The personal injury claims market has been fairly active of late due to government intervention on issues such as the Ogden rate. In reality the government will never please personal injury claim solicitors/claimants and insurance companies/defendants, because each is pursuing a very different agenda. So, what is the Ogden rate and will recent changes have any real impact?
What Is The Ogden Rate?
The Ogden rate is best described as the net rate of return that a claimant might expect to receive when prudently investing lump sum compensation. So, if it was agreed that a claimant was entitled to £1 million to cover medical expenses going forward, the Ogden rate would be used to calculate the actual lump sum payment today. If, as was the case, the rate was 2.5% then it would be assumed that the lump sum today would earn 2.5% each year and then interest on interest. So the actual lump sum payment today would be significantly less than £1 million.
However, if the rate was -2.5% then this effectively means that due to a factor of interest rates, inflation and average investment return today it would fall by 2.5% per annum. As a consequence, a £1 million lump sum payment today would need to take into account this 2.5% reduction each year and would be significantly greater than £1 million.
If we assume that a claimant receives a compensation payment of £1 million to cover the total cost of medical care for the next 10 years the difference between a 2.5% and a -2.5% Ogden rate are huge.
Ogden rate of 2.5%
A lump sum payment today to cover a £1 million payout for medical expenses for 10 years works out at £800,700. If you add 2.5% per annum to this lump sum payment then after 10 years it would be worth £999,965.
Ogden rate of -2.5%
A negative Ogden interest rate means that more funds will be required now on a lump sum payment to cover the same medical expenses for next 10 years. The actual lump sum payment needed today to arrive at a £1 million payment after 10 years is £1,257,000. Using a -2.5% annual reduction, after 10 years this would take the current lump sum payment down to £1 million.
While we have used +2.5% and -2.5% to exaggerate the financials, under these scenarios the difference in lump sum payments today would be more than £450,000.
Recent Changes To The Ogden Rate
Those who follow the personal injury claims market will be aware that the UK government changed the Ogden rate on 20 March 2017. Previous to that, going as far back as 2001, the rate had been set at 2.5% but was reduced by 3.25% percentage points in 2017. Therefore, the rate moved from positive down to -0.75% meaning that insurance companies would need to fund an annual reduction in lump sum payments going forward. This significant reduction in the Ogden rate saw personal injury claim solicitors upbeat while insurance companies were left contemplating the introduction of insurance premium increases. This prompted a war of words and lobbying of the UK government to review the situation.
Just recently the authorities announced that the rate will actually change, again, from -0.75% to -0.25% which was a partial win for the insurance companies. The problem seems to have been that indications coming from the Treasury suggested that the Ogden rate would be increased to 0% but this was not the case. As a consequence, lump sum payments today will need to take into account the negative Ogden rate although this is a significant improvement from the previous rate.
The Ogden Rate And Indicative Returns
Since 2008, when the US mortgage crisis rocked the world economy, it may be fair to say the Ogden rate of 2.5% was out of touch. UK base rates are currently 0.75% which, after taking account of inflation of 2% in June 2019, means that simply holding compensation on deposit would see it fall in real terms after taking account of inflation. In reality some savings accounts are offering less than 0.75% so the situation is perhaps worse than it looks.
Active investors will no doubt point to the potential to improve investment rates above the -0.25% Ogden rate. However, the key here is the use of prudent investment vehicles such as money markets and savings accounts rather than potentially volatile stocks and shares. It would be ultra-foolish of a victim in receipt of compensation to take above average risks with their compensation. Any losses may see them run out of money and be unable to pay for their future medical care.
Who Will Ultimately Pay The Price?
Insurance companies across the UK are already suggesting that car premiums as an example will increase in the short to medium term as a consequence of the smaller than expected increase in the Ogden rate. They will point the finger of blame at the UK government, the Treasury in particular, and highlight the massive increase in lump sum payment figures when compared to the Ogden rate of 2.5% back in 2017. So, will UK insurance customers really foot the bill?
Yes And No
The simple fact is that the larger the payouts as a consequence of insurance claims, the greater the premiums required to cover these claims. That is the way the insurance market works, pooled insurance premiums to cover compensation claims. Using actuarial figures it is possible to forecast with a degree of confidence the average number of compensation claims per year and compensation payments. However, what about the ongoing changes in relation to relatively small claims?
The UK government has also introduced an array of other changes to try and tackle the problem of fraudulent claims and legal fees which have often outweighed compensation awards. So, from 2020 there will be a significant reduction in the level of costs/legal fees which can be claimed for successful relatively small claims. As it was often the defendant’s insurance company that footed the legal costs of a successful claimant this has historically added to upward pressure on premiums. So, if legal fees and some types of personal injury claims are to be capped this will reduce the overall cost to the insurance industry.
Fixing The Ogden Rate In The Future
The fact that the Ogden rate remained at 2.5% for a 16 year period between 2001 and 2017 has not gone unnoticed by observers. The UK government has promised to be more proactive with regards to a more fluid Ogden rate which will reflect an array of economic factors going forward. It is safe to say that an average “safe return” of 2.5% between the worldwide economic crisis of 2008 and 2017 would be challenging in the interest rate environment of the last decade.
As a consequence of a more varied Ogden rate going forward this may, in theory, lead to greater volatility in insurance premiums, reflecting volatile insurance lump sum payment terms. However, if the insurance companies are made aware of the data used in calculating the Ogden rate going forward then they can make educated guesses. This should, in theory, allow insurance companies to plan ahead and avoid the potential volatility of premiums – balancing out the peaks and troughs. There is certainly a lot of work to be done and no doubt more lobbying and PR expenditure!
The Dangers Of Increased Premiums
While in theory some of the savings from reduced legal fees could be used to fund increased lump-sum payments as a consequence of the Ogden rate, issues like this are rarely straightforward. If insurance premiums were to increase in the short or even the medium/longer term, we may see some individuals and companies opting to reduce their cover or simply remove the cost of insurance altogether.
There are obvious consequences from a legal and financial liability standpoint if any personal injury claims were to be successful in the future. The motor industry, as one example, has an industry funded central compensation pot. This ensures that victims with a valid claim, who may not be unable to find or obtain funding from those found at fault, can still receive compensation. If more claims were to rely on the central compensation pot then this would likely lead to an increase in industry-wide funding, yet another cost which would likely be passed on to insurance company customers.
At face value it is difficult to see how such a relatively small change in the Ogden rate can have such a major impact on multi-million pound compensation claims. While the increase from -0.75% up to -0.25% has been welcomed, at least in private, by the insurance companies, it still means an increase in lump sum payments as a consequence of the Ogden rate. However, this pales into insignificance when you look back at the 2017 change from +2.5% down to -0.75%, a swing of 3.25 percentage points.
There have been some significant changes in the personal injury claims market over the last few years and more will follow. It is fair to say that many of these changes were fully warranted but due to the huge relative change in for example the Ogden rate many insurance companies saw a significant increase in their costs overnight. Will future changes be more balanced? Will the Ogden rate really be reflective of prudent investment returns at the time?