A year on: further evidence needed before discount rate changes can go ahead
'Fear of further delay' was the headline response to the Justice Select Committee's report on the proposed discount rate reform. If the Government accepts the recommendations that further evidence about claimant investment behaviour is required and that the independent expert panel should participate in the first review, then delay would seem inevitable. In this article, (written almost exactly a year since Liz Truss announced her decision to review the rate) we examine the Committee's recommendations and how they will affect the Government's reform programme. We also ask whether the time has come to start a conversation about the long term sustainability of the principle of full indemnity.
Full compensation and competing interests
Two clear issues arise from the Justice Committee's consideration of the Government's plan to change the assumptions on which the discount rate is calculated: the desire to safeguard vulnerable claimants against under-compensation, and the need to balance the interests of claimants, defendants and the wider society. Further recommendations on the proposed process for setting the rate arise from consideration of these key issues.
Achieving full compensation for claimants
What does 100% compensation mean?
The Committee welcomes the Government’s commitment to the principle of full compensation for claimants, but says it is unclear about what this actually means. Given that a lump sum award will nearly always either under- or over-compensate claimants, the Committee asks if the Government is targeting 100% compensation on average with around half of claimants being under-compensated (and presumably the other half being over-compensated)? If that is the case, the Committee believes that the Government should say so, although later in the report the Committee invites the Government to consider "adopting as a target the median level of compensation to tend towards over-compensation".
Evidence of claimant investment behaviour
The Committee acknowledges that it may be reasonable to change the assumptions on which the discount rate is calculated, as is proposed, if they are no longer representative of “real world” behaviour, but they recommend that "clear and unambiguous evidence" should be gathered about the way claimants invest their lump sum damages before any change is enacted. They did not appear to be satisfied by the Government's conclusion, based on the consultation responses and previous research that claimants are investing in low-risk diversified portfolios of assets. Nor did they seem entirely convinced by the Government Actuary's Department (GAD) analysis, based on the low-risk mixed portfolio approach: they had received no evidence about how closely that information represents advice given to and followed by claimants; and Richard Cropper of PFP had submitted that the “low-risk mixed portfolios” used in the GAD review are not appropriate as a benchmark for claimants, saying that that the portfolios could not be considered ‘low risk’ as they contain too great a proportion of equities. Data was a recurring question in the oral evidence sessions and it seems that the Committee was ultimately not satisfied with the responses given, no doubt heeding previous criticism of the inadequacy of the evidence obtained in support of the LASPO changes to the legal aid system.
Use of claimant investment behaviour when calculating the rate
Notwithstanding the recommendation for more evidence of claimant investment behaviour the Committee then went on to advise caution against using evidence of claimants' investment behaviour to set the discount rate. The Committee accepted the assertion made by the claimant lobby that investment by claimants in higher risk portfolios could indicate they are under-compensated and forced into higher-risk investments to generate sufficient return for their future living expenses.
Therefore if the rate is to take account of investment behaviour, the Committee says that a mechanism must be established to keep those responsible for setting the rate informed about that behaviour. Until the Government obtains data on whether claimants are being appropriately compensated, the Committee recommends that as a starting point the rate should be set at the lower end of the range of “low-risk”, and that the Government should aim for a higher proportion of over-compensation to safeguard the interests of vulnerable claimants who could be significantly under-compensated.
Balancing the costs and benefits for claimants, defendants and the wider society
The Committee recognises that setting the discount rate is more than a technical decision: it involves balancing the interests of claimants with those of defendants, and also balancing the social costs of increased clinical negligence payments and increased insurance premiums. Whilst it is reasonable for the Government to take into account the impact of the discount rate on clinical negligence payments and insurance premiums, the Committee says it should be open about this.
It would have been helpful, they say, for the Government to have given an estimate of the costs and benefits of the legislation in its impact assessment, based upon its “assessment” that the discount rate would be between “0% and 1%”. They also recommend that whenever the Government changes the discount rate under this legislation, it should publish an estimate of the costs and benefits of the change to claimants and defendants. It should also report on the impact of changes in the discount rate on motor insurance premiums and the extent to which increases in the rate are reflected in reduced premiums. If changes in the discount rate do not lead to the forecasted reductions in premiums, it would mean that some of the social benefits of changing the risk profile for setting the rate had not materialised and this would need to be taken into account in future reviews.
The process of setting the rate
The Committee agrees that the decision to set the discount rate should remain with the Lord Chancellor but recommends publication of the reasons for that decision, alongside the expert panel's advice, and reasons for not accepting the advice of the panel whenever that occurs.
They also agree with the Law Society that the expert panel should be involved in the first review of the rate. This was not in the Government's proposals and again would if adopted add delay to the process of changing the current rate.
The Committee does not express a view on the frequency of the reviews but acknowledges that the timing of changes to the rate should take account of the need to minimise disruption to the financial year end of insurers and the NHS.
It goes on to recommend that the legislation should require the expert panel and the Lord Chancellor expressly to consider whether to set different discount rates for different periods of loss or different heads of damage and also to consider the most appropriate way to take into account the cost of financial advice and management and inflation.
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.