Standing Committee H
Thursday 22 June 2000
[Mr. Frank Cook in the Chair]
(except clauses 1, 12, 30, 31, 59, 102 and 113)
The Chairman: Order. It will be necessary to suspend the Committee for two minutes.
The Chairman: That was a timely reminder of how much we all take things for granted-even geriatric Chairmen. I am obliged to the Economic Secretary for drawing to our attention the absence of Hansard staff. Under the circumstances, we shall begin from square one.
General insurance reserves
Mr. Howard Flight (Arundel and South Downs): I beg to move amendment No. 414, in page 76, line 39, after ``was'', insert ``insufficient or''.
The Chairman: With this it will be convenient to take the following amendments: No. 415, page 76, line 40, leave out
`For the purpose of making good to the Exchequer the loss occasioned by the excess, an' and insert `An'.
No. 416, in page 76, line 42, after second ``the'', insert ``insufficiency or the''.
No. 417, in page 76, line 42, after ``as'', insert
`an expense or, as the case may be,'.
No. 419, in page 77, line 14, after ``excessive'', insert ``or insufficient''.
No. 420, in page 77, line 15, after ``excess'', insert ``or insufficiency''.
No. 424, in page 78, line 45, after ``receipt'', insert ``or as an expense''.
Mr. Flight: Clause 106 covers tricky and technical areas. To understand the amendments, I wish to say a little up front about the provisions under the clause and explain why the insurance industry has, as the Minister will be aware, expressed considerable opposition to them. When we debated schedule 30, we dealt with matters the net effect of which will be to increase the tax paid by British insurance companies, especially non-life insurers, when changing the rules for the calculation of relief available under double taxation treaties.
Clause 106 will add further substantial United Kingdom tax bills to British insurers, first, by discounting insurers' technical reserves, which will lessen their reduction for recovery for tax purposes and, secondly, by recalculating insurers' taxable profits each year, with hindsight over each of the following 10 years or more. That will similarly increase taxation. It will make earnings volatile and impossible to know from the point of view of those dealing with those insurance bodies.
Mr. Edward Davey (Kingston and Surbiton): The hon. Gentleman speaks of the uncertainty introduced under the clause into the taxation regime for insurance companies. Will that be of any advantage to them or will it have a purely negative effect on insurance companies?
Mr. Flight: I thank the hon. Gentleman for his comments; I shall respond to them in more detail later. Such provisions will not only have a negative effect on the industry but present major problems for those who use a particular company who want to know whether it is solvent, because the figures will change in future. The provisions will present problems for pension funds that are making investments, which want to know the real earnings position of the business, which may be chucked up in the air and recalculated in future. From all angles, including that of creditors, it is extremely unsatisfactory to have tax law that rewrites major accounting profit and loss figures up to 10 years later.
During the three years that I have been privileged to be a Member of Parliament, I have learnt to spot a stealth tax when I see one. What lies behind schedule 30 and clause 10 is an increase in the tax yield from the insurance industry. The Government have forecast that it will be about £250 million per annum, but the total impact on the insurance industry could be several times that figure because, as alluded to, the measures will have major effects on the income, balance sheet and cost of capital of insurers. The proposals will increase by 10 per cent. the capital requirements of an insurer with an average length of tail on his insurance of four years. In essence, the knock-on additional costs are the costs of additional capital.
Mr. Oliver Letwin (West Dorset): Does my hon. Friend agree that Ministers should tell us that they are not inventing a stealth tax, but closing a dreadful loophole? I wonder which set of actions the Government believe that insurance companies have been taking that are illegitimate as opposed to perfectly normal actions in the course of ordinary business.
Mr. Flight: My hon. Friend makes a good point, although I suspect that the Government's excuse for the stealth tax will not be one of tax avoidance, but an incorrect argument that the changes would bring insurance companies in line with the tax provisions of insurance companies elsewhere in the world, as well as in line with the tax provisions for other businesses in this country. That has been the main justification for the proposals. As I shall demonstrate, neither the industry nor I think that those two arguments stand up.
Mr. Stephen Dorrell (Charnwood): I am listening carefully to my hon. Friend's line of argument. His response to the hon. Member for Kingston and Surbiton (Mr. Davey) was interesting. If declaring profits based on the Government's proposed provisioning policy introduced unacceptable variations of earnings and unacceptably raised the cost of capital to an insurance company, would the company's rational response not be to publish profits to the markets on a different provisioning basis from the one proposed in tax law? We might move into a position in which the tax computation assessed a higher level of profit to tax than the level of profit that the insurance company declared to the market.
Mr. Flight: I thank my right hon. Friend for his comments. That is the case and, if one thinks of a pension fund investing, it is also the case that someone may buy a pup, because the figures are false. I shall come to other related problems anon.
The Government's justification does not stand up. They argue that their proposed measures are fair because they will tax insurers broadly in line with other United Kingdom businesses, and because they are in line with other insurance markets. The correct basis for calculating a trader's profits has always been the commercial accounts of the business, which reflect, honestly and with the best endeavours, the profit and loss of the year. Clause 106 will depart from that and substitute a notional charge that might bear no relationship to the actual profits of the year. It would put UK insurers at a disadvantage compared to other UK businesses by taxing them on a figure that might be larger than their actual commercial profits. I am not aware of that approach being followed in any other industry.
The proposals do not simply have the effect of importing to the UK insurance industry allegedly the same standards as FRS 12-financial reporting standard 12-on the accounting of insurance technical reserves. FRS 12 requires a provision to be set up for what a company might rationally pay to settle or transfer its obligations. Best estimates are discounted only if they are material, and must account for differing risks and uncertainties. The Government seem to have overlooked the key territory of the massive difference between the portfolio of risk that different insurers and, within Lloyd's, different Lloyd's members undertake.
Mr. Michael Jack (Fylde): Will my hon. Friend confirm that FRS 12 explicitly does not apply to insurance companies?
Mr. Flight: I thank my right hon. Friend. That is my understanding. The Government's measures have been justified on the basis that FRS 12 should apply; I was endeavouring to explain that the Government have not made it apply, as one of the principles of FRS 12 is that best-endeavours provisions for risk should be discounted only if they are material, and that they must properly take different risks into account.
The Government propose to strip out all uncertainty and risk premium with hindsight, and to tax insurers as though they had perfect knowledge of risk at the time at which they wrote the business. That must surely be nonsense.
The Government have alluded to European Union legislation. For profit calculations in relation to insurance companies, I should point out that although European Union legislation permits discounting of reserves, it does so only in certain limited circumstances. Germany is the only country that has done that, but on a different basis from the approach that the Government are proposing.
Mr. Letwin: Does my hon. Friend agree that, in the context, there is an enormous difference between life business and general insurance business? The latter is the subject of the clause and the amendments. In the life business there is an actuarial valuation, which, although it may not provide certainty, at least provides a high degree of knowledge and hence a basis for discounting. In general insurance there are companies that, by the nature of the beast cannot accurately estimate long-term liabilities.
Mr. Flight: I thank my hon. Friend. That is the case, although I cannot resist saying that life companies have got it all wrong because we all live 10 years longer than we did 15 years ago. Lloyd's business is to insure all sorts of strange and sophisticated risks that are not easily insured elsewhere in the world. The measures would drive that business to other locations that did not have such inappropriate tax requirements.
I was surprised that the Government had not taken heed of the fundamental concerns of the actuarial profession and those expressed by the Faculty and Institute of Actuaries. Those people have made it publicly clear that the Government's proposals are not acceptable from actuarial principles and perspectives. The only discounting calculation by which general insurance reserves are discounted and of which standard actuarial approaches would approve is the incorporation of margin for risk deviation, reflecting any particular situation and distinct from any element of profit.
Evidence was given from insurance computations, in relation to transfer of business and from the actuarial and accounting professions in a recent case brought before the general commissioners of income tax in connection with a Lloyd's syndicate. The commission found that
it was neither intended, nor would it be reasonable, for the tax treatment of the reinsurance to close premium to be so significantly out of line with commercial reality if the premium was discounted for tax purposes
as is proposed by the Government in the clause. In short, the Government seem to have overlooked the real commercial value and importance of insurance liabilities and risk.
In addition, the proposed system of recalculating profits with hindsight for 10 years-