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12 Apr 17 15:27

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 Many other European countries also have 'out of
date' insurance claim discount rates that no longer reflect a real risk free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

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.

Category: Other

Location: London, United Kingdom


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