Lord Chancellor Liz Truss has today cut the discount rate from 2.5% to minus 0.75% but at the same time promised a consultation on whether the methodology needs to change.
The government has also committed to ensuring that the NHS Litigation Authority has “appropriate funding to cover changes to hospitals’ clinical negligence costs”.
The insurance industry has reacted with shock and fury.
Ms Truss said the law was “absolutely clear – as Lord Chancellor, I must make sure the right rate is set to compensate claimants. I am clear that this is the only legally acceptable rate I can set”.
In a statement to the stock exchange this morning, she explained: “The current legal framework makes clear that claimants must be treated as risk-averse investors, reflecting the fact that they may be financially dependent on this lump sum, often for long periods or the duration of their life.
“The discount rate was last set in 2001, when the then-Lord Chancellor, Lord Irvine of Lairg, set the rate at 2.5%. This was based on a three-year average of real yields on index-linked gilts. Since 2001, the real yields on index-linked gilts has fallen, so I have decided to take action.
“Having completed the process of statutory consultation, I am satisfied that the rate should be based on a three-year average of real returns on index-linked gilts. Therefore I am setting it at minus 0.75%.”
The statutory instrument to effect this change will be laid today, and will become effective on 20 March 2017.
Despite having gone through an exhaustive consultation process over the past four years, Ms Truss said the government intended to review the framework under which she set the rate “to ensure that it remains fit for purpose in the future”.
She said: “I will bring forward a consultation before Easter that will consider options for reform including: whether the rate should in future be set by an independent body; whether more frequent reviews would improve predictability and certainty for all parties; and whether the methodology – which in effect assumes that claimants would invest only in index-linked gilts – is appropriate for the future.
“Following the consultation, which will consider whether there is a better or fairer framework for claimants and defendants, the government will bring forward any necessary legislation at an early stage.”
In the meantime, acknowledging the “significant implications across the public and private sector” of her decision, Ms Truss said that in addition to supporting the NHS Litigation Authority, the Department of Health would work closely with GPs and medical defence organisations “to ensure that appropriate funding is available to meet additional costs to GPs, recognising the crucial role they play in the delivery of NHS”.
Finally, she said Chancellor of the Exchequer Philip Hammond would meet representatives of the insurance industry to assess the impact of the rate adjustment.
According to Bill Braithwaite QC, the change could double some damages awards. “For someone in their 20s, lump sum damages would change from £4.8m to £11m. For someone in their 60s, where it impacts less, lump sum damages would change from £3.8m to £6.5m.”
Huw Evans, director general of the Association of British Insurers, described the decision as “crazy”.
“Claims costs will soar, making it inevitable that there will be an increase in motor and liability premiums for millions of drivers and businesses across the UK. We estimate that up to 36 million individual and business motor insurance policies could be affected in order to over-compensate a few thousand claimants a year.
“To make such a significant change to the rate using a broken formula is reckless in the extreme, and shows an utter disregard for the impact this will have on consumers, businesses and the wider operation of the insurance market.
“We have repeatedly warned the Government that this could lead to very significant price rises, with younger drivers in particular likely to find it much harder to get affordable insurance. It is also a massive own goal that lands the NHS with a likely £1billion hike in compensation bills when it needs it the least.
“We need a fairer deal for consumers and claimants. We cannot wait until Easter – the Ministry of Justice must commit to alternatives immediately so changes to the law can be included in the Prison and Courts Bill.”
The Association of Personal Injury Lawyers welcomed the decision but said it was “long overdue”.
In a statement, it said: “People already coping with the most severe injuries have been deprived of the help and care they need for years. Meanwhile insurance companies, which have saved millions of pounds in unpaid compensation, have been aware that a decision to change the discount rate has been on the cards for six years, since APIL first began judicial review proceedings on the issue.
“They have had plenty of time to prepare for this change and the fact that many are now saying premiums will have to rise to cover the cost simply beggars belief.”
Jasmine Murphy, a barrister at Hardwicke, tweeted: “Claimant sols will be busy today withdrawing pt36 offers in any case with a significant element of future loss.”
Nigel Teasdale, president of the Forum of Insurance Lawyer, said the decision was “extremely concerning”.
He said: “The announcement has all the hallmarks of a rushed decision and the government’s current approach seems disjointed at best.
“On the one hand suggesting that saving the average consumer money on their insurance premium is a priority, then on the other reducing the discount rate which will have a major inflationary effect on premiums now and for many years to come.
“The timing is wrong given the uncertainty in the market, and the decision also fails to reflect how people actually invest their compensation. The reality is that when paid large amounts of money in a lump sum most claimants will invest in a range of assets through an independent financial adviser…
“The most likely outcome in addition to increasing premiums is a return to a more adversarial system of litigation where major heads of damage will be challenged.”
Christopher Malla, a partner at leading defendant firm Kennedys, said such a drastic cut would have “a massive impact” on the value of the most serious claims – adding 30% to the future loss element of catastrophic injury cases, and 50% to high-value clinical negligence claims involving children.
There would also be significant delays in current cases as claimants withdraw part 36 offers to settle.
He said: “This is not about denying injured people the compensation they need. At the same time, claimants should not be over-compensated, especially when it is public bodies, such as the NHS and local authorities, which are paying.
“Unfortunately, in the face of its own research and the fact that the investment climate has changed since the review began in 2012, the government is now at risk of doing exactly that…
“We don’t pretend that this is an easy balance to find but in Europe and the USA, the discount rate is significantly higher than even the old rate, which indicates just how out of step we have now become.”
Daniel Frieze, barrister and head of personal injury at St John’s Buildings, said the new rate was “undoubtedly a positive thing for claimants”, but added: “However, with claims now worth a lot more, the result of a successful claim leaves potential losses at up to double their previous amount.
“As a result, these changes also act as a benefit to insurers to argue for the implementation of fixed costs, which the government has already heavily championed in recent weeks.”
Admiral Group plc told the stock exchange in response that it was postponing the preliminary announcement of its 2016 annual results by a week to consider the impact of the change.
It told investors: “The reduction in the discount rate will have the effect of increasing the cost of personal injury claims, therefore also increasing the ultimate loss ratio for all business written up to the effective date, part of which will be earned and part unearned.
“The majority of the financial impact in respect of premiums earned during 2016 and prior years will be reflected as a one-off charge against 2016 second half profits…
“The estimated total net financial impact of all claims settling at the new rate is £140m to £175m. The estimated net financial impact on 2016 reported profit is £70m to £100m…
“The group anticipates that if market pricing adjusts future premiums to reflect the lower discount rate, there will be no significant impact on future business and its profitability after the change.
“The group is also confident that its strong capital position, along with its prudent approach to claims reserving, will allow it to address the outcome without significant change to its business or long term financial outlook.”