Car insurance is likely to become more expensive for millions of motorists, in particular young drivers, as a result of a change in the way compensation payouts are calculated.

The government has reset the personal injury discount rate, known as the Ogden rate, which is used to calculate compensation payments for people who are seriously injured in car crashes, industrial accidents or botched operations.

The Ministry of Justice announced on Monday that it would be set at -0.25%, compared with -0.75% previously, from 5 August. This will reduce the amount insurers have to pay out – but not by as much as insurers had expected. The higher the Ogden rate, the less insurers have to pay out as a lump sum.

Mohammad Khan, the general insurance leader and a partner at PricewaterhouseCoopers, said insurers had been pricing motor insurance and settling claims at a rate higher than -0.75%, typically between 0% and 1%.

“The announcement today means that motor insurance premiums – which have been broadly stable this year and slightly lower than last year – will probably increase. The average motor insurance premium will probably increase by between £15 and £25 but younger drivers may see their premiums increase by about £50 to £75.”

The Association of British Insurers said the new rate would add sizable additional costs for insurers that would be passed on to consumers through higher car insurance premiums, after a few months of falling premiums because of reforms to whiplash insurance payouts to stamp out bogus claims.

Huw Evans, the industry group’s director general, said: “This is a bad outcome for insurance customers and taxpayers that will add costs rather than save customers money.

“This will remain the lowest discount rate in the western world, leaving England and Wales an international outlier at a time when we need to boost our attraction to international capital.”

The Ministry of Justice had previously proposed a rate of between 0% and 1% after a furious backlash by the insurance industry against the surprise cut in the Ogden rate to -0.75% in February 2017, from 2.5%. The government has changed the way it is calculated and the latest rate is the first calculation under the new method.

David Gauke, the lord chancellor and justice secretary, said: “It is vital victims of life-changing injuries receive the correct compensation – I am certain this is the most balanced and fair approach following an extensive consultation.

“It is also right that the rate is informed by experts and reviewed on a regular basis to make sure this important calculation is accurate every time.”

The Association of Personal Injury Lawyers welcomed the government’s move. Its president, Gordon Dalyell, said: “The government has faced sustained pressure from the insurance industry to set a rate which would not be appropriate for injured people, who should not be forced to take any risk with their investments.”