The Financial Conduct Authority (FCA) has released its interim report on general insurance pricing practices which focusses on home and motor insurance. This follows last year's thematic review showing that customers who stayed with the same insurer for a long period paid significantly more than new customers for home insurance. This also follows the report of the Competition and Markets Authority which concluded, in response to a super-complaint, that the FCA needed to tackle so-called price-walking and other harmful practices in home insurance.
The FCA is concerned about certain pricing practices that take advantage of consumers who are less aware of how markets work, and it is also aware of the lack of transparency around how prices are set. The report notes that 6 million policyholders paid high premiums in 2018. If those policyholders had paid the average premium for their policy, they would have saved GBP1.2 billion. In addition, one in three consumers who paid high prices showed at least one characteristic of vulnerability.
The FCA has put forward potential remedies for consultation.
In the briefing below, we summarise the key points arising from the interim report.
How firms set prices and treat customers
The FCA found that the market was not working well for all consumers, and most firms in their sample were operating a price-walking strategy in relation to home and motor insurance, which means that policies are offered at a discount to new customers (sometimes below cost) and then prices are raised for customers that renew with them year-on-year. Therefore, customers who do not negotiate or switch usually pay more (although loyalty was not the only factor at play) and over time this price increase can become significant.
Impact of pricing practices on competition
The FCA found that there is strong price competition for new business, facilitated by firms discriminating between new and renewal customers, and that ancillary income is a key contributor to profitability. Firms are using margin optimisation, whereby prices take into account factors other than the risk, including the customer's likelihood of renewing and buying add-ons. However, the report does note that most firms are using certain constraints to respond to concerns about pricing practices; with growing use of caps on margins earned from individuals and further constraints to protect vulnerable groups. Competition is not working in the interest of all consumers because some are less aware of how pricing works, including those who have less financial knowledge, no internet access or those who trust insurance firms to offer them competitive prices. While most consumers are well informed, a substantial minority are not aware that a renewal price will often be higher, and a lack of transparency around how firms structure pricing makes it difficult to understand how searching and switching may be beneficial.
The FCA found that, although insurers are profitable, there was no evidence that profits were excessive.
Outcomes from pricing practices
The FCA considered who paid higher prices, finding that the main – but not the only –characteristic was the length of time that an individual had been a customer of a firm. High prices were not restricted to this group due to the complexity of firms' pricing models. Other factors included age (older customers tended to be of longer tenure), existence of auto-renewal (a key factor for home but not motor insurance) a lower level of knowledge of insurance products, strong brand preference, and lower price sensitivity. There was some evidence that potentially vulnerable consumers could pay higher prices for home insurance but not motor insurance.
The potential remedies put forward are grouped into three categories:
- Tackling pricing practices that take
advantage of those less likely to switch
Remedies proposed include: restrictions on price increases at renewal, for example not allowing an increase in margins beyond the first year; a ban on price-walking as a strategy; controls on using the customer's likelihood of switching as a factor in setting the price; imposing restrictions on price increases relative to a benchmark such as the new business price for the policy. Other proposals include requiring firms to move customers onto cheaper equivalent deals, either for those who have renewed multiple times or those who are paying high prices, or requiring firms to engage with these customers to prompt them to consider other options. The FCA also indicates it will look at strengthening or changing the rules on product governance.
- Tackling practices that discourage
Remedies proposed include a ban or restriction on auto-renewal, making auto-renewal opt-in-only or easy to decline at time of purchase; and ensuring that it is as easy to exit the insurance contract as it is to enter into it.
- Requiring firms to communicate more
clearly and transparently in their dealings with customers
Remedies proposed include improving communications with customers, such as requiring firms to make it clear that renewal prices have increased because the customer has not switched; increasing scrutiny of firms' pricing practices by requiring firms to publish information about them or about differences in prices between customers of equivalent risk.
The FCA also indicates that it will look at ways the general insurance markets could be positively impacted by technological developments and innovation such as Open Finance and the increasing use of consumer data.
Conclusion and what happens next...
The FCA interim report has concluded that complex pricing practices, including price-walking, are not working well for all consumers and that remedies are required. The FCA is asking for comments on the proposals in its interim report by 15 November 2019, which the FCA will then take into account in a final market study report to be published in the first quarter of 2020.
This work will sit alongside the other regulatory work in this area, including implementing changes following the Insurance Distribution Directive, working with firms following the FCA's Dear CEO letter to general insurance firms to improve governance, control and oversight of pricing practices, the value in the distribution chain guidance which has been consulted on, and the general insurance value measures policy. The FCA has indicated it expects to publish any policy statement on value measures to coincide with the final report for its pricing practices market study.
The potential remedies put forward by the FCA are wide-ranging, and in the interim firms should consider what action they can take now to seek to align their practices more closely with the intention of some of the proposals. We understand that the market is keen to ensure that the final remedies put forward avoid unintended consequences, and it will obviously wish to engage closely with the consultation.
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