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Discount rates – how will this affect the insurance industry?

Posted by
14 Mar 2017
InsuranceOn Monday 27th February 2017, The Lord Chancellor, Elizabeth Truss, announced to the London Stock Exchange that the discount rate last set in 2001 is to be reduced from +2.5 percent to -0.75 percent. This downward movement of 3.25 percent will come into effect on 20 March 2017.

Although a decrease in the discount rate was expected, this is a much more significant than what was anticipated by the insurance industry, with predictions initially ranging from 0.5-1.5 percent. It is acknowledged that this development will have a major impact on personal injury litigation, particularly large loss matters that include future loss claims.

The Ogden Tables are designed to assist with the calculation of lump sum damages for future losses in personal injury and fatal accident claims. These losses include future loss of earnings and care claims. Multipliers are applied to the present day value of a future annual loss to produce a lump sum award (i.e. accelerated receipt of future losses not yet incurred by the claimant). This lump sum must be adjusted to take into account the interest that can be earned on the sum before it needs to be spent. The discount rate reflects the interest that would be earned on the lump sum payment based on safe investment within Index Linked Government Stock.

Public services which carry large personal injury liabilities will also be severely impacted by the Lord Chancellor’s decision. For example, it is expected that there will be significant increases in compensation for medical negligence claims against the NHS. At the same time as announcing a reduction in the discount rate, the Lord Chancellor committed the government to ensure that appropriate funding for the NHS Litigation Authority would be provided to cover the change.
In practical terms, the announcement will require immediate action from both claimant and defendant lawyers in terms of how they wish to tactically deal with ongoing and future claims.  

The reaction to this news from the insurance industry has been one of dismay. The announcement prompted a sharp drop in the value of shares of motor insurance firms on the stock market and has forced many listed insurers to make unscheduled announcements to the London Stock Exchange
Many have been forced to delay reporting their financial results as they recalculate the hit they will take. For example, the Admiral Group have confirmed that they will postpone its full-year results until 8 March in order to fully calculate the impact of today’s change. The firm says that the impact of existing claims settling at the new rate is expected to be between £140 and £175 million. Direct Line have confirmed that following the decision, their pre-tax profits are likely to have been reduced by a figure approaching £230 million.

The Director General of the Association of British Insurers, Huw Evans has described the decision of the Lord Chancellor as ‘crazy’ and expressed the following view:

“Claims costs will soar, making it inevitable that there will be an increase in motor and liability premiums for millions of drivers and businesses across the UK. We estimate that up to 36 million individual and business motor insurance policies could be affected in order to over-compensate a few thousand claimants a year. To make such a significant change to the rate using a broken formula is reckless in the extreme, and shows an utter disregard for the impact this will have on consumers, businesses and the wider operation of the insurance market”.

The Lord Chancellor is expected to meet representatives of the insurance industry to assess the impact of the announcement in the coming weeks. It should be noted that the new discount rate may not remain at this level forever, as there has been an indication that there may be another consultation before Easter.

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