Do we need an FCA market study into premium finance?

This week's news that the FCA is launching a new market study into the premium finance market came as something of a surprise. The accompanying government announcement that it has set up a taskforce looking at motor insurance was more predictable - after all, it was a Labour Party manifesto commitment.

But a market study into this relatively small part of the insurance sector seems like an odd way to approach what seems to be a fairly straightforward problem.

Premium finance has come under pressure because it has been adding significant cost to motor insurance for those who can't afford to pay annually. And given the inflation we've seen in motor premiums over the past few years, many customers are now struggling to afford motor insurance at all.

Since the FCA first started shining a light on the issue earlier this year, a number of firms have cut their rates. There's no doubt in my mind that firms in the sector are now aware that they need to think carefully about levels of commission and the interest rates that are being charged.

Yes, there are still some outliers who have not moved quickly enough. But if you accept the premise that premium finance should exist at all - then it seems unlikely we are going to get prices down into single digits for what are often relatively small loans in the grand scheme of things. The FCA should be able to use the Consumer Duty to bring pressure to bear on the outliers to bring interest rates and commissions down. And as a last resort, it could sanction a firm that doesn't take the hint - or take the kind of approach that it did in the gap insurance market. But even after the market is working more efficiently, it's likely that premium finance will continue to add a double digit percentage increase to most insurance policies.

Do we need premium finance at all?

The bigger question is one that I'm not sure the market study will have scope to consider - and that is whether premium finance should exist at all. In personal lines insurance, motor stands out as being the only sector where almost every insurer insists that customers pay their annual insurance premium upfront - forcing them to borrow the money if they can't afford to do so.

In home insurance, around half of insurers allow people to pay monthly at no extra cost. And in sectors like pet and travel, it's very rare to find anyone who will charge you to pay in instalments.

The analysis that needs to be done is a calculation of what the cost would be of forcing insurers to allow people to pay monthly at no extra cost. There would be additional costs of capital - and this would need to be added to all insurance premiums. There would also be costs of dealing with those who default - but this should not be a massive cost as lapsed policies can be cancelled.

If the additional cost of removing the need for premium finance is not prohibitive, then it may be a ban on charging customers more to pay in instalments is worth considering. However, having read the terms of reference, it does not seem like this is within the scope of the upcoming market study -and any such decision would almost certainly need to be taken at a government level.

This will surely be something that gets discussed at the taskforce - and it seems to me that they should be leading the initial work on premium finance.

The FCA's report is unlikely to tell us much we don't already know - and there are many other areas of the insurance sector that could do with the scrutiny and resources of a market study.