European personal lines insurers are eager to understand exactly how EIOPA’s (European Insurance and Occupational Pensions Authority) planned recommendations on differential pricing practices will affect their business models – and look set to get the pertinent answers they need in the New Year.
EIOPA issued a draft supervisory statement on differential pricing practices and launched a three-month public consultation period, which closed on 7 October. The plan is to publish its final supervisory statement in January 2023.
The recommendations outlined in this statement are highly anticipated because, depending on how robust a stance EIOPA takes, they could have significant impact on how insurers across the whole of Europe price business and compete.
EIOPA defines differential pricing practices as techniques in which consumers with similar risk and cost of service characteristics are charged different premiums for the same insurance products. This, it said, has been going on for some years and is a growing phenomenon in several member states.
EIOPA highlighted one practice known as price walking – offering new customers heavy discounts then upping prices at multiple renewals – as having a particularly detrimental effect on policyholders who are unlikely to switch providers.
Not only does price walking unfairly penalise loyal customers but it can also disproportionately affect vulnerable groups such as the elderly, EIOPA said. For these reasons, price walking is likely to be a key focus in EIOPA’s recommendations – just as it was in recent reforms in the UK.
From 1 January 2022, the UK Financial Conduct Authority implemented a game-changing Pricing Remedy which mandated that renewal premiums for home and motor insurance must not be higher than premiums offered to new customers. It also introduced a Reporting Remedy which requires insurers to submit granular annual reports demonstrating compliance, adding significant paperwork for insurers.
The level of pricing differentiation being employed by insurers – and the extent to which it is policed – varies across Europe from member state to member state. However, a trend of increased oversight is emerging, with the likes of the German The Federal Financial Supervisory Authority and the De Nederlandsche Bank in the Netherlands, issuing robust actuarial guidelines and the Central Bank of Ireland the latest supervisor to propose changes to eliminate price walking.
EIOPA looks set to only issue its recommendations as ‘guidance’ so each member state’s supervisory body must decide how far to go in the implementation. However, history suggests supervisors and insurance companies will fall in line.
Implications for insurers
Earnix clients in Europe acknowledge the benefits EIOPA’s recommendations are likely to bring – namely increased protection for consumers and leveling up the playing field of actuarial approaches across the member states.
However, firms operating in countries where robust ethical rules and actuarial practices are already in place are concerned the recommendations could add a significant regulatory burden while bringing only marginal benefits to consumers.
If EIOPA recommends a similar regime to the FCA, in which new and renewal business must be priced the same, this will require a significant investment of resources by insurers to update everything from pricing algorithms to customer communications, in addition to increased reporting.
It would also have an undoubted impact on competitive dynamics. A year into the reformed pricing rules, UK insurers appear to have shifted their focus to sustainable, long-term profitability over short-term growth; Earnix clients report a significant increase in renewal business and a sharp fall in new business as discounts, with far less incentives being offered to new customers.
A similar environment could be on its way in Europe, with insurers having to think twice about any sort of price reduction, incentivisation or bundling of certain products if changes they make need to be replicated across their entire customer base.
Fairness goes beyond price walking
alt-text: aerial view of cars on a highway intersection symbolizing the fairness of price walking practices
EIOPA also said it is concerned that the algorithms behind these practices may be modeling non-risk-related drivers including socio-economic factors, consumers’ inertia and consumers’ willingness to pay for certain products or services, which are largely independent from the customer’s risk profile.
Our clients are keen to get more clarity from EIOPA on how non-risk-related pricing factors will be considered in the recommendations. Insurers need to be extremely cautious of using protected characteristics in their pricing methodologies and processes in case biases creep in that unfairly penalise people for factors out of their control.
At the same time, the line between ‘risk-related’ and ‘non-risk-related’ can sometime be blurry – and it is unclear at this stage, whether EIOPA will place equivalent emphasis on risk-based and non-based factors in its recommendations.
It also remains to be seen how EIOPA will consider incentives and product bundling within its recommendations. The FCA reforms effectively ended cash and cash-equivalent incentives on new business as insurers would have to roll any incentive out to renewal customers too, making the practice economically unfeasible.
Business models in the spotlight
With less competitive tools at their disposal, insurance companies whose growth strategies have historically focused on targeting new customers through a combination of competitive pricing and incentives may need to re-evaluate their tactics.
Given the huge impact inflation is also having on the claim environment too, 2023 will put all insurers’ pricing tools, strategies and algorithms to the test as they strive to protect their bottom lines. Those firms who can intelligently segment customers who are better risks while operating within the boundaries laid out by EIOPA will put themselves at a distinct competitive advantage.
What was clear from our clients is that having the right technology in place is of paramount importance from both an underwriting performance and regulatory compliance perspective. At Earnix, we are finding more and more relevance in recent research from Accenture, which stated: “With intelligent operations, insurers can reach new levels of operations maturity to choose smarter, act faster and win sooner. It’s about becoming future-ready.”
The industry will take an important step closer to understanding the exact nature of EIOPA’s recommendations, and the changes they’ll need to make, in the New Year