Critical Issue Report
Credit scoring debate continues
PIA National issues white paper to help agents protect themselves
By Phil Zinkewicz
Credit scoring, or insurance scoring as some in the insurance industry prefer to call it, for the purpose of rating auto and homeowners insurance has been a controversial subject for quite some time. Back in the 1970s, a few property and casualty insurers tried to use credit scores, which were designed solely for lending institutions for lending purposes, as an underwriting criterion for auto and homeowners insurance.
Almost immediately, they faced a court challenge, however, and lost. Basically, the court said that the insurers could not just take credit scores intended for another industry and use them without qualifying them in some way. The insurers ceased using the credit scores and the issue was forgotten—for a while.
Pat Borowski, senior vice president of the National Association of Professional Insurance Agents (PIA National), remembers not only the failed attempts of those insurers to use credit scores but also what brought the issue once again to the forefront.
“In the late 1970s and early 1980s, there was a rash of arson-for-profit incidents countrywide,” she says. “The insurance industry, along with regulatory and investigative authorities, was attempting to do battle with these arson rings but was having a difficult time. It was then that the insurance industry drew criticism from regulators and law enforcement officials because they said insurers, by providing coverage, offered an incentive for arson rings to crop up. They asked why insurers were not doing credit checks on purchasers of homes before providing coverage to determine where the money to buy the buildings was coming from.
“Insurers said they were not permitted to use credit scores because of that previous court decision,” Borowksi continues. “Now the industry’s critics reevaluated that court decision and said it meant only that insurers could not rely solely on credit scores when underwriting but could use credit scores as a part of the underwriting process. If an insurer is using credit scores to determine only whether a potential insured would be able to pay premiums, it was allowed.”
Borowski said the next major development came in the 1990s. “Credit bureaus wanted to broaden their customer base, so they approached insurers and said that an insurance-specific model for credit scoring could be created to be used carrier by carrier so that an insurer could demonstrate that credit scoring would make a significant difference to its loss ratio. We call that insurance scoring, and many states allow such scoring to be used as long as it is done in a fair, equitable and nondiscriminatory manner.”
The question now arises: Where do independent agents stand in all of this? It is the carrier that has the responsibility to decide whether to use insurance scoring in its rating process, and it is the carrier that must satisfy state insurance department regulations regarding insurance scoring. However, the agent represents the company and must inform the insured that insurance scoring is being used by the company and how it affects his or her premiums.
PIA white paper
PIA National has published a white paper that addresses these issues and more. The white paper makes no judgments as to the merits of insurance scoring but rather provides direction on what agents must do to protect themselves. Among its suggestions are:
• Carriers need to provide comprehensive documentation to their agents that they (carriers) have properly vetted their method and process for insurance scoring. In addition, the carrier needs to instruct its agents on the methods agents are to use.
• Carriers will advise their agents of the legal/regulatory sufficiency, modifications or prohibitions that may exist in the several states on the uses and methods of each carrier’s insurance scoring process. Agents write business in many states. Therefore, each carrier should have an accessible and accurate chart for agents to reference that shows each state’s regulation, if any, of the insurance scoring process.
• All carriers need to accept (as most do) that executing insurance scoring activities at the agent level is NOT an optional choice of the agent. The ramifications of this business practice and the practical consequences of its process “force” agents to take on this responsibility in order to best serve consumers, their carriers and their own business interests.
• Carrier/agency agreements must provide full and appropriate indemnification provisions for the agent’s activities in these areas in the event of any consumer complaint or legal/compliance action.
• Carriers must also use due care to ensure that the vendor licensing agreement, which agents are required to sign, with the outside source selected by the carrier to facilitate their insurance scoring, provides appropriate provisions that complement the obligations expressed in the agency/carrier agreement, and acceptable indemnification for the agent.
• Carriers must make available to the agent sufficient information allowing the agent to properly explain insurance scoring and how/where the consumer can obtain further information that clearly explains the insurance scoring result.
In favor of scoring
Consumer activists who are critics of insurance scoring say that it results in discrimination against minority groups and that it is just another excuse for insurers to raise rates. However, according to a white paper from the Insurance Information Institute (I.I.I.), a report on credit-based insurance scores by the Federal Trade Commission found that auto insurers’ use of insurance credit scores leads to more accurate underwriting because there is a correlation between insurance scores and the likelihood of filing an insurance claim.
The report also states that credit scores cannot easily be used as a proxy for race and ethnic origin. In other words, credit scoring predicted risk for members of minority groups in much the same way that it predicted risk for members of non-minority groups.
The I.I.I. white paper goes on to say that while consumers, when asked, think most people do not benefit from credit scoring, more than 50% of policyholders have a lower premium because of good credit.
Says the I.I.I.: “Some consumers are disturbed by the fact that, when applying for insurance, one insurer will reject their application based on their insurance score, yet another company will find it acceptable. They ask how insurers’ responses can be so different when they are all working from essentially the same credit report information in combination with standard actuarial data. Even when insurers use the leading vendors of insurance scoring models, they may have the model tailored to their own target market. Not all insurers are looking to insure the same kind of drivers or home owners. Some may target only the very best, with no recent accidents or traffic violations, while others may seek out people with less than perfect records. Since virtually all companies use credit information in different ways, insurance scoring fosters competition among insurance companies and more choices for the consumer.”
Jeff Junkas, director of public affairs for the American Insurance Association (AIA), says that many studies have shown that insurance scoring is one of the most accurate rating factors. “Insurance scoring is blind to race, nationality, income, etc. It helps insurers speed up the rating process. Conventional wisdom has demonstrated that when a person’s financial situation shows a certain level of responsibility, it carries over to other aspects of that person’s life, such as driving a car. Landlords use credit scores and even some employers. Why not insurers?”
Junkas says that, at present, 46 states allow some form of credit scoring. California and Hawaii have disallowed it. In other states, credit scoring is in legislative limbo.
“Most people benefit from insurance scoring,” says Junkas. “You take a young male living in Chicago, in a densely populated urban area, driving a muscle car and you have a bad risk. Credit information can improve his situation.”
There are still many unanswered questions regarding insurance scoring. What about people who don’t have credit records from which an insurer can draw information? Some religious groups, for example, don’t allow their members to use credit. And then, of course, mistakes can occur in credit reporting. If insurers are going to use credit scores in underwriting, they must be sensitive to the exceptions to the rule as well as the rule itself. *
The author
Phil Zinkewicz is an insurance journalist with some 30 years’ experience covering the international insurance and reinsurance arenas. He was the insurance editor of the Journal of Commerce for a number of years, handling all their domestic and international supplements. In addition, he regularly writes for a number of London publications.