Transcript Lump sums - the good, the bad & the ugly

Lump sums - the good, the bad &
the ugly
Richard Cumpston
Cumpston Sarjeant Pty Ltd
Topics
• how lump sums currently operate in
Australia
• how lump sums are spent
• lump sum pitfalls
• the structured settlement alternative
Cumpston Sarjeant Pty Ltd
Lumps sums currently
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Full common law
Common law with statutory restrictions
Partial common law
No common law entitlements
Commutations of statutory incomes
Impairment lump sums
Cumpston Sarjeant Pty Ltd
Full common law
• A lump sum intended to restore the plaintiff
to their former position
• Subject only to court decisions
• For example, the 3% discount rate of the
High Court in Todorovic v Waller 1981
• Only applies in the ACT, for work and road
injuries?
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Common law with statutory
restrictions
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Statutory discount rates of 5%, 6% or 7%
Thresholds for non-economic loss
Caps on non-economic loss awards
Caps on economic loss awards
Restrictions on legal costs
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Partial common law
• For work and road accidents in Victoria,
severely injured persons can receive
common law awards for earnings losses, but
expenses of care continue to be paid by
TAC or WorkCover
• ComCare also pays continuing expenses of
care
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No common law
• South Australian work accidents
• NT work and road accidents
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Commutations & redemptions
• Some severely injured Victorian workers
can commute weekly payments for 25% of
their actuarial value
• Some SA workers have been able to
commute for limited periods, at fair values,
but at the expense of the Commonwealth
• NSW injured workers appear to get less
than fair value
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Impairment lump sums
• Statutory entitlements, regardless of fault
• Originally based on “meat charts”
• Now largely based on medical impairment
assessments
• Sometimes severely biased against those
less than 100% impaired
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Where structures possible
• Annuity will be tax exempt if purchased
using money paid as personal injury
compensation, where that money would
have been tax-free if paid as a lump sum
(excluding compensation for workers
compensation and death)
• Bill ss.54-10 (1) (c ) & (d), & 54.20
Cumpston Sarjeant Pty Ltd
Lump sums paid pa
(Walsh & Davies 6/11/97)
Type
.1-.5m
.5-1m
1m-
Motor accident
2455
164
89
Work
2128
79
12
Public liability
501
33
18
Medical
158
13
9
5243
289
129
Total
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How lump sums are spent
• Colin Bass, study for NSW Law
Foundation, 1983
• Marcia Neave & Louise Howell, Adelaide
Law Review Resarch Paper No 5, 1992
• UK Law Commission “Personal injury
compensation “ How much is enough”,
1994
Cumpston Sarjeant Pty Ltd
Colin Bass NSW 1983 – sums
exhausted within 7 years
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Work redemption $20,000-$30,000
Work redemption $40,000Motor vehicle $20,000-$35,000
Motor vehicle $100,000
Work common law $40,000-
Cumpston Sarjeant Pty Ltd
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53%
43%
65%
31%
36%
Neave & Howell – 227 SA MV
awards of $25,000+ in 1980
• In families below poverty line
• Reliant on social security for reasons
related to the accident
• Financially insecure because of accident
• Compensation insufficient to cover
accident-related expenses
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• 16%
• 19%
• 22%
• 53%
Main reasons for inadequate
compensation (SA)
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Wrong predictions
Lawyer
Inflation
Need to settle early
What happened in court
Contributory negligence
Investment mistake
Cumpston Sarjeant Pty Ltd
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52%
34%
38%
13%
3%
6%
7%
% spent 3-4 years after receiving
UK award of 20,000+ pounds
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All of it
Over half
About half
Less than half
None of it
Cumpston Sarjeant Pty Ltd
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22%
22%
14%
33%
9%
Investments by UK recipients of
20,000+ pounds
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None
Building society
Bank account
Company shares/securities
Unit/investment trusts
Government stocks
Property
Other
Cumpston Sarjeant Pty Ltd
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10%
51%
26%
21%
30%
8%
7%
8%
Bad investment advice (UK)
• “The solicitor advised us to go to a financial
adviser. She put the money left into that
bank which crashed which lost all the
money we had in that”
• “the bank gave us duff information …went
to a broker who was a bigger dead loss”
• “everyone wants to sell you their own
product”
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Bad investments
• “I was advised to invest in stocks and
shares, and lost a lot of money”
• “I’m disappointed because of the drop in the
interest rate and the bank charges”
• “The return from my investments are only
just keeping up with inflation”
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Generosity to friends & relatives
• “Almost half of his 300,000 pounds
disappeared in the first 18 months, much of
it spent on contributing towards the
purchase of properties for his children and
mother, and taking his family on exiting
holidays … he would have preferred
periodic payments to the lump sum”
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Theft
• “Former Geelong mayor pleaded guilty to
the theft of $5 million from Tomislav Papic
… Mr Papic won a record $6m settlement
from a Geelong hospital after a medical
mistake left him in a wheelchair”
The Age 10/3/01
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Lump sum pitfalls
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Bad predictions
Bad legal advice
Bad investment advice
Bad investments
Generosity to friends & relatives
Theft
Cumpston Sarjeant Pty Ltd
Cases for structured settlements
"Structured settlements will be most
appropriate for those with lifelong medical
treatment and care needs. Structured
settlements remove the worry involved in
having to invest a large lump sum so as to
draw an income that can cover expenses
while making sure that the money won't run
out.“ (MAA 1998)
Cumpston Sarjeant Pty Ltd
Structured settlements less likely if
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Financially competent to self-invest
Financially secure
High statutory discount rate
Low current interest rates
Inexperienced annuity market
Distrust of insurance companies
Cumpston Sarjeant Pty Ltd
Impact of discount rate
• 3% discount rate
– Top down approach and bottom up approach
yield similar results (annuity cost and lump sum
calculation roughly equal)
• 5% discount rate
– Top down approach will be preferred by
defendants (lump sum calculation likely to be
less than annuity cost)
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3% discount rate
• Lump sum calculated to provide $5,000 pw
for life expectancy of 44 years = $6.4m
• With mixed investments and drawings of
$5,000 pw fund will run out in about 44
years
• Annuity providing $5,000 pw for life costs
about $6m
Cumpston Sarjeant Pty Ltd
Fund runoff with 3% discount
Fund ($m)
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7
6
5
Fixed
Mixed
4
3
2
1
0
0
10
20
30
Years since award
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40
50
5% discount rate
• Lump sum calculated to provide $5,000 pw
for 44 years = $4.7m
• With mixed investments and drawings of
$5,000 pw, fund runs out after 28 years
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Fund runoff with 5% discount
5
Fund ($m)
4
3
2
1
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5
10
15
20
Years from award
Cumpston Sarjeant Pty Ltd
25
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5% discount rate
• Lump sum of $4.7m allows drawings of
$3,884 pw for life expectancy of 44 years
• Annuity costing $4.7m provides $3,949 pw
for life
– avoids the risks of living too long
– avoids the risks of high inflation
– avoids the risks of poor investments
Cumpston Sarjeant Pty Ltd
Size of UK structures
• "In the UK, 100,000 pounds is suggested as
a minimum total value of a case, though
typical cases involve damages of 600,000
pounds, of which about 350,000 pounds is
used to purchase annuities.“
MAA 1998 p11
Cumpston Sarjeant Pty Ltd
Size of Australian structures
• Legislative requirement for minimum
monthly level of support (Bill s.54-40)
– Must be a lifetime annuity
– Must start at level of current Aged Pension
– Must be indexed to the CPI
• Minimum case size depends on age
• Expect cases $1m+
Cumpston Sarjeant Pty Ltd
UK types of cases
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Road
Medical
Work
Riding
Skiing
Criminal
Unknown
Total
Cumpston Sarjeant Pty Ltd
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23
9
3
1
1
1
5
43
UK types of disabilities
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Brain
Quadriplegia
Paraplegia
Cerebral palsy
Death
Arm
Unknown
Total
Cumpston Sarjeant Pty Ltd
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22
6
3
3
2
1
6
43
Estimates for Australia from UK
• Based on UK take-up rates and 1997
Walsh/Davies lump sum figures
• 30 to 60 structured settlements pa
• Average award $1.75m
• Average life expectancy 33 years
JR Cumpston, “Potential costs and savings
from structured settlements”, 4/2/00
Cumpston Sarjeant Pty Ltd
Conclusions
• Will be possible in most large personal injury
cases where common law lump sums are now paid
• Will address some of the pitfalls of lump sums
• Likely in motor vehicle, medical indemnity and
public liability cases involving brain and spinal
injuries
• Attractiveness will vary depending on personal
and economic circumstances
Cumpston Sarjeant Pty Ltd