Credit-Based Insurance Scores – The Battle Heats Up

Earlier this month, the Colorado Senate passed a bill prohibiting insurance companies from using any external consumer data and information source, algorithm or predictive model for insurance premium calculation found to be unfairly discriminatory.

Two weeks prior, on April 28, Washington State Insurance Commissioner Mike Kreidler sent a letter to members of the National Association of Insurance Commissioners, urging them to bar insurers in their states from using credit-based insurance scores in insurance premium calculations. At the end of March, Kreidler signed an executive order introducing such a ban in Washington for auto, home and renters’ insurance. Other states, including Maryland, West Virginia, Illinois, Oklahoma and Louisiana, have all seen legislative activity around the same restrictions of credit-related information. As even more states continue this trend, it’s critically important to understand the issues and the arguments of both sides.

First, there is a difference between credit-based scoring and a credit score. Credit-based scoring differs in that it considers numerous factors beyond simply payment history—including outstanding debt, credit history length, pursuit of new credit and a credit mix that includes student loans, auto loans, mortgages and more.

Whereas the battle over use of credit-based scores has been raging for close to a quarter century, in recent months the intensity and emotions of the rhetoric have risen. Commissioner Kreidler has been pushing for a ban on use of credit-based insurance scoring since he took the post in 2000. Insurance trade associations have pushed back, maintaining that use of credit-based insurance scores is both fair and factual. Consumer groups who agree with Kriedler are demonizing the insurance industry with accusations of “dirty tricks” and exploitative practices. Opponents of credit-based scoring are also framing credit-based score use in the light of today’s cry for social justice, characterizing it as a manifestation of systemic racism.

Examples of vitriol creeping into today’s arguments include Commissioner Kreidler calling the insurance industry’s argument “personally insulting,” and The Center for Economic Justice (CEJ) and the Consumer Federation of America (CFA) characterizing credit-based scores as “obscene” and “insidious.” To be sure, the CEJ has a long history of anti-insurance company sentiment. In a 2007 congressional hearing on credit-based insurance scores, CEJ Director Birny Birnbaum put down the actuarial profession with his rhetorical question, “Who but an insurance company actuary would say that it’s fair to charge people who have been displaced from their homes higher auto and homeowner insurance rates because they’re under financial stress? I don’t know of anyone.”

However, insults and histrionics detract and discredit—rather than support—debate. Birnbaum’s unkind swipe at insurance actuaries is an ad hominem attack, a rhetorical fallacy in place of reasoned argumentation. As usual in politics: If you cannot defeat the argument, attack the person sharing it. So to better inform the debate, here are the facts:

There is voluminous literature on whether insurers’ use of credit-based insurance scores is a useful aid to underwriting tools and whether or not it is discriminatory. The most detailed and comprehensive study was the 240-page 2007 report by the Federal Trade Commission (FTC). The report was the basis of multiple hearings before the House Financial Services Committee’s Subcommittee on Oversight and Investigations. The FTC report concluded that, “Credit-based insurance scores are effective predictors of risk under automobile policies. They are predictive of the number of claims consumers file and the total cost of those claims. The use of scores is therefore likely to make the price of insurance better match the risk of loss posed by the consumer.” At the hearings, then-Rep. Spencer Bachus (R-Ala.) cited a report by the Texas Department of Insurance finding that, “These scores were not unfairly discriminatory or based on race or income.”

A vast majority of personal automobile insurers use credit-based scoring because it is a valuable input to ratemaking. There is a correlation between scores and loss probability—and insurance is all about accurately measuring risk and minimizing loss. Lower scores are correlated with more insurance losses. Statistically, individuals with lower scores have higher risk, which results in higher premiums. Discrimination for reasons outside of loss probability would be bad business and a more savvy insurance company would step into the breach and offer insurance to the neglected or discriminated against individual at a fair price.

While the reason for the correlation between credit-related insurance score and losses is not known definitively, there are a number of theories. Individuals with low credit scores often live in neighborhoods where there are higher rates of automobile theft, driving up automobile comprehensive cover losses, which in turn leads to higher premiums. Some maintain that individuals with low credit scores are under more pressure because of financial strains, and are therefore more prone to be involved in accidents as a result.

Those who argue for restricting insurers from using credit-based scores often have noble intentions. Some seek to help break groups of people out of a vicious cycle of poverty by making automobile insurance more affordable. Others point to people whose finances were so severely negatively impacted by the pandemic that their credit scores dropped for reasons unrelated to driving habits or propensity to get into a car accident. But painting an entire industry with the same brush—much less an image not based in facts or figures—will not only lead to unintended consequences but likely conclude in stalemate and gridlock.

There are arguments to be made for and against use of credit-backed scores in insurance. In an era when facts too often are allowed to coexist with “alternative facts” and policy discourse is allowed to deteriorate into name-calling, it is important that cool heads prevail and that parties to the debates advance positions that are fair and factual.