Dealing with the damage

A new way of arranging compensation could help injured parties and the people who pay out. By Grania Langdon-Down

Ten-year-old Shahela Begum was left severely disabled and suffering from cerebral palsy after being starved of oxygen during her birth. Her legal advisers valued her claim against the Royal Free Hospital in Hampstead, north London, where she was born, at more than pounds 2m. Camden and Islington Health Authority, which took over the liabilities of the now defunct Hampstead Health Authority, which managed the hospital at the time, offered pounds 500,000. The attempt to overcome such a gap without having to go through a traumatic and costly trial illustrates a new way of structuring settlements.

It is seven years since the first structured settlement in a personal injury case was approved by a High Court judge, although they had been widely used in the US since the 1960s. Instead of the claimant being awarded a lump sum, the judge recommends a sum which uses part of the settlement to ensure he or she receives an annual tax-free income to meet their needs for the remainder of their lives. The money is invested in annuities bought from insurance companies. The amount can also be funded out of the defendant's own budget, for example in cases involving health authorities or other public bodies.

However, the initial enthusiasm for structuring settlements has come under pressure because of the unpredictability of financial markets and fluctuating interest rates. Now a new way of structuring is being used which again takes its lead from developments in American and Canadian personal injury litigation.

Usually settlements are structured from the "top down", with damages assessed as a conventional lump sum and an annuity purchased to provide a regular income for the rest of the claimant's life. The new method looks at an annual payment from the "bottom up". This involves negotiating a lump sum to cover immediate needs and pay any outstanding care bills and then calculating on the amount required to meet the claimant's annual needs.

Last month, Shahela's claim became one of the first bottom-up NHS settlements to be approved by the High Court, on the day the otherwise lengthy and complicated case was due to be heard.

Shahela's solicitor, Paul McNeil, a partner in the medical litigation group at Field Fisher Waterhouse, said one of the problems with cases of cerebral palsy was differences in opinion on a child's life expectancy. This had an enormous impact on the amount of damages recoverable. "On the basis of our medical evidence, Shahela's life expectancy was to 35 or more; the defendant's to 20 years or more. The gap was so large it is almost impossible to negotiate," he said.

The Manchester-based firm of forensic accountants Frenkel Topping, one of the leading experts in structuring, was instructed by Robert Sumerling, representing Camden and Islington Health Authority. Together they proposed a bottom-up settlement that proved the way out of a difficult situation.

For Shahela, it meant a pounds 420,000 lump sum to cover her immediate needs and then a commitment from the health authority to provide her with an inflation-proofed pounds 30,000 a year until she was 19 and pounds 60,000 a year from then on.

Whether the health authority will save money through the settlement as opposed to entering into a top-down arrangement remains to be seen and depends on the length of time Shahela lives. However, the attraction of this type of settlement is in cashflow terms. The authority does not have to pay out a huge sum in damages, while the commitment to annual payments ties up far less immediate capital.

Mr McNeil is awaiting final approval of the settlement from the Treasury and Department of Health, but said: "I definitely see this way of structuring as a progressive step because it is a way of negotiating a settlement which is beneficial to both parties."

Mr Sumerling, a partner in the solicitors Le Brasseur J Tickle, said this type of settlement enabled them to get round differences over Shahela's life expectancy. While the two sides put forward different amounts needed for Shahola's care, avoiding a costly trial enabled the health authority to channel more money into the settlement.

Mr Sumerling said they were waiting for the Treasury and Department of Health to decide whether the annuity would be paid by the authority purchasing it on the life market or funding it from its budget. He said that historically, structured settlements had existed for so much longer in the US because of the tax breaks offered on damages paid in effect by instalment.

It was not until the case of Cathy Kelly, a nurse involved in a car accident that left her husband dead and her in a coma in 1989, that the Inland Revenue put together a limited non-statutory tax break to allow a plaintiff to receive damages in the form of an annuity without having to pay tax. The Finance Act 1995 put the concept on a statutory footing.

Frenkel Topping has been involved in more than 300 structured settlements but only two or three have been structured from the bottom up.

Changes under proposed legislation are likely to increase the amount that defendants must pay in conventional lump sum awards, prompting strong opposition from insurers and other potential defendants. This is likely to increase the appeal of the bottom-up structured settlement because it is a way of giving plaintiffs what they need at a cost acceptable to defendants.

The Damages Bill proposes, for example, giving the Lord Chancellor the power to set the investment rate for lump sum damages. This currently stands at 4.6 per cent. But if it is based on index-linked government guilts with a return of about 3 per cent, the amount defendants will have to pay out on conventional lump sums will be much greater.

The Law Society will be publishing updated guidance on structured settlements running to 500 pages within the next few weeks.

SETTLEMENT OPTIONS

Structured settlements are a bit like the prize in a Reader's Digest competition - do you want pounds 125,000 in a lump sum or pounds 15,000 a year for life, said solicitor David Lawrence.

His first structured settlement was for a man whose wife was left with the mind of a six-year-old after suffering brain damage during preparation for surgery at the birth of their daughter, who died a week later. James and Philippa Mursell were awarded pounds 750,000 damages earlier this year after the High Court at Winchester heard that Mrs Mursell, 44, had been in a nursing home since the "rare and tragic accident" at the Royal Hampshire County Hospital, Winchester, 10 years ago.

Mr Lawrence, a partner in the Hampshire firm of solicitors Eric Robinson and Co, said he had contacted the forensic accountants Frenkel Topping about the claim after hearing one of their staff speak on structured settlements at a seminar. The benefits include preferential tax treatment and certainty of returns. However, structured settlements have a downside, Mr Lawrence said.

"First, as I understand from the legal press, structuring settlements are less popular at the moment because interest rates are lower, so returns are lower. Second, you are still going to have clients who are suspicious of the idea and may prefer to have the money in a lump sum. Third, there is the uncertainty: the preferential tax treatment of these settlements is only as good as the next government, but retrospective tax legislation is rare. Also, when you are investing in annuities bought on the open market, you are investing in private life companies which could go bust and result in some loss. This point is now being addressed in the new Damages Bill.

"Structuring a settlement is a complicated concept and one which continues to develop rapidly. My advice would be to get a forensic accountant to advise on the benefits at an early stage. Structuring is better for the client because there are tax benefits. So you can agree to discount part of the amount to be structured so the insurance company has to pay out less but the client still has more income than if he had accepted a lump sum," he said.

One benefit of an agreed settlement is avoiding a traumatic and costly trial, Mr Lawrence explained. At present, structured settlements must have the consent of all parties and can only be approved by the courts. "If these settlements are shown to be a success, I would not be surprised if courts were eventually given the power to impose them."