From the November 2010 issue of Investment Advisor • Subscribe!

November 1, 2010

Credit Where Credit Is Due

Should consumers' credit ratings determine how much they pay for insurance?

For the past couple of decades, insurance companies have been using credit scores to set premium rates, saying that a person’s score can serve as a fairly accurate predictor of whether he or she will be more prone to accidents or will file more claims on a homeowner’s insurance policy. Insurers have come to rely on credit scoring, and the companies that compile the data characterize their information as accurate and fair.

However, according to consumer advocates, using credit scores in an economy that has seen millions put out of work and into foreclosure is unfair and subjects consumers to unreasonable rate increases. Some insurance commissioners, too, have been very outspoken about their perception of credit scoring, characterizing it as discriminatory and inaccurate.

When NAIC issued a data call for specific information to help determine whether credit scoring was a fair factor in underwriting and in setting rates, and to consider whether those who provide credit data ought to be regulated, insurers and credit data providers rose up in rebellion.

According to comments filed by FICO with NAIC, several factors are taken into account for FICO Credit-Based Insurance Score models, all of which the company says may indicate more frequent or higher insurance losses: payment history; amounts owed; length of credit history; new credit; and types of credit in use. FICO also says that these factors are affected by state laws.

The National Conference of Insurance Legislators (NCOIL) came up with a model for credit scoring in 2002 that has been adopted by 27 states so far, according to a letter sent to NAIC on Sept. 21 that objected to the data call.

The data call itself brought a flood of objections from NCOIL and from numerous insurers; the providers of the credit information (FICO and others) also object to being regulated for providing information, stating that they are not “advisory organizations” and thus do not assist in “ratemaking-related activities.”

Insurers expressed concern about the amount of time and effort required to submit the data requested by NAIC (it was a voluntary data call) and the expense involved, as well as the question of whether confidentiality would be maintained on the data once submitted. Trade groups also weighed in against the data call. Hundreds of pages of documentation were submitted.

A day-long hearing was held on Sept. 30, and, according to Michael McRaith, director of the Illinois Insurance Commission and chair of the Property and Casualty Insurance (C) Committee, it was a “very productive, constructive discussion, framed as a hearing with the intention of eliciting comments from interested parties about the draft that had been exposed for comments.”
NAIC’s objective, he added, “is to provide policymakers at the state and federal levels with factual information [so they] understand what is the actual dollar impact on the consumer of the credit score or other risk factor.” Proponents on both sides of the argument have reasons that resonate with policymakers, he said, so the need for facts that can be used to inform policy is important.

The data call will be reissued once it has been redrafted, said McRaith, a process that should take the next several weeks, and NAIC hopes to receive “responsive information” within the next couple of months. The data will be compiled in such a way as to protect the proprietary nature of pricing formulas used by different companies, but still communicated “in a way that conveys to noninsurance people the actual dollar impact of different rating factors on the consumer.”     

Marlene Y. Satter can be reached at msatter@sbmedia.com.

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