discount rate - what insurers can do now
20 December 2016
The Lord Chancellor has announced that she is reviewing the UK Court discount rate for personal injury lump sums. It appears a new rate may be announced as early as January 2017.
It will be interesting to see how this is affected by the legal challenge from the ABI and, if there is a delay, whether this prompts a resurrection of the legal action threatened by the Association of Personal Injury Lawyers.
A change in the court discount rate could have a substantial impact on firms with exposure to UK personal injury claims. The current discount rate (a real rate of 2.5%pa) was set in 2001. By comparison, current long-dated real yields are about -1.5%pa.
The key thing that we are helping firms with right now is developing and testing methodologies for quantifying the impact on reserves, capital and pricing.
There is more to this than meets the eye, because of the uncertainty about:
- what the new rate will be
- when and how it will be implemented and
- when and how it might change in future
There are also a number of potential knock-on effects. For example, PPO propensity may reduce if lump sums become more attractive. Also, there could be a slow-down of claims settlements while everyone awaits the outcome of the review, followed by a catch-up after the announcement.
For 2016 year-end reporting, given the current uncertainty, there is a question of whether the best estimate reserves should be loaded for some assumed degree of movement in the discount rate or whether disclosure of a sensitivity analysis will suffice. There is also the question of what to do if the rate is announced prior to the finalisation of accounts.
It's worth discussing these issues with your auditors early to avoid any surprises.
Risk and capital
It's difficult to say how much impact the discount rate change should have on firms' capital requirements, in particular the tail scenarios that tend to drive the assessment of capital.
It's important to be able to model the potential effects, including the compounding effects of other claims drivers such as inflation and longevity.
On pricing, the big question is how soon markets will react and by how much. We've seen markets get it wrong in recent years, eg the large price reductions offered by some motor insurers immediately following the LASPO reforms.
A particular issue in this case is how to price in some of the knock-on effects of the discount rate change. Also, some insurers have been offering enhanced lump sums (to avoid going to court or paying a PPO), so some degree of movement in the discount rate is arguably priced in already.
Responding effectively to change
Regardless of the political and legal debate, insurers should prepare now for a change. As is often the case, the insurers who are able to respond most effectively to the change will be those who have good control over their data and modelling capabilities.
Is the Lord Chancellor adding insult to injury claims? See our latest update on the Ogden rate change. Click here