Credit Scoring Education Efforts Pay Off

Recounting some history, Mr. McManamy noted that "credit scoring has always been used for commercial lines to find out the financial health of a company before they insure it."

"But the debate that has been going on is all about personal lines, homeowners and auto," he said.

Homeowners insurers, he asserted, have "reams of actuarial data that shows that your credit history has a direct correlation to your risk of loss," and that those with a better credit-based insurance score are less likely to file claims.

Mr. McManamy explained that credit-based insurance scores should not be confused with credit scores. A credit score, he said, is what a bank runs "to find out if you are going to repay a loan." It is a formula that contains information about past credit history"whether you have paid your bills or not and the percentage of your balances to your available credit."

Insurance scores are derived from the same information, but predict different things, he said. Internal insurance company studies have found that credit insurance scoring allows companies to more accurately rate risks and to charge policyholders what they should be paying based on the risk they represent, he said.

He cited an independent study conducted recently in Texas. The Texas legislature, he said, ordered the study from the University of Texas to determine whether there really is a correlation between a persons credit and their losses.

Researchers found that "absolutely there was a significant correlation and that people who had better credit were better insurance risks," he said. "Insurance company data has shown that for years, but no outside unbiased organization had ever shown that."

Why are consumers suddenly so concerned about credit-based insurance scoring?

He explained that when insurance companies began using the method about seven years ago, "they didn't do a very good job of telling anybody about it." Insurers found a cost-effective tool that allowed them to pinpoint what a policyholder should be paying based on actual risk, "but they didn't tell anybodywhy they were doing it," he said.

Had insurers done a better job of letting others in on what they were doing, "I don't think you would be seeing the level of legislative activity that you have seen over the last couple of years," he noted.

Most importantly, Mr. McManamy added, insurers didn't communicate the information with their agents, who deal with policyholders on a regular basis.

Agents, he said, were accustomed to discussing with their customers what their premium was based on and how it could be lowered, such as living near a fire station and owning a car with anti-lock brakes. Because agents had policyholders who had been with them for several years, those policyholders "were seeing their rates increase because of their credit and the agent wasn't equipped" to tell them why.

Notifying agents and other customers about insurance credit scoring could have been done in several ways, such as in a letter, he said.

Because the agents didnt understand insurance credit scoring, "last year agent groups were the driving force behind some of the draconian legislation that would have banned the use of credit completely," Mr. McManamy said. "None of those passed."

Now, he said, agents are beginning to understand the issue and are able to discuss it with their clients. The industry is trying to right things by working with agents, producing educational materials, conducting seminars and educational sessions for continuing education credits, he said. Mr. McManamy said that a particularly bright spot is an NCOIL model.

Wes Bissett, vice president of state government affairs for the Independent Insurance Agents and Brokers of America in Alexandria, Va., said IIABA helped develop the NCOIL model and "strongly supports it."

What the NCOIL model has done "is made the debate over the issue far less contentious than it was a year ago," he said. "This was a very controversial legislative issue in 2002 and it is less so now because we have at least got a common starting point for bills in the states."

He said agents and brokers understand that there is a strong correlation between a person's credit history and their loss experience, "but there are still frustrations about how some individual companies implement and utilize credit information in their underwriting process."

He said agents are challenged from a business perspective because "every company uses it in a slightly different way." This has added additional time and steps to the underwriting process, he said.

"We're hoping we'll be able to address this issue from a business standpoint and get companies to work with us to enable agents to have truly comparative rating systems."

With the NCOIL model enacted last year, Mr. McManamy said, "We have gotten to a point where we can refine and deal with issues."

One of the issues that needed resolution is the "no hits" issue, which is how to evaluate a small percentage of the population that does not have enough credit history to generate a credit score. How can you have an adverse action for people who have no credit?

"Research has shown that this segment of the population has some of the highest losseseven more so than those with lower credit scores," he said.

Candace Frick, director of legislative affairs and education for NCOIL, said the model includes provisions for those with no credit history.

"There are provisions that say you either treat the consumer as if its a neutral score and dont count the score at all, or you can go to the commissioner. If the commissioner approves it, you can treat them as whatever score you can come up with," she said.

Generally this would apply to a group rather than an individual. "Ahead of time, when youre doing your filing, you would address that issue," she said. "If the insurer can prove this rates a greater risk to the company and if the commissioner grants it," the insurer can assign a score.

Ms. Frick said the NCOIL model recognizes that use of credit information "is important for a competitive marketplace, but also that there are essential consumer protections that must go along with using credit information." Credit information, she said, cannot be the sole basis for rating for underwriting. Other factors must be taken into account.

"The model also has provisions for how often you need to rerun an insurance scoreevery three years at least," she said. "But if the consumer or his or her agent request that the insurer do it more often, the insurer has to rerun it."

There are also protections as far as information on a credit report that insurers are not allowed to use. An example is anything marked with a medical industry code, such as inquiries initiated by the consumer.

Also, she said, if within a 30-day period of time there are a lot of inquiries regarding a mortgage, for instance, "those would either not count or they would count as one inquiry because it is obvious someone is looking for a mortgage," she explained.

Ms. Frick said the NCOIL model has been favorably accepted. North Dakota became the most recent state to enact legislation on April 8. A Kansas bill, which contains NCOIL model language, was recently sent to the governor and 13 more states have introduced some form of the NCOIL model, she said.

"Its fair to say that were quite excited about this," she said. "States have shown a lot of interest in this and have made their changes, she said. "A model is just a model. But I think the fact that the insurance industry and the agents are both behind the model is helpful."

Even though legislation trends look positive, she said there are measures introduced in some states that would prohibit the use of credit scores altogether. "This would be difficult for the industry, and Im not sure it would be good for consumers either," Ms. Frick said.

It's important to note, Mr. McManamy said, that the Fair Credit Reporting Act permits insurance companies to access consumer credit information for the purpose of underwriting and rating. However, he said, "The FCRA is very consumer-friendly. On top of that you have existing state law which says rates should not be excessive, inadequate or unfairly discriminatory." There are also market conduct examinations, "all to police the way insurers sell and price their products."

All of these things should be sufficient to regulate insurer use of credit, he said, "However, we understand that this is a new thing, that perhaps there is misunderstanding and political pressure attached. And we have been supportive of reasonable restrictions and regulations in many states."

Reproduced from National Underwriter Edition, April 21, 2003. Copyright 2003 by The National Underwriter Company in the serial publication. All rights reserved. Copyright in this article as an independent work may be held by the author.