WASHINGTON STUDY ON INSURER USE OF CREDIT
SHOULD BE USED CAUTIOUSLY, AIA SAYS
AIA Researchers Say Study Has Serious Limitations

WASHINGTON, D.C., Feb. 11, 2003 – A recent study by the Washington state Office of the Insurance Commissioner (OIC) about insurer use of credit history adds some interesting new pro-competitive angles to the public policy debate, according to American Insurance Association (AIA) researchers who examined the study’s methodology and contents. However, those researchers also cautioned that this limited study should not be portrayed as a definitive examination of credit-based insurance scoring.

“The Washington OIC study adds some insights into the vigorous debate over credit scoring, including further evidence that scoring is not a monolithic, standardized rating and underwriting tool used across the board in the property-casualty insurance industry,” said David Unnewehr, AIA senior research manager. “However, some critics of insurance scoring may be tempted to spotlight very weak statistical findings on demographic variables, while underplaying the cautious note sounded by the authors of the study. That would be a mistake.”

Led by Unnewehr, AIA’s Policy Development and Research team conducted a thorough review and analysis of the study released late last month by the Washington OIC. The study analyzed 3,000 policyholders from three large personal auto insurance companies in the state. The three companies in the study varied so much regarding the extent to which credit scoring was used that researchers were unable to combine data from the three companies for any overall analysis of credit scoring impacts.

“Because scoring generally helps to individualize and refine rating and underwriting variables that are more difficult for a consumer to control, such as age and location, scoring and its varying uses by insurers as they compete with one another may have helped to create a more competitive marketplace for Washington consumers,” Unnewehr said. “Ironically, the 2002 bill passed by Washington lawmakers will restrict insurers’ range of options for using insurance scoring in the marketplace, and could have the unintended effect of denying Washington consumers some of the competitive benefits they were receiving prior to the bill’s passage.”

The stated purpose of the study, which was mandated by the 2002 legislation that also restricted insurer use of consumer credit information, was “to find out whether credit scoring has unequal impacts on specific demographic groups.” The study focused on three demographic factors: age, income and ethnicity. The study’s strongest finding, according to its authors, was that policyholders’ insurance scores tended to rise steadily with age.

“The relationship between credit scores and age and the widely accepted finding that credit scores are a useful tool for predicting future loss experience has an intuitive logic,” Unnewehr said. “Loss experience, particularly in auto insurance, is much higher for younger drivers, and there is a societal understanding that on average, drivers become more responsible with both age and experience. Thus the Washington OIC finding on age may help further support the value of insurance scoring in predicting future risk, although the authors caution that this was a small study.” The AIA critique also pointed out that insurance scoring can soften the impact of the age variable on drivers in particular age groups. Young drivers with good insurance scores, for instance, could see benefits in lower premiums than they would have otherwise been charged had age alone been used.

The study uses several examples to show that score variations associated with income might result in premium variations (up or down) of plus or minus four percent. According to the National Association of Insurance Commissioners (NAIC), the 2000 average auto insurance expenditure in Washington was $722; four percent of the average expenditure is $28. “This is a very small range, and with so many other factors involved in the interaction of credit scoring, income and premiums that are not accounted for in the statistical model, it is difficult to attach much significance to the finding,” Unnewehr said.

On the issue of ethnicity, the Washington study notes that “relatively small numbers of ethnic minorities and the number of refusals and unclassifiable survey responses” made it difficult to pin down any statistical significance between minority status and credit scoring. In addition, the study indicates that results on ethnicity varied from company to company; however, after applying additional tests (regression analyses) to test the relationship, the researchers found that “while there are statistically detectable patterns in the demographics of credit scoring, most of the variation among individual scores is due to random chance or other factors not in this data.”

“We have already witnessed critics attempting to hold the Washington OIC study up as something more than it is,” said David Snyder, AIA vice president and assistant general counsel. “At the end of the day, however, the study does nothing to diminish the fact that credit-based insurance scoring is an actuarially sound underwriting and rating tool that is used in accordance with existing federal and state laws.”

For a copy of the complete AIA analysis of the Washington study, please e-mail Sean McManamy at smcmanamy@mw.aiadc.org.