Following the Ministry of Justice’s proposals in September to change the way the discount rate is calculated for lump sum compensation payments to people with serious injuries, Investec Wealth & Investment has warned that accident victims receiving smaller pay-outs will have to accept a higher level of investment risk to avoid running out of money.
Investec believes that the decision to review the way that the Ogden rate is calculated means investment portfolios will be under greater pressure to deliver higher returns to overcome rising inflation and low interest rates.
Many of the recipients of these awards are children whose parents or carers must decide how to invest on their behalf following large compensation awards for catastrophic injuries received through clinical negligence or road traffic accidents.
Investec calculates that these children may only be 10 years old when the firm begins investing their lifetime compensation.
Given that most victims experience no significant reduction in their life expectancy, compensation awards need to last well over 50 years, which often includes the purchase of a specially adapted home as well as specialist equipment.
In addition, the firm warns that many lifetime award investment portfolios are reviewed too infrequently and are not adjusted in line with changes in inflation, interest rates, currency movements and market volatility.
For example, over the last 50 years, inflation peaked at 24.2% in 1975 and fallen to a low of 1.2% in 20012, averaging at 5.8% per year.
Over the same period, interest rates have fluctuated between 17% in 1980 and their current rate of 0.25%. Without a hands-on management approach, such long-term economic volatility can substantially reduce investment returns.
Richard Fullman, head of the personal injury and Court of Protection team at Investec Wealth & Investment, said: “It’s understandable that serious accident victims who rely on lump sum compensation payments to fund the rest of their lives are reluctant to take large investment risks with the aim of growing their portfolio faster.
“But low interest rates and rising inflation mean that even a lower risk portfolio needs to produce an annual return of at least 4% and that means investing a portion of their money in higher rewarding but more volatile assets such as equities.
“Too many compensation portfolios are retained in notionally risk-free assets such as cash, but the returns are so small that they are effectively losing money and their lump sum won’t last the distance. In many cases, it’s already too late as the lump sum has become too small and the returns needed to get back on track are too high and require too much risk-taking. That can lead to parents and carers facing difficult decisions around cutting the costs of medical care and support.
“If the compensation runs out, the state will end up responsible for the cost of their bill for their end of life or top up care.”