Posted on: 16 May 2017
The UK discount rate must better reflect investment strategies, be subject to regular review and set by a politically accountable minister, the International Underwriting Association has declared.
Responding to a Ministry of Justice consultation on how courts determine lump sum compensation payments for personal injury claims, the association stated that reform of the current methodology is essential. It pledged support for the ‘100% compensation principle’ which states that claimants should neither be overcompensated nor undercompensated.
When the process for calculating the discount rate was last set, establishing a link with Index Linked Government Securities was reasonable and logical, the IUA argued. But poor returns have made such investments unviable and a low risk, diverse portfolio is now more realistic.
Dave Matcham, IUA chief executive, said: “It is clear that the methodology used and assumptions made to set the discount rate are flawed. The current rate of minus 0.75% will inevitably lead to overcompensation, which is compounded by the long-term nature of many settlements. A negative real return is assumed not just for year one, but for every year for decades to come.
“It is encouraging that the Ministry of Justice has issued this consultation so quickly, responding to the feedback of IUA companies and other industry representatives. Our members are keen to see a new system that ensures a professional and competitive marketplace capable of meeting the needs of all policyholders.”
In its consultation submission the IUA supported the principle of setting a discount rate on the assumption that claimants would be well-informed but prudent investors, opting for a balanced portfolio of low risk investments. Future rates of return should be considered in the process since historical rates and short term investment performance are not necessarily representative of income over several decades.
The law should also be changed so that the rate is reviewed at set intervals rather than at the discretion of the government. A regular review process, whether every one or three years, would reduce market volatility. This evaluation should be held in the second quarter of the year to avoid peak insurance renewal seasons and reporting periods.
The IUA stated that maintaining a single discount rate would be a simple and straightforward solution, but the benefits of a dual rate model could be explored through further consultation.
Mr Matcham added: “Stability in the discount rate is vital, both for the purposes of reserving against the liabilities of claims incurred and for pricing future business. Regular reviews of the rate should have a smoothing effect, reducing the likelihood of any dramatic adjustments and helping to avoid bottlenecks in the court system.
“We believe that the rate should continue to be set by the Lord Chancellor as it is important that, ultimately, a politically accountable minister is responsible for balancing the needs of claimants, defendants and society as a whole.”