Consumer Advocates Watching How Insurers Treat Credit in Recession

April 13, 2009

With consumers’ credit scores dropping as lenders tighten credit terms, insurance consumer advocates are stepping up their criticism of the use of credit scores by insurance companies.

They are also warning insurers that they could lose business and consumer confidence if they don’t treat consumers fairly in today’s economic climate.

“We have already seen credit scores having an impact on interest rates charged to consumers on their credit cards and loans. If insurers continue to use credit scores in determining risk levels, premiums will increase and consumers may be forced to reduce the insurance carried to protect their financial assets,” according to Karroll Kitt, associate professor at the University of Texas at Austin.

Pamela J. Bolton, director of policy and research for Texas Watch, thinks the credit crisis is hard on many consumers.

“The credit crisis has already lowered the credit scores of thousands. As lenders lower credit limits and increase rates, consumers are seeing their credit scores suffer through no fault of their own,” Bolton said. She said the “grave” situation has been documented by the Wall Street Journal, Fox News, Bloomberg, and others.

Bolton, who supports a ban on credit scoring, expressed doubt but hopes the insurance industry will take into account differences between changes in credit scores due to the consumer’s own actions versus economic conditions or changes by lenders.

“This crisis presents the industry with a very important choice: Will it choose to act in the best interests of its customers, rather than its bottom lines, by embracing fair practices that don’t unfairly penalize policyholders, or will it be business as usual?” Bolton asked. “Only time will tell.”

If insurers don’t somehow adjust, consumers and insurers both “will be worse off,” warned Brenda Cude, professor of housing and consumer economics at the University of Georgia in Athens.

“It is already very difficult to explain to consumers how their credit score could be related to their access to insurance and the price they pay,” she said. “It will be even more difficult to explain that when the drop in the credit score is due to, for example, their credit card company lowering their credit limit when the consumer’s behavior hasn’t changed in any way.”

Insurers taking advantage of insureds’ credit plight could pay a price. “One outcome will likely be a continued erosion of consumers’ faith in financial institutions,” Cude said.

Cude and other consumer advocates will also be watching how the economic recession affects consumers’ buying habits.

“The question is how many consumers and which ones will drop insurance coverage and which coverage? And, if consumers have lost confidence in financial institutions, the impact will be greater,” Cude said.

“The problem is compounded by the fact that, I believe, consumers already don’t understand what they’re buying when they buy insurance and how rates are set. If that’s true, they don’t know what they’re giving up when they drop their insurance coverage,” said Cude.

Kitt said that consumers are trying to do the best with what they have and want to trust providers. “Consumers are experiencing fear regarding their money and how to protect what money they currently have,” said Kitt. They are guarded in spending their money and want to feel confident that they can trust who is selling a product. This is reflected in purchasing less and only what is felt to be essential, foregoing luxury items.”

Cude thinks some consumers who have to make hard choices about which bills to pay will choose other items over insurance. “There’s already an indication that this is happening — there’s a Safe Auto ad in which the major point is that if you miss a few payments, SafeAuto will take you back. The ad doesn’t say whether you come back at the same rate as before, however.”

Bolton, too, has concerns about how insurers will treat consumers in the current economy. “Insurers have the vast majority of their funds in the bond market, which has been much less affected than the stock market,” Bolton said. “Despite this, I think insurance companies are likely to use the economic crisis as an excuse to increase rates.”

Cude, Bolton and Kitt are in a position to have their views on credit scoring and other consumer issues heard. They are three of the 17 consumer liaisons to the National Association of Insurance Commissioners (NAIC) for this year. They will have forums to air their opinions. NAIC recently announced that it will be holding public hearings to review the credit scoring issue.

Some state regulators also stepped up their scrutiny of credit scoring.

In February, Florida Insurance Commissioner Kevin McCarty, a credit score critic, grilled a group of insurers on how their companies use credit scores.

The credit scoring issue has also resurfaced in Michigan, where the issue is still before the state Supreme Court — when Insurance Commissioner Ken Ross denied rate increases that were in part based on credit scores. A county court on Friday blocked Ross from rejecting filings because they contain credit score factors.

Status of Credit Scoring
Proponents for the use of credit-based insurance scores argue that they 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 insurance scores unfairly discriminate against lower-income individuals and some protected classes of people and that they have no loss mitigation benefit.

Forty-eight states have taken some form of legislative or regulatory action limiting the use of credit-based insurance scores, including:

Some states have limited the use of credit-based insurance 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.

Some states prohibit the use of credit-based insurance scores.

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