The consultation paper, Damages Act 1996: The Discount Rate. How should it be set?, produced jointly by the Ministry of Justice, the Scottish Government and the Department of Justice, Northern Ireland, was published earlier this month and is open to response until 23 October 2012.

The paper considers the current discount rate that is applied to awards of damages for personal injury to avoid the over compensation of claimants, and proposes options on the appropriate methodology for setting the rate.

Compensation can be made by periodical payments to the claimant; however it is much more common for claimants to receive lump sum awards covering future care and future loss of earnings. It is then open to the claimant to invest and receive a return on this money.

In principle, compensation is intended to restore the claimant, as far as possible, to the position that he or she would have been in had the injury not occurred. In order to avoid the return on such investments resulting, over time, in the claimant being over compensated, the lump sum is reduced by the application of the discount rate. The discount rate is intended to reflect the rate of return expected from the investment of a lump sum award of damages for future loss, taking inflation into account.

The current discount rate of 2.5% was set for England, Wales and Northern Ireland in 2001 and for Scotland in 2002. The rate was set largely by reference to a three year average gross redemption yield of Index Linked Government Stock (ILGS). Yield on ILGS has been in decline in recent years and there are now concerns, prompting this consultation, that the 2.5% discount rate is too high and that claimants are in effect being under compensated.

The consultation invites views on two broad proposals for how the rate should be set:

  • Option 1 continues to use an ILGS based methodology applied to current data on the assumption that claimants will be willing to accept only a low degree of risk and their investments will be correspondingly low yielding;
  • Option 2 considers a move from an ILGS based calculation to one based on a mixed portfolio of appropriate investments applied to current data. This option is intended to reflect a claimant’s freedom to consider other types of low risk investment and choose accordingly.

The consultation paper makes clear that the consequences for the defenders of paying awards are not a matter to be taken into account in setting the discount rate. It will be interesting to see which methodology will be considered appropriate. Of course, even small changes to the discount rate impact significantly on lump sums received by claimants, particularly in higher value awards.

The full consultation document can be accessed here.