horwich farrelly

Discount Rate in Scotland comes as a blow for consumers and taxpayers

October, 2, 2019

The Government Actuary’s Department (“GAD”) published a report on 30 September 2019 recommending that the Personal Injury Discount Rate in Scotland should be set at -0.75%.  The report has been put before the Scottish Parliament and the “new” rate came into effect on 1 October 2019. The full report can be found here.

The events leading up to the report are by now well known and can be read here. The Damages (Investment Returns and Periodical Payments) (Scotland) Act 2019 (The Act), which came about as a result of the then Lord Chancellor suddenly amending the discount rate from 2.5% to -0.75% in February 2017, sets out the framework which the GAD must follow to calculate the discount rate applicable in Scotland.

In a report to the Scottish Government dated 5 September 2018, the GAD estimated that a return rate of 1% above RPI inflation would have applied then, taking the relevant economic parameters into account. This figure would have been reduced by 0.75% to allow for tax and the costs of investment advice/management and by another 0.5% to allow a “further margin” of error in relation to the rate of return on investments.  Both of these “standard adjustments” are provided for in the Scottish legislation. The Scottish discount rate therefore looked likely to be set at -0.25%.

This was considerably lower than the 0% to 1% being projected for England and Wales at that time. Due to the different methodology applied in each jurisdiction to calculate the appropriate rate (the Scottish legislation requires the GAD to consider a more risk-averse portfolio with investments made over a shorter period of time), concerns therefore arose about whether those initial projections would hold up when the discount rate for England and Wales was set at -0.25% in July, reflecting issues including post-Brexit uncertainty.

There became an increasing anticipation that the rate in Scotland may be lower still, which has now come to pass. It is somewhat ironic that having followed the new review process, the rate to be applied north of the border will now be the same as that set by the then Lord Chancellor, which was roundly criticised at the time.

So, what are the key points to consider from the announcement of the new discount rate?

Overcompensation

It is a fundamental principle of the law in Scotland that 100% compensation ought to apply, or put another way, that an injured party should (as far as is possible by way of a financial award) be put back in the position they were in prior to the accident occurring. The new discount rate is likely to result in claimants being overcompensated.

The methodology adopted not only specifically builds in leeway for possible underperformance of investments, but arguably does not reflect the realistic investment practice of those who receive significant awards of damages. Following the guidance provided, the GAD allowed for a gross annual return of 0.5% above RPI inflation (currently 2.6%) on the investments to be made. However, many low-risk investment vehicles available have a proven track record over the last 5-10 years of outperforming that projection. Furthermore, in reality, many claimants will invest at least part of their damages in vehicles that are considered more “medium” risk but which historically have provided a much higher rate of return still.

Rising cost of claims

The rise in the cost of claims will almost inevitably end up being passed on to policyholders, local authorities and public bodies who can ill-afford the further pressure on their finances. The new rate coming into effect today coincides with an article confirming that motor premiums are once again on an upward trajectory, having increased by 3.3% in Scotland over the last year. It also follows repeated pleas by representative bodies to increase funding for local authorities and public services in order that essential services can be provided; for example, COSLA stated in July that there has been a decrease in local government funding over several years which is impacting the ability to deliver core services.

These issues have arisen before the impact of the discount rate being set has truly been felt. It now seems unlikely that the picture will improve in the foreseeable future.

Forum Shopping

The lower discount rate in Scotland may incentivise forum shopping where possible, given the substantially higher award of damages that can be recovered north of the border in identical claims.

Review Period

The discount rate must be reviewed every five years.  Furthermore, the GAD may consult with other experts or industry bodies in future when setting the rate; no such consultation could take place on this occasion due to the short timescales applicable. It has also been confirmed previously that the standard adjustments will be kept under review. It will therefore be crucial to obtain and retain evidence of the impact of the new rate, as well as what elements of the calculation have or have not been accurate, with a view to appropriate factors being taken into account further down the line.

PPOs

The Act also provides a basis for the introduction of Periodical Payment Orders to be made by a judge, without needing the consent of the parties. However, the Court rules in this area are still being finalised and in any event, even despite the provision in the Act that there must be “special regard to the pursuer’s needs and preferences when doing so”, there is little impetus for claimants to seek such an order when a significant lump sum can be secured under the new discount rate. A hitherto unforeseen consequence may be that financially stable defenders seek to persuade the court of the benefit of a PPO in order to spread the cost of claims and avoid overcompensation.

Conclusion

Steven Smart, Partner and Head of our Glasgow Office, said “as feared, the different approach adopted in the Scottish legislation has resulted in another factor arising which makes the cost of the most serious claims in Scotland higher than in the rest of the United Kingdom. It is inevitable that the additional cost will be borne by consumers and taxpayers, further stretching finances across the country, notably for the NHS and local authorities. The introduction of measures which will likely lead to overcompensation is of some concern. It will be vital to review investment performance and the effect of the rate set over the next five years when a further review will take place in order to press for a fairer system to be introduced.”

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