Insurance companies rely on several characteristics to determine rates that are developed by the actuarial department and are used to establish the premium for that risk. Many of these characteristics are obvious for the property being insured. Distance to the fire station is important in assessing the risk of how much of a property will be burned before firefighters can come to put out the fire. Proximity to the ocean or a wildfire area are other factors important in insuring property. Automobile insurance is the same way.
The characteristics for rating auto insurance have changed over time. For decades the standard variables used in rating drivers on auto policies were age, gender, driving record, accident history, and location. The 1990's introduced a new variable, the insurance credit score. Insurers discovered that a correlation could be made between a certain insurance credit score and the chances that people would make claims against their auto insurance policies.
The insurance credit score is different from the credit score that is used when buying a car, house, or other expensive item where the seller may need to know whether the purchaser has the wherewithal to pay for that large purchase. The insurance credit score uses the same characteristics a regular credit score does, including payment history, level of debt, length of credit history, new credit or pursuit of new credit and types of credit used, but it weights these factors differently, putting more emphasis on past payment history and less on types of credit used.
Driving records, accident history, and even the age of an individual are easy to understand as characteristics that will predict the likelihood of someone having an accident and filing an insurance claim, and insureds understand those characteristics. However, when credit scoring came along many didn't understand what their credit score had to do with their likelihood of having a claim. They felt credit scores were discriminating against different races, inner city residents and those with lower incomes. The industry struggled with getting insureds to accept that credit scores were a valid indicator of the likelihood that someone would file a claim, despite it not being directly related to driving skills or accident history.
In 2007, the Federal Trade Commission (FTC) conducted a study on the impact of using insurance credit scores on racial, ethnic, and low-income minority groups. The study showed that credit scores were indeed accurate predictors of risk for auto policies. The study also showed that credit scores are distributed differently among racial and ethnic groups and that those groups would be affected by differences in premiums. The study also revealed that the scores appeared to derive a small amount of predictive power based on the race of ethnic group of the individuals in question. Likewise, the FTC could not develop an alternative scoring model that would predict as effectively and decrease the differences in scores among racial and ethnic groups. The report can be found here. Credit-Based Insurance Scores: Impacts on Consumers of Automobile Insurance. A Report to Congress By the Federal Trade Commission. This leads to a particular dilemma; allow insurers to use credit scores to most accurately predict chance of loss, even though it is discriminatory against certain groups, or prohibit insurers from using credit scoring because the practice discriminates against certain groups, forcing carriers to use lesser predictive tools. Issues of social fairness and equity are of paramount concern.
Regardless of public opinion, insurance credit scores have been used continually since the mid-1990's, even though there are still many who dispute the validity of them, and are concerned with the discriminatory aspects of using the scores. On February 24, 2021, Representatives Rashida Tlaib, Bonnie Watson Coleman, and Mark Takano reintroduced a bill to the Senate to guarantee that insurance companies only use driving-related criteria in determining car insurance rates and eligibility. The Prohibit Auto Insurance Discrimination Act, or PAID Act, H.R. 1270 would restrict insurer's ability to use certain factors in developing rates and eligibility.
The bill acknowledges that auto insurance companies spread risk of loss over a collective group of policyholders, and that all states but New Hampshire require residents to maintain auto insurance. The bill states that pure loss ratio is a measure of profitability for the industry, and that correlations between certain variables and pure loss ratio should be interpreted to mean that those variables relate to profitability, not necessarily the risk of having an auto accident.
The bill claims that income proxies such as education level, occupation, employment status, home ownership, credit score, consumer report, previous insurer and prior purchase of insurance results in higher rates being charged to lower income drivers.
The bill looks to outlaw use of certain factors and income proxies in the development of premium rates or eligibility for auto insurance. Those factors are:
Gender
Level of education
Occupation
Employment status
Home ownership
Zip code or adjacent zip codes
Census tract
Marital status
Credit score or credit-based insurance score
Consumer report
Previous insurer
Prior purchase of insurance from that insurer
The bill also carries a proposal to require all underwriting rules and rate filings be available for public inspection and may not be considered proprietary information.
Violations of the act will be considered to have occurred whenever the consideration of any of the listed factors prevents a consumer from obtaining the lowest rate available to the consumer from a private passenger automobile insurer or affiliate. Violations include using any such factor for:
Determining a consumer's eligibility for insurance
Calculation of a premium for that consumer
An action that prevents a consumer from receiving certain discounts
Action that prevents a consumer from obtaining insurance form an insurer or its affiliates
Denial, cancellation, nonrenewal or change in coverage or policy terms
Any other impact on a consumer's insurance premium
The Act does not intend to affect the authority of state or federal agencies so far as the enforcement of prohibitions against unfair or deceptive acts or practices, including making false or misleading statements in connection with an insurance transaction not initiated by the consumer.
Violations of the Act will be treated as unfair and deceptive acts or practices as proscribed under the Federal Trade Commission Act (15 U.S. C. 57a(a)(1)(B)). The FTC will enforce this Act the same way it would enforce the provisions of the Federal Trade Commission Act (15 U.S.C. 41 et seq.) if that Act were incorporated into and made a part of this Act.
Anyone violating the Act will be liable for a civil penalty of no less than $2,500 per violation. Insurers who willfully violate the act regarding a consumer will be liable to the consumer for the sum of any actual damage sustained by the consumer for failure to follow this act; punitive damages as a court may allow, and in light of successful action under this Act the cost of action with reasonable attorney fees as determined by the court.
Insurers negligent in following the Act are liable to the consumer for actual damages, cost of action to enforce with reasonable attorney fees, and if a pleading, motion or other paper was filed in bad faith or harassment, payment of the prevailing party's attorney fees regarding the work expended in responding to the pleading, motion or other paper.
Actions are to be filed within two years of the date of discovery by the plaintiff of the violation, or five years after the date on which the violation that is the basis for such liability occurs.
If the attorney general, agency or official of a state has reason to believe that an interest of the residents of the state has been threatened or adversely threatened by an act in violation of this Act, the state may bring a civil action on behalf of the residents in an appropriate state court to prohibit that act or practice, enforce compliance with this Act, obtain damages, restitution or compensation on behalf of the residents or obtain such other appropriate legal or equitable relief. Before such actions are filed, the state shall provide the FTC with written notice of such action and a copy of the complaint. The FTC can intervene in the action, be heard on all matters arising therein, and file a petition for appeal. Nothing is construed to prevent an attorney general, official or agency of a state from exercising its due powers to conduct investigations, administer oaths or affirmations, or compel attendance of witnesses or production of documentary or other evidence.
This Act does not affect, exempt, alter or annul any person subject to the provisions of this Act from complying with state laws regarding collection or use of any consumer information, prevention or mitigation of identity theft, or regulation of the business of insurance other than if those laws are inconsistent with the provisions of this act and only to the extent of the inconsistency. This allows states to regulate insurance and credit information as usual other than to the extent of the inconsistency.
This section is important since the McCarran Ferguson Act allows states to regulate insurance individually. The McCarran Ferguson Act states that no Act of Congress shall be construed to invalidate, impair or supersede any law enacted by any state for the purpose of regulating the business of insurance unless the Act specifically relates to the business of insurance. Since this new PAID Act applies to insurance, it overrides McCarran Ferguson in that Congress can make and enforce an act dealing with insurance.
The Act finishes with a number of definitions. An "affiliate" is defined to mean an entity that directly or indirectly, through one or more intermediaries, controls or is controlled by, or is under common control with another entity. This would be a subsidiary company of an insurer, for example a separate company that accepts higher risk drivers than the parent company does.
"Control" is taken to mean that the possession of power to direct or cause the direction of the management and policies of the company, whether that control comes through the ownership of voting securities, contracts other than a contract for goods or nonmanagement services, or contracts for goods or nonmanagement services where the volume results in a reliance relationship or ownership. Control is presumed if a company and its affiliates directly or indirectly own, control, hold with the power to vote or hold proxies representing 10 percent or more of the voting interests of the company.
"Automobile insurer" is defined as an insurer authorized to transact automobile insurance, motor vehicle insurance, automobile or motor vehicle liability insurance or similar business in the United States.
A "census tract" is any small, relatively permanent statistical subdivision of a county as used by the United States census bureau.
The definition of "consumer report" refers to the meaning given in the Fair Credit Reporting Act except that it does not include communication as it relates to the driving history or place of residence of a consumer. That definition states that "consumer report" is any written, oral, or other communication of any information by a consumer reporting agency bearing on a person's credit worthiness, credit standing, credit capacity, character, general reputation, personal characteristics or mode of living which is used or expected to be used to determine a person's eligibility for credit or insurance for personal, family or household purposes, employment purposes, or other purposes listed in the Fair Credit Reporting Act.
The "credit-based insurance score" is defined as a rating based in whole or in part on an individual's credit information used in underwriting and rating of consumers that takes into account certain elements of an individual's credit history to predict the likelihood of future insurance losses.
Again the Fair Credit Reporting Act is referred to for the definition of "credit score". That defines "credit score" as a numerical value or categorization derived from a statistical tool or modeling system by someone who makes or arranges loans in order to predict the likelihood of certain behaviors, such as default on the loan.
"Employment status" is defined as an individual's status as a current full-time or part-time employee, employed, unemployed, underemployed, or any other work status. Likewise, "home ownership status" is whether an individual currently owns any real property that can be used as a residence.
The "level of education" term refers to the highest grade level completed in a secondary school, trade school, professional licensure or certification, or highest undergraduate or graduate degree obtained. Traffic safety courses and scholastic achievement while enrolled in any sort of school is not included in the definition of "level of education".
"Occupation" is used to describe the individual's current employment position. Because of the variety of occupations and amount of driving required to perform some occupations, occupation became one of many factors used in automobile rating.
Because this deals with automobile insurance, "private passenger automobile" must be defined. A "private passenger auto" is defined as a four-wheel motor vehicle, whether owned or leased to an individual or individuals, and that is of a private passenger or station wagon type, or is a motor vehicle with a pickup body, a delivery sedan, passenger van, sports utility vehicle, or a panel truck or camper type vehicle.
The vehicle must not be used as a public or livery conveyance for passengers, not be rented to others, not have a gross vehicle weight over 15,000 pounds, not be used primarily in the course of an occupation, profession or business of a person other than farming or ranching. Also included in the definition is a motor vehicle owned by a farm family copartnership or farm family corporation, where the vehicle is principally garaged on a farm or ranch and otherwise meets the definition of "private passenger automobile".
Should the PAID Act be enacted, it would become effective one year after the date of enactment of the Act. So what does all this mean for the insurance industry? Insurers have long used and support credit scoring because it allows them to better predict losses and set rates accordingly. FICO estimates are that 95 percent of all personal lines insurers use credit scores for home and auto insurance. While carriers support it, many others do not.
Credit scoring is not allowed in California, Hawaii and Massachusetts, and other states have varying restrictions on its use. Mike Kriedler, the insurance commissioner of Washington, is asking state legislatures to ban the use of credit scoring because it unfairly favors those with good credit scores and charges safe drivers with low credit scores 79 percent more than those with higher credit scores. Kriedler has been quoted saying "Credit scoring is discriminatory and unjustly targets people of color, those with lower incomes and individuals and businesses struggling during the coronavirus pandemic. The insurance industry claims that people with lower credit scores are more likely to file claims in the future. I believe it's inherently abhorrent, unfair and unjust. There's plenty of more reliable information an insurer can use to determine your premium." This is not his first foray against credit scoring however, as he requested banning credit scoring both in 2001 and in 2010. A bill banning credit scoring is currently under review, although it has been amended to allow the use of credit scores when someone shops for a new policy. The original bill did not have enough votes to pass out of committee.
The state of New Jersey also has a proposed bill to end the use of the following socioeconomic factors: homeownership, marital status, education level, credit score, employment status or occupation. Representative Nellie Pou cosponsored the bill and states that this legislation would hold insurers accountable and help ensure that the most vulnerable citizens are given fair pricing for insurance policies. The bill is currently under review.
However useful credit scoring may be in predicting auto losses, bottom line it's been shown to also be unfairly discriminatory against those of different races and lower incomes.
A number of states have statutes regarding credit scoring and how it can or cannot be used. Many require a carrier to rerate a policy upon an insured's request, and indicate that credit rating cannot be used as a sole rating factor. The chart Credit Score Use Statutes outlines when and how credit scoring can be used in insurance eligibility, rating, cancellations, and nonrenewals.