When properly insured individuals are injured in an accident, it is right that they are compensated for any resulting reduction in their quality of life. Institute and Faculty of Actuaries’ (IFoA) Public Affairs Manager Michael Williams blogs on the compensation solution that helps provide extra protections to injured individuals.

The UK’s insurance arrangements provide that when someone is injured, they are covered for the most severe of eventualities. For example, if you are injured by an insured driver, you will receive compensation to cover any loss that you suffer as a result. In most personal injury cases, a lump sum will be awarded based on the claimant’s needs, including the loss of earnings associated with their condition, any adjustments to their home and the cost of their ongoing care. The sum also tries to reflect how long they are expected to live with their condition. In these cases, the responsibility for how that money is spent, and for ensuring that it lasts a lifetime, is handed to the individual as they are handed their compensation cheque.

The IFoA believes that the needs of injured parties should be at the centre of any compensation paid in these situations. Indeed, it is vital those who have been subject to life-changing misfortune are not subject to additional hardship as a result.

A periodical payment order (PPO) is a different type of compensation that pays the injured party a guaranteed income for life, again based on the specific needs resulting from their injury (a lump sum can also form a part of the initial award to cover immediate costs, such as household adaptions). In the case of a lump sum award, the individual is essentially asked to take responsibility for investment, inflation and longevity risk, ensuring they properly invest and manage this often very large sum of money, whilst also budgeting appropriately so that the money does not run out before they die. A PPO relieves the individual of these risks.

The IFoA believes that insurers and the Government (in the case of clinical negligence cases in the NHS) are better placed to manage these risks than the injured party; they have greater scope to manage longevity risk by pooling it in a way that individual claimants cannot.

However there are reasons why claimants, their representatives or the awarding insurer might favour a lump sum over a PPO:

•  The potentially large monetary value of a lump sum may appear more valuable than the PPO and claimants may not understand, or have properly explained to them, the risks and responsibilities associated with this.

•  It is clearly difficult to predict one’s future needs and ‘present bias’ suggests that individuals give greater weight to payoffs in the immediate term than in the future. A PPO protects against this to ensure that claimants are compensated for future as well as immediate needs.

•  A PPO represents a long-term liability for the awarding insurer which must be managed for many years into the future.

•  The current negative Ogden discount rate is further inflating the size of lump sums making them more attractive.

A combination of these concerns contributes to the relatively low take-up of PPOs by claimants, where in many cases they may be a better form of compensation for the individual.

The Government has a duty to ensure that vulnerable claimants have their interests best served by the compensation they receive. The IFoA has called upon the Government to act to address the issues by investigating further the award of PPOs in appropriate cases.

In April 2018, Lord Keen, Lords Spokesperson for the Ministry of Justice, indicated that in personal injury cases, the Government considers PPOs to be, in principle, a better form of compensation than a lump sum, provided that claimants are properly informed about their options. The IFoA supports this view, and has encouraged the Government to legislate to make PPOs the default award type in large personal injury cases through the recent Civil Liability Bill. In our responses to Government consultations on this issue we have argued that lump sum should only be considered when the claimant, or their advisers, can demonstrate they fully understand the risks of not accepting a PPO and that a lump sum is more appropriate for their needs.

After all, people receiving compensation in these cases are often catastrophically injured, experiencing a range of serious impairments to their physical and mental wellbeing, as well as their ability to live and work as they did before. They should not be expected to manage the investment, inflation and longevity risk associated with a lump sum compensation payment.