Why Credit-Based Insurance Scoring is Good for Consumers

Credit-based insurance scoring is a reliable, though often misunderstood underwriting tool that helps insurers accurately match the price of their products to the level of risk posed by any given customer. It is nonprejudicial and completely objective in its application. Given that consumers in any marketplace will always demand the lowest and most accurate price, and that no one wants even the appearance of being unfairly discriminated against, it is hard to imagine why its use has any critics, except those who do not fully understand the subject.

Numerous studies have confirmed the link between credit-based insurance scores and the risk of loss. While theories vary regarding why this correlation is so strong, the fact of its predictive value is beyond question. A study conducted by actuarial consultants Tillinghast-Towers Perrin that reviewed nine books of business found that eight of the books showed a 99 percent confidence level in the relationship between credit scores and loss potential, while the other book showed a 92 percent confidence level in the link.

Another report by Fair Isaac, which develops scoring models that use data to improve business decisions, looked at the link between credit information and personal property and auto losses. The data set consisted of 230,000 policies with claims and 1 million policies with no claims. Corresponding credit information for the policyholders was also used.

The study found that for personal property insurance, 89 percent of the policyholders reviewed did not have any credit accounts in delinquency for more than 60 days for a period of 24-months. Comparatively, the study found that policyholders with one such delinquency had a loss ratio that was 29 percent higher. The loss ratio was 80 percent higher for individuals with two or more such delinquencies. Simply put, those who paid their bills late had a much greater propensity for filing claims.

On the auto side, the study found that 82 percent of the people considered had just one or zero credit accounts opened in the previous year. Those considered who had opened two or three credit accounts the prior year had a loss ratio 8 percent higher than those who had opened one or none. Individuals considered who had opened four or more credit accounts had a loss ratio that was 27 percent higher than those opening one or none. Plain English: The people who opened the most lines of credit also filed more claims.

Even with a strongly established link between credit characteristics and insurance risk, there is a growing myth that the scores are used to discriminate against low-income customers. This accusation is unfounded. A 1999 study conducted by the American Insurance Association found that scores of low-income individuals were markedly better than individuals in the $40,000 to $49,000 per year income category and on par with those in the $125,000 per higher and above category. Many insurers indicate that since they began using credit scoring, it has helped them offer insurance to customers who otherwise might not have qualified for coverage.

The other popular myth is that credit scoring penalizes customers in general. However, a July 2001 study conducted by Conning and Company indicates that when credit scoring was used in the consideration of 1,000 hypothetical risks, 218 improved from “standard” to “preferred,” while only 35 dropped from “preferred” to “standard”.

One of the most frequent objections to the use of credit-based insurance scoring is that insurers do not know exactly why credit and risk of loss are related, despite the fact that there is compelling evidence to support the link. The link between credit history and risk of loss is actually better understood than many other correlations that are unquestioned. For example, the exact reason that “good students” pose less of a risk than their classmates and qualify for discounts is unknown as well. Since there is credible evidence that “good students” are a lower risk they pay less for insurance. This being the case, no one is asking insurers to stop providing the discount. What is important is not why there is a correlation, but that there is a correlation that allows insurance companies to reward people who are less likely to incur losses with lower premiums.

In Texas, where use of credit-based insurance scores is permitted in the underwriting process, the state’s Department of Insurance reports that in 2001, it received only 76 complaints from consumers about the use of credit scoring. That’s a fraction of one percent of the 3.9 million Texans who carry homeowners insurance and the 11.9 million that carry automobile insurance. That is fewer than five complaints per million policyholders.

This evidence makes it clear that applying credit-based insurance scores to the underwriting process provides an overall benefit to both insurers and their customers.

Doug Johnson is the public relations manager for the Insurance Council of Texas, a trade association of 424 property and casualty insurance companies operating in Texas.

Topics Carriers Texas Profit Loss