UK and Scottish governments begin review of discount rate calculation method

Out-Law News | 31 Mar 2017 | 12:22 pm | 2 min. read

The UK and Scottish governments are seeking views on the need for changes to the way in which the discount rate applied to lump sum personal injury compensation payments is set, in response to concerns that the current method is "flawed".

The new rate of minus 0.75%, down from 2.5%, came into force on 20 March in England and Wales and 28 March in Scotland, following an announcement last month by Liz Truss, the Lord Chancellor. This is the first change to the discount rate since 2001, and will effectively increase compensation awards in order to reflect assumed loss of value.

"There is a sense that the insurance industry was taken by surprise by the recent change to the discount rate to a negative figure," said insurance law expert Nick Bradley of Pinsent Masons, the law firm behind Out-Law.com. "So this consultation as to how the rate should be set is very much to be welcomed across the industry."

The consultation, which closes on 11 May 2017, does not make specific proposals for reform. Instead, it seeks views from respondents about the principles that should guide setting the rate; how often the rate should be reviewed; and whether it should continue to be set by the government and Scottish ministers or whether responsibility should be passed to an independent panel of experts. It also seeks views about whether sufficient use is being made of periodical payment orders as an alternative to lump sum payments.

Compensation awards for life-changing injuries are calculated in such a way as to put the injured party in the same financial position as if they had not been injured, including loss of future earnings and care costs. The discount rate, once applied by the courts, ensures that the actual amount received reflects the interest the individual can expect to earn by investing a lump sum payment.

The 1996 Damages Act requires that those receiving lump sum compensation awards are treated as risk averse investors, reflecting the fact that they will be financially dependent on the lump sum for perhaps the remainder of their life. The discount rate is therefore linked to returns on the lowest-risk investments, typically index-linked gilts. Both the 2.5% rate set in 2001 and the new rate of minus 0.75% were based on a three-year average of real yields on index-linked gilts, which dropped substantially in the 16-year period since the last review.

The consultation reflects concerns that the current method for setting the rate is "flawed". The main criticism of the current method is that it "intrinsically over-compensates many claimants, contrary to the overall objective of an award of damages, namely to meet in full the costs and losses caused to the claimant by the injury, neither more nor less".

As part of their review of the method, the governments are seeking evidence of how lump sum awards are actually invested and what, if anything, should be done to make the system for setting the rate more fair. They are also seeking to understand the use of periodical payment orders as an alternative to lump sum payments; and whether, and if so how, to encourage increased use in the future.