The unknown cost

' Periodical payments are continuing to trouble the insurance industry. And with the news that reinsurers are looking to wash their hands of the burden

(News, 20 January), primary insurers are looking for ways to manage them.

Few people doubt the value of periodical payments. The idea of offering injured parties the certainty of a fixed income over a set period seems to carry the weight of natural justice. The traditional alternative of a lump sum settlement can unbalance people's lives leading to disputes and, ultimately, further hardship.

But periodical payments will have an adverse effect on insurers. How will they reserve for a payment order that could stretch from five to 50 years? What effect will investment returns or inflation have over the same period? If the claim is reviewable after a certain length of time, how will that alter the balance sheet?

And perhaps most fundamental of all, how often will these orders be handed out?

Joe Monk, a partner at actuary Lane, Clark & Peacock says: "The level of expertise in general insurance companies for handling this kind of thing is nil and even in life companies there is not the right level of expertise.

"Mortality is an area that most general insurers will not have had to deal with.

"The other problem is that insurers will have this sitting on their balance sheet for the length of the claim, potentially in excess of 50 years."

He adds: "It is a strange situation to be in. General insurers will have to provide pensions that are longer and more complicated than traditional products without knowing how many of them they will have to provide."

Pension fund
One solution for larger composites such as AXA and Norwich Union is to source impaired annuities (pensions for injured parties) through their life arms.

Insurers without this option are either looking to the market to source annuities, or more likely, will self-administer the payments.

Groupama is one insurer to have taken the decision to self-administer. Claims director Graham Gibson said: " We know exactly what we will do with periodical payments.

"The products on the market are expensive and may not satisfy the courts. We are going to bring it in-house. If you make sure that your reserves and capital requirements are spot on it mitigates the risk."

But it may not be a case of just mitigating risk, many insurers are seeing periodical payments as a potential money spinner.

Monk says reinsurers are looking to insert clauses that will allow them to meet their liability for periodical payments by agreeing a 100% value of the claim. This means they can buy their way out of the liability by paying a lump sum.

"This could potentially be quite lucrative for the insurer if a good investment policy is put in place," says Monk

The upside for insurers is two-fold, he says. By allowing reinsurers to buy their way out of any long-term liability insurers can demand extra value in terms of the settlement and, as ever with mortality risk, the early death of the claimant will lead to a windfall for the liability carrier as payments will cease.

High value cases
The Department for Constitutional Affairs report into periodical payments, expected in the next few weeks, should make it more apparent how often the courts will award the schemes.

If, as expected, periodical payments are to be used sparingly for high value cases, then insurers may have to look again at how they administer the payments. Carrying one or two such liabilities on your book does not allow for a spread of risk or offer predictability, but carrying 1,000 liabilities would.

Some people in the market have raised the idea of establishing a mutual fund to pool the risks. Indeed preliminary discussions have taken place between some of the mid-tier insurers, though it is not thought to have gone further.

Monk says: "By pooling the risk insurers will be better placed to manage the liability. Ultimately, what the insurance market wants is predictability." IT