PPOs: Paying the price of care

In an attempt to improve care for people who will be affected by severe injury for the rest of their lives, the last government also inadvertently pushed up the cost of motor reinsurance.

Compulsory periodic payment orders (PPOs) were introduced in 2005. It meant that someone hurt in a car crash would not just receive a lump sum from their insurer. Instead, the cost of care could be spread over the course of their lives.

In the past, both parties had to agree to this method of payment. Few insurers were keen on it, as medical bills change over time and people live longer, making it difficult to predict the ultimate cost of care.

Over the past seven years the number of PPOs has increased, with more than 350 implemented, and there is no sign that their use is about to level out any time soon. One recent case saw a six-year-old awarded £450,000 a year to cover care and medical bills, worrying reinsurers who fear that the primary market will make regular claims as they look to offset the increased risk.

As a result, capacity is dwindling. Ace and Munich Re are among those believed to have scaled back their exposure to the UK’s motor excess-of-loss reinsurance, while those that have stayed, such as Swiss Re (see Q&A, below), have been able to increase their prices as they take up the slack.

Creating uncertainty

A source says: “This is a real issue for those who have 20, 30, 40 PPOs. The whole issue is creating a lot of uncertainty. For those of us with about five, it’s not on the radar in quite the same way.”

Indeed, some insurers have not yet experienced any noticeable increase in their reinsurance costs. A Direct Line spokesman says that it “has recently renewed its motor reinsurance at the expiring level of cover”.  

However, those who have remained relatively untouched so far cannot expect their good fortune to last: “We’re bound to start getting them,” says a primary market source who has yet to have even one through his books, meaning they will then probably look to increase their own cover.

And the increased demand will mean a further strengthening of prices. “It’s correct to say that we’re carefully managing our exposure to the UK motor market,” the source added. “It’s not something that we’re fully withdrawing from, but PPOs are a hot issue.”

Direct Line might have avoided a price increase, but Guy Carpenter found that, overall, cover had hiked 15%-25% in 2011. In its report on the 1 January renewals, it also warned to expect a repeat at the start of 2013.

Compulsory capitalisation

Deloitte insurance partner David Hindley (see market views, below), says the problem is that reinsurers are used to the unlimited amount of money that can be paid out in UK motor insurance, but struggle “to deal with it being unlimited in time”.

Reinsurers look to get around this by inserting compulsory capitalisation clauses into their contracts with the primary market. This means that the reinsurer pays a lump sum to the insurer, who has to take on the risk of how much the ongoing payments will cost for the ultimate claimant.

In a recent review of the PPO market, Gen Re said it would look at introducing the clauses on a case-by-case basis and insisted insurers are keen to see them as it could mitigate some of the reinsurance costs.

The report adds: “Insurers see such clauses as a means of addressing the credit risk associated with the long duration of their reinsurance recoverable asset, while reinsurers gain certainty over their ultimate liability.”

However, many insurers feel that this would be passing the buck, and negates the whole point of reinsurance decreasing their own risk. It may be that reinsurers are forced to offer a package of structures, so some of the cost is taken out with lump sum payments and other cover is comprehensive enough to protect the primary market from over-exposure to a growing problem.

Q&A with Russell Higginbotham, Swiss Re UK

The increase in PPOs is good news for consumers, but drivers will face further increases in motor insurance

Q: Has the increase in PPOs become a big issue for Swiss Re?
A: We have seen an increase year-on-year of settled PPOs. In 2008 there were 25; in 2009, 49; in 2010, 70; we haven’t seen the figures yet for 2011. So yes, definitely [it’s an issue]. What you’ve seen from us is that reinsurance excess-of-loss for motor [prices] have gone up. There have been reasonable - significant, even - double-digit price increases. We’re not talking 10%, but it’s not 90% either. However, this increase depends on the client and the structure of their reinsurance programme. We have made an attempt to phase in these increases, so that we do not take a big bite out of our clients straightaway.

Q: Does that mean that there are more price hikes to come?
A: Yes, there will be further increases. I don’t want to commit to a number, though I know it would make for a good headline. Medical and care inflation is also higher than RPI [retail price index], which means that prices still have a fair way to go.

Q: Have you considered scaling back from the UK market?
A: Reducing our scope? No, no, no. I am aware that some capacity has come out of the reinsurance motor market, but we were able to get business at prices that attracted us, so we remain committed to the
UK market. The reinsurance product still has very strong value. I wouldn’t say [overall] demand has gone up. People are aware of the issue and are looking to rebalance their reinsurance portfolio. We have had increased demand for our products because of the exits of our rivals.

Q: Troublesome though they may be, are PPOs a positive development for the UK?
A: This is good news for the consumer. If you are involved in one of these accidents you will be well covered with a PPO. However, the other side of that coin is that the cost of motor insurance to the consumer could go up again. We’re not at that stage yet and I do doubt we’ll reach that stage. But these claims are potentially very high because of the combination of high inflation and low interest rates. The primary market cost of motor insurance has gone up already, but that is not a hardening action in relation to PPOs, that was a market correction just to get motor insurance back into profit.

Market views

How are reinsurers reacting to the increase in PPOs?

“Pushing risk onto insurers” – Michael Lee, managing director of insurer services, Hastings Direct:

“The issue for us as primary underwriters is that the cost of excess-of-loss insurance is increasing, so as a result reinsurers have concerns over PPOs. There is some possibility of mitigating the risk for reinsurers, as there is a lot of talk about compulsory capitalisation clauses, which would turn the PPO back into a lump sum for them. We would be left paying the annual amount, while they would only have to pay a finite sum, giving them certainty and us uncertainty.

“For the primary market, we really don’t know at the moment what will happen to mitigate this. There is talk of an industry pool, but I struggle to see how that would work. I’m not really seeing any solutions right now.”

“Increased rates and cut capacity” – Jeremy King, executive director, property and casualty, Aon Benfield:

“We have seen some scaling back of capacity from the UK motor reinsurance market owing to an increasing frequency of motor claims involving PPO structures. PPOs result in long-term liabilities for those providing cover and much of this has, to date, been transferred to the reinsurance market. Companies such as Munich Re have stated that they will continue to write UK motor business but require rate increases to reflect the volatility in life expectancy. 

“Reinsurance rates in the sector have risen by 15% on average over the past 12 months. Given the recent trend towards large and lengthy payouts to claimants, further increases are possible to ensure that this business remains profitable to reinsurers. This may mean that insurers, whether they would like to or not, will have to retain more PPO risk on their own books.”

“They may walk away” – David Hindley, insurance partner, Deloitte:

“Back in 2006, when reinsurers signed on the dotted line on the excess-of-loss programmes for UK motor insurers, little did they think they were signing up to a 100-year plan. Insurers and reinsurers now recognise that one of the results of the Courts Act 2003 was to move the planning horizon for large motor personal injury claims out from 15 years to more than 50 years. 

“With about 200 periodic payment orders in place by the end of 2010, reinsurers of UK motor insurance now face the realistic prospect of paying out claims in the next century. Tying up capital for over 50 years as these liabilities run off may not fit well with many reinsurers’ risk appetite. Some reinsurers may walk away from this market entirely.”