The draft clause includes, in proposed new Schedule A1 to the Damages Act 1996, paragraph 4, which requires the Lord Chancellor to:
This results from the Government’s objective that the discount rate continues to “support a 100% compensation rule so that claimants receive full compensation … neither more nor less”, and consequent proposals that
18.The Government’s objective is not to disturb the longstanding legal principle that “claimants should be compensated in full for the losses they have suffered because of the injury caused by the defendant”. It says:
The objective of applying a discount rate will therefore continue to be to support a 100% compensation rule so that claimants receive full compensation for the loss caused by the wrongful injury neither more nor less.
19.Witnesses agreed that the Government should adhere to the “full compensation” principle. The Association of British Insurers (“ABI”) told us:
We certainly accept … that the principle of 100% compensation is absolutely the right one to work from. Parliament got it right 21 years ago when it passed the Damages Act, and that principle should be at the heart of any reforms.
Other insurers expressed support for the objective of 100% compensation.
20.While the principle of “full compensation” is agreed by all, it is less clear what it means. Ageas Insurance Limited described the concept of under- and over-compensation as “elusive because it can only be known after the period covered (often that between award and death)”. The Institute and Faculty of Actuaries (IFoA) believed it “crucial to investigate what ‘compensated in full neither more or less’ means in practice”. They pointed out that the Government could only achieve full compensation on average; full compensation for individual claimants is largely determined by whether they live longer or die sooner than expected:
The lump sum award is designed to meet loss over the expected future lifetime of the claimant. The expectation of future lifetime will be an expectation on average of a given sample of the population. In reality, very few individuals will live exactly for their expected future lifetime. As such, compensation can only ever meet the expectation of future lifetime costs in aggregate. Some claimants will die earlier than expected, meaning the lump sum was greater than required. However, other claimants will live for a shorter period than expected, meaning compensation is insufficient for their actual lifetime.
21.Lord Keen acknowledged that it is “not an exact science” and agreed:
No matter where you place the discount rate, … there is always the potential for some victims to be undercompensated, just as there is the potential for many victims to be overcompensated.
22.The Government refers to “full and fair compensation” but also to defendants “no longer pay[ing] greater than 100% compensation because of the application of an artificially low discount rate”. It presumably means 100% compensation on average, but this is not made explicit.
23.Notwithstanding the Government’s commitment to “full compensation”, the impact assessment that accompanies the Command Paper notes that the legislation, if enacted, “will lead to a higher PIDR” and “this will result in smaller lump sum compensation payments, which will be a cost to claimants”; but on the other hand, defendants will benefit. What is unclear is whether the Government is targeting 100% compensation on average, with around half of claimants being undercompensated, or something else. As the Forum of Complex Injury Solicitors (“FOCIS”) put it:
If the law is to change to force seriously injured claimants to take investment risk the debate needs to look at the flip-side of alleged over-compensation: what proportion of them do we consider it fair to potentially go “under-compensated”?
24.We welcome the Government’s commitment to full compensation, neither more nor less. However, we recommend that the Government clarifies what it means by 100% compensation. In practice a lump sum award will nearly always either under- or over-compensate claimants. Some will receive too much and some too little. If the Government is targeting a median level of 100% compensation in relation to interest earned on lump-sum investment, it needs to say so.
25.Although there was consensus about the 100% compensation principle, there was disagreement as to whether claimants are “over-compensated” now the discount rate is -0.75%.
26.The proposed new Schedule A1 to the 1996 Act would require the Lord Chancellor to set a rate that a claimant “could reasonably be expected to achieve”, assuming the lump sum is invested in a “diversified portfolio” involving “more risk than a very low level” but “less risk than would ordinarily be accepted by a prudent and properly advised individual investor” with different aims. In doing so, the Lord Chancellor must “have regard to” actual returns available to investors, and investments made by claimants.
27.The draft legislation is therefore founded on the principles that:
28.These two principles mark a departure from existing case law, which sets the discount rate according to the return on Index Linked Government Securities (ILGS) which is considered to be a “risk-free” or “very low risk” investment. The appropriateness of these principles is examined below.
29.The Government’s position is that the rate as it stands “may produce significantly larger awards than provide 100% compensation” because claimants are investing in “low-risk” diversified portfolios and are therefore likely to earn a higher rate of return than the discount rate, which is set assuming investment in ILGS (very low risk). However those representing claimants say that even if claimants earn a higher rate of return than the discount rate, this does not amount to over-compensation.
30.Professor Victoria Wass argued that claimants earning a higher rate of return than the discount rate are not “over-compensated”; they are earning a premium for taking on more risk:
If … the claimant accepts a greater risk in return for the opportunity for financial gain, that is up to the claimant. S/he ought not to be required to do so and it is of no concern to the Court or the defendant whether or not this is subsequently chosen.
31.Some evidence suggested that even when the discount rate assumes risk-free or “very low-risk” investment, claimants are under-compensated for a host of other reasons. Richard Cropper told us a claimant “gets to recover zero in respect of their future accommodation”, so they “start off with insufficient capital in their pot to meet all their future needs”; and “care costs and earnings rise over the long term at a faster rate than prices”. On the other hand, the ABI argued:
this view of care cost inflation is out of date. The ASHE [Annual Survey of Hourly Earnings] figures confirm that the current rate of inflation in care earnings is below RPI and in the longer term is expected to be close to RPI”.
32.The IFoA pointed out “Even if investment performance matches or exceeds the assumed discount rate, a claimant living much longer than anticipated will exhaust their assets.” Those representing claimants also advised us they saw no evidence of over-compensation in claimants’ behaviour. Brett Dixon from APIL told us:
As a practitioner, I do not see people behaving like they have a lottery win or money that they can freely invest. What they and their families actually have is a pot of money that has to last them for the rest of their lives. They have no other way of making any money, earning or otherwise, and their biggest focus is making sure that that money is available to meet their need.
33.It is possible that claimants may be “under-compensated” even when the discount rate is set at a “risk-free” rate because compensation may be inadequate for their accommodation needs; they may be living longer than expected or there may be real increases in their cost of care over time. We recommend that the Government find a means of assessing whether the legislative framework is compensating claimants fairly for their losses; otherwise by increasing the discount rate to remove what it sees as one type of “over-compensation” (primarily over-compensation due to greater than anticipated earnings from lump-sum investment), it may be simply increasing levels of under-compensation for claimants who were already under-compensated.
34.One of the foundations for the Government’s decision to stop setting the discount rate by reference to ILGS is investment behaviour. Lord Keen told us:
I think the problem is that ILGS is not used. We do not have a situation in which, generally speaking, claimants put their entire award into index-linked gilts. That just does not happen, so it does not present a realistic picture of what is happening.
35.The ABI told us it would be “crackers financial advice” for anyone to invest in ILGS. They acknowledged they were appropriate when Wells was decided, but argued that because of their high price (due to scarcity and the financial crisis) they can no longer be used as a proxy for very low risk or no risk investment.
36.Setting the discount rate with reference to ILGS returns was never based upon their actual use by claimants. Wells decided that investment behaviour was irrelevant to the discount rate (as did the courts in Ireland). The true reason for using ILGS was as a proxy benchmark rate which would protect claimants against RPI inflation, as the expert panel report to the Ministry of Justice confirmed.
37.It may seem intuitive that the discount rate should reflect actual investment behaviour. But we conclude that this proposition should not be adopted without some further critical examination.
38.Professor Victoria Wass suggested that the discount rate could not be based upon investment behaviour because the discount rate itself affects investment choices:
In temporal space, the discount rate comes before the investment choices. During the period between 2001 and March 2017, claimants were forced into risk-bearing assets in order to more closely match the return of 2.5% on which their lump sums were based.
39.This point was also put forward by APIL: “While the discount rate was artificially high at 2.5 per cent, however, claimants were often forced into the invidious position of having either to take chances with their compensation by putting it into higher risk investments, or struggling to make ends meet”. The Government’s 2013 research supported this, finding:
some evidence that those who have more acute concerns about future uncertainties related to a feeling that their current compensation does not meet their needs, currently feel pressured into higher-risk investments than they would like.
40.Those representing the claimants also strongly made the case that investors were not normal investors who are chasing high returns; instead their investment decisions are based on their needs. Richard Cropper from PFP said:
When we advise claimants about investment risk, it is to meet their need, not how much risk they are prepared to take and then maximise return. It is the other way round.
He also argued that for claimants who do invest in the stock-market, returns earned in the past are a poor indicator of future returns due to stock market volatility:
If we set the discount rate by reference to past returns, which is the only way in a basket, we are going to find ourselves increasing the discount rate at the peak and reducing the amount of compensation to a claimant who then has the most investment risk—having to invest today at what feels like an elevated price. If we then get a collapse, there will be pressure on the discount rate to fall. We give the most money to those with the least investment risk, because they get to invest at the bottom. It is counterintuitive.
41.We advise caution in considering evidence of claimants’ investment behaviour to set the discount rate. Investment by claimants in higher risk portfolios could indicate they are under-compensated and forced into higher-risk investments to generate sufficient return for their future living expenses.
42.In this section, we consider what evidence there is that claimants invest in low-risk diversified portfolios rather than “very low risk” investments like ILGS.
43.The Government says this is clear, “taking the responses and the results of other research together”. When asked what evidence there was of over-compensation, Lord Keen responded:
We have had submissions from both claimants and defendants about the issue of the discount rate and its impact upon the level of compensation that is received. We have the perceptions, for example, of insurers as well.
44.Thirty-nine of 135 respondents to the Government’s public consultation thought “claimants were investing in a low- to medium-risk mixed portfolio of assets”. The Government’s 2013 research found that although claimants were cautious about investing, they tended to take on “a mixed portfolio of investments, rather than just relying on ILGS”.
45.Much of the evidence of over-compensation we received was based on the Government Actuary’s Department (GAD) analysis, with many insurers and defence solicitors claiming it showed 95% of claimants to be over-compensated and the median level of over-compensation to be 35%.
46.GAD analysed outcomes for claimants receiving a lump sum award under different illustrative discount rates. The outcomes were examined under two assumed investment strategies (portfolios) set by the Ministry of Justice. The strategies were broadly derived from information provided by 4 firms of wealth managers and investment advisers and both strategies used a low-risk mixed portfolio approach. We received no evidence about how closely this information represents advice given generally, or how closely such advice is followed by claimants.
47.We did receive evidence that the “low-risk mixed portfolios” used in the GAD review are not appropriate as a benchmark for claimants. PFP said that the portfolios considered by GAD could not be considered ‘low risk’ portfolios as they contain too great a proportion of equities.
48.It is also unclear how many claimants do not seek investment advice and simply choose to keep their funds in a bank account. We received evidence to suggest that these claimants may well not be earning positive returns on their lump-sum, given current market conditions. Solicitors Slater and Gordon UK LLP thought it might be common for claimants to invest in an “easy-access savings account”. They calculated that against RPI, such claimants would be losing over 2.5% in real terms. Richard Cropper of PFP told us some of his clients have no other option but to keep their investment in cash:
I have clients who unfortunately have less than 10 years to live. They have no capacity for loss, so they are in cash. … They are getting negative 3.5% real and net. They are being woefully undercompensated, even at the current discount rate.
49.The Government’s 2013 research also indicated that gathering data solely from financial advisers may exclude financially vulnerable claimants:
the breadth of the claimant sample for this research was limited by the need to recruit predominantly through financial advisors. In view of this, the claimant sample was likely to include claimants who were more aware or supported in managing their claims. While the findings still indicated that claimants were a cautious and risk averse group, a more purposive sample may capture the most financially vulnerable claimants.
50.The Law Society cautioned that “before proceeding with reform additional advice should be sought from investment advisors on actual Claimant investment behaviour” and “changing the framework without wider research risks creating an unfair framework based on assumptions which may not be accurate.”
51.Advantage Insurance Company suggested the legislation should be amended to require that “all professional deputies acting for claimants in personal injury claims file annual returns” to which the Ministry has access. Advantage Insurance suggested that data could be anonymised and “a set of standardised criteria would need to be devised to ensure that the specific data required by the expert panel & Lord Chancellor was provided in each annual return”. The eSure Group plc supported the idea of submission of anonymised data by professional deputies. Lord Keen told us:
the Lord Chancellor, when he comes to fix the rate, will be able to look at a wide body of evidence, as will the expert panel. If that sort of material is submitted, it will clearly be available for consideration.
52.Moreover, the Federation of Insurance Lawyers (“FOIL”) said that “full opportunity has been given to claimant representatives to present evidence on claimants’ behaviour but very little has been forthcoming” and argued that therefore it is appropriate for Government now to assume “that claimants generally adopt a low-risk mixed portfolio approach”.
53.An adequate evidence base for policy changes is important: in 2012, the then Government introduced reforms to the legal aid system, in Part 1 of the Legal Aid, Sentencing and Punishment of Offenders Act 2012. Our predecessor Committee was critical of the failure to carry out adequate research. It may be reasonable to change the assumptions upon which the discount rate is currently calculated if they are indeed no longer representative of “real world” behaviour. However, we do not believe the evidence presented on this point so far is adequate. We recommend that clear and unambiguous evidence is gathered about the way claimants invest their lump sum damages before legislation changes the basis on which the discount rate is calculated. If the rate is to take account of investment behaviour, a mechanism must be established to keep those responsible for setting the rate informed about that behaviour. This mechanism must ensure it captures the behaviour of those claimants who do not access professional investment advice and fund management.
54.Another problem identified with setting the discount rate according to “low risk” investments is that there appears to be no clear-cut definition of what “low risk” is.
55.Richard Cropper told us that there is no consensus about what “low risk” investment is and that the advantage of using ILGS to determine the discount rate is that their rate of return is accurate, whereas this is not the case with other assets:
I have no idea how one defines what a low risk investment is, or where the border is between very low risk and low risk, where it becomes medium risk or where it is between medium and low. The beauty of index-linked Government stocks is that they do not predict the future. They are the future. That is the return you will get. With any other asset class, you have no idea; the crystal ball does not tell you. The most recent history is the least best estimator of future returns.
56.PFP argued that the ‘low risk’ rate of return must be clearly and narrowly defined, if Parliament supports the move from ‘very low risk’ investment. They said:
it should be measured by the observed standard deviation of the proposed portfolio of investments, and limited to a specific level of standard deviation … Without such definition, there will be too much scope for disagreement, subjectivity and bias whether the PIDR is being set by the Lord Chancellor or an expert panel.
However, Lord Keen stated: “fixed parameters or definitions would prove potentially unhelpful going forward”.
57.The Government’s Command Paper notes that there is likely to be “a range of portfolios and rates which might satisfy the parameters” in the draft clause of “more risk than a very low level” but “less risk than would ordinarily be accepted by a prudent and properly advised individual investor with different aims”.
58.Paragraph 4 of the draft clause requires that in setting the rate, the Lord Chancellor must:
59.There does not appear to be a consensus about what type of portfolio would be suitable to set a discount rate for claimants. There are likely to be multiple portfolios with differing rates of return that would fit into the Government’s requirement of an approach involving (i) more than a very low level of risk, but (ii) less risk than would ordinarily be accepted by a prudent and properly advised individual investor who has different financial aims.
60.We recommend that the Lord Chancellor publishes the basis upon which he or she has decided upon a particular rate out of the range available. We also think that it may be problematic for the Lord Chancellor to use investment behaviour of claimants to set the rate of return within the range. There are no such data widely available, and currently no mechanism in the draft legislation to obtain those data; and also claimants could be taking on more risk because they are being under-compensated. Until the Government obtains data on whether claimants are being appropriately compensated and not just with regard to investor risk, we recommend that the Lord Chancellor as a starting point sets the rate at the lower end of the range of “low-risk” to avoid the risk of under-compensation for claimants.
61.Alongside its Command Paper and draft clause, the Government published a comparative study produced by the British Institute of International and Comparative Law (“BIICL report”) which compared the UK with other jurisdictions in relation to the setting of the discount rate. The ABI told us that along with the GAD analysis, this study provides further evidence that there is over-compensation in the UK:
British Institute of International and Comparative Law looked at the discount rate for the UK versus 26 other common law jurisdictions and found that the new rate puts the UK at the lowest of the 27, whereas before it had been roughly in the middle. Both those independent areas point to a new rate that is likely to lead to overcompensation, and therefore not what Parliament intended
62.However, the BIICL report also suggests that a simple comparison of discount rates may not present the whole picture. For instance, the BIICL report observes:
63.For the above reasons, we have found the international comparisons to be of limited assistance in determining what is the right approach for claimants and defendants in this country.
Since 2005, the court has been able to award periodical payments in respect of future pecuniary loss.
The court must consider whether to make such a PPO, but cannot do so unless satisfied that continuity of payment is reasonably secure. Some payments are deemed secure, such as those from NHS, many motor insurers (if protected by the Financial Services Compensation Scheme), and the Motor Insurers Bureau.
64.Defendants argue that the existence of PPOs protects risk-averse claimants; claimants do not have to settle for a lump sum investment, which uses a “low risk” discount rate, instead they could ask for a PPO.
65.David Johnson from FOIL told us PPOs are a “route out for a claimant who is concerned about whether they can invest their damages to achieve the rate of return they need”. Huw Evans from the ABI said that “the area of the current system that most protects vulnerable clients is the existence of the PPO, because it ensures that they can never run out of money”. However, he said uptake was disappointing: the level of periodic payment orders has declined from 2012 and there is now about 10% uptake.
66.Those representing claimants argue that PPOs are not always realistically available to their clients. APIL said: “For a claimant, there often is not a choice. If a defendant makes an offer to settle on a lump sum basis that puts the claimant at risk, they take it, or they run the risk and there is no PPO, even if a PPO might have been a far better way of delivering”. On the other hand, Emma Hallinan of the Medical Protection Society described claimant uptake as “minimal”. FOCIS, PFP and Stewarts Law suggested an amendment to Part 36 of the Civil Procedure Rules (“CPR”) to require that any lump sum offer be made also on PPO terms.
67.PPOs might not always be appropriate. Stewarts Law said “Until claimants are fully compensated for accommodation loss, this will continue to be a driver towards lump sum rather than PPO settlements.” The ABI pointed to strong behavioural reasons why claimants might prefer lump sums over PPOs, a “desire to have control over something, rather than to feel that they are just the recipient of an ongoing payments”. Also, “if they take a lump sum, they may, depending on what happens to them, be in a position to leave some of that lump sum to dependants. People feel very strongly about that, given the loss of earnings for their lifetime”.
68.We were also told that insurers must reserve for PPOs at a negative discount rate of between -1.5% and -2%, because the regulator requires insurers “to reserve very cautiously”. The ABI explained to us that the real discount rate used for reserving (before applying a risk margin) was between -3% and +0.5%, and that this was because they are required to reserve at a “risk-free rate”.
69.Lord Keen told us:
There is mixed evidence about PPOs. There is some evidence that claimants are not particularly enthusiastic about them. There is some evidence that insurers are not always particularly enthusiastic about them, because of the regulatory regime that impacts on their capital requirements going forward, but, generally speaking, they are utilised in cases of catastrophic injury, where they are most needed.
70.PPOs offer a very useful alternative to lump sum awards, when appropriate, and can also be offered in combination with them. They transfer mortality and investment risk to defendants or the NHS, who are better placed to absorb those risks.
71.It is not certain whether the low uptake of PPOs is due to claimant or defendant reluctance or a mixture of the two. The enthusiasm of some witnesses, including those representing claimants, for amendment of the Civil Procedure Rules to make it a requirement for PPOs to be offered does not suggest claimants are strongly resistant. We believe that the low uptake means that PPOs cannot be viewed in all cases as a realistic alternative to a lump sum. Evidence that insurers must reserve for PPOs at negative rates means that PPOs are likely to be costly, and presumably less attractive, for insurers.
72.It is perhaps telling that insurers must be “cautious” and reserve for PPOs at a significant negative discount rate. Claimants must also be cautious, though for different reasons. We acknowledge that insurers are given no choice, but if a rate based on zero-risk investment is mandated for them, it strengthens the case for that being viewed as an appropriate investment strategy for claimants.
20 , para 3
21 , para 11
22 , para 3
24 The Medical and Dental Defence Union of Scotland () para 4.2, LV () para 12, esure Group plc () para 1, Ageas Insurance Limited () paras 13–14, Aviva (), Advantage Insurance Company Ltd () paras 15–18, ABI (), and British Insurance Brokers Association () para 31
25 Ageas Insurance Ltd and Tesco Underwriting Ltd (), para 4
26 We understood the IFoA to have meant “longer”, and not “shorter”.
27 IFoA (), para 7
30 , para 17
31 MoJ, , July 2017
32 Forum of Complex Injury Solicitors (), para 4
33 , pp 15–16 (new Schedule A1, paras 4(2); 4(3)(c) and (d); and 4(5)(a) and (b))
34 , paras 6– 7
35 Professor Victoria Wass (), para 1
37 ABI (). In contrast to evidence given by ABI, ASHE (Annual Survey of Hours and Earnings) data from the ONS shows that for 2016, growth of hourly earnings for care workers exceeded RPI inflation (though this was not the case for all years): care workers’ median hourly earnings grew by 3.9% compared to 1.8% RPI growth (see ONS 2016, ; ). The same dataset also shows that growth of median hourly earnings for all occupations was 3.3%, also well above RPI growth. There is also evidence that care workers’ real wages are likely to increase in the future. Skills for Care published a which states: “Given the National Living Wage is forecast to reach £9 by 2020, it is likely that the trend of decreasing real term pay will be reversed and care workers could see nominal and real term increases up to 2020” (Pay in the Adult Social Care Sector, December 2016).
38 The Institute and Faculty of Actuaries (), para 9
42 See Wells v Wells ;  AC 345, 394–5 and 373
43 British Institute of International and Comparative Law, Briefing Note on the Discount Rate applying to Quantum in Personal Injury Cases: Comparative Perspectives, April 2017, p 45: “plaintiffs are ‘entitled to take their award to Las Vegas or place it on a horse in the Grand National in the hope that they may enhance it’ ”
44 Cox, Cropper, Gunn and Pollock, , October 2015, p 8. The availability of Index-Linked Government Stock (ILGS) enabled the Court to consider a theoretical framework within which a claimant could invest in a portfolio of ILGS which … would provide for the future losses or costs as they fell due, without risk of erosion through inflation … or loss of capital. The availability of ILGS then provided the most accurate way of assessing the value of future losses in real terms (at least relative to RPI inflation).
45 Professor Victoria Wass (), para 11
46 Association of Personal Injury Lawyers (), para 2
47 MoJ, , October 2013, p 64
48 ; see also .
50 , para 6
52 MoJ, [Consultation response], September 2017, p 10
53 MoJ, , October 2013, p 4
54 Government Actuary’s Department, , para 1.9; , Keoghs LLP (, LV (), FOIL (), esure Group plc (, Zurich Insurance , DWF LLP (), Aviva (, Advantage Insurance Company Ltd (), RSA Group (), ABI (), BIBA ()
55 Government Actuary’s Department, , para 1.1
56 PFP ()
57 Slater and Gordon UK LLP () paras 15–16
59 MoJ, , October 2013, p 66
60 The Law Society of England and Wales ()
61 Advantage Insurance Company Ltd ()
62 esure Group plc () para 3(a)
64 FOIL ()
67 PFP ()
69 , para 12
70 British Institute of International and Comparative Law, Briefing Note on the Discount applying to Quantum in Personal Injury Cases
72 British Institute of International and Comparative Law, Briefing Note on the Discount Rate applying to Quantum in Personal Injury Cases: Comparative Perspectives, p 27, para 10
73 Ibid, pp 23–24, paras 15–16
74 British Institute of International and Comparative Law, Briefing Note on the Discount Rate applying to Quantum in Personal Injury Cases: Comparative Perspectives, p 13, para 40
75 Ibid, p 59, para 9
81 [Cropper], Stewarts Law, and FOCIS
82 Stewarts Law LLP ()
84 [Evans],; see also [Cropper]
85 ABI (); NHS Resolution have to reserve for PPOs at -0.8% in their accounts (). This is currently set according to risk-free rate: HM Treasury, Financial Reporting Advisory Board Discount Rate Update (16 March 2017)
29 November 2017