14 Jan 2020

On 15 July 2019 the Lord Chancellor announced that the discount rate in personal injury and clinical negligence claims would increase from minus 0.75% to minus 0.25%.

A look back at the discount rate

The discount rate is applied to damages paid on a lump sum basis for future loss to reflect the fact that damages are paid ahead of the loss falling due, and to reflect the investment return which a claimant might expect to receive from investing the lump sum.

For over 20 years the discount rate remained static at +2.5%, the average redemption yield on Index Linked Government Stock (ILGS) – in essence, a very low risk, long term safe investment producing average growth over a long period.

Applying the discount rate of +2.5% reduced the amount of damages.

However, over time, ILGS yields have fallen below a 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.

Claimant groups had long argued that the rate of 2.5% was too high and penalised claimants. But the insurance industry argued that the rate of 2.5% should not be reduced, because to do so would increase the value of claims excessively, leading to an increase in insurance premiums.

In 2017 the Lord Chancellor reduced the discount rate from 2.5% to minus 0.75% resulting in calculations for claimant's damages actually being increased (rather than reduced) to reflect the likelihood of erosion of the lump sum by inflation rather than accruing interest through prudent investment.

The Lord Chancellor's decision met with significant backlash from insurers who argued that settlement costs would soar and insurance premiums would increase significantly on both motor and liability policies for millions of consumers and businesses.

The decision also had a significant impact upon the calculation of compensation payments made by the NHSLA for clinical negligence claims – it was estimated that the NHSLA would face a £1 billion hike in settlement costs.

A widespread review and consultation followed.

Civil Liability Act 2018

On 15 July 2019, pursuant to the Civil Liability Act 2018, the discount rate was increased from minus 0.75% to minus 0.25%.

The new discount rate was set, not by reference to ILGS yields, but rather to the yields which would follow if a claimant invested in a “diversified portfolio of investments”.

The amendment of the discount rate to minus 0.25% still met with significant criticism from both claimant groups and insurers. Claimant groups believe that the calculation still significantly undercompensates claimants and essentially invites investments to be made in higher-risk investments with the obvious risk that these could fail and the damages so invested lost completely. Insurers continue to lobby Parliament for a further increase in the discount rate taking it into positive figures, on the basis that the present calculation still represents the lowest in the Western world and puts significant pressure upon insurers to raise premiums.

What is on the horizon for 2020 and beyond?

Under the Civil Liability Act the discount rate is set to be reviewed every five years to ensure that the calculation remains fit for purpose and to ensure that a fair balance is maintained between overcompensation and under compensation. A panel of cross-industry experts has been created specifically to advise in relation to future reviews.

At the time of announcing the amendment to the discount rate the Lord Chancellor rejected proposals for dual rates, which would have involved a lower short-term rate, followed by a higher long-term rate after a "switchover" period. The Lord Chancellor said that there was a "lack of quantity and depth of evidence" to adopt such an approach. However his comments suggest that a dual rate approach remains a possible option for future consideration by the panel and the Ministry of Justice.

There is a real possibility that a significant shake-up could take place over the coming years leading to an entirely new approach on how the discount rate is calculated.