Actuaries Have Special Role When Explaining Credit Scores and Losses
National News • November 16, 2007
By explaining why there is an association between credit scores and insurance losses, insurers and actuaries can promote a better understanding of why credit scores are a useful underwriting tool, ...
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Subject: Credit Scores & Insurance
Posted On: November 16, 2007, 3:22 pm CST
Posted By: Hon. Scott A. Adamsons
Comment:
It has been my general experience that the more complex an explanation is, the less credibility it has. Credit scores are based on repayment histories, and therefore make their use in evaluating the risk of future debt repayment reasonable. Now that's simple. What the actuaries are saying is not close to being simple. In fact, how much of contents in the proverbial black box do they know? Sometimes a correlation is valid and other times it is a post hoc ergo propter hoc - a logical fallacy and an assault to the senses of reasonable people.
As a banking executive who has risen through the ranks from being a part-time teller in my college days to a vice president of a national savings institution, I can tell you that credit scores alone are indicators at best. Good underwriting comes from having a good understanding of the subject, the risk if you will. In the case of the insurance industry, that would be the insured risk. Unfortunately, this concept still evades many people in the banking industry, where credit reports and scores have been used extensively for decades. It is not a far stretch believe that fresh users of this type of information have much to learn before they using this tool responsibly. It takes time to develop this kind of experience.
From a banker's perspective, a person whose credit score is average or below average is more often than not a higher risk prospect; however, the credit score alone is not used to make that determination (nor is it in insurance). An underwriter must be responsible and dissect the applicant's credit history, look for trends, irregularities, and learn about the person behind the report. Here are some factors that can impact a person's credit score but might not impact their personality as an insured risk: Single income households, parents of multiple children, prior divorce, a billing error that leads to a collection action (happens more people than one would think), identity theft, and mistaken identities on the part of the reporting agency.
In some of the cases above, individuals and families who would otherwise qualify for a low premium based upon their actual claims history and risk profile would be bumped to a less desirable pricing tier due to their credit score. A case example: In the case of a single-income household, where one parent sacrifices a salary to stay at home and raise their children, it makes a world of difference. In real life, such a family made the right decision. Instead of turning over the second income to a child care provider, they forego the income and eliminate that expense, an expense that would not likely be reported on a credit bureau report anyway (at least for timely payments). However, these households typically carry a higher leverage burden as there is only one income. This impacts their credit score adversely. It's not quite that simple, but the net trickle-down effect is the same. So in this example, a family doing the right thing, for the right reasons, pays more in premiums than a comparable family with two incomes and kids in daycare. This is but one example where credit bureau reports and scores may fall far short for their use in an insurance application.
Another thought to consider is that the formulas that the credit reporting agencies' use are unknown to the general public and will not likely be released anytime soon. It takes a great deal of experience to use this kind of a tool in an underwriting process in a way that is not prejudicial or skewed. Even then, the experts sometimes make poor decisions.
The only good reason for using the information from a credit bureau report is to hypothecate future risk of debt repayment – that is after all why they were initially created. Repayment history is used to predict future repayment behavior – that is about as apples-to-apples as it gets. Actuaries will have to be more convincing in their position promoting the use of credit scores for risk profiling in their industry. Show me.
Subject: Credit Scores & Insurance
As a banking executive who has risen through the ranks from being a part-time teller in my college days to a vice president of a national savings institution, I can tell you that credit scores alone are indicators at best. Good underwriting comes from having a good understanding of the subject, the risk if you will. In the case of the insurance industry, that would be the insured risk. Unfortunately, this concept still evades many people in the banking industry, where credit reports and scores have been used extensively for decades. It is not a far stretch believe that fresh users of this type of information have much to learn before they using this tool responsibly. It takes time to develop this kind of experience.
From a banker's perspective, a person whose credit score is average or below average is more often than not a higher risk prospect; however, the credit score alone is not used to make that determination (nor is it in insurance). An underwriter must be responsible and dissect the applicant's credit history, look for trends, irregularities, and learn about the person behind the report. Here are some factors that can impact a person's credit score but might not impact their personality as an insured risk: Single income households, parents of multiple children, prior divorce, a billing error that leads to a collection action (happens more people than one would think), identity theft, and mistaken identities on the part of the reporting agency.
In some of the cases above, individuals and families who would otherwise qualify for a low premium based upon their actual claims history and risk profile would be bumped to a less desirable pricing tier due to their credit score. A case example: In the case of a single-income household, where one parent sacrifices a salary to stay at home and raise their children, it makes a world of difference. In real life, such a family made the right decision. Instead of turning over the second income to a child care provider, they forego the income and eliminate that expense, an expense that would not likely be reported on a credit bureau report anyway (at least for timely payments). However, these households typically carry a higher leverage burden as there is only one income. This impacts their credit score adversely. It's not quite that simple, but the net trickle-down effect is the same. So in this example, a family doing the right thing, for the right reasons, pays more in premiums than a comparable family with two incomes and kids in daycare. This is but one example where credit bureau reports and scores may fall far short for their use in an insurance application.
Another thought to consider is that the formulas that the credit reporting agencies' use are unknown to the general public and will not likely be released anytime soon. It takes a great deal of experience to use this kind of a tool in an underwriting process in a way that is not prejudicial or skewed. Even then, the experts sometimes make poor decisions.
The only good reason for using the information from a credit bureau report is to hypothecate future risk of debt repayment – that is after all why they were initially created. Repayment history is used to predict future repayment behavior – that is about as apples-to-apples as it gets. Actuaries will have to be more convincing in their position promoting the use of credit scores for risk profiling in their industry. Show me.