10 March 2017

Will there be protests in the street about car insurance premiums?

James Daley

By James Daley LinkedIn

A legal decision to increase compensation payments will add hundreds of pounds to young drivers' car insurance. When it happened in Ireland, people took to the streets in anger.

Last summer, protesters took to the streets in Ireland after car insurance premiums took a sudden hike. Many people saw their renewal quotes more than double - and for certain groups, such as young drivers, the increases were eye-watering.

One of the main reasons for the sudden hike was a court ruling back in 2015, which led to an increase in compensation payments for people that are seriously injured in an accident.

To be specific, it was all about something called the discount rate - which is best explained with an example.

Discount rate explained

If you're seriously injured in a car accident, the amount of compensation that you're owed is calculated based on a number of different factors - such as what your loss of earnings might be and how old you are. Once a figure is reached, the amount that is paid out is reduced slightly to reflect that fact that it's designed to support the person claiming for many years - during which time the funds can be invested.

So if a 20 year old is seriously injured in a car accident - in a way that means they will never be able to work again - the calculation will be based on their future loss of earnings, and will be designed to ensure they have enough money to live on. Let's say that adds up to £3m. It will then be reduced by the discount rate - which is an assumption about how much the money will grow by each year if it is invested or deposited in the bank.

Until 2015, the discount rate used in Ireland was 3%. But in a court ruling two years ago, a judge decided that with interest rates and government bond returns much lower than they were, the rate should be cut to 1%.

So on our £3m payout, which is designed to cover someone for 40 years, the payout using a discount rate of 3% would only be around £1m. But if you use a discount rate of 1%, that doubles to over £2m.

Although these kind of large payouts are small in number, their impact is huge on insurance companies - who are the ones on the hook after a car accident. So with a sharp increase in the level of compensation payouts, the only way for Irish insurers to stay in business was to sharply increase their premiums.

First Ireland, now Britain

Back on this side of the Irish sea, exactly the same thing happened two weeks ago.

Our discount rate was set at 2.5%. But in its wisdom, the Ministry of Justice decided that with inflation and interest rates so low, it should be reduced to -0.75%.

That means that the cost of that £3m compensation award will have gone from a little over £1m to well over 3 times as much.

The effect of this was seen immediately. When Direct Line, the UK's largest retail insurer, announced its results last week, it said the impact on its profits would be an astonishing £217m.

And it will ultimately be customers that pay for this - through much higher premiums.

Car insurance is not exactly cheap as things stand. For young drivers, it 's already normal to pay four figure sums to get on the road. But we may now see some drivers being quoted five figure sums.

I really don't think  it's an exaggeration to say that we may see protests on British streets, just as we did in Ireland.

The ABI are right. This is crazy

It's not every day that I agree with the Association of British Insurers. But in this case, I think its description of the decision as "crazy" is accurate.

No one is suggesting that people who are severely injured should not get adequate compensation. But by using a discount rate of -0.75%, the implication is that all compensation payments are invested in index-linked gilts, which they aren't.

Worse still, this came as a complete bolt from the blue to the industry. Insurers have known that a reduction in the discount rate was on the cards - and the sensible ones had even reserved against a cut to 1%. But no one foresaw a reduction as sharp as this.

The government claims that it had no choice. The reading of the law is it stands required such a cut.

But all law is open to interpretation, and the government often chooses to take a more nuanced path when it suits. 

Time for a U-turn

There is still the potential to turn things around. There is regulation in parliament which could be amended to incorporate a change to the way the discount rate has to be considered.

If the government has any sense, it will jump on the opportunity to undo the damage it has done here.

At a time when taxes are rising and public services continue to be cut, the last thing most households need is a massive increase in car insurance. I'm not sure Liz Truss, the Justice Secretary, understands the potential political fall out here.

It's a massive government misstep which needs correcting as soon as possible.