Firms that manufacture and distribute general insurance products, or provide finance for their purchase, should be preparing for onerous new requirements taking effect over the coming months. The changes stem from concerns over consumer harm in the motor and home renewals markets but their impact is far wider. In this article, written for Compliance Monitor, Emma Radmore of Womble Bond Dickinson looks at the background to the changes, and what the new rules require.
Why the need for change?
The FCA has been concerned about pricing and renewal practices in the general insurance market for some time, and had published a thematic review on potential harms to consumers in the household insurance sector in 2018. This was the springboard for a more detailed investigation. In September 2020, the FCA published its final report into general insurance pricing practices. The report was the culmination of a significant exercise that looked at the potential for consumer harm in the home and motor insurance markets caused by pricing practices.
The FCA had been concerned about, and found extensive evidence of, "price walking", a practice where firms increase the price of customers who renew with them year on year. It found that firms used complex and opaque techniques to identify the customers likely to renew with them and then increased prices for those customers, resulting in some loyal customers paying very high prices – obviously not a good outcome for the customer. It said these customers would be unaware their renewal price might not be competitive, and so would not understand there could be a benefit to shopping around. It also found firms employing practices that would discourage consumers from shopping around. All in all, these practices distort competition and lead to higher costs for everyone, resulting in higher premiums for consumers.
As a result of the stark findings of its report, the FCA proposed a package of remedies comprising a pricing intervention for the home and motor insurance markets, together with measures that would aim to ensure firms offer fair value to all customers in the future. It wanted to encourage effective and innovative competition, with transparency for consumers and no barriers to their switching to better deals.
To put in place the pricing remedy, the FCA proposed to require firms in the home and motor insurance sector to offer customers a renewal price that was no higher than what the new business price would be for a customer using the same channel. The FCA recognised that firms may change the way they price as a result of this remedy, so proposed enhanced product governance rules that would help to ensure pricing practices would work to deliver good outcomes to all consumers. These rules would go wider than the home and motor sectors, applying to all general insurance and pure protection products. And they would cover initial offerings and renewals.
The FCA also proposed measures that would stop auto-renewal being used as a barrier to switching.
Alongside the Market Study, the FCA made its final rules on reporting and publication of value measures data and value measures product governance.
Following consultation, the FCA made new rules in May 2021.
Pricing – home and motor insurance renewals
A new part 6B of ICOBS will apply to home insurance and motor insurance pricing. The rules will apply where a firm:
- Sets the renewal price
- Sets the price for any additional product offered at renewal (this will include premium finance products, but the rules will not apply to group policies sold alongside relevant policies) or
- Determines the firm's remuneration, including fees earned when distributing a product at renewal.
It will also apply where a firm increased the price of a relevant policy sold on a subscription basis.
Who is the firm?
It may be the case that, for instance, an intermediary uses a panel of insurers – and, in this case, the intermediary may need to treat business as a renewal whereas the new insurer will not.
What must firms do?
The rules will require:
- Firms not to set renewal prices that are higher than the equivalent new business price (ENBR) at the time the renewal notice is prepared – and where home and motor insurance are packaged the renewal price for each element and the bundle must not be higher than the ENBR
- Firms that write net-rated business to apply the rules based on net-rates
- The renewal price of any retail premium finance to comply with the price rules
- In determining the ENBR, firms to assume the customer would use the channel through which they originally bought the policy, or, if this no longer exists, the channel most commonly used by new customers. Confusingly, if a customer used more than one channel, the price must reflect a combination of these channels – and firms should treat each intermediary chain, price comparison website or affinity or partnership scheme as a separate channel.
Firms may assume the use of a different channel only where the customer has agreed to take out a different product which is most frequently purchased through a different channel and where it is in the customer's best interests to take out the new product. Where this applies, firms should use as their basis the channel that customers most frequently use.
If a firm offers a customer a different product at renewal, it must be able to prove the new product is in the customer's best interest and meets their demands and needs, and should not offer the product if it is more commonly distributed through more expensive channels than the original product where the firm's primary purpose in distributing the alternative product is to enable it to charge the customer a higher renewal price. The FCA's original definition of "renewal" caused some problems to firms, so it has clarified that where an existing customer actively changes channels, that would be new business, but where a firm actively moves a customer to another channel, distribution arrangement, or similar policy, it should be treated as a renewal.
It is possible that a firm will not have the same information for existing customers as it would have for new ones, and, where this is the case, it will need to determine its own approach to how it takes account of missing information – but must also be able to show it is not discriminating on grounds of tenure and that it is providing fair value in line with the requirements of PROD. Conversely, a firm must take account of information that it has acquired during the lifetime of the current policy that would have an effect on the price, such as telematics data or fraud risk indicators.
Incentives on home and motor insurance renewals
The ENBR must include any cash or cash-equivalent incentives it would give to new customers that are funded wholly or partially by the firm. Cash or cash-equivalent incentives include percentage or monetary discounts, free time (such as one month free), a free additional product, cash back, retail vouchers or points in a loyalty scheme. Non-cash incentives would include toys, carbon-offsetting or a percentage chance to win back the premium.
The ENBR must also take account of any individually negotiated discounts the firm would agree with a new business customer – thus showing the firm would not discriminate on grounds of tenure and that it has taken account of its customers' best interests.
The FCA has clarified how rebates or vouchers offered by intermediaries, which would have the effect of lowering the price for the customer, must be taken into account.
Where the policy the customer has is no longer available, the firm must look for a closely matched product within its, or its group's product range and select the one that is the most similar to the existing product. It should calculate the renewal price based on that, but may make adjustments that fairly and proportionately reflect the difference in costs for the firm arising from differences between the products or other costs of providing the services in relation to the close matched product.
If there is no close matched product, or if the firm cannot determine an ENBR because it would not offer the product to a new customer, it needs to ensure it complies with a checklist of rules to show it is not discriminating against customers because of their tenure.
Firms should constantly assess whether their home and motor products are in closed books – on the basis of products that they write or distribute.
Intermediaries involved in price setting must ensure their remuneration is no higher than for a new business customer, and equally must apply the rules on incentives if foregoing any part of remuneration.
Finally, firms setting the price of additional products available in connection with a home or motor policy must apply the same standards to the additional products, including where the product is premium finance. If there is no new business customer offer of the product, the closed book rules will apply.
New rule ICOBS 6B.2.40 sets basic outcomes that all firms should seek to avoid when setting renewal prices for customers of longer tenure. Firms should take care:
- That the price should not materially exceed the new business price the customer would pay if shopping around for a substantially similar product, where the firm cannot identify a close matched product
- That the quality of service should be no lower than that of shorter-tenure customers, and
- That relevant value measures are not worse for customers of longer tenure.
Firms should not:
- Systematically charge higher fees to renewal customers
- Selectively close channels to take advantage of premium difference between channels
- Fund incentives offered by third parties in a way that results in the ENBP systematically exceeding the price actually paid by new business customers who receive the incentive
- Treat existing customers and new customers unless it is in the customer's best interests to do so and the price of the products does not adversely impact on the product offering fair value
- Establish new entities or transfer customers to other group entities where the effect of doing so is primarily to increase what customers pay
- Sell customers a product only superficially different from their current product where the effect of doing so is primarily to increase what the customer pays
- Systematically discriminate against longer tenure customers in communications, or communicate with them in a way designed to discourage them from shopping around or from negotiating their renewal price.
Notifications and record-keeping
Firms are to notify the FCA if they become aware of other firms in their distribution chain that may not be complying with the rules, and if they themselves change their pricing model such that there may be a material risk of harm for customers.
A firm must make and keep records of how it satisfies itself it does not discriminate against customers based on tenure and how its arrangements that enable it to treat existing customers as new business customers are in compliance with ICOBS. Records must clearly show the basis on which the firm is compliant, how it has resolved any areas of discretion, ambiguity or potential uncertainty and what expert input and advice it has relied on. Firms must have written policies and procedures to ensure they comply with the rules on an ongoing basis, and must attest annually that they have complied with the rules and are satisfied their relevant pricing practices are consistent with the ICOBS requirements and do not discriminate against customers of longer tenure. The attestation must be provided by the end of March in relation to the previous calendar year, and must be provided by an Senior Manager Function holder.
Retail premium finance disclosure and remuneration
Disclosure: Whenever a firm offers retail premium finance on a policy or a renewal, it must, in good time before the conclusion of the contract, provide the customer with information on the total costs of the policy with, or without the finance, and of the difference in cost. There would be an explanation that taking finance will be more expensive than paying for the policy up front. The disclosure would also need to draw attention to any difference between the duration of the policy and the finance, and where the price information is not presented annually, there must again be an explanation of the difference in total cost if using, or not using, retail premium finance.
For clarity, merely providing the customer with a choice between paying monthly or annually will not be enough to show they have made an active election to take the finance.
Remuneration: the new rules refer firms generally existing rules that need to be taken into account when firms remunerate distributors and providers, and require firms to assess whether their arrangements with finance providers or brokers could incentivise the firm to act otherwise than in the customer's best interests. So, for example, providers and distributors should not be chosen if the costs of their product is high, and a more suitable product would be available at less cost to the customer.
Auto-renewals – most general insurance products
New rules in ICOBS 6.2 will require firms to tell customers whether their policies will auto-renew, explain the effect of auto-renewal for the customer and provide information on how the customer can cancel the auto-renew element at any time. It must be clear, in good time before contract conclusion, that the right exists, the consequences of exercising it, and how to exercise it. These rules apply to all policies subject to ICOBS except for private health, medical or pet insurance.
An addition to ICOBS 5.1.3C will provide that where any policy included in a packaged bank account renews automatically, the statement must include information on the right to cancel the automatic renewal element of the policy at any time.
A new requirement in ICOBS 6.5.1 will require renewal statements to clarify whether the contract will auto-renew or whether the customer must take action to accept the renewal offer.
In terms of the mechanics, ICOBS 6A.6 has been introduced and requires firms to provide customers with "easy and accessible" methods for cancelling auto-renewal features – and these must as a minimum include all the methods by which a customer can purchase a new policy from the firm. The rules clarify that "easy and accessible" means not placing any unnecessary barriers on the consumer using it – so, for example, there should not be unreasonably long waiting times on a call or unnecessary steps or questions before the consumer can confirm the cancellation. The consumer should be able to cancel the feature on inception and at any time during the policy life, and to be able to do so free of charge.
When do the changes take effect?
Changes to SYSC and the product governance take effect from 1 October 2021. The rules on pricing, auto-renewal, premium finance disclosure and reporting take effect from 1 January 2022, with limited transitional provisions which give firms an extra couple of weeks to have processes in place, provided they backdate benefits to 1 January.
Change to PROD
Certain consequential changes to the FCA's product governance rules in PROD are introduced to look at when changes are made to products that would constitute "significant adaptations". New guidance sets out what firms should take into account in relation to the design of non-investment insurance products, including whether the distribution arrangements could mean that customers are at a greater risk of not receiving fair value from the product. Specifically, the guidance clarifies that firms cannot assume a simple product approval process is appropriate for a product intended for the mass retail market even if the product and/or distribution arrangements are straightforward.
A new section under PROD 4.2.14 addresses how firms must ensure fair value for individual non-investment insurance products and packages, and the records they must keep showing the value assessment they have made. It explains what "value" is, and how it should be addressed in the product approval process, looking at what must be taken into account and what information used as part of the assessment. It includes a requirement that firms must consider the fair value of a product not only for the initial term but also for renewals for a "reasonably foreseeable" period. And where retail premium finance will be offered, the firm will need to take into account whether the costs of that will have a material detrimental effect on the value of the product when the two are taken together. There is some useful evidential guidance on what FCA would consider likely to breach its expectations. Further additions to PROD include building in appropriate safeguards to consider whether distribution channels are suitable for the product and information the manufacturer will need to give the distributor so the distributor can understand the value pricing, and timings and factors to be taken into account in reviews. PROD also addresses how the new requirements apply to legacy products.
Again, there are some transitional provisions, allowing some leeway for firms for up to a year after the rules take effect.
The final set of changes comes to the reporting requirements in SUP, with a new rule 16.28 and associated forms applying to require detailed information to be reported in relation to home and motor insurance pricing, to enable the FCA to monitor compliance with the new rules and their effects.
Challenges for firms
The new rules clearly present significant new requirements for all affected firms, and will be particularly onerous for some – especially those involved in lengthy distribution chains. While many of the requirements seem formulaic, they also introduce several requirements which will require, variously, both subjectivity and objectivity to consider appropriate scenarios against which to set and test pricing. The complexity of the requirements is well illustrated by the detailed responses the FCA received to its consultation, and the fact that is has, since making the final rules, made two sets of changes, published a set of FAQs and delayed the effective date of the premium finance disclosure rules from 1 October 2021 to 1 January 2022.
The FCA has also made sure to tie in an element of senior manager responsibility, and made specific reference to these changes in its recent proposals on a Consumer Duty. The rules will clearly take time to bed in, and the FCA may well issue further FAQs as practices develop. And, once the FCA has a clear picture of the effects of the changes, we may see tweaks to the new rules or adaptations to apply to wider products and services.