* An assumption of stock market cyclicity of 6 years was used so that the same TSE 300 data repeated every 6 years leaving the starting time as the differentiating variable.

Conversely, a different picture appears if the same $1,200 per month adjusted for tax is withdrawn from the same sized portfolio beginning in the spring of 1998 (above right). Under this scenario, the personal injury claimant has the added anxiety of wondering whether his funds may dissipate before their specified time. Unfortunately for the claimant, a personal injury settlement date is not dependent and timed for receipt according to stock market investment cycles.

Hope in the ability to time markets need not be as critical a factor. By using a combination of a structured settlement and dollar cost average purchases in the TSE 300, one can reduce risk and, during volatile markets, virtually assure an increase in settlement withdrawal periods.

Consider providing for a claimant’s income requirements via a structured settlement for the first 16 years and the purchase of a second annuity to support the dollar cost average purchases in the TSE 300 over the same period. The following graph depicts the value of the investment fund at the end of the 16 years when purchased in the spring of 1998 in comparison to the value of the investment fund purchased by using an annuity and dollar cost averaging over the same period.

So what makes it all work? It is the combination of financial planning tools; diversification and risk reduction that go a long way to turn what could be bad timing into good (or at least better timing). But the biggest factor is the imputed contribution made to the settlement by Revenue Canada Taxation in the way of tax forgiveness on the interest element of the annuity contract supporting the settlement. In combination, the above enables a claimant to grow the investment fund prior to withdrawals thereby increasing the number of payment periods and reducing anxiety due to dissipating funds.

Heber Smith is the principal of Smith Structured Settlements Inc. a structured settlement and annuity brokerage with offices in Calgary and Vancouver. He is also a partner in Structured Settlement Software, a firm that provides tax driven software to the American structured settlement industry.

Not All “Bears” Are Bordering Extinction

Posted on June 1, 1998March 24, 2017 By economica

by Heber G. Smith

This article was originally published in the summer 1998 issue of the Expert Witness.

Plaintiff counsel’s job respecting a personal injury action is securing an acceptable offer. All of his/her energies are expended to that end with the result that little attention is given to after-settlement considerations. Now that the claimant has the cash, how does he/she convert the cash into income to provide for lost future income or the cost of future care?

Impressive gains in the market have headlined all financial publications in recent years. Consider recent mutual fund advertisements citing returns of 20.8% in one year and 21.2% in two years. What sensible personal injury or wrongful death award would not be enticed by the siren of such gargantuan returns?

In contrast, today’s interest and annuity rates seem inordinately low and may drive investors that should seek safety to the equity markets. However, consider the risks and costs with embarking on such a strategy.

One risk that needs to be considered is the nature of equity markets. In many respects we may have become lulled into a false sense of security with the extraordinary increases over the past few years. Recent market volatility and uncertainty are causing many investors to rethink their positions. As a result there has been a movement toward higher quality equities and a resurgent interest in bonds. Another uncertainty that today’s investor faces is trying to determine the length of this increased volatility and uncertainty. Is today’s uncertainty merely a pause, or does it foreshadow a greater correction? Historically, the usual market uptrends have been sporadically dotted with significant downturns that have taken many years to recover to pre-correction levels. Under these conditions, recipients of lump sum awards fully vested in equity markets could become severely disadvantaged especially if the downturn was to last for an appreciable amount of time. In the current issue of Investment Executive, Carlyle Dunbar is quoted as saying: “though they [investors] won’t sell if the market drops, most aren’t expecting a drop of 20% or 25%. The reality has been that most investors – especially newcomers go into shock when a bear market develops.”

Another consideration is the fiduciary role of financial advisors who are governed by the “prudent-man” rule. Should a lump sum recipient retain a financial advisor, it is likely that their risk position be classified as conservative. Under this classification, a recipient’s assets would be allocated across equities, fixed income and cash equivalents. The fact fixed income and cash equivalents typically return less than common equities would preclude the possibility that the recipient would achieve the type of returns advertised by many funds.

The prudent man rule dictates that, amongst other criteria, a financial advisor provides for “reasonable diversification”. Such diversification might suggest a common 50/40/10 (equity/bond/cash) portfolio investment split. Some formulas may suggest a 60/30/10 but the former may be more responsive for an investor requiring income. Consider the following example:

	Equity	Bond	Cash
Percentage Allocation	50%	30%	10%
Assumed Return	10%	5.5%	3%
Management Fee	2%	1%	0.5%
Tax	20%	40%	40%

Weighted Average, Net After Tax Rate of Return: 4.53%

Given that the above strategy assumes a high measure of equity exposure, one may wonder why the recipient of a personal injury award or wrongful death settlement might not consider a structured settlement when the net return is approximately 5.5% (the equivalent of a pre-tax rate of return of 9.17% for a tax payer in a marginal rate of 40%). An investment strategy, incorporating a structured settlement tailored to the specific circumstances of the claimant, will result in superior returns at a lower risk.

Structured Settlement Assignments

Posted on September 1, 1997March 24, 2017 By economica

by Heber G. Smith

This article first appeared in the autumn 1997 issue of the Expert Witness.

Unlike their American counterparts, property and casualty insurers in Canada typically (in compliance with Revenue Canada’s Information Bulletin, IT-365R2 dated May 8, 1987) remain liable to pay the periodic payments payable under terms outlined in the settlement agreement. They, effectively, become a guarantor of the life insurance company that underwrites the annuity contract(s) issued in support of the agreement.

The ownership obligations transcend its simple performance as a back-stop to the annuity contract. The property/casualty insurer, as owner and annuitant (beneficiary), must deal with the accrual tax ramifications of the internal interest component of the annuity contract. As an insurance company, however, it has access to the right to take a reserve under Section 1400(e) of the Rules and Regulations in the Income Tax Act (Canada). Since the interest build-up in the annuity contract is approximately equal to the increasing obligations of the defendant insurer to make future payments to the claimant, the two become a virtual wash and the tax cost to the insurer virtually disappears.

What options exist for the non-insured defendant to a personal injury action? Are such entities simply denied access to the structured settlement option as a method of resolving a personal injury or wrongful death action? The problems faced by such a defendant are twofold; the first is that, because it is not an insurer, it may lack the internal expertise to assess the risk that may be involved with the continuing obligations under the terms of the settlement agreement; and secondly, without access to Section 1400(e), it would be responsible for the tax liability arising out of the annuity and unable to take a write-off for the obligations to make future payments to the claimant.

Revenue Canada now permits a defendant to “assign” it’s contingent ownership rights and obligations inherent with the annuity contract and the performance requirements contained in the settlement agreement to a qualified assignee. Under the terms of such an assignment the defendant shall agree to absolutely assign to the assignee and the assignee shall agree to absolutely assume and to substitute its performance in respect of the obligation to make the required payments to the claimant. The plaintiff must agree to consent to the absolute assignment and assumption and agree to the substitution of the performance of the defendant for that of the assignee. The plaintiff may then absolutely release the defendant in respect of the liability of the defendant for damages resulting from the injuries or wrongful death.

The result is that self insured defendants now have access to the tax-free periodic payment option to remediate a claim with respect to personal injuries or wrongful death. In addition to the traditional self insured defendants, the beneficiaries of such an arrangement include defendants of product liability actions where aggregate claims exceed available insurance limits. Foreign insurers defending actions in Canada may avail themselves of such arrangements without modification to traditional structured settlement administration wherein they assign their obligations on all such transactions. Most insurers are not prepared to change their internal systems to accommodate the small number of potential claims that they may be required to defend in Canada. Another opportunity to use structured settlements, where without assignments it would be impossible, include criminal assault or abuse situations under which a victim has a right to initiate a civil action.

Plaintiff’s counsel may wish to lean on the structured settlement broker to ascertain the financial covenant afforded by the arrangement. The financial covenant may be better or worse than it would have been were the defendant insurer to remain as owner and guarantor under the terms of settlement. A report delineating the risks versus the benefits may be beneficial. For the comfort of the claimant, counsel may wish to be provided with a precedent Revenue Canada advance tax ruling of the scheme or alternately make application to Revenue Canada for such a ruling.

Structured Settlements: Case Suitability

Posted on June 1, 1997March 24, 2017 By economica

by Heber G. Smith

This article first appeared in the summer 1997 issue of the Expert Witness.

It has been said that “only the very large cases” merit consideration for a structured settlement. Some suggest that the list should be expanded to include actions that involve minors and/or those otherwise incapable of managing their own resources.

In reality any injury action that has been reserved for $50,000 or more may merit consideration for a structure, but that doesn’t mean that every case in that category should be structured. Typically, files that, if structured, might generate insignificant income, may not merit consideration in the final analysis. For example, actions involving tax-creditable Cost of Future Care under which the claimant may be financially sophisticated, may also not be worth consideration; but only if the claimant is elderly. A young claimant in a high marginal tax bracket may find him/herself in the unfortunate situation whereby the tax credits reduce tax payable at the lowest rate while investment income increases tax payable at the highest rates. The spread between the two rates of tax and the long period over which the investment must compound to offset inflation may tilt the scale in favour of the structure. Such little nuances make it tricky for plaintiff’s counsel to determine exactly when to recommend that his/her client entertain a structure.

Typically, those cases most suitable for structuring include:

Infants;
Those claimants not mentally capable of managing their own resources;
Claimants whose future life expectancy may be in doubt;
Claimants who are in high income tax brackets;
Cases involving a Cost of Future Care claim;
The elderly who wish to control the distribution of their estates;
Claims that might entail a Tax Gross-Up or Management Fees; and
Excess of Policy Limits cases.

Effects of Taxation

For any Canadian taxpayer, regardless of his/her tax jurisdiction, taxation will have an onerous impact on resultant net income. With 40% taxation on incomes in excess of $30,000 it becomes incumbent on plaintiff’s counsel to introduce the structure option and the tax free nature of the resultant income to a claimant. With a structure analogous to a “matching grant” or “imputed contribution” from Revenue Canada it is no wonder that such a settlement vehicle has become instrumental as the main incentive to conclude many personal injury actions.

Design Development

Input by plaintiff’s counsel to the modeling of the payment scheme is critical to the ultimate success and conclusion of an action by means of a structure. Consideration must be given to medical, rehabilitation, custodial and health care costs, adjusted for anticipated inflation. Future education costs (for both the claimant and/or his/her family) and loss of future income estimates should also be discussed during the settlement negotiation process.

Ideally, the structured settlement specialist should attend that meeting and work with the plaintiff and his/her counsel on the same basis that a mediator caucuses during that process. When accurate estimates of the claimant’s future income and eligible tax credits are known, it is possible to accurately estimate Revenue Canada’s imputed contribution to the proposed settlement — a sum that may very well be sufficient to bridge the gap between the parties.

Lost Years Maybe, Lost Care – Never

Posted on March 1, 1997March 24, 2017 By economica

by Heber G. Smith

This article was originally published in the spring 1997 issue of the Expert Witness.

Whilst the debate over methodology of compensation for the “Lost Years” may rage on, there does exist a simple solution for providing care for a claimant whose injuries (or for that matter, other health ailments) may result in a diminution of life expectancy.

Compensation for the cost of future care of an individual whose life expectancy is demonstrably impaired, need obviously be less than that required for someone whose anticipation of a future lifetime is normal. But who is to say that he or she will live that long? What happens if he/she lives longer?

On the flip-side of the life insurance industry’s practice of “rating-up” or declining an unhealthy applicant for life insurance, some insurers have a practice of improving the income provided by a fixed premium for an annuity applicant deemed by the insurance underwriters to have little likelihood of living to a normal life expectancy. The results of this practice may reduce dramatically the cost of providing “guaranteed-for-life” future care. Cases involving severe injuries have lead some insurers to rate-up prospective measuring lives (the person on whose life the payments are determined) by as much as and in some cases more than 50 years. As one might imagine, the saving inherent in providing lifetime payments for a 65 year old claimant as opposed to a 15 year old can be consequential.

To further reduce the cost is the flexibility that Revenue Canada confers on the structured settlement annuity. Since the casualty insurer is the owner and beneficiary of the supportive annuity and since paragraph 1400(e) of the Income Tax Regulations governing reserving taxation of insurers permits the tax free ownership of the annuity, it is possible to purchase more than one annuity to support the periodic payment stream. This permits the structured settlement annuity broker to ferret the most favourable components of a required stream from a number of companies; i.e. select the most favourable interest rates from one or more companies and the most favourable (negative) life expectancy offering from another.

Revenue Canada now permits a new twist in it’s heretofore “irrevocable and non-commutable” requirements under IT-365R2. Upon the death of the claimant the cost of future care payments under a structured settlement need not vest indefeasibly in the claimant’s estate. Since the death of the claimant negates the need to provide for care, Revenue Canada now takes the position that the future guaranteed payments may revert to the defendant insurer and that the insurer may commute those payments. Comforted by the fact that it may recover a significant percentage of its cost of future care outlay, the insurer may be somewhat more favourably predisposed to negotiate other components of the action.

Very seldom do people die at the “right” time. The problem becomes magnified in respect to a personal injury action since the defendant may overcompensate a victim that dies too soon and a victim that lives too long may find him/herself without adequate resources to provide for care at an age when it may be most imperative to so. The annuity is truly a no-waste solution.

Annuity Concepts (Continued)

Posted on June 1, 1996March 23, 2017 By economica

by Heber G. Smith

This article first appeared in the summer 1996 issue of the Expert Witness.

In the previous edition of The Expert Witness our contribution discussed annuities in general as well as some features that qualify annuities as the ideal tool to deliver a specified sum to a specified party at specified times. Whilst the ultimate purpose of this series is to provide users with an effective understanding of how they can use structured settlement annuities, a thorough background in annuity options may be helpful, not only to the litigation counselor in the remediation of tortous actions but also to the estates and wills practitioner. This article will address how the use of “non-commutable” terminology can give fluid expression to the wishes of the annuity settlor.

Costs

The settlor of a trust, intent on generating periodic payments rather than lump sum cash to a beneficiary, will most certainly face some onerous costs in an attempt to achieve an expression of his/her desires. But a cost far greater than that of disbursements for legal fees, fund management and trust costs are those costs associated with the failure of the trust to perform financially to the expectations of the testator. Most practitioners are familiar with the occasional inadequacy of investment performance, especially when considered net of costs and fees, but the biggest land mine in the path of the testator’s plan is the potential for litigation and the ultimate insufficiency of the trust to achieve the settlor’s wishes.

The inclusion of a simple irrevocable clause within the terms of an annuity contract may preclude such failure.

Income versus Capital

In all too many circumstances, the beneficiary has and may exercise, the litigation alternative to a trustee declared proviso for trust income or partial trust income. A dissatisfied income beneficiary may, possibly without expense to himself/herself, attack trust capital. Even in the event that the beneficiary might be unsuccessful in such an endeavor, that endeavor may be at the expenses of the estate or trust.

A “non-commutable” annuity, however, may not and cannot be converted to cash. This proviso within an annuity may or may not be ascribed to the initial payee under such contracts. In addition, the provision may apply only to the primary beneficiary or payee or possibly to both the primary and secondary right holder but not to a subsequent right holder. Once an annuity settlor has dealt with the issue of potential income beneficiaries, he or she may elect that the subsequent right’s holder (beneficiary or payee) be entitled to commute the then present value of the annuity payments.

A testator, facing the uncertainties with respect to the execution of his or her wishes under the terms of a trust, may find that an annuity represents a refreshing alternative especially when one considers the fact that the annuity contract is without additional costs or fees.

The Annuity Solution to Fund Cost of Future Care

Posted on March 1, 1996March 23, 2017 By economica

by Heber G. Smith

This article first appeared in the spring 1996 issue of the Expert Witness.

Ask any seasoned personal injury litigation professional what the advantages of a structured settlement are and you’re certain to hear that “the periodic payments are tax-free”. While true, there is more, much more to the structured annuity that makes it the preferred settlement vehicle. In order to fully appreciate the structure concept, how ever, it is important to understand the fundamentals of an annuity.

The much maligned annuity truly is a financial performer. A very competitive annuity marketplace has led to rates of return that out-muscle the after-management-fee yield available through a well managed bond portfolio. But the true magic of an annuity is it’s capacity to provide income – when it is needed and in the amounts that are needed. From a personal injury or wrongful death settlement point of view, every payment that is required to be paid, or expected to be paid, will be paid. And at the end of the required period all of the funds will have been fully and purposefully spent; truly a no-waste solution.

Pay Too Much; Solve Too Little

While it may be actuarially correct to remunerate a plaintiff in accordance with the possibility or probability of his (or her) surviving each successive year, does it make sense practically to compensate every cost of future care claimant to the end of the life expectancy table? Furthermore, does it make sense for the claim ant to expend only a portion of the required care cost, thereby permitting the reinvestment of the fund, in order to provide for the remote possibility of his surviving to the end of the life expectancy table? For example; a twenty five year old male has about a 30% chance of not surviving beyond age 70. Actuarially speaking, our 25 year old must spend progressively less of his required cost of care and progressively more must be reinvested to provide for the eventuality that he may survive past age 100, or to the end of the mortality table. If his cost of care at age 70 is $10,000 annually his fund would provide that $7,000 be paid out of the award or settlement and $3,000 must come from another source.

The above is academically fair – at least for a large number of claimants. But what of our single claimant? In order to provide for the possibility of a longer than average life expectancy he must deprive himself of much of his required care, although, depending on when he dies he may be survived by some very happy beneficiaries. If he assumed normal life expectancy, spent fully on his cost of care and outlived the investment, funding for his care would then cease or the family and/or society would pick up the cost.

Typically those who fund the excess are defendant insurers and the beneficiaries are not the claimants, but the estates of the claimants. An annuity can, however, pay fully 100% of the required cost of care every year that he remains alive.

By understanding how an annuity works you will be better prepared to advise your clients how to negotiate a settlement. Let’s look at how an annuity works!

Annuity Terms and Concepts

Annuities Defined

An annuity is an investment vehicle that pays periodic payments consisting of interest and principal until such time as the fund becomes extinguished. In this manner it resembles a mortgage in reverse, where the annuitant assumes the role of the bank and the insurance company the borrower. The annuitant may elect to have the term of the payments set out as a specific period of time (as a specified number of years) or set to some undetermined eventuality (to the death of the annuitant), or a combination thereof.

Term Certain Annuities

The term of the annuity may be for a certain number of years (i.e., 10 years, 25 years, etc.) and the entire fund including principal and interest will be paid out coincident with the final payment. At any given time the value of the annuity may be determined using tables or a spreadsheet that calculate the then present value of the remaining payments.

Life Annuities

The term of a life annuity is the life of the annuitant (or in the case of structured settlement annuities, the measuring life). The last payment that would be made to an annuitant would be the last payment due prior to death. A life annuity provides payments that continue for life, regardless of how long the claimant remains alive. By taking advantage of the annuity issuers capacity to spread the risk of “living too long” amongst many such claimants, not every claimant need provide for the contingency that it may be he who remains alive beyond the end of his appropriate life expectancy.

One of the common criticisms of life annuities is “It’s OK while I’m alive, but on my death the insurance company keeps all of my money”. To some extent that criticism is valid. That is why most annuitants elect a life annuity with a guaranteed period.

Life Annuities with a Guaranteed Period

A guaranteed life annuity overcomes the above criticism in that it contains a provision that guarantees the payments to continue for a minimum number of years and thereafter for so long as the annuitant or measuring life remains alive. Understanding annuity concepts and life expectancy enables the annuity broker to assist the parties in selecting the most advantageous guarantee period to place on the annuity. The existence of family dependents, existing life insurance policies and other assets would have an influence on the determination of the guarantee period.

“Rated-Up” Life Annuities

To successfully lead evidence at trial that a significant diminution in life expectancy may be ascribed to a given plaintiff may be difficult. Without the most compelling evidence a caring judge might be very reluctant to rule that the unfortunate victim before him was certainly going to die at some date much earlier than normal life expectancy.

An annuity issuer on the other hand is not faced with the onerous task of ruling on the future economic well being of a plaintiff and can easily categorize a given accident victim’s injuries and ascribe a life expectancy assessment within which that individual may be grouped. Whether he lived too long or died too soon would not be of concern to the insurer since it need only be concerned with averages. As a result, annuity issuers often attribute a much more pessimistic life expectancy than do the medical experts or the courts. The outcome is simple; less years to pay = lower cost.

The fact that major annuity issuers compete fiercely with one-another further enhances the defendant’s opportunity to purchase an annuity priced on the basis of the most pessimistic assumptions.

Indexed Annuities

Some annuities provide increases each year, typically to offset inflation. These are referred to as indexed annuities. The indexing rates normally vary from 2 to 4 percent annually and it is possible to purchase annuities indexed to the actual rate of inflation. To provide increased payments in the later years the issuer holds back a portion of what otherwise would be paid to the annuitant and reinvests it.

Misunderstanding can often arise with respect to assessing the rate of return on indexed annuities. The rates of return on level annuities are relatively easy to estimate but not so easy on indexed annuities. While level annuities may generate higher incomes in the early years, inflation erodes the purchasing power of future income which make level annuities inappropriate for long term solutions.

Economica

Assessment of damages in personal injury and fatal accident litigation

Tag: Structured Settlements