Update on the Discount Rate

Ministry of Justice Draft Clause to the “Response to the Report of the Justice Select Committee”

Having read through the document known as “Personal Injury Discount Rate Response to the Report of the Justice Select Committee”, which arrived yesterday. The following is a shortened version which contains my views on it.

The Committee have recommended that more evidence be gathered before legislation was introduced to change the basis on which the discount rate is to be set. The approach going forward will aim to depart from Wells v Wells and will be based on the fact that the majority of personal injury investors already invest in diversified low risk investment portfolios and not Index Linked Gilts. The proposals for the new approach are as follows:

1. The rate will be set by reference to expected rates of return on a low risk diversified portfolio of investments rather than very low risk investments as at present. Low risk is less risk than would be taken by an ordinary prudent investor and more risk than very low risk.
2. The rate will be reviewed promptly after the legislation comes into force and, thereafter, at least every three years.
3. The rate will be set by the Lord Chancellor following consultation with an expert panel (other than on the initial review which would be by the Lord Chancellor with advice from the Government Actuary) and, as at present, HM Treasury.

Under the proposed new law the discount rate will reflect the rate of return to be expected on a low risk diversified portfolio, as opposed to a very low risk basket of index linked gilts, which is the current approach. There will probably be a range of portfolios and rates of return that might be used in the setting of the rate. It will be for the Lord Chancellor to apply the legal principles set out in the legislation and on that basis to decide where in the range of low risk the rate should be set.

The aim of the new law is for the relevant damages to be exhausted at the end of the period for which they are awarded. In this exercise, the Lord Chancellor will consider the investments available and actual investments made by claimants; and must make such allowances for taxation, inflation and investment management costs as the Lord Chancellor thinks appropriate. To assist them with this the Government will be commissioning the Government Actuary’s Department to carry out further research and analysis of the assumptions to be made about inflation, tax and management costs, as the Government agrees that policy making should be evidence based.

After considering the above, the Lord Chancellor will decide on the discount rate to be applied and will be required to give reasons for the rate chosen on a review.

The Government’s aim is to achieve 100% compensation for all. The award for future loss or expense may take the form of a lump sum, periodical payments or a combination of both, but lump sum award should be exhausted at the end of the period for which it is given. Periodical payments should run for the period that the anticipated loss or expense in question is expected to continue or until the death of the claimant.

There doesn’t appear to be any proposed change in law relating to PPO’s. However the Government accept the need for proper financial advice both pre and post settlement and also appear to agree in the defendants paying for this. It will therefore be left to the litigating parties to decide when and where a PPO should be incorporated in an award. However, the Government will investigate the quality and effectiveness of the advice that is currently available and will provide or endorse guidance on standard practice to ensure that claimants are properly informed as to the implications of choosing between a lump sum and a PPO.

In recognition of the Committee’s concerns and in preparation for the first review of the rate under the proposed legislation, the Government commits to seek further evidence to inform the first review. In particular:

1. The department will issue a further call for evidence to obtain any additional relevant information.
2. The department will commission the Government Actuary’s Department to carry out further research and analysis of the assumptions to be made about inflation, tax and management costs.
3. The department will also commission the Government Actuary’s Department to carry out further analysis along the lines of the report published with the draft legislation but covering a wider range of assumptions (for example, as to the length of awards, the report only considered 30 year awards, while the new analysis could take other durations into account).

It goes on to state:

“If the rate is to take account of investment behaviour, a mechanism must be established to keep those responsible for setting the rate informed about that behaviour. This mechanism must ensure it captures the behaviour of those claimants who do not access professional investment advice and fund management.”

As the 30 year model is very likely to lead to a negative discount rate that is not too dissimilar to the current -0.75% rate. The cynic in me feels that the Government will look at many more scenarios until they find the one that provides them with a discount rate that is more in line with their stated target range of 0% to 1%.

As stated above, the Government will include the costs of financial advice in the discount rate going forward. They have considered this being set as an additional head of damage, but have concluded that the panel would not be the appropriate body to consider whether the cost of professional advice should be a separate head of damage as it does not have legal expertise. I suspect that this will ultimately be decided in court.

Conclusion

Before law is passed to make the proposed changes the paper will need to pass through the House of Lords and there will likely be some revisions to this.

There is a strong chance in my opinion that the Wells v Well principle of using a very low risk basket of index linked gilts to determine the discount rate will be overturned.

The new approach will most likely be linked to the performance of a low risk investment portfolio which is properly advised upon and managed throughout the claimants life with the specific aim of ensuring that the award last for their entire lifetime.

The Government will incorporate the costs of such advice and also the cost of tax within the discount rate. After taking advice on the likely costs of this from the Government Actuarial Department.

It is possible that in future, the courts will decide that the costs of financial advice should be treated as a separate head of damage. If this were to happen, I suspect it would have a negative effect on the new discount rate.

The Government aims to provide 100% compensation for claimants and as such recognise the benefits of PPOs. However there is unlikely to be any change in the law relating to inclusion of PPOs in settlements in future. As the Government recognise the need for proper financial advice both pre and post settlement the onus for the inclusion of PPO’s will most likely be left to the claimants legal advisers in conjunction with a financial adviser. However the Government will provide or endorse guidance on standard practice to ensure that claimants are properly informed as to the implications of choosing between a lump sum and a PPO.

Given that the discount rate will be set in future based on evidence supplied by the Government Actuarial Department. It would appear that the discount rate should remain at roughly the same point as it is currently. However the Government are likely to seek further data from the Government Actuarial Department which covers a wider variety of time scales than the previous paper used and will also incorporate their interpretation of inflation, investment management charges and taxation. I therefore suspect that armed with further evidence, the revised discount rate will be somewhere around the Government’s previously stated 0% - 1% range.

If the new law is passed, the document states: “the Government intends to begin the first review promptly after legislation is enacted”.

For more information about personal injury, clinical negligence and Court of Protection services, contact Paul Rosson

Paul@adroitfp.co.uk