Millions of motorists are facing increased insurance premiums while the NHS will have to find an extra £1 billion following a change to the formula used to calculate compensation payouts.

Announcing the move, which is expected to see a sharp rise in personal injury payments, Chancellor Liz Truss said she the change was the only “legally acceptable” course of action open to her.

But the decision was greeted with disbelief by the insurance industry, which described the changes as “crazy” and “reckless in the extreme”.

Liz Truss (Ben Birchall/PA)Liz Truss (Ben Birchall/PA)

Downing Street said the NHS would get the additional funds it needs to meet the increased costs of settling medical negligence claims.

A No 10 spokesman confirmed that estimates that it would add £1 billion to the service’s insurance costs were “broadly in the right ballpark”.

Liberal Democrat leader Tim Farron said ministers had failed to think through the consequences of their actions, saying it was “another Government omnishambles”.

The change, unveiled in an announcement to the London Stock Exchange, relates to the discount rate used to calculate payments to victims of life-changing injuries, which has been unchanged since 2001.

When victims of life-changing injuries accept lump sum compensation payments, the actual amount they receive is adjusted according to the interest they can expect to earn by investing it.

In finalising the compensation amount, courts apply the rate, with the percentage linked in law to returns on the lowest risk investments, typically index-linked gilts.

Ms Truss announced that from March 20, the rate would be cut from 2.5% to minus-0.75%, reflecting the changes in gilt yields.

Huw Evans, director general of the Association of British Insurers, “We estimate that up to 36 million individual and business motor insurance policies could be affected in order to overcompensate a few thousand claimants a year,” he said.

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

“It is also a massive own goal that lands the NHS with a likely £1 billion hike in compensation bills when it needs it the least.”

The AA’s director of insurance Michael Lloyd said it was an “astonishing” decision that would particularly hit younger drivers.

Downing Street said Chancellor Philip Hammond would be meeting with representatives of the insurance industry to discuss the implications of the changes.

Ms Truss, who is also Justice Secretary, said she had taken the decision in her capacity as Lord Chancellor, independent of the Government.

“The law is absolutely clear – as Lord Chancellor, I must make sure the right rate is set to compensate claimants. I am clear that this is the only legally acceptable rate I can set,” she said.