Credit Score Provider: No Disparate Impact

The NAIC Credit Scoring Working Group's move to instead focus on unifying states' research and applying credit scoring statutes was the "right thing to do at this point," said, Mr. Skelton, whose firm is based in Alpharetta, Ga.

"The useful role for the NAIC now is to look at public policy issues that have been identified at NCOIL [the National Conference of Insurance Legislators], and [to] meet challenges that new laws in various states are going to create for all of us," said Mr. Skelton, during his NAMIC presentation titled "Controlling Your Company's Losses."

"The appropriate role for the NAIC is to look at the proper oversight of state laws that have passed. For example, most laws now say credit-based scoring can't be the sole criteria in the insurance-risk assessment. But how do regulators know for sure that in fact that is not the only criteria insurers are using? This would be one of the issues we have to tackle."

ChoicePoint, which offers credit-scoring models and services to insurers, acknowledges it has been receiving complaints from various consumer groups, he said. "There have been legitimate concerns on consumers' part, as they try to understand this tool and how it works," Mr. Skelton observed. "Early on, there weren't a lot of good explanations. So it's understandable why there would be concerns and frustrations."

But he argued that some opponents of the use of credit scoring have been sensationalizing this topic, by putting the spotlight on extreme cases and few aggrieved consumers. "In fact, most policyholders benefit from the use of this tool because most consumers have good credit," he pointed out. "Most consumers pay their bills on time and use their credit cards responsibly. The danger is that just looking at extreme cases creates public policies based on exceptions rather than the rule."

And over time, a number of studies helped shed light on this topic, he added: "There have been several independent studies in Texas and, more recently, a study from EPIC Actuaries LLC in Minocqua, Wis., that demonstrates a strong correlation between credit scores and insurance risk."

Mr. Skelton also said that, short of conducting comprehensive disparate impact studies, one way regulators could get a sense of whether the use of credit scores has an unfair influence on minorities is to examine the change in marketplace.

"One indicator would be that if the use of credit scoring was a tool that had a disparate impact on certain classes, regulators would see a couple of things happen," he said. "First, the number of uninsured motorists and uninsured people in inner cities would go up, because of the concentration of minority groups in inner cities."

He argued that if the use of credit scoring impacts such groups disproportionately, there would be more inner-city residences without insurance because they wouldn't be able to afford it–"their rates would be so high, they would just opt out of the system," he said.

Additionally, a disparate impact would create a hike in high-risk pools in a number of cities including Baltimore and Chicago. "But that's not happening either. So the common sense says if this tool is so detrimental, why aren't we seeing this play out in the marketplace, with more people losing their insurance and high-risk pools exploding?" Mr. Skelton said.

He also said another common concern his firm has been hearing is that the insurers' use of credit scoring unfairly hurts new immigrants who have little credit history. "But the NCOIL model addresses that head on," he observed.

Typically, immigrants are grouped together with students, young people and senior citizens, most of whom have little or no credit activities, and the NCOIL model–and state laws that are similar to the model–lays out public-policy uses for these groups. Mr. Skelton noted: "If you don't have enough on your credit report to be scored, or if you have no report at all, then carriers, in some states, are prohibited from using credit scores. In other states, insurers are allowed to use them, but laws will prescribe how credit scores are used."

Mr. Skelton added, "These laws will require that such policyholders have to receive the average score of all policyholders, or they will say carriers have to provide actuarial justification for specific treatments for consumers who don't get a score."

He also acknowledged that the NCOIL model is not "the way the industry wanted it to turn out, of course." But the whole idea, he added, is that it is a compromise between various parties with various goals. "Our hope is that it's a compromise that regulators and legislators, as well as the industry, can live with. Consumers deserve the protection that the NCOIL model offers."

At any rate, the use of credit scoring is poised to become an integral insurance-risk assessment tool in more and more places, Mr. Skelton predicted.

"Initially, there was some hesitancy on the part of some carriers, because there weren't laws in place in all the states. So they were a little nervous about what to do and whether they should get into this," he commented. "But now that we have a clear guidance in almost all the states, insurers know what the ground rules are, and they can get in the game."

Now, more and more carriers that have been cautious about using credit scores are saying it's time to get in, he observed. "Insurers now have boundaries to work with in most states. And quite frankly, with so many other carriers already in the game, if these insurers don't get in, it's going to be much harder for them to compete," he said.