The Attack on Credit Scoring and Other Risk-Based Insurance Pricing Tools

Independent Agents and Their Customers Have the Most to Lose

As product manager for the state’s largest writer of auto insurance through independent agents, I want to take this opportunity to remind you that preserving our ability to use credit-based insurance scores and other risk-based pricing tools, such as territory classifications, is not a done deal in the current Texas legislative session. And, if we are not successful in preserving this right, I believe it will result in the greatest negative impact on independent agents and their customers.

What can we learn from TDI’s credit study?
In the January 2005 Texas Department of Insurance report on the use of credit-based insurance scores, which studied over two million consumers, Commissioner Montemayor put any actuarial arguments against credit scoring to rest for good concluding that “credit scoring significantly improves pricing accuracy when combined with other rating variables in predicting risk.” He also said that, “credit scoring … is not unfairly discriminatory as defined in current law.” And he concluded that all risk-based pricing tools used in insurance, including credit scoring, have a disproportionate impact to some extent and if one was going to use that as the basis to ban risk-based pricing and underwriting we would revert to a homogenized system in which everyone is charged the same price, regardless of risk. He added that that “… would be a setback to all Texans, of all races, especially those of moderate to lower income whose risk remains low.”

Drive Insurance agrees with Montemayor and we believe independent agents have the most to lose if this happens.

Why is this particularly bad for local independent agents?
If banned, direct writers would still be able to use credit. Even if there is a legislative outcome banning credit in Texas, direct writers would still have access to credit information to prescreen mailing lists, which is allowed by federal law. This would put independent agents at a distinct competitive disadvantage. Today prescreening provides little to no incremental value to direct writers competing against independent agent companies that use credit scoring as part of their rating algorithm. (Note: All insurers are allowed to use credit scoring to prescreen per federal law but the use of this tool is not economically feasible at the individual independent agent level.)

Adverse selection would disproportionately undermine agent competitiveness.
Companies selling through independent agents tend to be more broadly distributed than other insurers. This means that the cumulative book written by independent agency companies represents a much broader cross-section of the insurance shopping population and a much higher percentage of “nonstandard” drivers than the books written by captive and direct writers. The ultimate result of being more broadly distributed is that companies selling through independent agents are subject to more adverse selection when government regulations are put in place that ban the use of independently predictive risk-based pricing tools.

To remain profitable, insurers must address the adverse selection problem by: 1) limiting distribution of their product, 2) restricting underwriting to reject more applicants and/or 3) increasing their base rates higher relative to direct or captive writers. These actions will hurt the competitiveness of independent agents and restrict the number of options they have to quote their customers. This is an attack on independent agents’ key competitive advantages: local, in-person professional counsel offering customers a choice of insurance carriers.

So what does it all mean?
Drive Insurance believes that creating an environment that forces insurers to knowingly price their policies inaccurately is not good public policy and is inherently unfair to safe drivers of all ethnic and income groups. The only people who win from this are the consumers who receive an unjustified rate subsidy. Restricting the use of credit-based insurance scores–or any risk-based pricing tool–is particularly bad for independent agents who serve the most broad and diverse customer segments in the market.

If you agree, let your voice be heard by your state senator and representative. It is likely that there will be bills and/or floor amendments heard on the legislative floor that will attempt to ban risk-based pricing tools like credit scoring and territory. Our elected officials need to be put on notice that banning actuarially justified risk-based pricing is a bad market outcome for independent agents and their customers.

Jonathan Klein is Texas product manager with the Drive Group of Progressive Insurance Companies.