Nick Leech and Andrew Sands write the second in a series of more in depth articles, the intention of which is to focus on various aspects of damages awards and their investment.
They have already written extensively over the years, in their capacity as specialist financial advisers, on the hugely significant benefits of periodical payments as part of damages awards. Their view remains unchanged since the start of the statutory regime, and unaffected by the change in the discount rate.
Following on from our recent introductory piece, What Price Peace of Mind, which focussed largely on the benefits of periodical payments, we look this time in more detail at independent advice and management of lump sum personal injury awards.
Many high value cases settle on the basis of a once and for all lump sum, sometimes because the defendant cannot meet the requirements of reasonable security of continuing payments over the claimant’s lifetime. Otherwise, many defendants take the unfortunate position of refusing to negotiate settlement inclusive of periodical payments. In those circumstances, the claimant then has to decide whether to accept a lump sum offer, with the investment and life-expectancy risks that go with that; or to press on to trial and ask the court to order periodical payments – which in itself, would involve risks.
In addition to once and for all lump sum awards, settlements inclusive of periodical payments also feature a lump sum element. Both types of lump sum are much more substantial since the discount rate changed from 2.5% to minus 0.25%, and specialist financial planning and management is essential to ensure that awards are set up properly to last over the claimant’s lifetime.
Historically and anecdotally, the advice from the man in the pub to the lucky millionaire pools winner, was to bank the money and live off the interest. That was never a good strategy, as apart from being inefficient from a tax perspective, inflation rates would outstrip interest rates, so over time, the real value of cash funds would be eroded. Over a lengthy period, a significant reduction in spending power would result. Professional deputies and trustees operate under duties to ensure this does not happen, hence independent specialist investment advice is routinely obtained, so as to target appropriate and sustainable investment returns.
It is worth reminding ourselves of the duties of professional Deputies and Trustees. In particular the obligation to obtain independent advice. This is good guidance and practice. Also, the Trustee Act 2000 was introduced to ensure that the best interests of beneficiaries are served by Trustees. The Act introduced a new statutory duty of care. It was envisaged that this new duty would bring certainty and consistency to the standard of competence and behaviour expected of Trustees. In addition, it provides a safeguard for beneficiaries and thereby balances the wider powers given to Trustees elsewhere in the Act.
The statutory duty of care applies when Trustees carry out certain functions, for example when exercising their powers of investment. The Act imposes two special duties on Trustees. The first duty is a duty to have regard to the need for diversification and suitability of investments. These are known as the standard investment criteria.
A Trustee must from time to time review the investments of the Trust and consider whether, having regard to the standard investment criteria, they should be varied. The second is a duty to obtain and consider proper advice when making or reviewing investments. Proper advice is defined by the Act as, the advice of a person who is reasonably believed by the trustee to be qualified to give it by his ability in and practical experience of financial and other matters relating to the proposed investment.
The Office of the Public Guardian (OPG) produced a Deputy Standards guide in July 2015 to outline what is expected of a professional and public authority Deputy. Therefore, it is important that these are given high regard and rigorously followed, to ensure the efficient undertaking of duties in line with OPG expectations.
As such, care needs be taken when selecting a firm to provide advice as many direct discretionary fund managers and other advisers are only able to offer restricted financial advisory services contrary to the standards outlined by the OPG. Recently there has been a particular focus, reflected by the caselaw as regards conflicts of interest. Joint Ventures or similar structures present potential areas of conflict which need careful management and good governance to ensure clients receive access to unbiased and independent guidance, free from commercial sway.
Specialist Advice in the Era of the Negative Discount Rate
The Lord Chancellor has determined that the personal injury discount rate be set at negative 0.25%. How can damages be invested to produce minus 0.25%, a negative return, and still last to meet the claimant’s requirements? Most damages awards are invested on the basis of a cautious approach to investment risk. This reflects the theoretical approach adopted by the courts. In other words, claimants cannot avoid taking some investment risk, and that a cautious approach is toward the lower end of the risk spectrum, and that approach might target say, 4-5% annually by way of return. From that assumed gross level of return, once investment charges, tax and earnings based inflation have been accounted for, the resulting net, or real return can be in minus territory, hence the discount rate. This rate covers all future loss lump sum personal injury awards and is based upon a requirement that the claimant, having been properly advised, will invest their damages into a diversified portfolio of investments which has more risk than very low risk, but less risk than would ordinarily be accepted by a prudent and properly advised individual investor who has different financial aims in accordance with the legislation.
The -0.25% personal injury discount rate is based upon a number of investment return assumptions as follows:
- An assumption of a representative claimant investing over a period of 43-years.
- A representative low-risk portfolio with an allocation to growth assets at 42.5% and matching assets at 57.5%.
- Over a 43-year term this would provide a median rate of return of CPI + 2% per annum.
- A deduction for taxation and investment costs of 0.75% per annum.
- Personal Injury Damages inflation is assumed to be CPI + 1% per annum.
There are many types of investment which might form part of a suitable portfolio for a personal injury claimant. It is beyond the scope of this short piece to examine every aspect of suitable investment strategy but in summary the following may well be helpful.
Investment asset classes can be summarised as follows:
- Cash Deposits (Bank/Building Society/National Savings/Special Account(s))
- Gilts, including Index-Linked Gilts
- Fixed Interest/Corporate Bonds
- Property (residential and commercial)
- Shares (sometimes referred to as equities)
- Alternative Investments (hedge funds, commodities, timber, private equity etc)
Broadly speaking, these categories of investment increase in respect of their exposure to risk the lower they appear in this list. In order to obtain a balanced and well diversified approach, it might be necessary to have some or all of these types of investment for an individual client. Economic factors will inevitably influence the exposure bandings across various asset classes above, but most importantly financial strategies should be driven by the needs of the investor, constructed independently by suitably qualified and experienced advisors, free from commercial sway.
Over short-term investment periods, different asset classes can demonstrate high levels of volatility. Every long-term period is obviously preceded by a short-term period which, if it results in negative returns, can have a long-term impact on a portfolio that requires a high level of income. Over the longer-term, a well-managed portfolio may be able to overcome the issues associated with short-term investment fluctuations. It is vital for any investor to spread the risk by placing funds into a wide range of assets suited to their needs. Over longer-term time periods, it is possible to achieve real returns that are in excess of the theoretical expected real rate of return.
The Barclays Equity Gilt study provides extensive annual data and analysis on long-term asset returns in the UK and the US. The UK data (which goes back to 1899) is a useful tool to examine trends in equities, gilts, interest rates and inflation. The most recent study (2020) found that since 1899 UK Equities have returned 5.0% a year in real terms, compared to 1.4% for Gilts and 0.7% for Cash. Over the last decade UK Equities returned 4.9% a year in real terms, compared to 3.6% for Gilts and -2.5% for Cash. Over The Barclays Equity Gilt study provides extensive annual data and analysis on long-term asset returns in the UK and the US.
Real investment returns by asset class (% pa)
|2019||10 years||20 years||50 years||120 years*|
Note: * Entire sample. Source: Barclays Research
There is no cost relating to the ongoing management of a Periodical Payment Order. The management of a lump sum portfolio of investments does attract charges, and although the Lord Chancellor has allowed 0.75% per annum to cover taxation and charges, the actual cost to a claimant will vary depending upon their individual circumstances and may be higher or lower than the assumed deduction. In other words, in order fully to meet individual needs, the portfolio has to perform well enough to cover tax and charges as well as produce the assumed theoretical real rate of return.
There has never been a greater need for specialist independence advice.
The value of your investments can fall as well as rise and is not guaranteed.
Past performance is not a reliable indicator of future results.