The End of Credit Scoring in Insurance?

By Barbara Marquand on May 10th, 2010
Auto Insurance

For years car and home insurers have factored in customers' credit ratings to price insurance policies, but the practice is coming under growing attack across the country. It's too early to tell whether credit-based insurance scoring may survive, but insurers are already exploring other ways to gauge same risks.

Bad credit means higher car insurance premiums

You're probably well aware that your credit score determines the rates you get for car loans, mortgages and credit cards. But did you know your credit history also determines how much you pay for home and car insurance?

Insurers rely on something called an insurance risk score. Similar to your credit score, it's based on elements of your credit history. But instead of using the information to predict whether you'll pay your bills, insurers use the score to predict the number and cost of claims you'll file. They figure consumers with poor credit are more likely to file car and home insurance claims than consumers with clean credit records. The bottom line? If you have bad credit, you'll pay more for your car insurance than someone with good credit, even if you've never filed a claim.

Insurance companies began using credit-based insurance scoring for home and car insurance in the mid-1990s (it's not used for health and life insurance). The insurance industry maintains credit-based insurance scoring is a good predictor of risk and helps ensure accurate pricing for consumers. A 2007 Federal Trade Commission (FTC) study on the practice for car insurance backed up that claim.

But consumer advocates sharply criticized the FTC study, saying it was based on hand-picked data from the insurance industry, and they continue to hammer away at the practice. They point to previous studies by the Missouri and Texas Departments of Insurance, which found insurance credit scoring discriminated against minorities and low-income consumers because of inherent economic disparities. Consumer advocates also say the practice is patently unfair to people who have suffered financial losses through no fault of their own.

"If you ask proponents of the use of credit scoring to explain to a person who suffered a decline in credit as a result of being in Hurricane Katrina, or lost her job because of outsourcing, or lost his job in the current economic downturn, why these events that they had no control over made them a worse auto or home insurance risk, they have no response," Consumer Federation of America Insurance Director Robert Hunter told a U.S. House of Representatives subcommittee in May 2008.

Home and car insurance credit scoring debate revs up

The focus on credit scoring in insurance has intensified recently in the tough economy, with a growing number of critics calling for its end. This year some 26 bills targeting the practice were pending in state legislatures across the country, Roosevelt Mosley, a principal with Pinnacle Actuarial Resources Inc., told the Casualty Actuarial Society recently at a ratemaking seminar.

So far only a few states have banned credit scoring for certain types of personal insurance. California, Hawaii and Massachusetts have banned credit scoring for personal auto insurance, and Maryland has banned the practice for homeowner's insurance. Michigan also banned the practice for personal lines of insurance, but the insurance industry sued, challenging the validity of the rules. The case is now pending in the Michigan Supreme Court.

Pending bills to ban credit scoring face a tough fight from the insurance industry, and already much of the legislation has died this year, including proposed bans in both Washington state and Wisconsin.

Yet, the controversy will continue. A recent Dallas Morning News editorial called for the Texas Legislature to address the issue. An analysis by the newspaper found that consumers with poor credit reports paid on average 35 percent more for car and home insurance than those with better credit, and in some instances, premiums more than doubled for people with poor credit, even if they had similar claim histories as their neighbors.

"Credit scoring has its purposes, but setting insurance rates does not appear to be its highest, best or fairest use," the editorial concluded.

Car insurance companies drive forward

Meanwhile, some insurance industry experts are encouraging insurers to consider alternatives to assess risk.

"This issue is not going to go away," Mosley told the Casualty Actuarial Society. "In the last couple of years, the credit crisis and related economic troubles have served to reenergize the debate."

When credit is removed, Mosley said, insurers need to recalibrate factors and consider other variables that demonstrate responsibility, risk-taking behavior, and stability. Those variables could include payment history, accident and violation history, and number of years someone has been insured and employed.

Actuarial consultant Eliade Micu of EagleEye Analytics told actuaries that insurers who look for other behavioral variables to predict risk, rather than taking a wait-and-see approach to the credit scoring debate or merely tweaking their class plans, stand the best chance of making up for losses if credit scoring is removed.

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