September 8, 2017 / 10:31 AM / 9 months ago

Fitch: Ogden Reform Will Partly Reverse UK Insurer Earnings Hit

(The following statement was released by the rating agency) LONDON, September 08 (Fitch) The UK government's planned reforms of the Ogden discount rate will partly reverse the earnings hit caused by the previous change to the rate in February, Fitch Ratings says. Insurers' earnings will be boosted by one-off reserve releases. However, the change could also increase insurers' exposure to longevity risk as a result of greater propensity for claimants to take the periodic payment orders (PPOs) alternative. The Ogden rate, which is used to calculate lump-sum payments in bodily injury claims to cover long-term care costs or lost earnings, was cut to negative 0.75% from 2.5% earlier this year. This was the first time the rate had been changed in 16 years. The move reflected the significant fall in risk-free real returns in recent years, but the reduction hit insurers' earnings as they had to set aside reserves to cover higher claims costs. This drove up premiums. The government's new proposal, announced yesterday, is to introduce a discount rate that assumes claimants will take "low" rather than "very low" risks in investing their lump sum. If applied today, this could result in a rate of between 0% and 1%, the government said. The proposal still needs to be approved by parliament and the timing of implementation is therefore uncertain. While the 325 basis point rate change only took effect from 20 March 2017, it resulted in a significant reduction in 2016 earnings, as insurers set aside more reserves to cover higher costs of outstanding claims. Aviva said the change reduced its 2016 pre-tax operating profit by GBP475 million and Admiral said its pre-tax profit was hit by more than GBP100 million. The proposed new methodology for setting the rate will allow insurers to release some of these reserves, as outstanding claims may be settled under the new regime. The government plans to review the discount rate every three years, meaning future changes to the rate should be more predictable and insurers are less likely to have to make big step changes to reserves. The reduction in lump sum payments under the new proposal could encourage more claimants to opt for a PPO, where the insurer makes regular payments. PPO liabilities present significant challenges for non-life insurers in managing longevity, inflation and long-term investment risks, due to the need to keep making payments for the rest of the claimant's life. The reduction in the rate earlier this year sparked an 11.5% year-on-year rise in motor insurance premiums at the end of June, as insurers passed on the expected higher claims costs. We believe the now proposed change in the Ogden rate could leave premiums broadly flat for the rest of the year, but is unlikely to materially reverse the recent increases. This is because other major elements of claims costs are rising strongly, driven in part by the increasing complexity and cost of replacement vehicle parts. Insurers use reinsurance to limit the maximum costs of any individual claim. Reinsurers have generally not yet been able to adjust their pricing, as most policies of this type are renewed in January. Given the magnitude of the Ogden rate change in February, industry expectations were that the cost of excess of loss reinsurance could increase significantly. However, given the announcement and the competitive nature of the reinsurance market, we now expect reinsurance pricing to increase only modestly in the January 2018 renewal period, even if the new discount rate has not taken effect by then, which will be beneficial for both insurers and their policyholders. Contact: Ekaterina Ishchenko Associate Director Insurance +44 20 3530 1532 Fitch Ratings Limited 30 North Colonnade London E14 5GN Graham Coutts Director Insurance +44 20 3530 1654 Simon Kennedy Senior Analyst Fitch Wire +44 20 3530 1387 Media Relations: Athos Larkou, London, Tel: +44 203 530 1549, Email: The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at All opinions expressed are those of Fitch Ratings. ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEB SITE AT WWW.FITCHRATINGS.COM. PUBLISHED RATINGS, CRITERIA, AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. 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