by Peter Crowley, Windsor Actuarial
More financial problems in Britain have been caused since 1990 by the process of converting a series of future cash flows into a capital sum equivalent than anything else.
Pension and interest rate swap miss-selling, the demise of final salary pension schemes and Equitable Life are just four of those problems. No wonder that the Ogden Table Discount rate changes have opened up a hor nets’ nest.
Summarising the issues:
Lord Irvine - the then Lord Chancellor - set a real discount rate (i.e., one allowing for payments made to grow with inflation) on 25 June 2001 to 2.5% per annum, based on the then index linked gilt rates of return. However, he made no provision for this rate to change automatically if the yields on those gilts changed. Since then, the real yield on index-linked gilts (risk free investments issued by HM Govern ment) has fallen steadily.
The rate has been persistently criticised for being too high in the most trenchant terms in the annual publication 'Facts and Figures', recognised as authority in the Persona l Injury courts.
Facts and Figures is an incredibly detailed handbook covering up to date information to identify compensation costs. Of 385 pages, 125 were Ogden tables - the other 260 were other supportive information. Clearly, an enormous amount of work goes into this publicati on.
Using too high a rate effectively penalises the Permanently Injured (e.g., quadriplegics), and prematurely bereaved (e.g., a young widow with children). This must be seen as depreciable, as the weakest in society are not only undercompensated but unavoidably misled by the courts that the compensation is adequate and fit f or purpose.
Although it has been argued that some claims are bogus (e.g., false whiplash claims), it is clearly unfair to suggest that losses so generated should be reduced by undercompensating genuine victims. Examination by the courts should sift out the former types.
On 27 February 2017, the Lord Chancellor, Ms Liz Truss, announced a reduction in the discount rate (effective 20 March 2017) to -3/4% - a fall of 3 1/4%, which was clearly an enormous change. The reasons for the change were so well explained, I have included th em in full at the end of this article.
Outcry followed - mainly on behalf of those representing car insurers and medical establishments, as insurance premiums in respect of uninsured drivers and negligent medics would rise steeply. Little was said on behalf of the inadequacy of past rewards for the perio d 2001 – 2017 to the weakest in society.
If the revised rate of -3/4% is judged as "correct", there is the issue that awards since 2001 were understa ted, and should be reviewed.
Although the UK Courts take the Lord Chancellor's word as law (so the 2.5% rate up to 2017 cannot be challenged), the same may not be true of EU courts, under whose jurisdiction we currently remain.
As an example, in 2011, the "Test-Achats" ruling in the EU Court declared it illegal to discriminate by sex when setting life assurance, annuity or general insurance premiums in the UK after 20 December 2012.
As a result, male open market pensioners effectively subsidise similar female pensioners, who live longer - and female drivers subsidise their male equivalents, who have more frequent and expensive accidents.
Test-Achats ruling was not retrospective - however, the plight of undercompensated quadriplegics may seem more worthy of a revisit than the Test-Achats cases, du e to:
- Greate r levels of loss
- The far greater exposure to over-penal loss, bearing in mind the difficulty of obtaining remunerative work and the income and support needs which increasingly fail to be met from an over-rapidly decreasing fund
On the other side of the coin is the fact that there is a point at which insurance premiums become too onerous, if no t unaffordable.
Many of the claims are against public service sectors
- especially, negligence claims against the NHS – which can be expensive to fight, let alone pay. Some NHS trusts are rumoured to have embraced a coverup policy - contrast the aviation industry, which is more open about its failings - See the first chapter of Matthew Syed's b ook "Black Box Thinking".
We therefore have the following problems:
a Fair compensation
b Contained costs
c Appropriate interest rate if requirement is capitalised.
I suggest the following principles for operation:
a and b will always fight against each other - but we must see that the result of the fight is open and just. Similarly, there will be pressure to capitalise using weak assumptions (benefit payers clearly favoured a high real rate of 2.5%, even if this represented undercompensation), and recipients would require a certainty of payment reflected in gilt level rates, which payers would find unpalatable.
No less than nineteen documents are available from the Ministry of Justice website: https://consult.justice. gov.uk/digital-communications/personal-injurydiscount- rate/
To simplify matters, I suggest the following solutions:
Private Sector
As victims should not be exposed to the risk of the compensating company's possible insolvency, paying a capital sum appears unavoidable.
Similarly, an index linked gilt rate seems unavoidable, bearing in mind the inability of victims to take up future wor k to make up for under-compensation.
However, if the Lord Chancellor specified a rate based on the gilt rate at the time of compensation, the problem s with the 2.5% rate would be avoided.
Similarly, any risk that the -3/4% rate would become in time (hopefully!) too generous would be removed.
Public Sector
The risk of failures in payments is removed. Payments funded by the government directly can be regarded as fully secured.
As the government's practice for similar payments (i.e., public sector pensions) is not to fund, but to pay out of current revenue, there appears no good reason why the same should not be done for PI victims.
While a retiring nurse, teacher or civil servant can usually obtain post retirement employment to supplement any shortfall in income, the same cannot be said for our quadriplegic.
Notional capitalisation can then be carried out, using a discount rate of choice. The government needs only publish the projected aggregate cash flows year by year (along with any inflation assumptions used).
https://www.gov.uk/government/news/new-discountrate- for-personal- injury-claims-announced
When victims of life-changing injuries accept lump sum compensation payments, the actual amount they receive is adjusted according to the interest they can expect to earn by investing it.
In finalising the compensation amount, courts apply a calculation called the Discount Rate – with the percentage linked in law to returns on the lowest risk investment s, typically Index Linked Gilts.
Today’s decision by Elizabeth Truss to lower the Discount Rate from 2.5% to minus 0.75% was made in accordance with the law and in her capacity as inde pendent Lord Chancellor.
The law makes clear that claimants must be treated as risk averse investors, reflecting the fact that they are financially dependent on this lump sum, often for long periods or the duration of their life. Compensation awards using the rate should put the claimant in the same financial position had they not been injured, including loss of future earnings and care costs.
Lord Chancellor and Justice Secretary Elizabeth Truss said: The law is 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. The Discount Rate has been unchanged since 2001.
Today’s decision, as well as seeing compensation payments rise, is also likely to have a significant impact on the insurance industry and a knock-on effect on public services with large personal injury liabilities – particularly the NHS.
But in the announcement to the London Stock Exchange this morning, four key pledges were made:
- the government has committed to ensuring that the NHS Litigation Authority has appropriate funding to cover changes to hospitals’ clinical negligence costs
- the Department of Health will 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
- the government will launch a consultation in the coming weeks to consider whether there is a better or fairer framework for claimants and defendants, with the government bringing forward any necessary legislation at an early stage
- Chancellor of the Exchequer Philip Hammond will meet representatives of the insurance industry to assess the impact of the rate adjustment
The consultation, which will be launched before Easter, 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 is appropriate for the future.
The new discount rate will come into effect on 20 March 2017, following amendments to current legislation.
Mr Peter Crowley
Windsor Actuarial Consultants
FIA MEWI BSc
Windsor Actuarial is an independent firm of actuarial consultants with considerable expertise in corporate pensions. Established by Peter Crowley in 2005, their excellent actuarial and pensions consultancy is complemented by cutting-edge software and technical support.
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