Periodical payments orders (PPOs) which are also known as structured settlements, were introduced into personal injury litigation by the Courts Act 2003 and came into effect on 1st April 2005.
The new law enabled the court to make a periodical payments order, rather than a conventional lump sum, even if neither the plaintiff nor the defendant had requested it.
Therefore, if someone suffers serious personal injuries, such as in a motor collision, and makes a claim against the insurance policy of the person responsible, the compensation they receive may be in the form of either a lump sum or a series of regular lifetime payments – a structured settlement/PPO.
As such, the Courts Act 2003 represented a major change to the law regarding the calculation of the amount of compensation in the most serious personal injury cases and brought with it some quite significant implications for the claimant and the insurers involved.
The Motivation behind the Courts Act 2003
The reasoning behind the act was to enhance the compensation payable to claimants by removing the risk that they faced in investing a lump sum, the impact of inflation and the possibility that the lump sum would be insufficient if their longevity had been under estimated when the lump sum was calculated.
These risks are, instead, now placed firmly in the hands of the insurers, who are felt to be more capable of bearing them, thus affording greater certainty to the claimant. The implications of this for insurers and reinsurers are quite marked.
Effect on Insurers
The Courts Act 2003 has various implications for insurers in the most serious personal injury claims. These can be summarised as follows:
- The creation of uncertainty as to how to make provision for what is, in the final analysis, an unknown future cost.
- The introduction of a commitment that lasts the lifetime of the claimant.
- The imposition of significant administration costs over the lifetime of the claimant.
- The inability to match assets with liabilities, impacting on the net real investment return.
- The impact of retentions on buyers of reinsurance, meaning that the primary insurer may have to self-fund a PPO loss, possibly over a period of many years.
These factors have been added to by subsequent case law, which determined that inflation was to be linked to average earnings and ASHE 6115, rather than the retail prices index (RPI), which has, historically, tended to rise more slowly.
Over the lifetime of a claimant this could give rise to a substantial increase in the amount paid under the PPO.
Effect on Reinsurers
Because PPOs are normally awarded in serious or catastrophic injury cases recoverable under a reinsurance excess of loss contract, it is anticipated, as more of this type of order is made, that reinsurers will be called upon to handle a higher percentage of claims than primary insurers.
Reinsurers may also run additional risks, such as investment and timing of payment risks and, of course, their administrative cost of claims handling would rise.
The financial implications of a PPO were underlined in a recent case, marking the first PPO to be made in Jersey. In that case, the claimant was able to establish liability for a road accident that caused him serious injuries resulting in ongoing behavioural and cognitive problems.
The settlement that was ultimately agreed was in the sum of £9 million, part of which was to be paid by way of a lump sum, with the reminder to be paid over the claimant’s lifetime in a series of regular payments through a PPO.
The insurer, AXA, would be responsible for maintaining these payments throughout the claimant’s lifetime – a significant commitment.
Addressing the Risks
Traditionally, the risks of longevity, inflation, and investment are managed by the life assurance market and in an ideal world insurers would be able to transfer these risks to that market through purchasing annuities.
Regrettably, the UK annuity market is by no means in an optimum state and does not effectively cater for injuries of the severity suffered by those claimants who are awarded a PPO.
In the absence of an annuity, the insurer has the option of either using the capital markets or self-funding the PPO, neither of which is an ideal solution to the problem. Although it will not reduce the exposure of insurers and reinsurers to the effect of PPOs a new tool, created by Aon Benfield, enables insurers to calculate their exposure to PPO claims and to assess the extent to which reinsurance might alter the degree of exposure.
The ability to make a more detailed calculation of their exposure should assist insurers in analysing capital charges and making better informed strategy decisions with regard to new business and reinsurance.
PPOs clearly provide greater certainty to claimants in serious personal injury cases. They have also introduced challenges to the insurance industry.
For those challenges to be successfully overcome, the industry needs to work in a co-ordinated way to find solutions. These should include adopting a greater willingness to take on liabilities and the evolution of reinsurance contracts to shift the balance of power more in favour of purchasers of excess of loss reinsurance.