The Discount Rate

The Personal Injury Discount Rate

What is the discount rate and why is it used?

When a Claimant is awarded damages, the underlying principle is that the damages should put them in the same position as they would have been in had the accident not occurred, insofar as possible.  They should be awarded no more than is appropriate and no less, the so-called “100% principle”.

However, when assessing damages and how much a claim is worth, there will be some losses that do not occur at the time of the accident. In a case where a Claimant suffers a severe injury and will either not work again, or will not work in the same capacity, there will be future loss of earnings to take into account.

In addition, they may need aids and equipment which will help them on a day to day basis, for example an accessible vehicle. Whilst this can be purchased relatively soon after the accident it will at some stage in the future need replacing.

Following that thread, if the replacement cost of a vehicle is £20,000.00 in 2017 and a replacement is needed in eight years, one may assume that the Claimant can be given £20,000.00 at the time of settlement to put away and to spend in 2025 when they need a new car. However, this wouldn’t be just or appropriate. The money may be invested or the money may be subject to inflation and therefore the Court needs to apply a “discount rate” to take account of the expected costs and losses of holding money for several years. This discount rate could be negative.

Where did the discount rate derive from?  

So how do Courts decide the rate which should be applied to such sums? The Courts could in each case hear specific arguments and the views of experts on what the appropriate rate was for each individual case. However that would be timely and expensive.

Until 1999, the discount rate used was 4.5%. This was based on the idea that a Claimant could guarantee a return of 4.5% a year on their money by investing his damages in various portfolios. This changed in 1999 when in the case of Wells v Wells [1] the Judges set down some principles as to how to assess future losses in light of inflation and investment. They advised that an injured Claimant “was not in the same position as an ordinary prudent investor and was entitled to the greater security and certainty achieved by index linked government securities”. 

Effectively, a Claimant should be allowed the returns and security of low risk investments and the discount rate should be set in line with index-linked government securities.

As a result, a guideline rate of 3% was set for the discount rate as opposed to the previous 4.5% and was said to stand “until the Lord Chancellor specified a new rate under Section 1 of the Damages Act 1996.”[2]

In 2001, the then Lord Chancellor, Lord Irvine, followed the principles of how to calculate the discount rate by reference to the index linked government securities and set the rate at 2.5%. It remained at this level until the 20th of March 2017.

What changes have recently been made?

On the 27th of February 2017, the current Lord Chancellor, Elizabeth Truss, announced her decision to reduce the discount rate from 2.5% to -0.75% and this change came into effect on the 20th of March 2017.  In her summary of reasons [3], the Lord Chancellor confirmed she had followed the principles in Wells v Wells, relied on investment portfolios of 100% index-linked gilts and used a method consistent with that used by Lord Irvine when he set the discount rate. The consultation states that the “negative rates are simply a product of market conditions.”[4]

As a result, rather than it being assumed that whilst damages are invested and held they will increase, it is now assumed instead that a lump sum will reduce in value as there is a negative return rate.

How does this affect claims?

The consultation published on the 30th of March 2017 by the Ministry of Justice gave working examples of how the change in discount rate may impact claims.

When giving the example of an 18 year old Claimant who suffered a catastrophic injury which rendered them paraplegic, the impact of the reduced discount rate was that the care costs  increased by around 60% when paid in a lump sum.[5]

Previously £100,000.00 invested in 2017 would have a real value of £128,000.00 in 2027. The new change means the £100,000.00 invested in 2017 would have a real value of only £74,000.00[6]

What next?

The announcement by a reduction of the discount rate to -0.75% was unexpected and was followed by Insurers petitioning for an immediate change as the reduction would likely cost them a huge amount.

As the consultation explained, in March of 2017 the Office for Budget Responsibility stated that the Prudential Regulation Authority had estimated the cost to insurers at around £2 billion per annum.[7]

However, as the consultation published yesterday comments:

In setting the rate the Lord Chancellor and her counterparts in Scotland cannot be influenced by the effect of the change in the rate on defendants. To do so would be to address the wrong question. The rate is set to ascertain what Claimants are expected to need to meet their losses given present understanding of future investment returns.”[8]

The rate is now -0.75% although the Consultation does invite views on the principles used for setting the discount rate and it is clear that alternative methods will at least be considered. A change in the principle could mean a change in the discount rate once more.

The consultation itself can be found here: Discount rate consultation

Lois Norris

Legal Assistant to Gerard McDermott QC

Readers should note that this is not intended to be definitive legal advice but rather a basic guide to the issues raised by this consultation.

 

 

[1] [1999] 1 AC 345; see full report for quoted section of the judgement

[2] [1999] 1 AC 345

[3] Truss, E (2017) Discount Rate: Summary of Reasons

[4] Ministry of Justice and the Scottish Government, (2017) The Personal Injury Discount Rate – How it should be set in the future ­– page 17

[5] Ministry of Justice and the Scottish Government, (2017) The Personal Injury Discount Rate – How it should be set in the future ­– page 12

[6] Ministry of Justice and the Scottish Government, (2017) The Personal Injury Discount Rate – How it should be set in the future ­– page 12

[7] Economic and fiscal outlook, March 2017. http://cdn.budgetresponsibility.org.uk/March2017EFO-231.pdf

[8] Ministry of Justice and the Scottish Government, (2017) The Personal Injury Discount Rate – How it should be set in the future ­– page 10