Setting the Personal Injury Discount Rate
News article published on: 19th February 2019
The Personal Injury Discount Rate is determined by the Government. It is a tool used to calculate the value of damages awarded to personal injury claimants, taking into consideration likely future financial loss due to their injuries. The Civil Liability Act 2018 is an amendment to The Damages Act of 1996. Among other things, the Act stipulates that it is the duty of the Lord Chancellor to consult the Government Actuary during review of the Personal Injury Discount Rate, which must commence on or before 19th March 2019.
Currently, the Personal Injury Discount Rate is determined with reference to a three-year average of real gross redemption yields on Index Linked Gilts, which sits presently at a rate of negative 0.75%, with a 5-year median rate of negative 4.2%. This rate of negative 0.75% dates from 2017, when the then Lord Chancellor, Liz Truss (partly in response to pressure and threatened judicial review proceedings from campaigning group the Association of Personal Injury Lawyers) changed the rate from the 2.5% rate which had been in force since 2001.
Setting the Personal Injury Discount Rate: Technical Memorandum
On 20th December 2018, Royal Assent for the Civil Liability Act 2018 introduced a change in the way that the Personal Injury Discount Rate is to be set in future. On the heels of this Act, on 22nd January 2019, the Government’s Actuary’s Department published a technical memorandum entitled Setting the Personal Injury Discount Rate. This document lays out how the Government could plan to determine future Personal Injury Discount Rates, in an effort to be transparent and to encourage feedback and comments from interested parties. The memorandum describes the proposed methodology, the expected assumptions and the results, which will be used to formulate a response to the Lord Chancellor on the matter of setting the future Personal Injury Discount Rate.
The time-frame for feedback was short: the call for evidence closed on 30th January 2019 and the formal review will begin on 20th March 2019. On the basis of the evidence, the report and the outcomes of the Lord Chancellor’s consultation, the Government’s approach to the calculation of Personal Injury Discount Rates will be reviewed and updated if necessary.
The Government considers that due to the current legal framework, the existing Personal Injury Discount Rate is artificially low. Claimants are assumed to be very risk averse investors, unlikely to achieve much of a financial return from investing their lump sum of compensation at the time their personal injury claim settles. The case of Wells v Wells is the basis for this legal framework. The 1996 case resulted in the assumption that a portfolio which contained 100% Index Linked Gilts best meets the criterion set out in the judgment, namely that damages awarded should ‘place the injured party as near as possible in the same financial position he or she would have been in but for the accident’.
The Civil Liability Act amendment has now set in motion a change to this existing legal framework, in an attempt, says the government, to more accurately reflect how claimants invest their lump sums. The government’s stated intention is to make the compensation system fairer and more realistic, which should ultimately result in government savings from the NHS negligence bill which can be diverted to other services, or insurers managing to reduce premiums.
By contrast the view of the Association of Personal Injury Lawyers (APIL) is that ensuring fair and full compensation of claimants should be foremost in the government’s mind when calculating the Personal Injury Discount Rate. By assuming that a claimant awarded a significant lump sum (and therefore presumably having suffered a significant injury with large future losses) will invest that lump sum in a higher yield yet higher risk investment than previously, not only places yet another burden on the claimant, but creates a real risk of that claimant’s lump sum running out before the end of the period it was intended to compensate. In this situation a claimant will then be forced to turn to the state for assistance, creating additional burden for the public purse to the benefit of the insurance industry. Where claimants have previously taken investment risks, this was borne out of having no choice because the compensation sum was too low when a discount rate of 2.5% applied. It should be remembered that the discount rate at 2.5% reduced damages on the basis that a claimant would be able to earn a no risk return on their invested damages of 2.5% per annum after inflation (about 3%) and the cost of investment fees (about 1.5%) were taken into account.
The Ministry of Justice’s 2018 Impact Assessment examined the proposed interventions and options available. There are several points that should be noted within this document:
- The government’s starting point in changing the way in which the Personal Injury Discount Rate is set, is to reduce compensation awards to claimants, rather than ensuring that the Personal Injury Discount Rate is used to ensure that claimants are fully and fairly compensated.
- It is assumed that claimants receive proper financial advice, which may rule out direct access to Discretionary Investment Fund Management.
- For the first time the Independent Financial Adviser servicing fee has been included within the typical expenses incurred by claimants and therefore is included in the new Personal Injury Discount Rate.
- The Median Inflation of the Economic Performance Indicator, the Profitability Index, the Consumer Price Index and Earnings may be used to inflate damages in the analysis. Depending on the chosen method of averaging, this creates a rate of around 2.8%.
- References to projected returns allow for specified assumed withdrawals from the fund. After considering tax investment management expenses and so on, it would be easy to get to a discount rate that is 0% or lower. Indeed, based on historical long-term data, a rate of negative 0.8% is entirely possible.
- 2018 was a poor year for investment returns, meaning that investments are measured from a lower starting point when compared with 2017. Using 31st December 2018 rather than 2017 as a starting point, will potentially yield greater returns, resulting in a higher Personal Injury Discount Rate.
In summary, it is clear that calculating the Personal Injury Discount Rate is highly complex. The government’s aim in altering the way in which this is calculated is to bring savings to the public purse. Ultimately, therefore, this will be a political decision rather than a scientific or forensic one. The suggestion that the new method of setting the Personal Injury Discount Rate will reflect actual claimant investment behaviour is erroneous. Claimants will be forced to take higher risks if their compensation assumes an unrealistic rate of return on their investments. By burdening claimants with no previous experience of investing large sums of money, with a lifetime of careful investment management, the government risks falling short of a full compensation system, which ultimately will increase rather than lighten the burden on the public purse. The government states it is committed to maintaining the principle of full compensation as per Wells v Wells, but simply wants to adopt a Personal Injury Discount Rate that assumes a claimant will invest in low risk investments. When claimants run out of damages to fund their care needs though, how much is this going to cost the NHS in real terms?
Two other issues remain to be determined. First, if the insurance industry windfall from the reforms effectively means the tax payer is left subsidising insurer profits, at what stage will the government act to redress the balance, and second, with a Personal Injury Discount rate that mathematically must mean some claimants will be under-compensated, what is the percentage of claimants in such a position that the government will consider acceptable?
Sam Collard is an associate solicitor and specialist personal injury lawyer. You can speak to Sam or another member of the team by calling us on 020 7485 8811 or fill in an online enquiry form.