Car insurance premiums could rise by as much as £100 a year as providers are forced to increase the amount they pay out on serious claims.
The warning comes after Lord Chancellor Liz Truss and the Ministry of Justice announced changes to the Ogden rate.
This rate is used to calculate the compensation insurers pay to people who suffer severe and long-term injuries. If a claimant accepts a lump sum payment, the Ogden rate is used to ensure the consumer receives the correct amount after inflation and potential future earnings from interest are considered.
At present, the Ogden rate is set at 2.5% but this will change to -0.75% on 20 March 2017.
The Ministry of Justice says the change is to reflect that returns on government bonds are negative once inflation is taken into account.
But it means insurers must pay out higher sums as the value of this cash will depreciate over time. In effect, insurers will pay an additional 0.75% on top of a lump sum payment, rather than minus 2.5% from the lump sum like they do today.
This rate change is far bigger than the industry was expecting and has been described as “crazy” by the Association of British Insurers (ABI) trade body.
Insurance analyst, Consumer Intelligence, estimates that motorists will see their car insurance premiums rise by up to £100 per year. The total cost to insurers could reach as much as £3 billion.
This change predominately affects motor insurance policies, but separate changes to insurance premium tax (IPT) are also expected to increase the costs of premiums from June 2017.
‘It’s a crazy decision’
Huw Evans, director-general of the Association of British Insurers, says: “Cutting the discount rate to -0.75% from 2.5% is a crazy decision by Liz Truss.
“Claims costs will soar, making it inevitable that there will be an increase in motor and liability premiums for millions of drivers and businesses across the UK. We estimate that up to 36 million individual and business motor insurance policies could be affected in order to over-compensate a few thousand claimants a year.
“To make such a significant change to the rate using a broken formula is reckless in the extreme, and shows an utter disregard for the impact this will have on consumers, businesses and the wider operation of the insurance market.”
Ian Hughes, chief executive of Consumer Intelligence, adds: “Drivers will see their prices rising and will not be bothered about whether it is the Ministry of Justice or discount rates that are behind the premium increases.
“Average car insurance premiums will continue to accelerate and that is before yet another increase in insurance premium tax in June. Everyone should be shopping around to at the very least limit price rises.”
Meanwhile, Andrew Tyrie MP, chairman of the Treasury Committee, says: “Under the current legal framework, the Lord Chancellor appears to have had little choice but to reduce the discount rate from 2.5% to minus 0.75%.
“But the result will be sharp rises in people’s insurance premiums, and a big hit to the public finances.
“The principle that people should receive full compensation for the losses that they have suffered is a reasonable one. But implementing it in this way is probably not, and has a look of absurdity about it.
“Other ways of calculating the discount rate need to be examined, including one that reflects the long-term equilibrium risk-free yield. This is all the more important, given that the gilt markets have been heavily distorted since the financial crash, not least by emergency action to assuage its consequences, including QE.
“The Government is now consulting on how the discount rate should be set for the future. This is not before time. If changes to primary legislation are appropriate, controversial though they may be, the Government should consider them.”