Insurance Institute of Michigan
January 17, 2019

Key Issues : Credit-Based Insurance Scoring

The use of credit-based insurance scores is a benefit to insurance customers. Credit-based insurance scoring helps more accurately price insurance based on a consumer’s claim potential. That results in many consumers to pay less for insurance than they otherwise would, and enables insurance companies to offer coverage to more consumers than they had in the past.

In July of 2007 after years of extensive research, the Federal Trade Commission (FTC) found that use of credit-based insurance scores leads to more accurate underwriting of auto insurance policies in that there is a correlation between insurance scores and the likelihood of filing an insurance claim.

The FTC report, Credit Based Insurance Scores: Impacts on Consumers of Automobile Insurance, also states that credit scores cannot easily be used as a proxy for race and ethnic origin. In other words, credit scoring predicted risk for members of minority groups in much the same way that it predicted risk for members of non-minority groups.

Credit history provides a consistent and effective tool to evaluate risk that does not discriminate against any specific group of customers. In fact, the use of credit-based insurance scores actually allows insurance companies to offer lower rates by providing discounts to consumers who have proven to manage their finances well. In Michigan, two-thirds of policyholders are experiencing lower rates due to credit-based insurance scoring.

Credit-based insurance scores are developed from information contained in credit reports. A credit-based insurance score provides a numeric assessment of an individual’s insurance risk. It reflects credit payment patterns, length of credit history, types of credit and number of new applications for credit. Insurance companies consider only those items from credit reports that are relevant to insurance loss potential. Unlike a lender, an insurance company is not assessing a customer’s income and debt, they are evaluating how customers manage their finances and credit granted to them.
Key findings of the FTC study are:
●     Credit-based insurance scores are effective predictors of risk under automobile policies. They are predictive of the number of claims consumers file and the total cost of those claims. The use of scores is therefore likely to make the price of insurance better match the risk of loss posed by the consumer. Thus, on average, higher-risk consumers will pay higher premiums and lower-risk consumers will pay lower premiums.
●     Several alternative explanations for the source of the correlation between credit-based insurance scores and risk have been suggested. At this time, there is not sufficient evidence to judge which of these explanations, if any, is correct.
●     Use of credit-based insurance scores may result in benefits for consumers. For example, scores permit insurance companies to evaluate risk with greater accuracy, which may make them more willing to offer insurance to higher-risk consumers for whom they would otherwise not be able to determine an appropriate premium. Scores also may make the process of granting and pricing insurance quicker and cheaper, cost savings that may be passed on to consumers in the form of lower premiums. However, little hard data was submitted or available to quantify the magnitude of these benefits to consumers.
●     Credit-based insurance scores appear to have little effect as a “proxy” for membership in racial and ethnic groups in decisions related to insurance.

In Michigan, the Office of Financial and Insurance Regulation, the state regulator of insurance, attempted to implement a rule that would ban the use of insurance credit scoring in this state. That rule was challenged by the insurance industry. A circuit court judge ruled that OFIS did not have the authority to ban credit scoring through administrative rule. That decision is now being appealed in the Michigan Court of Appeals.

Prohibiting the use of credit scoring will have a detrimental impact on policyholders. In Maryland, policyholders faced double-digit percentage increases in their homeowners insurance because of a 2002 state law that banned the use of insurance credit scoring. In Oregon, voters defeated a ballot proposal last November that would have prohibited the use of insurance credit scoring in that state.

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