Elizabeth Truss has shocked the insurance industry by adjusting the Discount Rate for lump sum compensation payments for life-changing injuries from 2.5% to minus 0.75%.
The Lord Chancellor and Justice Secretary said that the new rate was the only legally acceptable one that she could set. The Discount Rate is linked to the returns that can be gained on the lowest risk investments that claimants can allocate their money to, which, typically, are index-linked UK Government bonds, or gilts, as they are often called. UK gilts have been providing very low returns for quite a few years.
Truss said that the law made it clear that claimants must be treated as risk averse investors, reflecting the fact that they are financially dependent on this lump sum, often for long periods or the duration of their life. Compensation awards using the rate should put the claimant in the same financial position had they not been injured, including loss of future earnings and care costs.
“The law is absolutely clear – as Lord Chancellor, I must make sure the right rate is set to compensate claimants,” said Truss.
The Discount Rate has been unchanged since 2001. The decision, as well as seeing compensation payments rise, is also likely to have a significant impact on the insurance industry and a knock-on effect on public services with large personal injury liabilities – particularly the NHS.
One market research agency has already calculated that insurers will face a bill of up to £3 billion due to the rate change, which will mean that damages paid for major injuries will grow in value. Consumer Intelligence, also warned that it would add up to £100 to motor premiums and trigger a “massive jump” in shopping around.
Huw Evans, the director general of the Association of British Insurers, said that the decision was “crazy”.
“ Claims costs will soar, making it inevitable that there will be an increase in motor and liability premiums for millions of drivers and businesses across the UK,” he said.
“We estimate that up to 36 million individual and business motor insurance policies could be affected in order to over-compensate a few thousand claimants a year.
“To make such a significant change to the rate using a broken formula is reckless in the extreme, and shows an utter disregard for the impact this will have on consumers, businesses and the wider operation of the insurance market.
“We have repeatedly warned the Government that this could lead to very significant price rises, with younger drivers in particular likely to find it much harder to get affordable insurance. It is also a massive own goal that lands the NHS with a likely £1billion hike in compensation bills when it needs it the least.”
The President of the Forum of Insurance Lawyers (FOIL), Nigel Teasdale, said that the reduction was extremely concerning.
“The announcement has all the hallmarks of a rushed decision and the Government’s current approach seems disjointed at best,” he said.
“On the one hand suggesting that saving the average consumer money on their insurance premium is a priority, then on the other reducing the discount rate which will have a major inflationary effect on premiums now and for many years to come.
He added that the timing was wrong given the uncertainty in the market, and that the decision also failed to reflect how people actually invested their compensation.
“The reality is that when paid large amounts of money in a lump sum most claimants will invest in a range of assets through an independent financial adviser,” he said.
“The rate should be a fair reflection of the real world, rather than just one option of index linked government securities rarely used in practice.”
Teasdale also said that the most likely outcome to the rate change – in addition to increasing premiums – was to return claims to a more adversarial system of litigation.
The Government made four pledges when announcing the new rate to the London Stock Exchange.
It said that it was committed to ensuring that the NHS Litigation Authority had appropriate funding to cover changes to hospitals’ clinical negligence costs; that the Department of Health would work closely with GPs and medical defence organisations to ensure that appropriate funding was available to meet additional costs to GPs; and that it would launch a consultation in the coming weeks to consider whether there is a better or fairer framework for claimants and defendants. Truss also said that Philip Hammond, the Chancellor, would meet representatives of the insurance industry to assess the impact of the rate adjustment.
The consultation, which will be launched before Easter, will consider options for reform – including whether the rate should in future be set by an independent body; whether more frequent reviews would improve predictability and certainty for all parties; and whether the methodology is appropriate for the future.
The new discount rate will come into effect on 20 March 2017, following amendments to current legislation.