Fair Compensation? What the discount rate means to you.

The Lord Chancellor announced the long awaited result of a review of the discount rate this morning. The shockwaves have yet to subside. The rate has been set at 2.5% since 2001. Today it was reduced to -0.75%. It doesn’t sound like much of a change, it doesn’t sound like an exciting subject, so why the furore?

What the discount rate means to you

If you sustain an injury which gives rise to a right to compensation, that compensation includes a right to claim financial losses which will arise in the future. A simple example – Mr X, a man aged 30 cannot work again due to injuries caused by an accident at work which was not his fault. He had expected to work until he was 65 years of age. Mr X has lost future earnings for the remainder of his working life, a period of 35 years. In that situation most clients expect that the calculation of the loss of earnings is a simple exercise, the amount earned each year multiplied by the number of years left to work. Thus in our example, if the Mr X had been earning £25,000 a year and had lost 35 years earnings, his claim would be for £25,000 x 35 years = £875,000.

In law, nothing is that simple. The basic principle of compensation is that it should put you in the position you would have been if the accident had not happened. If Mr X received £875,000 as a lump sum at the time his claim is settled, the law expects him to invest it in a safe investment, in order to provide him with an income equivalent to £25,000 a year for the 35 year period. By so doing Mr X will receive interest on the investment and the amount of money will grow (in theory). By adding interest to the sum of £875,000 Mr X will receive more money that he would have earned if uninjured and thus breaching the basic principles of compensation.

In order to reduce the figure to an amount that more accurately equates to the amount of lost income, a “discount rate” is applied. The figure is set by the government. For the last 16 years that discount rate has been 2.5%. In the case of Mr X, under the rules this would lead to him receiving the equivalent of 22.84 years of earnings instead of 35 years. The calculation of loss becomes £25,000 x 22.84 years= £571,000. The award for future loss of earnings is reduced from £875,000 to £571,000.

Back in 2001, it may have been possible to invest £571,000 over 35 years so that the interest generated made up the shortfall of £304,000, although it always seemed a doubtful proposition to Claimant’s lawyers. The problem has been exacerbated in the intervening period as rates of return on investment have plummeted. It is entirely impossible for Mr X in 2017 to make up the shortfall and he would end up being grossly under compensated for his loss.

A review of the rate to correct the injustice has been under consideration for over 6 years. The insurance industry and the NHSLA have fought tooth and nail, including resorting to the Courts, to prevent such a review so that they can continue to under compensate victims of accidents caused by their insured.

The decision

On considering all of the evidence, the Lord Chancellor has accepted that the discount rate is wrong and significantly so. Whilst a change of 3.25% may seem very small, the impact will be significant. Our Mr X will see his compensation increase to the equivalent of somewhere between 37 years and 40 years loss of earnings, to take into account low interest rates and deduction of investment costs. Using a midway point of 38.5 years gives rise to a significant increase in the level of compensation, our calculation of future loss of earnings is now £25,000 x 38.5 years = £962,500. That is an increase in compensation of £391,500 over the figure under the old system.

The principle applies to all types of claim: road traffic accidents, accidents at work and clinical negligence cases. It also applies to all types of regular future loss, such as the cost of future care, support or therapeutic treatment.

For the first time in many years injured individuals will receive a sum of money which will go further towards properly compensating them for financial loss, although the system remains weighted in favour of the Defendant.

Nor should it be forgotten that no sum of money can ever truly compensate for the devastating effects of serious injuries nor their impact upon the families of those injured.

Sadly the change will do nothing to assist those undercompensated under the old rules, from which the compensators have benefitted for far too long.

If you have suffered injury or loss as a result of the actions of others contact our experienced personal injury and clinical negligence team on 0800 316 8892.