On 4 October 2019, the Financial Conduct (the FCA”) published an interim report on its market study on general insurance pricing practices. A final report is expected in Q1 2020.
Set out below are Protiviti’s perspectives on the interim report, an overview of the FCA’s interim report and questions for the Board and senior executives to be considering as they assess the potential implications on their business of the FCA’s suggested actions.
Any debate around how much of the FCA’s proposals make it through to finalised rules and guidance misses the point of the FCA’s focus on preventing harm to vulnerable customers.
The FCA’s proposed remedies address long running concerns that insurers are effectively encouraging existing customers (especially those who are vulnerable) to overpay their renewal premiums in order to subsidise insurers’ acquisition of new customers in a highly competitive market.
The FCA is actively considering using the media and the court of public opinion to make insurers think very carefully about the implications of the harm their go to market strategy and their renewal pricing practices have on the most vulnerable in society.
Boards and management should consider the implications of the FCA’s proposals on their approach to treating customers fairly and especially vulnerable customers as well as on the business model, margin and profitability.
Increasingly we are seeing regulators intervening to ensure that product value matches customer needs across all segments through the customer journey (from product purchase to claims settlement). The challenge for the insurance industry will be to adapt to continual customer pricing sensitivities and prevailing market prices without damaging their profitability.
Overview of the FCA’s Market Study on General Insurance pricing strategies (interim report)
The FCA believes c. 6m customers every year are losing out in their insurance renewal to the tune of £200 each. And that 1/3rd demonstrate signs of vulnerability, including those with lower financial capability.
FCA research identifies that:
- Pricing models used by insurers target price increases at those policyholders insurers believe are less likely to switch providers at renewal;
- Customers with incomes of less than £30,000 per year pay higher margins than those with higher incomes;
- Customers who pay high premiums are less likely to understand the impact that renewing (compared to negotiating or switching) has on their premium;
- Loyalty in itself is not the key point. High prices were paid by some customers who had been with their provider for less than 4 years;
- Requirements on price transparency need further change to aid informed decision making by customers
Remedies proposed by the FCA include:
- Addressing auto-renewal practices, such as:
- Banning or restricting the use of auto-renewal;
- Making auto-renewal an opt-in only;
- Making auto-renewal easier to decline at purchase and at renewal;
- Ensuring it is as easy for a customer to exit a contract as it was to sign up.
- Making changes to disclosure and transparency, such as:
- Making insurers disclose their pricing strategy and justify price increases;
- Making insurers publish information about pricing differentials between customers to stimulate public scrutiny and increase competitive pressure.
Questions for board and senior management
Questions that the board and management of insurers should be asking include:
- Definition of Vulnerability: Has the organisation defined vulnerability? In what way is this definition consistent with the broad consensus of vulnerability including the approach being taken by the FCA? Does the definition adequately reflect the customer base and ensure that customers who are vulnerable are consistently identified? What governance is in place to oversee, and what management information is provided to inform management and the board, on how the organisation ensures they are not causing harm to these customers?
- Mitigating potential harm: What controls are in place (or are needed) to minimise the risk that products and the product and customer lifecycles take advantage of vulnerability causing harm to the customer, including but not limited to pricing strategies covered by the FCA market study?
- Protecting reputation: How does the organisation use data and to what extent are non-actuarial pricing factors used? What steps does the organisation wish to take in order to minimise the risk of being held in the court of public opinion because disclosure of pricing differentials between customers stimulates public scrutiny.
- Pricing: How do pricing algorithms treat existing customers compared to new customers; what is the justification for price differentials? By how much do existing customer pay for products more than new customers? What changes are required to ensure existing and new customers receive comparable outcomes and what would be the implications on the business? Should the organisation carry out data analysis on how customer segments are impacted and whether they correlate to corresponding complaints received?
- Profitability: How will margin and profitability be affected if auto-renewal is limited or prohibited? What changes are needed to financial forecasting models and their assumptions and what is their likely impact on margin and profitability? What are the implications on share price, investor confidence and market value?
- Operation costs: What impact will the expansion of pricing govenance requirements and enhanced communications and transparency have on our cost base?
In 2016 the Association of British Insurers (ABI) and the British Insurance Brokers’ Association (BIBI) launched a joint Code of Good Practice to help insurers and insurance brokers recognise and help potentially vulnerable customers, who may need extra support when renewing motor and home insurance policies. It seems that practices that would harm customers still continue which concern the regulator. .
The supply side remedies will create winners and losers so organisations need to assess the potential impact immediately.
Pricing – transparency on pricing will show how the organisation uses underlying data to set premiums and stop firms from setting segmental pricing.
Renewal processes – Additional training required to ensure that staff are able to articulate new and renewal premium setting.
Cost of enhanced communications and transparency - Transparent pricing may lead to a constant churning of products and lower levels of customer trust. Documentation and process changes will incur further costs.
Expansion of pricing and governance requirements – increased understanding at all levels of price optimisation and how it is used in the firm. Increased focus on price optimisation in conduct management information to ensure it is not unfairly discriminatory.
Pricing – may reduce the commission margins as providers try to recoup loss of revenue or mitigate rising costs associated with implementation of new rules.
Renewal processes – providers may impose greater transparency and scrutiny over renewals with the resource implications and potential distraction as well as impact on margins and profitability
Cost of enhanced communications and transparency – brokers will have to demonstrate the “best price for the customer” which may lead to greater market analysis documentation.
Providers may increasingly move to a direct model to reduce intermediary costs.
Expansion of governance requirements and management information - potential increase in scrutiny and expectations from providers with the resource implications and potential distraction.