This article is the first in a series of three articles about the change in the discount rate. Part 2 looks at the technical details of the change and how they effect claims. Part 3 covers FAQs about discount rates and the changes in particular.
What is the discount rate?
The discount rate is a percentage used by lawyers to calculate future losses in a personal injury and fatal accident claims. It is designed to discount a lump sum for future losses on the assumption that that money can be invested and earn interest for the future.
History of the discount rate – How did we go from 2.5% to -0.75%?
The discount rate was set at 2.5% 16 years ago in 2001. Despite significant cuts to interest rates, the discount rate has remained unchanged ever since.
The discount rate of 2.5% was set 16 years ago in 2001. It is calculated with reference to Index Linked Gilts. However, following 2001 there has been a stark decrease in interest rates and securing a safe investment with a return of 2.5% is virtually impossible. The real yield on Index Linked Gilts has also fallen. However, the discount rate has remained at 2.5%.
Claimant lawyers, and in particular the Association of Personal Injury Lawyers (APIL) have been campaigning for a review of the discount rate for six years.
In 2012 the Lord Chancellor held a consultation on the discount rate. However, the results of the consultation were delayed and it was not until APIL took the unusual step of starting legal action that the Lord Chancellor announced that the consultation results would be announced by the end of January 2017.
In the meantime, however, the insurance industry, led by the Association of British Insurers (ABI) sought their own judicial review in an attempt to prevent the Ministry of Justice going ahead with its promise to publish the results.
The ABI lost its application for judicial review and permission to appeal the court’s decision was refused. The ABI’s efforts only succeeded in delaying the publication of the results.
The announcement and its aftermath
On 27 February 2017 the Lord Chancellor, Liz Truss, issued a statement that the discount rate would change from 2.5% to -0.75% from 20 March 2017. You can read the statement here.
This announcement came as a surprise to both claimant and defendant lawyers and sent shockwaves through an outraged insurance industry who had been benefiting from under-compensating injured people for years.
In reality, without overhauling the entire system by which the discount rate is calculated, the Lord Chancellor had no choice in reaching the conclusion she did and reducing the rate to -0.75%.
On 28 February 2017, the day immediately after the announcement, 16 chief executives and representatives from the country’s largest insurance companies including AVIVA, Direct Line, Admiral, Zurich, AIG, RSA, Axa, LV, Allianz, Ageas, Esure, Hiscox and the Association of British Insurers met with the Chancellor of the Exchequer, Philip Hammond, to demand a re-think of the discount rate, bypassing the Ministry of Justice in the process.
The insurance industry had expected to benefit from reforms to the personal injury sector that they had been lobbying the Government for years over. It must have felt like a betrayal from a Government that had for so long supported the large insurance companies in reducing claims payouts and increasing insurer profits.
The change to the discount rate could see millions of pounds wiped off of insurance company profits unless they increase insurance premiums, which they will undoubtedly do to preserve their profit margins.
Arguments for and against the change
The arguments raised by the insurance industry against the new discount rate were that this change would be passed on to businesses and members of the public in the form of a rise in insurance premiums including car and home insurance (thereby reducing any impact on the insurance companies’ own profits).
The Lord Chancellor herself recognised that there would be an impact on the NHS Litigation Authority (the government funded body responsible for dealing with negligence claims against the NHS). In her statement, she stated:
“The Government has committed to ensuring that the NHS Litigation Authority has appropriate funding to cover changes to hospitals’ clinical negligence costs.”
There can be no doubt that such a significant change in the discount rate will impact upon defendants’ budgets and insurers’ profit margins resulting in a likely increase to insurance premiums. However, the calculation of the discount rate should have no bearing on Government budgets or insurance premiums. At the heart of this issue is the injured victim and the importance of correctly calculating their future losses to ensure they have sufficient funds to support themselves into their future. This also benefits the NHS by reducing the burden on public services as claimants will have the means to pay for their own care.
The fact that the discount rate has been altered so drastically by 3.25% reflects the fact that it has remained unchanged for the last 16 years. The real concern is not the change of the rate but how long this has taken. How long and by how much have seriously injured people been under-compensated in settlement of their claims utilising a discount rate that was out of date?
The insurance industry has claimed that it was reckless of the Lord Chancellor to “rush out a new discount rate”. However, this alteration to the discount rate has been long overdue and desperately needed by seriously injured people for years. The rate should have been reviewed years ago and kept up to date to ensure seriously injured people are correctly compensated and any change in the rate does not take the industry by surprise.
Claimant lawyers are in no better position than any other tax payer or consumer of insurance. I pay car insurance and home insurance in the same way and at the same rates as millions of others in the UK and any rise in those premiums will directly impact my family finances. However, the discount rate has never been about insurance premiums and the bidding war insurers are in with each other to offer ever cheaper insurance; it is about correctly compensating seriously injured people.
Why does it matter?
A fundamental principle of personal injury law is that the injured party should, as far as possible, be placed in the position they would have been in had the negligence (and resultant injury) not taken place. It is for this reason that is it vitally important that calculations of a victim’s loss are calculated accurately.
Firstly, we must not forget that the people we are talking about are often seriously or catastrophically injured. Injuries may include loss of limbs, broken spines and brain injuries. These are vulnerable people who require significant help with day to day living.
Secondly, defendants and insurers are only liable to compensate for injuries that have been caused as the result of negligence on their part or that of their insured.
We are therefore talking about seriously injured people who have sustained life changing injuries through no fault of their own. Why should they be left financially worse off as the result of someone else’s negligence? And why should the NHS be placed under further strain to fund treatments, surgeries and care that ought to be funded by the wrongdoer and their insurers?
It must be recognised that seriously injured people who rely upon the money they receive as part of compensation settlement for their entire futures are naturally and understandably risk averse. Generally, the greater the risk someone is prepared to take in their investment, the greater the potential return. The reverse is also true. Injured people will not receive the best interest rates on the market on their investments as they cannot afford the associated risk. The risk of getting an insufficient return or losing money would have dire consequences for their future care.
How much money will claimant solicitors make out of the discount rate change?
The answer is none. The calculation of solicitor costs and a claimant’s damages are dealt with entirely separately. In most cases, solicitor's fees in pursuing a personal injury claim on a claimant’s behalf are set in budgets by the court or are fixed fees in lower value claims. The change of the discount rate will increase damages for injured people with future losses but will have no impact on the level of fees recovered by solicitors or the hourly rates charged.
What's next for the discount rate?
This is not the end of the arguments over the discount rate.
The strongest indication of further reform can be found in the Lord Chancellor’s statement in which she stated:
“I will bring forward a consultation before Easter that will consider options for reform including: whether the rate should in future be set by an independent body; whether more frequent reviews would improve predictability and certainty for all parties; and whether the methodology - which in effect assumes that claimant's would invest only in index-linked gilts - is appropriate for the future. Following the consultation, which will consider whether there is a better or fairer framework for claimants and defendants, the Government will bring forward any necessary legislation at an early stage.”
Of some concern to lawyers acting for significantly injured people is the Lord Chancellor's reference to “a better or fairer framework for claimants and defendants”. If this means balancing the impact on the insurance industry against the benefits for injured people then this could indicate an attempt to part company with the fundamental principle of 100% recovery for the faultless victim. This would be vehemently opposed by claimant lawyers as it goes to the core principle of placing a victim in the position they would have been in but for the negligent act of the defendant.
Assuming that the defendant insurers are genuine in their statements of fairly compensating injured people, then the industry must work together as a whole to ensure the discount rate remains up to date and is calculated as accurately as possible to ensure injured people are adequately compensated for the future.
Following the meeting between the insurance chiefs and the Chancellor, a joint statement was released stating:
“The government will progress urgently with a consultation on the framework for setting future rates, and bring forward any necessary legislation at an early stage.”
“The industry will contribute fully to the upcoming consultation, and the government will carefully consider all evidence and arguments submitted.”
There is little doubt that the insurance industry will not rest until the discount rate has been amended again. However, on the current formula for calculating the discount rate, there is no other rate that could be set. Therefore, the government will hold a consultation on the method of calculating the discount rate. Hopefully, this will result in the rate being kept up to date and would not require legal action and a wait of 16 years before the rate is updated.
However, do not expect any change soon. In the recent spring budget, delivered on 8 March 2017, the Chancellor of the Exchequer, Philip Hammond, made no reference to the discount rate. Consultations, however “urgently" progressed, will take many months to complete; the results may take even longer to be published and drafting and passing new legislation to implement any decisions reached will not be a quick process.
We cannot expect the discount rate to remain at -0.75% for the next 16 years. There is a fear that insurers will try to delay claims settling or reaching trial until the Government review has been carried out and the rate changed. However, this will not happen quickly and seriously injured people should not be delayed compensation because an insurance company thinks the government is wrong and the injured person deserves less compensation.
However the discount rate is calculated in the future, we must not lose sight of the objective. That is to correctly and fairly compensate seriously injured people for the life changing injuries they have sustained through no fault of their own.