We live in interest-ing times – having recently celebrated 30 years in the profession I am old enough to remember when 20 cents bought you a bag of lollies from the corner store, no one knew what an avocado was [1] and I was earning 18% interest on the small amount of unspent pocket money deposited with the Bank of NSW.

How times have changed. You cannot buy a single Minty for 20 cents, I smash an avo on my soy linseed sourdough regularly and I am currently earning 0.11% interest on the miniscule savings in my Westpac account.

But some things have not changed, like the discount rate on lump sum damages payments as I will now explain.

Interest in lump sums

When someone is awarded lump sum damages to compensate them for future losses, a discount is applied to the lump sum to take into account the early receipt of future sums and the interest that could be earned and accrued if the lump sum was invested.

For example if a court or tribunal decides that an injured person will require a knee operation in 10 years time, evidence will be presented as to the present cost of that knee operation (assume it is $10,000). If the injured person received that $10,000, deposited it in the bank, the bank will pay interest on that sum which will, if not touched, compound over time. In 10 year’s time when the injured person needs to pay the surgeon for the operation, there will be more than $10,000 in the bank. Is that fair to the defendant, or their insurer, who has had to pay that lump sum?

It is a fundamental compensatory principle that damages are awarded on the basis of putting the injured person in the position they would have been in (as best money can) but for the accident. It would be a breach of that principle if the injured person was awarded too much and had money left over. Therefore there needs to be a method of discounting the present value of monies which will be incurred in the future. This is done by applying a discount rate calculated by actuaries and based on a deemed unmoving compound interest rate.

The deemed interest rate is usually set out in the legislation governing the particular scheme of compensation or damages. In a motor accident claim in NSW the discount rate is based on a presumed interest rate of 5%. The higher the deemed interest rate, the more the lump sump is presumed to be earning and therefore the bigger the discount applied to the lump sum paid to the injured person. In Western Australia and Victoria the discount rate is as high as 6% and in Tasmanian Workers compensation matters it is as low as 3%.

If we return to the case of the $10,000 surgery, let us consider the variations in damages which could be awarded depending on the various discount rates:

  • 3% – rate is 0.744 therefore $10,000 x 0.744 = $7,440
  • 5% – rate is 0.614 therefore $10,000 x 0.614 = $6,140
  • 6% – rate is 0.558 therefore $10,000 x 0.558 = $5,580

In NSW, the injured person would be awarded $6,140. If that sum was put in the bank and not touched for 10 years it would accrue the sum of $10,045 (according to the moneysmart.gov.au savings calculator) but only if the interest rate over those 10 years remained steady at 5%.

If the injured person received $6,140, puts it in the bank and leaves it there for 10 years and interest rates remain at an all time low of say 1% for those 10 years, the injured person will, in 10 years time, have only $6,775 in the bank which leaves them $3,225 out of pocket if they have to pay for the $10,000 surgery.

The case of a lump sum for surgery is a relatively simple example. The same principles apply for continuing losses such as lost weekly income and earnings into the future where the amounts concerned may be much larger (imagine if you could not work for 10 years what your lost earnings would be) and the variation in damages based on a difference in the discount rate and the prevailing actual interest rates could be significant. For example the Court or tribunal determines an injured person will retire 10 years earlier than they otherwise would have, due to their accident related injuries, creating a loss of earning capacity valued at say $400,000. Discount that at a deemed interest rate of 3% (multiplier 0.744) and the Claimant receive damages of close to $300,000 but at 5% (multiplier of 0.614) he or she receives damages of about $250,000. If the Claimant banks those damages, does not touch them and only earns 1% on average then he or she will have, at the 10 year mark, $331,000 or $276,000 both of which are a far cry from the assessed loss of $400,000.

The prescribed discount rate for NSW motor accidents was first set at 5% under the Motor Accidents Act 1988 (s 71) and repeated under the Motor Accidents Compensation Act 1999 (s 127) although that legislation introduced the ability to amend the rate under the Regulation (which has never been done). Section 4.9 of the Motor Accident Injuries Act 2017 maintains the discount rate at 5% and the ability to vary it in the Regulation.

The graph below shows the Reserve Bank’s cash rate (overnight money market interest rate) over the last 30 years. From 1993 to 2011, that rate has been relatively stable at around the 5% mark with the odd wobble in 1995/96, 2001 and 2008/09.

With interest rates declining since 2012 and now at an all time low and with economists predicting nothing is likely to change in the medium to long term, surely it is time to consider reducing the discount rate to those based on a deemed interest rate of 3%, or perhaps even lower.

[1] For the young people reading this blog, in order to gain a full appreciation of life growing up in the ‘60s and 70s, I can thoroughly recommend Richard Glover’s The Land Before Avocado published by Harper Collins UK in October 2018.