The Chairman: My instructions are to inquire into whether someone wants to make a statement, but I know the answer already. I call Mr. Laxton.

Mr. Bob Laxton (Derby, North) (Lab): Thank you, Mr. Wilshire. I apologise to the Committee, because I have two impediments: I have a permanent problem with my left ear, which I have had for years—I do not hear too well out of it—and my other ear is completely blocked, so if I shout at, or whisper to, the Committee, I apologise.

I have a note from the European Scrutiny Committee, which looked into financial issues a while ago. The note says that it might be helpful—I hope that it is—if I explain briefly the background to the document and the reasons why the ESC recommended it for debate today.

In order the facilitate the financial services market, no fewer than 13 Community directives relate to prudential supervision of life and non-life insurance, reinsurance, insurance groups and winding up. Legislation in relation to insolvency matters was updated on an interim basis in 2002 under the rubric, “Solvency I”, and in July 2007 the Commission presented a draft directive intended to establish the framework, “Solvency II”, to revise, amend and consolidate—to recast—current legislation governing the prudential regulation of insurance and reinsurance companies operating in the Community.

In February 2008, the Commission replaced its original proposal with an amended draft directive, which is in all essentials the same proposal, but takes account of new related legislation. The ESC considered this proposal on a number of occasions and noted that the proposed comprehensive updating of Community legislation on regulatory supervision of the insurance sector was clearly important, with the potential for benefits for customers generally and UK industry. However, the ESC thought that this Committee should be given the opportunity to explore with the Minister the general case for “Solvency II”, and in particular the issue of the supervision of insurance and reinsurance groups, where a company in a group is supervised as if it were a separate entity, but where in the future a group as a whole will be treated as a single economic entity.

The ESC thought that that was important, particularly in the light of the Government’s advocacy of advanced supervision of cross-border financial institutions in the Community. It also considered issues relating to the minimum capital requirement—the lower of the two capital requirements—in “Solvency II”, equity risk and the level of capital to be set aside to cover the inherent risk in holding shares, and surplus and bonus funds, which are a feature of the with-profit life insurance policies used in some member states to meet capital requirements.

Here endeth the statement. Having read it for the second time, it is a little clearer to me than it was after reading it the first time.

The Economic Secretary to the Treasury (Kitty Ussher): I thank my hon. Friend the Member for Derby, North for his exposition of why it is appropriate for the Committee consider the issues before us, which is an opportunity that I welcome. The “Solvency II” directive is important and will set the regulatory framework for prudential supervision of all insurance and reinsurance companies operating in the EU. The insurance sector is important to the UK; it is the third largest in the world with UK firms holding almost £1.5 trillion of assets and acting as major institutional investors as well as providing employment for about 324,000 people—we think—in the UK.

Prudential regulation of the insurance sector and the “Solvency II” directive are vital, therefore, to the UK and to the economies of other member state. In recent years, the UK insurance industry and the Financial Services Authority have made major strides in modernising and improving insurance regulation in the UK over and above the first solvency framework of the early 1970s.

Given the current advanced level of the UK’s prudential regime, the stakes were high for us in participating in the directive. It is therefore an extremely positive outcome that the Commission’s proposal enshrines the key principles of transparency, alignment of regulatory and economic capital, incentives for improved risk management, more principles-based regulation and more effective supervision, especially across national borders.

As with any major directive, several issues remain to be settled before we can achieve political agreement on “Solvency II”. My letter of 23 May to the Chairman of the European Scrutiny Committee provided an update on the progress that has been made in the Council of Ministers, including an overview of the four key political issues on which agreement is yet to be reached. Those issues are group supervision, the minimum capital requirement, the capital charge for equity risk and the treatment of surplus funds. I am happy to return to those issues later.

I shall briefly set out the Government’s approach to the directive. Throughout the discussions on “Solvency II”, they have sought a directive that requires high standards of policy holder protection and fully recognises the economic realities of insurance. The directive sets out the clear goal for policy holder protection that an insurer should not have a greater probability than one in 200 of insolvency occurring over a one-year period. That is a reasonable standard and is consistent with the approach adopted by the FSA for insurers in the UK. It ensures that the risks to policy holders are very low, but avoids imposing penal capital charges on the industry.

It is right to maintain standards of policy holder protection, but we should seek ways of reducing the cost of achieving them wherever we can. We have sought to achieve that through securing agreement to an overall method of organising “Solvency II” that ensures that insurers can use internal models to estimate their risk profile and thereby ensure that their capital requirements are suitable for the business they are writing. We have also argued strongly for a new approach to insurance group supervision that will have a significant impact on capital costs for insurance groups.

I want to comment on the consultation and regulatory impact assessment. The Treasury and the FSA have published several discussion papers on “Solvency II” to encourage debate on key areas. We have also published a partial impact assessment, the analysis for which confirms that the Government’s support for the “Solvency II” project is the right policy. It is right to undertake an analysis of the costs and potential benefits at an early stage.

We are approaching the final stages of negotiations on the directive. We expect that the French presidency will seek a general orientation at the Council of Ministers around October, and that the European Parliament will reach its own views at about the same time. Overall, we have, in my view, a good proposal from the Commission. Discussions in the Council have gone well so far and, although there can be no guarantee, I am cautiously optimistic that we can achieve a good outcome for policy holders and the industry both in the UK and across the EU as a whole. I am grateful to you, Mr. Wilshire, for allowing me to put our discussions into a wider context. The debate is very timely, and I look forward to our discussions.

The Chairman: We have until 5.30 pm for questions. I remind colleagues that they should ask one question on one subject, so that there can be a series of supplementaries on each subject, if necessary. I am happy to call Members again to ask more questions.

Mr. Mark Hoban (Fareham) (Con): It is a pleasure to serve under your chairmanship, Mr. Wilshire. I understand that at least 12 countries including Poland and Spain—some of the remainder are very small—do not support the strong group’s proposals. What assurance can the Minister give that the Government will ensure that the strong group component will continue and enable lead supervision?

Kitty Ussher: We are reasonably optimistic, given the balance of forces under debate. The matter concerns the way in which the industries are organised in different countries, and it is important that we understand those sensitivities. However, we should not change our policy of offering very powerful support for the Commission’s proposals on group supervision. The Commission is committed to them, and we feel that industry across the EU is broadly supportive, too. Therefore, although I can never say never, it is an avenue that it is worth continuing to push for and, as I have said, I am cautiously optimistic about the results.

Mr. Hoban: Given that the industry is broadly supportive, as is the Commission, what reasons are the smaller countries giving for their reluctance to embrace the concept of a strong lead regulator?

Kitty Ussher: I cannot speak for individual countries, but I suspect that there is a fear of the implications for their own policyholders if a subsidiary were to face difficulties. We think that those fears are misplaced because there will be a legal requirement of the group to recapitalise any subsidiary if required, and that is the basis on which I am cautiously optimistic.

Mr. Hoban: Is this reluctance, therefore, really aimed at protecting the local insurance market against competition from insurers based in other member states?

Kitty Ussher: That may well be the case, but I do not feel that I can argue for the sovereign Governments of other EU member states. I suspect that that is a question that the hon. Gentleman will probably have to put to them.

Mr. Colin Breed (South-East Cornwall) (LD): Can the Minister explain how this idea of an economic entity, which is said to resemble an insurance company operating with branches, can be applied to legally set-up groups—in other words the legal entity as opposed to the economic entity? I ask because insurance companies and reinsurance companies clearly operate under different regulations and laws in their own countries. Although I understand the idea of an economic entity, how is it possible to regulate through an economic entity as opposed to a legal framework?

Kitty Ussher: Precisely because one can set one’s legal framework to recognise what an economic entity is, I would have thought. So, it is quite clear legally that a subsidiary, for example, is a subsidiary of a larger company. We are simply proposing setting the law so that that is recognised—unless I did not quite understand the hon. Gentleman’s point.

Mr. Breed: That might be possible if the subsidiaries were all 100 per cent. owned, but if the subsidiaries are not 100 per cent. owned by the group, there is clearly a wider definition under a legal framework when there are other shareholders within a subsidiary.

Kitty Ussher: My understanding is that we are talking about situations where there is a very obvious legal ownership of a subsidiary company. I do not have the answer if the company is actually some kind of joint venture. However, I would be happy to get back to the hon. Gentleman on that point.

Mr. Greg Hands (Hammersmith and Fulham) (Con): The Minister mentioned earlier the impact that this regime may have on other EU countries. Can she tell us what impact assessment has been made of the potential business opportunities for UK insurers with regard to Europe as a result of this directive?

Kitty Ussher: One of the reasons why the UK insurance sector is broadly supportive of what is coming out of Brussels is that it sees opportunities arising from being able to compete on a more level playing field across the EU. As I said in my opening remarks, the proposals that are being put forward by the Commission are broadly in line, both in the principles behind them and in the actual numbers, with what already exists in the UK. Obviously, therefore, if the regulatory framework across the EU became more in line with what already exists in the UK, it would provide opportunities for UK companies.

Mr. Hands: As a follow-up to that, can the Minister tell us what numeric value she would put on those opportunities in the cost-benefit analysis?

Kitty Ussher: We have done a partial impact assessment, which depends in many ways on how the so-called level 2 implementation is conducted, in order for us to quantify exactly the compliance costs and so on. If I have a numeric answer to his question, I will provide it later on. However, my understanding of the general point is that UK insurance companies generally think that the overall benefits will be positive.