Lump sums - the good, the bad & the ugly Richard Cumpston Cumpston Sarjeant Pty Ltd.

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


Lumps sums currently

• Full common law

• Common law with statutory restrictions

• Partial common law

• No common law entitlements

• Commutations of statutory incomes

• Impairment lump sums


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?


Common law with statutory restrictions

• 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


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


No common law

• South Australian work accidents

• NT work and road accidents


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


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


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


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

Total 5243 289 129


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


Colin Bass NSW 1983 – sums exhausted within 7 years

• Work redemption $20,000-$30,000• Work redemption $40,000-• Motor vehicle $20,000-$35,000• Motor vehicle $100,000• Work common law $40,000-

• 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

• 16%• 19%

• 22%• 53%


Main reasons for inadequate compensation (SA)

• Wrong predictions• Lawyer• Inflation• Need to settle early• What happened in court• Contributory negligence• Investment mistake

• 52%• 34%• 38%• 13%• 3%• 6%• 7%


% spent 3-4 years after receiving UK award of 20,000+ pounds

• All of it• Over half• About half• Less than half• None of it

• 22%• 22%• 14%• 33%• 9%


Investments by UK recipients of 20,000+ pounds

• None• Building society• Bank account• Company shares/securities• Unit/investment trusts• Government stocks• Property• Other

• 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”


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”


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”


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


Lump sum pitfalls

• Bad predictions

• Bad legal advice

• Bad investment advice

• Bad investments

• Generosity to friends & relatives

• Theft


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)


Structured settlements less likely if

• Financially competent to self-invest

• Financially secure

• High statutory discount rate

• Low current interest rates

• Inexperienced annuity market

• Distrust of insurance companies


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)


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


Fund runoff with 3% discount

0

1

2

3

4

5

6

7

8

0 10 20 30 40 50

Years since award

Fun

d ($

m)

FixedMixed


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


Fund runoff with 5% discount

0

1

2

3

4

5

0 5 10 15 20 25 30 35

Years from award

Fun

d ($

m)


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


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


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+


UK types of cases

• Road• Medical• Work• Riding• Skiing• Criminal• Unknown• Total

• 23• 9• 3• 1• 1• 1• 5• 43


UK types of disabilities

• Brain• Quadriplegia• Paraplegia• Cerebral palsy• Death• Arm• Unknown• Total

• 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


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

Lump sums - the good, the bad & the ugly Richard Cumpston Cumpston Sarjeant Pty Ltd.

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