There is “no compelling evidence” that the use of credit scoring discriminates against minorities, the Federal Reserve Board says in a new report–cited by insurers as further evidence their use of the controversial tool in helping to set rates is not unfair or unreasonable.
The Fair and Accurate Credit Transactions Act of 2003 directed the Fed and the Federal Trade Commission to study the effects of credit scoring on credit and insurance markets, respectively, and to report their findings to Congress. The Fed’s report covers credit markets, while the FTC focused on the use of credit scoring in setting insurance prices.
However, despite the fact that the Fed’s report did not directly address insurance issues, officials of several industry trade groups said the study substantiates the conclusions in the FTC report released several weeks ago that was heavily criticized by consumer groups as misleading.
One interesting point is that the Fed report was based on data different from that used by the FTC to prepare its study.
Besides information from public comments and a review of previous research and surveys, the Fed said it created a database that, for the first time, combines information on personal demographics collected by the Social Security Administration with a large, nationally representative sample of the credit records of individuals.
According to Carl Parks, senior vice president of government affairs for the National Association of Mutual Insurance Companies, “Once again, the government found that credit scoring is generally not a proxy for race or ethnicity.”
Mark Racicot, president of the American Insurance Association, said “it is worth noting,” because of the criticism the FTC study received from certain interest groups, that the data set used by the Federal Reserve was different from that of the FTC.
“Yet, stunningly, the same conclusions were reached by both studies as to the numerous positive benefits of a credit-based risk-evaluation system for financial services companies–be they lenders or insurers,” Mr. Racicot added.
Specifically, the Fed report said it has found no evidence “any particular demographic group has experienced markedly greater changes in credit availability or affordability than other groups due to credit scoring.”
Moreover, the Fed report added, credit scoring serves a useful public purpose. “The limited available evidence, including from public comments and previous research, suggests that credit scoring has increased the availability and affordability of credit.”
The Fed said “the basic reason is that credit scoring allows creditors to quickly and inexpensively evaluate credit risk and to more readily solicit the business of their competitors’ customers regardless of location.”
Credit scoring, according to the Fed report, “likely increases the consistency and objectivity of credit evaluation, and thus may help diminish the possibility that credit decisions will be influenced by personal characteristics or other factors prohibited by law, including race or ethnicity.”
The process also increases the efficiency of consumer credit markets by helping creditors establish prices that are more consistent with the risks and costs inherent in extending credit, the Fed found.
“By providing a low-cost, accurate and standardized metric of credit risk for a pool of loans, credit scoring has both broadened creditors’ access to capital markets and strengthened public and private scrutiny of lending activities,” the report said.
Cliston Brown, federal public affairs director at the Property Casualty Insurers Association of America, said that credit scoring is a “highly predictive underwriting and rating tool that helps customers get a fair price on their insurance coverage.”
“Studies continue to show that this tool benefits consumers, and real-world experience has shown that the use of credit information is one of the most accurate ways to assess risks and price fairly and accurately,” he added.