Discount Rate Reform–the only way is up!

Published 22 March 2018

The Civil Liability Bill contains proposals relating to Whiplash Reform (click here to read more) and amends the Damages Act 1996. The amendments to this Act in Part 2 of the Bill set out both the basis on which the discount rate should be set and the mechanism and frequency of its review.

A Brief History of Time

In February 2017, the then Lord Chancellor Liz Truss announced a reduction in the discount rate to minus 0.75% which had a dramatic impact on the personal injury market. On 21 March 2018, the Government published the Civil Liability Bill which proposes to reform the way the discount rate is set, while remaining committed to the principle of full compensation.  Key changes are that the rate will be set by reference to 'low risk' and the Lord Chancellor will need to consult with a panel of independent experts adhering to defined assumptions.

Historically, the discount rate was reviewed by Lord Chancellors infrequently; the previous 2.5% discount rate was set on 25 June 2001, and was not changed until Liz Truss's announcement 16 years later. This situation will change, as the Bill provides that the discount rate will be reviewed not less than every three years. 

Part 2 of the Bill

The wording of the Bill follows closely the draft legislation published by the Ministry of Justice in September 2017, but with some amendments to take account of the report from the Justice Select Committee's pre-legislative scrutiny and other suggestions from stakeholders.

The Bill confirms the departure from the requirement that the discount rate should be based on the return on investment achievable by a risk-averse investor investing in a very low-risk or no risk security, specifically Index Linked Government Securities. Instead, the discount rate will be based on the assumption that claimants will be properly advised on investment and will invest in a diversified portfolio.  The level of risk on which the rate should be based will be within a range from 'more than a very low level of risk' to 'less risk than would ordinarily be accepted by a prudent and properly advised investor who has different financial aims'.

To provide a better understanding of the investment behaviour of claimants and the level of investment returns, the Bill requires the Lord Chancellor to establish an advisory panel of four independent experts plus the Government Actuary, who will chair the panel. The other four members must have experience: as an actuary, of managing investments, as an economist, and in consumer matters as relating to investments. A significant change to the draft legislation, recommended by the Select Committee, is that an expert panel will be established for the first review.

The Bill also gives the Lord Chancellor the ability to set different rates for different classes of case, The classes of case may be distinguished by reference to the description of the future loss, the expected period of loss or the time when it is expected to occur.

Next steps

The Bill is expected to receive its Second Reading in the House of Lords on 24th April.  In an uncertain Parliamentary period generally we expect this Bill to proceed and become law later this year.  The Lord Chancellor must start the first review within 90 days of the Bill coming into force and must conclude that review by determining the discount rate within 180 days of starting. In practice we expect a quicker process for this review.

Insurers and other compensators should be encouraged by the fact that the Government has stated, in its response to the Select Committee, that the current discount rate results in over-compensation and that a shift to a more realistic assessment of investment behaviour based on a low risk portfolio should result in an increased discount rate. Such an outcome would be fairer to claimants and compensators alike whilst still adhering to the 100% compensation principle.

For more information, please contact David Williams, Andrew Parker or Joanna Folan