The future of credit scores as an underwriting tool may hinge on the extent that credit-based underwriting has a disparate impact on minorities, according to comments made at a House Financial Services Subcommittee hearing last week.

Meanwhile, the growing power of Democrats in Congress who oppose credit scoring was underscored when the Federal Trade Commission disclosed at the hearing that it will use its subpoena power in gathering data for a new study on the issue.

The agency published a notice in The Federal Register last week of its plan to require nine homeowners insurers to provide all available data to the agency. That step, taken under pressure from House Democrats, was criticized by Republicans at the hearing, while a representative of the industry also voiced concern.

“We're continuing to work with the FTC to give them what they need to conduct the study,” said Marliss McManus, senior federal affairs director at the National Association of Mutual Insurance Companies. “We hope to develop a compromise whereby the FTC gets the necessary information from insurers without having to use the compulsory process.”

Democrats' concern about disparate impact was voiced in opening comments by Rep. Mel Watt, D-N.C., who chairs the Oversight and Investigations Subcommittee that convened the hearing.

He asked whether insurers should be making use of a credit-based score that has a disproportionate effect on minorities, even if the correlation between credit scores and future losses has been shown.

“Even a 'slight' proxy effect of race gives rise to public policy concerns,” Rep. Watt said. “I don't think anyone should favor a system in which, either directly or indirectly, racial classifications are allowed to hinder a person in their daily lives, whether in consideration for employment, buying a home, or purchasing financial products like automobile and homeowners insurance.”

Rep. Watt compared this to the prohibitions keeping life insurers from using race as a factor in their underwriting despite actuarially-sound evidence that minorities have shorter life spans.

He added that while he was “willing to be convinced” of the utility of credit-based insurance scores, he would be even firmer in his opposition if FTC studies show they are indeed discriminatory.

The “proxy” issue was raised in a report by the FTC last summer, which found credit-based scores to be an accurate predictor of auto insurance loss, but also one that can serve as a slight proxy for race.

Because of those concerns, Rep. Watt noted that two bills have been introduced. Rep. Luis Gutierrez, D-Ill., introduced H.R. 5633 (which would ban the use of credit scores for underwriting in any line in which the FTC found the proxy effect), while Rep. Maxine Waters, D-Calif., sponsored H.R. 6062 (which would ban the use of credit-based insurance scores altogether).

An FTC official testified that the agency has begun work on a second report, this time examining the use of credit-based scoring in the homeowners market, but using its subpoena power to gain industry records.

The FTC plans to use subpoenas because congressional critics of its auto insurance study said the information on which the report was based was provided voluntarily by the insurance industry, suggesting perhaps that not all the relevant data was provided. However, the move to force insurer compliance drew criticism from the Republicans on the panel.

Rep. Gary Miller, R-Calif., ranking member of the subcommittee, questioned the need for subpoenas, which he noted will increase the costs of the study significantly–especially when the FTC itself said insurers were “cooperative” in supplying data.

In response, Lydia Parnes, director of the Bureau of Consumer Protection for the FTC, said the commission was aware of the concerns expressed about voluntary participation in the auto report, and “by using our subpoena authority we feel we can address those concerns.”

Rep. Miller also made the argument that credit-based scoring is beneficial to Americans who have good credit. He questioned State Rep. George Keiser of North Dakota, who was testifying on behalf of the National Conference of Insurance Legislators, asking whether a proposed ban would be especially damaging to seniors, most of whom have good credit scores.

State Rep. Keiser said he “could not agree more strongly” with that statement, noting that NCOIL has crafted its own credit scoring model law to protect consumers while allowing insurers to use the tool to better gauge risk–a model that 26 states thus far have adopted.

Florida Insurance Commissioner Kevin McCarty, testifying on behalf of the National Association of Insurance Commissioners, said the NAIC supports the limited ban on the use of scores under the Gutierrez bill, and he drew a rebuke from Rep. Miller for offering his personal support for the Waters legislation.

After seeking to “make the record clear” on Mr. McCarty's stance on the Waters bill, Rep. Miller noted that it would negate the laws of almost every state, including Mr. McCarty's home state of Florida.

Other lawmakers sought to look at the basic premise behind insurer use of credit scores, as well as at the validity of credit scoring itself.

Rep. Patrick McHenry, R-N.C., questioned whether the issue of potential bias in the use of credit scores was merely a “symptom of the underlying disease of how credit scores are derived,” and asked if the problem lies in the system for creating a credit score in the first place.

Rep. McHenry also questioned whether a ban on the use of scoring wouldn't harm more consumers than it would help, drawing a response from State Rep. Keiser that there would be “winners and losers” under the proposed legislation, and that the losers would be those consumers who had maintained a good credit rating.

“There's no free lunch,” Rep. Keiser said. “The insurance companies are going to make their money.” He argued that the best way to let those companies do so was to encourage good credit.

The role of insurers and their finances was also a point picked up by Rep. Waters. Mr. McCarty, in response to questioning, said insurers can reduce their costs of underwriting by considering credit-based scores, and that the tool can be a significant factor for some insurers. Rep. Waters wondered if that was the fundamental part of the equation for them.

“To just get the credit score really reduces the [underwriting] costs,” she said, “and I'm beginning to think that is what this is all about.”

Rep. Waters said the findings in the FTC's auto report were “sufficiently disturbing” for her to seek to ban the use of scores by insurers outright, and she questioned the nature of the relationship between credit and losses.

“A correlation does not imply causation,” she said, adding that no one would allow insurers to use a driver's Zodiac sign as an underwriting factor, even if a correlation could be found between the Zodiac and future losses.

As an example, she noted that during the hearing, State Rep. Keiser said that some insurers effectively use a student's grade-point average as a factor when they offer lower auto rates to good students, and that a correlation on that factor exists. Calling that correlation “absolutely nonsensical,” Rep. Waters added: “Enough said. I'm moving forward with my legislation.”

The legitimacy of credit scores was also questioned by J. Robert Hunter, director of insurance for the Consumer Federation of America. An individual's credit rating, he noted, can be affected by factors outside of their control, such as those who suffered through Hurricane Katrina, or those who have lost their jobs due to outsourcing.

“Unlike insurance classifications that were issued before credit scoring was adopted, credit scoring is not based on an appropriate thesis, confirmed by statistical analysis,” he said. “In fact, there is no legitimate thesis for the use of credit scoring. There is only an alleged correlation based on proprietary information not open to public scrutiny.”

The industry sought to defend the use of credit-based scores, through the testimony of Charles Neeson, a senior executive for personal lines at Westfield Insurance, which is a member of the Property Casualty Insurers Association of America.

Five insurance industry trade groups said the position taken by Mr. Neeson represented their thinking as well, including the American Insurance Association, the Financial Services Roundtable, the Independent Insurance Agents and Brokers of America, NAMIC and the U.S. Chamber of Commerce.

Mr. Neeson said insurers have found that credit rating is an accurate predictor of losses, noting that those who have been delinquent in paying their bills twice or more within the past two years are 80 percent more likely to file an insurance claim than those who pay their bills on time.

“It is important to understand how insurers use credit information and to note there are significant differences between the credit scores used by lenders and the credit-based insurance scores used by many insurers,” according to Mr. Neeson.

“Although both are derived from information found on credit reports, the information is measured differently,” he added. “Insurers use credit information in developing insurance scores to predict the likelihood of future insurance loss. Credit-based insurance scores provide an objective measurement of how one manages the risk of credit.”

Several studies have reached this conclusion, a letter from the trade associations said, citing the FTC's auto study as well as others by the Arkansas and Texas insurance departments.

“Prohibiting or banning the use of [credit-based insurance scoring] would, as former Texas [Insurance] Commissioner Jose Montemayor stated, '…create pricing and availability disruptions in a market,'” the letter added. “Premiums would go up for a large number of policyholders if the collar on credit scoring (or any other risk variable, for that matter) is set too narrow, because it would force an immediate price shock that would be unrelated to a change in risk.”

The letter also said that use of credit scoring is regulated through provisions in the federal Fair Credit Reporting Act, and that states “comprehensively regulate” the tool's use, besides being “subject to antidiscrimination provisions.”

Special Reports /

House Challenges Insurer Use Of Credit Scoring Tool As FTC Seeks More Data

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