TO THE POINT
Correlation high, credibility low?
By Bruce Hicks, CLU, CPCU
The industry's continuous touting of the statistical correlation between certain elements in a person's credit history and their future profitability appears to fly in the face of credibility.
I thought I had paid close attention to the credit-based scoring issue, but now I'm convinced that I've missed some important point. The more I read about the issue, the more I read about correlation between credit scores and expected loss. The more I read about correlation, the more I expected to read about other justifications for using credit-based scoring. When I finally read from a knowledgeable insurance source that essentially "the correlation is the justification ..." well, I decided to stop reading and start writing because I'm confused.
Insurance people from the left, right and center have told anyone listening (peers, regulators, consumer advocates, legislators) that studies have shown a high correlation between credit histories and loss ratios. I understand that. However, I also understand why some people might refuse to make the leap of faith between the existence of that relationship and the use of credit scores as an insurance underwriting tool.
For one thing, it's counterintuitive. In other words, the statement doesn't "feel right." Answer the following questions as quickly as possible:
An insurance company states: "I'm sorry, we can't offer/renew your insurance because ..."
Does It Feel Right? (Yes/No)
"You've had three speeding tickets in the last two years."
"Your MVR says that your license was revoked."
"Your application says that you are not the legal owner of the car."
"You have caused two serious accidents in the last three years."
"Your credit-based score is below our standard of xxx."
Did all of the statements "feel right" to you? If so, you should have answered each question "yes" quickly. If you answered "no," or if there was a discernible pause before answering "yes," then maybe you also feel that something's a little off. An important point is that if an insurance person can have such feelings, how do you think things are perceived by the general public as well as by the people with the charge to protect the public's interests?
The industry's continuous touting of the statistical correlation between certain elements in a person's credit history and their future profitability appears to fly in the face of credibility. It raises a number of questions.
What about cause and effect?
In my opinion, any element that is described as an underwriting tool should bear a direct relationship to determining the quality of an exposure to loss. Most folks outside the industry seem to be sold on the idea that the type of car, or the amount of driving experience or how much you drive are valid components of underwriting. How quickly a phone bill or charge card bill for Christmas presents is paid just doesn't have the same logical hook.
But maybe the hook exists. After all, underwriting criteria that are accepted today were questioned in the past. I happened to find an American Insurance Association ad that ran in the May 1980 issue of Rough Notes. It was titled "Why should two men with identical cars and similar driving records have different auto insurance rates?" It then explained how rates were affected by geography, specifically urban vs. suburban locations. The justification struck me as logical and easy to understand. I didn't get a feeling that it was "counterintuitive." One difference found in today's underwriting criteria fight over credit-based scoring is that no one is talking about causation, only correlation. Why can't we apply the same method to encourage acceptance of credit-based scoring?
How was correlation first recognized?
I've read comments from several sources mentioning that at least one authoritative study was made to prove a positive relationship between lack of claim activity and higher credit-based scores. Well, who first came up with the idea to collect such information? Was the relationship first discovered and then applied by enough insurers, or were credit scores used first and the relationship discovered (hoped for) afterwards? Sharing more information about the events that prompted the use of credit scores in underwriting might help the idea gain acceptance from insureds and regulators.
How can companies be sure they are treating the information on the same basis?
Insurers consistently maintain that credit-based scoring improves pricing and underwriting. Is this position credible when companies do not have:
* a consistent method for integrating scores into automated underwriting programs?
* information on how their peers apply the information in underwriting decisions?
* objective information on how credit-based scores impact loss ratios?
This possible uncertainty undermines the better pricing argument. Different ways of handling credit-based information will create difficulties in making rating comparisons. Diminished uniformity also will lead to difficulty in the ability of agents, consumers and regulators to make meaningful comparisons.
What if credit-based scores involve serving self-interested parties?
Companies that supply credit-based scores claim that their method of developing the information is proprietary. Currently, at least one company not only sells the credit history to consumers, but also sells information on how to improve their credit history in order to maintain or improve their score. Selling the same core information to achieve two separate goals raises a legitimate question as to the bias and purpose of the scoring information. Creating scores that disqualify more consumers creates a new market and may influence the formulation used in the scoring.
How are credit history errors handled?
Hardly a week goes by without some news story about identity theft. Individuals who have been victimized by identity theft are saddled with errors in their credit histories. These errors have to be corrected by the affected persons, but before they are corrected an insurance company may have made a decision based on an inaccurate history. Further, businesses which discover that their customer data has been stolen often delay or even fail to notify their customers.
Why unfairly burden insurance consumers with a flawed underwriting tool? Insurers and credit-reporting agencies should consider verifying report histories with affected persons. This step would assure the public that only accurate information is used to make insurance-related decisions.
Why can't questions be added to an application to get similar information? Is it really necessary that insurers rely on some proprietary formula as part of their underwriting criteria? In other words:
if a correlation exists between a credit score and likelihood of loss and
if credit-scores are based upon certain elements found in credit histories,
... then why not just determine the relevant information and convert it into questions that appear on an insurance application? The answers could be subject to the same verification used for other questions. Further, dishonesty about the information would be subject to the same consequences--claim denial or policy voidance. It seems to this insurance veteran that, if at all possible, the industry should prefer straightforward methods of collecting underwriting information.
Why don't we respect the opinions of others?
I thought about asking, "Does our defense of credit-based scoring reflect a respect for outside opinions?" I changed my mind because my opinion is that we are not giving other parties the benefit of the doubt. During a recent review of nearly two dozen publications and Web sites I found:
* A variety of news stories criticizing credit scoring
* Several stories on increased ID theft
* Information on different states challenging the use of insurance scores
* Information on legislation or administrative rules limiting the use of credit information
Naturally, I also found articles that defended the use of credit history as part of the underwriting process. Naturally, the defenders were insurers or spokespersons for insurance associations or credit bureaus. And, naturally, our industry focus was on correlation and more correlation.
Productive discussions over important issues tend to involve parties who respect each other's position. Understanding and agreement (or at least compromise) can grow out of such mutual respect. On the other hand, our industry's single response to every objection or question on the use of credit-based scores appears to be defensive, ignoring the views of others. The proponents of credit-based scoring may win without offering a logical explanation for its use. But the victory may not be worth the damage to our industry's image. Will our gain of credit-based scoring outweigh our loss of credibility in underwriting criteria? *
The author
Bruce Hicks, CPCU, CLU, is senior editor, Technical and Educational Products Division, for The Rough Notes Company, Inc. He has been in the insurance industry since 1981, serving several regional and national companies in personal lines underwriting, product research and development, auditing, regulation and compliance.