EIOPA’s supervisory statements are aimed at national regulators and their intention is to bring supervisory convergence on particular sector practices. That in itself is important, yet to achieve it, a balancing act is needed between the generic and the specific. Has EIOPA’s statement got it right? Does it equip national regulators with the right tools to address unfair pricing practices?
To answer those questions, let’s look at how EIOPA has positioned its regulatory thrust. There are three issues that stand out for me in terms of the positioning of that thrust.
The first issue relates to how they’ve scoped these differential pricing practices. Perhaps I’m just a touch on the simple side, but the statement seems to send conflicting messages. EIOPA positions ‘differential pricing practices’ as outwith of those relating to underwriting risk and cost of service. The examples they give are the customer’s price elasticity, their propensity to shop around and their further sales potential.
Yet elsewhere in the statement, there’s a clear expectation on insurers to make sure that their product governance arrangements are proportionate to their use of differential pricing practices. And given that certain types of differential pricing practices (such as price walking) are seen to present a high risk of producing unfair outcomes, the clear implication is that other differential pricing practices could produce fair outcomes.
Now I may have read too many pricing reports in recent years, but to me, the message coming out of this statement is that insurers can use pricing practices outwith of underwriting risk and cost of service. They just have to show that they’re doing so fairly.
Now some of you will be thinking... “yeah, so what’s the problem?”
Consensus on Fairness
This brings us to the second of the three issues. The problem is that this relies on both national regulators and insurers already working with a structured approach to fairness. And to be brutally honest, I don't think either have achieved that yet.
Take the UK market as an example. Insurers here have been under a regulatory obligation to treat customers fairly, and to run their business in a fair manner, for many years. Yet given the events surrounding the ‘loyalty penalty’, it was clear that neither the regulator nor the market had been addressing this with anywhere near enough rigour.
Without that structured approach to fairness, the market will interpret fairness according to its own interests, which invariably put combined ratios and GWP first. It’s the classic conflict of interest that’s at the heart of the market – profit versus fairness. Unless some way is found to reconcile the two within a market situation, approaches like those taken in the EIOPA statement will struggle to achieve traction in relation to outcomes (more here).
Good Enough Governance?
This brings us to the third and final issue, which concerns the potential for change to happen. In my opinion, the EIOPA statement relies heavily on two things. Firstly, the culture of both regulators and insurers being firmly supportive of pricing practices that are clearly fair. I think we’re some way to go on that.
And secondly, the statement relies on the governance arrangements at insurers, and the supervisory resources at regulators, being strong enough and robust enough to make sure that only pricing practices that have been judged fair are brought to market. Again, I think we’re some way to go on that.
Take the boast in 2019 by the then FCA CEO that they have the expertise and resources to get inside insurers’ pricing models and tackle discriminatory pricing. There’s been little to no evidence of this happening. Instead, the regulator appears to have kicked this particular can further down the road by promising that the problem will be addressed through the new consumer duty.
One way to weigh up the situation is through the example of age as a pricing factor. Consider these three points…
- the FCA found that age was the main factor around which most price walking had been taking place.
- age is a protected characteristic under equalities legislation, but that legislation also allows insurers to use age for underwriting so long as this is reasonable and based upon sound actuarial practices.
- age is something that the FCA and EIOPA recognise as an indicator of vulnerability, which changes the evaluation of how fair a pricing practice is.
Bring points 1 and 2 together and it’s pretty clear to the person on the Clapham omnibus that insurers have not been abiding by their exemptions in equalities legislation. Add in point 3 and you would expect that regulators (financial or equalities) would be challenging how insurers use age in pricing. Yet there is little evidence of this happening.
Has the sector’s lobbying to ensure that proposed EU legislation on equal treatment carries on those exemptions been successful? On the face of it, yes. It’s a lobbying success, at least in the short term, but what about the mid to long term? Could it turn into a pyrrhic victory? In short, yes. EU insurers should expect the EU to pull the plug on their exemption around age within the next seven years.
Read this passage from the EIOPA statement
“…the capacity of insurance manufacturers to determine the propensity to switch and price elasticity (at the) individual level will likely confer them a disproportionate information advantage vis- à-vis customers.”
It’s the first time that I’ve seen a regulator acknowledge that the digital transformation of insurance could introduce inverse selection into the market (more here). So while in the past, the insured was taken to know more about the risk to be insured than the insurer, now it is more likely to be the insurer who knows more about that risk.
This reversal of informational advantage sends all sorts of ripples out across how the market thinks and works. Long established principles like selection need to be revisited and new thinking introduced to ensure that that informational advantage is not unfairly exploited.
I didn't expect the EIOPA statement to pick this up and run with it in any detail. However, it is something that they clearly now need to pay attention to.
To Sum Up
The EIOPA statement ticks boxes but has insufficient clarity and doesn’t set strong enough expectations. In terms of that balancing act between generic and specific that I mentioned earlier, I think they’ve come down too much on the generic side.
To deliver on its intended impact, it needs to be supported in the following ways:
- be more definitive around how the fairness of a pricing practice is to be determined, and which ones should be defacto deemed unfair;
- draw a line in the sand around what constitutes an acceptable use of age in pricing, and what will happen if exemptions continue to be abused;
- address cultural issues around how national regulators think about and interpret fairness;
- raise expectations in national regulators around the robustness with which they should be addressing the fairness of pricing practices.
- explore the implications of inverse selection.
I said a few years ago that the loyalty penalty was the end of the beginning. The EIOPA statement seeks to be the beginning of the middle. There's still work to be done there.