Competition and insurance

Martin Wheatley reflected[1] this morning on some of the future challenges and opportunities in the insurance sector; he outlined how working together is mutually beneficial for both the industry and the regulator and will ultimately achieve positive outcomes for consumers.

You also heard from Clive Adamson[2] how in the new regulatory dictionary, we have swapped compliance for culture, replaced tickboxes with outcomes and written ‘consumer’ at the top of every page.

This morning I want to take these sentiments further and explore how our competition remit will influence the relationship between the regulator, industry and consumers, and what this means for the general insurance sector.   

The language of competition challenges many to think outside of our individual comfort zones, in a way that the regulator and many parts of the industry haven’t been used to historically. To do this we are asking different questions, expecting different answers and proposing different solutions.

The vision is simple:

• we need to create a market where there is a regulatory framework and infrastructure that supports competition
• where firms compete on providing the best products for consumers, and
• where consumers have real choice and receive the products that meet their needs at a competitive price

However, the practice may be more complex.

We have to look at old problems with new lenses, new powers and new perspectives and it is some of these new perspectives I want to share with you today.

To do this, I want to take a look three things:  

1. First, what we expect from competition as the FCA, what our competition remit entails, the tools we will be using and the powers we have at our disposal.
2. Second, how we are starting to apply these tools by using our market study into GI add-ons as an example of our new approach in action.
3. And, what we will have to do as a regulator and an industry to promote competition in the interest of consumers.

Expectations and tools

When the consumer comes first – it changes everything – we see dramatic improvements in product quality, service, price and ingenuity.

To the first, I will start with a simple quote from the FCA’s objectives under the Financial Services Act 2012. It says the objective of the FCA is ‘promoting effective competition in the interests of consumers in the markets for regulated financial services’.

There are a few words to highlight.

First, ‘promoting’. That means not just waiting for problems to occur, but being proactive about how we encourage competition, new entry and try to address issues before they become entrenched problems.

Second, ‘in the interests of consumers’.

In short, a powerful driver of good conduct and good outcomes for consumers is effective competition. Competition is crucial to conduct because when firms have to work hard to win business, the consumer always comes first.  

When the consumer comes first – it changes everything – we see dramatic improvements in product quality, service, price and ingenuity.

In fact, some argue that competition is so powerful that if it were working well in an industry there would be no need for a regulator – in theory, customers vote with their feet, leaving behind firms that did not put them first.

In practice, most regulated industries – telecoms, energy, financial services – are far from being in this position.  Moreover, the underlying nature of some financial services (complex products with long lives and or contingent payoffs), means there are very real limitations to what competition alone can deliver.

If you only discover that you bought the wrong insurance after your house has burned down, your freedom to insure with a different company next time provides little consolation.  

So, I don’t see competition replacing regulation in financial services.  But I would like to see a rebalance over time – to see the market delivering more of what the customer wants, with the potential for less intervention – or at least less detailed intervention – from the regulator.

To help us achieve that, we can use the full range of FSMA powers including directions to firms or re-writing our rules. From April 2015 we also take on the full suite of concurrent competition powers and so we have the ability to investigate and enforce using the Enterprise Act and Competition Act.

We are also taking a hard look at ourselves, both in terms of the work we have already done and will update this year on barriers to entry created by our authorisations procedures, and looking at how we promote competition in our wider Handbook.

This brings me to my second point.

Market studies

But the main tool we are using to promote competition is our programme of market studies.

What do we see as our role in promoting competitive markets?

Essentially, we are here as a facilitator, we want to work with consumers and market players to improve competition in financial services.

We want competition to drive improvements in product quality, service and price.

To do this we will be shedding light on the markets where competition is hampered by opacity, or market structure, looking at business models and behaviour of firms and their customers, to help break down the barriers to effective competition and open the game to new players.  

We will use market studies as a tool to examine issues in the market that can prevent competition being effective. These issues can include barriers to entry and other supply-side problems as well as demand-side information issues and the way that firms respond to consumer behaviour patterns.

I wanted to turn now and talk a little about our first market study where we looked at the ‘add-on’ mechanism, across five different general insurance products to access whether competition was working in the interests of consumers.

While our detailed remedy design work is ongoing and we are still analysing the points made by consultation respondents, there are already a number of key take-aways from the GI add-ons work that help demonstrate the way we’re thinking about competition.

The first key take-away is that information matters.

Historically, this has tended to be interpreted as quite legalistic disclosure and where, if consumers didn’t seem to understand the obvious answer, was to give them more.

However, as marketing folk have know for years, the way information is presented – not just the facts themselves, can completely change the way we understand it.

In our competition work we will use behavioural economics to better understand understanding how consumers actually behave in markets rather than focusing more on how economic theory tells us consumers are likely to behave.

In the general insurance add-ons study[3] we looked closely at not only at what information was available but how choices are presented and how this affects consumer behaviour and decision-making.

Specifically, we carried out an innovative behavioural experiment stimulating the add-on sales process to understand how it affects their choices.

In the case of GI add-ons consumers were up to five times more likely to make mistakes and buy products they did not want or need, just depending on how choices were structured.

The second-takeaway is we will look for ways to try and make markets work that are realistic and proportionate.

One product that really stood-out in the study was guaranteed asset protection (GAP). In general, the public buy this in a showroom with the car dealer who has just sold them their shiny new car.

There are lots of behavioural issues that mean the purchase may not be the best deal for the consumer. It’s sold in reference to a much bigger purchase – the new car. Often consumers are under the impression this is the only place to buy it.

On average policies purchased online cost about a third of the showroom price, but are relatively unknown.

So we knew there was a problem. We could have chosen an outright ban, but we know some consumers have claimed on the product and some value the peace of mind. So instead we are proposing a way to make the market work better to ensure that consumers know other deals are available when they buy GAP face-to-face and a positive confirmation required after sale that the consumer really wanted the product.

The third takeaway is a focus on value.

I want to be crystal clear here – this does not mean that we want to regulate prices.  In fact, regulating prices is normally the last thing any competition authority wants to do.  However, we are interested in price as an outcome and what the prices we see can tell us about how well the market is working.

It also means that we think transparency around pricing and value is important – we will be taking steps to address hidden, complex or opaque pricing practices, and to shine a light on value for money.

Before I elaborate on value for money, let me just acknowledge we accept that general insurance products are somewhat different from many other financial services products, or from general goods and services people buy. People buy insurance to appease those ‘what if’ thoughts. They buy for peace of mind and the comfort of knowing that if things go wrong some one will be there to help them out.

So peace of mind is important. As are other factors. For example, consumers rightly value the service they may get. How they are treated when making a claim in what are often times of severe distress can make all the difference to alleviating or exacerbating anxiety. Equally it’s quite hard to experience without making a claim.

But let’s not forget that consumers are also parting with their hard-earned cash to pay for insurance. So general insurance products have a financial value too, and this is an area we will want to focus on more. We believe that at the moment there is no common or consistent method for measuring the value of insurance products, and there is not enough focus on the  value of products, both in financial terms, but that may also give a clue about the overall approach of the firm.

We consider that the claims ratio – which is broadly the amount paid out in claims as a percentage of what is received in retail premiums – is a useful measure of the value of insurance products.

I’d be the first to recognise that the claims ratio in and of itself isn’t a perfect measure, but it is a good enough proxy to start to make progress.

Our GI add-on work highlighted some instances of very low average claims ratios - as low as 8% or 9%.  We believe that our proposed requirement to publish claims ratios would shine a light on poor value.

It should prompt firms to ask themselves what is causing this seemingly low value.  Is it something about the product itself?

Are there features or terms and exclusions that stop consumers from claiming?

Is it distributed in a way that means it reaches people who are unlikely to claim?

For whom it is not the right product?

Who might buy it as an add-on without realising they own it all?

This latter question may seem far-fetched, but in our consumer research, we found 19% of add-on buyers had no recollection of owning the product only two to three months after buying.

This is something that has to change.

We take a broad view of value, and recognise that price is only one dimension.  I don’t believe there is a magic formula for calculating good value. A product that will be good value for one customer may prove poor value to another and context will be crucial to making this distinction. We won’t set an absolute threshold above which a product is OK, and below which a claims ratio is deemed poor.  But we do want it to be a lot more transparent.

There may be a genuine reason why a product has a low claims ratio. But if so, we want value to form part of the sales discussion, to be something firms place front and centre when they think about putting consumers at the heart of their businesses.

Challenges for the regulator and firms

We know that getting to markets where competition works more successfully won’t always be easy.

Sometimes we will have to use our formal powers. However, there is a lot the industry can do to work with us.

For example, we have started to conduct significant research into how smarter disclosures in renewal letters impacts decision-making. We want to understand how consumers act in response to different types of information and are using behavioural analysis to help understand how different information in renewal letters can prompt consumers to make more effective choices.  

To do this we are working with a small number of firms, some of whom are here today, to run a series of randomised control trials with modified renewal letters. I can’t go into much detail at the moment as the first of these experiments is currently live and I don’t want to inadvertently prejudice their results.

However, we hope that all of the trials will be completed early next year and we will be able to share our findings soon after. We hope that this work will give us insight and evidence in to what makes for better or more effective disclosure.

As I mentioned earlier, looking at competition means examining barriers to entry and over the past year as a regulator we have had to challenge ourselves to thinking how far our rules or procedures can be part of the problem.

We won’t get this all right on own.  We are already forming strong bonds with the new Competition and Markets Authority.  We also need industry practitioners like yourselves. I want to thank all those who have already been involved in our trials and engaged with consultations. This type of collaboration is an example of the mutually beneficial relationship that Martin Wheatley reflected on this morning.

We also recognise that promoting competition means reaching out and listening more intently to some different voices in the market, to potential entrants and innovators that we don’t regulate, but who could disrupt the status quo and improve competition in general insurance and other sectors.

To conclude, I really hope this speech has provided a little more insight into what we are trying to achieve through our new competition objective and how this is particularly relevant to the general insurance market.  

As a regulator, we are at the beginning of a new era where we have a powerful new mandate to promote competition in the interest of consumers.

Ultimately, competitive markets with firms innovating to serve the needs of their customers, and those customers rewarding good firms with profits should be a win for everyone.

I would very much hope firms will seize the opportunity and be part of that - to think about the products you are bringing to market in light of the issues I have talked about today.

Potentially, that could be a very different and better place to do business.