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Fitch: Ogden Rate Cut Adds Pressure on UK Motor Insurer Profits
February 28, 2017 / 2:16 PM / 7 months ago

Fitch: Ogden Rate Cut Adds Pressure on UK Motor Insurer Profits

(The following statement was released by the rating agency) LONDON, February 28 (Fitch) UK motor insurers will face a short-term hit to earnings from the increase in lump-sum reserves, and higher reinsurance costs following the government's announcement that it will reduce the Ogden discount rate by more than the industry expected, Fitch Ratings says. Insurers may also want to rebuild depleted reserve buffers, which could create a further drag on profitability for the next couple of years. But firms should be able to pass on these higher costs to consumers and we therefore do not expect any significant long-term deterioration in the credit profiles of rated insurers. The reduction in the Ogden discount rate, which is used to calculate lump-sum payments in bodily injury claims to cover long-term care costs or lost earnings, triggers a need for larger bodily injury claims reserves and will lead to substantially higher motor insurance premiums. The Ministry of Justice announced yesterday that the rate would be cut to -0.75% from 2.5%, effective from 20 March, to reflect the lower real risk-free returns in the UK economy in recent years. Reducing the rate has significant implications for motor insurers because bodily injury claims represent around half of total motor insurance claims costs. Many insurance payments are intended to provide compensation for several decades, so small changes in the rate have a big effect. For example, a 30-year-old woman who needs GBP50,000 a year to cover care costs would receive around GBP3.8m using the new rate, compared with a lump-sum payment of GBP1.5m at the previous rate. Insurers will need to increase reserve estimates to account for higher costs of claims on business already written. As large bodily injury claims may take several years to settle, reserves for claims already notified but not settled need to be taken into account, as do reserves for claims incurred but not reported. Some insurers already set aside reserves for a lower interest rate than the 2.5% Ogden discount rate. But we do not believe any had anticipated the size of rate reduction and they will therefore need to divert further earnings to strengthen reserves. The increase in bodily injury claim settlements caused by the Ogden discount rate cut is likely to increase demand for excess-of-loss reinsurance as firms attempt to reduce their exposure to individual large claims. Higher claims experience on primary insurance will be reflected in higher reinsurance costs, which will increase upward pressure on motor insurance prices. In the medium term, the revised Ogden discount rate represents a permanent, higher claims cost to motor insurers. We expect most of the extra costs to be passed to customers through higher insurance premiums, due to motor insurers' slim margins and lower reserve release capacity. Younger drivers will be most affected because of their higher average accident rate and because lump-sum payments to young accident victims are much higher to cover their longer life expectancy. The government also plans to consult the industry on the Ogden discount rate, including whether the existing methodology for setting the discount rate is appropriate. This review is likely to involve a number of steps and any change to the current methodology is likely to need parliamentary approval. Contact: Ekaterina Ishchenko Associate Director Insurance +44 20 3530 1532 Fitch Ratings Limited 30 North Colonnade London E14 5GN Harish Gohil Managing Director Insurance +44 20 3530 1257 Simon Kennedy Senior Analyst Fitch Wire +44 20 3530 1387 Media Relations: Athos Larkou, London, Tel: +44 203 530 1549, Email: athos.larkou@fitchratings.com. The above article originally appeared as a post on the Fitch Wire credit market commentary page. 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