The discount rate – the background story and current news

The Lord Chancellor's announcement on 7 December 2016 that she would announce the result of a review of the discount rate by the end of January 2017 led to an unsuccessful challenge, by Judicial Review, by the ABI in January 2017.

The Lord Chancellor's announcement on 7 December 2016 that she would announce the result of a review of the discount rate by the end of January 2017 led to an unsuccessful challenge, by Judicial Review, by the ABI in January 2017. As their application for leave to appeal has been refused, it is unlikely any further challenge will be made before the Lord Chancellor’s announcement, which we are now expecting in February. It could go up, down, or stay the same. The legislation providing for the rate to be fixed could also be amended, or not. The announcement, whatever it is, is eagerly awaited, and some would say, long overdue.

But what was the challenge, and why was it made?

The challenge was around an alleged failure by the Lord Chancellor, to publish the result of a series of consultations around the discount rate, and take further views on the outcome of the consultation (and no doubt any recommendations that were expected to be made in the published documents) before announcing any change to the discount rate or the methodology for applying it.

Why is the discount rate important ?

Courts regularly award damages for losses that will be incurred after the date of their award. These are called future losses. Where they do so, the court has to take into account the fact that the person to whom the award is granted is benefitting from the accelerated receipt of a lump sum at the date of the award to cover those future losses (ie losses which have not yet been suffered). Making an allowance to take account of that accelerated receipt typically involves using an annualised discount rate having regard to a number of factors, including how the investment markets (where any lump sum might be invested) are performing and might perform over a period of time.

Such future damages in personal injury or medical malpractice claims, are uniquely the subject of a statute on the point (the Damages Act 1996 – “the Act”) requiring the court to apply a discount rate prescribed pursuant to the Act, save in exceptional circumstances. No cases have ever sustained an argument for exceptional circumstances since the Act came into force (though one did at first instance, only to be overturned on appeal – Warriner v Warriner [2002] 1 WLR 1703).

The Act was enacted on 24 July 1996 coming into force on 24 September 1996. Section 1 of the Act provides as follows:

Assumed rate of return on investment of damages

(1)In determining the return to be expected from the investment of a sum awarded as damages for future pecuniary loss in an action for personal injury the court shall…. take into account such rate of return (if any) as may from time to time be prescribed by an order made by the Lord Chancellor. (2) Subsection (1) above shall not however prevent the court taking a different rate of return into account if any party to the proceedings shows that it is more appropriate in the case in question.

No rate of return was prescribed when the Act came into force. In July 1998, the House of Lords (as it was then known) decided a series of conjoined appeals reported as Wells v Wells [1999] 1 AC 345, and in the absence of a prescribed discount rate, decided that “accelerated receipt” should be assessed by modelling a risk-free rate of return, which they decided was best achieved by considering returns on index-linked government securities (Gilts). The upshot at that time was a discount rate of 3 per cent.

Their Lordships called on the Lord Chancellor to consider exercising the power under Section 1(1) of the Act to put the matter onto a legislative footing. That was finally done in June 2001 when an Order was made stating:

"The rate of return referred to in Section 1(1) of the Damages Act 1996
shall be 2.5 per cent."

The reasons behind the 2.5 per cent figure were formed from a substantial consultation exercise. About the same time, the Court of Appeal heard the Warriner case referred to above, deciding that the discretion under Section 1(2) of the Act (to depart from the prescribed rate) was to be reserved for exceptional cases and cases where it could be demonstrated that the factors being relied upon by whichever party contended for the use of a different rate, had not been matters taken into account by the Lord Chancellor when making the 2001 Order.

Since then a great deal of air time has been taken up arguing and lobbying that the discount rate is too high or too low. Investment returns are at present relatively low so the return from Gilts is reduced suggesting the discount rate is too high. The net result of that would mean an award for future losses would be too low. On the other hand most investors, even of personal injury damages, are unlikely to invest all their compensation for future losses in Gilts. They are more likely to consult experts and invest in a variety of investment options providing higher returns than an investment exclusively in Gilts, in which case the discount rate is too low and the awards being made are too high.

No doubt driven by the ongoing arguments and lobbying, by August 2012 a decision had been reached by the Lord Chancellor to consult on the discount rate and methodology of applying it. Interested parties were asked to respond to the consultation paper before the 23 October 2012. The consultation made reference to a response being "due to be published by 22/01/2012." As it turned out the Ministry of Justice (“MoJ”) did not publish a response and has still not done so.

In February 2013, the MoJ published a second consultation paper asking whether the legal framework provided by the Act remained appropriate or should itself be amended. The consultation sought views on whether the “low-risk investor” premise decided in Wells v Wells should continue to be assumed. The consultation also asked whether the discretion to depart from the prescribed rate should be as narrowly constrained as it is on the Warriner authority. Again, the consultation paper stated that a response paper would be published. Again, no such response paper was published or has been published.

In 2014, the then Lord Chancellor appointed an expert panel "to provide advice about the investments that claimants in personal injury cases should be assumed to make with their lump sum" suggestive perhaps of an interest in testing the “low-risk investor” premise. The evidence before the court on the challenge by the ABI in January 2017 demonstrated that a panel of experts had undertaken a substantial task on behalf of the Lord Chancellor and had reported, but whatever they produced has not been published.

By the summer of 2016, no result of the consultations had been announced or published nor had any date for such publication or announcement been set. Consequently the Association of Personal Injury Lawyers (APIL) returned to an earlier theme that the matter had been so delayed as to provide grounds for a Judicial Review of the Lord Chancellor's conduct. Responding to a pre-action protocol letter sent by APIL, the Lord Chancellor announced in December 2016, that the review would be completed “in short order” and announced by the end of January 2017.

How was the discount rate arrived at in 2001?

In 2001 the rate was set at 2.5% and detailed reasons for electing that rate were published identifying that the exercise of setting the rate was complex involving as it did, assumptions about future fluctuations in investment markets and the economy as a whole. Having arrived at a rate of 2.46% with reference to the yield on Gilts, and certain assumptions about inflation and other matters, the Lord Chancellor concluded that it was appropriate to set the discount rate at 2.5%.

That rate, fixed in 2001 has governed every assessment of future losses by the courts in personal injury cases in England and Wales since 2001. Accordingly a decision about changing it or the methodology behind it, including the circumstances where it might be departed from, would require a detailed and thorough review that commanded public confidence and, specifically, the confidence of all affected and interested stakeholders.

To that end there have been two major public consultations and a detailed analysis of the multiplicity of views arising from those consultations, including the commissioning of a panel of experts to inform the review and analyse their advice. There is also a mandatory consultation with the Government Actuary on technical issues arising from the panel's report and the obtaining of legal advice on various complex questions which have arisen in the course of the review, and so on.

All of which has taken time.

The ABI's claim for a judicial review of what the Lord Chancellor has now decided (that is to say when the announcement is to be made and what that announcement might be) was based on two grounds. First the Lord Chancellor's decision, it is said, infringes the legitimate expectations of the ABI engendered by the two consultations that the result of the consultations would be published, no doubt with recommendations that could be further considered and responded to. Second, prescribing a new discount rate, if the Lord Chancellor in due course does so, would be unlawful unless it was prescribed in terms that provided for the outgoing rate (the existing rate) to continue to apply to claims that are already afoot, otherwise it will have retrospective effect.

In response, the Lord Chancellor rejected the point that the consultations gave rise to any legitimate expectations in the ABI, or anyone else, sufficient to provide grounds for Judicial Review and that even if there were such expectations, they did not go as far as setting up an expectation that any published responses to the consultations would be a precursor to a further round of consultation or receipt of input from prior consultees.

APIL who were involved in the challenge as an interested party, submitted that the ABI has had, and indeed through its lobbying activities, has exercised, ample opportunity since the formal consultation processes in 2012 and 2013 to provide updated information and data to the MoJ and that there is no reason to believe that the views of the ABI have not been taken into account.

The court agreed with the Lord Chancellor on ground 1.

In respect of ground 2, the ABI invoked what they described as well-established principles of statutory construction that powers in primary legislation will not ordinarily be construed to permit a use which has retrospective effect. They say that it would be retrospective and/or unfair, for any new discount rate to apply to existing claims.

In response, the Lord Chancellor stated that, firstly, she has no power to make the sort of transitional provision within any order that she might make under the Act. Secondly, although it may to an extent be another way of saying the same thing, that it is a matter for the courts and not for the Lord Chancellor to decide upon the effect of and, in particular, the applicability to existing claims of a new prescribed rate, if a new rate is indeed prescribed.

Agreeing with the Lord Chancellor, the judge found the ABI's argument to be “wrongly conceived”. A power to prescribe a rate under the Act means exactly that and “is perfectly straightforward”. As she submitted in her response to the challenge - it is not for the Lord Chancellor to determine the question of the effect of prescribing a new rate.

As things stand the application by the ABI for leave to appeal has been refused and the Lord Chancellor has announced her decision on the discount rate will be made in February. As to what is expected, who knows? Lobbying continues. Headlines from the Medical Defence Union’s news page last month of a discount rate drop that “could increase indemnity costs, pushing some GPs out of practice” and APIL stating on their news feed in January that “Insurers have been getting away with undercompensating vulnerable injured people for years,” suggest a certain déjà vu around concerns that attend anything to do with the discount rate. Perhaps more fundamental is whether in looking at the investment risk model that is currently used as defined in Wells v Wells, the methodology behind the discount rate is correct. Is it right or unreal to link the discount rate methodology to returns on Gilts? Should it be based on a much wider range of investments?

Of course what lies at the heart of this issue is the principle underlying compensation for personal injury, which is "restitutio in integrum", which means putting the injured person back in the position that he or she would have been, were it not for the accident. No doubt this will be one of many factors the Lord Chancellor takes into account when announcing her decision on the discount rate.

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