New Discount Rate: Ac-Cent-Tchu-Ate the Positive; E-Lim-i-nate the Negative

The new discount rate is announced: good news for insurers although perhaps not quite as good for them as it might have been (and vice versa for claimants). In this article, Andrew Wille explores the impact. 

After months of speculation we now know the new discount rate. For the first time since 2017, when it first plunged into negative territory and sent our multipliers spiralling upwards, the discount rate now returns to positive territory, at 0.50%. The change (up from -0.25% at present) was announced by the Lord Chancellor (Shabana Mahmood) on 2^nd December 2024 and will take effect from 11^th January 2025.

So, in a stroke, the multiplier for a newborn girl will plumet from 102 to 73. Stakeholders have reacted along expected lines, with APIL criticising the increase and some insurers welcoming it (speaking of probable premium reductions).

And for those lawyers and insurers who value a more simple life, the good news is that the rate is to remain a single rate. We will not be entering a strange world of multiple or dual rates. (Although the enticing prospect of a calculator-free era of a 0% discount rate has once again been snatched away from us.)

In reality, many will have been expecting the new rate, particularly as it sees England & Wales fall into line with the same rate announced in September 2024 for Scotland and Northern Ireland (albeit reached in those jurisdictions by the somewhat more summary process of review by the Government Actuary).

Nonetheless, whilst the destination may seem relatively unsurprising, there is some interest in how the figure was arrived at. This was the second review carried out under the new framework introduced by the Civil Liability Act 2018 but only the first review in which an Expert Panel (on this occasion Fiona Dunsire (Government Actuary and Chair), Charl Cronje, Dr Rebecca Driver, Donald Taylor and Ed Tomlinson) was established and consulted (in addition to HM Treasury) before the Lord Chancellor made her decision.

We have the benefit therefore of the Expert Panel’s Report to the Lord Chancellor released alongside the Lord Chancellor’s decision and her own reasons. It is clear from that Report that it was very much open to the Lord Chancellor to have opted for a higher rate, say 0.75%, had she chosen to do so. So whilst insurers may welcome the change, it is perhaps not quite as beneficial for them as it might have been, and vice versa for claimants.

The Expert Panel report to the Lord Chancellor makes for interesting reading (so far as actuary-informed analytical reports ever can). We are introduced for the first time to three core claimant types intended to cover the range of the ‘claimant universe’, rather than one single notional claimant, namely:

• The 20 year investor, who will adopt a cautious investment strategy, has a lump sum of £500k to invest, other taxable income of £30k pa, and who could be expected to achieve a median net real rate of return (i.e. after tax, expenses and damage inflation) of 0.7% pa;
• The 40 year investor, who will adopt a central investment strategy, has £1m to invest, limited other taxable income of £7k pa, and who could be expected to achieve a median net real rate of return of 1.4% pa;
• The 60 year investor, who will adopt a less cautious investment strategy, has a lump sum to invest of £5m, limited other taxable income of £7k pa, and who could be expected to achieve a median net real rate of return of 1.0% pa.

The Panel identified the core principles underpinning the exercise. The majority of claimants should be more likely to be over-compensated than under-compensated. A high risk of significant under-compensation should be avoided. Significant levels of -over-compensation should be limited. It is appropriate to prioritise the mitigation of the likelihood and extent of under-compensation over the aim of limiting over-compensation.

The Panel defined significant under-compensation as less than 90% of a claimant’s future needs being met. Significant over-compensation was defined as being more than 120% of a claimant’s future needs being met. The Panel advised that, with the current discount rate of -0.25%, there was a 69% chance of 40 year investors and a 64% chance of 60 year investors being significantly over-compensated.

The options effectively put before the Lord Chancellor by the Panel ranged from:

• +1%: which would have met most of the core principles but with a lower likelihood of sufficient compensation;
• +0.75%: which would have met most of the principles (although with some concern as to the sufficiency of compensation for 20-year claimants);
• +0.5%: which would have met most of the principles but with a higher likelihood of over-compensation.

The Lord Chancellor chose the option which reduced the chance of 20-year claimants recovering insufficient compensation. She published with her decision a statement of her reasons.

In summary:

• She agreed with the move from reasoning on the basis of a single representative claimant to an assessment of several core claimant types (i.e. those with investment terms of 20, 40 or 60 years).
• As previously, the assumed investment approach was to be: more than a very low level of risk but less risk than would ordinarily be accepted by a prudent and properly advised individual investor.
• Inflation, consistent with the approach of Panel, was taken to mean damage inflation, i.e the rate at which a claimant’s costs are expected to rise over time. This was taken to be CPI plus 1%.
• The Lord Chancellor considered the range of options from 0.50% to 0.75% to 1%. She considered that the likelihood of under-compensation with all rates above 0.5% would be too high.
• She was in particular concerned that, at a rate of positive 0.75%, there would still only be a 47% likelihood of claimants investing over 20 years receiving at least full compensation: “I consider that this produces too high a risk of under-compensation, particularly for the 20 year core claimant.”
• Whereas at 0.5% it could at least be said that no core claimant was more likely to be under-compensated than over-compensated.
• The price to be paid for this, she conceded, was a 40% chance of those investing over 40-60 years being significantly over-compensated. This was regarded as an acceptable and necessary trade-off given the risks of under-compensation at the higher discount rate.
• The Lord Chancellor agreed with the Panel (and with HM Treasury and the respondents to the Calls for Evidence) that dual or multiple discount rates were not warranted having regard to the additional complexity and expense that would be introduced into the claim process

If you would like any advice on the consequences of this rate change for your caseload please contact the clerks on +44 207 583 9241, or via chambers@farrarsbuilding.co.uk.

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