The latest on the Discount Rate from Bill Braithwaite QC
December 16, 2019
This article was originally published in the Personal Injury Lawyers Journal (PILJ) in July 2019.
I wrote my first article about multipliers over 25 years ago, at a time when it was not standard practice to use the Ogden Tables and, if you did, the rate was 4.5%. I followed on with many articles, and I travelled the country lecturing about why we should use the tables, and why 4.5% was too high. Insurers and defence solicitors used to sit in the front rows, shaking their heads, asking questions which they thought were difficult. Fortunately, I had learnt about multipliers from an actuary who was on the Ogden Committee, so that I was well primed.
And here we are, a quarter of a century later, and nothing has changed! Insurers are still, with their paid henchmen, kicking up a fuss about the discount rate. Huw Evans, Director General of the Association of British Insurers, said: “This is a bad outcome for insurance customers and taxpayers that will add costs rather than save customers money. A negative rate maintains the fiction that a claimant and their representatives will knowingly choose to invest their damages in a way that would guarantee losing them money.”. This comment is phrased to appeal to the wider public, who don’t understand that the purpose of personal injury compensation is to provide guaranteed security for a lifetime.
Dave Matcham, Chief Executive of the International Underwriting Association, said: “We have always supported a rate which fairly reflects the ‘100% compensation principle’, ensuring claimants are put in neither a lesser or more advantageous position than any ordinarily prudent investor favouring a low-risk investment approach. The government’s statement today, however, indicates that a rate of minus 0.25% leaves a claimant twice as likely to be over-compensated than under-compensated. The likely effect will be to drive up the cost of insurance for policyholders across the market.”. My emphasis is intended to highlight that this senior person doesn’t seem to comprehend that a catastrophically injured claimant is not an ordinary investor. He’s someone who, when the money runs out, faces disaster. Again, he seeks to whip up the support of the wider public. Also, where does he get the statistic that the new rate makes it twice as likely that a claimant will be over-compensated?
Martin Milliner of LV said “Today’s announcement whist replacing the absurd and fiscally irresponsible decision to cut the Ogden Discount Rate to -0.75%, doesn’t in our view go far enough. At this level we believe that claimants will remain over-compensated….”. This is really just an uninformed soundbite.
David Williams of AXA said: “A negative rate simply does not reflect the economic reality of the investment opportunities for those receiving lump sum payments. The new rate sadly may stop the reduction in motor insurance premiums we have seen in recent months, as well as placing a huge burden on the NHS. ”. My emphasis is because claimants at this level aren’t looking for investment opportunities, but security.
Tony Cawley, member of the Forum of Insurance Lawyers and partner at Clyde & Co, said: “….FOIL does not believe that the new rate reflects how claimants actually invest their damages.”. See below for my comment on this point.
I think it’s helpful to understand the basic principles. Claimants should not be forced to run significant risk with their lump sum; it used to be no risk, but it’s now low risk – that’s a Government decision, changing the law set down in Wells v Wells in 1998. Much as I disagree with the decision, it is what it is, and it’s here to stay. For what it’s worth, that’s a significant result for insurers, based, in my opinion, on a false premise. They have argued for at least 20 years that, because anecdotally claimants do not put all their lump sum into GILTS, that shows that the basic premise of using GILTS as the yardstick (Wells v Wells) was wrong. The flaw in the argument seems to me to be this; if you award a lump sum based on the notion that a claimant has to achieve 2.5%, after tax and after inflation, you are effectively forcing the claimant to do exactly that – i.e to invest at a higher risk level, and not to use GILTS.
Turning to this recent change, the Government Actuary’s Department has based its forecasts on the asset allocation from the “central portfolio”, which the Lord Chancellor considers to be an appropriate one. This current low risk portfolio of investments contains a mix of lower risk (cash, gilts and corporate bonds) and higher risk (equities and alternatives).
The Government Actuary has based its forecasts on that portfolio, invested over an average of 43 years, passively invested, with a static asset allocation over the entire period. They estimate the impact of tax and charges (including IFA fees) on such a portfolio to be in the range 0.6% to 1.7%, and they have compromised that figure at 0.75%, which the Lord Chancellor considered to be reasonable. What they are saying is that it will cost between 0.6% and 1.7% to manage the money, and to pay the tax on income, but that they will assume an average much nearer the lower end of the range. That will produce unfairness for claimants who find that the management of their money is costing them anything above that low estimate.
In addition, there is an argument to say that the estimate of 0.6% to 1.7% is too low for tax and charges – that’s a topic in itself!
They state that the expected future growth in earnings will be 2% above the Consumer Price Index. Because not all future loss is based on earnings (eg support workers, case manager, maybe therapists) they advise an assumption of ‘damage inflation’ at 1% pa, which the Lord Chancellor accepted. But if you strip out the care and case management from a lump sum award (see two examples below), you’re left with a lump sum which has very little in it which should be linked to earnings inflation. That might mean that predicting only 1% is inaccurate.
A major change which favours defendants is the switch from the Retail Prices Index to the Consumer Price Index. It was thought that that change alone would add 0.8% to the rate, regardless of any other change, so to end up with only a 0.5% difference is interesting.
The end result is that the Government Actuary recommended to the Lord Chancellor a discount rate of +0.25%, made up as follows;
Expected gross return before deductions CPI+2.0% pa
Deduction for tax and expenses 0.75% pa
Deduction for damage inflation 1% pa
Expected net return CPI+0.25% pa
However, the Lord Chancellor considered this to be a starting point, and that the risk of under-compensation would be too high at that level, with only a 50% chance of achieving full compensation. Furthermore, GAD’s advice concludes with the warning that there is a significant risk that claimants will not achieve the median returns shown in GAD’s analysis. The Lord Chancellor considered it prudent to build in an allowance of 0.5% for sensitivity to GAD’s baseline assumptions, particularly in relation to shorter duration awards; hence the resulting figure of minus 0.25%.
Of course, the supposed impact of the new rate on insurance premiums, and on public bodies such as the NHS, can be softened by the use of periodical payments orders. Taking two of my recent settlements the total lump sums would have been £23 million and £22 million; using periodical payments for care and case management reduced the lump sums to £6.5 million and £7.3 million. That reduces the impact of the previous and the current discount rate considerably (a few hundred thousand in each case), but the point is never mentioned in the insurers’ vigorous complaints. Also, it seems to me to be common for insurers to refuse to offer periodical payments, thus forcing claimants to go to a full quantum trial if they really want a periodical payments order. Notably, both the above cases were against the NHS, who did offer periodical payments.
In my opinion, when you analyse the approach by the Government Actuary and the Lord Chancellor, you can see that they have carried out an impartial and fair process, trying to do justice when faced with starkly conflicting viewpoints. It really isn’t possible to be precise, as can be seen from the different aspects considered above, but a main driver has been the risk of under-compensation; that is undoubtedly, whatever the insurers say, the correct approach.
Over the years, I’ve been helped very much in this area of discount rates by Ian Gunn and Richard Cropper of pfp. To read their informative blog on this topic, visit their website here.