The UK’s financial regulator is weighing whether to ban insurers from “price-walking” customers on to more expensive policies when they are renewed, after finding that about 6m policyholders were being overcharged by £1.2bn a year.

The Financial Conduct Authority said the £18bn market for home and motor insurance products was “not working well for all consumers” as it laid out its findings of a sector-wide study into pricing on Friday.

The regulator is particularly concerned about how customers who do not shop around are penalised by higher prices. The study found that insurers jack up prices for customers who renew their policies, while offering cheaper rates to new customers.

In response, it is considering tough measures such as forcing companies to put customers on the cheapest equivalent deal, making them publish the price differentials between customers, or even an outright ban on raising premiums when policies are renewed.

The FCA, which aims to issue its final rules in the first quarter next year, also proposed restricting the way insurers use auto-renewal to move existing customers on to new policies.

The proposals knocked insurers’ shares on Friday, with Direct Line, Sabre and Aviva all falling slightly while Saga was worst hit, down 4 per cent. Shares in price comparison groups Moneysupermarket and GoCo both rose.

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

The watchdog is worried that vulnerable people account for about a third of these policyholders, and that those on lower incomes are paying more for their insurance.

Huw Evans, director-general of the Association of British Insurers, said the industry would work constructively with the regulator but added: “It is important that any unintended consequences are carefully considered to ensure that a fair and balanced approach is achieved for all customers.”

David Miller, a partner at KPMG, said insurers would be most worried by the proposals on renewal pricing and on auto-renewals. “[The FCA] certainly presents a full range of remedies, some of which the insurance sector will see as fairly far-reaching and impactful . . . it’s strong,” he said.

The FCA’s study follows a “super complaint” by consumer charity Citizens Advice last year to the Competition and Markets Authority over the “loyalty penalty” it thought amounted to about £4bn a year across five sectors.

“We’re especially happy to hear the regulator say that everything is on the table to make sure customers are getting a fair deal,” Gillian Guy, chief executive of Citizens Advice, said on Friday. “This includes tackling gradual year-on-year price increases and making companies automatically switch their customers to better deals.”

One person who came to Citizens Advice is Paul, from Staffordshire, whose mother-in-law was paying £800 in home and contents insurance for a terraced house. He found equivalent deals online for about £300.

“She is an 89-year-old lady and doesn’t have the capacity to sort all of that out herself,” he said. “I feel like she’s been cheated. And I think it seems like common practice, to rip off the people who are most vulnerable.”

However, there are concerns that cutting prices for some people will simply lead to higher prices for others.

“The only way that the price playing field can be levelled is for new customers to get a worse deal,” said Rob James, a fund manager at Merian Global Investors. “If prices on new business rise and those on renewals fall . . . then the attractiveness to shop around each year reduces.”

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