Credit Scoring Survival May Depend On Impact, Not Validity

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

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

Indeed, no matter how much evidence the industry comes up with to support the validity of this controversial practice, a fundamental issue of fairness and societal values might yet trump any stats generated by the numbers-crunchers.

Insurers might not have a hard time coming up with numbers to prove that an individual's credit history does have a direct correlation to loss history, and is therefore useful to underwriters. Indeed, the industry was quick to hail the latest credit scoring study at last week's National Association of Insurance Commissioners meeting.

The University of Texas study–”A Statistical Analysis of the Relationship Between Credit History and Insurance Losses”–matched policyholder loss records for some 153,000 auto policies with credit scores for the named insured driver, according to the American Insurance Association.

The result? Lower credit scores were generally associated with higher loss experience, AIA noted. The insurer group added that this demonstrates the legitimacy of credit scoring as a tool to better predict future loss experience and fine-tune premium quotes.

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

The University of Texas report cited by the industry did not examine the potential effect credit scoring might have on the premiums paid by specific groups of people based on race or income. Yet that's where the battle over credit scoring will almost certainly be fought when it comes time to debate potential restrictions or an outright ban before state lawmakers.

Insurers are quick to argue that even if credit scoring inadvertently raises premiums or limits coverage for any particular racial or income group, such a result on its face is neither illegal nor particularly relevant to the broader issue of fairness and accuracy in underwriting. As long as there is no intentional discrimination, 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 far murkier. Thus, any study that demonstrates disparate impact will prompt lawmakers to toss the industry's statistical arguments out the window.

The industry needs to ask itself two fundamental questions given these political realities: Is this battle winnable, and is it worth fighting? Should disparate impact be proven, the answer to both is probably no.

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

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Credit Scoring Survival May Depend On Impact, Not Validity

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