Price walking has dominated the headlines as the FCA, CMA and Citizens Advice have all talked about the risks of consumer harm arising from ‘general insurance pricing practices’ that have often treated new and existing customers very differently. The reality of the matter, following the FCA Final Report and Proposed Handbook changes, is that a significant proportion of insurers, brokers, MGAs and other parties involved in the production and distribution of a vast range of insurance products now need to give these proposals their careful attention. The pricing remedies may be restricted at this point in time to motor and household products, but proposed remedies looking at product governance, automatic renewal of policies and data reporting apply “more broadly to all types of general insurance and pure protection insurance”.

Background

Pricing has become ever more scientific as insurers strive to optimise sustainable profitability in high volume classes such as motor and household thanks to greater data availability. Large segments of the consumer base have become increasingly price sensitive and are continually encouraged to do so by price comparison sites regularly advertising potential savings in high profile television adverts. With acquisition costs squeezing profits for new business, it is no wonder insurers have sought to increase margins at renewal for customers who choose not to scan the market each year for the cheapest price.

The picture being painted is one of a market primed to focus on price as the sole determinant of value when buying a new policy, then faced with a barrage of barriers designed to deter us from switching at renewal.

The practice has been termed ‘the loyalty penalty’ by Citizens Advice in the super-complaint lodged with the Competition and Markets Authority in September 2018. But it was an issue already on the radar screen of the FCA, who at that time, were beginning to look at “the types of systems and data that firms use to decide the final price to consumers and the governance and oversight arrangements within firms.”

In my article dated 16th October 2019, Are you walking into a price problem? General Insurance Pricing and the FCA Remedies, I looked at the FCA Interim Report and considered what the implications for firms might be.

Fast forward to 22nd September 2020 and it will have come as no surprise to anyone involved in the household or motor insurance markets that the FCA have concluded there is harm being caused to consumers and that it needs to take action to address this. A review of the feedback received by the FCA following their interim report provides some interesting insight into the wider market response to the initial findings and proposals shared in October 2019. Feedback received was broadly in support of the proposed actions though the question of automatic renewal of policies was one that generated a significant range of views. Thankfully, common sense seems to have prevailed and it appears a sensible approach has been found that offers consumers adequate protection, both from unintentional renewal of policies, and also from the harm that might arise from a failure to renew their insurance policy.

Perhaps less well observed has been the fact that the FCA have concluded this risk of harm from the automatic renewal of policies extends beyond household and motor products. The FCA have concluded the issue of automatic renewal of policies is one that has the potential to cause harm to purchasers of all types of retail general insurance.

Having been rumbling along as an issue for over 2 years, the remedies now proposed will, in some cases, start to take effect pretty quickly if they are implemented as recommended. As ever, there is a further period of consultation and it is possible small changes might be made, but firms should begin looking at the implications of these and consider what actions are required. With many of the changes potentially requiring systems and process changes, the timelines could be tight.

The Proposed Remedies

The remedies proposed by the FCA are designed to improve competition and ensure that firms offer fair value household and motor insurance products to consumers. But they go beyond household and motor, affecting all types of retail general insurance and pure protection insurance, and almost every type of firm involved in the manufacture and distribution of such products.

It would appear that the likely outcome of the proposed changes is a market where consumers are encouraged to focus on value measures beyond simply price. This will come as a very welcome point of focus to those firms which have always sought to create a point of differentiation based on the quality of their products and the service they offer, as well as those who have placed a real focus on the way they communicate with their customers and prospective customers about the product features offered. These firms will likely have a lot of the information already available to enable them to meet the new obligations. Price does not cease to be a factor in the marketing of insurance products, but the ability of firms to use it as a new business acquisition tool to the detriment of renewing customers will be severely curtailed.

Pricing remedy

The headline change, and perhaps the point of distraction for some. This is the issue at the heart of the Citizens Advice super-complaint and the remedy most often referred to in the headlines.

The FCA will now require that…

“…when a firm offers a renewal price to a consumer, that renewal price should be no greater than the equivalent new business price that the firm would offer a new customer.”

This is aimed at stopping price walking in the motor and household markets and requiring firms to ‘walk back’ the price existing customers who have already been subject to ‘price walking’ are paying. That could have a significant impact for product manufacturers who have been using this approach for some years, with a potentially significant reduction in the price quoted for their next renewal.

The new rules will require that “When calculating an equivalent new business price, a firm must assume that the customer has approached the firm through the same distribution channel and is using the same payment method as when they first bought their policy.”. For volume classes of business, this is likely to require some potentially significant systems changes.

The FCA do envisage 3 scenarios where a renewal price might legitimately change compared to that which was paid initially. These are due to changes in:

1. consumer’s risk since they became a customer or the last renewal;
2. the firm’s margin (the amount of the price charged above or below the cost of underwriting the risk and serving the policy) for all customers; or
3. the pricing model that might alter margins across customers, as long as that change does not systematically lead to higher prices for renewal customers.

There also are special provisions proposed for firms with closed books, where no equivalent new business price is available for comparison.

The FCA are very clear that anti-avoidance measures will not be tolerated and there is a proposal that a senior manager will be required to provide regular confirmation that the firm’s pricing models comply with the proposed remedy. If a Senior Management Function holder, this may bring personal liability to the individual concerned. The timetable for implementation of these changes could see the first such attestation being required to be made in late 2021 or early 2022 and as such ICSR strongly recommends firms begin to consider who should assume that responsibility and ensure they are involved in sponsoring, overseeing or leading any project to implement changes required by the firm to meet these new requirements.

Product Governance

The product governance changes will affect any firm offering general insurance or pure protection products as well as firms offering premium finance for retail contracts of insurance. Both insurers and any other intermediary firm involved in product manufacturer will be subject to a new and very specific requirement to ensure products offer ‘fair value’ to customers. The FCA define fair value as being the relationship between the total price to the end customer and the quality of the products and services. Firms will need to keep records of these value assessments. It would appear the FCA are seeking to engineer a change in consumer behaviour where more focus is placed on the product itself – the cover and service provided – rather than the price in isolation. It won’t be an easy change in approach to engineer, but clearly the FCA feel consumers are too focussed on price alone and there is a significant risk of harm arising from that.

Certain price optimisation practices are also now being targeted, such as pricing based solely on whether the customer is using automatic renewal or premium finance, or if the customer has characteristics that might indicate a vulnerability has been identified. Any of these will be seen as clear indicators a product is unlikely to offer fair value, although not specifically prohibited as such. The burden of proof of ‘fair value’ will lie with the product manufacturer.

Product governance rules are currently defined in the Product Intervention and Product Governance Sourcebook (PROD) and currently only apply to products manufactured on or after 1st October 2018. The FCA are proposing that both the existing and proposed new PROD rules will now apply to all general insurance and pure protection products. Firms will have 1 year to complete this transition, a time frame likely to conclude sometime around Q2 2022. Additionally, firms will be expected to undertake a review of products at least every 12 months, or more frequently if the risk of harm is high.

Distributors of products are faced with additional obligations, including specifically a requirement to consider “any remuneration they receive as part of the distribution strategy, and ensuring that it does not result in the product failing to offer fair value to the end customers.” We’re not quite in the realms of mandatory commission disclosure but it further emphasises the obligation on those involved only as distributors of products to understand and be able to demonstrate how they add value to the consumer of those products.

The Senior Managers and Certification Regime already sets out clear expectations around responsibility for product governance within firms. Firms affected by new product governance ‘fair value’ principle will be required to ensure that their senior manager with responsibility for product governance and pricing is clearly identified and they will be required to make an annual attestation of compliance based on the new requirements. It is clear the FCA are looking for personal as well as corporate accountability for compliance with the new regulations.

Cancelling Auto-renewing policies

These provisions apply to all types of general insurance and with the prevalence of such processes across a wide variety of insurance products now, it is likely many firms will need to look carefully at their systems. Auto-renewal will remain an option that firms can offer, but the proposals impose new communication expectations on firms and require systems that allow consumers to cancel the auto-renewal element at any stage during the contract of insurance using a range of methods including online, by email, by telephone or by post. The process should be one that is straightforward and does not place any unnecessary barriers on the customer.

Reporting Requirements

New reporting requirements are being proposed which will affect those involved in the production and sale of motor and household products. All parties (insurers and all intermediaries) will have certain obligations to report data on premium finance, additional products, fees and charges.

Insurers and any intermediary with price-setting authority will be required to report a range of data including:

• The total and average premium charged to customers, net of Insurance Premium Tax
• Net and gross price for intermediated and affinity/partnership sales
• The number of policies sold/renewed during the reporting period
• The number of policies in force at the reporting date
• Expected claims cost
• Expected claims ratio
• The proportion of customers with average expected claims ratio 10 percentage points and 30 percentage points below the average for the reporting channel
• Gross incurred claims ratio at an aggregated level
• Total prior year’s reserve releases
• Total prior year’s reserve strengthening
• The proportion of customers paying high and very high premiums, defined as a premium 1.5 times to 2 times (high) or more than 2 times (very high) the average across the product.

These requirements will likely start taking effect in Q3 2021 and firms will need to ensure their MI, broking and underwriting systems are capable of extracting data in the format and granularity required by the FCA.

Who do the rules apply to?

The proposed rules will affect any insurer or distributor involved in the manufacture of a whole range of general insurance products. Whilst the pricing remedies are specifically limited to motor and household products, the other remedies have much broader scope. Firms including insurers, Lloyd’s Managing Agencies, Managing General Agents, Coverholders, Brokers and Affinity Partners are likely to find themselves within scope to some degree.

The rules have also specifically mentioned two additional types of firm:

• Gibraltar based insurers: firms based in Gibraltar doing regulated business in the UK whether from an establishment here on or on a services basis will be required to comply with the new rules;
• TPR Firms: Firms who are trading under the Brexit-related Temporary Permissions Regime will specifically be required to comply with the new rules, whether these firms are doing regulated business from an establishment in the UK or on a services basis.

Conclusion

Broadly, in our view, these changes should be seen as positive by progressive firms that see the connection between a customer-centric approach and profitability. There are likely to be a number of systems and process requirements that could involve potentially significant programmes of change and we would recommend firms immediately begin to understand the potential requirement for them to undertake such work. In some cases, it is likely that the timescales required to make changes to their products and processes could end up being quite short if the new rules are implemented as proposed, in the timelines suggested.

It is our recommendation that firms should immediately begin undertaking a number of tasks to ensure they are ready to act as soon as the new Handbook rules are published. Firms should be looking to:

• Identify all live and closed motor and household insurance products,
• Identify all general insurance products which currently include any form of automatic renewal process,
• Identify any products not currently subject to the PROD 4 rules – those manufactured before 1st October 2018,
• Review their pricing strategy for new and renewal business in their motor and household portfolios and understand any changes required to their pricing models,
• Identify the senior manager with responsibility for product governance and ensure they are fully aware of their new obligations to provide annual attestations of compliance, likely starting in late 2021,
• Review their likely obligation to provide data under the new reporting requirements and their ability to produce this data, and
• Identify the systems and applications which may require upgrade or other alternations to ensure the information and reporting requirements for customers and regulators can be met.

If you would like to discuss any aspect of these proposed Handbook changes and the potential implication for your firm, please contact us in complete confidence.

Kenneth Underhill

Director
Implement Compliance Solutions & Resources