Professional Indemnity insurers beware - the impact of the discount rate change on lump sum compensation payments
On 27 February 2017, the Lord Chancellor announced changes to lump sum personal injury compensation payments which are likely to have significant ramifications for large swathes of the UK insurance industry.
When victims suffer life-changing injuries; a person or legal entity is at fault for causing those injuries; and the victim successfully pursues a claim for compensation against the blameworthy party, the actual amount the victim receives by way of lump sum compensation is adjusted to reflect the fact that the sum is received in advance of need which (in theory) enables the victim to invest that sum and earn interest accordingly. The rate of adjustment is known as the 'Discount Rate', with the calculation linked in law to returns on the lowest risk investments, typically Index Linked Gilts. Since 2001, the Discount Rate has stood at 2.5% but the Lord Chancellor has, with effect from 20 March 2017, lowered the rate to minus 0.75%, a decision which she says was in accordance with the law and which reflects the reduction in average yields on Index Linked Gilts. The change will be implemented by The Damages (Personal Injury) Order 2017 which applies only to England and Wales. The Scottish Government has since followed suit and lowered the discount rate to 0.75% with effect from 28 March 2017.
The law makes clear that claimants must be treated as risk averse investors, reflecting the fact that they are financially dependent on the 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.
Those people and entities immediately affected by the reduction to the Discount Rate are fairly obvious. Lump sum compensation payments will rise which will impact claimants, insurers, reinsurers and policyholders, as well as having a knock-on effect on public services with large personal injury and clinical negligence liabilities – particularly the NHS. In existing litigation which directly concerns personal injury and clinical negligence claims, the likely immediate impact is that claimants will want to withdraw existing Part 36 offers in cases where there is a significant element of future loss, while defendants may well try to accept any such offer before they are withdrawn. Schedules and counter-schedules will need to be re-drafted and urgent consideration will have to be given as to whether defendant Part 36 offers which have been made on the current multipliers can afford costs protection.
However, the impact on the insurance industry goes beyond the immediately obvious providers' such as motor, employers' and public liability insurers. Professional indemnity insurers should also be alert to the rate change.
In light of recent personal injury and funding reforms, many claimant lawyers have resorted to novel ways in which to attract business. This includes advertising for business in respect of under settled claims which has led to an increase in the number of undersettled litigation claims pursued against personal injury and clinical negligence lawyers. Mistakes such as overlooking limitation dates, court deadlines and failing to advise on certain heads of loss are not uncommon and can lead to valid claims not being pursued, claims being struck out or claims being under-settled. In such cases, loss is ordinarily calculated on the basis of the lost opportunity to obtain what the claimant would have expected had the claim been pursued in a timely and proper manner. When calculating that loss and setting reserves, professional indemnity insurers and their lawyers would ordinarily apply the Discount Rate which has the anticipated effect of reducing the overall compensation payable. Applying the minus 0.75% Discount Rate to the relevant multiplier and the lump sum payment may well significantly increase the theoretical figure so that the potential impact of the Discount Rate change is there to be seen.
There are currently a number of unknowns in terms of how this rate change will take effect in practice. For professional indemnity insurers and their lawyers, the pivotal question is will the Discount Rate change have retrospective effect? If, for example, an insured solicitor is the subject of a current claim for failed litigation in circumstances where the claimant alleges that but for the solicitor's negligence he/she would have secured a £5million lump sum payment in say 2012, do insurers reserve on the basis of a 2.5% rate Discount rate or a minus 0.75% Discount Rate? Applying the ordinary legal principles for calculating loss suggests that the rate at the time that the lump sum payment would have been made should be applied. If that is the case it will come as some comfort to Insurers who are already litigating such claims and have adopted reserves. However, there may well now be a trend for claimants to seek to argue that their personal injury/clinical negligence claim would, in fact, have resolved at a much later date (after 20 March 2017) in order to take the benefit of the Discount Rate change.
With this in mind, professional indemnity insurers who have claims against their Insureds relating to significant personal injury and clinical negligence claims would be well advised to review their files to pre-empt any significant increase in the level of damages claimed. Settlement parameters, Part 36 offers and reserves may need to be adjusted accordingly.
A further impact on the professional indemnity insurance industry, is that premiums for solicitors and barristers who undertake work on behalf of claimants and defendants involved in catastrophic injury cases (where significant lump sum compensation payments are most common), may have to increase to reflect the higher level of damages.
In summary, the change to the Discount Rate has the potential to have a significant impact on the insurance industry and this is not confined to the more obvious 'casualties' such as motor, employers' and liability insurers. Those insurers offering professional indemnity cover should also be alert to the rate change; review current claims; and adjust the approach to handling those claims if necessary. It is fair to say that the impact on the professional indemnity industry will not be as great as it will be for other insurance providers (for whom the change is expected to be very significant indeed), as the number of PI claims related to personal injury and clinical negligence claims will make up a relatively small percentage of the whole book of PI business. Nonetheless, professional indemnity insurers should ignore the Discount Rate change at their own peril.
We will continue to monitor the position in light of the Lord Chancellor's recent comments that she is "personally commited" to finding a solution. Indeed, a consulation to consider the methodology by which the Discount Rate is arrived at is ongoing and remains open until 11 May 2017. It is not inconceiveable therefore (and certainly the hope of the insurance industry) that the current negative Discount Rate may prove to be short lived.
This information is intended as a general discussion surrounding the topics covered and is for guidance purposes only. It does not constitute legal advice and should not be regarded as a substitute for taking legal advice. DWF is not responsible for any activity undertaken based on this information.