The Ministry of Justice has concluded the long awaited review of the discount rate used in personal injury claims. Yesterday's announcement concluded that the long standing discount rate of 2.5% used in personal injury claims shall be reduced to -0.75% with effect from next month. The announcement has divided opinion across the insurance and legal industries.

The discount rate is applied to calculate deductions from injured people's compensation payments to reflect the interest those payments are assumed to earn.

The rate was last set by the Lord Chancellor in 2001 at the rate of 2.5% and has remained unchanged since that time. Claimant groups and The Association of Personal Injury Lawyers (APIL) have long argued that the current rate of 2.5% is too high and penalises claimants. The insurance industry has argued that the rate should not be reduced, because to do so would increase the value of claims excessively, leading to impact on insurance premiums.

What does the discount rate mean?

When calculating future pecuniary loss in personal injury claims, the multiplier / multiplicand approach is the standard approach. The multipliers to be used are contained in the actuarial tables commonly referred to as "The Ogden Tables". An important factor in determining the multipliers to be used is the net rate of return (the discount rate) which a claimant could reasonably expect to receive from investing the money in a prudent manner.

In the 1998 landmark case of Wells v Wells, the discount rate was set at 3%. Following a review by the Lord Chancellor in 2001 this was reduced to 2.5% and enshrined in the Damages Act 1996. The rate of 2.5% was calculated with reference to the average redemption yields on Index Linked Government Stock (ILGS).

However, global economies have slumped since that time and ILGS yields have fallen well below the 2.5% rate of return. Following the worldwide recession in 2008, the Bank of England embarked upon a programme of quantitative easing and following this, ILGS yields fell to less than 0.1% - significantly less than the 2.5% discount rate.

The problem for claimants

Claimants have long argued that the 2.5% rate of return was simply not enough to properly compensate them, because it assumes a rate of investment which cannot be attained – even with prudent, long term investment.

The degree of under-compensation, particularly for younger claimants claiming pecuniary loss for life, was argued to give rise to significant prejudice.

This argument was specifically raised in the 2010 case of Love v Dewsbury where a 17 year old boy suffered significant head injuries, and it was argued that his damages would effectively be reduced by up to 50% as a result of the 2.5% discount rate.

The problem for insurers

Yesterday's announcement has caused shockwaves across the UK insurance industry with the ABI calling it a "crazy" decision. They contend that the outcome will be that claims costs will soar, leaving insurers with little option but to increase the cost of premiums on both motor and liability policies for millions of consumers and businesses. Some analysts believe that annual motor insurance premiums could rise by as much as £50-£75 per policy per year. This is in addition to the overall rise of 9% on average motor policies during 2016-2017.

The net effect of the decision is also likely to have a significant effect upon the NHS which it is estimated will face a £1 billion hike in the cost of settling compensation claims.

The ABI previously threatened to launch a legal challenge to the Government's proposal to reduce the discount rate to -0.75%, stating that they should not base such a significant change to the rate on a "broken and outdated" formula.

The effect on insurers has already been felt with shares in the UK's two largest motor insurers – Admiral and Direct Line - tumbling overnight.

So what next….?

There will probably never be a satisfactory conclusion to this long running disagreement between claimants and insurers. Clearly a sensible balance needs to be struck between obtaining a fair rate of return reflective of the current projections for long term investments, and the need to keep premiums in check.

For the time being, insurers will press the Government to review the decision pursuant to their promise to consult further on whether this is indeed the best way to calculate the rate.

This is indeed a case of – watch this space. Bond Dickinson will keep you abreast of further developments in relation to this important issue.