02/11/2012

 

Consultation Paper: Damages Act 1996, the discount rate – how should it be set?

The Ministry of Justice has launched a consultation into how the discount rate used to determine the amount of future losses in personal injury claims should be set.   The fundamental issue at the heart of the consultation is the extent to which seriously injured Claimants should be regarded as a special class of citizens who require a higher level of financial protection than the rest of society.

The purpose of the discount rate is to reflect the real rate of return that a Claimant should be able to achieve on investing a lump sum award of damages, after taking into account the effects of inflation and tax.  Any change in that rate would inevitably have a very significant effect on compensation levels. Take, for example, two different Claimants whose annual care needs will cost £100,000.  The table below illustrates the effect on the future loss award with a change of discount rate from the current rate of 2.5% to 1%.

The possible effect of a change

 Gender/ Age  Award (Mulitplier @2.5%)  Award (Multiplier @1%)

%Increase (£) 

 Male (10)  £3.372m  £5.269m  56% (£1.9m)
 Female (30)  £3.015m  £4.34m  44% (£1.33m)
 

Despite the significance of this issue, the consultation process (which closed on 23 October) has an extremely narrow focus, primarily asking for views on two alternate methodologies for assessing the rate: should Claimants be assumed to invest in ‘ultra-safe’ index linked government stock (ILGS) or in a broader portfolio of ‘low risk’

 

The Current view – Claimants as protected investors?

 In the House of Lords case of Wells and Wells [1998], it was decided that successful Claimants should not be regarded as ordinary investors as they are heavily reliant on the damages award received to pay for necessities of life.  Accordingly, they needed to be protected from market fluctuations and should not be forced to make even low-risk investments to maintain the value of their compensation.

When the responsibility for setting the discount rate moved to the Lord Chancellor at the turn of the century, he largely adopted that logic and set the discount rate at 2.5% per annum, being roughly the average yield on index-Linked Government Stock (ILGS) at the time. Since then, Claimants  argue that yields from ILGS have dropped off significantly and that the discount rate should follow suit.

A new approach?

The aim of the consultation is to canvass views on the methodology by which the discount rate should be set, but within very narrow confines which may make a reduction in the rate almost inevitable.  If the discount rate is based on either ILGS or a ‘low-risk’ portfolio it is likely that the discount rate will reduce.  Claimants will achieve security, but will do so at the expense of the rest of society, either with increased insurance premiums or reduced public sector funds.

So what are the questions that the consultation should be asking? In our view the consultation should be far wider in scope and ask more basic questions:

  • Should successful Claimants be in a special category of protected persons who are immune to the financial risks faced by the rest of the population?
  • Should the discount rate reflect only ‘low-risk’ portfolios or a truly mixed portfolio, perhaps reflecting the investment strategies Claimants (and others) actually use?

To its credit, the consultation paper does ask one of the important questions:

 

What do Claimants actually do with their damages?

The evidence we see suggests that Claimants in reality do not invest all their damages in ILGS and never have done. Instead, they turn to Independent Financial Advisers who, perhaps inevitably, seem to advise investment in a fairly mixed portfolio.  IM Asset Management, the investment arm of one of the most successful Claimant firms in the country (Irwin Mitchell) indicates that even its ‘cautious fund’ invests  heavily (30%) in FTSE  equities.  Even in these straightened times, the fund boasts a yield of over 4.5%.  In the ‘balanced’ fund the investment in UK equities rises to almost 62% and the yield is still maintained at about 4.2%. 

What else do they invest in on behalf of their clients? Again, looking at IM Asset Management‘s data, there are a number of other relatively safe investment options available to Claimants, for example company bonds (by way of example, Tesco launched a set of index-linked +1% bonds in December 2011).  Whilst no-one would advocate investing all one’s money into a single company bond scheme, utilising a number of such schemes in combination with other relatively low risk investments , the risk can either be spread or minimised and the return maximised.

Unfortunately, however, the paper does not ask the other, more fundamental question:

Affordability: can the country afford a discount rate change?

In fact, the paper specifically says that affordability is not an issue that it should consider.  But the question remains and should go to the heart of the matter: in real terms, can the country afford the financial effects of a change in the discount rate?  Where is the money going to come from? In NHS cases it comes out of the already-squeezed NHS budget and in private sector cases we can fairly safely presume that will be covered by increased insurance premiums.  In other words, directly or indirectly, it comes from us.

But if it creates justice, surely it’s worth it?  Whilst a reduction in the discount rate would increase damages to some of the most seriously injured Claimants, does it grant justice to society as a whole?  Take, for example, two sufferers of cerebral palsy, where one can prove that his/her condition is a result of negligence and the other cannot.   The level of care and support the victim of negligence can expect may well be a 24-hour care package with multiple carers, 24 hours a day over his/her lifetime, living in a ‘nursing home for one’, perhaps with a multi-sensory room or even a hydrotherapy pool on site.  Compare that to the other cerebral palsy sufferer who has similar needs but is left reliant on family and the vagaries of state-funded care to meet his/her requirements.  If public sector budgets suffer further cuts to meet increased damages payouts, the (already huge) gulf between our two cerebral palsy victims will widen further.  In the private sector, motor insurance for young males under the age of 21/25 becomes even more unaffordable and the number of uninsured drivers will go up.  Is this really justice in action? 

 

Conclusions

In our view the scope of the consultation paper is far too narrow.  The real issues go far beyond whether an individual Claimant should have his/her damages assessed on the basis that the money will be invested in ILGS or not.  There needs to be a wider debate, prepared to deal with the difficult issues of:

(a)   Whether or not we want to create an ultra-protected class of successful litigants who will live within a financially risk-free bubble that the rest of society can only dream of (or whether they should accept similar financial risks to the rest of us); and, if so:

(b)   Whether or not we are willing to pay the price for it, both in financial terms by way of increased insurance costs and, in service terms, by way of further public sector budget reductions.      

It is a great shame that the consultation paper so clearly avoids not just one, but both of these issues.

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