A consultation by regulator the Financial Conduct Authority (FCA) published in May proposes the introduction of a new ‘Consumer Duty’ that would set higher expectations for the standard of care that firms provide to consumers. 

More specifically, it has outlined plans to eliminate the ‘loyalty tax’ as the FCA looks at ways to better ensure that consumers obtain fair value in the products and services they buy. The FCA believes that business models that rely on customer behavioural biases including loyalty are unfair and the regulator is particularly wary of such pricing falling most harshly on vulnerable customers. 

A response prepared by the ICAEW Financial Services Faculty welcomes the FCA’s aim to raise the bar and support better outcomes for the UK’s 50 million consumers but warns that the complicated and tiered system of new rules including plans to eliminate the ‘loyalty tax’ will fundamentally alter regulated firms’ business models irrespective of which products or services they offer.

“As we know from many sectors including energy, broadband and car insurance, new customers are sometimes charged a lower price to attract them in, a so-called ‘teaser rate’, but then eventually if they stay with the same product provider, the price they pay will rise. This means customers are effectively being punished for being loyal,” John Mongelard, Manager, Risk and Regulation in ICAEW’s Financial Services Faculty explained. 

In its response, ICAEW warns that a ‘raised bar’ means regulated firms inevitably face a heightened risk of misconduct as more practices and behaviours risk being found wanting. Therefore, some regulated firms may seek to de-risk the degree of conduct risk their business is exposed to. 

“For example, on product lines where their profits are lower they may reduce service provision and this may fall most heavily on vulnerable customers, those from lower income groups, or on those who are less wealthy. If the new consumer duty requirements result in regulated firms exiting the market, due to a lack of clarity or a perception of regulatory hindsight, customers could turn to unregulated sources of credit or simply go un-serviced, which could in turn lead to significantly more consumer harm,” ICAEW explains. 

ICAEW also warns that the inevitable costs incurred by elimination of the loyalty tax could have a material impact on the business models and the viability of many firms and the decision by some firms to exit the market could leave poorer customers and those who are most vulnerable, un-serviced. 

In May this year, the FCA set out measures designed to protect customers from the loyalty penalty in home and motor insurance markets including new rules dictating that renewal quotes for home and motor insurance consumers are not more expensive than they would be for new customers. According to FCA’s analysis, in 2018, 6 million loyal policy holders would have saved £1.2bn had they paid the average price for their actual risk.

“If other financial services sectors are affected by the FCA’s new consumer duty proposals, they could face similar losses of billions of pounds. For better or worse a number of business models are highly dependent on back book pricing. For example, several banks depend on paying lower rates on back-back deposits and earning income on SVR mortgages – and that supports the margin they are able to achieve,” Mongelard says.

However, a FCA review published in August found that too many insurance firms still do not fully meet the regulator’s standards on product governance and value, issued since 2018. At the same time, many firms are likely to be unprepared to meet new enhanced rules on product governance, which come into force on 1 October 2021. These new rules are part of a wider package of remedies introduced by the FCA to tackle the loyalty penalty and ensure that firms focus on providing fair value to all their customers.

ICAEW is encouraging members to feed back into the second consultation on a new Consumer Duty due to launch in December 2021. The new rules are not due to be finalised until 31 July 2022. In the meantime, Mongelard says firms should review their business model and identify which lines are dependent on back-book pricing. They should also analyse which lines are no longer viable and may need to close and review product design to look at other ways beyond price to make them competitive.