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02 March 2017

The maths behind the discount rate – and what this means for Claimants

4 mins

There is a lot of intricate maths involved when calculating compensation in personal injury and medical negligence claims. There are carefully compiled actuarial tables setting out how you calculate different losses based on when that loss arises, how long for and whether it will continue in the future.

These tables are almost always relevant when looking at future losses which will be based on the condition and prognosis of the injured person. For example, a serious injury to both legs may mean you can no longer work as a construction worker which you have been doing for 20 years but you can get a job as a less well paid non-manual worker. The difference in your earnings until retirement age is something that has to be carefully calculated. Whether you are now able to work until full retirement age, which you would have before you became injured, will also be relevant.

This calculation will depend on your age at the date of the accident, what you were earning at the time of the accident, your chances of promotion, whether you were disabled at the time of the accident, what your level of educational attainment was and your life expectancy, among other factors.

A key premise when calculating future loss of earnings is that the claimant should not end up with a windfall. A way to ensure that this doesn’t happen is to reduce the future losses by a percentage to take into account that you are getting a lump sum payment now which can be invested. Since 1996, the discount rate to reflect this was set at 2.5% which meant quite a significant discount to claimants compensation. This discount rate is linked to returns on low risk investments. The law makes it clear that claimants shouldn’t be encouraged to put their money into risky investments given that their compensation is so precisely calculated based on current and future needs. 

For example, if you were claiming for £100 worth of a loss to start in 10 years’ time, using the 2.5% discount rate, you would be paid £78.10 today to reflect the fact that £78.10 invested today would give you £100 in 10 years’ time. 

The problem with this and the problem for a long time now has been that return rates when investing money aren’t as good as they were when the discount rate was set. This means that clients have been undercompensated for years.

The change to the discount rate reflects this reality. Liz Truss has set the discount rate at -0.75% and said it was “the only legally acceptable rate” she could set after months of consideration. This reflects the reality of the poor returns investors have been getting for years. For Claimants it has meant having to use other elements of their compensation to make up for this shortfall when paying for medication, treatment and adaptations relevant to their disability.

The change to the discount rate, which comes into force on the 20th March means the claimant in the above example will get approximately £111 today and this is meant to reflect the fact that investment rates are so poor today that your money will be worth less in 10 years’ time and you won’t get a good return on it even if you do invest it. Claimant’s won’t be getting a windfall and this is a carefully calculated rate to take into account our economy.

The reality is that it could make defendant solicitors much more keen to try and settle claims without a careful breakdown of future losses. If they are able to argue that a general, broad-brush approach should be adopted and the carefully compiled actuarial tables are ignored, then the above will not apply.

Finally, there have been lots of cries about increases to insurance premiums, which will probably go ahead. Although increased bills are never good news, insurers are very reluctant to pass on profits by way of reduced premiums but extremely quick to pass on the increases. The changes to personal injury law in 2013 has meant significant savings for car insurance companies but I haven’t seen a reduction to my car insurance for 7 years. I’ll definitely be keen, or not, to see how much my insurance increases by in April.

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