When assessing future pecuniary loss in personal injury claims, the multiplicand/multiplier approach is often adopted. An important factor in determining multipliers is the net rate of return (discount rate) the claimant might expect to receive from a reasonably prudent investment of the lump sum compensation.

The last revision of the discount rate took place on 25 June 2001, when the then lord chancellor promulgated an order pursuant to section of the Damages Act 1996. He prescribed a discount rate of 2.5% per annum to reflect the change in the average redemption yields on Index-Linked Government Stock (ILGS) at that time.

The discount rate has remained unchanged since. Yet, for the past 10 years, ILGS yields have been sliding down and significantly below that rate. The rate recently dipped below the 0.5% mark and the average yield for the 36 months leading up to November 2010 was only 0.84%. This is demonstrated in the graph below showing the monthly gross redemption yields for ILGS (over 5 years, with inflation of 5%) from November 1998 to November 2010.

The prescribed discount rates, respectively 3% under Wells v Wells (1998) and 2.5% under the Damages (Personal Injury) Order 2001, are also plotted in the graph with pink lines. The new lord chancellor Kenneth Clarke, succumbing to tremendous pressure from overwhelming public opinion (chiefly led by Muiris Lyons, president of the Association of Personal Injury Lawyers), finally agreed to initiate a review of the discount rate in early November.

Gross redemption yields on Index-Linked Government Securities (over five years, with inflation of 5%) and the prescribed discount rates (pink lines) from November 1998 to November 2010. The primary data were kindly provided by the FTSE Group

Quantitative easingThe Bank of England embarked upon a programme of quantitative easing (QE) in March 2009, when the world economy was on the brink of collapse. QE is a mechanism through which money is injected into the cash-starved banking system. By repurchasing government bonds from commercial banks, the Bank of England is expected to help commercial banks build up their reserves.

The goal is for the commercial banks with additional reserves to lend some of the money out to ensure that families and businesses in need of money can obtain loans when they need them.

Over £200bn of assets have been repurchased. As a result, the yield of ILGS halved from 1% (at the beginning of the QE programme) to the current level of around 0.5% only. On the other hand, the US government recently launched a second round of QE.

Facing a great uncertainty of the future movement of ILGS yield rates, is now the right time for the lord chancellor to review the discount rate? The answer is definitely ‘yes’. It is abundantly clear from the current economic landscape that the rate of 2.5% is far too high, which could lead to serious under-compensation of injured claimants. After all, the lord chancellor’s decision should be based on long-term economic trends without being influenced by short-term interruptive events.

A threshold formulaRecently, a threshold formula for setting the discount rate is proposed by the authors of this article (see Journal of Personal Injury Law, Issue 3, 2010). Under this approach, the monthly discount rate is set by the following threshold rules:

  • If the three-year average of ILGS yields drops below the last month’s discount rate for more than the threshold value (the suggested value is 0.253%), this month’s discount rate will be revised downward for an amount of 0.5%;
  • If the three-year average of ILGS yields climbs above the last month’s discount rate for more than the threshold value, this month’s discount rate will be adjusted upward for an amount of 0.5%; and
  • If the three-year average of ILGS yields stays within the threshold bounds, there will be no revision and this month’s discount rate is the same as the last month’s one

The major advantage of the proposed formula is that it is adaptable to future long-term change of market conditions. It can also avoid controversies on the timing and size of the adjustment to the discount rate.

Serious under-compensation for younger victimsUsing the ILGS data from November 1998 to November 2010, the threshold formula sets the discount rate at 1% from May 2008 to November 2010. The degree of under-compensation for pecuniary loss for life, due to the suppression of the discount rate, is illustrated in the following table.

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Sex Age Multiplier (at 2.5%) Multiplier (at 1%) Degree of under-compensation
Male 10 33.72 52.69 56%
Male 20 31.63 47.14 49%
Male 30 29.05 41.19 42%
Male 40 25.79 34.7 35%
Male 50 21.86 27.86 27%
Female 10 34.14 54.5 58%
Female 20 32.54 49.22 51%
Female 30 30.15 43.4 44%
Female 40 27.09 37.01 37%
Female 50 23.37 30.24 29%

For a younger claimant such as a 17-year old boy who suffered serious head injuries in Love v Dewsbury ([2010] All ER (D) 217 (Nov)), the degree of under-compensation could be as high as 50%. For the sake of justice and public interest, judges and lawyers resolving personal injury disputes must bear in mind the lord chancellor’s current review of the discount rate, the result of which should be available promptly without delay due to its great public importance.

Without doubt, how a legal system responds to the needs of vulnerable victims of personal injury or clinical negligence is certainly one of the key parameters for judging its level of morality and civilisation.

Felix Chan is the associate dean of law at the University of Hong Kong; Wai-Sum Chan is professor of finance at the Chinese University of Hong Kong; Johnny Li is fairfax chair of risk management at the University of Waterloo