Warning - don't let Fees turn into Expense Optimisation
Fees now proliferate across personal lines insurance. Take out a policy – there’s a set-up fee. Cancel it – there’s a cancellation fee. Renew it – there’s a renewal fee. Change something on the policy – there’s an adjustment fee. I’ve come across only one insurer so far requiring a fee for submitting a claim, but I’m sure more have considered it.
There are two reasons for fees in personal lines. One is to manage demand for services. If people have to pay a fee, they’ll think twice before contacting the insurer. And the second reason is to remove some expense from your quotation calculation, so reducing the quote premium and moving it up the quote screen.
On the face of it, there’s some sense in this. To be sustainable in today’s market, firms need to manage expenses as much as claims costs and premium income. Yet how this is done raises clear questions about fairness, similar to those that became associated with price walking and the loyalty penalty.
In this article, I’m going to look at the extent to which fees are used in the UK personal lines market, and explore where the ethical risks lie based on emerging practices. The danger is that if insurers think of fees as something neutral and trivial (as in ‘a nice little earner on the side’), they will find themselves exposed, perhaps even 'name and shamed'.
Remember that the sector has mishandled fees before. The referral fees episode was probably the most short-sighted attempt at revenue grown that the sector has ever come up with. That's because it fuelled a huge rise in third party personal injury claims. My worry is that foresight could well be in short supply with regards to the fees I’ll be looking at here.
Fees Proliferate
So how prevalent are fees in the UK motor insurance market? A recent survey by Go Compare (a price comparison website) provides a useful overview.
When you take out a policy, there is often a set up fee. The Go Compare survey found that 45% of personal motor policies charged a set-up fee. And of those that did, one third of those set-up fees were higher than £60. Given that the average price of a UK motor policy towards the end of 2022 was £470, that’s makes set-up fees very expensive.
After the policy has gone live, the fees proliferate. Go Compare found that 41% of motor policies came with a renewal fee and of those, 21% were over £60. Then 87% of motor policies charged a fee for cancelling mid-term, and of those, 86% were more than £40. Half of all motor policies charged a fee if you cancelled during the cooling off period.
All of these percentages are on the rise. Fees are no longer unusual in the market – they’re now the norm. And they’re getting bigger too. Remember that a set up or renewal fee of £60 is 12.5% of an average motor premium.
Performance Anxiety
A key metric that insurers report on is their combined operating ratio (COR), which in simple terms means claims plus expenses divided by premium. Fees would be added into the denominator as another form of income. A COR under 100% points to profitability. Clearly, if your fees strategy can take several percentage points off your COR, then you’ll find a very happy senior management team, especially if bonuses are linked to it.
Loyalty Penalty Work Around?
The Go Compare research is good, but rather high level. It doesn’t tell us about any overlaps between those who charge set-up fees and those who charge renewal fees. Clearly, if you don’t charge the former but you do charge the latter, then that looks pretty much like a work round for the loyalty penalty ban.
I’ve been reliably informed though that PCWs tend to include set up fees within their inception quote, but not renewal fees within their renewal quote. The opposite of what would resemble price walking then.
Let’s move on and look at three sets of circumstances, which I am calling ‘where we are now’, the ‘immediate bigger picture’ and the ‘wider bigger picture’. As an insurer, I would suggest incorporating these three different horizons into your ethical risks assessment.
‘Where We Are Now’
Policyholders warrant that they will inform their insurer of any change in material facts relevant to the risks and the cover being provided. Yet in many cases, they now have to pay an adjustment fee for doing so. This creates a tension around that warranty – should a policyholder have to pay a fee to do what the insurer expects them to do? It seems unfair and a barrier to doing what is expected of them. I wouldn’t be surprised if this is tested in the courts at some point.
Then there’s transparency. How clearly are these fees, both expected and possible, spelled out to the policyholder? The very nature of an insurance policy means that, outwith of the set-up fee, all such fees are a possibility. Behavioural scientists know that many people discount the likelihood of having to pay them. Yet all too often, they’re paying at least one.
Then there’s the fact that fees in insurance are fixed. This means that policyholders only able to afford small limits of cover pay the same fee as someone insuring a large property. Hardly a recipe for fairness, and clearly part of the problem the poverty premium campaign is seeking to tackle.
Then there’s this research by Citizens Advice…
“Using findings from nationally representative polling we estimate that over one million people cancelled their car insurance in the last year amidst pressure from rising bills. Worryingly, people of colour were three times more likely to cancel their car insurance than white people.”
Clearly, if you’re charging a cancellation or cooling off period fee, then to put it bluntly, you could be fuelling this problem. Has your firm considered this in its discrimination pricing review? Does it consider this to be an indirect discrimination risk?
These are questions that a fees approach will naturally throw up. What your firm has got to be doing is ensuring that such questions are being recognised, weighed up and addressed, as well as the conclusions evidenced. Is this happening?
The Immediate Bigger Picture
This proliferation of ‘paid by customers’ fees often sits on top of a whole set of market payments. Let's look at the main ones, based upon the UK motor insurance market’s three channels - direct writers, price comparison websites (PCWs) and brokers. Most of the larger motor insurers are present in all three.
Every insurer selling through a PCW pays them a fee, while every insurer using the broker channel pays them a fee or commission, the latter roughly in the region of 10%. And even with direct writers, the frequent use of a UK based service company will probably involve fees being paid to the actual risk carrying vehicle. Remember that a huge amount of UK motor insurance is written out of Gibraltar.
Then don’t forget the overrider payments that insurers and premium finance houses pay to brokers and others for achieving account growth and/or profitability targets with them. And to complete the picture, there could well be additional commissions paid to brokers for issuing documentation, making adjustments and even handling claims.
What this adds up to is that the amount the average consumer pays over an average year for motor insurance bears little resemblance to what is required to cover the cost of expected claims. A lot of their premium is spent on feeding the supply chain.
Political Radars
This is not a healthy arrangement to be part of at the moment. Unhealthy levels of commission are very definitely on politicians’ radars at the moment (more here). It’s not every day that a Secretary of State calls for a ‘commission chain’ ban, in this case for building insurance for multi-occupancy properties.
The FCA will point to the consumer duty as the best means by which proliferations of commissions and fees can best be addressed. In doing so, the case of the Retail Distribution Review from 2012 will also be in their minds. Designed to change how retail investment products were sold, it essentially removed commissions and replaced them with fees.
One consequence of this was that advisers ended up tailoring their fees towards those consumers looking for the more expensive policies. This contributed to a protection gap. Not something the regulator wants to see happen in the general insurance market.
The Wider Bigger Picture
You’ll recall that one of the most common fees in motor insurance is for cancelling your policy. This is because, so I’m told, such events involve more servicing and an above average liability exposure.
Such arguments are not always convincing. Firstly, any interaction with an insurer involves some form of servicing, and aren’t many insurers seeking to build interaction opportunities in order to build loyalty? Fees push policyholders away from engagement. What do insurers want then?
And secondly, policies that don’t go full term are little different from the new types of ‘pay as you drive’ type policies being introduced with such enthusiasm. So why is the liability exposure under the former viewed so differently from that from the latter?
Let’s focus on the servicing side. One of the leading software houses servicing the insurance sector talks about having a database that covers 90% of the UK motor market. They use this cross sector perspective to track cancellations across insurers and feed back insight to individual subscribing underwriters. Their intention is not to set the right fee but to enable an underwriter to avoid ‘cancellation likely’ policies in the first place.
On top of this, I wouldn't be surprised if they were also looking at a variety of behavioural correlations around cancellations in order to highlight them as early as possible. After all, goes the argument, why take on a policy that has (historically), or is likely to have (predictively), an above average service cost?
Expense Optimisation
Such a practice would represent a form of expense optimisation. And to an economist interested in rational behaviours, pricing in this way makes perfect sense. Until that is, you bring in the human element. Remember this earlier quote from Citizens Advice’s second ethnicity report…
“Using findings from nationally representative polling we estimate that over one million people cancelled their car insurance in the last year amidst pressure from rising bills. Worryingly, people of colour were three times more likely to cancel their car insurance than white people.”
Optimising in relation to cancellation reduces access to the market for large chunks of the UK population. In this case, for people of colour and those on lower incomes. It does this by reducing the number of insurers willing to quote, as well as increasing quotes from those that remain. The line connecting this with the poverty premium and the ethnicity premium is pretty clear.
Beyond Cancellation
There’s little new in this. Back in 2015, the National Association of Insurance Commissioners recommended that US state insurance commissioners ban local carriers from optimising premiums based upon “a policyholder’s propensity to ask questions or file complaints”. In other words, price according to the anticipated cost to service.
Cancellations are just one of the ‘anticipated costs to service’ that insurers could optimise around. Here in the UK, optimising around complaints is very likely to already be happening in claims decision systems (more here). I expect it’s being looked at in relation to a whole variety of costs to service.
As with cancellations, these raise clear ethical questions. Are they fair? Could they be discriminatory? Aren’t they just dropping a big conflict of interest into the customer/provider relationship. There are lots of people who would answer those as no, yes and yes.
Are insurers actually able to do this with the UK handbook? If the price walking ban only talks about premiums, then the answer could well be yes.
To Sum Up
Fees raise questions about fairness and discrimination on several layers. As an insurer, your fees strategy needs to be thoroughly reviewed on both counts.
Your work on the consumer duty could help with this, but don’t rely just on it. Some of the issues raised here are wider than that.
Remember referral fees – just because you can doesn’t mean you should. And always look for unintended consequences - they helped fuel third party injury fraud.