A View From The Press Box

Credit scoring to determine risk is no more unethical than credit scoring to determine the interest rate on a loan.

As a catastrophe adjuster, I have been pressured by claimants who try to pressure me to fatten the contents loss without any evidence of loss. These same people have copious amounts of liquor, flashy cars and lots of electronic toys, but do not work.

I could easily surmise that they are living off the "fat of the land" and might also default on loans. If you owned an insurance company, would you take a risk like that? Or would you rather take the easy way out and raise EVERYONE'S rates a bit more to cover what could be a "politically incorrect" assumption.

From an Industry news reporter:

Just because it can be actuarially shown that a particular attribute (such as credit score) has a relationship to risk, does not mean that insurers should have the right (or in the estimation of some, the 'obligation') to use it?

What will be next? Criminal background? I'll bet we can show a risk relationship there as well.

A policyholder's claim history should always be the only factor.

Given the number of identity theives, lost data in laptops and the true subjectivity of the credit bureaus ratings, using FICO scores to determine underwriting really puts a "double-whammy" on millions of Americans.

Yes, we can point to them and say, well, if you were a better steward of your credit, you'd reap the benefits of lower rates, fees and in many cases, even being underwritten.

Just look at the housing market! Here's an article from CNN:

NEW YORK (Reuters) -- U.S. home foreclosures climbed in March, as subprime borrowers struggled to keep up with their monthly payments to lenders, real estate data firm RealtyTrac said Wednesday.

Home foreclosures rose 7 percent from February to 149,150. The figure, which comprises default notices, auction sale notices and bank repossessions, was 47 percent higher than a year ago, RealtyTrac said.

According to Fair Issac, there are as many as 50 million American's with poor credit scores.

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So, let's look at this from a REALITY standpoint.

We have a segment of society that has poor credit, NEEDS insurance on their car or apartment and they have to pay MORE, when they are the least able to afford higher premiums.

So, what do they do? THEY DON"T GET INSURANCE and drive without it and live in unprotected homes just waiting, hoping and praying that nothing happens.

Yes, we can all site examples of people who bilk the system, but they make up the vast minority in this group of people.

It's like having a "poor tax."

I'm sorry, I can't look at a young couple in their early 30s trying to start a life together, and say, "Well, if you didn't run up credit card bills in your 20s, you'd have a lower rate, get underwritten, etc.

What's really interesting, is that MANY mortgage underwriters will look at a poor credit score, and if you provide a written explaination for the score or that your fighting with the credit bureaus to update and change the report, they will proceed with a loan!

Yet, that same person can try to get car insurance and there is NO ablity to provide the same documentation to that P-C carrier for a lower rate, and we're talking THOUSANDS OF DOLLARS IN PREMIUMS A YEAR in some cases.

We're already facing pressure from consumers over Katrina cases, and now we're hearing that homes in the Midwest destroyed by tornados last weekend weren't insured. Why? PREMIUMS!

Yes, we have to make a profit, but maybe it's time to be a little less politcally correct and opt on the side of "doing the right thing" for folks.

It's tempting to run our industry by "the numbers." Turn a person into a FICO score instead of looking a bit more closely!

We often brag about wanting "long-term business relationships" with our clients, and yet we want to pick and choose who gets that relationship based on commission or profit.

I'm not saying to throw the whole system away, but I think we need to put a bit more of human compassion into the equasion and look past a SCORE on a report when making such decisions.

Just my 2-cents! (I'm putting on my bullet-proof vest now hee hee hee)

From a Commercial P&C Underwriter perspective:

An insured's ability to pay bills (as evidenced in their credit history) can indicate the insured's financial ability (or lack of financial ability) to maintain a viable business, correct physical [insurability] deficiencies, and pay premiums when due.

With respect to insureds in bankruptcy, the insurance policy is an asset that gets tied up in the bankruptcy process. The bankruptcy court will not permit the insuring company to cancel the policy even if the premium is in default in order to maintain the asset for the benefit of other creditors.

Thus if a prospective insurer cannot use credit history to ascertain previous bankruptcy filings and thus avoid writing a bad credit customer, all insureds must pay for the bankrupt insured, who through bad business practices cannot maintain financial strength and stability, and thus cannot carry his/her own weight among all insureds.

The credit history of an insured is only one consideration that a commercial P&C underwriter takes into account, but it is an important indicator.

If the credit history has errors, the insured has the option to get the error corrected and present the evidence of correction to the underwriter for reconsideration.

If low-income business owners (or individuals for that matter) stay within their financial means and thus keep their credit history clean, they should have no problem with an underwriter reviewing their credit history to verify that fact.

If they are unable or unwilling to keep a clean credit history, it would be unethical of them to burden the rest of society with the cost to support them in a custom they'd like to be maintained at (rather than in a custom they have earned in society).

There are two related issues here--using credit bureau data to predict risk (which is not what I think you mean) and actually using a credit score as part of a risk assessment. In other words, considering credit risk as a factor in underwriting risk.

Like anything, credit data can be abused--in particular by allowing a single data point to become too important. I posted about this once before (http://www.edmblog.com/weblog/2007/01/credit_risk_and.html) and provided some commentary on the two different uses here (http://www.edmblog.com/weblog/2005/09/data_mining_in_.html).

James Taylor
http://www.edmblog.com

Credit scoring sould be allowed as long as it is one of the tools to determine the rate. It should not be a primary tool.

There may be a valid reason why at the time of application the credit score is low. Loss of a job, unexpected large medical bills, or maybe a previous bankruptcy that the applicant has paid off but at that time, still shows poor credit. It may be from lack of character and the applicant is a poor risk.

A study by the University of Texas, Austin School of Business showed that credit scoring is legitimate in determining the probability of an applicant being a debatable risk or not. They determined that it was more likely that a poor credit risk would not continue to pay the premium and was somewhat more likely to be involved in filing a claim.

It has been said that credit scoring has been a major factor regardless of the driving history of the applicant. Accepting or rejecting a risk should be on the history of claims, driving record/type of property to be insured, condition of property/auto and not just the credit score.

As the above response indicates, your use of the word "ethical" strikes a nerve with some of us trying our best to develop fair ways to measure the probability of losses among our diverse driving public.

I won't go into the true ethical issues related to why we need to pay extra for services like ISO's rate pursuit modeling to find unreported drivers and vehicles in households, miles driven to work, etc. I think in fairness there are some true moral issues that we all, including agents, regulators, consumer advocates and some of our insureds need to address.

So let's try to separate ethics from the desired social engineering of pricing or complaints of the few relative to the many who have seen their rates drop dramatically over the past few years, precisely due to the greater accuracy in risk assessment through the addition of credit scoring, among a myriad of consumer profile information that was not available 20 years ago.

Credit scoring is not an ethical matter of right or wrong and I wish that you were not among those preaching from that pulpit.

If full disclosure is the issue, then let's disclose more--maybe even more than our banking friends, who seem to get a bye on the credit scoring ethics question.

But let's start by accepting that the science is fairly sound and inaccuracy is at least as signifcant when provided by the consumer as provided by credit bureaus.

And if the social-acceptance gods want to argue for eliminating credit scoring, why not just say "we don't like it" rather than calling it ethically and morally wrong.

Sam Responds: I am actually not taking a stand as yet, just posting the question...But as far as banks getting a bye, it seems to make sense to assess credit risk when a bank is giving out credit for a home, business or personal loan. The tie to insurance risk, it seems to me, is more tenuous, at best.

Frank gets the last word:

I think my frustration comes from raising your tenuous tie to a question of ethics.

In the old days (and I was there then) we used affinity marketing to achieve something akin to what today we use advanced analytics to achieve. USAA (military officers), GEICO (government employees), Hartford (AARP), AMICA (Business Managers) and others relied on the homogeneous characteristics of these groups to provide lower rates based on their belonging to that group because of the observation that they exhibited better underwriting characteristics.

Allstate, for example, capitalized on the growth of the middle class, suburban Sears customer who exhibited better underwriting characteristics.

Today, data mining and advanced analytics have taken us past the old bureau and ISO days and the sometimes inaccurate information contained in insurance applications. This has facilitated the growth in the consumer's ability to compare rates over the phone and on the Internet, and has generally lowered prices for more consumers than it has raised them.

To me it is a matter of advances in the rudimentary methods we used to use to classify risks.

Credit information--like occupation, marital status, age and other household stability factors--do increase predictability of future losses. If the public does not like the use of that information in setting rates, the scientists will try to find other ways until telematics takes over and we have those little black boxes in our cars to tell insurers exactly who and how cars are being driven.

But I will bet you that when those boxes are available, there will be resistance to their use as an invasion of privacy or some other "ethical" call for restriction on their use for rating purposes.

I think using credit scores is terribly unethical.

Of course, I am biased, since I form that opinion based on personal experience. My ability to juggle my finances has no impact on my driving skills. I am a 45-year-old woman who has never had even a minor MVA; nor any traffic violations of any kind for 20+ years, never speed, never drive in an unsafe manner.

However, as a single parent with a moderate income, my bills are not always paid as promptly as I would like--sometimes quite late. That, however, does not impact my safety as a driver or my driving record.

I understand the need to perhaps use other variables to determine risk for young drivers with no driving history to refer to. However, after being a licensed driver for nearly 30 years with no accidents and only one speeding ticket (in my early 20s), I believe it is safe to assume that I am a pretty low risk and my auto insurance premiums should reflect that.

My financial status should not affect my auto insurance any more than it should impact my health insurance rates.

Is that next?! Will my health insurance be the next to skyrocket because living expense increases in my geographical area far outpace the wages?

Readers may be interested in the paper I am presenting at the American Risk & Insurance annual meeting in August, titled: "Why Low Credit Scores Predict More Auto
Liability Claims: Two Theories."

One theory is Mr. Schober's and the other is an alternative relying on Demand Law theory. The Executive Summary is available on our Web site--http://centspermilenow.org.

Is it a surprise that banks and insurance companies are considered unethical by the public? We could discuss ethics, many corporate insurance executives don't know what ethics are! They know figures--the larger the better.

Anything that works to improve profits must be ethical because it is necessary to do profitable business--without underwriters and other human assets that cost too much!

I can understand carriers attempting to find a magic formula for determining who might be a good risk, but I believe insurance scoring, as the carriers refer to it, is not the correct approach.

The carriers using this approach--and there are some who do not--believe that there is a direct correlation between a low score and those policyholders who file the most claims.

If that is true, I would think that all carriers would be utilizing insurance scoring in their personal and commercial lines underwriting. Since not all are, I am somewhat skeptical.

From a personal perspective, I have seen mistakers made on my own credit report, as well as some of my clients. And, once made, it is difficult to rectify, although it is somewhat better now than in the past.

One situation stands out in my mind, and it involved a real estate closing for one of my clients, and I was involved as the agent wrriting the homeowners policy.

My client, John A. Smith (not his real name), was purchasing a home from John R. Smith (also, not his real name). The latter had bad credit, including a bankruptcy, while my client had a good credit history.

Unfortunately, the credit bureau had entered some of JR Smith's negative credit information on my client's credit file.
We alerted the credit bureau, but they still insisted that my Mr. Smith submit documentation to prove the error had been made, and they would investigate it and make a decision.

This takes time, which we didn't have, so I was unable to secure standard coverage at reasonable rates before the closing.

The result was my client had to obtain surplus lines coverage at more than twice the standard premium. It took us over six months to straighten out the mess that my client wasn't responsible for.

His only mistake was having a common name that millions of people have in this country.

My industry is using a methodology that is seriously flawed!

Credit scoring isn't being "forced" on anyone. There are plenty of companies that don't use it. If the consumer doesn't like it, he can shop at another store.

That kind of freedom is why insurance remains a marketplace, and not merely a government franchise (for now).

It would be far more accurate to say that limitations in underwriting are being "forced" on the industry.

As an industry, I believe we are too reluctant to discuss what we believe to be the underlying reason why credit is such an excellent predicter of loss.

Credit is an exellent indication of the human quality of fiscal responsibility (discipline for yourself and responsibility to your family and to creditors), which translates into responsibilty on the road and how you protect your own property.

We can't PROVE that, so we're afraid to say it. But it needs to be said.

Also, the use of credit in underwriting encourages people to monitor their credit and not overextend themselves. That has an intrinsic social benefit.

With all due respect to the single mom above who can't pay her bills on time--she made some life choices that put her in that situation. Those choices, and her inability to respond to them while honoring her commitments to her creditors, say something about her judgment and responsibility.

Yes, I know, that's an unpopular kind of thing to say. But it's quite true.

As a government relations attorney, I know that ethics are different from morals. Ethics are a defined set of rules. What is mandated to be ethical in one state, may be unethical (and illegal) in another.

Any discussion of ethics in the abstract is pointless.

If we're talking about morality, let's call it that. Otherwise, the answer is simple--the use of credit is ethical where it's legal and unethical where it's not.

Many businesses legitimately and ethically discriminate in the marketplace to target market and to achieve competitive advantage.

Whether credit scoring is ethical discrimination depends on its legitimacy as an underwriting metric. Unfortunately, the information systems and poor data management in most insurance companies do not enable sufficient granularity to provide adequate metrics for proper underwriting. As a consequence, use of credit scoring may be a blanket attempt to rationalize an inadequate underwriting capability.

In addition, good corporate governance often requires subordinating economic gain for higher ethical standards. Consequently, insurance company leadership may need to re-examine their governance policies to determine the proper course.

Alternatively, to settle the issue of whether credit scoring is unethical discrimination, insurance companies may need to produce the data used and let the facts be judged by an Ethics Panel, with a mix of members appointed from within and outside the industry.

Observation and personal experience puts my vote in the "NO" column, or at least the "minor criterion" camp. My credit score is excellent, but not THE BEST because I recently started a NEW agency and had many inquiries that will last for three years, I think. I haven't been a poor steward of my finances or my "life choices." In fact, there are no other negative comments on the reports.

Some people I know don't have a great credit score because they are financially very well off and don't even use credit. So their score is the average/basic. Explain the logic behind that one.

Now that you can set up payments automatically, it is no longer an individual that is responsible, but the financial institution.

I don't like the fact that ANYONE can get any information about a person now for any reason. I think it violates our personal rights to privacy, and as was stated before, an open invitation to those that would like a better credit score through identity theft (which also has happened to me). But I don't have an alternative to the question.

My clients have stated, "I have never had a claim. Why are my rates worse than X, who has had a claim about every five-to-six years?"

Maybe our equation is not balanced. Since the agent is the first line of underwriting, don't we need to know the truth about annual miles, usage, etc.? Aren't our ethics and the stated facts taken into consideration by the companies to whom we report?? Or am I too naive to believe that?

Thank you for the opportunity to vent.

P&C, Life & Health Agent

Being one of those dinasaurs from the 1950s and 1960s, I do not like credit scoring. I do believe figures do not lie, but "liars do figure."

There always will be those that get cheaper insurance because they know the system and how to cheat it.

Credit scoring is just like those past underwriting tricks of calling the neighbor to see who lives with who and does what on Saturday night.

Eventually one of the legislatures will have his/her rate increased or cancelled because of "Poor Credit Scores" and the credit score will disappear forever more.

I was a personal lines underwriter for Allstate when they first started using credit scores back in the mid-to-late 1990s. It was a difficult and sometimes impossible conversation to have--not just with the public, but with the Allstate agents as well.

Explaining to a customer how their good driving record wasn't enough to get them a better rate was forcing good drivers to go to other carriers.

The agents and the public did not understand why their rates were so high or why they didn't qualify for Allstate's (at that time) premier program.

Allstate trained the underwriters to have canned answers regarding the relationship of a poor driving history with a poor credit history. But when you had to have that conversation with someone who had a good or clean driving record it didn't make any sense.

I was definitely one of the underwriters who didn't believe that the credit score was a true picture of the insured's ability to drive. Either the insured can drive or they can't.

Credit doesn't play any role behind the wheel of a car or for determining the insurability of a home.

As for the insured being able to pay for the policy even with poor credit-- that should be the insurer's risk of doing business.

I think one of the biggest issues with the use of credit factors to set insurance rates is that people immediately link the issue directly to their ability to drive. For example, see the posts from the anonymous single mom and Steve Adam above.

The common argument from opponents of the use of credit is that your credit score is in no way related to your ability to drive. While this is true, the use of credit scoring is not attempting to determine if you are a good or bad driver. It is simply trying to predict an individual's propensity to file a claim in the future.

Towing, comprehensive, personal injury protection, and uninsured motorists claims are just a few examples of claims that can be filed completely independent of your ability to drive well.

This is why I think that credit scoring, if used in conjunction with other factors for setting rates--such as location of residence, age, driving history, claim history, etc.--can be a very valid and useful tool for underwriting and pricing.

There is existing literature which supports the correlation of credit score with auto claims. However, we would need to prove that it adds additional value to the current rating systems, not just as a convenient way which rates a policyholder.

As a statistician working in the P&C business, I can also say that one could develop useful credit scoring models, while at the same time protect the individual's privacy. This might satisfy the state regulators.

From a commercial lines person who is also a consumer:

I could almost accept the rationale of credit scores as a risk predictor. However, I think the true goal is in potential premium gain. Are people with the BEST credit scores getting any better deal beyond what their loss experience already allows them?

My thinking is, it's all about the EXTRA money to be made off the "bad" folks, like me. Maybe it's a case of 'whose ox is being gored."

My own situation is that my personal auto insurer raised my rates based on credit scores--despite their having 18 YEARS of loss history (one deer vs. car claim) that, seemingly, would be a more reliable predictor of risk.

I think a good compromise would be for credit scores only to be usable in an insured's first or second year with a carrier. After that, it's back to good, old-fashioned loss history.

Possibly the use of credit scores to determine "insurability" might be a good thing for consumers. It would be like a virus--going in, taking over the system and eventually destroying its host. The survivors will have learned a valuable lesson and protected themselves against the culprit.

My credit score is excellent. My husband and I have always paid our bills on time. In 20 years we have never had a late payment.

Last year my husband had a "coronary crisis," After recovering (I think he missed two days of work), he was downsized (but..within months replaced) and we had two 30-day lates on our mortgage waiting for his severance checks to be deposited, and trying to pay health insurance deductibles and the $1,200 a month COBRA bill.

Now, his credit score has suffered.

We have excellent driving records with no tickets, no accidents. My husband is now 47 and trying to rebuild his marred score.

I think this is disgusting. Think of it like this--the only way an insurance company can make money is if we pay them for nothing.