Change to discount rate will have major impact on insurers

This morning’s announcement by the Lord Chancellor, changing the discount rate used in calculating lump sum personal injury awards in England and Wales to -0.75%, will have a major impact on insurers, reinsurers, claimants and policyholders, as well as the NHS. At its core, the consequences of this decision highlight the basic nature of insurance with the higher cost of compensating injured people being spread over policyholders (both individuals and businesses) through raised insurance prices.

For claimants, this reduction in the discount rate will lead to much higher lump sum compensation amounts. However, a lump sum award means claimants still run the risk of running out of money if they live longer than expected, or their future costs are higher than expected when determining the lump sum. Claimants also face investment risk, if the real investment return they achieve after inflation, tax and expenses falls short of the new assumed rate of -0.75%. Although the increase in the amount of lump sums will now reduce that risk, the change to the discount rate does not settle the question of whether a lump sum award best meets the long term needs of the claimant. Periodic Payment Orders remain an alternative means of compensation which will continue to be suitable for many claimants as part of the overall compensation award.

Insurers will directly bear the financial consequences of the change to the discount rate. The ultimate settlement of outstanding claims will be greater than previously anticipated. Insurers will have to draw on reserves or raise additional capital to make those increased payments, and will also have to consider carefully the impact to the prices they charge for insurance policies, particularly motor insurance and employers’ liability.

Policyholders are likely to face increases to premiums, but this may vary by specific groups of policyholders. If insurers identify groups of policyholders that have the greatest risk of causing a severe bodily injury, those groups may face larger increases, while other lower risk groups of drivers may experience smaller changes to premiums.

We welcome the Lord Chancellor’s decision to consult on the framework for deciding on an appropriate methodology for settlement of these awards. The IFoA looks forward to making a significant contribution to that discussion. We would also welcome statements about the discount rate from the Scottish Government and the Department of Justice in Northern Ireland to clarify what will happen in those jurisdictions.

Michael Tripp, Chair of the Institute and Faculty of Actuaries’ General Insurance Board, said

“Today’s changes to the discount rate for calculating lump sum injury awards will have a major impact on insurers, reinsurers, claimants and policyholders. Whilst the resulting increased lump sums awarded for personal injury claims mean that the claimant is at less risk of running out of money, the question remains whether one-off payments are the most effective means of compensation for life-changing injuries.”