Insurers Dragged On The Carpet Over Credit Scoring

In case you missed the news during the New Year's holiday, the Federal Trade Commission subpoenaed nine carriers that control 60 percent of the U.S. homeowners insurance market, as part of a probe into how they use credit scores to set premium rates. I doubt they will find any intentional discrimination going on, but will that be enough to keep Uncle Sam from restricting or even banning the practice outright?

While the word “subpoena” has negative connotations of someone's arm being twisted, in fact this investigative process has been fairly civilized.

As reported by our Washington bureau chief, Dave Postal (click here for his complete story), the FTC in May asked for comment on a draft model order it could use in formulating its request for data in a fashion that wouldnt burden insurers. How sweet of them!

However, that doesn't change the fact that by April 24, Allstate, American Family Mutual, Chubb, Fire Insurance Exchange, Liberty Mutual, Nationwide Mutual, State Farm, Travelers and the United Services Automobile Association are going to have to cough up a load of data that could come back to haunt them, depending on the spin given of the FTC's analysis.

One major concern is the privacy protection, if any, to be afforded the client information handed in to Washington. But in the long-term, that's the least important concern of insurers, which have come to depend on credit scoring as a reliable indicator of underwriting risk.

Consumer fears about how credit information may be misused or misinterpreted cannot be rejected out of hand. And with so many more people defaulting on home and credit card loans in these trying economic times, the pressure is likely to be even greater on insurers to justify why someone who misses a loan payment is also more likely to file an insurance claim.

The bigger issue is an existential one: Even if the use of credit scoring can be statistically justified by actuaries and underwriters, if there is a disparate impact on the poor and minorities, will Congress and a more consumer-friendly Democratic White House allow it to stand?

We went through this debate in 2007, when both the FTC and Federal Reserve Board came out with legally-mandated studies of credit scores in auto underwriting, concluding that credit history is an effective predictor of auto risk.

I am still not sure I understand the underlying reasoning, as I personally know people of impeccable credit histories who are not the best of drivers. But statistically, insurers have been able to demonstrate a correlation.

Since race and income is not recorded on auto policy applications, theoretically at least, use of credit scores should be a color- and status-blind rating factor.

When race was banned as a rating factor on life insurance policies, the questionable practice was direct and overt. But with race not included on auto or homeowners applications, if there turns out to be a disparate impact, is that beside the point?

What do you folks think?