by US general insurers, is being contemplated in other sectors,
including life insurance. This has prompted aggressive opposition
from consumer groups and legislators and, in some states, use of
credit-scoring by insurers has already been banned. Charles
In the general insurance market, credit-based insurance scoring
is now a fact of life, but its potential spread to other insurance
products, including life insurance, has critics questioning its use
amid renewed concerns fueled by the rocky economy.
Insurers are facing legislative efforts in several states to ban
credit-based insurance scoring in underwriting decisions. Not
surprisingly, public discontent over credit-based scoring is
increasing, as rising mortgage defaults, increasing unemployment
and growth in late payments on homes, cars and credit cards have
greater numbers of Americans worried about damage being done to
their credit scores.
Insurers maintain that a person’s scores, originally intended to
measure creditworthiness, are also a predictor of whether – and how
often – someone will file an insurance claim. Insurers have found
credit rating to be an accurate predictor of losses, noting that
those who have been delinquent in paying their bills twice or more
within the past two years are 80 percent more likely to file an
insurance claim than those who pay bills on time.
The use of credit scores in insurance policy issuance and
pricing has proven endlessly controversial. Consumer advocates
argue its use discriminates against ethnic and socio-economic
minorities and creates disparities in pricing among those who can
least afford it. They also complain that errors in credit files can
result in lower scores and thus higher insurance premiums.
A June 2007 Federal Trade Commission (FTC) report found
credit-based scores correlated strongly both with the number of
claims a policyholder is likely to file and aggregate cost of those
claims. The report also found that credit-based scores are
distributed differently among racial and ethnic groups, with
African Americans and Hispanics being more likely on average to
have lower scores.
Differing state approaches
But the FTC report also found that, as a practical matter,
insurers are unable to use credit scores to single out any ethnic
or racial group for higher premiums. The FTC also found that
insurance pricing based on credit data “may result in benefits for
Four states – California, Hawaii, Maryland and Massachusetts –
have adopted total or partial bans on credit data use. State
legislatures in Colorado, Nebraska, Oklahoma, Wisconsin and Wyoming
defeated proposals to ban the practice last year, and a ban remains
under consideration in Michigan. Georgia, Illinois, and Utah
prohibiting the use of credit history information as the sole basis
in making underwriting or rating decisions. Oregon prohibits use of
credit history information to cancel or not renew existing
customers or increase their rates, and Maryland bans the use of
credit history when underwriting or rating existing customers.
Federal lawmakers are getting in on the act, too. Congressman
Luis Gutierrez recently introduced a bill to bar credit-based
insurance scoring where there is a government finding of
discrimination or when credit information could be used as a
‘proxy’ for race or ethnicity. Another bill, filed by Congresswoman
Maxine Waters would ban the use of credit-based insurance scores
The insurance industry prefers adherence to the model act
adopted by the National Conference of Insurance Legislators (NAIC)
in 2003, which has been adopted in about half of US states. Its
consumer protections include the requirement that insurers disclose
to consumers their use of credit scores in the underwriting process
and notify the policyholder in compliance with the federal Fair
Credit Reporting Act when credit is the basis for an adverse
The model law also prohibits use of credit information as the
sole basis for refusal to insure, non-renewal or cancellation. It
also encourages insurers to take into account extraordinary life
events, such as catastrophic illness or a spouse’s death.
States adopting the model law are unlikely to experience credit
scoring usage in life issuance, given the model act’s disclosure
requirements, which would usher in a predicable firestorm of
controversy should insurers attempt to expand its use beyond
Meanwhile, the growing power of Democrats in Congress who oppose
credit scoring was underscored when the FTC began using its
subpoena powers in gathering data for a new study on the issue.
The agency published a notice in late last year of its plan to
require nine homeowner’s insurers to provide all available data to
the agency. The FTC plans to use subpoenas because congressional
critics of its 2007 insurance study said the information on which
the report was based was provided voluntarily by the insurance
industry, suggesting not all the relevant data was provided.
Customers save money
The insurance industry maintains the majority of customers save
money thanks to credit scoring.
They argue the way consumers manage credit is a reliable
indicator of responsibility and, consequently, of habits less
likely to result in claims. Moreover, they point out that credit
ratings are just one of many factors carriers consider when they
set rates and credit histories are blind to race and ethnicity.
The National Association of Mutual Insurance Companies argues
that consumers benefit when insurance companies use credit-based
insurance scoring in underwriting and rating policies.
“Every serious study of the issue has reached the same findings
– there is a strong correlation between credit information and the
probability of a loss,” NAMIC said in written testimony to
“The same studies demonstrated the use of credit enhanced the
fairness of insurance underwriting by allowing insurers to offer
coverage to more consumers, more accurately price policies, and
actually lower costs for the majority of insurance consumers.”
Because carriers are regulated by each state, those that operate
in multiple states are accustomed to the potential headaches
created by states’ varying approaches to credit scoring. Credit
scoring is now fairly entrenched among carriers and credit scores
are reliable indicators of risk, leading to more sophisticated
pricing models, so insurers will continue to battle efforts to do
away with its use.
With a Democratic Congress in a regulatory mood, it is likely
the fighting is far from over.