First up this week I would like to thank the enormous number of people who rang or wrote in support of my article explaining the unworkability of the Victorian Fire Service Levy. I thought my iPhone was going to have a meltdown. All those that contacted me agreed that something had to be said and clearly I am not alone in my absolute frustration. Of particular interest was the number of employees of insurers who are equally ropeable at the situation that we find the insurance industry and our customers in.

What was equally interesting was the number of people said that while they hated what was going on, they would rather cast a donkey vote than vote the current Labor Party. A great deal of work clearly has to be done to undo all the brand damage they have suffered.

As requested, I will not publish the responses but will honour your wishes to remain anonymous.

Readers would have noted that another two major insurers have increased the Fire Service Levy payable on all Victorian policies. The first insurer has also made the decision not to allow the pro-rating of the Levy where the broker has asked that a policy subject to the tax be extended to July 1, 2013.

While I have had literally dozens of technical insurance questions that I have answered via email and would prefer to be concentrating on in this blog, I find myself again being diverted due to my being in strong disagreement with the Insurance Industry’s peak bodies on the subject of taxes and levies.

It was pleasing to see that the opposition in Victoria is now starting to take an interest in the Fire Service Levy due to last week’s post.

This week the budget included a dividend of $100 million to be paid out of the Terrorism Pool. It is not one, but two bodies that I take an opposing view on insurance taxes. I do not disagree with all they say, particularly on the token allowance made by the Federal Government on flood mitigation in this budget.

Why I am so frustrated is the lack of a strong voice in the industry and as a result the insurance industry and more importantly its customers, and the economy as a whole, remain at risk due to under-insurance and non-insurance. The Victorian Government only has a 2-seat majority. What they have done with the transition of the burdensome Fire Service Levy is woeful and if the industry stood up and put out a hard-hitting press release like the mining industry or any other major industry would have done in such a way that the insuring public understood it, not only would the Victorian Government be forced to change what is simply bad public policy, but the Federal Government may not have joined the bandwagon while it would have put the New South Wales and Tasmanian Governments who at this stage still retain the Fire Service Levy. It would also ensure that the Industry had more of a voice of reason in the transition of the Fire Service Levy in those states when they finally take the burden off their constituents.

Every week we see advertising firms on the Gruen Factor come up with advertising campaigns to sell the worst of products or services. Explaining the rip off of those businesses and home owners that insure would be a walk in the park for such an expert.

I genuinely believe that the people of Victoria deserve to be told why their insurance is, in some cases, double that of Queensland, South Australia and Western Australia rather than businesses and home owners buying less insurance and risking everything they have worked for. What is so radical or wrong with this?

After my continuing frustration of thinking that all governments believe the insurance industry is a bottomless pit of cash to tax, I have found the time to post the more interesting/important of the questions put to me this week by readers.

Finally, please keep in mind the new Masters of Insurance Law and Practice degree offered by Victoria University, which will start next semester. If you would like more details, please drop me a note for I am honoured to be the course director.

Too many taxes on insurance!

My ongoing concern this week arises from the press release following the Federal Government’s decision to take a hundred-million-dollar dividend out of the Australian Reinsurance Pool Corporation. The latest review of the Act suggests that this dividend will be $400 million over 4 years. This whole area is extremely complex and I cannot hope to address all the issues on one blog article but I will do my best without hopefully boring the reader to tears. I save the tears for the inequity of it all.

This is bad enough, but worse was the fact that two of Australia’s peak bodies, one representing the insurers and another the insurance brokers, have suggested that this money should be redirected to flood mitigation.

I fully understand that great need for flood mitigation in many Australian communities, but I feel strongly that this should not be funded by yet another hidden tax on those businesses that insure. The benefit  of any flood mitigation is to the entire community and the cost must be borne fairly by everyone in the community.

Before I explain my position on insurance taxes generally I would make the following points on the Terrorism Levy and why it should not become morphed into yet another tax on insurance no matter how noble the cause. The levy, if it must be retained, has to be preserved solely for its designated purpose.

Insurance premiums are based on the frequency of the risk of the insured peril occurring and the severity of the loss (should the event occur). I would ask you to consider the following:

1. The risk profile for flood is much greater in my estimation that the risk of terrorism.
2. With the death of Osama bin Laden and many of the top level people of the world’s terrorist organisations, coupled with the  decision of the Federal Government to take our troops out of Afghanistan early, should all other things being equal, means the risk of terrorism has reduced. I am not suggesting that the threat has passed and there is no further need for the scheme.
3. When the Australian Terrorism Reinsurance Pool was set up it started from a zero base. It has now collected billions of dollars in levies, since it started in 2003, which should now be invested and earning interest / dividends as any insurance or reinsurance company would be doing to keep future costs to their customers to a minimum. The levy should now only need to cover any shortfall in this income stream to cover increases in asset values due to inflation and on-going reinsurance costs. It should not become another hidden tax on insurance and SMEs.
4. The current premium rate for the terrorism levy is based on a flat percentage of property and business insurance premiums, which has not altered since the scheme was introduced in 2003. This ranges from 2% to 12%. (12% is a high percentage in anyone’s language when you compare it to the total premium covering all other insured risks.)
5. To my knowledge, no payments have been made from the reserves made by the Pool since it started. Remember that insurers bear the first $100,000 of any claim in any event.
6. Due to the massive payouts arising from the natural disasters in Australia over the past few years starting with the Victorian Bushfires and including the floods, cyclones and hail storms insurance premiums have had to go up and this means the amount paid by businesses for terrorism insurance is going up at the same rate and yet, if I am correct in points 3, 4 and 5, the cost to maintain the protection for terrorism has gone down. Therefore, to say that the rate paid by the insuring public has not altered is false and misleading.  Worse still is the call to morph the terrorism levy which would allow a government that clearly follows the philosophy that “the human mind can justify anything” to syphon off the excess collections in the guise of a dividend. We see that many of our politicians cannot be trusted with a cab voucher or a credit card, let alone hundreds of millions of dollars. I think all Australians have made up their own minds about the way the leadership of the country has dealt with these grubby dealings. I for one do not want any revenue streams or expenses being hidden from full and open scrutiny.
7. The terrorism levy attracts Fire Service Levy in NSW, Victoria and Tasmania, + GST + State Government Stamp Duties. This can more than double the cost to the Insured in some states.
8. Any and every impost on the cost of insurance means that people buy less, which is no good for the economy, the insured in the event of a loss, the insurance industry or insurance brokers who are doing their best to ensure that people get the right advice and take the right insurance.
9. The so called “dividend” is being justified as a reward for the Federal Government to provide a government guarantee of $10 billion while the pool was being collected. The same Government also provided a similar guarantee to the banking sector, but for a much greater amount. The published rate for this guarantee is 0.07% per annum for AAA to AA- rated Australian banks. On $10 billion this is $7,000,000 per year. While I appreciate the risks are different for banks -v- to a terrorist attack, it is still a big difference between $7 million to the $100 million taken as a dividend this year and the additional $300 million earmarked over the
   next 4 years. On the face of it, the banking sector has a more effective industry voice than the insurance industry and we and our customers deserve better!

In view of the foregoing, I have to ask why on earth would two of our peak bodies would not be tackling the government on reducing the terrorism levy to assist Australian business – particularly those in the north of Australia  who are being thumped with premium rate increases (I bet this does not feature in any of the gevernment enquiries into the affordability of insurance in Northern Australia) or with Victorian businesses, particularly in the rural sector that already being taxed into extinction by the Baillieu/Ryan State Government. It appears, on the face of it, to be a change of position by the peak broker group who previously took the position that the Terrorism Levy was yet another tax.  http://www.niba.com.au/tax/html/terrorism_levy_adds_to_the_costs_1.cfm.

Like many I talk to, I voted for the introduction of the GST on the misguided belief we would get rid of all the hidden taxes such as State Government Stamp duties, and the like. I simply cannot sit back and say nothing while yet another tax is being imposed on insurance, and, ultimately our customers, when we have not got rid of the destructive fire service levies in New South Wales, Victoria and Tasmania and have the new Carbon Tax which will undoubtedly lead to more under insurance.

The Henry Report into taxation reform clearly supports my position on hidden taxes.

I stress I am not opposed to flood mitigation which has all but been completely ignored by the Federal Government in this election. This came as a complete surprise after all the grandstanding and public insurance industry-bashing by the Federal Government, particularly by The Honourable Bill Shorten MP – Minister for Financial Services and Superannuation. Now that they need to put your money where your mouth is, the true measure of the man and the government can clearly be seen.

I am in fact all for flood mitigation to reduce the risk of loss for all just as I am for Australia to have well-funded and trained emergency services. What I will not accept is that this should be funded solely, or even primarily, by those in business that are risk averse and prudent enough to insure. Taxes on insurance are plain unfair and unsustainable. It is one, if not the most inefficient way, of raising revenue/tax for any g. This is the government not just me saying this, but a study by KPMG Econtech confirmed this.

This study prepared for the Henry Report on taxation clearly showed the ‘excess burdens’, that is the measure of the economic cost (or loss in living standards) per dollar of revenue raised when a tax is increased by a small amount is the worst when on insurance taxes. The following chart from that study clearly shows, the cost of insurance taxes per dollar of revenue is higher than for other major taxes, such as personal income tax on wages and corporate income tax.

KPMG explain in their study that there are a number of reasons for the high economic cost of insurance taxes. First, insurance taxes are applied to a narrow tax base, ie. insurance premiums. In general, the narrower the revenue base of a tax, the higher its economic cost. If taxes are applied to only one product (as insurance taxes are), then there is more opportunity for households and businesses to substitute away from consuming that product, leading to a greater loss in living standards.

Second, insurance taxes have a high effective rate. While the statutory tax base is typically the value of insurance premiums, the true cost of insurance services to policyholders is the value of premiums less the benefits that are paid to them. This is a much smaller tax base than the statutory base. This means that the effective rates of tax are far higher than the statutory rates.

I had hoped that this comprehensive study would have convinced Governments to remove all taxes on general insurance rather than allow our insurance industry to be the highest taxed in the world.

My firm position is that if any government needs to raise money for any infrastructure or service that will benefit the entire community, such as flood mitigation,  it should be honest enough to cost it, sell the benefits and then fund it in a way that all those that benefit pay their share. To suggest otherwise as two of our industry bodies have suggested is short sighted and naïve.

When it comes to taxation on insurance, my position is simple – take all tax off insurance other than the GST on businesses registered for GST. This is based on the following assertions:

1. Every economy requires honest, affordable insurance. We all saw what happened to the New South Wales when HIH collapsed. No one could build a home due to the fact that HIH was the insurer of the Home Owners’ Warranty Scheme until a new insurer(s) came on board. Charities could not run a fate and hazardous leisure activities nearly ended. Where would Australia be without the over $5 billion paid out by the insurance industry following the spate of natural disasters? How many lives were lost in the Victorian Black Saturday Bushfires due to people staying back in a hopeless attempt to protect their uninsured home or business? I genuinely believe that the loss of life was exasperated by the high tax on property insurance in Victoria at the time. A situation made much worse by the current Baillieu/Ryan State Government. The level of underinsurance caused by high taxes caused many businesses to fail causing loss of jobs to the business owners and their employees. Banks foreclose on the family home and a multigenerational cycle of poverty starts. At the end of the day, the government and the tax payers have to bear this burden. The more people that insure, the less stress there is on government. It is simple as that.
2. Insurance assists government. Unlike alcohol or tobacco, its use does not put a burden on government or society through the health sector, the insurance industry on the contrary protects the economy. Every dollar paid out by the insurance industry in claims, $20 billion last financial year, has a knock on benefit to many businesses and the economy as a whole.
3. Basic Economics 101 teaches us that if you increase the price of any product or service, people buy less until it reaches a point of equilibrium. Some products/services are less elastic to price changes than others. Insurance is not as price sensitive as other products, but in New South Wales, Victoria and Tasmania that still have Fire Service Levy, we have tax on tax on tax on tax. Namely, the terrorism levy, which in turn attracts the fire service levy; both of which attract GST; all of which then attracts State Government Stamp Duty. You do not have to have a PhD in economics to know that if you double the price of insurance, people will buy less. This takes the form of either no insurance or under-insurance. This does, without question, put the businesses and the economy at risk, as well as the job security of every person employed by those businesses that cannot afford to be fully insured.
4. The Government should, and needs to be, completely transparent in all its dealings. Hiding blatant over-the-top tax collection with insurance and making the industry the tax collector is not only inefficient, but downright dishonest. For example, as an accountant I find it an unacceptable double standard that the government can include the full cost of capital investment on the insurance industry each and every year and yet treat this same accounting practice as tax fraud if any business or tax payer were to do the same and claim the full tax deduction in the first year of any capital purchase. Another way of hiding the tax is the current Victorian Government taking out  $471.5 million out of WorkCover, but when you ask Treasury on what basis this is made they simply say this is not published. Further, rather than compensate the insurance industry for collecting all the taxes (the Terrorism Levy, Fire Service Levy, GST and Stamp Duties), they are subject to costly distracting audits, which only adds unnecessary costs to the insuring public.
5. The Federal Budget confirms that the Government will make GST concessions to those affected by a natural disaster. Does it not make more sense to take GST off insurance and have people insure and protect themselves?
6. The Federal and many State Governments have set up their own self-managed insurance schemes which take premium out of the Australian Insurance Industry and avoid many of the taxes they impose on business. Everyone, government and private business, should be operating on a level playing field.
7. My final reason for removing taxes is that, with the taxes so high, insurers cannot get the reasonable price rises that they require to make certain classes of insurance viable. As a result, several major insurers have withdrawn from farm and rural package business. This is not good for the consumer, the economy or the insurance industry.

Clearly, the current Federal Government does not support business, particularly small and medium enterprise (“SME”) businesses. We see that with yet another broken promise, this time to reduce company tax on SMEs. In addition, I see this “dividend” as yet another tax on all businesses and SMEs in particular who can least afford to carry the burden.

I think we can all understand why this government does this. SMEs are not highly unionised and therefore there is little revenue / benefit for the political party currently in power. They also feel that businesses do not vote. It is, of course, flawed logic for what they tend to overlook is that, collectively, SMEs are the biggest employers in our economy and the owners of SMEs do vote.

There is a definite two-speed economy and hidden tax on tax on tax etc. makes it harder for these businesses to survive, and, worse still, due to under, on non-insurance, almost without fail, guarantees business failure, job losses and more strain on our economy when a fire, natural catastrophe or other insurable event occurs affecting that business.

I have found that not all politicians are dishonest. I met with a Victorian-based Federal Government Senator a little while back when I was doing some research in preparation for my submission to Trowbridge Committee on the flood issue. The Senator did not support any government building up a pool of funds for flood as he believed that if things got tough the money would be used for some other purpose as this government did with the huge reserves the Howard/Costello built up for education and health. I came away from this meeting refreshed to find such honesty and reassurance that my own concerns were correct. I suggest the same may well apply to the Terrorism Pool and worry if this is just the thin edge of the wedge longterm.

For those not familiar with the formation of the Australian Reinsurance Pool Corporation, I offer the following brief summary.

Australia’s Terrorism Insurance Scheme was established under the Howard Government to minimise the wider economic impact that flowed from the withdrawal of terrorism insurance in the wake of the September 11 (2001) terrorist attacks in the United States of America.

In May 2002, the Government announced that it would act to protect the Australian economy from the negative effects of the withdrawal of terrorism insurance cover. Subsequently, the scheme was established under the Terrorism Insurance Act 2003 to replace terrorism insurance coverage for commercial property and associated business interruption losses and public liability claims. Under this Act, the scheme is administered by the Australian Reinsurance Pool Corporation (ARPC). The scheme commenced on 1 July 2003.

I was mortified to see that the only response that the Insurance Council of Australia made to latest news on the fire service levy was to applaud the news. See: http://www.insurancecouncil.com.au/media/89752/010512-victorian-budget-fsl-final.pdf

To my mind, this press release completely misses the boat. Let me explain why:

1. It was the Brumby Government under pressure from the Victorian National Party following the Victorian Black Saturday Royal Commission, and campaigns such as that mounted by www.NoTaxOnInsurance.com.au, Insurance News, Insurance News Australia, NIBA, Zurich Insurance and a great many individuals within the Insurance Industry that announced the removal of fire service levy back on 27th August 2009 and not this current Baillieu Government.
2. For this, the 2011/2012 period the Fire Service Levy imposed on the insurance industry went up by nearly $100 million from $544.2 million in 2010/2011 to a revised $641.9 million for 2011/2012.
3. The expected Fire Service Levy for 2012/2013 is a further $580.5 million.
4. The reason for the increase is that this government pushed through $250 million (1/4 billion dollars) of capital expenditure in full to the Insurance Industry before it moves to property rates. The benefit of this capital expenditure will benefit all Victorians for 20+ years and yet the Insurance Industry through the prudent and risk adverse have met the full cost.
5. Despite Queensland, South Australia and Western Australia all realising the need to pro-rate the transition of fire service levy between the outgoing tax on insurance and the property tax, the Baillieu Government are saying that the Insurance Industry has to meet the full cost.
6. The Victorian Government refuse to work together with the Insurance Industry to work out a uniform approach to solve the major problem. (I wonder if the Victorian Government will take the same approach to the local governments. I doubt it – the policitical backlash would be too great.)
7. Let us not forget the Baillieu Government delayed the removal of the insurance-based Fire Service Levy by 12 months!
8. The government have had since August 2009 to work this out and could have (or should have) followed the working success of the transitional arrangements used by Queensland, South Australia and Western Australia, but only give the Insurance Industry less than 1 month to sort it out.

It is point 5 that is causing the greatest grief to the Insurance Industry including the insurance companies that the ICA claims to represent.

Let me explain why. We all know that everyone in the community’s insurances do not fall due equally each month. There is still a cluster around the end of each quarter with 30 June the busiest time, particularly for business insurance.

The situation is made more complicated by different rates charged for Insureds in the Metropolitan Fire Brigade area as opposed to the Country Fire Authority area. On top of this there is a higher rate for commercial, business interruption and contract works than there is for home and contents.

Yet another complication is that the amount each insurer pays is based on their market share for the product at the end of the period not at the start. No-one can forecast their market share with 100% accuracy.

Let us ignore all these complications and for the sake of simplicity, let us assume that insurances did fall due equally each month and that people paid their rates each quarter. This means that if $580,000,000 is be collected the Insurance Industry need to collect $48,333,333 per month for 12 months.

If the Victorian Government had said in this year of transition: right insurance industry we need half from you ($290,000,000) and we need half from property owners ($290,000,000) through rates then it would be a realitively simple exercise to divide the monthly figure by 12 and the pro-rata the number of months the Insured is expected to meet the fire service levy. That is 11.5 months for July 2012 renewals down to .5 for June 2013 as set out in the following table.

With the Victorian Government refusing to allow the transition between property rates and the insurance industry, insurers are left with two choices. The first alternative is to just charge the $48,333,333 per month across all insureds.

The unfairness of this is easily shown. I have already explained that for historical reasons a disproportionate number of commercial policies fall due on 30 June each year. Australian insurance policies expire at 4 pm in most cases. This leaves 8 hours of insurance cover from 4 pm on 30th June to midnight on 30 June and the Insured is expected to pay 12 months fire service levy for that 8 hours bearing in mind they paid the other 365 days less 12 hours with the 30th June 2012 renewal. That same insured will then get hit for the full 12 months fire service levy with their property rates.

The alternative is that the Insurance Industry pro rata the Fire Service Levy for the full $580,000,000 to be collected. The effect of this approach is shown in the table below:

There is just no simple fair and reasonable solution other than to have a transition where the collection of the tax is partially funded by fire service levies and part by property rates.

With the state of the Victorian economy compounded by the uncertainty of the effect of the carbon tax on reinstatement and replacement values of insurance the position the Baillieu/Ryan Government have put home and business owners in is simply unforgivable and shows a complete abrogation of their duty as a government. (I mention Peter Ryan here as he is the responsible minister and the one who campaigned so hard against the fire service levy while in opposition. – To me he has broken an election promise as important and damaging on our economy as Ms Gillard on the Carbon Tax).

So what will happen? Insureds are already writing to me saying they will not insure and take the risk. That is no good for them, their employees or the economy. Clients will ask their insurance broker or insurer to extend their insurance until 1 July rather than pay for a full 12 months.  This will mean double the administration and at the end of the day most insurance in Victoria falling due on 1 July which from a protection point of view is unwise. I have spent the last 10 years campaigning to brokers to move the renewals way from 30 June.

Insurers are already changing their policy on refunds and will not refund Fire Service Levy or State Government Stamp duty on policies that are cancelled mid term. I have already posted that the first of the major insurers have increased their fire service levy across the board.

This is without doubt the biggest cock up I have seen in my 41 year insurance career. Like most of us, I have come to expect this from our politicians. They just do not get it. It is all about their position and stuff the economy, the business owner, the home owner and the employee.

But I think there is more to it than just a cockup. Remember the old adage about it being a cock up or a conspiricy? Well I genuinely believe the Victorian Government know exactly what they are doing. They want the benefit of the triple tax that GST and State Goverment Stamp Duty brings to them by leaving the Fire Service Levy with insurance for as much as possible. See http://www.allanmanning.com/?p=924. That is why they will are not prepared to follow the earlier states example. It is pure unadulerated greed when you factor in the 1/4 billion capital expenditure and the delay by 12 months of the removal of the levy! They think the electorate is stupid and cannot see the trickery that is going on because it is not spelt out in the budget.

What I cannot understand or accept is the Insurance Council of Australia’s stance on this. They got caught with unprepared with the flood issue. I can live with that as it was sudden and the media attack was fierce. This issue is completely different. The ICA should have been on top of this for our industry and more importantly for their members and the insuring public for the past 20 years or more. Clearly from their press release they appear to only have a superficial understanding of what is really going on and have fallen for government’s spin: hook, line and sinker.

I ask the member companies of the ICA to question the value of their industry association. To me, our industry and our economy would be better off without them. If they congratulate a government that has introduced such a flawed policy then it makes it even harder to have the position over turned. It also means that the New South Wales government, who are currently carrying out a review of their Fire Service Levy may well follow the Victorian example.

We have a completely ineffectual opposition in Victoria and while industry journalists clearly understand the problem, the main stream media do not.

So where does that leave the rest of us that can see just how damaging this is for our industry, our customers and for the Victorian government.

The first thing is to write to your local member and explain to them the problems that the current policy will create for the insuring public. Secondly, no matter what your political persuasion, show your displeasure at the next state election and remember who got rid of the tax (the Brumby Government) and who stuffed up and got unbelievably greedy with the transition (the Baillieu/Ryan government)!