On 27th February 2017, the Lord Chancellor issued a statement to the London Stock Exchange to announce that the discount rate for personal injury claims would be substantially cut from 2.5% to minus 0.75%.
The decision was met with dismay by insurance companies and delight by litigants. Many have argued that reform is long overdue, stemming from the fact that interest rates have declined since the 2008 financial crisis and compensation awards should therefore reflect this.
The predicament facing insurers and claimants is clear: what is the impact of this change and what is the likelihood of a Governmental U-Turn arising from pressure by insurance lobbyists?
The Discount Rate Explained
When individuals suffer serious injuries, compensation for future losses are awarded based on the Wells Principle (Wells v Wells, 1999), to put the injured party in the same position as he/she would have been but for the accident. Compensation for future losses are calculated to account for any future care or loss of earnings that the injured party would be likely to have received.
The award is usually in the form of a single lump sum payment. However, Courts recognise that this accelerated receipt of money can give the claimant a particular benefit if they were to invest it – additional yearly revenue could be made by doing so.
In order to avoid over compensating claimants, the Courts apply a ‘discount rate’ when finalising the compensation amount, which effectively adjusts the award to reflect the projected rate of return for any investment.
Why has the Discount Rate changed?
The pre-existing rate of 2.5% was set by Lord Irvine in 2001 to reflect the average yield (or financial return) claimants could expect to receive from investing their compensation award. The discount rate was applied at this figure to ensure that Courts could balance out the interest people could make by investing their compensation sum.
The Lord Chancellor has changed the rates to reflect the recent plummet of interest rates since the financial crash in 2008. Keeping the discount rate at 2.5% at a time where interest rates are at a historic low would serve to unbalance the scales to the disadvantage of claimants – meaning they would in effect lose money and would not be fairly compensated as per the Wells Principle. By changing the discount rate to minus 0.75%, the Government are ensuring that claimants receive the right amount of compensation, based on their likely return should they decide to invest it.
What does the rate cut mean for claimants?
At first glance, a 3.25% reduction seems minimal, but the impact is colossal. To put it simply, the amount of compensation will noticeably increase for claimants.
An example of the new discount rate in action can be illustrated as follows:
William, a 30 year old Claimant who suffers a life-changing injury in a road traffic accident may now require daytime and night-time care, equipment costs and increased care needs for the future. Twinned with this, he can no longer work and his plans for the future are destroyed as a result of the incident. The annual care costs total £100,000…
- Under the old rate of 2.5%, William would receive a lump sum award of approximately £5-6 million.
- Under the new rate of -0.75%, William would receive a lump sum award of approximately £9 million.
The increase in the award could therefore be up to 60% more as a result of the changes.
What is the challenge from insurers?
The change to the discount rate was met with instant criticism from the insurance industry. Within 24 hours of the decision, a delegation of insurance company representatives met with the Chancellor of the Exchequer Philip Hammond to lobby for a U-Turn.
Price Waterhouse Coopers has predicted that the additional cost to the insurance industry could be in the region of £2 billion a year. Insurers responded by indicating that they may target a change in the law governing how the rate is set, thereby seeking to return to the pre-existing position and ultimately lower compensation payouts for claimants.
The future of the discount rate is currently in a state of legal limbo. On the one hand, insurers are likely to be hesitant to settle whilst they fight for the prospect of reform to the rate and on the other hand, claimants are likely to push for settlement whilst the advantageous position is as it stands.
If you would like further advice on the matters raised in this article, please contact a member of the Personal Injury team on 020 3814 2020.