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The Discount Rate Conundrum

John Frenkel, Senior Partner, Frenkels Forensics, offers his significant experience in personal injury damages calculations to provide some must-read advice for litigators in advance of the Lord Chancellor’s decision on the Discount Rate at the end of January 2017.

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Introduction

I find myself in a rather unique privileged position. Having worked as a Forensic Accountant in the Personal Injury arena for almost 40 years I have seen significant changes as to how the Courts assess compensation.

The current dilemma for which we are all awaiting the formal response of the Lord Chancellor by the end of this month is what, if anything, she will do about the discount rate. It has been set at 2.5% since 2001 when the financial and investment world was a very different place to now. So too has the assessment of damages of changed beyond recognition.

In 1985 my firm was involved in the relatively unquoted case of Francis v Bostock. Russell J as he then was, when asked to rule as to whether or not a claimant was allowed to recover the costs of investment advice, held that:

“The defendant, in my judgment, should not be called upon to find further monies to assist the plaintiff in the proper administration of an award which, in itself, affords adequate compensation. Furthermore in my view the employment of financial advisers and the like is a consequence of my award and not a consequence of negligence of the defendant. The claim fails on the ground of remoteness.”

That of course was back in the day before the Ogden Tables, Structured Settlements, Periodical Payments, using personal injury trusts to protect means-tested benefits and any real concerns of the Courts or the litigation professionals as to what claimants actually did with their compensation money.

I am delighted to be able to say that what claimants do with their money is now very much on the agenda. Of course claimants with capacity are given the unfettered choice as to what they want to do with the money but usually not before they have at least been offered the opportunity to listen to experienced financial advice. I have always likened this to Camelot giving large lottery wins to the lucky ticket holders – which I understand Camelot will not do until the winners have been introduced to experienced professional financial advisers.

The Dilemma

The truth is there is no dilemma. There are only inconsistencies – between the rulings of the Courts and the real world.

In 1999 the House of Lords looked very carefully at the return on Index Linked Government Stocks (ILGS) over different periods of time, and ruled in Wells and Wells that, based on ILGS being the investment vehicle to be made by claimants, the discount rate should be 3%. Following changes in market conditions in 2001 the Lord Chancellor set what is still the current discount ie 2.5%.

It is one of the worst kept secrets that no claimants ever invested all of their damages (I suspect in fact the same could be said for any of their damages) in ILGS. In fact any IFA suggesting that would probably have been considered negligent for advising a client to do this.

So we continued to live in 2 worlds. The ‘notional’ world of the assessment of damages and the ‘real’ world of the investment of damages.

When the crash came interest rates plummeted. Returns on ILGS have since hit all-time lows. The Courts could not change the rate of 2.5%, as the Damages Act of 1996 gave that power to the Lord Chancellor.

Eventually, nearly four years after the collapse of Lehman Brothers, the MOJ issued a Consultation Paper trying to reconcile the ‘notional’ and ‘real’ worlds. Another nearly four and a half years on and nothing has changed.

It is well documented that the Government and insurance industry do not want damages to continue to escalate as a reduction in the discount rate would result in a significant increase in damages. However, it is equally clear that claimants want their damages to be assessed using the formula applied in Wells, i.e. based on ILGS.

A Possible Solution

The Lord Chancellor is shortly to provide a much-awaited decision on this. I offer a few words based on my 40 years’ experience.

Claimants are special investors and need to approach their investment strategy cautiously. That does not mean notionally investing in instruments (ILGS) that are very expensive, complicated and simply not fit for purpose. It means having a carefully constructed portfolio which gives the opportunity for long-term growth in the stock market as well as investing in income producing assets. The balancing of that portfolio will take into account the fact that, particularly in the cases with large future care needs, there should be a Periodical Payment Order.

There are many IFAs who have now made it their profession to understand the particular needs of personal injury claimants and they should be able to achieve returns well above that of ILGS. However, they need paying a fair rate for managing the portfolio and these costs should be recovered as part of the damages, and the long-standing ruling of Francis v Bostock (and the subsequent like cases) should be set aside.

Awarding claimants these costs while leaving the discount rate at 2.5% will increase damages, but nothing like the extent to which reducing the discount rate to a figure based on ILGS would produce. It would also bridge the gap between the ‘notional’ and the ‘real’ worlds – and that would assist all parties in the personal injury litigation arena.


To contact John Frenkel on this or any other forensic expert matter for both claimant and defendant cases, please email john.frenkel@frenkels.com

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