Addressing concerns about periodical payments in personal injury cases

The Court of Appeal in Thompstone determined that periodical payments for future losses for care and case management should be linked to an earnings index which annually has historically risen by 1-2.5% higher than the RPI. Those fortunate claimants getting earnings-related periodical payments can be comfortable that the money they get for care will meet their needs for the rest of their lives.

There are many more modest claims involving future losses, which are unsuited to periodical payments owing to immediate capital needs using the bulk of the award. There may be large and ongoing losses such as earnings or transport but also capital needs for accommodation and equipment. Claimants in these cases still have to rely on the lump-sum approach – this is the new battleground. The current discount rate is incorrect.

If the discount rate (currently set at 2.5%) is too high and is used to calculate the multipliers used in the schedule of future losses, claimants’ damages will run out earlier than their predicted life expectancy. The assumed returns on low-risk investments of 2.5% above the RPI, upon which the current discount rate is based, are not realistic. Claimants have to take more risks with their damages to achieve that rate or accept a shortfall.

It has been demonstrable for some time that the basis of the 2.5% rate is optimistic and the recent financial meltdown highlighted this. On the basis of the reality of returns, the discount rate should be no more than 1.5% and possibly as low as 1% – but that would mean a huge increase in damages for claimants.

Financial impact If RPI is 3% a year and earnings go up by 1.75% above RPI – the result would equate to a 4.75% assumed real return. Add to that the current 2.5% discount rate and the total required return is 7.25% a year.

Until recently, investment in index- linked government stock (ILGS) would not support that level of return. It is also unlikely that a more risky investment portfolio would come close. Any investment return lower than 7.25% net means claimants run out of money early.

The table (bottom) illustrates the lump-sum cost of a £50,000-a-year future loss, for a claimant aged 13 at trial. If the discount rate were reduced from 2.5% to 1% the damages would be 54% more.

Setting the discount rateThe discount rate of 2.5% set by the lord chancellor in June 2001 has not been changed since. It is based on the claimant investing the lump-sum damages into ILGS and achieving a 2.5% a year real return (2.5% above RPI).

Later in 2001, the lord chancellor reconsidered his decision. He did not change the rate but provided reasons and explained why he chose to round up to 2.5% rather than down. His reasons were:

i) The rate of inflation in future was expected to stay well below 3%;

ii) High demand for ILGS and the scarcity of supply has led to the yields being artificially low, but this is temporary; and

iii) He had applied the legal principles laid down in Wells v Wells [1999] 1 AC 345.

The lord chancellor did, however, say the 2.5% rate could be varied if there are exceptional circumstances which justify this.

Section 1(2) of the Damages Act 1996 Act states that variation can be made ‘if any party to proceedings shows that it is more appropriate in the case in question’.

Discount rate case lawThere have been two main legal challenges to the discount rate. In Warriner v Warriner [2002] EWCA Civ 18, the claimant had significant future losses and a further life expectancy of 46 years. It was argued that those factors were exceptional, requiring a reduction in the discount rate from 2.5% to 2%. The appeal court rejected the argument on the grounds that the circumstances in Warriner were not exceptional.

In Cooke v United Bristol Healthcare [2003] EWCA Civ 1370, the appeal court reached a similar conclusion to Warriner but differed in its reasons.

The central argument in Cooke was that care costs increased at a steeper rate than the RPI, the argument now so familiar after Thompstone. Therefore, the 2.5% discount rate is too high as claimants need a larger conventional lump sum to cover the differential between the RPI and care-related earnings.

The appeal court seemed sympathetic to the issue but considered that the Cooke appeal amounted to a plain attempt to subvert the lord chancellor’s rate.

However, these cases came before Thompstone had ruled on these issues fully.

What needs to happen?It is now settled law that periodical payments linked to RPI for future losses which are earnings-based potentially under-compensate claimants. The 2.5% discount rate and the lord chancellor’s reasoning should be ­revisited in light of Thompstone and the economic reality:

• Inflation, as measured by the RPI since 2001 has averaged 3.16% a year; not ‘well below’ 3% as anticipated.
• ILGS; the temporary aberration due to lack of supply in 2001 has continued. ILGS yields have been languishing in the 1-2% range since then. Recently, yields have risen but it appears that this is due to credit crunch conditions, with increased government spending and falling inflation which are unlikely to last.

Claimants cannot afford to take substantial risks in order to meet their future needs. Many who have witnessed the loss of 40% of equity values in the last 12 months will certainly not want to take those risks in future. For investments between 2001 to the end of June 2008, the real rate of return has been around 1.15% a year, significantly less than the 2.5% discount rate.

The lord chancellor’s reasoning appears, with the benefit of hindsight, incorrect on several fronts.

There is an urgent need to revisit the discount rate. A lower rate would give claimants a greater lump sum, which would allow investment at low risk in accordance with Wells.

Another chance?The financial analysis in the Thompstone periodical payment orders cases showed that RPI is inappropriate for the indexing of damages for future earnings-based losses. On that basis, a discount rate based on it must also be wrong.

Large lump-sum settlements simply may not work and lawyers must advise their clients as to the risks. Expert advice is vital to ensure that the flaws of the current discount rate are clearly assessed and explained.

Even in larger cases suited to earnings periodical payment orders the discount rate affects recoverable damages as all multipliers are based on it. Where there are already shortfalls between what must be spent and what the claimant can recover, such as Roberts v Johnstone calculations for housing, correcting the discount rate is even more important. Therefore, the incorrect and high discount rate infects the whole system and disadvantages injured claimants.

The lord chancellor should urgently review current economic and investment conditions and reconsider the discount rate.

Nick Martin is an IFA and a partner at the Nestor Partnership. Richard Money-Kyrle is a partner at Darbys in Oxford