Motor (re)insurers face significant reserve charge from potential discount rate change, warns Willis Towers Watson
In addition, there would be a roughly £700 million per annum increase in the cost of providing motor insurance in the future.
Given the size of this charge relative to existing reserve margins and capital requirements, and the current market dynamics of the insurance and reinsurance markets, a sizeable portion of the cost will of necessity be borne by consumers.
Willis Towers Watson expects UK motorists will be required to fund the cost of this change to the tune of between £20 and £55 per policy per year depending on the speed at which the motor insurance industry looks to re-establish its balance sheet strength.
Stephen Jones, a Director at Willis Towers Watson, said: “As a result, it appears unlikely that motor insurance is going to get cheaper anytime soon with rates up around 14% last year and perhaps a further increase of between 13% and 19% during 2017 if the response by insurers to such an outcome were to be added to underlying inflationary effects.”
Andy Staudt, a Director at Willis Towers Watson, said: “Instead of being reviewed and updated on a regular basis to ensure compensation remains fair reflecting prevailing economic conditions, the Ogden rate has been left unchanged for 16 years. As a consequence, pressure has been building and appears to have reached a politically unsustainable level. The immediate impact of trying to defuse this pressure now will be painful in the short term as reserves for past claims that have yet been paid would have to rise, while the costs of future claims would also go up.
“We are living in fairly interesting political and economic times. The government has put themselves in a difficult position having committed to providing an opinion with the markets in such a state of short-term flux. An opinion which could easily need to be reversed in a year or two’s time.”
If the government does believe a change is warranted, the consultancy suggests a more measured approach would be to take baby-steps in order to reduce the one-off impact.
Willis Towers Watson estimates that by setting a discount rate of 1% – the mid-point between the current rate and that argued for by APIL – the one-off impact would be £1.7 billion and the ongoing annual cost would be approximately £200 million per annum for future business. Amounts that imply an increase of between £5 and £20 per policy per year.
“Whatever the government decides in the next week, perhaps the key lesson is that this rate should be either regularly reviewed and revised or pegged to an independent economic indicator so that we do not find ourselves in a similar position in the future – a pressure cooker waiting to blow,” said Andy Staudt.
When calculating the size of compensation awards, the courts have to make an assumption about how much interest the money will earn when it is invested. This assumption is known as the discount rate – the higher the rate, the lower the initial lump sum required. The discount rate has been set at 2.5% since 2001, but interest rates have fallen sharply since then
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