Price walking in the insurance market
The basis for non-life insurance is that the premium should be proportionate to the risk. However, investigations in the UK, Ireland and, recently, Sweden show that loyal policyholders have to pay more than new policyholders. The phenomenon known as price walking is a form of price discrimination, i.e. a price differentiation that is not justified on the basis of risk. EIOPA now intends to take measures to prevent this type of price discrimination.
According to investigations carried out by regulators in the UK and Ireland, insurance companies raise prices for loyal policyholders more than newer policyholders[1]. In these countries, measures were recently introduced in the consumer insurance market to counter such unfair pricing, known as price walking. EIOPA has recently indicated a greater focus on the area with the aim of strengthening consumer protection by preventing unfair treatment of consumers and promoting convergence in the supervision of differential pricing practices. Further, Finansinspektionen (the Swedish FSA) has in a review[2] shown that also in Sweden, loyal policyholders are affected by unfair price increases for home and homeowners insurance and therefore intends to take action.
Should similar rules be introduced on the insurance markets in the EU, it could have a major impact on insurance companies’ operations. In addition to adaptations of pricing models, systems and processes, there are also more long-term aspects concerning the companies’ business models to take into consideration. Understanding early on how the business can be affected therefore becomes important. There is an opportunity for the industry to take advantage of upcoming changes and do something that benefits the companies’ brands, the customers and the industry as a whole. Potential risks of not acting on time are a longer starting distance for future regulatory changes, reputational risk and reduced customer confidence.
This article explains what price walking is, what has happened in the regulatory area, expected actions from supervisory authorities, expected impact on the insurance markets and the value of avoiding price discrimination of loyal policyholders at an early stage.
How does the phenomenon of price walking arise and is it allowed?
Price walking occurs when a company continuously raises prices at renewal, which normally occurs once a year for non-life insurance customers. The result is that loyal customers have higher margins than newer customers. Price walking can also be followed by various ways by companies to make it unnecessarily difficult for customers to turn down a renewal or to find out what price they would be offered if they were a new customer. As margins continue to increase, the most loyal customers are hit the hardest, as confirmed by reviews by regulators in the UK and Irish markets and also by an in-depth study by Finansinspektionen in the Swedish insurance market.
Price walking is not the same as a price increase on renewal. It is not price walking when a price needs to rise upon renewal because of changes in underlying risk and the margin remains reasonably constant. Price walking occurs when margins are systematically increased at multiple renewals without increasing underlying risk.
In the EU, there are no legal requirements that the price must correspond to the insured risk. On the other hand, it follows from the Insurance Distribution Directive (IDD) that an insurance distributor must take care of the customer’s interests and act honestly, fairly and professionally[3]. Loyal policyholders within the same risk group receiving higher premiums can therefore be considered to be in conflict with the requirement that customers must be treated fairly. Furthermore, Finansinspektionen believes that pricing where loyal customers pay higher premiums in relation to the risk they pose entails a great risk of reduced trust in the insurance industry. In turn, this may mean that some customers may refrain from getting the insurance they need.
What is happening in the area of regulations?
EIOPA has recently drawn attention to the area of differential pricing in general and the problems surrounding price walking in particular. In July this year, a three-month long public consultation was therefore launched on a draft supervisory opinion on differential pricing in the non-life insurance industry[4]. EIOPA mentions that the objective of their supervisory opinion is to 1) ensure that differential pricing practices do not lead to unfair treatment of consumers; 2) promote good practice in supervision. In its supervisory opinion, EIOPA identifies five different types of possible measures to address these objectives:
- No action (maintain status quo)
- Develop a thematic review of differential pricing practices
- Develop a Supervisory statement on differential pricing practices
- Develop a warning on differential pricing practices
- Ban on differential pricing practices
EIOPA mentions option 3 as the preferred measure to meet the objectives. They mention that option 1 will not strengthen consumer protection, especially for more vulnerable groups such as the elderly and low-income individuals. Option 2 would provide further clarity on the extent to which differential pricing is used across the EU, but EIOPA considers that the data collected so far are sufficient and that such an investigation would delay appropriate measures to strengthen consumer protection for an unnecessarily long time. Options 3 and 4 are considered to produce similar results, but option 4 could generate unjustified warnings in the sector as some consumers benefit from differential pricing through e.g., new business discounts. Option 5 is not considered to be the most appropriate measure because it affects customers’ ability to take advantage of offers via other insurance companies through e.g., the mentioned new business discounts. EIOPA mentions that option 3 can clarify that differential pricing practices which have a higher probability of causing consumer detriment, such as price walking, will be discouraged.
EIOPA points out that the Insurance Distribution Directive (IDD) and the Product Oversight and Governance (POG) requirements provide a regulatory framework covering the use of differential pricing. What EIOPA intends with a future supervisory opinion will therefore be linked to this framework and clarify expectations from a supervisory perspective.
In Sweden, Finansinspektionen has investigated whether loyal policyholders have to pay higher prices when it comes to home insurance, homeowners insurance and car insurance. These non-life insurance products are of great importance to consumers. The review shows that prices for home insurance are raised significantly more for loyal customers than for new ones. For homeowners insurance, prices are also increased more for loyal customers, but not for car insurance. For home insurance, the analysis showed that customers with the longest duration have had the premium increased 6-10 percent more than the average customer, while the corresponding figure for homeowners insurance was 3-4 percent more than the average customer.
It is generally difficult for a customer to understand how the companies’ set prices and even more difficult to determine what is too high a premium in relation to the risk. Finansinspektionen believes that the prices should reflect the risk posed by the insured and the insurance companies’ expected costs. Based on the review, Finansinspektionen considers that there are compelling reasons to take measures to counteract unjustified and unfair price increases for loyal policyholders. Finansinspektionen states as a measure that it wants to have a dialogue with the industry regarding pricing, and to follow how EIOPA and other member states choose to handle the issue.
It is not unreasonable to assume that both EIOPA and the supervisory authorities of the member states will be affected by how the issue has been handled in the UK and Ireland. In its review, Finansinspektionen refers to the rules that have recently been introduced there as a result of similar reviews. The UK Regulator (FCA) found through its review that six million policyholders paid rates that were more than 50% above the average for a group of customers with similar risk. They found a clear correlation between price and the number of times a customer renewed with the same insurer. The excess amount above average paid by these customers stood at £1.2 billion.
Since then, the FCA has implemented rules to deal with price walking that are completely unique in the world. Of particular interest in these rules are the pricing remedy and the reporting remedy, which mainly affect insurance companies (including intermediaries) offering home and motor insurance to consumers.
The pricing remedy came into effect on January 1, 2022. It requires that the renewal prices cannot be higher than the equivalent new business prices (but they can be lower). From all companies, the FCA also requires an annual attestation where a senior officer personally states that the rules are being followed.
The reporting remedy requires insurers to submit reports on key performance indicators by tenure to the FCA. This will likely have an impact on companies’ current reporting processes since the FCA requires information in new and special ways.
The proposed rules do not prevent firms from giving cash discounts to customers at new business, as long as these discounts are reflected in the equivalent new business prices when setting the renewal price.
In other countries too, it has been concluded that price walking must be dealt with, and various measures have been taken. In addition to the measures introduced in the UK and Ireland, the following are examples of different ways of regulating price walking:
- Requiring insurers to explain how their premiums are calculated and common reasons for increases.
- Including premium increase or previous premium information on the renewal invites.
- That customers should receive a breakdown of the premium, which shows how much is paid for each component. This could be for different policies or covers.
- Requiring insurance companies to publish rating factors and segmentation in a way that customers can understand.
- Standardization of definitions and products between several companies – thus, the regulator decides what to include in a policy to make it acceptable to customers.
- Publication of complaint information showing the most common reasons for customers’ dissatisfaction with various companies.
What effects would measures that discourage price walking have in the insurance market?
It is still too early to comment on the impact of the measures in the UK and Irish markets. However, there are a few expected effects that would probably occur in the insurance markets in EU if measures that limit price walking were introduced.
Profit margins will be pushed downwards: In the short term, limiting the possibility for price walking practices would affect insurance companies’ profit margins. When the companies’ leverage to differentiate on price between existing and new customers is removed, they will no longer have the same opportunity to charge larger margins from loyal customers.
Improved renewal rates: The willingness of customers to change insurers upon renewal will decrease as the price difference between renewal price and new business price decrease. This would partly compensate for the lower margins, especially for the more established companies.
Price competition will decrease: As there will be limitations on how insurance companies are allowed to set the prices, companies need to find alternative ways to differentiate themselves in the market.
The UK market is one of the most competitive markets in all of Europe and is characterised by price comparison sites (also called aggregators) where price often becomes the deciding factor when the customer buys insurance. In the Nordics, the market is not as competitive, and although price comparison sites exist in some of the countries, several companies are not represented. It is therefore possible that these effects would not be as strong there.
Not all insurance companies will be equally exposed to the consequences of limiting the possibility for price walking practices. The company’s position in the market, the extent to which the company targets competitive product areas and the presence on e.g. price comparison websites create different conditions for the companies. In the Swedish and Finnish insurance markets for example, there are relatively many mutual (customer-owned) insurance companies. Even though the study by the Swedish FSA did not show any significant differences in the pricing depending on the type of company, for-profit companies largely use more or less advanced methods for analyzing price elasticity and price optimization in their pricing strategies, which may mean a longer way of adapting to rules that limit price walking practices.
How can insurance companies prepare?
Forthcoming changes entail both challenges and opportunities for insurers. For the companies that prepare well in advance, there is the opportunity to lead by example, create long-term customer trust and strengthen their brands. Not acting on time is instead associated with reputational risk and reduced customer confidence, while the starting distance for future regulatory changes becomes longer. There are already today areas that are important to review.
Review and adapt business and pricing models
It may be of value for companies to review their business models today and assess the extent to which price walking occurs in the portfolios.
Long-term customer relationships become more important when price becomes less important in competition with other companies. A major challenge is therefore how the companies’ pricing reflects the customers’ lifetime value right from the start of the customer journey, by using sophisticated pricing methods and by taking changes in the market into account. Particularly important for profit-making companies is the balance between keeping existing customers and acquiring new customers based on costs and price elasticity.
The companies’ pricing models, or tariffs, will also need to be reviewed. The companies usually have different tariffs for renewals and new business, which can mean that several adjustments are needed. One way for the companies to manage reduced premium income on renewals can be countered by more granular and targeted pricing. This may mean that those who pose a higher risk, e.g. young drivers regarding car insurance or households in high crime areas, get higher rates than before.
In addition to price walking, there are also other forms of price discrimination which companies need to be aware of, such as situations where protected information can be inferred from non-protected information with correlations. For this reason, future pricing would likely need to a greater extent consider protected policyholder characteristics that are not allowed to be used for insurance pricing, to not have pricing that results in indirect discrimination by proxy. Discrimination-free pricing is a current international research topic, which FCG covers in upcoming articles.
Improve model governance
Model governance refers to the overall framework for managing model risk (the risk that models are incorrect, used in the wrong way or do not meet internal or external requirements), a framework on which higher demands are placed as the supervisory authorities increase interventions in the area of pricing. Boards and management teams should therefore establish appropriate principles for pricing and have clear oversight of activities and their results. In the long term, it is not unreasonable that pricing teams within the companies will need individuals with competencies in both pricing and regulatory compliance.
Increase focus on innovation to achieve competitive advantage
If price is no longer as decisive a factor, it becomes important for companies to create added value in other ways. Creating good customer experiences is a way of strengthening the long-term nature of customer relationships. That the companies have smooth processes for buying insurance, handling claims and customer interactions will become increasingly important aspects for the companies to focus on. Moreover, product innovation can be an area for companies to stand out from the crowd. For example, offering more tailored products that enable customers to buy the protection they need can be a way for the companies to reach a stronger position in the market.
What’s next?
Differential pricing and price walking is an area that has received increasing attention from EIOPA and other supervisory authorities. For insurance companies, it will be particularly important to follow EIOPA’s results of the consultation regarding the supervisory opinion on differential pricing in the non-life insurance industry.
Furthermore, it may be appropriate to review business models and pricing strategies right now. A feasibility study to analyze whether and to what extent price walking occurs in the company as well as the impact on processes, business models and pricing models given that adjustments would need to be made in the future can give an important head start in the market.
At FCG’s Insurance Forum on October 11 in Stockholm, we will report on the latest developments in the area. Sign up for the forum here (Swedish).
[1] FCA. (2021). General insurance pricing practices market study Feedback to CP20/19 and final rules. https://www.fca.org.uk/publication/policy/ps21-5.pdf
[2] Finansinspektionen. (2022). Får lojala försäkringstagare betala mer?. https://www.fi.se/contentassets/cb09f3ae4d964572be187b9726371ea4/rapport-lojala-forsakringstagare.pdf
[3] Directive (EU) 2016/97 of the European Parliament and of the Council of 20 January 2016 on insurance distribution. Official Journal of the European Union (2016). https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:02016L0097-20200612&from=EN
[4] EIOPA. (2022). Consultation paper on Supervisory statement on differential pricing practices in non-life insurance lines of business. https://www.eiopa.europa.eu/document-library/consultation/consultation-supervisory-statement-differential-pricing-practices-non_en
