I am obliged to all noble Lords for their contributions. The noble Lord, Lord McKenzie of Luton, began by referring to the briefing from APIL—the Association of Personal Injury Lawyers. I am familiar with it, and indeed, the association invited me to speak at its annual conference, where I confirmed that we would take the Bill through Parliament. I have not cleared my diary for next year. Much of what they had to say, which was repeated by the noble Lord, was, as the noble Earl, Lord Kinnoull, pointed out, met by the need to encourage the uptake of periodical payment orders. We are committed to that and we will take it forward in various ways. They need to be embraced more thoroughly, not only by claimants but by defendants —insurers—as well. Nevertheless, I make that point.
The noble Lord referred to the case of Wells v Wells, which has been mentioned before. There we saw the reference to what was essentially construed as “very low risk investment in UK gilts”, and we are moving away from that. However, there is an additional element in that, which is volatility: you have an investment portfolio which may be subject to volatility, and you may find that it is at a low point at a stage when you need to withdraw capital funds. That has to be factored in as well, and we appreciate all that.
On the suggestion that we are somehow inviting people to invest their savings, or a majority of them, in hedge funds, that will not do at all. The portfolio A that was examined included 13% UK equities,
15% overseas equities, and 18% of alternative investments which could be modelled as hedge funds. We have to see all this in context. We took clear evidence on the nature of a low-risk portfolio, and there was reference, for example, to widows and orphans, but we are in a different climate in this context. We are not seeking to move away from the idea of 100% compensation. I will come on to the probing amendment of the noble Baroness, Lady Bowles, on setting the rate by reference to not only a floor but, I suggest, a ceiling—there are reasons for that—and the question of investment objectives, as distinct from different financial aims.
Amendment 78 seeks to amend paragraph 3(2) of new Schedule A1 by removing the words,
“in the opinion of the Lord Chancellor”,
from the requirement that the Lord Chancellor must decide the rate on the basis that,
“the rate of return should be the rate that, in the opinion of the Lord Chancellor, a recipient of relevant damages could reasonably be expected to achieve”,
if he invested the relevant damages for the purpose of the assumed objectives. The effect of the amendment would be to prevent the Lord Chancellor seeking to justify a rate on the basis that it seems perfectly reasonable in his subjective opinion when, by any objective assessment, the rate proposed is not supportable.
The noble Lord referred to an “unfettered discretion” and conflict with a political interest, but we are talking about the Lord Chancellor making the decision in his capacity as Lord Chancellor. He does not have an unfettered discretion. He is subject to public law duties in the exercise of his functions. Any decision of the Lord Chancellor as to what the rate should be must be rational, and any failure in rationality can be challenged by way of judicial review. I have already touched upon that and the question of disclosure, and I shall not repeat it.
It is necessary to have reference to the opinion of the Lord Chancellor in relation to setting the rate because the setting of the discount rate is not now, and will not under the proposed legislation, be a precise science—it cannot be. The decision to be made on the rate will require the weighing of different potential outcomes for individuals in relation to a range of possible rates. An inevitable degree of subjective assessment is involved in this process. That is why it is appropriate that, although there is an expert panel, that subjective assessment is made by the Lord Chancellor, albeit with the reasons being given and explained, with a rational analysis of the information submitted to him.
Amendment 78A would require the Lord Chancellor to assume, when considering the damages to which the discount rate would apply, that the relevant damages would be payable as a lump sum or partly as a lump sum. The current wording of the Bill requires the Lord Chancellor to assume that the relevant damages will be payable wholly as a lump sum. We do not consider that this amendment is necessary. The discount rate will only ever be applicable to damages payable as a lump sum, and in setting the rate the Lord Chancellor will have regard to that.
Amendment 79 would include the requirement to assume, among the assumptions which the Lord Chancellor must make under paragraph 3(3) of new
Schedule A1 in determining the discount rate, that the cost to the claimant of investment advice shall not be recoverable by way of damages. I appreciate the point made by my noble friend Lord Faulks about the need to be clear about how investment management costs are to be treated in setting the rate, but we do not consider that this amendment is necessary.
Paragraph 3(5) of the schedule provides for the Lord Chancellor to make such allowance for “investment management costs” as he thinks appropriate. This provision has been included on the basis that under the current law the cost of investment advice is not, for the reasons explained by my noble friend Lord Faulks, recoverable as a head of damages and therefore needs to be taken into account as a factor in setting the discount rate. Should the law change, an allowance in the setting of the discount rate would then become unnecessary, as the claimant would already have the benefit of the compensation for the costs. However, we understand that paragraph 3(5) reflects the current law and can adapt to changes in the law. Therefore, we do not consider that it casts doubt on the present law regarding the unrecoverability of investment costs as a head of damage. That is a feature of fixing the discount rate.
Amendment 80, tabled by the noble Earl, Lord Kinnoull, seeks to change one of the assumptions that the Lord Chancellor is required to make under paragraph 3(3) of the new schedule. Under the amendment, the recipient of the relevant damages would be assumed to invest in a diversified portfolio of investment grade listed debt securities rather than a diversified portfolio of investments. The range of investments to be assumed to be made and included in the diversified portfolio under the amendment is clearly narrower than that under the proposed assumption in paragraph 3(3)(c) at present.
The Bill does not restrict the investments that are to be assumed, save that the overall investment approach must be assumed to fall within the range of risk described in paragraph 3(3)(d). We consider that this approach avoids the rigidity of tying the assumptions to a single type of investment. The Lord Chancellor and the panel can therefore assess what the appropriate investments should be in the circumstance of the review. In making their assessment, the Lord Chancellor and the panel will have to have regard to evidence of how claimants actually invest and the returns actually available to investors. We consider that to be a more sustainable system for the future.
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Amendment 80A would change the assumptions which the Lord Chancellor must make in relation to the assumed risk appetite of a hypothetical claimant when setting the discount rate. Paragraph 3(3)(d) currently provides for the assumption to be that the relevant damages are invested using an approach that involves more risk than a very low level of risk—that is the floor—but less risk than would ordinarily be accepted by a prudent and properly advised investor who has different financial aims. This is according to evidence on how claimants invest in reality.
The amendment would replace this range of approaches to investment risk with a very low-risk approach to investment. It would, in effect, return the
setting of the rate in this respect to the present law, which would lead to the rate continuing to be set largely by reference to the return on UK index-linked government stock. For all the reasons I have explained, we do not consider that to be an appropriate or sustainable approach.
Our research and analysis indicate that setting the rate on this basis leads to awards of compensation that are expected to produce, on average, around 135% of the funds anticipated to be necessary to meet a claimant’s losses. That might be reduced to 120% to 125% once due allowance is taken of taxation and the costs of managing investments. Our evidence shows that it is simply not the case that claimants invest in index-linked gilts. They invest in low-risk diversified portfolios, and that is the approach that will be taken. It is realistic and it is sustainable.
That brings me on to Amendment 80B, tabled by the noble Baroness, Lady Bowles. This would also change the assumptions that the Lord Chancellor may make about the approach to risk. It would essentially leave us with a floor but without a ceiling, which we would not consider to be appropriate.
As regards the question of who owns the risk, the noble Baroness makes a very good point. Where a claimant and his advisers have the option of taking a periodical payment order but choose instead to take a lump sum—for example, in respect of future care costs over 30 or 40 years—then in a sense, without perhaps using that terminology, they are making an assumption as to the risk that they are willing to meet instead of taking the periodical payment order, and that will no doubt be reflected in the way in which the rate is approached in due course.
As to a potential conflict between paragraph 41 of the Explanatory Notes and the terms of the Bill, two parties might have the same investment objectives—namely, to maintain a low-risk portfolio—but they might have different financial aims. The claimant might be prepared to treat that investment portfolio as he would an annuity, with the result that at the end of his expected lifespan there would be zero capital left, whereas another investor who is not in that situation but has the same investment objective of maintaining a low-risk and perhaps low-volatility portfolio will wish to maintain the value of the capital at the end of his life expectancy. So there might be differences between the two. However, I have taken on board the noble Baroness’s observations and will give them further consideration as we move on to the next stage of the Bill.
Amendment 81, tabled by the noble Earl, Lord Kinnoull, seeks to define the term,
“a very low level of risk”.
As I have indicated, while that amendment seeks to define that level of risk as being the level of risk equivalent to the risk associated with UK debt securities, we consider that that would potentially raise the floor of the range of investment approaches that should be taken. In a sense it would anticipate the role of the expert panel, and therefore we do not feel that it is necessary to take that approach.
In our view the interpretation of the relative risk levels of the approaches to investment is best left to the expert panel and the Lord Chancellor to consider on a review-by-review basis, rather than attempting to tie the definition to a single type of investment in perpetuity, which would lack flexibility. I acknowledge that the term “very low risk” is not susceptible to a precise and specific definition. However, it is a relative concept under which different types of investments may, from time to time, fall to be compared. Therefore, we suggest that it is an appropriate floor from which to work. The changes proposed in Amendment 81 are too prescriptive, and we consider that a better approach is to be more flexible and to provide the Lord Chancellor with a broadly defined range to bookend the range within which he will apply his mind.
Amendment 82 is intended to remove the power of the Lord Chancellor to make additional assumptions as to the setting of the rate over and above those already stated in paragraph 3(3). This stems from concern that this power could create an element of uncertainty as to the basis on which the exercise would be carried out. The power to make additional assumptions is surely beneficial. It avoids the possibility that the assumptions specified in paragraph 3 are the only ones that may be taken into account. The Lord Chancellor might, for example, make assumptions about the amount of investment management advice that is to be deemed necessary or about the duration of the assumed awards to be invested. The need for a particular flexibility may not be apparent in present circumstances, but we have to allow for future developments. I also point out that the power to make additional assumptions does not override the express assumptions already stated in paragraph 3(3) or the overall objectives of setting the rate specified in paragraph 3(2) of the schedule. The power cannot therefore be used to change the fundamental basis for any review.
Amendment 83 would remove the obligation of the Lord Chancellor in setting the rate to have regard to the actual returns that are available to investors and to the actual investments made by investors of relevant damages. The reforms proposed are intended to put the process of setting the rate on a clearer statutory footing and to provide full compensation to claimants in a manner that is fair to both claimants and defendants. In the Government’s view, it is fundamental to achieving this objective that the rate is set in a way that has proper regard to the investments that claimants actually make rather than relying on hypothetical assumptions as to what the returns should be. The requirement on the Lord Chancellor to have regard to actual returns and actual investments will, and is intended to, reinforce a more evidence-based approach. This approach will replace the present approach, which, in practice, is linked to returns on UK index-linked gilts. The requirements in paragraph 3(5) are important to ensuring that the rate is evidence-based.
Finally, Amendment 85 would remove the provision in paragraph 3(6) of the new Schedule A1 that provides that the factors that may inform the Lord Chancellor when making the rate determination are not limited to those specified in paragraph 3(5). That provision is intended to provide flexibility and to avoid the possibility of argument that the factors mentioned are the only
ones that can inform the Lord Chancellor’s decision. That would be an unfortunate position; it could result in challenges to the Lord Chancellor on the ground that he had taken account of factors that he was not entitled to take account of in fixing the rate. Removing paragraph 3(5) by Amendment 85 would be contrary to the effective evidence-based approach that we want to take to setting the rate, which is central to Clause 8 and to the amended Section A1 of the Damages Act 1996.
I appreciate that these were essentially probing amendments and, at this stage, I invite the noble Lord to withdraw his amendment.