Monday 29 July 2019 4:21 am

From energy to insurance: How Open Banking could fix the loyalty penalty headache

Sam Bowman is director of competition policy at the International Center for Law & Economics and a senior fellow of the Adam Smith Institute

You don’t get to be Prime Minister without having a few political gifts.

One of Theresa May’s was her ability to spot the issues that people cared about – even if she found it harder to come up with effective ways of improving them. 

That was why her maiden speech outside Downing Street was so inspiring to many people: the things she saw as problems, lots of voters did too.

One such problem, in many people’s eyes, is the so-called “loyalty penalty”, where businesses offer better deals to new customers than their existing users are getting. 

If you haven’t switched energy or insurance provider in the last year, chances are you’re on a tariff that charges you a lot more than you could be paying for the same service.

Even if you’re a savvy customer who remembers to switch insurance and energy providers every year, and cancel your mobile phone contract once you’ve paid off the handset, it’s a near-certainty that you have relatives and friends who aren’t. To many people, it’s too much of a hassle to switch, and the gains are too uncertain to bother checking. 

This practice seems like a rip-off, and that was the motivation behind the energy price cap proposed by Ed Miliband and implemented by the May government at the start of this year. 

As critics of the policy predicted, the energy price cap is now being ratcheted downwards, so that more and more customers will be caught in it and the price discounts that energy companies can offer will become smaller and smaller. In telecoms, Ofcom has just reached an agreement with most of the mobile operators to curb loyalty penalty pricing in mobile phone contracts.

This may sound like a good thing, but trouble with price caps and contract regulations is that customer switching is good for efficiency overall.

Customer switching forces companies to compete with each other and try to find ways of doing business more cheaply. Diminishing the rewards for switching means that fewer people will be willing to shop around, which weakens the incentive these companies have to improve.

The current regulatory approach tries to protect non-switchers by hurting switchers. That’s a dead end, making markets affected by it sclerotic, uncompetitive, and less innovative in the long run. 

A better approach may be to make switching easier, or even entirely automatic. And a model for this already exists, in banking. 

Open Banking was introduced by the Competition and Markets Authority last year, and is intended to allow bank customers to more easily compare financial products across the market, and access the best ones for them. 

For example, many people default to their home bank for mortgages and credit card borrowing, even when this is a more expensive option, because it is easier to manage. By lowering the barriers to comparing, accessing and managing loans from other lenders, Open Banking should drive competition and lower borrowing costs in the market. 

It is early days, but already services that use Open Banking are being rolled out and making it easier for customers to access and manage credit and other financial products from the whole market, not just their current account provider.

The Open Banking regime could do a lot more, as a recent paper by my colleagues at Fingleton, co-authored with the Open Data Institute, argues. 

If, for example, it were extended to other financial products like mortgages and insurance, customers could use Open Banking based services that monitor the market on their behalf and nudge them to switch when a better deal becomes available. 

The same approach could be extended to energy and telecoms. 

At a cost of over £11bn, the smart meter rollout has been enormously expensive and currently offers little more than easier meter readings. 

But giving customers control over their own smart meter data, so that they could share it with approved third parties, could make something worthwhile out of this project. 

Energy customers could provide their usage data and contract information to approved third party intermediaries that could guarantee to prompt them when a cheaper tariff became available, or even switch them automatically. Almost all the work would be shifted to intermediaries, and customers could be given certainty about the benefits of switching to a new supplier.

This kind of approach would allow this new government to address the problem of the loyalty penalty, while avoiding the mistakes made by the last one. 

Instead of more regulation, here’s a way for the new Prime Minister to show that he means business – and shake these markets up with a bit of competition.

Main image credit: Getty

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