The battle over the use of credit scores when underwriting insurance risks is reheating to a fever pitch following the release of a controversial Federal Trade Commission report hailed by the industry but hammered by consumer groups and a dissenter within the agency. Credit scores are an “effective predictor” of risk under auto insurance policies, the FTC concluded in its report, but counterattacks have undermined the study's credibility.

Industry trade groups praised the study–”Credit-Based Insurance Scores: Impact on Consumers of Automobile Insurance”–with officials of the National Association of Mutual Insurance Companies, for example, echoing other property-casualty organizations in stating that “the report confirms what the industry has been saying all along–that credit-based insurance scores provide an objective and reliable tool” for setting insurance rates.

Opponents of the technique argue that credit scoring unfairly impacts low-income and minority groups, and fails to account for those who deal in cash or are impacted by one-time events, such as medical emergencies.

However, the report–mandated by the Fair and Accurate Credit Transactions Act (FACT Act) of 2003–concluded that the use of credit-based insurance scores actually “may result in benefits for consumers.”

“For example, 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,” according to the report.

“Scores also may make the process of granting and pricing insurance quicker and cheaper–cost savings that may be passed on to consumers in the form of lower premiums,” the report adds.

However, the report cautions, “little hard data was submitted or available to quantify the magnitude of these benefits to consumers.”

At the same time, the report concedes 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 these groups pay, on average.

Specifically, the report says, non-Hispanic whites and Asians are distributed relatively evenly over the range of scores.

However, African-Americans and non-white Hispanics are substantially overrepresented among consumers with the lowest scores–those associated with the highest predicted risk–”and substantially underrepresented among those with the highest scores.”

The agency also said even though it tried a variety of alternative approaches, “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 said this doesn't mean a model could not be constructed to meet both objectives, “but it does strongly suggest, however, that there is no readily available scoring model that would do so.”

To the relief of carriers, the report concluded that, in general, credit scores “are predictive of the number of claims consumers file and the total cost of those claims. 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.”

Carl Parks, NAMIC's senior vice president of government affairs, said “the practice encourages competition, enables insurers to offer coverage to more consumers at a fair price, and helps streamline the decision-making process.”

June Holmes, interim CEO for the Property Casualty Insurers Association of America, said the report “reaffirms the strong connection between credit information and the risk of loss, and has determined that its use helps to increase the availability and affordability of insurance for most consumers.” She added that “now there should be no doubt about the value of using this highly predictive underwriting and rating tool.”

David Snyder, vice president and assistant general counsel at the American Insurance Association, said the study “confirms what we have long professed and many previous studies have shown–that credit-based insurance scores help refine insurance pricing to better reflect an individual's risk profile. We believe scores reduce subsidization of bad risks by good ones, meaning most consumers pay less for insurance.”

Mr. Snyder added that while “the report is very detailed and requires more thorough analysis…the FTC's initial conclusion says it all–'credit-based insurance scores are effective predictors of risk under automobile policies.'”

Consumer groups were outraged by the report and disputed its credibility. Indeed, a consortium of four such organizations called on Congress to reject the FTC's work and order the agency to conduct “an objective, independent study.”

The groups went on to say that “based on the available evidence of racial discrimination, Congress should ban the use of insurance credit scoring.”

The FTC study is fatally flawed because the insurance industry controlled data used in the analysis, according to a joint statement released by the Consumer Federation of America, the National Fair Housing Alliance, the National Consumer Law Center, and the Center for Economic Justice.

“Instead of requiring the submission of comprehensive policy data by a large number of insurers, the FTC used data handpicked by the insurance industry,” the groups charged in their statement.

“Buried in the report,” the organizations said, is the fact that the FTC noted in its study that “the alleged correlation between risk and credit-based insurance scores might be explained by other factors.”

“To add insult to injury, the FTC report mimics the insurance industry's blaming-the-victim psychobabble of claiming credit history is related to responsibility and risk management,” said Shanna L. Smith, National Fair Housing Alliance president and chief executive officer.

“A look at the actual scoring models shows that socio-economic factors have more impact on the score than loan payment history, and that an insurance credit score has little to do with personal responsibility and everything to do with economic and racial status,” she added.

Indeed, the groups said “the relationship between insurance credit scores and race is so strong that even though the FTC used data handpicked by the industry, it found that credit scoring discriminates against low-income and minority consumers, and that insurance scoring was a proxy for race.”

J. Robert Hunter, insurance director of for the Consumer Federation of America, said he was “disappointed” by the FTC report, adding that its conclusions were “kind of expected” given how the study was conducted. “They didn't go after real data. They just took what the industry gave them.”

Mr. Hunter added there were some positives to the report–most importantly that the FTC could not provide an explanation of why credit scores affect a consumer's risk. “It confirms there's no thesis,” he said, adding that the study is “just correlating a data set.”

By the same token, Mr. Hunter argued, insurers could use any number of other factors that have been shown to correlate with risk–specifically mentioning a study conducted in California which he said showed that the darker a consumer's hair color, the greater risk they are for insurers. “Why shouldn't we use hair color [to underwrite insurance]?” he asked.

Additionally, Mr. Hunter said that it was “important” that the report found a disaproportionate effect on consumers based on race.

Meanwhile, the report was also attacked by a dissenting member of the FTC. Commissioner Pamela Jones Harbour disagreed with the methodology used in generating the report and voiced doubt over the “reliability of any conclusions the report might draw.”

In her dissent, Ms. Harbour charged that the “data collection and analysis fell short of the FTC's gold standard for rigor and completeness, and did not reflect the agency's best practices.” She added that “better alternatives were available and should have been utilized.”

Ms. Harbour noted that “had this report been based on the real insurance marketplace–using actual, verifiable data on individual policyholders, from a broad cross-section of insurance companies–reliable answers might have emerged.”

She said she couldn't endorse the report “due to my grave methodological concerns. This study fell short of the rigorous research and data-collection standards to which the Commission usually adheres.”

A second FTC member–Commissioner Jon Leibowitz–cited other concerns, saying that while he thought the report “makes a substantial contribution to public discussions in this area,” the results “are, of course, no cause for celebration.”

The internal criticism prompted FTC Chair Deborah Platt Majoras and the two other supporting commissioners to issue a statement defending the report.

“While we respect the dissent's views as to the data and methodology used here, we have confidence in the quality of the process that the Commission staff used and the soundness of the results obtained,” the report's three supporters said.

A hearing to discuss the FTC's report scheduled for July 27 before the House Subcommittee on Oversight and Investigations, chaired by Rep. Mel Watt, D-N.C., was unexpectedly postponed, with no new date set as this story went to press.

“The growing use of credit-based insurance scores affects millions of consumers,” Rep. Watt said. “We look forward to hearing from a range of perspectives–including state insurance regulators, consumer advocacy groups and the insurance industry–on this important issue.”

The chief of staff for the Florida Department of Insurance said one reason the hearing was postponed was because Florida Insurance Commissioner Kevin McCarty informed the committee he had a personal emergency and had to return home as soon as possible. He was scheduled to represent the National Association of Insurance Commissioners at the hearing.

Special Reports /

Controversial FTC Report Reignites Fight Over Insurance Credit Scoring

Related Stories

Recommended For You