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FOCIS Response to Ministry of Justice Call for Evidence on the Discount Rate 2019


Q1:


(a) What asset classes are generally available to Claimants investing lump sum damages and suitable for the hypothetical “low-risk” investor envisaged in the setting of the discount rate?


(b) What asset classes are not generally available in practice to such an investor, for example due to reasons of scale, liquidity, cost-efficiency or unsuitability?


We are not financial advisers and so we defer to and endorse the submissions of Richard Cropper and Ian Gunn of PFP, and Christopher Daykin (former Government Actuary) in this respect. In particular we agree that any asset class must minimise the risks of sequencing, drawdown and deviation; they must have a narrow dispersion of real returns over time with a low level of downside risk and a low exposure to tail risks.


We agree with Christopher Daykin that “For practical reasons the portfolio should not be invested in more than a few categories of investment, except perhaps in relatively rare situations where the lump sum is very large indeed (e.g. over £20m) and intended to cover compensation over a very long future period.”


We also agree with the conclusions of the MOJ’s expert panel in their 2015 report that any truly low risk portfolio, would require at least 75% ILGS, with the remaining 25% invested in a split between UK corporate bonds, global government inflation-linked bonds and global equities. We agree that any other asset classes pose unacceptable levels of risk.


Q2:


(a) Please provide information regarding how recipients of lump sum damages awards for future financial loss are typically advised to invest, when they are normally advised and why?


The government comments in the Call for Evidence that whilst responses in 2017 suggested advice during negotiations is ‘more related to the type of settlement’, there is ‘little evidence on investment strategy for any resultant lump sums’. The reasons for this are set out below.


It is routine in the preparation of personal injury claims involving very serious injuries and consequently significant sums of future loss, for an expert report to be commissioned from an Independent Financial Adviser or Forensic Accountant with expertise in comparing the pros and cons of periodical payments (PPs) and lump sum awards of damages. They are reports prepared for both the Claimant and, notably, for the Court, pursuant to the expert’s duties under CPR 35. The scope of those reports is to consider what form of award is most appropriate to meet the Claimant’s future needs. Those reports do not attempt to advise a Claimant on how they might invest the lump sum element of their damages. That is an exercise that typically only takes place after the claim has concluded and once it is known how much the Claimant actually has left to invest.


In many cases the process is delayed whilst costs are resolved, a process which typically takes 6-18 months and usually leaves a shortfall that reduces the net damages award. Only then can the Claimant make informed decisions concerning any major initial capital expenditure, notably the purchase and adaptation of a property suitable for the Claimant’s disability-related needs. That property purchase and adaptation process commonly takes a further 12-24 months. So it may be 2, 3 or even 4 years after the damages have been agreed before the Claimant is in a position to make long term investment decisions.


The analysis of the investment risks associated with a lump sum are different depending on the duration of the loss, life expectancy, the need for capital, the capital shortfall created by the accommodation claim, the level of recovery both in terms of value of the claim and the impact of any liability deduction and where the Claimant lives. It is impossible to give reliable advice to a Claimant prior to settlement or trial, as the basis and level of recovery will be uncertain. To even attempt to do so would also run the risk of creating an expectation on the Claimant’s behalf that may not be realised by the damages they ultimately recover (if any).


(b) Is there any regulatory material or guidance available to those providing such advice? If so, what?


(c) Does such guidance help advisers achieve a suitable and consistent approach?


(d) Do Claimants follow the advice given? If not, please explain to what extent and why.


(e) Is the cost of pre-settlement financial advice given to the Claimant paid by the defendant as part of the settlement? What sums are involved?


It is not clear what the MOJ mean or intend by the phrase ‘pre-settlement financial advice’. Within this Call for Evidence the MOJ’s states its understanding is that ‘costs of financial advice to the Claimant during negotiations and litigation is generally met by the defendants as part of the general settlement of legal costs and disbursements’. That is incorrect.


We repeat our comments at paragraph 2a) above and would stress that the cost of litigation reports on the form of award are wholly irrelevant to the setting of the discount rate. They are usually provided by a forensic accountant1 or an independent IFA2, acting in the capacity of a CPR 35 expert whose ultimate duty is to the Court. The scope of these reports is designed to enable the Court to make decisions on the most appropriate form of award pursuant to the s2 of the Damages Act 1996, as amended by the Courts Act 2003 and pursuant to Part 41 of the CPR. The Court is required to consider which form of award is most appropriate to meet the Claimant’s needs and ensure continuity of payment of any periodical payment is reasonably secure. There is no consideration of how a lump sum may be invested in these reports.


Whilst the cost of such a report, on the form of award, would like other expert reports be recoverable as part of the inter partes costs of the litigation, it is well established in the common law that investment advice itself is not recoverable; see Page v Plymouth Hospitals NHS Trust [2004] EWHC 1154 (QB), where the Claimant was precluded from recovering as damages the costs of investment advice and fund management charges incurred in the management of his prospective award. This decision was reaffirmed by the Court of Appeal and extended to competent adults in Eagle v Chambers (No.2) [2004] EWCA Civ 1370.


The experience of our members is that there are a relatively small number of IFAs who specialise in advising seriously injured Claimants. We would not recommend to our clients that they seek advice from the majority of IFAs who lacked such expertise and hence do not have a full appreciation of what the Claimants lifetime needs are, nor the importance of ensuring that the compensation lasts to meet those needs. The advice is too specialist in nature and too important for Claimants to base their decision on who is cheapest.


1 We note that the Scottish Government propose that an Actuary provide these reports.


2 These reports are usually provided by someone other than the Claimant’s own IFA, if they even have one at that stage.



To conclude on this point, there is no ‘pre-settlement investment advice’ given during the course of the claim. Investment advice charges are costs that the Claimant’s bear after the claim has concluded and once investment is possible. The common law does not provide for the Claimant to recover the cost of that advice from the Defendant.


Consequently it is essential that the cost of suitably specialist investment advice and related ongoing financial management (“running the money”) is factored into the discount rate, as was acknowledged by GAD in their 2017 report for the MOJ.


Any other decision would require an Act to overturn the above common law and positively provide for the cost of investment management to be recoverable as damages. However, that would then require additional expert reports in each case as to the likely cost of that advice.


Q3


(a) To what extent do changes to financial conditions affect investment advice provided to Claimants who receive a lump sum award?


We agree with the submission of Cropper and Gunn of Personal Financial Planning (“PFP”), that “The financial climate is dynamic and constantly changing: constant reappraisal of plans is therefore necessary in order to ensure that Claimants have the best opportunity to meet their expected cash flow needs, taking account of their need to take risk (including the discount rate applied to their lump sum) and their ability and willingness to do so.”


(b) Is there any evidence available to show how the change to the discount rate in March 2017 directly impacted upon investment advice provided to Claimants?


We do not have access to any such evidence and it is probably too early to attempt to gather it. The rate of settlement of serious injury cases has slowed with many insurers delaying or withdrawing from settlement negotiations in the hope of postponing the outcome until after the new discount rate comes in. In addition, it can take 3 to 4 years post damages award to resolve costs, purchase and adapt accommodation, so many of the relatively small cohort who have received damages under the current -0.75% discount rate will not have yet fully invested their damages.


However, virtually all the IFAs, professional receivers and deputies we have spoken to have stressed that their investment advice is based on meeting the long term needs, rather than taking risk to maximise potential returns. Consequently, it is safe to assume that this cohort of Claimants will generally be advised to make lower risk investments that those whose cases concluded at the markedly unfair 2.5% discount rate, which effectively forced them to make riskier investments and/or reduce their outgoings (and hence not fully meet their disability related needs), if necessary partly relying on State support.


Q4:


(a) Please provide evidence of how recipients of lump sum damages awards actually invest, and why?


(b) What sources of balanced reliable data on investments actually made by Claimants are available?


We do not have access to this information. Gathering such evidence would be a very major and time consuming exercise, way beyond the time-scale of this Call for Evidence that has arisen at short notice. We also agree with the submission of Victoria Wass that is would be difficult or impossible to gather such evidence untainted by the dynamic of under-compensation under the former 2.5% discount rate.



However, we take the view that the premise of this question (and s5(b) of Schedule 1A of the Act) is flawed. It is irrelevant how Claimants have in the past actually invested their compensation when it comes to determining the policy or level of the discount rate for other future Claimants. Whether those past Claimants made risky or non-risky decisions and whether those decisions were wise or unwise is a post-claim event, individual to each of them, which should be irrelevant to how the compensation of other future Claimants is calculated and indeed to consideration of the 100% compensation principle. Claimants should not be forced or expected to take risk for the benefit of the wrongdoer who caused their injury. Insurers are in a much better position to aggregate their funds and hedge their exposure to fluctuations in the financial markets than individual Claimants.


This position is further complicated by any Claimant who did not recover compensation on a full liability basis, perhaps because there was a litigation risk of them losing their case, or where there has been a deduction from the global damages for contributory negligence. Some Claimants will also have been effectively forced to take investment risk because the cost of meeting their needs increased beyond the basis on which their claim was settled, or their damages awarded by the Court. This could happen by the effect of real earnings growth, and/or inflation for disability-related items that due to the specialist nature of the market do not necessarily increase consistently with RPI (or CPI).


Another factor is that some Claimants either settle or are awarded a lesser sum for any particular head of loss that they seek. This is often because of opposing expert evidence advanced by the Defendant suggesting a lower level of loss, or lack of corroborating evidence. However in the years that follow the conclusion of the case, the Claimant may actually incur expenses at or even higher than his own expert team anticipated. In addition, the Claimant’s injuries, and consequent needs, may increase beyond the level that had been anticipated when the claim was under consideration, or in a way that had not been identified at the time (such as the development of a secondary medical complication that had not been anticipated).


In our experience, it is common for the Claimants we represent to keep most or all of their compensation on deposit in the bank, often for several years. As mentioned above, the time scale for resolving the costs of their claim is relevant to the timing of investment advice and decisions. The timescale for finding, buying and adapting a home to live in can be a factor feeding into the delay in forming or implementing any investment plan. In theory, the investment returns in these earlier years are crucial to the performance of the fund invested. Therefore, when considering any modelling of the performance of hypothetical portfolios, and their potential applicability to real life behaviour of seriously injured Claimants, this delay factor ought to be factored in.


We agree with the following points made by PFP’s response to the 2017 consultation: that in their experience Claimants (a) do not invest in risk assets with the aim of maximising returns in order to generate over compensation that they can spend on ‘wants’ rather than ‘needs’, and (b) sometimes accept risk in order to facilitate the maintenance of their needs over time, often having also looked at family support to create a saving on care costs, state support and compromising or foregoing needs.


The historical data which formed the two portfolios in the GAD 2017 report was based on anecdotal accounts and assumptions of investments relating to the old discount rate of 2.5%, which forced Claimants into riskier investments, and cannot demonstrate a true picture of how Claimants are investing to meet their needs over their lifetime to ensure their compensation lasts.


Any evidence gathered relating to Claimant investment behaviour between 2001, when the rate was 2.5%, and its adjustment to -0.75% in 2017 would also be skewed by the fact that during that time there was massive under-compensation of Claimants. Those Claimants had



effectively been left with no choice but to contemplate taking investment risk in an attempt to achieve the assumed net real rate of return underlying the 2.5% discount rate.


If the intention behind this question is to ascertain whether Claimants are being over-compensated by the discount rate, we would suggest it would be impossible to provide credible evidence as such.


Q5:



(a) What data is available regarding the profile of Claimants of lump sum damages?


We are not aware of any such data. Most settlements do not have agreed breakdowns by head of loss. Reported decisions of damages assessments including future loss claims could be analysed if this data were required, but that would be a major exercise that would probably require looking at all such decisions over a period of at least 10 years.


(b) How are claims of loss typically split between loss of earnings and care needs, for notional investors with lump sums of around £0.5m, £1.0m and £1.5m respectively?


It is our members’ experience that in most injury claims, particularly those with injuries of utmost severity, damages for loss of earnings and care and case management account for 50% or more of the Claimant’s damages. The past losses will by definition already have been spent. Damages for PSLA and future loss of earnings are usually applied towards the capital cost of housing.


(c) Is a period of 30 years a reasonable overall average projection period to consider when analysing long-term investment returns from such portfolios, or would an alternative period or a range of periods be more suitable, and if so, which and why?


Each case varies as to its facts, including in relation to life expectancy. Both sides may make concessions on life expectancy, in order to achieve settlement.


Those seriously injured at birth or during childhood may well have a life expectancy of well over 30 years. A younger Claimant would be hugely affected by different growth rates in earnings and prices (including many non-standard items such as specialist disability related equipment).


A significant issue is that the investment adviser and their client must plan for outliving the impaired life expectancy, or risk the compensation running out before the end of the Claimant’s life. See further on this point our answer to Q6(a) below and our related proposal at Q10(a).


Whilst a notional period of 30 years might on the face of it be workable, it would not be applicable to all Claimants. The key point is that each client deserves full compensation and this should not be based on a set rate that leaves a cohort of Claimants under-compensated. There would be a significant minority of Claimants with life expectancy of less than 30 years, and the rate should not undercompensate those Claimants.


We are pleased to note from the GAD’s Technical memorandum that they plan to undertake and publish modelling showing the outcomes for Claimants with future loss periods rising in decade increments. We suggest that extend to 100 years. The modelling ought to be based



on a truly low risk portfolio (see our response to Q10 below) and factor in a realistic level of investment management and tax deduction (see our response to Q9 below).




...


The full response is available to download:


FOCIS Response to Ministry of Justice Call for Evidence on the Discount Rate 2019






























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