The Government is poised to announce a change in the rate used by courts to work out compensation payments for victims of car accidents. This could have a significant impact on motor insurers and their share prices.

Our preferred name in this space, Hastings (HSTG), looks relatively unaffected by the anticipated changes and could even benefit in some respects.

WHAT IS THE OGDEN RATE?

The Ogden rate is an assumption, used by the courts in determining compensations awards, on how much interest any money paid out will earn when it is invested.

The higher the rate, the lower the lump sum required. The rate has been set at 2.5% for nearly 16 years but with interest rates falling from more than 5% to a record low of 0.25% in the interim there has been clamour for a change.

In its annual report, Direct Line (DLG) says a one percentage point decrease in the Ogden rate would wipe £190m off its profits.

CRUNCHING THE NUMBERS

Investment bank UBS has made its own assessment of the sensitivities. The motor insurers have underperformed the market in recent weeks and UBS sees a reduction to 1% as being priced in, particularly as most of the insurers have already assumed a reduction in the rate when determining their capital buffers
(see table).

Investors could expect any move beyond 1% to have a materially negative impact on share prices.

‘Based on disclosures, we estimate that reduction to 1% could lead to reserving additions of 3% to 5% of market capitalisation,’ says UBS.

‘However, we highlight future earnings could be at risk up to 13% depending on levels of ongoing reserve release expectations in future earnings, reinsurance arrangements and ability for insurers to pass on required (high single digits) price increases.’

WHO COULD BENEFIT?

We think Hastings will stand out from the crowd. Most of Hastings’ policies are new and it does not have a backlog of liabilities which would be affected by changes to the Ogden discount rate.

We like the company for its low costs, well-integrated approach to price comparison sites and strong technology platform.

The insurer could also be a beneficiary if the change to the Ogden rate forces some of its rivals to increase their premiums, allowing it to capture market share more quickly.

Forecasts from Berenberg, which is a buyer of the stock with a 253p price target, imply a 2017 price-to-earnings growth (PEG) ratio of 0.5 times. A figure below 1.0 is generally considered to represent a cheap stock versus its growth potential.

Buy Hastings at 233p.

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