Most individuals involved in Financial Services will have heard about the Super-complaint filed in late September with the Competition and Markets Authority (CMA) from Citizens Advice, one of the major champions of individuals’ rights and a fixer of common wrongs. Citizens Advice were involved in bringing forward the PPI scandal and have been involved in many instances both individual and endemic, where the financial services industry, among others, has not treated its customers as well as it might have done.

The Complaint alleges that consumers are paying over £4 billion to financial services firms and other companies for their loyalty because they (8 in 10) are paying more than new customers lured to the same provider for the same service. It also alleges that up to 64% of consumers did not realise they are being charged more than new customers. According to the Super-complaint vulnerable customers are “disproportionately stung” with older or less educated customers being more likely to face the penalty. The main markets affected are household and motor insurance, mobile phones and savings institutions.

In the insurance world, which is where we will focus this article, many customers (approximately 75 % according to sources at the ABI) annually shop around for their motor and household insurance cover to achieve the best price. Of the 25% who don’t, evidence suggests that half are potentially vulnerable customers. The Financial Conduct Authority (FCA), in its initial response to the Super-complaint, has indicated that it is concerned more about the vulnerable customers than customers who make a choice to remain loyal and do not shop around.

There has been solid debate about pricing and value to consumers ever since FCA was formed and started to focus on the value proposition. There is a plethora of examples of action being taken against insurers and distributors over poor customer outcomes based on products having little or no value. However, the FCA has until more recently steered clear of being a regulator of pricing rather than principle.

In 2017 however the FCA introduced rules to increase transparency over what a customer was paying and for which services, as well as who was receiving elements of the premiums or other amounts being charged. These rules included the requirement that the previous years premiums be included in any quote for a renewal.

This did not seem to end the debate on pricing and earlier this year the Association of British Insurers and the British Insurance Brokers Association working together issued Guiding Principles and Action Points for General Insurance Pricing. While a step in the right direction these principles did not however, go so far as to rule out the possibility of differential pricing between new and loyal customers though it did promise a report within 2 years on the steps taken by the industry to tackle excessive differences.

At the same time the FCA have been conducting a Thematic Review (TR 18/4) on pricing in General Insurance and issued in October the outcome of that work. They identified three key issues:

  • Firms did not have effective governance, controls and oversight of pricing;
  • Differential pricing is leading to identifiable groups of customers paying significantly higher than other identifiable groups of customers; and
  • There was a risk of customer discrimination consequent upon the use of data (direct and indirect) from protected characteristics.

The FCA then reminded firms of the importance of pricing as one of the most significant business activities and warned firms in its Thematic Review paper that it expects them to comply with the rules. It then cited almost all aspects of its handbook as being relevant including PRIN, COCON, APER, ICOBS, PROD and SYSC. This may be taken as a warning to firms and their senior management to get their governance over pricing in good order or expect the consequences to involve both the firm and individuals.

What is the Issue

At first blush it may seem a simple issue. For many years insurers, along with retailers and many other industries (such as retail which commonly have price checks, two for one and other discounted offers) have sought ways to attract new customers and once attracted keep those customers. In general, a loyal customer costs less to service than a new customer because there is a cost built into attracting the new customer. However, the issue is that in many cases, and certainly in the case of household insurance, there can be an inbuilt annual increase in the cost of your policy. This is often justified on the basis of increases in base costs. The impact is that over a period of time a loyal customer will find that they may be paying significantly more than a new customer. Add to that the practice of offering new customers discounts and we can see that the price differential could be significant.

So in practice what might that mean? I, personally, present a good example of why the issue is not clear cut.

I have been loyal to my household insurer for something like 15 years. I have (until this year) not had a claim. However, the cost of my household insurance has increased each year. Unlike in the motor industry a no claims discount does not seem to exist. I have stayed loyal because, hopefully like everyone in this industry, I recognise that the service I may get is directly proportional to what I pay in the way of premiums. That is another way of expressing the adage that “you get what you pay for”. If you buy cheap insurance from an unrated insurer or one without a good reputation the possibility is that the service may not be very good.

I had a plumbing leak in underground pipes last month. My first claim ever on our household policy. The day after I notified my insurer there were three vans on the front yard and a plumber, builder and assessor from the insurer working out what needed to be done to stop the flow as an interim measure. I could not have been a happier customer.

On the other hand, over the 15 year period, my policy has only ever gone up in line with the CPI or some other indicator of the increase in the cost of living, generally somewhere between 2 and 3 %. This pricing increase is built into my policy and is purportedly to match the increase in the cost of repairs to the house driven by the increase in the cost of materials etc. So, if my policy was, say, £1000 in 2003, I would now being paying (using an average increase of 2.5% per annum) £1450 as the annual increase is compounded.

One can debate whether or not the CPI is a reasonable indicator. My own experience is that trade costs have not increased by that amount over that period. This year I replaced a boiler in the house and the cost of doing so in time, costs and materials was roughly what I paid 12 years ago to install the boiler being replaced.

This also ignores an important point. During the 15 year period the insurance market has become overcapitalised and prices may have dropped due to competition. The result may be that a new customer, say my neighbour who has a very similar home, might be offered a premium of £700 to £800 or even less were he to approach my insurer now. The result is that the price differential could therefore be significantly higher than it might otherwise be. Even if that were not strictly speaking accurate there is no doubt that in the 15 year period premiums have fluctuated both up and down. Mine has not.

This is the issue at the heart of the Super-complaint and while that is the core, there is of course more. My policy does not require me to declare jewellery, art and other high value items. I once thought of changing my insurer only to discover that the cheaper insurers would require me to go through my house and identify each and every item of reasonable value and declare them. As a busy individual I chose to not do that and remain with my current insurer, backing instead their reputation and service. Some might consider that the way the policy has been structured is both an incentive to insure with my reputable insurer and a disincentive or obstruction to leave. Others may suggest my insurers have identified a specific customer segment and very effectively created a unique service proposition to target that segment, competing on elements other than just price, which inevitably leads to compromises elsewhere.

For other customers, in particular those who are vulnerable, it may be difficult to change simply because they do not understand the industry or are not tech savvy. This issue of transferability is a key issue for the way the FCA may approach the pricing issue. Transparency alone has clearly not worked in the eyes of Citizens Advice and there is evidence of this being true.

At this point, the FCA has declared that it is interested in how vulnerable customers are treated and able to obtain the benefits which may be available by annual shopping around. It may or possibly should not be concerned with someone such as myself.

However, the Super-complaint is not aimed solely at vulnerable customers. Citizens Advice believes that all consumers should gain benefit from a fairer pricing policy. The example figures produced from my own experience would certainly suggest that I may be subsidising my insurer’s growth in new customers, but it should be remembered that I choose to remain with that provider because I see my house as one of my main assets and therefore take steps to protect it by remaining with a reputable insurer. On the other hand, if it had been easier for me to transfer to another insurer, I might have changed 3 to 5 years ago when I considered it.

The Super-complaint also looks at the motor market. In the intermediated motor market, it can be even more complicated with algorithms changing the price offered to a potential policyholder according to how long you hover with your mouse over a quote or brokers operating under a binding authority applying net pricing. In the latter case it may be that the insurer sets the amount they want to receive and the broker decides what the policyholder should pay. In this example it is possible that it is the broker who is creating a pricing differential rather than an insurer and it might not be because of an inbuilt annual price increase but simply a result of a practise adopted by the broker who does not have sufficient data points to establish that over a period of time a customer has consistently had an increase in cost of their policy because their IT system does not permit an historical review of this nature. Interestingly, motor insurance can see the reverse to household with the asset being insured devaluing while the premium is increasing though more often than not the significant cost of motor insurance is in the liability element rather than the property element of the cover.

The FCA has said that it is likely to use its learning to apply it across the general insurance market more consistently and mentions pet, travel and other products.

So using my example, in order to respond to the Super-complaint the FCA including the CMA should consider looking at:

  • Pricing differentials and the factors that drive them including:
    • new customer discounts
    • mechanisms that create automatic increases
    • general competition within the industry which creates pricing fluctuations
  • The benefits and detriments of fluctuating prices
  • Bars to transferability of policies
  • Impact on customers, particularly vulnerable customers

As we explain below, they are going to do so.

Additional Thoughts and Issues

At the top of the list for the FCA will be a review of governance over pricing. There are many reasons for this but first and foremost is that more often than not, if a firm is failing to meet the expectations of its regulators there will be a governance and control issue. The FCA is a multi-sector regulator and it therefore has the ability to look at the approach taken across other market places. In banking and other financial services sectors the approach to pricing is more advanced than is generally seen in the insurance industry where in some firms the underwriter still has a carte blanch to set prices albeit with the assistance of actuarial assessment. For example, in the world of retail mortgage lending, the governance around pricing is deeply embedded in the governance framework and very detailed. Often the pricing matrix is included in an Underwriting Policy and is approved by the Board of Directors.

In the insurance industry, the rules of product governance are not entirely new though they have been enhanced by the Insurance Distribution Directive (IDD) requirements added from 1st October. Product pricing should be at the heart of that process and if it is not those firms which permit the business to set the price without some oversight may find that they are not meeting the FCA’s expectations. The sort of oversight you might expect would include at the top level a Board approved Underwriting Policy. This may not set prices or rates but should as a minimum set the firm’s policy on what is expected from pricing and detail the expected controls including the approach to monitoring and review. It may also set the pricing parameters. At the next level any Product Governance Committee should have within its Terms of Reference the oversight and control of pricing practises and include pricing review as an element of its work. Depending on the firm’s structure this may or may not be undertaken collaboratively with any underwriting committee that may exist.

One possible solution to the differential would see all motor and household policies being the subject of repricing each year. There are benefits and detriments to a market which can be so price sensitive. The benefit is that the customer should then receive a competitive price each year. The key detriment is that this may mean, simply because of factors which have nothing to do with whether they have had a claim or not (such as economic downturns, over supply of capital, a benign investment environment etc), they may or may not be able to pay for their insurance from year to year and face a significant challenge over planning their household budgets.

Often an argument raised in response to regulatory change is that of cost and proportionality. That is, an increase in operating cost to the provider will result in cost increases to the ultimate customers. Would a change in these circumstances increase the costs to all customers? Pricing is an actuarial and underwriting art. In high volume consumer business, it is more algorithm than art these days as data is generally readily available including data based on assumptions for new and renewal business. If the outcome is a change which requires insurers to price all risks annually the new environment will add some administration (and cost particularly in relation to annual binding authority pricing) but appears unlikely to significantly increase administration or other insurer overheads.

However, what could happen is that we see the differential between new customers and loyal customers narrow with a consequential increase in cost to new customers. Such an event could have an adverse result by way of a reduction the number of customers who look around each year resulting in less competition, the antithesis of what might be wished for.

Transferability is a stickier issue. 75% is a high proportion and it would suggest that household and motor are already easily transferred between providers. Is there more that could be done? Requiring insurers to do more to identify vulnerable customers is likely to be an FCA focus and it is not always easy. There are many approaches to consider. One is the use of additional questions on renewals, which market research has proven time and again to deter customers from buying, thus again reducing the number of customers who move each year and thus competition. Another is the Association of British Insurers (ABI) approach of looking at customers who have been with a provider for more than 5 years and consider whether a repricing or other approach should be taken. If undertaken on an individual basis there would be significant administration involved though it may provide a potentially fairer system for all. Somewhere in between there is an answer or series of solutions and no doubt the debates about approach will be had through this process.

In passing, I note that so far, my reputable insurer, a member of the ABI, does not appear to have contacted me to explain what they have done to assess my policy under the ABI Guidelines which require them to review their pricing approach for customers who have been with them for 5 or more years. Given the number of years I have been with them and the apparent potential differential in what I am paying against what a new customer might pay I would expect them to be doing something.

An important point to note. If your products are designed to cater for those considered to be more vulnerable, often those more senior in years without an understanding of technology and those less educated who may not have a strong understanding of the financial services they are being sold, you can expect to be at the centre of the CMA and FCA’s attention.

What Is Next?

The draft Terms of Reference for the review were issued by the FCA in October, together with the findings of diagnostic work they have been undertaking in recent times via Thematic Review TR 18/4 and a Discussion Paper. Responses to the draft Terms of Reference were due by 3rd December.

The broad areas which the FCA proposes to cover include:

  • The harm from pricing practices and what drives this:
    • The differences between prices paid by different customers and the cost of providing the products to each group;
    • How many consumers are paying more;
    • The characteristics of those paying more and in particular, vulnerable customers; and
    • Why some customers end up paying more.
  • The fairness of pricing practices:
    • Whether firms’ practices lead them to take advantage of customers;
    • The information provided on renewal;
    • The impact of certain terms and conditions;
    • How firms address their responsibilities to treat customers fairly;
    • Customers’ understanding of how pricing works;
    • Customers’ attitudes to their provider and products and why they switch or not; and
    • Customers’ perspectives on pricing.
  • The impact of pricing practises on competition:
    • Are pricing practices conducive to competition;
    • What do impact do pricing practices have on access and extent of cover;
    • Are firms making high profits;
    • Does the current nature of competition lead to excessive costs; and
    • Does the current level of competition lead to barriers to market entry.

The Terms of Reference make it clear that the FCA will be looking at the entire distribution chain in so far as there may be different layers of pricing. They will also be looking at all distribution models from direct through the broker and MGA distributed models to the comparison websites.

The focus will be on household and motor insurance but the FCA propose to use the learnings from this work to establish their expectations within the Health, Pet and Travel markets in due course.

Interestingly, there is an overlap with the present FCA Wholesale Broker Review where the diagnostic work is considered to be close to complete and a report eagerly awaited. That review is looking at value in the distribution chain and the re-emergence of some old habits in the nature of pay to play and access to the markets which have resurfaced albeit in a new forms and disguises. It is not yet clear whether that review will be held back until this further work is completed or not. The obvious approach for the FCA would be to issue the Wholesale Broker Review report as an interim report pending the outcome of this additional work.

What Can You Do?

First and foremost, don’t be caught napping. If the governance of your pricing is not as good as it could be, get it in order now. This includes your controls over underwriting and your suite of MI to ensure that appropriate levels of governance are reviewing appropriate data which can provide evidence that the business is meeting expectations with pricing as a part of overall product governance.

Second, review your pricing outcomes. If your firm does have differentials in pricing between longstanding customers and new customers decisions will need to be made as to how you approach resolving the issue and justifying the position you have or any changes you adopt.

Third, consider what data you have which the FCA may request and how you may be able to structure it to be presentable. By this I obviously do not mean that you should structure it in a way which is difficult to understand but in a way in which it is easily understood, legible and supports the approach you have adopted.

Fourth, consider undertaking a survey of your longer standing customers asking them why they have remained loyal.

Fifth, if you are not the manufacturer and/or do not set the pricing on the products you distribute contact the product manufacturer and speak to them about what they are doing.

If you would like to discuss any aspect of your firm’s approach to pricing from a regulatory perspective, please do feel free to contact me in complete confidence.


Kenneth Underhill

Advisory | Resourcing | Training