Direct Line and Admiral first insurance companies to reveal impact of personal injury payout changes
The Government's move to change the way personal injury compensation payouts are calculated has begun to have an effect on the profits of insurance companies, with both Direct Line and Admiral citing the changes as the reason for a slump in year-on-year profits in recent days.
Direct Line reported a 30% drop in profits to £353m for the year up to 31 December 2016, with the recent reduction in the personal injury discount rate apparently costing them £217m in profits. The discount rate - also known as the Ogden rate - is used to calculate the compensation paid to people who suffer life changing injuries, and without the change Direct Line would have actually recorded an 11% rise in profits which would have triggered the payout of a special dividend.
Following the news from Direct Line, Admiral followed suit and announced a £105m drop in profits to the year up to 31 December - which led their chief executive to call the discount rate change an "eccentric Government decision."
The change in the discount rate caused a drop of 25% in Admiral's pre-tax profits to £284.3m. Without the 'Ogden rate' change Admiral would have seen a 3% rise in profits.
The decision from the Ministry of Justice to reduce the discount rate from 2.5% to -0.75% came as something of a shock to the insurance industry when it was announced last month - with analysts expecting a more modest reduction of between 1 - 1.5%.
The new rules come into effect on 20 March 2016 and mean that insurance companies will be expected to pay more to claimants, which will likely increase premiums.
What is the Discount Rate?
The Discount Rate, also sometimes referred to as the Ogden Rate, is a calculation that is used by the courts to work out how much compensation should be paid out by insurance companies to those who have suffered life-changing injuries.
When a victim of such a severe injury accepts a lump sum compensation payment, the actual amount they are paid is adjusted according to the interest they can expect to earn by investing it.
This percentage rate, which has now been reduced down to -o.75% from 2.5%, is used to calculate future losses.
For example, under the old rate of 2.5%, the insurance company would be required to pay out £975 to a claimant to cover a £1,000 loss. That’s because:
£975 x .025=25
£1000 – £25= £975
In other words, as the claimant was reasonably expected to earn 2.5% interest a year on a lump sum payment of £975, which would give them the overall £1,000 that was awarded.
With the new -0.75% discount rate, the insurance company will have now have to pay £1,007.5 to cover £1,000 compensation because:
£1,000 x 0.0075 = £7.5
£7.5 + £1,000 = £1,007.5
By law, the Discount Rate is linked to returns on the lowest risk investments, typically Index-Linked Gilts. The yield on these gilts, or Government bonds, has fallen dramatically since 2001.
The MoJ says: “The law makes clear that claimants must be treated as risk averse investors, reflecting the fact that they are financially dependent on this lump sum, often for long periods or the duration of their life. Compensation awards using the rate should put the claimant in the same financial position had they not been injured, including loss of future earnings and care costs.”
Have you read..?