Reinsurance is expected to limit the impact of potential rate changes to the Ogden discount rate, analysts at Berenberg reported, after the Ministry of Justice announced that it’s delayed its decision on whether the rate should be lowered until February, 2017.
Berenberg said it anticipated a discount rate reduction to 1.5-2 percent.
The analysts explained that while changes to the rate could negatively affect the market, carriers are likely to be protected from any significant impact on profitability as many have taken out excess of loss reinsurance cover and pre-emptively lowered rates to mitigate against losses:
“While it appears that this could have a very negative effect on the UK motor insurers, we believe that they have been expecting the discount rate to change for a number of years.
“As such, they have taken steps to mitigate the effects of a potential change, including pre-emptively applying a lower discount to reserves, taking out excess of loss reinsurance cover at a low-level to limit exposures from long-tail personal injury liabilities and focusing on settling large bodily injury claims using lump sum settlements. This should help limit the effect on profitability,” Berenberg analysts explained.
However, the investment bank analysts warned that companies with large amounts of long-tail exposure reserving using the 2.5% discount rate could face “a significant hit to profitability,” should the Ogden rate decrease.
However, all companies, and Direct Line in particular, have been extremely conservative on the reserving assumptions, meaning any negative reaction to this news may be overdone, according to Berenberg.
The purpose of the Ogden discount rate is to make it easier to calculate future losses in personal injury and fatal accident cases.
The tables take into account life expectancy and provide a range of discount rates from -2.0 to 3.0 percent in steps of 0.5 percent.
The discount rate is fixed by the Lord Chancellor and is currently at 2.5 percent, but it’s been argued that the present rate is too high and as “claimants were being unfairly penalised by the discount rate application,” Berenberg reported.
While many UK motor insurers have already opted for proactive protection from any decrease to the Ogden discount rate, if the rate change becomes effective in February, more insurers could start looking to reinsurance for ways to mitigate impact, particularly on long-tail risk exposure.
