The subject of hot debate for years, credit scoring is estimated to be used by over 90% of property and casualty insurers writing personal lines coverage today. Credit scoring use has been a controversial practice due to competing points of view – some consumer advocates argue that it is discriminatory while industry generally views it as a valuable risk selection and rating tool. Most current studies indicate that consumer credit scores are in fact an accurate predictor of loss. Could a newly enacted state law banning credit scoring use reactivate the debate on a larger stage?
What makes up a consumer credit score for insurance purposes? Information from an individual’s financial records is entered into a credit scoring model that weights various factors and generates a 3-digit “score” from 0 to 999. Generally, consumers with higher scores are viewed as more financially responsible with a lower probability of loss, and consequently, better insurance risks. Relevant financial data includes:
- Major negative factors — Bankruptcy, collections, foreclosures, liens, etc.
- Past payment history — Number and frequency of late payments
- Length of credit history — Amount of time consumer has recorded credit data
- Home ownership — Whether the consumer owns or rents
- Inquiries for credit — Number of recent new credit account applications
- Number of open credit lines — Number of major credit cards in use
- Type of credit in use — Major credit cards, store credit cards, finance company loans, etc.
- Outstanding debt — How much is owed vs. available credit
The Fair Credit and Reporting Act mandates specific consumer disclosure if an adverse action is taken against a policyholder based on consumer credit report information. Additionally, all states regulate the use of credit scoring to some degree. Some states have taken the additional measure of adopting the National Conference of Insurance Legislators (NCOIL) Model Credit Use Act “extraordinary life circumstances” exception. Under this provision, policyholders have an opportunity to mitigate the impact that financial hardships may have on insurance scores. Extraordinary life circumstances include major financial hurdles such as divorce, serious illness, job loss, the death of an immediate family member, identity theft and overseas military duty. In addition to state regulation of insurers, Federal Trade Commission rules apply to credit scoring model vendors. Are these legal protections enough to ensure that credit scoring use does not disproportionately affect insurance availability and affordability for all socioeconomic groups?
Although a long-standing Massachusetts Division of Insurance position maintained that credit scoring is not permitted to be used as a factor in private passenger automobile rating, the prohibition was signed into law last week. The legislation was backed by the Massachusetts Association of Insurance Agents and viewed as a victory for consumers. Does banning the use of credit scoring as a rating/underwriting factor actually keep overall automobile insurance premiums lower? Will this new Massachusetts law reawaken the discussion in other jurisdictions? The debate continues.
Editor’s Recommendation: Effectively research credit scoring use requirements and legislative activity in all jurisdictions with NILS INsource and the AuthenticWeb Credit Scoring Matrix.
The problem is not with the use of scoring. The problem lies in the way the scoring bureaus keep the credit standing or individuals. While one can’t change their actual score, there is no recourse to the score regardless of your objections to the bureaus of how right you are and how wrong the companies that report to the bureaus are. Yes you have the “100 words” you can file that attaches to your credit report, but that does not affect your score. There should be a way to penalize some of the false information reported by the irresponsible companies that report to the bureaus. There was a company that I entrusted to tell me the truth. They lied, and now I pay the price. If there was ever an unfair situation in the world, those who report to credit bureaus is it. Consumers have the Better Business Bureau, but that does not penalize the false reporting and damages their credit, now does it?
There is little doubt that using credit scoring is a valuable tool in predicting loss. A major problem with it is that several of the components that are used by scoring methods are already considered in other rating factors. I know of no one who has studied the effect of these double- dipping factors. The other major issue (which is closely tied to first one above) is that insurers over-use scoring. Several actuary types have stated they could use as much as 90% of their rating algorithms by scoring alone. Really? The two flaws on the other side (with the credit bureaus) are that there are still an extensive number of errors in the actual reports and even though there are ways to get your own credit score for free, most will charge you for what you should already own! The other is that the credit bureaus rely WAY too much on those reporting to them and don’t allow enough “power” to the individuals to contest the content in the reports. They give you “100 words or less” to state your position in the dispute, however where is the dispute in the credit score? That alone should be enough to at least draw attention to the need for revewing public policy in rating again.
How come this says no responses? I’ve sent two.