News analysis: Insurers take a hit from discount rate cut

Lord Chancellor Liz Truss shocked the insurance sector in February when she announced that the discount rate, otherwise known as the Ogden rate, would be cut from 2.5% to minus 0.75%.

The rate, designed to ensure injury victims receive the right pay out, had not been moved since 2001 and affects motor and liability claims.

The change came into effect on 20 March and left insurers slashing their profits as they attempted to cushion the burden of additional personal injury pay outs.

Truss commented when the change was announced on 27 February: “The law is absolutely clear – as Lord Chancellor, I must make sure the right rate is set to compensate claimants.

“I am clear that this is the only legally acceptable rate I can set.”

Rising costs

Some in the sector had expected the rate to be changed to 1%. Willis Towers Watson calculated before the announcement that at a rate of minus 0.5% the cost of insurance would rise by £700m and the one off charge could be as much as £4.9bn.

As it stands the impact is going to be even greater as insurers scramble to ensure there is enough in reserve for claims to be paid at the minus 0.75% rate actually set.

The insurance sector, while united in stating that personal injury claimants deserve the right compensation, reacted angrily to the change. 

The Association of British Insurers (ABI) called the move “crazy”. It described the new calculation as being based on a “broken formula” and “reckless in the extreme”. 

ABI director general Huw Evans commented: “We have repeatedly warned the government that this could lead to very significant price rises, with younger drivers in particular likely to find it much harder to get affordable insurance.

“It is also a massive own goal that lands the NHS with a likely £1bn hike in compensation bills when it needs it the least.” (see box below).

“Massive impact”

Similarly, the leaders of almost all the insurers also lined up to denounce the process. Tulsi Naidu, Zurich’s UK CEO, said: “This change today [27 February] will have massive impacts for customers – motorists, businesses and public services – and at a time when they can least afford it. 

This change today [27 February] will have massive impacts for customers – motorists, businesses and public services – and at a time when they can least afford it

Tulsi Naidu

“What is worse is that it was all entirely avoidable. We stood with the rest of the industry and warned the Lord Chancellor of the impacts of such a draconian change but this has fallen on deaf ears.” 

Steve Treloar, managing director of general insurance at LV, stated: “We absolutely believe that people who are seriously injured should be properly compensated but the method used by the Ministry of Justice to set the discount rate is obsolete and in need of reform. We urge the Ministry to work with all parties to agree a fair way forward.”

The market-wide negative responses and the vociferous reaction from the sector forced a meeting between Chancellor of the Exchequer Philip Hammond and 15 insurance CEOs on 28 February, where they called on him to intervene.

It is unclear how much premiums will rise, but it is certain that they will and they could be significant

Mike Dickinson

New framework

The success of the meeting was partial, the government offered no changes to Truss’ new rate, but did concede to consult on a framework for setting rates in the future.

The insurance market pledged to contribute fully to the consultation while the government promised to push forward with necessary legislation on the issue.

The fact that the Chancellor met with insurers the day after the decision was made and committed to an urgent review is telling

Amanda Blanc

Amanda Blanc, CEO, Axa UK, reacted to the meeting outcome, stating: “The fact that the Chancellor met with insurers the day after the decision was made and committed to an urgent review is telling. 

“He should hold to his commitment and act swiftly, as the consequence of lowering the discount rate will be felt by families and businesses across the country in the coming weeks and months.”

The financial hit to insurers was soon clear, with profits and combined operating ratios deteriorating as figures were adjusted in order to account for the recalculated pay outs (see graph above).

Even before the rate change was confirmed providers and brokers outlined their concern about potential changes, but no one imagined the rate would be slashed to minus 0.75%.

Ageas UK CEO Andy Watson warned that a “flawed process” would lead to a “flawed outcome”. Ageas had reserved €55m [£46.4m] in its 2016 accounts anticipating the rate being cut to 1%.

Difficult conversations

Brokers meanwhile were worried about how these additional costs could change the conversations they need to have with their customers. 

Andrew Gibbons, managing director of Mason Owen, pointed out that brokers “cannot influence what happens once the rate is set”. He accepted it would lead to having to explain to clients why premiums had increased.

Seventeen Group’s CEO Paul Anscombe warned that the discount rate, plus IPT, could make relationships between brokers and clients “volatile” for a time. He called on intermediaries to engage with their customers to explain what is happening sooner rather than later. 

Broker Russell Scanlan was quick to offer advice when the new rate came into force. Mike Dickinson, sales and marketing director, commented: “Our advice to businesses is simple: plan ahead now for the rise in premiums which will come as a result of this rate change. It is unclear how much premiums will rise, but it is certain that they will and they could be significant.”