It is now a month since the UK Lord Chancellor ruled that
the discount rate applied to lump sum bodily injury claim settlements – the 'Ogden rate' - would be reduced from 2.5% to -0.75%. Although a change was anticipated, the magnitude of it surprised many insurers, with the value of care costs in some 'long tail' claims tripling as a result. Much of the impact will be borne by reinsurers through excess of loss treaties, and it is anticipated that UK consumer motor insurance prices will have to increase as a result of this ruling.
The Ogden rate was last changed 16 years ago when interest rates were higher than today. Many other European countries also have 'out o date' insurance claim discount rates that no longer reflect a real risk free return. For example Germany, where both the annuity and lump sum portions of bodily injury claims can be discounted at up to 4%; or Switzerland, where lump sums are discounted at 3.5%. Could the Lord Chancellor's decision be a catalyst for wider change, impacting insurers across the continent?
The impact of further potential changes could be equally significant in other countries. A recent study by my colleagues and I suggested that a theoretical standalone annuity portfolio with a moderate asset-liability mismatch would have its solvency coverage ratio reduced by 40 percentage points as a result of a 50bps change in the discount rate. While this is hypothetical scenario that doesn't reflect the reality of insurance companies after diversification of business lines and capital charges, if the claims revaluation were to flow through the income statement (as was the case with Ogden in the UK) this may be sufficient to negate an insurer's entire annual profit.
As well as one off-hits to solvency, bodily injury claims reserves can make insurers' ongoing results vulnerable to factors with little correlation to 'pure' insurance risk. In some countries the discount rate is not fixed by official decree, but instead follows an index. In France, the annuity portion of bodily injury claims is discounted at 60% of the 24 month average of the 10 year government bond yield. Reserves are adjusted every month, potentially leading to volatility in an insurer's profitability, especially as corresponding changes in asset valuation do not flow through the income statement.
Underpinning these issues is the long term nature of some bodily injury claims, as changes in discount rates are compounded year on year, for the whole life / working life expectancy of the claimant. Compared to life insurers, general insurers providing motor and workers' compensation insurance typically have less experience with such long tail claims. While insurers that are part of a composite may be able to transfer the annuity to a life department, the duration of some bodily injury claims can even extend well beyond a life insurer's comfort zone, as the life expectancy of a young claimant can exceed that of a recent retiree.
I am eager to hear your views on these challenges.
Location: London, United Kingdom