Pursuers in personal injuries actions are to benefit from a reduction in the discount rate for future loss on their personal injury actions.
The change announced by Lord Chancellor, Liz Truss, last month came into effect in England and Wales on 20 March 2017 and sees the discount rate in personal injuries actions for future loss cut from 2.5% to minus 0.75%.
What is the discount rate?
The discount rate is used to calculate future losses in personal injury claims. When individuals suffer injuries that include an element of future loss such as future loss of earnings or future care costs, a calculation is carried out using the discount rate which adjusts the compensation awarded. As the injured party receives a future loss payment in a lump sum the effect of applying a discount is to reflect what the injured party may be expected to receive by investing the lump sum. Victims of personal injuries are to be treated as risk averse investors as they require to rely on the compensation awarded to them for future losses for a substantial period of time, if not for the rest of their life. The discount rate is therefore intended to reflect returns typically to be expected from low risk investments, most commonly Index Linked Gilts.
The discount rate has remained unchanged since 2001 when it was set at 2.5% by the then Lord Chancellor, Lord Irvine of Lairg. There has long been campaigns from bodies such as the Association of Personal Injury Lawyers for the discount rate to be reduced to take account of the changing economic picture which has seen returns on low risk investments falling significantly since 2001. The Government undertook two public consultations (in 2012 and 2013) to investigate those concerns and determine how best to proceed. This resulted in the Lord Chancellor stating last month “I am satisfied that the rate should be based on a three-year average of real returns on index-linked gilts. Therefore, I am setting it at minus 0.75%.”
Impact of the change
The change in the discount rate is likely to affect almost everyone whether they suffer personal injury or not with insurance premiums likely to rise as a result of the change. The insurance industry has reacted with fury and astonishment at the drastic change as there was a widely held believe that, while there was an acceptance the rate would be lowered, it may only be lowered to 1% or 1.5%. Following the announcement, shares in the insurance sector plunged and one insurer announced that it could cost them £150 million. The public sector will also be significantly effected, in particular, the NHS will likely have to find millions of pounds more to compensate victims which is going to have a serious impact on resources which are already stretched.
On the other side of the coin, the announcement is welcome news for pursuers who will see a significant increase and more accurate level of compensation awarded when there is a future loss element to their claim to reflect the likely return on low risk investments they will achieve in the future. The significant adjustment to the rate following a lengthy consultation process is considered by many to be long overdue. It is also a recognition of the detrimental impact and how far removed from the reality of what is achievable in the risk averse investment market the 2.5% discount has imposed for a number of years.
In reality, high value claims with a significant future loss element are now settling more frequently on a periodical payment basis. This means the future loss payments are made on an annual basis and increase with indexation. Therefore, in the future it is possible the impact of the discount rate change could be minimised by parties agreeing such a basis for settlement.
The UK Government, however, has also announced that they intend to launch a consultation to review the framework under which the discount rate is set with the Lord Chancellor stating the effect of this is “to ensure that it remains fit for purpose in the future”. The consultation process will consider whether:
- the rate should be set by an independent body in future;
- whether more frequent reviews would improve predictability and certainty for all parties;
- and whether the methodology is appropriate for the future.
The consultation is to begin prior to Easter and at the conclusion the Government have indicated that they will bring forward any necessary legislation “at an early stage”.
Of course it remains to be seen whether the Scottish Government adopts the rate set by the UK Government, reject the new rate and stick with the 2.5% rate, or set their own rate which they consider to be appropriate. One would expect, or at least hope, that the Scottish Government will make an announcement relatively soon otherwise pursuers, and defenders alike, could be left in limbo.