The Central Bank of Ireland (the Central Bank) has completed the first phase of a three-phase review of 'Differential Pricing in the Home and Motor Insurance Markets' (the Review), and it has issued a 'Dear CEO' letter to relevant insurers and intermediaries identifying weaknesses in insurance pricing practices and calling for immediate action in response.
In this Briefing, we consider the Central Bank's 'Dear CEO' letter of 8 September 2020 (the Letter) and what the future may hold for insurance pricing practices in Ireland, particularly in light of recent UK developments that indicate an outright ban on differential pricing practices may be imminent.
What is 'differential pricing'?
Differential pricing, also referred to as 'dual pricing', describes the practice of charging new and existing insurance customers different premiums, for reasons other than risk and cost of service, despite their having similar risk profiles. The Central Bank makes clear in its definition of differential pricing that it includes "the use of any modelling technique or the application of a non-risk adjustment during the pricing process which leads to customers with a similar risk profile and cost of service being charged differing premiums".
The most common example of the practice involves an insurer charging an existing customer, renewing an existing policy, considerably more than a new customer who has a similar risk and cost of service; thereby imposing what is termed a 'loyalty premium' on an existing customer for not seeking alternative quotes from other competitors. Other complex pricing practices such as 'price walking' (incremental increasing of existing customers' premiums at each renewal) are also in use in the Irish market.
What is the Central Bank doing and why?
In January 2020, the Central Bank commenced a multi-phase review into differential pricing practices focussing on the two most commonly held insurance products in the Irish market; private motor and home insurance. The Review is split into three phases and, with Phase 1 (market analysis) complete and its outcome outlined in the Letter, Phase 2 is now underway. Phase 2 involves a quantitative analysis by the Central Bank to assess the degree of differential pricing amongst policy types, in parallel with a consumer insights exercise designed to better understand how consumers engage with insurers and intermediaries. The Central Bank will issue an interim report after Phase 2 with its findings and observations from Phases 1 and 2.
Phase 3 will involve the issuance, by the Central Bank, of its overall conclusions and recommendations (taking account of its findings from Phases 1 and 2) which the Central Bank says will be in the form of "a report or consultation on proposals for reform, as appropriate"
In carrying out the Review, the Central Bank's stated purpose was to:
- establish the impact of differential pricing on consumers and to identify the drivers of consumer behaviours, including how consumers engage with the insurance sector; and
- assess the extent to which such pricing practices lead to outcomes that are consistent with the Central Bank's Consumer Protection Code 2012, as amended, (CPC).
While EU law strictly prohibits it from playing a role in insurance pricing practices, the Central Bank has a clear consumer protection mandate under which it must ensure that the pricing practices of insurers and intermediaries are compliant with the CPC.
Phase 1 of the Review – Key Takeaways
The primary aim of Phase 1 of the Review was to establish the extent to which differential pricing is utilised in the Irish private motor and home insurance markets and, where it is being used, to determine how so, and whether the practice is CPC compliant. In the Letter, the Central Bank identified three main issues:
- Differential pricing practices – the Central Bank identified a failure by some firms to recognise and/or acknowledge that they are using price differentiation practices. This is of significant concern to the Central Bank, as a firm's failure to recognise and/or acknowledge the use of such practices limits a firm's ability to assess the impact of these practices on its customers.
- Governance and controls - inadequate governance and controls arrangements, including insufficient evidence of levels of ownership and oversight of differential pricing practices. In particular, the Central Bank noted that it was not evident that firms' Boards had adequately considered or discussed the impact of differential pricing practices on their customers.
- Culture and conduct – insufficient evidence of a customer-focused culture in respect of pricing decisions and practices. A firm's failure to ensure that its customers are at the centre of pricing decisions raises significant concerns for the Central Bank in respect of a firm's culture and how it regards customers' interests.
What should Firms be doing immediately?
As set out in the Letter, the Central Bank requires a firm's Board and senior management team to immediately:
- assess the firm's pricing methodologies. If a firm does not consider its pricing practices to fall within the Central Bank's definition of differential pricing, the rationale for this view should be documented clearly and agreed by its Board;
- take responsibility at Board level for the impact of differential pricing on new and existing customers. The Board is required to take ownership of the firm's differential pricing practices and fully inform themselves as to the impact of those practices on a firm's customers; and
- ensure the firm's consumer protection risk framework fully embeds the management of conduct risk and the promotion of positive behaviours. The Central Bank views this framework as an integral part of the pricing process and one which ensures a firm is CPC compliant.
What is happening in the UK market?
A market study, similar to the Review, was undertaken by the UK's Financial Conduct Authority (FCA) and in October 2019, the FCA issued an Interim Report evidencing significant dispersion in margins across customers, and a positive relationship between firms' margins and customer tenure (i.e. longer-term customers were associated with higher margins). A Final Report was published in September 2020, in which the FCA found that some firms engaged in 'price walking' by gradually increasing prices for customers who continued to renew policies year after year.
In response, the FCA is currently consulting industry on several potential remedies to enhance competition within these markets and address the concerns cited within the market study, including:
- proposed requirements for firms to offer a renewal price that is no higher than the equivalent new business price for that customer through the same sales channel;
- enhanced measures to prompt disengaged customers to consider alternative options;
- consistent collection and monitoring of data in relation to price differentials; and
- measures to strengthen product governance rules, transparency, and customer communication.
Following the consultation process, the FCA intends, in the course of next year, to publish a Policy Statement and new rules
What's next in terms of the Review?
The Central Bank expects to complete Phase 2 by the end of 2020 and for the output of Phase 3, in the form of a report or consultation on reform proposals, to be published in the third quarter of 2021.
The extent of the Review's impact on the Irish insurance industry remains to be seen and, indeed, if it will be overtaken by primary legislation from the Oireachtas. The Irish Government's Programme for Government included a pledge "to work to remove dual pricing from the insurance market" (see our article here). However, the Central Bank's Director of Consumer Protection, Grainne McEvoy, has noted that the Central Bank is keen to avoid any "unintended consequences" such as the stifling of competition, and called for a "measured and proportional approach, based on actual tangible evidence". Meanwhile, in the political sphere, the Finance spokesperson for Sinn Fein, Pearse Doherty T.D., has since announced that he plans to bring forward a private member's bill that would immediately ban the practice of differential pricing in the Irish insurance market.
Most recently, on 16 November 2020, the Central Bank's Macro-Financial Division produced an interesting Financial Stability Note on 'Differential Pricing: The Economics and International Evidence'. Based on a review of international evidence (including the USA, Australia and the UK), the authors concluded that "a careful weighing of the likely costs and benefits of any potential policy solution is essential, with appropriate consideration given to potential competition and consumer price effects, as well as the impact on vulnerable consumers."
Based on the Central Bank's projected timeframe for the Review, the Irish insurance industry and its customers can expect to know the outcome of that "careful weighing" exercise before the end of 2021.
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