Discount rate review: back to square one
The Justice Committee has told the government that its evidence on claimant investment behaviour is “inadequate”. More is required to clarify its aims and motivation.
The Justice Committee has published its views on the draft legislation on setting the personal injury discount rate – confirming that the government must obtain “clear and unambiguous evidence” about claimant investment behaviour.
In emphasising the importance of the outcome being more than a technical decision, the report observes an apparent lack of transparency around the extent to which the legislation is motivated by a desire to limit the growth in clinical negligence costs and insurance premiums.
Specifically, the Committee advises caution in considering evidence of claimants’ behaviour to set the discount rate – concluding the risk they accept may be driven by the rate itself.
While it may be reasonable to change the assumptions on which the discount rate is calculated - if they are no longer representative of ‘real world’ behaviour – the Committee concludes that more evidence is required about the way claimants invest their lump sum damages, the reasons for their choices and the extent to which they obtain fair compensation.
With regard to PPOs, the Committee observes that “it is perhaps telling” that insurers reserve for PPOs at a significant negative discount rate. If a rate based on zero-risk investment is mandated for claimants, it strengthens the case for that being viewed as the appropriate strategy for claimants.
Until the government obtains data on whether claimants are being appropriately compensated (and not just with regard to investor risk), the Committee suggests that the Lord Chancellor as a starting point sets the rate at the lower end of the range of “low risk” to avoid the risk of under-compensating claimants.
Other recommendations include:
- Establishing a mechanism to keep those responsible for setting the rate informed about investment behaviour. This mechanism must ensure it captures the behaviour of those claimants who do not access professional investment advice and fund management.
- Instead of targeting 100% compensation, the government should consider adopting as a target the median level of compensation to tend towards over-compensation.
- Publication by the Lord Chancellor of his or her reasons for every decision to change the discount rate or to leave it unchanged, along with the advice of the proposed expert panel.
- The expert panel should be involved in the first review of the rate, and its quorum should be increased to four from a membership of five and duly enshrined in legislation.
- That legislation should require the expert panel and the Lord Chancellor expressly to consider whether to set different discount rates for different periods of loss or different heads of damage. Consideration to include looking at the experience of jurisdictions where differential rates have been used.
- Every review to include how changes in the rate impact on motor insurance premiums and the extent to which increases in the rate are reflected in reduced premiums.
- Consideration by the panel on what the most appropriate measure of inflation is to use.
In terms of next steps, the government has to respond to the Committee’s report. Whilst it can ignore the recommendations, doing so can draw criticism during the Bill’s eventual passage through parliament – although the criticisms would usually only come from Committee members themselves.
In practice, most often the government will ‘cherry pick’ elements to show it is listening, while ignoring the aspects it does not like.
Nevertheless, the timeframes now are really dependent on the extent to which the government will take on board these recommendations and revise the Bill. The government’s response will most likely come in the New Year, which should provide a better sense of how the Bill will progress.
The main consequence of the report appears to be the prospect of yet further delay before any change in rate. In addition to requiring fresh evidence regarding ‘real-world’ investment behaviours, the Committee recommends a slower first review that requires a decision of the full expert panel rather than just the Lord Chancellor. The review should also involve the mandatory consideration whether to move to a mixed-rate methodology rather than the present single rate approach.
When the government published its consultation response and command paper on the draft legislation in September 2017, it confirmed its belief that the current rate of -0.75% overcompensates claimants and is based on unrealistic methodology. It will therefore be a source of considerable frustration to compensators that the reform process looks set to drag on, especially as relevant evidence was submitted fairly recently for the consultation phase. We now appear to risk starting over again.
The worst world compensators can end up with is one that allows a ‘yo-yo effect’ caused by a short review period and the uncertainty that goes with that around setting reserves – especially for long-tail claims. The government is urged to work towards a framework that provides for long-term certainty of rate and short-term implementation of improved methodology.
Related item: Bringing the discount rate into the real world