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Credit Restoration

SHADES OF GREEN

	A dubious policy... Insurers face regulatory backlash for use of credit scores

By Chris Pummer, CBS.MarketWatch.com
Last Update: 10:33 AM ET Feb. 13, 2002

SAN FRANCISCO (CBS.MW) - The insurance industry is taking America for a ride, and few of us will like where we're headed.

Faced with falling profits, auto and home insurers are making widespread use of individuals' credit ratings as a key factor in deciding whether to offer coverage and at what price -- and as a means to rid themselves of undesirables.

The practice is now so prevalent that, by the industry's admission, someone with a clean driving record and marred credit may pay more for auto insurance than a driver at fault in an accident in the last year with a solid credit history. Worse yet, that perfect driver might be denied coverage outright or find his or her policy cancelled at renewal.

The underwriting change has set off a sudden regulatory backlash in more than 20 states, where insurance commissioners and legislators are seeking to ban or curb the practice. The concerns range from suspected racial discrimination to pricing out of the market the very people who most need coverage - those who'd be hard-pressed to pay for even a fender bender on their own.

"What became manifestly transparent is that there is a huge unfairness incorporated in how the companies are applying it," said Mike Kreidler, Washington state's insurance commissioner, who is pushing for limits.

"This will eventually destabilize the insurance market. The companies are getting carried away to where (credit scores) are becoming the most important factor."

The transgressors read like a Who's Who of the insurance world, including industry giants Allstate (ALJ: news, chart, profile) and Progressive (PGR: news, chart, profile). A survey last July found 92 percent of insurers said they now use credit scores in accepting polices and/or setting rates.

How can this even be legal? Auto insurers enjoy exemptions from discrimination laws if they can produce supporting data. Hence, young drivers, men and single people pay more because records show they file more claims - and account for more losses -- than older drivers, women and married couples.

On its face, that's discrimination on the basis of age, sex and marital status. But it's permissible in almost every state.

The industry now is using statistics showing people with good credit file fewer claims to justify charging higher premiums or banishing outright those with poorer credit histories. They're in essence thumbing their noses at regulators and the public alike, much the same as John Belushi and the cast of Animal House in an ad that appeared in National Lampoon, picturing them on the steps of their frat house, with one finger extended, over the caption: "We're college students and we can do whatever the #@!* we want."

"I will acknowledge it's hard to make the intuitive connection between how people handle their finances and their driving record," said Joe Annotti, spokesman for the National Association of Independent Insurers. "But over the last eight to 10 years, there's evidence that people with lower insurance scores file more claims. And as a result, we think people with better scores should pay less for insurance because they pose less of a risk."

Added Annotti: "Our impression is if you're willing to take risks on (the financial) side of your life, those behavior patterns are going to probably translate through to the rest of your life, not making repairs on your car or driving fast."

But it doesn't take a genius to understand why people with good credit file fewer claims than those with dings and dents on their credit records. Drivers with sounder finances are far more likely to cover the costs of a minor accident themselves, beyond the deductible, to avoid notifying the insurance company and getting hit with a higher premium.

Conversely, someone whose finances are in disarray, whether from profligate spending, a lost job or medical bills, is more likely to file a claim for that same minor accident. The flim-flam: Insurers want to load up on the customers who can afford not to use the very product they're providing.

"It's a basic fairness issue," Minnesota Commerce Commissioner Jim Bernstein said. "The use of credit scores should be banned entirely."

The issues raised by the practice are staggering in their ramifications:

Statistically justified racial bias: The industry's past dubious practices include the policy of "redlining," in which a red line was figuratively drawn around areas of a map where companies chose not to write any business. Of course, it wasn't a coincidence the areas were populated predominantly by the poor and racial minorities. Court rulings and legislative prohibitions ended such practices, but credit-based policy writing will in time result in the same de facto discrimination.

Secret formulas: The industry uses "insurance credit scores" fashioned by, among others, Fair, Issac (FIC: news, chart, profile). That's the same outfit that provides lenders with credit scores that it was long loathe to disclose to the public. Insurance credit scores are "a crypto-secret buried in a vault beneath the earth and if they reveal it to you they have to kill you," said Rod Guilmette, a spokesman for the National Association of Professional Allstate Agents, which has come out against the use of credit scores. "They would rather commit hara-kiri than release the algorithms." Not even state insurance commissioners are privy to exactly how they're fashioned.

Inaccurate data: Credit scores are notorious for containing incorrect information that results in countless applicants being denied for loans and credit cards. The same problem is certain to occur with insurance credit scores.

A black mark in perpetuity: Unlike accidents and tickets that drop off a person's record after a certain period, many insurers do not revisit credit scores at the time of renewal. "You're stuck with that credit score for the life of the policy," Guilmette said. Even if your credit is completely rehabilitated, "there is no possibility for improving your credit score" that was initially recorded.

Kick 'em when they're down. People who've lost jobs or suffer serious illness often endure financial setbacks that result in temporary scars on their credit. They stand to be hit with premium increases at a time they can least afford it.

Kick 'em for preferring to pay cash. People who don't use credit cards often end up with a low score due to their limited credit history. They could be the most financially disciplined people on the planet, but they'd be required to pay higher premiums simply because they don't use credit.

A tonic for falling profits: While the industry has been slapping higher premiums on people with lower credit scores, it says policyholders with good credit will see their rates fall. Yet state regulators say they've seen no evidence of widespread premium reductions.

Marketing ploy: By building a base of customers with better credit ratings, insurers are making a play to hawk them other financial services, said Bob Hunter, former state insurance commissioner in Texas. "They want to find the rich people and multi-line them by selling them life insurance and investment products."

It's a good indicator how suspect the practice is when insurance-agent trade groups like the NAPAA are standing up to the very companies they write policies for on behalf of their customers.

So far, only one state, Hawaii, bans the use of insurance credit scores outright in underwriting. California bans its use in auto insurance, but not in homeowners' policies.

Ultimately, as Hunter points out, the industry could produce statistics to justify charging any number of groups of people different premiums. The real issue is what over-arching principles do we as a society want the industry to be guided by.

"The California DMV did a study 30 years ago that showed people with dark hair had a significantly much worse driving record," Hunter said. "If black hair has a much higher correlation with risk, why not use that?"

Or better still: A study done in Australia showed that Geminis had the worst driving records among all astrological signs, followed by Taurus and Pisces. Why not then use astrology as a determining factor?

Maybe we shouldn't give the industry any ideas. As Cream sang some 35 years ago, many of us might soon rue the day we were "Born Under a Bad Sign."

Chris Pummer is personal finance editor for CBS.MarketWatch.com in San Francisco.