Analysis: Discount rate decision casts a shadow over personal injury settlements
The personal injury discount rate will be set at minus 0.25% from 5 August providing certainty for insurers and claimants alike, but uncertainty created by the Ministry of Justice review behind the new rate could have left claimants – as well as insurers – worse off.
Then Lord Chancellor David Gauke’s 15 July announcement that the discount rate would be set at minus 0.25%, and not somewhere in the anticipated range of 0% to 1% was met with a torrid reception by insurers.
The discount rate, also known as the Ogden rate, is used by courts in England and Wales to determine personal injury damages and takes into account the net rate of return a claimant can expect to receive from investing a lump sum award.
The upshot of this is that positive rates are preferred by insurers, while negative rates are more favourable to claimants.
The new rate was the outcome of a review mandated under the Civil Liability Act, which was signed into law in December.
The rate had been slashed from 2.5% to minus 0.75% by Gauke’s predecessor, Liz Truss in 2017, altering the rate for the first time since 2001.
Though Gauke has since resigned his cabinet post as Lord Chancellor and Justice Secretary in protest, the effects of his decision are only beginning to be felt.
It is expected to result in a hit to earnings for some insurers – Hastings, for example, has said the rate change would result in a one-off £8.4m blow.
Direct Line and Admiral are also among those predicted to take a hit a result of reserving on the assumption the new rate would be between 0% and 1%.
The assumption the new rate would be positive has also affected the way recent personal injury claims have been settled.
For instance, Andrew Hibbert, partner and head of the catastrophic injury team at BLM, said: “The new minus 0.25% rate is a disappointment to us and our insurance clients since we’ve very recently been settling cases at plus 0.5% and above – we’d hoped the new rate would be around that number.”
Insurers and lawyers weren’t alone in this assumption. Though personal injury claims can go to trial, in many cases the parties will settle before going to court, with adult claimants able settle on whatever terms they wish to sign off on.
In cases involving either children or protected parties who lack the capacity to make their own decisions, however, cases must go before a court, if only so a judge can approve an agreed settlement.
Rachel Di Clemente, legal services director at Minster Law, said: “We’ve had a few cases where we’ve seen judges, faced with advice from both parties as to what the level of damages should be, say in the round they felt it was OK to sign off on settlements where the rate that had been applied had been north of 0%.
“It wasn’t just something insurers were doing; it was something all parties, including the judiciary were anticipating.”
The key factor at play here is uncertainly: uncertainty over what the discount rate was going to be and also, for each case, uncertainty over if a claim would eventually get to trial.
“When a decision on a new rate is coming, it’s difficult from a claimant perspective because you’ve got to gauge what the discount rate is going to be at the time you potentially settle a case and these cases can go on for a very long time,” said Suzanne White, a serious injuries lawyer and head of clinical negligence at Leigh Day.
£15 to £25
The amount by which the rate change could increase average motor insurance premiums, according to PWC
£230 to £320m
The total estimated savings insurers will make as a result of the rate change, according to the Ministry of Justice
The number of days between the rate being dropped to minus 0.75% and the announcement of the new rate, during which uncertainty reigned
The number of responses the MOJ received from the legal profession to its call for evidence
The number of responses the MOJ received from insurers to its call for evidence
The number of years within which the Lord Chancellor must begin another review of the discount rate, under the Civil Liability Act 2018
Explaining how this uncertainty can lead to situations such as the one Hibbert describes at BLM, Di Clemente said: “It’s very difficult to tie down when a case is going to get to trial. It can take years.
“There will have been some cases that were ready to be settled, had a trial date that fell towards the end of this year, where there was an offer on the table, but you didn’t know whether that offer was better or worse than what you’d get in December because it depended on what the discount rate came out at.
“So the claimant is faced with a gamble: either take the offer on the table, which the insurers have calculated at, say, 0.5% or risk rejecting that offer, going ahead to trial in December, by which point the rate could have moved even further north, and you’re worse off.
“It seemed most claimants were – when the rate was still minus 0.75% – willing in negotiations to move up to 0%. Defendants were coming in with counter-proposals at, let’s say, 1% but willing to settle at somewhere between 0% and 1%. There was plenty of negotiation going on.
“That was largely driven by the fact they knew a revised rate was coming fairly soon, but also this unhelpful indication that it was going to come out somewhere north of 0%, which everyone jumped on the back of.”
Here Di Clemente is referring to statements made by Chancellor Philip Hammond in February 2017, and by the Ministry of Justice to the Stock Exchange in September 2017.
They respectively signalled that the government intended to quickly review the newly set minus 0.75% rate and that the rate resulting from the review may be in the 0% to 1% range.
The MOJ later rowed back on the latter of these signals, its House of Lords spokesperson Lord Keen saying in November 2017: “The figure of 0% to 1% that was given in the paper was not an estimate, essentially, of what the Lord Chancellor would be fixing as the discount rate.”
Both statements were referenced by the director general of the Association of British Insurers, Huw Evans, when he wrote to the Lord Chancellor in July following the announcement of the new rate.
Evans called the MOJ’s impact assessment “misleading and wholly disingenuous”, saying that in omitting any mention of the two 2017 statements, it had misrepresented the industry’s pricing and reserving following the setting of the minus 0.75% rate.
So what now for claimants whose cases have been settled on the assumption of a less favourable positive rate being set?
“If you’ve got a case where an agreement had been reached in principal, between a claimant and a defendant on a protected party claim, but it hasn’t yet been agreed at a hearing it in front of the court, it’s likely that the court would demand that case be recalculated,” said Di Clemente.
“For those that have already been before a court for approval, or have been settled for adult cases, they can’t be undone.”
In the uncertainty created by the first change to the discount rate in 16 years in 2017 and the ensuing review, it seems both insurers and claimants will have been left with a sour taste in their mouths. Until the next review of the discount rate begins, there is at least certainty.
Di Clemente continued: “It’s different now. Now, we’ve got a rate that has been set under the new framework with the government actuaries.
“They’ve got to review it within the next five years – it would take something significant for that to kick off anytime soon, a major crash of the market, for example.
“Claimants and defendants for the next couple of years at least will be to plead cases at the new set rate, and to settle at that rate.
White agreed that, for now, there is certainly, but warned this wouldn’t last indefinitely: “This is going to be rate for some time now, that’s the level it’s going to be set at for the next few years.
“But once you start coming up to period a year or so beforehand, and you’ve got a future trial at a point where the discount rate might be different, you’ll have to gauge at the time you have a settlement meeting what you’re going to do. It’s not an exact science.”
Di Clemente proffered a similar caveat: “What you need to bear in mind is that there will be accidents happening today and that claim might not settle for five or six years, and, therefore, may be impacted by the next review.”
A possibility for future discount rate reviews is that two rates are set. Under this dual rate approach, there would be a lower, short-term rate and a higher long-term rate that would be used after a set switchover period.
In reaching his decision on the new discount rate, Gauke was given an analysis of this approach by the government actuary, Martin Clarke.
In his statement of reasons published alongside the announcement of the new rate, Gauke said that the suggested switchover period is 15 years.
While Gauke said he found the idea “an interesting one, with some promising indications, particularly in relation to addressing the position of short term claimants”, it was one he ultimately decided against.
“I do not consider that it would be appropriate to adopt a dual rate for this review, as at present we lack the quantity and depth of evidence required to conclude that the proposed model would be more appropriate than a single rate,” he explained.
“For example, it may be appropriate to assume a different portfolio of investments and a different allowance for tax and expenses for claimants with shorter and longer term awards.
“I consider that the potential of the dual rate, and its potential consequences (positive and negative) should be explored in more detail, and I have asked my officials to set in train a consultation in due course to examine this in greater depth, and to inform the next discount review and the work of the expert panel who will be advising me.”
A dual rate has recently been introduced in Jersey, which as a crown dependency rather than part of the UK has its own legal jurisdiction.
There, under a law passed earlier this year, the rate has been set at 0.5% if the expected period of future pecuniary loss is shorter than 20 years.
If the expected period exceeds 20 years, the rate is instead set at 1.8%, the rationale being that real returns on investments are higher over longer periods.
Call for evidence
The approach was also suggested in some responses to the government’s call for evidence, a summary of which was published alongside the impact assessment.
It said that “while such an approach might add more complexity to the process, it would be more likely to support and achieve the 100% compensation principle”.
The promised consultation on the idea has been met favourably by insurers.
“Aviva welcomes the consultation on a dual rate,” said Andrew Morrish, Aviva claims director, following the announcement of the new rate.
“Aviva has long-advocated a dual rate approach, which better recognises differences in investment returns for compensating claimants with short and long-term injuries.”
The Lloyd’s Market Association also signalled its long-standing advocacy of a dual rate.
However, the approach is less popular with personal injury lawyers.
“This dual rate system creates conflict, especially in cases where life expectancy is around 20 years, and could create a situation where parties are going to court for a decision on life expectation and a further decision on the discount rate appropriate to that claim, opening up new grey areas and new litigation processes,” said Mark Holt, managing director of personal injury at personal injury settlement specialist Frenkel Topping.