Ministry of Justice: The personal injury discount rate: how it should be set in future

Executive Summary The personal injury discount rate exists to ensure that any lump sum awarded by a court to an injured claimant meets the 100% compensation rule. To make sure the discount rate is fair to both defendants and claimants, the Law Society ('we') believe that: The legal principle of 100% compensation should always be met by the methodology for setting the discount rate. Whilst there is no up to date evidence that claimant investment behaviours have changed, there should be no change to the assumption that claimant investment behaviours tend to be low risk. We would welcome a conversation with the Ministry of Justice about how they could further inform their decisions relating to the discount rate after the consultation period has ended. The setting of the discount rate should be driven by evidence and not politicised; in order for confidence to be maintained in our civil justice system, the Lord Chancellor should no longer have a role in the setting of the discount rate. Periodical payment orders (PPOs) are an invaluable mechanism for offering security to claimants, but they should not be forced upon claimants nor should the refusal to take one result in an assumption that the claimant has an appetite to invest in higher risk assets. A regular review of the discount rate would benefit both claimants and defendants; the review of the discount rate should take place on a fixed term basis, preferably every five years. Response We have addressed the questions posed in the consultation paper thematically. The current discount rate Q1: Do you consider that the present law on setting the discount rate is defective? If so, please give reasons. Q2: Please provide evidence as to how the application of the discount rate creates under or over-compensation and the reasons it does so. The current system is predicated on the 100% compensation rule which is crucial to delivering fair outcomes for both claimants and defendants. We do, however, welcome the opportunity for a discussion on alternative methodologies which continue to preserve the 100% compensation rule. With this in mind, we believe that a regularly reviewed discount rate with an improved methodology could deliver fairer outcomes to both defendants and claimants. We are aware of the research conducted by the Ministry of Justice ('the Ministry') and the Ipsos MORI Social Research Institute in October 2013. 1 This reinforced the findings of the earlier and more in-depth research carried out by the Law Commission into the behaviour of claimants in 1994. 2 Although these sets of research are dated, both indicate that claimants are risk averse in their investment decisions. Although there is anecdotal information about changes to claimant investment behaviours, further qualitative and quantitative research is needed to draw a more definitive conclusion. 1 Personal Injury Discount Rate Research (2013), MoJ and Ipsos MORI Social Research Institute 2 Personal Injury Compensation: How Much is Enough? (1994), Law Commission 2

We believe that obtaining a deeper understanding of claimant investment behaviour is a key component of the methodology and recommend that this is reviewed periodically alongside any discount rate reviews. Further analysis of claimant investment behaviour must be conducted before the Ministry consider changing the level or methodology of the discount rate. Given the short consultation period, we would welcome further discussion with the Ministry on their proposed work in this area. The Financial Conduct Authority's Business Plan 2017/18 3 includes a 'Risk Outlook' chapter; this outlines trends in consumer behaviour. The Risk Outlook states that low financial literacy levels mean that consumers are not able to appropriately assess their financial needs; the Ministry should consider this low level of financial literacy when examining the discount rate methodology. The Ministry may also want to consider a report carried out in 2009 for the Department of Work and Pensions. 4 The report reviewed a number of research projects into individual investment behaviour. The review found that a number of previous projects indicated that UK consumers have "low levels of knowledge and understanding about... investments" and that "... they also tend to be risk averse". 5 Investment advice and claimant investment behaviours Q3: Please provide evidence as to how during settlement negotiations claimants are advised to invest lump sum awards of damages and the reasons for doing so. Q4: Please provide evidence of how claimants actually invest their compensation and their reasons for doing so. Q5: Are claimants or other investors routinely advised to invest 100% of their capital in ILGS or any other asset class? Please explain your answer. What risks would this strategy involve and could these be addressed by pursuing a more diverse investment strategy? Q9: Do claimants receive investment advice about lump sums, PPOs and combinations of the two? If so, is the advice adequate? If not, how do you think the situation could be improved? Please provide evidence in support of your views. Regarding investment advice, it is our members' experience that financial advisers are brought in to advise claimants on the merits and disadvantages of a lump sum and a PPO where both are available. In our experience, investment advice tends to be sought where the amount awarded is more than a seven figure sum. However, we do not have any further information on the financial advice given to claimants in these situations. We advise that the Ministry seek evidence from investment advisers in order to build a fuller understanding of the issues before proceeding with any changes to the discount rate. 3 Page 20, Chapter 4, Business Plan 2017/2018 (2017), Financial Conduct Authority 4 Individual investment behaviour: A brief review of research (Jan 2009), Personal Finance Research Centre 5 Page 5, Individual investment behaviour: A brief review of research (Jan 2009), Personal Finance Research Centre 3

The availability and take up of PPOs Q6: Are there cases where PPOs are not and could not be made available? Are there cases where a PPO could be available but a PPO is offered and refused or sought and refused? Please provide evidence of the reasons for this and the cases when this occurs. Q7: Please provide evidence as to the reasons why claimants choose either a lump sum or a PPO, including where both a lump sum and a PPO are included in a settlement. Q8: How has the number of PPOs changed over time? What has driven this? What types of claims are most likely to settle via a PPO? PPOs are a valuable tool for injured individuals as they offer long-term security. They are tax free, index linked to an employment scale and provide a good level of security for claimants. The current use of PPOs is a complex picture, influenced by the differing incentives of those involved. We would support any effort to make the PPO market more attractive to defendants as there are external factors which impact, such as whether an insurer has a life arm or not, which could ultimately restrict a defendant's ability to offer a PPO. We also know that there are situations where PPOs would not be available. For example, where the defendant is not secure enough to guarantee the continued payment to the injured individual until death, a PPO would not be awarded. If the PPO is particularly high, the court may also not authorise a PPO as it would not consider that there are sufficient funds to meet a PPO over the relevant period of time. There may also be cases where claimants no longer wish to continue to interact with the defendants. Based on feedback from legal practitioners, a situation may also arise where a case concerns disability protected parties and the court or caretakers of the claimant will settle or agree a PPO on behalf of the claimant. For example, in the case of a baby who has been severely brain damaged at birth, the uncertainty relating to a lump sum (how the parents will use the money, the parents who worry what will happen to the money when they are gone etc.) is often too much of a risk. 4

The future of the discount rate Q10: Do you consider that the present law on how the discount rate is set should be changed? If so, please say how and give reasons. Q11: If you think the law should be changed, do you agree with the suggested principles for setting the rate and that they will lead to full compensation (not under or over compensation)? Please give reasons. Q12: Do you consider that for the purposes of setting the discount rate the assumed investment risk profile of the claimant should be assumed to be: (a) Very risk averse or risk free (Wells v Wells) (b) Low risk (a mixed portfolio balancing low risk investments). (c) An ordinary prudent investor (d) Other. Please give reasons. Q13: Should the availability of Periodical Payment Orders affect the discount rate? If so, please give reasons. In particular: Should refusal to take a PPO be taken as grounds for assuming a higher risk appetite? If so, how big a difference should this make to the discount rate? Should this assumption apply in cases where a secure PPO is not available? Q14: Do you agree that the discount rate should be set on the basis that claimants who opt for a lump sum over a PPO should be assumed to be willing to take some risk? If so, how much risk do you think the claimant should be deemed to have accepted? Please also indicate if you consider that any such assumption should apply even if a secure PPO is not available. Please give reasons. Q15: Do you consider that different rates should be set for different cases? Please give reasons. If so please indicate the categories that you think should be created. Q16: Please also indicate in relation to the categories you have chosen whether there are any special factors that should be taken into account in setting the rate for that category. Q19: Do you consider that there are any specific points of methodology that should be mandatory? Please give details and reasons for your choice. Fundamentally, any changes should not undermine the 100% compensation principle. We agree that the current methodology could be changed to better reflect the potential yield claimants could receive from investing a lump sum as long is it does not undermine the 100% compensation rule. We believe that a claimant's risk profile for the purposes of setting the discount rate should be assumed to be low risk. Financial advice has grown in sophistication since the methodology of the discount rate was set and a low risk profile, rather than a very low/no risk profile, is more likely to reflect the reality of today's markets. It is a fundamental principle of law that claimants should have the choice to decide how to receive their compensation. We believe that forcing a claimant to take a PPO would violate this principle. Furthermore, the assumption that the rejection of a PPO means that a claimant has a higher risk appetite is borne out of no evidence. 5

Therefore, the availability, offer or take-up of a PPO should not affect the discount rate and it should not be taken as grounds for assuming a higher risk appetite. The choice of a lump sum or a PPO depends entirely upon the circumstances of the claimant. Both come with practical considerations which need to be examined in the context of each individual case; we fully support the continuation of claimant choice. We do not support different discount rates being set for different types of cases. This would lead to the application of the discount rate becoming overly complicated for both claimants, defendants and their lawyers. Different rates for different cases could potentially result in drawn out cases, satellite litigation and increased costs for claimants and defendants. This should be avoided by keeping the one discount rate for all cases. Court powers Q17: Should the court retain a power to apply a different rate from the specified rate if persuaded by one of the parties that it would be more appropriate to do so? Please give reasons. Q18: If the court should have power to apply a different rate, what principles should apply to its exercise? The court should retain the power to apply a different rate from the specified rate if appropriate to do so. The current and tightly confined principles of applying a different rate should remain. Any wider powers to vary the discount rate could result in further litigation and cause delays and increased costs. This would be unfair to both claimants and defendants. Review of the discount rate Q20: Do you agree that the law should be changed so that the discount rate has to be reviewed on occasions specified in legislation rather than leaving the timing of the review to the rate setter? If not, please give reasons. Q21: Should those occasions be fixed or minimum periods of time? If so, should the fixed or minimum periods be one, three, five, ten or other (please specify) year periods? Please give reasons. Q22: When in the year do you think the review should take effect? Please give reasons. Q23: Do you agree that the rate should be reviewed at intervals determined by the movement of relevant investment returns? If so, should this be in addition to timed intervals or instead of them? What do you think the degree of deviation should trigger the review? Q24: Do you agree that there should be a power to set new triggers for when the rate should be reviewed? If not, please give reasons. Q25: Do you consider that there should be transitional provisions when a new rate is commenced? If so, please specify what they should be and give reasons. 6

We agree that the discount rate should be reviewed as per a fixed period specified in legislation. The timing of the review should no longer be left to the rate setter. Although there is a small risk of issues arising, such as 'gaming' of the system, we believe that it is beneficial to both claimants and defendants for the discount rate to be regularly reviewed. We suggest that the review of the discount rate take place every five years. Any longer than this and the discount rate may no longer be reflective of the potential for returns on investments. This will result in either the under or over compensation of claimants. Equally, if a review were to take place too frequently, it could result in too much uncertainty for both claimants and defendants. We believe that a review which takes place every five years strikes the right balance. Fixed periods of review can however introduce uncertainty in the period leading up to the review. It would be helpful as part of the process of review for the reviewer to give a precise date for the change. This would bring a greater degree of certainty to parties involved in proceedings. We agree that there should be an external trigger for an 'out of cycle' review of the discount rate. As we have seen with the most recent financial crash, external factors can quickly and profoundly impact whether the discount rate reflects the reality of the investment market. In these circumstances, it would be unfair to both claimants and defendants to ask them to wait five years for the rate to be reviewed should external factors have such an impact. However, to guard against the discount rate being reviewed too regularly, the trigger for an out of cycle review should have a relatively high threshold (such as changes in the financial market being significant, with a prolonged impact likely). Who should set the discount rate? Q26: Do you consider that the discount rate should be set by: a) A panel of independent experts? If so, please indicate how the panel should be made up. b) A panel of independent experts subject to agreement of another person? If so, on what terms and whom? c) The Lord Chancellor and her counterparts in Scotland or another nominated person following advice from an independent expert panel? If so, on what terms? d) The Lord Chancellor and her counterparts in Scotland as at present? e) Someone else? If so, please give details. Would your answers to the questions above about a panel differ depending on the extent of the discretion given to the panel? If so, please give details. Decisions on awards made by the courts should not be subject to political influence. In order for the civil justice system to retain the trust and confidence of claimants and defendants, the process should be fully independent from government. As such, we believe that the role of Lord Chancellor should be removed entirely and suggest that the discount rate is set by a panel of independent experts, chaired by a government actuary. The discount rate is based on rates of return from investments. Therefore, it is vital that the experts on the panel should all have qualifications relating to or a substantial background in financial investment. 7

The future of PPOs Q28: Do you consider that the current law relating to PPOs requires clarification as to when the court should award a PPO? If so, what clarification do you consider necessary and how would you promulgate it? Q29: Do you consider that the current law relating to PPOs should be changed by creating a presumption that if a secure PPO is available it should be awarded by the court? If so, how should the presumption be applied and on what grounds could it be rebutted? Q30: Do you consider that the current law relating to PPOs should be changed by requiring the court to order a PPO if a secure PPO is available? If so, what conditions should apply? Q31: Do you consider that the cost of providing PPOs could be reduced? If so, how. Q32: Please provide details of any costs and benefits that you anticipate would arise as a result of any of the approaches described above. Q33: Please provide any evidence you may have as to the use or expected use of PPOs in the light of the change in the rate and more generally. We do not believe that the current law relating to PPOs requires clarification as to when a court should award a PPO. We do not support the creation of a presumption that a secure PPO should be awarded by the court if one is available. The choice between a lump sum and a PPO should be entirely down to the preferences of the injured individual; a one size fits all approach is not suitable in personal injury cases, given the wide range of circumstances of claimants and the extensive number of factors that are weighed up by clients and their advisers on a case by case basis. Impact assessment and equalities statement Q34: Do you agree with the impact assessment that accompanies this consultation paper? If not, please give reasons and evidence to support your conclusions. Q35: Do you think we have correctly identified the range and extent of effects of these proposals on those with protected characteristics under the Equality Act 2010? Q36: If not, are you aware of any evidence that we have not considered as part of our equality analysis? Please supply the evidence. What is the effect of this evidence on our proposals? We agree with the Ministry's impact assessment and equalities statement. Contact details Hannah Feiner- Policy Adviser hannah.feiner@lawsociety.org.uk 020 7320 5658 8