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12.21 am

The Economic Secretary to the Treasury (Ruth Kelly): I congratulate my hon. Friend the Member for Brent, North (Mr. Gardiner) on securing this important debate. He is clearly an expert on these matters, and I am sure that we shall continue to meet from time to time, whether in this forum or outside.

First, I wish to restate the Government's great sympathy for victims of asbestos-related diseases, which are particularly unpleasant and distressing for both sufferers and their families. This suffering is made even worse when compounded by financial uncertainty. That was the case for a group of people whose no longer existent, or now insolvent, employers insured with Chester Street. That group faced the possibility of being ineligible for the compensation due to them following Chester Street's insolvency on 9 January.

The consequences of Chester Street's insolvency were particularly worrying for victims of asbestosis and their families whose former private sector employers had insured with Chester Street, but no longer existed or were insolvent. In particular, there were fears that those whose injuries had been sustained during employment in the private sector before 1972—or 1975 in Northern Ireland—would not receive the compensation for which their employers would have been liable.

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As my hon. Friend is aware, the Government worked extremely hard in partnership with the insurance industry in the spring of this year to end the uncertainty. The arrangements were set out on 10 May by my right hon. Friend the Chief Secretary to the Treasury. Under these arrangements, the Government are meeting their liabilities to former public sector employees, and the insurance industry is covering claims from former private sector employees.

The insurance industry will fund claims as follows. First, the PPB is making payments in accordance with its statutory powers if the compensation award or settlement was made prior to Chester Street's insolvency. Secondly, if the award or settlement was made on the day of, or after, Chester Street's insolvency, the insurance industry is funding equivalent payments pending the implementation of the new financial services compensation scheme—FSCS—at midnight on 30 November. The FSCS will supersede the PPB. Thirdly, the rules of the FSCS will ensure continuity of cover in respect of awards and settlements made after 30 November. I welcome my hon. Friend's remarks that this is a tremendously welcome improvement on the situation that existed before the spring of this year when the deal was negotiated.

My hon. Friend raised several points relating to the PPB and, in particular, to the way in which it is funded. Of course, the PPB will be superseded by the new financial services compensation scheme at midnight on 30 November. As I explained earlier, the particular problem that Chester Street raised in relation to compensation arrangements under the PPB has already been addressed by the Association of British Insurers and will be resolved by the new rules. I understand my hon. Friend's concern that sound insurers pick up the bill for those that become insolvent—companies which, as he points out, may have been in fierce competition with each other prior to the insolvency.

The FSA has long been familiar with the arguments that contributions to compensation schemes should be risk based. I understand that it considered a range of alternatives for the new compensation scheme, including a system of individually risk-weighted premiums, but concluded that at the present time funding arrangements similar to current arrangements were the most suitable and cost effective, relative to the available alternatives. Individually risk-weighted premiums were particularly expensive due to the prohibitive cost to the FSA and the FSCS of implementing an appropriate and objective risk assessment system on the basis of current information.

Risk-based premiums may turn out to be inappropriately weighted, cause competitive distortions and increase financial pressures on already weaker firms, particularly in a pay-as-you-go funded scheme in which contributions are collected only following an insolvency. Conversely, a scheme in which a fund is built up in advance may see a loss of capital from the industry, representing a deadweight cost, especially, as we would hope, if failures are low. I should also point out that the existence of a compensation scheme benefits the whole industry by boosting policyholders' confidence that, come what may, most if not all of their claims will be met.

None the less, the FSA has committed itself to reviewing that matter again as part of a wider review of compensation arrangements. It will consider their effectiveness three years after the scheme comes into effect. At that point, it will consider further international

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and domestic experience, the activity of the FSCS and levies in practice and ongoing academic analysis in this area.

My hon. Friend also set out a number of concerns about the regulatory framework and the FSA. I note his observations on the issues on which he believes the FSA's integrated prudential sourcebook should be brought to bear. I shall cover as many of those as I can in the time available.

First, my hon. Friend is concerned about the FSA's requirements for reserving. I understand that it recognises the importance of benchmarking and already takes it into account in its supervision of individual firms. It will, however, be further enhancing its expertise in that area and will be considering the role played by the actuaries and auditors of insurance firms.

Secondly, on reinsurance requirements, my hon. Friend made an interesting point on independence insurance. The FSA plans to review the use of financial reinsurance within the insurance market and the extent of the industry's reliance on it. That issue has also arisen in the context of other parts of the insurance market and I am sure that the FSA will comment on its prevalent use. Particular attention will be paid to arrangements that do not result in a material transfer of risk to the reinsurer and those that are, in effect, regulatory arbitrage.

Thirdly, my hon. Friend mentioned solvency standards. The FSA agrees that the current European solvency margin requirements for insurance firms are inadequate. It expects almost all firms to hold buffers in excess of the European minimum levels to meet its adequate financial resources requirement. The European solvency margins are also under review and there may be further improvements on that score. However, change at an international level will clearly take time. In the meantime, the FSA is making a number of enhancements to its capital adequacy requirements for insurance firms.

As my hon. Friend noted, the FSA issued a consultation paper on an integrated prudential sourcebook in June 2001. It sets out proposals for integrated prudential standards that will apply to all types of firm. It is proposed that, for insurance firms, these proposals will take effect from early 2004.

My hon. Friend expressed concern that solvency margins do not significantly differentiate between the different risks run by different insurance companies. The FSA's view is that determining required margins according to premium income by line of business would perpetuate inappropriate rigidity in the determination of solvency requirements. A better approach is to take account of all the risks in the business, including, for example, the adequacy of systems and controls and firms' own measurement of risk.

The FSA's risk-based approach to regulation is designed to take account of the full range of risks within each firm, and it is strengthening its expertise to carry

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out such assessments. It is also working to develop and consolidate the current approaches used in different sectors for setting individual capital requirements for firms, with the intention of extending that to insurance firms.

On the "one size fits all" framework, which my hon. Friend mentioned, it is not correct to say that the FSA currently takes no account of any sophisticated internal risk measurement frameworks implemented by insurance companies. It frequently discusses with the larger companies the outputs of their internal risk models, and the new regulatory regime for Lloyd's, for example, explicitly recognises the value of its risk-based capital model.

The FSA plans to take more account in future of firms' internal measurement of risk. As I have already explained, the draft integrated prudential sourcebook proposes placing a requirement on all firms to take a view of the overall level of financial resources required to enable them to meet their liabilities. The FSA also plans to add insurance risk expertise to its risk review department, thus further equipping it critically to assess risk models used by the industry.

My hon. Friend made a number of suggestions that he believes would address his concerns. The FSA accepts that insurance firms' risk profiles and financial positions should be more transparent and easier to interpret, especially for life business. However, it believes that this would be best achieved by improving information in the public domain, for example in the regulatory returns and in the accounting treatment of insurance business in accounts under the Companies Acts. Some improvements in the regulatory returns have already been made or are being consulted on; others will be proposed as part of a fundamental review of regulatory reporting, starting next year.

It would be inappropriate for the FSA to publish confidential regulatory information. However, it is considering the need to improve its environmental analysis of the insurance sector, and it will also consider whether to publish that type of analysis for the benefit of consumers and the market.

It is not possible in the time available to address all my hon. Friend's points. However, these are important issues and I undertake to pass on his comments to the chairman of the FSA, who I am sure will be delighted to respond more fully than I can. I thank my hon. Friend for securing this debate. I am sure that he agrees that there are great strides to be made in the regulation of insurance companies and the move to a more risk-based regime. I recognise the points that he made about the regulatory and compensation regimes that affected Chester Street, and I hope that I have addressed the most important of them.

Question put and agreed to.

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