§ 5.41 p.m.
§ The Earl of Northesk
My Lords, I beg to move that this Bill be now read a second time.
On 6th March, the Insurance Companies (Reserves) Bill was read in this House for the first time, having been passed by the other place. The Bill seeks to amend the law relating to insurance companies, in particular the Insurance Companies Act 1982. The main purpose of the Bill is to confer power on the Secretary of State to make regulations requiring the maintenance of reserves by insurance companies.
It is an indication of how desirable this measure is that it is supported by all the main parties, as well as the industry itself. It is worth noting particularly the very great depth of consultation between the Association of British Insurers, the DTI, the Government Actuary's Department and the Inland Revenue that prefaced the matter being brought before Parliament.
Although the Bill is short—it comprises only three clauses—it is highly technical. That said, this should not be allowed to obscure its importance and the very 1446 considerable and beneficial impact that it will have on the prudent regulation and international competitiveness of the UK insurance industry.
Before embarking on a detailed explanation of the Bill's clauses, it may be helpful to the House if I indicate the areas of the insurance industry where these regulations will not have effect. First, the Bill will not impact upon the operation of Lloyd's; nor will the scheme apply to or have any effect upon insurance brokers or other insurance intermediaries. Equally, those areas of the market that are non-volatile—for example, health and motor insurance—will not be subject to the regulations. The reality is that claims equalisation reserves would not, in fact, have any impact upon claims management of such business on the basis that the judgment as to the likely exposure to claims pay-out in any given accounting period is a relatively predictable discipline. Therefore there is no requirement to set aside any additional contingent reserves in expectation of a random and unexpected increase in exposure.
Indeed, this factor lies at the heart of the perceived requirement for equalisation reserves. The July 1993 consultative document envisaged that any CER scheme should apply to,certain types of particularly volatile non-life insurance business … [where] the requirement should be focused on high risk/high reward lines where the profitability of the underwriting is dependent on the random incidence of infrequently occurring events".Such classes of business have an inherent instability. Unpredictable tragedies and events create sudden and substantial claims within the industry. For example; the dreadful storms of 1987 and 1990 in the south east resulted in property damage claims of £1.4 billion sterling and £2.4 billion sterling respectively over and above and beyond the normal cycle of experience for this class of business. Thus, there is a strong argument in favour of limiting the impact of this volatility by introducing mechanisms whereby the insurance industry can impose as much stability as possible upon its management of catastrophe risk and claims. This is the purpose of equalisation reserves; namely, to equalise the level of risk and claims exposure over the perceived cycle of the class of business.
I turn now to a detailed examination of the clauses in the Bill. Clause 1(1) is its main provision. It inserts the new Section 34A in Part II of the Insurance Companies Act 1982, which contains various provisions relating to the regulation of insurance companies, and is particularly concerned with various continuing financial obligations of insurers. Subsection (1) of Section 34A confers, and defines the scope of, the power of the Secretary of State to make regulations in respect of equalisation reserves.
It is important here to recognise that the phrase "general business" is specifically defined in Section 1(1) of the 1982 Act and, for the purposes of interpretation, can be assumed to be "non-life" business. The intention is to ensure that those certain types of general business that display the characteristics of volatility for which equalisation reserves are appropriate can be subject to the regulations.
1447 The Bill does not contain any express rules for determining how such regulations may be made, although subsection (4) of Section 34A defines their anticipated structure in broad terms. This is entirely consistent, in so far as Section 97 of the 1982 Act already confers power on the Secretary of State to make regulations for any purpose for which regulations are authorised or required to be made under that Act. In this context, my understanding is that the consultative process entered into by the DTI on this is ongoing and it is likely to be in a position to present its proposed regulatory framework in the near future.
By way of explanation, it is envisaged that general business insurers will be required to place a proportion of their premium income, the amounts being varied according to type, in the described business to a non-distributable equalisation reserve. A maximum size of the reserve will also be prescribed. Amounts will he required to be taken from reserves according to a prescribed trigger related to exceptional claims. It should also be noted that the regulations will make appropriate provision for special circumstances, such as where insurers transfer or cease writing business.
Nor does the Bill make express provision for penalties for non-compliance with Section 34A. Again, this matter is adequately covered by the 1982 Act, Section 71 of which will automatically apply in cases of default.
Subsection (2) of Section 34A describes in, as it were, a geographical sense the insurance companies to which Section 34A applies. Essentially, as defined in Section 15 of the 1982 Act, the intention is to include all insurance companies which are subject to the requirement to obtain authorisation and which are subject to supervision in the United Kingdom.
It is possible that equalisation reserves may be inappropriate for certain descriptions of insurance company, notwithstanding that they may qualify for the regulation by virtue of subsection (2) of Section 34A, and that therefore facility for such companies to be excluded from the scheme be allowed for in the regulations. This is the purpose of subsection (3) of Section 34A.
Clause 1(2) of the Bill inserts in Section 32 of the 1982 Act a new subsection (7), the purpose of which is to require insurance companies to treat their equalisation reserves as a liability for the purposes of calculating their margin of solvency.
The primary purpose of Clause 2 is to enable the Secretary of State to provide in regulations that Section 68 of the 1982 Act should apply to Section 34A. Section 68 allows the Secretary of State to ensure that the suitability and appropriateness of regulations and obligations imposed on individual companies by virtue of the 1982 Act can be assessed on a case-by-case basis. I should stress that, at this stage, no clear need for Section 68 to apply to Section 34A has been established—hence the provisions of subsection (2) ensuring that it does not apply automatically —but it remains important to ensure that the Secretary of State is in a position to respond positively should such a need arise.
Clause 3 concerns the Short Title of the Bill together with its commencement and extent.
1448 Noble Lords will be aware that the Bill has a European dimension. Few would question the enormous importance of the insurance industry to the nation. Despite some of its recent difficulties, it continues to be one of the UK's greatest assets, making substantial contributions to the economy in terms of employment (some 60,000 jobs in London) and invisible earnings (some £4.6 billion sterling in 1993). Here, I cannot resist the opportunity to celebrate the very welcome balance of trade figures published last week. It is therefore salutary to reflect that that performance has been achieved against a background of competitive disadvantage with a number of our European partners.
As your Lordships will be aware, the Insurance Division of the DTI is the regulatory and supervisory body of the UK insurance industry. The main statutory authority for its work is the 1982 Act. However, there is also an extensive history of insurance directives emanating from the Commission and being implemented by member states. The primary aim, effectively sealed by the implementation of the third non-life directive in July last year, has been of harmonising the regulation of insurance companies and the introduction of home state supervision, thus facilitating the development of the single market in insurance throughout Europe. Further harmonisation is anticipated from such measures as the insurance accounts directive, which is intended to take effect from the current financial year onwards.
However, it is generally accepted that the UK insurance industry cannot compete on an equal footing with many of its European counterparts, notably France and Germany, because of the availability of equalisation reserves in such countries. As the DTI/Inland Revenue consultation document observed in that context:for a variety of reasons there has been a decline in the UK share of world insurance markets. It is often argued that this decline will accelerate as the single European market in insurance grows in importance".Thus, since 1989, over 60 UK and foreign-owned companies have ceased writing business in London, contributing to the loss of some 10,000 jobs in the industry. That has occurred during a period of increasing competition and a run of natural disasters—for instance, the Piper Alpha tragedy, Hurricane Andrew and the storms of 1987 and 1990, to which I have already referred.
Recent results demonstrate a welcome recovery—again, I sing the praises of last week's trade figures—but there can be no doubt that equalisation reserves can play a very important part in further improving the UK industry's European and international competitiveness.
In this context I venture to suggest that, whatever the state of the current debate about Europe and wherever individuals may wish to place themselves on the Europhile/Eurosceptic divide, there appears to be a consensus that Europe should be a free trade area. Thus, I see no inconsistency at all in seeking as a matter of priority and urgency to put our non-life industry on a more equal footing with those of other member states. Indeed, I would further argue that it is entirely prudent and desirable that we should seek so to do.
1449 That leads me to a secondary plank of the Bill. It was said in another place that, however sensible its provisions are, implementation of the scheme will be meaningless unless it is accompanied by a corresponding accommodation with respect to the tax treatment of the equalisation reserves. The competitive advantage of other nations' insurance companies is as much a function of the tax relief allowed against their reserves as of the schemes themselves. In that context, my right honourable friend Stephen Dorrell, when Financial Secretary to the Treasury, observed:Given the overall fiscal position, I am clear that it would not be appropriate for the Exchequer to suffer a net cost from the introduction of such a scheme".In fact, implementation of an equalisation reserves scheme would be broadly neutral, except in so far as payment of tax on sums transferred into reserves would be deferred until such time as they were transferred out. In effect, the amount of tax due will not change but its payment will be spread over a longer period. Viewed from a more sanguine perspective, there is a mitigating principle of prudence that argues in favour of tax relief for reserves.
I have already alluded to the impact that the equalisation reserves scheme will have on the UK industry's ability to compete more effectively in Europe. But over and above that, there exists the clear benefit of giving considerable additional comfort both to regulators and to policy holders as to the underlying financial and commercial security and health of the companies concerned. Pursuing the logic of that a little further, it is entirely possible, if not very likely, that those UK companies which are subject to the proposed regulations will be very much better placed to expand their business. Given the considerable expertise that exists in this country, it is churlish to imagine that the industry would not be able to respond positively to that challenge. Increased turnover implies improved profits, which in turn would generate more revenue for the Exchequer.
I am mindful that the Treasury prefers to think in terms of certainties rather than such speculative postulations. Nonetheless, it is my understanding that Treasury Ministers have given an undertaking to consider tax relief for a suitable scheme. DTI and Revenue officials have been working together to that end. Proposals for a scheme of tax relief which the Government might be minded to implement will be included in the consultation document which is due for publication in the spring.
I am equally conscious of the concerns of many noble Lords with respect to delegated powers—notably the concerns of the noble Lord, Lord Peston. I would not seek to dissuade the noble Lord from his deeply held convictions on this matter; but there are some broad principles underlying the regulation of the insurance industry which may be instructive in this context.
As I have already explained, the 1982 Act confers a number of regulation-making powers on the Secretary of State. In that sense, a body of delegated legislation already exists in this area. It is entirely appropriate that the purposes of the Bill should be consistent with 1450 existing procedures. Indeed, Section 97 of the Act prescribes the use of the negative resolution procedure as the means for effecting regulations made under its existing powers. It is also worth noting that equalisation reserves are necessarily complex and technical instruments, requiring considerable flexibility in the light of changing circumstances and experience. Because of that, a considerable amount of time-consuming consultation is required to draft workable regulations. It is for those reasons that the negative resolution procedure is deemed appropriate.
My explanation of the Bill thus far has been entirely enthusiastic. That said, I am not blind to a need for some minor consequential amendments. Therefore, I should like to give your Lordships advance notice that I shall propose amendments to the Bill in Committee. It occurs to me that a requirement exists, as it were, to broaden the scope of the reporting arrangements in Companies Act accounts. At present the Companies Act only refers to credit equalisation reserves. In my view, it will also need to refer to any equalisation reserves required by this Bill.
Finally, although I have touched on a number of these points already, I should like to consider in a little more depth the potential benefits which will accrue from the Bill being enacted. Let us first consider the consumer. It is the general perception of the industry that those classes of business which are anticipated to be subject to regulation have in the past, because of their volatility, exposed policy holders to knee-jerk price reactions arising from sudden increases in claims exposure. For example, home building premiums increased by some 50 per cent. between 1989 and 1993, principally, although not exclusively, because of the high incidence of claims arising from the windstorms of 1987 and 1990. However, many households are now experiencing level or reduced premiums. Equalisation reserves will considerably assist insurers to smooth the impact of such random peaks of claims experience, thereby enabling them to pass that on to the consumer in the form of very much more consistent pricing of premiums and, by extension, increased price stability should have the eventual benefit of making policy premiums more affordable.
What of the industry itself? I have already mentioned the benefits of increased competitiveness, particularly in the single market, and a potential upturn in general business capacity. Such effects are very welcome, the more so if they contribute favourably to maintaining the UK's special status in the global insurance market. Perhaps more importantly, equalisation reserves attracting tax relief will enable insurance companies to manage and administer their capital more efficiently. Additionally, they will add to a company's solvency and availability of capital to underwrite risk. In an industry so reliant on public and market confidence in its financial health and well-being, that is of crucial importance. In this context, as I have already intimated, the prudential aspects of the Bill are paramount and will make a major contribution to the protection of the policy holder, thereby greatly improving the reputation of the UK industry globally.
1451 In conclusion, the thrust of the Bill is to achieve two worthy objectives: first, to make the regulatory supervision of volatile non-life business more prudential; and, secondly, to confer competitive equality upon UK insurance companies in the single market. With that in mind I commend the Bill to the House and hope that your Lordships will be content to give it a Second Reading.
§ Moved, That the Bill be now read a second time.—(The Earl of Northesk.)
§ 6 p.m.
§ Lord Ezra
My Lords, the House will be indebted to the noble Earl, Lord Northesk, for the comprehensive way in which he introduced this Second Reading. The purpose of the Bill (which, although very technical, is very simple), is, as he explained, to introduce a scheme for the equalisation of reserves for the non-life business of insurance companies, particularly in relation to insurance claims arising out of catastrophes. It is not hard to think of the sort of catastrophes that may arise, because there have been so many in the recent past. We had the Piper Alpha catastrophe in the North Sea in 1988; the European storms in 1987 and 1990, to which the noble Earl referred, and the various hurricanes in the United States and elsewhere. It would seem obvious, therefore, that something needs to be done to build up reserves to meet that sort of situation. That in itself is sufficient justification for the Bill.
A further justification relates to what is happening on the Continent of Europe. As the noble Earl clearly stated, these arrangements apply to our main competitors, particularly in Germany and France. If we are to compete with them, then clearly we ought to be observing the same broad rules so long as they appear to be justifiable, which I believe them to be in this case.
I am a great believer in smoothing-out operations. If we had been able to work out a way in which we could smooth out the ebbs and flows of booms and busts, I am sure that we should all be much better off. For one thing, the level of unemployment would be much lower. That may be more difficult to achieve than the limited objectives of the present Bill, but, where we can carry out smoothing operations and where, from the fiscal point of view, that can have a neutral impact, then we should do so.
The fiscal aspect is of great importance. It is not mentioned in the Bill, but the understanding is that, when within the next few weeks the Government release their consultative document, they will lay down the basis on which the regulations will be framed and that will include the fiscal aspects. Clearly this scheme could only work if there was a fiscal benefit to the insurers to set up the fund which will be offset when the reserves are drawn out.
We from these Benches support the Bill for three reasons. First, it would give the insurers greater stability of earnings and thereby help them to promote and extend their business and make them more competitive. Secondly, it would lead to greater stability of premiums for the insured. After the storms of 1987 and 1990 particularly in this country, premiums went up to a high 1452 level and subsequently subsided. That volatility of premiums is to the disadvantage of those who take out insurance and to some degree it may be avoided. Finally, from the Treasury's and the taxpayers' point of view, it could lead to a smoothing out of tax receipts and, let us hope, to some increase in overall receipts if the regime expands the amount of insurance business. We therefore support the Bill.
§ 6.5 p.m.
§ Lord Peston
My Lords, I too support the Bill and thank the noble Earl, Lord Northesk, for introducing it. I made the mistake of looking at the Bill too closely. I feel that I would be better off if I had preserved my original ignorance of the subject. However, having become involved in certain matters, I feel that I must continue.
I agree with the noble Earl regarding the importance of the UK insurance industry. It follows, a fortiori, that we must make sure that in a single market the industry can compete effectively with industries from other countries. However, I shall not follow the noble Earl—not out of any discourtesy—on the subject of the balance of payments. I agree as to the contribution that the industry makes to the balance of payments. If by chance the noble Earl should venture into your Lordships' Chamber on Wednesday afternoon, he may hear me offer a correct interpretation of the figures that the Government announced last week.
The purpose of the Bill is to deal with insurance companies' non-life business. It concerns the UK insurance industry. One of my puzzles, and perhaps either the Minister replying or the noble Earl himself may resolve it, relates to what constitutes the UK industry for this purpose. The philosophy behind the Bill would appear to mean the industry as owned and operated in this country. One of my difficulties is that, when reading the Bill, I wonder whether that is in fact the case, or whether it is the case that non-British businesses may gain from the provisions simply because of their location in London and their being subject to UK regulation.
Perhaps I can say in my usual acerbic way, en passant, that subsection (3) of the new Section 34A, to which the noble Earl referred, is completely incomprehensible to me. I am sure that it means exactly what he said it means, but if I were asked to say what it means, even having heard him, I would have to say that I do not have the faintest idea. Presumably it does have a purpose and means something.
The noble Earl referred to my attitude as regards the use of regulations. As I understand it—I believe he confirmed this—the philosophy of regulations introduced by the Minister goes back to the Act of 1982 and the negative procedure. I believe that the noble Earl is saying that the negative procedure would apply in this case and he believes that to be right. One of my objections is the usual pig-in-a-poke one; that is, that I have not the faintest idea of what will be in the Secretary of State's regulations when they occur. Since the essence of the Bill is in the regulations, we face our usual problem of approving the Bill and giving it a 1453 Second Reading without the faintest idea of what it is we are agreeing to. Also, your Lordships are not consulted in any sense when the negative procedure is invoked. We simply receive the regulations in due course and chat about them at that stage; but we would not dream of voting against them. That is the reason I find this sort of thing most unsatisfactory. But that is a general comment and has nothing specifically to do with the Bill. It will not cause me to say that we should stop the Bill proceeding.
Perhaps I may raise another matter which did not occur to me until the noble Earl spoke. He said that he had been assured by the Financial Secretary to the Treasury that the Bill would proceed on the assumption that it was fiscally neutral. I am afraid I became lost at that point. I believe he said that it would not represent a net claim on the Exchequer. What eludes me is that I assumed immediately that the whole point of the Bill was to make a tax concession to the insurance companies in order to encourage them to put it into practice. I cannot follow the logic of what the noble Earl said. For it to be an incentive, there must be a tax concession. The whole point is that the claims equalisation reserve should be tax deductible. That is the whole logic that lies behind the Bill. Therefore I do not see how it becomes fiscally neutral. What else will be raised in tax to offset it?
Speaking as someone who used to regard himself as an expert on the economics of taxation, I must say that it was at that point that I completely lost the basis of the Bill. Without wishing to prolong the proceedings, essentially if the total revenue is constant, if there is not a tax concession here, what else makes the whole thing add up? I do not know the answer.
My last comment on this matter relates to the taxation side and to how we proceed anyway. Of course I am delighted that the Bill is going forward. I am delighted that the noble Earl is taking a leading role. But, on reflection, where we are discussing matters of tax deductibility and of essentially a form of regulation—we are discussing a form of order-making power—I have to say that I am not all that happy that any of this should be taking place by means of a private Member's measure. Given the importance of the industry and given the importance of this reform, I at least would have been happier if the department itself had felt that this was government business and that it should therefore take the lead. I say this again with no disrespect to the noble Earl or to Mr. Oliver Heald MP, who carried the Bill forward in another place. But I am a little puzzled that legislation of this kind should come forward in this way.
What I have said sounds a little acerbic and churlish. I do not mean it to be that, because it merely results from my interest in the subject. Perhaps I may add that I am a little taken aback that we may have an amendment or two, but we shall look at those in due 1454 course. What I most hope is that we shall give the Bill a Second Reading and that it will become law in the very near future.
§ 6.11 p.m.
§ Lord Inglewood
My Lords, on behalf of the Government I should like to start by congratulating the noble Earl, Lord Northesk, on introducing the Bill to the House and on the skill with which he has described what is a very technical matter and, to the layman, a very arcane one. I should also like to thank the honourable Member for Hertfordshire, North who introduced the Bill in another place.
This is a worthwhile and welcome Bill and one which I believe enjoys wide-ranging support in general and certainly on the Floor of the House this afternoon. As we have already heard, the insurance industry has for some time sought the introduction of a scheme for establishing equalisation reserves. Industry leaders have made it clear that they regard this as of great importance to their future competitiveness. I also welcome the measure as an addition to the regulatory options available to us, since such reserves should assist insurance companies in settling exceptional levels of claims in bad years from funds put aside in good years. The Bill is an important step along the way to establishing such a scheme, which we believe will assist the British insurance industry as a whole as well as the consumer.
The noble Lord, Lord Peston, asked what constitutes the UK insurance industry. It is best described in new Section 34A(2). That refers to those insurance companies which are controlled here in the United Kingdom, bearing in mind the workings of the European single market in insurance, where the underlying principle is that there is home country control tied in with host country rules of business: in other words, first, those whose head office is in this country; secondly, firms whose business is restricted to reinsurance, because reinsurance falls outside the scope of the single market in insurance; and, thirdly, those firms whose head office is not in this country or in another member state but outside the Community and which obviously do not fall within the scope of the single market either.
As the noble Earl has explained, the Bill is an enabling measure. It may be helpful if I say a little about the work that has been done and the Government's plans in this regard. While no final decisions have yet been taken on the details of the regulations which will be introduced following the passage of the Bill, officials in the DTI and the Inland Revenue have been involved with the working group led by the Association of British Insurers—the ABI—in carrying out considerable preparatory work on a proposed scheme. The working group has already made recommendations about the details of the scheme and a report has been sent to government and circulated to a wide cross-section of ABI members. I should like to take this opportunity to thank the ABI for the work it has done.
The insurance industry generally declared its support for the working group's recommendations and it is now the Government's intention to issue a second 1455 consultation paper this spring, giving details of a proposed scheme which I expect will incorporate many of the industry's recommendations. It is our intention to publish the actual regulations in draft form before they are laid before Parliament to enable the industry and other interested parties to have the opportunity to comment on them.
I should also like to say something on the matter of tax relief for such reserves and to turn briefly to the point made by the noble Lord, Lord Peston. With regard to fiscal neutrality, the effect of putting money into reserve is essentially to pay a claim on account. Provided that the claims come out of the reserves in due course, the procedure will turn out to be tax neutral.
§ Lord Peston
My Lords, is the noble Lord saying that it is tax neutral over time rather than at a point in time?
§ Lord Inglewood
My Lords, that is my understanding of the matter. At the end of the day this is a matter for Treasury Ministers and any legislation would be included in a Finance Bill. I can say, however, that my right honourable friend the Member for Ealing Acton, the Financial Secretary, has indicated that they will be prepared to consider tax relief for an acceptable scheme, which is something on which officials in the DTI and Inland Revenue are working. Before any scheme is introduced we would be looking to ensure that it was acceptable to the industry, Treasury Ministers and the Secretary of State.
In closing, I should once again like to thank the noble Earl for his work on the Bill. The Government welcome the Bill and we intend to assist its safe passage.
§ 6.14 p.m.
§ The Earl of Northesk
My Lords, I shall be very brief. I wish to express my gratitude to the noble Lords, Lord Peston and Lord Ezra, and my noble friend Lord Inglewood for their support. I can but hope that it presages safe passage for the Bill through your Lordships' House.
I think that the noble Lord, Lord Peston, slightly misheard what I said with regard to tax treatment. The reality is that the Bill is only about regulatory requirements. Changes to the tax regime are specifically the province of my right honourable friend the Chancellor. It would be wholly inappropriate for me or the Bill to seek to address those. The inescapable reality is that unless the regulations are in place any judgment about the tax regime is wholly redundant. Without the chicken the egg cannot be laid.
In conclusion, the Bill is concerned primarily with imposing greater levels of prudence on the supervision of the insurance industry as well as putting it on a more equal footing with our European partners. That seems to be the consensus of all your Lordships. I ask the House to give the Bill a Second Reading.
§ On Question, Bill read a second time, and committed to a Committee of the Whole House.