The going rate
24 September 2001
For decades, the discount rate - the amount subtracted from a victim's damages to account for any profit gleaned from the investment of the award - was set at between 4 and 5 per cent. The Ogden working parties of 1984 and 1994 criticised that rate, arguing that to achieve that rate of return on investment, claimants would need to speculate with the investment of their awards and put themselves at the mercy of the market. Instead, it is believed that discount rates should have been based on investment in Index-Linked Government Securities (ILGS), which are almost risk-free.
Wells v Wells
In 1999, the House of Lords endorsed an ILGS-based discount rate. A claimant was entitled to receive a sum of money which, when invested prudently and at low-risk, provided full compensation for future losses.
Taking an average return of investments in ILGS during a three-year period, net of tax, produced a guideline figure of 3 per cent. The House of Lords made that the discount rate, with the Lord Chancellor, Lord Irvine having the power to prescribe a different rate pursuant to Section 1 of the Damages Act 1996.
LCD Consultation Paper
The controversy started in March 2000, when the Lord Chancellor's Department (LCD) issued a consultation paper on the discount rate. Question 2 of the paper asked: "Do consultees agree that the Lord Chancellor can prescribe a discount rate that is not based on the assumption that claimants will invest in ILGS? If yes, on what basis should the rate be set?"
The Association of Personal Injury Lawyers (Apil) pointed out that the House of Lords had unanimously decided this point, as it ruled that accident victims should not be required to expose themselves to risk in order to achieve their full compensation. On this basis Apil believed that the Lord Chancellor was surely required to follow the decision in Wells Wells.
Apil argued that changes in the rate of return on ILGS required the discount rate to be reduced to 2 per cent.
The Association of British Insurers (ABI), the Forum of Insurance Lawyers (Foil) and other insurance bodies repeated their objections to Wells Wells. Claimants generally invest in mixed portfolios and the discount rate should be based on the performance of such portfolios. A discount rate based on those rates of return would be 3.4 per cent. However, Foil was content for the rate to remain at 3 per cent.
The LCD's first response
The consultation exercise was followed by a year's silence. On 25 June, the LCD revealed a new discount rate of 2.5 per cent. This was based partially on the average gross redemption yield on ILGS for the three previous years, said to be 2.61 per cent. Adjusting this to take into account tax, assumed to be a flat rate of 15 per cent, placed the discount rate between 2 and 2.5 per cent, but nearer to 2 per cent.
To support the choice of 2.5 rather than 2 per cent, the Lord Chancellor said: "The fact that yields in ILGS appear to be artificially low at present militates against the suggestion that these yields should be taken as the sole indication of the rates of return that can be achieved through low risk investment in the market." He relied on the fact that many claimants did invest in mixed portfolios, as did the Court of Protection.
Response from claimants' groups
First, the Lord Chancellor got his maths wrong. Some sources argue that the correct figure was 2.16, not 2.61. With this in mind, and taking into account taxation, the appropriate rate was at most 2 per cent.
Second, by taking into account the rates of return from mixed portfolio investments, the Lord Chancellor had ignored the House of Lords in the Wells case and had, therefore, acted unlawfully.
Response from insurance groups
The ABI complained that, even though the LCD had listened to its request to take into account mixed portfolio investments, the reduction from 3 per cent would increase insurers' costs and increase premiums. Similarly, questions were asked in Parliament on the increased burden of clinical negligence claims on the Department of Health.
The LCD's second attempt
Accepting that the maths was slightly wrong, a figure of 2.46 per cent was provided for ILGS returns. Adjusted for tax, this still put the figure between 2 and 2.5 per cent, but very close to the 2 per cent line. The Lord Chancellor denied that it was simply an arithmetic matter of setting the rate to the nearest 0.5 per cent. He argued that, while Wells Wells provided the basic principles that he had followed, it allowed him to take into account matters that he considered to be relevant. Such matters included the rates of return for mixed portfolio investments.
And by setting the discount rate at a point which angers both claimants' and insurers' groups, the LCD considers that there is no doubt it reached the correct result.
Daniel Bennett is a barrister at Old Square Chambers