The UK motor fleet and liability market is reeling from the effects of the change in Ogden discount rate that came into effect from 20 March 2017. But what can clients expect to happen with their insurance renewal rates now? And what will happen in the future, read on to find out more.
What is the Ogden rate?
The Damages Act of 1996 outlined rates of life expectancy for men and women for future care costs and loss of earning calculations when settling large claims which would include future earnings, dependent sand future care costs. When a lump sum is awarded to an injured third party it is assumed that interest will accrue in excess of the rate of inflation.
What has happened to the rate?
In 2001, when RPI was 1.34% and the Bank base rate was 5.75% the rate of 2.5% was first set. It is represented a discount to allow for the rate of investment return, above inflation, that is anticipated to be enjoyed on any settlement. At the time the Courts could expect a £100 award invested to return a 4.36% yield which was outpacing inflation – a worked example
Award £100
Discount - 2.5% £97.50
2002 value of £100 with RPI £101.34
£97.50 plus 4.365% £101.75 3 year gilt yield 4.365% as at 2001
The Lord Chancellor has always had control of this rate but despite much debate since the banking crisis in 2008 has only adjusted this for the first time in February 2017, sixteen years later, the RPI is 3.5% and the Bank base rate is 0.25%.
The Lord Chancellor ruled that the 3 year average Government gilt yield should be used as the measure of current investment yield. Gilts, as widely reported, are at an all-time low due to economic factors and pension fund inflation fears. Fortunately the rate that was achieved by the Bank of England in October 2016 of RPI -1.72% for £850m of gilts sold on a 20 year bond was ignored. A compromise rate was decided at -0.5%.
Award £100
Discount of -0.5% £100.50
2018 value of £100 with RPI £103.50
£100.50 plus 1.5% £102.01 3 year gilt yield 1.5%
Arguably the rate is still above gilt yields and not the lowest that could have been justified. The industry would argue that typical investment returns are higher than this particularly in view of current strong equity prices.
Is this real or just an excuse for increases?
As brokers and customers of insurers we typically look at these situations with a degree of cynicism. Initial reports were that Philip Hammond; Chancellor had meetings with the Lord Chancellor over revisiting this decision and redrafting how the 1996 Damages Act is structured. However following the announcement of a snap election, the earliest any reform in rate is likely to be considered is January 2018. Insurers have now had to account for losses in the first quarter of 2017 as follows:-
- Aviva £385m
- Axa £50m
- Direct Line £215m
- QBE £160m
- NFU £72m
- Zurich £105m
The Regulator considers the impact to be in excess of £1bn in the motor market and a similar amount for NHS compensation claims. Politically you would like to believe this needs redressing. Ironically the biggest beneficiary of the Ogden changes is the personal injury legal profession. Most lawyers have moved to charging for their services by taking a percentage of the compensation.
What does this mean for real claims costs?
Only larger claims, typically over £20,000 up to £5,000,000 are affected by this change. Above this level Insurers are forced into structured settlements where payments are made year by year and reviewed periodically. A worked example of the new rate looks as follows:-
£25,000 loss of annual earnings plus a £75,000 annual care bill for a 30 year old.
Claim settlement increases from £2.79m to £6.3m.
Now that is a dramatic increase in the provision of claim reserves.
Why not use structured settlements?
We have seen a trend in insurers settling motor and liability claims more quickly. This is partially due to new legal timescale rules introduced in 2015 but more significantly the Solvency II regulations introduced by the Bank of England in January 2016. Following Solvency II insurers have to reserve for future economic and inflation uncertainty. The Regulator typically requires annualised top ups of circa of 11% over any straight line reserve. This is unfortunate as the Court system prefer structured settlements as they want to see claimants correctly compensated. An early demise warrants a reduction, for example, or a worsening condition that then needs increasing care an increase.
What does this mean for my insurance?
The Daily Telegraph suggested that for the average car insurance premium of £718 a 15% rate increase could be expected. The issue at hand is far greater in effect than the 2015 changes on nuisance whiplash claims and capped solicitors costs. (Valued at £200m for the total industry)
Insurers are concerned particularly on Haulage and Distribution fleets that claims for serious injuries that once happened regularly in the
£50,000 to £100,000 bracket will now be
£100-£250,000. Traditionally insurers have worked on a 30% costs and expenses ration above claims settlements. However another
10% -25% will be needed to fund these serious losses and related reinsurance costs.
Reinsurance rates will put a sting in the tail for later in the year!
The short-term good news is that this announcement came after most insurers concluded their reinsurance agreements - a process where they protect their balance sheet against large claims by agreeing a rate on premium for certain levels of protection. A small insurer may reinsure any one claim above £500,000 whilst a larger more diverse insurer may have up to £25m any one claim limit in place before reinsurance kicks in.
Large claims could now be calculated at
x2 or x3 of their previous level. This will clearly have a number of implications later in the year when insurers seek to renew their reinsurance programme (generally 31st December).
What can I expect now and later in 2017 and beyond?
Rates will begin to increase throughout 2017. Each insurer will have a different view on the adequacy of their claims reserves, the performance of their book of business, expected retention levels and balance of book. We are seeing
7.50-20% on liability rates and
10-30% on motor at present.
As we become nearer to the reinsurance renewal season, I would expect to see insurers forced to increase their self-retention level on large claims, this will mean that in the example above the smaller insurer will be forced to reinsure above £1m any one claim and the larger insurer
£37.50-50m any one claim and both with rate increases.
So if they are having to take double the large claims provision, then we can expect premiums to substantially increase to fill the large balance sheet gap that will appear - I would not be surprised to see
+50% on risks that have high risk exposure or a history of claims.
Some insurers may decide to pull out of certain sectors altogether - thus pushing rates further as a lack of capacity and competiton takes effect.
And what about your present policy limits? Are they now adequate?
Hopefully you have reached this far! There are a number of strategies that you can adopt now – please feel free to contact us to have a no obligation consultation – 01245 449061 – info@ascendbrokingold.co.uk
Matthew Collins
Managing Director
Ascend Broking Group Ltd
