UK: UK Government Announces Plans To Change The Discount Rate

Last Updated: 15 September 2017
Article by Elena Fry and Kate Donachie

Yesterday, the UK Government published a paper along with draft legislation in response to this year's consultation on the discount rate. The proposed changes are likely to result in a discount rate between 0 and 1%. The timescale for any such change is not set out but it seems it may not happen any sooner than 12 months from now. However, the paper does provide answers to questions that have been asked but left unanswered by successive governments; how, when and by whom should the discount rate be changed?

The discount rate is used to calculate a lump sum for future ongoing losses. The current discount rate is -0.75% and was changed to that figure in England on 20 March 2017 and in Scotland on 28 March.

When she announced the change in England, the Lord Chancellor also announced a consultation on the correct mechanism for fixing the discount rate. Her discomfort at the new discount rate was obvious, however she considered herself bound by the current law to fix the rate at -0.75%. The consultation was therefore to consider changes to the underlying principles that dictate the calculation of the discount rate. The consultation closed on 11 May 2017 and a response was planned for 3 August 2017. However no response was issued on that date and the following day it was announced that there would be an unspecified delay.

That delay did not come as a surprise. There have been several previous consultations which sought to answer the same questions; stakeholders were asked for their views on the correct way to calculate the discount rate in 2012, 2013, 2015 and 2016. Yet none of those consultations reported with recommendations.

However, yesterday the UK Government did finally publish a response to the most recent consultation, a paper on the correct method for determining a discount rate along with draft legislation.

Although the consultation was a joint one, held by the UK and Scottish Governments, the current proposals extend only to England and Wales. However the Scottish Government has previously stated that there is no basis for a different approach north of the Border. Further, the Scottish Government's legislative programme for 2017/18 (published on Tuesday) includes a Damages Bill, which will "amend the law on the discount rate following the joint consultation with the UK Government". Accordingly, it seems likely that the Scottish Government will follow the UK Government's lead in any changes.

What is proposed?

The consultation posed three questions; how should the discount rate be changed, when should it be changed and by whom? Those questions are answered in the UK Government's proposal as follows:

  1. How? - with reference to the actual investment practice of claimants and the actual investment returns to be expected.
  2. When? - every three years or more frequently. Once such a review begins it must be concluded within 90 days.
  3. By whom? - the Lord Chancellor, who is obliged to consult a panel of experts. The panel will be chaired by the UK Government actuary and will include four others including those with expertise as an actuary, an investment manager, an economist and someone with expertise in consumer investment affairs. The HM Treasury will be a statutory consultee at all such reviews.

This represents a fundamental change to the current principles. The existing law was set down by the then House of Lords' decision in Wells v Wells 1999 1 AC 345. In that case it was stated that the rate should be calculated on the basis that the claimant is a "very risk-averse investor". Application of that principle resulted in the rate being fixed with reference to yields on index linked gilts. The current proposals require that the claimant is viewed as willing to take "more risk than a very low level of risk but less risk that would ordinarily be accepted by a prudent and properly advised individual who has different financial aims". The focus is on what claimants actually do and what returns they can actually expect. In that regard the proposals appear eminently sensible.

It was accepted by financial advisors responding to the consultation that claimants are never advised to invest exclusively in Index Linked Gilts. nor do they; the notional claimant who took almost no risk was just that, notional.

Responses to the consultation were not agreed in relation to the correct timescale for review of the rate. The current proposal is that the rate should be reviewed at intervals no greater than three years. There is obviously a balance to be struck between ensuring an accurate rate and avoiding uncertainty about the value of claims. At present it is difficult to estimate the likely effect of such frequent reviews although it should be noted that there is no requirement for the rate to change at each review. It will also be possible to have a review within a shorter timescale, if there is reason to do so.

There was also a lack of agreement about who should make the decision. It has been concluded that there should be full political accountability for the decision and that therefore it is ultimately for the Lord Chancellor to determine the rate. This proposal will disappoint those who argued that the decision-maker should be politically independent. Their concern was that policy and economic considerations may prevent the correct rate being set. The proposed system can be compared to the current Bank of England system for fixing interest rates.

The current proposals allow the UK Government to maintain its commitment to the principle of 100% compensation. That is, that a claimant should be compensated for all of their loss, but no more. Some of the responses to the consultation suggested that this principle should be abandoned because the cost of claims was otherwise intolerably high. The UK Government's proposals include the conclusion that the current discount rate results in over compensation and in that way the UK Government avoids difficult questions about economics and funding policies. However, as the application of the 100% compensation principle should remove such economic and policy considerations, the need for political accountability is a little difficult to understand.

What are the practical implications?

The response contains only proposed legislation. It is stated that responses to the proposals are sought but no final date for such responses is given. If the proposals do become a Bill, it will be subject to the scrutiny of Parliament. Despite the UK Government's statement that it will legislate promptly and its obvious desire to change the rate as soon as possible, it seems unlikely that the legislation will be passed before the end of the year. Although the Scottish Government could pass its own legislation sooner, it seems more likely that it will await a decision in England and Wales before making changes in Scotland.

If the proposed legislation is passed, the Lord Chancellor will have a further six months in which to arrive at a new discount rate.

If the proposals are accepted, the discount rate will increase and thereafter be reviewed on a regular basis. However the immediate timescale for any such change remains unclear and it could be as long as a year before the current discount rate is changed.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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