When we assess a bank’s creditworthiness, typically much of the focus is on its business model, the strength and composition of its balance sheet, whether it holds sufficient capital buffers, as well as analysing all manner of financial ratios. However, following being hit with a £91m fine, Lloyds Bank has helped bring how banks treat their customers into the credit mix.
Under the Financial Conduct Authority’s (FCA) Conduct of Business Sourcebook (COBS) rules (number 4.2.1 for those who may wish to have a read), a firm must ensure that its customer communications are fair, clear, and not misleading, particularly when conveying information to a client classified as retail under MiFID II.
The FCA deemed that Lloyds Bank General Insurance (LGBI) had failed to communicate with customers about their home insurance in a way which complied with these rules and hit the division of Lloyds Banking Group with the fine.
According to the FCA, LGBI sent almost nine million communications to home insurance customers over a seven-year period, implying it was offering them a ‘competitive’ policy renewal price. However, LBGI failed to ensure the accuracy of that statement. What LBGI did do, however, was erroneously send 1.5 million communications telling customers they would receive a discount based on loyalty or on a discretionary basis, despite ultimately not applying these discounts, or having any intention of applying them.
In its investigation, the FCA highlighted that the ‘competitive’ price offered to existing customers was in fact (you’ve guessed it) higher than the premium quoted to new customers. However, due to this information asymmetry, around 87% of customers receiving the communication renewed their insurance policies.
Rating agency Moody’s issued a research document this week noting that it considered the fine credit negative for Lloyds, not because of the hit to the bank’s profitability – while £91 million is a relatively large proportion of the division’s £338 million profits, it pales into almost insignificance compared to the group’s underlying profit of over £2 billion – but because the fine stems from a significant operational error which highlights the risks UK insurers face as a result of the FCA’s scrutiny on consumer protection and business conduct.
The FCA’s focus has been on whether insurers’ treatment of existing customers matches their treatment of new customers, and in a market study conducted last year they found that existing customers who choose note to switch or negotiate a better deal, typically pay more than new customers even when their risk profile is unchanged.
Following these findings, earlier this year the FCA announced new measures which come into place at the start of 2022, aimed at improving customer protection and market transparency, including ensuring that existing customers pay no more than they would as a new customer.
While this is undoubtedly good news for consumers, as the FCA estimates buyers of insurance policies will save over £4 billion over 10 years, it is bad news for the banking sector in general. Moody’s deems this action to be credit negative due to its likely impact of reducing profitability, increasing competitive pressure, and increasing regulatory supervision.