Consumers to feel pain of injury payout changes as insurers take hits

Consumers face higher insurance premiums after a bigger-than-expected cut by the government in the discount rate to calculate personal injury claim awards led to insurers facing one-off write downs.

In a decision described as "crazy" by the Association of British Insurers (ABI), the 'Ogden rate' was reduced to -0.75% from 2.5% which the industry said would increase the cost of personal injury claims in England and Wales.

Set at 2.5% since 2001, analysts were expecting it to be reduced to 1% or 1.5%. Lord Chancellor Liz Truss said the cut reflected the fall in index-inked gilt yields, which are used in the calculation.

The announcement knocked shares in general and motor insurers this morning, with Direct Line Group shares down 7.5%, Admiral 3.1%, Esure 3%, Hastings a very slight 0.13% and Novae 3.48%.

Admiral said it would take a £70m-100m hit on 2016 profits. Direct Line said it would reduce profit before tax by between £215-230m after reinsurance recoveries, though this was not as bad as it had feared. Industry peer Hastings said it would make a one-off £20m charge, while Esure Group said it would not be as badly affected. Novae said it would expect a total hit of around £55m.

Truss said the changes were necessary, adding that it was the "only legally acceptable rate I can set".

"Today’s decision, as well as seeing compensation payments rise, is also likely to have a significant impact on the insurance industry and a knock-on effect on public services with large personal injury liabilities – particularly the NHS," she said.

The Ministry of Justice (MoJ) said when victims of life-changing injuries accept lump sum compensation payments, the actual amount they received was adjusted according to the interest they could expect to earn by investing it.

In finalising the compensation amount, courts apply the discount Rate, with the percentage linked in law to returns on the lowest risk investments, typically Index Linked Gilts. The law states that claimants must be treated as risk averse investors, reflecting the fact that they are financially dependent on this lump sum, often for long periods or the duration of their life.

Compensation awards using the rate should put the claimant in the same financial position had they not been injured, including loss of future earnings and care costs, the MoJ said.

Increased motor and liability premiums

In a furious response, ABI director general Huw Evans claims said claims costs would soar and make 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 36m individual and business motor insurance policies could be affected in order to over-compensate a few thousand claimants a year," Evans said.

“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."

“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 £1bnn hike in compensation bills when it needs it the least.

As a direct result of this change, PwC said it anticipated an increase of £50-£75 on an average comprehensive motor insurance policy, with potential increases of up to £1,000 for younger drivers and a rise of up to £300 for drivers over 65 years old.

"This announcement, on top of the recent increases in insurance premium tax, will make redundant any savings to premiums as a result of the government’s personal injury legal reforms which were anticipated to generate approximately £40 saving per motor insurance policy," said PwC's Mohammad Khan.

Hargreaves Lansdown equity analyst Nicholas Hyett said consumers will end up paying the cost of the change through increased premiums as the sector raised prices to reflect the increased compensation payouts.

"Higher prices should help the industry to largely offset the impact on profitability in the longer term. If prices in markets such as motor insurance, which has significant exposure to personal industry claims, do start to increase then it’s a potential windfall for the price comparison industry, which should benefit from the increased switching that usually accompanies rising prices."

"Today’s discount rate is lower than some companies had expected, with esure for example budgeting for a fall to 0%. That will negatively impact full year results for 2016 as well as affecting the loss rates on any business written up to this point. However, in the longer term the impact on insurers is likely to be limited.”

Insurance companies count the cost

Admiral said it was postponing the release of its annual results by a week to March 8 to allow the full impact of the change to be reflected.

“The majority of the financial impact in respect of premiums earned during 2016 and prior years will be reflected as a one-off charge against 2016 second half profits,” Admiral said in a statement.

It estimated the total net financial impact of all claims settling at the new rate at £140m - £175m, adding the final dividend should be held at 51.5p a share.

“The group anticipates that if market pricing adjusts future premiums to reflect the lower discount rate, there will be no significant impact on future business and its profitability after the change,” Admiral said.

Direct Line said the change would reduce profit before tax by between £215m and £230m after reinsurance recoveries, increase its combined operating ratio for ongoing business by approximately 6 percentage points and reduce its year end Solvency II capital coverage ratio before dividends close to the higher end of the group's target range of 140-180%. As at 30 June 2016, the Group's Solvency II coverage ratio was 184% after interim dividends.

Last week Direct Line estimated the change would have less of an impact on the business than it previously thought and also deferred its 2016 results to March 7 from February 28.

The company said it had already been applying a lower rate of 1.5% in its calculations of injury claims liabilities, given the potential for a reduction.

In its 2015 results, Direct Line had said that its profit before tax sensitivity to a 100 basis points increase/decrease in the discount rate around the group's assumed rate of 1.5% was £131.9m, a loss of £190m.

As at the end of 2016, however, the group said its sensitivity to a 100bps increase/decrease in the discount rate is “materially lower” than indicated in the 2015 annual report.

Esure said its 2017 capital position would only be hit by £2m but its reserve margin allowance had to be increased to £3m from £2m.

Novae said it would meet the initial cost through reserve releases and a reduction to 2016 profits. However, also said it would consider the impact “when assessing the appropriateness of a final dividend”. Novae rescheduled the release of its 2016 results to March 9.