» Responses
» Overview of this consultation paper
» Introduction - how damages are assessed
A: THE DISCOUNT RATE - ISSUES AND PROPOSALS
» The origin of the discount rate, and the effect
of the Damages Act 1996
» Section 1 of the Damages Act 1996
» Should the power be exercised at all?
» How should the rate be calculated?
» Alternatives to the ILGS approach
» Arriving at the relevant rate: ILGS and the alternatives
» Fixed rate or formula for ILGS?
» How should a fixed rate for ILGS be calculated?
» The impact of taxation
» How should the ILGS rate be reviewed?
» Questions for consultation on the Discount Rate
B: LUMP SUM PAYMENTS
» What are the advantages of lump sum payments?
» What are the disadvantages of lump sum payments?
» What are the alternatives to lump sum awards?
» What are the options for reform?
» Questions for Consultation - alternatives to lump
sum compensation
Please send your response by 31 May 2000 to:
The Department may wish to publish responses to this consultation document in due course. If you wish your response to be treated as confidential, please ask. Confidential responses will be included in any statistical summary of numbers of comments received and views expressed.
Further copies of this consultation paper can be obtained from Jon Yates
at the above address.
Overview of the Consultation Paper
This paper seeks views on the rate of return which the courts should take into account when assessing damages for future pecuniary loss in personal injury claims. The rate of return will govern the discount which is applied to an award of damages to reflect the fact that a lump sum will be available to the claimant immediately, although some of it is intended to compensate for lost earnings which he would not have received, or to cover expenses which he will not have to pay, until later years.
This paper also canvasses views on alternatives to lump sum awards of damages, under which payments to the plaintiff might be made wholly or partly by periodic payments. Under such arrangements, it would be for the defendant to decide what investment, or other financial arrangement, was necessary to provide the money required, for as long as it was judged to be necessary to make the payments to the claimant.
The object of an award of damages for personal injury is to put the claimant in the same position, financially, as he would have been in if he had not been injured. In most cases the claimant will have suffered several different kinds of loss. He will usually receive a lump sum, which is arrived at by adding together the money values that are as close an approximation as possible to the proper compensation for each loss. Some losses can readily be expressed in terms of money, for example medical and other bills which the claimant has already paid, and earnings which he has already lost through being unable to work. But he may suffer other losses which have no obvious money equivalent, or which cannot be valued with the same degree of accuracy.
Non-pecuniary or personal losses such as pain and suffering, and loss of amenity, are not susceptible of measurement in money. So money can only be a conventional medium of compensation, by payment of a sum which is seen as fair and reasonable. In cases of serious injury, damages for future losses, such as loss of earning capacity and the cost of continuing medical and other care, are likely to be by far the largest element in the lump sum award. These losses are difficult to value accurately, because there can be no certainty about what will happen in the future, or about what would have happened, but for the accident. Damages therefore have to be assessed on the basis of many assumptions about the future, both as it will affect the claimant personally, and more widely. The aim in assessing those damages is to provide a capital sum which can be used to yield exactly enough to cover the anticipated needs and lost earnings every year, for so long as they are expected to continue. That period will be determined by the Court, or agreed by the parties if the case is settled. The award should cover the whole of the period, as exactly as can be arranged. If the capital sum is exhausted before the period finishes, or if the claimant should be left with a capital sum when the period covered by the award has expired, the claimant will have been under, or over-compensated.
Against this background, the process of assessment requires three separate steps to be taken, although in practice the second and third tend to be combined.
First step: the multiplicand. The first step is to estimate the annual loss of earnings, or the annual cost of care which the claimant is likely to need while he continues to suffer from the injury. That is the multiplicand. The estimate will take into account such assumptions as can be made about factors such as whether the claimant could have expected rapid advancement in his or her career, or whether it is anticipated that there will be a rise or fall in the cost of providing the particular care he or she will need.
Second step: the multiplier. The second step is to estimate the number of years for which the losses are likely to continue. That is the basis of the multiplier. As actuarial methods of assessment have become increasingly more sophisticated, there has been growing recognition of their usefulness in forecasting. Paragraph 16 of this paper explains that the Government also intends to bring into force section 10 of the Civil Evidence Act 1995, which is concerned with the use of actuarial tables.
Third step: the discount. If the multiplicand is multiplied, without any discount, by whatever figure emerges as the multiplier, the resulting lump sum would over-compensate the claimant. A large part of the money would be in the claimant's hands much sooner than it would have been if he had been able to earn it, and sooner than it is needed to meet care costs. The advance payment of that money would enable the claimant to receive interest on investment on top of the amount needed to cover future loss. He should instead receive the lump sum which, once invested, provides exactly the right amount every year by drawing on both income and the capital, which will be exhausted by the end of the period of loss. Therefore the final step is to apply a discount to reflect the effects of paying the whole amount in one lump sum. So before the multiplication is done, the multiplier is discounted by the amount equivalent to the anticipated investment return.
The Origin of the Discount Rate, and the Effect of the Damages Act 1996
For many years there was a convention, endorsed by decisions of the House of Lords, that a discount rate of 4 to 5% should be used in the calculations. The practice appears to have become settled, in times of stable currency, before there had been any attempt to break the multiplier down to show exactly what discount was being applied to reflect accelerated payment. The same practice continued through the collapse of the equity market in 1972 and the rapid inflation of the 1970s. No adjustments were made for inflation, beyond an assumption that it was taken care of in a rough and ready way by the higher rates of interest obtainable as a consequence of it. No other practical basis of calculation had been suggested that was capable of dealing with so conjectural a factor as inflation with greater precision. Recent commentators have sought to justify this conventional rate as being the long-term average rate of return on a basket of securities, with a preponderance of equities, in which a prudent investor should be expected to invest.
A change to the economic landscape began in 1981, when Index-Linked Government Securities ("ILGS") were introduced. Unlike equities, these securities are protected against inflation, because they are tied to the retail price index. They are virtually risk-free. They are therefore ideal for investors who require a safe investment, although the returns may not be as good as those of a mixed portfolio. A working party chaired by Sir Michael Ogden QC recommended, in 1984, and again in 1994, that the discount rate should be based on the assumption that funds would be invested in ILGS. Their availability meant that a prudent investor was no longer forced to speculate by investing in equities in order to provide the annual sums required. The working party recognised that because the ILGS rates were less than 4-5%, the effect of using them would be to increase the size of the multipliers and hence the size of awards. The recommendation was endorsed by the Law Commission in their Report on Structured Settlements and Interim and Provisional Damages (1994, Law Com. No. 224).
Until the House of Lords considered, in 1998, the issues in three appeals, there was some uncertainty as to whether the courts might be constrained by the decisions in earlier cases to continue to use the conventional 4-5% discount rate. In Wells -v- Wells [1999] 1 A.C. 345, their Lordships unanimously concluded that investment in ILGS was the most accurate way of calculating the present value of the loss which claimants would actually suffer in real terms. They agreed that the court should calculate the damages on the assumption that the claimant would invest prudently.
Their Lordships also concluded that this did not mean that the court had to reach any conclusion about what an individual claimant would actually do with the money when he received it: they considered this irrelevant. Their assumption about investment in ILGS was made for the purpose of arriving at a figure which should provide full compensation for future losses. That meant it should be sufficient to enable the claimant, investing prudently, to receive the income needed to cover the assessed future losses, and for the capital sum to have expired at the end of the period covered by the award. It may be that the average investor would not regard it as imprudent to take some risk by investing in a mixed portfolio, including some equities. But the House of Lords concluded that, for a claimant who was not in a position to take risks, and who wished to protect himself against inflation, it was clearly prudent to invest in ILGS. It also concluded that greater risk was not even justified for a long term investment because, if there is a depressed market at an early stage, the claimant may have to draw on so much capital for his early needs that there will not be enough to provide for later years even if the market recovers.
The House of Lords went on to lay down a guideline rate of return of 3%. This figure was worked out by taking the average return over a particular period, net of tax. The judgments recognised that assessment by reference to ILGS would result in a heavier burden on defendants, and on the insurance industry in general, so that premiums would have to increase. It can be demonstrated that the combination of a low rate of return on ILGS - and the rate has recently been as low as 1.59% - and a very young claimant with a normal life expectation can lead to a multiplier of around 45, which is two and a half times greater than the 18 which was the theoretical, yet seldom reached, maximum under the old regime. The judgments stressed that there had been no change in the objective of the law, which was, and remains, that the claimant should be compensated as nearly as possible in full for all pecuniary losses. Their Lordships said courts should apply the 3% rate in other actions, unless there was a very considerable change in economic circumstances, until a rate was prescribed under section 1 of the Damages Act 1996.
Insurance industry sources estimate that reducing the guideline rate of return from 4.5% to 3% increases by about £115 million a year the sums needing to be paid out in damages as constituting the appropriate compensation laid down by the courts. If passed on, these will increase motor insurance premiums by about 1%, employer liability premiums by 2% and public liability premiums by 7%. As the courts apply the reduced guideline rate to all cases already in the pipeline, insurance industry sources also estimate a one off increase in their costs of around £440 million, as premiums cannot generally be adjusted retrospectively. If the guideline rate applied by the courts fell again from 3% to 2%, the further annual cost is similarly estimated to be around £100 million, and £380 million one off. The scale of expense necessary to deliver in ongoing terms the compensation held appropriate by the courts is not a matter to which the Lord Chancellor may have regard in prescribing for the first time a rate under section 1 of the Damages Act 1996. This is because, as the House of Lords made clear in Wells v Wells, claimants are entitled in law to full compensation for their injuries and the discount rate must be set so as to provide, as nearly as possible, full compensation.
It is against this background that the Government now invites views about the Lord Chancellor's exercise of the power conferred by section 1 of the Damages Act 1996 to prescribe the rate of return which the courts should take into account. Section 1 is reproduced below. This consultation paper is concerned with the exercise of the power for England and Wales and Northern Ireland. A further consultation will be undertaken in Scotland before Scottish Ministers prescribe a rate for Scotland.
(2) Subsection (1) above shall not however prevent the court taking a different rate of return into account if any party to the proceedings shows that it is more appropriate in the case in question.
(3) An order made under subsection (1) above may prescribe different rates of return for different classes of case.
(4) Before making an order under subsection (1) above the Lord Chancellor shall consult the Government Actuary and the Treasury; and any order under that subsection shall be made by statutory instrument subject to annulment in pursuance of a resolution of either House of Parliament.
(5) In the application of this section to Scotland-
The issue now to be addressed is whether the power under section 1 of the Act should be exercised, and if so, how.
It is open to the Lord Chancellor not to exercise the power under section 1. The House of Lords has, in effect, set a guideline rate, which will be followed by the courts unless economic circumstances change very considerably. However, it is plain that their Lordships' decision was made in anticipation of the power under section 1 being exercised. Moreover, the Government believes that to leave it to the courts to decide in individual cases whether there had been a sufficient change in economic circumstances to justify adopting a rate other than 3% would place an unreasonable burden on litigants and courts, which the exercise of the power can avoid. Accordingly, the Government proposes to set a rate pursuant to the power under section 1. At the same time, the Government intends to bring into force section 10 of the Civil Evidence Act 1995, which provides that the "Ogden Tables" (the actuarial tables, together with explanatory notes for use in personal injury and fatal accident cases issued from time to time by the Government Actuary's Department) are admissible in evidence, and may be proved by production of a Queen's Printer's copy.
The Lord Chancellor has consulted the Government Actuary and HM Treasury, as required by the Act. However, the Government is also interested in the views of those with a personal or professional interest in the outcome and believes that it should consult as widely as possible before coming to a decision on how the rate should be set.
The Government has carefully considered the reasoning behind the House of Lords' decision that ILGS provide the best basis for setting the rate. The logic of the argument that an investor who wishes to protect himself against inflation and who is not in a position to take risks will invest in ILGS is clear. However, as Oliver Wendell Holmes commented, "the life of the law is not logic but experience". Experience suggests that the recipient of a damages award covering a relatively short period who seeks professional advice is likely to be advised that investment in ILGS is the best course of action for him to take. On the other hand, someone receiving a substantial award covering a longer period, during which changes in market conditions might even out, is likely to be advised to invest in a mixed portfolio that consists largely of equities. This is because a mixed portfolio is likely to generate considerably more income than investment in ILGS and, although a mixed portfolio is not risk-free, the levels of risk may be very low. In such a case, it would not be incautious advice that an investor should accept this small risk in order to maximise income from the investment. A claimant who follows this advice with an award calculated on the assumption that it will be invested in ILGS could be left with a substantial capital sum when the period of the award has expired. This would clearly be contrary to the objectives behind the award of damages. It is of course true that Lord Lloyd said that even long term investment has its dangers in a depressed market (see paragraph 12), but it may be thought that such a claimant would still be resorting largely to the income in the early years rather than to the capital, especially as there would be the cushion from the proportion of the investment that has been put in gilts. It is also likely, bearing in mind the lesson of history, that the capital value would eventually recover enough to offset any loss of capital at the beginning of the investment period.
Before we consider the policy question, it is important to consider the objectives behind the award of compensation and the roles that are played by the court, the defendant and the claimant in meeting these objectives. The objective is to award a lump sum that will enable the claimant to meet his assessed needs over the relevant period.
The Court: The court's task is to calculate the lump sum so that it meets the objectives of the award - that is to meet the claimant's assessed needs over the relevant period. In order to do this, it cannot take any account of what the claimant will do with the money - the House of Lords concluded in Wells -v- Wells that what the claimant actually does with the money is irrelevant, according to the law as it stands. But the Court does assume that the claimant will invest the lump sum: otherwise there would be no need for a discount. The House of Lords concluded in Wells v Wells that it was reasonable to assume the claimant might be a cautious and conservative investor who would invest in ILGS, and set the discount rate accordingly.
The Defendant: The defendant's task is to compensate the claimant for his losses. He will do this by providing the lump sum calculated by the court. It is unfair on him if the sum awarded is greater than is necessary to discharge his responsibility, especially if it provides the claimant, or those who will inherit from his estate with a substantial profit.
The Claimant: It is reasonable to expect that the claimant will conserve the lump sum so that, as far as is possible, it meets his needs as assessed by the court. The objective behind the award is defeated if he either squanders the award extravagantly or succeeds in investing it in such a way as to make a substantial profit.
The policy question which the Government must address is how to set a discount rate which meets the objectives of the compensation award, ie. which will fully compensate, but not over-compensate, the claimant,given the principle that, once a lump sum award is made it is entirely a matter for the claimant what he does with it. However, since it must be assumed that the individual claimant will invest the money, it might be thought appropriate to take into account, when setting a rate under section 1 of the Damages Act, how the claimant ought to invest the award. If one is willing to contemplate that approach, is there an alternative to the ILGS-based rate, which will provide full compensation, while minimising the risk of over or under- compensation?
One option is for a rate that is based on the average return from a mixed investment in equities and gilts, including ILGS. It has been suggested that assuming that the claimant will invest on this basis would reflect the way in which the majority of claimants would be advised to invest their money. The House of Lords dismissed this approach because it was not consistent with the view that what a claimant actually does with the money is irrelevant. However, the argument is not that the claimant would invest in this way but that he ought to in order to meet the objectives of the award. He would certainly be advised to take this approach if he obtained proper financial advice and it may be thought that what claimants, under such advice, will do with their awards is also of relevance. Insurance industry sources estimate reducing the courts' guideline rate of return from 4.5% to 3% increases by about £115 million a year the sums needing to be paid out in damages as constituting the appropriate compensation laid down by the courts. If passed on, these will increase motor insurance premia by about 1%, employer liability premia by 2% and public liability premia by 0.7%. As the courts apply the reduced guideline rate to all cases already in the pipeline, insurance industry sources also estimate a one off increase in their costs of around £440 million, as premia cannot generally be adjusted retrospectively. If the guideline rate applied by the courts fell again from 3% to 2%, the further annual cost is similarly estimated to be around £100 million, and £380 million one off. The scale of expense necessary to deliver in ongoing terms the compensation held appropriate by the courts is not a matter to which the Lord Chancellor may have regard in prescribing for the first time a rate under Section 1 of the Damages Act 1996. This is because, as the House of Lords in Wells -v- Wells made clear, claimants are entitled in law to full compensation for their injuries and the discount rate must be set so as to provide, as nearly as possible, full compensation.
Another approach develops the option which is outlined in the previous paragraph. It involves the use of a rate based on investment in ILGS for short-term awards, and the average return from equities and gilts for long-term awards. In the House of Lords judgement, Lord Lloyd said that a single rate applying across the board would facilitate settlements and save the expense of expert evidence at the trial. He did not favour distinguishing between different classes of claimants according to the length of time that the investment might be expected to continue. However, it is likely that investors with long term needs will receive different advice from those whose needs are over a shorter period. It may be very likely that a claimant whose award is intended to cover a short period would be advised to invest exclusively in ILGS, because the period concerned would not be long enough to enable his fund to recover from losses sustained early on. But, for the reasons given above, a claimant with a large award covering a long period might not be acting incautiously in investing in a mixed portfolio. If these hypotheses are sound, then the rate set under section 1 of the Damages Act might reasonably take account of the two scenarios. If the break between the two categories stands at five years or 10 years, the disparity between awards at the upper end of the ILGS discount rate and those at the lower end of the higher rate would be insignificant. However, it is, of course, important to decide where the break in years should come and the views of consultees favouring this approach would be welcomed.
If ILGS are to be used as the basis for setting the discount rate, then questions arise as to how to arrive at the appropriate rate, whether by formula or by specific figure, and as to when the rate should be reviewable; these matters are considered below. If however, a mix of equities and gilts is to be used, then it is necessary to come to a view as to what figure represents the true return in real terms on such a mix, taking into account capital appreciation as well as income, and that there will be a preponderance of equities over gilts. It may be that respondents favouring a discount rate based on a mix of equities and gilts are able to nominate a suitable index that could be used as a guide to arrive as to the appropriate rate. Those respondents who favour such a rate and are unable to nominate an index are welcome to give their views on what the net rate should be (the impact of taxation, which will have to be taken into account when deciding this figure is discussed in paragraphs 28 and 29 below).
It would be possible to use the power in section 1 of the Damages Act to direct the courts to refer, in each case, to publications from which they could calculate the appropriate rate of return, gross or net of tax. Alternatively, the power could be used to prescribe some other formula, or a fixed rate. For example, the Working Party Report attached to the Ogden Tables explained how the real return on ILGS on a particular date could be ascertained by referring to the section of the Financial Times for that day entitled "FTSE Actuaries Govt. Securities UK Indices". It explained that the most appropriate figure was shown in the entry on the average gross redemption yield for index-linked securities, over 5 years, with inflation 5%.
As has often been said, the assessment of damages is not an exact science. More sophisticated techniques have led to a greater degree of precision, and full advantage should be taken of them. However, a formula which requires the courts to base its calculations on the average rate for a particular day would create an illusion, but only an illusion, of precision. Whatever method is chosen for setting the rate, the figures will fluctuate, sometimes daily, albeit within a relatively narrow band. It would be unrealistic to suppose that claimants always receive their damages on the day when the exact amount is worked out. Even minor movements in the market, between calculation or, rather, the day before calculation and payment would undermine the accuracy of the calculation.
Moreover, many more cases are settled by negotiation out of court than by the judges. Anticipation of such movements might encourage either of the negotiating parties to defer final settlement, or to press ahead to trial or appeal, because manipulation of the time when the calculation is made might produce a financial advantage. Moreover, in the event of an award being adjusted by the Court of Appeal, it would be necessary to decide whether the rate prevailing at the date of trial or at the date of the appeal decision should apply. Logically, the award should be calculated using the rate current when the award is adjusted, but that might encourage parties to appeal only because they believe that the rate will change before an appeal would be heard. All these considerations suggest that the better course is to set a fixed rate.
The fixed rate needs to reflect the performance of ILGS and the incidence of tax. The first question is the degree of precision required. In Wells -v- Wells, Lord Hope said the figure set under section 1 of the Act should be expressed to no greater accuracy than half a decimal point. The Government believes this is the right approach. As to the particular rate to be fixed, and remembering the inevitable compromise between accuracy and practicality, one approach, which seems realistic, would be to set a period over which relevant rates should be averaged to provide a figure for the average gross return.
As the lump sum award is invested to produce an annuity, by drawing down on capital and income, the claimant will almost certainly be liable to both income tax and capital gains tax. It follows that the effect of taxation must be taken into account in arriving at the discount rate, so that the claimant is compensated for the net loss suffered. In arriving at the guideline rate in Wells -v- Wells, the House of Lords made an adjustment for tax, so that the 3% applied was a net rate. The impact of taxation needs to be taken into account whichever method is selected for calculating the discount rate.
The incidence of tax may vary considerably according to the size of the settlement and the claimant's other means and outgoings. It would be possible to adopt an approach similar to that used in divorce cases, and commonly known as "the Duxbury method". The rate prescribed under section 1 would then be the gross discount rate, which the courts would then adjust to take into account the individual's tax position. A simpler alternative would be to assume a flat rate, which might reasonably be set at a rate equivalent to the standard rate of tax. Although that approach has been criticised as "crude, unrealistic and favourable to claimants", other approaches are likely to be no less crude, and have the additional disadvantage of requiring intricate and complex calculations and assumptions. Also, it might be possible to prescribe a special rate which would apply only to those cases where it is anticipated that the income will be insufficient to require payment of tax at the standard rate.
The House of Lords commented in Wells -v- Wells that it was undesirable for the guidelines to be changed too often. The options for review could either be linked to changes in the market, or to calendar periods. So, for example, arrangements could be put in hand to alter the rate, as it were, automatically, once the average rate over a period, however calculated, moved by more than, say, half a percent. Or there could be yearly, half-yearly or other regular reassessments of the rate. In different ways, both approaches risk distorting settlement negotiations, as parties might jockey for a more favourable settlement date. It would also need to be clear which rate would apply if the award were changed on appeal. And it should be borne in mind that, whichever method is chosen for reviewing the rate, the Act gives the courts the discretion to use a different rate when the circumstances of the case justify such a course. The Government would welcome views on how, and how often, the rate should be reviewed once it has been set.
It is also necessary to consider the question of retrospection. If a rate is prescribed which is higher or lower than before the power was exercised, there could be an element of retrospection in that exercise of the power. The general principle is that Parliament should not legislate retrospectively except in very exceptional circumstances. Should special provision be made for claims which arose before the power was exercised? The Government's view is that, if the first exercise of the power follows the guidelines that were laid down in Wells -v- Wells, no transitional provisions will be required. It was not a problem when judgement was given in Wells -v- Wells because there was no change in the law. However, this may not be the case if a different basis is used to set the rate. The Government would welcome views on whether retrospection would be a problem in these circumstances and, if so, how the problem should be addressed.
Q1 Do consultees agree that the power under section 1 of the Damages Act 1996 should be exercised?
Q2 Do consultees agree that the Lord Chancellor can prescribe a discount rate that is not based on the assumption that claimants will invest in ILGS and, if yes, on what basis should the rate be set?
Q3 If consultees favour a discount rate based wholly or partly on the rate of return from equities, what indicator should be used to assess that return?
Q4 If consultees favour a discount rate based on the average return from ILGS and equities, how should the average be calculated?
Q5 If the power is exercised, should it prescribe a fixed rate or should it prescribe a formula by which the parties and the courts can calculate the applicable rate in the particular case? What strengths and drawbacks to these two approaches do consultees see?
Q6 Do consultees favour fixing the rate by averaging the relevant indicator over a period, and if so, what period do they recommend and why? If not, how else might the rate be fixed?
Q7 Do consultees agree that the rate, if set, should be accurate to the nearest half a percent?
Q8 If the power is to be exercised, what arrangements should there be for the discount rate to be reviewed, and at what intervals?
Q9 What views do consultees have on the issue of different rates for different classes of case, and where consultees favour different rates according to the length of the award, where should the dividing line be drawn?
Q10 Do consultees believe that there is a problem with retrospection and, if so, what form should transitional provisions take when the rate changes?
Q11 How do consultees think that taxation should be taken into account?
Q12 Bearing all these issues in mind, what rate would consultees now set?
It will be recalled that, in most cases, successful claimants receive their damages as a lump sum. Actual costs (apart from legal costs, which are paid separately) incurred up to the date of trial constitute what are called special damages. These might include, for example, the costs of hiring vehicles or equipment, procuring particular services, or replacing damaged property. Other elements reflect non- pecuniary loss, and costs and losses which will be sustained in the future.
Assessing special damages is usually a matter of simple calculation. Assessing the level of damages for pain, suffering and loss of amenity requires more judgement, but there are precedents in decided cases and guideline texts (for example, Kemp and Kemp on Damages) to assist the parties and the court in reaching a decision. As explained in earlier paragraphs of this paper, future loss is assessed by calculating an annual amount (the multiplicand), to which is applied a multiplier, which represents the best appraisal that can be made - by forecasting or by assessing the probabilities - of the period over which the loss will continue. Very often, this is the expected life-span of the claimant. This total sum for future loss is then discounted to reflect the investment benefit that the claimant can receive as a result of being awarded all the money in a lump sum.
Payment of damages by lump sum (as distinct from a structured settlement, on which see below) has been the norm for very many years. It enables the proceedings to be concluded with a "clean break" between the parties: once the damages are paid, the defendant is clear of any further responsibility. The claimant has a degree of flexibility to choose what to do with the lump sum damages: investment, spending and purchasing decisions are entirely for the claimant, advised as he chooses to be.
The problems surrounding the determination of a fair discount rate are considered in preceding paragraphs in this paper. The claimant may have a windfall if medical expenses are lower than anticipated (perhaps because of a partial recovery), or may be in difficulties if the opposite occurs. Should the claimant die much sooner than the life expectancy incorporated in the settlement, the balance of his damages might become a windfall to his beneficiaries. However, a claimant who survives significantly beyond the anticipated life expectancy, may be forced to spend his last years relying on welfare benefits, with the damages award exhausted.
A second problem concerns the behaviour of the claimant. Whilst the calculation of the award might be based on what the claimant ought to do, it cannot be ignored that he might do something else which undermines the purpose of the award. For example, the award could represent a significant opportunity to a claimant who is willing to take a greater degree of risk to make a significant investment profit. Conversely, a reckless claimant could, through ill-advised or extravagant spending, dissipate the damages award quickly, and then (for example) fall back onto the benefits system for support. Other claimants, who are unused to handling large sums of money, may feel unable or not sufficiently confident to spend as much as is needed to compensate them for the injury.
• Structured Settlements
Leaving aside special arrangements for interim payments of damages or provisional damages, some compensation may be paid by regular instalments, rather than in a single lump sum, using structured settlements. The development of structured settlements was considered at length in the Law Commission's report on Structured Settlements and Interim and Provisional Damages, published in 1994.
Elements of that report were enacted in the Damages Act 1996. The report defined a structured settlement as "an agreement settling a claim or action for damages for personal injury on terms whereby (a) the damages are to consist wholly or partly of periodic payments; and (b) the person who is to receive the payments must receive them as the annuitant under one or more annuities purchased for him by the person against whom the claim is brought, or if he is in insured against the claim, by his insurer". This definition does not include self-funded structured settlements, where the payments are made directly rather than via an annuity.
Structured settlements may be "top down", in which a lump sum is calculated in the normal way and an annuity purchased to provide annual payments, or "bottom up", in which the calculation of the lump sum, and therefore of the annuity, is more informed by an assessment of the claimant's future needs. In practice, as the Law Commission's Report said, there is flexibility in the availability of both approaches to enable parties to reach a negotiated settlement. The majority of structured settlements are "top down", but the Report comments that there is evidence of a changing culture towards the more needs-based settlements which the bottom-up approach can provide.
• What are the advantages and disadvantages of Structured Settlements?
The Law Commission's report identified a number of key advantages of structured settlements. There are financial benefits to both parties as a result of tax concessions. The structure can be tailored to the claimant's needs. The claimant does not have the burden of managing the investment (and consequently cannot dissipate or waste it). In the light of recent developments on discount rates, defendants might be more attracted to structured settlements because, especially in the case of insurance companies, they could make less risk-averse investment decisions than the claimant, thus providing the level of compensation required at lower cost.
However, the ability of structured settlements to adapt to changes in the claimant's needs, or to improve the accuracy of compensation, is limited. Neither type of structured settlement is reviewable: the level of payment remains as fixed in the agreement, regardless of changes in the claimant's circumstances. To some extent, this can be ameliorated by including a contingency fund in the settlement, from which additional payments can be made in the event of, for example, the claimant's condition worsening. However, contingency arrangements vary widely. It must be accepted that, even with structured settlements, there is a risk that the claimant will be under- compensated or over-compensated because the settlement is based on appraisals of need, costs, and life expectancy made at the time of the award.
Structured settlements are only possible with the consent of the parties. Inevitably, settlement negotiations in litigation are informed by judgements about financial advantages and disadvantages on both sides. If either party thinks that they will get a "better" deal from a lump sum award, they are unlikely to consent to a structured settlement. There might, for example, be different judgements about life expectancy, or it may be that claimants might be willing to invest more riskily, or simply wish to spend the money other than envisaged in the way the award is made up.
• Periodic payments
The possibility of extending current arrangements for periodic payments has been explored several times in recent years. The Law Commission's 1971 working paper on "Personal Injury Litigation: Assessment of Damages" identified the limitations of lump sum awards and invited views on whether reviewable periodic payments should be introduced. On that occasion, the Commission concluded that the introduction of such payments would meet widespread and strong opposition. The Pearson Commission, in 1978, recommended that reviewable periodic payments should become the main remedy in cases of serious or lasting personal injury and death, but their recommendation was not implemented. In its 1994 Report, the Law Commission considered whether structured settlements might be imposed in the absence of the consent of both parties, but concluded that they should be given more time to "settle in" before such a step should be considered.
The aim of section 2 of the Damages Act 1996 was to resolve existing doubts as to whether the court had power to make a consent order to give effect to a settlement which included an obligation to make periodical payments. It gives courts the power to make an order under which damages "are wholly or partly to take the form of periodical payments" where both parties consent. Existing arrangements might be extended by giving courts powers to make such orders without the consent of both parties. These payments might be reviewable in the light of changing medical or other circumstances. Alternatively, some periodical payments could be made variable, by tying the amount payable to the retail price index, or to some other index which might be prepared specially for this purpose, and which reflected fluctuations in particular costs, such as the cost of care, or the average rise in incomes. The following paragraphs outline some of the advantages and disadvantages of such an approach.
• What are the advantages of reviewable periodic payments?
Reviewable periodic payments would, in effect, achieve the advantages of "bottom up" structured settlement, with the added benefit of enabling either party to apply for the level of payments to change in the event of changing circumstances. This would ensure that compensation was not dissipated by unwise spending decisions, and avoid creating windfall benefits for the claimant's estate in the event of his early death, or years of dependency on the welfare state if he survived beyond the assumed life expectancy. The discount rate issue could be avoided, because the defendant could make his own investment decision, as long as it was sufficient to produce the income needed for the claimant.
Moreover, there is a certain logic in compensation which is partly lump sum (for non-pecuniary loss and special damages) and partly income-based (for future loss) since the defendant's actions have created income and expenditure effects, in the shape of liability for medical, etc, expenses, and reduction or removal of the claimant's ability to earn income. Non-reviewable periodic payments would in practice be little different from bottom up structured settlements. The payments would continue until the claimant's death, but otherwise (subject to whatever can be arranged by way of a contingency fund) the risk of over or under compensation remains in the need to settle the level of payments at the time of the award, based on estimates of future requirements.
• What are the disadvantages of reviewable period payments?
Arguments against reviewable payments include the abandonment of the "clean break" principle. Both lump sum payments and structured settlements offer both parties some financial certainty. The claimant can plan for the future on the basis of a fixed award, and the defendant and his insurer, if there is one, can effectively close the case once damages are paid or the necessary annuities purchased. Reviewable payments would create a lifetime relationship between the claimant and the defendant/insurers, with the possibility of considerable and continuing strain being placed upon the parties. This relationship would create additional administrative costs, and legal costs in the event of further applications to the court. It has been argued that, especially if such arrangements were optional, they would be applied in only a minority of cases because of the likely continuing preference, by claimants at least, for lump sum awards, especially in the light of developments on the discount rate.
The Government would be grateful for responses on the following questions:
Q13 Should courts be given powers to impose structured settlements, even when both parties do not consent?
Q14 Should the court have power to order non-reviewable periodic payments (other than structured settlements), even when both parties do not consent?
Q15 Should the court have power to order reviewable periodic payments? If so, should such orders require the consent of both parties?
Q16 Should the possibility of lump sum awards be retained, for some or all heads of damage? If so, for which heads of damage would lump sum awards, and periodic payments, be applicable?
Q17 What comments do consultants wish to make about tax and inflation provisions which periodic payments might attract?
Q18 If periodic payments are to be available, how should the court be satisfied as to the defendant's financial means, and the security of the payments in the future?
Q19 Should periodic payments be restricted to personal injury and death claims? If not, in which other types of claims should they be available?
Q20 What other issues do respondents believe should be taken into account in reaching a conclusion on these questions?
The Government is aware that the Clinical Disputes Forum has recently published a discussion paper on periodical payments. Consultees are welcome to submit joint responses to both papers where appropriate or to submit a copy of a response to the Clinical Disputes Forum's paper in response to the second part of this paper.