Credit Scoring Survival May Depend On Impact, NotValidity

Insurance, in its purest form, is a numbers game. The morenumbers insurers have at their disposal, the more likely they areto accurately assess an exposure, and to price it properly if theychoose to accept the risk at all.

However, the quantitative nature of insurance often clashes withthe more qualitative world of politics. The use of credit scoringin the underwriting and rating process is a prime example.

Indeed, no matter how much evidence the industry comes up withto support the validity of this controversial practice, afundamental issue of fairness and societal values might yet trumpany stats generated by the numbers-crunchers.

Insurers might not have a hard time coming up with numbers toprove that an individual's credit history does have a directcorrelation to loss history, and is therefore useful tounderwriters. Indeed, the industry was quick to hail the latestcredit scoring study at last week's National Association ofInsurance Commissioners meeting.

The University of Texas study–”A Statistical Analysis of theRelationship Between Credit History and Insurance Losses”–matchedpolicyholder loss records for some 153,000 auto policies withcredit scores for the named insured driver, according to theAmerican Insurance Association.

The result? Lower credit scores were generally associated withhigher loss experience, AIA noted. The insurer group added thatthis demonstrates the legitimacy of credit scoring as a tool tobetter predict future loss experience and fine-tune premiumquotes.

However, we can't help but doubt that this argument willultimately carry the day. Regulators at the NAIC gathering,considering a study of their own, said their prime considerationwould be whether rating plans using credit history systematicallyproduce different results for minorities, as well as for differentages and incomes. Such a finding would constitute a dreaded“disparate impact” and politically undermine any statisticalvalidity claimed by the industry.

The University of Texas report cited by the industry did notexamine the potential effect credit scoring might have on thepremiums paid by specific groups of people based on race or income.Yet that's where the battle over credit scoring will almostcertainly be fought when it comes time to debate potentialrestrictions or an outright ban before state lawmakers.

Insurers are quick to argue that even if credit scoringinadvertently raises premiums or limits coverage for any particularracial or income group, such a result on its face is neitherillegal nor particularly relevant to the broader issue of fairnessand accuracy in underwriting. As long as there is no intentionaldiscrimination, insurers are in the clear, they contend.

On the letter of the law, the industry is probably correct.However, the standards in the court of public opinion are farmurkier. Thus, any study that demonstrates disparate impact willprompt lawmakers to toss the industry's statistical arguments outthe window.

The industry needs to ask itself two fundamental questions giventhese political realities: Is this battle winnable, and is it worthfighting? Should disparate impact be proven, the answer to both isprobably no.

Reproduced from National Underwriter Edition, March 17, 2003.Copyright 2003 by The National Underwriter Company in the serialpublication. All rights reserved. Copyright in this article as anindependent work may be held by the author.