Launched in October 2024, the premium finance market study aims to assess whether consumers are receiving fair value and if competition is functioning effectively across the insurance sector. This is particularly important in the context of the cost-of-living crisis, with more consumers relying on premium finance to manage their expenses. While these customers may have lower financial resilience, the FCA highlights that they’re typically charged 8-11% more than customers who pay annually – effectively subsiding their costs.
In addition to Consumer Duty fair value expectations, there’s also PROD 4 compliance to consider. This requires firms to demonstrate that premiums bear a reasonable relationship to their costs and charges (including APR and profit margins) and are not disproportionately high.
The interim report summarises key findings to date, and firms should prepare for further interactions with the regulator during the second phase of the study.
FCA market study on premium finance: What to expect
Premium finance does incur material costs
The FCA’s initial findings confirm that there are operational costs associated with paying for insurance in instalments, including resourcing, IT and compliance. There are also additional costs in the form of bad debt, which accrues during periods of non-payment, but before the provider cancels the policy to mitigate further losses. The FCA notes that this forbearance is integral to consumer protection.
Bad debt was highest for intermediary brokers that had recourse arrangements with specialist premium finance providers (SPFP). In these instances, there was a 3% bad debt to loan balance. However, it was significantly lower for SPFPs (0.6%) and intermediary lenders (1%). Benchmarking these stats across the wider financial sector, a sample of retail banks carried bad debt of 1.9%.
While premium finance is priced to cover those potential losses, the FCA found that some providers’ revenues materially exceed costs, with margins varying from 14-62% (2018-23). The lowest weighted margin was 24% (SPFPs), with the highest of 53% (insurers) – with the FCA noting an exception in 2023 due to broader market conditions. Firms with higher margins should be prepared to demonstrate how their pricing structure reflects fair value to consumers.
No APR cap in premium finance
Around 60% of consumers pay annual percentage rates (APR) between 20-30%, however, nearly a fifth pay more. Comparing these figures across the consumer credit market, the FCA notes average APRs of 35% for overdrafts, around 23%-32% for credit cards (combining Bank of England and FCA reports), and 11% on £5K personal loans. As such, some APRs could be disproportionately high from some providers.
APR over 30% is more common where premium finance is funded by SPFPs and distributed by brokers, although the FCA highlights the importance of the SPFP/broker relationship to enable smaller firms to compete effectively.
Despite greater margins and higher APR in some quarters, other firms are offering premium finance at 0%. This is particularly prevalent in home insurance, where more than a third of consumers pay the same across monthly vs annual payments, compared to less than 3% in motor insurance. This is partly due to more consumers buying home insurance direct from the insurer, with many selecting their own mortgage provider for added convenience – with expected customer loyalty relieving some cost pressures for providers.
Recognising the range of business models and different customer groups across the sector, the FCA has ruled out a market-wide APR cap. But it will explore whether current practices accurately reflect costs and offer fair value to consumers.
No ban on commissions for premium finance
In addition to running costs and APR, there’s also commission to consider. While the FCA’s initial observations don’t discuss commission arrangements in depth, they remain a fundamental element of the premium finance market study.
Brokers need to demonstrate that commission is proportionate to their services and that it doesn’t affect fair value for consumers. Where commission is paid, firms must consider whether the consumer is exposed to a higher APR to offset the cost of commission to the finance provider. If so, firms should undertake an analysis to determine and evidence fair value.
The FCA will continue to assess commission and clawback throughout the remainder of the study, but has ruled out banning commissions. This is due to existing rules around remuneration, fair value and consumer understanding – but the regulator highlights that it will take action on breaches of those rules.
No ‘double dipping’
The FCA has also noted the so-called ‘double dipping’ practice. In these instances, the insurer treats the inability to for pay for insurance upfront as a risk factor, resulting in a higher premium. On top of that, those customers are charged interest to pay by monthly instalments. The regulator stresses the need for an ‘objective and reasonable’ basis for any increases to premiums for customers paying on finance, and will consider its supervisory approach on a firm-by-firm basis. The FCA and consumer groups view this as particularly concerning because this typically affects lower-income customers.
Premium finance market study: How will it impact firms, insurers, and intermediaries?
Next steps
The FCA’s update sends a clear message: that firms must be able to robustly demonstrate that their products offer fair value or face regulatory consequences. As seen with the Product Oversight and Governance thematic review (PROD 4 and PROD 1.4), firms that can’t adequately evidence this could face firm-specific actions such as skilled person reviews or remediation and mitigation plans.
With premium finance remaining in the spotlight, throughout the FCA market study and beyond, it’s essential for firms to review their product governance processes. This includes a critical review of cost models to assess how all costs are allocated and how they translate into the final price.
Recognising that changes to the cost model could have a significant impact on the wider business model, firms should also carry out financial forecasting and scenario planning for longer-term profitability. Embedding appropriate methodologies and effective governance to regularly review these cost models will also help premium finance providers continue to meet good practice and deliver fair value in the longer term.
For further information on premium finance, contact Jon Sperrin.
