Government discount rate research highlights claimants’ investment caution

Setting the discount rate: just how much risk are claimants willing to bear?

Research commissioned by the Ministry of Justice (MoJ) into the discount rate contradicts the premise of a government consultation that claimant recipients of lump sum compensation payments tend not to invest them as cautiously as is assumed.

The research, by Ipsos MORI Social Research Institute, estimated that around 10% of all settlements, or some 72,000 a year between 2009/10 to 2011/12, were subject to the discount rate of 2.5%, which is currently set by reference to the expected rates of return of index-linked government stock as a safe investment.

In the second prong of the MoJ's consultation on whether to change the discount rate, published in February, it said: “There is evidence that recipients of… lump sums do not invest in the cautious way that is envisaged in the guidelines [and] seem to invest in mixed portfolios, including higher risk investments.”

The consultation noted that if this were true and the existing discount rate was too low, it “would result in over-compensation for claimants and extra cost for defendants and those who fund them”. Uncertainties over whether awards were sufficient could be avoided if periodical payments were made in place of lump sums, it suggested.

The Ipsos MORI project, involving both quantitative and qualitative research, concluded that although most did invest in mixed portfolios, “a key message from the research was that claimants overall were cautious and risk averse in their investments. Claimants tended to focus on minimising the risks that they face, rather than seeking opportunities to get higher rates of return”.

Those with the lowest risk appetite included those managing funds on behalf of injured children and those who had to support dependents. The findings also suggested that those who feel most uncomfortable with risk also feel pressured to take risks that they would opt not to given a higher compensation payment. “In view of this, a decrease in the discount rate would reduce the pressure on them to take such risks.”

The research also noted that “even a small shift in the discount rate would have a significant impact on the amounts for future pecuniary loss calculated in the claim schedule for large-value cases”. This also highlighted “the potentially important impact of the discount rate on the insurance industry and bodies such as the NHS”.

But changes to the discount rate would not necessarily mean changes in claimants’ attitudes to investment or spending habits, it said, “with many claimants interviewed believing they would remain relatively risk averse in this hypothetical situation”.

The rate was last set in 2001, under the Damages Act 1996, according to guidelines set by the House of Lords in Wells v Wells.

The MoJ’s February consultation asked whether the legal framework produced a rate that reasonably ensured that a person was fully compensated and not over or under-compensated, and whether periodical payments should be encouraged.

Christopher Malla, a partner at leading insurance law firm Kennedys – which has run a campaign to put the defendant point of view on the discount rate – said: “I was pleased to see the research recognise that even a small reduction in the rate would have a significant impact on public bodies and insurers. However, it is unfortunate that the research did not go wider to actually address whether a claimant's damages run out.

“In fact the research concludes by highlighting a significant number of evidence gaps, which may lead the MoJ to further delay a decision into the rate. Public bodies and insurers are waiting for clarity on this important issue and we continue to urge the government to maintain one discount rate for all heads of loss. Furthermore, once set, the discount rate should be in place for at least 10 years so as to provide stability.”