The Lord Chancellor has cut the discount rate on personal injury payouts to 2.5%, a move which could hit insurers hard in the pocket.

The discount rate applies when a person bringing a personal injury claim is awarded substantial damages and takes into account the fact that the claimant can invest the original sum. The Lord Chancellor has the power to set the discount rate under the Damages Act 1996.

Originally, the discount rate was set at 4% to 5% in times of stable exchange rates, but a recommendation was made that this be lowered and the sum pegged to government bonds, after the landmark Wells vs Wells case in 1998.

The insurance industry could be looking at a £320m one-off cost and increased annual costs of up to £85m following the Lord

Chancellor's decision to lower the discount rate for personal injury multipliers to 2.5%. The Lord Chancellor has prompted the first fall in the rate since it was confirmed at 3% in 1999.

Best practice partner at law firm Weightmans Laura Wilkin said: “The decision brings certainty but will be unwelcome news for insurers already under pressure from mount-ing costs and a claims culture fuelled by the new funding arrangements such as conditional fee arangements (CFAs). Applying a 2.5% discount rate to future lost earnings for a 20-year-old male with an anticipated retirement age of 65 results in a rise of 2.19 years. Assuming his projected annual earnings were £20,000, this represents an increase of a little under £45,000.”

This change is likely to make structured settlements of all types more attractive from the defendants' point of view. While there may be slight comfort for some within the industry, that reduction of the rate makes it less likely that funds will be used up within a claimant's lifetime – reducing the likelihood that claimants will return to the state and the NHS, and the cost of claims will rise.

Longer term indications suggest less slavish adherence in the future to linking discount rates to yields on the Index Linked Government Scheme (ILGS). This may give the industry greater scope to petition for the rate to be increased at a later date where there is significant, established change in real rates of return.