A third of those paying too much are on low income or vulnerable, says watchdog

Six million home and motor policyholders are being overcharged around £200 a head every year by insurance firms, according to a damning assessment of the industry by the Financial Conduct Authority.

The City regulator found that elderly and low-income people were among the worst hit groups overpaying a combined £1.2bn in annual premiums because insurance firms are not giving good deals to loyal customers.

Its investigation found widespread evidence of a “loyalty penalty”, and it accused insurers of specifically targeting loyal customers with big premium hikes in the knowledge they were less likely to switch. It also found a “range of practices to raise barriers to switching”, such as automatic policy renewals for customers.

“This market is not working well for all consumers,” said Christopher Woolard, the executive director of strategy and competition at the FCA. “While a large number of people shop around, many loyal customers are not getting a good deal. We believe this affects about 6m customers.”

The report suggests that insurers make bigger profit margins on low-income customers, who are less likely to shop around online. It found that consumers with earnings below £30,000 a year who buy combined building and contents cover pay higher margins than those on higher incomes.

A home insurance renewal letter sent to a profoundly deaf couple aged 91 and 92 last month by one of the major insurers, seen by the Guardian, demanded a 20% increase to £579 for a small semi in the Midlands. When the couple’s son went to the same insurer’s online site and posed as a new customer, the premium was just £108.

Investigations by Guardian Money in 2016 uncovered a 97-year-old charged £1,000 by Lloyds Bank for insurance on a small bungalow compared with the £247 that the bank wanted for the same cover online. Another woman in her 70s found that Saga was charging her four times the rate available on a comparison site.

The FCA told insurers two years ago to prominently publish the previous year’s premium when sending out renewal letters, but while the move had saved around £185m so far for customers, it said more needs to be done.

The interim report suggests banning or restricting practices such as raising prices for consumers who renew year-on-year, or requiring firms to automatically move consumers to cheaper equivalent deals.

It also raised the prospect of compelling insurers to publish information about price differentials between customers.

Consumer groups said insurers have been engaged in “sharp pricing practices” for some time. Gareth Shaw of Which?, said: “Our research has found existing insurance customers can be left paying hundreds of pounds more than new customers as a result of complex and opaque pricing systems.

“The regulator must now ensure these proposals are brought in swiftly, and that it is ready to take strong action against firms that continue to rip off consumers simply for staying with their providers.”

But Huw Evans, the director general of the Association of British Insurers, representing the industry, said: “Millions of insurance customers get extremely good deals by shopping around regularly, but we agree that the household and motor insurance markets could work better for consumers who do not shop around at renewal.”

The FCA said it would publish its final report, including its consultation on which remedies to introduce, in the first quarter next year.

Customers who stay loyal to their mobile, broadband or insurance providers are paying as much as £1,000 a year more than serial switchers – costing them a total £4.1bn more – according to research from the charity Citizens Advice, which filed a “supercomplaint” last year, prompting the Competition and Markets Authority (CMA) to investigate.

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“It’s great to see the FCA acknowledging that the insurance market isn’t working for consumers and pledging to crack down on the loyalty penalty,” said Gillian Guy, the chief executive of Citizens Advice.

In June, the government launched a consultation looking at whether to give the CMA new powers to impose direct fines where consumer law has been broken. This means the competition watchdog would not have to go through the courts and could intervene earlier and move more quickly.

Ministers believe this will act as a powerful deterrent to firms that are harming consumers with misleading claims, unfair terms and conditions and hard-to-exit contracts.