As Credit Scores Fall, Criticism of Insurers’ Credit Scoring Rises

With consumers’ credit scores dropping as lenders tighten credit terms, insurance consumer advocates are stepping up their criticism of the use of credit scores by insurance companies.

They are also warning insurers that they could lose business and consumer confidence if they don’t treat consumers fairly in today’s economic climate.

“We have already seen credit scores having an impact on interest rates charged to consumers on their credit cards and loans. If insurers continue to use credit scores in determining risk levels, premiums will increase and consumers may be forced to reduce the insurance carried to protect their financial assets,” according to Karroll Kitt, associate professor at the University of Texas at Austin.

Pamela J. Bolton, director of research for Texas Watch, thinks the credit crisis is taking its toll. “The credit crisis has already lowered the credit scores of thousands. As lenders lower credit limits and increase rates, consumers are seeing their credit scores suffer through no fault of their own,” Bolton said. She said the “grave” situation has been documented by the Wall Street Journal, Fox News, Bloomberg, and others.

Bolton, who supports a ban on credit scoring, has her doubs but hopes the insurance industry will take into account differences between changes in credit scores due to ta consumer’s own actions versus economic conditions or changes by lenders. “This crisis presents the industry with a very important choice: Will it choose to act in the best interests of its customers, rather than its bottom lines, by embracing fair practices that don’t unfairly penalize policyholders, or will it be business as usual?” Bolton asked. “Only time will tell.”

If insurers don’t somehow adjust, consumers and insurers both “will be worse off,” warned Brenda Cude, professor of housing and consumer economics at the University of Georgia in Athens.

“It is already very difficult to explain to consumers how their credit score could be related to their access to insurance and the price they pay,” she said. “It will be even more difficult to explain that when the drop in the credit score is due to, for example, their credit card company lowering their credit limit when the consumer’s behavior hasn’t changed in any way.”

Insurers taking advantage of insureds’ credit plight could pay a price. “One outcome will likely be a continued erosion of consumers’ faith in financial institutions,” Cude said.

Cude and other consumer advocates will be watching how the economic recession affects consumers’ buying habits.

“The question is how many consumers and which ones will drop insurance coverage and which coverage? And, if consumers have lost confidence in financial institutions, the impact will be greater,” Cude said.

“The problem is compounded by the fact that, I believe, consumers already don’t understand what they’re buying when they buy insurance and how rates are set. If that’s true, they don’t know what they’re giving up when they drop their insurance coverage,” said Cude.

Kitt said that consumers are trying to do the best with what they have and want to trust providers. “Consumers are experiencing fear regarding their money and how to protect what money they currently have,” said Kitt. They are guarded in spending their money and want to feel confident that they can trust who is selling a product. This is reflected in purchasing less and only what is felt to be essential, foregoing luxury items.”

Cude thinks some consumers who have to make hard choices about which bills to pay will choose other items over insurance. “There’s already an indication that this is happening — there’s a Safe Auto ad in which the major point is that if you miss a few payments, SafeAuto will take you back. The ad doesn’t say whether you come back at the same rate as before, however.”

Bolton, too, has concerns about how insurers will treat consumers in the current economy. “Insurers have the vast majority of their funds in the bond market, which has been much less affected than the stock market,” Bolton said. “Despite this, I think insurance companies are likely to use the economic crisis as an excuse to increase rates.”

Cude, Bolton and Kitt are in a position to have their views on credit scoring and other consumer issues heard. They are three of the 17 consumer liaisons to the National Association of Insurance Commissioners (NAIC) for this year. The NAIC has announced it will begin public hearings to review credit scoring.

Insurance Journal spoke with some of the NAIC liaisons and found that in addition to credit scoring, their issue lists include Internet sales of insurance; the effectiveness of current insurance regulation; insurance fraud and agent compensation and disclosure.

Internet Sales

Consumer advisors see pros and cons to shopping for insurance on the Internet.

“The Internet is a great option for many consumers in the purchase of many products. It has the potential to vastly increase the transparency of the insurance marketplace,” Cude said.

Yet there is a downside.

“Unfortunately, many consumers probably use it simply to find the lowest price — which does not always mean they have found the best insurance product to meet their needs.”

Cude said she wants to work with regulators to improve consumer information about insurance products. “I will do this through revisions to NAIC buyer’s guides as well as other opportunities that may arise to communicate with consumers, including through state insurance department Web sites,” Cude said.

Independent Agent Value

Some consumer liaisons believe that independent insurance agents play an important role in insurance. Because they sell products representing multiple insurers, “consumers can benefit from having more choice in their insurance protection, that is several policies to review for their insurance needs,” Kitt said.

“A trustworthy, ethical and truly independent agent who offers unbiased advice and guidance is an invaluable tool for consumers in our increasingly complex insurance marketplace,” Bolton said.

But Daniel Schwarcz, associate professor of law at the University of Minnesota Law School, is concerned that contingent commissions can compromise the value of independent agents.

“When it comes to contingent commissions and any sort of differential compensation paid to an agent I think is independent, I think there needs to be closer regulatory scrutiny to that,” he said.

Schwarcz thinks the problem is deeper than many recognize and that simple disclosure is not a solution.

State Vs. Federal Regulation

Birny Birnbaum, executive director for the Center for Economic Justice, said his group is interested in the debate over state versus federal regulation with an eye to seeing where consumers can get the best regulatory treatment. “Right now, the federal proposals are very anti-consumer,” he said.

While state-based regulation has its problems, Birnbaum said “consumers still have better protection [with state-based regulation] than with any hypothetical federal approach that we’ve seen.”

There is a way to design a national regulatory scheme that is better than what consumers get now with the state-based treatment, according to Birnbuam. “But that doesn’t seem to be on the table just yet.”

Amy Bach, executive director for United Policyholders, is not afraid to take a side on the state versus federal question. “At NAIC, we’ll lend our support to commissioners that want to preserve the state regulations system,” she said. “We think the optional federal charter will be a huge mess.”

Bach suggested that disaster programs show that a state or regional perspective has advantages over a national perspective. Her organization works closely with the California Earthquake Authority and she hopes to share some of the best practices learned in California with the NAIC. “We want to help export our success to other states as best we can, and brainstorm how to resolve failures,” Bach said.

Howard Goldblatt, director of government affairs for the Coalition Against Insurance Fraud, is in a unique position among the NAIC consumer representatives since his group is industry-supported. But anti-fraud efforts benefit consumers as well as insurers since everyone shares in insurance fraud costs.

“Having someone on the liaison committee with a background that understands insurance fraud issues and how it impacts consumers is a benefit when [the NAIC] discusses issues,” Goldblatt said.

Insurance Journal editors Stephanie Jones and Andrew Simpson contributed to this story.