The UK government has today announced its decision to move the Ogden discount rate for bodily injury claims from -0.75% to -0.25%. This follows much speculation, with many insurers believing that the rate would have moved up to at least 0%, with the majority expecting the rate to be raised to between 0% and +1%.
The Ogden discount rate determines the size of lump sum awards claimants receive from courts for long-term injuries and illnesses. The purpose of lump sum awards is to allow claimants to be indemnified via a single payment rather than provide ongoing payments to cover loss of earnings and costs of care.
The previous methodology supposed what income a lump sum award would yield to the injured party if invested in a ‘very low risk’ portfolio of investments and accordingly calculated an appropriate discount rate to be applied to the lump sum. The rationale behind the Government’s announcement of a negative discount rate (of -0.75%) in February 2017 was grounded in the fact that the return on short term UK gilts and other ‘very low risk’ fixed income investments was less than the rate of inflation. Lump sums awarded by courts, therefore, needed to be revised upwards rather than discounted downwards in order to provide an equitable return to claimants.
The latest discount rate (of -0.25%) announced today uses a new methodology since the rate has been set to match the inflation adjusted return on a ‘low risk’ rather than ‘very low risk’ portfolio of diversified investments.
Lloyd’s Market Association head of non-marine underwriting David Powell has commented: “Whilst the change is positive for compensators, such a small movement that retains a negative rate is a severe disappointment and well below the level underwriters were expecting.” He felt that this was calculated on the basis of on “a very negative view of the wider economic factors that are assessed as part of the new rate-setting mechanism”.
Alpha comment: there was a ripple of disappointment across the insurance industry at today’s announcement and it is very much felt that a negative rate simply does not reflect the economic reality of the investment opportunities for those receiving lump sum payments. Whilst a discount rate is needed to ensure fair compensation for accident victims, this move was not as much as anticipated. This may also have the effect of halting any reductions in motor insurance premiums seen in recent months.
Following the previous change to the discount rate in February 2017, many insurers faced a significant hit to earnings as reserves needed to be topped up to reflect the movement from a discount rate of +2.5% to -0.75%. Since then, with such wide speculation that the discount rate would move to a positive number, many insurers chose to reduce their reserves and assume a 0% rate. This may have seemed optimistic, but these insurers were actually managing to settle their large compensation claims based on a positive discount rate (ie smaller awards). It is of course possible that this will still be the case, in that lawyers accepted and may continue to accept that lump sum payments can be invested and generate a positive return over and above inflation. So whilst this announcement is great disappointment to many in the UK insurance market, it is not expected to have anywhere near as great an effect as the 3.25 percentage point swing seen in 2017.