FCA releases rules on Pricing Fairness

May 28, 2021 Paul De'Ath

Summary

• A Policy Statement on the new rules has been released this morning
• Overall, the rules are much the same as the proposals
• New guidance on some aspects including incentives, closed books and negotiation
• Implementation timeline remains at 7 months but with a small amount of slippage allowed
• The big strategic questions still remain unanswered as these will depend on customer and competitor behaviour
• The winners are likely to be those firms with true agility in pricing and product development as the landscape could change quickly in 2022

Analysis

New rules

This morning the FCA has published its policy statement on the General Insurance Pricing Practices (Pricing Fairness). The 202-page document sets out the rules and also the FCA’s response to the consultation. While the fundamental principles of the rules are the same there have been a number of changes and clarifications to the details of the rules to reflect the feedback received from insurers, intermediaries and other interested parties.

Clarification on implementation

There is plenty in the document for technical teams to get their teeth into, but we would highlight a few key areas of clarification that will be important for
implementation. Firstly, the timeline has been reconfirmed with 1 January 2022 the key date for compliance, however, the FCA will allow firms until 17 January
to bring in the pricing and auto-renewal changes if required and as long as customers are reimbursed for any detrimental impacts. Other areas of interest
will be the new guidance on cash and non-cash incentives, definition of closed books and treatment of negotiations in the buying process. We have set out some thoughts on each of these topics on the next page.

The Oxbow Partners View

When the FCA first proposed the equalisation of new business and renewal pricing we highlighted three questions for insurers to consider: What is the future of PCWs?; What should your strategy be for 2021?; and Is there a way to protect margins on your back book? The publication of the final rules doesn’t answer either of the first two questions and only further clarifies that there is not really an answer to question three that is within the spirit of the rules.

The difficulty for everyone in the industry at the moment is that we are in a world of game theory and scenario planning until the rules come into effect. The ‘right’ outcomes to win in the new world will greatly depend on the actions of both customers and competitors and while we can hypothesise what these might be, until we actually get there it is all just informed speculation. Agility in pricing and product design will be key and this is where insurers should be investing their time and resources at the moment, in our view.

Clarification in a number of key areas

The FCA’s policy statement has taken a number of the concerns raised by the industry and adjusted or clarified them to make the final rules more fit for purpose. We highlight three areas that we have been talking to market participants about in recent weeks.

• Cash and non-cash incentives
• Definition of closed books
• Negotiation in the sales process

Cash and non-cash incentives

There has been some debate around the use of incentives to encourage new business sales under the new rules. The concern is that if incentives are used to attract new business customers, then we could end up in the same situation as we have now where customers are offered discounts to sign up and then their premium costs are increased at renewal. The FCA has made clear its position on incentives. While incentives are a key part of a competitive market, they should not be used to discriminate between customer tenures. The FCA also completed some research on customer behaviour and discovered that customers found cash and cash-equivalent incentives more difficult to separate from the price for the core product and therefore the long-term cost of the insurance product.

As such, the new rules state that where cash or cash-equivalent incentives are used to attract new customers, these must be factored into the equivalent new business price (ENBP) offered to renewal customers. In other words, cash incentives form part of the price and renewal customers need to be offered a price that is the same as the net price paid by new business customers. This is not the case for non-cash incentives such as toys or carbon off-setting.

Definition of closed books

One aspect of the rules that has caused much debate in recent months has been the FCA’s anti-avoidance measures within the rules around closed books. In the original proposals, any book of business that is actively marketed but sells less than 15% as new business would be defined as closed. This would mean providers having to benchmark the pricing of the product to an equivalent open book within their portfolio, or ultimately open books of competitors. The FCA has changed the definition of what constitutes a closed book to reduce the risk of unintentionally classing books of business as closed when they have high retention levels.

For products that have been on sale for more than five years, the new business proportional requirement has been reduced to 7.5% rather than 15%. For products under five years old the threshold remains at 15%. In addition, products expected to sell over 10,000 policies a year to new business customers will not be classed as closed. This will ensure large books with high retention levels are not classed as closed despite selling more new business than many other products in the market.

Negotiation in the sales process

Another area of debate has been the negotiation process. Currently the back and forth with your existing provider is a key part of the renewal process. The FCA stated in the original proposals that firms would still be able to negotiate with customers to offer to match or beat competitor prices at renewal. The concerns raised by many in the industry is that this could lead to the same behaviour of price walking customers that do not have the time or inclination to negotiate a better rate. The new rules continue to allow customers to be offered lower prices as part of the negotiation process, however, the discounted rate needs to be reflected in the ENBP for all renewing customers. This should prevent firms from using negotiation as a way of price walking customers. It is hard to know how this will work in practice, however, as firms will be less willing to give individual customers discounts during renewal negotiations if the lower price offered then has to be rolled out across the whole portfolio. This could fundamentally change the renewal process for the majority of customers and encourage more switching.

The three big questions to answer

As a reminder, we believe that there are three key questions that the market needs to consider:

1. What happens to price comparison websites in the future?

2. What should my pricing strategy be for 2021?

3. How do I protect the value of my back book?

What happens to price comparison websites in the future?

It would certainly be premature to announce the death of PCWs – and certainly GoCompare’s acquisition by Future Plc would suggest that some see the model in fine health. Given that new regulation is likely to take a considerable amount of time to implement and would take even longer to be felt by customers on the ground, PCWs will continue to operate as normal for some time to come. The outlook for price comparison is uncertain, however, with all of our survey respondents believing that the rule changes are either neutral (60%) or negative for PCWs.

We continue to believe that the gap between the best new business quotes and renewal pricing is likely to reduce. This means there will be less business to access on PCWs, potentially at higher prices, and so insurers will need to think about alternative distribution channels. In short, diversification will be key, and an omni-directional distribution strategy will be beneficial in the new world. We have already seen a number of insurers looking to cultivate direct relationships with customers and move them away from price comparison and this is only likely to accelerate as part of the transition to the new regulations, in our view.

What should my pricing strategy be for 2021?

Pricing strategies for 2021 will depend on the size and nature of insurers’ current business models. Holding back on new business in 2021 may arguably be the right strategy for smaller players who can move in and swoop when prices rise (assuming they do) in 2022. This is particularly the case for those who are not very reliant on their back books, have more efficient business models and, overall, can sustain lower equilibrium prices than the market average. Conversely, those with a larger back book of business might find that 2021 is the last opportunity to generate significant new business sales via discounting.

While it is possible that we have seen some players pursuing an aggressive growth strategy so far in 2021, the impacts of COVID-19 on the frequency of Motor (and to some extent Home) claims have driven down market prices with different companies taking different approaches to the amount of discount that is sustainable. These other market effects make it harder to judge whether lower prices from competitors are driven by a desire to take market share in 2021 or a genuine belief that pricing should be lower to reflect the claims environment. Gaining market share of customers most likely to switch again in 2022 is not a good strategy so insurers will need to rely heavily on their ability to predict the customer lifetime value – something the FCA has highlighted has not been done very well by many in the past.

How do I protect the value of my back book?

There is no sugar coating the outlook for insurers when it comes to the impact of the new rules on back books. That said, pricing of the front book is likely to be significantly more profitable than in the past and could offset some of the reduction in back book value.

As if were not already clear, closing to new business is not an option for the protection of back book margins and the new rules have reiterated this point in the new guidance around closed books. The hard truth for many in the industry is that renewal prices are going to come down and therefore becoming more efficient is the main lever that can be pulled in order to protect margins in the long-run. An additional aspect will be the success of moving customers onto brands or products with higher coverage and (potentially) higher margins over time.

How Oxbow Partners can help

Market response and assessment of Pricing Review readiness

• How do we expect the market to respond to the recommendations? What are the different scenarios?
• What does that imply for the operation of the market?
• What positions do we think which players will take? What are the implications on brand?
• What does this mean for the likely impact on pricing, distribution, products and service?
• Overall, do we think this will lead to a simplification of pricing and product, or increased fragmentation and therefore complexity?
• Will this encourage or deter new entrants into the market? How might the new players differ in approach to the current participants?
• What is the implication for M&A strategy? Is there value we should realise now, or are there targets we should consider now or in the future?
• What new business models might emerge in the new market?
• How can we respond to these regulatory challenges strategically, creating long term, sustainable value for our business, rather than just ‘ticking the box’?
• Overall, what is our response and how do we position ourselves?

Operations and technology

• How do we continue to ensure cost leadership?
• What changes do we need to make to our pricing capability and function to succeed?
• What impact does this have on our technology estate? Is now the time to make fundamental changes?
• What governance and reporting requirements will emerge, and what data and other changes do I need to make to be ready?

To discuss this topic further with our Market Intelligence or Consulting teams, please get in touch.