Insurance credit scoring: 21st Century redlining and the end of insurance

Disagreements about insurance credit scoring really boil down to what “fair” means. For insurers, “fair” means that an insurer can produce data showing a statistical relationship between credit scores and insurance losses. For consumer groups, such a statistical relationship is a necessary, but not sufficient, definition of fair insurance practices. Fair rating factors must also not penalize consumers for rational behavior, for factors outside of their control and for arbitrary practices of insurers and lenders.
Because credit score depends on having the “right” kind of information in a credit report, someone can have a perfect credit history and still get a bad credit score. Contrary to insurer credit scoring myths, credit score has nothing to do with “financial responsibility.” Fair Isaac, the inventor of credit scoring models, estimates that 20 percent of the population is unscorable with traditional credit bureau reports because of “thin” files and this group of “unscorables” is disproportionately poor and minority.

Insurance scoring penalizes consumers for the business decisions and practices of lenders. Abuses by credit card companies and lenders place many consumers in financial distress. Consumers should not be penalized with higher insurance rates because of abusive subprime mortgage lending or because a lender decides not to report information to a credit bureau.

A disproportionate impact
Insurance scoring has a disproportionate impact on poor and minority consumers. A study by the Missouri Department of Insur-ance found that a consumer’s race was the factor most predictive of insurance score. And despite relying on data hand-picked by insurers, a recent Federal Trade Commission report found that insurance scoring was a proxy for race. If insurers are prohibited from using race as a risk classification, they should not be able to use a proxy for race.

Insurers tout the FTC report as affirmation of insurance scoring, but the report is so biased and methodologically flawed that one of the FTC Commissioners voted against issuing the report and wrote a detailed criticism of it.

Insurance is essential for individual and community economic development. First, it is a financial security tool that enables individuals and businesses to avoid financial ruin in the aftermath of a catastrophic event. Second, insurance is the primary mechanism for loss prevention and loss mitigation. Insurance accomplishes loss prevention by providing economic incentives for less risky behavior and economic disincentives for more risky behavior.

Insurance scoring undermines these goals by making insurance less affordable and available for those who most need the economic protection of insurance — poor and minority consumers. It undermines the loss prevention role of insurance because it deemphasizes rating factors under the consumer’s control.

Insurance scoring represents 21st century redlining and the end of insurance as insurers develop rating schemes based more on economic status — credit score, education, occupation, prior liability limits — than risk of loss and should be prohibited.

Birny Birnbaum is executive director of the Texas-based Center for Economic Justice (www.cej-online.org).