Injury Law – Structured Settlements

By : Robert Leonard, Steven Weddle

Significant changes are afoot in the personal injury world. Following the publication of the Master of the Rolls’ Working Party Report of August 2002 on Structured Settlements the Practice Direction at 40C PD has been amended with effect from 6th October 2003, the main aims being to require parties to give thought to structuring at an early stage in claims for substantial future loss and to make much more detailed provision as to the contents of counsel’s advice and the written report for the approval hearing where a child or patient is involved. Meanwhile, the Courts Bill is proceeding through Parliament and may well become law by next April. If it maintains its draft form it will enable the court to impose a structured settlement irrespective of the parties’ wishes, to make secured periodical payments orders and, in circumstances yet to be defined, to vary such payments at a later stage.

Paradoxically, however, at the same time as these initiatives towards structured settlements and periodical payments are advancing, the market for the products which enable them to be underwritten is contracting and other impediments to the matching of income to needs and losses have emerged.

In this article we consider the nature of a structure, the principal changes in approach now required by the new practice direction and examine the market and other forces against which it falls to be implemented. Then we concentrate on the practical problems which lawyers will face in trying to comply with the practice direction before turning to a consideration of the further conflicts likely to be raised if and when the Courts Bill becomes law.

A structured settlement involves payment by instalments over a specified period, which may be for the claimant’s life, and which are either funded by an annuity from an insurance company or, where the paying party is a government body, by direct payments. The advantages for the claimant are that such payments are free of tax, disregarded for the purposes of means-tested income and housing benefits, and secure in the sense both that they have statutory guarantees and that, in most cases, they are linked to the RPI. Despite this, there has not been a huge take-up in the 15 years or so of their availability and this is variously attributed to the conservatism of lawyers and the desire of claimants of capacity to have control of their own money.

Structures are either Top Down or Bottom Up. The first is where a lump sum for future loss and expense is reached by use of the traditional tools of multiplier and multiplicand. It is then a question of determining what periodical payments that sum will purchase and how to fashion the structure so that particular needs and losses are met.

The second proceeds straight from the need/loss to the periodical payments which meet it and the structure is shaped accordingly. However, orders for periodical payments under s. 2 of the Damages Act 1996 may only be made by consent. Thus, because the court has at present no power to impose a structure, a Bottom Up will only appeal to a defendant if it is cheaper than a conventional lump sum.

With, for the most part, minor drafting alterations the new Practice Direction follows the recommendation of the Working Party, which felt that, in practice, insufficient consideration was given to cases where a structured settlement would be to the benefit of the parties, in particular the claimant. So an important change is represented by paragraph 2.1, which provides that, in all cases where future loss is likely to equal or exceed £500,000 or in any other case where a structure might be appropriate, the parties should raise the question of structuring during case management and that the court may explore the issue of its own initiative.

In child and patient cases advice about the appropriateness and desirability of a structure must be put before the court (paragraph 2.4). The reasonable costs of financial and relevant medical and legal advice become costs in the litigation and therefore, at least in theory, recoverable by the claimant.

The other important change lies in the provision for approval hearings in relation to claims by a child or patient. Under the former 40C PD counsel’s or the legal representative’s opinion was quite limited in the matters to which it had to be directed. The requirements of the new paragraphs 4 and 5 are now much more specific. Consideration must be given to the general desirability of entering into a structured settlement (paragraph 4.2 (1)(a)), which will, in practice, require a comparison between the effects of a conventional lump sum award and a structured settlement. The written advice or report must also specifically address a number of matters, including: whether or not the sum payable in compensation is sufficient to fund payments which will fully meet anticipated annual and recurrent losses occasioned by the injury (paragraph 5(1)); where there is continuing care the periodic payments should aim to cover the anticipated costs, unless there is good reason to depart from this benchmark, while leaving an appropriate sum to allow for unexpected contingencies, and a proposal that the sums payable should in either respect be less than these benchmarks will require justification (paragraph 5(2)); and whether and if so on what events there should be stepped increases and when such increases should be, e.g. the child/patient becoming unable to care for himself in certain respects or gratuitous carers can no longer continue to care or to provide for loss of increased pay following promotion in lost employment (paragraph 5(4)). Advisers should also consider other means of meeting future income needs, e.g. provisional damages, an indemnity or personal injury trust (paragraph 6).

It will be noted that both paragraphs 5 (1) and (2) proceed on the assumption that it will be possible to match payments to needs and losses and to do so for the whole of the period for which provision is made, usually for life.

Addressing many of these questions will present formidable difficulties in the current state of the market. Particularly challenging are the requirements in paragraph 5(1) that periodical payments should fully meet anticipated needs and losses and in paragraph 5(2) that, where there is care, the periodic payments should aim to cover the anticipated cost. We will identify three particular problems.

Firstly, it is well known that medical costs and wages, both a feature of large claims on behalf of seriously damaged claimants, have risen well above the rate of inflation. That medical costs rise above the RPI was recognised in Houghton v Drayton [16.12.92] unreported, of which, more below.

Life Offices making indexed payments under structured settlements are required to match their funds to their liabilities over the period of the structure. Yet the only available index-linked gilt is ILGS which is based on the RPI. There is no gilt which is linked to the National Average Earnings index or the rise in medical costs (and no doubt if there were there would be little demand for ILGS)*. So it is just not possible for periodical payments under a purchased structure to rise by anything other than the RPI. A With Profits structure will provide an annuity which increases in accordance with the bonus declared but while there is the statutory guarantee against the failure of the provider, there is none in relation to the performance of the fund.

There are other drawbacks to ILGS – the price on the market to the provider varies according to conditions and it is not available beyond 2035. There are practical limits to the efficacy of provisional damages awards and indemnities, as pointed out by the Working Party. Nor are these problems confined to the purchased structure – NHSLA structures do not generally contain escalation beyond RPI and recent alterations in the Treasury’s “value for money” criteria are likely to mean that structures are offered less frequently.

Secondly, the running yield on ILGS is rather lower than the 2.5% discount applied to the multiplier for future loss or expense in a traditional lump sum calculation, as is illustrated by the following example, which is based on an actual case**. The agreed conventional multiplier was 14.6 and with an assumed (for illustrative purposes) multiplicand of £200,000, the value of the claim for future loss would be £2,920,000. RPI-linked quotations for what £1m would purchase were obtained as follows:

Provider               Price        Annuity            Equivalent multiplier
NFU Mutual          £1m         £66,522.60     15.03
Windsor Life        £1m         £65,436.00     15.28
Standard Life       £1m         £39,629.52     25.23
Scottish Widows £1m         £30,300.00     33.00

The cheapest cost of providing £200,000 per annum is therefore NFU Mutual at £3,006,497.04 – but it is almost £86,500 more expensive to the defendant than a lump sum award.

Thirdly, the market is contracting. The vast majority of structured settlements in recent years have been provided by NFU Mutual and Windsor Life. Windsor Life is withdrawing from the market at the end of the current year. NFU is writing no further policies for this year and although it may write new business as from January there may well be a premium cap of £200,000, a sum which scarcely scratches the surface of the larger cases and is even well below the level at which the Practice Direction specifically requires consideration of a structure. If the quotations from other providers continue in line with the above illustration, the effect of the contraction of the market and any NFU cap at £200,000 can be demonstrated by adapting the figures given earlier.

Provider              Price                     Annuity                 Multiplier
NFU Mutual         £200,000.00        £13,304.52
Standard Life      £4,711,020.47     £186,695.48
Total                     £4,911,020.47     £200,000.00         24.56

The cost to the defendant’s insurer would rise by £1,904,020.47 or over 63%**

The consequence of these developments is that structures of any size are likely to become significantly more expensive for defendants who have to purchase the structure in the market. A further likely consequence is that, at least in cases of substantial future loss over a significant period, defendants will simply refuse to structure, thereby defeating some of the purpose behind the new Practice Direction. It may be, as suggested by the Working Party, that a judge on an approval hearing could withhold approval to a conventional award, thereby in effect forcing the parties into a structure. However, claimants of full capacity would not be affected and whether a judge would take that approach if faced with evidence that the cost to the defendant of a structure was very much greater than a traditional lump sum award must at least be open to doubt.

We now turn to examination of some of the questions raised and the way practice may develop.

Costs of researching a Structure

Defendants have traditionally resisted bearing the cost of financial and legal advice as to whether or not a structured settlement might be appropriate in any case. Paragraph 2.1 specifically states that the reasonable cost of such advice will be regarded as a cost in the litigation. However, it is interesting to note that paragraph 2 could be interpreted to mean that, in cases where the Claimant is of full capacity, this is so only where the Court has approved such investigation in advance of it being undertaken by an order made by way of Case Management. (Paragraph 2.1) Therefore claimants’ advisers may risk the cost of investigating what is appropriate only to be challenged by defendants that such costs were unreasonable. In cases of doubt (which in view of the wording of paragraph 2.1 will probably be frequent) it will be prudent to agree with the defendant that a structure might be appropriate before incurring the costs of investigation or obtaining the Courts approval prior to investigation.

Cases under £500,000

The requirement in paragraph 2.1 that structures be raised during case management covers not only cases where future loss is likely to equal or exceed £500,000 but “any other case where a structured settlement might be appropriate”. These words were not in the Working Party’s draft and the parties thus have little or no guidance as to how to identify those cases for which a structure might be “appropriate”.

The NHSLA consider a structure in all cases with a likely value higher than £250,000, but of course this was not the figure chosen for the Practice Direction. Structures involving smaller sums may produce advantages in terms of tax and state benefits to the claimant and any of these may suffice to make a structure “appropriate”. The facts of each case would require examination but it might be, for example, that a structured settlement to provide specifically to fund the payment of a wage to a support worker would be beneficial. The salary could be paid entirely out of the tax-free income from the annuity and would be ignored for the purposes of benefits.

Children and patients

Read literally, paragraph 2.4 appears to require a structure to be considered in every child or patient case, irrespective of the value. This cannot be the intention, and it is only sensible that the requirement is construed as being limited to those cases where a structure is required to be considered in the case of a claimant of full capacity under paragraph 2.1. However, there will be some cases where it certainly should be considered below that level. In case the wording is construed strictly it would probably be wise always to consider structured settlements in cases where the damages include, or are likely to include, an element for long term income replacement, care, or provision of equipment or aids.

Paragraph 5 of the PD

How, then to address paragraphs 5 (1) and (2) where there is a substantial ongoing claim for future care and medical expenses? Paragraph 5(1) requires the legal advice to state whether the sum payable in compensation is sufficient to fund periodical payments which will fully meet the anticipated annual and recurrent losses occasioned by the injury.

For Top Down structures with a substantial future care or treatment requirement the answer will have to be in the negative for the present. In the appeals of Warriner v. Warriner [2002] 1WLR 1703 and Cooke v. United Bristol Health Care and Others [2003] EWCA Civ 1370 (CA) the Court of Appeal would not move away from the rate of return set by the Lord Chancellor despite substantial evidence that the rate he had set would not be adequate to compensate the future claims fully.

If that expert accountancy evidence was factually correct, then the rate will always be inadequate until such time as the Lord Chancellor introduces a new rate. For this reason alone a top down structure is likely to be substantially cheaper for the Defendant than a bottom up structure. It is perhaps simplistic to criticise the Court of Appeal for appearing to be unwilling to accept as unfair a rate of return that is designed as a ‘one size fits all’ response to a wide and varied problem. It is important to remember the exercise of statutory interpretation that must be undertaken by the Court.

However, the decisions are inconsistent with an important part of the philosophy behind the new Practice Direction, which is predicated on the need for income to match loss and expenditure through the whole period of the loss. As a consequence, many Top Down structures are likely to fail to satisfy the new Practice Direction; and in many cases Bottom Up structures will be so much more expensive to Defendants that they will have little incentive to enter into them. Hence the importance of the Courts Act 2003.

Courts Act 2003

The Courts Bill received Royal Assent on Thursday 20th November 2003 containing a substitute paragraph 2 to the Damages Act 1996 which will permit a judge to order that damages in respect of future pecuniary loss for personal injury be paid by way of periodical payments. The new sections 2A and 2B set out powers for rules to be made under the CPR and making conditions for variation of periodical payments. We cannot know how a judge will be expected to exercise his or her discretion until rules are published but the first impression is that the provisions could be expensive for Defendants.

The Regulatory Impact Assessment published on the website of the Department for Constitutional Affairs attempts to deal with some of the issues. Under ‘Issue and objectives’ it is said that

‘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.’ and ‘It hopes an order for periodical payments will become the norm in larger cases.’

It continued by stating that

‘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’.

Some may argue this leaves the Defendant with excessive control.

If the Government’s professed desire is to be achieved, then the balance of the rules must be in favour of Structured Settlements however much more expensive they may be for Defendants. It is perhaps unfortunate that the substantial additional costs of structures which do aim to match income to losses and expenditure throughout the period of loss is not specifically addressed in the Assessment, especially in the light of the recent decision in Cooke.

Contrast

In the examples set out above it was demonstrated that a claim valued on a traditional basis would be £2,920,000 yet, as a structure, it could cost £4,911,000 which is nearly 2/3rds more. Faced with such substantial differences there can be no doubt that there will be early attempts to narrow the scope of the application of these changes.

Uncertainty

The potential for future variation creates uncertainty for Defendants. In order to be able to plan its business, an insurer needs to have reasonable certainty for the future. Contingent or potential claims are traditionally thought to be a fetter on this ability. That is why Defendants are so unwilling to agree to awards for Provisional Damages. They first were available in 1981 yet their use is very limited because of the way the Courts have interpreted the words “develop some serious disease or suffers some serious deterioration in his physical or mental condition”.

Conversely, it may be that the Defendant will have the opportunity to benefit from significant changes in some circumstances. The early death of the Claimant within a certain time may be a consideration as may a degree of recovery which was not expected or even hoped for at the time of the earlier order. One hopes that the “specified circumstances” will be clear and not too restrictive for either party.

Present situation

The fact that there may be a shortfall does not yet need to prevent the Court from approving a proposed settlement with a structure. A practical way around the problem in many cases is for the structure to include a substantial contingency fund in order to provide for the additional escalation of care and medical costs over the period in question and for any care beyond 2035. Paragraph 5(2) already requires a sum for “unexpected contingencies”. So the “justification” for the failure of the periodical payments to cover the anticipated costs will be that the current market in gilts does not permit this to be done; and the total cost to the insurer may be substantially greater than a traditional lump sum.

There has been some discussion that it might be possible to develop an annuity product linked to the rise in cost of care and medical expenses. It would need to have a higher than average rate of return to take into account the objections but then it would potentially be very popular leading to the need to have restricted market access.

Other forms of damages

Paragraph 6 of the PD reminds practitioners that there are other forms of damages than lump sum and structured settlements. It states that other means should be considered including provisional damages, an indemnity or an appropriate form of trust. It is to be hoped that most practitioners will be alive to these in any event but perhaps it is not a wasted reminder. We have already mentioned that the use of provisional damages is restricted.

1. It may be worthwhile trying to include an award of provisional damages to cover situations, for example, where a specific condition degenerates such that independent mobility is lost prior to a specific date.
2. It is to be hoped that whenever any adviser looks at Structured Settlements a Personal Injury Trust will be considered as a more flexible alternative.
3. Indemnity for a specific item that may or may not be needed can be a useful tool but one should look not only at the desirability of an indemnity but also at its value; What is the prospect that the Defendant will still exist and be good for the indemnity in X years time?

Check list

1. Is the case worth more than £500,000 or do factors exist to make a structured settlement potentially appropriate?
   If Yes
   Read PD40C
   Claimant of full age and capacity – Agree that structured settlement should be investigated or, in default of agreement, seek an order at the next case management hearing (or apply for an order)
   Child or Patient – Start to investigate.
   If No – Advise as briefly or as fully as seems necessary for the instant case.
2. Obtain Part 35 expert independent financial advisers’ report in accordance with paragraph 2. It must be on an independent fee paying basis for a child or patient and should normally be so. A Claimant of full capacity may make other arrangements for payment but it is possible that it will be more expensive and therefore may cause the cost to be challenged by a Defendant. This is something to be considered carefully where a Conditional Fee Agreement exists and the Claimant is responsible for disbursements.
3. The legal advisers must then consider the financial advice, all facets of the case, and advise on the merits taking into account all matters in paragraphs 5 and 6.
4. If the Court of Protection is involved then approval must be obtained from the Master before judicial approval is given.
5. If the Defendant will not agree to structure then an application under the Courts Act will be necessary (when the Rules are in force).
6. If settlement includes a structure no final judgment should be entered until such time as the parties have agreed, or a judge has ordered, a final order incorporating that structure and a firm quotation exists and can be accepted.
7. Court approval should be sought in principle first and, once up to date quotations are available which can be put into place immediately, final approval can be sought.
8. Efficient practice dictates that where there is time between agreement subject to court approval and the hearing all efforts should be made to have all dealt with in one final hearing.

Comment

There is no doubt that the above can only be an educated guess at the way the use of periodical payments will develop in personal injuries practice once the Courts Act comes into force. One thing is certain; there is no room for us to be complacent and assume we need do nothing. The arguments involve very substantial sums of money. If the increased costs to a Defendant translate to the smaller case then the additional cost of a 63% increase to a £200,000 future loss claim is over £120,000. We must learn to understand the issues, and advise on them properly, or risk exposing ourselves to satellite litigation.

*It would be possible for the government to issue a gilt linked to the NAE index and restrict its availability to Life Offices or self-funding insurers; whether it could do the same for medical costs would depend upon the availability of a suitable index.

**Example and illustrations provided by courtesy of Richard Cropper of Personal Financial Planning Ltd.