The expectations around this outcome raise particularly challenging questions for providers to address. One example question we have seen emerge is whether risk-based pricing is compatible with ‘fair value’.

Definitions first. Risk-based pricing is what it says on the tin: pricing that adjusts for the expected losses for a given customer. Customers are assessed for their level of risk, with higher risk customers charged more, and lower risk customers charged less. Providers will have a number of ‘segments’ that customers are sorted into based on their risk level, with a corresponding price. Often providers have two to four segments, but some may use more granular approaches.

There is a clear customer-focused case for risk-based pricing: it improves fairness, market efficiency and access to credit. Consider if we didn’t have risk-based pricing, you would have only one price, with three important implications:

1. There will be a group of customers who won’t be offered credit because they are too high risk and costly relative to the single price. They lose access to credit.
2. There will be another group of customers who are low risk, who will pay a lot more than is warranted by their expected losses. They would in effect be cross-subsidising other customers. There is likely to be less demand for credit from these customers, given the high price they pay.
3. Market competition is reduced, as firms only have one price to offer and cannot seek to undercut competitors with a price that better reflects risk and cost for particular segments of customers.

The FCA recognises the importance of risk-based pricing in a healthy pro-consumer market. So the practice of risk-based pricing is not an issue per se. But there are questions that providers need to ask themselves about how they carry out risk-based pricing, and any deviations around it. Here are a few of them:

• For higher risk customers charged the highest prices, are they still receiving a good outcome?
• How are customers re-priced (up and down) as the level of risk changes?
• Do customers across different segments receive a fair price given their risk?
• Where there are deviations from risk-based pricing, is there a ‘fair value’ justification for these?

At the margin of credit provision for the highest risk customers, questions need to be asked about whether the access to credit is in customers’ interests. Providers need to reflect holistically on the likely outcomes for such customers (including the rates and consequences of default) and whether credit is a suitable product.  

There is likely to be greater concern about ‘fair value’ where segments of customers are charged much higher prices than appear to be justified by their risk and expected cost. Other deviations from risk-based pricing should also be considered. For example, if relationship managers for SMEs can deviate from standard pricing, are there patterns that suggest bias against some customer groups (e.g. whether groups with protected characteristics, such as ethnic minorities and women, or groups who may be financially vulnerable)?

These sorts of questions and issues are at the heart of the ‘price and value’ outcome, with the FCA looking for providers to reflect on and explore their approach and the outcomes for customers.