The head of the Financial Conduct Authority (FCA) has reminded insurance providers of the need to be careful in their use of big data to ensure some customers are not unfairly penalised.

Speaking at the Association of British Insurers' annual conference, chief executive of the regulator Andrew Bailey noted the ability to capture and convert information into insight has led to a "revolution" in how businesses approach data. However, he cautioned that there need to be boundaries on how this is used to ensure that the technology serves everyone effectively.

The use of big data can allow insurers to determine premiums for consumers at a much more individual level, rather than pooling them into wider risk groups. This puts more emphasis on adjusting policies based on how an individual behaves. For example when it comes to car insurance, it can offer discounts to those who can be determined to be safe drivers.

"That strikes me as a good thing," Mr Bailey said. "It prices risk more accurately, and importantly, it should incentivise improved driving as a means to reduce the insurance premium."  

However, the use of this technology does pose risks, and could be used to penalise some customers – not only those determined to be at higher risk.

For example, Mr Bailey noted that big data may also identify and differentiate between customers who are more likely to shop around for the best price and those more likely to remain with the same insurer for years. He suggested this could be used as a justification to provide more 'inert' customers with higher quotes as they are less likely to switch providers.

These customers therefore pay more and end up subsidising cheaper quotes offered to customers who are more likely to shop around, and Mr Bailey suggested this is where the industry needs to draw the line on the use of big data.

“We are … asked to exercise judgment on whether as a society we should or should not allow this type of behaviour. To simplify, our view is that we should not,” he said.

There have already been questions raised recently about the use of big data in the insurance industry and how it affects customers' privacy. For instance, Admiral recently proposed a new service aimed at first-time drivers that would make decisions about their risk level based on what they posted on Facebook – with certain words and phrases being used as signifiers of personality traits that may translate to greater or lesser risk. 

However, this move was blocked by the social network giant as it would have violated the company's terms of service and privacy policies.

The FCA itself also recently completed a study into the use of big data in the sector, which concluded that despite these concerns, the technology is generally performing well, delivering "broadly positive consumer outcomes".

Mr Bailey noted that the full potential of big data in insurance has yet to be explored – particularly in areas such as life insurance, where the use of information such as genetic data could have "potentially profound" implications for the future of the industry.

It will therefore be up to both regulators and the government to determine how to approach issues such as this. He noted: "Understanding the effect and significance for insurance of big data and how it evolves requires a clear framework to disentangle the issues."