Pricing — Theory & New Practice?

Insurance is a deeply commercial undertaking but significantly different in many ways to the Retail sector, to which it is so often (unfavourably) compared. It is a measure of the social and economic necessity of Insurance that our sector is subject to expectations way beyond anything purchased on Amazon. If, as expert Insurance critical friend Duncan Minty says, ‘Insurance regulation is political’ — so, of course, is pricing, and it extends to commercial lines (how else does it feel when the FCA 2020 Sector Views points to operational inefficiencies in the London Market impacting commercial customers with higher prices?).

It’s not that we don’t talk a lot about pricing strategy, is it? A staple in the Insurance playbook is growth fuelled by ‘competitive’ rates and the consequent cleansing of the resultant ‘bad book’. And it is the quest for the pricing ‘edge’ propelled by superior data, and dynamic portfolio optimisation, that drives much of the adoption of algo-driven methodologies across the sector, in established firms as in InsurTech entrants.

Pricing — the Theory

Business theory dissects pricing strategy in a variety of ways, all of them as levers for the firm in execution of market positioning, and achieving the business plan. There are 4 main approaches:

(1) Cost-based

(2) Value-based

(3) Value pricing

(4) Competition-based

Theory also discusses the differences between Product and Service: the key distinguishing factor is that much goes into providing the Service that the customer simply does not see or even intuit. I think Insurance is actually a service: the average customer — arguably any type of customer — does not see it that way. And our sector in the main does not sell that way either.

Insurance Pricing — more questions

But there are bigger questions, too, as evidenced by two recent articles, both prompted by FCA activity around pricing. Oxbow’s Chris Sandilands writes his piece in anticipation of the FCA’s final report on pricing practices in (and their remedies for) the UK personal lines market, and in the context of their interim report identifying 16 million customers paying more than they should for Insurance, including 2 million they define as ‘vulnerable’.  Duncan Minty, the indefatigable expert commentator and activist on Insurance Ethics, aims his fire at the FCA for being ‘myopic’ about personalisation, and its detrimental impacts on market functioning and consumer trust. These different pieces exemplify the range of issues:

• Is Risk Rating appropriate?
• What is acceptable price discrimination?
• Are variable margins appropriate?
• By putting Personalisation outside their remit are the FCA endangering what’s left of Customer Trust in Insurance?
• Should Insurance pricing be a matter for public policy?
• Are Insurers prioritising the ethics of exploiting ‘vulnerabilities’ large and small (what others might characterise as supply and demand factors)?
• What is the stance of regulation likely to be on pricing issues? Is it true that “Flood underwriting was a harbinger, not an exception”.

Vulnerability in a personalised world

Minty and Sandilands both see the possibility (in Minty’s case, the certainty) that data- and algo-enabled personalisation will create uninsurable customer groups or segments. But they see other things differently. Sandilands points to “No clear public policy definition of what vulnerable constitutes”. That may be the de jure position, but de facto, and as Minty quotes of Andrew Tyrie, chair of the Competition and Markets Authority (CMA): “We are all vulnerable now”. ‘Vulnerability’ is quite simply about being human and can as easily be defined by pregnancy, moving house or a mental health episode, as about seen disabilities or living with cancer, dementia or diabetes.

Data and ever-better modelling means this vulnerability can be identified, quantified, predicted even, and squirted into a commercial logic that makes ‘need’ (or ‘points of vulnerability’) an input into the pricing equation. And what is wrong with that? Shouldn’t this simply be about supply and demand? How is this different to the ‘information asymmetries’ that underpin much of investment and asset management operations?

The short answer is that history tells us that Insurance in the UK simply does not work like that. Where do you stand?