Now that the discount rate has changed, what’s next?

By Joe Pendle June 19, 2017

Insurers are still reeling from the drastic change in the discount rate that went into effect 20 March 2017. The rate is used to adjust lump-sum compensation payments according to the interest that claimants are expected to earn by investing it. Historically, the rate has adjusted settlements down, but poor returns on investments have led to a different scenario entirely—as the rate has been cut from 2.5 per cent to minus 0.75 per cent. Catastrophic injury claims, whilst small in number, account for a large portion of costs spent on injury claims. Therefore, this change has been estimated to cost the insurance industry between £17 million and £100 million per year.

After a 16-year gap in government review of the discount rate, officials are now considering how to move forward. One idea is to conduct yearly reviews of the discount rate. What would that mean for the industry? Knowing that claimants and their solicitors would be wishing to get the largest lump sum possible, the unwieldy scenario of claims being paced in response to anticipated changes in the discount rate may play out. In other words, if the discount rate were expected to drop (giving claimants more cash), solicitors might stall settlements until the change went into effect. Conversely, if the rate were expected to rise, we could expect the pace of settlement to be hastened so that the claimant benefits from the better rate. The difference in cash payouts could be huge—and would change in a day. Big winners and losers on both sides would create a process full of tension as the discount rate change date approaches.

As the government looks at ways to move forward, it’s important to be sensitive to industry solvency issues generated by changes in the discount rate. One approach to consider is to broaden the use of periodic payments versus lump-sum payments. For claimants, periodic payments would ensure money for continued care for the entire life of the injured party. For insurers, the periodic payments—since they are smaller yearly payments—would add a bit more stability to future changes in the discount rate.

While the unintended consequences of premiums, loss ratios, and profitability have not yet been fully seen, we’ll be closely watching the impact of discount rate reform as it moves ahead.