08 September 2023

As the deadline to respond to the Scottish Government’s invitation for views on the discount rate passed on 11th July 2023, we look back at the recent history of the discount rate in Scotland and consider what lies ahead.

History of the discount rate

The discount rate is a tool used to help calculate lump sum compensation payments for high value personal injury claims. It is an adjustment of an award of damages to reflect the fact that the injured person is able to invest the money before the loss or expense for which it awarded has actually occurred, generating a return. The discount rate aims to prevent a situation where an injured person is either over or under compensated.

In 2001 the discount rate in both Scotland and England & Wales was set at 2.5% where it remained for almost two decades. The methodology behind that rate was based on an assumption that investments would be made through index linked gilts. There were, however, concerns that investments such as index linked gilts were so low that the rate failed to give a reasonable rate of return. In 2017, the Lord Chancellor then adjusted the discount rate in both Scotland and England & Wales to -0.75%. This led the way for change, with sector wide consultations on the discount rate taking place in both England & Wales and Scotland in 2019.

The consultations both north and south of the border were held throughout 2018/2019, leading the Lord Chancellor to adjust the discount rate in England & Wales to -0.25% with effect from August 2019. After previously having an aligned approach, it came as something of a surprise when the Scottish Government Actuary announced in September 2019 that Scotland would depart from the approach of the Lord Chancellor, with the discount rate remaining at -0.75% in Scotland from October 2019.

The discount rates set in 2019 have remained unchanged. However, both the Scottish Government and the Ministry of Justice are currently undergoing separate, but similar, reviews on their respective approaches to the discount rate, ahead of their 5-year statutory reviews.

The Scottish Government’s request for views

The Scottish Government’s review, link here, is a joint approach with Northern Ireland Department for Justice. They invited views firstly, on the current factors that are used to set the discount rate and secondly, on whether a single or multiple rates should apply.

The range of factors to be taken into account when calculating the discount rate in Scotland includes:

• the makeup of the notional portfolio
• the assumed period of investment (currently 30 years)
• the impact of inflation (currently allowed for by reference to the Retail Prices Index); and
• the standard adjustments that must be made by the rate-assessor to a rate of return (currently set at 0.75% which represents the impact of taxation and the costs of investment advice and management; and 0.5% which is the further margin involved in relation to the rate of return)

Scottish Ministers may, by regulations, adjust these factors and so the Government invited views on the above. Views were also invited on whether a single or multiple rates should apply and what the preferred model should be.

Ministry of Justice – Call for Evidence

Whilst the Scottish Government/Northern Ireland Department for Justice’s review simply asks for views on whether single or multiple rates should apply and views on the specific model, the MoJ’s “Call for Evidence” link here goes further and produced a paper inviting views on a range of questions which are helpful when considering the prospect of a dual/multiple rate. 

The paper reviews the approach to the discount rate of different jurisdictions including Hong Kong, Jersey, Republic of Ireland and the Canadian province of Ontario. The paper also considers three possible models for calculating duration-based discount rates, as follows:-

• A ‘stepped’ approach whereby the rate to be used depends on the total period of damages. In this system, if the total period was under the designated short-term period all the damages would be discounted at that short-term rate. If the period stretched beyond the short-term period, then the long-term rate would apply.
• A ‘switched’ approach where the award prior to the identified switching point could be discounted at the short-term rate. If, however, it stretched beyond this switching point it would be discounted using the long-term rate.
• A ‘blended’ approach where all periods before the switching point could be discounted at the short-term rate and any cashflows beyond this discounted further at the long-term rate, for each year after the switching point.

As an alternative to the dual/multiple rate, another option discussed is adopting a multiple rate system. This would work by awarding damages by multiple rates, which has the effect of awarding different rates for different classes of claim. It also enables the courts to take different rates of return into account.

What lies ahead?

The response deadlines to both reviews have now passed. Neither the MoJ’s “Call for Evidence” nor the Scottish/Northern Irish request for information, amounts to the formal rate reviews required under the respective Acts, all of which are scheduled for statutory review in 2024. The responses will, however, be considered as part of the review process.

Moving to a dual or multiple rate (or a combination) would mark a significant shift from the current, longstanding application of a single rate. It will, therefore, be important for insurers and compensators to consider what impact different rates and approaches to setting the discount rate may have on current and future claims reserves. A dual/multiple rate, it is suggested, will be fairer across the board and arguably reduces the potential for over-compensation. However, it also has potential to increase complexity with the knock-on effect of rising costs and delays at all stages of the process. The arguments in favour holding to a single rate are that a single rate brings with it simplicity, transparency and certainty.

It remains to be seen what the next steps will be, but BTO will continue to keep a close eye on developments and issue a further briefing note as matters unfold.

For more information or to discuss any point arising from the above please contact Jennifer Mackenzie, Associate on 0141 221 8012 or by email jmk@bto.co.uk.