Sovereign Solvency Requirement and moral hazard guardrails

If the Insurer of State is to viably expand the state's fiscal tools, the power to create money must be balanced by prudence. This piece introduces the concept of a Sovereign Solvency Requirement and explores the moral hazard guardrails needed to protect it. At stake is the credibility — and sustainability — of the entire platform proposed.

The thesis for this project is busily being shared and briefed to stakeholders across the spectrum. Political policymakers, civil servants, Lords, Knights, ex-MPs, MPs, and economists. Every single meeting is appreciated and welcomed - and very often incredibly constructive! The most frequent question lately, has been political and prudent in nature.

"OK, I understand how this works. My concern, is I can see how it might be misused by politicians".

or latterly from an economist:

"there's no such thing as a free lunch"

These are every bit the nuggets of wisdom they seem. To succeed in this project, scepticism and cynicism must be embraced until there's no air left in their metaphorical lungs. After all, when the project makes sense, it really makes sense.

The Insurer of State's Primary Solvency - its premium

The Insurer of State is similar to private sector insurers in the sense that it earns premium. Because of its position as the monopoly and insurer of last resort - it can set a levy premium across all insurance sales in the economy. It may choose to make that fee uniform, or tailor it to different sectors (that is for another post). But that is the source of its Primary Solvency. That income can be used to pay for risk management and other claims made on its mandate.

An example might be that NHS negligence claims (currently estimated to be c£2.8bn per annum). This sum could be partially paid for by Primary Solvency, whereby Private Medical Insurance is charged a 15% State Insurance Premium, and the sum raised simply pays towards NHS claims. Perhaps a structure where the NHS budget has a capped liability of £1bn? Health Re - a kind of NHS captive for Professional Indemnity.

This is a simple example of how the Insurer of State and risk can interact - without it using any superpowers. There is precedent for this. It's in the fantastic models via Pool Re and Flood Re. In fact, the very presence of the Insurer of State provides a mechanism for retrocession that could accelerate the creation of more of these types of "Re" entities and public-private-partnerships.

Alchemy? No, it's Sovereign Solvency

But, unlike a standard insurer, its solvency isn't capped. This insurer can never run out of capital, because it can create money to satisfy claims from (or liability admitted by) the state. So that NHS coverage can be funded by both Primary Solvency and Sovereign Solvency. That is precisely how the FIAT money system and government financing works.

But that can often be misused, which is where political accusations of a "magic money tree" can emerge - what was a toolkit and indemnity policy wrapper for all state risk, risks becoming alchemy.

Creating money - money printing, has disastrous consequences and can lead to hyperinflation. This platform cannot be seen as a backdoor means (either by economists, policymakers or the debt markets) to simply print money. It isn't.

Our thesis is that creating money strategically, specifically for indemnity and risk events - breaks the irrational monopoly that banks have on money creation. A process where it is estimated that every £1 created then goes on to create up to £6.

A simple way to interrogate this is to consider if an insurer offering you a loan to rebuild your burnt down house would really be a good idea? You'd be in debt, and might be tempted to borrow more than you need. Put simply, insurance puts "humpty" back on the wall, banking creates more "humpties".

Therein lies the problem with the state turning to the money creation process to fix issues like the pandemic, or the Horizon compensation scheme. (Which it does so presently through a deficit which it funds with gilt market debt.) Money from debt should be used to create assets & income - through economic growth. Compensation funded by debt, or cuts in spending or raised taxes, is arguably a drag on economic growth.

The Insurer of State offers a different tool. Much like a central bank, it can create money exogenously (through its loans to a Loss Purpose Vehicle). That money can be used to pay indemnity - which is the precise amount needed to put Humpty back on the wall. Not get humpty's balance sheet in distress - which he duly passes on to his customers in the form of inflation. That mechanism clearly stunted growth - as is logical.

£76.89 billion was sent into the economy as standard loan debt during Covid - the CBILs regime. That had to be paid back to banks - and the cost of servicing it passed on to customers. The many businesses that likely limited investment, and expenditure that could have driven growth was myriad.

There's also the impact it had on fiscal headroom - with £10.96 billion being the amount paid out to lenders under the all schemes’ Guarantee Agreements. Again, a sum financed by issuing gilts purchased with money created by the Bank of England under the QE programme. (A programme now being unwound at a loss with said losses underwritten by HM Treasury - which is funding it with a budget deficit.)

These things effect both growth and inflation. Objectively. All the King's horses and men could see, right Humpty?

The State's balance sheet is always correlated to the economy. Thus, events like Covid have a gravitational effect on the State's ability to drive growth through policy. Where the Bank of England seeks to manage interest rates, inflation (and therefore the money supply), ultimately ensuring sentiment is stable - the Insurer of State offers an entirely new pillar of tools for the State. It is strategic money, where the money supply tracked by the Bank of England is tactical money.

Because the Insurer of State can create money distinct to the current way money is created [and we must emphasise that if you do not yet grasp how money is created, you must attempt to] by the Banking system - there is potential for the Government of the day to misuse this added power to create money. Because it offers the state fiscal headroom options.

Retroactive Dating and a limit on claims made for losses since then

The starting capacity of this platform could be tethered to the expected Yield of State Insurance Premium - with a "coupon lock" capping the amount that can be created immediately for "prior losses" on a "claims made" basis. In lay terms - when the platform is set up, it is our intention that it offers immediate fiscal relief and indemnity for some, not all, prior relevant losses (that would, in future, be covered.) In the private insurance world, this is known as a Retroactive Date.

That total might be some £400bn of a total estimate £3 trillion in fiscal capacity this platform could offer - assuming that State Insurance Premium simply replaces Insurance Premium Tax and yields a similar sum.

So what guard rails of prudence can one put, politically and economically, around this platform?

State Risk Transfer Parameters [the coverage]

Given that the Insurer of State will require an Act of Parliament to be established (the draft of which this project endeavours to create), measures can be placed into the act to discern when the Executive may call upon it and "make a claim".

Bank Deposits (vastly increasing the FSCS' limit), Terrorism (reinsuring the Pool Re platform), Flood (reinsuring the Flood Re platform), Cyber Warfare, Pandemics, compensation scandals, institutional negligence (NHS professional indemnity), uninsured drivers (replacing the levy on car insurers and backing the MIB), civil unrest, acute acts of god, unexploded ordnance - even limited nuclear fallout (do you know how many British sheep were culled after Chernobyl?).

All of these areas are typically outside the appetite, let alone the remit of the private sector. Plus, with extreme weather events driving the proliferation of "coverage deserts" - the State will face even more pressure to pick up the remediation - to indemnify the communities affected.

Coverage is therefore imperative. The perils, the risks that are effectively transferred to the Insurer of State and therefore deemed legitimate. As a private sector insurer would, the entity must consider Political Moral Hazard.

Therefore coverage can be clearly proscribed - with the Insurer of State, its Select Committee and Parliament, further powers may be added to it, or they may require it to self-evolve. Primarily - the entity should be covering the State (and therefore the economy) for the things that the Private sector cannot or will not. Things that would clearly imperil its liquidity. Thus is coverage pegged, but also dynamic - evidence and risk-based.

Budget Deficit rules and Sovereign Wealth sweeps

Just as the current regulators of the insurance sector call and require for carriers to hold capital (a mix of money, assets, etc) against their exposure - so should the Insurer of State be mandated to apply similar principles to the Executive "making a claim".

Since a State with a central bank like the UK's cannot theoretically "run out of money" - the requirement is slightly different. Here, the guardrails need to protect against the platform contributing to hyperinflation or reckless fiscal management by politicians.

It is therefore prudent to consider that when an Executive is running a budget deficit, a fixed proportion of the IoS originated "indemnity"- money which the IoS ultimately creates - must [by law] be placed into a Solvency Pot. Naturally, that pot should generate income - so that similar degrees of money creation are not always required.

In essence, the Insurer of State contributes to its own Primary Solvency, or the Executive's long term fiscal surplus/balance (or both.) At the least, it must not drive further deficits. Where gilts are borrowed "as well" as IoS indemnity being claimed. Such a Sovereign Wealth Fund, in our opinion already exists - and it exists in the form of The Crown Estate.

In such a model, The Crown Estate is wired a large slice of the created money- instead of the Treasury. This escrows it from immediate short term use. It then, in turn, invests that money in assets [globally] that yield non-tax income for the State. Thus does the platform allow the modern UK executive increased tools to finance its activities.

Whilst this model may not be foolproof, and nor should it bind any democratic Executive, it does somewhat restrict the full force of this mechanism being misused in the short term. It attempts to contribute to medium and long term fiscal prudence. That, in turn, should have a positive impact on the UK's wider standard state debt auctions and requirements - and may even act to depress interest rate requirements on bond issuances.

Governance and amendment

The Insurer of State Act 20XX would represent an extraordinary moment for the British state. The first Western and capitalist society to have a platform of its ilk. Where better for this structure to operate than the country that Lloyd's of London calls home - the world's most prestigious and ancient market.

In fact, it may be that, when considering this Act, a debate takes place on whether Lloyd's of London should, in fact, be imbued with these powers. Amending its own government-legislated uniqueness.

Regardless, the presence of a global and elite insurance market, packed with expertise makes the prospect of finding a prudent and viable Governor for the Insurer of State that much more probable. It also makes the creation of an Indemnity Policy Committee readily feasible.

Since the "IPC's" main task would be to annually review and renew the coverage, and operate the National Risk Register (alongside the Cabinet Office), as well as set the State Insurance Premium rate across different classes of business, pursuant to risks presented.

Thus does a risk management, risk transfer, and stable state solvency mandate achieve adequate oversight and administration.

So, the Insurer of State isn't alchemy - it isn't a new magic money tree. Its first line of defence is its ability to muster a state level focus and response to risk. Its second is the ability to create money. Done so, in order to rapidly solve problems and indemnify the state's balance sheet, with a mechanism distinct to credit and money creation through the banking sector.