The Final Report
On 24 July 2014 the FCA published Market Study 14-1: General Insurance Add-Ons: Final Report – Confirmed Findings of the Market Study.
This followed the March consultation of the FCA’s Provisional findings and proposed remedies, and the regulator has since considered the feedback received. The FCA notes that “[o]nly a small number of respondents were critical of our general conclusion”, but concludes that this “does not challenge our overall conclusion”. The “majority of feedback … focused not on findings but on our proposed remedies”.
MS 14-1 was the first OFT-style Market Study carried out by the FCA under its new competition powers, and in pursuit of its new competition objective.
The subject was the sale of General Insurance (GI) ‘add-ons’: insurance products sold alongside – and at the same time as – other retail or financial products. The Market Study looked at five such products: travel, gadget, Guaranteed Auto Protect (GAP), home emergency, and personal accident insurance; in each case, comparing the details for add-on sales and stand-alone sales. From this the FCA sought to extrapolate broader conclusions about the add-on sales mechanism and the GI market in general; it also noted that some products fared better (travel) and worse (GAP and personal accident) than others.
The background to the Market Study was the 2012 FSA study into the sale of general insurance add-ons; 2013 FCA Thematic Reviews of motor legal expenses insurance and mobile phone insurance; OFT’s review of extended warranties; and various FSA actions involving the misselling of insurance, including PPI.
For more background information on the use of behavioural economics in financial services sector competition regulation, please see our recent RegZone report ‘Behavioural economics – a new basis for FCA intervention’.
The Final Report declared that March’s provisional findings were now final: competition in the sale of GI add-ons is not effective, and there was a “clear case” for intervention by the regulator.
The main evidence for consumer detriment was the difference in the claims ratios (i.e. the value of claims paid out as a percentage of premiums paid) for similar products, depending on whether they had been sold as add-ons, or stand-alone policies. The FCA estimated that consumer ‘overpayment’ could be as high as £216m per year.
Research into add-on sales suggested various possible causes for the failure of market forces to keep prices competitive:
- consumers are sometimes not aware that alternatives (either stand-alone, or other add-on bundles) are available, and are more likely to buy the first insurance product they are presented with;
- where consumers are aware of the availability of alternatives, they sometimes struggle to compare products, and calculate the different costs; in particular, consumers often underestimate the annual cost of a policy when only a monthly fee is quoted;
- consumers might also be dissuaded from shopping around by the ‘cognitive’ and ‘action costs’ involved: in other words, once they have made the effort of buying a primary product, they do not care to expend the additional mental effort involved in comparing different insurance deals as well;
- the ‘endowment effect’, whereby consumers contemplating a new primary purchase are more inclined to buy insurance to protect it;
- buyers of add-on products tend to have worse understanding of product coverage, and are sometimes even unaware that they own a particular insurance product; both factors make it less likely that consumers will claim under a policy, which in turn drives down the claims ratio figure;
- buyers of add-ons were more likely to be vulnerable to ‘soft’ pressures, including the apparent trustworthiness of salespersons, especially where sales took place face-to-face. (However, consumers in general did not consider that they had been “pressured” into buying).
The FCA concluded from the above that add-on sellers were often making (sometimes extremely large) profits by taking advantage of consumer behaviour, and the point-of-sale advantage, rather than by improving their products or prices in response to effective market competition. In particular, add-on insurance prices were not constrained by competition from stand-alone insurance products (except travel).
Although the focus had been on the effectiveness of competition, and not on assessing firms’ conduct, the FCA nevertheless uncovered some cases of non-compliance with ICOBS. No evidence of actual misselling was found, although the problems with the add-on sales process identified above could increase the risk of consumers ending up with unsuitable insurance products.
The FCA did not find evidence of any major barriers to entry into the market for either underwriting or distributing GI add-on products.
Response from firms
In their response to the March consultation, firms highlighted consumers’ own stated satisfaction with their insurance products (although the FCA had previously observed poor consumer understanding of policies).
Firms also argued that, by focusing on the claims ratio, the FCA had failed to give sufficient weight to matters such as consumer peace of mind, brand trust, and the convenience of the add-on sales process.
Another criticism of the FCA’s use of the claims ratio was that this figure does not reflect all relevant costs; further, the FCA ignored the ‘waterbed’ effect, where overpayments for add-ons might be returned to consumers through subsidised prices for primary products.
The FCA is considering this feedback as it works on its proposals for remedies (see below).
Beyond the add-on process
Some of the FCA’s findings went beyond the add-on sales process and concerned GI sales more widely:
The FCA considered that even stand-alone GAP and personal accident insurance was often still very poor value for money; it also had wider concerns about how well consumers can assess the value of different insurance products. There was a further concern with poor consumer understanding of policy details.
On the other hand, the FCA is aware that too much information can also be unhelpful to consumers - “disclosure must be smart”. Respondents to the March consultation warned that some of the FCA’s remedy proposals risked “overwhelming consumers with information”.
The FCA is still in the process of designing remedies (taking into account feedback received from the March consultation), and these will be the subject of a detailed consultation “later in the year”.
However, the FCA has suggested a few possible options that it is considering:
- A mandatory deferred opt-in for add-on sales of GAP insurance; i.e., a car salesman can offer a GAP policy at the time of selling a car, but cannot conclude the contract there and then; instead, the consumer will need to confirm the policy later on. The FCA intends to introduce this remedy as soon as possible, although in consultation respondents raised practical concerns over it, and also questioned whether the deferred opt-in would actually achieve its aim.
- A ban on opt-outs (e.g. pre-ticked boxes) in GI add-on sales processes. This proposal received “broad support” from respondents, although they also warned of “unintended consequences … including inadvertently restricting legitimate business practices”.
- A requirement for firms to publish claims ratio data. (This relates also to the FCA’s concerns with poor value stand-alone insurance products.) As noted above, firms “were largely critical of the claims ratio proposal", raising both “objections in principle … and also … a number of practical concerns”.
- Further work on how to improve the presentation of information about add-ons on price comparison websites; this could either involve a “market-led solution” or new FCA rules.
- The FCA will also “continue to consider what other remedies may be appropriate”, including alternative remedies proposed by consultation respondents, such as: alternative product value measures to the claims ratio, consumer education campaigns, commission disclosure, point-of-sale information about alternative products, and even price and commission caps.
This Market Study further emphasises the FCA’s focus on ensuring that the customers are at the heart of any business interests and, together with the FCA’s Thematic Reviews of 2013-14, demonstrates the regulator’s continued scrutiny on the insurance sales process.