Andrew Oswald proposes that to cope with possible bank collapses we should devise an effective insurance solution in which governments are only minimally involved (Independent on Sunday, 30 March 2008). He sees this as a cast-iron guarantee. I beg to differ.
Mr Oswald’s idea is that when depositors open an account they should be offered insurance deals that, for different levels of premium, would guarantee different amounts of their funds. Those customers who wish for complete security will have that option, but only at the cost of a substantial premium.
Those slightly less worried will be able to opt for a smaller premium and a larger "excess" where, in the event of a bank collapse, they will forgo the first X hundred pounds of their savings.
This wheeze seems to overlook the existence of The Financial Services Compensation Scheme. The FSCS is the UK's statutory fund of last resort for customers of authorised financial services firms. It pays compensation if a firm is unable, or likely to be unable, to pay claims against it. In general this is when a firm has stopped trading, and has insufficient assets to meet claims, or is in insolvency. The service is free to consumers.
The FSCS protects deposits, insurance policies, insurance broking (for business on or after 14 January 2005), investment business, and mortgage advice and arranging (for business on or after 31 October 2004).
As a statutory fund of last resort there are limits to the protection FSCS can provide. The maximum levels of compensation are:
· deposits: 100% of the first £35,000.
· investments: £48,000 per person (100% of the first £30,000 and 90% of the next £20,000).
Other levels govern insurance and mortgage provision.
The point being that 100% cover was in place for most small depositors of Northern Rock. It made no difference. People wanted their money out. Demonstrably, offering guarantees is wholly ineffective in such circumstances. People want to avoid the turmoil ahead of a collapse and the interregnum following a collapse when everything is sorted out at some other institutions’ leisure. Substituting commercial insurance cover for the Government-backed provision offered by the FSCS is unlikely to work.
Andrew Oswald also holds a somewhat rose-tinted view of the insurance industry. He believes that the large institutions who might offer this kind of saver insurance have assets spread widely enough, across many nations, to survive even major financial shocks within a single country. And, moreover, insurance companies are better placed than government inspectors to keep an expert eye on any profligate lending practices inside banks.
This is serious cloud cuckoo land. Maybe Mr Oswald is too young to remember the collapse of Lloyds. Let me remind him.
Between 1940 and 1970 many Lloyds syndicates took on enormous amounts of excess insurance business for leading asbestos companies. Underwriters ignored the medical evidence of the risks they were running, even though insurance companies had been refusing to sell life insurance to asbestos workers since 1918. The syndicates were enticed by the lucrative stream of premium and investment income which such business produced.
In 1992 the Yale School of Organisation and Management predicted 200,000 asbestos-related deaths over the next quarter of a century at a cost to asbestos manufacturers and their insurers of $50 billion. The combined book value of their 45 primary and excess insurers was estimated at only $50 billion, before allowance for all other types of claim likely to arise and make a call on those assets.
Many Lloyds Names were ruined financially. Some went bankrupt. Some committed suicide.
It doesn’t end there. On January 10, 2001 Chester Street Insurance Holdings Ltd., formerly Iron Trades Holdings Ltd was declared insolvent. Financial uncertainty over the escalation in asbestos liabilities led Chester Street’s directors to propose a run-off of the company’s business. The High Court approved the Scheme on February 28. Within ten days, the Scheme Administrators, in consultation with the Creditors’ Committee, set an initial payment percentage of just 5%. The likelihood of obtaining insurance-backed compensation for many UK victims of asbestos-related diseases evaporated.
The woeful record of the insurance industry is not confined to asbestos. In August 2001 the business of the Frontier Insurance Company was seized by officials of the New York State Insurance Department in a move designed to avoid insolvency. Harry W. Rhulen, the group's president and chief executive, said that the company's collapse had been caused by unsound underwriting and pricing of medical malpractice policies in the early and mid-1990's. “We did a poor job of determining which were the good doctors and which were the bad”.
In the same year the HIH Insurance Group collapsed and the NSW Supreme Court placed it into provisional liquidation. HIH insurance is now in run–off, which means it is managing its outstanding claims and not writing any new business. This could take several years to complete; some have suggested as long as 10 years.
Also in 2001 Independent Insurance, based in the UK, collapsed. The business consisted mainly of home contents insurance for council tenants, which involves the regular payment of small premiums. An initial valuation of the company's assets ran into "tens of millions", while estimates of its liabilities ranged as high as £1bn. The liquidators described the disaster as the worst “since Maxwell”.
Saver insurance is not the answer. It merely hands the hot potato to an industry no better placed to moderate risk and mitigate disaster than the banks themselves.
Mr Oswald’s idea is that when depositors open an account they should be offered insurance deals that, for different levels of premium, would guarantee different amounts of their funds. Those customers who wish for complete security will have that option, but only at the cost of a substantial premium.
Those slightly less worried will be able to opt for a smaller premium and a larger "excess" where, in the event of a bank collapse, they will forgo the first X hundred pounds of their savings.
This wheeze seems to overlook the existence of The Financial Services Compensation Scheme. The FSCS is the UK's statutory fund of last resort for customers of authorised financial services firms. It pays compensation if a firm is unable, or likely to be unable, to pay claims against it. In general this is when a firm has stopped trading, and has insufficient assets to meet claims, or is in insolvency. The service is free to consumers.
The FSCS protects deposits, insurance policies, insurance broking (for business on or after 14 January 2005), investment business, and mortgage advice and arranging (for business on or after 31 October 2004).
As a statutory fund of last resort there are limits to the protection FSCS can provide. The maximum levels of compensation are:
· deposits: 100% of the first £35,000.
· investments: £48,000 per person (100% of the first £30,000 and 90% of the next £20,000).
Other levels govern insurance and mortgage provision.
The point being that 100% cover was in place for most small depositors of Northern Rock. It made no difference. People wanted their money out. Demonstrably, offering guarantees is wholly ineffective in such circumstances. People want to avoid the turmoil ahead of a collapse and the interregnum following a collapse when everything is sorted out at some other institutions’ leisure. Substituting commercial insurance cover for the Government-backed provision offered by the FSCS is unlikely to work.
Andrew Oswald also holds a somewhat rose-tinted view of the insurance industry. He believes that the large institutions who might offer this kind of saver insurance have assets spread widely enough, across many nations, to survive even major financial shocks within a single country. And, moreover, insurance companies are better placed than government inspectors to keep an expert eye on any profligate lending practices inside banks.
This is serious cloud cuckoo land. Maybe Mr Oswald is too young to remember the collapse of Lloyds. Let me remind him.
Between 1940 and 1970 many Lloyds syndicates took on enormous amounts of excess insurance business for leading asbestos companies. Underwriters ignored the medical evidence of the risks they were running, even though insurance companies had been refusing to sell life insurance to asbestos workers since 1918. The syndicates were enticed by the lucrative stream of premium and investment income which such business produced.
In 1992 the Yale School of Organisation and Management predicted 200,000 asbestos-related deaths over the next quarter of a century at a cost to asbestos manufacturers and their insurers of $50 billion. The combined book value of their 45 primary and excess insurers was estimated at only $50 billion, before allowance for all other types of claim likely to arise and make a call on those assets.
Many Lloyds Names were ruined financially. Some went bankrupt. Some committed suicide.
It doesn’t end there. On January 10, 2001 Chester Street Insurance Holdings Ltd., formerly Iron Trades Holdings Ltd was declared insolvent. Financial uncertainty over the escalation in asbestos liabilities led Chester Street’s directors to propose a run-off of the company’s business. The High Court approved the Scheme on February 28. Within ten days, the Scheme Administrators, in consultation with the Creditors’ Committee, set an initial payment percentage of just 5%. The likelihood of obtaining insurance-backed compensation for many UK victims of asbestos-related diseases evaporated.
The woeful record of the insurance industry is not confined to asbestos. In August 2001 the business of the Frontier Insurance Company was seized by officials of the New York State Insurance Department in a move designed to avoid insolvency. Harry W. Rhulen, the group's president and chief executive, said that the company's collapse had been caused by unsound underwriting and pricing of medical malpractice policies in the early and mid-1990's. “We did a poor job of determining which were the good doctors and which were the bad”.
In the same year the HIH Insurance Group collapsed and the NSW Supreme Court placed it into provisional liquidation. HIH insurance is now in run–off, which means it is managing its outstanding claims and not writing any new business. This could take several years to complete; some have suggested as long as 10 years.
Also in 2001 Independent Insurance, based in the UK, collapsed. The business consisted mainly of home contents insurance for council tenants, which involves the regular payment of small premiums. An initial valuation of the company's assets ran into "tens of millions", while estimates of its liabilities ranged as high as £1bn. The liquidators described the disaster as the worst “since Maxwell”.
Saver insurance is not the answer. It merely hands the hot potato to an industry no better placed to moderate risk and mitigate disaster than the banks themselves.
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