Surprise: minus 0.25% discount rate

The first discount rate set under the new scheme mandated by s10 of the Civil Liability Act 2018 has been set at -0.25% with effect from Monday 5th August 2019.

Although higher than the -0.75% rate set in 2017, the new rate has been greeted with a degree of surprise on both sides, relief by claimants and dismay by defendants and insurers. It was widely expected that the new rate would be between 0.5% and 1%: another negative rate came as a surprise to most experienced personal injury litigators.

How the new discount rate system works

After 2017’s shock drop to -0.75%, parliament and the Lord Chancellor determined an amended, and more structured, process by which the rate should be set. Although the objective remains the same – no less, but also no more, than 100% compensation for the injured Claimant – the Lord Chancellor now has particular assumptions imposed by the legislation when finding that rate:

  • The Claimant is properly advised on the investment of their lump sum;
  • The Claimant will use a diverse portfolio of investments;
  • The Claimant will accept “more risk than a very low level of risk”, but less than would be accepted by the typical investor with different financial aims;

He must additionally have regard to:

  • Actual returns available to Claimants;
  • Actual investment decisions made by or on Claimants’ behalves; and he must
  • Make appropriate allowances for taxation, inflation and investment management costs.

These assumptions were a modest but significant departure from the rationale that Claimants should only have to accept the very lowest level of risk available on the investment market, measured by a three year rolling average of Index Linked Government Stock (ILGS).

This rationale, set out in Wells v Wells [1999] AC 345 and followed in discount rate decisions since then, was what caused the -0.75% rate in 2017. Although the former 2.5% rate was sound when set in 2001, the global financial crisis of the late 2000s meant ILGS returns had been outstripped by inflation for nearly a decade before the rate was revised.

The new system for setting the discount rate was set after universal outcry from the insurance sector, and was designed to meet the objection that the -0.75% rate would overcompensate Claimants.

How did the Lord Chancellor arrive at this rate?

All this begs the question: why are Claimants smiling, and insurers frowning, now that the new system has been implemented?

The Lord Chancellor’s full reasons were published late in the morning of 15 July 2019, and are revealing. He sets out a stepped approach, based on the assessment of the Government Actuary:

  • First, he takes a representative portfolio, using the new assumptions: this results in a median rate of return of 2% over CPI inflation.
  • This is then reduced to take account of tax and expenses (chiefly, the cost of fund management). The Government Actuary’s analysis suggests 0.75% for these costs, reducing the rate of return to 1.25%.
  • Then inflation is factored in. Again based on the Government Actuary’s advice, this is taken to be 1% on average, reducing the rate of return to 0.25%.

But this is a positive figure: why, then, is the new rate minus 0.25%?

The “margin of prudence”

The answer to that question is in the next part of the Lord Chancellor’s reasoning. He concludes that a rate of +0.25% “would result in an even (50:50) risk of claimants being under or over-compensated”, which follows from the preceding analysis. However, he then says that this is “a starting point, rather than an end point”, and that “I consider that a rate of plus 0.25% would run too high a risk of under-compensating claimants”: at this rate a claimant has only a 50% chance of being fully compensated, and a 65% chance of receiving at least 90% of their compensation.

The Lord Chancellor therefore applies a further alteration to the rate: what a Claimant may consider to be a form of contingency provision, but which Defendants and insurers might equally label putting his finger on the scales. After considering both 0% and -0.25%, he notes that at 0.25%, the median Claimant “has approximately a two-thirds chance of receiving full compensation and a 78% chance of receiving at least 90% compensation”.

Does this mean that Claimants as a group (and the notional “median” Claimant within that group) will be overcompensated? Yes, and this is expressly acknowledged: “such a claimant is approximately twice as likely to be over-compensated as under-compensated and is approximately four times as likely to receive at least 90% compensation as they are to be under-compensated by more than 10%”. The Lord Chancellor considers this a “reasonable additional margin of prudence”.

A “dual rate”?

It is of interest to note that the Lord Chancellor rejected the idea of setting a dual rate (i.e. different discount rates for shorter and longer periods of loss) this time, but found the idea “interesting” and has suggested that he (or his successor) will re-visit that possibility on the next review.

Reactions

Even before the full reasons were published, the insurance industry expressed its disappointment with the new rate: Huw Evans, Director General of the ABI, commented that “This is a bad outcome for insurance customers and taxpayers that will add costs rather than save customers money. A negative rate maintains the fiction that a claimant and their representatives will knowingly choose to invest their damages in a way that would guarantee losing them money”.

Mr Evans’s reaction (given before the full reasons were published) perhaps misses the point about the assumptions on Claimants’ appetite for investment risk, which are hard-wired into the new regime. But he and they are sure to be even more put out by a discount rate which expressly departs from the well-worn principle that Claimants should neither be over- nor under-compensated.

It is early days to be making predictions, but the ABI has not shied away from judicially reviewing a previous Lord Chancellors over the discount rate; although unsuccessful on that occasion, it would be unwise to bet against them trying again, since – on one view – the Lord Chancellor has driven a coach and horses through the full compensation principle.

Practice notes

Leaving the (now) familiar discount rate soap opera aside: what practical points arise for personal injury lawyers?

  • Part 36 offers all need to be revisited. Many recent Claimant offers will now seem unduly pessimistic, based as they were on an assumption that the rate would become positive again. Equally, Defendants may now be keener to snap up these offers where they remain open for acceptance.
  • There is likely to be at least a degree of stability in the system now, as the next review does not need to be started until 2024, five years from now. The strange world of the last two years, where the rate was -0.75%, but parties settled cases based on figures anywhere between 0% and 2%, is unlikely to be replicated or tolerated by judges approving settlements for children and protected parties for at least the greater part of those five years, though some uncertainty is likely to re-appear towards the end.
  • The extent to which the new rate includes allowances for the cost of investment advice will come under close scrutiny, and may spell the end of claims for those costs in substantial cases.
  • The status of accommodation claims remains substantially unaltered: Roberts v Johnstone [1989] QB 878 remains good law, and following decisions such as JR v Sheffield Teaching Hospitals [2017] EWHC 1245 (QB) and Swift v Carpenter [2018] EWHC 2060 (QB), Claimants are likely to remain unable to recover damages for purchasing new accommodation so long as the discount rate stays negative. But the Claimant’s appeal in the Swift case, which seeks a fundamental review of how such claims are approached (possibly unshackling them from the discount rate) is due to be heard by the Court of Appeal later this month.
  • PPOs will continue to be attractive for insurers in many cases of long or uncertain life expectancy, and they may well become slightly more attractive for Claimants again as the lump sum equivalent award will be worth less than before. Parties will no doubt continue work to structure settlements for a mix of PPO and lump sum to make offers and achieve settlement which are attractive and workable to both sides.

 

Steven Snowden QC and David Green