In June 2001 the Lord Chancellor exercised his power under section 1 of the Damages Act 1996 to prescribe the rate of return (more commonly known as the discount rate) to be used in personal injury claims in England and Wales. He set the rate at 2.5%, previously the rate generally used by the courts was 3%. This analysis is concerned with the impact of that change.
If a person is successful in bringing a personal injury claim, they will be entitled to damages. For permanent and long-term serious injuries, the award can be considerable as it will take account of future loss of earnings and any necessary future care costs, as well as past costs and losses and compensation for non-financial loss. The discount rate is a deduction made from the sum awarded for future loss, on the basis that the successful claimant will invest their damages award and increase the value of the original sum.
On 27 June 2001, the Lord Chancellor announced that he would be setting the discount rate at 2.5%. The Order prescribing the new rate came into force on 28 June 2001. The reasons for the Lord Chancellor's decision, which he considered afresh in July 2001, can be found on the LCD website.
The legal principle that the Lord Chancellor followed in setting the rate was laid down by the House of Lords in the case of Wells v Wells (1999), "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".
A regulatory impact assessment (RIA) could not properly be undertaken before the discount rate was set. When setting the rate, the Lord Chancellor could not take into account the effect of any change either on businesses or on the Government's purse.
A reduction in the discount rate will impact on defendants in that they will have to pay more money to successful claimants. To assess the impact of the new discount rate, we consulted those Government Departments that act as defendants as well as representatives from the insurance industry. This impact analysis does not consider the impact on successful claimants, as it is assumed that the effect of the change in discount rate will be to restore them as near as possible to their position prior to the accident.
In many cases the Government is a defendant in claims for personal injury, the most notable of which is when a person is injured whilst in the care of the NHS. The NHS is legally liable for clinical negligence by its employees, including hospital doctors (but not those who are self employed). The National Health Service Litigation Agency (NHSLA) is responsible for handling the larger claims, including the funding of their defence and any legal costs or damages that are payable. Small claims are handled by NHS trusts but these tend to be for less serious injuries for which the discount rate is not a significant factor. The costs of clinical negligence claims are met from NHS funds.
In May last year, the National Audit Office produced a report, Handling Clinical Negligence Claims in England. In that report they identified that, "in 1999-2000 the NHS received some 10,000 new claims and cleared 9,600. At 31 March 2000 there were an estimated 23,000 claims outstanding. The estimated net present value of outstanding claims at 31 March 2000 was £2.6 billion (up from £1.3 billion at 31 March 1997). In addition, there is an estimated liability of a further £1.3 billion where negligent episodes are likely to have occurred but where claims have not yet been received".
The NHSLA have estimated that the annual cash cost to the NHS of the reduction in the discount rate is £100m. They estimate that the impact of the discount rate change on their potential liability for existing claims will be £493m. This represents the increase in the notional book value of known claims and not a cash cost to the NHS. The figure relates to the total potential liability for claims already in the system should they all be successful. In practice, many may not be successful, or may take several years to resolve. The NHSLA does not hold capital assets to meet potential liabilities as they are funded from within the overall NHS budget. There will also be additional notional liabilities for claims that have been incurred but not yet reported, and for those that are expected to occur at some future date. These costs are estimated to be £281m and £140m respectively, although the figures are of necessity very speculative.
We have also been informed that there will be an impact of £4m each year to the Ministry of Defence for personal injury claims made against them. The other Government Departments contacted did not consider that the change in the discount rate would have any effect upon their budgets or resources. They will mainly be concerned with relatively minor injuries involving no significant future losses ('trips and slips').
We contacted the Local Government Association in order to determine the impact of the discount rate on Local Authorities. They have informed us that the cost to Local Authorities is negligible. Most personal injury claims are for 'trips and slips'.
| Government Department |
Annual cash impact of discount rate change
(£ m) |
| Department of Health |
100
|
| Ministry of Defence |
4
|
| Other Government Departments |
Negligible
|
| Local Authorities |
Negligible
|
| Total |
104
|
Claims arising from private health care, NHS general medical and dental practitioners are dealt with by the Medical Defence Union (MDU) and the Medical Protection Society (MPS). Those organisations do not rely on insurance but make payments generated from subscription income. The MDU calculates its members' subscriptions on the basis that they will provide adequate funds when claims come in, and offers indemnity on an incident occurrence basis. They have estimated that the change in the discount rate from 3% to 2.5% could add £1.5m per annum to their liabilities in future, and approximately £8m retrospectively to their existing liabilities. The MPS also provide indemnity on an incident occurrence basis and estimate that for incidents already occurred the cost of the change will be £6.7m. On that basis, an increase of £1.25m per annum could be assumed for future liabilities using the ratio implied by the MDU figures.
We contacted the Association of British Insurers (ABI) in order to determine the effect that the rate change would have upon the insurance industry. The data in the table below is a "best estimate" based on data collected from a wide range of insurance companies. The figures below were based on reasonable assumptions about claims patterns across the general insurance market as a whole. Using different reasonable assumptions would produce different results. The table shows both the future annual and the retrospective costs that will be incurred. Retrospective costs reflect the additional liability on claims under existing policies as a result of the rate change. The additional future liability is likely to be reflected in higher premiums. The table shows that the rate change implies an average increase in premiums of 0.5%.
The information we have received relates to the UK Insurance Company Market only and does not include any estimates in respect of Lloyd's and other markets. The possible impact on the Lloyd's insurance market could be estimated approximately on the broad assumption that around 10% - 15% of motor insurance business has traditionally been placed in this market.
Miscellaneous motor business has not been included in the analysis. By miscellaneous, we refer to motor business that does not fall into one of the following four categories: private car comprehensive, private car non-comprehensive, commercial vehicle and fleet. For example, invalid carriages and some motorcycles may fall under this heading and the ABI has confirmed that this business is of limited significance as a percentage of all motor liability insurance.
There is likely also to be a marginal impact on other types of insurance business which include an indemnity for liability for personal injury, for example household insurance policies. The number of claims affected is likely to be very small and is considered to be negligible in terms of all insurance business. In addition, the ABI analysis could not, for technical reasons, include an analysis of the impact of the change in the rate on industrial disease claims.
We were unable to obtain figures for any other organizations that self-insure.
|
Estimated Annual and Retrospective Costs to the
UK Insurance Company Market of a change in Discount Rate from 3% to
2.5%
|
||||||||
|
Motor
|
Liability
|
Total £m
|
||||||
|
Comprehensive
|
Non-Comprehensive | Fleet | Commercial | Total Motor | Employer's Liability | Public Liability | ||
| Annual Cost of Discount Rate Change from 3% to 2.5% £m |
25.3
|
5.5
|
7.8
|
5.0
|
43.7
|
8.7
|
5.0
|
57.3
|
| Gross Written Premium in 2001 £m |
5, 559
|
971
|
1,757
|
850
|
9,137
|
780
|
1,399
|
11,316
|
| Annual Costs as % 2001 GWP |
0.5%
|
0.6%
|
0.4%
|
0.6%
|
0.5%
|
1.1%
|
0.4%
|
0.5%
|
| Retrospective cost of discount rate reducing from 3% to 2.5% £m |
96.2
|
20.9
|
29.7
|
19.2
|
166.0
|
33.0
|
18.8
|
217.9
|
In addition, on the basis of the above figures, the 10-15% of motor insurance business placed in the Lloyd's insurance market would result in an estimated additional annual cost of between £4.3m and £6.5m (say £5.4m).
The tables below summarise the total estimated annual cash effect and estimated retrospective cost of the change in discount rate from 3% to 2.5%. These figures are of necessity best estimates based on the available information. Because of the need to rely on sample information in some cases, and to make a number of assumptions, there is likely to be a significant margin of error.
|
Organisation
|
Total estimated annual effect of discount rate
change (£m)
|
| Government (including Local Authorities) |
104
|
| Insurance industry |
57
|
| Lloyds motor insurance |
5
|
| MDU and MPS |
3
|
| Total |
169
|
|
Organisation
|
Total estimated retrospective effect of discount
rate change (£m)
|
| Insurance industry |
218
|
| Lloyds motor insurance |
21
|
| MDU and MPS |
15
|
| Total |
254
|