Regulatory update: Occasional Paper 22 – price discrimination and cross-subsidy in financial services

Posted: 12th October 2016

Background

The FCA published Occasional Paper 22 on the 21st of September, which focuses on the nature of price discrimination and cross-subsidisation and whether it presents issues for consumers.

The FCA acknowledges that both are legitimate pricing techniques in a competitive market, however, where they are leading to poor outcomes, the regulator wishes to explore why.

The paper seeks to address, in the scenarios where price-discrimination and/or cross-subsidisation are taking place, whether the best interests of customers are taken into account, and whether this has the potential to lead to detriment.

Key points from Occasional Paper 22

The paper makes the following assertions about the nature of price discrimination and cross-subsidy in today’s financial services market:

1) Price discrimination is widespread in retail financial service markets, as in many other markets. In part, this reflects the characteristics of many financial services markets, such as consumer-specific contracting or a strong position of firms in some or all of the market

2) Price discrimination can allow firms to cover their fixed costs while enabling more customers to buy than would be possible under uniform pricing. It also allows for more intense competition for individual consumer segments than if firms make a single offer to all of their customers

3) Cross-subsidy often arises from ‘loss leading’, where a core product is offered below cost because a firm expects to make additional sales of related products at above cost prices

4) The regulator has of course imposed a price cap in the high-cost, short-term credit market. However, the challenge the FCA faces is that they are not a ‘price regulator’ and direct regulation of price risks a number of unintended consequences, including stifling competition. As such, intervention is only likely to be appropriate in rare circumstances

5) Firms should consider the universality of price discrimination and cross-subsidisation across all areas of financial services, and that it can have different implications in different areas of financial services:

1. In general insurance, the paper outlines how add-on products have been found to be cheaper than the equivalent standalone products
2. In banking, life and pensions and wealth, the paper outlines how the ‘back-book’ consists of the established customer base, but is often offered less favourable conditions and rates (this builds on the recent long-standing customer thematic review findings)
3. Consumer credit was not explicitly referenced, however price discrimination does occur in the sector (for example, difference in charges) and firms may wish to monitor the issue for further regulatory developments

Regulatory Next Steps

As with all FCA Occasional Papers, the findings will influence future regulatory work in the area, however there is no work planned that will specifically follow on from Occasional Paper 22 at this stage.

From a market perspective, the FCA appears to be particularly concerned where larger firms are selling products below cost and distorting market dynamics, which is proving to be a barrier to competition. This is particularly noticeable for small challenger firms who are not large enough to absorb fixed costs.

From a consumer perspective, the FCA appears to be concerned that vulnerable consumer groups might be particularly affected by higher pricing. For example, customers with poor credit history may believe their options are limited, not shop around and pay higher prices as a result.

In addition to this, consumers who are less “savvy” may inadvertently pay higher prices when compared to more savvy customers.

The discussion feeds into the regulator’s increasing interest in competition, behavioural economics and some of the behavioural drivers behind decision making. We would expect further work to be conducted in these areas.

Considerations for firms

Firms should be considering the following:

• The FCA is not a price regulator, so any action against firms in this area is overbearingly likely to be conduct related – i.e. whether pricing strategies exclude certain demographics of consumers
• Do you have sufficient oversight of any intermediaries selling your products? Can you get under the bonnet of pricing structures to understand if, where and why price discrimination and cross-subsidy exist?
• Can you do any more thinking about what prompts price discrimination internally in your firm?
• How does price discrimination and cross-subsidisation affect your vulnerable customers? Does it leave them paying more for services due to the greater level of care they require and therefore their associated cost and is this fair?

Huntswood will continue to monitor this area and provide firms with relevant insight and considerations.