The drive for consumer protection is seeing global regulators experiment with directly regulated prices.
In a nutshell:
- There are early signs of an emerging global trend towards pricing regulation in the insurance sector
- In the UK, the regulator has prohibited certain pricing models in the insurance sector. Recent discussions and steps taken by regulators in the EU and Australia reflect similar concerns
- If taken to extremes, could this undermine our market system?
Setting the price on value
Free markets are founded on parties being able to enter into a contract at whatever price they choose to agree between themselves. Intervening in this process warrants a healthy dose of caution. Yet we are seeing some emerging signs of a global willingness to directly regulate prices in the insurance sector, set within a wider global regulatory shift toward enhanced consumer protection.
Regulatory interference with pricing and product terms is particularly difficult in some parts of the insurance market. To select the risks that they want to underwrite and the price at which they are willing to take them on, insurers often need to differentiate. As a result, different prices are charged for different risks, which means that at least some forms of differentiation (or, depending on your point of view, potential discrimination) necessarily arise as part of the pricing process. While insurers could be required to price at the level of a population (which would remove discrimination), this would be a significant step that would likely have wide-ranging impacts on the affected market.
Financial firms in jurisdictions not yet affected by such interventions should expect that in the coming year, their regulators may contemplate whether similar steps are necessary and appropriate, and will wish to be ready to engage in any such debate at an early stage.
Concerns about regulators intervening in pricing are not new. Milton Friedman said in 1970 that nothing "could do more in a brief period to destroy a market system and replace it by a centrally controlled system than effective governmental control of prices and wages".
In the UK, however, the question seems no longer to be whether the FCA should intervene in pricing, but how far it is appropriate for the FCA to intervene. The FCA has moved to ban certain pricing practices in parts of the general insurance sector. In particular, “price walking” - the practice of charging a customer more (and sometimes considerably more) on renewal of a policy than would be charged on first purchasing the same product - is no longer allowed for home or motor insurance products sold in the UK.
The FCA's proposed new consumer duty raises the prospect of rules on pricing governance applying across the financial sector. While the details are yet to be finalised, the FCA's consultation paper said firms would need to be able to demonstrate that their products represent "fair value", a requirement that has already been introduced for general insurance products.
In Australia, the pricing of most general and life insurance products is not directly regulated, although the price of certain types of health insurance is. Some recent noteworthy developments, however, have strong correlations with regulatory themes in the UK and EEA.
The Australian Financial Complaints Authority (AFCA) is a non-judicial external dispute resolution service whose decisions are binding on member insurers, and whose jurisdiction expressly excludes disputes over the level of premium payable for an insurance product. Even so, AFCA has shown an increasing appetite to hear matters relating to insurance product pricing. AFCA has recently ruled that a significant premium increase on renewal for a home insurance product was “unfair”, and that the insurer should in consequence halve the amount of the premium increase, as the insurer had not demonstrated adequate evidence of flood risk to justify it.
Insurer practices exploiting elasticity, behavioural economics (e.g. consumer likelihood to shop around) and other non-technical factors in the determination of prices payable by consumers for insurance products have also raised concerns. Echoing FCA interventions in the UK general insurance market, the Australian Competition and Consumer Commission has criticised the lack of transparency over pricing strategies involving new customers routinely paying less than renewing customers – commonly referred to as a “loyalty tax”. Certain general insurance products must now include a specific disclosure comparing the expiring and renewal premium payable by a consumer. Australian insurers should be alive to the possibility that their regulators may go further in intervening in firms' pricing models.
Other non-transparent pricing adjustment strategies, including the calculation of discounts, have also attracted regulatory attention. The first litigation brought by the Australian Securities and Investments Commission (ASIC) against an insurer began in mid-October 2021 and follows a voluntary agreement by the insurer to provide some AU$375million in premium refunds to consumers in respect of self-reported failures to honour promised price discounts. Further ASIC litigation against other insurers is widely expected, following recent announcements that 7 other general insurers have also voluntarily agreed to provide premium refunds. Such ASIC actions have strong correlations with similar FCA enforcement, and reflect a general trend of increased willingness among regulators to take strong actions where there are perceived issues in the sales process.
Finally, a range of regulatory authorities and consumer advocates have called for insurers to provide more support to consumers experiencing financial hardship. This became particularly pressing during the severe economic downturn experienced in Australia in light of the Covid-19 pandemic lockdowns in 2020 and 2021, but it is not limited to the pandemic. Widespread unaffordability of home insurance for high flood risk jurisdictions in certain northern regions of Australia has led to a proposed reinsurance pool for cyclones and related flood damage to be backed by a Government guarantee. This proposal has similarities with the Flood Re initiative in the UK, which also addresses pricing issues resulting from flooding risks. While the consultation concluded in mid-2021, it remains to be seen whether the Australian reinsurance pool will be established.
In the EEA, EU-level legislation for the insurance sector does not seek to regulate the price charged for insurance. One would therefore not have expected EIOPA (which oversees how national regulators implement such legislation) to concern itself with price regulation. Nonetheless, insurer pricing has featured in some of its recent publications on artificial intelligence (AI), climate change and big data. Whilst these papers aim to facilitate consideration of some difficult areas, and may not necessarily lead to future regulation, some of the points made in the context of price regulation deserve careful consideration, particularly in light of other regulatory interventions described in this article.
EIOPA's papers express a fairly negative view of the practice of using AI to adjust premiums to reflect customers' willingness to pay: it asks whether insurers should be allowed to use AI and big data to maximise the price charged to any given customer; the use of factors that indicate a customer's greater willingness to pay is a particular concern.
Similar questions are asked about using customers' willingness to accept certain offers (e.g. a lower claim settlement or a change to the product without a corresponding change to the price). Unsurprisingly, these concerns are most pronounced in respect of vulnerable customers and products of vital importance, such as health and motor insurance.
The EIOPA papers also raise issues related to price discrimination and the extent to which it should be allowed. They recognise, for example, that pricing based on certain characteristics (such as race, sexuality and gender) is already prohibited in some countries but that national approaches differ.
For now, insurers (and, indeed, financial firms generally) should consider the position they want to take on these issues and the benefits of engaging on these points at an early stage. Forming a position is unlikely to be straightforward. A firm's view will need to take account of not just its position on pricing regulation, but also wider considerations; for example, the reputational risks associated with taking certain positions and the likely views of the firm's wider stakeholders. As it tends to be more difficult to influence the debate at the later stages, however, there are benefits in grappling with these issues now.