Latham & Watkins LLP

The new rules follow coordinated regulatory and antitrust scrutiny of overcharging loyal customers.

On 28 May 2021, the FCA published a policy statement setting out new pricing practices rules for insurers and insurance distributors. The new rules follow a September 2020 consultation paper and final report. The FCA’s objective is to improve the way general insurance markets function, in particular by preventing firms from “price walking” customers (a pricing behaviour that the FCA considers anti-competitive) and ensuring that firms deliver fair value. The new rules also aim to increase transparency for customers who are renewing their insurance products.

Notably, the new rules:

  • Prescribe the information that firms must give to customers whose insurance products automatically renew
  • Include criteria that firms must take into account when determining whether a product offers value for money
  • Attempt to prohibit price walking

The FCA believes that price walking distorts competition and leads to higher overall prices for customers and that regular switching can help to bring prices down.

Renewals and Product Governance

With respect to renewals, from 1 January 2022, firms will be required to inform customers of whether the terms and conditions of their policy provide for automatic renewal, the effect of the renewal, and how the customer can easily cancel the automatic renewal element at any time.

Under new product governance rules coming into effect at the same time, firms will be required to ensure that the product approval process identifies whether an insurance product provides fair value to customers in the target market — and whether the product will continue to do so for a reasonably foreseeable period. The rules include a long list of factors that must be considered by the firm when measuring value for money, including the “type and quality of services provided to customers”. Firms will also be required to use a new prescribed metric to consider whether the price has been fairly set.

The FCA has allowed for a transitional period until 17 January 2022 for firms to implement the necessary processes, provided that benefits are backdated to customers from 1 January 2022.

Price Walking

In its General Insurance Pricing Practices Market Study Final Report, the FCA considered that certain firms were using complex and non-transparent pricing techniques for home and motor insurance to identify customers who were more likely to renew with them. Firms would then increase prices for those customers at renewal, in a process known as price-walking.

The FCA believes that such behaviour is anti-competitive, since it can lead consumers to believe that their renewal price is more competitive than it actually is. According to the FCA, 6 million insurance customers would have saved £1.2 billion in 2018 if they had paid the average price for their actual risk, rather than the price created by the price walking formulae.

As such, from 1 January 2022 the FCA will require that firms “must not set a renewal price that is higher than the equivalent new business price”. The equivalent new business price (ENBP) is in effect the price that would be offered to a new customer of the same risk profile purchasing the same product.

Information Gaps

The FCA noted that renewal prices may differ from the premiums previously charged due to changes in the consumer’s risk in the intervening period, or to new information that informs the ENBP. The FCA clarifies that the ENBP should reflect the customer’s actual risk, regardless of whether that risk has increased or decreased over the term of the insurance. As such, if the customer’s risk has reduced, then the ENBP should reflect the change.

If there is missing information — for example, if a firm gathers information from new customers that it did not gather in the past — the FCA leaves it to the firm to determine how to adjust for this information gap. However, firms will need to be able to demonstrate that their renewal price does not systematically discriminate by customers’ tenure.

Closed Books

For closed books in which legacy products may be offered by way of renewal to existing customers, but are not available (or are not actively marketed) to new customers, the new rules present a challenge.

Firms that have both closed books and currently active new books will be required to benchmark their closed book legacy product against a comparable new business price, to form a “close matched product”. This product should have core cover and benefits that are broadly equivalent to the core cover and benefits issued under the legacy policy. The FCA has chosen not to introduce further rules or guidance to assist firms in identifying a close matched product (presumably recognising the potential need for judgment to be applied in the context of a specific product and fact pattern).

Firms that do not offer actively marketed or distributed products that are suitable to use as a benchmark will be required to ensure that each customer’s renewal price does not systematically discriminate against them based on their tenure. In addition, firms must ensure equal value of the products relative to similar products available to new customers in the market.

Loyalty Penalties

The new rules follow coordinated regulatory and antitrust scrutiny of overcharging loyal customers. In 2018, the Competition and Markets Authority (CMA) reported on five markets (mobile, broadband, insurance, savings, and mortgages) in which firms were accused of penalising long-standing customers. The practices criticised by the CMA included year-on-year price rises, costly exit fees from contracts, time-consuming and difficult cancellation processes, and auto-renewal policies that switched customers to more expensive contracts without warning. Regulators have sought to bring increased scrutiny and, where they have deemed necessary, introduce new rules with the aim of better protecting customers.

Conclusion

The insurance industry is likely to welcome the new rules, which have been long anticipated, as they seek to apply fairness to different segments of the market. However, the price walking practices that have developed in recent years have been driven by structural features of the market, not least the role of price comparison websites. These market features have fuelled the need for the industry to provide significant incentives to attract new customers. In light of the new rules, insurers will inevitably need to consider their business models and distribution arrangements with a view to adjustment. Segments of the market used to benefitting from the market features can expect to see their prices increase as the ENBPs that will operate as the benchmark increase to reflect that adjustment. Insurers will need to carefully review and consider their business policies and terms in order to establish the appropriate benchmark, as well as implement processes and update their systems to reflect the requirements of measuring ENBPs and prepare for changing risk profiles.

This post was prepared with the assistance of James Mathieson in the London office of Latham & Watkins.

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