Three-yearly discount rate reviews should reduce ‘shocks’ for insurers, says expert

The package of changes, which would also see the rate calculated with reference to ‘low risk’ rather than ‘very low risk’ investments, should also return the rate to a range which is more in line with industry expectations, according to insurance law expert Colin Read of Pinsent Masons, the law firm behind Out-Law.com.

A new discount rate of minus 0.75%, down from 2.5%, came into force on 20 March in England and Wales and 28 March in Scotland this year, effectively increasing lump sum compensation awards in order to reflect assumed loss of value. The change, which was the first since 2001, was criticised by the insurance industry, which said that it reflected a flawed method for setting the rate and ultimately over-compensated claimants.

“The changes announced in February 2017 created significant disquiet within the insurance industry,” said Read. “A flurry of insurer-ministerial meetings followed that decision and reflected how the original discount rate had proved an unexpected surprise to insurers, many of whom were in the middle of reporting annual results.”

“The revised figure is likely to bring the ‘Ogden rate’ within a range originally anticipated before February’s changes. It is to be hoped that a fairer system, with less of a ‘shock’ value, could follow from the three-yearly review process set out by the government,” he said.

The current law requires that those receiving lump sum compensation awards be treated as ‘risk-averse’ investors, reflecting the fact that they will be financially dependent on that lump sum for perhaps the remainder of their life. The discount rate, which is applied by the courts to ensure that the actual amount received by an individual reflects the return they could have expected to earn if they had invested the payment, is therefore linked to returns on index-linked gilts as the lowest-risk investments.

After consultation with the industry, the government now intends to amend the law so that the rate would be set by reference to a portfolio of ‘low risk’ investments rather than the lowest risk investments: a proposal which it says is a better reflection of the evidence of actual investment habits. It also intends to ensure that the rate is reviewed more regularly in future, with once every three years being proposed; and to extend the expertise available to the Lord Chancellor when carrying out the reviews by creating a role for an independent expert panel in the process.

Justice secretary David Lidington said that those awarded compensation should receive “neither more nor less than 100%” of what they were due once the changes took effect. The new system, if applied today, would result in a rate in the region of between 0% and 1%, and would “more reliably reflect” how compensation awards are actually invested, he said.

The government was “keen to engage” with industry on the issue ahead of draft legislation being introduced to parliament, he said. While no timetable has yet been provided for the introduction of the new formula, the government intends for the first review to begin within 90 days of the new law coming into force.