On the surface the personal injury market is fairly straightforward, an incident occurs, a court case is arranged and liability is ruled upon by the judge. Of course we know that the personal injury market is nowhere near as straightforward as this and there would appear to be a further complication on the way.
Liz Truss, the Lord Chancellor, has already shaken up the personal injury market with her whiplash claim reforms but if the rumours are correct there could be some even greater tremors on the way.
The Ogden Rate
The Ogden rate is not something openly discussed by those outside of the legal and insurance profession but it is central to potentially 40% of total claims costs. While this may mean nothing to the person on the street, changes to the Ogden rate will change the way in which compensation payments are calculated.
At the moment the range for the Ogden is set at -2.00% to 3.00% (recently revised from 0.00% to 5.00%) with the actual figure currently 2.5%. In layman’s terms this is the discount rate used to calculate how much compensation should be paid today bearing in mind an assumption of how much interest the funds will earn going forward.
In traditional markets it would not be outrageous to consider a 2.5% increase per annum but in the current low interest rate environment that figure does not bear any resemblance to the marketplace today. So, what does this mean for compensation payments going forward?
Higher Initial Payments With Lower Returns
It goes without saying, if going forward £x is required to fund medical treatment and other expenses then a lower return on funds held on deposit awarded will automatically mean a higher initial compensation payment. There are all kinds of rumours swirling around the industry with many trying to guess what Liz Truss will announce next month.
It is obvious that the current discount rate of 2.5% is way out of kilter with the market and this will likely fall dramatically. While there are rumours suggesting the government will move to a -0.5% discount rate this seems very unlikely with a figure around 1% or 1.5% more likely. On the surface a 1% reduction in the discount rate seems negligible but if you assume that some compensation payments may be required to last 20 years or more, the figures very soon start to change.
In Practical Terms What Does This Mean?
As we touched on above, it could mean a potential 40% of total claims costs will be influenced by the change in the Ogden rate. Indeed, Direct Line has gone as far as to suggest a reduction of one percentage point in the Ogden rate would hit profits by £90 million per annum over and above current reserve margins. This figure may seem extremely high but when you bear in mind the billions of pounds of compensation payments made each year in the UK, it seems perfectly plausible.
If this level of increased cost was replicated right across the industry we can only imagine the additional billions of pounds in costs incurred by the insurance companies.
Many of us may sit back and assume that the insurance companies can afford these increased costs and in many ways it is payback time. If only the situation was that simple!
Who Will Pay In The End?
At the end of the day who always pays for increased costs in business? Yes, consumers will eventually be hit with increased premiums if Liz Truss goes ahead with her potentially game changing revision to the Ogden rate.
It is very unlikely she will move the rate below 0% but even a change to 1.5%, as highlighted above, would have a massive impact upon insurance company profits. This in turn will lead to increased premiums across the board and while the government might be “doing its best for victims” it is the good old consumer who will eventually pay the price.
Is It Really Time To Move The Rate?
Whatever the consequences for businesses and consumers there is no doubt that the current Ogden rate of 2.5% does not reflect market conditions. It is also fair to say that a rate below 0% seems well out of kilter so we can assume with some confidence the rate will be somewhere between 1% and 1.5%. It is only when you annualise the change in the discount rate that you begin to see the impact on insurance company profits.
On one hand we have the Association of Personal Injury Lawyers campaigning in favour of a reduced Ogden rate while the Association of British Insurers (ABI) has attempted a number of legal challenges. The ABI seems to have used every manoeuvre in the legal handbook to delay any change to the discount rate but after losing their last attempt to delay the decision by the government the ABI was refused leave to appeal. Therefore, it would appear that all legal challenges have so far been thwarted and we await with anticipation the announcement in February from Liz Truss.
Why The Secrecy And Confusion?
The UK government initially ran a number of consultations back in 2012 and 2013 but for some bizarre reason the results were never released into the public domain. It is difficult to understand why the results of these consultations were never made public because surely that is the whole purpose of this process?
We all know that investment markets react badly to a lack of clarity and situations where information vacuums breed rumours and counter rumours. It is also worth noting that the UK government has recently attempted to reduce insurance premiums across the board yet a reduction in the Ogden rate would effectively undo all of their work so far. If you look into the personal injury market there is no doubt that reforms are required but whether giving with one hand and taking with the other is of any benefit to anybody is debatable.
The little known Ogden rate could become headline news over the next few weeks and have a major impact upon the level of insurance premiums for UK businesses and consumers. On the surface, a 1% reduction in the discount rate seems negligible but in reality it can have a major impact upon initial compensation payments where funding may be required for years to come.
It is a little difficult to understand why the UK government has chosen the last couple of years to reform the insurance market, reducing premiums via whiplash reforms yet potentially undoing all of the work before by reducing the Ogden rate.
The next few weeks will be a very interesting time for the insurance industry!