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An update to how insurance premiums are calculated

At a glance

  • Many may not appreciate the wide range of factors that insurers must consider when calculating premiums
  • This can cause frustration if premiums change and do not meet a customer’s expectations
  • Our update discusses some of the key factors that can influence insurance premiums

A wide variety of factors affect how insurance premiums are calculated. A large proportion relate to customers’ specific risk profiles, whereas others will be out of their control and determined by a range of other influences.

The effect of the Ogden rate on Insurance Premiums 

The Ogden discount rate is a tool designed to ensure personal injury compensation claimants are not under or over-compensated. It adjusts damages awards to take into account the return expected when a compensation lump sum is taken, which can then be invested.

On 7 September 2017 the Lord Chancellor and Justice Secretary, David Lidington, announced measures to change the way the discount rate is calculated. The proposal would have to be approved by Parliament but if the new system were in force today the rate might be in the region of 0% to 1%.

The current discount rate was implemented on 20 March 2017 by the then Lord Chancellor, Liz Truss, who changed the original discount rate from 2.5% to -0.75%.

At Zurich, we are pleased that the Government has listened to the industry and recognised that something needed to be done.

The change from 2.5% to -0.75% in March has significantly impacted injury claims’ reserves which has had to be reflected in casualty and motor pricing.

To take the example of a customer with a £4m open motor injury claim (of which £2.5m is Ogden-related), with a male claimant aged 30, the change in the Ogden rate has increased the size of the Ogden-related portion of the claim by 106%, leading to an overall increase in the claim of approximately £2.65m.

Tulsi Naidu, UK CEO at Zurich comments: “I hope legislation around the new mechanism will reflect the real-world investment options claimants can choose for their compensation payments and provide a fairer system for all involved.”

Many of these are not widely understood, which can lead to surprise and frustration if insurance premiums go up.

We look at a number of key factors that affect how insurers determine premiums.

Politics and economics

Political change and its economic consequences can have a significant influence on individual insurance premiums.

One example is the current uncertainty over Britain’s exit from the EU, which has already reduced the strength of the pound. This is affecting, among other things, the cost of motor parts manufactured outside of the UK, which in turn increases the cost of repairing a vehicle and therefore the premiums needed to cover future motor claims.

Two other examples are the recent increases in insurance premium tax (IPT) and the Ogden discount rate. The UK Government has announced a number of successive increases to IPT over recent years, directly impacting the amount customers pay for their insurance. While this tax is collected by insurers, it passes straight to the government.

The Ogden rate, meanwhile, has had a significant impact on personal injury compensation awards and on injury claims reserves (see boxout).

Cost of doing business

Insurance companies face the same sorts of changes to the cost of doing business as their customers. For example:

  • Exchange rate fluctuations
  • Reductions in investment returns
  • Salary inflation
  • Energy cost rises

Insurer business models

In addition to typical business outgoings, insurers’ business models also feature a number of unique factors that will influence insurance premiums. These include:

  • Solvency requirements – Insurers are legally required to set aside a significant proportion of earned premiums to ensure there is always enough money to pay future claims. This includes large and catastrophic losses, such as extreme weather events
  • Future claims trends – Insurers must adjust premiums over time to cover the cost of future claims. If, for example, a type of workplace injury becomes prevalent, this is likely to affect future claims experiences due to the increasing trend of Periodic Payment Order (PPO) awards for serious personal injury claims
  • Investment income – Many lines of business, such as Employers Liability (EL) and Public Liability (PL) have historically run at an underwriting loss, with insurers relying on investment income to generate an overall profit. Global interest rates have fallen significantly over recent years (the Bank of England base rate, for example, recently dropped to an all-time low of 0.25%), putting more pressure on insurers to make an underwriting profit, putting upward pressure on premiums

The following are examples of specific factors that have recently affected particular lines of insurance business:

Public/products’ liability

  • Rise in activity from claims management companies following the introduction of regulatory restrictions to other, previously more lucrative, lines of business such as motor
  • High claims inflation for bodily injuries, particularly for catastrophic losses

Property

  • Following the recession, many businesses were forced to cut back on risk management expenditure, leading to increased losses and larger claims. Property is also still commonly being underinsured, despite the significant risks this poses for customers
  • Increase in number of unoccupied buildings, leading to rise in metal thefts, arson and fly tipping
  • Catastrophic losses from extreme weather events

Motor

  • Currency fluctuations – the drop in the value of the pound is increasing repair costs, as everything from parts to paint becomes more expensive
  • Although better technology in vehicles is reducing the number of collisions, this technology costs more to replace or repair if it is damaged, with much of it featuring in high impact areas such as bumpers
  • Fraud – 70,000 dishonest motor claims were detected in 2015
  • Growth in periodic payment orders (PPOs) for personal injury claims, increasing insurers’ long-term costs, along with impact of Ogden rate reduction

Employers’ liability (EL)

  • Latency – insurers must price for the fact that decades can pass between an employers’ liability policy being underwritten and a claim being made, e.g. for asbestos-related illnesses
  • High claims inflation for bodily injuries and growth in PPOs
  • Impact of low interest rates on investment income

How can customers manage premium changes?

The information above should offer some insight into the wide range of factors that can influence insurance premiums.

Despite the importance of these factors in determining premium levels, we will always look at each customer on an individual basis, and try to limit the impact of factors outside of your control.

To better manage some of the risks discussed in this article, please explore the range of content on Zurich Insider, including:

How to keep empty properties safe

An interactive guide to spotting motor fraud

Quick guide to risk assessments

Identifying and dealing with flood risk

Understanding Commercial Insurance Premiums 2017

To find out more please speak to your usual Zurich contact.

You can also find out more and access helpful guides and insight with our new UnderinsuranceFire and Flood Risk Resources.

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