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Credit-Based Insurance

Background

A credit-based "insurance score" uses information from a consumer's credit report to predict how often he or she is likely to file claims, and/or how expensive those claims will be. Studies by insurance regulators, universities, independent auditors and insurance companies all have shown that an individual's credit history is a proven, strong indicator of how likely that person is to file a future claim.

Here are some basic, undisputed facts about credit-based insurance scores:

  • They allow insurers to charge lower premiums to customers who are better risks.
  • These types of scores are totally objective and "blind" - insurance scores never factor in a consumer's income, race, address, marital status, age or nationality.
  • They promote competition which means more choice for consumers.

Public Policy Highlights

  • The National Conference of Insurance Legislators (NCOIL) passed a Model Act on Credit Scoring in November 2002. As of August 2004, NCOIL reports that 24 states have adopted laws or regulations that are either identical or similar to its model.

  • In a report to the National Association of Insurance Commissioners (NAIC) in November 2002, a subcommittee of the American Academy of Actuaries found that "credit history can be used effectively to differentiate between groups of policyholders and therefore it is an effective tool."

Research

In a June 2003 study of more than 2.7 million auto insurance policies, researchers from EPIC Actuaries, LLC, found that individuals with the lowest insurance scores incurred 33 percent higher losses than average, while those with the highest scores incurred 19 percent lower losses than average:

   

The EPIC analysis also firmly established that the value of the information insurers obtain from using insurance scores cannot be found by using other traditional, more general rating factors (such as age, vehicle type or location, driver gender or driving record). As a result, insurance scores allow insurers to more accurately and objectively assess individual risk.

  • A study released in March 2003 by the University of Texas found a "significant relationship" between an individual's insurance score and the incurred losses on the policy.

  • A February 2003 study by the Alaska Division of Insurance showed that more Alaskan consumers have been placed in standard or preferred rating categories than they were before the advent of insurance scoring in the mid- to late-1990s, particularly in less affluent and minority areas.

Legal Basis


Insurer use of credit is expressly permitted and governed by the federal Fair Credit Reporting Act (FCRA), which provides numerous consumer protections.

An Objective Tool


Credit-based insurance scores are "blind" and objective. Credit-based insurance scores NEVER factor in a consumer's income, race, address, marital status or nationality. In addition, credit-based insurance scoring has allowed many insurers to progress from the old pass/fail underwriting system with high denial rates to multiple tier rating with more than a dozen prices, thereby enhancing an insurer's ability to offer insurance to almost anybody and the capability to charge the best risks less.

Promotes Competition


The use of credit-based insurance scoring promotes competition. Since most insurance companies use credit information in different ways, rates may vary giving consumers more choices.

Consumer Rights


If a consumer is denied coverage or placed into a higher pricing bracket based on their credit-based insurance score, the insurer is required to send that consumer an "adverse action" notice. Consumers are legally entitled to review their credit report and have the right to have the credit reporting company correct or remove inaccurate information. Many insurance companies will reevaluate and recalculate premiums upon request if a consumer finds an error and has it corrected by the credit bureau.

Existing Regulation


In addition to state and federal laws, insurers' use of consumer credit information, like any other rating factor, is subject to market conduct review by state regulators, whose job it is to ensure that consumers are not charged rates that are excessive, inadequate, or unfairly discriminatory.

The Wrong Public Policy Decision: Banning Credit-Based Insurance Scores

For more than a decade, routine but important everyday activities as diverse as renting an apartment, getting a job, obtaining utility service, and insuring an auto or home have come to depend, to some extent, on an individual's credit information. Use of credit information in insurance has generated significant public policy debate in more than 40 states during the past few of years.

Most states have taken a common-sense approach to regulating the use of credit information, i.e., they have struck an appropriate balance that both protects consumers and allows insurers reasonable use of this valuable tool. The National Conference of Insurance Legislators (NCOIL) developed a model law on credit-based insurance scoring that achieves this balance. The model bolsters disclosure to consumers, regulates what information can be used to calculate a score, and requires that refunds be given to a policyholder when credit report information has been corrected via the federal Fair Credit Reporting Act (FCRA) dispute resolution process. NCOIL reports that 18 states have adopted legislation, and four others have issued regulations, based on the model. Insurer use of credit information also is expressly permitted and governed by the FCRA. State-by-state bans impede the uniformity goals of the FCRA, which was reauthorized in December 2003.

Maryland is the only state that has legislatively banned the use of credit information by insurers, and that is only for homeowners insurance. The Maryland ban has had a negative effect on that market, and has resulted in consequences that were neither intended nor expected by supporters of the ban. For example, individual insurers have reported the following:

  • Rates have had to be increased by a higher margin than if the ban had not been in effect.
  • The writing of new business has been curtailed.
  • Concerns about being unable to collect adequate premiums have heightened in the absence of highly predictive, beneficial credit information.
  • Company costs have increased as necessary systems changes have been implemented. One company reported that complying with the ban has cost them more than $400,000.
  • At least one company was forced to eliminate its most preferred rating tier, causing their lowest-risk customers to pay more in premiums.
  • Rates for 59 percent of one company's policyholders were forced upward by 14 percent.
  • Rates for one company's homeowners insurance increased up to 25 percent.

Studies by insurance regulators, universities, independent auditors, and insurance companies all have shown that an individual's credit history is a proven, strong indicator of how likely that person is to file a future claim. Claims costs, not credit-based insurance scoring, drive premium increases. Banning such a predictive tool from insurance underwriting and rating clearly is the wrong public policy decision and based on Maryland's experience, will unfairly disrupt and skew the marketplace.

An outright ban is an extreme - and harmful - "answer" to concerns about the practice of insurer use of credit information. Policymakers should consider reasonable measures, such as the NCOIL model law, which preserve the proven benefits of credit-based insurance scores, while protecting consumer interests.