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The Discount Rate: no longer a constant in a changing world?

The Discount Rate: no longer a constant in a changing world?

In the current era, when the House of Commons seems consumed by Brexit fever, it is easy to lose sight of the fact that some parts of the government apparatus are still having to get on with the day job, and more prosaic legislation is also rumbling towards passage. 

This week there have been developments that will be relevant to lawyers and casualty insurance professionals alike. On Tuesday, the Scottish Parliament agreed the general principles of the Damages (Investment Returns and Periodical Payments) (Scotland) Bill when it passed Stage 1. Today, the Civil Liabilities Bill covering England and Wales received Royal Assent. These pieces of legislation are designed, amongst other things, to reform the way the “discount rates” used in calculating long term future awards of damages are set.

In this context, the discount rate is an important part of the calculation of the capitalised value of future losses, allowing personal injury claimants to be paid a lump sum now, to cover those losses. When Lord Irvine of Lairg, the then Lord Chancellor, first fixed the rate in 2001, he fixed it at 2.5%, based on a three year average of real yields on Index Linked Government Stock. Without getting into the actuarial nitty gritty, the purpose was to give claimants current lump sums which were adjusted to take account of the notional investment value of having the future money early. Scotland followed suit and introduced the same rate in 2002. 

Thereafter, the discount rate remained a constant in a changing world. A lot has happened since 2001, notably the financial crisis of 2008. The steady decline in gilt yields meant that the 2.5% discount rate parted company with the actual yields rate, and the discount rate became increasingly controversial.

At the beginning of last year, Liz Truss, the then Lord Chancellor, responded to the clamour for reform by fixing a new discount rate of -0.75%. Shortly afterwards Scotland followed suit again. This was a much more significant swing in favour of claimants than insurers had been budgeting for. There were concerns from insurers about the destabilising effect on the insurance market, and the impact on big public compensators like the NHS. 

Now, as a result of the legislation that has been forward in the UK and Scottish Parliaments, the pendulum looks to have swung back towards equilibrium. Both pieces of legislation depart from the artificial Index Linked Government Stock approach, and are supposed to allow the discount rate to reflect the actual behaviour of low risk investors, and avoid under or over compensation.  Both provide for a review every five years, in Scotland by the Scottish Ministers and in England by the Lord Chancellor. The first reviews of the rates should take place next year. It remains to be seen whether the rates north and south of the border will diverge, if at all. 

Here in Scotland, the Minister, Ash Denham, said at the Parliamentary debate on Tuesday, "The bill seeks to remove the exercise of determining the [discount] rate from the political arena.” But I wonder if that is going to be possible. The Scottish legislation provides for out-of-cycle reviews in case there are particular economic shocks which drastically alter the investment landscape. It seems to me that certain other events which may or may not be happening in 2019 and beyond might adversely affect the life expectancy of any new rate that is fixed.

Please contact Gary Moffat, if you would like to talk to us.

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Burness admin