Ogden rate change causes overcompensation concerns for insurers

It was theoretical physicist Albert Einstein who once called compound interest the eighth wonder of the world, adding: “He who understands it, earns it – he who doesn’t, pays it.”

This bon mot accurately sums up the importance of changes to the personal injury discount rate, more commonly known as the Ogden rate.

While the rate rise implemented by the government from -0.25% to 0.5% on 11 January 2025 is small in percentage terms, it has a gargantuan impact when applied to payments made to thousands of claimants across their lifetimes.

So, what will this discount rate change mean for motor insurers, premium levels and payments for personal injury claimants?

What is the discount rate?

The discount rate is set by the Ministry of Justice (MoJ) and then used by courts to work how much lump sum compensation insurers must pay personal injury claimants in England and Wales.

The aim is to provide 100% compensation, putting the claimant in the same position as if their injuries had never happened.

As the discount rate rises, lump sum payouts fall – and vice versa.

The rate heavily affects car insurers, as road traffic accidents comprise around 50% of all personal injury claims, according to Waldrons Solicitors.

Public liability makes up a further 21% of overall personal injury claims, while employers’ liability claims comprise 16% of the total.

Why has the rate been raised?

The principle of receiving lump sum compensation is that the claimant invests this money, using returns to fund their care.

The discount rate is assessed every five years. With higher investment returns now than five years ago, the discount rate has been moved upwards.

But, not all claimants get what they need once varying inflation and investment returns are factored in. In practice, many claimants are either overpaid or underpaid.

Even lord chancellor Shabana Mahmood, who set the discount rate, said: “It is very important to recognise that the personal injury discount rate will always be a relatively blunt instrument, since no one choice of rate can ever ensure that all claimants receive exactly their full compensation.”

In her December 2024 announcement about the discount rate changes, Mahmood explained that the chance of a claimant getting all the compensation they need, or more, is 55% from 11 January 2025. The prospect of being very undercompensated is 25%.

A fresh change for the 2025 updated discount rate is the assumption that the average claimant is a low risk investor, rather than a very low risk one.

What do the changes mean for claimants and insurers?

The discount rate change will shave millions of pounds off lump sum compensation payments.

As an example, before 11 January, a disabled child that needed care for the rest of their life could reasonably have needed £12.9m to fund £200,000 a year for 60 years.

After 11 January 2025, the discount rate change would trim that amount to £10.27m, according to the Association of Personal Injury Lawyers (Apil).

Apil treasurer Gordon Dalyell said: “Any increase in the discount rate makes it more likely that more injured people will be undercompensated.

“Victims of negligence, who have already been through so much, should not have to face financial pressure to have their basic needs met.”

Insurers, on the other hand, tend to be wary of criticising the discount rate because this indicates a public argument with seriously injured claimants.

However, many did write to the MoJ ahead of the latest rate change, arguing for an even higher discount rate – and resultant lower payouts.

The panel that advises the lord chancellor on the discount rate – including actuarial, economy, investment and consumer experts – recommended that the Ogden rate be set between 0.5% and 1% for this year. But, the lord chancellor decided that anything above 0.5% posed too high a risk of undercompensation.

Ultimately, the discount rate increase has not caught any insurers wildly off guard.

Deloitte partner James Rakow said: “With the Bank of England real yield curves having been camped in positive territory throughout 2024, the Ogden discount rate now doing likewise should therefore not have been much of a surprise to anyone.”

Insurers have also benefited from the discount rate being 2.5% for a long time – approximately between 2001 and 2017.

The Association of Consumer Support Organisations (Acso) executive director Matthew Maxwell Scott added: “The discount rate was 2.5% for decades when it should have been a minus figure because real interest rates were so low and returns were so low.

“That suited insurers well and there must have been significant undercompensation in that period.”

In theory, lower insurer payouts should also mean lower premiums – particularly in very affected areas such as car insurance.

Professional services firm PWC UK said that the average motor premium could fall by £50 due to the discount rate change.

But other commentators doubt that premiums will be much affected.

Maxwell Scott continued: “You would think a higher discount rate would help keep motor premiums lower than previously. But there’s nothing mandating insurers to pass any savings through.”

The ABI, meanwhile, is concerned about the risk of overcompensation pushing up premiums.

An ABI spokesperson told Insurance Times: “We and our members firmly believe in full and fair compensation for claimants.

“However, the lord chancellor’s approach embeds significant caution into the calculation, which could lead to overcompensation. This could have an adverse impact on all premium paying customers, particularly young drivers for whom costs are typically higher, and the taxpayer.”

What is the future for the discount rate?

For the next five years, the discount rate will not change.

But this only applies to lump sum payments and some lawyers think the new discount rate level could encourage different forms of compensation.

The alternative to a lump sum payment is periodic payments, for example, which see claimants paid money at intervals. These models are currently rare and disliked by insurers – they prefer to get liabilities off their books if possible.

A December 2024 report by global law firm Kennedys Law said: “We anticipate that claimants with large future loss claims may well be advised to opt increasingly for smaller retained lump sums and more heads of loss by way of periodical payments, due to lower lump sum awards under a higher discount rate.”

The impact of the latest discount rate change will take time to filter through.

Certainly, payouts will fall overall and there will be a big question mark over premiums possibly changing.

But the real impact will be seen over the next five years, as the level of the discount rate interacts with investment returns and claims payouts in the real world.