The Civil Liability Bill sets out an effective new framework for how, when and by whom the discount rate will be calculated. The changes improve transparency and accountability in the process, which should lead to a more stable and fairer method for setting the rate in the future.
A real-world approach, based on how claimants actually invest their damages is central to the draft legislation. This is critical to establishing a fairer and more robust framework for setting the rate, in order to ensure the 100% compensation principle is properly adhered to.
The previous framework led to a wholly theoretical rate that failed to reflect the investment practices of claimants and led to chronic over-compensation. Indeed, the UK is currently an international outlier; at minus 0.75% our discount rate is the lowest, and accordingly the most costly, of the world's major economies.
The proposed changes have already begun to benefit consumers, with car insurance premiums falling at their sharpest rate in four years (January to March). An average motor policy is now £13 cheaper than it was a year ago. 26 insurers, representing 86% of the motor and liability markets, have pledged to pass on future savings to consumers following enactment of the Bill.
How should the rate be set?
The Bill confirms that claimants are ‘low risk', not ‘no risk’ investors, judged by reference to their actual investment practices. This is a helpful change, as it will now reflect real world investment behaviours and will more accurately reflect how claimants invest their awards. Research undertaken by the Ipsos Mori Social Research Institute in 2013 demonstrated that injured parties invest in a mixed portfolio of investments, so it has a solid grounding in reality.
The option of a PPO is retained, so if a claimant truly wishes to take no investment risk and be unaffected by the discount rate, PPOs operate to transfer that investment risk to the compensator. The low uptake of PPOs, even when the discount rate was set at 2.5%, arguably demonstrates that most claimants prefer a lump sum award and are therefore prepared to accept some investment risk.
The question of what rate the new methodology will produce is still up in the air. Interestingly the Government advised their previous September 2017 estimate of 0-1% was only intended to be an indication of the potential scale of the change. Unhelpfully the Government now claims it would be inappropriate to speculate further. Despite this, the smart money probably still backs this previous estimate which is operating as the ballpark for current settlements in the market, where trial is not imminent.
Following criticism about the evidence available when considering setting the rate, the Government will issue a further call for evidence on the details of claimant investment behaviour. The necessity of this requirement is questionable, with the Government already having received a range of evidence of claimant investment behaviour, particularly given the potential to further delay the enactment of the Bill. Perhaps a more useful question that should be asked is how claimants should invest their lump sum.
The Lord Chancellor and the appointed expert panel will consider the possibility of different rates for different cases, although it remains to be seen whether this option will be exercised. Both Ontario and Hong Kong adopt dual rates, resulting in two or three rates respectively for a single case. The ABI has stated that the Ontario model would be their preference, or it may be that the expert panel comes up with something entirely new. Allowing different rates for different heads of loss for example would cause logistical difficulties, uncertainty and further complicate the process.
The Bill requires that in any review, the Lord Chancellor and the expert panel will also investigate whether there are ways in which PPO use could be increased. PPOs are not commonly favoured by claimants and therefore only limited increases in demand may be seen. It is possible to question what extent under the current system claimants are receiving appropriate PPO advice, given advisors' potential conflicts of interest. It is therefore prudent that such an investigation is undertaken.
The review may also consider whether investment management costs should be recoverable as a head of damage. The Bill includes provision for fees to be included as a consideration when setting the discount rate, which would be calculated by reference to returns that are net of charges both for management and fees for advice, negating the need for such costs to be recoverable as a head of damage. To allow such a head of damage is contentious; it would necessitate expert reports on both sides, which would only serve to increase costs. It is to be hoped confirmation that these fees will not be included as a head of damage is obtained during the Bill's passage through the Lords.
Who should set the rate?
The Lord Chancellor will set the rate in consultation with an expert panel consisting of the Government Actuary and four other individuals with experience in actuarial work, managing investments, economics, and consumer matters as relating to investments. This is a useful composition for the panel, providing non-partisan experts are utilised.
As proportionately more experts work with claimants than defendants, an appropriate balance will need to be struck in the appointment process and any potential conflicts of interest will need to be addressed. It is also imperative the selected experts must possess experience in the actual management of investments for claimants, rather than just in providing advice on a potential investment strategy.
The quorum for the expert panel is to be increased from previous proposals to four, one of whom must be the Government Actuary. The decision to set the discount rate will continue to rest with the Lord Chancellor, who must provide reasons for the chosen rate. Given the political hot potato the rate has become, this provides an improved level of transparency and accountability previously lacking from the process. However the Chancellor only has to publish information in relation to the expert panel's response that is considered appropriate, which could operate to obscure the process somewhat.
When will the rate be set?
The initial review of the rate must be started within the 90 day period once the Bill becomes law and a decision must be reached within 180 days. The expert panel will also need to be convened for the review, which is likely to take up to three months to recruit. Given the need for speedy enactment, these provisions have the potential to further delay the inception of a new rate after the Bill has been enacted. Consideration should be given to refining and limiting these timeframes.
Each subsequent review must be commenced within three years of the last review. Given large loss cases typically take up to five years to resolve, there is likely to be the possibility that either a claimant or compensator might seek to use a pending review to their advantage in the context of a settlement negotiation. A longer review period of 5 – 7 years may prevent such 'gaming' tactics. However the frequency of review should lead to smaller changes in the discount rate and therefore a lower impact from any rate change.
Whilst the Bill does make great strides in setting out a workable basis on which the new discount rates will be established, the minutiae, including what the new rate will be, will remain up in the air until the Bill becomes law and the first review takes place. It is somewhat disappointing the provisions link with the more controversial whiplash reforms, as this may delay the passage of the Bill in an already uncertain Brexit laden legislative timetable.
For the immediate future, the market is already adapting and adopting a pragmatic approach, with claimants and insurers both agreeing settlements on a rate of between 0-1% in all cases except for those cases where trial is imminent.
Once enacted, insurers will need to remain vigilant in respect of the implementation of the new methodology, to ensure the legislation actually achieves fairness when setting the rate and prevents claimants from continuing to be overcompensated.