Campbell, Jane --- "Ending the Discount Rate Disgrace: State Governments Are Depriving Seriously Injured Australians of Fair Compensation" [2023] PrecedentAULA 28; (2023) 176 Precedent 10

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Ending the discount rate disgrace

State governments are depriving seriously injured Australians of fair compensation

By Jane Campbell

For far too long, the discount rates applied in personal injury cases in Australia have been too high, to the great detriment of seriously injured plaintiffs and to the benefit of insurers and those paying compensation. The people most affected – children with lifelong disabilities and adults with brain injuries – are in no position to make a lot of noise about this injustice. Nor are their parents and carers, who may not be familiar with how the law is supposed to work. Efforts made by plaintiff lawyers, the Australian Lawyer’s Alliance (ALA) and some parliamentarians have been met with seeming indifference. So, what can be done?

The Federal Government has taken no responsibility for discount rates, considering them a state and territory issue, even though they significantly impact on the national budget by way of Centrelink and National Disability Insurance Scheme (NDIS) costs. State governments take comfort from the fact that they all have the same or a similarly high statutory discount rate. But this does not make discount rates fair or acceptable.

HOW DID WE GET HERE?

For those unfamiliar with the theory and history of personal injury discount rates, here is a quick refresher.

The theory

The personal injury discount rate is a percentage adjustment to a lump-sum award of damages for future financial loss to a person who has suffered personal injuries. It is applied to take into account the amount that would be expected to be earned from investing the lump sum, after tax and after inflation.

The award, adjusted by a discount rate, should put the plaintiff in the same financial position they would have been in had they not been injured. The theory is that a fair discount rate, when applied, will mean that the plaintiff is neither under- nor overcompensated. In practical terms, the higher the discount rate, the lower the lump sum payable to the plaintiff.

The common law rate

In 1974 the High Court of Australia held that the Court of Appeal in NSW could not prescribe a discount rate to be applied by trial judges. But, seven years later, in December 1981 in Todorovic v Waller,^[1] the High Court decided that, in the interests of predictability and securing uniformity, it should set the discount rate.

The court considered extensive evidence and discount rates ranging from 5 per cent to unspecified negative figures, before five of the seven judges reached the compromise agreement that 3 per cent should be the rate.

In his book Assessment of Damages for Personal Injury and Death, Professor Harold Luntz wrote:

[INDENTED QUOTE]

‘Although it was intended that the 3 per cent rate should apply only so long as economic conditions remained unchanged, and though there have been considerable economic changes since 1981, the court has refused to review its ruling, mainly because meanwhile legislatures all over the country have laid down rates for different types of accidents.’ ^[2]

The statutory rates

Unfortunately, soon after 1981, state and territory governments around the country moved to prescribe statutory discount rates above 3 per cent.

Most statutory rates were set at 5 per cent, with some punishingly high at 6 per cent. Only the ACT retained the common law discount rate of 3 per cent.

Different rates were set in the different jurisdictions – either for all or for only some types of accidents. Some rates apply to all personal injuries and others only to damages arising from the death of a close relative.

Why so high?

Professor Luntz has suggested that the high discount rates might have been due to a fundamental misunderstanding by the courts and legislatures of the relationship between market interest rates and inflation, with this flawed thinking resulting in too-high rates and thus under-compensation.^[3]

In his 2017 contribution to a report from the United Kingdom (UK), Professor Mark Lunney noted that statutory provisions setting discount rates provide no detail on when or how any regulation setting the rate should be determined. Apart from Western Australia, which refers to the Governor making an order-in-council determining the rate ‘on the recommendation of the Attorney General’,^[4] the process is left entirely unregulated.^[5]

The Ipp review in 2002

In 2002, the Ipp Review Panel (‘the Panel’) was commissioned to report on ways in which liability under the law of negligence could be reduced in response to what was widely perceived to be an insurance crisis. Given the context, it was surprising the Panel recommended that the common law rate of 3 per cent be the preferred rate. Despite evidence that statutory rates were set at 5 per cent or higher, the Panel thought a 3 per cent discount appropriate, given evidence from the Australian Government Actuary that a realistic after-tax rate might be 2–4 per cent.^[6]

Unfortunately, and somewhat predictably, subsequent tort reform legislation did not adopt this recommendation.^[7]

The enduring stasis

In 2017, Professor Lunney explained the lack of movement on discount rates in this way:

[INDENTED QUOTE]

‘When opportunities for reviewing the discount rate arise, the battle lines drawn are predictable: the insurance industry suggests decreases in the rate will raise premiums while plaintiff advocates note the unfairness of setting a rate which does not reflect market conditions.

As the question is decided in each jurisdiction in Australia, insurers are also able to argue that reducing the rate in one jurisdiction would mean it would be ‘out of line’ with rates in other jurisdictions.

Given that primary or secondary legislation is required to change existing rates so that the decision is essentially political, this creates something of a stasis in the absence of compelling evidence to change the status quo.’^[8]

So, here we remain: stuck. Our courts and legislatures seem to have long abandoned any adherence to the common law principle of retitutio in integrum (restitution to the original position).

THE PRACTICAL REALITY OF HIGH DISCOUNT RATES

Families forced to seek growth and minimise tax to make every dollar count

For the past 20 years I’ve been giving financial advice to injured plaintiffs post-settlement. My focus has been the very seriously injured, most of whom lack capacity and have been able to recover the cost of funds management, including specialist financial advice.

When I started advising in 2003 it was just accepted that plaintiffs needed to invest their settlement funds for growth. I quickly realised that they could not look at annuities, which were popular overseas, as they did not generate adequate returns to fund the necessary annual expenses.^[9] Plaintiffs and their lawyers became increasingly conscious of the fact that it simply wasn’t an option to hold settlement funds in cash or similar ‘safe’ investments, and they needed to seek growth and try to minimise tax to help make every dollar count.

It’s always been tough explaining to families that they actually need to take on significant investment risk and will have to ‘stay strong’ through market downturns (of which there have been many). This is not what parents want to hear when their child has expenses that need to be met regardless of what’s happening with share markets.

Over the past 20 years, those plaintiffs who have had the benefit of good financial advice, and the right structures and strategies in place to minimise tax have been able to stay invested through downturns and get by (at least to date). This was possible while investment market returns were reasonable and inflation was under control. Clients who have been able to achieve consistent investment returns of around 7 per cent and have paid little or no tax in an environment of low inflation (say 2 per cent) have been able to accommodate a 5 per cent discount rate. But only just. Unfortunately, this is no longer the case.

The injustice of fixed discount rates when inflation is high

The situation for Australian plaintiffs is now seriously and quite disastrously unfair. In Australia, and worldwide, inflation is no longer under control. We can no longer continue to assume in good faith that inflation is 2 per cent when it’s currently over 6 per cent.

It is likely that inflation will eventually fall back from the current highs, but long-term economic assumptions point to an inflation rate more like 2.4 per cent or 2.5 per cent rather than 2 per cent.

When inflation is combined with other problems that are impacting countries worldwide (such as wars and climate change), long term-investment returns for a growth type asset allocation may be more like 6 per cent rather than 7 per cent.

Under these conditions, plaintiffs cannot accommodate a 5 per cent discount rate, no matter how aggressively they invest. Their 6 per cent return will be eroded by an inflation rate of 2.4 per cent, so they will be going backwards from the day their matter settles.

This changed economic environment must drive changes to the status quo.

LOOKING TO THE UK

In 1998 in Wells v Wells,^[10] the House of Lords set the discount rate to be applied by the courts at 3 per cent, by reference to a three-year average rate of return on Index-Linked Gilts (ILGs).^[11] This rate remained in force in England and Wales and Northern Ireland until 2001 and in Scotland until 2002, when the then-Lord Chancellor, in relation to England and Wales and Northern Ireland, and the Scottish ministers, in relation to Scotland, respectively prescribed a rate of 2.5 per cent under the Damages Act 1996 (UK), s 1.^[12]

In view of the decline in the yields of ILGs, the discount rate was reviewed, and in 2017 the Lord Chancellor reduced it from 2.5 per cent to minus 0.75 per cent. Lawyers in the UK have noted that this decision was met with a significant backlash from insurers.^[13]

On 15 July 2019, pursuant to the Civil Liability Act 2018 (UK), the discount rate was increased from minus 0.75 per cent to minus 0.25 per cent. This discount rate was set, not by reference to ILGs yields, but rather to the yields that would follow if a claimant invested in a ‘diversified portfolio of investments’.^[14]

The next formal review of the personal injury discount rate in England and Wales must begin by 15 July 2024. The Ministry of Justice issued a call for evidence on 17 January 2023. The consultation closed on 11 April 2023, after which the Ministry of Justice will prepare and publish its response by July 2023.^[15]

The vast gulf between discount rates in the UK compared with Australia (particularly since 2017) cannot be explained based on real-world investment opportunities available to plaintiffs. Simply put, Australian plaintiffs have been significantly undercompensated.

CALL TO ACTION

In the new economic environment of higher inflation, the burden of the cost of compensation is being too heavily borne by those least able to accommodate it. It’s no longer possible for state and territory governments across Australia to point to market returns and waive away the serious injustice to injured Australians that has long been endured.

Action is urgently needed, starting at least with a review of current discount rates. The review should cover:

• who sets discount rates;

• the process for setting such rates;

• the application of rates – which types of accidents etc;

• whether a single rate is appropriate;

• the relevance or influence of other factors – policy, political, economic; and

• international models.

The Federal Government needs to support this review and pay attention to this issue. After all, it directly impacts budgeting for Centrelink and the NDIS. State and territory governments are currently cost-shifting not only to vulnerable plaintiffs but also to the Federal Government (and thus all taxpayers).

The current Disability Royal Commission should also support this review. Their active support may be needed if neither level of government is prepared to contend with this issue, which has an impact on the welfare of people with disabilities all over Australia.

Now, like never before, we as lawyers and members of the ALA need to demand action on discount rates.

Jane Campbell is a lawyer and financial adviser who specialises in providing independent financial advice to plaintiffs. WEBSITE www.aeran.com.

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^[1] [1981] HCA 72; 1981) 56 ALJR 59.

^[2] Harold Luntz, Assessment of Damages for Personal Injury and Death, 4th ed, 2002, 407, note 80: Ionnu v Mitchell [1986] 17 Leg Rep SL 5; Commonwealth v Blackwell [1987] HCA 44; (1987) 163 CLR 428; Blake v Norris and Rosniak v Government Insurance Office (NSW) [1998] 6 Leg Rep SL 1.

^[3] Harold Luntz, op cit, 408, [7.4.4].

^[4] Law Reform (Miscellaneous Provisions) Act 1941 (WA), s5(2).

^[5] British Institute of International and Comparative Law, Briefing Note on the Discount Rate applying to Quantum in Personal Injury Cases: Comparative Perspectives, 20 March 2017, Annex 2 re Australia by Professor Mark Lunney, 22, [11], <https://www.biicl.org/documents/52_biicl-comparative-law-report.pdf>.

^[6] Ipp et al, Review of the Law of Negligence: Final Report, Commonwealth of Australia, 2002, 211, [13.106].

^[7] Ibid, 22, [12].

^[8] British Institute of International and Comparative Law, see above note 5, Annex 2 re Australia by Professor Mark Lunney, 23–24, [16] (citations omitted).

^[9] Structured settlements were popular in the US and had been gaining popularity in the UK by the time legislation was passed enabling them in Australia. The small lifetime annuity market in Australia was not able to offer investment returns that were in any way competitive with managed funds that could be held inside or outside superannuation accounts.

^[10] References to the decision of the House of Lords in Wells v Wells are to the judgments of the conjoined appeals of Page v Sheerness Steel Co Ltd; Wells (Suing by Her Daughter and Next Friend Susan Smith) v Wells; Thomas (Suing by His Mother and Next Friend Susan Thomas) v Brighton Health Authority [1998] UKHL 27; [1999] AC 345.

^[11] This rate was also relevant in Scotland and Northern Ireland, even though Wells v Wells was an English case.

^[12] Damages Act 1996: The Discount Rate – Review of the Legal Framework, A joint consultation produced by the Ministry of Justice, the Scottish Government and the Department of Justice, Northern Ireland, Consultation Paper CP3/2013, 12 February 2013, <https://consult.justice.gov.uk/digital-communications/damages-act-1996-the-discount-rate-review-of-the/supporting_documents/damagesact1996discountrateconsultation.pdf>.

^[13] D Brown, S Brock, ‘The rise and fall of the personal injury discount rate’, Womble Bond Dickinson, 14 January 2020, <https://www.womblebonddickinson.com/uk/insights/articles-and-briefings/rise-and-fall-personal-injury-discount-rate>.

^[14] Ibid.

^[15] C Malla, F Hamilton-Wood, R Davis, ‘Personal injury discount rate in England and Wales: exploring the options’, Kennedys Lawyers, 9 March 2023, <https://kennedyslaw.com/thought-leadership/article/2023/personal-injury-discount-rate-in-england-and-wales-exploring-the-options/>.