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The Discount Rate – what it means for insurers and customers

The Lord Chancellor has announced a change in the discount rate, which is a figure used to help set compensation pay-outs when people suffer serious injuries, for example following a car crash or medical negligence. It has been reduced from 2.5% to -0.75, effective from 20 March 2017.

We want the discount rate to be as accurate a reflection as possible of what happens when people receive a lump sum payment, so it needs to reflect current investment practices and the investment environment.  Instead, the Ministry of Justice has announced a new figure based on an outdated method which risks distorting the compensation process and pushing up insurance premiums.

Director of General Insurance James Dalton has blogged about the issue. Read more here.

The Discount Rate: What do you need to know?

  • What products are affected by this change in the discount rate?

    The discount rate is used to calculate payments made under motor and liability policies. A change in the rate from 2.5% to -0.75% will cause a significant increase in the cost of claims. This means the change has implications for around 36 million motor insurance policies, covering both domestic and commercial vehicles. It also affects insurers who provide employer’s liability cover and those who sell public liability insurance to businesses.

    Public authorities who pay compensation, such as the NHS, will also be affected and will see their compensation bills increasing significantly at a time when their budgets are already under severe strain. 

  • Is this going to affect the cost of insurance?

    The discount rate impacts claims often worth millions of pounds so such a significant change in the rate will result in a significant increase in claims costs. Although each insurer will take their own pricing decisions in a competitive market, the pain will inevitably be felt by everyone.

  • Are some customers likely to be affected more than others?

    Yes. It’s likely that those groups most at risk of being involved in a claim for a serious injury will be most affected, such as young drivers and much older drivers. Businesses with high motor insurance costs such as road hauliers could also be particularly affected.

    Many businesses are required by law to buy motor and liability insurance, and this will add to their costs

  • What is the insurance industry doing about this?

    The insurance industry believes strongly in the principle of full compensation, to ensure severely injured people get the support they need for the rest of their lives. However the ABI was extremely concerned about the MoJ’s approach to this issue and took legal action to try to force the Lord Chancellor to finalise a public consultation exercise on the discount rate before announcing a new figure. The discount rate announced by the Lord Chancellor assumes that claimants would only invest their compensation in Index Linked Government Securities (ILGS), which is factually and legally wrong. The Lord Chancellor would appear to know this because she has announced an immediate consultation  on whether this should change.

    We believe more needs to be done to get the balance right between appropriate compensation for injured people and affordable insurance premiums for everyone else. We cannot wait until Easter for a consultation on this issue - the Ministry of Justice must commit to alternatives immediately so changes to the law can be included in the Prison and Courts Bill.

  • What does the discount rate do? Why does it exist?

    Insurance exists to ensure severely injured people get the help and support they need for the rest of their lives in the form of appropriate compensation. The ABI supports the principle of full compensation, which is that injured claimants should be neither under nor over-compensated.

    Some claimants will choose to receive their compensation in a series of payments over time but most will opt for a lump sum. Part of the process for deciding the appropriate amount is considering how that lump sum payment when invested will grow over time, meaning a claimant is able to earn a return on that money for the rest of their lives. The Discount Rate is applied to ensure that the lump sum takes account of the expected return. It is a calculation used by justice systems all over the world, the UK is not unusual in having a process of this type.