New discount rate is minus 0.25%

The headline might tell you all that you need to know. If you want to know more, read on.

Discount rate explained

Damages to claimants in personal injury claims are usually awarded on a lump-sum basis. The claimant gets a single sum of money to cover past and likely future losses caused by an accident. The claimant gets the money up front and has the chance to invest it. If the claimant’s investment does well, by the time the loss would have arisen in future, (s)he has more money than (s)he would have had but for the accident. Similarly if the investment does badly the claimant has less money than (s)he would have had but for the accident. The discount rate (“DR”) is the mechanism used by a court to balance the claimant’s opportunity to invest with the inevitability of inflation. By how much should a claimant’s investment be expected to outstrip inflation over time? If a claimant’s investment is expected to outstrip inflation by 1%, the DR is 1%. If the claimant’s investment is expected to fail to keep pace with inflation, the DR is a negative number; for example if inflation is likely to be 1% higher than the claimant’s likely investment return, the DR would be -1%.

Recent history of the DR

Until Wells v Wells [1999]1 AC 345 courts tended to use a 4.5% DR. The effect of the decision in that case was that in future the DR should reflect the net return on index-linked government stocks (gilts). That is an ultra-safe investment, the thinking being that claimants ought not be required to take risks with their damages to avoid loss occasioned by the defendant. Following Wells a rate of 3% was used until the summer of 2001 when the rate was reduced by the then Lord Chancellor to 2.5%. That was, effectively, a determination that claimants investing in gilts ought to find that their investment beat inflation by 2.5%/ year.

That 2.5% rate came in for a lot of criticism on the basis that gilts did not outstrip inflation by 2.5% (indeed, in recent years they have not kept pace with inflation).

That led to a review and in 2017 the then Lord Chancellor reduced the DR to -0.75%. That was, in effect, on the basis that gilts would fail to keep pace with inflation by 0.75%/ year: rather than this being a “discount rate” it was really an “enhancement rate” enabling claimants to invest in ultra-safe gilts and still have enough money to cover their future loss when the future came.

Having reduced the DR to -0.75% the government announced a review of how the DR would be set. That led to the Civil Liability Act 2018 which provides that the DR must be set on the assumption that a claimant will invest in a “diversified portfolio of investments”. The big change is a move away from ultra-safe gilts as the sole benchmark of what rate of return a claimant can expect to receive on investments.

The latest change

Announced this morning (Read here) the latest change is a move from -0.75% to -0.25%. Courts must now work on the basis that claimants will invest in something that will fail to keep pace with inflation by 0.25%/ year. Claimants can still invest in low-risk investments.

Further review

A further review has been promised within 5 years.

Matthew White
15 July 2019