Where compensation for damages for personal injury is payable, at present courts may:
Traditionally, most damages have been paid as lump sums. When successful claimants are awarded a lump sum they are paid in full for all past and future losses at once. The Government considers that it is generally preferable for claimants to receive periodical payments, rather than a lump sum, where significant damages are awarded for future care costs and loss of earnings. The Government is proposing to give the court power to order that damages for future loss take the form of periodical payments, without requiring the consent of both parties. It hopes an order for periodical payments will become the norm in larger cases. Against this background, it can be expected that parties settling claims out of court will more commonly agree to periodical payments too.
The objective of the proposal is to make the system for compensating seriously injured accident victims more accurate in reflecting the amount and nature of the claimant's loss and so fairer as between claimants and defendants; while enabling defendants to fund awards in the most cost-effective way. It does this by removing the risks associated with life expectancy and investment from recipients of damages and placing them on defendants, who are better placed to manage them.
With a series of periodical payments it is more likely that permanently injured claimants awarded damages for future losses and care costs receive the compensation to which they are entitled for the remainder of their lives. Defendants would be free to choose how to fund the award, provided this offers claimants adequate security that the award would continue to be paid. There would be major cash-flow benefits for public sector and other defendants, particularly the NHS, who fund awards from their own resources.
In March 2002 the Lord Chancellor published the consultation paper Damages For Future Loss: Giving the Court the Power to order Periodical Payments for Future Loss and Care Costs in Personal Injury cases. A partial Regulatory Impact Assessment was attached. The post-consultation report was published on 7 November 2002. This impact analysis reflects the responses to consultation and further discussions with, and data provided by, a number of organisations including the NHS Litigation Authority, Association of British Insurers, medical defence societies, and Lloyd's of London.
In 2001 there were 1,340 actions set down for trial relating to personal injury claims and 580 relating to medical negligence in the Queen's Bench Division (which would deal with the most serious issues). But many claims are settled without the need for court proceedings. In 2001-02 the NHSLA estimates that it settled 2,211 cases by way of an award to the claimant. It is estimated that will be 4,764 successful claims ( see note 1 ) for awards greater than £100,000 for personal injury dealt with by motor and liability insurers in 2002. Table 1 below breaks these figures down between the major categories of case. Fuller details are attached in the Annex.
The proposal is most relevant to larger claims relating to a substantial future period in which loss of earnings and additional care costs are incurred by the claimant. There is some debate about the level of award for which periodical payments may be appropriate, and in practice it is not only the quantum that is the sole deciding factor but also the period the award is intended to cover. The disadvantages associated with lump sums are less significant with small and medium claims, so it will not usually be worth providing for periodical payments in these cases. But it is not proposed to limit the power to cases over a certain amount; this will be a matter for the court's discretion.
| Public | Private | ||
| Clinical Negligence |
Motor | Liability | |
| Estimated awards | 2,211 | 320,000 | 184,000 |
| Of which >£100k | 524 | 3,160 | 1,604 |
| Of which >250k | 282 | 1,682 | 662 |
| No. of structured settlements | 51 | N/k | N/k |
| Weighted avge value of lump sums >£100k | £630k | ||
| Total value of lump sum damages >£100k | £411m | £1,651m | £613m |
| Total Damages awarded | £460m | £4,569m | £2,479m |
Currently structured settlements remain the exception. In 2001-02 the NHSLA paid 2,211 lump sums, of which 524 were for claims in excess of £100,000. Yet only 51 structured settlements were agreed. Part of the reason may lie in the fact that both parties have to agree to such a settlement which creates negotiating tension. Ingrained legal culture sees a lump sum as the norm, and claimants with imperfect economic information may be attracted by a large lump sum without fully appreciating the risks involved. A further explanation may lie in the perception that, with an appropriate portfolio of investments it will be possible to achieve a higher rate of return than implied by the discount rate used to calculate the lump sum (although it is not the purpose of damages awards to provide claimants with a stake with which to speculate).
The legal costs associated with large personal injury claims can be substantial. In 2001-02, in the case of large awards in excess of £100,000 the average defence costs faced by the NHSLA were £49,000, while successful claimants recovered average costs of £83,000 from the NHSLA for legal fees. While nothing in these proposals is likely to impact significantly on these legal costs, it is hoped that by switching to a system in which periodical payments are the main vehicle for large scale awards that disputes over the life expectancy of victims will generate less legal argument and a reduced need for distressing expert evidence. In turn this might then have an overall downward effect on costs.
Giving courts power to impose periodical payments is intended to address the inherent risk with lump sums that permanently injured claimants will almost always be over- or under-compensated because they will not live for exactly as long as predicted. Claimants may spend the lump sum cautiously for fear of the money running out, and so will not enjoy the quality of life intended. Claimants who outlive their award may have to fall back on State benefits. Where the claimant dies sooner than expected, there is a windfall to the heirs at the expense of the defendant. In privately funded cases the proposal is also intended to transfer the risks associated with the investment of large lump sums and uncertain life expectancy from individual claimants to life insurers.
Three options have been identified:
Option 1 - No change - all large awards and most settlements will continue to be paid as lump sums with a minority structured.
Option 2 - A discretionary power for the courts to order periodical payments for future loss and care costs, but with no power to order revised amounts beyond the existing scope of provisional damages.
Option 3 - A discretionary power for the courts to order periodical payments for future loss and care costs, with power to order revised amounts in strictly defined circumstances.
The proposed change will mainly affect claims under the following headings:
As such we can identify the following groups with an interest in these proposals:
A substantial majority of respondents who commented agreed with these assumptions. But some suggested that increased complexity of offers to settle would be a problem. On the other hand under periodical payments there is less need to spend time debating a claimant's life expectancy.
In the analysis we take the status quo as given. Detailed criteria remain to be developed, and it is difficult to predict how extensively the courts would exercise a power to order periodical payments, and how quickly and extensively this would be reflected in settlement practice. We have developed two alternative scenarios as a guide against which the impact could be assessed (see the Annex for full details). However the scenarios should not be interpreted as a forecast of the extent to which there will be a switch to periodical payment based compensation.
Where damages for future loss take the form of periodical payments, claimants would receive damages that more closely match their loss, paid in a way that better reflects the on-going nature of that loss. They would not face the risks associated with an uncertain estimate of life expectancy and with investing a lump sum. Claimants' heirs would not be able to benefit from a windfall if the claimant died sooner than expected.
The most significant impact for claimants would be that they no longer face the risk associated with uncertain life expectancy. Unless a claimant lived for exactly the number of years expected, periodical payments for life would provide more than a lump sum in some cases and less in others. The overall impact on the amount of compensation received by claimants would tend to zero to the extent that life expectancy was not systematically over- or under-estimated so there was an even distribution of actual life span around the predictions.
Periodical payments would only be ordered by a court (or agreed by the parties) where there was a satisfactory guarantee of continued payment. For public sector defendants, such as the NHS Litigation Authority, the payments would be guaranteed under the terms of the Damages Act, as is presently the case. For private sector defendants and their insurers, future payments would effectively be guaranteed under the Financial Services Compensation Scheme, typically by purchasing an annuity from a life insurer.
The amount of compensation received by claimants would also be affected by any difference between the value of the stream of periodical payments and the value of the income earned on an equivalent lump sum and the drawdown of the capital. This depends on whether and how claimants choose to invest lump sums and how successful those investments are over time. Some claimants may choose to make more risky investments in the expectation that they will be more remunerative over the long term. Others may spend the lump sum immediately or place it in a bank account. Periodical payments, on the other hand, would guarantee the level of income intended by the award.
A further impact on claimants would be that they would no longer have to fall back on State benefits or the National Health Service in the event that the award ran out for whatever reason. But it has not proved possible to estimate how many claimants fall into this position or the extent to which they have to make claims for benefit.
The overall impact on claimants would be that they would lose the ability to speculate with their lump sum, but they would be relieved of investment risk and the risk that funds would be exhausted because they outlived the predicted life expectancy. In addition claimants and their families would no longer have to face distressing arguments about life expectancy. While these impacts are difficult to estimate because they depend on the behaviour of individual claimants and because of the inherent uncertainty of the future development of the stock market and medical science, we believe that the net effect for claimants will be positive.
The main categories of defendant affected by this proposal will be public sector defendants (primarily the NHS) who self-fund awards, and motorists and employers who are covered by general insurance policies. In so far as the liabilities of general insurers are raised or lowered, insurance premiums can be expected to increase or decrease.
The principal impact on general insurers would arise from the difference between the cost of funding periodical payments and the equivalent lump sum. In the great majority of cases, the insurer would purchase an annuity calculated to produce the required stream of payments. This means that the impact on insurers (unlike that on claimants) arises immediately and depends on economic rather than behavioural factors.
The combination of three main factors is likely to create a difference between the price of the annuity and the lump sum alternative: different assumed rates of return, transaction costs and tax treatment.
Rates of return. At any given time, there is likely to be a small difference between the prescribed discount rate ( see note 2 ) used to calculate lump sums and current market annuity rates. The difference would not be large because the discount rate and the regulatory framework for index-linked annuities follow broadly similar (although not identical) principles, founded on low risk. ( see note 3 )
Transaction costs. Individual claimants need to incur costs on financial advice and management fees in order to invest and manage a lump sum award. Damages awards can include an allowance for these costs which inflates the value of the award. Under these proposals the insurance industry may be able to provide annuity payments with significantly lower average expenditure on financial expertise, investment transaction costs and other administrative expenses.
Tax treatment. Lump sums are calculated on the basis that the earnings on them will be subject to income tax. Periodical payments are calculated and paid free of tax. So the same net income for claimants could be provided at a lower cost to insurers and their customers.
The Annex sets out the assumptions and methodology used to estimate the overall impact of these factors. As a conservative estimate, we believe that general insurers would achieve savings of around 4% by purchasing annuities compared to paying a lump sum. This is subject to changes in annuity rates. Taking our mid-range estimates of the total annual value of lump sum awards likely to convert to periodical payments, this suggests an overall annual reduction in the liabilities of insurers in the order of £17 million, of which £14 million relates to claims against motor policies and £3 million to claims against liability policies. These figures need to be viewed against the estimated £10 billion paid in liability insurance premiums in 2000. However, given the uncertainties involved in this calculation the safest conclusion to draw may be that these proposals will not materially increase the value of claims against liability insurers.
The impact on the NHS and other defendants who make periodical payments directly from their own resources derives from similar factors.
Damages by way of periodical payments would not need to include the claimant's costs for investing a lump sum and liability for income tax.
There would be immediate cash savings in the short to medium turn as streams of periodical payments were put in place instead of immediate lump sums. The net present value of these streams would be less than the cost of the lump sum to the extent that the defendant's internal cost of capital or return on capital exceeded the prescribed discount rate.
There would be savings relative to a lump sum where the claimant died earlier than expected, and costs where he or she lived longer. Assuming an even distribution of actual further life spans around predictions, these effects would tend to cancel out if inflation and the time value of money are ignored. In terms of discounted net present value, the savings would tend to weigh more heavily than the costs. The effect is difficult to quantify given our current knowledge of claimants' actual life spans.
The NHS is by far the largest single defendant likely to fund damages in this way. The table below sets out the current situation in respect of lump sum awards and structured settlements. We have tested two alternative scenarios:
a) when 80% of the value of the future loss and care costs component of awards over £250k and 40% of lower awards in excess of £100k are structured and
b) when 60% of the value of future loss and care costs in larger awards and 30% of lower awards are structured.
On the basis of scenario A the net present cost (ie discounted the periodical payments by the Treasury discount rate of 3.5% ( see note 4 )) of providing compensation to successful claimants in one year would be reduced by £32m. On the basis of scenario B the saving would be £22.2m. Assuming the policy would be in force over the next 30 years then the net present value of the savings generated under scenario A would be of the order of £590m and under scenario B £408m (see Annex for details).
Of crucial importance to the NHS is not the theoretical economic saving arising from the policy outlined above but the actual impact on its cash flow. This again depends crucially on the extent to which there is a switch from lump sum to periodical payment. We analysed the impact using the two alternative scenarios A and B. The modelling suggests that under scenario A there would be a reduction in cash requirement of £245m in year 1 reducing to a neutral effect by year 24 and then building to a negative impact on cash flow of approximately £96m by year 34. Under B the initial impact would be to reduce cash flow requirement by £126m in year 1, neutral in year 32 and an increase in cash requirement of £7 million by year 34. Ultimately the impact on cash flow is negative because instead of making an up-front payment of capital upon which the claimant is then expected to earn income, the NHSLA would be providing the full value of future loss and future care directly. All of this analysis ignores the impact of inflation and assumes the number of claims and their real value remains constant. (see annex for details). Furthermore it is highly unlikely that any switch to periodical payments will occur immediately but these cash flow savings refer to the period after the transition has occurred.
Taxpayers will benefit from any savings to the NHS and other public sector defendants arising from the benefit of staging payments over a number of years. They would also benefit because the risk of claimants running out of money and falling back on social security benefits and NHS/Local Authority care would be reduced. These benefits are difficult to quantify given our limited knowledge of how claimants invest their money and how long they survive. They also tend to arise well in the future, so discounting would erode their value substantially and we therefore do not consider this issue further.
On the other hand there would be some reduction in tax revenue arising from the shift to tax-free periodical payments. In calculating the impact of the proposed change on the NHS, we made no allowance for the fact that lump sum recipients are liable for tax on the income from lump sum investments. That is, we assumed that any saving for the NHS from lower payments because of the tax free status of periodical payments would be offset by lower tax receipts. In the case of awards against employers and motorists, there would be some reduction in tax revenue from a switch to tax-free periodical payments. On the assumption that the claimant is liable for an effective tax rate of 15% on the income derived from lump sum earnings (allowing for capital draw down), this would imply a loss of tax revenue. This would be partly offset by higher tax liabilities in other contexts (for example corporation tax paid by general insurers and their business customers) which it is beyond the scope of this assessment to calculate.
It seems likely that there is a substantial market for financial advice and management of investment portfolios given the scale of lump sum awards for future loss and future care made against both public and private sector defendants. If compensatory payments were switched to periodical payments this market would shrink. With insured claims, there would be a corresponding growth in the share of compensatory payments made through Life Insurance companies. The large growth of structured settlements in the USA suggests that annuities underpinning personal injury damages can be profitable, although it is unknown to what extent that would be true under UK conditions. So far as claims against the NHS are concerned, there would be a substantial reduction in the market for financial advice to successful claimants.
Courts and lawyers could be affected by any change to the length and complexity of court cases and the number of trials. However the major element in these cases is establishing liability, causation and quantum. These issues would be unaffected by this proposed change. By removing as a core issue the life expectancy of the claimant from the legal arena, one element of cases would be eliminated. On the other hand it is possible that in the short term there could be an increase in the number of appeals against orders for periodical payments when either party would prefer lump sum compensation.
In the annex we test the central estimates above against a range of possible outcomes of the proposed change. In particular we examine the impact of assuming awards of over £100,000 and £250,000 as the benchmark above which periodical payments would commonly be used. We have also estimated the outcome if different percentages of the total value of larger awards switched to periodical payments.
This section considers the potential impact of empowering the court to vary orders for periodical payments. It is intended that the Lord Chancellor will have the power by Order to specify the circumstances in which variation of court orders will be possible. Any exercise of that power will be subject to preparation and consultation on a separate Regulatory Impact Assessment. This section therefore does not go beyond a general consideration of the issue.
It has been argued that lump sum settlements provide more flexibility to claimants in the event that their circumstances change unexpectedly, for example if major alterations to accommodation become necessary. However it should be realised that this flexibility can only be achieved at the expense of reducing the income and capital available to offset future loss and care costs. And the same effect could well be achieved by capitalising part of the income stream arising from periodical payments. There is considerable scope to offset this risk with flexible annuities that allow for predictable contingencies or through paying a proportion of the future losses as a lump sum 'contingency fund'. But there may remain some circumstances that would create injustice and hardship if the system could not respond. The option of allowing periodical payments to be varied, in strictly limited and controlled circumstances, is intended to address this risk.
There would be potential costs and savings for claimants and defendants depending on whether awards were varied up or down. Although the right to apply for variation would be available to both parties, most applications would probably be made by claimants and lead to increases. This assumes that defendants will not invest significantly in monitoring claimants post award or settlement.
It is intended that the scope, if any, for variation should be limited and the process strictly controlled. So far as possible, predictable contingencies should be built into the terms of the original annuity. We would expect variation to be necessary in only a small minority of cases.
There is anecdotal evidence that awards of damages, and so possibly also settlements, tend to err in favour of the claimant where there is uncertainty about his or her future needs. In other words, there may be a tendency to build contingencies into awards to allow for events which might never happen to avoid the possibility of under-compensation. This tendency may be reduced by the possibility of variation if major contingencies did arise. Any effect of this sort would produce immediate savings for defendants and their insurers.
The existence of a right to apply for variation means that insurers will not be able to close their books on some claims once they are settled. This will have an impact on their balance sheets. They will be required to hold assets to cover a prudent assessment of this contingent liability. But there will initially be little or no evidence on which to base an estimate of the size of the liability, and a consistent and reliable pattern will take many years to emerge. Accounting prudence suggests that, in the interim, insurers will tend to over-estimate the liability, and will therefore face the cost of holding assets that exceed their true liability.
When variation takes place, there will be further legal and court costs. These will fall mainly on defendants, assuming claimants make most applications and are generally successful.
Most of the costs and savings described arise from the policy objective of transferring risk from individuals to life insurers and self-funding defendants. The only significant implementation costs of Option 2 are the transaction costs imposed on liability insurers purchasing annuities, but these will be more than off-set from savings arising because damages no longer need to include provision for financial advice and the cost of investing lump sums. The implementation costs of Option 3 would be the legal costs of variation and the cost of any prudent over-reserving to cover the uncertain contingent liabilities created.
The issue of compliance does not arise here as it does with a classic regulatory proposal. The underlying impact of tort liability is unaffected. Exercise of the proposed power would be at the courts' discretion. Criteria would however be set out and it is expected that this will also influence the terms on which cases are settled. But parties will remain free to agree to lump sum settlements.
Where small businesses and charities take out insurance (for example motor insurance or employers' liability) they will be affected, along with others, in so far as these proposals may lead to changes in insurance premiums.
The purpose of the proposal is to make the compensation system fairer by ensuring that injured people receive the compensation to which they are entitled for as long as it is needed; and conversely that they and their heirs receive no more than that at the expense of defendants, their insurers or the State. There is no reason to think that the proposals outlined above will impact differently on different classes of seriously-injured claimant. The court will have the discretion to do what is right in a particular case.
The competition filter undertaken as part of the Competition Assessment suggests that if the courts are given the power to order periodical payments for future loss and care costs in large cases there is unlikely to be a negative impact on competition.
Currently, there are a handful of players in both the structured settlement advice service and providers of life-impaired annuities. The market is not characterised by rapid technological change, and the number of structured settlements is small relative to lump sums. Detailed criteria have yet to be developed, therefore it is impossible to predict how extensively the courts will exercise a power to order periodical payments, and how quickly this will be reflected in settlement practice. In the long run, as the market for life-impaired annuities matures, the level of sophistication, complexity and valued added services offered will increase.
Whilst the Structured Settlement annuity market is dominated currently by two life offices, we envisage that were structured settlements to become more common a number of UK based life insurance companies would re-enter the market. There is also evidence of interest among US-based life insurance companies who have a bank of experience in providing annuities to back structured awards within the US.
We highlighted in Section 2B that in the future as periodic payments become common in large cases, we would expect the claimant's need for specialist financial advice to reduce. In addition, the economies of scale of in-house expertise available to life insurers should mean that the per case transaction and administrative costs are considerably lower than an individual lump sum. Our central estimate of the change in the value of claims against motor and liability insurers generated by the proposal (a reduction of £17.4m) will be very small compared to the overall level of liability and motor premiums (approximately £10 billion).
If competition works well, claimants and defendants will have choice and flexibility of payments. The proposals outlined above will thus deliver choice, lower costs, innovation and efficiency.
Periodical payments offer significant advantages over the current system of lump sum awards
Claimants are relieved of the risks associated with large scale investment and do not face the uncertainty of outliving an award.
The NHS would achieve a significant improvement in its cash flow situation
Significant real economic benefits would arise from a transfer of the risk of providing the compensation from individual investment portfolios to the State. Individual risk-averse injured people would achieve a lower real rate of return on lump sum investment than the 3.5%Treasury Discount Rate that the NHS uses to evaluate the real cost of periodical payments.
It is possible that general insurers would make relatively small gains from such a transfer but it seems unlikely that such a proposal would significantly raise their costs.
The existence of a power to vary periodical payments orders in strictly prescribed and controlled circumstances would ensure that the right balance can be struck between ensuring claimants receive compensation which accurately reflects their needs without imposing unacceptable burdens on the NHS and insurers.
For the above reasons, the Government has decided to implement Option 3. As noted above, a further Regulatory Impact Assessment will be prepared and consulted on prior to any exercise of the power to allow variation of orders.
I have read the Regulatory Impact Assessment and I am satisfied that the benefits justify the costs,
Signed by the responsible Minister:
Date:
Tony Jeeves
Lord Chancellor's Department
Room 3S4 Southside
105 Victoria Street
London SW1E 6QW
Tel: 020-7210 1214
Fax: 020-7210 1216 Email: A Jeeves
This section estimates the current size of NHS clinical negligence compensation in England and Wales, with particular reference to large cases as they are likely to be affected by our proposals.
The data in the section was provided by the NHS Litigation Authority (NHSLA). The NHSLA is a Special Health Authority, set up under the NHS Act 1977 to administer clinical negligence and other pooled risk schemes for the NHS. It initially took responsibility for larger litigation but now has responsibility for all cases. It manages two schemes: the Existing Liabilities Scheme (ELS) and the Clinical Negligence Scheme for Trusts (CNST). The CNST was created in April 1995 as a mutual risk pool, which received contributions from trusts to finance clinical negligence costs. The liability risk from claims relating to medical treatment prior to April 1995 initially remained with individual trusts but in April 1996 these risks have been covered under ELS.
Data held by the NHS is incomplete because individual trusts hold the data on open claims below their excess. They are required to inform the NHSLA of cases they settle (again below their delegated excess level) but this is done inconsistently. However, the NHSLA data for large closed cases in recent years is comprehensive. This assessment concentrates on closed case data for 2001-02, aggregated for both ELS and CNST.
Lump Sum Damages
Table 1 shows the breakdown of damages awarded for the merged data (ELS and CNST) for cases closed in the financial year 2001/02.
| Tranche of Damages | No. of claims | Total damages | Average damages awarded per claim |
| 100k - 250k | 242 | £39m | £162k |
| 250k - 500k | 95 | £35m | £365k |
| 500k - 1m | 57 | £42m | 742k |
| 1m - 2m | 60 | £95m | £1,584k |
| >2m | 70 | £200m | £2,854k |
| Total or average excluding (1-100k) | 524 | £411m | £631k |
Future loss and care costs estimates
This section describes the methodology used to estimate the percentage of total damages that relate to future loss or care costs. We need an estimate of the proportion of the overall damages awards relating to future loss of earnings, future loss of pensions and future cost of care as it is this element of the award that would be suitable for payment as a periodical payment.
Research was undertaken by Lane, Clark and Peacock in 2000 for the NHSLA, relating to the percentage of total damages that relate to future loss or cost of care. Their model assesses the proportion of each claim that relates to future loss using a linear interpolation between claim sizes. We have converted the model to take account of the bands used above. The results are shown below:
| Total Damages (excluding legal fees) |
Average percentage of total claim Relating to future loss/ cost of care |
| 1 - 100k | 20% |
| 100k - 250k | 53% |
| 250k - 500k | 63% |
| 500k - 1m | 76% |
| 1m - 2m | 85% |
| >2m | 88% |
The table suggests that as total damages increase the percentage of future losses increases, but at a diminishing rate. The proposed power to order damages for future loss in the form of periodical payments is primarily aimed at larger claims. In order to provide a comprehensive sensitivity analysis we estimated the proportion of damages that relate to future loss and care costs for cases greater than £100k but less than £250k, and for those awards greater than £250k.
| Damage size | Total Damages | Total future loss component | Percentage accounted for by future loss and care costs |
| £100k-£250k | £39.3m | £21m | 53% |
| >£250k | £372m | £310m | 83% |
Provisional Damages and existing structured settlements
We estimate that between 1999 and 2001 claims valued at £8m per annum were settled in the form of provisional damages for awards greater than £100k. During this period the NHSLA agreed to 18 provisional awards.
In 2001-02 there were 51 structured settlements agreed between the NHSLA and claimants. All but two of these structured settlements related to claims in excess of £500,000. It is not necessarily the case that the whole of the claim was paid as a structured settlement. To calculate the proportion of these structured awards that relate to future loss and future care costs we applied the estimates from the study by Lane, Clark and Peacock.
| Tranche of Damages | No. of claims | Total damages (£000s) | Average total claim (£000s) | Assumed future loss and care costs per claim (£000s) |
| 1 - 100k | 0 | 0 | 0 | 0 |
| 100k - 250k | 1 | 166 | 166 | 89 |
| 250k - 500k | 1 | 450 | 450 | 281 |
| 500k - 1m | 12 | 8,947 | 746 | 568 |
| 1m - 2m | 22 | 31,561 | 1,434 | 1,219 |
| >2m | 15 | 39,565 | 2,638 | 2,308 |
| Total | 51 | 80,690 |
Industry estimates suggests that in 2001 the medical defence societies paid £51m in damages and claimant costs for cases over £100,000. The estimates are based on the same assumptions used in deriving aggregate NHS damages.
This section estimates the current size of the insured market for personal injury damages in England and Wales with particular reference to large scale cases which are more likely to be affected by our proposals. Table 5 gives an estimate of the total motor and liability premiums paid in 1999 and 2000.
| Motor (b) | Employer liability | Other liability | Total Liability | |
| 1999 | 7,231 | 650 | 1,260 | 9,089 |
| 2000 | 8,343 | 560 | 1,172 | 10,075 |
(b) the motor premiums cover both accident to vehicle and property liabilities as well as personal injury
The ABI is the trade association for Britain's Insurance Industry. The ABI supplied estimates of the total number of personal injury claims and their value resulting from accidents in 2002. These estimates included Lloyd's and other insurance markets and compensators who report claims to the Compensation Recovery Unit. These estimates are shown in table 6.
| Number of claims | Total Cost | |||
| Size of claim | Motor | Liability | Motor | Liability |
| 100k-250k | 1,478 | 942 | £288m | £192m |
| 250k+ | 1,682 | 662 | £1,363m | £421m |
(a) the total cost includes both the value the claim and associated legal costs
Future loss and care costs
The ABI also provided estimates of the proportion of these claims which would relate to future loss and future care costs. They estimated that on average 50% of motor awards by value relate to future loss and 40% by value to liability insurance. This proportion does however vary by size of claim. Combining this with estimates of the proportion of claims which have a future loss component provided an estimate of the total value of the future loss component in motoring and in liability claims shown in table 7 below.
| Number of future loss claims | Total Cost of future loss component | |||
| Size of claim | Motor | Liability | Motor | Liability |
| 100k-250k | 1,074 | 736 | £95m | £71m |
| 250k+ | 1,565 | 596 | £712m | £161m |
The industry estimates of the overall proportion of claims resulting from future loss of earnings and future care costs are drawn from estimates of the proportion of claims in different bandwidths. The table below illustrates the assumptions for claims in certain categories although estimates were made against a comprehensive set of bands.
| Damage size | Total Damages involving future loss | Total future loss component | Percentage accounted for by future loss and care costs |
| £100k -£250k | 362m | 166m | 46% |
| £1m- £2m | 378m | 206m | 55% |
| Total | 2,627m | 1,221m | 46% |
NHS
The average legal costs incurred for damages below £100,000 are significant and often greater than the actual award. As the level of damages awarded increases, the cost of legal fees increases but at a diminishing rate. Claimant legal fees are considerably higher than defence costs partly because of the burden of demonstrating causation. Table 9 shows the average legal cost for the NHS between 1999-00 and 2001-02.
| Tranche of Damages | Average No. of claims | Average total defence costs | Average total claimant costs | Average defence costs per claim | Average claimant costs per claim |
| 100k - 250k | 249 | £5,496k | £9,739k | £22k | £39k |
| 250k - 500k | 92 | £3,116k | £5,566k | £34k | £60k |
| 500k - 1m | 66 | £3,164k | £6,007k | £48k | £91k |
| 1m - 2m | 63 | £3,784k | £7,607k | £60k | £121k |
| >2m | 43 | £3,497k | £6,991k | £82k | £164k |
| Total excluding (1-100k) | 512 | £19,058k | £35,911k | £37k | £70k |
| a. All figures are based on annual data and may not add up due to rounding | |||||
Claims against Liability Insurers
Estimates of the legal costs on claims where there is an element of damages for future loss were obtained from the ABI. These suggest that legal costs in these cases were typically lower as shown in table 10 below but this may reflect differences in the complexity of cases compared to those resulting in claims against the NHS.
| Motor Insurance | Liability Insurance | Total | |
| Insurer's legal costs £ | 14,684 | 20,537 | 17,347 |
| Claimant's legal costs £ | 22,259 | 28,176 | 24,441 |
In the modelling analysis, which follows, we make the assumption that legal and experts' costs of substantive cases are unchanged (although there might be some savings in the use of financial advice). There may be some savings arising from the reduction in argumentation over life expectancy. Additional legal costs are likely to be incurred on review.
Currently structured settlements remain the exception. As the data above shows only 51 structured settlements were agreed to compensate litigants against the NHS for clinical negligence in 2001-02. This pattern is unlikely to change significantly when either party can insist on a lump sum. It will be for the courts to develop the principles and guidelines for deciding which form damages for future loss and future care should take. It is envisaged that the majority of cases that settle out of court will do so against this background.
We expect the court to develop clear criteria on the circumstances when future losses should not take the form of periodical payments. These may include payments for an immediate capital purchase, a small percentage contingency fund, where there is significant contributory negligence and in various exceptional circumstances. The court will also have to be satisfied, in the case of a private sector defendant, that there will be an annuity or other suitable security for the future payments. The relevant criteria will be set out. But it is difficult to estimate how quickly and extensively this will be reflected in settlement practice. The clear intention of this proposal though is to promote the use of periodical payments as the government believes that they are more accurate in reflecting the amount and nature of the claimant's loss.
It can be expected that the speed of take up will build over time. It may also be that the use of periodical payments will be more common in NHS and other public sector cases, because their security is guaranteed. There will be no need to consider whether an appropriate annuity or other security is available. In the longer term, the differential may reduce as the annuities market matures and the confidence in periodical payments of the courts and settling parties develops.
In order to quantify the likely impact of a change to periodical payments in many large cases, we need to estimate the total annual value of lump sum awards that will in future take the form of periodical payments.
Periodical payments will tend to be used most commonly in larger cases. However respondents to the consultation pointed out that it was not only the quantum of the award that determines the suitability of an award for periodical payment but the circumstances of the claimant and the length of time over which the award is intended to last. We nevertheless believe that it is reasonable to assume that the larger the award, the more the inherent risk that the claimant is facing with a lump sum award and therefore the more likely it would be for a court to order periodical payments.
The partial RIA suggested the benchmark should be £250k on the basis of current NHS practice in seeking to negotiate structured settlements. About half of respondents who commented agreed with this approach, while about half of the remainder argued for a higher and half for a lower figure.
We have therefore tested the implications of two alternative scenarios against the status quo. In Scenario A we assume that the future loss and future care costs of 80% of all awards with a value above £250,000 will take the form of periodical payments and that 40% of all awards with a value of £100,000-£250,000 will do so. This may be the upper limit of claims which can be delivered through periodical payments. In a more cautious Scenario B, 60% of future loss and future care costs relating to larger claims (ie those with a value greater than £250,000) will become periodical payments but only 30% of those claims in the bracket £100,000 - £250,000.
The current NHS benchmark of £250k reflects existing legal culture and practice. As periodical payments become more familiar and accepted, we believe that they will be increasingly used for lower awards, and that £100k is therefore a better benchmark for the purposes of this assessment. A discounted award of £100,000 future losses represents significantly more than £10,000 a year for ten years.
In insured cases, there is the further factor that appropriate annuities may not readily be available, or it could take some time for the market in annuities on impaired lives to develop fully. It has however been difficult to estimate whether there would in fact be such a delay and there is also reason to believe that any gap in the market would be rapidly closed. We therefore assume that a total of 50% of future losses in large insured cases ie those above £250,000 will convert to periodical payments, and test the sensitivity to conversion rates of 25% and 75%.
This section explains our assumptions about the transaction costs involved when an individual invests a large lump sum to produce a stream of income, and when a defendant insurer purchases an annuity for the claimant.
An individual investing a large lump sum will incur the following costs: (a) financial advice on an appropriate portfolio; (b) initial fees, typically perhaps about 4-6%, on purchasing the portfolio; and (c) on-going management fees, typically 1-1.5% a year. These costs will vary depending on the nature of the investment portfolio being higher the more managed the fund is, although this factor will have to be balanced with the extent to which a managed fund succeeds in out-performing portfolios based on gilts or tracker funds which will attract lower fees.
The Consultation Paper suggested that, typically, the costs of investing and managing a lump sum constituted between 3% and 5% of a typical large award. Responses to consultation on this point were mixed. This no doubt reflects the fact that the extent to which investment costs are explicitly included in damages varies in practice. Some claimants may not seek damages under this head; some defendants may be more ready than others to include such damages in settlements; and the position is often unclear because claims are compromised in global terms.
We propose to assume that, on average, large sum awards currently include 4% for financial advice and investment costs. This represents a cost to defendants that will be largely eliminated in cases that switch to periodical payments in future. To the extent that actual investment costs are higher than this, the burden currently falls on claimants who must meet it from damages intended for other purposes.
The savings from eliminating the costs involved in investing lump sums, which we assume to be met by unsuccessful defendants, will be partly offset by the equivalent transaction costs of an annuity.
We assume that the general insurer will purchase the annuity from a life insurance company, which will hold and manage assets to back the annuity and incur other administrative costs which will either be priced in the annuity or charged separately. The economies of scale and in-house expertise available to life insurers should mean that the per case transaction and administrative costs are considerably lower than those associated with investing an individual lump sum. These costs (and the life insurer's profit margin) will be reflected in the annuity prices used in the calculation in section 3A below,, so there is no need to make a separate assumption about them.
At present, claimants contemplating a structured settlement may also take financial advice about whether and to what extent to structure a prospective settlement, and through what annuity product. The adviser may charge a fee, which may be recoverable from the defendant as part of the costs of the case, and/or receive commission for arranging the annuity (the cost presumably being reflected in the annuity price). It is the current policy of the NHSLA to agree to pay costs of up to £3000 for the claimant's financial advice on a structured settlement.
In future, as periodical payments become more common in large cases, we would expect the claimant's need for specialist financial advice to reduce. Also, it would normally be the defendant insurer, rather than the claimant, who would purchase the annuity. ( see note 5 ) Liability insurers may use outside brokers or their own staff to test the market and purchase annuities (or they may deal directly with an associated life company); but in any event the average cost should be less than the equivalent cost incurred now by individual claimants. On the basis of an estimate provided by a large scale life insurer, we assume that the average transaction costs where periodical payments are funded by annuity, other than those reflected in annuity prices as described above, will be £700 per case.
Life expectancy. Data provided by the Department of Health reveal that approximately 53 per cent of a random sample of damages in excess of £250,000 had an average term of 23 years, whilst 29 per cent had an average term of 38 years and 18 per cent had an average term of 61 years. This paper therefore uses 34 years as the weighted average life expectancy for clinical negligence damages. For non-NHS cases we estimate the average remaining life expectancy to be 20, because with particular reference to large cases, there is a smaller proportion of injuries involving babies.
Effective tax rate.The proposal would reduce tax revenue because periodical payments are exempt from income tax whereas investment income generated by a lump sum is taxable. The loss of tax revenue will depend on the speed of take-up, outlined in section 2A, time taken for take up to reach steady state, and time value of money (the discount rate). In principle, this saving would be offset in part by an additional liability for corporation tax paid by life insurers. We assume an effective income tax rate of 15%, in line with the assumption used in determining the prescribed discount rate.
Inflation. All calculations are done ignoring the effect of inflation on the cost of providing compensation and on investment returns ie at constant prices. In practise both investment in Index Linked Government Stock and index-linked annuities are inflation-proofed means of securing the income stream of a successful claimant.
In order to estimate the overall impact of these factors, we made the following assumptions:
That the return on the lump sum was in line with the prescribed discount rate of 2.5%
That the Ogden tables 19 and 20 provided the appropriate multiplier by which to multiply the annual award to get to the lump sum
That the defendant met financial advice costs to the claimant of 4% of the award
That the annuity provided was index-linked and the annuity provider paid a fee of £700 to an IFA
That the net tax rate faced by lump sum recipients being 15% of their annual income stream.
We then compared the cost of providing lump sum compensation on these assumptions with commercial quotes for index-linked structured awards for a range of cases. As most of these awards would result for claims against employers and for motoring accidents the cases relate to adults. The results are shown in the table below. It should be noted that while the cost to the insurer is lower, there will be a loss of tax receipts by the government and a loss of income to financial advisers to lump sum recipients.
| Type of case | Annual Gross future loss and medical care costs (£) | Cost of Lump sum to insurer(£) | Cost of index-linked annuity to insurer (£) | % Saving through annuity |
| 20 y/o male | 40,000 | 1,278,784 | 1,227,156 | 4 |
| 20 y/o female | 40,000 | 1,319,968 | 1,275,489 | 3.4 |
| 40 y/o male | 20,000 | 518,544 | 469,197 | 9.5 |
| 40 y/o female | 20,000 | 546,416 | 501,402 | 8.2 |
| 60 y/o male | 20,000 | 332,800 | 276,152 | 17 |
| 60 y/ o female | 20,000 | 373,984 | 319,984 | 14.4 |
| a. All figures are based on annual data and may not add up due to rounding | ||||
As can be seen in none of the above cases is the cost of providing the annuity higher than the cost of providing a comparable lump sum. The savings to the insurance company are more significant the shorter the period of the award and therefore the lower the uncertainty over the claimants life expectancy. The benefits to the claimant conversely would be more pronounced the longer the award and therefore the greater the uncertainty whether they would outlive the value of the lump sum. It should certainly be borne in mind that this estimate is based on a snapshot of current annuity prices and that these can fluctuate. But over time similar factors would also tend to impact on the prescribed discount rate.
Estimates provided by the ABI suggest that in 2002 the future loss and future care cost component of claims against motor insurance policies will amount to approximately £712 million. Taking as a conservative estimate the saving of 4%, this would offer motor insurers a saving of £14.2 million per annum on total payments suitable for periodical payments (which currently amount to £712m) if 50% of payments were switched to periodical payments. Under similar assumptions liability insurers would face a reduction in claims of £3.2m per annum compared to the estimate for 2002 of £161million.
Table 12 and 13 shows the estimates of the overall impact on motor and liability insurers on the basis of a range of assumptions about the extent to which compensation for future loss and cost of care is paid in the form of periodical payments.
Given the uncertainties involved in these calculations the safest conclusion to draw is that a switch towards a system in which compensation for future loss and future care cost is delivered through periodical payments would not materially increase the cost of meeting these claims.
| Future loss and future care estimate for 2002 | £712m | ||
| Discount rate | 2.5% | ||
| Assumed margin over lump sum settlement | 4% | ||
| Transfer rate | 25% | 50% | 75% |
| Annual saving | 7.1m | 14.2m | 21.4m |
| Future loss and future care estimate for 2002 | £161m | ||
| Discount rate | 2.5% | ||
| Assumed margin over lump sum settlement | 4% | ||
| Transfer rate | 25% | 50% | 75% |
| Annual saving | 1.6m | 3.2m | 4.8m |
The impact on the NHS will depend on the extent to which there is a switch from lump sums, currently the norm, towards periodical payments. We model the two scenarios described in section 2A. We assumed that the number and value of claims would remain constant for the purpose of the analysis.
Two approaches can be taken to estimating the impact of this change to the way in which the NHS meets claims for clinical negligence. The first approach is to compare the cash flow requirements for the NHS under the two alternative scenarios. The second approach is to compare the real economic cost to the NHS of providing the same real stream of payments to claimants via lump sums and via periodical payments.
Clearly there is a short-term cash benefit to the NHS arising from the deferral of payments to claimants over a number of years. However in the long run once there has been a complete cycle ie all payments that were going to switch to periodical payments has been switched, then the cash required by the NHS would actually be higher as the compensation would no longer be being met partly by returns on invested lump sums The chart below illustrates the impact of scenario A and scenario B on NHS cash flow over 34 years.
The calculation has been carried out on the basis that the NHSLA would provide the same net stream of income to claimants either via lump sums or periodical payments. We calculated the stream of income implied by existing lump sums given the life expectancy of claimants and the 2.5% real returns which the prescribed discount rate assumes they achieve on investment of their lump sums by virtue of a cautious investment policy. We then assumed an alternative policy in which this stream was provided directly by the NHS.
In estimating the cash flow implications we have made a number of assumptions. For awards greater than £250,000 we use 34 years as the expected life expectancy based on a sample of cases from the Department of Health. For awards between £100,000 and £250,000 we have assumed an average life expectancy of 20 years based on the following methodology:
Calculate the average annual future loss and care costs for awards greater than £100k.
Calculate the average annual future loss and care costs for awards greater than £250k.
Divide b) by the weighted average life expectancy of awards greater than £250k (34 years).
To calculate the implied life expectancy for awards between £100 - £250K we divide a) by c).
|
To calculate alternative cash flow requirements: a) We treat the two bandwidths £100-250k and £250k+ separately b) Firstly we calculate the existing required cashflow for lump sum awards in the two bands over a period of 34 years c) To compare this cashflow with that under periodical payments we annuitise the future loss and cost of care element of lump sums using the prescribed discount rate of 2.5%, make allowance for the inclusion of £3,000 for financial/legal advice within lump sums, and assume any periodical payment stream must provide the same constant income stream as under the lump sum. We assume a life expectancy of 20 years for smaller awards and 34 years for larger awards. d) Then we use the assumed proportions of lump sums and periodical payments under scenario A and B to calculate the new cash flow requirement over a period of 34 years, although after 20 years (the assumed life expectancy in this band) this cash flow in the £100k-£250k band achieves a new steady state equilibrium e) In calculating the annual cash flow savings we introduce a new cohort of cases each year. f) The cash flow saving is the difference between the cash required to meet the existing annual volume and value of lump sums and the estimated cash requirement to meet the alternative mixes of lump sum and periodical payment implied in scenarios A and B. |
Our estimates suggests that over an average life expectancy of 20 and 34 years for awards between £100,000 and £250,000, and greater than £250,000, respectively, the net NHS cash flow profile ignoring inflation is positive for the first 24 years. Table 14 shows the first ten years profile for illustrative purposes.
| Year | Status quo cash requirement (£ millions) | Cash flow savings under higher rate of switchover (£ millions) | Cash flow savings under lower rate of switchover (£ millions) |
| 1 | 330 | 245 | 126 |
| 2 | 330 | 235 | 122 |
| 3 | 330 | 224 | 117 |
| 4 | 330 | 213 | 113 |
| 5 | 330 | 203 | 109 |
| 6 | 330 | 192 | 104 |
| 7 | 330 | 182 | 100 |
| 8 | 330 | 171 | 96 |
| 9 | 330 | 160 | 92 |
| 10 | 330 | 150 | 87 |
It should however be noted that in the long run the cash flow impact is negative as can be seen in chart 1 below. This effect occurs because under a more widespread use of periodical payments a smaller proportion of claimants' income will be provided via income generated by lump sum investments.
Real economic savings
Analysis of the cash flow alone does not capture the real economic impact of a switch from lump sum to periodical payment compensation. The core reason why there are economic gains to be made from such a policy is that the recipients of lump sum awards are by definition likely to be risk averse investors often having no alternative source of income or means of meeting future care costs. This risk aversion was recognised by the Lord Chancellor in setting a discount rate of 2.5% based on benchmark investment in index-linked government bonds.
If one were therefore to annuitise the lump sums it would be on the basis of a 2.5% rate of return. However turning to the stream of payments paid by the NHSLA the Net Present Value of future payments is determined by discounting the payments at a rate determined by the Treasury to be 3.5% or the Social Time Preference Rate. The derivation of this rate relies on "regarding society as the sum of individual members" whereas the particular subset of members in receipt of large clinical negligence awards are clearly atypical and likely to be significantly more risk averse than the average. This implies that they ought to pursue less risky investments that typically attract lower real rates of return and we therefore annuitise the lump sum using the prescribed discount rate of 2.5%.
Annuitising the future loss and future care element of £87k within the band £100k to £250k total award at a rate of 2.5% implies an average annual award of £10k. Over an average life expectancy for these claimants of 20 years discounting this stream of payments at the Treasury discount rate of 3.5% would give a Net Present Value of £76k. In other words the same stream of annual payments implied by the lump sum could be provided by periodical payments by the NHS and there would be a real economic margin of £10k in current value for each settlement. A similar calculation of the difference between the average lump sum of £631k for future loss and cost of care for clinical negligence awards in excess of £250k and the Net Present Value of the equivalent periodical payments paid directly by the NHS gives a real margin of £139k on each claim settled.
The results of grossing up these margins by the estimated annual number of additional periodical payments under scenario A and B is illustrated in table 15 below. As this added value occurs annually, to estimate the longer term benefit arising from the switches under A and B we used a 30 year time horizon on the assumption that it was difficult to see the future of approaches to clinical negligence in the very long term. Discounting these annual benefits by the Social Rate of Time Preference of 3.5% would yield a NPV of approximately £590 million under scenario A and approximately £408 million under scenario B.
| Margin per claim | Annual added value under scenario A | Annual added value under scenario B | |
| £100-£250k | £10k | £1m | £0.7m |
| £250k + | £139k | £31m | £21.5m |
Note 1: That is any settlement or award of money to the claimant, whether for all or part of the claim.
Note 2: This is set by the Lord Chancellor under the Damages Act 1996
Note 3: However where the award covers future loss and medical care over a very long period even a small difference between discount rate and annuity rate could be significant to defendants.
Note 4: The Treasury Discount Rate is used to compare the real value of costs or benefits arising in the future with those occurring in the present.
Note 5: The so-called 'bottom-up' approach means that it will be in defendant insurers' interests to secure the best price, because any costs or savings caused by a difference between the annuity price and the discount rate will fall in future on insurers not claimants.