Milwaukee Business Journal
March 14, 2003

More insurers checking consumers' credit history

Trend prompts debates in two dozen states
Becca Mader  
When it comes to buying insurance coverage for your car or home, you might not immediately think about the number of credit cards you have in your wallet or the last credit-card payment that was late.

But insurance companies are keeping score. Some property and casualty insurers are using credit history in underwriting policies and determining premiums, and more are adopting the practice, believing it to be a more accurate way of assessing a consumer's potential insurance risk and setting rates.

"It comes down to responsibility issues," says Ed Felchner, vice president of personal lines and marketing of Sheboygan's Acuity Insurance, which uses credit scoring. "We found the more responsible you are with your finances, the more responsible you are with other things you have. It is not an arbitrary score."

Some legislators and consumer advocate groups disagree. The issue has become a contentious one in the past year, especially in the Midwest, as a wave of proposed bills  ranging from outright bans to tight restrictions have made their way to many state legislative agendas.

In 2002, Wisconsin's assembly considered a bill prohibiting insurers from using credit scores when setting auto rates. The bill died, but the debate has not, says Rep. Gregg Underheim (R-Oshkosh), one of the bill's authors, along with Reps. Robert Turner (D-Racine) and Leon Young (D-Milwaukee). He expects the measure to resurface.

Underheim took up the cause after his insurance agent told him about several instances where credit scores were used inappropriately, such as when a consumer had a good risk profile but poor credit score and was thus placed into a higher premium category. He contends that credit scoring unfairly discriminates against the poor, minorities and those without established credit histories.

"Some argue it is de facto red-lining," Underheim says. "It is an attempt to exclude people based on their geographical location and sometimes even their race. The greater extent to which they use credit scoring, the greater extent to which they exclude (low-income and minority consumers') access to reasonably priced insurance."

The federal Fair Credit Reporting Act in 1970 permits insurers' use of consumer credit information. Wisconsin's Office of the Commissioner of Insurance issued guidelines for insurers in 1997 on the use of credit scoring, mandating that insurers cannot refuse to issue or renew a policy solely on the basis of a person's credit history.

Credit scoring has been an accepted practice for many years in other industries, but insurers started to pick up the practice in the mid-'90s.
"Your credit history is becoming more important in all sorts of things," says Sean McManamy, Midwest regional director of public affairs for the American Insurance Association, a Washington, D.C., trade association representing 424 insurance companies.

"It is another reason for people to be careful with their credit history," agrees Eileen Mallow, assistant deputy commissioner of insurance for Wisconsin.

"Insurance underwriting is extremely complex," says Eric Englund, president  of the Wisconsin Insurance Alliance, a state trade association in Madison.
"Some insurers choose to use it because it gives them more precision in determining how much you should pay vs. your neighbor."
Studies have shown a correlation between a person's financial history and the likelihood of insurance claims, insurers say. People who have good credit histories are likely to file fewer or less expensive insurance claims.
While there is no clear explanation for the correlation, it's similar to the theory behind good student discounts, Englund says.
"We don't know for certain what the correlation is between good students and having lower auto insurance premiums," he says. "We just know that good students have fewer claims, so they get reduced auto premiums."
An insurance score, like a financial score used by banks and retailers, is acredit-based statistical analysis. Financial and retail companies use it to determine the likelihood of a person paying a loan or debt on time while insurers use it to assess a consumer's risk exposure.

Outstanding debt, bankruptcies, late payments and length of credit history are some characteristics factored into an overall score. The higher the score, the more financially responsible the consumer.

While some insurers request the actual credit report, many insurers, like Acuity and General Casualty in Sun Prairie, use models developed by outside vendors, such as ChoicePoint Inc. in Alpharetta, Ga., and receive only the overall credit score.

Other companies, such as Bloomington, Ill.-based State Farm Insurance and Northbrook, Ill.-based AllState Insurance, have developed their own models. State Farm uses scores only for auto insurance.

Credit scoring often results in cost savings for the consumers, insurers said, as most people have good credit and will receive appropriately priced premiums. After Acuity implemented scoring, it found 60 percent of clients received rate reductions, Felchner says.
In addition, insurers' policy applications often inform consumers about the use of credit ratings in the underwriting process.
States debate practice While insurers tout the benefits, critics have raised concerns. In 2002, more than two dozen states debated whether to regulate the industry's use of credit histories.

Maryland has shown the most opposition by passing a bill, effective last October, that completely bans the use of credit in homeowners' insurance and excludes insurers from using it in auto insurance underwriting decisions.

In the Midwest, legislators in Illinois, Indiana, Kansas, Minnesota, Missouri, Nebraska and North Dakota have proposed varying bills to curb or prohibit credit scoring.

Insurers insist scoring models don't use such factors as disability, income, marital status or nationality that could potentially lead to discrimination.
"If a person has little income but still manages their finances well, they could have a score as high as someone who is wealthy," says Acuity's Felchner.
Credit scoring is only one of many variables that factor into the underwriting process, insurers say.
"Insurance scores are a smaller piece of the puzzle in putting together an accurate rate," says Anne Smith, spokeswoman for General Casualty, which uses the scoring for auto insurance only.

Motorists' records and past claims filed are still important variables, insurers say. The use of credit scoring impacts competition as "different insurers look at a variety of tools and risks and come to their own individual conclusions as to what they want to use," Englund says.
"The challenge of evaluating risk by insurers is an endless one," Englund says. "(Credit scoring) is a tool, but it can't be a decisive tool."
Consumers who feel disadvantaged can file a complaint with the OCI, says Mallow, or they can shop around because some companies, like American Family in Madison, do not use credit scoring.