UK personal lines: calm after the storm?

2023 was a challenging year for the finance and reserving functions of personal lines insurers. They have had to grapple with: a forthcoming review of the personal injury discount rate (PIDR) – colloquially known as the ‘Ogden rate’, claims backlogs and inflation, uncertainty over ‘whiplash’ claims and navigating their first-year reporting using the new IFRS 17 accounting standard for insurance contracts.

In this article, we share Deloitte’s observations from 2023 on personal lines insurers’ reserving from the perspective of external audit actuarial professionals. We conclude on a hopeful note for 2024. Regulatory restrictions on ‘price walking’, introduced at the beginning of 2022, have now bedded in. Given the sharp rise in interest rates in recent years, the currently negative ‘Ogden rate’ is widely expected to increase, with a corresponding fall in liabilities. This spring’s Supreme Court ruling on ‘mixed injury’ claims will reduce payouts and associated reserves. Inflation is on the wane, allowing the pace of insurance premium inflation to fall too. Similarly, we expect claims inflation to reduce, perhaps allowing inflation allowances within reserves to be released. While there is political concern about “soaring costs for consumers”, the industry is fighting back, pointing out how competitive the market is¹. Finally, while insurers have survived the IFRS 17 test, we believe that there may be more efficiencies to be had by streamlining internal processes.
 

Changing the ‘crazy’ ‘Ogden rate’
 

The personal injury discount rate, also known as the Ogden rate, may be little known outside the UK’s insurance heartland in London’s EC3 postcode, but it is a key driver of the insurance premium inflation that exercises customers, consumer champions and politicians. As the discount rate is used to determine the claims payable in large bodily injury and death claims, such as those following a car crash, it is arguably the single most important number in insurance.

The rate is intended to represent the return that a recipient of the damages could expect if they placed the award in a reasonably prudent investment. The lower the Ogden rate, the higher the settlement will be. The rate is prescribed by the Lord Chancellor in England and Wales under the terms of the Damages Act².

The rate has been negative since 2017, when the reduction prompted the then boss of the Association for British Insurers to label the -0.75% assumed return as “crazy”. The industry was disappointed when the rate for England and Wales was raised to -0.25%, rather than the 0% to 1% anticipated, in 2019. 

The industry is now preparing for the next change with two things under consideration – what level the rate should be and whether there should be a shift from a single to a dual or multiple rate³. The new rate must be agreed between the Lord Chancellor and HM Treasury no later than January 2025, although the industry expects that it may be announced earlier.

In a survey conducted in August 2023 by the Institute and Faculty of Actuaries’ (IFoA) Ogden Working Party, most respondents expected the new discount rate to be a single rate (rather than the dual or multiple rates consulted on) and to be between 0% and +0.75%⁴.

Despite the widespread expectations of an increase from the current -0.25%, our internal benchmarking indicates the majority of motor insurers maintained a best estimate view of -0.25% owing to uncertainty surrounding the factors below:

• Uncertainty on the relative importance of investment yields versus other factors to be considered by the Lord Chancellor and an independent expert panel. Existing modelling indicating alternative rates higher than the current -0.25% have been based predominately on modelling of yields from index-linked government securities. When the Ogden rate was last changed, the Lord Chancellor gave a number of reasons for the change, including the acceptance that claimants may not be investing all of their lump sum in index-linked government securities and that the rate set has used a portfolio of low risk investments instead.
• Personal lines insurers have pointed out that volatility in inflation and investment returns means that even if the Ogden rate were predominantly investment yield-based, there is no certainty these yields will increase.
• Political uncertainty owing to the general election on 4 July 2024 and coinciding with the timing of the next Ogden review.
• A dual or multiple rate system may replace the current single rate increasing the challenge of predicting what the future rate(s) may be. 

Among insurers who have moved away from the -0.25% assumption, we observed +0.75% and 1% being selected. Even with the new Ogden rate not due until 2025, we expect the government to provide further clarity following the call for evidence. Therefore, we expect more UK personal lines insurers to rebase their Ogden rate assumptions from -0.25% to a positive number, thereby allowing significant reserves releases. 
 

Inflation
 

Inflation remains a key topic of UK insurers who have had to adapt their claims management programmes to keep pace with the price volatility seen in recent years.

UK insurers typically base inflation forecasts on publicly available indices such as the Retail Price Index (RPI), Consumer Price Index (CPI), Bank of England’s (BoE) average weekly earnings forecast and various construction cost indices.

Most UK personal lines insurers discontinued explicit additional financial reserves for inflation risk (also described as ‘inflation loading’) for property damage perils in their 2023 accounts. Their rationale is that the peak of related goods and services inflation has passed and that any future inflation is adequately allowed for by standard actuarial reserving techniques.

A different approach is taken for bodily injury claims where almost all benchmarked insurers hold reserves for inflation. Insight from insurers’ financial accounts showed claims reserves were ‘loaded’ from as low as 0.3% to as high as 16% at the end of 2023. This huge range (the highest is more than fifty times the lowest loading), reflects the uncertainty and wide range of views held by insurers around future inflation.

The Judicial College, which trains judges in the UK and which publishes guidance on a range of topics, published the 17^th edition of its ‘Guidelines for the Assessment of General Damages in Personal Injury Cases’ on 5 April 2024. It factored in average increases of 22% for inflation based on RPI up to August 2023⁵. The guidelines provide monetary brackets for each category of personal injury. For the remaining months of 2023, the guidelines stated that damages should be further uprated, based on RPI, to allow for inflation between August 2023 and the date of assessment of the claim. Deloitte observed that, while the guidance was not published until this spring, most insurers had anticipated this RPI increase and made appropriate adjustments in their reserves by the end of 2023.

As market inflation remains subdued it will become increasingly important for actuaries, claims teams and other related parties to work together in understanding the allowance for inflation within claims case estimates as insurers may look to reduce excess loadings during 2024 or release reserves. While each insurer will adopt its own approach reserving, effective claims management will also be key in striking the appropriate response to any inflation changes. 
 

Motor insurance reserving
 

The motor insurance industry saw claims processing backlogs and whiplash reforms impact insurers in 2023.

• Market backlogs. The UK motor insurance industry has seen market-wide backlogs in invoicing and payment of salvage and subrogation, which started in 2022 and has continued into 2023. Subrogation is a mechanism allowing the insurance company to recoup money paid to a policyholder for damages or losses from the party which caused such losses. The backlogs have delayed the development of ‘claims incurred and paid’ data. We have observed some insurers adjusting their claims assumptions to mitigate against these distortionary impacts. This has increased the estimation uncertainty for motor insurance damage reserving. 
• Reduced recoveries. Deloitte observed insurers reducing subrogation claims (i.e. recovering money from a third party who has caused the accident to pay for the damage to their customer’s vehicle). This was driven partly by the processing backlogs mentioned above. This suggests that the reduction on was due to a timing issue rather than a genuine reduction in ultimate recoveries. Other factors included change to the claims mix towards claim types that resulted in a reduced opportunity for salvaging the vehicle. Processing backlogs are expected to reduce over the course of 2024, allowing insurers to get a clearer picture of the extent of genuine reductions in subrogation recoveries. 
• Civil Liabilities Act 2018 and whiplash reforms. The government has for several years attempted to reduce motor insurance claims for whiplash, with a new, reduced, scale of payouts finally beginning in 2021.

Even so, there was uncertainty about so-called ‘mixed injury’ claims, where whiplash and an additional injury are presented. Several such claims had been stalled ahead of a Supreme Court hearing of an appeal instigated by the Association of British Insurers. The judgment, which was handed down in March 2024, provided clarity on the approach to mixed injury claims. It has mandated separate valuations for general damages for the whiplash and the non-whiplash injuries, summing up the resulting values and applying a “step back” test to check if the total amount should be reduced to prevent the possibility of double counting in compensation for the same injury.

A consequence of this clarity is that many mixed injury cases awaiting this Supreme Court judgment may now progress to completion. Reserving actuaries and finance functions of insurers will now be able to adjust for what amounts to a likely reduction in motor injury liability.
 

International Financial Reporting Standard 17 (IFRS 17) adoption
 

2023 was UK insurers’ first reporting year since the IFRS 17 accounting standard went live. It is designed to reflect more accurately “insurance obligations as assets and liabilities, depending on whether expected and discounted cash inflows from premiums outweigh those of claims and expenses. A positive difference counts as a “service margin,” earned as income over time. An expected loss must be recorded straightaway”⁶. The IFRS 17 reporting standard introduces a consistent principles-based approach to accounting for insurance contracts. It requires insurers to use a global, uniform accounting model for all insurance contracts making it easier for investors and analysts to compare the financial performance of different insurers⁷.

Deloitte has observed increasing maturity in insurers’ IFRS 17 processes, with greater capability and confidence in the teams running the associated processes. Reserving teams in insurers have also sought synergies between IFRS 17 and other regulatory requirements such as Solvency II, particularly in areas like claim payment patterns. Nonetheless, our market observations suggest that the increased number of interactions between actuarial, finance and other business teams has resulted in less clarity on the ownership of the complete process.

Timelines proved a challenge for many teams as previous sign-off dates in place for IFRS 4 were adopted for IFRS 17 with no or limited extension. IFRS 17 replaces IFRS 4, a reporting standard issued in 2004 which provided a wide range of accounting practices for insurance contracts. Our market observations showed, perhaps unsurprisingly, that insurers with dedicated IFRS 17 reporting staff fared better than ones without.

The complexity of IFRS 17 requires insurers to collect and manage larger and more granular data which may necessitate a significant overhaul of accounting policies and actuarial methodologies. Market observations have shown insurers adopting labour-intensive processes and manual adjustments to maintain compliance. Some insurers have embraced software solutions to mitigate some of these challenges, but IFRS 17 implementation practices to date reveal opportunities to find further efficiencies in process improvements and control environments.
 

Looking to 2024 accounts
 

We expect the largest operational challenge for UK personal lines reserving in 2024 to be the much-anticipated Ogden rate update. While UK personal lines insurers are broadly prepared for a movement within the existing single rate system, a move to a dual or multi-rate system would increase complexity and organisational strain on reserving teams in insurers, particularly if introduced close to finalising year-end accounts. The dynamic nature of the market highlights the need to have robust and flexible reserving, pricing and capital setting processes.

As UK inflation continues to abate, we expect reduced management and regulatory focus on the adequacy of inflation allowance within reserves. Some UK personal lines insurers might even adopt negative inflation loadings for risks from property damage, thereby enabling them to release reserves.

IFRS 17 will continue its transition into a standard business activity much as Solvency II did when it came into force in 2016. We expect to see increased integration of IFRS 17 activities into existing business processes and efficiency improvements as teams, processes, and control environments mature. While insurers’ focus may have been on meeting regulatory and financial reporting deadlines, the future is likely to be on how to create value beyond compliance.

References

1. Aviva chief rejects Labour’s ‘flawed’ view on car insurance pricing, Financial Times, June 2024.
2. Damages Act 1996 on https://www.legislation.gov.uk/ukpga/1996/48/contents
3. Ministry of Justice, Consultation outcome, Personal Injury Discount Rate: Exploring the option of a dual/multiple rate, September 2023.
4. Ogden Discount Rate Working Party Update (Institute of Actuaries 2024 GIRO Conference, November 2023).
5. Judicial College et al., Guidelines for the Assessment of General Damages in Personal Injury Cases 17th edition, Oxford University Press, March 2024.
6. Lex: Insurers/IFRS17: charge of the light brigade, Financial Times, November 2017.
7. IFRS 17 Fact Sheet on https://www.ifrs.org/content/dam/ifrs/project/insurance-contracts/ifrs-standard/ifrs-17-factsheet.pdf