The UK's Ogden discount rate should no longer be calculated using index-linked government bond rates as the base figure according to the International Underwriting Association (IUA).
The argument was made in a letter to the Lord Chancellor this month which called for legislation to create a new methodology to determine how the rate is calculated. The IUA would not share a copy of the letter with InsuranceERM and did not say whether they proposed an alternative to using index-linked gilts in the calculation.
Currently the Ogden rate is determined by a three-year average of real returns on index-linked gilts and was reset from 2.5% to -0.75% in February, the first review since 2001. The IUA argued the sudden rate cut, which took effect on 20 March, was "plainly unexpected" and had material consequences to re/insurers.
IUA's chief executive Dave Matcham said: "It is clear that the process to review and amend the discount rate is flawed. Furthermore, the assumptions used to set the rate are completely out of step with current investment practices.
"Removing the relationship to index-linked government securities in the calculation methodology is essential."
The government is set to launch a consultation before Easter to review the framework for setting the discount rate. Last month a group of chief executives from the UK's largest motor insurers met with finance minister Philip Hamond, who promised to review both sides of the debate.
Matcham said: "It is encouraging that HM Treasury is working urgently on a consultation to review this process and the sooner changes are made, the better for the efficient operation of an insurance marketplace that provides security for all policyholders."
When the new rate was announced, Axis Capital announced it would increase reserves, while Aviva said its IFRS profits would be reduced by £385m ($478m) after tax.
"The effect of the recent, unprecedented rate change was immediate and we have already seen sizeable increases in premium rates," said Matcham.
"Companies currently have little option, but to set their reserves according to the new rate and this could lead to a substantial reduction in reinsurance capacity."
People:Dave Matcham
