Retail premium finance and fair value

The recent statements of direction from the FCA couldn’t be clearer. Products should provide long term fair value and companies should not recommend retail premium finance that unfairly prejudices customers. These are both joint and several and the gauntlet that it throws down for insurers is very similar to the gauntlet that second-hand car dealers experienced when looking at retail premium finance.

Let’s be clear - there is a very simple message that insurers are being sent. This message was actually best articulated across the Irish border where the Central Bank recently said that “a number of pricing practices led to consumers with similar risk and cost of service paying different premiums.”

The causal link between “price” and “risk and cost” is what the regulator in Ireland is talking about and it is the signpost that the UK regulator is giving to insurers here. This effectively means that you need to make money out of insurance as the core product and things like Retail Premium Finance and other add-ons need to stand or fail by themselves. More substantially the primary focus has to be the customer.

If you really like detail, the actual rules are at the end of this blog. The excerpt is taken from the consultation document published in September 2020, so the detail of it MIGHT evolve over the coming months. But the direction of travel is totally consistent with action taken by the FCA in other markets like second-hand cars and savings.

There are some interesting words in the FCA’s document which demonstrate their direction of travel, but insurers should not be lulled into a false sense of security from the words below. Where the FCA says “They give clear information about the cost of premium finance arrangements, and make clear to customers that the use of premium finance makes the contract more expensive.” You should also read “They give clear information about the cost of premium finance arrangements, and make clear to customers that the use of premium finance makes the contract less expensive.” In short, insurance is insurance and retail premium finance isn’t.

It is also important to understand that where the cost of insurance is “fair” and the retail premium finance is not fair, the entire contract will be considered to be unfair.

What this means is that companies that have used retail premium finance income to either discount prices for consumers or as a source of income for a below net rate premium will now walk a fine line of being “unfair”.

In the medium-term, insurers need to think about how they make money out of selling insurance and this will almost certainly come from better understanding of risk and a managing cost. It may also come from packaging insurance differently, like fractional insurance or usage-based insurance.

If insurers are in this space then they need to consider the impact of writing business in a way that might become “unfair” in the future, and what that will be for future renewals. If insurers are not using these forms of income to drive profitability, then they need to understand the potential upside that will come when competitors exit the space.

Excerpt from the FCA's September consultation document

Premium finance

4.22 We remind firms that premium finance is an additional product and is subject to existing rules within the Insurance Conduct of Business Sourcebook (ICOBS) and, in particular, the requirements in ICOBS 6A.2 (optional additional products) and 6A.3 (cross-selling). When selling insurance with premium finance, we also remind firms that the remuneration, or associated incentives, firms receive in connection with it, must be consistent with the firm’s obligations under ICOBS 2.5-1R. Firms must not propose premium finance arrangements to customers where this would be inconsistent with the firm’s obligations, including the customers’ best interest rules. For instance, where the firm proposes premium finance with a higher annual percentage rate (APR) than would be available elsewhere (for example, directly from the insurer, or from another finance provider), based on the remuneration the firm will receive, this may conflict with the firm’s obligations including the customers’ best interests rule.

4.23 Where firms offer or arrange premium finance to finance a contract of insurance, we propose to require that firms ensure that:

• • They give clear information about the cost of premium finance arrangements, and make clear to customers that the use of premium finance makes the contract more expensive.
  • When firms give customers a choice on whether or not to take out premium finance, they must do more than simply ask the customer to choose between paying monthly or annually.
  • Firms are not influenced by remuneration to offer premium finance at higher rates of interest than are available elsewhere. To meet this requirement, firms will need to review regularly the premium finance they offer to ensure that it does not adversely impact the value of the product. We understand that many firms will have existing arrangements with premium finance providers, and will currently receive remuneration from them. Some of these may be exclusive arrangements. Firms will need to consider whether these arrangements are compliant with the existing requirement to act in the customer’s best interests and the new requirement to deliver fair value.

4.24 We will look closely at firms increasing the cost of premium finance to offset changes to the cost of the insurance product. Where the customer faces higher costs for the insurance product as a result of paying on credit, for example due to a higher premium compared to the cost if paying without credit, the additional cost may constitute a credit charge and, if so, the APR must reflect these costs.

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