A review of the UK discount rate, used to calculate lump sum compensation payments, must break its current tie to index-linked government bonds, the International Underwriting Association has stated.
In a letter to the Lord Chancellor, the association called for legislation to establish a new methodology for how courts determine personal injury settlements.
Review periods should also be introduced to enable regular, more gradual changes to the calculation and avoid sudden, costly alterations.
A recent reduction in the discount rate from 2.5% to -0.75 was plainly unexpected and has material consequences for insurance and reinsurance business, the IUA said. Its impact has been to significantly increase company reserves, raise customer premiums and will potentially lead to more uninsured drivers.
Dave Matcham, chief executive of the IUA, commented: “It is clear that the process to review and amend the discount rate is flawed. Furthermore, the assumptions used to set the rate are completely out of step with current investment practices.
“Removing the relationship to Index Linked Government Securities in the calculation methodology is essential.
“It is encouraging that HM Treasury is working urgently on a consultation to review this process and the sooner changes are made, the better for the efficient operation of an insurance marketplace that provides security for all policyholders.
“The effect of the recent, unprecedented rate change was immediate and we have already seen sizeable increases in premium rates. Companies currently have little option, but to set their reserves according to the new rate and this could lead to a substantial reduction in reinsurance capacity.”
After consulting with senior casualty insurance and reinsurance underwriters, the IUA added its voice to those of many industry representatives, setting out a series of recommendations and observations for Liz Truss MP, Lord Chancellor and Secretary of State for Justice.
The association’s member firms recorded an overall premium income of £21.6bn in 2015. Of this some 54% comes from commercial and wholesale UK clients and at least £4bn is from motor fleet, employers’ liability and public liability business directly impacted by setting of the discount rate.