Clifford Chance

Amid a climate of rising insurance premiums and the wider cost-of-living crisis, the Financial Conduct Authority (FCA) has announced it will carry out a full evaluation of the impact of its pricing reforms implemented in early 2022. The evaluation would mark a new chapter in the FCA's ongoing focus on providing fair value to customers.

In a January 24th letter to the Treasury Select Committee, FCA Chief Executive, Nikhil Rathi, acknowledged that the FCA was "acutely aware" of the impact of higher premiums on consumers, particularly in the home and motor insurance market.

While Rathi maintained that the FCA's reforms to tackle "loyalty penalties" have made the insurance market fairer overall, his intention to carry out an evaluation of the reforms signals heightened scrutiny surrounding the unintended consequences of their earlier intervention. Notably, the proposed review comes after the implementation of the "price-walking" ban, which prohibits insurers from charging existing customers higher prices than new ones for the same coverage. This included a "pricing remedy" requiring insurers to offer renewal quotes at the same level as new business offers.

Pricing reforms

In January 2022, the FCA banned home and motor insurers from engaging in price-walking – the practice of gradually increasing premiums by quoting existing policyholders a higher price to renew their insurance than the offers available to new customers. The ban was part of a package of remedies aimed at improving competition which came after the FCA's general insurance pricing practices reforms in the summer of 2021.

Before the ban, the FCA found that existing policyholders could end up paying significantly more than new customers for the same coverage – sometimes even double the price. The FCA found that this practice exploited customer inertia and distorted the market. Driven by their September 2020 market study on general insurance pricing practices, the FCA enacted reforms to address these concerns.

There were a number of eye-catching statements from the FCA at the time of the announcement of the proposals:

• 6 million policyholders were paying above average for their risk cover and, if they paid that average, there would have been an overall saving of £1.2 billion.
• The FCA estimated that the proposals will save consumers £3.7 billion over 10 years (later revised to £4.2 billion).
• In the long term, the proposals would lead to improved competition and lower prices.

These reforms included:

• Product governance: This was to ensure insurers offered fair value through well-designed products and pricing models and require home and motor insurance firms to report data to the FCA so that it can supervise the market more effectively.
• Ban on price-walking: This prohibited insurers from charging existing customers more than new customers for the same coverage.
• Simplified renewal process: This was to empower customers to easily switch providers if they find better deals.

As a result of these reforms, general insurers cannot increase prices for renewal customers for motor and home insurance without also increasing the prices they offer new customers. To ensure compliance, insurers now need to submit an annual report confirming their adherence to these new rules.

Fairer Market, Higher Prices?

The price-walking ban aimed to level the playing field in insurance. However, at the time, some critics worried it could stifle competition and lead to higher overall costs. This analysis examines reported developments in pricing since the ban.

1. Higher Premiums

In the FCA's letter, Rathi acknowledges the adverse impacts of rising premiums but explains that unsustainably low-priced deals were no longer viable, necessitating increases for some customers. It is, however, clear that the reforms are far from the only contributor to the rising premiums. Rathi highlighted additional factors contributing to rising prices despite a competitive market: increasing repair costs, labour shortages, higher pay-outs, and fluctuating energy costs. This aligns with the Association of British Insurers (ABI) report of rising second hand vehicle costs (up 32% in Q3 2023), further impacting insurers' claims expenses. In addition, Rathi found that, considering these products were loss-making or marginally profitable for many insurers, price increases were expected.

Since the ban, both motor and home insurance prices have risen significantly. This 'new normal' reflects insurers matching renewal quotes to new customer prices, resulting in a 40% increase in motor insurance compared to pre-ban levels. Similarly, home insurance is projected to rise by 30% by year-end. While motor insurance has risen 21% since June 2022, other categories have seen much steeper increases, with further rises anticipated. Confused.com reported an average 58% increase in motor insurance premiums for 2023.

Rathi affirmed that the analysis the FCA conducted when implementing the rules indicated there would be a substantial net benefit to customers overall. However, although intended to benefit consumers by ending unfair pricing practices, many customers may feel they have not seen a positive financial impact since the pricing reforms.

2. Shifting Pricing Strategies

Evidence from Globaldata suggests that there is now significantly less difference between the largest and smallest average quote for a car policy. As a result, there would appear to be reduced emphasis on price discounts to attract new customers and insurers are focusing on differentiation strategies. According to Confused.com, there is a move to offer new flexible products or target specific segments to attract new customers. They indicate that this suggests a shift away from acquisition based on price and a move towards retaining existing customers.

Rathi states that the FCA has observed that both the home and motor insurance markets are highly competitive, and firms are still incentivised to offer lower prices to attract customers. He notes that the FCA's reforms have made the insurance market "fairer, as loyal customers can no longer be penalised for staying with their provider". Nevertheless, Rathi affirmed that the FCA has "always encouraged customers to shop around to find the best deal" and would support customers switching to get the best deal. While switching providers may still offer benefits, it is unlikely that consumers who are purchasing products as a new customer will see the same cost savings than pre-ban levels, all else being equal. Ultimately, however, factors such as distribution channels and the date of purchase will have an impact on pricing, meaning some new customers will still be better off than existing customers renewing the same policy.

Research from Go Compare found that pricing practices in motor insurance has changed as more products are subject to administrative and set-up fees since the introduction of the reforms. Go Compare reported that, while this could be due to inflation and other factors, there is a possibility that insurance companies are feeling the impact of the new pricing rules and had to look at other ways to recoup these costs. According to the FCA's general insurance pricing practices market study from 2019, 11% of insurers revenues comprised of non-core revenue, of which up to 48% related to premium finance. Certainly, the package of reforms means that firms will need to holistically consider whether their pricing strategies across all products offer fair value, as insurance add-on products are also captured under the product governance rules. The impact of the reforms on the pricing practices with respect to non-core revenue streams remains to be seen.

In summary, it is clear that the price-walking ban has catalysed insurers to re-strategize their pricing practices to attract new customers. That said, the long-term benefits for consumers remain uncertain. The FCA therefore plans to investigate the ban's impact.

As part of this evaluation, the FCA will assess:

• the current state of the market;
• the underlying profitability of insurers; and
• concerns about some insurance add-ons and additional costs, such as those incurred by using premium finance.

The FCA's letter serves as a reminder that firms need carry out detailed assessments to demonstrate a clear and reasonable link between the price they charge and the value they deliver, including with regards to covering claims costs. Insurers would therefore be best advised to review their compliance with the new rules and review the fair value position on ancillary products.