Back in 2016, the UK’s Financial Conduct Authority – FCA – raised concerns about the pricing practices in general insurance markets when it published several papers suggesting those practices may lead to consumer harm, with pricing not always reflecting the risk.
In October 2018 the paper TR18/4, Pricing practices in the retail general insurance sector: Household insurance was released.
A relatively short paper at 27 pages, it was intended as a diagnostic piece looking at specific practices from a limited number of firms. Household insurance was chosen for the study due to it being a relatively profitable, stable line of business, where the consumer rarely switches provider.
The study would go on to show that some customer cohorts were priced less fairly than others and that the high level of customer retention at renewal had led to higher prices. Rather than providing a product that represented value for money, customer loyalty was being taken advantage of.
The problem wasn’t found to be that insurers had explicit strategies to take advantage of consumers, but that there were no controls in place to prevent it from happening.
Other external and internal drivers were being allowed to drive pricing. In other words, the problems were institutional, rather than deliberate.
For some lines of business, private auto, for example, this issue is even more pronounced. In such a highly competitive market, winning new business often comes at the cost of profitability, with the first year written at a loss.
An assumption built into pricing models assumes a high level of customer retention, so higher premiums are charged at renewal to make up for those losses, sometimes these increases occur over multiple renewals, a practice known as price walking.
As the market becomes more competitive, the more the losses need to be recovered when policies are renewed. Groups more likely to remain loyal and renew, bare the brunt of those premium hikes. Often these groups are the most financially vulnerable.
In competitive markets, the drive for market share demands staying one step ahead of the competition, and in the UK the popularity of price comparison websites has intensified this competition greatly, where new business is often only won by the cheapest price.
In 2018, 6 million auto and household policyholders would have saved £1.2bn had they changed insurers, rather than renewing with their existing insurer. This clearly shows the cost of price walking to the consumer.
As a result of these findings, the FCA decided external regulation was required to force greater consideration of the consumers best interests.
New rules will come into force on 1 January 2022 and are documented in detail in the 2021 paper PS21/5, General insurance pricing practices market study.
At 217 pages it goes into some detail and includes new rules on:
- Cancelling auto-renewals on policies
- Internal governance for treating customers fairly
- Reporting requirements that will help the FCA monitor insurers
However, the rule that will most likely have the most significant impact, is that insurers will now be required to offer a renewal price to a customer that is no greater than the equivalent new business price – ENBP.
How will this change the insurance landscape for consumers? Well, we can expect to see more consistent pricing between renewals, and possibly overtime this consistency in pricing will actually lead to an increase in retention at renewal.
Almost certainly we will see new business premiums go up, but by what margin is unclear. Which insurers will take the leap first? Who will raise their new business prices first, at a risk of losing their competitive edge? Will anyone be prepared to reduce their renewal prices to remain competitive for new business? There are many uncertainties.
For a while at least the market dynamics may well be a little fluid, businesses will need to be agile, they will need to not only provide pricing that complies with the new rules, but that also enables them to react quickly to the differing strategies their competitors take.
Companies will need to have both the actuarial and technical capability to monitor and react quickly. Those that do will be able to make small adjustments to their underwriting models quickly and efficiently, and those who can react in real-time will have the greatest advantage of all.
At Nuon AI, our entire focus is on helping insurance businesses remain agile, our technology is designed to observe, learn and react to benefit both business and consumer.
Our artificial intelligence – AI – is an efficient way to provide real-time advantages.
Whilst actuaries focus on developing an insurer’s underlying risk appetite and pricing models, we recognise that it is really difficult for them to react to market demands or fine-tune the model on the fly.
This is an area in which AI can really support the business. AI can observe shifts in market behaviour as they occur and respond immediately, and this can all be done within the confines defined by the insurer’s underwriting model.
The learning that the AI gains can also provide incredibly valuable data for the business to consume as they develop future underwriting strategies and models.