Periodical Payments – What Price Peace of Mind?
Nick Leech and Andrew Sands provide a brief overview which precedes a series of more in depth articles, the intention of which is to focus on various aspects of damages awards and their investment.
We have already written extensively over the years, in our capacity as specialist financial advisers, on the hugely significant benefits of periodical payments as part of damages awards. Our view remains unchanged since the start of the statutory regime, and unaffected by the change in the discount rate.
A Brief History
For a large portion of the last century, lawyers and judges were reluctant to use consistent calculations for the compensation for future losses. This created uncertainty and arguably unfairness in awards of damages.
The Ogden Tables, first published in 1984, thankfully provided a consistent approach to calculating future loss. Sir Michael Ogden QC stated the following:-
“When it comes to the explanatory notes we must make sure that they are readily comprehensible. We must assume the most stupid circuit judge in the country and before him are the two most stupid advocates. All three of them must be able to understand what we are saying.”
The difficulties involved in calculating damages were perhaps best expressed in Hodgson v Trapp;
“Essentially what the court has to do is to calculate as best it can the sum of money which will on the one hand be adequate, by its capital and income, to provide annually for the injured person a sum equal to his estimated annual loss over the whole of the period during which that loss is likely to continue, but which, on the other hand, will not, at the end of that period, leave him in a better financial position than he would have been apart from the accident. (Lord Oliver, Hodgson v Trapp  AC 807).”
The well-known case of Wells v Wells  1 AC 345 concluded that Personal Injury Claimants should not be treated as ‘ordinary investors’ and should invest in Index Linked Gilts, or ILGs, due to the greater security compared to equities. The House of Lords, as it then was, decided that the discount rate should be 3%.
This was followed by the Lord Chancellor in 2001 exercising his power under the Damages Act, and the discount rate was reduced to 2.5%. This was based on real yields on ILGs of 2.46%, rounded up to 2.5%, and the rate stayed in place until 20th March 2017, despite serious economic headwinds during that period. It had been clear to most practitioners that the discount rate was incorrect for a long period of time. News of the Lord Chancellor’s decision to reduce the 2.5% per annum discount rate to minus 0.75% per annum, did come as a surprise to many involved in personal injury and clinical negligence litigation.
On 15th July 2019, the Lord Chancellor announced the outcome of the first review of the discount rate under the Civil Liability Act and altered the rate from minus 0.75% to minus 0.25% effective from 5th August 2019.
Whilst there is still debate surrounding the accuracy of the Government Actuarial Department (GAD) modelling to help set the discount rate it is here to stay for the foreseeable future. Of course, most claimants have welcomed the move to a negative discount rate, albeit arguably not negative enough. The comforting thought of increased lump sum settlements brought about by the negative rate provides a theoretical degree of security previously never imagined. All a claimant investor must achieve is minus 0.25% return. How hard can that be in the long term?
GAD estimates are that at least 0.6% p.a. and up to 1.7% p.a. is a tax / cost drag on larger portfolios. Factor in 2.5% price inflation, additional 1.5% earnings inflation and other ancillary transactional fees a nominal 5% annual investment return can quickly become less than minus 0.25%. The hard numbers of course do not take account of the more subtle, unquantifiable costs such as worry, stress, or concern about how the uncertainty of world events impacts money. Hugely magnified in the context of catastrophically injured investors and their families.
Consider the situation where a claimant lives years beyond what is expected and investment returns match the assumption in the discount rate. The likely result is that damages will be extinguished during the claimant’s lifetime.
If however, investment returns for that same claimant lag the theoretical expectation, a perfect storm ensues, and damages will fall very significantly short. The risks relating to life expectancy and investment performance can therefore, be eradicated by a periodical payments order.
A further, perhaps hitherto largely unsung benefit of periodical payments is the tax freedom associated with that type of award. Now would be a good time to consider that benefit, particularly against the certain effects of the changed discount rate, and the likely ramifications of the pandemic.
Of course, awards inclusive of periodical payments, will not be entirely tax free, as the investment returns from the lump sum accompanying the periodical payments order, will be taxable. The recent change in the discount rate has resulted in lump awards increasing in value substantially. This includes those with a periodical payments order, where investment returns on larger invested sums, can push claimants into higher tax brackets. This effect serves only to emphasise the value of tax freedom relating to periodical payments, whereby about two thirds of an award, where typically care and case management is met by a periodical payments order, is not subject to tax. Contrast that with the tax burden on a traditional lump sum award, which is a major headwind to investment returns.
As we emerge from a global pandemic that has cost the world many trillions in yet more borrowing, the Treasury will be looking to increase the tax take generally. Taxation, therefore, is likely to increase, and remain at greater levels for some time to come. Inflation will play its part and we may exit the lockdowns with a short term explosion of consumer spending fuelling inflation and the mirage of longer term recovery. All uncertain and debatable.
Whilst central banks have flooded the financial system with money during the pandemic and interest rates have been slashed to near zero investors have been forced to riskier areas in a constant hunt for yield and growth. Whilst there may well lie some opportunities for the skilled value manager or stock picker these are dangerous waters for low-risk investors in receipt of injury damages.
Professional guidance is key but still not without risk. We have always advocated the importance of avoiding unnecessary risk and never more so during these uncertain times. It pays to be reminded of the adage ‘measure twice cut once’ as investment decisions are made.
In technical speak there is no financial asset called ‘Periodical Payment’. It is far too simple and valuable for that and ranks high above any conventional rating given to traditional assets. Surely, on any measure, the value of a tax free, lifelong, secure, suitably indexed income in the form of a periodical payment order must be the AAA+ standard. Given the uncertainty ahead, What price peace of mind?
The value of investments can fall as well as rise and are not guaranteed. Past performance is not a guide to future performance