What just happened to car insurance?

So you might have seen a few articles recently about a government announcement that got a pretty bad reaction from the car insurance industry. I just wanted to give you a quick heads-up on what is going on, and what is going to happen, and how it might affect your car insurance. So here are the facts:

For underwriters, small accidents are easy; how much is a new bumper and a coat of paint?... £2,567 ...okay, great let's pay out to fix it. Conversely, big accidents are hard; how much is the loss of the ability to walk worth to a person over a lifetime? What will their impairment be and how should it be compensated? Enter... the Ogden tables. These are a standard way for insurers to calculate how much needs to be paid out over a lifetime to a claimant, taking into account loss of earnings, carers and lots of other factors.

Great, so what changed?

When a claim is settled all the money is paid out at once, even though it is calculated on an annual needs basis. The insurer is allowed to assume that as a prudent human you'll invest it to provide for your future needs (wheelchairs, nursing, support, living etc). They use what is called the discount rate to calculate the return you are expected to get when investing your money.

Let's assume for example, a 60 year old who was being paid £40k/year is hurt in a crash and can never work again. The insurer calculates they need an RPI linked £40,000 a year for the rest of their 30 year expected life span, at a rate of inflation of 2.0%. Until a week ago the insurer was allowed to assume you could invest the lump sum payout at a 2.75% return. This means the total claim would have cost the insurer £1,052,500. If you want to see how this is calculated I've attached my workings here.

That 2.75% is the discount rate, and it's just changed. On 30th March it will go to -0.75% and that means the government now expects that every year you have that £1m in your account, you'll lose money holding it (which is ridiculous) at a rate of 0.9925% a year. This means that instead of paying out £1m for the claim, it now costs £1.85m. It's basically doubled.

So, as of the 30th March bad accidents cost will double. There are a couple of big problems with this:

Problem 1

The industry wasn't expecting this to be such a big change, which means it wasn't properly priced into old policies that will claim on the new rate. So - not only do new premiums need to go up to pay for the new discount rate applied going forwards, they are also going to need to cover the losses on the old policies that were written before the change.

Problem 2

Because there is very little margin on motor policies it is really easy to tip over the edge into a loss-making situation and this change is more than enough to do that. That's why all of the motor insurers are giving out profit warnings already.

So who will it affect?

If you are young or old or live in a city postcode, expect a big jump in your premium. Young people are the worst (they live the longest so require more annual payments) so they'll be going up a lot (£1k+).

With the cost of car insurance on the rise the need for flexible, low cost car insurance that is priced according to how much you drive and not just on generic buckets like age and location. This is what we're hard at work on at Cuvva.

What do you think of the discount rate change? Let us know via the in-app chat.