“setting the discount rate is more than a technical decision: it involves balancing the interests of the claimants with the defendants and also balancing the social costs”

Today the Justice Select Committee published its analysis of the draft discount rate legislation. We set out our initial thinking on the report below.

The Committee had been asked to report on this by the end of November, following the Government publishing the legislation in early September.

What happens next is not totally clear. The Government has already indicated that it will respond to the report within two months. On that basis, its plan should be clear by the end of January.

We fully expect the Government to press on with the proposed legislation but to take some note of the Committee’s recommendations about research and clarity on the necessary balance to be struck here between claimants, defendants & indemnifiers and society generally. But it seems to us that a good deal of those issues have been already addressed, for the most part, in the materials published by the Ministry following its consultation.

The tone of the Committee’s report today may be cautious, but from remarks by Ministers in the consultation material and in evidence to the Committee, the Government clearly intends to proceed as promptly as it can. If it is able to respond to this report as planned and to hold to its sense of urgency then we would expect the proposed legislation to be introduced in the New Year and before the Easter recess.

This is a hugely controversial area and it is realistic to expect the Bill to be subject to robust, and perhaps hostile, scrutiny in Parliament. It could still even be the subject of yet another judicial review; which would bring a very real risk of delay if it were to happen.

We shall provide further information as this issue develops.

First thoughts on Justice Select Committee report: “Pre-legislative scrutiny: draft personal injury discount rate clause”

The Committee’s central recommendation is that the Government should be explicit about why it wants to change (a) the current assumptions about how damages for future losses will be invested and (b) the balance in this area of the law between different elements of society (i.e. claimants, defendants and taxpayers). You might well have thought that the Government was clear enough about these points when publishing its post-consultation policy paper along with the new legislation in September:

“The key legal principle will be that the rate should be the rate that, in the reasonable opinion of the Lord Chancellor, a properly advised recipient of a lump sum of damages for future financial loss could be expected to achieve if he or she invested the lump sum in a diversified low risk portfolio with the aim of securing that (a) the lump sum and the income from it would meet the losses and costs for which they are awarded when are expected to fall; and (b) the relevant damages would be exhausted at the end of the period for which they are awarded. In this exercise the Lord Chancellor must consider the investments available and actual investments made by claimants; and must make such allowances for taxation, inflation and investment management costs as the Lord Chancellor thinks appropriate.”

As might have been expected, the Select Committee hones in on the claimant investment risk assumptions which have to be made in order to set a discount rate for use in personal injury cases. It notes that the proposal to set a rate on the basis that claimants invest in low-risk diversified portfolios and the use of actual investment behaviour and yields to determine the discount rate “marks a departure from existing case law, which sets the discount rate according to the return on Index Linked Government Securities (ILGS) which is considered to be a ‘risk-free’ or ‘very low risk’ investment.” This is precisely the point: the recent Government consultation responses showed that the current link between the ILGS yield and the discount rate had serious flaws:

“A large proportion of respondents indicated that they thought the current law was defective in some way. Around half of those who responded to the consultation believed that the methodology for setting the rate was wrong … The main arguments of the majority who said they believed that the methodology for setting the rate was flawed included that the current approach does not reflect how claimants actually invest; that Index Linked Government Stock (ILGS) are not used in practice, and that calculating the rate be reference to them has resulted in over-compensation; that market changes since the Wells v Wells case in 1998 make that judgment and its principles out of date; and that the effect on consumers and taxpayers needs to be considered.”

Perhaps unsurprisingly, the MPs point out that there is no consensus on what “low risk” investment actually means in this area. The ILGS rate has long been regarded (by compensators) as not fit for purpose and leading to over-compensation (a conclusion supported in material released by the Government Actuary’s Department). The Select Committee recommends that Government finds a way to assess whether the legislative framework - presumably the current one in the Damages Act 1996, rather than the proposed Bill? - is compensating claimants fairly, calling for “clear and unambiguous evidence is gathered about the way claimants invest their lump sum damages before legislation changes the basis on which the discount rate is calculated.”

Although this which would seem to be a sound and evidence-based way forward, the Committee seems to go back somewhat on its recommendation, advising “caution in considering evidence of claimants’ investment behaviour to set the discount rate” and suggesting that “investment by claimants in higher risk portfolios could indicate they are under-compensated and forced into higher-risk investments to generate sufficient return for their future living expenses.” The MPs also state that “It may seem intuitive that the discount rate should reflect actual investment behaviour. But we conclude that this proposition should not be adopted without some further critical examination.”

On periodical payment orders, it is both evident and regrettable from the following passage in the report that the Committee seems to have completely misunderstood the very clear separation of the discount rate used to calculate for a lump sum award from the assumed index required by an insurer when reserving for a PPO:

“It is perhaps telling that insurers must be ‘cautious’ and reserve for PPOs at a significant negative discount rate. Claimants must also be cautious, though for different reasons. We acknowledge that insurers are given no choice, but if a rate based on zero-risk investment is mandated for them, it strengthens the case for that being viewed as an appropriate investment strategy for claimants.”

Specifically on the draft legislation, the MPs make several recommendations which are largely aimed requiring the Lord Chancellor to give reasons and provide evidence for decisions he or she may make when setting a discount rate (or rates). These include being explicit about the measure of inflation used (be it RPI or CPI) and timing any changes so as to minimise disruption to insurers and NHS years end accounts. The MPs also call for the proposed expert panel to be involved in the first review of the rate.

The Committee also concludes that the same expert panel “should consider whether the law should be changed to identify a distinct and separate head of damage based on professional advice.” This appears to be misplaced. First, because the experts to be involved here are drawn from the investment field and would probably have little insight into whether tort law should be changed in such a way. Second, is that the Government has already decided to deal with “investment management costs” in the legislation by requiring the Lord Chancellor to incorporate an explicit allowance for it into the discount rate he or she sets. This is far from an unreasonable way of dealing with the matter (although further clarity would have been welcome on any distinction between fund management charges and the cost of investment advice). It also it seems to be a much more efficient and effective approach than that proposed by the Committee, which would surely lead to satellite disputes about this proposed head of loss in each and every claim, and to the inevitable “armies of experts” which the Court warned against over a decade ago in in Flora v Wakom.