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 Two – Personal Injury Discount Rate Inflation Index

Retail Prices Index

2.1 In 2023, when GAD were asked whether the RPI remains the most suitable reference for allowing for the impact of inflation, they were clear in their advice that it indeed no longer remains a suitable inflation index measure. This is because, as mentioned in Chapter 1, the methodology used to calculate RPI is to be changed to align with the CPIH in 2030. As the process was looking at a 30/43-year investment period GAD projections would need to reflect the change due in 2030 and as CPIH is projected to be lower than RPI, pursuers would receive less compensation as a result. That RPI no longer remains a suitable inflation index measure was also clear from the consultation responses.

2.2 As the Damages Act 1996 (as amended by the 2019 Act) provides that a single unadjusted published index must be used to represent inflation when reviewing the discount rate, the Scottish Government opted for what it considered to be the most suitable published measure available - Average Weekly Earnings (AWE) which is an earnings measure. Compared to a prices-based measure, an earnings measure better reflects inflation in relation to loss of earnings and care costs (including nursing) – both of which are likely to be associated with awards of future pecuniary loss to which the discount rate is relevant. An unadjusted prices index - such as the consumer prices index (CPI) - is likely to undercompensate. AWE was preferred over other earnings measures because it is considered to be more appropriate for projecting future rates of change and provides a continuous measure. The requirement to use an unadjusted index contrasts with the position in England and Wales where the choice of inflation index is discretionary and is capable of being adjusted. In 2019, the UK Government’s index for damages inflation was CPI +1% which was then broadly similar to RPI.

Choice of Inflation Measure – price or earnings

2.3 There are two decisions to be made on the inflation measure to be referenced in legislation. Firstly, whether to use a price or earnings index. Secondly, once that decision is made, what the relevant index should be. The average rate of inflation faced by injured persons is likely to fall between prices and earnings. It is anticipated that an earnings-based index would potentially overestimate the average damages inflation experienced in practice and a prices-based index would potentially underestimate the average damages inflation experienced in practice.

2.4 We consider that price inflation is a more robust measure than earnings inflation as the latter is based either on survey data or a sample of UK businesses. From an investment return modelling perspective, a price index (for example, CPI or CPIH) is preferable. Additionally, a practical point to consider is how to estimate future rates of inflation. For instance, there are no readily available investments that reference an earnings index and therefore there is no observable market view of future earnings inflation. On balance, our view is that a price index is therefore preferable to an earnings index.

Choice of price index – CPI or CPIH

2.5 We would welcome views on which price index would be most appropriate. We note that CPI and CPIH have tended to be very close historically.

2.6 With RPI changing to CPIH from 2030, it is worth considering whether CPIH is a better reference index than CPI, i.e., because it will be easier to get a market-based view of future CPIH than for CPI by looking at index-linked gilt prices. CPIH is also the headline inflation rate used by the Office of National Statistics.

2.7 A reason in favour of referencing CPI rather than CPIH is that CPI has a longer history than CPIH and is used for the Bank of England’s inflation target. Therefore, it is more commonly referenced in contracts with an inflation measure (outside of index-linked gilts). It is for this reason that there is an argument that heads of losses linked to price inflation could be more likely to increase in line with CPI rather than CPIH.

Question One: Do you have a preference for CPI or CPIH or another index as the appropriate inflation index to be referenced in the legislation? Please give your reasons.

An adjusted index

2.8 Rather than continue to have to choose the best published index available, recognising that none will be a perfect solution and they are likely to be either higher or lower than damages inflation, it is considered that views should be sought on making provision for a more flexible framework. The framework would enable an adjusted inflation index to be used if, at the time of any review, it is advised that it would be more appropriate to do so.

2.9 The policy imperative remains, as outlined in paragraph 1.6, that the process for setting the PIDR should be apolitical and very much an actuarial calculation. For that reason, it is not proposed to move to a model which does not meet the criteria of being clear, certain, fair, regular, transparent and credible. It will still be for the legislation to provide the inflation measure to be used as part of the framework in which the rate should be set and thereafter the mechanics of determining the rate will sit with the rate-assessor (the Government Actuary). It would therefore not be the intention to leave the rate-assessor to use their (albeit professional) discretion to determine the rate allowed for inflation as this would run counter to the intention of the 2019 Act as passed by the Scottish Parliament.

Question Two: Do you agree that the Damages Act 1996, schedule B1, should be amended to enable the possibility of a modified or adjusted inflation index to be used in the calculation of the discount rate? Please provide reasons for your answer.

2.10 The Scottish Government considers the policy considerations relevant to the methodology for the calculation of the discount rate remain central to any proposal to change the default inflation index. If provision is to be made for a damages inflation index capable of being modified this could be achieved in one of the following ways: -

Option A

2.11 The legislation could be amended to change the default index from RPI to another recognised inflation index – probably CPI or CPIH – whilst retaining the ability for Scottish Ministers to prescribe an alternative source of information. There would be additional provision that either the default or alternative source of information should be capable of adjustment by the rate-assessor, such that a number of percentage points could be added or subtracted from the published index, e.g., the rate of inflation could be CPI + 1.25%.

2.12 In this option, both the mix of damages and level of inflation for each would be considered by the rate-assessor who, as now, has the ability to be informed by relevant experts in the personal injury field

2.13 This approach strikes a balance between clarity and transparency on the face of the legislation whilst delegating some discretion to the rate-assessor to enable them to draw on their professional expertise.

Option B

2.14 An alternate option would be to amend the legislation to change the default index from RPI to another recognised index – probably CPI or CPIH – and include a percentage point adjustment in the legislation. Scottish Ministers would have the ability to prescribe, by regulations, an alternate index and/or adjustment. It would be the intention to seek advice from the Government Actuary’s Department about the appropriate adjustment to prescribe. The power for the Scottish Ministers to prescribe different published information for use and/or the adjustment would be retained. This would mean full transparency and certainty in the legislation in advance of a review being carried out, but may require regular amendment to legislation.

2.15 This approach gives greater weight to transparency and certainty but it does not provide the rate-assessor with any discretion within which to exercise their professional judgement.

Question Three: Do you prefer Option A or Option B as a means of enabling the possibility of a modified or adjusted inflation index to be used in the calculation of the discount rate? Please provide reasons for your answer.

Question Four: Do you have an alternative option for enabling the possibility of a modified or adjusted inflation index to be used in the calculation of the discount rate? Please fully describe the alternative option and provide reasons for your answer.

2.16 In either option, the selection of an adjustment to an index is being driven by two components, the mix of inflationary pressures (effectively the proportions of different heads of loss) assumed to apply and the levels of those inflations. There is currently limited information available on the split of claims by different heads of loss in Scotland and the inflation measures that are most applicable.

2.17 We note that the Ministry of Justice collected evidence on the breakdown of damages by heads of loss as part of the Call for Evidence^[10] for the most recent England and Wales PIDR review. The Expert Panel’s Report to the Lord Chancellor considered this evidence and suggested earnings-related damages are 65%-85% of claimants’ overall lump sum damages.^[11]

2.18 The Scottish Government considers that the mix of inflationary pressures affecting awards of damages is likely to be in line with that affecting awards in England and Wales. We invite views from respondents on this matter.

Question Five: Do you agree that the mix of inflationary pressures affecting lump-sum awards of damages in Scotland is likely to be the same as that in England and Wales? Please provide evidence for your view either way.

Periodical Payment Orders

2.19 Part 2 of the 2019 Act relates to Periodical Payment Orders (PPOs). A PPO is a court order which requires a defender to pay damages compensation in the form of annual or regular payments to the pursuer rather than via a single lump sum payment. They tend to be used in cases where substantial damages have been awarded. A PPO is capable of being varied over time and linked to inflation so that if a pursuer’s needs change or economic conditions change, a pursuer is not impacted in the same way as they might have been had they taken their award of damages in the form of a single lump sum.

2.20 Whilst Part 2 of the 2019 Act is not yet in force, section 3(2) of the Act will insert a new section 2D into the Damages Act 1996 which will mean that in the future, PPOs will need to include a requirement for the amount of payments to be altered at intervals. This allows the real value of periodical payments to be preserved over the whole period for which they are payable. In the absence of provision to the contrary the amount of payments is to be altered by reference to the RPI, with rules of court prescribing the timing, frequency and manner of alterations. RPI was chosen as the default inflation index point in order to replicate sections 2(8) and (9) of the Damages Act 1996.

2.21 In addition, Scottish Ministers will have the power to prescribe an alternative to the RPI as the default basis of alteration.

2.22 Given the status of the RPI it would seem sensible to take views on whether the references to RPI should be changed and if so to what alternate inflation index. Given that there are likely to be differences in the types of heads of loss typically covered by a lump sum payment as opposed to a PPO and the different timescales to which payments relate (potential PPO lifetime may be different to the 43-year investment period currently used in the PIDR) it may point to different inflation indexes.

Question Six: What do you think the appropriate inflation index should be for PPOs? Please provide reasons for your answer.

2.23 We consider that the ability to adjust the chosen inflation index for the PIDR could apply equally to PPOs as, equally in this context, one index might not completely reflect expected future increases in needs.

Question Seven: Do you agree that provision should be made to enable the possibility of a modified or adjusted inflation index to be used for PPOs? Please provide reasons for your answer.