This article was Originally published on Thomson Reuters Regulatory Intelligence here.
Everyone needs access to essential services such as insurance, payments systems, credit and energy, yet these markets are designed to cost more if someone is poor. Low-income consumers pay more for products and services, spending on average an extra £478 — the equivalent of 14 weeks’ food shopping — just to access the same essential services as those who are better off. This is known as the poverty premium, and the insurance market has become a huge contributor to it.
Motor insurance is a case in point. Those with a car are legally obliged to have insurance. The need to use a car does not diminish just because someone is on a low income. A car is often essential, for getting people to work, or enabling them to visit loved ones, and it is often the only form of transport suitable for some disabled people, yet the poor are charged a premium. People in less affluent areas are hit by a postcode penalty and can pay almost £300 more a year than others living in more affluent areas. If they pay monthly, this can mean an extra £160 or so on top, amounting to approximately £460 simply because they are poor, and seen as riskier and costlier to serve.
The use of the term “seen” is not a casual choice of words. It is unclear whether these long-held assumptions across the financial services industry — that low-income customers represent higher risk and cost — always hold true.
A new research report into insurance and the poverty premium was launched in March by the Social Market Foundation and Fair By Design. It was based on a survey of more than 1,500 adults from low-income households in the UK, as well as focus groups with people living in poverty and interviews with experts. It found that the poverty premium in insurance can be driven by two factors, each requiring a different form of intervention to solve. These factors are cost and non-cost reflective pricing.
If costs are truly reflective of risk, then a social policy intervention is needed. This is because the market is acting “rationally” — pricing accurately and offering the best deals to the best “risks”. If not, a regulatory intervention is needed, to ensure that the market is working “rationally” and is “fair” in terms of competition and decisions based purely on risk.
The main problem in terms of anyone taking responsibility for addressing this access and affordability issue is the opacity of insurers’ pricing models. This has resulted in inaction by the government and by the regulator, the Financial Conduct Authority (FCA). Before it can intervene, the Treasury wants information on how accurately the market is pricing risk — which only the FCA is able to ascertain. The FCA does not, however, feel required to act, as it points to this as a social policy-related issue. As a result, both the government and the regulator play “policy ping-pong”, shifting responsibility to each other.
The new Consumer Duty
Most in the industry will be aware of the FCA’s new Consumer Duty. It aims to raise the bar in terms of consumer treatment and protection. The wide-ranging proposals will require firms to consider changes in areas including product design and pricing. Many are heralding it as the new silver bullet to ensure good outcomes for consumers, and indeed it may well have implications for the insurance industry when it comes to tackling the poverty premium in insurance.
There are two main elements of the poverty premium in motor insurance: being charged more for where a person can afford to live, and being charged more for being unable to pay for insurance all in one go.
The Consumer Duty is likely to affect the latter. Firms will need to ensure that their products offer value for money for low-income customers. It has been argued that the cost added to people’s policies for paying monthly may not be in line with the actual costs to service this method of payment, especially as an insurer can cancel an insurance policy as soon as a person stops paying. This is an area which the author believes will sit within the FCA’s appetite to act upon, as part of the new Consumer Duty.
In this regard, therefore, the new Consumer Duty is to be welcomed, and the author urges insurers to take note. A non-cost reflective premium here would suggest that the market for those on lower incomes is failing to function “efficiently”, and that regulatory intervention may be needed to ensure firms are delivering value for money for lower-income consumers.
The Consumer Duty falls short, however, when it comes to addressing the bigger part of the poverty premium for those on the lowest incomes. The Consumer Duty primarily deals with existing customers and those consumers to whom markets want to sell. If a firm can justify charging higher prices due to higher risks, the problem remains. As the FCA’s Consumer Duty guidance says:
“The specific focus of the price and value outcome rules is on ensuring the price the customer pays for a product or service is reasonable compared to the overall benefits (the nature, quality and benefits the customer will experience considering all these factors) …
… It also does not mean that firms are expected only to offer products and services at a low price …
A product or service that meets all of the other elements of the duty (for example, if it is designed to meet the needs of its target market, is transparently sold, customers are able to exercise choices to switch or exit, and are properly supported) is therefore more likely to offer fair value.”
As exemplified in the quotes above, the Consumer Duty does not address the needs of those whom the market views as more expensive and less profitable to serve and who are, sometimes, excluded because of this. It means that markets that are getting better at judging risk at an individual consumer level can continue to chase, ever-more efficiently, those who are best-placed to make them a profit — or the best “risk”.
In other words, the insurance market can continue to chase the healthy and the wealthy. Despite motor insurance being mandatory, the Consumer Duty does not appear to be able to interfere with the market acting “rationally”.
This leads to the recommendations made in the SMF research report mentioned above. With a complete stalemate when it comes to addressing the poverty premium in insurance, the logical option is to try to understand the main drivers of the poverty premium in risk pricing.
Only then will it become apparent what interventions the regulator needs to make, and what needs to be addressed by social policy: whether to make car insurance a luxury only for the well-off, or to ensure that insurance is provided based on need.
The author has been playing this “policy ping pong” between the Treasury and regulator for far too long. As the cost-of-living crisis deepens, tackling such premiums becomes more important than ever. Now is surely the time for the industry referee to step up to the mark and create a win for those whose voices are least heard, yet who are the hardest hit.
Martin Coppack, director, Fair By Design