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Credit-Based Insurance Scores

Most insurance companies nowadays are using insurance scores, in addition to other factors, to determine the premiums to charge customers for auto and home insurance, or whether to insure them at all. For instance, according to the Consumer Data Industry Association (CDIA), which represents more than 400 consumer data companies, 92% of the largest auto insurers use credit data for evaluating new potential customers, and half started doing so after 1998.

A credit-based insurance score is a 3 digit number resulting from a statistical analysis of a consumer’s credit record that is highly predictive of future claim costs. Several studies by actuarial groups, notably Tillinghast Towers-Perrin and the Casualty Actuarial Society, have found, with a statistical correlation greater than 99%, that the loss ratio, which is the ratio of losses and associated expenses to premiums, is significantly higher for people with lower scores. In fact, for those with the lowest credit scores, the loss ratio actually exceeds 1, where losses exceed the premiums collected. A recent study by the Texas Department of Insurance showed that the loss ratio for homeowners with the worst scores was triple that of those with the highest scores and drivers with the highest scores had 40% fewer accidents over those with the worst scores. The insurance industry also believes that credit reports are more accurate than motor vehicle registration records for predicting future auto accident claims.

The main company providing insurance scores is Fair Isaac Corporation , which sells the scores to the 3 main credit reporting agencies—Experian, TransUnion, Equifax—and to ChoicePoint. Fair Isaac also supplies the FICO credit score, which is the most popular credit score used by lenders. According to Fair Isaac, 90% of the top property and casualty insurers and 300 others use insurance scores for rating and underwriting. Each credit reporting agency uses their own name for the insurance score:

• CPLS (Canadian Property Loss Score) score at Equifax, Canada
• InScore at Equifax, USA
• Experian/Fair Isaac Insurance Score at Experian (also available from ChoicePoint)
• Fair Isaac Insurance Risk Score at TransUnion

Although the algorithm used to compute the Fair Isaac score is the same, insurance scores, like the FICO and other scores that are based on credit information, will probably differ to some extent from each of the credit reporting agencies, since the information that each agency has on each consumer differs.

Although insurance scores are calculated using the information in the consumer’s credit file, only some of the information is used and it is weighted differently than the information used in calculating credit scores. There is a greater weight given to payment history and total debt and less for types of credit used or the number of inquiries made for loans and credit than in credit scores, for instance.

Many states have limited the use of insurance scores for rating and underwriting. Montana, New Mexico, and Washington have recently enacted legislation that restricts the use of insurance scores in rating and underwriting consumers. Washington state law forbids companies to deny insurance or base rates on the lack of credit history; credit available; number of credit inquiries; collection accounts for unpaid medical bills; and using a particular type of credit. Kansas has similar laws. Maryland banned the use of insurance scores for determining premiums for homeowner’s insurance in 2002. Texas law prohibits the absence of credit information to be used in underwriting decisions, and insurers must account for extraordinary circumstances, such as hospitalization or identity theft, that could cause declines in one’s insurance score if the insured request special consideration in writing. Michigan requires insurance companies to recalculate the score annually, and also when consumers successfully correct information in their credit records.

In response to criticism about using insurance scores for rating consumers, insurance companies have argued that:

• there is a high correlation between low credit ratings and future claims;

• people who are responsible with money are generally more responsible in other areas of life, such as driving and preventing hazards at home;

• using insurance scores is more objective and less discriminatory, and most consumers will pay less since most people have fairly good credit;

• and that the Fair Credit Reporting Act allows them to use credit information for rating and underwriting.

Insurance companies have also argued, in opposing changes to regulations in Michigan, that eliminating the use of insurance scores will increase prices for most consumers:

• Auto Club Insurance Association (AAA) claims that 2/3 of its policyholders will see rate increases if insurance scoring is eliminated.
• Hastings Mutual has a 5 tier discount level for premiums that range from 0 to 35% for auto insurance and 0 to 27% for homeowner's insurance. Hastings Mutual claims that 77.6% of its auto customers and 84.4% of its homeowners will see rate increases if the use of insurance scores are banned.

People opposing the use of insurance scores have argued that:

• it discriminates against ethnic groups or economically disadvantaged people, such as single mothers;
• credit reports often contain errors that would increase premiums for people who would otherwise qualify for lower premiums;
• and insurance scores are socially unacceptable.

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