Those organisations sitting on the defendant side of the compensation see-saw now feel, more than ever, that their feet are dangling in mid-air with little prospect of a return to terra firma. The recent reduction of the personal injury discount rate, announced by Lord Chancellor Elizabeth Truss on 27 February 2017, has been greeted with dismay on the defendant side and elation on the claimant side. But is it justice?
What is the discount rate?
When settling compensation claims for catastrophic injuries, the courts must make an assessment of the claimant’s future needs. Where the settlement recognises damages for future issues, such as long term care or loss of earnings, the amount is discounted to reflect investment returns (over and above inflation) that may be gained between the payment date and the time that the funds are required. This discount rate was originally set in 2001 at 2.5% by reference to the three year rate of return of Index Linked Gilts (ILG).
The bad news
In the current low investment return environment, this rate has reduced to the extent that it now underperforms inflation by 0.75% per annum. The Lord Chancellor, in making her decision, has elected to assume that investors will be of the most risk averse type, and the discount rate has therefore been amended to minus 0.75%.
As a result, future catastrophic awards will be increased (as opposed to reduced) to reflect real terms investment losses.
Why does this feel inequitable?
The Lord Chancellor has used the Index Linked Gilts rate to reflect the approach of a risk averse investor. However, whilst other countries use a more realistic investment profile, this decision (which affects England and Wales only) has ignored the basic fact that successful claimants follow a very different investment strategy.
The disappointment is compounded as it was felt the Ministry of Justice (MoJ) was addressing imbalances in the system. This new development could undo the cost reductions anticipated from the MoJ’s whiplash reforms and the increase in the small claims limit.
Where to next?
The Association of British Insurers, having already sought unsuccessfully to force a judicial review, has pledged to appeal. There is also the possibility of a rebalance of the metaphoric see-saw, with the announcement of a new consultation starting before Easter – less than a month after the new rate comes in – on a wide range of possible reforms, such as whether the discount rate should be set by an independent body, whether more frequent reviews would be preferable and whether the ILG based-methodology remains fit for purpose.
What will the impact be?
Much of the focus of these changes has been on the insurer community, with talk of slashed profit forecasts and the requirement to bolster claims reserves which have been squeezed throughout years of a soft rating environment. However, the impact will ultimately filter its way down to the customer, be they an individual or corporation. For construction companies, especially those with more sophisticated insurance programmes that retain risk through captives or self-insured retentions; this could mean a direct cost to the bottom line. Directly funded claims costs for motor, employers’ liability and third party liability will increase as claimant settlements are inflated. There will be no respite either for those that transfer some or all of their risk to the insurance markets. The increase in claims costs will inevitably increase premiums and in this case there is a “double whammy” in that these will also attract IPT at the exchequer’s increased rate of 12%.
What does it mean to me?
This adverse development asks a number of important questions of construction companies and their insurance programmes:
- Would your insurance programme benefit from a more strategic risk retention approach to reduce both the total cost of risk and the IPT burden?
- If you have already adopted a retained risk approach, is this properly optimised to secure the best value from the insurance market?
- Managing the risk transfer cost can only deliver a finite value to your business. To unlock meaningful and long terms savings it is necessary to reduce the frequency and severity of claims. Are you making best use of claims defensibility techniques to achieve this?
For further information, please contact Dave Cahill, Senior Partner on +44 (0)20 7558 3482 or email email@example.com