Insurers are dancing in the streets, hailing a long-awaited (and feared) report from the Federal Trade Commission concluding not only that credit scores are an effective predictor of risk for auto policies, but that the use of credit-based insurance scores may result in benefits for consumers. The question is, will the party last? Or will carriers soon be left with a bad hangover?

(For full coverage of the report and the industry's reaction, click here.)

Much to the delight of carriers, the report said credit scores “permit insurance companies to evaluate risk with greater accuracy, which may make them more willing to offer insurance to higher-risk consumers for whom they would otherwise not be able to determine an appropriate premium.

The report went on to say that credit scores “also may make the process of granting and pricing insurance quicker and cheapercost savings that may be passed on to consumers in the form of lower premiums.

The report said that, in general, credit scores are predictive of the number of claims consumers file and the total cost of those claims, and that the use of scores is therefore likely to make the price of insurance better match the risk of loss posed by the consumer. Thus, on average, higher-risk consumers will pay higher premiums and lower-risk consumers will pay lower premiums.

It doesn't get any better than this for insurers, who have been on the defensive about credit scoring in insurance underwriting and pricing since the practice began.

However, before getting too crazy here, insurers should also note that there is plenty of material skeptical consumer advocates can seize upon to continue their campaign to ban the use of credit scores by the industry.

For one thing, while noting how credit scoring can benefit consumers, the FTC sheepishly concedes that such savings remain theoretical. Indeed, the report cautions, little hard data was submitted or available to quantify the magnitude of these benefits to consumers.

Are there benefits or aren't there? Insurers shouldn't gloat until they can demonstrate actual savings for buyers.

In addition, one of the big problems opponents have with credit scoring is that it unfairly hurts low-income and minority groups, and does not make allowances for those who deal in cash or are impacted by one-time events such as medical emergencies, as NU's Dave Postal reports.

Unfortunately for insurers, the FTC report confirms this negative trend. As Mr. Postal writes, “the report does say that credit-based insurance scores are distributed differently among racial and ethnic groups, and this difference is likely to have an effect on the insurance premiums that these groups pay, on average.”

In his article, Mr. Postal writes, “African-Americans and Hispanics are substantially overrepresented among consumers with the lowest scoresthe scores associated with the highest predicted riskand substantially underrepresented among those with the highest scores.

The FTC tried valiantly to reconcile the fact that credit scoring appears to accurately predict insurance risk, without the disparate impact on low-income and minority groups, but they couldn't pull it off.

The FTC was not able to develop an alternative credit-based insurance scoring model that would continue to predict risk effectively, yet decrease the differences in scores on average among racial and ethnic groups, the agency lamented.

The FTC didn't give up hope, however, noting that while it could not construct a model that meets social and economic objectives, one might yet be developed. Still, the agency admitted, it does strongly suggest…that there is no readily available scoring model that would do so.

Could it be that credit scores are accurate predictors, but its results are not politically correct? Will I be decried for even introducing the question?

Another report issued earlier this week doesn't help at all. The study by the Consumer Federation of America and Washington Mutual revealed that consumer knowledge of the potential impact from credit scores remains low, and on some issues has declined in recent years. (For Matt Brady's coverage of this report, click here.)

The study also found that while there were some gains in the public's understanding of the practice, there were also increases in the number of consumers with mistaken beliefs about credit scores.

Bottom line, while the FTC report may rally insurer spirits, as long as there is a politically unpopular disparate impact, and as long as so many people remain in the dark about the subject, credit scoring will continue to come under fire. But at least now insurers will have more ammunition to fight back.

Special Reports /

Party Time For Credit Scoring!

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