How changes to compensation claim charges affect your insurance premiums

Bills, bills, bills – they only seem to go one way – and that’s higher. And the latest bill that’s set to increase is car insurance. We know it feels like car insurance does nothing but drain your bank balance, so the announcement probably barely raised an eyebrow. But for anyone interested in the whys and wherefores of why your premium’s set to soar (again), then here’s the reason: compensation.

The reason car cover could start costing more is because of increased compensation pay-outs. It’s been estimated that the average car insurance premium could increase by up to £75 – and with the average policy costing £714 according to our Premium Drivers Index in December 2016 – it’s not an insignificant amount to part with.

When insurance providers work out how much to pay in compensation, a few assumptions are made. The first, is that anyone receiving a payment, will invest it; the second assumption is that they will invest their lump sum in government bonds.

Now, this is where it can get complicated; because it’s presumed that pay-outs will be invested (and will increase in value over time), insurance providers are allowed to reduce the amount of compensation offered. This reduction is called ‘the discount rate’ and at the moment it’s set at 2.5%. In basic terms – the higher the discount rate, the lower the upfront compensation amount and vice versa.

However, the Ministry of Justice has reviewed the discount rate and reduced it to minus 0.75%. They’ve done this because in real terms, returns on government bonds will be negative once inflation is factored in. What this means is larger pay-outs for accident victims and bigger bills for insurance providers – who will have to pass the cost on to customers in order to meet increased expectations.

So, what does all this theory mean for policyholders? Insurance experts reckon that younger and older drivers will be hit the worst with premiums potentially rocketing by up to £1,000 and £300 respectively. With our data showing the average young driver’s policy costs £1,246 already, a potential increase of up to £1,000 will make car ownership even more expensive than it is now.

The Association of British Insurers (ABI) have made it clear where they stand, calling the changes ‘crazy’ and ‘based on an outdated method which risks distorting the compensation process and pushing up insurance premiums’. Of course, there are two sides to every story and people who have suffered life changing injuries due to car accidents, have welcomed the news.

Whether or not the changes are ‘crazy’ the reality is, they are happening and the new -0.75% discount rate will come into effect on the 20 March 2017. If you’re worried about escalating prices and your policy’s up for renewal, then take the plunge and do something about it. But remember, it’s about getting value for money and finding the right deal – not the cheapest one going. Because what’s an insurance policy that doesn’t adequately cover your needs? Useless. So, get it right and comparethemarket.com

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