What does the change in the ‘discount rate’ mean?

There has been much in the news, both legal and general, about the announcement of the revision of the ‘discount rate’.  This is the notional rate of return of investments, after allowing for inflation, against which awards of damages intended to cover future loss or future expenditure are calculated, so that at the end of the intended period (and not before) the entire sum will be spent. The Lord Chancellor is required to review this from time to time as inflation, interest rates and the investment market changes.  It was last reviewed in 2001 and set at 2.5%.  Subsequent governments and Lord Chancellors have declined to review it again until now, despite the change in interest rates and in the economy more generally.  In the light of the change in the economy and markets it has now been set at minus 0.75%.

The press has headlined the consequence that this will have in greatly increasing the level of awards of damages.  It will.  It will also mean that a claimant will be able to invest damages in a low risk environment and have a greater chance of having enough cash to cover the expected expenses or the expected losses as they are incurred or suffered.

Take a 30 year old man.  The multiplier to be applied to an annual loss he will suffer, or expense he will incur, to calculate the capital sum he requires now in damages for such loss of expenditure for the remainder of his life is now increased from 29.60 to 71.43, more than doubling the capital sum which will be awarded.  The multiplier to apply to the annual loss of earnings to retirement at age 65 is increased from 20.78 to 38.71, slightly less than doubling the sum.  For an item of expenditure required because of injury for 10 years, the multiplier applied to the annual sum is increased from 8.86 to 10.386 – a modest increase – but if required for 30 years the increase is from 21.19 to 33.658, and if 50 years, it is increased from 28.71 to 60.711.

What this demonstrates is that the increase resulting from this change is modest where the period concerned is fairly short, but very substantial for longer periods.  Therefore for most (modest) claims, the increase in damages will be modest, but for large claims, where typically damages are awarded for a substantial period of loss or expenditure, the increase in damages will similarly be large.  However in large claims a substantial part of the claim, such as future care costs, will not be paid in a lump sum but will be satisfied by the payment of periodical payments, which is a specified annual sum increased annually for inflation, paid to the claimant for life or for the duration of the expenditure or loss.  These periodical payments are not affected by the change in discount rate, although the insurer making such payments (and to a lesser extent the NHSLA) will have in mind the discount rate factors in making future provision to cover the periodical payments.

For many years claimants have been undercompensated because of the unrealistically high discount rate.  The change will improve the chances of compensation being adequate, but the uproar from the insurers paying damages (and the NHSLA) will almost certainly ensure the planned review of discount rates and their application to personal injury damages will result before too long in an increased rate, and reduced burden, on insurers and the NHSLA, and a reduction in compensation for injured claimants.

The actuarial tables can be found here so that you can carry out your own comparisons.

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