Study Says Lower Scores Mean Higher Loss Claims

By | March 24, 2003

The lower a named insured’s credit score, the higher the probability that the insured will incur losses on an automobile insurance policy, and the higher the expected loss on the policy.”

That’s the bottom line, both literally and figuratively, of a report recently submitted to the Texas Legislature that studied the relationship between consumers’ credit scores and their claims histories. The report, “A Statistical Analysis of the Relationship Between Credit History and Insurance Losses,” was commissioned by the legislature and prepared by the Bureau of Business Research, part of McCombs School of Business, at the University of Texas.

The Bureau analyzed a random, representative sample of 153,326 Texas automobile insurance policies with credit scores, and 22,321 without credit scores, that were in place in the first quarter of 1998. It employed Choicepoint, a firm that provides underwriting information to U.S. property/casualty insurers, to supply a credit score for each of the named insureds on the policies used in the study. The identities of the named insureds were unknown to the researchers. The study then assessed “the relationship between credit scoring and insurance losses, after accounting for other underwriting variables” by relating an established relative loss ratio for each policy to the credit score.

The aim of the study was to “determine if: 1) credit history and losses were statistically related and 2) whether such a relationship, if it exists, is explained by standard underwriting variables.” What it did not attempt to find out, if credit scores and loss histories were found to be related, is why such a relationship exists. The study was blind to such variables as race, ethnicity and income, and “does not speculate about the possible effects that credit scoring may have in raising or lowering premiums for specific groups of people.”

It found that groups with the lowest credit scores had higher than expected losses—up to 53 percent higher for the lowest scores—while those with the highest scores had losses 25 percent less than targeted. The dollar amount of the claims was also significantly higher for those with lower credit scores.

Insurer trade groups, such as the Alliance of American Insurers and the National Association of Independent Insurers (NAII), say the study reinforces what insurance companies have been saying for years, that the use of credit scores is a valid tool in predicting future insurance claims.

“This is a significant study that should clear up the misperceptions about the use of credit as a valid tool in the insurance business,” said Joe Woods, assistant vice president and Southwest regional manager for the Alliance. “As we’ve said all along, research shows that people who manage their personal finances responsibly tend to manage other important aspects of their life—and financial assets such as their home and vehicle—responsibly as well.”

The groups are hoping that the Bureau’s analysis will convince legislators that a ban on the use of credit scores would be counterproductive.

“The University of Texas study reaffirms the previous independent studies on insurance scoring,” said Donald Hanson, southwestern regional manager for the NAII. “Based on the strong relationship between insurance scores and risk of loss that the University of Texas researchers found, we are hopeful that legislators will see the positive impact that insurance scoring can have in helping to make insurance coverage more available and affordable for millions of drivers and homeowners. Insurers have found that when used with other familiar factors such as driving record and the age of a home or type of vehicle, insurance scores help provide a clearer picture of an individual’s risk of loss. This helps insurers more accurately price policies based on a policyholder’s potential for filing a claim. Legislation that would ban the use of this tool would be a disservice to consumers.”

According to the NAII, since December 2002 the Alaska, Kansas, Michigan, Washington and now Texas legislatures have received independent studies that provide further proof that insurance scores are very accurate predictors of loss. Texas is one of at least 35 other states examining insurance scoring this legislative session.

Insurers may have some support within the Texas legislature, at least on a limited scale. Texas Lieutenant Governor David Dewhurst and Senator Troy Fraser of Horseshoe Bay, chair of the Senate Business and Commerce Committee, favor “putting sunshine on the issue,” as Fraser said, by regulating insurers’ use of credit histories rather than banning the practice altogether. The two lawmakers have yet to comment specifically on the Bureau’s findings, but according to a report on the Senate Web site, they have indicated they would support insurers’ use of an individual’s credit score as long as it is not the only factor used in underwriting and rating that person’s policy. Fraser, particularly, is adamant about making sure that people with little or no credit, those who have had medical emergencies, and those with disputed credit are not subject to discrimination because of their credit history or lack thereof.

Texas consumers, on the other hand, and consumer groups remain skeptical about the issue. According to a recent poll conducted in Texas by the Scripps Data Center, 67 percent of those surveyed want legislators to ban the used of credit histories by insurers. And critics of the practice maintain the poll shows that consumers believe insurers’ use credit history in order to deny insurance policies and to justify rate increases. Consumer groups like Texas Watch, Consumers Union and the Center for Economic Justice want a total prohibition against the practice. They believe, among other things, that the use of credit scores raises premiums across the board and discriminates against minorities and people with low incomes.

Topics Carriers Texas Claims Profit Loss

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