Discount rate reduction after 16 years

Lord Chancellor Elizabeth Truss has dramatically reduced the personal injury discount rate from 2.5% to minus 0.75%. The change will become effective on 20 March 2017.

In exercising her powers pursuant to Section 1 of the Damages Act 1996, the Lord Chancellor treated claimants as a risk averse investor and applied the 3 year rate of return of Index Linked Gilts to reach minus 0.75%. The Lord Chancellor has ignored the fact claimants do not only invest in Index Linked Gilts.

The Lord Chancellor accepts the reduction will have “significant implications across the public and private sector” and in particular for the NHS with the government ensuring the NHS Litigation Authority has appropriate funds to cover NHS claims.

The Lord Chancellor will announce a further discount rate consultation to consider options for reform to include whether an independent body should set the rate and whether the methodology of assuming claimants will only invest in Index Linked Gilts is appropriate.

Implications

The discount rate cut will have a massive impact on the injury market – dramatically increasing damages awarded to all claimants receiving future loss awards. Public authorities and insurers now face a profound hit by increased compensation awards in catastrophic personal injury and high value clinical negligence claims.

Looking at our own files, we consider the majority of catastrophic personal injury claims will have a future loss element of 65%, whilst the percentage future loss for clinical negligence claims will be approximately 75%. For a young claimant with a long life expectancy and significant annual care package, the proportion of damages that relate to future loss is likely to be as high as 80%. Those future loss elements of a claimant’s damages will now be affected by a reduction in the discount rate.

The higher the life expectancy of a claimant, the greater the impact of the discount rate reduction on the increase in the claimant’s damages. The discount rate cut to minus 0.75% will increase the majority of future loss awards by approximately 30% if the claimant has a life expectancy of a further 15-30 years. A life expectancy of a further 30-50 years or more will potentially increase the overall future loss award by approximately 50%. The higher the future loss element of an award, the greater the impact on the overall size of a claimant’s damages. The higher the multiplier the greater the difference between the 2.5% multiplier and the minus 0.75% multiplier.

Table A shows the percentage of future loss to an award based on an overall lump sum settlement of £8,000,000. The impact of the discount rate is dependent on the proportion of the future loss element to the total compensation award – applying a range of between 65-85%.

Table A

Download table A (PDF)

A claim involving an injured child with a long life expectancy, which settled at £12 million at a 2.5% discount rate is now likely to cost approximately £17,280,000, an additional £5,280,000 per claim.

Table B shows the increase in multiplier from a discount rate of 2.5% to minus 0.75% and increase in a future loss claim of £200,000 when applying the new multiplier.

Table B

Download table B (PDF) 

The discount rate reduction is dramatic. We may see claimants opting for lump sum awards rather than periodical payments – attracted by the prospect of an increased final settlement as opposed to annual periodical payments to fund their care. This will have acute cash flow implications for public bodies which fund the majority of high value claims by periodical payments.

Similarly, some compensators may seek to circumvent the impact of the discount rate cut by paying more heads of loss by way of periodical payment. We may see loss of earnings, deputyship costs and therapies, in addition to care and case management being funded by periodical payments.

Time will reveal the full impact of this reduction. This will include the effect on the form of awards sought by claimants and whether, in particular, we see a departure to settle by way of periodical payment. The increase in claims costs also poses a number of consequences. Will we see, as has already been predicted by some insurers, loss of any potential benefit from the current measures aimed at reducing whiplash claims? Indeed, might motor insurance premiums now continue to rise? Might this decision prompt questions as to whether the State can afford to comply with the 100% compensation principle? Will we see the introduction of caps on damages awards? Time will tell. For now, while claimant representatives will be welcoming the decision, compensators are faced with varying their claims reserves and navigating any business impact that follows from ongoing pressure from injury claims.

Background

The Lord Chancellor’s decision today follows two Ministry of Justice (MoJ) Consultations relating to the setting of the personal injury discount rate. Its first consultation on the methodology to be used in setting the rate closed on 23 October 2012. The second consultation closed on 7 May 2013 and focused on the legal framework for setting the rate under the Damages Act 1996. The MoJ has not published the outcome of either consultation.

The Lord Chancellor’s decision follows the legal action taken by the Association of Personal Injury Lawyers in December 2016 challenging the delay in providing a conclusion to the review.

Elizabeth Truss has followed the reasoning of the then Lord Chancellor, Lord Irvine, who last set the discount rate 16 years ago in 2001. At that time, Lord Irvine justified a reduction in the rate from 3% to 2.5% based on the three-year rate of return of low risk investments, index linked government stocks (ILGS). He also took into account additional factors, such as the Court of Protection continuing to invest in multi-asset portfolios and the likelihood of claimants investigating in a mixed portfolio. The current Lord Chancellor is following the guidance set by the House of Lords in Wells v Wells [1999], accepting the importance and exclusivity of ILGS.