Responses to the UK government's consultation on the Ogden damages discount rate have fallen along predictable, conflicting lines that will put the onus back on the government to make a tricky decision.
Lord Chancellor Liz Truss launched the consultation on how the rate should be set in February, alongside her announcement that the discount rate would fall from 2.5% to -0.75%.
The unexpectedly steep cut in the discount rate caused outcry among re/insurers and many in the motor and liability markets had to bolster their reserves and take hits to their first-quarter profits.
The February consultation, which closed for comments yesterday (11 May), asked similar questions to a 2012 consultation. The report from the earlier consultation concluded that: "Widely diverging views were expressed by different interest groups, and overall the responses demonstrated very little consensus on the methodology which should be used in setting the rate."
This year's consultation shows every sign of reflecting that statement.
Basis for discount rate
The core question in the consultation is the basis for calculating the discount rate, currently set by referencing the average returns on index-linked government securities (ILGS).
David Powell, non-marine manager at the Lloyd's Market Association (LMA), said the discount rate should be based on the average yield of a model low-risk portfolio, "better reflecting what claimants actually do with their money" and reducing the risk of over-compensation.
The Association of British Insurers (ABI) also urged a move away from ILGS as the basis for compensation, but favoured introducing a 'stepped' dual rate – two rates for a single case to reflect different investment periods.
"This would take into account lower returns likely for claimants with short-term needs, while reflecting the higher returns that can be expected for claimants investing over a longer time horizon. A similar system is in place in Ontario, Canada, where for the first 15 years a short-term variable rate applies, updated annually to reflect returns on yields, with a fixed rate of 2.5% applying for any period over 15 years."
The ABI said an expert panel should be set up to help the government set an appropriate rate.
The Association of Personal Injury Lawyers (Apil) said the current basis should be maintained, as it does not require claimants to invest their compensation in riskier assets. "This is exactly how it should be when that money is supposed to look after them for the rest of their lives," said Apil president Neil Sugarman.
If the government does choose a riskier basis for setting the rate, then the additional costs of investment management must be met by the insurer or wrongdoer, Apil said.
The Institute and Faculty of Actuaries (IFoA) said that the ILGS basis is the most appropriate, but that it is not good at reflecting changes in inflation rates. The IFoA suggested that the government "could alter the discount rate to reflect an appropriate inflation-linked measure. Such a measure could reflect the inflation mis-match, the potential of reinvestment risk or even incorporate an adjustment to reflect how an insurance company would price a PPO [periodical payment order]."
The current law does not specify a review period for the discount rate. Apil urged that a periodic review be introduced, without expressing a preference for the frequency, and reiterated that the timing of the review should not be in the hands of politicians nor be determined by movements in investment markets.
The LMA agreed that the discount rate should be reviewed periodically, but otherwise disagreed, arguing that the review should take place when there were material changes in the yield of the model portfolio.
The LMA also advocated measures to smooth the effect of short-term economic volatility, such as limiting rate changes to one per year, and a maximum shift of 100 basis points.
The ABI said if the single rate was retained, then the review should happen at intervals determined by the movement of relevant investment returns or identified indices, rather than specific dates.
Actuaries at the IFoA suggested that once the current rate differs by more than 0.25% from the market, the rate should be changed, adding: "The fair and correct approach is to use is a current, forward-looking market rate rather than having regard to a historical average."
The IFoA and Apil dismissed the idea of having transitional measures, as they will be difficult to apply.
Periodical payment orders (PPOs) are another way of compensating injured parties, giving them regular payments instead of a lump sum, and therefore passing the investment and longevity risk to the insurer or wrongdoer.
The consultation asked several questions about the appropriateness of PPOs, how they are awarded, how likely claimants are to accept them, and how the cost of providing them could be reduced.
The ABI argued that claimants who do not wish to take on investment risk could opt for a PPO, but personal injury lawyers represented by Apil said that claimants should have recourse to both, possibly in combination, and "refusal to take a PPO is not an indicator of an increased appetite for risk". There are also instance where PPOs are not, and could not, be made available, it added.
Apil also urged the government to encourage non-legislative means of encouraging claimants to opt for a PPO. These include a proposal for a "government-backed PPO product to offer a financial product to certain classes of claimant so that they can purchase a suitable property without the need for a large lump sum award, allowing the PPO to include repayments for a mortgaged purchase instead."
The IFoA set out three ideas for reducing the cost of PPOs: making PPOs easier for insurers to match by changing how they are indexed; pooling PPOs into a government or industry scheme, similar to Flood Re or the terrorism reinsurer Pool Re; changing the way in which insurer capital requirments are calculated.
What happens next
The government pledged a quick resolution to the discount rate question, but the 8 June general election is delaying debate and the passage of legislation - and the mixed responses will do little to encourage a swift resolution.
"The consultation and the responses so far highlight that there is no perfect answer," said Charl Cronje, a partner at consultancy LCP. "It's essentially a policy decision whereby our society expresses what degree of compensation is appropriate for injured parties. Unless government better articulates that policy, no independent expert panel is going to be able to come up with a rate that people can broadly agree on.
"From an insurer's point of view, the important thing is avoiding further unexpected shocks to the Ogden rate. It's arguably unfair to expect insurers to pick up the tab when government didn't give sufficient notice of the change to enable them to charge a fair premium for the additional risk."