UK: Full Compensation & The Discount Rate: Revisited

Last Updated: 11 January 2018
Article by Julian Chamberlayne

Julian Chamberlayne, Head of International Injury, reviews the Justice Committee's report on the discount rate

The Justice Committee acknowledges early in its recent report, issued as part of its inquiry into draft legislation related to the personal injury discount rate that 'a negative discount rate was counterintuitive because it requires that a sum paid now will be worth less in the future. It is usually the other way around: people would ordinarily expect to earn a positive return on the sum received,' (see Pre-legislative scrutiny: draft personal injury discount rate clause, 30 November 2017).

This quote reminded me of Daniel Kahneman's seminal work, Thinking, Fast and Slow. Kahneman observed that our initial reactions are frequently directly contrary to what careful analysis of statistics and evidence would lead you to. The Justice Committee quite rightly flagged the danger of thinking too fast on this issue commenting: `The evidence currently presented by the Government concerning claimant investor behaviour is thin`. Sensibly, the committee has called on the Government to clarify its aims, gather proper evidence about how claimants invest lump-sum damages and ensure adequate safeguards to prevent under-compensation of the most vulnerable claimants.

The Justice Committee also recognised that there were other aspects of the law of damages that needed to be addressed in tandem with any discount rate change. They hoped the Civil Procedure Rule Committee would look at the Pt 36 point made by the Forum of Complex Injuries Solicitors, in its submission to the inquiry, that insurers should not be allowed to put financial pressure to settle on seriously injured claimants without offering them periodical payment order (PPO) terms.

The committee also picked up on a point made by my firm, Stewarts, in its submission that 'until claimants are fully compensated for accommodation loss, this will continue to be a driver towards lump sum rather than PPO settlements. Reforming compensation for accommodation losses is an aspect of the consultation on the law of damages back in 2007 and it is high time the Government dusts off those responses and takes action`.

It is telling that those consultation responses on numerous important compensatory issues (including the incompatibility of the Fatal Accidents Act 1976 with the European Convention on Human Rights) have been ignored for 10 years, whereas within weeks of the change to a negative discount rate announced earlier this year the insurance lobby had forced the Government into action.

The challenge of the evidence gathering exercise called for by the Justice Committee contrasts with the compelling simplicity of continuing the ILGS (index linked gilts) approach that followed Wells v Wells [1999] AC 345, [1998] 3 All ER 481. One of the real beauties of ILGS as a proxy for the discount rate is that it is the only measure which avoids crystal ball gazing about both inflation and investor returns.

A further factor that the Justice Committee recognised is that not all claimants would seek investment advice and so we cannot just try and look at the evidence from investment advisers to get the full picture. Richard Cropper, an investment adviser who has spent his whole career providing financial advice to recipients of personal injury damages, gave evidence to the committee that: `I have clients who unfortunately have less than 10 years to live. They have no capacity for loss, so they are in cash....They are getting a negative 3.5% yield and net. They are being woefully undercompensated, even at the current discount rate'.

Cropper further explained that his advice to claimants was predominantly based on their needs rather than the risk profile. He highlighted the following danger: `If we set the discount rate by reference to past returns, which is the only way in a basket, then we are going to find ourselves increasing the discount rate at the peak and reducing the amount of compensation to a claimant who then has the most investment risk – having to invest today at what feels like an elevated price'.

The courts are well-known for thinking slow, rather than fast, and requiring compelling evidence. Each time in recent years when such evidence has been presented to common law courts they have settled upon a negative discount rate conclusion and also allowed 1.5%-2% differential for earnings inflation: see Helmot v Simon [2012] UKPC 5 and the Bermuda Court of Appeal decision Thomson v Thomson et al No 14 of 2015. No doubt careful thinking is behind the cautious reserving for PPOs by insurers, (-1.55-2% and by the Government at -0.8%).

Likewise the expert report commissioned by the Ministry of Justice (MoJ) in 2015 was a further example of thinking slow pointing to a more cautious approach and likely negative discount rate. Perhaps Justice Minister Lord Keen is starting to realise this when, before the committee, he appeared to backtrack from the indicative 0-1% rate that had been suggested when publishing the draft legislation: `I emphasised that it was not intended as an estimate of what the rate will be. With the benefit of hindsight, it is perhaps unfortunate that the figure was there, but it was just to indicate the direction of travel when you moved the risk element of the portfolio.'

The committee was also critical of the Government's impact assessment and made the important observation that: `We do not think there is sufficient evidence for the Government conclusion that its proposed legislation is a proportionate means of achieving a legitimate aim, so as to justify possible disadvantages to those with protected characteristics. Indeed, without adequate evidence about the potential characteristics of claimants, or the cost to claimants, it is hard to see how the Government can draw any sound conclusion about proportionality'.

The Government has said repeatedly that it intends to preserve the full compensation principle. Even the insurance lobby says that it subscribes to that principle, but there is no such thing as an average claimant and we cannot have a system in which a substantial minority of severely injured are, through no fault of their own, seriously undercompensated. It was heartening to see the Justice Committee recognise this. We can only hope the MoJ will think slowly about this issue, undertake the necessary research and at the same time address the related issues concerning the law of damages.

This article first appeared in the New Law Journal, the original can be found here.

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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