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How will the FCA pricing practices report affect the insurance industry?

Insurance Consulting and Technology
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By Stephen Cox and Sarah Collier | October 16, 2020

The latest rules proposed by the FCA require a whole new pricing strategy for insurers and intermediaries alike. As with any new regulation there will be winners and losers.

In September 2020, the FCA released its long-awaited final report into GI pricing practices. On the day this was released the market broadly welcomed the report and it is widely recognised that these changes are the right thing to do and that the rules should benefit customers. There is still considerable uncertainty surrounding the full implications of the report. Insurers have started to digest the detail and think strategically about the future, firstly from their own perspective, and then more widely. It is this second point, and the question of what will happen in the market, which is considered here.

Winners and losers

The impact of the new rules will vary considerably by insurer, by broker and between the two. Will one set of players be hit harder by the changes? This is uncertain but there is potential for companies who sell direct to customers to be relatively more competitive compared to brokers, who may suffer. Companies having a large back book, especially of home insurance policies, where renewal margins have been particularly high, will take a hard hit to their profits. Of course, there will also be a wider impact, including on the companies who support the insurance industry. Price comparison websites are likely to take action to address the likelihood of reduced-price dispersion and triggers for customers to shop around, though the strong customer appreciation of aggregators seems unlikely to dissipate any time soon.

Some particular challenges for brokers are that the rules indicate that commissions cannot increase with tenure even if this would not see gross prices rise; however, it is not clear that the same restriction applies to direct writers. Pressure on premium finance and other additional product margins compound this and the options around panel dynamics may reduce. If this impacts the broker channel to such an extent that brokers struggle to compete then this could also reduce the marketplace for intermediated insurers; for this reason, direct insurers may be have the early advantage, at first reading.

What happens next?

Even though the final report has been published, there remains potential for change following the consultation period, with the final rules expected to come into effect by the end of 2021. Given that some parts of the report remain unclear, with different interpretations possible, changes to drafting (though not substance) seem likely. There is already concern in the market that these timescales are not long enough given the scope of change required. Clearly the full impact on the market will not be known for many years. However, as we consider different future points in time, we can draw out some expectations.

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Alongside the proposed introduction of new product governance rules for renewal pricing, there is also a substantial requirement around evidence and governance in respect of the enhanced rules surrounding customer value for all products, including additional products and premium finance. With this in mind, everyone involved in the insurance distribution chain will want to consider whether they should contribute to the consultation.

So what happens immediately? Insurers will be starting to work out what the rules mean for their pricing and whether they need to make any changes now. Given that many insurers set new business prices based on the lifetime value of a policy we could logically expect some price adjustments now since future assumptions will be changed. While for renewals, margin changes may become less common in preparation for reductions in premiums when the rules come in. On the other hand, insurers may start to loosen price capping at renewal, resulting in increases for some customers. This could make the transition to more risk based pricing smoother; however, insurers need to strike a balance between profit, reputational risk and simply doing the right thing.

Some of these trends are likely to continue until the new rules are implemented. Given the scope of the changes, insurers will have to spend considerable time and resources on this project, from both a pricing and IT perspective. Naturally this will distract from other planned activities with a reduction in resource in some areas but a considerable increase in any area affected by this ruling. As with any market shift there are new opportunities. Will insurers manage to take these by moving into a new product or channel? Those who are the most agile, have a simpler set up, and embrace change could do well.

Challenges and opportunities

Looking forward to when the rules come in, it is likely that prices will be more stable now that new business and renewal premiums will be the same, since renewal considerations will dampen new business movements. For renewing customers, many will benefit from reductions, although there will be some who have benefited from capped price changes who may see significant rises. This brings the possibility that some struggle or fail to find insurance policies at an affordable price, owing to the now higher equivalent new business premium. Customers who have always shopped around may also find themselves worse off in this new world. The changes will need to be considered by all areas of the insurance business; reductions in lapses and new business volumes will impact expenses and staffing requirements. Additionally, there is opportunity for innovation with many citing the potential for increased competition on the features of insurance products as a way for insurers to differentiate themselves. Though we might ask what has changed to make this more effective than today? This could happen if aggregators encourage switching on features rather than price though any reversal of historical hollowing out would quickly flow through into renewal books and so weaken the impact.

After the initial impact of the changes coming into force, the market is likely to reach a lower churn steady state with greater price stability and lower market price dispersion at new business, driven by a need for insurers to protect renewal prices and so retention rates, benefiting customers. At this stage, companies will start to consider the future with a likely increased focus on predictive analytics and innovative machine learning techniques across a wider range of applications.

The future

Finally, what will the future state of the market become? If the broker model is challenged then the overall market level of competition may decrease to the detriment of consumers, though the broker market has shown an ability to reinvent itself and remain relevant over many years. As ever, those insurance providers with lower cost, simpler businesses and strong brands have a greater chance of being amongst the winners. This move by the FCA to further regulate the market may hint at the direction of travel. Will the industry be allowed to continue under a relatively principles-based approach to ensure customer protection or will the FCA put more, and possibly stricter, rules in place? It is in all of our hands and only time will tell.

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