Compensation is to put an injured person back in the position he/she would have been had the accident not occurred. For persons who have suffered life-changing injuries, there can be many future losses such as loss of earnings, treatment and care needs. Where lump sum payments are made, the discount rate is applied to account for investment.
What is the discount rate?
The discount rate is a multiplier used to adjust compensation for future losses to take into account interest and inflation. Currently, the discount rate is set at -0.75%.
Why all the fuss?
If the rate is too high an injured person will not receive enough compensation to take into account inflation and if the rate is too low an injured person could be overcompensated.
Before 20th March 2017, the rate was 2.5% and had been this rate for some years since 2001. There was a heavy criticism of this, as the rate was linked to the Index-Linked Government Stock (ILGS) and the yield on this fell significantly below the 2.5% rate leading to injured persons not receiving enough compensation to cover future losses. From March 2017, the rate was reduced to -0.75%. This resulted in a significant increase in the value for future losses. Immediate uproar ensued as the insurance industry reeled from this change and has since argued for the discount rate to change. As a result, the Ministry of Justice commenced a consultation process.
Changes to the discount rate are detailed in the Civil Liability Bill which had its first reading in the House of Lords on 20th March 2018. The second reading is due to take place on 24th April 2018. In summary, the Government are of the view that the discount rate is unrealistic and injured persons are receiving larger awards than necessary to provide 100% compensation.
The proposed changes are as follows:
- The rate will be set by reference to expected rates of return on a low-risk diversified portfolio of investments rather than very low risk investments as at present. Low-risk is less risk than would be taken by an ordinary prudent investor and more risk than very low risk.
- The rate will be reviewed promptly after the legislation comes into force and, thereafter, at least every three years.
- The rate will be set by the Lord Chancellor following consultation with an expert panel (other than on the initial review which would be by the Lord Chancellor with advice from the Government Actuary) and, as at present, HM Treasury.
The changes are set to come into effect in April 2019 and a new discount rate will be calculated. It is anticipated the new rate will be set between 0-1% which will reduce compensation for future losses.
The insurance industry have predictably welcomed the changes as the anticipated new rate will see them paying much less in compensation. It is yet to be seen whether these savings will be passed on to customers and reduce insurance policies. However what is looking clear is that it is expected injured persons will have to invest settlement payments at a slightly riskier level.