BILL ANALYSIS SENATE JUDICIARY COMMITTEE Adam B. Schiff, Chairman 1999-2000 Regular Session SB 491 S Senator Johnston B As Amended April 5, 1999 Hearing Date: April 20, 1999 4 Insurance Code 9 GWW:jt 1 {u SUBJECT u} Sale of Structured Settlements Received in Tort Claims: Disclosure and Court Approval Requirements {u DESCRIPTION u} This bill {u u} would prohibit the sale of structured settlement payment rights received to settle a tort claim unless the buyer discloses certain financial terms of the purchase to the seller 10 days before the contract is signed, and a court approves the sale upon a noticed hearing involving all interested parties and upon its finding that the sale is necessary for the financial welfare of the seller. The bill would not apply to structured settlements which were imposed by law. (This analysis reflects author's amendments to be offered in committee.) {u BACKGROUND u} According to news accounts, US News and World Report, January 25, 1999, more than $5 billion in structured settlements are awarded each year. SB 491 comes to the committee at the behest of a coalition of insurance and annuity companies for the stated purpose of protecting injured consumers. These sponsors say that consumers who received a structured settlement to compensate them for tort injuries are being preyed upon by (more) SB 491 (Johnston) Page 2 unscrupulous "factoring companies" (or structured settlement purchasers) that seek to purchase the payment rights at a deep discount, as much as 50% to 75% of present value in some cases, thus causing financial hardship for the consumer when the lump sum buyout is spent. While true, a more plausible reason for their sponsorship of SB 491 is their fear that these buyouts threaten the favorable tax treatment given to the parties (particularly the insurance and annuity companies) under a structured settlement if the periodic payment rights are sold to another. In opposition, the structured settlement purchasers allege that the real aim of the sponsors is to protect their present ability to use structured settlements to settle cases with fewer outgoing dollars instead of having to pay lump sum amounts. Opponents allege that their recent increased activities to purchase structured settlement payment rights has had the side effect of educating consumers about the real worth of structured settlements, thereby making injured consumers less likely to accept a structured settlement and making it more difficult for an insurer to settle a case for cheaper dollars. The opposition also disputes that any tax advantages would be lost, pointing to a private opinion. (See Comment 5.)For their part, the opposition believes it is providing consumers with a valuable alternative and wishes to continue its business undisturbed. In an actual sales agreement provided to staff by the sponsors, the agreement between the tort claimant seller and the payment rights buyer stipulated all of the following: Seller has received independent tax and accounting advice and legal representation, or has waived legal representation. Seller agrees to forego favorable tax treatment and acknowledges that sale may result in increased income taxes paid by the seller. The purchase agreement is confidential proprietary information belonging to the buyer. The seller agrees not to sue and expressly waives jurisdiction and standing to bring suit under the contract, and further agrees to indemnify and hold harmless the buyer if any suit is brought by the seller or on the seller's behalf contesting the sale for any reason (including fraud). (News account report cases SB 491 (Johnston) Page 3 where the seller also stipulates to a confession of judgment.) The seller is responsible for paying the buyer's attorney's fees and costs if the purchase agreement is not completed, after a three-day cooling-off period, because the seller later changes his or her mind. Brokerage fees paid by the buyer shall be added to the purchase price for purposes of calculating the seller's rate of return or the discount rate applied to the transaction. (The effect is to distort the net cash benefits to the seller, making it appear as if the seller were netting a higher return in the sale.) Exclusive jurisdiction for any action is vested in New Jersey federal court. The parties stipulate New York law to be the controlling law. {u CHANGES TO EXISTING LAW Existing law u} permits a personal injury tort damages award, and a workers' compensation award for permanent disability, to be paid in periodic payments (also known as a structured settlement) rather than a lump-sum payment. In some cases, such as the installment payment of more than $50,000 in future damages in a medical malpractice action or the installment payment of certain judgments against a state or local public entity, structured settlement payments are required. (Code of Civil Procedure section 667.7, Government Code sections 970.6 and 984.) {u Existing law u} does not limit the plaintiff receiving a structured settlement in a tort action from selling the payment rights. However, existing law prohibits the transfer of payments rights received in a workers' compensation claim without the approval of the workers' compensation appeals board. {u This bill u} would, on or after January 1, 2000, prohibit the sale or transfer of structured settlement payment rights received in settlement of a tort claim by a California resident or by any other person receiving payments originally funded by a California domiciled insurer, and would prohibit payments to a buyer or transferee of the structured settlement payment rights, unless all of the following conditions are met: SB 491 (Johnston) Page 4 At least 10 days prior to the entering of the transfer agreement, the buyer (or transferee) provides the seller with a written disclosure disclosing all of the following: 1) the amounts and payment dates of the payments to be transferred; 2) the aggregate amount of the payments; 3) the gross amount of all expenses; 4) the amount paid to the seller, net of all expenses, in exchange for the payments; 5) the discounted present value of the payments to be transferred and the discount rate used in determining that discounted present value; and 6) the seller may be subject to adverse federal and state tax consequences as a result of the sale. A court approves the transfer upon finding all of the following: 1) that the transfer is necessary to allow the seller or seller's family to avoid imminent financial hardship, and the transfer would not subject the seller or the seller's family to undue financial hardship in the future; and 2) the transfer of the payment rights is in the best interest of the seller and is fair and reasonable to all other interested parties (defined to include the annuity company making the periodic payments and the insurer that funded the annuity contract) under all of the circumstances then existing. The bill would establish a procedure for giving notice of the court hearing to all interested parties, who would be made parties to the proceeding and be given an opportunity to support, oppose, or otherwise comment on the proposed transfer. As amended by author's amendments to be offered, the bill would not apply to structured settlement payment rights in workers compensation cases or where the structured settlement was imposed by law upon a tort claimant. COMMENT 1. {u Need for reform, but solution may be less than clear u} News accounts and other documentation provided to committee staff evidence a problem in need of reform. SB 491 (Johnston) Page 5 The purchase agreements require the consumer to stipulate to a host of provisions which severely restricts consumers rights and raises questions as to their basic fairness. To forestall suit, however, the contracts also require the consumer to defend and hold harmless the purchasing party in any lawsuit. (See Background, above, for description of several standard clauses in the contract.) Nor are the price terms always fair or even reasonably fair. News and summary accounts provided to committee staff show that some sales are completed with a 12 percent or 15.8 percent discount rate, but other sales have been completed with a rate as high as 55, 65, and 75 percent. In addition, since the discount rate is invariably calculated on the purchase price which includes brokerage and other expenses "agreed" to by the seller in the contract, the real discount rate and cost of the transaction to the seller is artificially depressed. Moreover, there is no requirement to disclose to the seller, in understandable terms, the total costs of the transaction. The proposed written disclosure requirements (10 days before entering of contract) would solve a part of the problem. However, the disclosures themselves appear slightly inadequate. For example, the bill would require disclosure of "the discounted present value of all payments to be transferred and the discount rate used in determining that discounted present value." Without more, that disclosed number will be meaningless to consumers who are unsophisticated as to the meaning of discount rates. What may be needed is a commonsense disclosure of the effective interest rate being paid by the consumer in selling his or her payment rights, e.g., if the consumer had borrowed an amount equal to the net purchase price, what would the annual percentage rate of interest be if that money had to be paid back at the installment rate and terms specified in the purchase agreement? Moreover, the bill does not prohibit the buyer from including "expenses" such as brokerage fees as part of the purchase price in calculating the discount rate, a practice which produces a deceptively lower discount SB 491 (Johnston) Page 6 rate. SHOULD THE PROPOSED DISCLOSURE REQUIREMENTS BE STRENGTHENED, OR ARE THEY SUFFICIENT TO GIVE A CONSUMER ACCURATE NOTICE OF THE COSTS OF THE PROPOSED TRANSACTION? 2.{u Requirement for court approval is overly broad as proposed u} Particularly if a seller of structured settlement payment rights seems likely to squander the lump sum buyout and thereby create the likelihood that he or she may have to rely on future public assistance, a requirement for court approval seems justifiable. This should not, however, warrant a general rule requiring court approval of all sales. Structured settlements are not limited in their monetary range. While used initially in catastrophic injury cases, they have been used increasingly in recent years to resolve much smaller tort claims. This use in smaller cases must be considered if court review will be required for any sale of structured settlement payment rights; it would be a poor use of court resources for it to consider a petition to sell payment rights only worth a small sum. SHOULD THE REQUIREMENT FOR COURT APPROVAL BE LIMITED TO CASES INVOLVING THE SALE OF PAYMENTS RIGHTS TO A SIGNIFICANT SUM OF MONEY, FOR EXAMPLE, $25,000? The proposed process may also be overly cumbersome and prejudicial to the tort claimant seller, to the benefit of annuity companies and their insurers. For example, the bill would make "all interested parties" a party to the proceeding and permit them to support, oppose, or otherwise respond to the transfer application. The bill would define "an interested party," to include the annuity company as well as the insurance company funding the annuity. Because of the threat of adverse tax consequences, proponents contend that the insurer and annuity company SB 491 (Johnston) Page 7 should have standing in the proceeding. However, it is unclear, though unlikely, that adverse tax consequences would follow. (See Comment 5.) (If the sale were to trigger adverse tax consequences for the annuity company, their standing in the proceeding would allow them to argue that the court should require the seller to make the annuity company whole, perhaps by ordering a deduction from the periodic payment to offset the new tax liability.) It is also unclear why the insurance company should have standing since its obligation (and tax treatment of such) was completed by funding the annuity contract. The tax fear appears speculative at most, and may in fact be groundless. Thus, providing insurance and annuity companies with standing to challenge a person's sale of his or her property rights seems both premature and unwarranted. SHOULD THE COURT BE REQUIRED TO CONSIDER THE INTERESTS OF THESE OTHER ENTITIES WHEN THE CONSUMER WISHES TO SELL HIS OR HER PROPERTY RIGHT? SB 491 would also provide that a court may approve a sale only if the transfer is in the best interest of the seller, "and is fair and reasonable to all other interested parties under all the circumstances existing at the time of hearing." This standard, say proponents, is necessary to protect the seller as well as the annuity company and insurer. The Consumer Attorneys of California contend that the only standard for court approval should be the "best interests of the consumer." Allowing others to interject or intervene would interfere with the consumer's right to utilize his or her property right in the best manner he or she sees fit. SHOULD NOT "THE BEST INTERESTS OF THE CONSUMER/SELLER" BE THE SOLE STANDARD? Cost considerations may also make the required court approval impractical for consumers. Unless the consumer is able to represent himself or herself, or the buying company prepares the paperwork for the consumer at additional expense, the consumer will likely have to hire SB 491 (Johnston) Page 8 legal counsel to obtain the court approval. Given the intricate process proposed, attorneys' fees could easily exceed $1,000 or more, further eroding the consumer's finances. Court filing fees would be an additional cost unless the fees are waived. IS REQUIRED COURT APPROVAL NECESSARILY IN THE BEST INTERESTS OF INJURED CONSUMERS? 3. {u Should instead of court approval, or in addition thereto, a cap be placed on the permissible discount rate? u} Critics of factoring companies contend that their purchase/sales differ very little from loans and should be treated similarly. They argue that usury and consumer credit disclosure laws should apply. In both cases, the consumer gets a lump sum and is obligated to pay a specified number of payments in a specified amount. The only difference is that in the case of payment rights being sold, the purchasing company has a guarantee of payment, which in theory should make these "loans " cheaper since there is little risk of default. In reality, however, these "loans" are usually more expensive for consumers. SHOULD CAPS BE SET ON THE PERMISSIBLE DISCOUNT RATE, SIMILAR TO THE CAPS PROHIBITING USURIOUS LOANS? 4. {uShould, in addition thereto, the right of consumers to rescind the contract and seek damages be protected by statute? u} Given the unfairness of some of the sale agreements, some mechanism is needed to protect consumers against factoring companies taking unfair advantage. A traditional remedy has been rescission and restitution, along with recovery of a civil penalty to deter bad conduct. However, the two purchase contracts reviewed by committee staff specifically require the consumer to waive any right to sue under the contract and further require the consumer to defend and hold harmless the factoring company in any lawsuit. Some contracts even require the consumer to agree to a "confession of judgment." SB 491 (Johnston) Page 9 SHOULD IT BE DEEMED AGAINST PUBLIC POLICY TO REQUIRE A SELLER OF PAYMENT RIGHTS TO WAIVE ANY RIGHTS TO SUE UNDER THE CONTRACT, OR TO "CONFESS TO A JUDGEMENT"? SHOULD, ALSO, CHOICE-OF-LAW AND FORUM SELECTION CLAUSES, WHICH MANDATE OUT-OF-STATE FORUMS AND USE OF OUT-OF-STATE LAWS, BE PROHIBITED IN THESE PURCHASE AGREEMENTS? SHOULD, IN ADDITION, A SPECIFIC REMEDY FOR CONSUMERS BE CREATED, WITH A RIGHT TO RECOVER DAMAGES, A CIVIL PENALTY, AND ATTORNEY'S FEES? 5. {u Fears of loss of tax advantages do not seem compelling u} The California Structure Settlements Coalition, sponsors of SB 491, asserts that the sale of payment rights may jeopardize the special tax rules adopted by Congress to encourage and govern structured settlements. The proponents contend that a claimant's unilateral selling of payment rights takes the structure out of the "structured settlement," without the knowledge of other parties who may be affected, and jeopardizes the tax benefits for all. No cases have been cited by proponents in support of their claim. Opponents assert that the proponents' tax fears are without merit. In support, they cite a February 25, 1999, PricewaterhouseCoopers tax opinion which states that the sale/transfer of structured settlement payment rights for a lump sum payment does not affect the tax status of the insurance company funding the annuity contract. Nor does a sale cause the loss of tax benefits to the annuity payment company or affect the tax exempt status of the income for the person selling the rights. Of relevance, the opinion opined that a person receiving a lump sum payment for structured settlement payment rights is not in "constructive receipt of the present value of the damages" (which would void the tax benefits) since the person does not have the unfettered ability to demand payment of the present value of damages from the annuity company. (In fact, any lump sum payment negotiated with another party only obtains a sum which is discounted below the present value.) Also, the opinion SB 491 (Johnston) Page 10 cites Western United Life Assurance Company v. Hayden et al.64 F.3d 833 (3rd Cir. 1995), wherein the court rejected an argument by debtors in a bankruptcy proceeding that once payment rights are assigned, the payments were no longer excludable from income by the transferee and thus annulling the annuity company's tax exclusion. While that ruling occurred in a bankruptcy context, the legal reasoning appears valid as a general proposition. Finally, the opinion ventured that it would be poor tax policy to allow the unilateral acts of one party, the seller of payment rights, to alter the tax liability of the annuity payment company many years after the creation of the settlement. In the absence of contrary authority, and because the opinion seems well-reasoned, the proponents' fear of losing tax benefits is not compelling. (Worth noting also is the fact that some insurance companies are now competing with the factoring companies to purchase the payment rights.) 6. {u Opponents argue for front-end disclosures too, and other changes u} The National Association of Settlement Purchasers (NASP) opposes SB 491, contending that it is unbalanced in requiring disclosures when the payment rights are being sold, but not requiring disclosures when the rights are first being established in the settlement or judgment. Consumers would also benefit from meaningful disclosures at the "front-end," asserts NASP. SHOULD "FRONT-END" DISCLOSURES ALSO BE REQUIRED? The NASP also expresses concern over court congestion and court costs, and suggest that court review should be reserved for those cases where the structured settlement was approved by the court in the first instance, and not to every single case. This proposal seems arbitrary, as it would not necessarily filter out cases involving minor amounts. Opponents object additionally to the broad application of the bill to "cases and settlements across the country." As drafted, the bill would apply to any transfer of SB 491 (Johnston) Page 11 payment rights by a California resident, or by a person entitled to receive payments under a structured settlement "funded by an insurer domiciled in this state or owned by an insurer or corporation domiciled in this state." (Page 4, lines 6 to 12.) NASP argues that such broad application would inundate California courts and is of dubious constitutionality. SHOULD THE APPLICATION OF THE BILL TO OUT-OF-STATE RESIDENTS WHOSE PAYMENTS ARE FUNDED BY A CALIFORNIA INSURER BE CLARIFIED TO ALLOW COURT JURISDICTION WHERE THE "MINIMUM CONTACTS" TEST FOR DUE PROCESS IS SATISFIED? Support: State Attorney General's Office; Association of California Life and Health Insurance Companies; Pacific Life Insurance Company; Transamerica Occidental Life Insurance Company Opposition: National Association of Settlement Purchasers {u HISTORY u} Source: American Insurance Association; California Structure Settlement Coalition Related Pending Legislation: None Known Prior Legislation: None Known **************