The New Discount Rate – ‘It’s here, but how did we get here?’

The Lord Chancellor announced the new personal injury discount rate of -0.25% to take effect from 5th August 2019.  It will cover all personal injury claims, irrespective of the term of the future loss.

It is Nestor’s view that this new rate appears to be a reasonable and fair position for the Lord Chancellor to take in the interests of ensuring the 100% damages principle is applied.

The provisions of the relevant sections of the Civil Liability Act 2018, which amended the Damages Act 1996, enshrine the principle of ‘low-risk’ investing rather than the previous ‘no-risk’ portfolio of Index Linked Gilts. The -0.25% rate takes into account how and where personal injury claimants invest their damages to reflect real-world investing. Taking advice from a suitably qualified and experienced independent financial adviser now takes centre stage. Full future loss compensation can only be achieved with suitable advice.

Why is the rate set at -0.25%?

Under the provisions of the Civil Liability Act, the Lord Chancellor, when conducting the first review of the rate was compelled to consult with the Government Actuary’s Department (GAD).  Despite the lack of an expert panel for this first time setting of the ‘low-risk’ rate, the GAD consulted widely with many of the organisations that took the time to respond to the consultation, including Nestor.  It appears the Lord Chancellor has fully understood from the Government Actuary the investment position in which claimants find themselves.

The central points of his determination of the new rate and the Lord Chancellor’s reference to GAD advice are summarised below:

  • A single rate to cover all claimants: The Government Actuary’s advice to the Lord Chancellor explored the idea of having two distinct discount rates (based on term of loss). The Lord Chancellor decided to stick to one rate for all claimants based upon simplicity of use and certainty. Although he did not completely ignore the logical twin-rate approach, we now know that for the next few years, a single rate covers all claimants.
  • A 43-year average term/loss period: The Government Actuary assessed that the average term for a personal injury claimant’s losses was 43-years. This was based upon evidence gathered during their consultations. This loss period determines the level of investment return.
  • A mid-range ‘central’ risk portfolio was considered correct: The Government Actuary, based upon evidence gathered during the consultation, determined that a 42.5% allocation to ‘higher risk growth-assets’ such as shares and 57.5% to ‘lower-risk matching assets’ was a suitable median point. This was considered by the Government Actuary to be sufficiently ‘low-risk’ to adhere to the wording of the legislation.
  • CPI + 1% was the correct damages inflation: The Government Actuary concluded that Consumer Price Index (CPI) plus 1% reflects the real inflationary pressures experienced by personal injury claimants.
  • Charges, Expenses & Tax drag was 0.75%: Based on the evidence, the Government Actuary concluded that the cost and taxation on an average personal injury portfolio was 0.75% per annum.

Taking all these assumptions into account results in the following return:

% per annum above CPI

Representative Claimant

Expected Gross Return before deductions

CPI + 2.0% PA

Deduction for tax & expenses

0.75% PA

Deduction for Damages Inflation

1.00% PA

Expected Net Return:

CPI + 0.25% PA

A discount rate therefore set at +0.25% would mean that there would be a 50/50 percent chance of a claimant being under compensated:

‘Whilst it might be possible to set the PI discount rate equal to this median net portfolio return of CPI + 0.25% pa, there is a 50/50 likelihood that a representative claimant experiences a rate of return that is lower than this level. To safeguard claimants from some of the effects of lower than expected investment performance, it may be considered appropriate to set the PI discount rate at a lower level than the expected portfolio return’.(1)

(1) Para 4.25 of the GAD report 25th June 2019.

From the Lord Chancellor’s perspective and in accordance with the fundamental requirement to uphold, as best he can, the 100% principle, he was bound to consider reducing this figure to ensure that a greater percentage of claimants were not exposed to the prospect of being undercompensated. Given that there is only going to be one discount rate to cover all claims and terms of loss, he was under a duty to ensure that the 50/50 chance was further weighted to ensure the 100% principle.

To quote the Lord Chancellor:

‘I note that, on the baseline assumptions, at a rate of minus 0.25%, the representative claimant as modelled by the Government Actuary has approximately a two-thirds chance of receiving full compensation and a 78% chance of receiving at least 90% compensation. Such a claimant is approximately twice as likely to be overcompensated as under-compensated and is approximately four times as likely to receive at least 90% compensation as they are to be under-compensated by more than 10%. I consider that this leaves a reasonable additional margin of prudence which reflects the sensitivities of the rate to the baseline assumptions.

Para 20 of the Lord Chancellor’s statement on the 15th July 2019.

Nestor has been involved in all aspects of the discount rate journey since the -0.75% decision back in 2017.  We are pleased with this outcome and welcome the Lord Chancellor’s prudence with the new rate.  Questions remain over the matter of appropriate compensation for accommodation claims now that it has been confirmed the discount rate remains in negative territory.  Now, more than ever, personal injury claimants need help and advice with the investment choices that they need to make to ensure that their damages last throughout life. The Nestor directors are here to help. Please contact us on any aspect of personal injury investing.

Should you wish to read any of the documents referred to in this article follow the links:
To read the Lord Chancellor’s 15th July 2019 statement on the discount rate
To read the Government Actuary’s Advice to the Lord Chancellor on the 25th June 2019.
To read the Summary of Responses to the Call for Evidence on the discount rate published on the 15th July 2019.