What percentage of injured people is it acceptable to leave undercompensated when claiming to have a justice system providing 100% compensation?

After 16 years of manifest under compensation using the 2.5% discount rate, it would seem that the minus 0.75% rate, which came into effect in March 2017, will soon be replaced.

Setting the discount rate has prompted voluminous commentary over several years of an extended consultation process. There are many facets to it and I am not going to attempt to cover them all in this short series. What I will be focusing on in this article is what is full compensation and what proportion of seriously injured claimants should we as a society be prepared to accept will be under compensated, while still claiming to maintain a framework of laws that provide for full compensation. In Pt 2 I will discuss the key risks that ought to be considered by the Lord Chancellor when setting the new discount rate.

Underlying principles

The Ministry of Justice’s papers accompanying the draft legislation (echoing a point made in the preceding consultation) said: ‘The discount rate proposals will not affect the underlying principle of the law of damages, which is that claimants should be compensated in full for the losses they have suffered because of the injury caused by the defendant. The objective of applying the discount rate will therefore continue to be to support a 100% compensation award so that claimants receive full compensation for the loss caused by the wrongful injuries neither more nor less.’

There has been noisy rhetoric from the insurance lobby that the Wells v Wells methodology and the minus 0.75% discount rate set by the former Lord Chancellor, Liz Truss, would result in ‘over-compensation’. That could only ever conceptually be true if the law concerned itself with how claimants spend and invest damages after they receive them. Time and again the courts have refused such an approach, for good reason. It involves unwarranted intrusion into the lives of the claimants long after their litigation has finished. If you go down this route it becomes inherent that every seriously injured claimant will either be ‘over-compensated’ or ‘under-compensated’, because:

  • virtually all claimants will live either longer or shorter than the life expectancy prediction
  • numerous assumptions about their future needs, what they will cost and when expenditure will occur, will prove to be either an over or under-estimate
  • their investment may perform better or worse than projected, often simply through the timing of when those investments are made and when sums are withdrawn in the cycle of the financial markets
  • inflation over their period of loss will differ from that projected

If the law is to change to force seriously injured claimants to take investment risk, the debate needs to look at the flip-side of alleged overcompensation: what proportion of claimants do we consider it fair to potentially go ‘undercompensated’. This fundamental question does not get a mention in the Ministry of Justice’s paper.

Some insight into this can be found in the paper by the Government Actuary Department (GAD), which accompanies the draft legislation (Personal Injury Discount Rate Analysis, 19 July 2017). The GAD acknowledges at 3.4 of its paper that as it exclusively focuses on investment risk its analysis ignores the other significant risks faced by the claimant (eg mortality risk, inflation risk and the risk that funds are required in a different manner than was expected when the award was granted).

The GAD also emphasise that its analysis has not yet factored in the necessary reduction of about 0.5% for tax and investment management charges. Once this adjustment is made to the GAD’s graphs showing the distribution of over/under-compensation at figure 1 (page 3) the following observations can be made:

  • if the Lord Chancellor were to set the rate at 0% then about 26% of claimants would be under-compensated
  • at a discount rate of 0.5%, the rate of those under-compensated would be about 41%

Unfortunately, the GAD analysis, at the Ministry of Justice’s request, only provides for predictions of a gross return of RPI plus 1%. So, we cannot see what the rate of undercompensation would be for a net RPI plus 1% after the 0.5% adjustment. However, I suspect that that would be over 50%.

Similar modelling and evidence relating to low risk portfolios were carefully considered by the Supreme Court in Bermuda in Thomson [2015] SC (Bda) 44 Civ, in which the defendants had advanced evidence from a Canadian actuary, Peter Gorham.

At paragraph 93 of the Supreme Court’s judgment, it was observed that Mr Gorham: ‘… conceded under cross-examination by Mr Harshaw that on his investment model between 50 and 33% of plaintiffs would not have sufficient funds. He viewed his approach as fair to both claimants and defendants’.

In Chief Justice Kawaley’s opinion: ‘…[Mr. Gorham’s] approach [was] a stunning dilution of the prevailing legal policy preference, in the future loss discount rate calculation context, for a hypothetical investment in an instrument likely to generate a risk-free rate of return.’

The Bermuda Court of Appeal agreed, and Bell JA endorsed the critique of this approach by the claimant’s actuary: ‘… if one were to test a model proposed in place of the Wells mechanism (as advocated by Mr Gorham), then there would have to be a demonstration that the payments were sufficient for the claimants in at least 90 to 95% of cases in order to come close to providing full compensation.’

It is crucial that the draft legislation is amended to require the Lord Chancellor to actively consider the proportion of claimants who would be undercompensated by the rate he sets and give reasons for all aspects of his decision-making.

It would make a mockery of our claim to have a civil justice system providing full compensation, if one of the key principles by which damages are assessed, the discount rate, were set on a premise that inherently resulted in a significant percentage of those claimants going undercompensated.

This article first appeared in the New Law Journal, the original can be found here (subscription required).