The Ministry of Justice has announced its decision to reduce the discount rate from 2.5% to minus 0.75%, effective from 20 March 2017. Ruth Lawrence considers the decision and what it means for the insurance industry.

What is it?

When calculating an award of future loss, courts discount lump sum figures to reflect the assumed rate of return a claimant will receive when they invest the award. The discount rate applied is prescribed by the Damages Act 1996. The level of discount was last reviewed in 2001 when it was set at 2.5%.

In 2001, the rate was set based on a three year average of real yields on index-linked gilts. However, since 2001, yields from these investments have fallen, and claimants have called for the rate to be reviewed to avoid under-compensation. Debate has focused both on the rate itself, and the methodology used to calculate the discount. Defendants have argued that the rate is appropriate as in reality claimants invest their damages in ways that yield higher rates of return.

Consultation about the rate has been ongoing for a number of years. The Government consulted on the discount rate methodology in 2012 and, more generally on the discount rate in 2013, but did not take action to alter the rate following those consultations. In the absence of a response, the Association of Personal Injury Lawyers (APIL) commenced legal action to elicit a decision.

Having now completed the consultation, the Government has confirmed that there should be no change to the methodology for calculating the discount rate, but that the rate will reduce, from 2.5% to minus 0.75%.

What does it mean?

This is a significant change which will result in much higher lump sum damages awards.

Example 1

A 20-year-old man is injured at work and pursues a claim against his employer. His claim includes continued loss of earnings of £25,000 per annum until retirement at age 65. The claimant turns 23 at the time of trial.

On the basis of the 2.5% discount rate, this would equate to a multiplier of 25.59 which would result in a loss of earnings claim of £639,750. However, on the basis of the new minus 0.75% discount rate, the multiplier is 48.01, resulting in a loss of earnings claims of £1,200,375 and an additional payment of £560,625.

Example 2

A 65-year-old man dies from mesothelioma and his widow brings a financial dependency claim for pension loss valued at £10,000 per annum and for services of £750 per annum claimed for 15 years, until the deceased would have reached the age of 75. Medical evidence confirms the deceased would have been prevented from carrying out the claimed services due to his co-morbid conditions.

In first dealing with pension loss, the multiplier would be 15.86 based on the 2.5% discount rate, resulting in a dependency claim of £158,600. However, in applying the minus 0.75% discount rate, our extrapolated multiplier is 23.72 equating to a financial dependency claim of £237,200 – a 33% increase.

Equally, on the basis of the 2.5% discount rate, the dependency on services claim would amount to £9,405 but this increases to £11,917.50 when the minus 0.75% discount rate is applied.

What next?

While the new rate will come into effect for all claims from 20 March 2017, it is possible that it will not remain in place for long. At the same time as announcing the change, Lord Chancellor Elizabeth Truss also confirmed that a consultation will be released before Easter to consider whether there is a better or fairer framework for setting the discount rate.

The consultation will consider whether it is right to assume that claimants will invest only in index linked gilts, whether more frequent reviews of the rate are required, and whether the rate should in future be set by an independent body. Given the significant financial implications of the current change, insurers and other compensators are already preparing their responses to these questions. A group of insurers also met with The Treasury to discuss the position on the day following the announcement. The ABI and the chancellor of the exchequer have released a joint statement underlining commitment to set a fair rate.

In the meantime, compensators need to:

  • review current reserves to ensure that they meet the increased potential liability
  • review open claimant offers to consider whether they can be accepted before the new rate comes in. Defendants will have a limited opportunity to accept any claimant offers currently within the 21 day relevant period, and
  • review part 36 offers made to ensure that they remain protective.

Other potential impacts include:

  • Costs budgets – may need to be reviewed to take account of work needed to recalculate schedules, although there should be minimal work involved in substituting the new figures, so attempts by claimants to secure substantial costs increases as a result should be resisted.
  • Increased premiums – to cover the increased cost of claims. Limits of indemnity may also be insufficient, and policyholders will therefore need to review levels with their brokers and insurers to ensure that there is sufficient provision in place.

What we will be doing

While it is undoubtedly important that seriously injured claimants are compensated fairly, we are concerned about the significant impact that the discount rate reduction will have on our clients. We are committed to taking steps to ensure that the Government consultation forms a meaningful view which considers the reality of how settlement sums are invested and the returns achieved.