The Personal Injury Discount Rate – Clarity at Last?

Nicholas Martin, Independent Financial Adviser at Nestor considers the latest developments on the Personal Injury Discount rate, and the Lord Chancellor’s conundrum when setting the new rate under the Civil Liability Act 2018.

The following article appeared in the Personal Injury Law Journal May 2019.

On the 19th March 2019, the Lord Chancellor announced that he is commencing his review of the Personal Injury Discount Rate under the Damages Act 1996, as amended by the Civil Liabilities Act 2018. This means that he has 140-days to conclude his review and announce the new discount rate by the latest 5th August 2019. As part of the review process, he must consult with both the Government Actuary and HM Treasury.

Part 2 of the Civil Liability Act 2018 amends the relevant sections of the Damages Act 1996 as follows:-

Determining the rate of return

4   (1)  The Lord Chancellor must comply with this paragraph when determining under  paragraph 2 or 3 whether the rate of return should be changed or kept unchanged (“the rate determination”).

(2)  The Lord Chancellor must make the rate determination on the basis that the rate of return should be the rate that, in the opinion of the Lord Chancellor, a recipient of relevant damages could reasonably be expected to achieve if the recipient invested the relevant damages for the purpose of securing that—

(a)  the relevant damages would meet the losses and costs for which they are awarded;

(b) 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

(c) the relevant damages would be exhausted at the end of the period for which they are awarded.

(3)  In making the rate determination as required by sub-paragraph (2), the Lord Chancellor must make the following assumptions—

(a) the assumption that the relevant damages are payable in a lump sum (rather than under an order for periodical payments);

(b) the assumption that the recipient of the relevant damages is properly advised on the investment of the relevant damages;

(c) the assumption that the recipient of the relevant damages invests the relevant damages in a diversified portfolio of investments;

(d) the assumption that the relevant damages are invested using an approach that involves—

(i) more risk than a very low level of risk, but

(ii) less risk than would ordinarily be accepted by a prudent and properly advised individual investor who has different financial aims.

(4)  That does not limit the assumptions which the Lord Chancellor may make.

(5)  In making the rate determination as required by sub-paragraph (2), the Lord Chancellor must—

(a)  have regard to the actual returns that are available to investors;

(b) have regard to the actual investments made by investors of relevant damages; and

(c) make such allowances for taxation, inflation and investment management costs as the Lord Chancellor thinks appropriate.

(6)  That does not limit the factors which may inform the Lord Chancellor when making the rate determination.

(7)  In this paragraph “relevant damages” means a sum awarded as damages for future pecuniary loss in an action for personal injury.

The above provisions fundamentally alter the key principle of ‘no-risk’ investing for a personal injury claimant. After years of inertia by previous Lords Chancellor, in March 2017, following a threat of judicial review, the then Lord Chancellor, Elizabeth Truss MP, altered the personal injury discount rate from 2.5% down to -0.75%. In her statement, she indicated that she was bound to set the rate according to the return available from a three-year average of real (above inflation) yields on index-linked gilts (ILGS). The 2.5% rate was last set by Lord Irvine back in 2001. Ms Truss acknowledged in her statement, that since 2001 the returns on ILGS had fallen, thus forcing her hand. In financial terms, this had a significant impact on the size of future loss damages. Assuming a future loss of £50,000 per annum and using Table 28 Ogden over a 30-year loss, the following comparison, puts the effect of the change into context:

£50,000 per annum X 21.19 =   £1,059,500  (@ the 2.5% rate)

£50,000 per annum X 33.66 =   £1,683,000 (@ the -0.75% rate)

This resulted to an increase in damages of around 38%. It was clear that when Ms Truss altered the rate so dramatically that it was going to create a storm of protest from the defendant lobby including government departments, as funders of the NHS and MoD. Ultimately the taxpayer was faced with larger potential damages pay-outs and increases in insurance premiums. The ‘multi-millionaire’ claimant became the subject of some unfortunate commentary.

It had long been accepted that the previous 2.5% discount rate had been too high for too long. Returns available on ILGS had, since 2001 been consistently reducing, meaning that throughout the last 18-years, personal injury claimants had in effect been undercompensated because of the lack of action by previous Lords Chancellor.

It was therefore considered, that the system of calculating future loss personal injury damages was long overdue for reform. It was widely accepted that personal injury claimants would or could not invest their damages into ILGS. Availability, and paucity of return, made them unattractive investments. The law was seriously in need of reform, and it was announced in March 2017 that the government were going to tackle the issue.

The first consultation: The Personal Injury Discount Rate – How Should it be set in the Future, was published in March 2017, at the same time as the rate changed. The Lord Chancellor accepted the need for reform, whilst at the same time supporting the integrity of the 100% principle (1):

It is a longstanding and basic principle in common law that when someone is wrongfully injured, they should be paid damages that compensate them fully for their injuries. The idea is to put them in the same position that they would have been in if they had not been injured, to the greatest extent possible. That means a claimant being paid no less than they should be, and no more. I remain absolutely committed to the principle of full compensation – the ‘100% principle’.

But for the courts, determining precisely what will provide full compensation for claimants, many of whom are among the most vulnerable people in society, is no easy matter. The future is inherently uncertain, we cannot know precisely how the costs of someone’s care will go up or down, we cannot always know what sort of earnings and pension they have lost out on, and we cannot always make accurate predictions about the way inflation will affect a sum of money. We do, however, know that where the award of damages includes compensation for future losses, some adjustment must be made to allow for the possibility that the claimant may invest the award. This adjustment is made by applying a discount rate.

(1): Excerpt from the statement of the Lord Chancellor, 27 February 2017

It has long been accepted that balancing the needs of personal injury victims, and the wider economic needs of defendants is fraught with difficulty. On the one hand, the law must try to ensure that personal injury claimants achieve a fair outcome and their needs are met, whilst on the other, defendant bodies need to be able to manage risk and run economically. Inevitably, there must be a balance between the two parties. Personal injury investors are not lucky lottery winners and need their damages to last for the period for which they were intended. Unfortunate headlines are not helpful. What was clear, was that the 2.5% discount rate was so wrong for so long.

The Civil Liability Act 2018 seeks to redress the imbalance. The principled idea behind the changes, seeks to compel personal injury claimants to invest their damages, seeking a return which is in excess of ILGS (no-risk), to a ‘diversified portfolio of investments’ albeit ‘less risk than would ordinarily accepted by a prudent and properly advised individual investor who has different financial aims.’  We therefore appear to move from ‘no-risk’ to ‘very low-risk’, but what does that mean?

In simple terms, for a claimant to achieve the 100% principle, the legislation and the new discount rate will assume that a personal injury claimant will be awarded a lump sum, designed to be fully exhausted at their death, which they will need to generate a return above inflation, using an investment strategy, rather than just ILGS. Claimants will be expected to subject their awards to investment risk and the vagaries of investment markets.

The Lord Chancellor therefore, has a difficult decision to make. When announcing the new rate by August 2019, he must consider carefully the reality of how investment returns behave over various timeframes, as the economic data indicates differing return characteristics depending on the period of investment. For example, the UK stock-market over the last 30-years has returned, on average, 2.5% above RPI inflation, whereas over a shorter-term, the 10-year corresponding data is 1.9% over RPI. Each asset class, including ILGS and shares shows a differing return over differing timeframes. If he is to create one simple and uniform rate for all personal injury claimants, the Lord Chancellor must pay due regard to both short and longer-term losses.

He also needs to adequately consider the cost of investment advice. By definition, a properly advised claimant, needs to take proper advice, and this costs money. Financial / Investment advice involves annual fees and charges, and if a claimant needs to establish and maintain an investment strategy, then the costs of ongoing advice and management needs to be adequately reflected in the discount rate.

The Lord Chancellor also needs to consider the effects of inflation. Although ILGS did not provide the required level of investment return, at least they were able to keep up with inflation, as measured by Retail Price Index (RPI). Under the ‘invested’ approach, the choice of the correct inflation measure is crucial to ensure fair compensation. If future losses are designed to compensate a claimant for earnings related losses, such as care, or lost earnings, then an earnings-related inflationary measure ought to be considered. Historically earnings have risen faster than general prices and the new rate should reflect this.

Finally, the Lord Chancellor is consulting with HM treasury on the effects of taxation. Whilst we have historically low rates of personal taxation at present, this may not continue over the life of the claimant and needs to be considered, as taxation reduces the rate of investment return available.

We welcome the expertise that the Lord Chancellor has called upon as part of his deliberations. We hope that the 100% principle of full and fair compensation is upheld for personal injury claimants, who have suffered life changing incidents and require care and support for the rest of their lives.  We look forward to his determination of the new rate and his rationale behind it by August 2019.

At the centre of his deliberations will be the need, as best he can, to uphold the 100% damages principle for personal injury claimants. This principle has always been central to the calculation of personal injury damages although for too long the discount rate was ignored. When the rate dramatically reduced to -0.75% in 2017 this was long overdue and as we expected a storm of protest from tortfeasors resulted. Now, two years later we are hopeful that the Lord Chancellor will be well advised to ensure fair compensation to personal injury claimants.

The recent Call for Evidence which concluded in January and the Government Actuary’s Technical Memorandum made for some interesting reading. As you would expect, Nestor responded to the MOJ with our thoughts. At the centre of our contribution was to ensure that personal injury claimants were adequately compensated and that they ought not be forced to take high levels of investment risk in order to achieve the 100% principle. Claimants, who will be forced to take investment risk to achieve fair compensation will need suitable ‘proper advice’ in accordance with the law and this must be adequately paid for.

Similar personal injury damages legislation has recently passed through the Scottish Parliament. Of note is a late amendment to increase the standard adjustment for investment advice and taxation from 0.5% to 0.75%, which will likely result in the discount rate in Scotland being reduced further. We hope that in England & Wales that the Lord Chancellor pays due regard to the actual cost of advice and the effect of taxation when determining the rate in August.