Insurance shake-up set to increase compensation – and premiums

The average annual car insurance policy is set to rise by as much as £75 a year, according to insurers, who plan to transfer the cost of the increased pay-outs to policyholders.

Insurers are being forced to give more to accident victims by a change in the law. Their industry body warned today that they will transfer the cost to car owners. The Association of British Insurers (ABI) says its members will increase the premiums on 36 million policies.

The change in the law is designed to compensate accident victims, who have suffered long-term injuries, for the poor rates of interest available on lump sum payouts in the current financial climate.

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Once the amount of compensation has been set after an accident, the money the insurers actually pay out is reduced by a "discount rate" related to the amount of interest the victims could in theory earn by investing the money.

Because that possible interest is now much lower than it was before the financial downturn, the government has ruled that the discount rate must be reduced from 2.5 per cent to just 0.75 per cent.

This is great news for victims – who will get more money – but bad news for insurers, and bad news for their clients, to whom they will pass on the extra costs.

The ABI says the decision is "crazy". Some of its members are warning that their profits would be hit by millions of pounds.

Huw Evans of the ABI said: "Claims costs will soar, making it inevitable that there will be an increase in motor and liability premiums for millions of drivers and businesses across the UK.

"We estimate that up to 36 million individual and business motor insurance policies could be affected in order to over-compensate a few thousand claimants a year."

Mohammed Khan of PwC told the BBC that the costs would be passed on to policyholders.

He said: "We anticipate an increase of £50-£75 on an average comprehensive motor insurance policy, with higher increases for younger and older drivers – potentially up to £1,000 for younger drivers, and a rise of up to £300 for older drivers."

But the Association of Personal Injury Lawyers has welcomed the change. "People already coping with the most severe injuries have been deprived of the help and care they need for years," it said.

Direct Line says its pre-tax annual profits could fall by as much as £230m after the change. The Treasury warns that the NHS may have to pay out an extra £1bn annually in compensation claims.

Justice Secretary Liz Truss said the existing law was "absolutely clear" and she had no choice but to reduce the rate drastically. But the Ministry of Justice is to launch a consultation on the changes and says it will bring forward any new legislation "at an early stage".