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Discount rate change will save insurers and NHS £400m

Discount rate: Gauke explains reasons for decision

The new personal injury discount rate (PIDR) will save insurers and the government up to £400m a year, Ministry of Justice (MoJ) figures have indicated.

But Lord Chancellor David Gauke said setting it any higher would have risked too many injured people being under-compensated.

Mr Gauke surprised the market yesterday by raising the current rate of -0.75% to only -0.25% [1] from 5 August, when a rate of 0-1% was widely expected. Insurers reacted angrily to the news.

According to the impact assessment [2] that accompanied the announcement, the MoJ estimates that insurers will save between £230m and £320m a year, and the NHS nearly £80m a year under the new rate.

But it also noted: “Society will suffer a cost if claimants need to fall back on the state because the return on their investments fails to match the rate of return specified by the PIDR. They may also need to rely on other assets to meet their needs.

“As a higher PIDR will lead to lower lump-sum awards, this outcome may be more likely than under the current PIDR.”

However, the assessment said there should be benefits to wider society in terms of lower insurance premiums “if insurance companies respond by reducing premiums”.

The Civil Liability Act 2018 includes a statutory duty on insurers to report on the amount of savings generated by the reforms, both the whiplash changes and the higher discount rate, and the extent to which these have been passed on to consumers – although the outcome of this exercise will not be known until 2024 at the earliest.

In a statement of reasons for his decision [3], Mr Gauke said that advice from the Government Actuary was that setting the rate at 0.25% would result in a 50:50 risk of claimants being under or over-compensated.

“However, I have regarded that conclusion as a starting point for my determination rather than an end point… I consider that a rate of plus 0.25% would run too high a risk of under-compensating claimants.

“At this level, the representative claimant as modelled by the Government Actuary has only an approximately 50% chance of being fully compensated and approximately only a 65% chance of receiving 90% compensation.

“I consider this to give rise to too great a risk that the representative claimant will be under-compensated.”

A rate of 0% meant the representative claimant would have around a 60% chance of receiving full compensation and a 72% chance of receiving at least 90% compensation.

But these figures were subject to assumptions and Mr Gauke said he decided it “reasonable to build in further prudence, when setting the rate, in order to recognise that in any individual case one or more of those baseline assumptions may not apply (either resulting in additional over-compensation or under-compensation), and in particular with regard to the Government Actuary’s analysis of the rate as applied to shorter-term awards”.

At a rate of -0.25%, he continued, the representative claimant “has approximately a two-thirds chance of receiving full compensation and a 78% chance of receiving at least 90% compensation.

“Such a claimant is approximately twice as likely to be overcompensated as under-compensated and is approximately four times as likely to receive at least 90% compensation as they are to be under-compensated by more than 10%.

“I consider that this leaves a reasonable additional margin of prudence which reflects the sensitivities of the rate to the baseline assumptions.”

Mr Gauke said the advice was that a rate of -0.5% risked over-compensating claimants – there was a 70% chance of the award not being exhausted at the end of the term.

The impact assessment said that, at the current rate, the ‘median’ claimant could be expected to be over-compensated by around 25% for an award expected to last for 30 years.

“This analysis therefore supported the view that the current PIDR would lead to a significant level of over-compensation with the associated costs to insurance policy holders and the public sector. This, in turn, could be seen as in contravention of the ‘100 per cent’ principle.”

At the same time, the assessment showed that, had the existing methodology been retained – setting the rate with reference to a very low-risk investment portfolio of index-linked government gilts – it would have to be changed to “around -1.5% or even lower”.

The MoJ received 40 responses to its consultation on the new rate. Of these, 13 were from the insurance industry, 14 from law firms, six from financial advisers, three from the health sector, and four from other experts.