Impact of Lord Chancellor’s dramatic discount rate reduction
The Lord Chancellor’s announcement on 27 February 2017 to reduce the discount rate from 2.5% to minus 0.75% surprised those representing both claimants and defendants.
Whilst all parties anticipated it would fall, it was not expected to be a reduction of this magnitude. The intervening period, since the announcement, has seen a flurry of activity with claimants seeking to withdraw Part 36 Offers and defendants accepting them out of time.
The Lord Chancellor, when making her announcement on 27 February 2017, indicated that she would be publishing a further consultation on the discount rate, and in particular, will review the framework under which the rate is set and whether it remains fit for purpose for the future. The significant discount rate reduction may yet be short-lived, with an increase following that consultation. Few anticipate the discount rate remaining at minus 0.75%.
To coincide with the new rate becoming effective on 20 March 2017, we explore the following practical issues now facing those dealing with CAT claims:
- Impact on CAT claim damages reserves
- How do we deal with Robert v Johnstone?
- Will claimants still opt for periodical payment orders?
- Withdrawal and acceptance of Part 36 Offers
- Can defendants use s1(2) Damages Act 1996 to disapply the discount rate in “exceptional” cases?
Impact on CAT reserves
The change in the discount rate from 2.5% to –0.75% has had a dramatic impact on reserves for nearly all claims where there is a future loss element. However, this change is seen most dramatically in catastrophic injury claims. This is clearly demonstrated by an analysis of the percentage increase in Ogden Table 1 multipliers:
However, these percentage increases do not provide an accurate indication of the increase in the value of the overall claim. In trying to get a sense of the increase of a claim’s total value, after applying the new discount rate, a number of variable factors need to be taken into account.
Variable factors include:
- Is the claimant male or female?
- The claimant’s age. The younger the claimant, the more dramatic the impact of the rate change is likely to be. A large sample of our cases across all lines of business has indicated that the average age of a claimant where the claim is £1 million plus is 30 – 40.
- Life expectancy of claimant.
- The period from the date of accident to the date of calculation as this increases the total value of past losses.
- The percentage of future losses to the overall claim. Where a claimant falls within the average age bracket of 30 - 40 our cases indicate that the percentage of future losses to the overall claim is 80 – 90%.
In view of the number of variables there is ‘no rule of thumb’ which can be applied to assess the overall impact to the total value of a claim due to the increase in the discount rate. We will refine our analysis of the impact of the new rate as time progresses. In the meantime, we set out below an early ‘broad-brush’ assessment of the impact of a –0.75% discount rate on a £5 million claim of a claimant with normal life expectancy:
|Age||% increase in value of claim||revised total|
|10 - 20||100 - 200%||£10m - £15m|
|20 - 30||80%||£9m|
|30 - 40||75%||£8.75m|
|40 - 50||70%||£8.25m|
|60 - 70||40 - 50%||£6m - £7.5m|
Roberts v Johnstone
Since 1989, the Roberts v. Johnstone (R v J) formula has provided a pragmatic method of calculating damages for a seriously injured claimant’s increased accommodation requirements without gifting a windfall to the beneficiaries of the estate on death.
The R v J formula involves an assumed rate of return being applied to the additional capital sum required to purchase a larger property and for this figure to be multiplied by the claimant’s life expectancy multiplier.
The assumed rate of return set by the Court of Appeal in R v J  was 2%. Subsequently, the House of Lords in Wells v Wells , approving the R v J approach, increased the rate to match the net return from ILGS, then 3%. In 2001, under power given to the Lord Chancellor in the Damages Act 1996, this was reduced to 2.5% until the current drastic revision to -0.75% by the current Lord Chancellor.
Whereas this new rate massively increases the level of awards for future losses, a negative discount rate will extinguish the R v J element of the accommodation award as whatever the additional capital sum required, the application of a negative discount rate will produce a negative multiplicand to which the lifetime multiplier is to be applied, even if that life time multiplier itself will have increased as a result of the new discount rate.
A claimant will still receive compensation for adaptation/building costs and other incidental items but the compensation for the lost income and investment return under R v J will now be nil.
It would seem that, unwittingly, the Lord Chancellor has dealt the death knell for the R v J formula, something claimant lawyers have long been campaigning for because of perceived unfairness in particular for claimants with short life expectation.
A new approach is inevitable as the negative discount rate makes the R v J formula unworkable and it is unlikely to withstand judicial challenge before the Court of Appeal or Supreme Court absent further intervention by the Lord Chancellor and legislation.
What will take its place is speculative. Over recent years many alternatives have been proposed all with advantages and disadvantages including:
- Full funding of capital purchase subject to charge over the property (one issue will be whether the charge is limited to return of capital or capital plus capital gain).
- Lump sum to cover interest element of mortgage (assuming lenders available).
- Adapting PPOs and indexation to cover interest on mortgage.
- Actual notional rental costs (assuming suitable property and adaptation available).
- Insurers purchasing property and granting life interest to claimants at a peppercorn rent (there has been discussion about this in recent years although nothing more tangible).
What is clear is that innovative thinking is now urgently required by either government, parliament, judiciary, insurers and lawyers or any combination thereof to remedy this unintended consequence of the negative discount rate.
In the meantime negotiating the accommodation head of loss will require pragmatism on both sides which of course was the intention behind the R v J formula in the first place! For the present, R v J remains binding authority and defendants can argue there is no loss as with a negative discount rate, no income is generated on the tied up capital.
Periodical payment orders
Parties to CAT litigation have long been familiar with periodical payment orders (PPOs) as an alternative form of award, which has historically been more popular in the healthcare than general liability market. Defendants can circumvent the impact of the discount reduction by actively promoting use of PPOs and paying future losses annually, index linked to an inflationary index, rather than paying a lump sum award calculated using a minus 0.75% multiplier. Rather than limiting periodical payments to care and case management (index linked to ASHE 6115) as is the general practice, PPOs could be extended and used more regularly to address future loss of earnings (index linked to ASHE Median) and various therapies and non-earnings related future losses (index linked to RPI). The Practice Direction supplementing CPR 41 expressly provides that the court must take into account the defendant's preferred form of award, not just the claimant's. It is therefore feasible that the parties could proceed to a contested hearing regarding the most suitable form of award, with the defendant arguing the advantages of PPOs in the circumstances of the case.
Some commentators have suggested claimants may not be interested in PPOs following the discount rate reduction. Whilst this may be the case in adult CAT claims we consider those child claimants with long life expectancies will remain committed to PPOs, particularly for the largest head of loss, care and case management. It is a brave claimant advisor who ignores the clear advantages of PPOs.
Jennifer Stone, Director at Nestor and an independent financial advisor who specialises in advising claimants on mode of award of any high value claim and thereafter managing the lump sum of any high value settlement says:
Although a discount rate reduction makes a lump sum award more attractive, on the face of it, all the advantages of periodical payments continue to apply.
"Although a discount rate reduction makes a lump sum award more attractive, on the face of it, all the advantages of periodical payments continue to apply.
"Comparing a future loss lump sum (albeit bigger using -0.75% compared to 2.5% discount rate) versus earnings-linked PPOs is still a complex decision, and one which will affect the lives of personal injury claimants for many years to come. Time for adequate consideration at the end of the litigation process is, in our view, just as vital as it has always been.
The fact that future loss lump sums will be greater in value does not in itself allow those advising personal injury claimants to give a cursory glance towards a PPO then disregard it. There are, and always will continue to be, significant advantages for a claimant to have part of their future loss damages paid by way of a PPO.
As regards the reduction, the assumptions used when the Lord Chancellor made her decision still remain only assumptions. The new rate ignores mortality, and lump sum awards cannot match the lifelong, tax free, inflation proofed certainty of a PPO.”
Time will tell over the next few months whether the discount rate reduction has changed perception of PPOs for both claimants and defendants.
Part 36 offers
Our experience has been that, for claims with a value over £1 million, we do not often receive Part 36 offers save on liability. It is frustrating for defendants that claimants show a marked reluctance to put a value on their claim until very close to trial despite the advantages that they could gain from an early and well-judged Part 36. For greater insight into how the change in the discount rate has impacted upon claims and behaviours, we may see trends more clearly emerging on cases valued between £250,000 and £1 million.
We can report that, within that value band, since the announcement we have seen a number of Part 36 offers withdrawn before the expiration of the 21 days. In some no new Part 36 offer has been made wheareas in others an increased offer reflecting the % change has replaced it.
In cases requiring court approval settled at JSM’s / mediations prior to the announcement, we have experience of opposing counsel advising that he or she can no longer recommend the agreed figure and renegotiating the settlement. This has led to some significant increases from the initial figure.
A lot of the initial commentary about the practical implications of the rate change has rightly urged parties to review Part 36 offers made under the old discount rate. The ability of claimants to quickly withdraw such offers or defendants to quickly accept is of course regulated by Part 36 which operates as a self-contained code.
Accepting a Part 36 offer out of time
If a Part 36 offer is accepted beyond the 21 day relevant period (accepted “out of time”), unless the parties are able to reach an agreement in respect of liability for costs, the parties will need to apply for a hearing and have the court decide on the issue.
Where a Part 36 offer is accepted out of time, it is open to the offeror to argue that their costs incurred after the 21 day relevant period expired should be paid on the indemnity basis, rather than on the standard basis. For defendants accepting claimant offers, any additional costs liability is likely to represent a fraction of the damages saving if settling on the basis of the old discount rate. This opportunity is in any event likely to be short-lived as claimants gradually withdraw old offers representing an under-valuation compared to the new rate.
Accepting a withdrawn Part 36 offer within the “relevant period”
This is governed by CPR 36.10 (1) and (2) which makes it clear that where the claimant makes a valid Part 36 offer and, within the “relevant period” (usually 21 days or longer), then serves notice of withdrawal, the defendant may nevertheless serve a notice of acceptance of the offer within the same period, but the onus is then on the claimant to apply to the court for permission to withdraw within seven days. CPR 36.10 (3) comes into play which is relevant to the Lord Chancellor's announcement. The court will give permission to withdraw if it is “satisfied that there has been a change of circumstances since the making of the original offer and that it is in the interests of justice to give permission”. In the current climate that may be a relatively easy condition to satisfy considering the financial impact of the rate change.
Damages Act exception from applying discount rate
Subsection 1(2) of the 1996 Act expressly provides that a court may take a different rate of return into account “if any party to the proceedings shows that it is more appropriate in the case in question”. That provision has previously been invoked by claimants in common law jurisdictions applying the law of England and Wales, where the Lord Chancellor’s discount rate would lead to under-compensation based on local economics and inflation. The best-known example is probably Helmot v Simon  where the Privy Council endorsed Guernsey rates of -1.5% for earnings-related losses and 0.5% for other future heads. That exception could, alternatively, now be argued by defendants in cases proceeding in England and Wales but where the claimant is foreign-domiciled and local performance of index-linked gilts generates a higher net return than -0.75%. For example, Kennedys is currently defending cases involving claimants injured in the United Kingdom who have since relocated to the United States of America where the local rate is 2.5% or higher.
The arguable fallacy of the current approach is that all claimants are assumed to select entirely risk-free investments generating the lowest returns, when a significant proportion of them benefit from financial advice, often provided by the investment arms of the same law firm, and achieve net returns from a balanced portfolio exceeding the old rate of 2.5%. The rate methodology is to be examined during the further consultation and it is to be hoped that empirical evidence is collected regarding actual investment products and behaviours, in order to ensure a more realistic approach to setting the rate in future. If the methodology remains based on the risk-free principle, a creative solution for the government, looking at the projected cost to public sector defendants, would be to create a dedicated investment vehicle for personal injury claimants, underwritten by the treasury and offering a risk-free return of more than -0.75% net.