CRITICAL ISSUE REPORT

CREDIT SCORING DEBATE CONTINUES

As states enact various protective legislation,
agents and insurers air their views

By Phil Zinkewicz

"Insurers need to reexamine their use of credit information and should adopt balanced and reasonable business practices that consider the interests of consumers."

--W. Cloyce Anders, IIAA President-elect

A battle royal has been brewing between state insurance legislators and regulators and segments of the property/casualty insurance industry. At issue is whether--or to what extent--insurance companies should be allowed to use an insurance applicant's credit information and credit scores in underwriting or rating insurance policies. At present, it is well known that insurers use such information in rating homeowners and auto policies, but insurers admit privately that they use "scoring" in small commercial products as well. Insurers insist that scoring is an essential part of the rating process and that, in many cases, it works to the insured's advantage. Legislators are not so sure. So far, agent representatives have taken a middle-of-the road approach to the controversy. Most agents recognize that scoring exists but say that it should not be the only criterion that an insurer uses, and that consumers should be fully informed of the process.

Speaking recently at the National Conference of Insurance Legislators (NCOIL) 2002 spring meeting, Independent Insurance Agents of America (IIAA) President-elect W. Cloyce Anders said that the insurance industry must closely examine its increased use of credit information and credit scores. This examination should include an evaluation as to whether or not changes need to be implemented--preferably through the adoption of new business practices.

"As the number of companies using credit data and industry reliance on such information has increased, so has the amount of controversy," he said. "Consumers, legislators, regulators, and agents have all raised questions and concerns about the manner in which some companies use credit information," continued Anders, who is president of VFIS of North Carolina, as well as Anders, Ireland & Marshall, Inc., both of Raleigh, North Carolina. Anders said that a 2001 Conning study found that 92 of the largest 100 insurance companies use credit data in underwriting or rating, and of those 92 companies, more than half of them have begun doing so since 1998.

"While IIAA and most agents and brokers strongly support underwriting tools that foster enhanced competition and fair and accurate pricing of risk, agents and brokers are concerned that the increased reliance on credit information has led to a large jump in counterintuitive underwriting results. Such anomalies are causing increased frustration among IIAA members and their clients," said Anders. "Some companies overuse or overemphasize credit information and, as a result, model clients are inexplicably non-renewed or experience dramatic rate hikes, and consumers with little or no credit history find it harder to obtain affordable coverage. Consumers are rarely notified of the role that credit histories play in the underwriting and rate-setting process, and they are often not aware when their credit history has affected them negatively. In addition, while many companies use credit information, some do not educate consumers or agents about their practices, and some have yet to develop guidelines or standards."

Anders singled out Progressive Insurance for taking positive action on this issue. He pointed out that the largest writer of auto insurance through independent agents has implemented a series of new business practices governing its use of credit information. "Progressive's new policy includes consumer disclosures; a ban on using credit scoring to refuse, cancel or non-renew coverage; a ban on using disputed information in its credit formula; elimination of certain elements from their scoring formula, including non-consumer initiated inquiries; periodic reviews of consumer credit information and rewriting only when the benefit is to the consumer; sharing of specific information to consumers that explains how credit data adversely affected their underwriting; an exception process for consumers whose credit data are unduly influenced by extraordinary life events; and filing its credit scoring model where required or encouraged by state regulators."

Anders said that if other leading companies were to take a similar approach, much of the current controversy would subside. "IIAA encourages other companies to follow these types of pro-consumer best practices," he said. "Insurers need to reexamine their use of credit information and should adopt balanced and reasonable business practices that consider the interests of consumers. The failure of companies to do this on their own has led to a proliferation of legislative proposals, and we would prefer to see the insurance community step up to the plate on its own."

Anders does not exaggerate when he says that there has been a proliferation of legislative proposals regarding credit scoring--some pro, some con and others in between. On the pro side, the National Association of Independent Insurers (NAII) says that legislators and regulators in some states have resisted efforts to limit use of credit information. James Taylor, southeastern regional manager for NAII, praised Illinois for enacting legislation that permits the use of insurance scores as one of many criteria that insurers may use in the underwriting process. He added that the Connecticut Insurance Department has determined that the use of credit information is consistent with Connecticut law and that consumers can benefit from its use. He said also that the Virginia Department of Insurance has concluded that credit scoring is an accurate predictor to assess insurance risks and that the use of credit does not discriminate based on income, race or other demographics.

On the other hand, at least 15 states either restrict or are considering restricting the use of credit information. In Indiana, for example, several proposed laws would severely limit or ban the use of credit-based insurance scoring, according to Robert Hurns, counsel for the NAII. He lists those proposals as follows:

* SB 409 - Under this proposal, consumers who have been denied insurance, whose policies have been canceled or not renewed, have 90 days to ask insurers for an explanation. Insurers have 21 days to respond to consumers' requests. "The majority of insurance companies already notify consumers of any adverse action they take," Hurns said. "Imposing these burdensome notice requirements will require more time and resources to fulfill, and those costs could be passed on to the consumer." Another portion of the bill requires that insurance scoring be used in conjunction with other underwriting methods. NAII supports that provision, said Hurns.

* SB 149 - Under this proposal, insurers would be banned from considering any adverse information contained in consumers' credit reports, while positive information is permitted. "This would skew and undermine the objectivity of insurance scoring," Hurns said.

* HB 1074 - This proposal calls for the outright prohibition of credit-based insurance scores. "Blanket prohibitions on insurance scoring will ensure that the majority of policyholders will pay more than necessary to insure their cars and homes," Hurns said. "Why eliminate an underwriting method that actually opens the door to more insurance availability and equity?"

* HB 1164 - Under this proposal, before being able to use credit data in insurance scoring, a company's insurance scoring method would have to be approved first by the Indiana Department of Insurance. The bill also would mandate notification requirements similar to SB 409. "This is over-regulation and micromanagement of a company's business," according to Hurns. "The practice of insurance scoring does not warrant such scrutiny."

At press time, some other states were seriously looking at credit-based insurance company scoring, according to the NAII. In Colorado, the legislature considered a bill prohibiting the use of scoring, but it died because of the deletion of a technical reference. It could be reintroduced later. In the state of Washington, the legislature was considering two bills that would severely restrict insurers' use of scoring. In Idaho, if passed, Bill 1323 would prohibit an insurer from charging a higher premium or canceling a policy "based primarily upon an individual's credit rating or credit history."

It is clear then that the subject of insurance company credit scoring is a volatile one. One man who is absolutely against its use is John Bryant, an agent who sits on the boards of the National Association of Professional Allstate Agents and the Coalition of Exclusive Agents Association. He has spoken with congressmen/women about what he believes are the problems with scoring and has testified before the Maryland Assembly and Washington state's department of insurance.

"Credit scoring is an abomination," he says. "It discriminates against people in rural areas of the country, where residents may be traders, fishermen or loggers. Some of these people are fourth generation and they deal only in cash. It discriminates against the older generation, people who have worked all their lives and paid off their debts and don't want to spend their sunset years establishing more credit. What about a young widow with a small child, who has never established credit on her own? Or how about a young couple with a child who develops a serious illness, who spend every dime they have and every dime they can borrow to get the necessary medical treatment? Will their credit score deny them the opportunity to obtain insurance or cause them to pay astronomically high prices? What about people who are victims of identity theft? While they are spending the time to unravel a mess that is no fault of their own, will they have to do without insurance or pay unreasonably high prices for it?"

Bryant says that one problem is that insurers "absolutely refuse" to allow regulators to examine the formulas they use in scoring to see if they are acceptable. "And agents are in a quandary over credit reporting," he says. "If an agent has a client who has been turned down for insurance or is quoted at a high rate, the agent can't explain to that client why, because the agent doesn't know. The company won't go into detail. If insurance companies are going to use credit scoring, they should be held accountable. They should have to provide full disclosure to the insureds in all particulars."

Anders says that the IIAA is in favor of more disclosure on the part of insurance companies in their use of credit scoring, although he would rather it see it come about voluntarily rather than by legislative edicts. "The use of credit data offers many advantages to the industry, but its application must be fair and reasonable. It is a powerful tool, but it must be used in a balanced way. Otherwise, consumers and policymakers will be skeptical of its use, which could ultimately lead to the loss of such tools altogether."

The author

Phil Zinkewicz is an insurance journalist with some 25 years' experience covering the international insurance and reinsurance arenas. He was the insurance editor of the Journal of Commerce for a number of years, handling all their domestic and international supplements. In addition, he regularly writes for a number of London publications.