 By Arthur White and George Netherton, Oliver Wyman
The UK retail general insurance market is one of the most competitive in the world – meaning fierce competition for customers who are willing to switch supplier.However, regulators have long expressed concerns about the overall fairness of pricing, especially where this leads to worse outcomes for long-standing customers. Many of these are likely to be older, less well financially informed or otherwise vulnerable.
The most recent regulatory pronouncements suggest much more rigorous scrutiny of pricing in future. They also open the possibility of more stringent action – maybe even going as far as “supply side remedies” like price caps or restrictions on pricing differentials.
Specifically:
• On 31 October the Financial Conduct Authority (FCA) published a diagnostic of home insurance pricing and a paper on fairness in pricing in financial services, and launched a market study on pricing in retail insurance, to report in mid-2019
• A “super complaint” from Citizens Advice is currently being investigated by the Competition & Markets Authority (CMA), to report in December 2018
• Various other studies from the FCA, CMA and others in recent years have used increasingly strict language in describing current pricing practices and desired outcomes.
What are the big themes of these recommendations and actions to date?
One major theme is governance, control and oversight of pricing. The FCA wants firms to significantly improve their practices here, and to be able to demonstrate that this has happened. This implies 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. The focus will be fair outcomes for consumers (not just profitability), especially for customers in legacy product designs and/or systems.
There is a particular focus on new and renewal pricing, in particular where those have not switched supplier over time (through loyalty or inertia) end up with higher prices than others with similar risk characteristics. For example, the FCA paper calls out “inertia pricing” and mentions home insurance as a market where “price walking” is prevalent. At a minimum, we believe firms will need to be able to analyse and justify divergences in pricing outcomes – with particular attention to which customers win and lose. This may lead to big shifts in the distribution of prices and margins in the portfolio.
More generally, we see new language around potential remedies and actions 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 (it would be brave to raise prices unilaterally…) or collectively (due to obvious competition concerns).
The FCA say they prefer “demand-side” remedies for the consumer (e.g. more extensive disclosure at renewal). However they are concerned this may not be enough, and so they also explicitly discuss “supply-side” remedies: in both product design (e.g. unbundling, changing the default offer) and in pricing (e.g. relative price caps, and/or limits on how much prior renewal behaviour can be taken into account).
Finally, there is more focus on discrimination against protected groups (e.g. race / ethnicity, or prior convictions). There is so far no evidence of explicit discrimination in rating, but there is concern this may come about inadvertently 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 “Dear CEO” letter, and to respond to the latest round of consultations. The bar has been raised significantly on showing adequate governance and oversight of pricing decisions around customer fairness.
• Management information in particular has been called out as a gap, but there will be many other areas where upgrades to existing processes will be needed
• Some players, long frustrated by market dynamics, may support renewed pressure to unwind customer detriment; others will silently curse additional regulatory scrutiny and margin pressure in an already competitive market
In the medium term, it seems highly likely that there will be pressure 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
• Prices should also rise for first-year policies, as insurers should be less willing to discount heavily to acquire customers with lower lifetime value
• 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
• There could be unintended consequences if players respond by pushing penetration and margins harder in ancillary income.
• 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.
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