Insurance lemons

Price comparison

Inattentive, time-constrained customers are buying insurance through price comparison websites, taking it on trust that the insurer will cover them if they ever need to claim.

Given the way that price comparison websites tend to design their choice architecture, it is not surprising that customers end up focussing on getting the best price. But insurance policies vary considerably in their quality - i.e. coverage and claims experience.

Use your common sense

Some will argue that it should be obvious to consumers that cheaper products will have lower quality. Use your common sense. What do you expect for £50? Buyer beware.

But the point is that is not obvious whether the worse quality affects a dimension that matters to you. A home insurance policy might be worse because it doesn’t cover outbuildings, or has a very low coverage limit on bicycles. How you feel about this will depend on whether you have an outbuilding or a bicycle.

Two similarly priced policies may have very different levels of quality on the things that affect you. You need more than common sense - you need industry knowledge, a lot of time, and a strong coffee.

Even this might not be enough. A close technical reading of the T&Cs cannot predict whether insurers are likely to pay 'grey area' claims. New Fairer Finance analysis found that it comes down to the insurer's culture and way of working, rather than anything observable to outsiders at the point of sale.

Avoiding lemons

In this context, it's unreasonable to expect consumers to make well-informed decisions about the price - quality trade-off.

This affects the market dynamics. If consumers only understand price - providers will be incentivised to offer the lowest possible price, regardless of the quality.

It's what economists call a 'market for lemons'. In a market where you might accidentally buy a lemon, you might decide not to buy anything at all. Trust is eroded. The market shrinks.

FCA intervention

Solving the lemon problem is bread and butter for regulators. The FCA has tackled similar problems across financial services. There is a playbook.

For example, the regulator could intervene to make it easier for people to shop around on quality, or to maintain minimum quality standards.

This intervention cannot be rushed and needs careful analysis. Some interventions cause more problems than they set out to solve. But something needs to be done - even if it generates an uncomfortable conversation with insurers and price comparison websites.