In the fourth quarter of last year a Supercomplaint was raised by Citizens Advice with the Competition and Markets Authority raising issues in relation to a number of products offered within the Financial Services industry primarily in relation to pricing differentials between new and existing customers. For insurance this primarily focussed on motor and household insurance and the potential impact on vulnerable customers. However no-one should be surprised that the issues covered have a much wider application to other insurance products and customers.
The timing was interesting as the FCA was just overseeing the introduction of the new rules on Product Governance and the Best Interests rule both brought about by the commencement of the application of the EU’s Insurance Distribution Directive in the UK and the rest of Europe. These new rules required product manufacturers, whether they be insurers or intermediaries such as brokers or MGAs, to have in place detailed and effective methods for governing the development and oversight of their insurance products. The Best Interests rule requires all insurance distributors (again insurers or intermediaries be they brokers or MGAs) to act in the best interests of their customers, a significant change in regulatory tools and approach and a considerable extension of what was known as the Treating Customers Fairly principle which subsequently morphed into the FCA’s approach to Conduct Risk.
The FCA had already done some diagnostic work in the areas covered by the Supercomplaint and consequently their response was rapid and detailed. Because of the importance of all of these changes and the Supercomplaint, these are subjects we have already covered extensively, looking not only at the introduction of the new Product Governance requirements and Best Interests rule under the IDD but also the potential issues and impact of the Supercomplaint tying these together in an interwoven series of articles which can be accessed here:
- Super-complaints, The FCA And The Problem With Pricing In Financial Services
- The FCA’s Latest Warning: Value, Pricing, the GI Distribution Chain and the Customers’ Best Interest Rule
- IDD: Been There And Bought The Postcard?
- Bridging The Gap: Distribution Chains and FCA Expectations
However, the CMA and the FCA had further diagnostic work to do and over the intervening months this work has been underway. They have worked with insurers and distributors and consumers and groups representing consumers. The outcome of that work was recently released in the form of an Interim Report on General Insurance Pricing Practices (MS18/1.2).
The FCA is doing its best to not be a regulator of prices charged to customers which would see them applying the approach utilised in other jurisdictions. However, the FCA is interested and statutorily responsible for ensuring customers are treated appropriately, that is fairly, and that the market is operating without anti-competitive practises impacting the ability for new entrants to be involved. The work undertaken and the proposed approach adopted in this Interim Report divides that thin line neatly and provides further evidence of how the FCA is seeking to ensure the fine balance remains. It is also a report which evidences the increased reliance that the FCA will be able to place on the Best Interests rule, a rule which we have highlighted the danger of to the market about for a considerable period of time because of the all-encompassing application that it appears to have, and which the FCA appears prepared to use as appropriate.
For those concerned about the direction of travel who require a concise summary but without the time to read our analysis the following will help clarify where the FCA is heading:
- The report finds that “These [household and motor] markets are not working well for consumers”.
- “Firms use complex pricing practices that allow them to raise prices for consumers that renew with them year on year” – a practice which is now being called “Price Walking”.
- Unsurprisingly, consumers “think price walking is wrong” with one individual saying that it “is not fair, it makes me feel cheated”.
- The report also found that “Insurers often sell policies at a discount to new customers and increase premiums when customers renew, targeting increases at those less likely to switch”. The discounting is not the issue but the designed and intentional targeting is of serious concern to the FCA particularly as many of the customers who do not shop around are likely to be vulnerable customers.
- “Firms engage in a range of practices that could make it more difficult for customers to make informed decisions an could raise barriers to switching”.
- Firms are profiting from other activities not related to underwriting such as add-ons, premium finance and fees and charges.
These findings substantially support the FCA’s earlier views and are in line with the concerns raised by Citizens Advice in the Supercomplaint.
We do not propose to go over the issues again as we do not consider that the report identifies any significant new issues since we wrote on them substantially in the articles which are referred to above though we would note the following:
- The FCA has certainly done its homework and is now well armed with evidence to support the approach that it has proposed.
- One of the most important findings in the industry’s favour is that the FCA acknowledged how complex pricing can be. From that point however, the FCA was able to establish that there are clear cases where the insurers have utilised the advantage they have with their data access to price products intentionally in a way which could not be described as in the best interests of their customers. This is not necessarily a widespread and uniform practice, but it is one which we may rightly expect will be ceasing very soon.
- Insurers and intermediaries should assume that, while the FCA diagnostic work was focused on household and motor products, they are likely to find parallel issues in other products and will expect the market to look at its behaviour and practices across a wider range of products. The implications should not therefore be taken by the market as limited to the two products which were the subject of the FCA diagnostic work.
What we are going to look at as how the FCA is proposing to resolve the issue and seek to re-balance the position so that customers may receiving a fairer outcome.
The Proposed Remedies
The findings of the FCA lead them to conclude that customers are not being treated fairly by insurers and intermediaries through ‘price walking’ and that there is evidence that the under-pricing of new business is leading to potential new entrants finding it difficult. The approach they intend to adopt comes in a fourfold attack on current arrangements and includes remedies to tackle high prices for those who do not shop around, remedies to tackle practices which discourage switching, remedies which will improve transparency and an approach involving a longer term reform of the market using innovation. In parallel they intend to strengthen the IDD imposed Product Governance and other requirements which they anticipate will stamp out some of the more concerning pricing practices. A bi-product of that will be to increase transparency within a firm of their pricing decision making and therefore make it more obvious who is responsible for any decisions which impact customers negatively.
When combined with the complimentary work the FCA is undertaking on pricing within the distribution chains (another product governance and IDD inspired FCA initiative) and SMCR the consequence could easily lead to increased risk for individuals where pricing practices are inappropriate and lead to poor customer outcomes.
The following are our take on the FCA proposals. Interested parties have until the 15th of November to write to the FCA and comment on the report or proposals if they wish to do so.
1. Tackling Higher Prices for Non-Switchers
Restrictions on Pricing Practices
An obvious approach but one which would be harmful to insurers sees the FCA suggesting that it would impose restrictions on price increases for renewing customers or even ban ‘price walking’.
Insurers who continued to offer discounts to new customers and were then unable to increase the price later may find their book of business became unprofitable in short order. The likely effect therefore would be to drive up the initial price for new customers and potentially flatten the long-term pricing curve for renewing customers. This should not preclude insurers from continuing to make a reasonable return on their capital. It would simply require them to base their pricing for all customers on the data they have as to what price is required to make a profit without offering discounts to new customers.
It might also have the consequence of reducing the number of people who shop around, however, that is conjecture and without data only testing would establish any other potential consequences on both insurers and their customers.
An alternative would be the use of restrictions on use of certain factors for setting premiums such as the assessment of whether a customer is likely to switch or not.
The FCA has looked at similar approaches adopted by regulators in other jurisdictions so insurers and intermediaries should expect to see some activity of this nature as it seems likely that they have a good understanding of what does and does not operate to nudge a market in the right direction.
Helping Consumers find and switch to better deals
Requiring firms to move consumers who have renewed several times to better deals is an option the FCA is looking at. This might require a firm to offer a longstanding customer the same price as a new customer for roughly the same cover.
This has its complications particularly for high net worth consumers who might have very individualised needs and cover. How does a firm identify a similar customer when values and types of property may very considerably and when products for such customers might be packaged. One individual with two houses three cars, a boat and an art and jewellery collection may not be the same as another with similar but very different assets. For example, the houses may have the same value but one may be several hundred years old and have a thatched roof while the other may be new and one may drive 4 x4 and have a clean driving record while the other may drive Ferraris and be on his last point.
While more vanilla consumer risks and properties may be easier to deal with the underlying issues identified in the example can still arise.
The FCA have also identified that campaigns to improve switching can have a positive outcome for consumers.
Strengthening Product Governance
Rules exist which require manufacturers to consider whether costs and charges are compatible with the needs, objectives and characteristics of the target market. Evidence suggests that the market is not consistently meeting these requirements which only apply to new products or products with significant changes after 1st October 2018. The FCA is considering whether to apply this to all live products and elongating the value issue to require manufacturers to consider the value to the target market over a longer period of time.
That would require a firm to take account of its target market and how the product would perform for sub-sets within the target market including those who renew. A firm which took the view that the product was suitable and appropriate for the needs of a renewing customer when it included an automatic price increase may find it hard to justify their decision. Arbitrary reasons would be obvious.
At the moment there are a variety of mechanisms used to drive automatic pricing increases on renewal. One such example is CPI increases to assess or value increase in cost or risk. Evidence suggests that the long-term risk on house losses does not increase with CPI but insurers continue to rely on the argument that this is an acceptable attempt to value or assess the increase.
Similarly, cars generally devalue with age rather than increase but there are to our knowledge few policies where the premiums decrease each year to recognise this change.
These may be a very good examples of where insurers will need to modify their approach.
Added to this strengthening of the product governance requirement is a proposed approach which would see an individual responsible for value of products sold to a target market. This is one way of nudging firms. The individual would need to have very clear and thought through reasons for continuing automatic increases in light of the personal responsibility attaching to them and one could see this driving significantly greater focus on the underlying reasons for pricing.
Where there are co-manufacturers all of the senior managers in the chain of distribution who are co-manufacturers would either need to agree the ownership of responsibility for this aspect or need to understand and be clear about the pricing decision and it may be necessary for a level of communication between them to take place for them to be able to evidence that they have acceptable and reasoned decisions for the pricing applied to a product across the chain if they are to evidence that they have fulfilled their duty of responsibility. An individual with such responsibility would need to be very comfortable about the approach being adopted by the others in the distribution chain and this would no doubt assist the FCA in its stated approach of ensuring that the manufacturers are aware of the ultimate cost to the consumer and the value provided by each distributer in the chain.
The FCA is looking at how it might monitor pricing differentials. This may for the subject of a separate piece of work at some point in the future, but firms should not be surprised if this includes some form of public disclosure of the prices for new and renewal customers.
2. Tackling practices that discourage switching
The FCA is looking at how to deal with practices that discourage switching. They consider this to primarily be an anti-competitive issue and take account of the CMA’s approach set out in its response to the Supercomplaint. The FCA does however also acknowledge that there are advantages to auto-renewal such as saving consumers time and effort.
Some of the proposals being considered include a ban or restriction on auto-renewal as arises in other jurisdictions, making it opt-in only or easier to decline and ensuring that it is as easy to exit a contract as it is to sign up.
With advantages and disadvantages this is an area where the market and those affected should take their time to respond to and provide comments on the proposals being considered as there may be real benefits to all if the FCA has a good and varied response on this topic to assist it in making its decision on how to proceed.
3. Transparency Remedies
The FCA concludes that the consumers who do not switch and end up paying higher prices are unlikely to fully understand the implications and believe that transparency is healthy for a properly functioning market though they recognise that transparency is not always the answer.
There are a series of issues with transparency and communication. Not the least of these is that many consumers, a significant portion of people within the insurance industry included, do not read the significant amount of material they are sent setting out the cover provided to them, the services offered or the inherent costs.
Requiring disclosure of the reason for an increase or even explaining the existence of alternative cover at cheaper costs is not necessarily going to resolve or partially resolve this issue unless it is done in a way that a consumer will read it. That is, by highlighting the issue rather than it being lost in the fine print. The FCA would, to make disclosure effective, therefore have to mandate the where and how.
The two areas being considered are set out below.
Improving Communications with Customers
The FCA is considering requiring firms to inform their customers that the reason that their cover has increased is because they have not switched for some time.
To do this on a significant scale is assuming that this reason applies to all consumers who have renewed. If it does not it means that a distributor will have to assess whether the increase results from the renewal of some other reason such as a loss having occurred, there being a hardening of prices etc. This requires an ability to manipulate the data on a book of business in a way that may firms may find quite difficult at present.
Firms concerned about this should respond to the FCA.
Increasing public scrutiny
As we highlighted above firms may be required to publicly disclose details of their pricing practices. This would have to be undertaken in a clear, fair and not misleading manner. The FCA consider that this may nudge firms towards lowering prices rather than face a potential backlash from consumers.
4. Long Term Market Reform
The FCA believe that there may be future benefits from the increased use of technology which could help the market improve its relationship with its customers and how they interact in a more transparent environment. It is not making recommendations or proposals at this point on these potential reforms but it has set up an advisory group made up of industry experts, consumer and business representatives and academics and government employees who are working on the concept of Open Finance.
This is definitely something to keep an eye on.
The FCA has put forward a series of proposals which it sees as a proportional response to the manner in which the market is operating at the moment but which will require increased investment by firms in their IT and employees time and effort on product governance.
At the moment this is focussed on the household and motor markets but there can be no doubt that some of the issues with which they are concerned have a wider application to other products leading to the possibility that this is the thin edge of a bigger wedge which will have benefits to consumers and hopefully to the reputation of the market in the longer term.
Firms should engage in order to be heard. The date by which to do so is no later than 15th November.