Julian Chamberlayne provides an update in New Law Journal on the current position on the discount rate, and analyses the recent call for evidence.

The Ministry of Justice (MoJ) closed its call for evidence on the discount rate at the end of January. The evidence will inform the lord chancellor on his discount rate review which was triggered on 19 March. He has 140 days to set the new rate, which will mean the revised rate will be in place by 5 August 2019.


The call for evidence

The bulk of the call for evidence was directed at financial advisers and investment managers in an attempt to ascertain claimant investment behaviour. This is to inform the lord chancellor’s decision-making because under s 4(5) of the Civil Liability Act 2018 (CLA 2018) he must have regard to actual returns available, actual investments made by investors of damages, and make appropriate allowances for tax, inflation and investment management costs.

On behalf of Forum of Complex Injury Solicitors (FOCIS), I submitted a detailed response to address several misconceptions in the call for evidence and to provide data on the cost of investment advice incurred by claimants after their litigation is over. Below, I consider some of the key points raised in that submission.


Real earnings growth

The experience of the FOCIS members is that more than half of future loss awards are for earnings-related heads of loss. This makes it impossible to ignore the long-standing economic phenomenon of earnings-related inflation rising faster than prices inflation. This has been accepted in the indexation of periodical payments and by every court that has had to address the issue, including the Privy Council in Helmot v Simon [2012] UKPC 5, [2012] All ER (D) 215 (Mar).

CLA 2018 gives scope to the lord chancellor to set a differential rate form earnings-related losses. Pursuant to ss 10(1) (4), the lord chancellor has the power to make an order that distinguishes between classes of case by reference to the description of future pecuniary loss involved. Under sch 1a, s 4(2)(b), the lord chancellor must determine a rate that could reasonably be expected to meet the claimant’s losses and costs ‘at the time or times when they fall to be met’ by the relevant damages. Schedule 1a, s 4(5)(c), requires the lord chancellor to make such allowances for inflation as he thinks appropriate.

The FOCIS response stressed that if the lord chancellor does not provide for real earnings growth, by setting a differential rate for earnings-related heads of loss, then the discount rate will not be providing full compensation. Some of those claimants will fall back on the state to plug the gap for their complex care and medical needs. The scale and impact of this would be worsened if there were a shift from the retail price index to consumer price index when setting the discount rate.


Investment behaviour

The conceptual difficulty with the MoJ’s attempts to seek coherent evidence on investment behaviour under the current and previous discount rate is that any evidence on investment behaviour will be skewed by examples of the ‘old’ and markedly unfair rate of 2.5%. That effectively forced claimants and their advisers to either take more risk to ensure their needs were met for life, or cut back expenditure so that some of those needs went unmet. It is too early to obtain reliable data of investment behaviours since the current rate of -0.75% was only implemented in March 2017 and it can take many years post-settlement for the claimant to resolve costs, and to purchase and adapt accommodation.

So, it is unlikely that those few who have received damages under the -0.75% rate will have fully invested damages at this stage. In any event, looking at past investment markets and related investor behaviour is a fundamentally flawed approach to predicting the likely future investment climate and related investor behaviour. Personal injury specialist financial advisers Richard Cropper and Ian Gunn of Personal Financial Planning have illustrated that this could create the perverse effect of increasing the discount rate at a time when markets pose the greatest investment risks and injured claimants would need to be most cautious with their investment decisions.


Investment advice during a personal injury claim

Contrary to the government’s misconception, investment advice is not given to the claimant during the litigation, and the cost of such advice, in any event, is not a recoverable head of loss (as per Page v Plymouth Hospitals NHS Trust [2004] EWHC 1154 (QB), [2004] 3 All ER 367, reaffirmed by Eagle v Chambers (No 2) [2004] EWCA Civ 1033). The wording of the call for evidence suggested that the MoJ had been led to believe that claimants receive advice on investment strategy in the course of their claim, and then claim the cost of that advice from defendants. Claimants are unable to receive such advice before they know what their damages might be and often receive this advice some time post-settlement, at their own cost.


Longevity risk

FOCIS also pointed out that claimants and advisers make investment decisions based on meeting the claimant’s long-term needs, such as complex care, treatment, and equipment. They have to factor in the distinct possibility that the claimant may well outlive the life expectancy predicted during the course of their claim.

It is inherent in the court’s approach to life expectancy statistics that about half of all claimants will live longer than has been predicted, but all prudent claimants will plan for that possibility. The fact that claimants face this risk, and plan for it, should not be conflated with the differing concept of appetite for investment risk. Even periodical payment orders do not fully protect claimants from the life expectancy risk, as they typically only provide for one or two of the heads of future loss.

This factor did not need to be brought into account under the Wells v Wells [1996] 1 AC 345, [1997] 1 All ER 673 methodology, because that was a legal inflation-proof proxy that was not premised on claimants actually investing in Index Linked Gilts. Now that the methodology for setting the discount rate is to be based on how claimants invest, the fact that they have to, and do, build in a life expectancy buffer needs to be reflected.


Investment management charges

In preparing the response to the MoJ, FOCIS gathered data from professional deputies, trustees of personal injury trusts and independent financial advisers (IFAs) in relation to investments and the corresponding charges on their client portfolios.

The data set we gathered was of 389 clients across nine firms, with investments ranging between £67,336 and £7,450,000.

The call for evidence was focused on investments up to £1.5m and the data showed that the average charges across the 169 claimants with damages below that threshold were 1.77%, with the range between 1.66% and 1.93%.

It is important to note that investment charges were not accounted for in the 2017 Government Actuary’s Department (GAD) analysis, but an assumption was then made that a reduction of 0.5% might be required to account for such charges. None of the 389 portfolios in the FOCIS data set had charges that low and only 1.8% of the portfolios up to £1.5m had charges of less than 1%. The vast majority, 74%, were in the range between 1.5% and 2%.

Once the further allowance is made for capital gains and income tax liabilities, FOCIS argued that a composite reduction in the discount rate of at least 2% is required, prior to factoring in further reduction of 0.5% for longevity and other risks.


Full compensation & under compensation: GAD modelling

As detailed in my earlier series on the discount rate—see ‘Full compensation & the discount rate: Pt 1’ (167 NLJ 7763, p8), ‘Pt 2’ (167 NLJ 7765, p8), and ‘Pt 3’ (167 NLJ 7770, p12)—the [LB1] GAD analysis 2017, applying its assumption of just a 0.5% deduction for investment management charges and tax, demonstrated that if the rate was set at 0%, then around 26% of claimants would be undercompensated. If the rate was set at 0.5%, then about 41% would be undercompensated.

It is obvious that once investment charges data is factored in, at around 1.5% and 2%, those claimants considered to be at risk of under compensation on the two potential discount rates of 0% and 0.5% will surely significantly increase.

The GAD released a technical memorandum shortly before the end of the response period to the call for evidence. It was reassuring to see that memorandum’s promise that the GAD modelling will include updated graphs to shine a light on the extent of any under compensation. In response to this technical memorandum I have invited the GAD to consider addressing longevity risk in their modelling, as the Office for National Statistics has highly reliable statistics for this and it is a phenomenon that increases the scope for a significant proportion of claimants to end up under compensated. In the alternative, I suggested the discount rate be reduced by 0.5% to provide for the effects of this well-known risk.

FOCIS queried the GAD’s earnings inflation figures in their Table 5, as they were materially lower than the Bank of England’s projections and those used by GAD for its quinquennial review of the UK social security scheme. To better understand the impact of real earnings growth on claimant damages funds we invited the GAD in its further modelling to either:

  • Apply an appropriate level of earnings inflation to at least 50% of the assumed damages investment; or
  • Run a second version of the modelling solely for earnings-related heads of loss applying a reasonable forecast of likely future earnings inflation.

I remain of the view that it is incumbent on the GAD to come up with a truly low-risk portfolio and for the lord chancellor to set a related discount rate that would not result in under compensation for more than 5–10% of claimants. If it does not, there would be a significant and unacceptable departure from the 100% compensation principle.

In the meantime, it remains difficult to advise claimants in any cases where negotiations are currently taking place on what the new level of discount rate might be. While many commentators seem to assume the discount rate will be in the 0–1% range previously suggested by Lord Keen (notwithstanding his subsequently expressed regret for ever mentioning those figures), it is increasingly hard to see how the lord chancellor could credibly come up with a positive number and yet still claim that was full compensation.


Julian Chamberlayne is a partner at Stewarts. He has written this piece in his capacity as chairman of FOCIS. This article originally appeared in New Law Journal – Will the new discount rate remain negative? (subscription required)



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