Insurance has come under fire for the way it prices policies. Jonathan Davidson, director of retail at the Financial Conduct Authority, discusses the problem with Martin Croucher
In terms of its public image, the past year has been a rough one for the industry. Insurers have been slammed as “pirates” who are set on ripping off vulnerable customers and people from minority backgrounds.
The national media has been occupied with stories about elderly customers, who have seen their premiums rise at renewal every year they don’t shop around.
Insurers that reportedly quote entirely different premiums to the same customer, depending on whether the name is entered as ‘Mohammed’ or ‘John’ have similarly been censured.
The debacle has attracted the attention of the Financial Conduct Authority, which is currently in the process of carrying out its own investigation into insurer pricing.
Post sat down with FCA director of retail supervision and authorisations, Jonathan Davidson, to discuss the topic, as well as wider issues of Brexit, insurtech and the weight of regulation.
The first interest the FCA showed in the issue of pricing was back in 2015, when it launched a call for input on the use of Big Data in insurance.
A year later, in September 2016, the authority published a feedback statement to those inputs, finding “broadly positive outcomes” come from the use of Big Data.
To many, the issue was done and dusted. But not for the FCA. It has since then been working on a wider investigation into pricing practices at insurance companies.
“It evolved into the work on pricing,” said Davidson. “We have been looking at some of the factors that are being used and whether they are appropriate. That is one of the things that will be coming out, and we will be talking about, fairly shortly.”
He said the issues addressed were not only over dual pricing but some of the underwriting criteria that are used to price premiums, and whether they are fair.
“It’s not just the focus on differential pricing,” he said. “It is also about trying to understand the use and abuse of data. There have been some questions that have come up recently on what factors influence underwriting. We want to look at some of the factors and ask if they really make sense.”
Davidson said the majority of work so far has been preparing. “Quite a large number of companies have been working with us collaboratively and openly, to help us understand how it works,” he said.
“It has been really exploratory, to try and understand some of the phenomenon that everyone knows about. For instance, there are quite big differentials between the front book and back book pricing.
“We are trying to find if that is a market that is working well. You could argue it could lead to some very competitive pricing if you’re shopping around. But with vulnerable customers, or customers who aren’t able to shop around, firms really need to take that into account.”
He said the authority was still some way from a solution to the issue. “We’re a bit too early to say whether there are any remedies,” he said. “We’re still in the exploratory stage, understanding the scope and the causes of it all.”
2015 to present
Director of retail supervision and authorisations
Financial Conduct Authority
2013 to 2015
Member of strategic advisory council
2010 to 2012
Chief operating officer
Direct Line Group
1986 to 2009
McKinsey and Company
1982 to 1984
Business development in banking section
Davidson, a Harvard graduate, joined the FCA in 2015, around the time the call for input on Big Data launched.
Prior to that, he worked on the strategic advisory council of JLT. And, before that, he was a key player in the divestment of RBS’s insurance division and the formation of Direct Line.
However, his formative years were at McKinsey, both in the UK and in North America. His focus throughout his career has been on ‘big picture’ transformative work for companies.
When the opportunity to join the FCA came up, he saw it as an opportunity to adjust the wider, systemic issues that were impossible to fix with the narrow focus on individual firms.
“It made me think that, instead of doing transformation of individual firms, I get to actually do transformation of the whole sector,” he said.
He now has 45,000 firms under his watch, from a wide range of sectors from general insurance to retail banking. His mandate covers everything from major corporations like Lloyd’s down to tiny 10-person consumer credit firms.
That scope will likely eventually broaden out further when claims management companies likely fall under the FCA’s umbrella next year. Similarly the emergence of, and greater reliance on, insurtech has caused the authority to weigh up whether it should extend its reach further.
The issue of whether the Claims Management Regulator has sufficient teeth to regulate the freewheeling CMC sector was finally put to bed in June, when the Financial Guidance and Claims Act received royal assent.
The legislation paved the way for the transfer of regulatory responsibility for the sector to the FCA on 1 April 2019.
The FCA immediately followed up with a consultation on regulation for the sector, which was expected to be published on 3 August this year.
The paper revealed three main areas of focus for the authority: ensuring customers get a value-for-money service; ensuring that CMCs act within legal parameters; and regulating to ensure “high standards of conduct” for the sector.
At the time, the FCA’s CEO Andrew Bailey said a well-functioning CMC sector provided access to justice or redress for thousands of people, but regulation was needed to ensure customers were “protected and treated fairly”.
Davidson said some of the work the authority was doing on pricing had helped understand how CMCs can inflate insurance claims costs, and, therefore, premiums for customers.
He said: “I don’t think it’s a mystery that the industry has been very concerned about referrals to CMCs. A lot of these things have been going on for a long time, and we want to get the latest picture of what is going on.
“We’re not going in with a hypothesis. This is not a prelude to us taking action. What we really want to understand is how claims farming is working today.
“Let’s get under the skin of the business model and really understand what is going on.”
Another area that has attracted the authority’s attention recently is the emerging insurtech sector. In recent years there has been an increasing reliance of traditional incumbents on newer, more dynamic insurtech partners. And yet, the sector has so far remained off the FCA’s radar.
“Do I think it’s under-regulated? I don’t know if it is yet, but I am looking at it very closely,” said Davidson.
“There are increasingly activities that are being outsourced. Insurance is almost becoming an ecosystem. That creates challenges for the regulator. We want to make sure that in regards to the bits that present the biggest risk of harm to either consumers or the market, that we have some insight into or powers to manage it.
“We’re looking at it all the time, and trying to understand how that risk is evolving. We think it’s evolving quite quickly. It’s on our horizon, we haven’t concluded that it’s under-regulated yet.”
He said the basic rules still applied. Incumbents were still responsible for the parts of the business they outsourced. However, with offshore data centres used by insurtechs, it was becoming increasingly hard for incumbents to keep total oversight.
On the other hand, a common complaint is that the barriers for market entry are too high in the UK, which was stifling innovation. Davidson said the authority was pro-innovation, and had demonstrated that by introducing its sandbox, to help new insurtechs understand the requirements for the sector.
However, he ruled out lowering the requirements for entry. “Absolutely not,” he said. “The threshold conditions are inviolable. They’re not something where we decide we’re going to be tough for some and not for others.
“It is a minimum standard and everyone has to reach that. It wouldn’t be fair on existing firms to let in small challengers that weren’t being held to the same standard. We like innovation but it has to be a level playing field.”
Five words to best describe him
One of the more illustrative examples of the weight of regulation on the industry, was at the British Insurance Brokers’ Association conference in May.
“70% of Biba member firms have fewer than 10 staff,” he said. “For them especially, 1240 pages are just too much.”
Davidson admitted it was an issue the authority was keen to address, but it was currently an issue of manpower.
“We would like to make our rulebook and guidance as simple and easy to understand as possible,” he said. “Right now though, there’s very little we can do. Our whole policy effort and rule writing is totally consumed by the Brexit effort.”
In April the authority announced it will spend £5m on Brexit preparations in the year 2018/2019, with a total projected withdrawal cost of £30m.
Davidson said the preparations fell broadly into two categories, transcribing European Union laws into UK laws, and helping insurers with regulatory permissions to transfer books of business to the continent.
“We have to take a lot of European rules and transcribe them,” he said. “That process is very time consuming and it’s very important to get it right. That extra expense is primarily around all of the rules.
“Some of those things that have reference to Esma [European Securities and Markets Authority] and other things in those rules are non-operable. You can’t just copy and paste them. The whole focus of our policy and rule writing is on Brexit.”
He said there was no scope either to lighten the regulatory burden on firms by amending the EU rules as they are transcribed into UK law.
“Does Brexit pose an opportunity to revisit those rules? No. I say that quite categorically because if we start trying to rewrite the rules as we transcribe them, we won’t finish.
“We have got many years of European rules that need to be carefully analysed and transcribed into a UK-only setting. If we start trying to get into how we can improve them, we wouldn’t get it done in time.”
He said the authority was also working to minimise disruption to customers through a loss of the passporting arrangement with the EU.
He added: “Brexit does have a huge impact potentially in the insurance sector for several reasons, primarily because of more cross-border business than there is in some other sectors. We want to make sure that for firms passporting in, people aren’t suddenly affected by losing their services overnight if we have a hard Brexit and no more passporting.
“In any circumstance, if firms are required to passport in, we will have an interim permission regime, where firms can continue to operate for a period of time while they get ready to apply for a UK license.”
Davidson said the authority was also helping insurers that had relocated their European base of operations to the continent.
“We’re also conscious that a lot of UK firms are passporting out into Europe, including wholesale firms like Lloyd’s. As they’re getting ready, we’re trying to help them, because they’re trying to move books of business into different entities through Part 7 transfers. That’s a lot of work, so my team help them get that done so that they’re prepared for any outcome.
“We’ve got a steady stream of the large firms who are executing their contingency plans. I don’t think it’s dying down. We’re a year away, so firms are trying to get it ready right now.”
He said the authority had in all around 40-50 people working specifically on Brexit-related insurance supervisions.
Role of the FCA
The FCA has often been disparaged by brokers, in particular, as a dreary Death Star, whose existence is there purely to make the lives of intermediaries a nightmare.
Davidson said the authority didn’t view itself in that way.
“Our vision is that we’d much rather come along and pre-empt problems occurring, rather than come along later when a problem is something major and it’s really disruptive to fix it,” he said.
“When we think at a systematic level what causes things to go wrong, it’s normally in the business model and strategy of the firm. Or in the culture, or things that drive culture in firms.”
The majority of the work of the FCA, he said, is in protecting and empowering consumers. That is a mindset he wishes would percolate into boardrooms of major insurers and brokers.
“The biggest message is to really think about their business model and how it works,” he said. “What risks might that create, not for a breach in rules, but of harm coming to customers.
“Compliance is better than nothing at all. But instead of a compliance culture, I would like to see the industry to be customer centric. And that not to be a function of ticking boxes for the FCA, but of doing the right thing for consumers.”
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