The article originally appeared in Issue 2 (July 2019).
We couldn’t omit from this edition of QMLR the Lord Chancellor’s announcement on 15 July 2019 of a revised discount rate of minus 0.25% to take effect from 5 August 2019. It will cover all personal injury claims, irrespective of the term of the future loss. As the Lord Chancellor rightly noted in his statement of reasons the legal framework was changed by the Civil Liability Act 2018. This inserted key provisions into the Damages Act 1996 which mandate a number of requirements and assumptions for the Lord Chancellor to take into account when setting the rate. Those provisions at paragraph 4 of Schedule A1 to the Damages Act 1996, require inter alia, that the rate should be set at the rate that the Lord Chancellor considers a recipient of relevant damages could reasonably expect to receive if they invested their damages award for the purpose of securing that—
- the relevant damages would meet the losses and costs for which they are awarded;
- the relevant damages would meet those losses and costs at the time or times when they fall to be met by the relevant damages; and
- the relevant damages would be exhausted at the end of the period for which they are awarded.
The Lord Chancellor in his statement of reasons describes these provisions as the codification of the guiding “full compensation” principle for the award of damages, as set out by the House of Lords in Wells v Wells  1 AC 34 per Lord Hope of Craighead:
“… the object of the award of damages for future expenditure is to place the injured party as nearly as possible in the same financial position he or she would have been in but for the accident. The aim is to award such a sum of money as will amount to no more, and at the same time no less, than the net loss.”
The surprise, at least for some, was that the Lord Chancellor concluded that a negative rate of minus 0.25% was the ‘appropriate’ rate having regard to the responses to the Government’s Call for Evidence, and the Government Actuary’s Department (“GAD”) advice. Indeed the summary of the responses to the Call for Evidence reports how, in the lead up to the Lord Chancellor’s announcement, a positive 0.5% or 1% rate was being adopted in offers to settle by Defendants, which reflected a market view that the negative discount rate at minus 0.75% was too heavily weighted in favour of the Claimant and was likely to result in overcompensation in a significant proportion of cases. To best understand how the Lord Chancellor reached the conclusion he did it is worth recalling what he was required to take into account and what he was required to assume by the Damages Act.
Assumptions and considerations in setting the discount rate
By paragraph 4(1)(a) to (c) Lord Chancellor was required to assume that:
- relevant damages are payable in a lump sum (rather than under an order for periodical payments);
- that the recipient of the relevant damages is properly advised on the investment of those damages; and
- that they invest in a diversified portfolio of investments.;
- that the sums are invested using an approach which involves more risk than very low risk, but less risk than would ordinarily be accepted by a prudent and properly advised individual investor who has different financial aims.
The Lord Chancellor was also required to have regard to:-
- the actual returns available to investors;
- the actual investments made by investors of relevant damages; and importantly
- to make such allowances for taxation, inflation and investment management costs as he thought appropriate.
The advice of the Government Actuarial Department
Perhaps most importantly he was also required to consult with the GAD, who advised that:-
- for the time being at least there should be a single rate to cover all claimants;
- that such rate should be set on the basis of a representative claimant profile where by regular future damages costs are to be met over a 43-year period through the investment of a portfolio of assets constructed according to the mid-range portfolio of those suggested in the responses to the Call for Evidence;
- That such portfolio was likely to produce an annual gross return of Consumer Price Index (CPI) of plus 2% (before deduction for tax and expenses (CPI + 0.75%) and damage inflation (CPI +1%)).
- That the resultant figure was 2% less 1.75% = +0.25%. This was the figure which the Government Actuary described as being the annual rate of return he would expect the mid-range portfolio to produce over the period (43 years) but acknowledged that it may produce more or less with equal likelihood.
The Lord Chancellor’s decision
However rather than set the rate at positive 0.25% using this analysis, the Lord Chancellor adjusted the discount rate downwards by 0.5% to minus 0.25% because he felt that there may be ‘too great a risk that the representative claimant will be undercompensated” (risk 50%) or undercompensated by more than 10% (risk 35%). The adjustment has the consequence that the representative Claimant now has 67% chance of receiving of (at least) 100% compensation and 78% of receiving (at least) 90% compensation. The sceptic might turn those percentages around and say the representative claimant now has at least a 50% chance of being overcompensated, and a 22% (or at least 1:5) chance of being overcompensated by more than 10%.
The Lord Chancellor noted the GAD’s analysis of dual rates, which was “interesting with some promising indications” but it was not appropriate at this stage to adopt a dual rate until it had received further detailed consideration and impact analysis.
One might have thought that if the aim of compensation “is to award such a sum of money as will amount to no more, and at the same time no less, than the net loss” then the simplest thing for the Lord Chancellor to have done was to have set the rate at +0.25% on the basis of the GAD’s advice. At +0.25% the risk is 50:50 between a Claimant recovering too much and recovering too little. That decision could easily have been justified as one that was fair to Claimants and Defendants alike. But the logic of the Lord Chancellor’s decision – no doubt guided by his regard to the principle of full compensation – is that when setting a discount rate it is better to risk overcompensation then under-compensation and therefore a downward adjustment to the discount rate was justified. Nonetheless, while a negative discount rate might reflect short term investment risks e.g. (5, 10 and 15 year), the same is not true of longer term investment, where gross annual returns for medium risk investment as the GAD’s appendix 4 shows, are more likely to be in the region of 3.75 – 4% resulting in a real rate of return (after deductions for damages interest, tax, fees and expense) of around 1.5%.
For those dealing with high value long life expectancy cases, a discount rate of -0.25% is still, objectively, a very favourable decision for Claimants. The GAD’s suggestion that the Lord Chancellor should investigate dual rates (something that already operates in some other jurisdictions: Ontario and Jersey are mentioned) is to be welcomed. Indeed, in November 2018 we note that Jersey published a draft law proposing that the discount rates would be:
- +0.5% – where the lump sum is to cover a period of up to 20 years
- +1.8% – where the damages will cover a period of more than 20 years (applicable to the whole of the award, not just the costs arising after the first 20 years).
which are very significantly higher discount rates than that applied by the Lord Chancellor.
Overall, the long-awaited discount rate decision has been something of a surprise. It is lower than many expected and has come with an indication that dual rates may be something to be pursued in the future. Thus while there is some ‘certainty’ for now, one cannot help but think that at the next review there is a real possibility of the introduction of dual rates to avoid the substantial risk of overcompensation in cases where the damages are payable over a period of more than 15 years. Having regard to the relevant provisions of the Act, there is not much certainty as to when that next review will commence. The Act requires that “each subsequent review of the rate of return must be started within the 5 year period following the last review” and that it is for the “Lord Chancellor to decide when, within the 5 year period following the last review, a …[subsequent] review is to be started.”
There will be many on the Defendant side who will say that such a review cannot commence too soon. In which case the uncertainty which led up to the present decision and was reflected in a large number of settlements for Claimants at +0.5% or +1% may well be repeated until a rate is arrived at by the Lord Chancellor which the market accepts is a ‘fair’ one.