The UK government has put in place new legislation that could see a change in the discount rate used to calculate personal injury damages awards. The so-called Ogden rate, which is used to calculate how much interest a victim would receive on any payout, was set at 2.5 per cent in 2000. But, in February this year, it was reduced to -0.75 per cent to reflect the fact that the return on gilt-edged investments is lower than inflation.
Car insurers reacted with dismay at the initial change, with both profits and Solvency II ratios coming under pressure. Direct Line (DLG), which was using a 1.5 per cent discount rate estimated at the time that profits could be affected by as much as £230m. However, in the first six months of 2017, pre-tax profits actually rose by 14 per cent after £49m was released from reserves as the increase in claims costs were not as much as expected. Admiral (ADM) took a more cautious stance, warning that profits and reserve releases were likely to be affected for the next two to four years, and while the share price gained on the review announcement it remains well down from this year’s peak.
Insurers also benefited from an inevitable increase in premiums as the increased costs were passed on to customers. For esure (ESUR) it was a win-win situation because as well as benefiting from a rise in premium rates, its low-risk approach to underwriting, which anticipated a change to 0 per cent, meant that its reserve margin allowance was a nominal £2m.
The decision to review the Ogden rate comes as a considerable coup for the insurance industry after some intense lobbying. It’s also good news for the taxpayer, who was likely to foot a £1.2bn increase for mis-treatment damages paid out by the NHS. Under a new system, the Ogden rate is likely to be set using low-risk investments rather than very low-risk investments, equating to a new rate of somewhere between zero and 1 per cent.
