Damages Discount Rate (Ogden) Consultation – how it should be set in the future
4th August 2017
The BIBA response to the consultation on possible changes to setting the Ogden discount rate is set out below.
Q1: Do you consider that the law on setting the discount rate is defective? If so, please give reasons.
Yes, we do believe the law on setting the discount rate is defective, as it has been interpreted in different ways by two Lord Chancellors. Lord Irvine had previously incorporated tax that is paid on investments into the discount rate as well as considering the impact on defendants as well as claimants, whereas the recent decision by Liz Truss, the current Lord Chancellor did not take into account tax or the impact on defendants. In fact in the current Lord Chancellor’s statement following her review of the discount rate, she said she could not take into account defendants in to this decision – contrary to Lord Irvine’s approach.
Problems that the existing law have created include:
A -The insurers had to cope with a dramatic change to their business model to reflect the requirement to massively increase reserves across the industry. Willis Towers Watson have estimated the impact of the change on insurers as a one off reserve charge of approximately £5.8 billion, which represents 56% of the overall claims cost of £10.43 billion in 2015 (the most recent figures available). With an anticipated £868 million per annum increase in the cost of motor insurance as well as a estimated increases of £57 million per annum for Employers liability insurance.
We have been provided with an actual example by a leading insurer of the massive increase in their costs on one impacted claim, where a reserve for a private motor personal injury claim of £9 million has had to be increased following the Ogden rate change to £22 million.
Another example brought to our attention, is of a recent case involved a 7 year old boy at the date of accident who suffered catastrophic injury including to his spine, the reserve at 2.5% Discount rate had been £10.4 Million, but the change to -0.75% has seen this increase to £22.7 million.
BIBA fully supports the position that a severely injured person, particularly someone who experiences a life-changing injury at a very young age, receives appropriate support. We are mindful though, of the impact on the wider insurance-buying community (see C below).
The changes to the multipliers are significant also. The younger the claimant, the more the whole life multiplier will outstrip their life expectancy, this does not reflect a typical real life situation as the life expectancy of a 10 year old previously stood at 78.3 years, moves to 108.3 years.
B -The share prices of some Insurers were negatively impacted, resulting in some giving profit warnings. Investors in insurers will include the trustees of group pension pots and a reduction in the share price of insurers will have a knock-on impact in the actuarial value of the underlying pension pots.
C – Customer premiums have been estimated to increase sharply by PWC, it has been reported that young people could be priced out of owning a car after insurers warned their annual premiums could rise by up to £1,000.
Drivers aged over 65 could also face an extra £300 charge; while the average comprehensive motor insurance policy could increase by up to £75 a year to cope with changes the Government has made to personal injury pay-outs.
This is all happening at the same time businesses are facing a ‘perfect storm’. Insureds now need to buy greater indemnity limits but the prices are increasing and this has been compounded by the fact that insurance premium tax has doubled in the 18 month period between October 2015 and June 2017.
The CBI have also raised concerns regarding the burden on business of this increased cost.
D – New Underinsurance risk: We know of a public liability claim against an EL/PL policy with a £10 million PL limit, held by an SME insured. An £8 million reserve was increased to £15 million using the revised Discount Rate, leaving the insured exposed to an additional £5 million (on top of their policy excess). In the underwriters opinion if the claim settled anywhere near the reserve the insured would be unable to pay their retained share. Assets would therefore have to be sold to meet as much of the claim as possible and it is possible that this could push the insured into insolvency, unless other finance could be accessed.
The Underinsurance concerned is also shared by the CBI.
The date any change to the discount rate comes into effect has not been raised as a point for consideration in this consultation , however, part of the underinsurance problem would be addressed if the decision only impacts on incidents notified post 20th March 2017 or other future review dates.. The problem being that a sudden major change to the rate can render clients underinsured when previous claims already incurred by the business can exceed their limits. Therefore going forward, only new claims from an agreed date should have the new rate applicable, allowing for suitable limits of insurance to then be arranged. This approach would be in line with wider applications of varying changes in domestic law.
E – There are significant concerns around the availability of capacity in liability and motor going forward. This includes smaller insurance carriers and those based in overseas territories such as Gibraltar.
BIBA is also seeing some insurers reducing their limits under liability policies.
The confusion, lack of clarity and uncertainty that has been created by this situation leads BIBA to conclude that primary legislation is required to bring greater clarity to the process of setting the discount rate. This explained further in our response to question 14.
Q4: Please provide evidence of how claimants actually invest their compensation and their reasons for doing so.
BIBA does not have data on this, but the Money Advice Service, which was set up by Government; provide advice on what to do after receiving a lump-sum payment: https://www.moneyadviceservice.org.uk/en/articles/making-an-investment-plan and https://www.moneyadviceservice.org.uk/en/search?query=lump+sum. At no point does it advise to invest in ILGS. Further, the advice page on buying Gilts or IGLS states:
Fixed interest securities might be suitable as part of a mix with other types of investment, in order to adjust the overall amount of risk you’re taking. (https://www.moneyadviceservice.org.uk/en/articles/fixed-interest-securities-gilts-and-corporate-bonds).
Q5: Are claimants or other investors routinely advised to invest 100% of their capital in ILGS or any other asset class? Please explain your answer. What risks would this strategy involve and could these be addressed by pursuing a more diverse investment strategy?
Most prudent independent financial advisers would provide advice to invest as appropriate to the investors own individual unique circumstance.
Investing in a single asset class is more risky than investing in a mixed portfolio. We recently spoke with an individual who retired from their firm and approached a financial advisor for help in making some longer term investment with some of their retirement funds. They said that that being at the end of their career and looking to full retirement, they wanted their risk exposure to be minimal. They have been tracking the performance of their investment since it incepted in October 2013 and it is running at a little over 6% per annum.
Hence BIBA’s view is if someone can obtain that sort of return on a relatively low risk investment how can the -0.75% discount rate be justified?
We believe it is very unlikely that a prudent investor with appropriate advice would receive a negative return.
Q9: Do claimants receive investment advice about lump sums, PPOs and combinations of the two? If so, is the advice adequate? If not, how do you think the situation could be improved? Please provide evidence in support of your views.
We do believe that advice is freely available, but BIBA is not aware of how customers are aware of, or directed towards obtaining this advice. We note that the previous President, now Secretary of the Association of Personal Injury Lawyers (APIL), was quoted in an APIL press release stating: “Victims who receive high value awards usually take financial advice on how best to invest their compensation”.
Whilst BIBA does not collect information on how claimants invest lump-sum payment awards, we do have members that can assist with this and report that it is not unreasonable to achieve a 6% return with a low risk strategy.
It is of interest to note that many claimant law firms also offer financial advice services on how to invest their payments, with some anecdotally advising rates of return of between 3-4%. Examples of law firms that offer these services include Irwin Mitchell and the Brain Injury Group. Additionally, the APIL code of conduct states:
APIL members recognise the need to… ensure that clients have the opportunity to receive advice on the investment and/or use of damages: https://www.apil.org.uk/files/code-of-conduct-september-2016.pdf.
This demonstrates that investment advice does indeed form part of the consideration lawyers should be giving as part of their service.
Further, anecdotal evidence from a press article suggests that Frenkel Topping, a firm specialising in advising clients who have received personal injury payouts, said in a recent statement to the market that the Lord Chancellor’s decision to change the Odgen discount rate from 2.5% to -0.75% would significantly boost the company’s performance in the next three years, revising upwards their asset growth expectation for 2018 and 2019 by £80 million. This is another clear indicator that claimants do not invest in IGLS, but often take financial advice on how and where to invest their payment award. http://citywire.co.uk/new-model-adviser/news/national-ifa-expects-80m-boost-from-personal-injury-payout-change/a997113
The £80M Frenkel Topping upward revision demonstrates how, due to increased awards, money will be taken from insurer reserves intended for policyholder compensation, and be converted to further profits the legal/investment/personal injury claims sectors. This upward cost leads to increases in policyholder premiums and serious financial pressures on the insurance sector.
Q10: Do you consider that the present law on how the discount rate is set should be changed? If so, please say how and give reasons.
We strongly recommend the law be changed due to the interpretation issues and subsequent consequences outlined in our answer to Q1.
Q11: If you think the law should be changed, do you agree with the suggested principles for setting the rate and that they will lead to full compensation (not under or over compensation)? Please give reasons.
We agree, people should not be over or under compensated. This matches with the principal of indemnity which is a key legal principle of insurance. Further, we note with interest that APIL’s code of conduct states:
APIL members recognise the need to… maximise the amount of compensation receivable in the hands of the client. https://www.apil.org.uk/files/code-of-conduct-september-2016.pdf.
This is not the same as full compensation and when investment income is take in to account, we believe that the change to a -0.75% discount rate could see many claimants over-compensated due to the returns achievable – even with a low-risk investment strategy.
Q12: Do you consider that for the purposes of setting the discount rate the assumed investment risk profile of the claimant should be assumed to be: (a) Very risk averse or “risk free” (Wells v Wells) (b) Low risk (a mixed portfolio balancing low risk investments). The Discount Rate Consultation Paper 39 (c) An ordinary prudent investor (d) Other. Please give reasons.
This will depend on the circumstances of the individual, some may be in a better financial position than others and more able to take higher risk approach. We understand that advice commissioned by the Government and received in 2015 stated a discount rate of 0.75% could be achievable if the investment portfolio for a claimant was deemed to be 50% ILGS and 50% best risk investments (which comprises of 25% corporate bonds, 15% overseas developed country bonds and 10% equities). We disagree with the catch-all assumption that claimants are very risk averse and would invest their damages in ILGS as risk appetite is an individual preference.
Q14: Do you agree that the discount rate should be set on the basis that claimants who opt for a lump sum over a PPO should be assumed to be willing to take some risk? If so, how much risk do you think the claimant should be deemed to have accepted? Please also indicate if you consider that any such assumption should apply even if a secure PPO is not available. Please give reasons.
The case of Wells v Wells in the court of appeal stated that the claimant should not be treated any differently from any ordinary investor, to do so would put them in a more privileged position.
Q17: Should the court retain a power to apply a different rate from the specified rate if persuaded by one of the parties that it would be more appropriate to do so? Please give reasons.
BIBA has faith in UK judges to look to apply a different rate only in exceptional circumstances, where to do so would achieve an equitable outcome.
Q20: Do you agree that the law should be changed so that the discount rate has to be reviewed on occasions specified in legislation rather than leaving the timing of the review to the rate setter? If not, please give reasons.
This would create greater certainty and avoid the massive changes and huge consequences we have outlined in our answer to Q1. However there is some concern that this could create a log jam in the courts as law firms play the system.
Q23: Do you agree that the rate should be reviewed at intervals determined by the movement of relevant investment returns? If so, should this be in addition to timed intervals or instead of them? What do you think the degree of deviation should trigger the review?
One suggestion might be; in addition or instead of a time period review could perhaps be a basket of low risk mixed portfolio investments and when they fall outside a pre agreed ‘standard deviation’ this would trigger a review.
Q24: Do you agree that there should be a power to set new triggers for when the rate should be reviewed? If not, please give reasons.
Yes see Q23.
Q25: Do you consider that there should be transitional provisions when a new rate is commenced? If so, please specify what they should be and give reasons.
Transitional periods may help prevent the significant problems that we have outlined in Q1
Q26: Do you consider that the discount rate should be set by: a) A panel of independent experts? If so, please indicate how the panel should be made up. b) A panel of independent experts subject to agreement of another person? If so, on what terms and whom? Would your answers to the questions above about a panel differ depending on the extent of the discretion given to the panel? If so, please give details c) The Lord Chancellor and her counterparts in Scotland or another nominated person following advice from an independent expert panel? If so, on what terms? d) The Lord Chancellor and her counterparts in Scotland as at present? e) Someone else? If so, please give details.
The decision should ultimately be made by a cabinet minister following formal advice from experts and in consultation with representatives from claimants and defendants from specified and pre agreed groups.
Please note that we have not responded to the remaining 10 questions as they are not as relevant to our Association.
We hope the above aids your deliberations of this issue. We would be happy to discuss any of the points we make above if this would assist.