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Pantelis Koulosavilopoulos — Wed, 08 Sep 2010 07:18:54 GMT

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PPOs are likely to affect the cost of large claims that involve providing long term care or replacing income lost. As it has already been mentioned in other sections of this paper, PPOs are likely to add to the uncertainty over the ultimate cost of such claims as well as extend the length of the underlying loss reserves.

It is useful to differentiate between the actual price that the insurance buyer is likely to pay and pricing, that is, the sellers’ process for formulating a best estimate of the cost of providing the insurance product allowing for an appropriate contribution towards the expected cost of claims of the relevant insurance portfolio, internal expenses, external costs and profit (often referred to as the technical price of the product).

The impact of PPOs on the actual price will depend primarily on the significance of the PPO related costs within the relevant portfolio and the prevailing market conditions. Therefore, it is likely to be more marked for high layers excess of loss reinsurance and much less so for primary insurance.

The direct insurers may need to adjust prices in response to:

• Changes in the availability and terms (including the cost) of reinsurance

• Changes in the legal environment affecting the expected frequency and severity of PPO claims

• Changes in the regulatory environment affecting the required solvency capital

• Inflationary affects on their balance sheet linked to the longer tail of the underlying liability

The ability to effectively transfer risk to reinsurers will be affected by:

• The application of indexation clauses on the priority and limits

• Treaty wordings and particularly the basis on which claims will be split between primary and excess layers.

• Potential commutation of treaties enforced to, amongst other reasons, contain reinsurance credit risk

• Risk inherent to capitalisation of long tail liabilities that may be implemented by insurers or reinsurers

On the other hand, reinsurers may be concerned with accumulation of risk within their balance sheet liabilities and also underwriting and pricing risks.

Small companies are more exposed to the effects from PPOs than larger companies as they will rely more on the availability of appropriate reinsurance.

As has been discussed elsewhere in this paper, the legal environment around PPOs is currently at an embryonic state and as such pose an increased risk for both insurers and reinsurers.

The impact of PPOs on pricing is likely to be linked to the increased uncertainty over the ultimate impact of PPOs. The increase in the capital intensity of the relevant insurance and (particularly) reinsurance products and would be expected to increase the technical prices.

Apart from the increased uncertainty and its impact of capital intensity the pure risk premium component of the technical price may also be affected by the assumption that will need to be made on he number of large claims that will end up being settled by PPOs and how the value of the corresponding annuities will compare to the value of these claims under the current Ogden regime.

At present there is little information available to help actuaries and underwriters produce estimates of the additional cost from PPOs with any confidence. Insurers and reinsurers will be watching closely the developments around PPOs and their impact on their efforts to manage risk effectively and within the financial resources available to them.

Another challenge for calculating the technical price (especially for reinsurance) will be linked to the data that is likely to be available. At present, large claims involving annuities are shown in submissions at their valuation costs and as such efforts to estimate the development of such claims will be affected by changes in the underlying valuation basis over time.

In continental Europe (France) all claims above a certain size that include compensation for loss of earnings and care costs are settled through periodic payments for a number of years now. The claims are split between insurers and their reinsurers using 3 main types of annuity clauses:

a) Proportional follow-up: The value of expected future payments is added to the cash loss and after application of the treaty limit and priority the reinsurer’s share is calculated. The reinsurer will then pay this proportion of each annuity payment even if the total payments made has not reached the priority of the treaty.

b) Additional follow-up: The annuity payments made by the insurer are added to all other claim payments and the reinsurer pays the annuity in full after the sum of all prior payments exceed the treaty priority.

c) Valuation or commutation basis: The reinsurers pay their share of the annuity reserve. This can happen at the time of the allocation or after a fixed period of time (typically 5 or 10 years)

At present, the later of the above three basis is by far the most common. Variations in the annuity amounts are allowed and when they occur they follow the original basis selected. The reinsurers would typically be entitled to ask for proof of life on all existing annuitants and in the event of death they would be entitled to get back an amount pro-rata to the relevant annuity values.

The valuation interest rates can either be linked to a proportion (60%) of the earnings inflation index subject to a max (currently 3.5%) or be fixed (curently at 3%). In terms of mortality, the latest population mortality table is used throughout and the business will be priced on the same basis.

It should be noted that in France, the bulk of the annuity is for the cost of care which is calculated based on an estimate of the expected number of hours of care needed at the prevailing rate at the time of allocation. Typically, there is a distinction between active care and passive (supervision) care. The hours of care needed may change during the life of the claims and the annuity payments will adjust accordingly. It should be noted that inflation on the cost of care after the annuity has started is borne by the State. This is funded via a levy on insurance premiums and as such does not affect the relevant reinsurance treaties.

In France, the loss of income component is less significant that the UK. It is typically around 5%-7% of the total cost of a claim and includes only the loss of future salary increases (the loss of the opportunity to increase the level of income). The loss of income at the current level is borne by the State’s Social Security system.

PPO Working Party

Pantelis Koulosavilopoulos — Wed, 08 Sep 2010 06:15:01 GMT

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Case Studies of Recent Court Cases

Avni Gohil — Tue, 07 Sep 2010 13:14:52 GMT

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-	~~[[Image~~:~~The_naughty_pigs~~.~~jpg]]~~	+	The legal landscape of periodical payment orders is changing. Each ruling has the potential to set a case precedent and become extremely influential in the settlement of future cases. We have already seen that there are many issues to be dealt with when issuing a PPO. Here we will examine some practical examples of the situations that can give rise to a PPO and the considerations to be addressed.
		+
		+
		+	== Moving away from RPI as standard ==
		+
		+
		+	Periodical Payment Orders and structured settlements were originally indexed according to RPI. RPI has historically been lower than earnings indices, meaning that the real value of compensation is eroded over time. PPOs are usually used to cover ongoing care costs. If the compensation is not enough to cover these care costs then it no longer fulfils its primary purpose. One solution would be to link to the national earnings index. However, each profession’s salaries rise at different rates on average and historically carer’s earnings have risen at a slower rate than national average earnings. That is where the Annual Survey of Hours and Earnings (ASHE) becomes useful. It provides information on salaries of occupational groups at a more granular level. This is the conclusion that the judge came to in the Court of Appeal of the Flora v Wakom case in July 2006.
		+
		+
		+
		+	== Flora v Wakom ==
		+
		+
		+
		+	This case revolved around the interpretation of the wording in the Courts Act 2003. The Damages Act 1996 gave the court the power to order a periodical payment in personal injury cases as long as all parties agreed. The Courts Act 2003, which came into effect in April 2005, amended this to:
		+
		+	2(1) A court awarding damages for future pecuniary loss in respect of personal injury –
		+	(a) may order that the damages are wholly or partly to take the form of periodical payments, and
		+	(b) shall consider whether to make that order.
		+
		+	2(8) An order for periodical payments shall be treated as providing for the amount of payments to vary by reference to the retail prices index (within the meaning of section 833(2) of the Income and Corporation Taxes Act 1988) at such times, and in such manner, as may be determined by or in accordance with Civil Procedure Rules.
		+
		+	2(9) But an order for periodical payments may include provision –
		+	(a) disapplying subsection (8), or
		+	(b) modifying the effect of subsection (8).
		+
		+	The course of events that led to the predictable questioning of the interpretation of the wording began in May 2002 when a 50 year old Mr Tarlochan Singh Flora fell 35 feet from a ramp at work at Wakom (Heathrow) Limited. It was deemed that Flora’s loss of earnings were £12,000 per annum and care costs would be between £18,000 and £27,000 per annum. In July 2006 the Court of Appeal heard a number of arguments from the claimant and defendant on the interpretation of the clauses. The claimant’s position was that the historic Average Earnings Index (AEI) and RPI differential had demonstrated that the cost of care and loss of earnings would not be well matched by RPI. The defendant maintained that 2(9) should be used only in exceptional circumstances. The Court of Appeal held that the wording did not imply that section 2(9) can only be used in exceptional circumstances.
		+
		+
		+	== Thompstone v Tameside ==
		+
		+
		+	One of the most influential rulings that deals with using indices other than RPI was in respect of four linked cases in January 2008:
		+
		+	• Thompstone v Tameside & Glossop Acute Services NHS Trust;
		+	• Corbett v South Yorkshire Strategic Health Authority;
		+	• RH v United Bristol Healthcare NHS Trust;
		+	• De Haas v South West London Strategic Health Authority
		+
		+	All four cases involved young people who had suffered birth asphyxia injuries which had left them with catastrophic brain damage. In each case the defendant had admitted liability but there were issues outstanding regarding the agreed damages:
		+
		+	• whether a lump sum or periodical payments should apply
		+	• if periodical payments should apply then whether the court had the power to apply an index other than RPI
		+	• if the court had power to apply a different index, could it only do so in exceptional circumstances
		+	• if another index can be used, which one
		+
		+	Flora v Wakom was the case of reference for the judge in all four cases. In this case it was decided that an index other than RPI could be used whenever it was deemed appropriate and fair to do so. In each of the four cases the judges made periodical payment orders and used ASHE 6115 as the index, which is based on the occupational group of care assistants and home carers.
		+
		+	As ever, the defendants argued against this citing:
		+	• the judgment made in Flora had been decided without reference to a statutory provision or earlier judgment which would have been relevant and therefore was not binding
		+	• in the Damages Act 1996, s.2(8) specifies the RPI and s.2(9) refers to “modifying” the “index”. Therefore the argument is that the index must be RPI and the modification can only be to increase or decrease it
		+	• an index other than RPI should only be used in exceptional circumstances due to the principle of distributive justice
		+	• the claimant must show that another index is appropriate
		+	• using ASHE 6115 would lead to a different compensation to a lump sum settlement and therefore contravened the principle of how compensation of future losses should be assessed as set out in Cookson v Knowles 1979 AC 556.
		+	• ASHE 6115 is unsuitable to use as an index
		+
		+	These appeals were dismissed and ASHE 6115 was granted. The ruling allowed judges to vary indices at their discretion to inflation-proof compensation and ensure compensation is fair and appropriate for the claimant.
		+
		+
		+	== Using other indices ==
		+
		+
		+	In one of the most recent periodical payment orders the Hospital and Community Health Services Index (HCHS) has been applied. This is a significant step forwards in using an index that most appropriately meets the claimant’s needs. Not surprisingly, the judge commented in this case that periodical payment issues are “uniquely complex and difficult”.
		+
		+
		+	== Considerations: interim payments ==
		+
		+
		+	The period until the final compensation is determined can be long and the claimant will often need interim payments. We will now see that even here there are many issues to consider.
		+
		+
		+	== Cobham Hire Services Limited v Benjamin Eeles, March 2009 ==
		+
		+
		+	Benjamin Eeles, was born in November 1997 and suffered a serious head injury in a car accident in 1998 when he was only 9 months old. He has made a good physical recovery but will never be able to lead a fully independent life, requiring supervision, therapies and some care. He is very unlikely to be be able to work for a living. Ben’s legal team believed that it would not have been possible to quantify his claim until about 2010. In the mean time, Ben received interim payments amounting to £450,000.
		+
		+	The existing family home would not provide sufficient room for the family and for Ben's increasing needs. Suitable housing was difficult to find in the village of Brightlingsea in which they live but, in 2008, Brightlingsea Hall came onto the market. It had formerly been an hotel with 9 bedrooms and a separate bungalow in the grounds. They felt that they must move quickly. The asking price was £840,000 and the estimated cost of refurbishment was £200,000. With the costs of purchase, the parents estimated that they needed £1.2m and applied for an interim payment of that sum.
		+
		+	It was likely that the final compensation would consist of both a lump sum and periodical payments. The lump sum that would be awarded at trial was estimated at £1.1m, less than the £1.2m claimed as an interim payment. The defendant argued that this would reduce the judge's freedom to allocate the future losses as he thought fit i.e. the effect would be to reduce the amount of the periodical payment order. The judge decided that although the reduction in available capital may well reduce the amount of periodical payment, the lump sum would be invested in an asset that would provide a source of income in later years.
		+
		+	The defendant appealed this, arguing that the trial judge may wish to make a periodical payment order for some heads of damage and the likely lump sum would not be large enough to sustain the awarded interim payments and that the current housing was adequate. The result was that the interim payment was refused on appeal.
		+
		+
		+	== Considerations: contributory negligence, ASHE range, lump sum v PPO ==
		+
		+
		+	Where the injured party in some way contributed to their injury, the compensation can be reduced by the proportion they are deemed to have contributed. This means that the award may not meet the intended purpose if the injured party cannot meet the deficit.
		+
		+
		+	== Sarwar v Ali, 2007 ==
		+
		+
		+	This well known case is interesting in that it dealt with many of the issues that arise concerning awarding periodical payments.
		+
		+	Mr Sarwar was seriously rendered tetraplegic as a passenger in a car accident. Mr Sarwar hadn’t been wearing his seatbelt at the time of the accident and was therefore suffered a 15% reduction in compensation due to contributory negligence.
		+
		+	Mr Sarwar initially wanted a settlement in the form of a periodical payment but later changed his mind and requested a lump sum settlement, although the judge awarded a periodical payment order. Mr Sarwar was expected to have gone on to earn higher than average earning had it not been for the accident. Therefore his compensation for loss of earnings was linked to the ASHE aggregate for male full-time employees at the 90th percentile. This is an example of where the range of the ASHE is considered rather than just the median.
		+
		+	For care costs, the judge realised that RPI would most likely be too low to keep up with wage inflation. However, he also noted that AEI would most likely be too generous as it has historically increased at a rate greater than carer’s wages and awarded ASHE 6115 (90).