The last straw

The financial services industry continues to be punished for the worldwide economic meltdown. The EU is trying to enforce strict new regulations on hedge funds and private equity, while the UK’s new coalition government is to examine the break-up of the retail and investment arms of the big banks through an independent commission.

The insurance industry, despite having nothing to do with the subprime mortgage disaster and ludicrously cheap debt boom that fostered the crisis, is set to be trapped in the latest wave of attacks.

At the next G20 meeting of world leaders during the final weekend of June, two hard-hitting tax measures proposed by the International Monetary Fund (IMF) will be discussed.

In April, the IMF introduced these levies in a self-explanatory document called A fair and substantial contribution by the financial sector. Though fairly light on detail, the report called for a so-called financial activities tax (FAT), levied on profit and remuneration, and a financial stability contribution (FSC), which would be used by government to support any future bailouts.

Financial institutions in Europe and the USA could end up paying more than $35bn a year combined. The FSC tax would provide 2%-4% of GDP against any future bailout. This tax will evolve so that insurers should pay significantly less than riskier banking institutions. The FAT levy is highly controversial, as it could attack successful institutions that have simply made chunky profits out of satisfied customers.

Insurers’ rebellion

The insurance industry as a whole has already hit out at the plans, pointing out that – AIG aside – the sector has been proved to be risk-averse and therefore no threat to the taxpayer. The industry wants to be made exempt from the measures.

Financial advisory group Collins Stewart’s analyst Ben Cohen points out that these taxes are particularly harsh on the reinsurance sector. “The key function of reinsurers is to be the last step [protecting the rest of the industry in times of heavy claims], and it means that they must keep sensible balance sheets. With the exception of Swiss Re, they have, so taxing the backstop is unfair,” argues Cohen.

Only Swiss Re was hit during the crisis, and this only because it had diversified into risky banking-style products rather than sticking to its traditional work. As a result, it suffered a record loss of £511m in 2008, but has since moved back to profit.

PricewaterhouseCoopers tax partner Colin Graham says it was “a surprise” that the IMF had widened the scope of its plans beyond banks. “Insurance is not a source of the systemic risks,” he says. “The industry faces a significant job to persuade governments that it shouldn’t pay a share of this cost.”

Given that profits and remuneration tend to be lower in insurance than banking, Graham adds that any FAT levy is weighted towards other types of institutions so it becomes but a marginal extra tax.

Tackling the chancellor

The ABI hit back the day after the 56-page report was launched. Director-general Kerrie Kelly was not subtle in her riposte: “Insurers were not a source of failure and their business model means they are not subject to the types of credit and liquidity risks that destroyed so many banks. Any inclusion of insurers within the scope of levies designed to impact on banks is essentially inappropriate and not justified.”

An ABI spokesman said that the body had since written to new chancellor George Osborne to explain its position. The ABI hopes that this government manages to water down these proposals as the previous administration did on the EU directive hitting hedge funds and private equity.

The spokesman added that the ABI is to strike back with an assessment of how badly the twin taxes could hurt the industry: “The ABI is working with other trade organisations from around the world on a letter to be presented at the next G20 meeting, highlighting the potential impact of the levy.”

Industry thinktank The Geneva Association sent a strongly worded letter to G20 finance ministers last month. It pointed out that the industry has stable asset portfolios, unlike banks that buy into and then exit assets quickly. “The IMF’s interim proposals … do not sufficiently take into account that the business model of insurers differs significantly from that of banks.”

Given the current public and political mood against anything labelled ‘financial services’, total exemption appears to be a long shot, even for extremely risk-averse insurers.

However, the IMF report does at least reveal some understanding that the insurance industry is less problematic than its banking peers. On page 10 of the report, the IMF suggests strongly that the base of the levies could even differ between industries straightaway: “For quick implementation, the levy might initially be a fixed-rate assessment on such a base, which will differ by institution type – for example, an insurance company would have a lower base than a bank, reflecting the lower volatility of its funding.”

The differences would not be hugely significant at the start, but insurers can at least hope that the levies will be reduced over time, so that they become a bureaucratic nuisance rather than a financial pitfall. IT