The Future Value of Money

The future value of money was a question highlighted by a Government decision yesterday. The discount rate to be applied to awards to road accident victims and others, to ensure they always have enough to support their future needs, is to be changed to -0.75% (that’s minus 0.75%). Previously, and for many years, it has been assumed that they could invest a cash lump sum at a rate of plus 2.5%. That was on the assumption that they could invest in risk-free assets and get a return of that amount. But the Government is proposing to revise the rate. This will result in much higher payouts for major road accident injury claims, and for medical negligence claims.

There was a negative impact on the share prices of insurers such as Direct Line (down 7% on the 27th Feb), but others such as Admiral and Esure were little changed. However the Association of British Insurers (ABI) called the ruling a “crazy decision” and also said “To make such a significant change to the rate using a broken formula is reckless in the extreme, and shows an utter disregard for the impact this will have on consumers, businesses and the wider operation of the insurance market”. They forecast sharp rises for all forms of vehicle insurance with suggestions being made that it could be as much as £75 extra per car on average.

In addition because the NHS is one of the most frequent defendants to medical claims, it might add £1 billion to their annual bill for such costs. Something that the NHS surely cannot afford at present.

You may be wondering what is the risk free rate of return that one can actually get at present. The best measure traditionally for this has been assumed to be long-dated index linked gilts. The yield to redemption on those is now about -1.6% (see http://www.fixedincomeinvestor.co.uk for a good source of information on those). That’s taking account of inflation of course. In other words, you would actually definitely lose money by investing in them! That of course drives up the capital that is required to cover future investment losses enormously.

Now we all know that the Government has driven down interest rates to a ridiculously low level and negative gilt yields is one consequence. Together with tougher rules for pension and other funds, to ensure they cover future liabilities, this has led to an excess of demand for index linked gilts over their current availability. Hence the below zero interest rates. But surely no sensible person investing for the long-term would at present put all their assets into such gilts?

Even the most conservative and risk averse investor would surely not do so, and it seems unreasonable to argue that beneficiaries of court awards should be assumed to do so. Indeed they probably don’t and it seems unlikely that any financial advisor would suggest they do so either with current interest rates. Having some certainty of future income is important, but having absolute certainty about future finances for those dependent on a court settlement does not seem fair when nobody else does – pensioners for example, many of whom are also incapacitated and rely on Government care assistance, or even divorcees who benefit from other court awards. Incidentally there are specialist firms that look after funds for such beneficiaries such as listed company Frenkel Topping who presented at one of the ShareSoc seminars and there is a big market for “Personal Injury Trusts”.

The ABI previously launched a legal challenge by a judicial review to the Government’s inadequate consultation and decision process on this issue but it was rejected by the High Court.

Roger Lawson

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