Readers of this blog listening to the ABI’s Huw Evans on Wake up to Money, may have been spluttering into their tea and biscuits!
The ABI are faced with a cut in the discount rate used to calculate compensation claims on serious injuries (typically from vehicle accidents). The discount rate will move from it’s current 2.5% to (0.75%).
To use less tecchie terms, the expected return on the investment of a claim shifts from 2% over inflation to 0.7% less than inflation. With inflation at below 2%, the ABI would hardly be able to take any investment credit when calculating claims and claims payments are going to shoot up.
I’m not sure that Huw Evans had thought this through when he described a negative discount rate as “absurd“. I wonder if those of his members making good money from the ultra high premiums received from occupational pension schemes want him using language like that!
Evans demonstrated that demanding more for long-term injuries and bereavement compensation was not a victimless crime. The impact would be passed on to other policy-holders in increased premiums.
This is a good point – well made. It is the same point that the CBI have been making when arguing that pension schemes should not have to value assets against gilts for the damage it is doing to cash-flow, dividends and the capacity of employers to invest for the future.
But once again we have to ask whether the buy-out and TV payments his members are receiving because of super-low discount rates in pensions come at “no expense”.
Of course they don’t!
The cost of transfer payments impacts the ongoing funding rate employers are asked to make to our closed DB schemes. It can add to the demands to close open schemes to future accrual, it can create such cash-flow problems for an employer that it puts the security of other members existing benefits at risk.
Whether it be through higher insurance premiums, or lower pensions, there is a price that consumer pay for gilt-based valuations and funding plans.
A change of heart or special pleading?
I have every sympathy with this particular argument. His solution is to establish an approach that takes into account “everything that impacts the discount rate“. Since the (0.7%) rate is based on returns on index-linked bonds, then he has a good point.
Nobody is going to invest a sum of money into index linked-bonds at current prices. Evans is actually arguing to adopt FABI, the First Actuarial approach to valuing liabilities which uses everything that impacts the discount rate.
I will be sending Huw Evans the FABI charts to show him how consistent liability valuations are when measured on a best estimate basis and how much easier it would be for insurers to use a best-estimate basis in claim.
Put graphically, the ABI’s claim experience could move from positive territory to negative territory as easily as pension scheme valuations could move from surplus to deficit.
If he wants our support for moving to a FABI style approach to claims discount rates, I want his support for moving pension scheme valuations to a best-estimate basis for funding purposes!
Other wise , it’s just another case of ABI special pleading!
Further reading and listening
This is what the fuss is about, a recent court ruling that went against the ABI ; https://www.abi.org.uk/News/News-releases/2016/12/ABI-legal-challenge-on-discount-rate
The ABI’s arguments are set out here
The discount rate is a tool that adjusts personal injury damages awards to take into account the return expected when a compensation lump sum is invested and to ensure that claimants are not under or over-compensated.
It has been set at 2.5% since 2001 and governs all compensation awards in England and Wales. In Europe, it is typically between 1% and 4%.
In the past the rate has been based largely on the gross redemption yields of Index-Linked Government Securities (ILGS). The principle of full compensation, which the ABI entirely accepts, is that injured claimants should neither be under-compensated nor over-compensated. This is no longer served by the linkage to ILGS because the long-term investment behaviour of those compensated is, in practice, very different. The Lord Chancellor needs to conclude the process of finding the right way of achieving the full compensation principle.
ABI blog on the matter; http://blog.abi.org.uk/category/discount-rate/
The Podcast of the Wake up to Money show on which Huw Evans appears is here ; the discount rate discussion starts at 21.15 http://www.bbc.co.uk/programmes/b08j97bs