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GAD Report to Scottish Government indicates Discount Rate of 0%
The UK Government Actuary’s Department published a report on 5 September 2018 to assist the Scottish Government in setting the Discount Rate. They have considered the likely return on a “low risk” portfolio over a 30 year period and established that the baseline portfolio returned 0.9% above RPI. However, the Scottish Damages Bill specifies that a deduction of 0.5% must be made for tax and management charges and a further deduction of 0.5% must be as a “further margin”. Allowing for those produces a Discount Rate of 0%.
The latest report from the Government Actuary’s Department to the Scottish Government in setting the Discount Rate in Scotland provides some useful clues as to what their report may contain when they are asked to advise the Lord Chancellor in setting the rate in England and Wales.
In the 2018 report they said:
“Based on the 1,000 economic simulations from our third party provider, the expected return on the portfolios considered at December 2017 was in the range of 0.3% - 1.8% pa above RPI (considering the median return). The Baseline portfolio is expected to produce a median return of 0.9% pa above RPI.”
When carrying out a similar exercise in December 2016, GAD established a median return of 1% for the Baseline portfolio and stated that if it is assumed that interest rates remain depressed for longer than is the case, with standard calibration the median return drops from 0.9% to 0.7%.
This compares with a 1.3% return predicted for a 30 year investment in the GAD report of 19 July 2017 which formed part of the MOJ consultation on the Discount Rate.
The construction of the investment portfolios is different:
RPI was projected to be 2.7% over 30 years in the 2017 report. It is projected to be 2.8% over 30 years in the 2018 report.
In order to calculate the discount rate a deduction has to be made for tax and expenses. GAD analysed this in more detail than they did in the July 2017. In that report they suggested a reduction of 0.5% to reflect investment fees, management charges, adviser fees and tax. They now say:
“Based on an initial assessment of possible tax liability for illustrative pursuer profiles and based on publically available data on fund expenses and charges, we believe that the reasonable allowance for expenses and tax might be in the region 0.5-2.0% pa. However, subject to Scottish Government’s policy preferences, we believe that it is likely to be more appropriate to choose an allowance towards the lower end of this range, for instance 0.5-1.0% pa, because:
- it is reasonable to assume that pursuers will shop around for competitive fees;
- it is reasonable to assume that pursuers will directly invest in passive funds (on the grounds that any IFA advice or investment in active funds would be expected to deliver outperformance over passive fund returns);
- in the current economic environment, income yields are low in comparison to historical levels (particularly on bonds which make up a significant proportion of the portfolio) which eases the possible pressure of higher tax charges; and
- there are further prudence deductions included elsewhere in the PI discount.
Although we believe that a deduction towards the lower end of the range is likely to be appropriate, we would stress that a larger adjustment could be plausibly justified.
We would also stress that, although the Bill specifies that the rate is determined with respect to the three separate components (expected return, tax and expenses and the prudence adjustment), what influences pursuer outcomes is the total rate and how this compares to the returns the pursuer achieves.”
GAD suggests (as they did in July 2017) that the deduction should be towards the lower end of the range i.e 0.5% but it could be as much as 1%.
If the Scottish Government adopts the GAD suggestions then the Discount Rate in Scotland would be 0% or 0.5%.
The decision makers
The setting of the discount rate necessarily involves the consideration of many of the factors outlined in the GAD report as discussed above. However, it is worth remembering, as in England & Wales, that the decision ultimately rests with Scottish ministers. This can be seen in paragraph 1.10 of the GAD report, which says:
“Therefore reducing the discount rate (or equivalently increasing the margin for prudence) will ultimately improve the likelihood of the pursuer having sufficient funds to meet their damages. The level at which to set this further deduction (or margin for prudence) is a decision for Scottish ministers.”
This context is important; politics can and does often play a part when discretion on these sorts of matters is clearly in the hands of politicians. Remember pleural plaques?