The discount rate should be set by a panel of experts and not linked to one particular investment asset, according to proposals by the Association of British Insurers (ABI) released today.
Used by insurers to calculate compensation awards for serious personal injuries, the discount rate is currently linked to the Index Linked Government Securities (ILGS), and was cut from 2.5% to -0.75% earlier this year.
This is to take into account the return that claimants can typically expect to receive if they invest their compensation, but is criticised for not reflecting how people actually use their payout in real life.
"It is now widely acknowledged that the current methodology used to calculate the discount rate is fundamentally flawed as it does not reflect the reality of how claimants invest their damages in practice," ABI director of general insurance policy, James Dalton, said.
"This broken methodology means significantly higher costs for all compensators, including the NHS, and inevitably higher insurance costs for millions of consumers and businesses."
Instead, the ABI propose that two rates be used to reflect different investment periods, taking into account the lower returns likely for claimants with short-term needs, as well as higher ones that could be made investing long-term.
In addition, the group believes that claimants should receive 100% compensation, and if they want to minimise investment risk, could choose a periodical payment order where the risk is borne by the compensator.
A panel of experts including insurers, claimant lawyer representatives, independent financial advisers, and actuarial firms should also be set up to assist the relevant Secretary of State in setting the rate.
"Ensuring that claimants receive full compensation must be at the heart of how personal injury compensation is calculated," Dalton continued. "Retaining the status quo is not an option."
"It is essential that the new government changes the framework to ensure we have a system that is fit for purpose for claimants, insurance paying customers and compensators.
"If delivered, our proposals will help keep down costs for motorists, businesses and taxpayers, while still delivering fair compensation to those who need it most."
Sign up to our free newsletter here and receive a weekly roundup of news concerning the actuarial profession