Discount Rate – Why is Scotland Different?
Introduction
It will be well known to most readers but to set the context, the discount rate is a percentage used in the calculation of lump sum damages awards for future loss claims such earnings or care costs.
The discount rate is designed to reflect the fact that someone receiving a lump sum payment may invest this and would expect to get a return on that investment. The discount rate is applied to make sure that the amount received by the claimant reflects the return that would be earned if the lump sum received were to be invested. It is about ensuring that injured persons are properly compensated.
Background to current position
For over 15 years, the discount rate in England and Wales and in Scotland was 2.5%. Traditionally, the rate was calculated on the assumption that investment would be made in index linked gilts. However, in more recent years, when savings and investments, particularly those like index linked gilts, have failed to give a reasonable rate of return, the discount rate of 2.5% led to unfairness as claimants were commonly undercompensated. In an attempt to address this, the discount rate in England and Wales was changed to -0.75% in March 2017 and later that month the same change was introduced in Scotland. This level of reduction had not been anticipated and the change attracted criticism from the insurance industry, which asserted that the method of setting the rate was unsound and that the significant reduction in rate would lead to claimants being overcompensated.
A review of the discount rate regime followed, and in July this year the Lord Chancellor announced an increase in the discount rate for England and Wales to -0.25% (effective from 1st October 2019), which still disappointed insurers as they had evidently hoped for a more significant increase.
There was much speculation about whether Scotland would follow suit, but it came as something of a surprise when the Scottish Government confirmed that there would be no change to the discount rate north of the border, which would remain at -0.75%.
Why is there a difference?
There are several aspects that help to explain the difference in rates. In England and Wales, the Civil Liability Act 2018 provides the framework for setting and reviewing the discount rate, which is decided by the Lord Chancellor, who must consult the UK Government Actuary, but is not bound by any advice given.
In Scotland the framework is set out in the Damages (Investment Returns and Periodical Payments) (Scotland) Act 2019, in terms of which the UK Government Actuary is tasked with carrying out a separate assessment before setting the Scottish discount rate. In both jurisdictions, the rate must be reviewed at least every 5 years.
Although there are similarities in the approach taken in each jurisdiction, there are also significant differences in the method of calculating the discount rate. The key differences that appear to have resulted in the disparity in rates are:
- The notional investment portfolio from which the rate for Scotland is derived is a little more conservative and risk-averse than the one used by the UK Government Actuary when advising the Lord Chancellor. The arguments are well-rehearsed but surely it is right and proper that severely injured persons are not compelled to invest in more risky investments simply to ensure their lump sum compensation is sufficient to meet their anticipated future care costs.
- The assumed investment period for the Scottish rate is set at 30 years, while in England and Wales there is no prescribed period (for the current rate, a period of 43 years was adopted). As it is generally accepted that a longer period of investment will provide a higher return, it is not surprising that the discount rate in Scotland has been calculated to factor in a lower return than that south of the border.
- The date at which the economic modelling was carried out differed. The discount rate in England and Wales was based on conditions prevailing in December 2018, while the Scottish rate was based conditions in both December 2018 and June 2019.
Reaction to the Scottish discount rate
The lower discount rate in Scotland has attracted a great deal of comment, much of it from insurers and those representing them, expressing disgruntlement on the basis that insurers and public bodies will now face the prospect of paying higher levels of compensation in Scotland and warning that the lower discount rate will lead to higher insurance costs and premiums for Scottish businesses. That rather overlooks the fundamental principle that the discount rate is set to ensure injured persons are justly and properly compensated for their losses and care costs.
It has also been widely asserted that the differing rate will lead claimants who have sustained serious injuries to “forum shop” and choose to bring proceedings in Scotland rather than in England. This suggestion shows a serious lack of understanding of the basic rules of jurisdiction which govern the courts’ ability to deal with cases. In most actions for damages, jurisdiction is based on either the domicile of the defender or the place where the accident occurred. If neither of these places is in Scotland, the Scottish courts are unlikely to have jurisdiction to deal with the claim – it is as simple as that. To suggest otherwise seems to be nothing more than scaremongering. It is well known that there are differences in the way in which some types of damages are assessed in Scotland as opposed to in England and Wales. One example is awards for the family members of deceased relatives, which tend to be more substantial north of the border. Yet it is not routinely suggested that, as a result, relatives will try and bring claims in Scotland.
Perhaps more startling is the suggestion by insurers’ representatives that the difference in discount rate and the prospect of “forum shopping” will lead to an increase in fraudulent claims in Scotland. Given that litigants can not simply select a jurisdiction at will, and even those representing insurers acknowledge that organised fraud is not a significant issue in Scotland, there appears to be no sound basis whatsoever for this alarmist suggestion.
It is worth remembering that, before the recent changes, the discount rate remained at 2.5% for well over a decade, including a period of significant recession, throughout which claimants were often penalised as a result of the high discount rate, which led to under-compensation. Against that background, it would be more accurate to say that the recent review and update of the discount rate is no more than the righting of a wrong from which insurers have benefited for a good number of years.
As the discount rate provisions on both sides of the border include a requirement that the rate be reviewed after 5 years, any genuine adverse effects of the new rates can no doubt be addressed then.
Brian Castle, author of “Discount Rate – Why is Scotland Different?” is Partner, Digby Brown and MASS Regional Co-ordinator of Scotland.
This article has previous appeared in the MASS Insight Magazine, Issue 22, Autumn 2019.