Public Backing Needed To Save Credit Scoring

This year, the Texas Legislature will decide whether credit history should be used to underwrite insurance policies, but the issue goes much further than that.

Ultimately, Texas lawmakers will determine if fiscally-responsible consumers who drive safely, maintain their homes and avoid risk should pay higher insurance premiums to cover the losses of those consumers who live more recklessly.

The focal point of the debate is a recently completed Texas Department of Insurance study that reaffirmed the link between credit history and claims experience. Not only did the study confirm the correlation between credit and risk, it also determined that credit history provides “additional predictive information distinct from other rating variables.”

What that means is that by using credit history, companies can more accurately price their products so that high-risk consumers pay more for their policies and low-risk consumers pay less.

In his letter to state legislators that accompanied the study, Insurance Commissioner Jose Montemayor stated: “Prior to the study, my initial suspicions were that while there may be a correlation to risk, credit scorings value in pricing and underwriting risk was superficial. The study, however, did not support those initial suspicions. Credit scoringis not unfairly discriminatorybecause credit scoring is not based on race, nor is it a precise indicator of ones race. Further, its useadds value to the insurance transaction.”

End of story, right? Not quite.

The insurance departments study also determined that, on average, a higher percentage of younger, lower-income, African-American and Hispanic consumers have poorer credit histories than white, Asian-Ameican, older and higher-income consumers.

As a result, some public policymakers are now calling for the Legislature to ban the use of such scores because they do not affect every segment of the population in exactly the same waythe so-called “disproportionate impact.”

Because the action taken by state legislators will be felt in the pocketbook of every consumer in the state, it is important that lawmakers proceed deliberately and with a full understanding of the consequencesintended and unintendedof their actions. Again, one of the best places to start their deliberations is Commissioner Montemayors letter.

“By the nature of risk-based pricing and underwriting, all factors used in insurance have a disproportionate impact to some extent,” wrote Mr. Montemayor. The commissioner dismissed implications that the use of credit was somehow unfairly discriminatory, saying that reverting to a pricing system that homogenizes risk and charges everyone the same price “would be a setback to all Texans, of all races, especially those of moderate-to-lower income whose risk remains low.”

The bottom line is that insurers underwrite individuals, not ethnic or economic groups, and apply every underwriting factor equally to everyone. Insurers never collect information on the income or ethnicity of a consumer, ensuring that the underwriting process is objective and colorblind.

The response from opponents of risk-based pricing has been predictable. Essentially, they have said that they dont care what any study saysuse of credit history is “immoral” and should be banned. In the greatest irony, the head of the Texas chapter of the American Association of Retired Persons is publicly supporting a ban on credit despite the insurance department reports findings that older consumers are most likely to benefit from the use of credit in underwriting. Go figure.

In 2003 state legislators enacted a law that allowed insurers to consider credit history with some important restrictions. For instance, insurers cannot use credit history to underwrite policies for individuals who face unexpected and difficult economic challenges such as divorce, death of a spouse, medical catastrophe, temporary loss of employment or identity theft. These safeguards make certain that every consumer gets a fair shake.

Insurers will communicate these messages to Texas lawmakers when proposals to ban the use of credit history are heard in committees or get attached to other legislationsuch as school financing measureson the House or Senate floors.

However, some legislators are going to need more than a study and the opinion of industry lobbyists to convince them that a ban on credit history is a bad idea. Insurers need to muster the grassroots strength of the millions of consumers that benefit from the use of credit historyand whose rates will increase if it is bannedto win the day in Texas.

It wont be easy. Weve seen that critics of credit history are quite willing to play the race card to achieve their ultimate goal of rate subsidization. We must make sure that legislators see through this smoke screen.

The best way to accomplish this is to make certain that they hear from financially responsible constituents in every ethnic and income category who would pay higher insurance premiums if credit history were banned.

Ernie Csiszar is president and CEO of the Property Casualty Insurers Association of America in Des Plaines, Ill., and former president of the National Association of Insurance Commissioners.

Reproduced from National Underwriter Edition, February 25, 2005. Copyright 2005 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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Public Backing Needed To Save Credit Scoring

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