7 th May Damages Discount Rate Consultation Ministry of Justice Post Point Petty France London SW1H 9AJ

Transcription

1 7 th May 2013 Damages Discount Rate Consultation Ministry of Justice Post Point Petty France London SW1H 9AJ LMA Response to Damages Act 1996: The Discount Rate - Review of the Legal Framework About the LMA The Lloyd s insurance market underwrites insurance business from over 200 countries and territories worldwide. In 2011, premium capacity was in excess of 23 billion. The Lloyd s Market Association (LMA) represents all the managing agents at Lloyd s, which manage the syndicates underwriting in the market, and also the members agents, which act for third party capital. We appreciate the opportunity given to us by the Competition Commission to respond to this important issue. Whilst this response is distilled from the views of our members, the views of individual members may differ. Summary of the LMA Response We believe that the current system is the most appropriate. We would support amending the legal framework which sets out the methodology used to calculate the discount rate to reflect the investment choices made by claimants (i.e. the use of a mixed portfolio rather than solely investing in ILGS). We consider that by changing this methodology the current discount rate of 2.5% will be proved to be sufficiently accurate. Ultimately, compensation is often provided by the private (re)insurance market or the NHS which in turn passes the costs of this compensation on to policy holders and tax-payers respectively. Lack of certainty around how the discount rate is set and the possibility that the rate might change regularly will inevitably introduce additional and unnecessary volatility to (re)insurers which will need to be included in the pricing of insurance products - most likely increasing the cost of liability and motor insurance for customers. We would not support a new framework that encouraged more periodical payments. The current balance between lump sum awards and periodical payments is appropriate. In the opinion of the (re)insurers writing motor and other liability business in Lloyd's, all the evidence suggests that periodical payments are already

2 used in the cases where they are most appropriate, generally being the cases in which the claimant's injury has impaired their capacity. Despite the challenges arising from periodical payments, the insurance industry has adapted quickly and there has been, to date, very limited impact on policyholder premiums. This reflects the fact that the balance and flexibility of the current system where a claimant can select periodical payments or a lump sum settlement, based on a discount rate of 2.5%, is sensible. Question 1: do you agree that the general principles of accuracy, transparency and simplicity and stability should be used to asses the appropriateness of proposed solutions? If not please give reasons. Yes Question 2: do you agree that accuracy is the most important of these three general principles? If not, please give reasons. While it is clearly important that the methodology used to set the discount rate is decided upon with a view to ensuring that claimants receive compensation commensurate with their loss, it is equally important to ensure that the principles of transparency, simplicity and stability are not overlooked. Ultimately, compensation is often provided by the private (re)insurance market or the NHS which in turn passes the costs of this compensation on to policy holders and tax-payers respectively. Lack of certainty around how the discount rate is set and the possibility that the rate might change regularly will inevitably introduce additional and unnecessary volatility to (re)insurers which will need to be included in the pricing of insurance products. This should be considered in combination with the fact, acknowledged in the Consultation Paper, that inevitably there will be some inaccuracy in the compensation awarded given it involves the up-front provision of a lump sum to cover future costs which are affected by variables (including life expectancy) which cannot be accurately predicted at the time the lump sum is awarded. Further, the focus on accuracy is undermined in the current system because the discount rate is based on returns from ILGS while all the evidence suggests that, in the majority of cases, claimants opt for an alternative investment strategy. In the event that the strategy adopted provides a better return than available from ILGS then claimants will likely be over-compensated. Even where a more appropriate mixed portfolio is used to calculate the discount rate, a Court cannot impose an investment strategy on a claimant therefore leaving open the possibility of under or overcompensation. Question 3: are there any other issues relating to the setting of the discount rate and the possible encouragement of the use of periodical payments that you would wish to draw to our attention? Please give reasons. As noted above, it is important to take into account the effect that a change in the discount rate will have on the claims quantum and the knock-on effect this would have on insurance premiums and the costs to other compensators (e.g. the NHS). Additionally, we would highlight the complexity faced by the (re)insurance market in handling periodical payments. This complexity extends beyond the obvious administrative

3 burdens (e.g. the need for continuous case management throughout the claimants life) to the uncertainty introduced by claims indexation and mortality inherent in periodical payments. Such uncertainty affects the cost of (re)insurance which is ultimately passed on to policyholders. The impact of Solvency II, particularly in respect of capital requirements to be held by (re)insurers), should not be overlooked. This European Directive, when implemented, will impose the need for (re)insurers to hold a risk margin in their balance sheets equal to the present value of the cost of capital required to run off PPO liabilities. For PPO claims, where the claim can run for a considerable period of time (equal to the claimant's life expectancy), the amount of capital to be held will be substantial. The long-tail nature of periodical payments also gives rise to the need for supplementary interaction between insurers and their reinsurers, including around claim management and issues such as capitalisation (where, in effect, a periodical payment is converted into a lump sum for the purposes of recovery from reinsurers). These complexities (and the uncertainty they introduce) affect the attractiveness of writing motor business in England and Wales as evidenced by the fact that there has been a significant reduction in the capacity available in the market to provide unlimited reinsurance protection. Clearly, this could impact the competitiveness of the market further impacting premium levels. The Periodic Payment Studies paper published by the General Insurance Research Organisation (GIRO) Working Party in 2010 suggested that, where 30% of claims over GBP1m were settled by way of periodical payments, an insurer would see its gross reserves (on a current value basis) increase by 30% (compared to the reserves if 0% of claims over GBP1m were settled by way of periodical payments). In the same scenario, the impact on a reinsurer's reserves was larger still: 116%. This clearly presents a challenge to the (re)insurance industry. It is worth noting at this point that, despite the challenges arising from periodical payments, the insurance industry has adapted quickly and there has been, to date, very limited impact on policyholder premiums. This reflects the fact that the balance and flexibility of the current system where a claimant can select periodical payments or a lump sum settlement, based on a discount rate of 2.5%, is sensible. As a final point, also made in our response to the earlier consultation (Damages Act 1996: The Discount Rate Consultation Paper), we are not aware of any evidence that claimants have received inadequate compensation under the current system. This suggests that there is little need to introduce wholesale change, beyond the need to base the discount rate on an investment strategy more usually adopted by claimants (i.e. a mixed investment portfolio as opposed to ILGS). Question 4: do you consider that the legal parameters governing the setting of the discount rate should be changed? Please give reasons. Yes. As we stated in our response to the earlier consultation (Damages Act 1996: The Discount Rate Consultation Paper), ILGS are not a suitable indicator for setting the discount rate - a mixed portfolio of investments would frequently provide a better return for claimants as well as allowing them a greater degree of flexibility. This position would also more closely match how claimants choose to invest damages awards. We would submit that, the fact

4 that the evidence clearly shows claimants do not invest in ILGS, undermines the principle of accuracy in compensation as the discount rate is currently set with reference to returns from investment in ILGS. We would also take this opportunity to suggest that the current position, whereby the Lord Chancellor sets the discount rate only taking into account advice received from the Government Actuary should be changed to allow for representations to be made by a broader spectrum of stakeholders. Question 5: if you consider that the legal parameters governing the setting of the discount rate should be changed, what do you think they should be? Please give reasons and define any terms used. We consider that the legal parameters governing the setting of the discount rate should acknowledge the fact that claimants, with advice from investment experts, currently utilize a mixed portfolio of investments when managing the funds from a damages award. Additionally, any framework around how the discount rate is set should take into account the importance of clarity in respect of the methodology to be used to ensure that all parties can understand the level of award likely to be reached in any particular claim. Question 6: if you consider that the legal parameters governing the setting of the discount rate should be changed, what investments do you think the hypothetical claimant should be deemed to make for the purposes of calculating the rate of return? Please indicate the types and proportions of assets that should be included in the hypothetical claimant's portfolio of investments. Please give reasons. As we stated in our response to the earlier consultation (Damages Act 1996: The Discount Rate Consultation Paper), we support the general principle of a mixed portfolio of assets being the most appropriate basis upon which to set the discount rate, but we do not have sufficient expertise in this area to suggest a specific asset mix. Question 7: do you consider that the availability of periodical payments should affect the level at which the discount rate is set? Please give reasons and indicate what effect you think it should have. We believe that the current framework for the settlement of damages claims is appropriate. Claimants are currently able to seek compensation in the form they consider most appropriate (be that lump sum, periodical payment or a combination of the two). Periodical payments are only unavailable in very limited circumstances and, ultimately, can only be made unavailable by a Court, which is currently empowered to impose periodical payments against the express wishes of the claimant, the defendant or both. Question 8: should the Court have the power to depart from the described rate and, if so, should the terms on which it may do so be expressly defined? Please specify the terms and give reasons. We would re-emphasize the need for certainty and stability in respect of the discount rate whilst acknowledging that, in exceptional circumstances, it may be necessary for a Court to deviate from the prevailing rate. As noted in the consultation, a Court is currently able to amend the discount rate if deemed necessary and we would submit that this position should be maintained.

5 Given the benefits of stability highlighted in our responses to the questions above, it might be beneficial to provide some clarification in respect of circumstances in which a claimant or defendant might argue that their case was 'exceptional' and warranted a change to the discount rate. Question 9: Should the power to prescribe different rates be available for: Before answering the specific questions in this section we believe that the use of different discount rates in different circumstances introduces and unappealing level of uncertainty. It will inevitably lead to increased litigation costs as claimants and defendants argue over which set of discount rates should be applied in their particular set of circumstances. a. Different classes of case? No. We do not believe that different discount rates should be applied to different classes of case. There seems to be little reason to adopt such an approach and it would therefore undermine the simplicity of the application of a single discount rate unnecessarily. Further, as noted above, the Court can apply a different discount rate from that prevailing at the time, where it considers the facts of the case warrant such a decision. b. Different periods of time over which damages are paid? No. We would once again highlight the importance of the simplicity of utilizing a single discount rate. Periodical payments are available to those claimants who consider that this form of compensation is more appropriate. It is worth reiterating that many claimants opt for a lump sum settlement which suggests that the current system is appropriate. c. Different heads of damage No. We would submit that periodical payments utilize differing indices to calculate inflation of different heads of damage. Claimants are therefore able to select this method of compensation if they consider it appropriate. The fact that, under the current system which includes periodical payments, claimants generally choose a lump sum settlement, clearly suggests that the application of different discount rates to different heads of damage is not a significant factor in claimants' decision making process. d. Cases where periodical payments are available and where they are not? No. As stated in our response to Question 7, periodical payments are only unavailable in very limited circumstances and therefore there is no need to introduce additional complexity for a very small number of cases. Question 10: if you consider that the legal base for setting the rate should be changed, what methodology should be used to set the rate, including: a. What quantitative and qualitative data should be used (e.g. historic or forward looking, specific indices)?

6 We are not in a position to comment on the most sensible data to be used when setting the discount rate as this requires input from investment experts. However, we would emphasize the fact that the General Insurance Research Organisation (GIRO) Industry PPO Survey 2012 evidenced that the life expectancy of some claimants exceeds 75 years and, on average, life expectancy is around 25 to 35 years. This would strongly suggest that data used to set the discount rate should be based investment performance over a similar timeframe. Additionally, we would request that any methodology used is transparently set out so that all parties can understand it and predict any potential changes in the future. b. What assumptions should be made (e.g. asset mix, weighting of assets)? As noted in our response to Question 6, we do not have sufficient expertise in this area to suggest a specific asset mix or comment on weighting of assets. c. How should inflation be taken into account? Once again we are not in a position to comment on this question. d. What allowances should be made for tax, administration or management expenses and investment expenses? In respect of allowances for tax, we would once again leave this to respondents with more expertise in this area. In respect of administration / management and investment expenses, we would caution that evidence suggests that, where these are included in any damages calculation (for example in Western Australia), they tend to increase over time as providers of such services realize that the cost of such expenses are ultimately paid for by defendants (be they insurers or others such as the NHS). However, the Lloyd's market accepts that, if a mixed investment portfolio is used there are likely to be higher expenses associated with investment advice and portfolio management compared to a portfolio invested solely in ILGS. Therefore, it seems sensible that investment expenses should be included in the calculation of the award. Given our preceding comment in respect of the impact this may have on driving investment expenses up we would suggest that there should be a cap on the amount of the award that can be attributed to investment expenses. We would also note at this point that, given the fact that inclusion of investment expenses in the award will lead to an increase in the level of lump sum settlements, there may be a resultant (limited) adjustment to insurance premiums. Question 11: do you consider that the present level of usage of periodical payments is appropriate and that no change is necessary? Please give reasons. We submit that the flexibility of the current system enables the usage of periodical payments where needed / wanted by claimants. The fact that this is the case suggests that the current usage of periodical payments is appropriate. In the opinion of the (re)insurers writing motor and other liability business in Lloyd's, all the evidence suggests that periodical payments are used in the cases where they are most appropriate, generally being the cases in which the claimant's injury has impaired their capacity, there are significant care and case management costs over a long period of time (usually where the

7 claimant is a child and / or has suffered injuries of the utmost severity) and where there are special circumstances that may significantly impact life expectancy. While it is possible for a defendant to request payment of damages in the form of a lump sum even when a claimant requests a periodical payment, a Court is currently empowered to overrule the defendant's submission based on its own judgment. To aid this decision, a Court is able to seek advice, under Civil Procedure Rule Part 35, from an independent expert on how a claim is best settled (whether by lump sum or periodical payment). We consider therefore that the current system provides sufficient flexibility to ensure that the best outcome is reached. Question 12: If not, please indicate the measures that you think should be taken to increase their use. Please give reasons. In light of our response to Question 11, we have no comment to make on this question. Question 13: do you consider that claimants and defendants are sufficiently informed about the availability of periodical payments and how they operate? Please give reasons. We can confirm that knowledge of periodical payments is extensive amongst (re)insurers. Our experience suggests that claimant advisors are very aware of periodical payments as evidenced by the fact that they are often raised for consideration as part of settlement discussions. Question 14: why are periodical payment orders not used in a larger proportion of cases? Are there, for example, types of cases where periodical payment orders not appropriate? Or are there particular costs, obstacles, risks or circumstances which limit the use of periodical payment orders. We would query the suggestion inherent in this question that periodical payment orders would be used more regularly if certain barriers were removed. We would suggest that there are numerous rational reasons why claimants prefer lump sum awards to periodical payments and the fact that claimants do not opt for the latter does not necessarily evidence the fact that they are flawed in some way. Claimants (and their representatives) have suggested that, in many cases, they prefer the flexibility afforded by a lump sum award. Claimants also prefer a clean break from the cause of their injuries. Many consider that this clean break is not provided by periodical payments even though these are paid, not by the person who caused the injury but by a (re)insurance company or other compensator (e.g. the NHS). This may be because, in the case of (re)insurers, the claimant is required to provide a proof of life on an annual basis and also submit for a medical review every seven years. A lump sum award may be a more appropriate method of compensation for a claimant who was, in part, responsible for some of the injuries suffered, e.g. in cases where there is an element of contributory negligence. In such cases a periodical payment which is subject to a defendant's liability reduction, may not meet the claimant's annual needs, while a reduced lump sum will cover their needs in full for a period of time after which investment returns may make up the shortfall. We would argue that periodical payments are not used in a larger proportion of cases because claimants consider they are not the most attractive or appropriate form of

8 compensation in those cases where they are not used. However, the fact that they are available highlights the flexibility of the current system. Question 15: where periodical payments are used in conjunction with a lump sum, what determines the balance between the lump sum and the periodical payment elements of the overall award? We would submit that the balance between the lump sum and periodical payment elements is entirely determined by the facts of the case. Generally, the lump sum element of the overall award is used by the claimant to cover their immediate costs (e.g. the cost of altering or improving their accommodation to reflect their needs) and therefore its quantum will be determined by the claimant's needs. We would take this opportunity to emphasise that this question highlights the flexibility in the current system whereby a claimant can have their compensation awarded by way of a lump sum, periodical payments or a mixture of both depending on their circumstances. Question 16 [Scotland Only]: given our support for the flexibility of the system in England and Wales outlined above, we submit that it would be equitable for claimants in Scotland to have the option of receiving compensation in the form of periodical payments if it is considered appropriate. Question 17: do you agree with the impact assessment that accompanies this consultation paper? If not please give reasons. We believe that the current system is the most appropriate. It seems sensible to amend the methodology used to calculate the discount rate to reflect the investment choices made by claimants (i.e. the use of a mixed portfolio rather than solely investing in ILGS). We consider that by changing this methodology the current discount rate of 2.5% will be proved to be accurate. In the event that the discount rate is reduced the quantum of lump sum settlements will increase significantly and (re)insurers will be forced to increase premiums to reflect this. Similarly, an increase in the discount rate will make lump sums less attractive and drive up the use of periodical payments. As outlined above this has significant implications for (re)insurers in terms of administration and capital requirements and would therefore also impact premium levels. This therefore supports the need to maintain the current position which we believe provides claimants with flexibility while ensuring that the most accurate compensation is available. Question 18: Do you have any information regarding: the effect of the current discount rate on the size of awards of damages and as to the likely effect of a change in the rate on the size of awards in the future; on whether awards made under the present law turn out to be inadequate; on the reasons why periodical payments are used; the effect of periodical payments on the overall long term cost of awards; or on any other issues relevant to the assessment of the impact of the proposals under consideration? As noted in our response to Question 3, we are not aware of any evidence that awards made under the present law turn out to be inadequate. Question 19: do you consider that a change in the approach to setting the discount rate or any encouragement of the use of periodical payments would affect the behavior of businesses or voluntary sector organizations? If so, please give reasons.

9 We would refer back to our comment in response to Question 17, in respect of the impact a change in the discount rate or any encouragement of the use of periodical payments would have on insurance premiums. Question 20: do you consider that a change in the approach to setting the discount rate or any encouragement of the use of periodical payments would have any direct effect on small or micro-businesses? Please give reasons. The potential impact on premiums (as reference in our response to Question 17) caused by a change in the discount rate or any encouragement of the use of periodical payments would clearly impact small micro-businesses as well as larger businesses and consumers. Question 21: do you consider that a change in the approach to setting the discount rate or any encouragement of the use of periodical payments must apply to small and microbusinesses as it applies to other? If not, please give reasons. On this question we would wholeheartedly support the response submitted by the ABI: "There is no justification for saying that a different approach should apply to small firm defendants as opposed to any other type of defendant. The discount rate is used to demonstrate the rate of return which can be realised by a claimant in practice. That rate of return should apply equally to all categories of claimant, irrespective of the nature of the defendant. The only fair way of applying the discount rate is to apply a single rate for all types of claimant and defendant, otherwise the use of separate rates would create uncertainty and frictional costs as parties sought to differentiate their individual position to their best advantage." Question 22: do you agree with the initial assessment of the equalities impacts of the possible changes under discussion in this consultation paper? If not, please give reasons. We would support the comment made by the ABI in respect of the impact of the changes on young drivers. Question 23: if you consider that the changes under consideration in this consultation paper in relation to the discount rate or the use of periodical payments will affect people with different protected equality characteristics please give reasons and provide evidence of any ways in which this will occur? We have no comment on this question. Please Contact: David Powell, Patrick Davison Manager - Underwriting Technical Executive Tel: Tel: david.powell@lmalloyds.com patrick.davison@lmalloyds.com