Car insurance premiums 'to soar' after compensation changes

The cost of the average car insurance premium could increase by up to £75 a year after a government ruling changed the way crash compensation is paid to victims.

The Ministry of Justice has released details regarding a new formula for calculating compensation payments for those injured and suffering long-term injuries, saying it had no choice under the current law - a decision the Association of British Insurers (ABI) called "crazy".

The change is set to take place later this month on the 20th March, but the impact was felt immediately. Shares in UK insurance companies fell and some experts commented that profits would almost certainly be hit by millions of pounds.

As it currently stands, accident victims are paid compensation in a single lump sum - for the most serious cases, this amount is intended to support them for the rest of their lives. However, any individual that receives a payment like this can invest it wherever they choose, ultimately earning themselves a cash return.

To ensure fairness to UK insurance companies, the payout is reduced accordingly. For the past 16 years, this discount rate has been set at 2.5% - but the Ministry of Justice has decided to reduce this rate down to 0.75% - meaning the payout provides more money for the victim but comes at a higher cost for the insurer.

The change has been instigated due to the fact that the current formula assumes the victim would invest their payout in government bonds. By the time inflation is taken into account, any return on these bonds would have become negative.

Reducing the discount rate to minus 0.75% was a "crazy decision", says Huw Evans, director-general of the Association of British Insurers (ABI).

"Claims costs will soar, making it inevitable that there will be an increase in motor and liability premiums for millions of drivers and businesses across the UK," he said. "We estimate that up to 36 million individual and business motor insurance policies could be affected in order to over-compensate a few thousand claimants a year."