Car insurance prices 'could stabilise' as Government rethinks compensation shake-up

In March, the Government changed the way it calculates the compensation due to someone who's suffered life-changing injuries in an accident – and insurance firms predicted premiums would rise steeply as a result.

But today (7 September) the Ministry of Justice announced proposals partly reversing those changes, leading to hopes that the price of car insurance – which is up 11% in the past year according to the Association of British Insurers – will stop climbing.

For how to slash the cost of your car insurance – and why you should NEVER auto-renew – see our Cheap Car Insurance guide.

How are compensation payouts changing?

When someone who has suffered a life-changing injury accepts a lump sum compensation payment, the sum they get is adjusted according to the interest they could expect to earn by investing it – what's known in industry jargon as the 'Ogden' or 'discount rate'.

The discount rate – the amount by which insurers can reduce a payout – stood at 2.5% between 2001 and March this year, when it was reduced to -0.75%, meaning insurers would have had to pay out more than previously. But it now looks set to be moved to a figure between 0 and 1%, following a proposal laid out today by Lord Chancellor David Lidington.

The Ministry of Justice says the planned alteration to the discount rate will make sure personal injury victims get the right compensation, and will help keep premiums down.

The discount rate is supposed to put claimants in the same financial position they would have been in had they not been injured. The rate is based on the assumption that claimants invest their money into Government bonds, and the reduction of the discount rate was initially implemented in March because interest rates on these bonds had fallen.

But a consultation launched in March following a media backlash to the change has found that claimants often don't invest their money in these bonds and take slightly more risk – so the Ministry of Justice now plans to increase the rate to reflect this. It also plans to review the rate more regularly in future – at least once every three years.

At the moment, these proposals are just that – proposals. There is no indication of exactly what the rate will be, and the changes will have to be voted on in Parliament before they become law, which could take weeks to months.

How will car insurance premiums be affected?

According to some estimates, car insurance premiums rose by an average £75/year after the changes to compensation payments in March. As you'd expect, insurers have welcomed the Government's announcement today – but what remains to be seen is how the changes, if they become law, will affect prices.

Experts we've spoken to today think it's likely to have a positive impact for drivers, but with prices already on the up before the discount rate was changed in March, don't expect an immediate price cut.

Mohammad Khan, UK general insurance leader at professional services firm PwC, said: "This morning's announcement by the Ministry of Justice should bring some relief to motorists. Premiums had already risen by about £75 on average and about £250 for young drivers following the original discount rate announcement earlier in the year as insurers passed on roughly half of the expected costs caused by the original rate move.

"If this morning's announcement had not been made, insurers would have been forced to pass on the remaining costs and annual motor insurance premiums would have risen again in November and December by an average of £100 for UK motorists and by between £300 and £500 for young drivers.

"Today's announcement, if passed through Parliament, should mean that motor insurance rates remain stable for the next six months. However, if the legislation is not passed, it could mean motorists facing steep premium rate rises early next year."

Huw Evans, director general of the Association of British Insurers, said the changes announced today "will help relieve some of the cost pressures on motor and liability insurance in a way that can only benefit customers".

However, an AA spokesperson was more cautious. He told us: "It's hard to tell what the effect will be. It's a while before the legislation will be enacted.

"It's hard to put a figure on it, but premiums will probably continue to rise until the end of the year. They may stop or even drop slightly in the first quarter of next year."