The Lord Chancellor has announced the discount rate is to fall from 2.5% to minus 0.75% from 20 March 2017 in England and Wales. This significant reduction will mean insurers will have to pay injured claimants additional damages for future losses.
At present, the changes will only apply to England and Wales, as it is for Scottish Ministers to set the discount rate in Scotland. There is no official word yet from the Scottish Government, but it can perhaps be expected they will bring the approach in Scotland into line fairly quickly. It is also likely that any arguments in court before the anticipated change will make reference to the amended discount rate.
The Ministry of Justice noted the current legal framework makes it clear that claimants must be treated as risk averse investors, reflecting the fact they may be financially dependent on this lump sum, often for long periods or the duration of their life.
The discount rate was last set in 2001 at 2.5%. This was based on a three year average of 'real' yields on Index Linked Gilts. Since 2001 and significant changes in the financial markets, the real yields on Index Linked Gilts has fallen. The Lord Chancellor advised the rate should continue to be based on a three year average of real returns on Index Linked Gilts and accordingly set the rate at minus 0.75%.
The change may cost insurers billions of pounds. According to estimates by accounting firm EY, the move will result in a reserving impact in the region of £3.5bn for outstanding claims.
Peter Walmsley, Head of Large Loss and Catastrophic claims at Clyde & Co stated:
“While we recognise that the people affected by this decision are severely injured and great care must be exercised, the government’s decision will result in gross over-compensation based on the Ministry of Justice’s use of an unrealistic and outdated legal framework. Even in its attempt to create certainty, the government has failed. It’s going to make cases very difficult and will probably delay the compensation process.
It’s important to note that there is no mandatory requirement for an injured party to behave in a risk averse manner. This means they will be compensated on that basis but could make their investment decisions on an entirely different basis.
This decision still leaves us open to future developments. Having taken years to reach this stage, we now face another consultation on methodology and process, the fourth the industry has been through, which seems unbelievable.”
The Government has advised it will review the framework under which rate is set to ensure it remains fit for purpose in the future. A consultation is being launched before Easter that will consider options for reform including:
- Whether the rate should in future be set by an independent body;
- Whether more frequent reviews would improve predictability and certainty for all parties;
- Whether the methodology is appropriate for the future.
Following the consultation, which will consider whether there is a fairer framework for claimants and defendants, the Government will bring forward any necessary legislation at an early stage. The MoJ is to meet with the ABI in respect of the decision and it is to be hoped that they listen to their genuine concerns regarding methodology in order that fairness can be achieved for all parties.