IPT yield signals £3.5 trillion of potential fiscal capacity

As the UK's Government spending deficit ballooned to £151.9bn last year, there again appears an enormous "two birds with one stone" opportunity to both refinance the State's tattered balance sheet, and make the UK more resilient to the 21st-century's "Age of Risk". There's a plausible £3.5 trillion available - if you know where to look.

HMRC has also released the figures for the 24/25 yield of Insurance Premium Tax. It now yields an eye-popping £8.8bn per annum for the government - yet this might betray a far greater cost.

When you consider the compensation awards the Chancellor made in her first budget - to the tune of £13.8bn. Had this been an insurance case study, and IPT was the government's captive premium for claims [against the State] like this, then the "loss" directly relating to this claim alone would be roughly 156%.

In an underwriter's world, that's a disaster. For the Treasury? It all balances out.

As it is, that isn't how IPT works. In fact, no tax is "hypothecated" like that. No tax ever will be, either - because of UK political culture, experience and dogma. It isn't up to this project to take that on, so let us side step it.

IPT's gone up six times - what was the strategic gain?

Insurance Premium Tax is therefore a stealth tax being added to the price of most insurance sales in the UK. It wasn't always with us - introduced in 1994 by then Chancellor Ken Clarke - it has crept up since birth.

Since its inception, IPT has been increased six times - adding 9.5% to its initial sum. It feeds on the monopoly of fear and the mandatory nature of some insurances like Motor Insurance or Employers' Liability.

Many would argue that by its nature, it widens the economy-wide "Protection Gap". Because it doesn't serve any directly useful or hypothecated purpose, it's been tempting for consecutive governments to poke it upwards - without considering or modelling the implications on the economy's ability to transfer risk.

IPT is not just misused presently - it's ill-considered. Especially so, when you put it into the context of how much forecasting and modelling goes into other economic tools and policies. Would the Office for Budget Responsibility even consider the government's exposure to contingent liability? Or the effect of a non-hypothecated [to risk] tax on growth?

You can assuredly doubt it.

How could we then use the levy better?

This project already advocates that the tax should be culminated, repurposed and instead become a fee - much like the regulators' charge the industry to regulate it. Instead of it getting thrown into the pot of all tax, lost to the risk environment it originates from - it's used to power a brand new "underwriter of last resort". One that effectively insures the State for things tax, borrow and spend doesn't always cover.

A repurposed use for this tax would not only unlock immediate fiscal headroom - presuming the government used the tools on offer to draw down fiscal capacity - it could also offer both wider macroeconomic benefits and domestic "nudges" to close the very protection gap IPT's existence widens. We've covered this in our posts.

Loss Purpose Vehicles vs Asset Purchase Facilities

Let's offer a simple example. You may need to read the section on "Loss Purpose Vehicles", first. These ape the way the Bank of England created money during its well-known Quantitative Easing programme.

In short - it leant money to a new company entity (the Asset Purchase Facility or APF). This created money. The APF then used that money to buy Bonds - thus removing illiquid assets from the market and replacing it with money (to stimulate growth.)

The Bank of England lent money to the APF at the Bank Rate - which between 2009-2021 fluctuated between 0.1% and 0.75%. Whilst it could have theoretically applied any arbitrary rate it wished, it did not. An issue arises here, though - smart as the system was in reaction to the "Credit Crunch" and The Great Recession. The Bonds the APF acquired could fall in value. Liquidating them below the price they were purchased for means the APF makes a "loss" on the trade - placing its debt to the Bank of England in peril.

To solve this, the Bank of England formally asked HM Treasury to "insure" it for potential losses to this credit system - and the Treasury agreed. In so doing, the parties created a paradox for the State's finances. Because the State (as we began by reminding readers) runs a deficit by issuing vast debt. Thus, the very entity created to stimulate growth begins to hoover up State "fiscal headroom" as it unwinds down the line. In an environment where there's a lot of inflation - it ties the hands of the Government of the day to spend big or borrow big. Borrowing big tends to nudge the market to increase the interest yields it demands.

Contrasting Liabilities for the Treasury

The Insurer of State's system does no such thing. When it creates money [by loaning an LPV the money, which is its own version of an "APF"] - the LPV can only use that capital buy Perpetual Bonds. These bonds cannot be sold to anyone else other than the State - on a buy back basis. That breaks the QE insolvency loop that the APF creates.

Instead of applying the Bank Rate to this loan (and capital creation) transaction, the Insurer of State creates a "Risk Yield Rate", which represents the proportion of Insurance Premium Tax the LPVs are entitled to, let at least 10% of the rate. So the rate of coupon yield the bonds offer is pegged to the underlying rate of interest that the LPF "owes" the Insurer of State for the loan.

The interest rate? Here's where we arrive back at the IPT yield and do the math. Let's assume we want the LPV's bonds to be paid 0.25% "coupons" for their bonds. IPT is our pool of potential coupon money, we can now calculate how much that yield can fund underlying.

Over time, the Insurer of State accumulates capital in the form of the repurposed IPT, it also gets paid interest on the loans it makes to LPVs. The LPVs are always solvent, and their bonds cannot reduce in value. HM Treasury gets a lump sum of capital from the transactions and a close loop of balance sheets tracks and accounts for the capital.

All of this happens "as well as" Monetary policy and Tax and Spend.

Calculating the system's capacity

Fiscal Capacity = Coupon Pool (IPT's current yield) / Proposed Interest rate

Fiscal Capacity = £8.8bn / 0.25%

Here's our £3.5 trillion.

This mechanism also doesn't require the Insurer of State to write HM Treasury any letters requesting a unilateral insurance policy for LPV's and its credit losses. It's a closed loop, it only requires

Making the case

The short term "loss" of £8.8bn in tax receipts for HM Treasury would be more than offset by the reduction in its liabilities, and the upfront "claims" the State could make against this new institutional structure. As discussed, previously, such a model could also immediately supercharge the Crown Estate as the UK's existing Sovereign Wealth Fund (in all but name.)

On our travels privately consulting with eminent policymakers and experts, we've raised this prospect. The most notable, anecdotally shared below, certainly gives food for thought.

"So, I am the Treasury here, you're asking to take my IPT of roughly £8bn and turn it into a premium income [for your new Bank of England sibling, this Insurer of State] - what am I getting in return for that?"

- The Unnamed Lord

"Well, it depends how much you'd like to draw down on a "claims made" basis - but you could likely immediately claim £400bn for all the costs of Covid."

- James York, co-Convenor, Insurer of State.

"Well, that does sound like rather a good deal.... what's the catch?"

- The Unnamed Lord

Let's find out, shall we? Let's ensure this concept is modelled by economists and we can see if it creates more inflation then monetary policy tools do alone. The portents say... it won't. Your support would be most welcome.

Either way, another year rolls by where we miss the chance to use the UK's huge insurance industry to help the State's finances. Who wouldn't seriously consider a new, World-first power tool for Statecraft and the prospect of less tax rises?