The Financial Conduct Authority (FCA) has initiated a comprehensive market study (MS24/2.1) into the provision of premium finance for motor and home insurance. This study, announced in October 2024, aims to address concerns about the fairness and competitiveness of premium finance products available to UK consumers.
Why the study?
Premium finance allows customers to spread the cost of their insurance premiums over time, typically through monthly instalments. With rising insurance premiums and the ongoing cost-of-living crisis, more consumers are turning to premium finance to manage their expenses. However, the FCA has raised concerns that these products may not always represent fair value and that competition in this market may not be functioning effectively.
Key issues explored
The study explores a number of critical issues, including the following:
Fair value
Assessing whether premium finance products offer fair value to consumers. The FCA is concerned that premium finance is expensive relative to the low credit risk associated with the product, with gross APRs ranging from 20 to 30%. Some providers offer the product for free on certain policies, raising questions about pricing fairness.
Competition
Evaluating the level of competition among providers and its impact on pricing and product offerings. The FCA believes that complex commercial arrangements and poor consumer information limit customers' ability to make effective decisions.
Consumer impact
Understanding how premium finance affects consumers, particularly those who rely on it to afford their insurance. The FCA is aware that the cost of premium finance disproportionately affects vulnerable consumers, with 79% of adults in financial difficulty having used the product.
Similarities to MOBI study
This market study bears similarities to the FCA's previous thematic review into the multi-occupancy buildings insurance (MOBI) market. Launched in response to rising insurance costs following the Grenfell tragedy, the MOBI study aimed to uncover the underlying causes of price increases and restricted coverage availability. Both studies reflect the FCA's commitment to ensuring fair value and effective competition in insurance markets, and protecting consumers from unfair practices.
Additionally, the FCA undertook a further review of broker remuneration related to multi-occupancy buildings insurance. This review highlighted concerns about high commission rates and poor practices that did not consistently deliver fair value to customers. The findings from this review underscore the importance of transparency and fairness in the distribution of insurance products.
By drawing parallels between these two studies, the FCA emphasises its ongoing efforts to scrutinise and improve market practices across different insurance sectors. The lessons learned from the MOBI study will likely inform the approach and expectations for the premium finance market study, ensuring that all market participants adhere to high standards of product governance and fair value.
Connection to FCA's GIPP work
The premium finance market study and the MOBI review before it build on FCA's general insurance pricing practices (GIPP) work. Through GIPP and the resulting enhanced product governance rules, the MOBI review and now the premium finance market study, the FCA aims to ensure that insurance markets operate fairly and transparently, providing consumers with products that offer genuine value.
The FCA's focus on premium finance and multi-occupancy buildings insurance reflects its commitment to addressing systemic issues in the insurance sector, driven by insights gained from the GIPP evaluation.
FCA’s scope and next steps
The FCA's study engages with various stakeholders, including current and potential suppliers of premium finance, industry groups, and consumers. The FCA will look at the entirety of the distribution chain to determine whether the market is operating effectively. This examination will include premium finance providers (lenders), insurance aggregators, insurers, and intermediaries, assessing the degree to which distribution chain participants' activities are delivering an efficient market.
Five things firms can do now
1 Product governance and pricing methodology
Premium finance providers need to evidence a robust product governance process with a robust pricing methodology when determining the net APR price offered to insurers and intermediaries. Providers will also need to justify how and why net rates differ between different downstream distributors.
2 APR rate justification
Insurers and intermediaries need to clearly demonstrate how, and more importantly why, the gross APR rate offered to customers reflects the risk and distribution-related costs for home and motor insurance. Simply relying on basic APR peer benchmarking and feeling reassured by being within the industry average will not be sufficient.
3 M&A activity and distribution channel considerations
Firms, especially those with a backdrop of M&A activity, need to consider both current premium finance arrangements and APRs, as well as legacy arrangements for acquired firms. They must justify any variances in APRs incurred by customers based on different distribution channels and associated costs. This includes how APRs differ by distribution channel (eg, digital versus branch-based distribution), if there is cross-subsidisation, and whether this is fair and justifiable.
4 Income stream and earnings model review
Firms need to prepare for pressure on their income streams and revisit their earnings models. Firm should be modelling a range of business model outcomes, and testing business model profitability and viability. For example, for distributors this will likely include revisiting and renegotiating lower commission arrangements, which may have previously been offset by higher APRs.
5 Customer journey review
Firms also need to review their customer journeys for frictional barriers, including the positioning of, clarity, and ease of customer communications, to ensure they don't exploit customer behavioural traits.
Anticipated outcomes
We anticipate this market study will bear similarities in regulated firm outcomes to our experience in relation to FCA's MOBI review, with initial findings later in 2025, potential further enquiries into distribution chain remuneration, potential s166 Skilled Person reviews, a thematic report to the market, and firm-specific attestations.
On a micro level, firms with clear PROD 4 breaches or product governance weaknesses from their documentation submissions might reasonably expect an s166 Skilled Person review.
We might also see a limit or cap encouraged for APRs, just as we saw challenges on higher commission levels for MOBI and the effective introduction of a commission cap through firm-specific interventions. At the extremes, a firm could be required to temporarily withdraw from offering premium finance were the FCA to have significant doubts about whether an APR was fair and representative of the costs of the technical price of the product, and the associated distribution costs. Such product intervention would mitigate APR-related harm by preventing customers from buying premium finance from some providers and ‘nudge’ consumers to other market participants where the FCA has less concern while firms revise their business models and associated APRs.
The FCA’s market study will not only shine a light on product governance arrangements but will also expose any weaknesses in management’s thinking based on board and committee oversight, as well as the quality of internal risk, compliance and internal audit functions.
On a macro level, we expect fundamental challenge and resultant change to the motor and home premium credit sector with APR rates supported by distribution cost allocation models of varying degrees of sophistication.
Whatever the outcome on home and motor premium finance, this market study will have broader product governance and fair value implications to premium finance for other insurance classes in future years.
For information and advice, contact our experts.
