There is a case to cut the discount rate to 0% – and a case to keep it at 2.5% depending on the kind of investments it is based on, a debate on the current government consultation heard last week.
The discount rate is the rate of return to be expected from the investment of a lump sum award of personal injury damages for future loss, and applied to the lump sum to ensure a claimant is not over-compensated.
The rate has been 2.5% since 2001, set largely by reference to yields from index-linked government gilts (ILGs). This is on the basis that claimants would seek low-risk investments. But the yield from ILGs has fallen in recent years and there is pressure from claimant representative to cut the rate; the impact would be to increase the cost to defendants. The government also asks whether the rate should instead be set by reference to a ‘mixed portfolio’ of investments.
Speaking a debate organised by City defendant law firm Kennedys, Dr John Pollock, actuary and founder of Pollock & Galbraith, told the audience in London that the government should stick to ILGs, arguing that only they guarantee a return relative to the retail prices index (RPI). “If a claimant invests in a suitable portfolio of ILGs at a yield equal to the discount rate at which his compensation has been calculated, he will be fully compensated without risk.
“Even ILGs do not provide full compensation if the losses of expenses grow faster than the RPI. All other investments, even if offering the prospect of higher returns, cannot guarantee full compensation.”
Dr Pollock said that given the decline in yield in ILGs in recent years, the rate should now by 0%.
However, Doug Hall, head of forensic services at Smith & Williamson, a firm of both accountants and wealth managers, explained how his firm has advised clients on a mixed portfolio where the net return in a balanced index over both an eight- and a four-year period would justify the rate remaining the same.
“You can effectively manage risk over the long term [with a mixed portfolio],” he said, “but you can’t eliminate it.” Mr Hall added that tax is a big issue for claimants, and shows how one size does not fit all – there should be multiple discount rates. Keeping the rate where it is now is “the least worst option”, Mr Hall suggested.
But pressed by top legal commentator and event chairman Joshua Rozenberg as to what they thought the outcome is likely to be, Mr Hall said he saw “a lot of momentum to make a reduction. If it came down by 1-1.5%, it will be a good result for the defendant community”. Dr Pollock said he could not see how the rate would not fall to between 0% and 1%.
Mr Hall added that the second consultation due on the rate – which will examine the legal basis for setting it – could yet play an important role in the final figure the government chooses.
Kennedys partner Christopher Malla said: “If there is any reduction in the discount rate, it will increase a claimant's damages. The larger the future loss, the greater the increase in damages will be… Bearing in mind the potential impact a reduction to the discount rate will have on the NHS, other government departments and local authorities, I anticipate the Lord Chancellor will be attracted to the mixed portfolio option.”