Legal lottery beats national lottery
Richard Heighton, Managing Director of Lucas Fettes & Partners, shares his views on the recent changes to the personal injury rate. Here's Richard's comments:
We all support compensation for injuries suffered by innocent victims however, we all bear the costs of that compensation through our insurance premiums and our taxes. If the cost is about to spiral out of control we should pay more than just passing interest.
The insurance industry is reeling from a recent decision to cut the “discount rate“ from 2.5% to -0.75%. This sounds like an inconsequential change, however, the effect on the cost of damages awarded is mind boggling. We are aware of one claim reserved by an insurer at £43m where the expected cost has increased to £70m because of this change.
The amount of compensation for any given injury now depends on when the case comes to court and cases were being delayed deliberately until the new system came into effect this week – is this fair on anyone who settled recently?
How can damages increase so much?
We all agree a pedestrian mowed down by a reckless driver should be compensated for their injuries. It is the amount of compensation which is sometimes difficult to assess as it depends on the victim’s potential earnings and his age expectancy.
In a simple example, if a 30 year old was expected to earn £100,000 per annum to age 65 then 35 x £100,000 = £3.5m is a reasonable starting point. However this does not take in to account inflation which is likely to double his earning capacity and will probably increase the damages to £5m.
Then we have to take in to account investment returns on the £5m. Until recently these investment returns were expected to be +2.5% and therefore there was a “discount” rate of 2.5% per annum and this would reduce the damages back down to about £4m.
In their infinite wisdom our Government presides over a system whereby the discount rate has been set at -0.75% on the basis this is the return on index linked gilts. We are now due to start paying compensation on the basis that the claimant will have a negative investment return for the next 35 years.
THIS IS MADNESS – WHY NOT PUT THE MONEY UNDER YOUR MATTRESS?
The amount of compensation depends on life expectancy, however, if in our example the victim dies after five years, there is no clawback of compensation, he leaves behind a very rich family.
While my example concentrated on loss of earnings, the sums can be much larger where someone is disabled and needs care on a daily basis. Nobody resents the victim having an award that reflects the costs of their future living expenses but I do wonder if their beneficiaries should be entered in to a lottery more rewarding than the National Lottery.
We will all bear the additional costs of this madness through increased insurance premiums. Asking the general public for sympathy for insurers is a completely thankless task, however some of them are facing a significant financial challenge. The cases coming to court today are usually the result of an accident more than five years ago. The premiums charged five years ago could not predict this unbelievable increase in damages awarded and today’s claims are being paid out of inadequate premiums collected many years ago.
A fairer system
It strikes me that the government should step in and bring some sanity to this situation. Society as a whole should look after injured and disabled members of our society irrespective of legal rights and remedies. I believe it should set up a support network to provide the care, the facilities and money on an annual basis to victims who receive compensation. Damages awarded would be administered by this body and any surpluses will serve to reduce the overall cost of compensation.
In 2015 the NHSLA estimated the money needed to settle all medical negligence claims was between £25bn and £30bn. The change in the discount rate is likely to cost the tax payer enough money to build a considerable number of hospitals and fund a considerable amount of treatment. The first case to be settled under the new system by an NHS trust saw the compensation for a 10 year old girl increase from £3.77M to £9.29M.
At some point we need to stop and ask whether this is good use of our money particularly bearing in mind the significant proportion paid to the lawyers.
Effect on our clients
Apart from the additional premiums our clients will be forced to pay there are two other important considerations to ensure they are adequately protected.
Limit of Indemnity
Is the current limit of indemnity adequate?
Bearing in mind the significant increase in potential claim amounts, unless the Limit of Indemnity was previously too high it now needs to increase. If the accident has already occurred and the injury has been suffered, I am afraid this increase in the Limit of Indemnity will be too late. We do not believe any of our clients face significant claims already in the system which could breach their Limit of indemnity but it is difficult to plan ahead when the compensation landscape changes so dramatically overnight.
This huge increase in the cost of compensation will affect Insurer profitability and could push some of the weaker players over the edge. Insurer Solvency ratings will be even more important to clients wishing to be sure their Underwriter is still able to pay their claims when cases come to court in 7 years time.
On a brighter note inflation is picking up and the return on Index Linked Gilts is likely to be positive again in the near future so the winners of this lottery will be those injured between 5 and 7 years ago whose cases come to court during the next year.
Instead of delaying cases as some lawyers did recently there may be a rush at some point to take advantage of this one off opportunity for greater compensation.
The actuaries are burning the midnight oil and revising estimates for outstanding claims. Some of the weaker insurers may face a precarious future in view of the unexpected increase in the cost of outstanding claims.
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