A year ago the Future of Financial Services summit debated how to restore faith in the financial services sector and examined the changes needed in both industry and regulation to help make that happen.
One year on, this is still the right question to ask, but one which the FCA is now answering through a very different lens.
Since we were created in April, the FCA has had a new competition duty - an objective to promote effective competition in the interests of consumers. Since April we’ve evolved as a regulator to meet this objective and grown into our new competition skin.
In a short period of time we have brought to life our competition objective and started to take action where we saw that markets might not be working in the interests of consumers.
To achieve this we have steadily built our competition resources.
We have established strong working relationships with the Office of Fair Trading (OFT) and the new Competition and Markets Authority (CMA). We are working closely with the OFT on their SME work[2] and will continue to do so with the CMA as announced this morning.
Within our first few weeks we published an occasional paper on behavioural economics: a paper now being shared by regulators around the world.
In July we confirmed our first market study - looking at the issue of competition in the general insurance add-ons market. In September we built on this to announce a full suite of market studies.
And now, this morning, we have announced the next step on that journey: the first results of our work – into the general insurance add-ons market[3].
This is a billion pound market that touches the lives of almost every family in this country: from GAP insurance on a new car to mobile phones through extras offered on your home insurance and almost everything in between.
In other words, we all have a vested interest in making sure this market works as effectively for as many consumers as possible. Today’s publication is a step towards achieving that goal.
So, I want to explore three themes.
- What does effective competition look like?
- What we have said in our first study.
- And through that, give a flavour of what you might expect to see from the FCA’s competition work over the coming months and years.
Framing the question
So what does competition look like through an FCA lens?
To start I want to say that it is not distinct from our other regulatory objectives and functions. Issues that we spot through authorisation, supervision and during enforcement investigations will inform our work in competition.
The same is true in reverse: insights from the competition department will help inform thematic work, supervisory action and other policy interventions.
During the course of our market studies we will be looking to promote competitive markets; protect consumers and help firms by building trust in the markets they rely on for growth. And this is where today’s study enters the picture.
The UK is blessed with one of the strongest insurance markets in the world. Its focus on policy holders, as well as its ability to price and write almost any risk - from shipping to space - is unmatched.
But we have a long-term responsibility to make sure insurance markets continue to work well.
The add-ons market study was launched following growing concerns about the way that insurance as a secondary product was being sold.
PPI was the classic example. But the concern was wider, drawing in issues like credit card protection or emergency breakdown cover. In particular, there was clear evidence that when consumers were offered additional or ‘add-on’ insurance, they ended up buying products that were not designed to suit their needs. As a result, both consumers and the industry suffered.
Einstein once said that the definition of insanity was doing the same thing over again and expecting different results.
With this in mind, we had to ask whether there was something about the way that products were being sold, a feature of the add-on distribution mechanism itself, which was leading consumers to buy products that later proved to be poor value, not needed or unfit for purpose.
I should stress that there is no suggestion of the products we have studies for our latest work having been deliberately mis-sold on a mass-scale, but it did lead us to question whether the market for add-ons was working well.
For this we had to answer two fundamental questions: 1) was competition working effectively and, if not 2) how was this impacting consumers?
Our study focused on five products that are sold as add-ons and also on a standalone basis. We wanted to understand the common impact of the add-on mechanism across these products.
We did this by benchmarking add-on sales against standalone sales across a number of indicators - including shopping around, net rates, claims ratios and firm profitability.
We did some initial work that found that consumers were often offered several add-ons during the course of a sale. Most people will recognise this when they are booking flights as the number of times the computer asks you, “If you are really sure that you want to fly without travel insurance”, while kindly reminding you how many people ended up stranded in hospital in Spain or Turkey.
We also noted that ‘add-on’ sales often occurred at the end of the primary sales process. It was when you are close to confirming the flight booking or the car deal is nearly done that the add-ons were offered, often as a default option.
From my own experience, I know having spent hours looking at different flight combinations; I want to pay, confirm the booking, and shopping around is the last thing on my mind.
Our approach – behaviourally informed
Knowing what this process can be like, we wanted to better understand and analyse what happened at the point of sale from a behavioural perspective.
For this we commissioned a broad programme of consumer research to analyse consumer behaviours and experiences when purchasing add-on insurance.
This type of consumer engagement and research is and will be characteristic of the new FCA approach to regulation.
We want to understand how consumers actually make financial decisions - what they really do, what their purchasing experience is like, what they pay attention to at the time of the choice and afterward. That will help us to determine how we as a regulator can help frame these decisions and drive better outcomes for consumers.
One element of this was a behavioural experiment we ran in collaboration with University College London and London Economics.
This really was the first experiment of its kind in our sector to look at how consumers buy products and how they interact with them.
The results of our consumer research were striking.
When an insurance product was sold on a stand-alone basis, 17 out of 20 consumers shopped around and paid an average price of £72. When we took that same insurance, but it was sold as an ‘add-on’ with the price only revealed after the main product was first selected, 13 out of 20 consumers did not shop around. The average price they paid for that same insurance was £102 - £30 more.
How does this discrepancy happen?
Put simply add-on buyers were much less likely to be engaged with the purchase.
Our research also told us that more than two-thirds of consumers couldn’t remember, even approximately, the prices they paid for their add-on. Quite a few of them didn’t even remember that they had purchased the add-on at all.
We also found that when consumers purchased products as add-on they were less likely to plan buying their insurance in advance or shop around.
These products seemed like the equivalent of sweets placed carefully by the till.
Our research shows that, for a variety of reasons, consumers are less likely to shop around when purchasing add-on products.
This may seem like a simple finding but the ability to compare the prices and quality of alternative products is the fundamental driving force of competition.
If consumers don’t shop around or understand the value of the product they are purchasing, there is little incentive for firms to improve add-on quality or price.
This worries us since firms that are focused on customer service and good value products will find it difficult to win significant market share from incumbents - even those who treat their customers poorly or like cash cows.
Our study reveals that add-on sellers enjoy a clear advantage at the points of sale over standalone products. This is exacerbated by the way that the-add on mechanism affects consumer behaviour.
Consequently, distributors are able to significantly mark up prices above costs and offer consumers products that are poor value for money.
In some cases we saw that less than 10% of the money paid by consumers went to cover the actual risk consumers are trying to protect against. So, for example, in a travel insurance policy costing £30, less than £3 went to the underwriter.
The market for these kind of add-on products just isn’t working well for consumers.
Drawing from our different strands of analysis, we found distortions significant enough for us to intervene and start thinking about new kinds of remedies to improve competition in the interests of consumers.
Proportionate remedies
So what do remedies look like in FCA market studies? The answer is that they could take a number of guises, there is no ‘one size fits all’ solution. We might work with firms to address specific issues, issue directions, consult on policy changes or refer issues to the Office of Fair Trading and, in future, the Competition and Markets Authority. In future years we will also have access to the full range of concurrent competition powers.
In the add-ons study, we are bringing forward a range of behaviourally informed remedies, which are designed to help consumers make better decisions and increase competitive pressure on firms to improve the value and quality of products.
One of these specific remedies involved GAP insurance; this is a product that is sold in showrooms by car dealers and which gave us particular cause for concern.
Many consumers believe that the the only chance of buying this product is face-to-face with a dealer, which just simply isn’t true.
In many cases the products being offered in showrooms are very expensive compared to those which you could get if you shopped around on the internet.
In a classic behavioural move, the insurance may seem cheap, relative to the price of a car, but it costs on average £300 from a dealer and in many cases less than half that online.
So we are proposing a cooling-off period, where the consumer would have to come back and positively confirm that they really wanted that GAP from the dealer at a later date. And in the mean time they would be given information to encourage shopping around. We believe that this will stimulate competition and lead to better value for consumers.
We also are proposing to ban pre-ticked boxes (so-called ‘opt-outs’), for the sale of add-ons. Opt-outs exploit consumer biases and can result in consumers making ill- informed decisions, undermining effective competition.
During our investigation we have also found some incredibly poor value products, where the premium that you pay as a consumer is actually not reflected in the kind of insurance cover that you are really getting.
In some cases claims ratios averaged 9% with some individual products even lower - against an average 60% to 70% for home or car insurance.
So one of the things we propose is to ask firms to disclose their claims ratios.
We know for a lot of consumers they will not want to get into that level of detail, but consumer organisations and the financial press will be able to publish comparisons to shine a light on who’s offering really good value and who is just trying to sell you something that is very high margin for them and very low value for you and me.
Conclusion
Overall, our investigation has shown that the add-on mechanism provides an opportunity to sell a product to a customer whose focus is elsewhere, and who is therefore less likely to be thinking clearly about whether they want, need, or even fully understand the product they are buying.
We want consumers to be in a better position to decide whether they need a product, to be better able to assess the options open to them and get a good deal if they do decide to buy.
Without effective competition, firms that are focused on customer service and good value products can’t win significant market share from those that don’t.
We believe there are changes that we can make as a regulator to help address these problems, and improve competition in the interest of consumers. We’ll be consulting on those changes over the coming weeks.
I hope that this has also given a flavour of the longer term agenda we will have and the kinds of changes we will look to make where we don’t believe competition is working well.
Ultimately, competitive markets are not just in the interest of consumers. Markets that consumers can trust are also key to the long term health of the financial sector as a whole. There is a big prize here. Today is a step towards that goal.