Taxation can be good for insurers

An unusual heading to grab the attention? We take a brief deep dive into past loss of earnings workings and show how the common methodology misses a trick.

Traditionally loss of earnings are calculated by collating payslips for the last thirteen weeks of employment before an accident, calculating the average net pay, assuming that the average net pay would have continued but for that accident and then deducting any net pay received in the absence. 

Strictly this may overstate the loss and an alternative calculation, which takes into account liability for income tax for the relevant tax year the loss falls in, can prove to be a more accurate demonstration of the loss actually sustained.

This calculation looks at the net amount which the claimant would have earned, but for the accident, in each tax year concerned.

The missing piece of the jigsaw?

By only taking into account average pre-accident net figures to calculate loss of earnings, this can inflate the net loss figure as it does not reflect the reduction in tax deductions after a return to work. If this is not taken into account then the claimant is overcompensated.

Example:

• Claimant employed as a teacher earning £35,000 per annum gross.
• Injured in an incident on 8 September 2017 and off work for 11 weeks.
• Returned to work on 25 November 2017.
• Payslip Summary

 The traditional loss of earnings calculation sees loss of earnings at £4,374.64

• Average net monthly pay £2,256.64
• Projected net pay for Sept-Nov 2017 £6,769.92
• Less actual net pay for Sept-Nov 2017               £2,395.08
• Loss of net pay               £4,374.84

 However, a loss of earnings calculation based on the tax liability for the year would equal £4,033.64 (£341.20 less than the traditional calculation)

• Average net monthly pay £2,256.64
• Projected net pay for tax year 2017/18               £27,079.68  (£2,256.64 x12)  
• Less actual net pay for tax year 2017/18 £23,046.04
• Loss of net pay               £4,033.64

 Whilst the sums involved are modest on this example, in longer periods of loss or higher earnings the sums could be material and in any event “every little helps!”

A couple of practical considerations:

1. Where the absence spans two tax years it will be necessary to do a projected calculation for the next tax year that assumes no further absence.
2. Watch out for pay reviews that kick in after the return which may serve to negate the saving.
3. Tax liability on return to work will always be less for the tax years affected.

 For more information, please contact Kayla Rees, Solicitor.