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Passing the fairness challenge

Insurance Consulting and Technology

By Liz Michael and James Tanser | August 5, 2019

The Financial Conduct Authority’s long-awaited judgement on dual pricing will soon be published. Liz Michael and James Tanser analyse just how significant a change this will be to the rules of the game in pricing and what this will mean for UK insurers.

The UK is one of the most competitive insurance markets in the world, with competition for new business particularly fierce, and distribution dominated by price comparison websites. The Financial Conduct Authority (FCA), the Competition Markets Authority (CMA) and other bodies have long stressed the importance of treating all customers fairly but also protecting the interests of vulnerable customers.

Willis Towers Watson’s pricing decision-support software Radar now includes a range of algorithmic definitions of what fairness is and the capability to demonstrate that prices are actually delivering on any chosen definition of fairness. This will support firms in deploying and evidencing an approach to pricing fairness, in line with agreed pricing policy, as part of an appropriate pricing governance framework.

The FCA promises to get tough

Historically, the FCA has stated that it is not a pricing regulator in insurance and its level of intervention in insurance pricing has been relatively light. The FCA has, however, come under increasing media and political pressure to take stronger action against any unfair pricing practices and, with the findings from its market study on pricing practices in retail insurance to be published later this year, more direct intervention and greater scrutiny of pricing approaches are widely expected.

This shift in approach comes as part of a raft of changes aimed at improving the consumer experience of financial services products. By way of reinforcement, Theresa May announced in June 2019 that the CMA will be given new powers to impose fines on companies that overcharge or mislead customers.

The FCA’s interest in pricing practices represents a significant adjustment from the watchdog’s previous focus of ensuring that customers are treated fairly in the context of transparency and disclosure. While the FCA has said it would prefer ‘demand-side’ remedies for the consumer, such as more extensive price disclosure at renewal, it is concerned these may not be sufficient and so has signalled a sharply increased willingness to act robustly, including the use of ‘supply-side’ remedies such as price caps.

The FCA is also keen to see firms significantly improve their practices concerning governance, control and oversight of pricing, and to be able to evidence these improvements. This implies more active, and potentially prescriptive, oversight. Firms may now need additionally to demonstrate how fairness is embedded at every level from the pricing committee up to the board, and across the whole operation at every customer interaction.

Disparities between new and renewal pricing is a particular focus of the FCA, especially concerning customers who have not switched provider for some time and see higher prices than other, newer, customers having similar risk characteristics. Additionally, in its feedback statement published in July 2019, the FCA indicated that it expects all firms to exercise “extra care” when dealing with the issue of pricing where consumers may be vulnerable and that it would be “more likely” to intervene if price differentiation in the industry resulted in their harm.

As a minimum, we expect that firms will need to be able to analyse and justify divergences in pricing outcomes in the context of their own agreed pricing policy – with particular attention on which customer types apparently win or lose. This may result in material shifts in the distribution of prices and profit margins across each insurer’s portfolio.

What does “fairness” mean?

A particular challenge in this debate is that there is no single universally accepted definition of “fairness”. What each of us means by fairness is driven by both culture and legislation.  Current insurance pricing, for example, relies on fairness defined by an “unawareness” of certain protected characteristics, such as gender, race and religion, which have been specified by Parliament and which cannot form part of the pricing calculation.

In practice, it is difficult for external third parties, lacking full access to the insurer’s premium setting calculations, to demonstrate that any particular insurer’s prices are “unaware”. Fairness, as a result, is more often judged by externals using an alternate definition. This usually looks at the average premium for matched groups of different individuals, a type of fairness sometimes referred to as “conditional demographic parity”.  However, owing to differences in characteristics which have not been used in defining the matches, this will often result in some degree of arguable unfairness. In practice, many cases of apparent unfairness are the consequence of two parties selecting different fairness definitions, each with good intent.

More widely, firms can consider which other characteristics they wish to consider as part of their fairness framework. The Association of British Insurers (ABI) and the British Insurance Brokers’ Association (BIBA) have already set out new Guiding Principles and Action Points for members to ensure customers who don’t switch every year are offered a fairer deal. These principles include avoiding excessive price differences between new customer premiums and subsequent renewal premiums and working towards better outcomes for longstanding customers.

The first steps for insurers wishing to evidence fairness in their pricing approach is to state how they choose to define fairness, and to establish processes which demonstrate that their prices then satisfy this definition. While having clear internal policies on fairness, and accompanying MI demonstrating compliance with these policies, will enable a firm to demonstrate its fairness commitments to the regulator, the selected fairness definition may not be the lens which other outside parties will use. For this reason, it is useful for firms to consider, and to quantify the extent of compliance with, competing reasonable definitions of fairness alongside their own favoured definition. This analysis can be used to highlight areas in which certain customer segments may appear less well served by the selected fairness definition, allowing the firm to engage with consumer organisations, the media and its customers more proactively.

In all this, insurers should consider not only the minimum legal requirements around protected characteristics and evidencing adherence to their own chosen expression of fairness, but also how their pricing practices impact vulnerable customers. The FCA has recently published draft guidance looking specifically at this issue of vulnerability.

The back-book issue

A particular focus of the current fairness debate is the “back-book issue”.  As insurers’ pricing analytics have become more sophisticated, the information obtained from the customer to help set the premium has proliferated. This can mean that customers who have renewed for many years are on a legacy product, which has less accurate pricing based on a smaller set of pricing information.  These legacy products may also be more expensive for the insurer to administer, if on older technology and in smaller portfolios. These considerations can give rise to large differentials between the renewal price on a legacy product and the new business price on a current product, and so the unintended appearance of wilfully inconsistent pricing and poor value for longstanding customers.

As the industry moves to remedy this issue, it is important to note that it is not necessarily expected to need to reduce its overall margins, but rather to change the groups of customers for which it is more profitable. Where insurers move to lower prices for some groups, premiums will increase elsewhere. In some extreme scenarios regarding future regulatory outcomes, in which the FCA limits the differential between new business and renewal, this portfolio rebalancing will likely result in material increases in new business prices.

Unexpected consequences of intervention

The FCA will be keenly aware of the risk of unexpected consequences of intervention in insurance pricing. The highly competitive market, with price comparison websites enabling customers to shop around and switch between providers, is driven by the difference between the renewal price of the customer’s current insurer and the new business prices of alternative providers. Any action which significantly reduces this difference will reduce the incentive to shop around, reducing the competitive pressures and increasing insurers’ profit opportunity. With less traffic, the income of price comparison websites might also drop, potentially challenging their current business models. In these circumstances, an intervention designed to benefit longer-standing customers might result in all consumers paying more.

Unlocking the market’s potential

Willis Towers Watson regularly works with insurers and intermediaries to review and benchmark pricing practices against the wider market. This work provides deep insight into the different ways that firms are preparing for the changes to the market.  In the UK market, there are a number different established approaches to insurance pricing, each with differing levels of new business discounting. 

There are significant benefits to be gained by looking beyond the immediate need of demonstrating what a fair price looks like. Insurers can compete effectively at new business by deploying modern analytical techniques to  granular claims data to ensure leading-edge technical models of claims costs, and by analytically-driven optimisation of claims operations, indemnity spend and customer outcomes.

Insurers are familiar with constant change, but they will still need to think carefully about how to compete in a market within which traditional pricing practices may be restricted by regulatory intervention. Successful insurers will need to work hard at being competitive at all policy durations, integrating legacy systems, skills, technology, data and insights from across the value chain to deliver the tailored products that meet the needs of the 21st Century consumer. This will require a conscious culture shift for most organisations that will rely on buy-in and leadership from the executive.

Organisations that have developed the capabilities to react quickly to volatility, establishing pace and agility in decision making, will find themselves best placed to evolve, adapt and deliver value in the face of change.


Liz Michael
Director, Insurance Consulting and Technology

James Tanser
Director, Insurance Consulting and Technology

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