With the Florida Legislature recently confirming the Oct. 2,2008, legislative sunset of Florida's public records exemption forcredit scoring methodologies and related trade secret information,some insurers may have reason to be uneasy.

Pending bills in the current legislative session would prohibitthe use of credit scores or credit reports in insuranceunderwriting. Companion Senate and House bills would amend theUnfair Insurance Trade Practices Act to prohibit the charging ofmotor vehicle insurance premiums based on credit information, therefusal to insure or continue to insure based upon an individual'scredit information, and the use of credit reports or credit scoresin making rate and underwriting determinations.

In addition, the Florida Office of Insurance Regulation (OIR)has proposed rules to regulate this issue. The proposed rulesrequire insurers to utilize methodologies furnished to the OIR andto provide statistical validation proving that the use of creditscoring does not result in a disproportionate impact on certainprotected classes of individuals. Any 2009 legislation could affectthe disposition and substance of these proposals, which are in therule development stage.

Can a failure to pay bills on time reliably predict thelikelihood that an individual would suffer losses, file insuranceclaims, or be a greater insurance risk than others? If so, thendoes the use of a consumer's credit score for underwriting purposesresult in discrimination against people of certain racial, ethnic,or income groups? During the current session, the FloridaLegislature will likely consider whether insurers should bepermitted to continue to use a consumer's credit score forinsurance underwriting purposes. The topic is one of greatcontroversy at both the state and federal levels, and it shouldspark considerable debate.

Limits Already in Place

There has been a trend to eliminate or restrict the use ofcredit scoring in connection with the underwriting of personallines insurance. This trend can be traced to a growing concern thatcredit scoring may be a proxy for discrimination, based on studiesthat have shown lower credit scoring to be more prevalent amongindividuals of certain racial, ethnic, and income groups.Forty-four states currently have laws or regulations limiting orconditioning the use of insurance credit scoring, and four states —California, Georgia, Hawaii, and Michigan — have effectively bannedthe use of credit scoring with respect to all or select lines ofinsurance.

Florida currently has in place a statute allowing the limitedand conditional use of credit scoring for the underwriting andrating of personal lines motor vehicle and residential insurance.In part, insurers must comply with the law's notice requirements toapplicants or insureds, and must not base the request for creditinformation upon race, income, national origin, or other protectedfactors.

However, concern over the use of credit reports and creditscoring in insurance underwriting has been escalating. The OIR'slong-standing efforts related to its proposed rules appear to bereflective of the growing nationwide trend, and they raisefundamental arguments regarding the use of this underwritingmechanism. While difficult to predict because of the dynamic natureof the legislative process, the Florida Legislature may attempt totake the next step by possibly limiting, or prohibiting altogether,the use of insurance credit scoring.

The Federal Trade Commission (FTC) studied the effects of theuse of credit-based insurance scores in a benchmark report releasedin 2007. The study concluded that credit scoring was a validpredictor of risk as it related to automobile insurance, and wasnot a proxy for discrimination, though the FTC recognized theprevalence of lower credit scores among certain racial and ethnicgroups. Because of sharp criticism of the study and its findings,the FTC's research is continuing, and the agency recently orderednine national insurers to provide information regarding their useof credit scoring for homeowners' insurance.

In mid-March, Insurance Commissioner Kevin McCarty issued astatement in support of the decision by the National Association ofInsurance Commissioners to hold a hearing to examine how insurancecredit scoring is affecting consumers in today's economic climate,reiterating his long-held position that allowing the use of creditscores in the underwriting process unfairly discriminates againstminorities and low-income individuals.

Additionally, CFO Alex Sink recently expressed opposition tousing credit scores when determining Florida auto insurance ratesand availability, saying she was "unimpressed" by auto insurers'explanations about their need to apply the practice.

Valid Rating Tool

General industry reaction has been that credit scoring is areliable predictor of loss that allows insurers to more accuratelyand efficiently allocate and price individual risks. Insurersfurther counter that racial, ethnic, and income data is notnormally made available to them, there is no intent todiscriminate, and the use of credit scoring does not in factdiscriminate. Insurers argue that the elimination of credit scoringas a factor in insurance underwriting would, in effect, subsidizehigher risk insureds by increasing premiums charged to lower riskinsureds.

A related issue and concern for insurers is the possibility ofthe release of sensitive proprietary information regarding theircredit scoring models and methodologies, which may be filed withthe OIR and open to public review. The sunsetting of the specificcredit scoring public records exemption, along with issues relatedto possible discrimination and concerns about the predictivereliability of credit scoring, may have been a catalyst for thelegislative proposal to ban insurance credit scoring.

There are also pending bills related to proprietary confidentialbusiness information, including trade secrets provided to a stateagency, which could further affect public records exemptions forinsurance credit scoring records.

Any possible action will have to be prioritized among Floridabudgetary issues and a number of important insurance-relatedmatters, including issues surrounding the Florida HurricaneCatastrophe Fund, Citizens Property Insurance Corp., workers'compensation attorneys' fees, and surplus lines matters.

All of these issues will be considered within the context of adifficult legislative environment with regard to the insuranceindustry and the recent announcement of State Farm Florida's planto withdraw from the state.

The banning of insurance credit scoring would likely be regardedas the loss of a valuable tool by those insurers (mostsignificantly, automobile) who use it in the rating process.

If prevented from considering credit scoring as a factor intheir rate setting, these insurers may increase rates for some, andpossibly a majority of, policyholders who benefited from highcredit scores, and decrease rates for others. The resulting ratechanges could have broad competitive ramifications and potentiallyaffect the market share and policyholder profile of individualinsurers.

If the issue is not decided during this session, then the use ofcredit scoring in the insurance arena is sure to foster additionalsignificant study, debate, and possible legislative action in theforeseeable future.

Fred E. Karlinsky is a shareholder in the law firm of Colodny,Fass, Talenfeld, Karlinsky, Abate. Richard J. Fidei is a partner inthe firm. Jennifer C. Erdelyi is an associate at the firm.Karlinksy may be reached at 954-332-1749 or by e-mail [email protected]. Fidei may be reached at 954-332-1758 or bye-mail at [email protected]. Erdelyi may be reached by e-mail [email protected]. All three are based in Ft. Lauderdale. Thefirm, which also has offices in Tallahassee, specializes ininsurance, legislative, regulatory and transactional law,commercial and civil litigation, governmental consulting andadministrative law. Its litigation practice group handlescommercial, civil rights, employment discrimination and childadvocacy matters in both trial and appellate levels. Moreinformation is available at www.cftlaw.com.