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The Discount Rate - Time to Draw the Line?

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Keoghs Insight

We keep you up-to-date on emerging market issues and their impact on the insurance sector, through a variety of publications, events and our leading market initiatives.

Author

Matthew Perkins

Matthew Perkins

Partner

T: 0238 190 7017

The Discount Rate - Time to Draw the Line?

Blogs||25/10/2017

The dust has now settled on the MOJ’s response to the Discount Rate consultation and all stakeholders have had time to reflect.  Following this period of deliberation, there is significant concern that the underpinning rationale for the MOJ’s calculations is fundamentally flawed. If left unchallenged this could lead to an unrepresentatively high discount rate being set.

The GAD Report

As part of their response the MOJ asked the Government Actuary’s Department (GAD) to analyse investment return outcomes for claimants under different discount rates based on information gathered during the consultation, in order to reflect the way claimants actually invest and are advised to invest their damages awards.  The GAD report was published with the MOJ’s response.

The ‘True’ Measure of Inflation

On the day that the response was issued, 7 September 2017, the Government made a statement to the London Stock Exchange stating that on the basis of the evidence currently available, had a single rate been set on that day this ‘might’ have been within the range of 0% to 1%.  The Government’s rationale for making such a prediction can be clearly seen within the GAD report, but a closer analysis of the report raises serious question marks.

The Discount Rate is of course intended to reflect the return a claimant can achieve when investing damages after accounting for inflation, tax, investment fees, management charges and adviser fees.  The key component is the measure of inflation and the GAD report assumes the Retail Price Index (RPI) should be used as the correct measure, but this presents a significant problem as RPI is now universally recognised as an unreliable index.  

In fact, an overwhelming majority of economists now argue that the Consumer Price Index (CPI) is a far more reliable measure of inflation, and indeed this has formed the basis for the Government’s own inflation targets since 2010.  The flaws in the calculation of the RPI led the Office of National Statistics to officially cancel its designation as a ‘National Statistic’ from 2013 onwards. Access the Retail Prices Index here.

Historical data shows that RPI consistently measures inflation at a significantly higher level than the CPI, and last month the disparity was measured at 0.9%, with the historic gap of around 1% illustrated by the comparison below.

In simple terms, the argument follows that if the Lord Chancellor decides to adopt the CPI rather than the now discredited RPI, the Discount Rate based on the GAD report ‘might’, to borrow the Government’s own wording, in fact have been set at between 1% and 2%, rather than the 0% to 1% stated, which would of course have a major impact on the calculation of future damages.

What Happens Next?

In our responses to the draft legislation issued by the Government and the Justice Select Committee’s ancillary questions, Keoghs firmly advocates for the CPI to be adopted as the correct measure of inflation . In the meantime, insurers and their advisers will now turn their focus to this key issue and no doubt careful re-appraisals of tactics set in the immediate aftermath of the MOJ’s response will be taking place, with claimant solicitors reconsidering their position in light of the possibility that the Discount Rate could in fact be restored to a level closer to its former rate. Indeed with higher than expected growth figures announced today (click here to read the bulletin),  the Government’s September prediction of a 0% - 1% Discount Rate could well fall short in the final analysis no matter which inflationary measure is ultimately adopted.

The Government will also come under increasing pressure to expedite the process of considering and reacting to the industry responses and fast track the relevant legislation in order to minimise the acknowledged adverse impact of the current rate on tax payers and consumers and to remove the uncertainty which the Government’s refusal to commit to a timetable has caused.