Articles - The Past Present and Future of the Ogden Discount Rate

As readers will be aware, the Ogden discount rate - “ODR” – is the rate used to calculate the value of lump sum awards for personal injury claims. The ODR is meant to represent the investment return on the lump sum payment a badly injured claimant will receive from an insurer if they are injured in an insurance incident (e.g. a bad car crash). It sounds like a very technical and boring discount rate and up until two years ago very few people outside of the insurance industry knew what it was.

 By Mohammad Khan, Head of General Insurance and Partner of PwC LLP and Sundip Mistry, Senior Manager Nonlife Actuarial, PwC LLP.

 However, that changed with two recent significant moves in the ODR which significantly increased the cost of liability claims and therefore the premiums that all of us who drive cars pay.

 After 15 years of no change in the ODR at 2.5%, the insurance industry was surprised by two unexpected moves in the ODR. In December 2016 the then Lord Chancellor – Liz Truss - announced she would revisit the ODR. Most in the insurance industry expected the rate to move to 1%. However, in February 2017, the Lord Chancellor announced that she would move the rate to -0.75%. What did this mean practically? If you were a 21 year old man with a serious head injury your compensation increased by over £14m from £15.1m at 2.5% to £29.3m at -0.75%! However, it was not just the insurance industry that was surprised by this significant change. Critical illness claims paid for by the NHS were also significantly increased causing a much bigger liability on the Government balance sheet. In September 2017, the new Lord Chancellor – David Liddington – proposed that the Government would revisit the setting of the Ogden rate using a new measure. The rate, he announced, would be set with reference to how claimants actually invest their lump sum payments and would use “low risk” investments rather than “very low risk” investments. The statement from the Lord Chancellor indicated that “based on currently available information if the new system were to be applied today the rate might be in the region of 0% to 1%”.

 Based on this, the insurance industry expected the new ODR would be between 0% and 0.25% when the new announcement was made in 2019. However, when the new ODR was announced on 17 July 2019 it was to be -0.25%, effective from 5 August 2019.

 The new mechanism for the ODR means that it can be revised within the next five years and at most in five years time. For those in pricing this introduces further uncertainty as the liabilities that the ODR impacts often take 3 to 5 years to go to court to determine what the value will be. Conceivably accidents that occur later this year may be subject to the next ODR, not the current -0.25%.

 We understand that the Association of British Insurers (ABI) is in discussions with key supportive members of the House of Lords to table a prayer motion to object to the Statutory Instrument being used to apply the new ODR (i.e. if this motion is passed within 40 days of the Ogden discount rate announcement on 15th July, the new rate could be overturned). The ABI is also considering a judicial review.

 Whilst the move from 2.5% to eventually -0.25% has improved claimant payouts, what has the impact been on the millions of motorists who pay for motor insurance?

 There has been a misconception that the when the ODR moved to -0.75% that motor insurance and long term liability insurance pricing shifted to reflect this new ODR.

 However, that is not what happened. Due to discussions with Government and the September 2017 announcement from the Rt Hon. David Liddington MP, insurers priced motor and liability insurance assuming an ODR of about 0.5%. Insurers were relying on the statement that the new ODR may end up between 0% and 1%. Nearly all injury claims settled in this period - i.e. between 2017 and 2019 – were also settled assuming an Ogden rate of between 0% and 1%.

 Now that we have some certainty with the move to -0.25%, motor insurance and liability premiums will almost certainly rise in the second half of the year reflecting the lower than expected ODR. For motor insurance premiums in particular we also have the impact of higher than expected inflation on motor damage claims which increases the upwards pressure on premiums.

 In reality this means that the average motorist will pay about £15 - £25 more for their insurance premium by the end of the year. Younger (than 25) drivers – who historically account for 90% of the worst accidents that result in the severe injuries that the ODR impacts the most - will pay between £50 - £100 more per year for their insurance premiums.

 What does the future hold?
 The ODR is supposed to represent the investment return that a claimant would get by investing the lump sum given appropriate financial advice. With investment conditions uncertain for the foreseeable future - especially given the UK’s potential departure from the European Union, what a consumer may receive from a lump sum insurance premium could change significantly.

 From April 2020, the second part of the Civil Liability Bill - regarding whiplash injury payment reforms - will come into force. This could lead to potentially some further reductions in premiums for consumers. Given that motor damage claims inflation is currently running between 5% and 15% for insurers, the impact of this potential reduction may be mitigated.

 As one might expect for long tailed insurance, there is a lot of uncertainty within liability insurance and motor insurance and it will be interesting to see how insurers reflect this in their pricing in the coming year.


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