FTC Sees Credit Scoring As Valid Tool

WASHINGTON–Credit scores are an “effective predictor” of risk under automobile insurance policies, the Federal Trade Commission says in a report, an advance copy of which was obtained by National Underwriter.

Industry trade groups, who also have had an advance look, hailed the findings, with officials of the National Association of Mutual Insurance Companies saying, for example, “that the report confirms what the industry has been saying all along–that credit-based insurance scores provide an objective and reliable tool” for setting insurance rates.

Opponents of the technique in the past have argued that it unfairly impacts low-income and minority groups, and fails to account for those who deal in cash or are impacted by one-time events such as medical emergencies.

But the report says the use of credit-based insurance scores “may result in benefits for consumers.”

“For example, scores permit insurance companies to evaluate risk with greater accuracy, which may make them more willing to offer insurance to higher-risk consumers for whom they would otherwise not be able to determine an appropriate premium,” according to the report.

“Scores also may make the process of granting and pricing insurance quicker and cheaper–cost savings that may be passed on to consumers in the form of lower premiums,” the report adds.

However, the report cautions, “little hard data was submitted or available to quantify the magnitude of these benefits to consumers.”

At the same time, the report does say that credit-based insurance scores are distributed differently among racial and ethnic groups, and this difference is likely to have an effect on the insurance premiums that these groups pay, on average.

Specifically, the report says, non-Hispanic whites and Asians are distributed relatively evenly over the range of scores.

However, African-Americans and Hispanics are substantially overrepresented among consumers with the lowest scores–the scores associated with the highest predicted risk–”and substantially underrepresented among those with the highest scores.”

The agency also says that even though it tried a variety of alternative approaches, “the FTC was not able to develop an alternative credit-based insurance scoring model that would continue to predict risk effectively, yet decrease the differences in scores on average among racial and ethnic groups.”

The agency adds that this does not mean a model could not be constructed that meets both of these objectives, “but it does strongly suggest, however, that there is no readily available scoring model that would do so.”

The report says that, in general, credit scores “are predictive of the number of claims consumers file and the total cost of those claims.”

“The use of scores is therefore likely to make the price of insurance better match the risk of loss posed by the consumer,” the report adds. “Thus, on average, higher-risk consumers will pay higher premiums and lower-risk consumers will pay lower premiums.”

Carl Parks, NAMIC's senior vice president of government affairs, said that “the practice encourages competition, enables insurers to offer coverage to more consumers at a fair price, and helps streamline the decision-making process.”

June Holmes, interim CEO for the Property Casualty Insurers Association of America, said the report “reaffirms the strong connection between credit information and the risk of loss, and has determined that its use helps to increase the availability and affordability of insurance for most consumers.”

Ms. Holmes added, “Now there should be no doubt about the value of using this highly predictive underwriting and rating tool.”

David Snyder, vice president and assistant general counsel at the American Insurance Association, said the study “confirms what we have long professed, and many previous studies have shown, that credit-based insurance scores help refine insurance pricing to better reflect an individual's risk profile.”

“We believe scores reduce subsidization of bad risks by good ones, meaning most consumers pay less for insurance,” Mr. Snyder said.

“The report is very detailed and requires more thorough analysis, but the FTC's initial conclusion says it all–'credit-based insurance scores are effective predictors of risk under automobile policies.'” he added.

The FTC study–”Credit-Based Insurance Scores: Impact on Consumers of Automobile Insurance”–was mandated by the passage of the Fair and Accurate Credit Transactions Act (FACT Act) of 2003, along with a Federal Reserve study of credit use in banking.

Robert Hunter, insurance director of for the Consumer Federation of America, said he was “disappointed” by the FTC study, adding that its conclusions were “kind of expected” given how the study was conducted.

“They didn't go after real data,” he said. “They just took what the industry gave them.”

Mr. Hunter added that there were some positives to the report, however, most importantly that the FTC could not provide an explanation of why credit scores affect a consumer's risk.

“It confirms there's no thesis,” he said, adding that the study is “just correlating a data set.”

By the same token, Mr. Hunter argued, insurers could use any number of other factors that have been shown to correlate with risk, specifically mentioning a study conducted in California that showed that the darker a consumer's hair color, the greater risk they present for insurers.

“Why shouldn't we use hair color?” he asked.

Additionally, Mr. Hunter said that it was “important” that the report also found a disaproportionate affect on consumers based on race.

This article was updated June 23 at 2:33 p.m. EDT