The Discount Rate: Where are we now? How did we get here? And where might we be going?
August 14, 2017
By Amanda Yip QC
Personal injury lawyers on both sides of the claimant-defendant divide were busily refreshing the MOJ website on 3rd August 2017 when an announcement about the discount rate was expected. All they learnt was that the response would be published “in due course”. Until the review is complete and the outcome is known, we will continue in a climate of uncertainty. It is important for practitioners to be aware of the principles underlying the setting of the discount rate and to think sensibly, and at times creatively, about what they are seeking to achieve. Settling personal injury claims has become more difficult; the unthinking application of multipliers sometimes without really understanding their basis cannot continue. However, armed with a good understanding of how the discount rate operates, sensible lawyers will find opportunities to achieve good results for their clients. With that in mind, this article looks at history of the discount rate; where we are now and what may come next.
Life before Ogden
It is striking how much the quantification of personal injury damages has changed in a relatively short time. The practice of assessing separate heads of loss only really started in the 1970’s. Even then the assessment of damages was very ‘rough and ready’ with quantification being seen as an art rather than a science. The use of multipliers underpinned by a ‘discount rate’ developed in a rather ad hoc way. There was a conventional ceiling of 18 for the lifetime multiplier and generally a whole number was selected, often around 11 or 12 for an adult.
The Ogden Tables were first published in 1984. There were only 6 tables, compared to the current 28. In the introductory notes, the Working Party concluded that while the courts were then conventionally using multipliers implicitly assuming a discount rate of between 4% and 5%, it would be fairer to work on the basis of multipliers calculated by reference to returns on Index-Linked Government Stock (ILGS).
Index-Linked Government Stock
The Government introduced index-linked gilts in 1981. They are government bonds that pay interest at a rate that is linked to the RPI. The term ‘gilts’ reflects the security of the investment. Interest and principal payments are guaranteed by the Government so they offer a very safe vehicle for investment with the advantage of protecting against inflation. However, there are significant limitations. ILGS are only released periodically and in fairly random tranches. The stock has a fixed life. There is no consistent stream of ILGS maturing each year. Only institutions and not individuals can buy the stock at issue. Therefore personal injury claimants are only able to access ILGS on the re-sale market where there can be fluctuations in value. Although setting the discount rate has evolved around the idea that personal injury claimants will invest in ILGS that is better seen as a theory rather than a reality.
The Damages Act 1996
In 1994, the Law Commission recommended that courts should take into account the returns on ILGS with provision for the Lord Chancellor to prescribe an alternative indicator. The Act took a different approach, giving the Lord Chancellor the power to set the default discount rate but allowing the courts to take a different rate of return into account if “more appropriate”. The Act came into force in September 1996 but the power to set the rate was not exercised until 2001.
Wells v Wells
In 1999, the House of Lords considered how multipliers for future loss should be calculated in three linked appeals, Wells v Wells; Thomas v Brighton Health Authority; Page v Sheerness Steel Co. PLC  A.C. 345. The House of Lords concluded that the lump sum should be calculated on the basis of the rate of return available on ILGS.
The House set a guideline rate of 3%, deriving this from the net average return of ILGS, the majority considering that the average should be taken over the past 3 years. It was suggested that “only a marked change of economic circumstances should entitle any party to re-open the debate in advance of a decision by the Lord Chancellor”. One reading of this is that the House of Lords was not intending to tie the hands of the Lord Chancellor as to how the rate was set under section 1 of the Damages Act 1996. However, it is interesting to note that the last Lord Chancellor appears to have accepted that any change in the methodology adopted in setting the discount rate under the powers conferred on her by section 1 would require primary legislation. Recent debate also seems to accept this.
The Damages (Personal Injury) Order 2001
Finally, on 25th June 2001, the then Lord Chancellor, Lord Irvine, exercised his powers and set the rate at 2.5%, based on the three-year average yield on ILGS. The rate was subject to immediate criticism suggesting that it was in fact too high. No doubt with an eye to possible Judicial Review, the Lord Chancellor reconsidered the decision afresh and on 27th July 2001 restated that 2.5% was the appropriate rate, giving more detailed reasons for that. The statement indicated that the Lord Chancellor had applied the appropriate legal principles laid down authoritatively by the courts and in particulars in Wells v Wells. It noted the desirability of setting a single rate to cover all cases and one that was easy for all parties and their lawyers to apply in practice across a range of different circumstances over a period of time. It also referred to the detrimental effect (particularly on settlements) of frequent changes to the discount rate.
Lord Chancellor’s review of the discount rate
Following repeated calls for the rate set in 2001 to be reviewed and intimation of a claim for Judicial Review by the Association of Personal Injury Lawyers, on 1st August 2012, the first consultation paper was launched, entitled “Damages Act 1996: The Discount Rate and how should it be set”. This was followed in 2013 by a second paper “Damages Act 1996: The Discount Rate -Review of the Legal Framework”. In 2015, the Lord Chancellor appointed a working party of financial experts. They provided their report on 7th October 2015. Following the further threat of Judicial Review and with Liz Truss now in the role of Lord Chancellor a new rate of -0.75% was set, taking effect from 20th March 2017.
Despite the controversy caused by the dramatic drop from a rate of 2.5% to one of -0.75%, in fact all the Lord Chancellor had done was to essentially repeat the exercise performed in 2001 in a very different economic climate. The methodology was not changed. The Lord Chancellor stated “I am clear that this is the only legally acceptable rate I can set.” She was merely applying the principles laid down in Wells v Wells. That involved assuming that a claimant would invest wholly in ILGS.
The new consultation opened on 30th March 2017 and closed on 11th May 2017.
So where are we now?
For cases coming on for trial, the rate is -0.75%. Where trial will not take place before the end of the year, there is unfortunately uncertainty. Defendants generally are anticipating that there will be either a change in rate or a change in methodology that will benefit them. There is therefore a reluctance to settle claims, certainly on the basis of a discount rate of -0.75%.
There are possible solutions. There may be opportunities to settle some claims where liability is in dispute or where there are particular uncertainties over quantum. For some claimants, securing a sum that can be made to work may well be preferable than waiting until there is a clearer view of where we will end up. The appropriate approach to any settlement is very fact specific and calls for creative thinking and a sensible approach. In some respects, it may be useful to move away a little from our way of thinking that there is a single “right” valuation of a claim. For adult claimants with capacity, they may choose to take what they can get now. Good financial advice prior to settlement may allow claimants to really see the options and recognise the choices available to them.
What comes next?
The Consultation Paper says this:
“Following the consultation, which will consider whether there is a better or fairer framework for claimants and defendants, the Government will bring forward any necessary legislation at an early stage.”
The Lord Chancellor considered herself bound by Wells v Wells and therefore concluded that -0.75% was the only rate she could set. However, the House of Lords clearly did not rule out the possibility that the Government would take a different view.
Lord Lloyd said this:
“No doubt insurance premiums will have to increase to take account of the new lower rate of discount. Whether this is something which the country can afford is not a subject on which your Lordships were addressed. So we are not in a position to form any view as to the wider consequences.”
Lord Steyn’s judgment contained an important warning for claimants:
“It must not be assumed that the 100 per cent principle is self-evidently the only sensible compensation system.”
However, the Lord Chancellor appeared to commit to the principle of 100% compensation in the consultation document, expressly stating:
“The 100% rule will continue to apply.”
Once the principle of 100% compensation is accepted, it seems that the real issue is whether the assumption that claimants are to be treated as a special category of investor who will invest only in ILGS should remain. Whether a different solution can be found which still meets the 100% principle remains to be seen. There is much speculation that the discount rate will be brought back up, perhaps ending up at around 1%. However, this speculation is not always underpinned by any particular analysis. It will be interesting to see what additional information is going to emerge from the latest consultation, particularly bearing in mind that the Ministry of Justice has already had a detailed report from the very experienced Working Party briefed to assist with the last review. The Working Party paper is not particularly easy to locate but may be found with this link:
At Chapter 4, the Working Party considered a “financial economics approach to the discount rate” and in particular two possible low risk portfolios. The panel were unanimous that any portfolio involving less than 50% in ILGS and more than 50% in an optimal mix of more risky investments would be inappropriate for a very low risk investor. A portfolio of 50% ILGS and 50% mixed riskier investments would produce a discount rate of 0.75%. A portfolio of 75% ILGS and 25% other investments would produce a discount rate of 0%. So far, I have not seen any other analysis leading to a suggestion for specific alternative discount rates.
We will find out “in due course” whether the use of low risk mixed portfolios is to be adopted or whether a wholly new methodology is to be applied. In the meantime, the debate will continue. Such debate needs to be properly informed by the underlying principles.