July 18, 2019

Discount rate review: analysis and implications

Initial reaction to the imminent increase in the discount rate, albeit a meagre one, has been widespread and largely negative from an insurance perspective.

The change in 2017 to a negative discount rate of -0.75% was met with shock from the insurance industry, who sought a transformation of how the rate would be calculated in future. The Civil Liability Act brought about that transformation, and the outcome of the first review under the Act has now been completed.

From 5 August 2019, the new rate will be -0.25%. So, how did the Lord Chancellor reach this conclusion?

Lord Chancellor decision

The statement issued by the Lord Chancellor following the outcome of the review sets out the basis of his decision, having considered the advice of the Government Actuary Department (GAD) and submissions from various key stakeholders.

The advice provided by the Government Actuary Department was that the rate should be set at +0.25%.  The Lord Chancellor states that this was the "starting point of his determination rather than an end point".

He had made clear that this rate would have, in his view, resulted in too high a risk of undercompensating claimants. By contrast, the degree of under/over compensation at -0.25% was felt to be more appropriate. The issue of under and over compensation was clearly at the forefront of the Lord Chancellor's stated rationale when reaching his conclusion.

It is therefore not unreasonable to suggest, that the overcautious approach taken by the Lord Chancellor to ensure Claimants are not undercompensated suggest that concerns over economic stability, including Brexit, played their part. 

Impact assessment and GAD report

The Government's Impact Assessment and the GAD's advice have been made available and the following important points are noted:

  • It is expected the insurance industry will be a net beneficiary of the change. An estimated reduction in the total value of compensation of between £310 and £400 million per year compared to the previous rate of -0.75%. These reductions would benefit the NHS by approximately £80 million and insurers by between £230 and £320 million per year.
  • One of the key 'non-monetised benefits' was stated to be "benefits to wider society in terms of lower insurance premiums if insurance companies respond by reducing premiums."
  • The immediate response from the insurance industry suggests that the opposite will be true. Profit warnings were issued by some insurers and media reports that motor insurance premiums will rise on the back of this decision. The inconsistency arises due to the fact that insurers and defendant representatives had expected the rate to be set at a value between 0% and +1%, in line with the Government's own previously stated intentions. Indeed, many claims had been settled prior to the announcement on that assumption.
  • The GAD accepted that an investment period of 43 years was more appropriate than the 30 year period used in the 2017 report.This was in line with the submissions of the insurance industry.
  • Weighting for taxation and management charges was increased from 0.5% in 2017 to 0.75%.
  • The risk and disruption caused by claimants or defendants seeking to delay settlement in anticipation of the pending review (current or future) was deemed to be modest, and were further "mitigated by the discretion of the Lord Chancellor to review the rate at an interval of less than 5 years."

Dual-rate discount rate

Similar to the dual rate recently established in Jersey, the GAD and the Lord Chancellor assessed the prospects of adopting such a measure in England and Wales.

In short, the Lord Chancellor considered it inappropriate to adopt a dual rate "as at present we lack the quantity and depth of evidence."

Nonetheless, the GAD analysis and working model proposed a lower short term rate; a switchover rate (after 15 years) and a higher long term rate.

It will be of great interest to see whether future reviews bring about a dual rate, particularly as the Lord Chancellor stated in his reasoning that he had asked officials to commence a consultation on this issue in order "to inform the next discount review and the work of the expert panel."

Uptake of PPOs

The Impact Assessment stated that the issue of PPOs was considered, and the consensus amongst interested parties was "that the current legal framework concerning PPOs was appropriate and not in need of the potential reforms discussed in the consultation document".

It was also suggested "an increase in the PIDR [from -0.75%] may make PPOs more attractive to claimants, which would mean some defendants face higher costs. This is offset, however, by the reduced lump sums they would pay in other cases."

The Institute of Actuaries last year suggested a policy shift to using PPOs as the preferred settlement method for catastrophic claims. However, despite the suggestion that PPO uptake may increase, we are of the view that a continued negative discount rate results in higher lump sums and is unlikely to prompt a further uptake in PPOs from claimants.

New Ogden tables

Updated copies of the Ogden table for calculating the lump sum compensation due were released to reflect the updated discount rate.  Copies can be found at the link below on the Government Actuary Department website.

https://www.gov.uk/government/publications/ogden-tables-actuarial-compensation-tables-for-injury-and-death

Scotland

As we have previously reported, the Damages (Investments Returns and Periodical Payments) (Scotland) Act 2019 came into force this month. The GAD is currently preparing recommendations for its reports to Scottish Ministers before its deadline of 28 September.

However, the forecasted Discount Rate – based on changes made to the Act at Stage 2 – is expected to be -0.25%, the same as England and Wales.

The consistency of a single discount rate across the jurisdictions of the mainland UK will perhaps prevent forum shopping, although Jersey will continue to remain an outlier.

Brexit

As noted above, the degree of over and under-compensation which the proposed rates provided appears to have been the predominant factor in the Lord Chancellor's decision. 

Whilst the current investing conditions available are considered, along with issues such as inflation, to what extent the decision to continue with a negative rate was influenced by Brexit uncertainty can only be speculated.

The GAD did state that it may have been inclined to recommend a figure of 1% within its advice, as those investing at the end of the maximum 5 year period allowed before the next review could expect to benefit from more favourable economic conditions.

However, such an assumption was based on a reversion back to usual economic conditions. The short-term outlook linked to Brexit makes such a reversion uncertain, as was noted within the Impact Assessment. The GAD proposed that the most appropriate outcome would be for the Government to review the DR before the 5 year period passes if the economic climate changes for the better.

What next?

From a practical perspective, it is our understanding that the new rate will be effective from 5 August. The Impact Assessment refers to settlements after the effective date suggesting that the new discount rate will apply to all cases settled after 5 August, as opposed to applying to cases where the index incident date is after 5 August 2019.

Pursuant to the Civil Liability Act, the Lord Chancellor will commence the next review cycle within five years of the last determination of the rate – so the next review cycle must be started by 14 July 2024.

Unlike this first review, which sought assistance from the GAD, the consultation will be undertaken with assistance from an independent expert panel.