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With Profits Structures (Autumn 2001)

A few years ago now there was a great drive to learn about structured settlements. These were paraded as the great new development in compensation. For a few years they a very useful tool, varying in popularity as annuity rates fluctuated. The basic principle is that the compensation is used to purchase annuity. This is based on Index linked gilts, and so is as close as possible to being risk free. The tax advantages conferred on them over a lump sum investment was often enough to compensate for their lower return.

The problem has been that inflation has continued to fall. As a result so has the return on index linked gilts and hence the income from any new structured settlement. In the last few months there has been a major new development in the field. Windsor Life has brought out a "With Profits Structured Settlement". The idea of this is that it is an annuity based product founded on "a with profits fund" that invests in a basket of investments, rather than being based wholly on government gilts.

The reason that this is of great interest to the P.I. practitioner is that the annuity rates that it projects can be higher than those of a conventional structure. The income is guaranteed not to fall over the life of the claimant and may rise as the fund outperforms its projections. Being based on a mix of assets rather than Index Linked Gilts it is not guarantied to rise with inflation, but historically the return from equity backed investments (which such a product is) has been a better match for earning-related costs over the long term. Additionally inflation has always been a poor basis for predicting future costs as both medical equipment inflation and care costs have historically risen by more than RPI. Any product that gives the opportunity to match these rises should be considered.

Turning to the numbers, Windsor Life have suggested that a 30 year old male claimant, with a rated age of 47 purchasing £200,000 could expected a return (based on a 6% growth rate for the new product and a similar medium inflation rate for the conventional one) of:

Annuity (£ per Annum

Year

RPI-Linked Structure

With Profits Structure

% Difference

1

7,404

9,447

+28%

5

8,173

11,068

+35%

10

9,247

13,491

+46%

15

10,462

16,444

+57%

20

11,836

20,044

+69%

It does not take much to see that the "With Profits" structure gives a better return in this case. This is to be expected. The reason structured settlements, quite rightly in many cases, fell out of favor is that the stock market gives a much better rate of return. So much so that the tax benefits of the structure were not enough to outweigh the shortfall. What the "With Profits" structure does is to give the advantages of a reasonably cautiously managed stock market exposure, but with all the tax benefits of a conventional structured settlement.

The alternative to a structured settlement is an investment portfolio. Such a portfolio is likely to cover a range of investment options, from cash investment through "bundle" type investments such as Unit trusts, trough to direct shareholdings. The different products will be selected to combine a range of risk exposures, liquidity and investment period. As part of such a portfolio it is hard to see a generic argument against a with profits structure. It fills at least one part of that spread, with the tax advantages and most of the certainty of a conventional structure. While it is not totally risk free it is as close as you can get with a reasonable return.

I expect many claimants to be considering these over the coming months, which may bring other players to the market. If we can just break the barrier of Health Authorities insisting on doing all structures themselves and so making providers reluctant to provide quotes, the new dawn will certainly have arrived.

 

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