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Changing the discount rate - what, when and why?

This afternoon there was an announcement to the London Stock Exchange of a forthcoming change to the discount rate in relation to calculating compensation payments. Most people had probably never heard of it this morning, but the development has wiped billions off the value of major insurers and looks set to be front page news tomorrow.

So what happened? The Lord Chancellor announced that the discount rate, set at 2.5% since 2001, will move to -0.75% on 20th March 2017. Note that nothing at all has actually happened yet. Changing the rate will require the amendment of secondary legislation, but that could happen very quickly indeed. In the meantime, cases decided next week will be decided in exactly the same way as they were last week – although claimants would do well to seek an adjournment.

What is the ‘discount rate’ in relation to compensation amounts?

The discount rate is basically used by actuaries to work out how much someone needs to be paid today, as a lump sum, in order to have a given sum of money on a particular date, or dates, in the future.

For example, if someone has a serious accident today and will need expensive adaptations made to their house in 20 years' time, the law states that their compensation payment today should yield sufficient funds to cover the work then. The compensation calculation has to take into account the effects of inflation and also the likely return the claimant will receive by investing their award long-term.

The discount rate is basically a balance between those factors. 

Inflation, interest rates and the discount rate

A positive discount rate means that the government assumes investment will outrun inflation over time. The awarding body must base the compensation payout on the projected future cost of the work minus the projected investment income the claimant would receive. A negative discount rate is exactly the opposite, viewing inflation as outrunning investment returns and therefore demanding a higher compensation payment to meet the future cost.

This makes a big difference to the largest claims for personal injury, which often involve long-term care requirements that are likely to increase in the future. In many cerebral palsy cases, for instance, a child born last year could need care in 80 years' time. The size of their award made at the new minus 0.75% rate to pay for that care is likely to be very much greater than under the current 2.5% discount rate.

What will the new negative discount rate mean for compensation payouts?

The government also announced that it will ensure the NHS Litigation Authority has sufficient funds to cover damages awards. This a clear sign that it is expecting a big increase.

While this announcement doesn't take effect immediately as a matter of law, any Claimant with any significant claim for future losses whose case is due for trial between now and 20th March is likely to be asking for an adjournment to take advantage of the new discount rate, which will give them a higher award.

It remains possible that the discount rate will not, in fact, change on 20th March, as announced. This announcement was originally expected a month ago, but was mysteriously delayed. The big insurers have already had one shot at stopping it by judicial review, which failed. Given the current effect on their stock prices, they may well be tempted to have another go.

Government whiplash announcement

Finally, for now, some of the early reporting on this has conflated government moves on the discount rate with government moves on whiplash claims. These are entirely separate matters, though both are of great importance to insurers.

Whiplash claims are numerous, with most of them worth a few thousand pounds in general damages. They tend not to involve future loss at all. Changes to the discount rate make no difference whatsoever to them.

Catastrophic injury claims, where people need care and equipment for decades to come, are thankfully rare, but when they happen they are very expensive. The effect of this change is to make those claims more expensive for insurers. The government says that this is necessary in today's investment climate to make sure the claimants' damages do not run out in decades’ time.

Ross Beaton / 27th Feb 2017


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