- What is the discount rate?
- When does the discount rate apply?
- How is a payment calculated?
- When was the discount rate introduced?
- How has the rate changed over the years?
- What effect does the discount rate have on insurance premiums?
The Discount Rate is a figure used to help calculate lump sum compensation payments for high value personal injury claims and is set by the Government.
The principle behind a personal injury settlement is that it should leave the recipient in the same financial position as if the injury had never happened. It should also compensate for any changes to their lifestyle caused by their injuries, known as “loss of amenity.” Each case is different but factors that may be considered are ongoing medical and care costs, access needs and loss of employment income.
It is assumed that any lump sum payment will be invested, with the returns on the investment providing an income to the claimant. When investment returns are good, more money will be generated. But when investment returns fall, the money doesn’t go as far. Inflation will also play a role in the ongoing value of any settlement. The discount rate is designed to account for these factors.
The higher the discount rate, the smaller the lump sum will be. Conversely, the lower the discount rate, the larger the initial lump sum will be.
The rate is applied to lump sum payments which include compensation for a claimant’s future losses following a serious injury. Often these settlements are covered by motor, pubic liability or employer’s liability insurance policies.
Alternatively, an insurer may come to an agreement with the victim to arrange a structured settlement annuity. Instead of making a lump sum payment structured settlements make regular, tax-free, payments over a defined period of time. Again an annuity would be set up to reflect the discount rate and changes in inflation for the lifetime of the agreement.
The calculation can appear complicated, but in essence it will reflect the losses the claimant will suffer and for how long, plus additional expenses such as ongoing medical care.
Various factors are taken into account, such as life expectancy, how much the victim was earning and how long they had left before retirement.
Actuarial tables (the Ogden Tables) are then used to determine the lump sum figure.
The discount rate was introduced under the Damages Act 1996. The Lord Chancellor fixes the discount rate which was first implemented in 1999.
Originally the discount rate was to be set between a range of 0% and 5%, but this was later changed to a range of between -2% and 3%.
From its introduction until 2017 the discount rate was set at 2.5%.
However, in 2017 the Lord Chancellor adjusted the discount rate to -0.75%, which was subsequently amended to -0.25% in July 2019.
As the discount rate affects the level of claims settlements Insurers will potentially have to make, any changes will inevitably affect insurance premiums. The lower the discount rate the higher settlements will be leading to increased premiums.
The exact change will vary from insurer to insurer, but when the change to the rate was announced in 2017, Huw Evans, Director-General of the Association of British Insurers, said it would be inevitable that “there will be an increase in motor and liability premiums for millions of drivers and businesses across the UK”.
It’s impossible to say exactly what the impact on premiums is, as there are always other factors in play, such as changes to insurance premium tax, cost of repairs, availability of parts and labour. The 2017 change to the discount rate had a big impact on premiums as insurers were forced to hold far higher reserves to reflect the potential settlement in the event of a victim making a successful claim.