NAIC Credit Scoring Debate Heats Up

A consumer advocate accused state regulators, who met in NewYork last week, of failing to act on the issue of insurers use ofcredit records for customer risk assessment–a process he said couldbe inherently unfair to poor and minority applicants.

Members of the National Association of Insurance Commissionersresponded vigorously by noting that many states have taken steps toregulate the process, which by some research disproportionatelyimpacts population sectors.

The commissioners were challenged at the NAIC consumer liaisoncommittee meeting this past weekend by Birny Birnbaum, executivedirector at the Austin, Texas-based Center for Economic Justice,who accused the NAIC of abandoning the credit scoring issue.

“The NAIC as an institution has failed so miserably. It hasn'tdone anything on this for the last seven years,” he said at themeeting. “It has been missing in action. It failed miserably inputting forth policy issues about risk classifications,” hesaid.

Insurance trade groups at the session released a report thatfound credit scoring is an accurate predictor of risk.

According to Mr. Birnbaum, NAIC's inaction on this issue hasmade the insurance industry's arguments “the only ones on thetable” in the credit-scoring debate.

“So when the industry goes to state legislators, legislatorshear all these arguments from them and say, Well, who else can wego to for other opinions? But there isn't any. So instead of theNAIC producing some good products that legislators could look at asan alternative to what the industry is putting forth, there is avoid,” Mr. Birnbaum argued.

He also asked the NAIC to develop a model that would do one oftwo things: “First, the NAIC could develop a model that bans creditscoring. Alternatively, they could develop a model that actuallyprovides meaningful consumer protection if credit scoring is stillgoing to allowed.”

Mr. Birnbaum also added that, at this point, “we don't think anew comprehensive study is necessary.” Already, he argued, there isenough evidence to show that credit scoring has disproportionateimpact on poor and minority communities.

But a number of commissioners who were present at the meetingwith Mr. Birnbaum took issue with his portrayal of the NAIC.

Mike Pickens, Arkansas insurance commissioner and president ofNAIC, responded by saying 41 states have already dealt with creditscoring this year. “And 11 states have passed the NCOIL (NationalConference of Insurance Legislators) model plus other consumerprotections where the NAIC had input,” he said.

Commissioner Pickens said the NAIC has dealt with all of theseissues, such as no-hits/thin files. The measures passed in thesestates say credit scoring can't be used as a negative factor forthose who don't have much credit history at all, he explained.

“Also, other important consumer protection measures prohibitinsurers from using credit information as the sole basis forincreasing rates or denying, canceling or not renewing policies. Itprohibits insurers from using factors such as income, race, gender,address, zip code, ethnic group and similar factors in the creditscoring formula,” Commissioner Pickens said.

“We would like to let people know that state regulators haveworked with our state legislators to address the credit scoringproblem,” said Mr. Pickens.

He also told National Underwriter, “Frankly, I think atotal ban on credit scoring is unrealistic in most states. I thinkwe are addressing the concerns, at least the immediate concernsregarding credit scoring, and we need to continue to look at theissue.”

Mike Kreidler, insurance commissioner for Washington state andco-chair of the NAIC credit scoring work group, also defendedNAIC's approach on credit scoring.

“I want to make it clear that what we are doing is thoughtful,”Commissioner Kreidler said of his group's planning for theNAIC-sponsored or NAIC-organized study on credit scoring and itspotentially disproportionate impact on certain groups. “Mr.Birnbaum suggested that we don't even need to do a study now. But Ithink a study still should be done,” Commissioner Kreidlersaid.

He also noted that his credit scoring work group was going tohave a meeting this week in New York, “but we decided to cancel itbecause we wanted to make sure we had a well-thought-out proposalfor how a study like this should be done,” he explained. “It wasimpossible to do it because we were still collecting additionalinformation. We are anticipating holding that meeting at the fallNAIC meeting coming up in Chicago.”

One of the challenges in discussing credit scoring's impact isthat no two companies use credit scoring in the same fashion,Commissioner Kreidler observed.

“Companies all have different methodologies for applying creditscoring and they don't all use it to the same degree. Some use itas a principal underwriting tool, but others use it as one ofseveral. So it's very hard to make a general statement about creditscoring,” he noted. “So the study has to be verycomprehensive.”

Still, Commissioner Kreidler acknowledged that a smaller studyalready conducted in his state has indicated signs ofdisproportionate-impact problems.

“We did a study in the state of Washington. In that study, therewas a clear indication that the use of credit scoring had adisproportionate, adverse impact on low-income [cconsumers]. Italso gave indications that credit scoring adversely impacted peopleof color,” he said.

“But we don't have a high degree of diversity in our state'spopulation. We weren't able to do the study the way it should bedone–you need a state that has a lot more diversity. In otherwords, our state tends to be too white, for example, on thequestion of race,” Commissioner Kreidler added.

That's why, he said, a NAIC study still needs to be done on alarger scale with more diverse populations to “really findout.”

“But there were indications that there were problems and we needa bigger study to resolve this issue.”

But for Mr. Birnbaum, the very concept of using credit scoringin the risk assessment process is troubling. And he argued the onlydefense of credit scoring by insurers is that there is somestatistical relationship between credit scoring and the lossrisk.

“But even if there is this statistical relationship, the use ofcredit scoring is so antithetical to the basic risk-spreadingmechanism and antithetical to the public-policy goal of universalcoverage and loss prevention–the very reason we have insurance,” hesaid.

Mr. Birnbaum also said the notion that a model doesn'tspecifically consider race or income doesn't mean anything. “Ofcourse, it can still have disproportionate impact. A few yearsback, companies were using age and value of the home asunderwriting guidelines. If your home was too old, if it was undercertain value, companies didn't want to offer coverage,” herecalled.

Insurers said those were objective criteria and that they hadstatistics to back it up, he noted. “But the problem was, it waseliminating insurance in entire communities, economicallydisadvantaged communities, with bigger impact on minoritygroups.”

It was casting too broad a net, Mr. Birnbaum argued, and theremay have been some low-value homes where consumers were takingreally good care of them. “So the National Fair Housing sued,saying that this violates fair-housing laws. And companies stoppedusing those underwriting guidelines,” he said.

These guidelines didn't have anything to do with race or income,he added, “but they had a disproportionate impact by race andincome. It's the same thing with credit scoring. Credit doesn'tconsider race or income, but it has a disproportionate impact byrace and income.”

Mr. Birnbaum recommended that this is the place for legislaturesto say, “You know, we have to draw a line even if there is astatistical relationship. We know there is a correlation, but as amatter of public policy, we are not going to allow creditscoring.”

Reproduced from National Underwriter Property &Casualty/Risk & Benefits Management Edition, June 30, 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.