State regulators recently told Congress that more study of the use of credit scoring by insurance companies is needed to determine if the practice is unfairly discriminatory.
“As state regulators, it is our sincere desire that the federal government assist, not detract, from the states’ regulatory efforts to address this important issue,” Florida Insurance Commissioner Kevin McCarty said. “A more in-depth and objective study by the FTC [Federal Trade Commission] on the relationship between credit scores and race/ethnicity is needed to determine if there is, in fact, a ‘proxy effect’ that shows a demonstrable correlation between credit scores and race/ethnicity.”
McCarty was testifying on behalf of the National Association of Insurance Commissioners (NAIC) before the U.S. House Financial Services Committee’s Subcommittee on Oversight and Investigations at a hearing titled, “The Impact of Credit-Based Insurance Scoring on the Availability and Affordability of Insurance.”
The subcommittee is weighing legislation to further study and potentially ban the use of credit scoring in insurance.
“Proponents argue that credit-based insurance scores are predictive of an insured’s future claims experience, and are necessary tools for underwriting and/or rating. Critics argue that the use of credit-based scores are merely another example of imposed discrimination against lower income individuals and protected classes of people,” said McCarty, who chairs the NAIC’s Property and Casualty Insurance Committee.
“That is the heart of the debate: studies do show that credit scores can be predictors of future claim activity, but the same studies also show that the use of these scores disparately impacts certain classes of people, and thus has a discriminatory effect,” the Florida regulator continued.
McCarty said that he would like to see the inquiry expanded into the use of occupation and education as insurance rating criteria as well.
McCarty acknowledged that the world is in a new information age in which “a dizzying myriad of information may be obtained about an individual” through health records, sex offender databases, insurance claims histories, consumer buying habits, Internet usage, DNA/gene-testing and credit scoring.
Yet the availability of all of these information tools does necessarily justify their use to rate or underwrite insurance, he told Congress.
“It is important to understand that although many of these tools may show mathematical correlations with insurance claims, this does not necessarily make them fair and valid criteria for insurance purposes,” he said.
He cited the use of race and genetics as two examples of criteria that while they might produce actuarial useful information, their use is prohibited for public policy reasons.
“Clearly legislators and regulators must weigh the benefits of simplistic claims prediction with sound public policy,” he testified.
McCarty cautioned that the use of credit scores could weigh more heavily given today’s economy. “Historically, rising unemployment rates, rising home foreclosures, and rising inflation in the costs of goods and services have contributed to a deterioration in credit histories. A downturn in the economy could potentially magnify differences in credit scores among vulnerable populations,” he noted.
He took issue with previous credit scoring studies because, he said, they focus on the frequency of claims filed by people with low credit scores, rather than the losses. “This is a subtle but important
distinction. The studies show only that consumers with lower credit scores file more claims, not that they have greater loss events,” he suggested.
He also charged that the empirical studies to date, including the 2007 FTC study, suggest that the “claims being filed are not legitimate, and moreover, that the rates being charged, absent credit-based insurance scores, are not actuarially sound.”
In addition to raising questions about race and ethnicity bias, credit scores have a “disparate impact on other segments of society” including young people and the elderly, McCarty maintained.
He said that in testimony provided during a hearing in Florida, an industry actuary admitted that average scores in the 25 to 30
year old age group are disproportionately lower than in older age groups. Also, he said that other research has shown that the elderly, because they tend to use credit less, frequently have lower or no credit scores and are penalized as well.
He maintained that the use of credit-based insurance scores has a disparate impact on consumers of certain racial, age and religious groups. In his view, the “predictive power of these scores is very likely not measuring any event risk, but rather indirectly measuring socioeconomic status” and they are not necessary for proper underwriting and rating.
He added that he does not think the insurance industry intended to use credit scores to impact minorities negatively. But the industry’s attempt to ignore this issue shows a “failure to treat its consumers fairly and equitably,” in his opinion.
McCarty, whose own state restricts the use of credit scoring, told federal lawmakers that 48 states have taken some form of legislative or regulatory action limiting the use of credit scoring in the provision of insurance products. According to McCarty, not all state insurance regulators agree with him on credit scoring. States have, in fact, taken a variety of approaches:
Some states have limited the use of credit scoring, requiring that it not be the sole rating factor used by insurers to evaluate risk.
Some states believe that the process itself is not intended to be discriminatory, and any disparate impact based on race or ethnicity is merely coincidental.
Some states believe that a majority of policyholders benefit from the use of credit scoring.
Some states have taken issue with the use of credit scores and other rating criteria, such as occupation and education.
Whatever the federal government does in the area of credit scoring, McCarty said, “it is essential that federal action not preempt or diminish consumer protection efforts already enacted by state legislatures.”
Source: National Association of Insurance Commissioners
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