Opinion

The New Discount Rate - the Claimants' Perspective

30th June 2017

The New Discount Rate - the Claimants' Perspective

In 2001 the then Lord Chancellor, Lord Irvine stated that he was “ready to review the discount rate whenever I find that there is a significant and established change in the relevant real rates of return to be expected”.  

Since 2001 the net average yield of investments in Index Linked Government Gilts (“ILGS”) which was used as a basis to set the discount rate has fallen.  Despite this, Lord Irvine’s successors did not make good on his promise.  In 2011 a public consultation was planned.  In 2014 the Lord Chancellor agreed to set up a panel of experts to consider the issue.  It was not until February 2017 that the Lord Chancellor Liz Truss finally announced a new discount rate.

For too long have injured Claimants had to take unnecessary risks to achieve a suitable return on investment to provide for their long term needs.  For nearly 16 years Defendants have undercompensated Claimants

Whilst the Claimant community welcomed the Lord Chancellor’s decision to reduce the discount rate from 2.5% to -0.75%, the reaction from the ABI, the intervention from the Chancellor and the prompt subsequent consultation was perhaps not expected.  I think it is fair to say that the decision was probably a shock to everyone but the Lord Chancellor made it clear that she had no other choice as she had to follow a specific formula.

The uncertainty around the sustainability of the new discount rate consequently presents a number of challenges for both Claimant and Defendant stakeholders in terms of assessing the value of claims and timing settlement.

The impact of the  change is significant. A 20 year old male with future losses of £30,000 opting for a lump sum award would see his claim increase in value from annual losses  of £864,000 to £2.16m.  The multiplier increases nearly threefold. The decision has a profound impact.

Somewhat predictably, the insurance industry argue that the change over-compensates a few thousand claimants each year and that the formula used is a broken formula. They contend that the there should be no discount rate at all.  They suggest that the change will result in premium increases and negate the savings insurers expect to achieve by the introduction of the Prison and Courts Bill.

Claimant’s on the other hand say that that the insurance industry have saved millions of pounds in compensation for many years and that they have had plenty of time to prepare for a change.

The Rationale Behind the Discount Rate The House of Lords in Wells v Wells [1999] 1 AC 345, held that the correct approach to setting the discount rate for calculating lump sums for future loss was to assume that a Claimant would invest in Index Linked Government Stock rather than by the previous approach of assuming that a Claimant would invest in a mixed portfolio of equities and gilts.

The rationale for this decision was set out by Lord Steyn who said

“The premise that plaintiffs, who have perhaps been very seriously injured, are in the same position as ordinary investors is not one that I can accept. Such plaintiffs have not chosen to invest: the tort and its consequences compel them to do so. For plaintiffs an investment in equities is inherently risky, notably in regard to the timing of the investment... Typically, by investing in equities an ordinary investor takes a calculated risk which he can bear in order to improve his financial position. On the other hand, the typical plaintiff requires the return from an award of damages to provide the necessities of life. For such a plaintiff it is not possible to cut back on medical and nursing care as well as other essential services. His objective must be to ensure that the damages awarded do not run out. It is money that he cannot afford to lose.

"The ordinary investor does not have the same concerns. It is therefore unrealistic to treat such a plaintiff as an ordinary investor. It seems to me entirely reasonable for such a plaintiff to be cautious and conservative. He does not have the freedom of choice available to the ordinary investor.  The position of plaintiffs is much closer to that of elderly, retired individuals who have limited savings which they want to invest safely to provide for their declining years. Such individuals would generally not invest in equities. But for plaintiffs the need for safety may often be more compelling. In any event, it seems to me difficult to say that an investment in index-linked securities by plaintiffs would be unreasonable … I therefore share the views of the Ogden Working Party and the Law Commission that it is reasonable for such a plaintiff to take the safe course of investing in index-linked government stock. From this it follows that the discount rate ought to be fixed on this assumption.”

The formula adopted by the House of Lords in Wells v Wells was to calculate the appropriate discount rate by reference to the net average yield of investments in ILGs over the previous three years, as adjusted for tax at the rate of 15%.

Liz Truss felt constrained to follow this approach when setting the new rate at – 0.75%. In announcing the new rate, she stated: “The law is absolutely clear – as Lord Chancellor, I must make sure the right rate is set to compensate Claimants. I am clear that this is the only legally acceptable rate I can set”. In her statement giving reasons for setting the rate at the level she did she stated:

“The principles in Wells v Wells lead me to base the discount rate on the investment portfolio that offers the least risk to investors in protecting an award of damages against inflation and against market risk. I take the view that a portfolio that contains 100% index-linked gilts (ILGs) best meets this criterion at the current time…  In particular, the case has been made by a number of respondents to the consultation exercises that it might be more appropriate and realistic to use a ‘mixed portfolio’ approach (in which other securities feature). I acknowledge that those arguments have some merit. However, I am not persuaded by them.

I consider that a faithful application of the principles in Wells v Wells leads to the 100% ILGs approach as the best way, in the current markets, of ensuring that there is “no question about the availability of the money when the investor requires repayment of the capital and there being no question of loss due to inflation.” That said, on the 30th March 2017 a 6 week consultation was published which closes on the 11th May 2017 and it is highly likely the current discount rate will change again. What could be next? The discount rate does not just reflect likely returns on investment.  It also factors inflation on wages, care costs and the costs of aids and equipment which all fluctuate over time. There is support for  different discount rates for different heads of loss.

There is a recent and influential precedent regarding an alternative approach to a single rate discount rate, set by reference to index-linked gilts.  In  Simon v Helmot [2012], a case head in Guernsey, the Court of Appeal applied different discount rates for earnings (-1.5%) and other losses (0.5%) on the basis that the evidence showed that inflation would affect different heads of loss in different ways.

The defendant lobby continue to argue that Claimant’s are securing significant returns on properly managed funds but ignore the argument that Claimant’s should not be compelled to take unnecessary risks (Wells v Wells). Whilst some Claimant’s might be prepared to take risks, one cannot expect all Claimant to take risks.

Consideration may also be given to the possibility of differing discount rates for different periods.  Investments for a relatively short period of time will need to be conservative and totally free of risk whereas  where a fund is to be managed over a 30 year plus period an investor might be able to afford to be more ambitious in the early years and achieve better rates of return that through ILGS but should we expect this.  I still however come back to the same point. Why should an injured Claimant have to take any risks? Practical Implications of the Change in Discount Rate

Following the consultation, we may see the discount rate reviewed and change more regularly.   If so, the timing of offers/settlement meetings will be a key consideration for practitioners. Annual reviews could lead to chaotic outcomes with parties potentially hedging their bets against what is likely to happen at the next review depending on the direction of the prevailing economic circumstances.  Lawyers will be forced to become economists.

In terms of the current change,  it is vital that the following steps are taken:

  • offers may need to be withdrawn or amended
  • any advice given on settlement or reserves will need to be revisited
  • applications may need to be made to increase the statement of value on Claim Forms, and for increased court fees to be paid as a result
  • schedules of Loss and Counter-Schedules will need to be redrafted
  • costs budgets may need to be revised in light of further work necessitated by the change to the discount rate.

There is great uncertainty about what the Courts approach will be in relation to  Part 36 offers particularly if the Claimant only beats an offer because the discount rate has changed. What will the effect be on offers made after 20th March 2017 if the discount rate changes again following the consultation?

Claimants may wish to be more flexible with regard to settlement on the basis of the new discount rate in light of the current consultation and the likelihood of further change. It is clearly  going to be very difficult to advise clients given the lack of certainty that exists.

Expect Defendant’s to deploy various tactics to postpone trials or vacate trial windows in the expectation of a favourable change to the rate later in the year.

Periodical Payment Orders (“PPOs”) A Claimant are unlikely to favour settling claims on a PPO basis given that they will favour the advantage that the flexibility of a lump sum award affords.   Defendant’s on the other hand are likely to be pushing for PPOs. It might be that agreeing settlement on a PPO basis will be a pragmatic way of reaching settlement whilst uncertainty as to the consultation continues. This could appeal to claimants too.

In considering whether to order PPO’s the Court shall have regard to the form of the award and each party’s preference.   If the only reason for the Claimant’s preference is that he or she stands to obtain a windfall, the Court may not consider this is good reason for his or her preference. A Claimant may want to avoid the risk of proceeding to court for fear of a PPO being ordered.

Accommodation Claims The Roberts v Johnsone calculation is clearly unsuitable in light of the new discount rate as there will be no loss on the net capital outlay. Potential alternatives includ

  • a PPO linked to the cost of the mortgage
  • the Defendant makes an interest free loan
  • the Defendant purchases the property and grants a life interest in it

There are clearly many issues for Practitioners to consider in light of the new rate and the potential for further change in the near future.  Flexibility may be key in securing the right settlements for our clients. It is in the interests of all that we arrive at a fair approach to the setting of the discount rate and that the process that results from the consultation is one that gives all those involved in making and responding to claims the certainty that enables those claims to be resolved in a timely manner and as consensually as possible.

Andy Shaw, Head of Personal Injury.

 

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