The issue of whether or not auto insurers should base premium costs in part on customers’ credit ratings rather than purely on their driving record has industry representatives buzzing.
“Insurance scores, comprised of credit scores, have proven to be remarkably predictive in terms of claims filing, not necessarily as individuals, but as a group,” said Jeanne Salvatore, vice president of consumer affairs for the Insurance Information Institute (III). “Those with the best credit scores file either very few or no claims. Those with the worst credit scores file the most.”
For decades, underwriters have used credit information to help them determine whether to accept or reject applications for insurance. Advances in information technology have expedited the development of insurance scores, which insurers say allows them to better assess the risk of future claims. Insurers claim that insurance scores, based in part on credit scores, are non-discriminatory because they do not include data on race or income.
“We studied 50,000 credit reports for that very reason, and discovered that 20% of the cases were misclassified,” said Robert Hunter, director of insurance for the Consumer Federation of America. “Besides, insurance has created as many as 50 tiers. If one split causes a 20% error, what’s the error ratio with 50 tiers?”
Last December, the Texas Department of Insurance released a report on the use of credit information by Texas insurers. Based on an analysis of data from two million auto and homeowners insurance policies, the study revealed a strong correlation between credit scores and claims experience. A second phase of the study, published in January, found that the use of insurance scores significantly improves pricing accuracy in predicting risk when combined with other rating variables such geographical area and age of driver.
However, the study showed a consistent pattern of differences in credit scores among different racial and ethic groups, with blacks and Hispanics having worse scores on average than whites and Asians.
“The Texas Insurance Department studies seem to support the idea that credit scoring is simply a surrogate for identifying low-income and minority groups,” he said.
Addressing the situation
Few states have very restrictive rules regarding the matter. In March 2002, Washington state lawmakers passed legislation prohibiting insurers from canceling and non-renewing policies based partly or wholly on credit history. In Maryland, a state that previously allowed the use of information from credit histories, legislators banned the use of credit in auto insurance underwriting decisions on existing business. And while credit-related information may be used in rating decisions about new insurance policies, the law imposes a 40% cap on discounts and surcharges related to credit.
Many states have passed credit-scoring bills based on the National Conference of Insurance Legislators model law, adding modifications as necessary. For example, in New York, where such a bill was passed in 2004, insurers are not allowed to deny coverage, non-renew, or increase premiums based solely on credit information.
In August 2004, the National Association of Insurance Commissioners approved a “best practices” white paper on credit scoring, intended as a list of suggestions to states considering such legislation. Industry watchers believe that some of the suggestions are overly broad interpretations of Federal Trade Commission requirements and often inconsistent with the National Conference of Insurance Legislators (NCOIL) model law.
“Some of the laws that states have passed are meaningless,” said Hunter. “Only a handful of states have really done anything significant about this practice.”
Not the only factor
Last year, Mississippi Insurance Commissioner George Dale issued a bulletin warning insurance companies not to use credit scoring as a prerequisite for writing and/or pricing insurance policies.
“Credit scoring with other factors can be used, but not alone,” he said.
State lawmakers have not passed legislation mandating such action, and Dale said it was unnecessary.
“I can argue both sides of this issue, though I do think insurance companies have probably gone overboard,” he said.
There’s also the question about what to do with consumers who have little or no credit. The NCOIL model law notes that in those cases, the credit score should be considered average or not used at all as an underwriting factor.
“I’m convinced that a senior citizen who pays cash for everything is not a credit problem,” said Dale. “A college student who has too many credit cards, and a rich daddy back home who allows him to get into credit card trouble, is a credit problem. Overall, I think insurance companies should use more discretion.”
Dale said the bulletin was not prompted by consumer complaints, but by inquiries from one-line insurance agents who were “really perturbed at their own company’s director of underwriting for kicking out any policies they submitted because of credit.”
Salvatore said the weight given to credit scoring varies among underwriters, and that extenuating circumstances related to poor credit, such as paying medical bills for a sick family member or enduring a messy divorce, are usually noted on credit reports.
“But if you’ve been financially irresponsible, it’s important to get on the right track because insurance is only one of many situations in which credit is used,” she said.
Consumers should query insurance companies about the weight given to credit scoring, suggested Salvatore.
“Ultimately, you care about getting a good policy at a good rate, so the best thing to do is shop around,” she said.
Contact MBJ contributing writer Lynne W. Jeter at firstname.lastname@example.org.