The change announced at the start of this week will result in an increase in the size of payments made to successful claimants.
Andrew Jepp, managing director at Zurich Municipal, told Public Finance that reducing the discount rate from 2.5% to -0.75% later this month would put extra pressure on public sector budgets “at the worst possible time”.
A discount rate is applied to lump sum payouts to reflect the fact that the money can be invested and can earn interest. Since 2001, the discount rate has been set at 2.5%, effectively reducing the size of payments.
However, on Monday, Lord Chancellor Liz Truss announced a major reduction of the rate into negative territory, which will see compensation payments increase.
She said: “I am clear that this is the only legally acceptable rate I can set.”
The new -0.75% rate is set to take effect on 20 March.
Truss’s move has sparked uproar in the insurance industry, with the Association of British Insurers branding the decision as “crazy”.
While much national press attention has focused on the impact on consumers, through, for example, expected hikes in motor insurance premiums, Jepp said the effect on the public sector would also be significant.
“Changing the rate so dramatically is going to have a big impact on local authorities and public services,” he told PF.
Large, top-tier authorities, which tend to see the biggest personal injury claims, would need to review their reserve levels to ensure they can meet larger payments, Jepp explained.
Additionally, insurers – who tend to bear the risk of very large claims – will have to look again at the premiums they charge their public sector customers. Jepp also highlighted that insurance premium tax is set to go up to 12% this year.
“So when you look at all that, the concern we’ve got is that this change is going to have a dramatic impact on public sector finances at the worst possible time. We’re concerned about the unintended financial consequences that flow through to the taxpayer and that really can’t be underestimated
“The dilemma is, the more you’re paying out in compensation, the less you’ve got to pay out to mend highways and spend on public services. It feels like it’s a lose-lose all the way round.”
Worked examples shared with PF by ZM show significant increases in the amount that will be paid out once the discount rate is adjusted down to -0.75%.
A customer with an open motor injury claim valued at £200,000 with a male claimant aged 44 and a deductible level of £300,000, would lead to increased compensation costs of £42,575 once the -0.75% discount rate is applied.
For a very large claim valued at £4m with a 20-year-old male claimant, related damages would increase by almost £3.84m with the new discount rate.
The government acknowledged that the change will increase costs faced by the health service and said it was “committed to ensuring that the NHS Litigation Authority has appropriate funding to cover changes to hospitals’ clinical negligence costs”.
Yesterday, a delegation of insurers led by the ABI, met with chancellor Philip Hammond to discuss the discount rate. A joint statement released after the meeting said: “Claimants must get the money they’re entitled to following an injury in order to support their future needs.
“It is important that going forward, personal injury discount rates are set at a level that is fair to both claimants and consumers.”
The government currently links the discount rate to index linked government stock, a methodology Jepp suggested was “somewhat flawed” given claimants were likely to take a balanced, rather than very low-risk, approach to the investment of their lump sums.
Ministers have pledged to consult on the way it sets the discount rate, and bring forward any necessary legislative changes quickly.
