Missing Perspective in Missouri

In the last year, policymakers have crafted more measured responses to political concerns about insurers’ use of credit information. Such a balance is lacking in the Missouri proposal.
Property/casualty insurers’ use of credit information in underwriting and pricing automobile and homeowners insurance conforms with federal and state law and the fundamental principle of fairness that rates should correlate with risk.

Nothing in the recent Missouri Department of Insurance study (see page 8, “Missouri DOI Finds Insurance Scoring Harms Poor, Minorities”) demonstrates or even suggests otherwise, yet the governor has called for a ban on “the use of credit scoring as a factor in establishing the price of auto and homeowners insurance.” Because the study ignores the essence of underwriting and rating—differentiating risk and pegging premiums to expected losses—this is radical policymaking supported by incomplete analysis.

The Missouri study does not evaluate or even consider the actuarial benefits of credit scoring models. Yet it concludes that carriers’ use of credit information has an unfair, “significant disproportionate impact on minorities and the poor.” In fact, the study had no access to policyholders’ ethnicity. Rather, it assumes that a purported relationship between credit scores and ZIP code data should be assigned to ethnic status based on ZIP code demographics.

The study argues that its statistics “possess[ ] broad implications for important public policy issues” because “federal courts, as well as statutes in many states, restrict or prohibit the use of geographic area as a rating or underwriting factor in personal lines. … In fact, nonminorities have been recognized in both lending and insurance litigation as possessing an actionable claim if they are harmed by business practices with negative consequences associated with the racial composition in areas in which they reside.”

These legal assertions are misleading at best. Missouri law allows substantial use of territory as a rating factor. Territory is a nationally accepted pricing tool; traffic and crime patterns around a consumer’s residence significantly affect the likelihood that she will file a claim. Furthermore, to bolster its claim about the law governing “business practices” and “racial composition in areas in which [consumers] reside,” the Missouri study cites a 1994 U.S. Seventh Circuit case, which turned to a previous decision of the same court, NAACP v. American Family Mutual, for rules to evaluate allegations of “redlining.” American Family, however, belies the study’s claims about the legal standards pertaining to geography.

The American Family court analyzed the case by “assum[ing] that plaintiffs can establish that the defendant intentionally discriminates on account of race.” But no such allegation of intent is present in the Missouri study, nor could it be, since the state (and presumably the companies) did not know the ethnicity of individual consumers in the survey. American Family is particularly instructive because its premises about insurance, which stress the importance of properly evaluating risk, are absent from the Missouri study. The court explained that pooling risks is an essential part of insurance and declared, “Risk discrimination is not race discrimination. … [C]lassification of risks is important to insurance, and assigning higher rates to greater risks differs from assigning rates by race.”

The court thus recognized that a racially neutral factor cannot be meaningfully judged without evaluating its effectiveness at projecting future loss. In fact, the Wisconsin law involved in American Family required that certain aspects of territorial underwriting be backed by “a business purpose which is not a mere pretext for unfair discrimination.” Carriers have repeatedly demonstrated an actuarial justification (the central “business purpose” in insurance) for both territorial and credit underwriting and rating practices.

State courts too have recognized that effective risk evaluation and classification is central to fairness in insurance law and policy. Appellate courts in Florida, New York and Massachussets have ruled that laws barring discrimination cannot be applied to actuarially justified underwriting and rating criteria. Therefore, attempting to ban the use of this accurate, facially neutral rating factor—whose use is explicitly authorized by Congress in the Fair Credit Reporting Act—violates the most basic norms of insurance regulation.

In the last year, other policymakers have crafted more measured responses to political concerns about insurers’ use of credit information. A federal law authorizing a study on credit scoring’s impact requires consideration of the “quantifiable risks and actual losses experienced by [carriers].” Many states have targeted legislation to soften certain aspects of credit scoring, such as laws restricting the use of credit information tied to medical debts.

These measures, though not necessarily perfect, address reasonable policy concerns about credit scoring while also accounting for and preserving the important consumer benefit of efficient risk spreading which results from the use of credit information. Such a balance is lacking in the Missouri proposal to ban the use of credit scoring.

Nathaniel Shapo is the former insurance director of Illinois and now a partner in the insurance regulatory group of the law firm Sonnenschein, Nath & Rosenthal.