This month we bring you news of the UK’s regulatory approach to the rapidly developing crypto-assets market and the Financial Conduct Authority’s proposals for chacing its fees and levies in 2019-20. Also in this update, we examine the regulator’s recent interest in fair pricing.

The FCA recently published a discussion paper on various forms of 'price discrimination,' which occurs (although the term scarcely suggests it) when identical goods or services are sold at different prices by the same provider. This also feeds into the recently announced general insurance market study, which seeks to uncover the market harm caused by various pricing strategies and the impact on competition.

General insurance market study begins

In its 2018/19 Business Plan the FCA announced its intention to undertake a thematic review of pricing practices in the general insurance industry, having grown worried that consumers, particularly vulnerable consumers, are at risk of harm.

The FCA has now published the results of this review and says that further measures, including a market study, are necessary so that it can gain a better understanding of the scale of any harm and spot poor conduct.

The main findings of the thematic review

In a document called TR18/4, the FCA examined pricing practices in the home insurance sector, where it has found types of behaviour that cause it the most concern. Problems stem from inertia, dual pricing and renewal practices.

The regulator believes that the following practices might be causing consumers significant harm and poor results.

• The absence of appropriate pricing strategies, governance and controls, with firms unable to assess - and show the FCA - whether they are treating customers fairly.
• Differential pricing, which can lead to identifiable consumer groups paying significantly more than others.
• A risk of 'discrimination' (which, one might think, describes something that a customer does when he judges one price or service to be better than another, but which actually means something else and might even be the same thing as price discrimination) when 'price rating factors' are based on data relating to, or derived from, 'protected characteristics.'

A 'price rating factor' is, according to TR18/4, "a characteristic about the individual buying the insurance, their behaviours or a detail about the property/item being insured and is used, for example, to rate the likelihood of the individual making a claim, the cost of a claim should it occur, the consumer’s propensity to buy/price elasticity for the insurance cover."

The paper goes on to say that the Equality Act 2010 mentions nine 'protected characteristics.' They are age, disability, gender reassignment, marriage and civil partnership, pregnancy and maternity, race, religion or belief, sex and sexual orientation. There are certain circumstances that allow the use of protected characteristics in general insurance pricing when it is a proportionate means of achieving a legitimate aim. The paper does not say what these characteristics are being protected from, or why, but it does believe that companies can use them to conduct 'price discrimination.' It states at para 4.20, however, that "we found no evidence of direct discrimination based on protected characteristics," and seems to regard this favourably.

Firms have a duty to treat customers fairly and pay due regard to their interests. If the FCA is to consider a firm’s systems and controls sufficient, it expects to see that firm collecting 'robust' management information, whatever that means, and inducing its senior managers to analyse it to determine the effect of its pricing practices.

The word 'price,' which the FCA often links to the pricing of insurance products and which is definitely something it worries about consumers paying, might have something to do with the premium that insurance carriers charge those consumers, but TR18/4 never says this. It does once mention the prices that consumers pay being above or below the risk premium, but is otherwise silent on the subject. The risk premium, in its turn, is the forward-looking estimate of the burning cost for a given consumer. A burning cost is defined in the glossary as the estimated cost of claims in the approaching period of insurance generally calculated in accordance with previous years’ experience, adjusted for changes in exposure (e.g. total sum insured), inflationary factors and the nature of cover. Consumers also pay expenses and margin, a term the FCA describes as the amount of premium (excluding insurance premium tax) left over after the deduction of the cost of claims and expenses. Indeed, the paper describes something called the 'technical price' as a mixture of premium and margin.

The study's terms of reference

The FCA’s general insurance market study will examine the pricing strategies of retail home and motor insurance, focusing on three areas.

• The causes of harm arising from different pricing strategies.
• The effect of pricing on competition.
• The fairness of various pricing strategies.

When considering the causes of harm, the FCA will concentrate on:

• the difference between the prices paid by various groups of consumers, compared with the cost of providing insurance;
• the volume of consumers who pay higher prices;
• the things that those consumers have in common, especially if they make them vulnerable; and
• the things that cause prices to go higher.

To understand how differentiated pricing (a term that TR18/4 does not mention) affects competition, the market study will focus on whether:

• pricing practices are restricting or increasing consumers' access to appropriate insurance products of high quality;
• high profit margins are being generated by the servicing of particular groups of people, especially vulnerable ones;
• levels of competition are leading to higher or lower costs; and
• there are barriers to entry or expansion.

On the issue of fairness, the FCA will try to find out how well consumers understand the way in which insurance is priced, whether they think that it is fair and whether firms are treating their customers fairly.

Fair pricing throughout financial services

The FCA’s latest discussion paper on this subject is designed to start a debate about the fairness of certain pricing practices and gather feedback from the financial sector. The paper acknowledges that the issue of whether price discrimination is fair is not always clear-cut.

The paper considers two specific pricing practices: price discrimination, which is pricing based on customers’ price sensitivity, i.e. whether their behavior is affected by the price of products or services; and inertia pricing, which entails higher costs for existing customers than for new ones.

Price discrimination

Price discrimination can be good or bad for competition, access and distribution, depending on conditions in the market.

The FCA asks itself the following questions when trying to decide whether price discrimination is fair or not.

• Who is harmed?
• How much harm does he suffer?
• How significant is the proportion of consumers affected?
• How is the price discrimination being undertaken?
• Is the product/service essential?
• How would society view this example of price discrimination?

Inertia pricing

The paper includes a number of examples of inertia pricing and discusses the fairness of this practice. There are two important considerations when assessing the fairness of inertia pricing. The first is that some consumers are better off as a result of inertia pricing, while others are worse off, and vulnerable customers can fall into either camp. Secondly, the specific circumstances surrounding the practice must be taken into account as generalised remedies can have unintended consequences.

The FCA is keen to understand the impact the competitive landscape has on the fairness of inertia pricing. This includes whether it creates barriers to entry or expansion and whether interventions could lead to increased costs or poorer service levels.

How might the FCA ward off the potential harm it has identified?

The final chapter of the discussion paper outlines the supply-side and demand-side remedies that the FCA may consider in its efforts to deal with the problems it has identified. The regulator is seeking feedback from the industry about its strategies and other suggestions that might reduce the cost of shopping around.

The UK’s regulatory approach to crypto-assets

As part of the HM-Treasury-led Crypto-assets Taskforce, the FCA has published a report on the UK’s regulatory approach to cryptoassets, which springs from the regulator’s work on distributed ledger technology.

The taskforce wants to offset a number of risks, including harm to consumers, threats to the integrity of markets, threats to financial stability and the use of crypto-assets for illicit activities. The report outlines a number of initiatives.

• Perimeter guidance is due to be published at the end of 2018, outlining which crypto-assets come under the existing regulatory regime and which fall outside it.
• The Treasury will decide whether to extend the regulatory perimeter to cover unregulated assets whose features are comparable to those of regulated ones.
• In Q1 2019 the regulators will ask interested parties whether derivatives which refer to certain types of crypto-assets should be out of bounds for retail customers.
• The Government will consult the public about on how exchange tokens, e.g. Bitcoin, and related services can be effectively regulated.
• New regulatory rules will appear to tackle the use of cryptoassets for illicit activities. These will go beyond the contents of the European Union's fifth Anti-Money Laundering Directive.

Cost Transparency Initiative launched

A new working group has been dedicated to the use of new 'cost transparency' templates to standardise information about costs and charges for institutional investors. The CTI will progress the work conducted by the Institutional Disclosure Working Group (IDWG), supported by the Pensions and Lifetime Savings Association (PLSA), the Investment Association (IA) and the Local Government Pension Scheme Advisory Board (LGPS SAB).

Speaking at the body's first event, the FCA’s Christopher Woolard said: “We welcome the launch of the CTI and have passed on the IDWG’s report and draft templates in full. The CTI has the right experience, resources and market coverage and will represent a broad and balanced range of suppliers and clients of the institutional asset management industry to deliver results in the market and continue to build on the momentum created by the IWDG. The FCA has been asked to join the CTI as an observer and we look forward to our continuing involvement in this area.”

The results of the FCA's retail and wholesale banking whistleblowing review

The FCA has released the results of its investigation of the effectiveness of retail and wholesale banks in obeying its 'whistleblowing' (informant) rules. It based these rules on recommendations published by the Parliamentary Commission on Banking Standards report (entitled "Changing Banking for Good") that came out in 2013 and put them into effect in 2016.

The FCA and the Prudential Regulation Authority expect firms to have effective arrangements that let employees raise concerns, secure in the knowledge that the firms will handle them in an appropriate and confidential manner. Every firm is also required to appoint a "whistleblowing champion" - a senior manager who oversees the integrity, independence and effectiveness of the whistleblowing process.

The regulator examined firms policies and procedures, especially to do with protecting confidentiality and preventing victimisation. It also gauged the effectiveness of their "whistleblowers’ champions," their "whistleblowing annual reports" and their whistleblowing training.

On the whole, the FCA found that firms are obeying the rules and managing cases in a fair and consistent manner. The regulator published the report alongside some examples of good practice and key areas for improvement, which include effective whistleblowing training, more effective documents to describe the investigative process and the production of detailed annual reports.

Proposed changes to FCA charges in 2019/20

The FCA has proposed to change the way it calculates and collects the money it charges the firms it regulates in 2019/20. It wants to recover the cost of authorising and regulating credit rating/reference agencies and trade repositories once the UK has left the EU.

CRAs and TRs

When Brexit happens, each UK-established credit rating/reference agency and trade repository that is registered with the European Securities and Markets Authority will be able to convert its registration to an FCA registration without incurring an application fee. After the date when the UK leaves the EU, firms will incur periodic fees, with each type of firm assigned to its own fee bloc. The FCA plans to stick to ESMA’s thresholds and 'minimum fees.'

Costs for mutual societies
 
The FCA is proposing to remove fee-block F (to do with unauthorised mutual societies) and instead recover the cost of acting as the registrar of the Mutuals Public Register through its overheads and is also removing most of the charges for public access to the register. The costs for societies applying for registration will remain the same.

Insurers’ tariff data

In 2017 the FCA consulted firms in CP17/38 about its wish to change the weighting between the premium data part (gross written premium – GWP) and the liabilities data part (best estimate liabilities – BEL) in the insurers' tariff data. For the A3 fee-block the FCA's proposals differed from those of the PRA. Having consulted firms yet again, both regulators are proposing to leave the weightings unchanged.

For fee-block A4, the FCA proposed to amend the weighting, but not to the extent propopsed in 2017.

Other amendments

• On-account payment rules will not apply to levies collected on behalf of the Treasury or Department for Work and Pensions.
• The FCA is proposing to exempt community finance organisations and credit unions from all consumer credit fees.