Last month, the UK Financial Conduct Authority (FCA) released a consultation paper on proposed policy changes to the product pricing and governance rules applicable to personal lines insurers in the UK. The proposed changes are expected to have a disruptive effect on the UK personal lines insurance market which the regulator hopes will increase competition in the market. Despite the many differences in the Australian insurance market, it is entirely plausible that a similar regulatory focus could arise here in the future.
The proposal put forward by the FCA follows an in-depth market study into pricing practices over the last couple of years. While a number of issues were investigated as part of the study, the main issues, as perceived by the FCA, that the proposal is seeking to address are:
- Renewal premiums being consistently higher than the new business premium customers are currently offered for an identical risk, resulting in higher prices being charged to loyal customers.
- High levels of acquisition costs that are ultimately passed on to consumers.
- Practices that discourage switching, such as complicated processes for customers to cancel or switch off auto-renewal of policies.
- Ensuring transparency in insurers’ dealings with customers and providing fair value to customers.
The FCA proposal
In short, the FCA’s proposal involves:
- The “pricing remedy”, which requires:
- Insurers to offer new business prices that are not lower than the renewal price offered to an identical customer. This essentially represents a reversal of current market practice where insurers compete hard to win new business and subsequently increase premiums on renewal.
- Insurers should not systematically charge more or price to earn a higher margin for renewal customers. Although disbanded on 30 June 2020, the NSW ESL Monitor perceived similar issues occurring in the Australian market. Indeed, a number of insurers continue to offer explicit new business discounts to attract customers.
- Requiring insurers to provide attestations and demonstrate that renewal premiums are no greater than the new business premium that would be offered to that customer.
- Putting in place detailed price monitoring to highlight and punish any attempts to circumvent the intent of the pricing remedies.
- Extending the pricing remedies to cover add-on products, to mitigate the risk of new business inducements through pricing variation in add-ons.
- Strengthening of product governance obligations to ensure insurers have policies and procedures in place to ensure:
- Products are fit for purpose, with clear target markets and that customers are being offered fair value.
- Distribution of products has adequate oversight from the manufacturing insurer.
- There is a formal responsibility on distributors in delivering fair value to customers.
- Insurers and distributors have mechanisms in place to protect vulnerable customers.
The proposals in this regard are very similar to the Design and Distribution Obligations (DDO) soon coming into force in Australia.
- Reducing barriers for customers to cancel auto-renewals, by offering a range of easy and accessible options for cancelling a policy. This seems to be a feature unique to the UK market and we expect most Australian insurers to meet the minimum standards set out.
Challenges for the industry
We expect the FCA’s proposed rules to present a number of practical challenges for insurers to navigate, with the core “pricing remedy” being the key disruptive factor:
- Insurers will no longer be able to engage in fierce price competition for new business (as they have done historically) with the hope of pricing actions on renewal to ensure lifetime profitability.
- Equalising new business and renewal prices could reduce the capital barrier to entry for new market entrants (start-ups) as they won’t have to fund the same level of new business strain.
- Increasing the incentive for insurers to discriminate to attract more potentially long-term, profitable customers at new business – information that an insurer learns about a customer by the mere fact that it continues to renew a policy cannot be used to increase the margin on the customer as this information emerges.
- The need to maintain price competitiveness, whilst equalising the back book and new business pricing, may lead to large premium movements for individual customers. This in turn could lead to significant churn across the industry, particularly if different insurers take a different approach. The “transition risks” will need to be carefully managed.
- The proposed monitoring approach may give false signals about an insurer’s pricing practices with respect to this remedy. For example, margins may be higher on renewal business despite premiums remaining flat as technical cost decreases with policy duration. In addition, some rating factors (eg asset value) may be correlated with policy duration to the extent that it appears that premiums are increasing with policy duration. The implications from the proposed monitoring framework may take some time to work through.
- The required attestation from a senior manager within the insurer that its pricing complies with the pricing remedy should decrease the incentive for insurers to attempt to “game” the system by exploiting loopholes.
In summary, the proposed remedy should have wide-ranging impacts on how insurers approach personal lines pricing and significant changes to current practices will likely be necessary to ensure compliance. Potentially we may observe more non-price incentives or “product innovation” to induce customers to switch. However this may be frowned upon as contrary to the intent. Indeed practices such as offering a higher quality of service or coverage to newer customers are explicitly called-out as practices which would be seen as attempting to “frustrate” the remedy.
What it means for Australian insurers
Our expectation is that an analysis of premiums in Australia would also indicate some discrepancy between premiums charged to renewing versus new business customers. Indeed, despite the challenges with the approach, the NSW ESL monitor had published several papers on this whilst actively monitoring new business vs renewal pricing in the market. So whilst the controversial “loyalty tax” issue has not yet received the same focus in Australia to date, given the ongoing regulatory focus around conduct, it is quite possible that the issue may receive more attention in the regulatory agenda in the near future.
So what should Australian Personal Lines insurers be doing?
- We think that the issue represents an example of a “non-financial risk”, carrying downstream financial risks, that companies should be giving some regard. At a minimum, we think insurers should be discussing the UK developments in internal pricing and product governance forums.
- Thinking strategically about the approach to pricing and the potential longevity of this in an environment with evolving customer expectations and regulatory focus. This would include reviewing the current state of portfolio pricing to understand consistency with the potential future operating environment. For example, to understand if there are systematic discrepancies between renewal and new business pricing
- If there are potential conflicts, a qualitative and quantitative assessment of the drivers of those differences could be carried out – e.g. contribution of using tenure in pricing models vs effects of historical cupping/capping of premiums vs optimisation decisions vs explicit new business discounts etc.
- Using this assessment to form a view about the potential impact of any change in the pricing approach and devising an approach to transition whilst managing any potential impacts on financial performance.
By forming such a framework and fact base to support pricing decisions, insurers will be better positioned to defend and articulate their positions – to regulators as well as customers.
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