The UK's discount rate used to calculate bodily injury compensation is likely to increase to between 0% and 1%, the Ministry of Justice (MoJ) announced this morning.
Known as the Ogden rate, in February the government reset the rate from 2.5% to -0.75%, with effect from March. The drastic cut was heavily criticised by the insurance industry.
Many insurers including Aviva, Admiral and Direct Line took a hit to their profits, as they were forced to boost their reserves in anticipation of higher claims costs. These costs were immediately passed on to insurance buyers in the form of higher premiums for motor and liability policies.
The government also admitted that the lower rate would mean compensation paid by the National Health Service would soar, and set aside an extra £1.2bn ($1.6bn) a year.
However, following a consultation in March to examine the methodology used to calculate the rate, the MoJ concluded claimants often take more investment risk than the law currently assumes.
"The changes, proposed in draft legislation, mean the rate would be set by reference to 'low risk' rather than 'very low risk' investments as at present, better reflecting evidence of the actual investment habits of claimants."
The MoJ estimated that in the current markets, this methodology would produce a rate of 0%-1%.
The proposals will also ensure the rate is reviewed more regularly in future – at least every three years – and extend the expertise available to the Lord Chancellor in carrying out the reviews by creating a role for an independent expert panel in the process.
Market reactions
The Association of British Insurers (ABI) welcomed the proposal, describing the rate as "fairer for claimants, customers and taxpayers alike".
Huw Evans, director general of the ABI, said if implemented, it will help relieve some of the cost pressure on motor and liability insurance.
"The reforms would see the discount rate better reflect how claimants actually invest their compensation in reality and will provide a sound basis for setting the rate in the future," he said.
Dave Matcham, chief executive of the International Underwriting Association (IUA), said the plans promise to establish a "much fairer and more realistic assessment" of investment strategies.
The IUA supported a move away from basing the Ogden rate on index-linked government bonds.
"Assessing the rate against a wider range of investment products is a move that has widespread support. Its effect will be to create a more efficient insurance marketplace to the benefit of businesses and consumers across the UK."
Stephen Hester, group chief executive of RSA said: "We welcome the proposed reforms, which much better reflect the realities of how claimants invest their compensation payments today, and provide a means to continue to review the situation over time. If passed, the benefits will be felt by all our customers, helping to stop the rot of steep rises in premiums, which are having a disproportionate impact on costs for motorists, businesses and the NHS."
Mohammad Khan, UK general insurance leader at PwC, said if the proposal gains parliamentary approval, motor insurance rates should remain stable for the next six months, but warned: "If the legislation is not passed, it could mean motorists facing steep premium rate rises early next year.
"The announcement will also be welcomed by motor insurers, some of who's results at the half year were adversely affected by Ogden. If passed before the year end, it should bring some relief to motor insurers."
The Institute and Faculty of Actuaries (IFoA) said it was disappointed with the announcement, as it believes what claimants should receive as a lump sum compensation and how they invest it are two separate issues.
IFoA president Marjorie Ngwenya said: "Claimants should receive compensation that does not force them to take on any investment risk. A system which leaves individuals open to investment loss is not one which places the needs of the injured party at the centre of the compensation process."
She added that claimants receiving lump sums are already at risk. "If they live longer than expected, they could be left without any money. Forcing claimants to then manage the investment of their lump sum places too much risk with them rather than those best placed to manage it: namely, insurers and government."
However, the IFoA welcomed the MoJ's commitment to review the discount rate every three years.
Lawyers say: no benefit to victims
The Association of Personal Injury Lawyers (Apil), the body that campaigned hard for a review of the Ogden rate, said it will examine the MoJ's response.
Apil's president Brett Dixon said: "Insurers say an increased discount rate will 'benefit' customers through their premiums. It is of no benefit if they are severely injured and forced to take risks with the compensation they so desperately need."
- The government's consultation response is available here and the draft legislation is available here
