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Mr. Michael Jack (Fylde): When we discussed this in Committee, concern was expressed that the clause as originally drafted would disadvantage UK insurance companies in comparison with world competitors because of the global nature of the insurance market. In the discussions that were subsequently held with the industry, did the Economic Secretary receive positive assurances from the industry that the amendments addressed the competition issue to its satisfaction?
Miss Johnson: Many countries, including the United States, Canada, Australia and Germany, already require discounting for tax purposes. France has rules very similar to our proposals to counter over-reserving. The UK has the lowest rates of corporation tax of any major industrialised nation. The long-term costs of the clause to the industry will be far less than the cost of typical European corporate tax rates, which are about 10 per cent. higher than in the UK. The cost is also much less than the industry would pay if insurance premium tax were increased to typical European rates. Our rates are well under European rates.
Companies can choose to base their tax deductions on discounted liabilities. That will cost them more in the short term, but it will reduce or eliminate their long-term costs. They can choose to do that all at once, or to spread
the costs over several years. Therefore, the clause will not produce a competitive disadvantage for UK insurers. I hope that that answers the right hon. Gentleman's question.
Mr. John Greenway (Ryedale): I beg the Paymaster General to revisit what she has said because companies do not pay insurance premium tax; consumers do. If I am lucky enough to catch your eye, Mr. Deputy Speaker, I shall acknowledge that the current provision represents a significant improvement on the original proposal. However, such issues are still not entirely resolved to the satisfaction of those of us who are concerned about the continuing competitiveness of the UK insurance industry.
Miss Johnson: The point that the hon. Gentleman makes about insurance premium tax is correct. Nevertheless, if we were to raise the rate of insurance premium tax, he would say that that would, in effect, cost the companies money, or that the cost would be passed on to the consumer. The cost is not lost depending on the point at which it enters or leaves the system; it affects the entire system. That point would always be made in such circumstances.
On the general principle of such discounting, there is an increasing acceptance that the proposal represents the right way to proceed. In Committee, I put on record the joint response to the proposal of the International Accounting Standards Committee. Perhaps it is worth while briefly reminding hon. Members of that comment on discounting.
The IASC's steering committee concluded that the use of the present value in measuring general insurance claim liabilities is consistent with the emphasis on information that is relevant and decision-useful. A claim that is payable within one month imposes a higher economic burden than a claim for a similar amount that is paid two years in the future. The use of present value allows financial statements to provide information that differentiates those claims from each other. The steering committee found no basis to exempt general insurance claim liabilities from the present value measurement. That was not a lone voice, as was suggested in Committee.
The IASC's view has been widely endorsed by UK accountants, actuaries and companies. There has been a joint response to the proposals on insurance accounting from the Institute of Chartered Accountants in England and Wales, the Institute of Chartered Accountants in Scotland, the Faculty of Actuaries in Scotland, the Institute of Actuaries and the Association of British Insurers. Their joint comment on discounting was simple. They agree that the use of present value in measuring general insurance claims is appropriate. That is the key issue.
Our large insurance companies agreed with that view. CGNU expressed support for the joint response, and Royal and Sun Alliance commented:
- We do not think there is any argument for not discounting general business under a fair value basis of measurement of liabilities.
I appreciate that the hon. Member for Arundel and South Downs (Mr. Flight) has not yet spoken to his amendments, but perhaps I might comment briefly. Amendment No. 152 would allow companies to elect to reduce their tax deductions to a discounted best estimate of liabilities, creating what has been called a safe harbour. In return, a company that so elected would be given immunity from later interest charges. However, that change would not sit well with the other provisions in clause 107, which sets out a wholly automatic approach to determining tax liabilities. The clause would not require matters of judgment to be decided on or argued about between the insurance company and the Inland Revenue. I could go into much more detail in response to whatever points the hon. Gentleman makes, but the amendment would add an element that could be disputed. I suggest that it might be subject to considerable legal activity, which would probably not benefit anyone except the lawyers.
Under amendment No. 153, the discount rate would not be prescribed by secondary legislation. Indeed, it suggests that the legislation should merely specify that the discount rate should be the "commercial" rate. That seems to be a recipe for disagreement. Requiring that the rate be commercial is not good enough properly to describe what is needed and companies, tax inspectors and the courts would have insufficient guidance. To avoid ambiguity, the rate must be prescribed in secondary legislation. Perhaps a commitment is being sought that the discount rate will include an allowance for risk. I await clarification. I gave such a commitment in Committee, but, if that is the issue, I am pleased to do so again and reassure Conservative Members that it holds just as true.
Mr. Jack: The Minister said that an allowance for risk would be made, which is an important point. Will she be kind enough to develop that by saying how the amount is to be calculated?
Miss Johnson: The allowance for risk in the discounting calculation could be made either by including a margin for error in the undiscounted value and then discounting the result, or by including an allowance for risk in the discounted rate. There may be some combination of the two. If the legislation did no more than specify that the discount rate should include commercial allowance for risk, that would be ambiguous. It would not specify the commercial purpose, as is suggested by a commercial allowance for risk, nor would it deal with the related question of the margin for error. The proper allowance for risk will be prescribed in secondary legislation, along with the determination of a proper margin for error and other matters of detail. Draft regulations will be made available for comment at the appropriate time.
Mr. Jack: The Minister says that the question of risk will be the subject of secondary legislation. Will she give an assurance that the insurance industry will be consulted on the legislation's detailed points so that it may have an input?
Miss Johnson: I have no difficulty in giving the right hon. Gentleman that assurance as we want to achieve
legislation that is workable and right. I have given a commitment on the discount rate and the way in which it will be considered.Amendment No. 154 would insert "or rates" alongside the reference to a discount rate. The amendment is not necessary, but perhaps clarification is being sought and I hope to provide it. I can confirm that clause 107 would allow secondary legislation to specify different rates for different types of business. For example, it would allow discounting to proceed according to a non-sterling rate when the liabilities were denominated in another currency. In view of those assurances, I trust that the amendment will be withdrawn.
Mr. Flight: I begin by welcoming the Government amendments and the concessions. Despite those, the industry still feels that clause 107 is damaging to UK competitiveness and, ultimately, not worth the candle of the revenue that it will generate.
The amendments are to permit insurers to treat the negative adjustments arising from under-reserving as expenses of the trade. Those are welcome. The Revenue has also indicated that, if the negative adjustment remains unrelieved, it should be allowed to be carried back against previous positives. It has suggested that subsection (5)(c)(i) and (ii) as amended permits that. It would be helpful if the Minister confirmed that understanding in responding.
What is particularly welcome is that the recognition of risk in the discounting calculation will be on a commercial basis. As well as the references made by the Minister, I mention her letter to my hon. Friend the Member for Ryedale (Mr. Greenway). It states:
- I agree that the discounting calculation should proceed on a commercial basis, which is why I gave a commitment during the debate that the discount would include a risk margin.
Unlike other UK companies, insurers are required to compute claim provisions on the basis of 100 per cent. accuracy, with interest charges where that is not achieved. The Revenue's initial proposals were to allow a small--some 5 per cent.--margin of tolerance. The Revenue has indicated that that margin may not be necessary on the basis of the discount rate taking account of risk, but the industry continues to believe that the discount rate and the margin achieve different, although connected, objectives and that the margin should remain.
The insurance industry, unlike other businesses, will be taxed on its liabilities, which is different from being taxed on its accounts, and required to discount in all circumstances. In our view, the proposals remain harsher than the rules on discounting applying to other insurance markets. Indeed, many other businesses--banking in particular--make reserves, but have no requirement to discount. However, the proposals are harsher in the sense that the ability to write insurance cross-border in European insurance markets and the developments in telephone and e-commerce mean that insurers in other
European Union member states must be seen as domestic competitors not subject to these measures, which will apply to UK-based insurers.While the Government have argued correctly that UK corporation tax rates are among the lowest in Europe, there is a general move to lower company taxation in Europe. As the Government know, Ireland is the main threat to the UK industry; it is rapidly expanding its financial services and the insurance sector, which has not introduced discounting, and it is reducing its corporation tax to 12.5 per cent. as of January 2003.
As was pointed out in Committee, comparisons with insurers in other countries such as the United States are difficult because of the different regulatory rules and more protected domestic markets. The international business, meanwhile, is highly mobile, and the proposals are negative for the continued success of the UK as the centre for both national insurance and reinsurance.
The compliance, regulatory and administrative aspects of the proposals are complex and can lead to uncertainty. They are burdensome and make operating in the UK difficult. The Government have calculated the cost of the proposals to insurers at £250 million, but that does not include the effect on insurers' balance sheets, and therefore the cost of capital.
Under the regime, insurers have two choices: to pay more tax later and recognise a future liability both in their accounts and for regulatory purposes now, or to pay more tax now and set up a deferred tax asset not normally recognised for solvency purposes. With regard to the weakening of the capital base of companies, one leading group estimates that the effect on it will be some £140 million, in line with estimates by other groups.
In summary, despite the Government's welcome attempts to make their proposals more realistic to operate, the proposals are harsh on short-tail business compared with other sectors, and particularly harsh on long-tail, largely international and increasingly mobile lines of insurance, where competitiveness is of the utmost importance.
As the Minister pointed out, our amendment No. 152 is designed to create a safe harbour. Contrary to the hon. Lady's comments, we remain of the view that that is appropriate within the regime that the Government seek to put in place. The amendment would allow insurers to elect for an alternative to the hindsight test in the Government's proposals. The proposed freedom to pay more tax liability will not relieve insurers from the requirement to make retrospective recalculations. Any insurer electing to pay tax earlier can therefore still be subject to prolonged uncertainty about the eventual tax position.
The amendment would allow the industry to explore with the Revenue whether an alternative arrangement might be available as an option. It has been described as a "make your bed and lie on it" approach, and could be based on previous years' experience. The industry's aim is, indeed, to agree a safe harbour arrangement, which would satisfy the Revenue's concerns and protect insurers and pension funds investing in insurance companies from the uncertainty and significant additional compliance costs involved in the retrospective recalculations. Without the amendment, clause 107 would not permit an election for a safe harbour. The amendment permits such an option
to be available if subsequent consultation between the Revenue and the industry shows that arrangement to be feasible.In amendment No. 153, the intent of the word "commercial" is not, as the Minister suggested, to create a confusing situation, but that the rates prescribed should be commercial which, as the Minister kindly confirmed, is the Government's aim. Amendment No. 154 is designed to seek confirmation that more than one rate of discount could be applied, as different rates are likely to be appropriate to different classes of business. The two amendments aim at the same objective.
In short, although there appear to be those in the Treasury or Revenue who are determined to achieve their long-term objective of shifting to a discounting regime, we do not see that in terms of revenue--the Minister made it clear that the £250 million was the total over time, not a per annum figure--that is worth the candle, compared with the damage, albeit not huge, to the international competitiveness of the industry. If, as seems likely, the Government intend to pursue their objective, we look to them to co-operate with the industry, as they have done, to make their proposed new regime as workable as possible and to minimise the damage to the industry's competitiveness.
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