Consultation on the inflation index for the calculation of the personal injury discount rate and the methodology for calculating the judicial rate of interest

Chapter One – Introduction and Background

Personal Injury Discount Rate

Background

1.1 An award of damages is designed to compensate a wrongly injured person for the loss and harm caused by the injury – no more and no less. Where damages for personal injury are awarded for future pecuniary loss in the form of a lump sum, that award is adjusted 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. That investment will generate a return and the factor by which the award is adjusted is determined by the personal injury discount rate (‘discount rate’) which represents the rate of return which can be expected from an appropriate investment. The discount rate is only relevant in cases where there are losses which will require to be met – such as future salary losses and/or future care costs.

1.2 Part One of the Damages (Investment Returns and Periodical Payments) (Scotland) Act 2019 (“the 2019 Act”), reformed the law on the setting of the discount rate by making provision for a method and process which is clear, certain, fair, regular, transparent and credible. It put in place a new statutory regime for calculating the discount rate which should be applied to future pecuniary losses for personal injury cases; established a timeframe for the review of the discount rate; and provided that the task of reviewing and assessing the rate will fall to the Government Actuary.

1.3 The 2019 Act amended the Damages Act 1996 to provide a detailed methodology for determining the discount rate for Scotland, as set out in schedule B1. This is based on returns from a hypothetical investor investing in a notional investment portfolio over 43 years^[1]. Deductions are then made to the rate of return to take into account: inflation (in order to provide a rate of return net of damages inflation); taxation; the cost of investment advice; and to reduce the risk of under-compensation.

1.4 The discount rate is set separately for Scotland, England and Wales, and Northern Ireland, although Northern Ireland’s legislative framework is very closely aligned with the Scottish legislation. In England and Wales it is for the Lord Chancellor to set the rate having regard to a range of statutory factors and a requirement to consult an expert panel chaired by the Government Actuary. The methodology used however is at the discretion of the Lord Chancellor.

Policy relating to the methodology

1.5 Placing the duty to review the discount rate on the Government Actuary was, and remains, consistent with, and integral to, the overall policy aim of reforming the law so as to make provision for a method and process for setting the discount rate which is clear, certain, fair, regular, transparent and credible.

1.6 The policy approach has been to regard the determining of the rate as an actuarial exercise in which there should be no need to exercise political judgement. The proposal was, therefore, to shift the mechanics of determining the rate to a suitably qualified and credible professional. The Government Actuary was selected because of the particular expertise and standing required by the holder of that office. The legislation provides, in an accountable way, the framework in which the rate must be set and thereafter the mechanics of determining the rate sits with an appropriate professional. The Scottish Government remains of the view that this strikes the appropriate balance.

Inflation Index

1.7 Currently, there is provision for an adjustment to the rate of return to take account of inflation by reference to the Retail Prices Index (RPI) or to an alternative source of information as prescribed by Scottish Ministers in regulations subject to the affirmative procedure^[2]. There is no provision to use a modified rate, whether that be an adjusted index or an average (or other percentage combination) of two or more indices.

1.8 At the time of the 2019 Act being considered by the Scottish Parliament there was an awareness that whilst the RPI had been one of the most common measures of inflation, it was no longer used by the Office of National Statistics as a National Statistic.^[3] Further, in 2020, the UK Statistics Authority consulted on proposed changes to the RPI which would align it with the Consumer Prices Index (including housing costs) (CPIH) and these changes will come into effect in 2030.

1.9 In schedule B1 of the Damages Act 1996 (which was inserted by the 2019 Act) the reference to the inflation index which must be used in the calculation of the PIDR was therefore deliberately broadly cast to allow flexibility around what might be used in place of RPI at some point in the future.

Reviews of the discount rate in 2019 and 2024

1.10 Prior to the 2019 Act, the discount rate was last set by Scottish Ministers in 2017^[4]. Schedule B1 of the Damages Act 1996 (inserted by the 2019 Act) set out that the first discount rate review under that schedule was to be started on 01 July 2019 and concluded by 28 September 2019^[5]. That schedule also set out that, thereafter, a review is to be carried out every five years^[6]. Each review is to determine whether the rate should remain as it is or be changed. A cyclical review of the rate had therefore to be started on 01 July 2024 and concluded by 28 September 2024^[7].

1.11 To inform the 2024 review, in May 2023 the Scottish Government carried out a joint targeted consultation with the Department of Justice for Northern Ireland, to seek views on whether the range of factors to be taken into account when calculating the discount rate in Scotland (set out below) required to be adjusted. Views and evidence on whether or not a single or multiple rate should apply, were also sought.

1.12 The factors, capable of adjustment, which must be taken into account when determining the discount rate are: -

• the makeup of the notional portfolio (as laid out in paragraph 12 of schedule B1 of the Damages Act 1996);
• the assumed period of investment (30 years at the time of consultation);
• the impact of inflation (allowed for by reference to the RPI at the time of the consultation); and,
• the standard adjustments that must be made by the rate-assessor to a rate of return (at the time of consultation this was 0.75% which represented the impact of taxation and the costs of investment advice and management; and 0.5% which was the further margin involved in relation to the rate of return).

1.13 The consultation responses were forwarded on to the Government Actuary’s Department (GAD) so that they could consider them as part of the work they were commissioned to do in respect of offering advice on whether or not any of the parameters listed above at paragraph 1.12 required modification.

1.14 Based on GAD’s advice it was decided that:

• the index/allowance for the impact of inflation should change from RPI to Average Weekly Earnings (AWE);
• the standard adjustment for tax and costs should change from 0.75% to 1.25%; and,
• the period of investment should change from 30 to 43 years.

1.15 The necessary regulations were made to give effect to these changes ahead of the 2024 review taking place. At the time of the regulations being considered by the Scottish Parliament, the Scottish Government recognised that the work on updating the parameters ahead of the 2024 discount rate review had served to highlight issues not just around the chosen inflation index but the inability to provide for an adjusted inflation index and that ahead of any future reviews the matter should be consulted on. Chapter 2 sets out some further detail on the issues and seeks views on options for change.

1.16 In the most recent review of the discount rate, GAD determined that the rate should be +0.50%. The table below provides a breakdown of the rate and sets out the different component parts that make up the discount rate.

Judicial Rate of Interest

Background

1.17 The Judicial Rate of Interest, very generally speaking, is the default rate of interest which applies when interest is included or payable under a decree of the Court. It would not apply if parties have agreed their own rate of interest or where there is statutory provision on the applicable rate of interest.

1.18 The rate of interest is set by Rules of the Court in the Court of Session and by Act of Sederunt in the Sheriff Courts and is currently 8% in both courts. This is the same rate that applies in England and Wales and was last changed across all jurisdictions in 1993.

1.19 The Scottish Law Commission (SLC) published a Report entitled Interest on Debt and Damages in September 2006, following a reference by the then Minister for Justice, in November 2003. That Report was wide ranging and recommended the introduction of a statutory entitlement to interest in respect of all debt and included recommendations relating to the Judicial Rate of Interest. The Scottish Government consulted on the Report in January 2008 but did not comment specifically on the recommendations relating to the Judicial Rate of Interest.

1.20 It had been the intention that the Scottish Government would consult jointly with the UK Government on the judicial rate but for various reasons no such consultation took place.

1.21 Subsequently the Accountant in Bankruptcy issued a consultation as part of a review of the Bankruptcy and Debt Advice (Scotland) Act 2014. The consultation covered the statutory interest rate applicable to debts and it was agreed that a question should be included in that consultation about the Judicial Rate of Interest. It was however highlighted that as this particular interest rate is applied beyond bankruptcy, a wider consultation on this topic should be considered.

1.22 In December 2022 the Lord President, in his capacity as Chair of the Scottish Civil Justice Council, wrote to the Scottish Ministers about the mechanism for setting the Judicial Rate of Interest. The then Minister for Community Safety responded in January 2023 and noted—

“the limitations that the Court of Session is under in making changes to the rate beyond the application of a new flat rate. Any move to a tracker rate, which was the option that received support when the Accountant in Bankruptcy consulted on the matter at the end of 2019, would require some further consideration and work and of course a suitable legislative opportunity.”

1.23 At that time there were competing priorities. The Scottish Government is now taking the opportunity to again seek views on the Judicial Rate of Interest and more detailed information is set out in Chapter 3.