On 25 June 2001 I made the Damages (Personal Injury) Order 2001 ("the 2001 Order") pursuant to section 1 of the Damages Act 1996. In setting a rate of 2.5% in the 2001 Order I had regard to what I believed to be the accurate figure for the average gross redemption yield on Index-Linked Government Stock for the 3 years leading up to 8 June 2001. Following my announcement of the discount rate, questions were raised as to the correctness of the 3-year average yield figure upon which I had relied.
These questions led me to have the information about the 3-year average yield figure checked thoroughly. Those checks revealed certain limited inaccuracies in the information underlying the average yield figure on which I had based my reasoning in making the 2001 Order. In the light of the correction of that average yield figure, I think it right that I should consider completely afresh, on the basis of the accurate average yield figure, what rate I should have set when I made the 2001 Order on 25 June 2001, in order to determine whether the 2001 Order should be withdrawn.
Having considered all the material available to me, including the accurate, corrected average yield figure, I have come to the conclusion that a discount rate of 2.5% was the appropriate rate to set. Therefore, I do not consider that the 2001 Order should be withdrawn. This statement sets out my reasons for coming to that conclusion.
In determining the discount rate, I have applied the appropriate legal principle laid down authoritatively by the courts, and in particular by the House of Lords in Wells -v- Wells [1999] 1 AC 345.
I also consider that it is highly desirable to exercise my powers under the Act so as to produce a situation in which claimants and defendants may have a reasonably clear idea about the impact of the discount rate upon their cases, so as to facilitate negotiation of settlements and the presentation of cases in court. In order to promote this objective, I have concluded that I should:
set a single rate to cover all cases. This accords with the solution adopted by the House of Lords in Wells -v- Wells. It will eliminate scope for uncertainty and argument about the applicable rate. Similarly, I consider it is preferable to have a fixed rate, which promotes certainty and which avoids the complexity and extra costs that a formula would entail;
set a rate which is easy for all parties and their lawyers to apply in practice and which reflects the fact that the rate is bound to be applied in a range of different circumstances over a period of time. For this reason, I consider it appropriate to set the discount rate to the nearest half per cent., so as to ensure that the figure will be suitable for use in conjunction with the Ogden Tables, which are a ready means for parties to take into account actuarial factors in computing the quantum of damages;
set a rate which should obtain for the foreseeable future. I consider it would be very detrimental to the reasonable certainty which is necessary to promote the just and efficient resolution of disputes (by settlement as well as by hearing in court) to make frequent changes to the discount rate. Therefore, whilst I will remain ready to review the discount rate whenever I find there is a significant and established change in the relevant real rates of return to be expected, I do not propose to tinker with the rate frequently to take account of every transient shift in market conditions.
(I consider that the reasoning and conclusions in the above paragraph, which appeared in my original reasons for setting the discount rate in the 2001 Order, continue to apply.)
The principle which I must strive to apply is clear: ". ..the object of the award of damages for future expenditure is to place the injured party as nearly as possible in the same financial position he or she would have been in but for the accident. The aim is to award such a sum of money as will amount to no more, and at the same time no less, than the net loss." (Wells -v- Wells at 390A-B per Lord Hope of Craighead). I acknowledge that claimants who have suffered severe injuries are not in the position of ordinary investors. Such claimants have a pressing need for a dependable source of income to meet the costs of their future care. It is accordingly unrealistic to require severely injured claimants to take even moderate risks when they invest their damages awards.
Setting a single rate to cover all cases, whilst highly desirable for the reasons given above, has the effect that the discount rate has to cover a wide variety of different cases, and claimants with widely differing personal and financial characteristics. Moreover, as has become clear from the consultation exercise (including responses by expert financial analysts to questions which I posed them), the real rate of return on investments of any character (including investments in Index-Linked Government Securities) involves making assumptions for the future about a wide variety of factors affecting the economy as a whole, including for example the likely rate of inflation. In these circumstances, it is inevitable that any approach to setting the discount rate must be fairly broad-brush. Put shortly, there can be no single "right" answer as to what rate should be set. Since it is in the context of larger awards, intended to cover longer periods, that there is the greatest risk of serious discrepancies between the level of compensation and the actual losses incurred if the discount rate set is not appropriate, I have had this type of award particularly in mind when considering the level at which the discount rate should be set. (The above paragraphs also formed a part of my original reasons for setting the discount rate, and I consider that they continue to apply.)
The House of Lords in Wells -v- Wells determined the real rate of return obtainable by claimants through low-risk investment by reference to the gross redemption yields on Index-Linked Government Stock. Their Lordships assumed that a claimant would use his damages award to purchase the right portfolio of Index-Linked Government Stock to ensure that in future years the sums which he received from his portfolio by way of coupon payments and payments on redemption would be sufficient to meet his financial needs. The risk that an early sale of Index-Linked Government Stock might cause capital losses was removed by assuming that such a claimant would hold all his Index-Linked Government Stock until redemption.
The House of Lords thought it appropriate to set the discount rate by reference to the average yields on Index-Linked Government Stock. There is no single correct method by which this average yield may be calculated. Among other factors, the calculation will depend upon the length of the period under consideration, the stocks which are to be included within the average, the inflation assumption made and the form of average taken.
The majority of their Lordships considered it appropriate to set a discount rate by taking a 3-year average of Index-Linked Government Stock yields. I agree that, having regard to the benefits to be obtained in setting the discount rate for the foreseeable future, 3 years is an appropriate period over which to take an average. I note that Lord Lloyd of Berwick preferred a one year period; this confirms the need for judgements to be made in determining the appropriate average yield.
It appears from the speech of Lord Hope at 393E-F that his Lordship had regard to an average of gross redemption yields on Index-Linked Government Stock with lives of over 5 years. He did not give reasons for adopting that particular approach. I am aware that this approach has also been favoured by the Ogden Working Party. However, having regard to the basic reasoning of the House of Lords in Wells -v- Wells, I do not consider that I am obliged to follow it. As noted above, the House of Lords in Wells -v- Wells assumed that a claimant would generally hold all his Index-Linked Government Stock until redemption. Further, as was stated by Lord Clyde at 395H-396A, it was to be assumed that in each year of loss a proportion of the capital would have to be used. If these two assumptions are to be rendered consistent then it will be necessary for the claimant to purchase Index- Linked Government Stock which will mature in the short term, for otherwise the claimant would have to sell a proportion of his Index-Linked Government Stock prior to redemption in order to realise, in the short term, some of the capital value of his investments. Some claimants, whose losses extend over periods of about 5 years or so or less, would have to purchase all or most of their Index-Linked Government Stock (if that is what they chose to do with the damages paid to them) in this category of stock. I have therefore decided that it is proper to take an average over all Index-Linked Government Stock rather than to exclude Index-Linked Government Stock with less than 5 years to maturity.
Nevertheless, I consider that it would be inappropriate to include the gross redemption yields of such stock which is very near maturity ("near maturity ILGS" -which is stock for which the nominal value of the final coupon and redemption payments have become known with certainty). The gross redemption yield on such near maturity ILGS is a nominal yield rather than a real yield. Accordingly, I asked for a calculation of the size of the real yield element in the gross redemption yields of the near maturity ILGS and have included those real yields within my calculation of the average yield.
The average yield figure upon which Lord Hope relied at 393E-F in Wells -v- Wells was based on an inflation assumption of 5%. I consider that, given both the current rate of inflation and the Government's policy aim of maintaining that rate within an upper limit of 2.5%, an assumption of 3% is to be preferred for present purposes.
The House of Lords in Wells -v- Wells did not discuss what form of average should be taken of Index-Linked Government Stock yields. One method is to take an average which is weighted in accordance with the market value of each stock. To my mind, such a weighted average is not relevant to the present circumstances, as the choice of Index-Linked Government Stock portfolio which is necessary to ensure that the future financial needs of a claimant are adequately and promptly met does not depend upon the prevailing market values of Index-Linked Government Stock. I have therefore decided that it is appropriate to take a simple average of Index-Linked Government Stock yields.
A calculation of the simple average of the gross redemption yields of an Index-Linked Government Stock (with an appropriate adjustment for the yields of near maturity ILGS) at an assumed rate of inflation of 3% produces an average yield figure of 2.46%. Accordingly, I conclude that the net average yield on Index-Linked Government Stock, as adjusted to take account of tax, lies in the range between 2% and 2.5%. In my opinion, following Wells -v- Wells, the discount rate should be set within this range. Further, given that the rate is to be set to the nearest 0.5%, it is clear that the discount rate should either be 2% or 2.5%. I do not consider that the choice whether a rate of 2% or one of 2.5% is appropriate is a simple arithmetical matter, nor that Wells -v- Wells requires me to set one rate or the other. I must have regard to the basic principle to which I have referred above, and I have taken account of matters which I consider are relevant to the setting of a discount rate which is just as between claimants as a group and defendants as a group.
In the light of all the information now available to me, and considering the matter completely afresh, I have decided that on 25 June 2001 I should have set the discount rate at 2.5%.
In doing so, I have noted that the real rate of return to be expected from Index-Linked Government Securities tends to be higher the lower the rate of inflation is assumed to be (figures at assumed rates of inflation of 3% and 5% are readily available for comparison). The average gross redemption yield figure of 2.46% assumes an inflation figure of 3% extending into the future. But over recent years inflation has been kept close to or below the 2.5% target set by the Government, and Government policy and the function of the Bank of England remains firmly to maintain inflation according to that target. Although economists differ as to what inflation rates may be expected for the future, I note that the market's general expectation as to the rate of inflation for the future (as implied by market valuations of gilts) is well below 3%. I consider that it is reasonable to assume an inflation rate for the foreseeable future somewhere below 3%, and this in turn provides comfort that a discount rate set at 2.5% is reasonable. (The above paragraph and the larger part of the following four paragraphs were contained in my original reasons for setting the discount rate. They set out considerations which I consider continue to apply).
I am further supported in my conclusion that a discount rate of 2.5% is reasonable by indications that the rate of return in respect of Index-Linked Government Securities does not represent a pure and undistorted measure of the real rate of return which markets would afford in relation to investments with minimal risk which have emerged from the information which was provided in the responses to the consultation paper and the responses from expert financial analysts which I obtained, and by consideration of rates of return on other investments which are available at low risk to claimants. I have treated the following points as significant.
First, some responses to the consultation maintained that the market in Index-Linked Government Securities is at present distorted so that the prevailing yields are artificially low, and do not necessarily give a reliable indication of the real rate of return which markets would afford in relation to investments with minimal risk. The expert financial analysts whom I consulted concurred that the market is distorted at present. This appears to be a result of the minimum funding requirement introduced by the Pensions Act 1995 (which has, in effect, created additional demand for such securities on the part of pension funds) combined with a reduced supply of government securities generally, as the Government has reduced the national debt. The market in Index-Linked Government Securities has changed significantly since Wells -v- Wells was argued and decided. It is widely held that the continuing high demand for Index-Linked Government Stock and the scarcity of supply has led to yields being artificially low as compared with both past record and the yields presently available on similar investment instruments issued by other, comparable, national governments. I consider that the fact that yields in Index-Linked Government Stock appear to be artificially low at present militates against the suggestion that these yields over recent years should be taken as the sole indication of the rates of return that can be achieved through low risk investment in the market. Also, I consider that there is some reasonable prospect of a return to higher rates of return in respect of Index-Linked Government Stock when the Government's already announced plans to abolish the minimum funding requirement are carried into effect. Any distorting effect of the minimum funding requirement would be expected to be particularly pronounced in relation to the longer maturity stocks, whose yields have recently been lower than shorter maturity stocks.
Second, I have noted that the Court of Protection, even in the wake of Wells -v- Wells, has continued to invest, on the behalf of claimants, in multi-asset portfolios, including an equity element. Investment in this manner could be expected to produce real rates of return well in excess of 2.5%. The Court of Protection has specific responsibility to ensure that the financial needs of those for whose benefit it acts will be met, ie its investment objectives are closely similar to those of the prudent claimant which the House of Lords identified in Wells -v- Wells. The Court of Protection takes competent financial advice as to the investment strategy which will best secure those objectives. Despite the decision of the House of Lords in Wells -v- Wells to set the discount rate by reference to yields on Index-Linked Government Securities, the Court of Protection has continued its former policy, with the agreement of the families concerned, of investing in portfolios comprising of a mixture of equities, gilts and cash. Master Lush of the Court of Protection has stated that none of the families of the Court's patients have chosen to invest in Index-Linked Government Stock since Wells -v- Wells, despite having been offered that option. Thus it appears that there are sensible, low risk investment strategies available to claimants which would enable them comfortably to achieve a real rate of return at 2.5% or above, without their being unduly exposed to risk in the equity markets. Although the House of Lords in Wells -v- Wells chose not to be guided by the practice of the Court of Protection, this was principally on the grounds that what the Court of Protection might do in the future was uncertain, and not on the grounds that its practice was irrelevant. I consider it is appropriate to take account of what has happened in the period since that decision.
Third, I consider that it is likely that real claimants with a large award of compensation, who sought investment advice and instructed their advisers as to the particular investment objectives which they needed to fulfil (as they could reasonably be expected to do) would not be advised to invest solely or even primarily in Index-Linked Government Securities, but rather in a mixed portfolio, in which any investment risk would be managed so as to be very low. This view is supported by the experience of the Court of Protection as to the independent financial advice they receive. It is also supported by the responses of the expert financial analysts whom I have consulted. No one responding to the consultation identified a single case in which the claimant had invested solely in Index-Linked Government Securities and doubts were expressed as to whether there was any such case. This suggests that setting the discount rate at 2.5% would not place an intolerable burden on claimants to take on excessive, i.e. moderate or above, risk in the equity markets, and would be a rate more likely to accord with real expectations of returns, particularly at the higher end of awards.
Finally, in deciding that a single rate of 2.5% should have been set by me on 25 June 2001, I have borne in mind that it will, of course, remain open for the Courts under section 1(2) of the Damages Act 1996 to adopt a different rate in any particular case if there are exceptional circumstances which justify it in doing so.
Irvine of Lairg
Lord Chancellor
27 July 2001