The future of credit scores as an underwriting tool may hinge onthe extent that credit-based underwriting has a disparate impact onminorities, according to comments made at a House FinancialServices Subcommittee hearing last week.

Meanwhile, the growing power of Democrats in Congress who opposecredit scoring was underscored when the Federal Trade Commissiondisclosed at the hearing that it will use its subpoena power ingathering data for a new study on the issue.

The agency published a notice in The Federal Register last weekof its plan to require nine homeowners insurers to provide allavailable data to the agency. That step, taken under pressure fromHouse Democrats, was criticized by Republicans at the hearing,while a representative of the industry also voiced concern.

“We're continuing to work with the FTC to give them what theyneed to conduct the study,” said Marliss McManus, senior federalaffairs director at the National Association of Mutual InsuranceCompanies. “We hope to develop a compromise whereby the FTC getsthe necessary information from insurers without having to use thecompulsory process.”

Democrats' concern about disparate impact was voiced in openingcomments by Rep. Mel Watt, D-N.C., who chairs the Oversight andInvestigations Subcommittee that convened the hearing.

He asked whether insurers should be making use of a credit-basedscore that has a disproportionate effect on minorities, even if thecorrelation between credit scores and future losses has beenshown.

“Even a 'slight' proxy effect of race gives rise to publicpolicy concerns,” Rep. Watt said. “I don't think anyone shouldfavor a system in which, either directly or indirectly, racialclassifications are allowed to hinder a person in their dailylives, whether in consideration for employment, buying a home, orpurchasing financial products like automobile and homeownersinsurance.”

Rep. Watt compared this to the prohibitions keeping lifeinsurers from using race as a factor in their underwriting despiteactuarially-sound evidence that minorities have shorter lifespans.

He added that while he was “willing to be convinced” of theutility of credit-based insurance scores, he would be even firmerin his opposition if FTC studies show they are indeeddiscriminatory.

The “proxy” issue was raised in a report by the FTC last summer,which found credit-based scores to be an accurate predictor of autoinsurance loss, but also one that can serve as a slight proxy forrace.

Because of those concerns, Rep. Watt noted that two bills havebeen introduced. Rep. Luis Gutierrez, D-Ill., introduced H.R. 5633(which would ban the use of credit scores for underwriting in anyline in which the FTC found the proxy effect), while Rep. MaxineWaters, D-Calif., sponsored H.R. 6062 (which would ban the use ofcredit-based insurance scores altogether).

An FTC official testified that the agency has begun work on asecond report, this time examining the use of credit-based scoringin the homeowners market, but using its subpoena power to gainindustry records.

The FTC plans to use subpoenas because congressional critics ofits auto insurance study said the information on which the reportwas based was provided voluntarily by the insurance industry,suggesting perhaps that not all the relevant data was provided.However, the move to force insurer compliance drew criticism fromthe Republicans on the panel.

Rep. Gary Miller, R-Calif., ranking member of the subcommittee,questioned the need for subpoenas, which he noted will increase thecosts of the study significantly–especially when the FTC itselfsaid insurers were “cooperative” in supplying data.

In response, Lydia Parnes, director of the Bureau of ConsumerProtection for the FTC, said the commission was aware of theconcerns expressed about voluntary participation in the autoreport, and “by using our subpoena authority we feel we can addressthose concerns.”

Rep. Miller also made the argument that credit-based scoring isbeneficial to Americans who have good credit. He questioned StateRep. George Keiser of North Dakota, who was testifying on behalf ofthe National Conference of Insurance Legislators, asking whether aproposed ban would be especially damaging to seniors, most of whomhave good credit scores.

State Rep. Keiser said he “could not agree more strongly” withthat statement, noting that NCOIL has crafted its own creditscoring model law to protect consumers while allowing insurers touse the tool to better gauge risk–a model that 26 states thus farhave adopted.

Florida Insurance Commissioner Kevin McCarty, testifying onbehalf of the National Association of Insurance Commissioners, saidthe NAIC supports the limited ban on the use of scores under theGutierrez bill, and he drew a rebuke from Rep. Miller for offeringhis personal support for the Waters legislation.

After seeking to “make the record clear” on Mr. McCarty's stanceon the Waters bill, Rep. Miller noted that it would negate the lawsof almost every state, including Mr. McCarty's home state ofFlorida.

Other lawmakers sought to look at the basic premise behindinsurer use of credit scores, as well as at the validity of creditscoring itself.

Rep. Patrick McHenry, R-N.C., questioned whether the issue ofpotential bias in the use of credit scores was merely a “symptom ofthe underlying disease of how credit scores are derived,” and askedif the problem lies in the system for creating a credit score inthe first place.

Rep. McHenry also questioned whether a ban on the use of scoringwouldn't harm more consumers than it would help, drawing a responsefrom State Rep. Keiser that there would be “winners and losers”under the proposed legislation, and that the losers would be thoseconsumers who had maintained a good credit rating.

“There's no free lunch,” Rep. Keiser said. “The insurancecompanies are going to make their money.” He argued that the bestway to let those companies do so was to encourage good credit.

The role of insurers and their finances was also a point pickedup by Rep. Waters. Mr. McCarty, in response to questioning, saidinsurers can reduce their costs of underwriting by consideringcredit-based scores, and that the tool can be a significant factorfor some insurers. Rep. Waters wondered if that was the fundamentalpart of the equation for them.

“To just get the credit score really reduces the [underwriting]costs,” she said, “and I'm beginning to think that is what this isall about.”

Rep. Waters said the findings in the FTC's auto report were“sufficiently disturbing” for her to seek to ban the use of scoresby insurers outright, and she questioned the nature of therelationship between credit and losses.

“A correlation does not imply causation,” she said, adding thatno one would allow insurers to use a driver's Zodiac sign as anunderwriting factor, even if a correlation could be found betweenthe Zodiac and future losses.

As an example, she noted that during the hearing, State Rep.Keiser said that some insurers effectively use a student'sgrade-point average as a factor when they offer lower auto rates togood students, and that a correlation on that factor exists.Calling that correlation “absolutely nonsensical,” Rep. Watersadded: “Enough said. I'm moving forward with my legislation.”

The legitimacy of credit scores was also questioned by J. RobertHunter, director of insurance for the Consumer Federation ofAmerica. An individual's credit rating, he noted, can be affectedby factors outside of their control, such as those who sufferedthrough Hurricane Katrina, or those who have lost their jobs due tooutsourcing.

“Unlike insurance classifications that were issued before creditscoring was adopted, credit scoring is not based on an appropriatethesis, confirmed by statistical analysis,” he said. “In fact,there is no legitimate thesis for the use of credit scoring. Thereis only an alleged correlation based on proprietary information notopen to public scrutiny.”

The industry sought to defend the use of credit-based scores,through the testimony of Charles Neeson, a senior executive forpersonal lines at Westfield Insurance, which is a member of theProperty Casualty Insurers Association of America.

Five insurance industry trade groups said the position taken byMr. Neeson represented their thinking as well, including theAmerican Insurance Association, the Financial Services Roundtable,the Independent Insurance Agents and Brokers of America, NAMIC andthe U.S. Chamber of Commerce.

Mr. Neeson said insurers have found that credit rating is anaccurate predictor of losses, noting that those who have beendelinquent in paying their bills twice or more within the past twoyears are 80 percent more likely to file an insurance claim thanthose who pay their bills on time.

“It is important to understand how insurers use creditinformation and to note there are significant differences betweenthe credit scores used by lenders and the credit-based insurancescores used by many insurers,” according to Mr. Neeson.

“Although both are derived from information found on creditreports, the information is measured differently,” he added.“Insurers use credit information in developing insurance scores topredict the likelihood of future insurance loss. Credit-basedinsurance scores provide an objective measurement of how onemanages the risk of credit.”

Several studies have reached this conclusion, a letter from thetrade associations said, citing the FTC's auto study as well asothers by the Arkansas and Texas insurance departments.

“Prohibiting or banning the use of [credit-based insurancescoring] would, as former Texas [Insurance] Commissioner JoseMontemayor stated, '…create pricing and availability disruptions ina market,'” the letter added. “Premiums would go up for a largenumber of policyholders if the collar on credit scoring (or anyother risk variable, for that matter) is set too narrow, because itwould force an immediate price shock that would be unrelated to achange in risk.”

The letter also said that use of credit scoring is regulatedthrough provisions in the federal Fair Credit Reporting Act, andthat states “comprehensively regulate” the tool's use, besidesbeing “subject to antidiscrimination provisions.”