Economic Costs of the 'Compensation Culture'

By: J.A.J Aaronson - Updated: 8 Sep 2012 | *Discuss

 

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The press abounds in recent years with sensationalist statements regarding the 'compensation culture' that is apparently sweeping the nation. However, the true economic costs of this supposedly new taste for compensation claims are difficult to state with real accuracy; they are determined by a number of unique factors and the total cost is impossible to estimate, as reliable figures for payouts are not always available. Drawing on some of the more reliable evidence available, however, it is possible to make judgements that should give some sense of the magnitude of these costs.

It is interesting to note that comparatively little research has been done by the government into the true costs of compensation claims. While a number of committees have been established with the purpose of ascertaining whether or not the compensation culture really exists, their terms of reference have tended to concentrate on the psychological effect that this culture is apparently having on businesses; the House of Commons Constitutional Affairs Committee Report on Compensation Culture in 2005-06, for example, focused on the ways in which increased volumes of claims may be encouraging "unnecessary risk aversion in public companies". This report, however, did not look at how much compensation is actually costing the economy.

Actuaries' Working Party

For information on the tangible cost of compensation culture, it is helpful to look not to a government publication, but to the report 'The Cost of Compensation Culture', penned by a working party of the Institute of Actuaries. Indeed, the fact that the Institute of Actuaries is one of the organisations most concerned about the 'compensation culture' is indicative of where the true costs lie, as is explained below.

The working party divided compensation payouts into eight separate groups: insurance; NHS; LEAs (Local Educational Authorities); Police/Ministry of Defence; the Criminal Injuries Compensation Authority; the Ministry of Agriculture; and the Department for Trade and Industry. In 2001 (the most recent reliable figures available), the cumulative total cost of compensation claims is estimated at £10.1bn. This is equivalent to slightly over 1% of GDP.

Insurance

The largest of the categories, by a considerable margin, is insurance. Insurance claims are responsible for £7,100m annually, while the next largest category (the NHS) accounts for only £900m. Of this, it is estimated that around 50% is paid out for personal injury claims. As was mentioned above, the insurance industry has a vested interest in compensation claims by definition. In the first instance, it is of course in their interests to see as low a claim rate as possible in order to keep their profits up. However, there are more intricate reasons why the compensation regime can be damaging to insurance companies, particularly with regard to 'no win no fee' arrangements. Under these arrangements, the claimant's lawyers are allowed to take on cases on the basis that they will receive payment only if the claim is successful.

In order to cover against potential losses if they were to lose the case, they are permitted to take out 'After the Event' (ATE) insurance, which will be paid by an insurance company if the case fails. The increasing number of compensation claims has obviously led also to an increased number of failed claims, meaning more insurance payouts. Furthermore, schemes such as the Motor Insurers' Bureau (covered in more detail elsewhere on this site), which are underwritten by the insurance industry, have meant that the economic costs of the compensation culture are twofold; in the first instance they affect businesses and public organizations on an individual level to the tune of £3bn or more per year. Furthermore, the costs of successful claims covered by insurance, as well as failed claims made under no win no fee arrangements, have meant that the cost of compensation is being passed onto the consumer through higher premiums.

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