The discount rate, fair compensation and a predictable ABI response

I have written before about the discount rate. It is an extremely important part of our system of compensation for injured people, despite its rather understated name. In short it is a principle that tries to ensure that victims are not over or under compensated. The rate is what an award of damages is assumed to earn over a long period of time.

The idea of compensation is to put the victim in the position they would have been in, but for the incident.

For example; Alan, who is 45, has an accident at work. He is so badly injured that he will never work again. He earns £20k a year and would have worked to 65. He has lost 20 years earnings at £20k. But if he wins his case, he does not simply get 20 x £20k - £400k. Because that would not be fair on the insurers who pay the damages. Alan would be receiving money now that he would not otherwise have earned for many years. If he was to put that money on deposit, it would earn interest and he could end up with a lot more that £400k in 20 years’ time. So, the number of years that he actually receives is calculated by reference to what his money might be worth at that time. This can be even more important for victims who require high levels of care for life.

For many years, the assumption was that the money would earn 2.5% per annum. A victim is assumed to place the money in sensible, safe investments. This significantly reduced the amount of any lump sum that the insurers pay out. The £400k would be discounted to less than £350k. So it is important, for all concerned that we get this right. Whilst the rate was 2.5% there was a huge risk that money would run out, at a time when real interest rates were nothing like that amount.

In 2017 the government dropped the rate to -0.75%. This was a huge relief for victims and led to far more realistic awards of damages. It also led to a predictable outcry from the insurance industry who were having to pay out more money. Their powerful lobby led the government to promise a review of the rate. We have all waited with eager anticipation for today’s news of what the new rate is. Any significant increase, in the current economic climate, would have taken us back to the bad old days. I have pessimistically been predicting an increase to 1%, particularly in the light of the present government’s affection for their insurer friends. It was a pleasant surprise therefore to see that the new rate is -0.25%. It could have been better, but we expected far worse! I am never slow to criticise this government, but they have got this one, at the lower end, of just right.

The reaction from the ABI was swift and predictable. Their director General, Huw Evans says –

“This is a bad outcome for insurance customers and taxpayers that will add costs rather than save customers money. A negative rate maintains the fiction that a claimant and their representatives will knowingly choose to invest their damages in a way that would guarantee losing them money. This will remain the lowest Discount Rate in the Western world, leaving England and Wales an international outlier at a time when we need to boost our attraction to international capital.”

Note that he claims to complain on behalf of insurance customers and taxpayers and not his members’ shareholders. Most citizens would agree that a modern system of justice must ensure that people who need care for life do not need to worry that their money might run out. He then, rather bizarrely, seeks to compare the rate with that of other countries. Why would the assumed rate of interest earned on damages in this country have anything to do with other countries? I don’t expect the volume to be turned down any time soon. Equally I doubt if we are going to see another review unless a new PM has a rush of blood to the head. Mind you....

I do hope that this rate now stays at the same level for a very long time so that victims and their representatives can plan for the future with some level of certainty.

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