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Is the general insurance industry (price) walking to its doom?

5 December 2018

Last month the FCA announced that a market study on general insurance pricing practices was “needed”, and published its terms of reference (‘ToR’) for such study. The FCA’s aim is to “deepen our understanding of consumer outcomes from pricing practices, the scale and nature of any harm and inform how to, if necessary, improve the market” with a view to delivering “competitive and fair pricing outcomes for consumers”. 

Without pre-judging the study’s findings, the FCA said that “potential remedies … could include:

  • Changes to the way that firms price insurance.

  • Contractual changes, such as limiting auto-renewal.

  • Limits on differences in prices between different groups of consumers.

By way of context, the FCA observed that: “General insurance pricing practices have attracted wide interest and debate”, including “a super-complaint” by ‘Citizens Advice’ to the Competition and Markets Authority (CMA) about excessive prices for disengaged consumers. The FCA said that it was “working closely with CMA in relation to the … super-complaint [which] will also inform this market study.

The FCA also noted that:

  • The Financial Ombudsman Service published a report in April 2018 that … set out its approach to dealing with” insurance pricing complaints

  • ‘Which’ has “also published the findings of an investigation into home insurance policy prices

  • the Government’s “Consumer Green Paper highlighted that there is a large gap between the best and worst deals received by consumers …”

The market study will focus on pricing practices in home and motor insurance markets: “these use personalised pricing based on specific personal characteristics and consumers’ histories, and consumers usually pay a different price at renewal.

The FCA observed that “Different parties are involved in supplying [home and motor] insurance. This includes those who provide or sell insurance directly to consumers, and third parties such as brokers and digital comparison tools, including price comparison websites. Not all of them set the price consumers pay for insurance, but they do influence the dynamics of competition and pricing outcomes for consumers.” This approach of looking across the entirety of a marketplace is also a feature of the FCA’s Wholesale Insurance Broker Market Study, and potentially raises implications for the way that close relationships between risk-carrying and distribution players within the general insurance marketplaces may or may not be clearly understood factors in insureds’ purchasing decisions. 

A particular factor that the FCA wishes to explore in the home and motor markets is the exploitation of ‘consumer inertia’. This concept was raised by ‘Which’ and the FCA’s “diagnostic work” has found some evidence for it: “Where consumers are inert, firms can operate a ‘price walking’ strategy. This is where firms gradually increase prices and after a few years prices reach a level considerably above the price for new customers and the cost of supplying insurance. As a result, inert consumers can be very profitable.” The concept of excessive profitability – or of profits being derived on an unfair basis from individual consumers or across customer bases – is a prime line of inquiry for the study: the FCA will consider “The differences between prices paid for insurance by different consumers compared to the cost of providing them with insurance.

‘Differentiated’ or ‘diversified’ pricing represents a significant compliance risk for firms (in short, the risk of adverse regulator action) and is far-removed from ’diversification of risk’. The latter is a key concept in the management and regulation of insurance businesses, in particular the idea that different social or economic groupings gain protection from the insurance market’s ability to provide benefits at any given time to one particular grouping through deriving profits from other groupings. However, what the FCA is now considering is whether the home and motor insurance industries are benefiting not from diversification of risk, but customers’ passive or active acceptance of paying diversified prices for essentially the same risk. In other words, products – and systems for their distribution – are being designed and priced not on the basis of potential purchasers’ risk profiles, and insurers’ appetite for underwriting risks with such profiles, but on the basis of purchasers’ appetite for product price alone.

The risks associated with differentiated pricing have been readily apparent for a number of years, including from findings in the 2013 Final Notice for Swinton in which the following sales methodology was found to be a feature of “a culture of placing the drive for profit over the fair treatment of customers”:

Swinton put in place two different levels of cover for [its home emergency product], Gold and Standard … Despite … warnings [as to potential mis-selling, and the differentiation of the products being unclear, unfair or misleading for customers] Swinton decided to implement the two levels of cover in order to give sales executives two chances to sell the product; in the event that customers rejected the initial, more expensive level of cover a second, cheaper level of cover could be offered …”

On differentiated pricing, the FCA has said that the study will enable it “to understand the scale of any harm created by pricing practices, including the proportion of consumers that may pay very high pricesand [what] their characteristics [are] … [and] what drives firms to price differently and some consumers to engage and pay less than others …”

The FCA says that it will consider the “fairness” of pricing practices. In this regard the ToR uses the phrase “price discrimination”, and emphasises an approach along the lines of social discrimination more broadly:

Are firms price discriminating [on a] hidden [basis, by reference to] intrinsic characteristics which consumers cannot easily change (eg personal characteristics)

Would society view the price discrimination as egregious / socially unfair?

The concepts here are similar to those explored as to gender-discriminatory practices in the ‘Test Achats’ case, which resulted in substantial changes to pricing practices in the motor insurance market.

Other features of the ToR are similar to the Wholesale Insurance Broker Market Study: costs and competition; the costs element is also a feature of market-led initiatives that aim to assess the risk of UK insurance markets ceasing to be attractive because of the distribution and pricing structures comprised by customers’ premium payments. The FCA will explore whether price differentiation based on customer inertia could be a cause and/or an effect of market inefficiency in the form of higher prices: “Firms may need to spend large sums on trying to attract new customers, which could also increase the cost of supplying insurance.

In relation to competition, the FCA is questioning the extent to which:

  • firms with “a large number of longstanding consumers paying higher pricesis a barrier to [market] entry and expansion …”; and

  • business models [that] have developed to enable firms without [such customer numbers] to compete, result in good outcomes for consumers …”

The remedies the FCA is considering could have profound effects on longstanding practices and operating systems across the general insurance industry. Depending on the study’s findings, some firms, not just in motor or home insurance, may have to change radically in order to be viable. More may be understood when the FCA publishes “an interimreport in Summer 2019” ahead of a consultation on proposed remedies later that year.

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