An announcement by the Ministry of Justice will dramatically affect the way that personal injury pay-outs are calculated, with the expected increase in pay-out likely to lead to significant premium hikes for millions of consumers.
Under current legislation, all compensation pay-outs currently feature a “Discount Rate”, which takes into account the effect that investing the lump sum would have on its future value. The current rate is set at 2.5%, a figure that has remained unchanged since the spring of 2001. New proposals will change the discount rate to -0.75% due to the dramatic decline in the interest rates that investment products attract in the current economic climate.
Under the existing rate, insurance companies will pay out £975 for every thousand pounds of earnings loss that the accident has caused. In other words, if the claimant was to invest all the money in an account which pays out 2.5% interest, the shortfall of £25 would be recouped in full. However, dwindling investment rates now mean that companies will actually pay out £1,007.50 per thousand pounds of expected loss of future earnings!
While nobody would expect to invest money in a scheme that attracts negative interest, the discount rate is legally bound to returns on those investment products which are of lowest risk – these are often products such as Index-Linked Gilts, which have seen hugely reduced yields over the past 15 years.
The effect is significant for both the company paying out the settlements and also for its consumers. The much-increased level of compensation will have a quite dramatic effect where settlements fall into hundreds of thousands, or even millions, of pounds. The companies will be expected to try and recoup these large additional losses by hiking up premiums for all their customers. In effect, settlements that are paid out to a small number of parties will have an effect on premiums for tens of millions of people taking out insurance products.
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The effect on companies extends beyond the pay-outs; with changes to future earnings now clear, many companies will be forced to downgrade profit forecasts, which in turn will lead to diminishing share prices; this will affect the companies and also their investors (some of whom may also be paying additional premiums too, effectively a double blow). Insurance firms such as Direct Line are already predicting that additional pay-outs may run into hundreds of millions of pounds, wiping large amounts from their profits and company value.
With the end consumer again feeling the brunt of changes to legislation, it’s clear that motorists will look to change their buying habits again. After a bumper few years for sales of both new and used cars, will motorists walk away from forecourts and trade plates and return to second hand purchases? Lower new car sales will have a knock-on effect for the motor trade, which will also see lowered sales figures and profits; if insurance policy costs and petrol prices also continue to rise, 2017 will not be a great year for the motor industry as a whole.