Posted: 25th November 2020
After more than two years of warning signals to the industry, the Financial Conduct Authority’s (FCA’s) proposed fair pricing remedies are not a surprise for most insurers. However, the final proposals are far more than a mere set of compliance rules. With an estimated impact of up to an £11bn reduction in expected premiums over a 10-year period, not to mention potential compliance costs of around £1b[i], they will be a game changer for the entire industry not just motor and home insurance providers as initially expected.
The new rules will also be a catalyst for higher conduct and governance standards across all corners of the general insurance sector.
Given this context, Boards and Senior Management Teams face a number of strategic questions, including:
- What is a sustainable pricing strategy and profitability model for our firm going forward?
- How must the firm’s governance and internal control arrangement be upgraded to ensure we deliver fair value to consumers and maintain regulatory compliance?
- How do we raise the bar and align our firm’s conduct culture to the concept of fairness in line with the FCA’s expectations?
There are several ways in which firms can consider these questions to generate both positive customer outcomes and business benefits.
Reimagining the pricing strategy and profitability model
In recent years insurers have optimised their margins by looking at customers’ behaviours (‘behavioural pricing’), whilst simultaneously attracting new business by subsiding price discounts. Typically, they have funded the new business strain by charging existing customers a ‘loyalty’ premium (potential up to £2.3bn per year[ii]).
Under the new rules, insurers will still be able to offer a range of brands and types of products to consumers at different prices and through different channels. However, the FCA’s remedies will put significant constraints on an insurers ability to exploit consumer behaviours and to take advantage of existing customers.
Overall, this could create additional margin pressures for insurers in an already extremely competitive market. According to the FCA’s cost benefit analysis, for customers who have renewed 5 times, median premiums are projected to fall by 17% for combined home building/contents customers, and 14% for motor customers.
Insurers will have no choice but to review their pricing strategy and business models. Some initial areas of attention include:
- Strategic considerations to rebalance the pricing between new and legacy customers. Interestingly, players with smaller back books and less rebalancing to do may have an opportunity to take business from larger players that will have to increase prices for the new business.
- A refocus on technical pricing excellence and underwriting capabilities. This includes better use of customer data at the point of underwriting and better use of technology during the customer cycle.
- Understanding the new profitability drivers and impacts in the business model. Insurers would need to assess how to fund the new business strain (e.g. charging new business cost upfront or spreading costs based on the average tenure of policies). Technology and innovation should play a part in achieving a sustainable business model.
Enhancing the conduct risk framework and governance
The pricing remedy will be accompanied by enhanced product governance as well as value metric disclosure requirements. The aim is to drive changes in firms’ behaviour by requiring them to consider how they deliver fair value to customers throughout the lifecycle, including the design, approval, marketing, and ongoing management of products.
This will likely require firms to upgrade their conduct risk framework and reporting capabilities. Some potential areas of challenge include:
- Upgrading the firm’s conduct reporting capabilities. Firms would need to ensure clear and consistent conduct metric dashboards across the product range and consider any resource and system changes. This is likely to create some operational and resource challenges for the front-line product teams, given the increase level granularity and reporting timelines to regulators.
- Enhancing the conduct risk framework. Firms will need to consider holistically how all components of the conduct framework, including the internal measure of customer harms and tolerance levels, hang together and enable an effective control environment and oversight of customer outcomes.
- Accountability and ownership of the pricing models. While FCA’s proposals do not explicitly require changes of the existing Senior Management and Certification Regime (SM&CR), the pricing remedy implicitly increases expectations for the Board and the senior manager responsible for compliance.
Align the firm’s conduct culture to the concept of fairness
A good ‘conduct culture’ requires showing the right behaviours and outcomes when engaging with customers. Underneath the firm’s conduct culture, the FCA’s proposals shine a light on the concept of fairness, vulnerability, and responsibility.
At that practical level, Boards and management teams will need to establish a well-articulated definition of fairness that is aligned to the firms values and objectives. The overall aim is to find a ‘fair’ relationship between the total price to the end customer, and the quality of products and services.
The FCA’s proposals are likely to drive better outcomes for customers, including a reduction in average premiums at renewal, easier switching, and higher competition. Beyond the new regulatory requirements, it requires an internal strategy debate about a firm’s business model and pricing strategy. With the right leadership and approach, Board and senior management can not only generate both positive customer outcomes, but also strategic benefits and value for the business.
[i]FCA - CP20/19 – September 2020 - General insurance pricing practices market study, Cost benefit analysis
[ii]FCA - MS18/1.2 – October 2019 - General insurance pricing practices, Interim Report