Damages (Personal Injury) Order 2017 — House of Lords, 2017-07-18
Topic: Domestic Commerce
Robin Granville Hodgson (Conservative, Centre-right): My Lords, the regret Motion I have tabled may appear dry, complicated and technical. It is technical and complicated but it is not dry. It will have practical, everyday consequences for every taxpayer, for everybody who has an insurance policy, especially if they drive a motor car, and for every person who receives a long-term award of damages following an accident The setting of the discount rate to be applied to lump-sum damage awards is a critical decision. On the one hand, the situation cannot be allowed where, because the discount rate has been set too high, someone who suffers a catastrophic injury, maybe as the result of a road accident or an NHS operation going awry, finds that the lump sum runs out too soon. On the other hand, setting the rate too low means that the accident victim is overcompensated, which has a knock-on effect on motor and other insurance premiums, and on the overall operating costs of the NHS While the power for the Lord Chancellor to set the discount rate is to be found in the Damages Act 1996, the process by which the rate is set is based on case law, in particular on the 1998 House of Lords judgment in Wells v Wells, which reached two important conclusions. First, any lump sum awarded should neither overcompensate nor undercompensate the unfortunate victim. Who could possibly disagree with that conclusion? Secondly, the legal judgment was that the appropriate benchmark for setting the discount rate should be the yield on index-linked government stocks—that is, index-linked gilts or ILGs. I understand that the court concluded that the sums paid in compensation should be invested only in what the court saw as risk-free assets. The court appeared to anticipate that 100% of every amount paid in compensation would or should be invested in index-linked gilts. In such circumstances, it is not surprising that the conclusion was drawn that the benchmark for setting the discount rate should be that on index-linked gilts That second conclusion, 20 years on from the Wells v Wells judgment, is a good deal more controversial than the first, for the following reasons. First, the supply of index-linked gilts is limited. They offer particular attractions to those insurance companies and other financial institutions that seek perfect risk-matching. As a consequence, index-linked gilts tend to be fully priced—some may say overpriced—and arithmetically, as a result, the running yields are driven down. Many index-linked gilts are today traded above par so that a capital loss on redemption is inevitable. Further, if portfolio theory teaches us one thing, it is that diversification is the best way to offset risk. Any proposal that suggests investing in only one asset class needs to be approached with care. It is the all-your-eggs-in-one-basket belief. A more conventional approach might suggest, in addition to index-linked and other gilts, investing in some prime corporate bonds and some blue chip UK or overseas equities This rate setting is such a sensitive issue that successive Governments have shied away from changing the rate. Until earlier this year, the discount rate was set at 2.5% and had not been changed since 2001. That is patently unfair. The shape of the yield curve has altered dramatically as a result of the 2008 financial crisis and interest rates remain at historic lows. I am afraid that, as a result of the failure by successive Governments to address this issue, victims may prove to have been undercompensated in recent years Then suddenly, essentially out of nowhere, in February the then Lord Chancellor took action. And my goodness, it was draconian. At a stroke, she changed the discount rate from plus 2.5% to minus 0.75%. What is the effect of this rather arcane statement? A simple example may help clarity. Let us assume that you are a 25 year-old young man who has, sadly, been catastrophically injured in a motorcycle accident. The court must consider what sum is needed to look after you for the rest of your life—that is, probably more than 40 years. If the court concluded that on the old rate a sum of £2 million was sufficient, under the new rate that sum would arithmetically need to be £7.3 million. That is an increase of more than £5 million, or more than triple the original sum. Of course, the award assumes that interest rates will stay at the present low—historically, very low—level for the rest of your life. If they begin to rise, you will have been overcompensated at the expense of the taxpayer and other insured people Specifically, the Lord Chancellor’s decision had a direct and substantial effect on the public finances. Box 4.2 in the spring Budget policy costings paper indicates that as a result of this decision, the Chancellor of the Exchequer will have to find an additional £1.2 billion every year for the next five years as a guard against future claims. On page 35 of the same report, the suggestion is that the Lord Chancellor’s decision will result in an increase of 0.1% on CPI, or 0.2% on RPI. The Times of 28 February this year, while pointing out the importance of not undercompensating victims, said: "But basing the so-called Ogden formula on just three years’ history of index-linked gilts is crazy, as insurers point out. No accident victim in their right mind would invest their entire lump sum in inflation-protected gilts in this era of superlax monetary policy. One-third now opt for ‘periodic payment orders’, which guarantee a return of at least zero in real terms. Most others invest in a mix that includes higher yielding corporate bonds and equities" It went on to say: "Either way, assuming that the best a prudent investor can achieve is a long-run real return of -0.75 per cent displays an Eeyorish level of pessimism. If this is really the government’s official thinking on likely future investment returns then its policies to encourage pension saving amount to mis-selling on a gigantic scale" More recently, on 24 June, the same paper highlighted that drivers now face a rate of increase in the cost of their motor insurance that is five times that of inflation. Not all of the increase can be attributed to the change in the discount rate but its impact will be felt particularly by younger drivers, those under 25, who have seen an increase of 13.1%, and—this may be of more interest to Members of your Lordships’ House—to older drivers, those over 50, who have seen an increase of 17.9%. Of course, this rate of increase will continue as reinsurance contracts run off—they last for only 12 months before they have to be renewed, and will have to be replaced at the higher rate I suspect—perhaps I should say I hope—that the Lord Chancellor did not understand or was not properly briefed or advised on the likely full impact of her decision. Certainly, having made this dramatic decision on Monday 27 February, which led to a storm of controversy, she then announced that there would be a further consultation. As my regret Motion makes clear, this appears to be putting the cart before the horse. I understand that the consultation is now closed and the MoJ has to report back by 3 August A regret Motion is probably not the place to discuss a remedy in detail but perhaps three brief conclusions can be drawn. First, it is critical that accident victims are properly compensated but in future the discount rate needs to be renewed more frequently to minimise the risk of overcompensation or undercompensation. This will also avoid the massive jerks on the tiller which have so disconcerted the insurance industry this year. Secondly, any new system should recognise that an assumption that all the compensation sums will be invested in the same asset class fails to account for the different circumstances of the various injured parties, so that the Wells v Wells conclusion that investments should be ILGs only is no longer appropriate. Thirdly and finally, those parties that are very risk-averse should place increased reliance on periodic payment orders as a better means of offering security to the injured party while avoiding overcompensation or undercompensation While tonight the House cannot discuss any remedies in detail, there is a need for action quickly to right the costly inequities of the present system. Following the recent consultation, the Government now have a wealth of information at their disposal. They also have a legislative vehicle on the stocks in the shape of the civil liability Bill announced in the Queen’s Speech. When the Lord Chancellor herself said, as she did on 7 March, that, "the system needs to be reformed, because I do not think it is right that a discount rate is set on an ad hoc basis by the Lord Chancellor"—[Official Report, Commons, 7/3/17; col. 657]— we can surely all agree that action is needed, and quickly. When he comes to reply, I hope that my noble and learned friend will be able to reassure me and the House that the Government recognise the significance of this issue and intend to take remedial action shortly. I beg to move.