Lump sum compensation payments for life-altering personal injury claims are designed to represent the present value of future losses the claimants will suffer. The Discount Rate which is applied in doing so reflects the amount of interest that a claimant can expect to earn by investing the money, above the rate of inflation.
The Discount Rate was set at 2.5% in 2001, this figure being reached according to the average return on Index Linked Gilt Securities. The rate then remained unchanged until 20 March 2017 when it was reduced to -0.75%. This decision was taken by the Lord Chancellor, after a five-year review period, to reflect the drop in interest rates and to challenge the assumption that claimants would adopt risk-averse investment strategies.
However, the insurance industry met this change with consternation, in response to their projected loss of profits and the issues surrounding having to increase their customers’ premiums to offset this. Huw Evans, Director General of the Association of British Insurers (ABI) commented that up to 36 million policies would be affected, as the costs of some payouts in real terms would rise by up to 70% depending on a claimants’ age and future earnings potential.
As a result, in December 2016, the ABI launched a legal challenge for a change to be made to the methodology of setting the Discount Rate. This was rejected by the High Court, but in September 2017 an announcement was made by the current Lord Chancellor that a new system for setting the Discount Rate should be adopted. Under this new system the Discount Rate would be set at between 0% and 1% and would be reviewed every three years.
This would still result in an increase in payouts and associated premiums compared with the historic 2.5% rate, but they would be less severe and the periodic reviews would allow them to more fluidly react to economic changes. In the meantime, of course, it is to the benefit of claimants to try to maximise their settlements at the current -0.75% rate.
However, in general, insurers have applauded the announcement and coinciding with the news, share prices in major insurance groups such as Direct Line and Admiral saw a marked increase. Huw Evans, Director General of the ABI, has since commented: “This is a welcome reform proposal to deliver a personal injury discount rate that is fairer for claimants, customers and taxpayers alike… The reforms would see the discount rate better reflect how claimants actually invest their compensation in reality."
Although the announcement does seem to signal good news for the insurance industry, insurers will still need to remain vigilant, as there is currently no time frame set for the amendment, and the new system is yet to be approved by Parliament. If interest rates are foreseen as likely to rise, it would favour claimants to settle early.
The forensic accountant specialists at BTG Advisory are able to provide realistic and robust personal injury claim compensation values, which fully take into account the potential impact of Discount Rate amendments. Our partner-led team has the knowledge and expertise required to support the complex calculations required in personal injury claims.