Defence Secretary Bob Ainsworth announced he was bringing forward a review of the controversial compensation scheme for injured servicemen and women.
The Government was criticised after it launched a court challenge on Tuesday that could slash the payment made to a soldier serving on the front line in Afghanistan.
Mr Ainsworth said recent public debate had demonstrated that the scheme was not fully equipped to deal with "anomalies, legal complexities and wider issues" relating to compensating wounded troops.
He said: "The purpose of the current appeal process was to ensure that our Armed Forces Compensation Scheme remains fair and compensates most those more seriously injured.
"As Defence Secretary I cannot allow the situation to continue that leaves the public in any doubt over my or the Government's commitment to our servicemen and women.
"Therefore, in order to deal with this complex issue in the most sensitive, effective and fair way possible, I have ordered the planned review of the compensation scheme to be brought forward from next year."
Mr Ainsworth faced personal criticism for being on holiday while the legal challenge at the Court of Appeal got under way.
But he cut short his break and returned to the Ministry of Defence yesterday.
The review of the compensation scheme begins immediately and will involve consultation with legal experts, service charities and troops and their families.
The Court of Appeal case brought by the Ministry of Defence focuses on the levels of payment made to Corporal Anthony Duncan, who is on active service in Helmand Province, and Royal Marine Matthew McWilliams.
Cpl Duncan, of the Light Dragoons, who was shot while on patrol in Iraq in 2005, was originally awarded £9,250, which was increased to £46,000 by a Pensions Appeal Tribunal.
The £8,250 award made to Mne McWilliams, who fractured his thigh in a training exercise, went up to £28,750 on appeal.
Derek Sweeting QC told the court yesterday that the Ministry of Defence had argued the purpose of the compensation scheme was to focus on the original injury and not subsequent treatment or complications caused by the injury.
This would be "grossly unfair" because it would mean that the effect on the individual was ignored, he said.
The court's ruling in the case is not expected to be handed down before October.
Mr Ainsworth said the current compensation scheme was already "much fairer" than its predecessor, noting that the lump sum payments for the most serious injuries were doubled to £570,000 last year.
But he added: "I recognise that the changing requirements of our people mean that we cannot stand still.
"The world-class medical care that we provide on operations means that more people are surviving very serious injuries than before.
"We need to ensure that the scheme is responsive enough to meet their needs."
The Defence Secretary pledged that the new arrangements would benefit troops with claims under the existing scheme, including Cpl Duncan and Mne McWilliams.
He said: "We always said that we would review the scheme. Now that the recent hearings in court have finished, I have decided that this review must begin.
"In particular it will look at whether current awards adequately provide both for the injuries sustained on operations by our servicemen and women, and for their recovery.
"The underlining principle of the scheme, that those most seriously injured should receive the most compensation, is an important one that we will maintain.
"I can offer an assurance, however, that new arrangements will benefit those with claims under the existing scheme, including those mentioned in the current court case."
Shadow defence minister Andrew Murrison said: "We welcome the Government's decision to expedite the review of its Armed Forces Compensation Scheme (AFCS), which is clearly not fit for purpose in its current form.
"Why has it taken the Government so long to realise that the system needs to be looked at?
"So far, the AFCS appears to have produced a number of perverse decisions that have taken no account of the likely long-term needs of people who have suffered from serious mental or physical disability in the service of their country.
"The review must look at the amounts which are paid out, the time within which claims can be made, and a way in which awards can reflect the real care needs of our injured service personnel."
Dr Murrison went on: "The Government needs to say why it originally intended this review to happen next year, rather than immediately as the Conservatives have called for.
"It now looks like the Government's decisions are made thanks to legal action rather than a genuine desire to do the best for our troops.
"It's a pity that everything has to be dragged out of this Government, and that they have to be forced to make these decisions to look after our brave service personnel."
Liberal Democrat defence spokesman Nick Harvey said: "This is a very welcome u-turn by Bob Ainsworth.
"However it shouldn't take media pressure for the Government to do the right thing by our serving men and women.
"It has been clear for some time that the current compensation does not reward the levels of bravery and sacrifice that we see from our troops on a daily basis.
"This review must move quickly to address long-standing concerns. The issue is too important to kick into the long grass."
Pressed on whether it was a mistake to launch the court challenge to reduce payments made to soldiers, Mr Ainsworth told Radio 4's Today programme: "In isolation, it possibly was, but we had to clarify the situation that we were left with with the tribunal.
"What I couldn't have is people with the exact same injury getting different levels of compensation and what I couldn't have is people with the most serious injuries not having that reflected in the payments that were made.
"Those two things had to be sorted out."
He said the review of the compensation scheme would not be independent but would take people's views into account.
"The Government can't abdicate its responsibility; we can't leave decisions to other people," he said.
"But what we need to do is be inclusive, to take other people's points of view into account, make sure that they have a role and an involvement and a say."Reuse content