In February this year, the Lord Chancellor Elizabeth Truss decided to lower the Discount Rate from 2.5% to -0.75% which could have “profound financial consequences”. This revised rate came into effect in March and applies retrospectively to all current claims, as well as new incidents.

When victims of life-changing injuries accept lump sum compensation payments, the actual amount they receive is adjusted according to the interest they can expect to earn by investing it.

In assessing the compensation amount, courts apply a calculation called the Discount Rate – the net rate of return the claimant might expect to receive from a prudent investment of lump sum compensation. The current rate of 2.5% was set in 2001 and reflects the gross redemption yields of the lowest risk investments, Index-Linked Government Gilts.

The law makes clear that claimants must be treated as risk-averse investors, reflecting the fact they are financially dependent on this lump sum, often for long periods or the duration of their life. Compensation awards using the Discount Rate should put the claimant in the same financial position had they not been injured, including loss of future earnings and care costs.

The decision, as well as seeing compensation payments rise, is also likely to have a significant impact on the insurance industry in respect of the potential additional costs relating to personal injury claims relating to Motor & Casualty (Liability) risks, as well as existing reserves on open claims which will need to be increased to reflect these changes.

For example, a 30-year old female is disabled in an accident and cannot work again. It is determined she would have earned £20,000 a year until retirement at 65. Rest of life care is determined to be £100,000 a year. Under the 2.5% Discount Rate, the total sum award (consisting of Loss of Earnings and Cost of Care) would result in a lump sum award of £3,414,350. With the new Discount Rate of -0.75%, it is estimated that this would increase to £8,480,400.

This will have the greatest insurance impact to policyholders with higher potential for large injury claims as these costs will be disproportionately affected by increases in large awards resulting from the Discount Rate reduction. The new Discount Rate can only compound the upward trend in large claims. This will no doubt be reflected in insurance premiums. Furthermore, with the inevitable increase in claims cost the reduced Discount Rate will produce, businesses need to review the adequacy of the limits of cover under both their Employers and Public/Products liability policies.

It is important businesses have in place an effective Risk and Claims Management programme which can identify necessary risk control measures and the implementation of any actions to reduce the likelihood of large losses and mitigate the financial impacts of these changes.

Risk Management forms an important part of Tysers’ services to clients. We help businesses and their senior managers develop effective risk management strategies that identify, manage and reduce exposures, stay compliant with current and increasing legislation and to protect their long term survival.