I note that the purpose of the review is to assess the effectiveness of the tax exemption and to identify any changes that need to be made.

Transcription

1 5 November 2007 Mr Alan Cameron Review of Division 54 Secretariat The Treasury Langton Crescent PARKES ACT 2600 Dear Mr Cameron, I am pleased to make this submission in response to the Government s review of the income tax exemption provided by Division 54 of the Income Tax Assessment Act 1997 for payments made under structured settlements to seriously injured people. I note that the purpose of the review is to assess the effectiveness of the tax exemption and to identify any changes that need to be made. Given the review s focus on what has happened since the structured settlements legislation was passed, I have written this submission in my capacity as a financial adviser with ipac securities ltd, where I have worked since September The submission reflects my own views, and does not necessarily represent any corporate view of ipac. The submission has been set out in three parts: 1. executive overview 2. background Jane Campbell and ipac securities ltd 3. structured settlement activity from September 2003 to date 4. the value of allocated pensions My view is that structured settlements have failed in Australia, and that the abovementioned legislation should be removed. The good news is that Australian plaintiffs are generally well served by having access to quality financial advice, and a range of strategy and investment options which can deliver taxeffective income streams, such as allocated pensions. There are a few minor amendments to the allocated pension rules that would enhance their application in cases involving the seriously injured. 1

2 Thank you for the opportunity to provide input on this issue. I would be pleased to discuss any issue raised in my submission with the review team. Yours sincerely, Jane Campbell Client Adviser ipac securities ltd 2

3 Executive overview The concept that seriously injured people should get expert advice and invest their lump sum compensation so that they receive an income stream to meet their long term income needs was and still is a good one. Structured settlements, meaning annuities purchased with compensation funds which are given special taxfree status, were developed in the US and worked well there. In the US: o the market for annuities was large, competitive and sophisticated; o there were not many other options available to protect compensation paid to the seriously injured o structured settlement brokers were not highly regulated. By contrast, in Australia: o our annuity market is small; o we also had a range of protective options such as the NSW Office of the Protective Commission, the Victorian Supreme Court s Senior Master s (Funds in Court) Office, and a range of government trustees and private trustee companies (who played a role in cases of minors and those with mental incapacity); o anyone providing financial advice was subject to strict ASIC requirements (including qualifications and disclosure). When lobbying began in Australian for structured settlements (in around 1997): o there was concern on the part of defendant insurers and state government bodies such as the NSW Motor Accidents Authority that lump sum settlements were becoming very large (and that the money might not be spent/invested appropriately); o there was some discontent amongst plaintiff lawyers with existing mechanisms which seemed overly intrusive, controlling and/or expensive; o allocated pensions derived from superannuation funds were not available as an option for compensation proceeds; o there was little communication between the lobbyists and financial advisers (who knew at a practical level what was important to plaintiffs) or product providers (who also knew what products were possible and popular). The original idea was to seek very flexible legislation which would essentially say that if compensation funds were used to buy any annuity delivering periodic payments, then those annuity payments should be taxfree. The idea was that any periodic payments would be better than none. When the Federal Government seemed unconvinced by this notion, those lobbying sought to make it more attractive by seeking taxfree status primarily for lifetime annuities. Those lobbying (and later those legislating) underestimated the importance of flexibility to plaintiffs, the importance of access to capital and the importance of being able to invest in growth assets so as to have the opportunity to achieve good investment returns. 3

4 The structured settlement legislation, when passed, was too restrictive and the Australian lifetime annuity market was not able to provide attractively priced product. ipac has long held a reputation for providing quality financial advice to plaintiffs (as well as the broader Australian population). ipac was well placed to facilitate the introduction and use of structured settlements into the Australian market. ipac worked hard to lead the way in terms of educating the parties about structured settlements and obtaining quotes. However, when structured settlements were compared with other options it very quickly became clear to all concerned that they were not attractive. Both plaintiff and defendant lawyers on behalf of their clients stopped seeking quotes. Many plaintiffs with lump sum compensation continue to seek financial advice from financial advisers. They have been able to weigh up the pros and cons of different strategies and approaches and decide what best meets their individual preferences and circumstances. Many plaintiffs are able to utilise the superannuation system to achieve their goals. By contributing their compensation funds into superannuation and then rolling these funds over into an allocated pension (by satisfying a permanent incapacity condition of release), they are able to receive a taxeffective income stream which also provides flexibility, access to capital, investment choice and the opportunity to pass on any remaining funds to one s estate or named beneficiaries. The existing legislation enabling the use of structured settlements in Australia ought to be removed from the statute books. Background The following three documents provide some background information about: the history of my involvement with structured settlements prior to joining ipac (attachment 1, ) ipac the company (attachment 2, current); ipac article on structured settlements (attachment 3, April 2003); and why ipac was wellplaced to help introduce structured settlements to Australia (attachment 4 June 2003 proposal document). 4

5 Structured settlement activity at ipac from 2003 to date The following summary of activity is intended to help answer the question what has happened to structured settlements since their legislative introduction?. Immediately upon joining ipac in September 2003, I was asked to provide structured settlement expertise in a case involving a boy who was injured at the time of his birth. In this case the boy s Australian parents were living in the US at the time of their son s birth. The boy s parents successfully sued the US doctor and hospital. The settlement sum was approximately US$4 million (after legal fees). The US Court was keen for the money to be paid in the form of a structured settlement. The Court was in fact very close to approving a US structured settlement (using annuities provided by USbased life insurance companies) when it was realised that tax would be payble on the periodic payments paid under such an arrangement to an Australian resident (as the boy and his family were). Australian structured settlement law only made certain annuities paid by APRAregulated Australian life insurers taxexempt. The boy had a short life expectancy. US based life insurance companies (who had prepared quotes assuming an American structured settlement) assessed him as having the same life expectancy as a 60 year old man. I was able to obtain annuity quotes from AMP, however AMP were unfortunately unable to take the boy s reduced life expectancy into account. The AMP annuity quotes were not attractive. In fact a rough calculation in our office showed that whereas the US quotes showed an internal rate of return of 5.186% pa, the Australian quote had a negative internal rate of return even after 25 years. The case later settled for a lump sum. I understand that the family took up investment advice provided by a local South Australianbased financial adviser/trust specialist. During October 2003 my colleagues and I sought to inform as many plaintiff lawyers as possible about the need for them to consider structured settlements. We helped them to draft standard paragraphs to include in their letters of advice. Attachment 5 is a deidentified by one of my colleagues to a plaintiff lawyer with draft wording attached. In November 2003 I was contacted by both the plaintiff lawyer and the defendant lawyer in a NSW case involving a boy who was rendered paraplegic in a car accident at the age of two. The plaintiff was now aged 20. The defendant lawyers were particularly keen to make sure that the plaintiff lawyer did get advice on the option of a structured settlement. I sent a letter to a defendant general insurer explaining what services ipac offered in relation to structured settlements. Attachment 6 sets out the deidentified contents of that letter. 5

6 In November 2003 I also sent a similar letter to a large general insurance company, who wished to clarify what they ought to be doing about structured settlements (attachment 7). In December 2003 I mentioned in an to my life insurance actuary contact at AMP that I was still getting a few queries on structured settlement, but none serious enough to require quotes. That month I did, however, seek some quotes from AMP to incorporate into a presentation that I was preparing to present at some upcoming legal conferences in Queensland. The case example used in my presentations was based on a real Queensland case that was settled for a lump sum. Attachment 8 is a copy of the PowerPoint presentation delivered at a Catastrophic Injuries conference in Brisbane on 17 February In January 2004 I was contacted by a Sydneybased plaintiff lawyer who was interested in investigating the option of a structured settlement. His case involved a male client in a persistent vegetative state. There were greatly varying expert opinions on his life expectancy. We did not proceed to the point of obtaining quotes. Also in January 2004 I was contacted by a Melbourne based plaintiff lawyer who wanted quotes at very short notice. His case involved a then 20 year old female. He wanted quotes to determine the annual payment amounts based on a CPIindexed lifetime annuity with a 10 year guarantee period, given premiums of $1.5 million or $2 million. The quotes provided by AMP were for approximately $34,000 pa and $45,340 pa. Also in January 2004 I provided quotes in respect of the abovementioned case of the 20 year old paraplegic (see November 2003 above). A deidentified copy of my letter to the plaintiff lawyer is attached (attachment 9). In April 2004 I was asked to provide advice to a plaintiff lawyer in Melbourne. The case involved a Melbourne boy who suffered injuries as a result of treatment received at a hospital. The claim was for approximately $7 million, with $4.9 million being claimed for future care costs. Quotes were duly obtained and the letter was sent to the plaintiff lawyers that month. A deidentifed copy of that letter is attached (attachment 10). Also during April I was asked to provide advice to a defendant lawyer in Sydney. This case involved a boy whose injuries as a child resulted in amputation of his arms. The settlement estimate was $3.5 million, with half of this sum being for future care costs. Quotes were obtained and a letter was sent in June A deidentified copy of this letter is attached (attachment 11). This was the last case for which I was asked to obtain structured settlement quotes. I believe that interested plaintiff and defendant lawyers had come to the view that structured settlements would not provide good financial outcomes for their clients. For a known lump sum premium amount, only a relatively low periodic payment could be secured. Equally, for a known periodic payment requirement, the premium cost was high. 6

7 In October 2004 I provided IFSA (the Investment and Financial Services Association Ltd) with a small amount of editing input in relation to their submission to NSW Treasury, which recommended extending the structured settlement regime to Term Allocated Pensions. This was considered to be an improvement from the use of lifetime CPIindexed annuities as: 1. life insurance companies would no longer have to take a punt on life expectancy; and 2. if the plaintiff dies, the remaining balance in their Term Allocated Pension account can be left to their beneficiaries/estate. My contact at AMP who was assisting with the submission noted in an to me that the Ministers on Insurance Matters for both State and Federal Governments (through the NSW Treasury) were seeking a submission from IFSA on why there was no life insurance product in the marketplace to meet the need created by government with the structured settlement legislation. He commented that [w]hile we haven t sold any, we have, as you know, been happy to quote for the business. A copy of the IFSA submission is attached (attachment 12). In November 2004 I was asked to make comment on the (non) use of structured settlements in an article subsequently printed on 25 November 2004 in Canberra Times (attachment 13). In January 2005 I was contacted by the VMIA (Victorian Managed Insurance Authority), which had some involvement in Victorian medical indemnity cases. In an to this organisation I provided an informal overview of the current state of play (attachment 14). In March 2006 an article that I wrote was printed in the Accord magazine autumn 2006 edition, entitled Compo, Lump Sums and Structured Settlements. In this article I highlighted some of the problems with structured settlements and mentioned Term Allocated Pensions as a possible option (attachment 15). Since starting at ipac in September 2003 and later becoming a fully qualified financial adviser I have seen many plaintiffs and provided advice on how they could best make use of their settlement proceeds. Despite me (more than anyone) wanting them to succeed, I have not been able to recommend structured settlements in any case. I have however, seen allocated pensions working extremely well in the compensation context. Allocated pensions From well before the time I started with ipac, the superannuation system offered a valuable investment structure for Australian plaintiffs. 7

8 Those plaintiffs with serious injuries, such that they could meet the permanent incapacity condition of release, could contribute their compensation funds into superannuation (as an undeducted contribution pre1 July 2007, or a nonconcessional contribution from 1 July 2007) and then roll over the funds to commence an allocated pension. Usually little or no tax was/is payable on the pension income stream. In May 2006 the Federal Treasurer, in his Budget Address, announced the introduction of caps in respect of aftertax (undeducted) contributions that could be made into superannuation funds. This caused a problem for many compensation recipients who were seeking to contribute sums well in excess of the new caps. Later that month, I provided some input to a submission being prepared by Kassie James from ipac to Federal Government on the Adverse impact of restrictions on undeducted contributions to superannuation for the totally and permanently disabled (attachment 16). This submission was successful to the extent that on 5 September 2006 the government announced that compensation funds could still be contributed into superannuation without restriction by the new caps, so long as these contributions were made within 90 days of settlement. Thus, as things currently stand, allocated pensions are indeed an extremely attractive investment option for plaintiffs who have suffered serious injury. They are very attractive to plaintiffs because they: deliver a regular income stream; offer flexible payment options (eg. amount and regularity); provide investment choice; provide access to capital/lump sum withdrawals; are available to a plaintiff s estate or beneficiaries in the event of the plaintiff s death; are a commonly used investment vehicle easily understood and widely available; are relatively inexpensive to establish and administer; don t lock you in. Three possible enhancements which could be made to help very young and very old plaintiffs would be: allowing a minimum pension of less than 4% in cases involving very young plaintiffs; clarifying the rules such that those who have never worked before (such as children) will be able to satisfy the permanent incapacity condition of release. Confirmation that it has been envisaged by Treasury that those who have never worked will be able to satisfy the definition of permanent incapacity would be helpful; allowing contributions into superannuation for the purpose of immediately commencing an allocated pension for those who cannot contribute to superannuation because they are aged over 65 and do not meet the work test. 8

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10 Attachments Attachment 1: Overview of Jane Campbell s involvement with structured settlements prior to joining ipac I was heavily involved in the push to introduce structured settlements to Australia. In fact, I devoted many years of my life to this issue. I strongly believed that they would improve outcomes for the seriously injured. The basic idea was: Periodic payments of compensation make more sense than a single lump sum for the seriously injured; Ideally the payments should last for as long as you live; The payments could be designed to match likely (living and medical) expenses over time; Plaintiffs would lose less of their settlement to tax and would gain peace of mind; These types of settlements would not cost any more for defendants; The government would see fewer plaintiffs needing to fall back on government financial support. The concept was working extremely well in the US and was growing in the UK. In 1995 I was working as a defendant insurance lawyer in Melbourne. My insurance clients (and I) often used to worry about how the settlement funds would be used after the case was over. Would it be wasted? Would it last? Was it enough? One evening after work I attended a Women in Insurance function. The guest speaker was Patrick Hindert of Benefit Designs, Inc (BDI). He was the CEO of a structured settlement company based in Cincinnati, Ohio. He explained what structured settlements were and how they work. Patrick was in Australia as a guest of the NSW Motor Accidents Authority. The General Manager of the MAA at that time was Martin McCurrich. He was a great supporter of structured settlements. I believe that they met through a networking group called TED (The Executive Connection). The MAA was overseeing a scheme which was seeing the largest lump sum settlements in Australia at that time. There was some concern about rising settlement sums. NSW was being 10

11 compared with California as the most litigious place in the world. The MAA also had concerns about the welfare of the seriously injured. When I came on the scene, Dallas Booth, was just taking over as General Manager of the MAA. He was enthusiastic about structured settlements. He was particularly keen to see that the money was being appropriately used for the long term care of the seriously injured. He was concerned about a lack of services available to help the seriously injured and he thought that plaintiffs with regular income streams would be attractive clients for new service providers. After some discussions (largely between the MAA and BDI), I was invited to spend a year in Cincinnati, Ohio, working for BDI. The idea was that I would learn as much as possible about structured settlements and then return and help the MAA introduce them to Australia. This is exactly what happened. I spent all of 1996 working for BDI then returned to Australia to base myself in Sydney. I was engaged by the MAA to write a submission on structured settlements. The idea was that it would be a sixmonth job. Preparing the submission took all of A draft was widely circulated in July In early 1998 this submission was duly sent to the NSW Carr Government for approval and then onforwarded to the Federal Howard Government. The proposal was rejected by the Federal Government by way of short letter dated August At about this time Dallas Booth left the MAA to work for the Insurance Council of Australia (ICA). This signaled the end of the push for structured settlements. My funding disappeared, but I did not want to give up. I believed in the concept and in the process of writing the MAA submission saw that there was broadly based support. I felt that the best approach was to show the Federal Government that all the key stakeholders agreed with the proposal in particular, injured people and their lawyers, and defendant insurance companies and their lawyers. I therefore approached the Australian Plaintiff Lawyers Association, the Law Council of Australia and Dallas Booth, who was then at the ICA. All agreed to support me in my efforts (though not financially). I then approached the new head of the MAA, David Bowen, for revived funding support. With some initial reluctance, he agreed. This was the start of the big push as The Structured Settlement Group. 11

12 At the start of 1999 I was put in touch with Judie Stephens. She was the Sydneybased grandmother of a catastrophically injured young boy. She was a strong woman, full of passion and unafraid to speak out. She and I joined forces. During the first half of 1999 I wrote a new structured settlements submission. The new submission was put to the Federal Government in mid Judie and I made regular lobbying trips to Canberra and around the country. Funding from the MAA kept us (particularly me) going through 1999, though after that I needed to secure full time employment to cover my living costs. In 2000 I took up a job as Director, Public Affairs at the Institute of Actuaries of Australia. The IAAust allowed me to continue the push for structured settlements (largely after hours ). The MAA funded any trips to Canberra. Judie s local Federal Member was Danna Vale and she was very supportive. Given that we were seeking an amendment to the Income Tax Assessment Act, we primarily focused our efforts on targeting Rod Kemp, who was then Assistant Treasurer. He directed us to his Department and we had some meetings with Treasury over time. We also met with Peter Costello, as Treasurer, and many other Federal MPs. The Opposition Assistant Treasurer was Kelvin Thompson and he agreed to support our proposal. We were disappointed not to gain much support from the Minister for Family and Community Services. We did meet with members of the Department (FACS). Our lobbying persisted over time. We did gain some good media support. The Institute of Actuaries supported the cause and an actuarial paper on the topic was written. Danna Vale MP, Judie Stephens and I spoke at the Sydney Institute in support of the concept. We did make some progress, but the whole issue could easily have gone nowhere until the tort law reform issue came to prominence. Over a relatively short period of time ( ) tort law and compensation payments became a big political issue. There were newspaper articles about huge settlements, insurers were crying poor and politicians were desperate to do something about the issue. We were suddenly listened to. Structured settlements were no solution to the perceived problem of overlygenerous judges, but it was one issue that both sides of the debate supported. 12

13 As the tort law reform issue hit fever pitch, the AMA took centre stage (crying poor over large medical negligence damages awards) and demanded action. Dr Kerryn Phelps, then head of the AMA, was having meetings with the Prime Minister himself. One of the AMA s long list of demands was action on structured settlements. I expect that this was the one issue that wasn t going to cause any controversy if it was agreed to. It seemed to me that it was in this environment that a decision was made to give structured settlements the green light. At about this time I resigned from the Institute of Actuaries to focus on getting the legislation sorted and over the line. I secured some funding from an organization called Benfield Grieg, who were reinsurance brokers. They were interested in how the concept might help to bring down the cost of big claims for their insurance company clients. They were well connected in terms of general and life insurers and reinsures, in Australia and overseas. Reality hit when I started to get down to the nitty gritty of what the legislation might look like. The bottom line was that it was going to be highly restrictive. Maybe we had won the battle but lost the war? I can understand that the Department of Treasury was keen to see that any tax break for any particular group would need to be carefully targeted and tightly circumscribed. Although, I was deeply worried, I thought that something was better than nothing and at least it was a start. From the time the legislation passed, I started to focus on life insurers and the annuity products that they could deliver. This was sobering work. The two life companies who had been quite supportive of the structured settlement concept to date, Tower and Challenger, had recently decided to pull out of the lifetime annuity market altogether. Only two life insurers, AMP and Comminsure offered lifetime annuities that were indexed to the CPI. I did some consulting work for the ATO at the end of 2002 and the start of 2003, preparing some fact sheets on structured settlements. My first child was born in March 2003 and my time was taken up with this. Mid 2003 I approached ipac securities ltd for a job with a view to becoming a financial adviser. 13

14 I can fairly confidently say that there have not been any structured settlements entered into in Australia since the legislation was passed. I make this statement on the basis that I know most, if not all, of the key players and would be surprised if I was not contacted by one of the players particularly the plaintiff lawyers or the actuaries working for the life insurers. 14

15 Attachment 2: ipac securities ltd extract from brochure entitled Helping plaintiff lawyers achieve better financial outcomes for their clients who is ipac? ipac is a specialist financial advice and investment management firm. The company has been providing specialist financial and investment advice since Among the founders of ipac are leading financial commentator Paul Clitheroe and respected investment strategist and author Arun Abey. Both remain actively involved as directors of ipac today. ipac employs over 250 people and manages over $15 billion dollars for over 30,000 clients, ranging from individuals to large institutions. We have offices in Brisbane, Sydney, Melbourne, Newcastle, Parramatta, Mosman, Hong Kong and Singapore, with a network of partner firms around Australia that aim to deliver the same highquality service. We presently manage in excess of $150 million on behalf of clients with personal injuries. The majority of these funds are invested on behalf of clients who lack legal capacity. In some cases we work with a trustee company who carries out the administration role and engages ipac to provide financial advice and to manage the investment of the funds. In other cases we work with a lay person (usually a family member of the plaintiff) who has been appointed financial manager or administrator by the relevant court or tribunal. Again in this scenario we provide advice and invest the funds. We also assist the financial manager or administrator with various financial management tasks as required and provide referral to service providers such as case managers, rehabilitation specialists, occupational therapists, carers when needed. ipac uses a multimanager investment approach to control and reduce risk for its clients through the diversification of investments across asset classes, fund managers and investment styles. We have an inhouse investment research team of 30 specialists who identify, select and monitor specialist investment managers in all asset classes. Portfolios are constantly monitored and the mix of managers within the portfolios is changed if needed. A plaintiff who invests with ipac will have his or her funds invested across up to 10 assets classes, with more than 20 specialist funds managers, in over 2,000 securities. The choice of portfolio is determined by each client s personal needs and circumstances. 15

16 helping you to help your clients As a plaintiff lawyer, your client relies on your good judgement to secure the best possible outcome from their case. Often this will involve consulting experts in other fields, either during or at the conclusion of the case. This is where ipac can help. Compensation money often needs to last a lifetime, so financial support for your client is essential. ipac can provide specialised financial advice to your client to ensure that their damages will last the distance. We can help you and your client navigate the complex world of management options and make sure that all available options are assessed. Some of the ways we can assist include: ~ Convincing a court that your client can responsibly manage a lump sum ~ Helping your client to evaluate a settlement offer ~ Advising on social security and tax dilemmas ~ Developing a living financial plan to ensure that the damages will last Professional financial advice will bring significant benefits to your client and you play an important role in helping them make informed decisions about their financial future. our advisers ipac s financial advisers hold the highest professional designation of CFP and receive ongoing professional development to keep them at the top of their profession. They have extensive experience working with plaintiff lawyers and their clients and take a holistic approach to advising. Our advisers can give your client advice on a range of issues including: ~ What should I do with my money? ~ What tax will I pay on my compensation? ~ Can I get Centrelink benefits? ~ Should I get a structured settlement (and what is it anyway?) 16

17 ~ How will I make this money last and still have a life? There is no charge for you and your client to meet with one of ipac s financial advisers and we understand that it may be necessary to meet a number of times along the way. Our advisers will also endeavour to travel to your client if mobility or travel is difficult. 17

18 Attachment 3: Plaintiff article, April 2003 PLAINTIFF MAGAZINE APRIL 2003 written by Gavan Young and John Wakim, Financial Advisers at ipac securities limited a financial planning perspective on structured settlements To achieve our goals requires preparation. There is information to be gathered and considered, a preliminary plan to be formulated, any necessary finetuning to be done, and then the implementation to achieve the final outcome. Financial planning for individuals who receive compensation is no exception. The advent of structured settlements makes the financial process particularly essential. It also makes it necessary to move financial planning forward so that initial consultations take place before the settlement process. People often seek financial advice with cheque in hand or on the way. It is our experience that the average compensation recipient has done very little to prepare themselves for a financial planning consultation, and this will have serious repercussions for those considering taking a structured settlement option. Clients are also often primarily concerned with the investments they intend to make. Little or no consideration is given to the ability of these investments to deliver on their longterm objectives. The information they have may be an ad hoc conglomeration of wellintended advice from family and friends that often does not meet their needs. Until now, the nature of the compensation process has been to focus the client on a lump sum. However, as planners, we have been refocussing clients for years on the unbundling of that lump sum into different parcels to meet their key needs such as longterm lifestyle costs and capital expenditure. Redirecting the attention of a client on his or her real needs and exploring the appropriateness of a structured settlement will bring forward consideration of the key issues. The decision whether or not to opt for a structured settlement may then be made with a full understanding of all of the issues and alternatives. This article revisits a series of case studies recently presented at APLA s Queensland Conference 2003 and looks back at how advice in these client situations may have varied had structured settlements been available at the time. 18

19 1. too many cooks John was literally surrounded by advice. He was a chef who left the military on account of a nonfunctional leg caused through the negligent treatment of a football injury. He had a compensation payment of approximately $500,000 to manage. His family was keen to go into business with him and he had a friend who had shady connections, although these connections were not known at the time. John initially wanted to develop a quality financial plan. However, this never eventuated. Instead, John entered into an unsuccessful business venture. He also chased a quick return by placing a loan to a Gold Coast business through a friend. This debt became bad. A few months later, his own business was not travelling well, and he had to deal with the police in relation to the recovery of his loaned funds. Soon after his settlement, 80 per cent of it had been lost. This was a disastrous outcome. the appropriateness of a structured settlement Had a structured settlement been available for John and had he accepted it, such capital losses may have been prevented. Apart from providing tax effective income streams, the essential aim of structured settlements is to protect hard earned compensation payments from early dissipation. In John s case, too many cooks spoilt his broth. Furthermore, his mindset was cast in stone even at the time when he was apparently enthusiastically involving himself in a financial planning process. 2. song and dance Jane, aged 25, received a compensation payment of around $150,000. She now had the funds to pursue her dream of studying music and dance, although this meant deferring her business studies. To do this, Jane needed to relocate from Brisbane to Sydney for three years. Working on her financial plan, it was agreed that she required around $15,000 per annum to meet her costs of living in Sydney, including rent and supporting herself through three years of study. A wellintended relative suggested that she invest in a home unit in Brisbane. From a planning perspective, it is important to match investments with the goals the money is to fund. Whilst raising no objection to the idea of an investment property, it was pointed out that the rental income from a Brisbane property would not even cover Jane s Sydney rent, let alone her lifestyle costs. The advice given was that Jane establish a broadly diversified investment portfolio. Jane would need to draw on 10 per cent of her portfolio for each of the three years that she would be living in Sydney. Projections demonstrated that when she earns an income after completing her business studies she would no longer need to draw on her portfolio to the same extent and that it would grow for her future from this time. 19

20 the appropriateness of a structured settlement In Jane s case a structured settlement would not have been appropriate. First and foremost, she had insufficient capital to purchase an annuity capable of delivering the required pension equivalent due to her life expectancy. Further, given her relative youth and potential earning capacity, greater flexibility in her planning was required. 3. a change of plans Bob, aged 30, sustained a leg injury and could not return to his employment as a plumber. He received compensation of approximately $500,000. However, as he owned his own home outright and had a longterm income stream from income protection, he had no need to derive an income from his compensation monies. He had already sought financial advice and had his compensation payment placed in a portfolio of managed funds. The overall effect of this investment strategy was to increase his taxation liability over and above that for the income protection by $6,000. Through the superannuation system, John was able to unwind his earlier investment portfolio and contribute the proceeds to superannuation. With assistance, he obtained doctors certificates that satisfied the Permanent Incapacity Condition of Release which enabled him to convert his portfolio to an allocated pension even though he is only 30 years of age. The overall effect of this strategy was to provide John with a taxfree investment portfolio and taxfree income. As he did not need the income from his allocated pension he subsequently made tax deductible superannuation contributions and reduced the tax on his income protection to zero. Quality advice resulted in John holding essentially the same portfolio through a different structure and saving around $9,000 in taxation per year. the appropriateness of a structured settlement Given the size of John s funds, he was an ideal candidate for a structured settlement. This may have been particularly so if he had not been in receipt of his income protection. This case study demonstrates the value of advice over and above simply determining where money should be invested. It also demonstrates that good taxation outcomes can be obtained outside the structured settlement regime. Where this is the case, the issue will largely be whether or not a client should have investments that they control and consequential investment risk, versus the longterm certainty of an indexed income stream coming from a life assurance company. 20

21 so who will structured settlements suit? The situation of each client situation requires casebycase analysis. There is more to deciding upon the appropriateness of a structured settlement than simply taxation, financial calculations and investment projections. It ultimately comes down to how people feel about things. Experienced financial planners are used to explaining and considering the pros and cons of annuities versus the investment of lump sums. What is new about structured settlements is the availability of annuities on a taxfree basis for the compensation recipient. What is not new is the annuity itself. For many years now, similar decisions regarding annuities versus the control of capital have manifested themselves in the general population. For example, those in public sector superannuation schemes have choices between indexed pensions and lump sums. Other examples come up in age pension planning and superannuation. In fact, there are many issues in common that apply in choosing between an annuity and a lump sum in which planners have experience. These issues include: ~ the client s attitude to control of capital; ~ the likelihood of the need to access capital for contingencies; ~ the client s attitude and willingness to take investment risks; ~ the client s overall level of financial sophistication and the likelihood that they may stick with a longterm investment strategy; ~ the client s ability to earn an income and not be dependent on a longterm income stream; and ~ other factors unique to that client s situation (for example, when dealing with a younger client who has been catastrophically injured, it may be necessary to take into account parental concern regarding the longevity of capital and their own ability to provide care in the future). the impact on the planning timeline In the prestructured settlements regime, it was possible to leave financial planning to the settlement or beyond because the time frame for making investment decisions was uncapped. With structured settlements, however, it is imperative that all relevant issues are considered well in advance of settlement so that clients may make informed decisions in their longterm interest. PL 21

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23 Attachment 4: Jane Campbell proposal to ipac securities ltd dated June 2003 Why structured settlements? THE CONCEPT DEFINITION AND TAX TREATMENT Structured settlements are a way of paying compensation for personal injury whereby all or part of the compensation is paid in the form of periodic payments and these periodic payments are funded by the purchase of an annuity. Until recently, periodic payments of compensation were likely to be subject to income tax. Common law lump sums received by a claimant for personal injury are generally characterised as capital and are therefore not taxed as income (and exempt from capital gains tax). However claimants are subject to income tax on investment income arising from an invested lump sum. A lump sum compensation payment could always have been invested in an annuity (to simulate a structured settlement), but the investment income component of the annuity payments would have been subject to income tax. In December 2002 the Federal Government amended the Income Tax Assessment Act to encourage the use of structured settlements. This tax change involves making structured settlement annuities purchased by a defendant or its insurer for an accident victim taxexempt. The government has agreed to forego some tax revenue (that would otherwise be collected from invested lump sums) in order to provide a financial incentive for accident victims to choose to receive their compensation in the form of an annuity. CREATING DEMAND FOR FINANCIAL ADVICE I see structured settlements as essentially a way of ensuring that accident victims get financial planning advice before they receive a large compensation payment. Whether they decide to opt for a taxfree annuity or not, they will at least have been encouraged to get financial advice. Structured settlements can only be arranged at the time of settlement, and not thereafter. Their new availability means that in appropriate cases plaintiff lawyers will be forced to raise the issue with their client and investigate suitability. If they don t they risk liability for negligence. In NSW, new legislation takes this responsibility further and explicitly requires lawyers to advise their clients about the availability of structured settlements and the desirability of getting financial advice. CREATING DEMAND FOR SPECIALIST ADVICE 23

24 In the US and Canada structured settlements are considered an area of expert knowledge and firms specialise in providing structured settlement service and advice. There are dozens of such firms competing in the US market. In 2002 there were 160 professionals with the CSSC (Certified Structured Settlement Consultant) designation working for these firms. The firms do not generally provide general financial planning advice. Sometimes an accident victim will engage both a structured settlement adviser and a financial adviser (who may have competing interests). In Canada there are four major structured settlement firms, though one dominates the market. They are all feeling the pressure as financial planners compete to win the hearts and minds (and business) of accident victims. In the UK one firm dominates the market to a great degree. In recent years that firm has broaden its expertise to provide conventional investment advice so that all clients can be serviced, whether they opt for a structured settlement or not. In Australia there is an opportunity to be the one firm that dominates the structured settlement market. I believe that the winning market formula will be the combination of the best structured settlement adviser with the best financial advisers to accident victims. Without this partnership structured settlement advisers and financial advisers will compete and clients won t be able to easily compare options available to them. A onestopshop will avoid market confusion and make getting appropriate advice easy. REFERRAL SOURCES The primary referral sources for this structured settlement/financial advisory team will be personal injury plaintiff lawyers (and their clients who are entitled to receive reasonably large lump sum compensation). Defendants to personal injury claims, their insurers and lawyers may also be referral sources (where there is no conflict of interest, where there are joint instructions, etc.). Defendants include government health departments and organisations that selfinsure. Insurers range from large general insurance companies to medical defence organisations and local government insurance pools. Other referral sources include overseas brokers and lawyers (dealing with cases where Australians have been injured in the US, Canada or the UK). INTERNATIONAL MARKET SIZE AND GROWTH International experience is that the market for structured settlements develops relatively slowly as people start to learn how the process works and the advantages it offers. 24

25 Estimates of annuity premium received by life insurers from third party sources in the US during 1975 to 1988 for funding structured settlements were as follows: Year Annuity Premium (US$) $5m 1977 $15m 1978 $40m 1979 $150m 1980 $350m 1981 $575m 1982 $900m 1983 $1.3b 1984 $2b 1985 $2.5b 1986 $2.9b 1987 $3.3b 1988 $3.6b In 2000 the US structured settlement market was worth about US$6 billion (structured settlement premiums). Structured settlements did not get off to a good start in the UK in 1987 when an unattractive model agreement was approved by the Inland Revenue. The model required a defendant s general insurance company to purchase and thereafter own the annuity. Each annuity payment had to go back to the general insurer, which would then gross it up for tax and pass on the periodic payments to the claimant. The general insurer could not close their file until the claimant died. Not surprisingly demand grew only slowly. Two structured settlements were entered into in 1988 and in 1989 a structured settlement was approved by a court. In 1990 five more structured settlements were entered into, with total annuity premiums of about 1m. In 1991 one structured settlement intermediary arranged 35 cases with premiums totalling approximately 12m. At least 5 other structured settlements were arranged that year. By November 1992 one structured settlement intermediary had arranged 100 cases. The numbers of structured settlements gradually increased. 25

26 In 1995 legislation was finally passed in the UK that enabled a much more attractive way of arranging structured settlements. This legislation enabled the defendant general insurer to purchase the annuity for the claimant and then close its file. This is the model upon which the Australian legislative model is based. In 1996 this legislation was improved further and since then the demand for structured settlements has grown, but slowly. A report by a Structured Settlement Working Party delivered at the 2000 General Insurance Convention of the UK Faculty and Institute of Actuaries noted that the market had grown to about 200 cases per year. This report suggested that in 2000 about 6 8% of large claims (above 200,000) by number, or 730% by volume result in a structured settlement. The US market is obviously more developed than the UK market, having been established for 25 years. About 5% of all casualty settlements in the US are settled this way. There is a relatively low average case size of about US$100,000. AUSTRALIAN MARKET SIZE The potential market for structured settlements in Australia will be shaped by a large number factors including: the wording of the tax exemption our population the number of compensable serious accidents general levels of compensation being awarded by the courts the rules applying to State Government compensation schemes interest rates, annuity prices and perceptions of financial security, and the behaviour of claimants and defendant insurers. The tax exemption restricts structured settlements to personal injury cases, excluding workers compensation and wrongful death cases. Essentially the areas of accident compensation where claims will arise will be from: medical indemnity; motor vehicle accidents in most States, with the exceptions of Victoria and Tasmania which already have nofault long term care programs for seriously injured claimants; public liability; and product liability. In 2001 I sat on a working party of the Institute of Actuaries of Australia which estimated that the potential market for structured settlements in Australia is likely to be in the order of $50100m p.a. These figures correspond to 5% and 10% respectively of an estimated annual claim cost of about $1bn for motor vehicle CTP, public liability and medical indemnity classes combined. This would represent, perhaps, 1025% of claims settled for amounts above $0.5m. 26

27 These figures are based on a table taken from an actuarial report produced in 1997: Annual number of lump sums in the range Type of insurance $100k$500k $500k$1m $1m+ Total Total amount Amount > $500k $m $m Motor accident Public liability Medical indemnity Total Increases in the size of awards and the frequency of large claims since 1997 mean that this table probably understates the incidence of large claims, especially for medical indemnity. POTENTIAL MARKET GROWTH There is a potential for the structured settlement market to grow as a result of legislative developments. In many States in the US structured settlements can be used in the context of statutory workers compensation (annuities purchased to pay out statutory periodic payment obligations). They are also used in environmental cases (where compensation is needed over time). In the UK there are moves to empower judges to order periodic payments without the prior consent of the parties. This was anticipated by the Australian Parliament and our legislation has been written to accommodate structured orders which will be possible if supported by appropriate State legislation. I have led the way with structured settlement legislative reform to date, as manager of the Structured Settlement Group, and can continue to do so. The SSG is the de facto industry body for structured settlements and can also play a role in education and the development of industry standards, codes of conduct and ethics, etc. Building the market for structured settlement advice should also lead to building the market for financial advice in general. Relationships with lawyers built in the context of structured settlement advice, should encourage lawyers to refer other clients who need financial advice in a broader range of circumstances (small business, family law, superannuation, etc.). 27