An end to “loyalty penalties” – what the FCA home and motor pricing review means in practice

The FCA has released its long-awaited review into motor and home insurers’ pricing practices.

The reforms, which go further than many expected, will broadly speaking ban insurers from charging renewing customers a higher premium than the equivalent new business price.

So, who wins and loses from these reforms and how should the market respond?

Loyalty penalty vs shopper’s reward – the impact on consumers

The FCA argues that the practice of “price walking”, where a customer’s premium is increased year on year at renewal, is distorting the market and leading to loyalty penalties for customers who regularly renew their policies without shopping around.

The new regulations will effectively end this loyalty penalty, meaning that people who stick with a single insurer in the long run should be charged a lower premium compared to today. This premium should be more directly related to the customer’s risk.

This benefit is likely to come at a price. Policyholders who regularly shop around rather than accepting their renewal may face higher prices as their “shopper’s reward” will no longer be available. This is because currently insurers tend to under-price new business to attract people, hoping to make a profit via price-walking in the longer term.

Under the FCA’s new rules, under-pricing new business will no longer be sustainable as the renewal book will have to be equally under-priced. The shopper’s reward will be eroded as new business premiums increase to more closely reflect the customer’s risk.

It is not clear whether the new pricing rules extend to offers like cash-back or reward vouchers that could entice new customers. If permitted, this may give firms limited scope to continue offering a shopper’s reward.

There are likely to be some more subtle effects too. For example, acquiring new business is expensive for insurers, so if the FCA’s intervention means people switch insurers less frequently, then this might drive overall premiums down slightly. However, any gains here may be offset by additional risk, reporting, and compliance costs that are likely to accompany the new regime.

How might insurers respond?

• Price walking is relatively common in home and motor insurance, so many insurers’ pricing practices could be in need of an overhaul.
• Until now, insurers have been able to use lifetime value models that attempt to optimise the profitability of customers over multiple renewals. These have helped insurers to cultivate portfolios of profitable (loyalty-penalty paying) policies which reliably renew year on year. These sometimes cross-subsidise less profitable risks in the wider portfolio.
• The new restrictions will limit the effectiveness of lifetime value models and will reduce the profitability of insurers’ long-term renewal book. To maintain profitability, insurers will need to focus more on accurate rates across the whole portfolio and place more emphasis on risk pricing to differentiate themselves from competitors.
• A key driver behind the FCA’s intervention is that customers paying the loyalty penalty are more likely to be elderly or vulnerable. Fairness to customers, especially those who are vulnerable, is not a new concept. Insurers who have already invested in identifying vulnerable customers and protecting them from price-walking will be much better placed to respond to the new rules.
• With pricing practices restricted, insurers may need to place more emphasis on other ways of standing out from competitors, for example quick and simple proposal forms and efficient, customer-friendly, claims processes.

Industry set for more intrusive pricing monitoring

The FCA clearly intends to take a pro-active approach to supervising these reforms and is proposing that firms will submit data on their pricing for review. The FCA has also indicated it may make the data public in the future if it sees sufficient public interest in doing so.

Insurers should already be thinking about pricing transparency – a key requirement of the delayed whiplash reform bill is that insurers must demonstrate that savings from the reforms are passed on to consumers. The FCA intervention looks likely to build on this, and firms will need to strengthen their pricing governance accordingly.

A more intrusive monitoring regime will also discourage insurers from looking for loopholes in the rules. A particular concern of the FCA’s was that pricing reform might lead to lower quality products, with cover topped up via more “add-ons”. Central to the new regulations is a requirement for firms to ensure their products (including add-ons) offer fair value to consumers. The FCA will be requiring senior manager attestation that insurers are meeting this requirement.

When will we see changes?

These reforms are likely to cause a big shakeup of the market. A final FCA consultation runs until 25 January 2021, with the final statement of policy expected in Q2 2021. Policies sold today are likely to be captured by the new rules at renewal, so insurers will need to move quickly to assess the impact of the likely changes to their portfolios and begin testing revised rating models.