Keeping Score: The Battle Over Credit Reports

Caught in the Legal Mire

It was in the 2003 legislative special session that, at the behest of regulators and the industry, lawmakers set out the first detailed law of how credit scores could and couldn't be used when calculating a policyholder's premiums. The law was primarily based on a 2003 National Association of Insurance Commissioners report, "Credit-Based Insurance Scoring: Regulatory Options."

Among other things, the 2003 law prohibits a carrier from requesting a credit report on a prospective consumer based on race, color, religion, marital status, age, gender, income, national origin, and place of residence. Carriers also are not allowed to non-renew, increase a policyholder's premiums, or refuse to place them in the lowest bracket of insurance they would otherwise qualify based on the following conditions; the absence of a credit history, liens against the policyholders for medical treatments, place of residence, or other circumstances as set out by the Financial Service Commission.

Additionally, the insurer is required to inform a prospective policyholder that the insurer is using a credit report when reviewing their application for coverage. If the consumer is rejected based on the credit report, the insurer must provide the consumer with a copy of the report. Consumers may appeal the decision if they provide the insurer with a reasonable documentation showing a temporary loss of employment, dissolution of marriage, or death of a spouse. Carriers must also periodically review the policyholder's credit report to see if any changes would impact the policyholder's rates.

Per usual, while the statues seem clear cut, the path to enacting the law through the rulemaking process is anything but. In October 2003, the OIR issued a draft rule that the industry argued was crafted to in effect make sure that carriers couldn't use credit scores. For example, the industry representatives said the requirement that carriers prove rates are fair based on the policyholders' place of residence is outside carriers' purview since they don't collect the demographic information. That proved to just be just the start of the beginning of the bad blood between the industry and regulators.

Early on in the process, there were charges and countercharges levied against regulators and industry representatives alike, where both parties accused the other of negotiating in bad faith. "Some people in the OIR were virulently opposed to the use of credit scoring regardless of what the law said," said Stander. The next two-and-a-half years witnessed a series of regulatory actions in the form of rule workshops and hearings, where regulators kept pushing for a rule while the industry appeared intent on stopping them.

In March 2005, PCIA, the Florida Insurance Council, the American Insurance Association, and the National Association of Mutual Insurance Companies formally filed suit against the OIR, the Department of Financial Services, and the Financial Services Commission on the basis that the law changes regarding the reorganization of the former Department of Insurance Regulation had rendered moot the OIR's statutory ability to promulgate a rule on credit scoring. For all practical purposes, that is where things stood until the FSC moved forward and approved two parts of the rule governing the use of credit scores.

OIR General Counsel Steven Parton said by challenging the statutory authority of the OIR to promulgate the rule, he realized the industry had no desire to reach an agreement on the rule. "We could have had a rule challenge a year ago," he said. "Here we are a year later and the industry has repeatedly asked for delays. Clearly, they have no intention for this rule to be heard."

It was at this point that the FSC weighed in and approved the two sections of the rule. On a number of levels, the move is highly controversial. First of all, one would have to look far and wide for another government action that would implement a rule that is in litigation. In a memo to carriers, regulators spelled out their reasons for moving forward. As stated in the memo, "In light of the delays associated with the ongoing litigation and the potential harm to consumers resulting from the use of credit reports and credit scores, the FSC has authorized the OIR to begin implementation of the provisions of the rule."

Another legal question is whether the FSC's decision is allowable under the state's Administrative Procedure Act, which requires all rules to be tied to a specific statutory provision. "If a company files a rate with a credit scoring component and it is turned down, the company would risk having to stand in court because it is an unpublished rule," said Stander. From Parton's position, however, he said the FSC had more than enough authority to move forward with the rule under Chapter 626.9741(4)(8), Florida Statutes, which grants the commission the authority to issue rules with regards to the use of credit scores.

A National Debate

Florida is not alone in its quest to regulate the use of credit reports. Delaware, Colorado, Minnesota, New Mexico, Michigan, and Washington State are all in the process of either drafting laws or rules governing the use of credit scores. And the list is expected to get longer, not shorter.

Depending on one's point of view, credit scoring is either an institutional method to discriminate against certain classes of policyholders or is an important piece of the puzzle to ensure that individual rates adequately reflected the risk. From the industry's point of view, the use of credit reports has become a key indicator of a policyholder's claim record. An Insurance Information Institute white paper makes the case that credit reports indirectly provide a more realistic picture of a potential consumer's behavior.

As noted in the study, "The character trait that leads to careful money management seems to show up in other daily situations in which people have to make decisions about how to act, such as driving. People who manage money more carefully may be more likely to have their car serviced at appropriate times and may also more effectively manage the most important financial asset most Americans own, their house."

A study commissioned by the state of Texas, conducted by the University of Texas Bureau of Business Research, studied 150,000 policies from the top five insurers providing coverage in the state. When matching the claim data to the credit scores, researchers found that those drivers with lower scores had slightly higher claim costs. Claim costs for drivers with poor credit reports average $918, which is 53 percent higher than expected. Those drivers with higher scores reported losses of $558, which was some 25 percent lower than average.

More specifically, the Texas report found that the average loss per vehicle among drivers with poor credit records was double that of people with the best scores. And drivers with the best credit were involved in about 40 percent fewer accidents. The same pattern held true with regards to homeowners' insurance, where the loss ratio for people with lower credit scores was triple that of people with the best scores. For Parton, however, that study still begs the question of who is penalized by the use of credit scores. "When you look at credit scoring you can't help but come to the conclusion that people with low incomes or groups like African Americans are having to pay higher premiums," he said.

The III report also made two other points. First, given the flow of information in the electronic age, the access to and use of credit reports is only going to increase. Likewise, computer models employed by carriers that include factors for credit scoring are going to get more and more sophisticated. Even so, however, the III maintains that too much of the emphasis on the use of credit scores is painted in the negative when in truth it does help stabilize rates for auto and homeowner policyholders. As noted in the report, "Many people have no idea that they are beneficiaries of credit scoring. Two-thirds of policyholders have a lower premium because of good credit, insurers say, although consumers themselves think most people do not benefit."