The Discount Rate – a fair solution for claimants and premium payers
When people suffer serious injuries, for example following a car crash or medical negligence, insurance exists to ensure they get the help and support they need for the rest of their lives in the form of compensation. The ABI supports the principle of full compensation, which is that injured claimants should be neither under nor over-compensated, and also wants to see a system which is fair to everyone paying insurance premiums.
Some claimants will choose to receive their compensation in a series of payments over time but most will opt for a lump sum. Part of the process for deciding the appropriate amount is considering how that lump sum payment when invested will grow over time, meaning a claimant is able to earn a return on that money for the rest of their lives. The Discount Rate is applied to ensure that the lump sum takes account of the expected return.
We want the discount rate to be as accurate a reflection as possible of what happens when people receive a lump sum payment, so it needs to reflect current investment practices and the investment environment. Instead, the Ministry of Justice is preparing to announce a new figure based on an outdated method which risks distorting the compensation process and pushing up insurance premiums.
Director of General Insurance James Dalton has blogged about the issue. Read more here.
The discount rate adjusts amounts of money awarded as personal injury damages to take into account the return which can be expected when that lump sum is invested. Since 2001 it has been set at 2.5%.
The 2.5% was based on the performance of Index-Linked Government Securities (ILGS). In practice, people getting lump sum payments are likely to seek professional financial advice and invest in a mixed portfolio of investments to maximise their returns in a low-risk way. The process of setting the discount rate should reflect this.
There have been two incomplete consultations about how the rate should be set. In February 2013 the Government consulted on “whether the legal parameters governing the way the rate is currently calculated produce a rate that is ‘right’ [so that] the person injured is fully compensated but not over-compensated or under-compensated”. No-one has yet seen the outcomes of this consultation.
In December, Lord Chancellor Liz Truss announced she is preparing to announce a new rate, based on the old, outdated process. This announcement was not made to Parliament but to the stock market.
The discount rate impacts claims often worth millions of pounds so even a change of half a per cent will have a substantial impact.
Lowering the rate means the cost of paying for personal injury compensation will increase and, given the size of the cost impact, it is almost inevitable that premiums for insurance customers would go up as a result. Young drivers, who already face higher premiums because of their increased risk of claiming for catastrophic injuries, could find it even harder to get affordable cover. Businesses with high motor insurance costs such as road hauliers will also be particularly affected.
Public authorities who pay compensation, such as the NHS, will also be affected and could see their compensation bills increasing significantly at a time when their budgets are already under severe strain.