The UK discount rate must better reflect investment strategies, be subject to regular review and set by a politically accountable minister.
The three demands have come from the International Underwriting Association (IUA) in its response to the Ministry of Justice’s consultation on the discount rate, which was changed for the first time in years in February. The IUA has pledged support for the 100% compensation principle, which states that claimants should neither be overcompensated nor undercompensated.
When the process for calculating the discount rate was last set, establishing a link with index-linked government bonds was reasonable and logical, the IUA argued. But poor returns have made such investments unviable and a low risk, diverse portfolio is now more realistic.
In its consultation submission the IUA supported the principle of setting a discount rate on the assumption that claimants would be well-informed but prudent investors, opting for a balanced portfolio of low risk investments. Future rates of return should be considered in the process since historical rates and short-term investment performance are not necessarily representative of income over several decades.
The IUA also said that the law should also be changed so that the rate is reviewed at set intervals rather than at the discretion of the Government. A regular review process, whether every one or three years, would reduce market volatility, it said. It added that this evaluation should be held in the second quarter of the year to avoid peak insurance renewal seasons and reporting periods.
Dave Matcham, IUA chief executive, said: “It is clear that the methodology used and assumptions made to set the discount rate are flawed. The current rate of minus 0.75% will inevitably lead to overcompensation, which is compounded by the long-term nature of many settlements. A negative real return is assumed not just for year one, but for every year for decades to come.
“It is encouraging that the Ministry of Justice has issued this consultation so quickly, responding to the feedback of IUA companies and other industry representatives. Our members are keen to see a new system that ensures a professional and competitive marketplace capable of meeting the needs of all policyholders.”