Motor and liability premiums will rise in the UK due to a “crazy” government decision to slash an interest rate figure used to calculate compensation awards for serious injuries, the Association of British Insurers (ABI) says.

“Claim 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,” Director-General Huw Evans said.

“We have repeatedly warned the Government this could lead to very significant price rises, with younger drivers in particular likely to find it much harder to get affordable insurance.”

The ABI estimates up to 36 million individual and business motor insurance policies may be affected by the decision, in order to “overcompensate” a few thousand claimants each year.

The discount rate used in calculating lump sum payments will be cut from 2.5% to minus 0.75%, effective from March 20. Lord Chancellor Elizabeth Truss says the move reflects declining interest payments on government securities since 2001, when the percentage figure was last set.

A weaker rate of return would imply more funds are required up front to meet a claimant’s long-term funding needs.

“The current legal framework makes clear that claimants must be treated as risk-averse investors, reflecting the fact they be financially dependent on this lump sum, often for long periods or the duration of their life,” Ms Truss said.

The decision is expected to have significant implications across the public and private sector, and Ms Truss says she recognises the impact on insurance.

Further discussions will be held with the industry, she says.

The Government has agreed to review the framework for setting the rate, and Ms Truss says she will bring forward a consultation before Easter to consider reform options. These could include the rate being set in future by an independent body, and more frequent reviews to improve predictability.

It will also review the methodology, which effectively assumes claimants will invest only in safe, index-linked British gilts.

QBE says the UK decision is likely to lead to a one-off increase in the group’s net estimate of outstanding claims liabilities of about $US160 million ($208.8 million).

“As a consequence, industry-wide price increases are expected in affected classes,” it says.