By Arthur White & George Netherton
The UK regulator's announcement on the review of retail insurance pricing suggests a significant change to the rules of the game – with particular focus on remedying the new / renewal price gap. What are the implications for UK insurance companies?
The UK retail general insurance market has long been acknowledged as one of the most competitive in the world, with multiple waves of disruption, many new entrants in underwriting and distribution, and an arms race in pricing approaches.
However, despite fierce competition for customers who are willing to switch their supplier, regulators have expressed concerns for some time about the overall fairness of pricing, especially where this leads to worse outcomes for long-standing customers. Worse, these customers are more likely to be older and less well financially informed, displaying many characteristics of “vulnerable” customers. The language of the most recent regulatory investigations and actions suggests much more rigorous scrutiny of these issues (for example in identifying the phenomenon of “price walking” over successive renewals), and opens up the possibility of more stringent action. This includes “supply side remedies” that could potentially go as far as price caps or restrictions on pricing differentials.
Specifically, on 31 October the Financial Conduct Authority (FCA) published an initial diagnostic into home insurance alongside a wider paper on fairness in pricing in financial services, and launched a market study on pricing in retail insurance, due to report back in mid-2019. A separate “super complaint” from Citizens Advice is currently under investigation by the Competition and Markets Authority (CMA) and due to report back in December 2018. All of this is the context of various recent studies from the FCA, CMA and others that have used increasingly strict language in describing current practice and desired outcomes.
One big theme of the recommendations so far is governance, control and oversight of pricing. It is clear that the FCA wants firms to significantly improve their practices here, and to be able to demonstrate that they have done so. There is a clear implication that there will be more active, and potentially prescriptive, oversight. Firms will need to show that they have set up effective controls and governance, clarified decision making, and upgraded their MI – with a particular focus on fair outcomes for consumers (not just profitability), and on customers in legacy product designs and/or systems.
There is also a specific focus on new and renewal pricing, especially where customers with apparently similar risk characteristics end up being charged differently – in particular, where customers who have not switched supplier over time (through loyalty or inertia) end up receiving higher prices and generating higher margins for the firm. For example, the FCA paper calls out “inertia pricing” – specifically mentioning home insurance as an example of a market where “price walking” is prevalent, and showing direct analytical evidence of how margins increase with longer customer tenure. It seems clear that, at a minimum, firms will need to be able to analyse and justify any divergence in pricing outcomes – with particular attention to who the winners and losers are from this practice. This may lead to big shifts in the distribution of prices and margins in the portfolio.
More generally, the language around potential remedies and actions appears to be shifting. Historically new / renewal pricing has been a knotty collective action problem: regulators have been reluctant to prescribe pricing, and insurers have been restricted on acting either individually (fearing unilateral price rises in a highly competitive market) or collectively (due to obvious competition concerns). The FCA have expressed a preference for “demand-side” remedies for the consumer (e.g. more extensive disclosure at renewal), but also a concern that this will not be enough for the most inert/unaware customers. Hence, they also explicitly discuss “supply-side” remedies: this includes both product design (e.g. unbundling, changing the default offer) but also pricing itself (e.g. relative price caps, and/or price discrimination bans to restrict how much prior renewal behaviour can be taken into account).
Finally, there is more focus on discrimination against protected groups (e.g. based on race / ethnicity, or prior convictions). The FCA see no evidence of these factors being used explicitly in rating, but are concerned that there may be implicit impact via insufficiently scrutinised external data or insufficient attention to testing for discriminatory outcomes.
What are the implications for insurance firms in the retail sector?
In the short term, firms need to mobilise, respond and explain.
- Firms will need to rapidly orchestrate a response to the explicit requirements of the “Dear CEO” letter, and to respond to the latest round of consultation requests. It is clear that the bar has been raised significantly on demonstrating adequate governance and oversight of pricing decisions with respect to customer fairness.
- Management information in particular has been called out as a gap, but there will be many broader areas where insurers and intermediaries will need to formalise and/or upgrade existing operating processes
- Some players, long frustrated by market dynamics, may support renewed pressure to unwind customer detriment; others will silently curse regulatory scrutiny and margin pressure in an already competitive market
In the medium term, it seems highly likely that there will be pressure through various means for the industry to change the shape of the new / renewal pricing curve.
- We do not necessarily expect the industry to reduce overall margins, but it will have to change where it expects to make money – and do much better at explaining why
- Those with large, profitable books of long-standing customers may have to pass some of that profit back to their customers. This will affect profitability, the long-term value of their in-force portfolio, and their ability to fund new business price wars
- We do not expect the intensity of competition to reduce, nor the need to stay abreast of the pricing technology arms race. However the boundary constraints on the industry will shift, and the rewards for executing well in a period of uncertainty will be significant
- A market where first year pricing is less aggressive could also become more attractive to new entrants and InsurTechs, leading to a more rapid transformation of how insurance is structured and delivered and putting even more pressure on incumbents
- Given the zero-sum nature of the industry, there could be unintended consequences if players respond by pushing penetration and margins harder in ancillary income. By design prices should also rise for first-year policies, as insurers should be less willing to discount heavily to acquire customers with lower lifetime value
- We also anticipate a renewed assessment of partnerships – in particular, some long term partnerships struck at the “top of the market” could be significantly underwater if the value of the “back book” of long-standing customers reduces
Above all, it is becoming increasingly apparent that regulatory tolerance is running out for insurance pricing perceived to be unfair, in particular for divergent pricing between newer vs. more loyal customers. Firms need to think carefully about how they will compete in a market where this practice is severely restricted – and take action early to stay abreast.
An opinion editorial on the retail insurance pricing was also published in the Actuarial Post.