Michigan Supreme Court Lifts Ban on Use of Credit Scores by Insurers

By | July 19, 2010

The Michigan Supreme Court has ruled that the administration of Gov. Jennifer Granholm exceeded its authority when it banned the use of credit scoring by insurance companies in the state. The decision means insurers in Michigan can continue to use credit scoring in calculating car and home insurance premium discounts. Credit scoring can’t be used in the state to determine whether a person can be insured by the company or to apply a surcharge.

The 4-3 decision invalidates rules against credit scoring proposed by the Granholm Administration and permanently blocks their enforcement.

“The Commissioner has the authority to insure that insurers’ practices comply with the Insurance Code. Nothing about the practice of insurance scoring, however, amounts to a violation of the Insurance Code per se. The Commissioner exceeded her authority by enacting a total ban on a practice that the Insurance Code permits,” the ruling written by Justice Maura D. Corrigan states.

The ruling is a solid victory for the Insurance Institute of Michigan (IIM) and individual insurance companies that have been fighting for years for carriers to be able to use credit scores in figuring home and auto insurance discounts.

According to the insurers, it’s also a victory for their customers.

“This decision is a win for Michigan policyholders,” said Peter Kuhnmuench, executive director of the IIM, which represents 39 of the state’s property/ casualty insurance companies. “Insurance carriers will continue to be able to offer discounts to policyholders who are less likely to have a claim.”

The decision drops Michigan from the ranks of states that prohibit the use of credit scoring. Only four – California, Massachusetts, Hawaii and Maryland – either fully or partially ban its use.

Endorsement of Credit Scoring

The ruling goes beyond finding that the Insurance Commissioner and the Office of Financial & Insurance Services (renamed the Office of Financial and Insurance Regulation in 2008) exceeded their authority in issuing the ban. It dismisses the OFIS arguments against the use of credit scoring and reads in many places like an endorsement of the widespread industry practice.

The court said insurers have shown a “clear correlation between insurance scores and risk of loss” and demonstrated that insurance scoring may be used to establish a “reasonable classification system.” Consequently, the court concluded, the use of credit scoring does not result in rates that are unfairly discriminatory as OFIS alleged.

OFIS had contended that scoring ignores one of the “express purposes of the Insurance Code, which is to make insurance available and affordable for everyone.”

But the high court said it is likely that the opposite is true, that “it is the prohibition, not the allowance, of insurance scoring that will, in fact, make insurance both less available and less affordable to Michigan residents.”

The court cited evidence that the majority of Michigan residents will see an increase in their insurance premiums if insurance scoring is prohibited and that the availability of insurance would be diminished because insurers would no longer be able to use “the most powerful predictor of losses” to determine rates.

“It is difficult to see how offering discounts to some insureds on the basis of good insurance scores is inconsistent with the Insurance Code’s general purpose of availability and affordability of insurance for all,” the court said.

The decision even criticizes OFIS for complaining about the use of credit scores in insurance while doing nothing to curb the widespread use of credit reports in banking, which it also regulates, or by its own agency or others in state government.

The court said that the studies OFIS used to suggest flaws in credit reports – one by the Consumer Federation of America and National Credit Reporting Association, one by the U.S. Public Interest Research Group, and a survey conducted by Consumers Union and published by Consumer Reports – are “inconclusive at best.” Also, it said evidence in the administrative record showed that that most of the “errors” in credit reports are minor ones, such as misspelled street names, “that have little or no substantive effect on the actual insurance scoring itself.”

While OFIS attempted to distinguish discounts for safety devices that it supports from discounts for higher insurance scores, the court said there is “little difference” between the two. “The more insureds there are with anti-lock brakes, the lower the risk of overall loss. Likewise, the more insureds there are with high insurance scores, the lower the risk of overall loss,” the court said.

Justice Corrigan was joined in the majority opinion by Justices Stephen Markman, Elizabeth Weaver and Robert Young Jr., while Chief Justice Marilyn Kelly and Justices Michael Cavanagh and Diane Hathaway dissented.

Reactions

“We are very pleased with the court’s decision,” said Ann Weber, vice president, state government relations, for the Property Casualty Insurers of America (PCI).

Weber said credit-based insurance scoring saves the typical insurance consumer anywhere from 30 to 59 percent on auto insurance “for the simple reason that there is a proven correlation between insurance scores and the likelihood of filing insurance claims.”

David Snyder, vice president and associate general counsel of the American Insurance Association (AIA), said the decision will mean lower premiums for many consumers.

“In reality, the majority of consumers benefit from the use of insurance scoring through lower insurance rates. Insurance scoring is highly predictive of risk and helps increase the availability of insurance products because this tool enables insurers to accurately write virtually any risk,” Snyder said.

The vast majority of states (46) permit insurance scoring subject to regulation including non-discrimination standards. Twenty-six states utilize model legislation developed by the National Association of Insurance Commissioners (NAIC) to regulate credit-based insurance scoring, according to Neil Alldredge, senior vice president of State and Policy Affairs for the National Association of Mutual Insurance Companies (NAMIC). Several other states incorporate ideas from the model to govern credit scoring.

“This is a huge win for Michigan consumers and insurers to ensure that premiums are fair and accurate,” Alldredge said. “We couldn’t be happier to get a fair outcome from Michigan’s high court, and we commend them for focusing on the law and rendering a decision that protects consumers.”

Alldredge said NAMIC will join other insurance trade groups to back Rep. Andy Neumann’s HB 5297 that adapts the NCOIL model on credit-based insurance scoring into Michigan’s insurance code.

Consumer advocates blasted the Supreme Court for siding with insurance companies.

“Today, our Michigan Supreme Court, in a 4-3 decision sided with the powerful special interests and powerful insurance companies against Michigan consumers” said Linda Teeter, executive director of Michigan Citizen Action. “Using a person’s credit score as one of the factors used to determine an insurance rate has nothing to do with their driving record, which is the only standard that should matter in a person’s driving record, not their financial standing. Instead of standing up for Michigan residents, the Supreme Court today slammed the doors of justice in their faces and showed just how out of touch it is with the people of Michigan.”

Background

The ruling’s roots can be traced back as far as 1997, when the Legislature enacted a law permitting insurers to employ rating schemes without prior approval of the OFIS. As a result, a number of insurers began using various credit scores formulas in their premium discount plans.

However in subsequent years, criticism of credit scoring mounted and the OFIS began requiring insurers to report on how they were using credit scores.

In May, 2003, then Insurance Commis-sioner Linda Watters and Gov. Granholm made it clear they thought the use of credit scoring “was problematic at best” and began pushing the Legislature for a ban.

By July 2004, Watters and the Granholm Administration were impatient with the Legislature’s failure to act. OFIS drafted and eventually adopted rules prohibiting the use of a credit-based score as a rating factor after Jan. 1, 2005. OFIS also required insurers to adjust rates they charged that included credit scoring.

Some lawmakers balked but, in the face of threatened vetoes by Granholm, no bills overturning the OFIS actions were passed. So insurers went to court. On April 25, 2005, a trial court concluded that the OFIS rules were “illegal, invalid, and unenforceable” and permanently enjoined their enforcement. The court concluded that Watters had exceeded her authority in promulgating the rules by ordering an industry-wide reduction in rates rather than challenging rates on an individual basis through the contested case hearing process set forth in the Insurance Code. The court also concluded that the rules’ “blanket prohibition” on insurance scoring violated the Insurance Code because there was evidence establishing a correlation between scores and risk of loss.

An OFIS appeal resulted in the Court of Appeals issuing three separate opinions on Aug. 21, 2008 – two of which vacated the trial court’s judgment and one that agreed with it, all for different reasons. That set the stage for the state Supreme Court to get involved.

While the case was pending before the high court, OFIR began rejecting insurer rate filings that contained credit score factors, forcing insurers to go to court again to thwart OFIR.

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