The FCA is reviewing pricing practices across general insurance, including a crack down on ‘price walking’ in the home and motor insurance markets. Simon Sheaf takes a look at the key implications for firms and what to do now.
Released in September 2020, Consultation Paper 20/19 (CP 20/19) outlines significant changes to current pricing practices to level new business and renewal prices. Price walking is a key concern for the FCA. This is where customers initially pay a competitive premium, with the price increasing year on year depending on the client’s likelihood to renew.
The policy statement with the final rules is due to be published by the FCA in May. Then, systems and controls and product governance rules must be implemented by the end of September 2021, and pricing remedy, auto-renewal and reporting requirements must be in place by the end of 2021. The FCA initially indicated a four month implementation period, but this has been phased to the end of 2021 following industry pressure. With the regulator having already conceded to the industry on the deadlines for implementation, we do not expect the final rules to be materially different to the draft version.
Figure 1: A timeline of GI pricing deadlines
The short implementation deadlines mean that it's important to start preparing for the new rules early. As well as meeting regulatory expectations, it will also help insurers find new business models to support long term growth.
How will the new rules impact the general insurance market?
There are unlikely to be any surprises in the policy statement. As the regulator has already conceded to the industry on the deadlines for implementation, we don't expect the final rules to be materially different to the draft version. So, now is a good time to consider the potential impact of these changes on the market.
Insurers and brokers
It will take time to find the balance between sales volumes and margins, so there is likely to be an initial period of pricing volatility while insurers test strategies.
Regular updates to the combined conversion and retention models are a good option for tracking effectiveness. The changes will also lead to some pricing anomalies.
Insurers with agile pricing frameworks can create a competitive advantage by monitoring their competitors, and rapidly updating their rates in response. Governance frameworks must be similarly responsive to support this.
The FCA expects day one compliance on all new rules, and the extended implementation period will reduce regulatory tolerance further.
Pricing governance, including the associated testing and QA frameworks, must effectively monitor and enforce immediate compliance. Balancing these competing objectives may require firms to de-centralise key governance and decision-making activities, at least on a temporary basis.
A shift in pricing practices will also affect consumer behaviour. Customers who tend to switch annually for cheaper premiums may find prices have gone up to balance new business v renewal prices. As a result, such customers are more likely to query their premiums. There is also a higher risk of complaints if customers are not satisfied with their quote.
These demands will increase conduct risk and add pressure on contact centre resourcing. Insurers must also consider the financial impact of addressing these complaints. Discounts and refunds would affect the balance of new business and renewal prices.
Increased risk of insurance fraud
Financial pressures from COVID-19 mean some customers will be keen to obtain cheaper first year premiums, potentially increasing application fraud. This may be intentional misrepresentation, or because of greater susceptibility to ‘ghost broker’ scams. Detecting and combatting fraud could increase workloads at both the inception and claims stages of a policy.
Of course, most customers will try to reduce their premiums legitimately: for example, by using telematics boxes to negotiate quotes for car insurance.
Price comparison websites
In the short term, price comparison websites (PCWs) will see more customers shopping around for cheaper deals, as direct channels carry higher than expected new business prices. With greater pricing volatility post-implementation, the price ranking data on PCWs will become more important for the insurers listed.
In the long term, lower renewal prices will encourage customer loyalty and reduce the need to find cheaper new deals. While that’s not the only reason customers use PCWs, it will remove a key motivation, leading to a potential decline in usage. PCWs may need to find benefits beyond money-saving to attract new customers.
How can insurers meet operational challenges?
The new rules pose significant operational challenges for all firms in the UK general insurance market. The principal issues are likely to be in governance and pricing. There are things insurers can do to reduce the impact of these challenges.
A risk assessment can help firms apply lessons learned from the FCA’s transparency rules on insurance renewals.
Early planning will broaden the existing compliance framework and attestation cycle to cover the new requirements. Appropriate forums and committees will facilitate reviews and discussions to ensure that proper processes are followed. Insurers must clearly define the accountability of senior managers overseeing attestation.
As all products must be captured, the new governance requirements will have a particular impact on legacy or complex products.
The attestation cycle must include processes to identify and remediate breaches, and offer effective challenge.
An appropriate escalation process will enable every part of the insurance company with sight of pricing to report non-compliance, including the front-line staff. Insurers need to know the specific evidence they require to demonstrate compliance, and it's obviously important to have an internally consistent interpretation of the rules.
When enforcing the new pricing rules, the FCA is likely to use the Senior Managers and Certification Regime (SM&CR), to hold senior managers personally accountable. As such, it’s important that senior managers have personal input on pricing decisions, or take steps to ensure they have total confidence in the actions of their delegates.
An agile pricing model will help firms find fair prices for customers and the best profit margins. As such, it’s important to review the current rate setting and approval processes, and to consider if they will allow for rapid prices changes to stay competitive. Red flags include bottlenecks in the approvals process, overly centralised decision making, and any limits on price change frequency in the current structure. Changes in team structure may also improve agility moving forwards.
Good use of technology can promote agility, increase pricing engine flexibility and support algorithms for quick rate changes. This also includes platforms to increase the speed of analysis, including better use of data. Effective monitoring will track if pricing strategies are working, and real time monitoring can be beneficial where available.
The pricing rules will apply to “renewal notices sent after the rules take effect”, as opposed to policies renewing after the rules take effect. Many firms may be tempted to bring forward renewal notices into late 2021, but this will create competition for the policies renewing in early 2022, causing workflow peaks and high volumes on comparison sites.
Given the increased scrutiny on fair value, getting an accurate risk price is more important than ever.
Price testing framework
Pricing teams must run testing procedures before rates are approved to go live.
In line with the new rules, there must be no discrepancies between new business and renewals with the same risk profile. Insurers can develop a standard testing report or add to the existing report, which can be run with each rate change as needed. Reviewing the sample cases used for testing will ensure sufficient coverage of the risk profile.
Insurers can also consider combining new business and renewal datasets when modelling price elasticity, and by using the same algorithm for new business and renewal pricing.
How to meet the strategic challenges?
Meeting the new regulatory requirements will require a fundamental rethink of some business and operational processes. Again, there are several things that insurers can do to meet these challenges.
Strategy by channel
Low introductory premiums have been a staple for attracting new business, and insurers will need to re-evaluate their channel strategies. Customers purchasing policies on PCWs tend to be more price sensitive, with the cheapest ranked brands getting the most attention.
Insurers cannot reduce new premiums without constraining the lifetime profitability of a policy. Insurers can potentially provide a tiered product to achieve competitive prices: for example, by reducing core covers and allowing add-ons after click-through. However, it is important to understand the value to the customer of the tiered product offering and communicate it effectively.
Adapting the pricing strategy
Insurers must think about how their overall pricing strategy will bring lifetime profit on the policies and build this into the business plan. The new rules will also affect retention rates. New business premiums will likely increase, and renewal premiums will reduce, but the overall relative change will depend on the following:
Previous pricing strategy over new business v renewals differentials
Mix of new business and renewal volumes
Relative risk mix of new business and renewals
Establishing a new value proposition
Insurers need to understand their unique selling points. For example, is it the quality or identity of their brand, product, or service, or simply having cheaper premiums? If price is the deciding factor, will insurers be able to maintain this advantage?
Similarly, intermediaries competing purely on price must consider other ways of adding value for customers. This may affect business models built around high-volume sales obtained via price optimisation models, based on net-rated premiums from panel insurers.
Measuring and delivering fair value
It is important to establish what’s meant by ‘product value’ to develop the right MI/evidence to demonstrate if a product (or channel) offers fair value for money. This should not only focus on loss ratios, but also include other financials, such as fees and commissions, as well as repudiation rates or numbers of complaints.
How to meet the FCA's expectations?
While the FCA has relaxed the timetable to accommodate industry concerns, it has stated “[we] do not want to see consumer harm continue into 2022”. As such, requests for extensions are unlikely to be considered. Besides planning and designing the implementation framework, insurers need to consider the wider impacts the rules will have on their business models, strategies and value propositions. This will take time and starting early will help firms meet the compliance deadline.
Effective resourcing is essential for implementation, including planning, analysis, development, change and testing. More employees may take leave as lockdown lifts, so it’s important to plan around these absences. Similarly, the regulator may want to check progress, so it’s crucial to have the right information available including a project plan mapped to requirements, business impact assessments, an assurance approach and detailed delivery MI. This will keep the project moving internally and minimise customer disruption. Firms without a clear plan will face increased scrutiny, which can slow down progress.
There will almost certainly be some high-profile enforcement cases, including poor progress, abuse or disregard. The FCA explicitly notes the need to repair harm and provide financial redress, so it may also focus on the adequacy of monitoring, escalation and remediation processes. With short implementation deadlines, getting started while waiting for the final rules will help firms meet regulatory expectations and find new business models to support long term growth.
For information on the FCA's review of pricing practices in general insurance contact Simon Sheaf.