The Government’s response to the APIL challenge to their failure to review the discount rate is due in January 2017. It is unlikely the rate will go up, or even stay the same. If it goes down damages for future loss will increase, possibly substantially. Is there anything you should be doing about this now?
What is the discount rate and why do we have it?
Compensation in personal injury claims is intended to put the claimant back in the position that he or she would have been, had injury not been sustained. A claimant should not be under or over compensated.
In most larger cases a claimant will receive a lump sum which will include amounts to cover future losses such as earnings, treatment and care. It would be usual for a claimant to invest the sum and receive a return on it. The discount rate reflects the expected rate of return or the investment of the lump sum.
How is the discount rate set?
Claimants are placed into a special category of investors who need to be able to access their funds when required. They are assumed to only accept a low risk on investments, receiving a low rate of return. Whilst the claimant remains free to invest their money as they wish, the discount rate is set to reflect this low level of return.
The discount rate is set by the Lord Chancellor in accordance with section 1 of the Damages Act 1996. The current discount rate is set at 2.5% and has not changed since 2001. The rate was set in keeping with the three year average of the gross redemption yields of Index-Linked Government Gilts (ILGS) at the time.
Why is the discount rate being reviewed now?
The rate has remained unchanged for 15 years. By August 2012, the yield on ILGS had been declining for some time, routinely falling under 1% a long way below the 2.5% set under the Damages Act.
Despite this no review was undertaken by the Lord Chancellor and therefore, the Association of Personal Injury Lawyers (APIL) began proceedings for Judicial Review in July 2014.
Two public consultations have now taken place, and the mandatory consultation with the Treasury and Government Actuary is underway. The results of the review are expected at the end of January 2017.
APIL are putting pressure on the government to set the rate against the fairly risk-free index-linked government investment bonds returns (net of income tax). This would mean a substantial reduction in the discount rate. The government may be reluctant to reduce the rate because it is the largest compensator of injury claims through the NHS, MoD etc.
Although there are arguments that Claimants actually invest their money in a way that generates a greater income than ILGS and that the discount rate should reflect this reality, given the current and historic return on investments, there must be a real risk that the current discount rate will be reduced substantially as a result of this review.
How does a change in the discount rate affect you?
Any reduction in the rate will increase the value of claims for future losses, and therefore, the costs of claims as a whole.
By way of example:
A future care claim for a 35 year old male is calculated at £50,000.00 per year for the rest of his life:
1. At the current rate of 2.5% the damages for care would be £1,407,500.00
2. If the rate were to fall to 1.5% the damages for care would be £1,747,500.00
3. And if the rate were to fall to 1% the damages for care would be £1,967,500.00
A potential increase of £560,000.00 for just one head of loss.
What should you do now?
1. Review any claims which involve future loss elements;
2. If you can, settle any claims that may be adversely effected by a decrease in the discount rate. This applies particularly to claims where there is a prolonged period of future loss; and
3. For those which cannot be settled, consider increasing reserves to account for a potential decrease in the discount rate and a consequent overall increase in value.