In March 2017, the insurance claims sector was sent into turmoil when the Personal Injury Discount Rate (PIDR) was reduced. New legislation is set to increase the rate to between 0% and 1%. So does this return justice to the system? And what will be the impact on construction industry insurance costs?
There’s barely a construction outfit in the business that doesn’t have a financial interest in the PIDR. This short, innocuous-looking acronym has huge implications for a high-risk industry where 3% of workers annually sustain a work related injury and 43 workers were fatally injured in 2015/16, according to Health and Safety Executive (HSE) figures.
Liability and motor policies are must-haves in construction, along with any class of insurance where there’s exposure to personal injury claims.
The PIDR (also known as the Ogden rate) influences the lump sum paid to successful claimants. And rate changes that are a fraction of a percentage point on paper could have a huge impact on the cost of risk.
What is the discount rate?
When courts calculate compensation for personal injury or fatal claims, they apply a discount to recognise that claimants will earn investment returns on their lump sum payments.
This discount is calculated by applying the net per annum percentage rate of return that the claimant could expect from prudent investment of the lump sum. This percentage is known as the PIDR and from 2001 until March 2017 it had been fixed at 2.5%. Following a government review, the discount rate was reduced by 3.25 percentage points, to minus 0.75%, with effect from 20 March 2017.
The rate change applies retrospectively to all outstanding claims. By applying a negative discount rate, the government was insisting defendants and insurers had to inflate lump sum payments to reflect that investments were likely to underperform inflation.
The March change, from plus 2.5% to minus 0.75%, over-compensated certain personal injury claimants, said insurers. The government’s keenly awaited post-consultation response was published on 7 September this year. It sign-posts a rate increase that has been welcomed by the insurance industry.
Why has the PIDR hit the headlines?
The UK economy has underperformed for long periods during the 16 years that the discount rate was pegged at 2.5%.
Catastrophic personal injury claimants argued they were being short-changed.
Typically, such claimants opt for low-risk investments for the lump sums. The 2001 discount rate was set with reference to the return rate of index linked gilts (ILGs).
As investments, ILGs have reflected the UK economy’s underperformance. Claimant representatives argued that a lump sum that had been cut by the 2.5% discount rate and then invested in ILGs was leaving claimants out of pocket.
Claimant lawyers, along with the Association of Personal Injury Lawyers, had been campaigning for a discount review for several years. Following the review earlier this year, the government recalculated PIDR to reflect the low return climate for ILGs.
On 27 February 2017, the Lord Chancellor, Elizabeth Truss, announced the discount rate would change from 20 March 2017.
The new, March 2017, discount rate was reset at minus 0.75%. This means successful claims will be increased in value to recognise that ILGs investments were underperforming inflation.
Following the March announcement, insurers argued that claimants would choose alternative low risk investments other than ILGs. These investments would, they said, offer a more generous return than ILGs.
They sought a partial rate increase of between 0% and 1%, saying it will more accurately reflect the rate of return of the schemes where claimants’ lump sums are invested.
Now, the government has published draft legislation to change the way the rate is calculated. If it’s agreed by Parliament, the cost of catastrophic injury claims should fall.
What could PIDR cost me?
For insured companies, the financial consequences of the March 2017 changes can be huge.
Following the March 2017 discount rate reduction, law firm, Weightmans LLP, issued a report illustrating how catastrophic personal injury claims are affected.
In one scenario, Weightmans calculated the change in damages awarded to a male traffic accident victim in his early 20s.
Having sustained a severe traumatic brain injury, with significant cognitive function impairment, Weightmans estimated that the damages paid would rise from £9,072,028 to £20,023,103, under the new minus 0.75% rate.
What will happen to my insurance premiums if the PIDR increases?
Since February 2017, insurers have been seeking to increase premium rates to reflect the deterioration in large personal injury claims which are already having a negative impact on their profitability.
The more recent proposed rate change will inevitably correct some of these increases, although with the final rate still lower than the 2.5% it was beforehand, the net cost of risk is still going up versus what it was last year.
When it comes to renewals, the implications are huge for companies with two or three big claims on their books.. In what is a continuing soft market, this about-turn by the government will impact significantly on any actual increases that may have been previously inevitable.
With the new rate now firmly on the horizon, companies are looking to wrestle some money back.. As supporting insurance brokers, in cases where premiums had been increased following the reduction, JLT are putting pressure on insurers to decrease their reserves and reduce company renewal premiums to more realistic levels.
Industry commentators have however speculated that insurers may refuse to cut premiums even when there is a PIDR increase. It’s suggested that as an alternative they might keep their current prices static for an extended period.
There’s been a lot of noise and hot air about this.. Some insurers have been building their reserves in anticipation of a PIDR cut but others have simply ring-fenced these amounts until the government’s longer term aims were in place. Going forward, however, reserves and rate adjustments can now be set with much greater accuracy.
What’s the downside of a PIDR increase?
Whilst the PIDR increase is largely all good news, there are some commentators who think this simply doesn’t go far enough. Claimant lawyers often speculate about high cost private care regimes, adaptations to properties and other costs that badly injured claimants will never ultimately pay for, leading to an in-built element of over-compensation..
There are others who point out that in other foreign jurisdictions, much higher discounts of between 3% and 6% are the norm. It remains to be seen what will happen in Scotland, where separate legislation will be required to effect change.
With an end in sight to the current negative rate, tactical behaviours are expected from both sides, in anticipation of lower awards being likely. However, following the change, as the rate will likely be reviewed every three years, tactical behaviours could also be expected in the run-up to each rate review.
It should also be noted that any formal changes will take time to implement, with Easter 2018 the earliest likely date being suggested.
In the interim period, claimants could benefit from the windfall of over-compensation. A substantial number of ongoing cases will be listed for trial beforehand, especially as some claimant firms have deliberately been commencing proceedings early with the aim of forcing resolution under the current generous rate, according to law firm, Kennedys.
On the other side of the fence, defendants will be seeking to delay trials where possible until after the new changes have been implemented. In the meantime, offers will inevitably mirror the new rate.
What’s my next move and how can my construction insurance broker help?
Specialist construction brokers will be monitoring developments, and yours should be working hard to find the best coverage at the most competitive rates.
Review your claims reserves immediately with your brokers and claims handlers and engage appropriately with insurers to ensure a realistic stance is taken.
Ensure you review and enhance your claims defensibility strategies, ensure you have robust contractual indemnity clauses with your supply chain and seek confirmation that your supply chain carries sufficient insurance. That way, in the event of an expensive claim, you can pass on the financial impact.
Find out how the Personal Injury Discount Rate affects your business. For further information please contact Mike Johnson, Contractor Group Leader on +44 (0)20 7528 4759 or email email@example.com.