Preparing for a positive discount rate: some predictions

The then-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 and has led to overcompensation in many cases. Fortunately, the Civil Liability Act 2018, which reforms how the discount rate is set, received Royal Assent on 20 December 2018, and should restore fairer compensation levels.

In accordance with the statutory process, the Lord Chancellor started the first review of the discount rate on 19 March and must make a determination about the new rate on or before 5 August 2019.

In preparation for a rate change, we offer some further predictions about likely practical consequences for the serious injury market.

Compensation awards will soon decrease

Bob Neill MP (Chair for the Justice Committee) has said that the new rate will be in place during Q2 2019 and will be set at between 0.5% and 1%.

Accommodation claims will be recoverable again, but claimants will continue their attempts to reform the current methodology

One unintended consequence of a negative discount rate was to extinguish the R v J element of accommodation awards. Some claimants sought to mitigate that inequity by maximising their claims for adaptation costs and other incidental heads of accommodation loss, such as extra running charges in the new larger property, which are not dependent on a positive discount rate.

A return to a positive rate at a lower level than the historic 2.5% will reinstate recoverability of the R v J component, but is highly unlikely to satisfy those claimant lawyers who have long been campaigning for an overhaul of accommodation methodology because of perceived unfairness in particular for claimants with short life expectancy.

A judicial challenge before the Court of Appeal or Supreme Court seems inevitable. In the interim, many claimants are trying to overcome the current R v J difficulties by seeking an award reflecting the likely mortgage interest (as determined by IFA experts) on the extra capital amount.

Offer levels should be carefully reviewed in the build-up to every rate change

In the present environment where the discount rate is expected to increase, and awards correspondingly decrease, the greater risk of adverse costs consequences arguably weighs on claimants who might have rejected defendant Part 36 offers under the old rate, which become protective under the new rate.

Compensators will still need to review their historic Part 36s and withdraw any that might otherwise overcompensate, in order to avoid claimants accepting them out of time, or preferably vary them downwards to avoid losing the preceding costs protection.

The rate change also potentially creates some uncertainty for cases settled prior to the announcement but still requiring court approval, where the compensator may decide that it can no longer recommend the agreed figure. We may even see test cases during the transition period where claimants are recommending the original settlement and defendants are actively challenging approval of the outdated terms. Whilst not an attractive prospect, that is merely the reverse of the situation in early 2017, when many claimant advisers sought to renegotiate settlements upwards as a pre-condition of recommending approval.

IFAs will be recommending a higher proportion of periodical payments than currently

A discount rate increase will reduce the potential lump sum award due to lower Ogden multipliers, and therefore alters the financial balance of interests in relation to whether periodical payments are the more appropriate form of award, factoring in their lifelong, tax free, inflation-proofed certainty for claimants.

The IFAs will not necessarily have the last word on choice of award. One of the revelations of the consultation process was the high proportion of respondents who admitted that an important factor in choosing a lump sum settlement over periodical payments is the ability to leave an inheritance for your family, when strictly the compensation principle requires that a fair award will be exhausted at the end of the relevant period.

The 2018 Act will provide compensators with some much-needed certainty

The last two years have been a challenging period for serious injury compensators, featuring unprecedented awards and a slow process of reforms despite patent overcompensation. The 2018 Act provides a helpful structure and restores stability to the insurance market, including by specifying the investment assumptions and five-year review cycle, and by obliging the Lord Chancellor to publish their reasons for each rate determination, which will allow all stakeholders to monitor investment performance and obtain rolling financial advice regarding likely discount rate projections.

However, that may also inadvertently encourage tactical behaviours in the run-up to the next review, by parties seeking to accelerate or delay issue or trial dates depending on expected review outcomes. Compensators will need to stay alive to behaviours that may develop in that regard.

Comment

The serious injury market deserves significant praise for showing such flexibility in navigating the fallout from the minus 0.75% discount rate.

The same flexibility is highly likely to be required as the review process is refined in future cycles, including if the Lord Chancellor decides at some point to impose different rates for different cases if fairness requires, including for different heads of loss, or size or duration of award. A multi-rate model already operates in other jurisdictions. Jersey has recently passed legislation that includes a statutory rate of 0.5% for losses of up to 20 years, or 1.8% for losses of more than 20 years. Hong Kong has rates of minus 0.5% for losses of less than five years, 1% for losses of between five and 10 years, and 2.5% for losses of more than 10 years.

There are divergent approaches even within the United Kingdom. Northern Ireland has a prevailing discount rate of 2.5%. In Scotland, the Damages (Investment Returns and Periodical Payments) (Scotland) Bill is progressing through Holyrood, and seems likely to result in a different discount rate in Scotland compared to England and Wales. That inconsistency may invite tactical forum-shopping.

There will undoubtedly be more work for compensators in relation to their discount rate strategies, but at least the more rigorous methodology that has emerged from the reforms will hopefully avoid future shocks of such magnitude and ensure a fairer process going forwards.

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