Discount rate review - what next?

09 Dec 2016

Many of you will have seen the news announced this week that the Lord Chancellor is to announce result of the Discount rate by 31 January 2017. Initial coverage was in the BLM Policy Blog.

This note provides a brief reminder of the scope of the consultation and also raises some points that might be worthy of consideration in the short term, although it is not possible to predict any decision.

Decision date

More than 4 years after the consultations closed, the Lord Chancellor has stated that a decision on the review of the discount rate will be announced by 31 January. The content of that announcement cannot be predicted, though it is worth recalling the structure of the consultation. There were two parts. Together they consulted on (1) whether ILGS should remain the investment return benchmark even if the “Wells” safe investor approach remained and (2) whether the safe investor principle was correct. Additionally whether measures should be taken to encourage greater use of periodical payments was raised.

What this means to you.

The decision may reflect some or all or none of what was consulted upon. If changes are made, and in particular to the discount rate the timetable for legislative implementation could be very short. Existing claims will very likely be caught. Insurer provisions may need reviewing or implemented into case reserves. There may also be some consequences for risk assessments as to acceptability of settlement offers or how some aspects of outstanding claims should be approached tactically. Although not suggesting that a reduction in the rate will arise (and there are many arguments for the alternative) BLM has provided some initial thoughts as well as indication of the impact on annual costs.  Further updates will be issued as the outcome becomes clearer.

The Consultation

 The consultation was in two parts.

Part 1: Damages Act 1996: the discount rate – how should it be set?

The “overview” on the MOJ site reminds that the consultation related to the methodology to be used by the Lord Chancellor and his counterparts in Northern Ireland and Scotland in independently setting the discount rate. The consultation closed more than 4 years ago on 1/8 2012. The recent news refers only to the Lord Chancellor, which would mean technically that it would be relevant only to the rates in England & Wales and Northern Ireland. That said, it seems highly likely that the rate in Scotland would reflect whatever decision will be reached by the Lord Chancellor by 31 January (the rate in Scotland was set at 2.5% in February 2002, eight months after the same rate was prescribed for England & Wales and Northern Ireland).

This consultation proceeded on the basis that the existing “Wells” safe investor basis should continue [1]. However, it raised two competing methodologies to achieve that aim through the setting of the discount rate either:

  1. By using an ILGS-based methodology applied to current data

  2. To move from an ILGS based calculation to one based on a mixed portfolio of appropriate investments.

It was stated that whichever approach was adopted the need (in the context of this consultation) was to achieve a rate which gave effect to the principle of full compensation under an appropriate low risk investment strategy.

Part 2: Damages act 1996: the discount rate – review of the legal framework

The MOJ “overview” on the MOJ site reminds that this consultation sought views on two subjects relating to the setting of the discount rate:

The review of the legal framework addressed two issues:

  1. Whether the legal parameters defining how the rate is set should be changed – in effect whether the current approach to setting the discount is correct or an alternative approach should be taken. Recognition was made of the fact that many claimants did not invest in the cautious way envisaged by the existing “risk free” guidelines. It was suggested that might mean that rate was too low, though equally the risk of under-compensation was cited if the rate were too high. The option was to retain the current “Wells” approach or set the rate by reference to investment strategies which may produce higher returns (though possibly higher risk)

  2. The second point was whether there was a case for encouraging the use of periodical payments. The consultation raised a number of questions around the use of periodical payments, why the level was as it was, and whether greater information about their availability was the key to greater use. In the run up to the periodical payment regime being implemented the Government expressed a wish to see PPOs as the “norm” in future loss cases. Recent market data shows that still only roughly a third of cases over £1m settle under a PPO.

As we look towards the Lord Chancellor announcing the “result of the review”, we should bear in mind the scope of the consultations which that announcement might address.

  • It may be that a decision is made solely in relation to the rate: to retain, increase or reduce it; or to, as the power exists, apply it differentially to different heads.

  • In parallel there may be decisions around some of the important points which underpin the approach to assessing the discount rate: the link (or not) to ILGS; the status of the claimant as a “risk free investor”.

  • Whether measures are required to encourage the use of periodical payments.

The panel of experts engaged by the Lord Chancellor involved expertise in the investment market, financial planning and an actuary. That would suggest (but not more than that) some of the questions relating to alternative investment vehicles and returns remained under consideration, as well as a comparison between lump sum and periodical payment regimes.

Against that history, any prediction of what will be in the announcement is impossible.

Implementation and “trigger”

If there is a rate change when might it be implemented and what cases would it apply to?

Any decision will need to be implemented in accordance with the provisions of s. 1 of the Damages Act 1996 – the decision will need to be “prescribed by an order made by the Lord Chancellor”. So legislative action is needed. It also  has to be assumed that just like the last exercise of the power in 2001 the change will be implemented in such a way as to capture any outstanding case.

The Damages Act sets out that the order “shall be made by statutory instrument subject to annulment in pursuance of a resolution of either House of Parliament”. In effect a fast track approach involving no vote or debate unless a formal objection is raised. The 2001 order setting the rate at 2.5% came into effect the day after the order was made in parliament. If the same approach is adopted it is possible that all new and  outstanding cases will be subject to any new rate from February 2017 onwards.

As already mentioned, note should be taken of s. 1 (3) of the Damages Act that the order may prescribe different rates of return for different classes of case.

Impact on costs

With no information as to what the outcome might be all that can be done is to show a range of impacts.  Most insurers will have been holding provisions against a change in rate in any event so will have already had to make a decision over how to reflect the possible change.

Nevertheless – we append two charts where we have used an annual loss of £50,000 and one of £200,000. The charts show for each of the discount rates in the Ogden tables (including 3%) the effect on the total cost using the appropriate multiplier and periods of loss at 10 year stages from 10 years to 50 years. The data uses Table 28 multipliers to isolate the effect of the changing discount rate without mortality. The lines on the graph show the changing value of the annual loss across the discount rates – one line for each loss period. Reading across the data table indicates the extent of any change dependent on the rate used.

These tables cannot replace the detailed impact assessments insurers will have made but are provided for illustration of some of the points below which are mainly focussed on short term consideration of cases pending the announcement.

Part 36 offers

Claimant Part 36 offers may have been made but rejected or not responded to, but still be open for acceptance. Until the outcome is known, an additional risk factor is how those offers will look if the claim has to be recalculated at a different discount rate. More importantly, whether assessment of damages under an altered rate makes the settlement more advantageous to the claimant with the consequence of costs and damages sanctions under CPR Part 36.

In the current climate it is sensible to review cases where claimant part 36 offers have been made and remain open for acceptance. Even if after the initial period, a view might be taken on by how much the rate would need to change to make that offer attractive, the defendant’s view of the probability of that change coming about and then whether the risk of that makes the offer one that should be taken (before withdrawn).

Different considerations apply to defendant Part 36 offers. Only if anticipating a rate increase would a reduced offer be the outcome, but even then extra protection from the existing figure may be more attractive.

The difficulty may arise whenever a case is due to be fought on an existing part 36 and it is possible that the case will be heard after the rate change has taken effect. The risk then is that the part 36 offer will be exceeded even though a reasonable one prior to the rate change.  Leaving adjustment until the rate change is known runs the risk of reduced costs protection. No firm rule can apply in the current uncertainty, and again it comes down to a risk assessment for each defendant to make. However, a review of the margin on a part 36 offer, particularly for cases coming to trial in early 2017 would be prudent.

Roberts v Johnston – Accommodation claims

If it happens, a discount rate reduction would reduce the damages awarded on the Roberts v Johnston basis. The rate used was pegged to the discount rate in Wells v Wells. For example – if a claimant with a 25 multiplier, net replacement accommodation purchase cost of £400,000, recovered damages now on a 2.5% basis he would receive £250,000 (2.5% x 400,000 x 25). If (for illustration only) the rate went down to 1.5% he would receive £150,000. A reduction of £100,000 even though £400,000 still needs to be found to fund the new property.

This might lead to renewed attempts to undermine the R v J approach, or claimant behaviours to build other heads of loss (in conjunction with a new rate) to offset the costs.

Impact on interim payments

Linked to the above point is the impact to interim payments under the “Eeles” approach. Whereas capitalised accommodation costs are usually included in “Eeles” stage 1 calculations, a reduced R v J amount  reduces in the available sum, conservatively assessed, against which an interim payment can be safely awarded. True, the future loss elements may be higher if the discount rate reduces, but that depends on the claimant being able to satisfy the “need” requirement, and the confidence threshold as to  eventual capitalisation of other heads., before those heads of loss can be brought into account under “ Eeles” stage2.

Attractiveness of Periodical Payment Orders

With their protection against investment, inflation and mortality risk, it is surprising that, as we report elsewhere, the level of take up of PPOs in high value cases remains low (and some reports suggest is in fact dropping). Presumably the current 2.5% lump sum assessment is still seen as a good outcome for claimants. In so far as the consultation looked at the question of encouraging periodical payments, any downward change in the discount rate would have the contrary effect (and arguably contrary to the Governments previously stated views on their use). Claimant representatives conducting modelling of lump sum against periodical payment outcomes will want to see what emerges after 31 January.

Life expectancy

Perhaps not a short term issue, but if multipliers do increase, greater scrutiny may be needed on the underlying loss period to which they relate. That includes consideration of population or background life expectancy. Reports of reducing life expectancy in the States due to lifestyle issues mirror those which have been mentioned during setting of projected life expectancies in the UK. The Office of National Statistics (ONS) next bi-yearly (2016) review will not be available until well into 2017 and we wait to see if the continuing extension of life expectancies continues. Equally interesting is the concept of health life expectancy – longer life does not mean longer health life. The ONS published “Health state life expectancies” reports on disability free life expectancies. Whereas life expectancy for a male born today is 79.2 years, the proportion of that likely to be disability free is only 63.1 years. How that might feature within the 100% (but not more) compensation principle is something BLM has under consideration.

BLM assistance with Reserving

BLM is able to assist customers by:

  1. In the run up to the decision providing alternative views on reserves using any alternative rates that a customer wishes. This may assist scenario planning.

  2. After the announcement, assisting customers in reviewing reserves so that any provisions can be transferred into case estimates as quickly as possible

Should you wish to discuss either of the above please contact your BLM customer relationship partner.

 

Mike Dobson

Partner

 
 
 
 

Stuart Hardy

Partner

Mike, Andrew and Stuart are members of the Financial and Socio-Economic Subject Matter Expert Group within BLM’s Catastrophic Injury Group.

Appendix

The charts below show for an annual loss of £50,000 (first chart) and £200,000 (second chart) the impact on overall costs using multipliers under each of the discount rates (horizontal axis) shown in the Ogden Tables. 5 lines are shown representing loss periods of 10 to 50 years by 10 year increments.

 

 

[1] That the particular circumstances of claimants meant that they should not be treated like ordinary investors but needed greater security around investments and returns.

<< Back

Disclaimer: This document does not present a complete or comprehensive statement of the law, nor does it constitute legal advice. It is intended only to highlight issues that may be of interest to customers of BLM. Specialist legal advice should always be sought in any particular case.

Related Sectors


Who to contact


For more information about any of our news releases, please contact:

Natalie King
 +44 20 7638 2811
+44 20 7920 0361
Email Natalie

Fi Khan
+44 161 236 2002
+44 161 838 6324
Email Fi

|