The discount rate ruling – how will it affect insurance?
Minimising the effects of the Discount Rate Ruling
You may have seen press headlines in February relating to expected insurance cost increases due to a judicial ruling on “The Discount Rate.”
Rightly or wrongly the Lord Chancellor decided that from March 20th 2017 the discount rate should be cut from 2.5% to -0.75%. Although this change of 3.25% sounds fairly minor, its impact will be dramatic.
It’s been estimated that it will cost the insurance industry a one off amount of £5.8 billion and £850 million each year from now on. For example, Aviva have allocated £385 million to cover the impact on their 2016 figures.
The impact of the Ogden Ruling
In the immediate aftermath there were many panicked announcements from insurers. A number have subsequently announced rate increases of between 5% and 20%. At Plan we have been assessing the impact of the ruling before issuing an informed response.
Clients of Plan can rest assured that they are best placed to minimise the cost of this change. With insurance premium tax also doubling in recent years the ruling provides another challenge for us as brokers to overcome. As always we will remarket our client’s renewals to our extensive panel of specialist commercial insurers.
We will do all we can to prove the value of our service.
What is “The Ogden Ruling”?
It is fairly difficult to explain what the Ogden Ruling is as it is quite technical. Please bear with us as we make an attempt.
Since 2001, on large claim payouts where recipients are severely injured and require compensation for loss of earnings and the cost of ongoing care assistance, the amount paid was discounted based on the fact that recipients could invest the lump sum into low risk “Index Linked Government Securities” (sometimes known as bonds) and receive interest (source: Cossé Law Firm, LLC).
However due to the global economic problems in recent years these securities have not consistently out-performed the rate of inflation. Hence Lord Chancellor Elizabeth Truss ruled that claimants should actually receive an increased amount to cover depreciation.
Insurers believe the new rate is unfair because claimants are unlikely to place their compensation into investments that they know will be loss making. The Association of British Insurers (ABI) remain confident that the Chancellor will intervene to amend the basis on which the rating is set but this is by no means certain.
How does the Discount Rate change affect insurers?
Essentially the discount rate change that came into this week means that insurers will have to:
- Payout more money to settle claims.
- They will also have to put more money aside to cover the potential cost of substantial claims.
- With significantly less funds available the insurers will also make less money via their investments.
Investment can profits often subsidise their loss making motor insurance premiums. Additionally some insurers have already been struggling with the introduction of new regulations imposed by the Financial Conduct Authority (FCA) known as Solvency II. These rules also require them to hold far more capital in reserve to cover the cost of unforeseeable and substantial changes in claim payout amounts.
The question remains, “How can a 3.5% swing have such a dramatic impact?” Many insurers had anticipated a worst case scenario of half the amount that the Lord Chancellor decided upon. In the attached pdf Allianz provide a breakdown of the calculations and the new rate’s impact.
They provide an imaginary example of a 30 year old man who has been seriously injured in a car accident. At the time of accident he was earning £25,000 a year. His injuries are so severe that he’ll be unable to return to work and he will need nursing care for the rest of his life. The cost of the nursing needed is currently £75,000 per year. Projecting these factors over the course of his life expectancy and applying the new discount rate gives a settlement figure for future loss of earnings and cost of care of £6.325m. The increased amount that the insurer will need to pay is £3.534m or 127%.
It Pays to have a Plan
As per above, Plan’s expert account handlers will do everything possible to reduce the impact of the changes. Should you require any further information please do not hesitate to get in touch.
Email Us or Call: 0333 003 0041