The increasing use of credit scoring by insurers in underwriting and rating personal lines of insurance has reportedly brought on increased interest, oversight and even some action by insurance regulators and state legislatures to ensure the practice is being used fairly and in compliance with existing and new regulations, panel members on the subject told a recent session at the Casualty Actuarial Society’s Seminar on Ratemaking.
Comprehensive legislation limiting how credit scoring can be used was passed last year in the state of Washington, modeled, in large part, on guidance issued from the Connecticut Insurance Department, which they seem to enforce like a rule or law, said Lisa Smego, senior policy analyst for the Washington Department of Insurance.
“We decided to adopt that particular approach because there are a number of us in the department who believe the attributes in the (Conn.) model are very important and are things that perhaps should be reviewed and analyzed more than they have been in terms of who they impact,” she said.
“While there have been allegations that credit scoring has an impact on certain classes of people, I’m not sure it has an impact overall, but I think there are certain attributes in the models which are worse than others, Smego noted. “We eliminated insurers’ ability to use some of these attributes, including the number of credit inquiries because of a number of consumer complaints that it caused them problems. There was no hard, statistical evidence there, but that issue resonated with a number of lawmakers and they agreed that should be eliminated.”
Unexpected medical expenses were eliminated, Smego noted, after a number of people testified at public hearings that these had made their insurance rate score go down and they ended up paying more for insurance at a time when they could least afford it. The impact of the type of credit card used by consumers also was eliminated, as well as use of the total line of credit because we felt that this may have an effect on lower income people, the Washington insurance official pointed out.
“The most important element of the law, from our stand point, was the restriction on insurers’ ability to cancel or nonrenew based upon credit and our law is stronger than most in that it does have the standard where an insurer cannot cancel or nonrenew when credit is solely the reason for that,” she continued. “In Washington, it has to be a significant factor and it cannot be just a single incident where they (the insurer) are not going to take action against every single policyholder in that particular case,” Smego emphasized.
One expectation regulators have is that companies and agents need to explain why customers’ rates are what they are and we feel the insurance industry needs to explain the use of credit scoring. “It is in the best interest of the industry to improve consumer education,” she concluded.
Addressing the actuaries from a credit-scoring vendor’s perspective, John Wilson, assistant vice president – analytics for ChoicePoint, outlined what score vendors should do to help address regulatory concerns over insurance credit scoring, the key concerns about its use, and what other groups are involved.
Wilson said his company can provide satisfactory support materials and/or data to insurance carriers and/or regulators to support that using scores is actuarially sound and credible. “We can meet with regulators to explain how the scores were developed and provide full model disclosure,” he said.
ChoicePoint believes it is incumbent on vendors to provide full model disclosure and has have done that in several states where there is no confidentiality protection, Wilson pointed out. But there are other vendors who have spent a lot of money building their own models and are hoping to achieve an advantage in the marketplace from that, so they are taking a slightly different position, he said. Even there, though, every vendor or every insurance carrier that develops their own model ought to be willing to disclose how it works, Wilson added.
“There is some concern, I think, about how scores get delivered for use and we have spent some time talking with regulators about the general processes used, whether they are being applied for prescreening, new business or renewals and the impact of their application so consumers feel that the process treats them as fairly as possible,” the ChoicePoint official said.
Insurance agents want to know how to explain the use of credit scoring, so ChoicePoint can produce explanatory materials in print and make them available on the web. “It’s important to explain everything,” Wilson continued, “and it is appropriate for carriers to provide guidance on definitions and obligations.”
“While there are specific state concerns, part of the problem is that some concerns (about credit scoring) are derived from anecdotes and often it is unclear what the support for removal of a variable is or what the impact will be,” Wilson said. These requests for changes can be taken care of and some states have suggested an appeals process for special considerations. It’s a balancing act where you want to be consistent and objective while making allowances for extenuating circumstances, he said.
Examining the issue of credit scoring from the insurance company perspective, Roosevelt Mosley, consulting actuary, Pinnacle Actuarial Resources, Inc, talked about some of the things heard in the market from insurers and regulators and the responses to insurance scoring in the past, as well as how the issues might be addressed in the future.
A year ago, credit scoring was an issue in about 30 states and now at least 40 states have addressed it in some fashion, Mosley told the actuaries. There has even been some judicial attention to the issue, he said, with a federal court suit in which an insurance company was accused of using credit to mask intentional racial discrimination. “And there could be more such cases,” Mosley added.
“There is the potential for increased attention to the issue in 2003 with some additional legislative activity, increased regulatory and judicial attention, and studies on the subject being released,” Mosley remarked. How insurers addressed the issue of credit scoring in the past gives some insight into how it may be addressed in the future, Mosley suggested.
Companies often treated the use of credit scoring as a trade secret and regulators have expressed some frustration over companies and vendors “passing the buck” on the issue, Mosley noted. Often, there has not been a lot to back up the arguments in favor of the use of credit scores, “so we better do more in the future or run the risk of losing the ability to use credit models,” he warned.
Mosley said something that could assist the industry are the results of a University of Texas-Austin study – a true multivariate study that concludes that credit has strong predictive power. And if other states follow the lead of Washington in regulating the use of credit scoring, companies many need to continue to justify their use of scoring independently to regulators and the public.
The use of credit scoring will survive in some form, Mosley concluded, but that form could potentially take on 51 different shapes (for each state and the District of Columbia). “It is important for insurers to be proactive in forming what those shapes look like,” he added.