New uniform credit agencies’ scoring system not likely to affect insurers

A recent announcement by the three major consumer credit reporting agencies that they have created a new credit scoring system is unlikely to have a major effect on insurers’ current use of credit in underwriting and rating for homeowners and automobile insurance policies.

Equifax, Experian and TransUnion told the Associated Press that the new “VantageScore” was the result of market demand for a more consistent and objective approach to credit scoring, and it is aimed at simplifying the loan process.

In the past, the agencies each used proprietary formulas to create their own scores, meaning that a lender dealing with a consumer’s application for a credit card or a mortgage might have had to reconcile three widely different scores. The new system will allow a single methodology to be used to create the scores.

The new system may make it easier for lenders and may eliminate some of the criticism leveled at the credit scoring companies by lenders and consumers. Yet several national insurance trade groups don’t believe the simplified approach of the three companies will create any splash in the controversial world of insurers’ use of credit scores.

“Insurers use different systems and scoring models such as Fair Isaac Corp. (FICO), Choicepoint and proprietary scores. These models are different from the consumer lending focused credit scores by Equifax, Experian and TransUnion,” said Jeff Junckas, director of public affairs for the American Insurance Association. “A likely guess is that this new scoring system from the three companies is designed to rival FICO’s generic credit score, which is designed to predict the likelihood of a bill going 30 days late in a 24-month timeframe. This is not what insurers are looking for when they use credit-based insurance scores. Insurers are trying to predict future claims.”

The Property Casualty Insurers Association of America testified before the Federal Trade Commission last year in the hopes of better explaining why credit is important to insurers and how it is used differently by lenders or credit card companies.

“Credit-based insurance scores can only be developed using insurance claims data. They are completely distinct from scores based on credit histories that are designed and developed for other purposes such as making decisions about the granting of credit,” Diana Lee, PCI assistant vice president of research, told the FTC last year. “Data elements that for any reason should not be used for insurance underwriting purposes are held out of the analysis and so do not affect the resulting credit-based insurance scoring model.”

When asked how many insurance scoring models are being used today, Lee responded that “a survey done by the National Association of Independent Insurers in 2002 found that about 20 percent of participating insurance companies using credit scores created their own models or had customized ones developed with outside help.”

Lee also told the FTC that a survey conducted by Conning found that more than 90 percent of insurance companies use credit data. She said how much of the data is used and how it is used by companies varies.

Oregon Insurance Administrator Joel Ario said that he thought the standardization of the three major agencies was good move. “I personally believe insurers would be better off if they had more standardization, much like the banking industry,” he said. Ario is a former chairman of the NAIC’s Credit Scoring Working Group, which disbanded after the group finalized its document, “Insurance Credit Scoring Regulatory Best Practices.”

Ario agreed that the types of scoring models used by the insurance industry and the criteria used in those models vary greatly, and he doesn’t see that changing dramatically in the near future. “Standardization is a good move no matter what, because it will benefit consumers who still have difficulty dealing with so different credit scores from different agencies,” he said.

The National Association of Mutual Insurance Companies agreed that insurer’s use of credit scoring models varies but said that the decision by the three major credit scoring companies is a positive one. “Strictly from a consumer standpoint, this move will definitely ease some consumer frustration and generally is a positive development,” said Neil Alldredge, NAMIC senior director of state advocacy.

However, NAMIC said that even with the news about the new methodology, insurers could face another challenge when the FTC releases its study on credit use. The study will focus on all uses of credit, not just on the insurance industry’s use of it.

Insurance industry representatives and rating agencies have cooperated with the FTC in the past year to provide data and input for the study. “The FTC study was supposed to be released in 2005 and at this point, there is speculation that it could be released late in 2006,” Aldrege said. “The results could be a bombshell for the industry, or the study could be very positive. We just don’t know how it will unfold at this point in time.”