How Are Structured Settlements Calculated?
A structured settlement is a financial arrangement where a claimant receives a series of periodic payments, rather than a lump sum, as compensation for a legal claim. Structured settlements are commonly used in personal injury, workers’ compensation, and wrongful death cases. The calculation of a structured settlement involves multiple factors to ensure the recipient receives the necessary financial support over time. Below, we break down the process of how structured settlements are calculated.
1. Determining the Total Settlement Amount
The first step in calculating a structured settlement is determining the total settlement amount. This is the total amount of money that the defendant (or their insurance company) agrees to pay the claimant to resolve the legal case. The total amount is typically negotiated during the settlement process and reflects the severity of the injury, future medical costs, lost wages, pain and suffering, and other relevant damages.
In personal injury cases, for example, the total settlement amount includes:
- Medical expenses: This covers both current and future medical costs associated with the injury, such as surgeries, therapies, medications, and ongoing care.
- Lost wages: Compensation for the income the claimant has lost due to their inability to work because of the injury.
- Pain and suffering: A monetary amount to compensate for the emotional distress and physical pain caused by the injury.
- Future care needs: Any future expenses that are expected, such as rehabilitation or long-term nursing care.
Once the total amount is agreed upon, the next step is to determine how the claimant will receive these funds.
2. Designing the Payment Structure
After the total settlement amount is determined, the next step is to design the payment structure. The recipient (often with the help of an attorney or financial advisor) works with the insurance company or annuity provider to decide how the periodic payments will be structured. There are several factors to consider when creating this structure:
a. Payment Frequency
The claimant can choose how often they wish to receive payments. Common options include:
- Monthly payments
- Quarterly payments
- Annual payments
The frequency of the payments can impact the overall amount received over time, as the distribution schedule is tailored to the recipient’s needs. More frequent payments may lead to higher payment amounts initially, while larger, less frequent payments could be set for longer durations.
b. Payment Duration
The duration of the structured settlement is another important factor. Payments can be set to last for a fixed term (e.g., 10, 20, or 30 years), or they can continue for the claimant’s lifetime. Lifetime payments are common for individuals who experience permanent disabilities or injuries that require long-term care.
The duration will be determined based on the claimant’s life expectancy, which is often factored into the calculation, especially for lifetime settlements. In the case of lifetime payments, actuaries will use life expectancy tables to ensure the payments continue until the individual’s death.
3. Calculating the Present Value
To ensure the structured settlement is properly funded, the present value of the future payments needs to be calculated. This represents the amount of money that must be invested today to meet the future obligations of the settlement. The present value is calculated using a discount rate, which reflects the time value of money—the idea that money available today is worth more than the same amount in the future due to its earning potential.
For example, if the claimant is due to receive payments of $5,000 per year for 20 years, the present value of those payments would consider:
- The amount of each payment
- The frequency and duration of the payments
- The discount rate (interest rates)
- The claimant’s life expectancy (in case of lifetime payments)
4. Inflation Adjustments
Many structured settlements include inflation adjustments to ensure that the payments keep pace with rising living costs, particularly for healthcare or other long-term needs. This is important because inflation can erode the purchasing power of fixed payments over time.
Typically, the settlement may be structured with annual payment increases, often ranging from 2% to 4%. This ensures that the recipient’s payments maintain their value throughout the life of the settlement. Calculating inflation-adjusted payments involves determining the base payment and adding a set percentage increase each year.
Conclusion
The calculation of a structured settlement involves several factors, including the total settlement amount, the payment frequency, the duration of payments, the present value of future payments, and inflation adjustments. These elements come together to create a plan that ensures the claimant receives reliable and adequate financial support over time. Structured settlements are customized to meet the unique needs of the recipient, providing financial security and stability in the aftermath of a legal settlement.
