Paying Tomorrow's Claims with Tomorrow's DollarsAuthor(s): Perry L. FullerSource: Litigation, Vol. 3, No. 1, PROVING AND DISPUTING DAMAGES (Fall 1976), pp. 27-29Published by: American Bar AssociationStable URL: http://www.jstor.org/stable/29758289 .

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Paying Tomorrow's Claims

with Tomorrow's Dollars

by Perry L. Fuller A California case of a 9-year old girl severely brain?

damaged by alleged medical malpractice received much attention because of a $26-miHion settlement reported by the press. Actually, the settlement was bought by payments of less than a million dollars, and the case

dramatically illustrates how using tomorrow's dollars for tomorrow's damages can provide for economical settle?

ment of big-money claims.

Nowadays it is much easier for lawyers to settle cases with future dollars than for juries to use this technique in

litigated cases. However, some changes in the tax laws and in litigation rules and procedures?as well as in the way we think about the traditional lump-sum method of

awarding damages?could encourage a widespread use of tomorrow's dollars, with results that might satisfy party litigants, their lawyers, and society in general.

In the California case, the little girl was going to

require extensive medical care for the rest of her life, whatever that eventually proved to be. The settlement? which in fact would total $26 million only if the girl survived to age 74 (the 65 years predicted in life-expec? tancy tables)?was achieved through payments totaling $820,000 on the following terms:

? Two defendants' liability insurance carriers paid out $150,000 in cash.

? For a single premium of $430,000, the defendants

purchased an annuity from a life insurance company, which agreed to underwrite the risk of paying $16,000 a

year for the special care the parties agreed would be necessary to maintain the girl. This contained a built in inflationary increase of 7.75 per cent a year and also

provided that if either parent survived the child he or she would receive $100,000.

? The defendants bought another annuity for $240,000 to pay the plaintiffs' attorneys' contingent fee of $30,000 a year over a ten-year period. The agreed

-

upon fee, according to one report, was computed as one

Mr. Fuller, a Chicago lawyer, is a member of the firm of Hinshaw, Culbertson, Moelmann, Hoban & Fuller.

third of the smallest probable jury award estimated by anyone associated with the case.

Had the case gone to trial, the plaintiffs might have convinced the jury, through expert testimony, that there was a reasonable likelihood that the girl would survive to age 74 and that the expense of maintaining her to that

age would be increased by inflation at a compound rate in excess of 10 per cent a year. The projections, however, do not indicate she will actually live that long, and the life insurance company, relying upon its experience in the field of annuities, was willing to assume this risk. It knows its obligation ends upon death.

Awards similar to this settlement could also be made

by juries in cases where the parties are unable to agree on liability or on critical elements of the damage award. As the example demonstrates, once it is determined by a fact finder or by agreement what the amount of damages is for the next year and that the loss is a continuing one, the question remains: when will the defendant's obliga? tion cease? Use of the annuity makes it immaterial whether the claimant's contentions about life expectancy are exaggerated. The fact of death will determine that. (A life expectancy of, say, 40 years simply means that the

person statistically has a 50 per cent chance of living that

long.)

Changes Required The tradition of awarding all a plaintiffs damage in

a single lawsuit, however, can probably only be changed by statute?or, in some instances, by court rule. Within its special medical malpractice legislation, California has taken such a step. Section 667.7(a) of the California Code of Civil Procedure now provides:

(a) In any action for injury or damages against a provider of health care services, a superior court shall, at the request of either party, enter a judg?

ment ordering that money damages or its equivalent for future damages of the judgment creditor be paid in whole or in part by periodic payments rather than

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by a lump-sum payment if the award equals or exceeds fifty thousand dollars ($50,000) in future

damages. In entering a judgment ordering the pay? ment of future damages by periodic payments, the court shall make a specific finding as to the dollar amount of periodic payments which will compensate the judgment creditor for such future damages. As *

a condition to authorizing periodic payments of future damages, the court shall require the judg? ment debtor who is not adequately insured to post security adequate to assure full payment of such

damages awarded by the judgment. Upon termina? tion of periodic payments of future damages, the court shall order the return of this security, or so much as remains to the judgment debtor.

Before juries could award damages in this fashion, jury instructions would need to be revised to provide for use of special findings. Special interrogatories to the jury would elicit necessary findings on such things as the amount of the monthly or yearly loss of income or profit, monthly or yearly expenses to be incurred and the dura? tion of each particular loss or expense. Also, an inflation

percentage could be built into the calculation, either by jury finding or by legislation. For example, future pay? ments could be tied to a cost of living index that could fluctuate either way (although this could complicate the actuarial computations for buying the annuity).

No Need to Discount On the other hand, it would no longer be necessary

for the jury to determine an appropriate interest rate to discount an award to its present value. The defendant or insurer would invest the sums as it saw fit and long, sometimes convoluted instructions on reduction to

present value could be eliminated. In states that allow subjective awards for pain and

suffering, disability or disfigurement, the fact finder would have to set some unit value for these elements. This approach, however, will trouble those who believe

plaintiffs counsel should be forbidden to argue that awards should be based on a mathematical formula that allows a certain number of dollars for a unit of time.

Modifying or abolishing the collateral source rule should also be considered. California chose to do away with it for medical malpractice claims. If the periodic payments are to conform to reality and the plaintiff is to be put back in pocket, then those collateral sources really should be taken into account.

It has been argued that the tortfeasor should not benefit from the plaintiffs precaution to protect himself

against expenses or lost wages or the largesse of the

plaintiffs employer. It is accepted, however, that the

plaintiff should enjoy the benefits of the defendant's pre? caution in procuring liability insurance which often far exceeds what would be available if the defendant were uninsured.

The equitable solution may be to allow a setoff where both parties have exercised good sense and provided for the payment of compensable obligations. First-party obligations of health and accident coverage, workmen's

compensation benefits, social security, and life insurance

proceeds could be declared the primary source, and

proceeds available from third party liability coverage would be a secondary source to satisfy the balance of the award.

The impact of tax laws and regulations now favorable to the claimant should be carefully considered. The Internal Revenue Code now excludes from gross income any damages received by "suit or settlement" on account of personal injuries or sickness. Int. Rev. Code, 1954, ? 104(a)(2). If the claimant receives a lump-sum settle? ment or award and puts it in an interest-bearing account, the interest is included in his gross income for tax pur? poses.

If a settlement is made on an annuity basis, segment? ing the payment should not affect the claimant's right to exclude the amount from his gross income for tax pur? poses. Any tax on the increment would be charged to the stakeholder. On the other hand, if the I.R.S. determines that the periodic payments represent only wage or in? come continuation for a taxpayer, the statute and regula? tions should be amended to include the lump-sum awards and settlements in the gross income of the

recipient. Paying the plaintiffs attorney's fees raises still another

problem. The lawyers for the nine-year-old California

girl were to be paid $30,000 a year over a ten-year period. It would encourage this kind of settlement for the I.R.S. to recognize this arrangement and allow the lawyers to treat the payments as income received in each year a

payment is made. Under present tax law, a lawyer may not defer his fee to a later year if it is earned pursuant to a conventional contingent fee contract. Upon settle?

ment, he has performed his services and earned his fee. He has constructive control of the fee and it therefore

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must all be included in his gross income for the tax year in which earned. One partial way to solve this problem may be for the

attorney to amend his back returns for the years in which services were actually performed. The lawyer also may assure equitable tax treatment for himself under present law if he is willing to commit himself to a deferred fee

when he contracts with his client. The I.R.S. recognizes a taxpayer's agreement to accept deferred payment if the

agreement is made unconditionally before the service is to be performed. But if the lawyer retains the right to choose afterward, he must include the whole fee in his

gross income for the year in which it is first received.

Whatever way one underwrites the obligation for

periodic payments, this does not change the amount to be received by the claimant or vary the terms of the settlement or award. The only one who stands to gain or lose as the future becomes history is the stakeholder. If the events that are to begin or end payments occur in a

manner favorable to the stakeholder, he may salvage a sum from the single premium and profit from the under?

taking. If future events occur in a manner that requires him to pay over a longer period than estimated, he loses from it.

Several options are available to the defendant, or his

insurer, when called upon to make periodic payments. One that has much to commend it is the annuity type, as in the California example. The company undertaking the

obligation will undoubtedly be a life insurance company with considerable information in the field. It will accept a single premium from the defendant and invest it. Its assumed risk will be spread among all of its annuitants. It will be an established company with sufficient capital and assets to offer adequate security to the claimant.

Another alternative is to establish a trust fund. A trustee will invest the money, collect the income and, subject to the contingency requirements of the settlement or award, guarantee the periodic payment. If the con?

tingency that ends the obligation occurs earlier than estimated and a balance remains in the account, this is returned to the defendant or his insurer. However, if the estimate of the trust's requirement is too low, the defen? dant or his insurer must deposit additional funds with the trustee. Without some mechanism to make sure this occurs automatically, this complication is one the claim? ant would probably choose to avoid.

A third choice is an extended claims settlement device now in use by some casualty insurers. Under this system, the casualty insurer (and not a separate life insurance

company) is the stakeholder and in effect buys an an?

nuity from itself to guarantee payments of the future sums. However, under their charters casualty companies cannot ordinarily engage in the sale of annuities. There? fore these settlements are treated as a lump-sum pay? ment of the present value of the amount necessary to meet the future obligations.

This is set aside in a special account from which the

payments to the claimant are made. If the estimate of the period for payments works in the insurance com?

pany's favor, any unpaid portion may be returned to the

company's capital account. If the company is stable and

well-managed, with adequate assets and a good history, there should be no reason to refuse to permit it to under? write the obligation.

When periodic payments are agreed to by way of set?

tlement, the parties can establish terms and conditions that will serve the best interests of the particular claim? ant. His own and his family's future needs may not be

protected by the traditional form of award, including the

periodic payments provided under most workmen's com?

pensation statutes.

For example, a totally disabled claimant may have

planned a college education for his children. This am? bition can be fulfilled by providing an agreed amount for each child, either a lump sum or periodically, when he reaches a certain age. This amount would be available for the child's use in college whether the claimant sur? vived or not.

Additionally, the need for future medical care is many times speculative and a specified sum can be set aside and available for use by the claimant as the need arises. If he dies before the fund is exhausted, the balance will revert to the defendant or his insurer and not become a

stranger's windfall.

Unlimited Options The options for contingencies are unlimited. A settle?

ment can be tailor-made for the particular needs of the claimant. In meeting these needs, the periodic payment approach provides a form of money management that the average person recovering damages for substantial future losses badly needs. Like the lottery winner, the claimant whose future damages have been paid in ad? vance may not be able to manage that fund to achieve the

goals for which it was paid. Thus, periodic payments may have a social value that goes beyond achieving great? er fairness in measuring awards.

The adversary system cannot survive if it is perceived generally as unjust or unworkable. Both lawyers and

laymen are becoming aware of the economic impact of the proliferation of claims and the dramatic increase in the size of awards by courts and juries. The medical

profession is frantically trying to solve the threat of

professional liability judgments. Manufacturers are

studying alternatives to submitting product liability claims to a jury. Accountants, lawyers, brokers and busi? nessmen are reacting to class actions that seek to impose obligations for ill-defined and speculative damages alleged to result from securities law violations. Corporate executives shiver at the prospect of antitrust treble

damage claims.

The speculation, guess and conjecture about future

damages that the courts have authorized and encouraged are a result of the concern of judges to protect from the future's uncertainties someone who has suffered sub? stantial loss. The alternative suggested in this article should satisfy the courts and restore confidence in the

adversary system. If each wrong deserves a remedy and if that remedy must be an adequate award, let us borrow from the wealth of experience gained in the fields of

pensions and annuities and award only the amount needed, only at the time it is needed, and only to the

person entitled to receive it.

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