Settling: A real-life example

How does a settlement typically "wash out?" Here's a real-life example:

The 45-year-old claimant became disabled because of carpal tunnel and cervical problems in August 1996. He has lifetime benefits with cost of living adjustments (COLA) to age 65. His original monthly benefit, before COLA, was $18,550.

The claimant has a life expectancy to age 79.2, according to recent Society of Actuaries standard mortality tables. With COLA already applied, his current benefit is $25,228. COLA, related to CPI (consumer price index), has a 4 percent minimum increase and has been assumed to be 4 percent in the future.

The maximum payout of the claim, including future 4 percent COLA increases, would be $14,383,240. If these benefits were received today, discounting at a 5.5 percent interest rate, the value would be reduced to $5,940,352, or 41.3 percent of his maximum anticipated payout. The reduction in value is significant because of his young age and long expected lifetime.

An insurance company is able to hold reserves based on the 1987 Commissioner's Group Disability Table and is allowed to include additional morbidity factors. This reduces the value of benefits to $4,058,169 or 28.2 percent of his full payout. Again, this reduction reflects the claimant's young age, which, according to the standardized insurance table, projects a chance of recovery from disability. That prognosis may or may not apply to this claimant.

Finally, an insurer might settle this liability for approximately 80 percent of the reserve, or $3,246,535 — 22.6 percent of his maximum payout.