The FCA tweaks its final general insurance pricing rules

Intended Audience:

Board Members and Senior Executives of firms manufacturing or distributing general insurance and pure protection products, as well as premium finance providers.

 At a Glance:

• The headline measures announced in the FCA’s previous consultation remain largely the same, barring a few key changes and clarifications. Whilst many of these tweaks will be helpful to firms, they do little to reduce the scale of operational change required.
• The FCA has provided detailed rules around what incentives must be included in any pricing considerations.
• The FCA has narrowed its definition of “closed book” policies compared to its previous proposals.
• The FCA has given firms additional guidance on how they must set renewal prices where there is new risk information available or where risk information is missing.
• The FCA has amended its auto-renewal rules so that firms will need to allow consumers to opt-out of auto-renewal using at least the same methods by which they allow consumers to purchase a new policy.
• Firms must assess the fair value of all their non-investment insurance products and will need to gather information from all parts of their distribution chains to do so.
• New rules relating to systems and controls, retail premium finance and product governance come into effect on 1st October 2021. Rules on pricing, auto-renewal and reporting remedies will come into effect on 1st January 2022.

Introduction

The FCA recently published a policy statement setting out its final rules in relation to its general insurance (GI) pricing practices market study. Last September, we published one blog on the study’s pricing remedy, and another covering the wider fair value and product governance rules. This blog summarises how the FCA’s final rules have changed compared to its earlier proposals, and sets out the key implications for GI firms and the wider insurance market.

Key changes to the pricing remedy

The headline measure in the FCA’s policy statement is confirmation of the ban on differential pricing or “price walking” in the motor and home insurance markets. In practice this means that firms must not offer a renewal price to an existing customer that is greater than the equivalent new business price (ENBP) for a new customer with the same risk profile. The FCA is moving forward with this remedy but has tweaked or provided additional clarification around some of the proposals in light of the feedback it has received. Key changes or clarifications include:

• The pricing rules apply at the point when a firm prepares a customer’s renewal notice, not at the point the customer’s contract is renewed. This is the point at which a firm should calculate the ENBP.
• The FCA says that a firm should take into account “all available information on changes to the consumer’s risk, irrespective of its source” when calculating an ENBP. However, the FCA notes that consumers’ risk often falls over time and has changed its rules to make clear that firms must take into account any information that may suggest a reduction in a customer’s risk when calculating the ENBP at renewal.
• The FCA seem to have moved towards a margin remedy under paragraph 6B.2.41 of the FCA's guidance: "When comparing a firm’s new business price with the renewal price for individual customers, we would not expect to see that the longer a customer’s tenure is, the greater the difference between: (1) in the case of an insurer, the risk price and the net-rated price or gross price; or (2) in the case of an intermediary, the net-rated price and the gross price."
• The FCA has added guidance to enable firms to determine their own approach to how they take account of any missing information when calculating the ENBP. However, firms must be able to demonstrate that the “product offers fair value and the renewal price does not systematically discriminate by tenure”.
• The FCA has provided more detailed rules on what incentives should be included or excluded in the ENBP calculations. For example, the value of a free toy, carbon off-setting, or a chance for the consumer to win back the cost of their premium do not need to be included in calculations for the ENBP as these are considered to be “non cash incentives”. However, a wide range of other benefits, including cashback, one month of free premiums, retail vouchers, loyalty scheme points, and other discounts to the premium must be included in ENBP calculations.
• The FCA has removed the requirement for firms to assume that customers had selected the same payment method (annually or monthly) as they originally used to pay for their policy when determining the ENBP. Firms will need to consider how they use customer payment methods to determine the risk price and whether this is consistent with providing fair value.
• Where firms do not have a record of the original distribution channel, the FCA has introduced a rule requiring firms to use the channel most commonly used by new business customers when calculating the ENBP.
• If an intermediary re-brokes a customer to a new insurer, that insurer is not bound by the pricing remedy until the subsequent renewal. The same customer could be regarded as a new customer for one firm and a renewing customer for another firm, when renewing the same contract.
• The FCA has amended its definition of a closed book product, so that a product that has been on sale for 5 or more years will be considered closed if the firm has not sold, or does not expect to sell, on an annualised basis, more than 7.5% of active policies under the product to new business customers. For products on sale less than five years the threshold will remain 15% of active policies. Importantly, any product that sells, or is expected to sell, more than 10,000 policies per year to new business customers would also not be a closed book product.
• Firms with closed books will be required to benchmark their renewal prices against a “close matched” open book policy, where they have one. The FCA says that “a close matched product should have core cover and benefits that are broadly equivalent to the core cover and benefits enjoyed under the existing policy” but does not provide any additional guidance beyond this. Firms must assess whether any of their policies meet the definition of a closed book product at least once per year.
• The FCA is introducing a new form, to be submitted via the RegData platform, for firms to make the attestation that their pricing model complies with the pricing remedy. The person making the attestation must hold a relevant Senior Manager Function (SMF). Where the firm is not subject to the SM&CR, the person making the attestation must be a director of the firm.

Key changes to product governance rules

The FCA’s previous report also consulted on a wider set of product governance related rule changes, to ensure firms have processes in place to deliver products that offer fair value to customers. These provisions would apply to all non-investment insurance contracts, including all types of GI and pure protection insurance, not only to home and motor insurance. As with the pricing remedy, the final rules are largely the same as in the previous report, but with a few key changes and clarifications:

• Manufacturers are not required to share commercially sensitive information, such as their costs and profit margins, with distributors.
• Firms must obtain all necessary and relevant information in relation to the remuneration associated with their distribution arrangements so they can assess the ongoing value of the product. At a minimum the FCA expects this will include the type and amount of remuneration of each person in the distribution arrangement and an explanation of the services provided by each person in the distribution arrangement.
• Firms are not expected to carry out a fair value assessment each time they make an individual contract level change, such as adding an exclusion to an otherwise standard individual contract; this only applies at product level. However, where contract level exclusions or changes are frequently applied, this could become a product issue.
• Additional clarification around what constitutes a “reasonably foreseeable period” for products to provide fair value. This may vary depending on the type and length of the contract. The FCA expect firms to exercise their judgement to decide on this point.
• The FCA has stated that providing specific illustrations on what amounts to fair value or acceptable remuneration for every product, or a standardised template of value data would be impractical and would remove the flexibility for firms to make judgements based on their business. Firms should use examples in the guidance of what to look out for and measure.
• All co-manufacturers are responsible for meeting all the product governance rules and cannot share or contract out of that responsibility. However, one may lead on operating an aspect of the approval process.
• All products must be reviewed at least annually (including commercial, pure protection and closed book products), but the FCA has amended the rules to provide firms with more flexibility to identify what information they will need to consider when assessing a product for fair value, and to bundle similar products when carrying out a review, allowing firms to take a more risk-based approach.
• Both the new SYSC and ICOBS rules are amended to exclude premium finance arrangements which do not increase the price the customer is paying for the insurance policy (for example, 0% financing deals) from the definition of “retail premium finance”.

Key changes to auto-renewal policies

The FCA is moving forward with its policies to provide consumers with a range of accessible options to stop their policy from auto-renewing. The FCA has tweaked its proposals so that rather than mandating firms allow consumers to opt of out auto-renewal via telephone, post, and email or online, firms will need to allow consumers to opt-out of auto-renewal using at least the same methods by which they allow consumers to purchase a new policy. The FCA has also said that private health, medical insurance, and pet insurance will be exempt from these new auto-renewal rules due to the potentially serious consequences if consumers do not renew these types of cover.

Deadlines for implementation

The FCA’s deadline for new rules relating to systems and controls (SYSC), retail premium finance and product governance remain unchanged and come into effect on 1st October 2021.

The FCA has confirmed that the rules on pricing, auto-renewal and reporting remedies will come into effect on 1st January 2022. The FCA has added a transitional provision, allowing firms until 17th January to implement processes in relation to the rules on pricing and auto renewal disclosure, providing they backdate benefits to customer to 1st January. For disclosures required under the new auto-renewal rules, firms must contact customers to provide the required information by the end of February 2022.

The first value attestation must be submitted on or before 31 March 2022.

Implications for firms

The headline measures from the FCA’s GI pricing final review remain unchanged and whilst many of these tweaks will be helpful to firms they do little to reduce the scale of operational change required.

Firms have a demanding set of implementation deadlines to meet and should have conducted their gap analysis and have programmes in place to implement the key FCA requirements. Firms will need to act quickly to identify where additional metrics and data may be needed to undertake effective value analysis and reporting.

Firms will want to clarify their understanding of the FCA's new rules 6B.2.39 and 6B.2.41 in order to establish whether the FCA expects firms to maintain consistent margins between all types of consumers. This will have a significant impact on the cost of the remedies to firms, and their trading strategies post implementation.

Firms will need to institute at least an annual review of their products to assess them from both a pricing renewal and more general value perspective. Firms should consider the best way to differentiate products lines appropriately so that effective comparisons can be made across similar products.

Firms will need to designate a SMF (or equivalent) to take overall responsibility for pricing and ensure a focus on delivering fair customer outcomes, rather than adherence to processes alone. This SMF will also need to be responsible for signing the FCA’s value attestation.

Firms should proactively engage with their customers to ensure they are informed as to how they can stop their contract from auto-renewing and understand where paying their insurance premiums using retail premium finance may be more costly than paying the premiums annually.

The final definition of “closed book” was eagerly anticipated by a number of firms. Whilst there has been an amendment to the definition, there is a lot of work required to analyse legacy policies and ensure the designed benchmark can be operationalised with a build of the subsequent customer journey and communication strategy. This may disproportionately affect smaller firms given the rule that a product that sells more than 10,000 policies per year to new customers, is not classified as “closed book”.

You can find out more about how Deloitte can help by contacting any of the authors of this blog