Pre-legislative scrutiny: draft personal injury discount rate clause Contents

4Balancing the costs and benefits

73.The Government’s impact assessment confirms the proposals will lead to a higher discount rate because of the higher rates of return associated with “low-risk” mixed portfolios; and that smaller lump sum compensation payments will impose costs on claimants, while benefiting defendants.87 Those representing claimants argue that increasing the discount rate would impose greater costs on a vulnerable sector of society and that this is not properly addressed in the Government’s analysis.

74.A further driver behind the proposed legislation also appears to be the social benefits which would arise from lower insurance premiums and reduced clinical negligence costs resulting from the higher discount rate. The Command Paper argues that “The unrealistic assumptions currently being used” to set the discount rate:

are having a significant effect on taxpayers through the additional cost of personal injury settlements paid by the National Health Service and other public sector bodies; and businesses and individual consumers through insurance premiums that are higher because awards of damages may be providing more than 100% compensation.88

75.We give below a graphic representation of the balancing act which we consider the Government is undertaking: the sizes of the weights on either side of the scales are not meant to be a proportional representation of the respective size of costs.

Quantifying the costs and benefits

76.As the Government says, “the discount rate has important financial and economic effects”.89 But the impact assessment does not quantify the benefits to the defendants or the costs to the claimants of the proposed legislation on the grounds that the “rate will not change until the Lord Chancellor conducts the first review under the new framework and so the impact of a rate change has not been quantified”. However, as noted earlier, the Lord Chancellor indicated that a rate set now might fall “within the range of 0% to 1%”.90 The impact assessment confirms the proposals will lead to a higher discount rate because of the higher rates of return realised.91

77.We asked Lord Keen why the Government did not calculate the costs to claimants and benefits to defendants based on the estimated rate. He responded:

I think one has to be careful. The figure of 0% to 1% that was given in the paper was not an estimate, essentially, of what the Lord Chancellor would be fixing as the discount rate. It was an assessment of the direction of travel of the rate, in the event that we moved from a very low risk portfolio to a low risk portfolio. It is based on figures in the Government Actuary’s report that indicate a growth rate of about 1.3% during the first 30 years of an investment portfolio, moving up to 1.6% and then taking that back by about 0.5% to allow for management charges and tax. That is how the 0% to 1% figure was arrived at, but I emphasise that it was not intended as an estimate of what the rate will be. With the benefit of hindsight, it is perhaps unfortunate that the figure was there, but it was just to indicate the direction of travel when you moved the risk element of the portfolio.92

78.The Office for Budget Responsibility in its March Economic and Fiscal Outlook calculated that the recent reduction in discount rate from 2.5% to -0.75% would increase insurance premium tax receipts by “around £0.1 billion a year as the increased costs for the insurance industry, particularly in the motor sector, are passed on in higher premiums”,93 clearly indicating that it is possible to estimate how changes in the discount rate would affect costs to insurance companies.

79.We believe that the Government should have given an estimate of the costs and benefits of the legislation in its impact assessment, based upon its “assessment” that the discount rate would be between “0% and 1%”. This would have given Parliament and stakeholders a far better idea how this legislation will affect claimants in the short term. We recommend that whenever the Government changes the discount rate under this legislation, it publishes at the same time an estimate of the costs and benefits of the change to claimants and defendants.

Social costs

Effect on equity

80.The Government’s impact assessment94 indicates that the legislation will lead to greater equity (fairness) if there is a reduction in over-compensation. But Professor Victoria Wass argued it will lead to losses of equity and efficiency:

There is inequity when you transfer risk from the claimant to the defendant.95 There is also inefficiency, because claimants are going to be much less efficient than the Government and the insurance industry in bearing and managing that risk.96

81.Professor Wass also told us:

In distributional terms, it is preferable to spread the cost of risk across society (tax payers and consumers of insurance) than to concentrate it on a few claimants97

Additional costs to the state

82.APIL also argued that if there is under-compensation, the state is likely to bear the brunt of care costs not covered by the award. This implies that the savings to the state are likely to be less than anticipated if the discount rate increases to benefit defendants:

If they do not have the money available at the end—for example, in relation to care, because something has happened, say, they have invested it in a less than low risk way—the state picks it up, rather than the insurance company that took the premium for that risk.98

Costs borne by vulnerable groups

83.Professor Wass reminded us about the public sector equality duty:

The public sector equality duty requires statutory decision making and Government Departments to pay due regard to the impact of their policy on protected groups. Virtually all claimants are disabled. They would qualify as a protected group under the Equality Act.99

84.APIL argued that how the Government sets its discount rate is indicative of how society treats its most injured:

this is all about how society should treat people who are injured and how we deal with people when there is negligence, when somebody has been catastrophically injured.100

85.In its equality impact assessment,101 the Government says its understanding of the impact of the proposals is limited by the fact it does not collect comprehensive information about the protected characteristics of personal injury claimants. It accepts, though, that those with particular protected characteristics (disability, age and gender) are likely to be more affected by the choice of a particular methodology for setting the rate.102 The Government does not think such claimants will suffer a particular disadvantage. Even if they would, the Government believes this a proportionate means of achieving a legitimate aim.103

86.When formulating policy for setting the discount rate, we would expect the Government to have given careful consideration to safeguarding the interests of those claimants who could be significantly under-compensated.

87.We do not think there is sufficient evidence for the Government’s conclusion that its proposed legislation is a proportionate means of achieving a legitimate aim, so as to justify possible disadvantages to those with protected characteristics. Indeed, without adequate evidence about the protected characteristics of claimants, or the cost to claimants, it is hard to see how the Government can draw any sound conclusion about proportionality.

88.We recommend that instead of targeting 100% compensation, neither “under” or “over” compensation, the Government should consider adopting as a target the median level of compensation to tend towards over-compensation; or should at least ensure that there are adequate safeguards to prevent significant under-compensation of the most vulnerable claimants.

Social benefits

Motor insurance premiums

89.The impact assessment noted that there will be “benefits to wider society in terms of lower insurance premiums if insurance companies respond by reducing premiums and equity if there is a reduction in over-compensation”.104

90.We received evidence that the recent reduction in the discount rate from 2.5% to -0.75% had increased pressure for insurance premiums to rise. In its written evidence, the ABI quoted a Will Towers Watson report as calculating that the reduction “would increase the cost of motor insurance by £868 million per annum in the future”.105 The British Insurance Brokers Association (“BIBA”) also blamed “recent increases in premium” on the “increased cost of catastrophic claims due to the change in the DR”.106

91.Witnesses disagreed as to whether insurers would pass on any reductions in their costs to consumers in the form of reduced premiums. Lord Keen told us:

one of the major motor insurers, LV, has already publicly stated that they will reflect the savings in premium savings … If one of the leaders in that market is going to pass on those savings, it would be surprising if others did not feel obliged to do the same.107

92.BIBA argued customers would benefit from an increase in discount rate; “any opportunities to cut premiums in order to attract customers are readily taken” because “many classes of insurance such as motor insurance are highly competitive”. The ABI was more circumspect:

Insurance premiums are affected by a number of different factors. The cost of whiplash claims, increasing repair prices and insurance premium tax rises as well as the large increase in claims and reserving costs caused by the discount rate announcement have all contributed to recent increases in insurance premiums. While insurers will strive in a highly competitive market to pass on savings to customers afforded by any future increase in the discount rate, premiums will ultimately be influenced by a range of cost factors.108

93.Access to Justice noted that it had commissioned economic analysis on the impact of the current proposed small injury claim reforms and this had shown that there “is highly unlikely to be any pass-through of savings” on to insurance premiums “without direct government compulsion”.109

94.We recommend the Government report each time it reviews the discount rate on how changes in the rate impact on motor insurance premiums and the extent to which increases in the rate are reflected in reduced premiums, to use this information as a guide to setting the discount rate in the future. If changes in the discount rate do not lead to reductions in premiums as forecast by the Government in its impact assessment, it would mean that some of the social benefits of setting the discount rate based on a “low risk” investment rather than a “very low risk” investment had not materialised. The Government would need to take this into consideration when setting the discount rate at later stages.

Clinical negligence costs

95.The impact assessment noted that “defendants, including public sector bodies (such as NHS Resolution) and insurers, will benefit from lower lump sum payments”.110 The former Lord Chancellor, when announcing the recent reduction in discount rate, drew attention to the repercussions it would have on clinical negligence costs.111

96.We were told that the discount rate reduction has sharply increased clinical negligence pay-outs. The MPS explained that the recent change in the rate from 2.5% to -0.75% would result in a sharp increase in clinical negligence costs. They pointed out that, in 2016–17 alone, the NHS paid out £1.7bn for clinical negligence claims.112 Emma Hallinan from the MPS told us this “could have an impact on subscription rates, but [they] would have to weigh that with other factors”.113

97.In March 2017, the OBR stated that the reduction in the discount rate to 0.75% would affect their fiscal forecast: “the Government has added around £1.2 billion a year to the … reserve to meet the expected costs to the public sector, in particular to the NHS Litigation Authority”.114

98.Richard Cropper of PFP argued that the impact of the discount rate on clinical negligence costs was mitigated by the fact that for most large claims, PPOs were used and the Government currently must reserve for them at a negative rate of -0.8%:

Changing the discount rate, which would have the greatest impact on care, case management and loss of earnings, if they continue to be paid in periodical payment terms, will not save the NHS a penny from an accounting perspective, because they will still be reserved for at negative 0.8%.115

99.Lord Keen told us: “This is not about reducing the cost of clinical negligence claims. This is about ensuring fair and reasonable compensation for those who become the victims of clinical negligence.”116 But in Professor Wass’s view the Government needs to be more transparent about its motivations about the Bill:

The question gets to the heart of what is driving the Bill: the cost to the NHS and the inflationary costs of car insurance. The Bill must be presented with that as the motivation—that the Government think that, for prudent fiscal and financial reasons, we should change the discount rate on the basis of a mixed portfolio. But we then cannot also claim that we are achieving the 100% compensation principle. You cannot have them both. You have to choose one or the other.117

100.The report by the British Institute of International and Comparative Law noted that the setting of the discount rate in other countries was “often not a neutral application of figures” but represents “a balance between competing considerations”, resulting in a:

compromise between a discount that accurately reflects the real rate of return a tort plaintiff might obtain if investing in reasonably safe investments and one that takes into account the fact that too low a rate of return might have adverse consequences on the provision and cost of liability insurance.118

101.It is not clear to what extent the proposed legislation is motivated by a desire to limit growth in clinical negligence costs and insurance premiums. We think it is reasonable for the Government to take into account the impact of the discount rate on clinical negligence payments and insurance premiums and it should be open about this.

102.It is clear from past Government action (or inaction) in changing the discount rate that setting the discount rate is more than a technical decision: it involves balancing the interests of the claimants with the defendants and also balancing the social costs of increased clinical negligence pay-outs and increased insurance premiums with protecting the interests of vulnerable claimants and reducing their risk of under compensation through interest rate movements.

88 Cm 9500, para 7

89 Cm 9500, para 24, p 11

90 HC Deb, 7 September 2017, col 13WS

92 Q98

93 Office for Budget and Responsibility, Economic and Fiscal Outlook (March 2017), p 96, Box 4.2

95 In light of the rest of her written and oral evidence, we understood Professor Wass to have meant to say “There is inequity when you transfer risk from the defendant to the claimant”.

96 Q27

97 Professor Victoria Wass (IDR0008)

98 Q9

99 Q28

100 Q9

101 Headed “Equality statement, at Annex B to MoJ, The Personal Injury Discount Rate: How it should be set in future [Consultation response]

103 Ibid, p 59

105 ABI (IDR0029)

106 BIBA (IDR0030)

107 Q99

108 ABI (IDR0029)

110 Setting the Personal Injury Discount rate, Impact Assessment, 13 July 2017

111 HC Deb, 27 February 2017, col 2WS

112 Medical Protection Society (IDR0002)

113 Q66

114 Office for Budget Responsibility, Economic and Fiscal Outlook (March 2017), p 96, Box 4.2

115 Q26

116 Q94

117 Q24

118 British Institute of International and Comparative Law, Briefing Note on the Discount Rate applying to Quantum in Personal Injury Cases: Comparative Perspectives, p 14, para 42

29 November 2017