21 December 2016 Insurance

UK discount rate for personal injury damages review ‘potentially game changing’

Lord Chancellor’s decision to review the discount rate for personal injury damages, which is being legally challenged by the Association of British Insurers (ABI), is potentially game changing, according to law firm Clyde & Co.

The Association of British Insurers (ABI) on Dec. 19 launched a legal challenge of the Lord Chancellor’s decision to review the discount rate for personal injury damages, calling on the Government to complete its consultation and change the methodology before proceeding.

Without doing so the review will take a flawed approach based on a fundamental misunderstanding of how people invest their compensation, the ABI said.

The discount rate is a tool designed to ensure claimants are not under or over-compensated. It adjusts personal injury damages awards to take into account the return expected when a compensation lump sum is invested.

Peter Walmsley, partner at Clyde & Co, said: "The ABI has taken the unusual step of pre-empting the decision of the Lord Chancellor expected at the end of January that may change how personal injury compensation claims will be calculated. While it is impossible to know which way the government will go, we believe the ABI is right to flag up insurers’ concerns around lump-sum payments for life-changing injuries. "

The Lord Chancellor announced on Dec. 7 that a review of the discount rate would be complete by Jan. 31, 2017. In her statement the Lord Chancellor conceded that any change could have ‘profound financial consequences’. The current discount rate is set at 2.5 percent.

The UK is an outlier internationally in its reliance on a single measure when determining the discount rate (gross redemption yields of Index-Linked Government Gilts) rather than a formula similar to one used by a real life investor, according to ABI.

Nowhere else in Europe follows this flawed methodology and the ABI says it is critical the Lord Chancellor update it.

"A decision on the discount rate by the government could potentially cost insurance companies, and their customers, hundreds of millions of pounds,” said Walmsley. “While there have been two comprehensive consultations, and a review by a panel of government appointed experts, worryingly the government has never published the results of the Consultations or the findings of the panel.

"Even small percentage changes would have a significant impact on the pay-outs that insurers will need to make. If Ms Truss decides the time is now right to introduce a lower rate, claimants are more likely to seek larger lump sums up front that could severely impact the industry."

The discount rate is a tool that adjusts personal injury damages awards to take into account the return expected when a compensation lump sum is invested and to ensure that claimants are not under or over-compensated.

It has been set at 2.5 percent since 2001 and governs all compensation awards in England and Wales. In Europe, it is typically between 1 percent and 4 percent.

In the past the rate has been based largely on the gross redemption yields of Index-Linked Government Securities (ILGS). The principle of full compensation, which the ABI entirely accepts, is that injured claimants should neither be under-compensated nor over-compensated. This is no longer served by the linkage to ILGS because the long-term investment behaviour of those compensated is, in practice, very different. The Lord Chancellor needs to conclude the process of finding the right way of achieving the full compensation principle.

The consultation goes a long way back. The then Lord Chancellor consulted in 2012 on the methodology that should be adopted in setting the discount rate and in 2013 on a review of the legal framework for setting the rate. The ABI responded to these consultations but no response has ever been issued by the Ministry of Justice. This is a breach of Cabinet Office guidelines and promises made at the time, the ABI said.

In 2015 a panel of experts was appointed to consider the responses to the consultations and advise the then Lord Chancellor on the rate review and they reported in January 2016.  That report has not been published either, according to ABI.

On Dec. 7, 2016 the Lord Chancellor announced that she would review the rate by Jan. 31, 2017. No further information was published and no statement to Parliament was made, according to ABI.

"There has been no opportunity for the insurance industry, or the Claimant lawyers, to respond to the results of the consultations and voice their concerns.  Despite the length of time that has passed since the first Consultation, the decision appears to be being rushed through without completing a proper and full consultation of all the stakeholders impacted.  It is only right that the insurance industry is properly consulted on this potentially game changing decision.

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