Supplementary evidence from the Association
of British Insurers (CMI 13a)
1. The UK insurance industry is the third largest
in the world and the largest in Europe, it is a vital part of
the UK economy, managing investments amounting to 24% of the UK's
total net worth and contributing the fourth highest corporation
tax of any sector. Employing over 275,000 people in the UK alone,
the insurance industry is also one of this country's major exporters,
with a fifth of its net premium income coming from overseas business.
2. EXECUTIVE
SUMMARY
2.1 The ABI has already submitted a response
to the Transport Select Committee regarding the rising costs of
motor insurance. This supplementary submission should be read
in conjunction with our earlier evidence. This submission outlines
the ABPs position with regard to the Lord Chancellor's recent
confirmation of his intention to conduct a review of the discount
rate. For the reasons outlined below, the ABI strongly opposes
any reduction in the discount rate as this will lead to substantially
increased costs to insurers, which will ultimately have to be
passed onto consumers through higher insurance premiums.
3. THE DISCOUNT
RATE
3.1 The discount rate is used to calculate the
size of the lump sum payment awarded to a claimant to meet their
ongoing needs. The discount rate is applied to all lump-sum payments
(but not to periodic payments which are paid, as the name suggests,
in regular instalments) and is set by the Lord Chancellor pursuant
to section 1 (1) of the Damages Act 1996.
3.2 All insurers are bound to apply the discount
rate set by the Government to lump-sum payments of compensation.
The discount rate set by the then Lord Chancellor in 2001 was
based on yields generated by index-linked government securities
(ILGS) and was calculated at 2.5%. The current Lord Chancellor
confirmed he is reviewing the discount rate in early November
2010, following pressure from the Association of Personal Injury
Lawyers.
4. IMPACT ON
THE INSURANCE
INDUSTRY AND
ITS CUSTOMERS
4.1 Any reduction in the discount rate will have
an immediate effect on the settlements made by the industry. Reducing
the rate from the current level of 2.5% would lead to a smaller
discount being applied to compensation payments and, therefore,
significant and immediate increases in settlements which would
have both a retrospective (i.e. claims filed but not yet settled)
and ongoing effect. These substantial and immediate increased
costs on insurers are likely to be passed onto consumers through
higher premiums.
4.2 ABI members have provided us with actuarial
calculations estimating the potential impact of a change to the
discount rate. This information has enabled us to estimate that
a reduction in the discount rate will result in immediate and
ongoing extra costs to insurers amounting hundreds of millions
of pounds. As we indicated in our earlier submission (see paragraph
2.6), last year motor insurance made an underwriting loss of £1.5
billion - the 15th successive year the industry made an underwriting
loss. Against this background, it is difficult to imagine the
industry not passing on the increased costs associated with reducing
the discount rate to consumers through increased premiums.
4.3 It is important to recognise that these are
only the potential costs to the insurance industry. Any rate reduction
would also apply to compensation payments made by Government,
in particular through the National Health Service and the Ministry
of Defence.
5. CALCULATION
OF THE
DISCOUNT RATE
5.1 The ABI is not aware of any objective evidence
demonstrating that claimants are undercompensated. In the vast
majority of claims, future losses are settled on a conventional
lump sum basis, despite the facility for parties to agree, or
the courts to order, periodical payments, suggesting there is
a general acceptance by ail parties that opting for a lump sum
approach does not result in an award which is too low.
5.2 In addition, average yields from the investment
of lump sum awards are, in practice, likely to be, higher than
the conservative returns on which the calculation of the discount
rate is currently based. This suggests the discount rate should
be calculated on wider classes of assets than the current focus
on ILGSs. Doing so would bring payments into iine with how claimants
actually invest their compensation. This would also align the
UK more closely with other European countries - for example, both
Germany and Luxembourg have a 4% discount rate.
5.3 Although rates of return on ILGSs
are currently depressed, they can be expected to rise in time.
This may mean that ILGS yields over recent years provide an inaccurate
basis for the future projection of a net rate of return. Given
the current volatility of international financial markets and
overall economic conditions, the ABi believes that it is not possible
to make any accurate predictions about valuing future returns.
6. CONCLUSION
6.1 The ABI is not aware of any objective evidence
demonstrating that claimants are undercompensated. Any reduction
in the discount rate will lead to increased costs for consumers,
including motor insurance premiums. We, therefore, urge the Committee
to recommend that the Government not reduce the discount rate.
December 2010
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