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Scottish parliament passes discount rate and damages reform

Out-Law Analysis | 04 Apr 2019 | 11:03 am | 3 min. read

ANALYSIS: A bill to reform the method of setting the discount rate for personal injury  damages claims, and to permit the courts to order periodical payments of damages awards rather than a lump sum, has passed its final stage in the Scottish parliament.

The Damages (Investment Returns and Periodical Payments) (Scotland) Bill ('the Bill') aims to provide, in an accountable way, the framework under which the discount rate should be set and maintained, placing responsibility for it with an appropriate professional and away from the political arena where there is the potential for pressure from external interests to attempt to influence the outcome.

Whilst similar changes have been introduced to the discount rate in England and Wales following the joint consultation between the UK and Scottish governments on the issue, some differences remain. This raises the possibility that different discount rates could apply north and south of the border: although the rates have differed for short periods in the past, wholly different rates may now be set.

The Bill will also give courts in Scotland the power to impose periodical payment orders for future financial loss, meaning payments can be spread over a period such as an individual's lifespan, usually via an annual payment. Until now, this could only be achieved if both parties agreed to that method of payment. 'Special regard' must be had to the views of the individual to whom the payment is to be made when a court is considering whether or not to allow a periodic payment order.

What is the discount rate?

When compensation for future loss is awarded as a lump sum, the person receiving that award is arguably being given a financial advantage by essentially being paid today for something that will happen in the future. The individual can invest the money and so receive an additional return on the payment. This would result in over-compensation, in breach of the 100% compensation principle.

The personal injury discount rate is designed to address this, by adjusting the initial lump sum in a way that represents the notional rate of return if the money were invested. A discount rate was first prescribed in Scotland in 2002, when the Scottish ministers set it at 2.5%. In 2017, the discount rate was cut to minus 0.75%, with the result that monetary awards were increased rather than decreased once the discount rate was applied. This caused concern amongst insurers and some public sector bodies which pay compensation from their own funds rather than having insurance. They argued that paying significantly larger compensation awards would have an impact on insurance premiums or their ability to meet other commitments.

The Bill puts in place a new methodology for calculating the discount rate applied when calculating lump sum personal injury awards covering an element of future loss. It provides that the discount rate will be set by the UK government's actuary instead of the Scottish ministers, although courts would be free to apply an alternative rate in individual cases if "more appropriate in the circumstances".

The methodology focuses on a hypothetical investor, with the discount rate calculated by reference to the notional return on a portfolio of investments over a 30-year period. This period can be changed by the Scottish government. Allowance is made for changes in the rate of inflation, and a set of defined "standard" adjustments are also made to the rate, namely:

  • a deduction of 0.75% to represent tax and investment advice, up from the 0.5% originally proposed; and
  • a deduction of an additional 0.5% as a "further margin" to reduce the risk of investment underperformance.

The UK government's Actuary's Department published a report in September 2018, designed to assist the Scottish government in setting the discount rate. This predicted a discount rate of 0%. On this basis, the increase in the deduction for tax and investment advice produces a forecasted discount rate of minus 0.25%, which will continue to concern insurers and other paying parties.

The Scottish government originally proposed to review the discount rate every three years. However, this has been extended to every five years, bringing it into line with the review period in England and Wales set out in the Civil Liability Act.

It is anticipated that the Bill will receive Royal assent by the end of April and become law sometime thereafter.

Bruce Craig is a Scottish litigation expert at Pinsent Masons, the law firm behind Out-Law.com.