Price cap successor needs ‘considerable’ assessment

“Considerable” further design and assessment is needed on the price cap’s successor before Citizens Advice reaches its own position, the charity has warned.

The default price cap was introduced on 1 January 2019 and as the law stands it will be reviewed annually until 2023 when it will cease to apply.

In a discussion paper published on Friday (31 January), Citizens Advice explores arguments for protecting a narrow group of vulnerable consumers (like the pre-payment meter cap does) or a broader group of disengaged customers (such as the default tariff cap).

The charity does not provide a firm recommendation on which proposal should succeed the wider cap and believes it is “too soon to reach a firm conclusion” on this.

The paper begins by looking into how wide the protection should be.

Arguments for a narrow intervention such as the PPM cap include a stronger moral case to defend those who can’t afford to be ripped-off than those who can and that targeted intervention may provide more assistance to those eligible than a mass market intervention.

It also says there is lower risk from unintended consequences such as supplier failure.

Arguments for a wider intervention include the point that while some people can afford to be ripped off, it doesn’t make it right and that narrower interventions may simply push detriment from the protected to the unprotected.

There are eight options as to what approach can be taken. These include:

• Some form of continuing price cap
• Mass opt-out collective switching
• Setting up a backstop supplier offering fair prices, that disengaged consumers would be moved to
• Opt-in collective switching, with much stronger nudges and/or support to try and improve take-up
• Reforming the current universal supply obligation
• The creation of a ‘price to beat’
• Social tariffs
• Do nothing

Option 1 – Some form of continuing price cap

The first option is considered a more “tried and tested” approach even though the cap is still relatively new. Early experience of the cap, Citizens Advice argues, suggests that engagement and quality of service have “held up reasonably well”.

The risks of this approach however include that it might be hard for regulators to set caps at the right level – too high and they will not protect consumers, too low and they may discourage investment or cause financial failure, risks which grow the longer any cap is in place.

Option 2 – Mass opt-out collective switching

The second option involves progressively auctioning off the accounts of disengaged consumers. Having been notified they will be switched, the consumer can opt-out – but would have to take action to do so. If they ignored the communication, they would be switched to the successful supplier.

Citizens Advice argues the large number of participants in the market should, subject to auction design, lead to a high degree of competition for new accounts, driving good prices.

Furthermore, it argues, while auctions are naturally price-focussed, there is the potential to also have an incentive effect on quality of service (eg poorly performing suppliers could be excluded).

However, disengaged customers may actually be happy with their supplier and therefore might not want to switch.

In addition, there may be inefficiency costs associated with allowing incumbents to scale down very rapidly, such as customer service functions designed for millions now only serving hundreds of thousands or challenger brands scaling up very rapidly (eg they may be unable to cope, or to serve vulnerable consumers well).

Option 3 – Setting up a backstop supplier offering fair prices, that disengaged consumers would be moved to

Citizens Advice says this model could ensure fair prices for eligible consumers, providing the supplier is efficient. It might defuse public concern that these consumers are paying more than they should.

Problems with this option “could threaten the ongoing operation of the larger suppliers, perhaps forcing some out of business”. It could also leave a very limited pool of suppliers – perhaps principally just the backstop supplier – serving the most vulnerable consumers.

Option 4 – Opt-in collective switching, with much stronger nudges and/or support to try and improve take-up

Option four would build on Ofgem’s trials with its disengaged customers database. Consumers who are disengaged would be approached with personalised offers, tailored through knowledge of their current tariff and consumption levels.

These offers could be generated by collective switching, by highlighting best existing offers on the market, or both.

Positives from this “very scalable” approach are that it has been quite heavily trialled and comes with “low risks of unintended consequences”. Trials have resulted in a “significant uplift” in switching rates, with up to 8 times as many households switching as in the control group.

The paper does warn however that while it has led to a significant increase in engagement levels, to date it has still only resulted in a minority of consumers switching.

“It may therefore be argued that while an improvement on the status quo, it does not solve the problem of majority disengagement”, it added.

Option 5 –  Reforming the current universal supply obligation

Under the current universal supply obligation suppliers are required to offer terms to all domestic consumers. Some argue that the framework prevents specialisation. For example, even if a supplier wanted to be a prepayment specialist they would have to be able to offer credit payment terms.

This may deter the creation of niche or genuinely innovative business models.

Reforming this obligation or even allowing some suppliers to be exempt from certain conditions may foster more innovation and specialisation. However, it may result in worse outcomes for “hard to serve” consumers.

Option 6 – The creation of a ‘price to beat’ 

Under this option Ofgem would set a non-obligatory “price to beat” which reflects a fair price to supply energy. Although suppliers would not be compelled to beat the price, this option could be used as a “naming and shaming/faming” mechanism.

The paper argues that from a government and regulatory perspective, this option could be seen as relatively light-touch and potentially straightforward to implement and operate.

Yet Citizens Advice points out that there is “little reason” to think this approach would work. Awareness of the right to switch is “extremely high” and consumers are already bombarded with messages that there are cheaper deals out there and they should switch, yet most do not.

Option 7 -Social tariffs 

Suppliers would provide social tariffs at or below cost to their vulnerable consumers. If below cost, the losses would be recovered from their other consumers. Eligibility criteria for this would need to be developed.

This approach could allow for deeper financial support for qualifying consumers than a price cap, as it could be designed as a subsidy (while price caps are intended to be challenging, they are not intended to set prices below efficient costs).

The weaknesses of this option include the possibility of inconsistencies in qualification criteria or price setting between suppliers, resulting in perceptions of unfairness.

Furthermore, this approach is only compatible with a narrow intervention, and would not help most consumers.

It would be likely to increase prices for those consumers who are disengaged but not vulnerable, as they would be contributing to the costs of providing the scheme while not receiving any benefit.

Option 8 – Do nothing 

The “do nothing” approach may result in better customer service outcomes for those with the largest suppliers as they would be under less cost pressure. It could also reduce the risk of supplier failure.

Yet a reversion to something similar to the status quo prior to the introduction of the price caps is likely to result in similar outcomes.