Letter from Washington: Credit-scoring and the downside of market prices
Dealing with insurance-related credit scoring is like playing whack-a-mole: whenever one effort to ban the generally beneficial practice is defeated, another one pops up. At the National Conference of Insurance Legislators’ Spring Meeting, where I was last week, there was lots of debate and discussion relating to credit scoring for insurers and, in particular, proposals from the Department of Housing and Urban Development to ban the practice if it shows a “disparate impact” on minority groups. A resolution against the rule was passed by NCOIL but that’s probably not all that important.
(The use of credit scores probably will have a disparate impact, but the impact is: (a) explained partly by factors unrelated to things like skin color, such as the fact that the African-American and Latino populations of the United States skew younger. (b) stems from personal decisions and behavior, not bigotry, in any case.)
Anyway, the debate and discussion is going to go on with both sides making overheated claims. Insurers can and do underwrite and make decent profits without the use of credit scoring and are being dishonest if they imply otherwise, as they sometimes do. The use of credit scores, however, is not bigoted, wrong, or even problematic and in fact, lowers rates for everyone. And the last point should be a key part of an argument in their defense.
Here’s what I think: the use of credit scores probably should raise a few eyebrows, because its correlation to risk is not obvious at first blush. That said, it works well largely because one’s financial life is among the only aspects of personal behavior that is continually monitored in an evenhanded fashion and for which monitoring is generally welcome. Any number of types of personal behavior—alcohol use, junk food consumption, personal hygiene—might well be shown to correlate with insurance claim behavior as well or even better than credit scores. But there’s no central way to monitor these things, almost nobody would want them monitored and the additional social utility of monitoring them beyond insurance-related risk behavior is probably close to nil.
Credit scores, on the other hand, are an obvious benefit to almost all borrowers, since they allow lenders to make loans to people they don’t know personally and have never met before. Even better, the issues they deal with aren’t considered private. (Just today, I saw a Facebook post from a college friend bragging about her low interest rate mortgage.)
Thus, since the collection of credit information is an obvious net positive per se and since there’s nothing that could easily substitute for it in setting insurance rates, its use is pretty sensible. But, given that there are legitimate raised eyebrows at the use of credit scores, some might think differently and still give into those who want to ban credit scoring.
The best rejoinder: because it is such an efficient way to determine risk, credit scoring makes rates for almost everyone lower than they otherwise would be, while allowing insurance companies to earn the same (or higher) levels of profit. Bottom line: banning the use of credit scores is a sure path to much higher insurance rates for everyone and this argument, more than any other, provides the best way to fight back against those who wish to ban it.
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A look at the Mississippi Gulf Coast—my first visit here ever—shows the difficulties of an insurance-related public policy that’s basically sensible. More than other Gulf Coast states, Mississippi has continued to let the market (more or less) set insurance rates. There’s no overgrown wind pool (yes, it’s big, but nothing like Florida’s or even Louisiana’s) and, although the state has some price controls, they aren’t terribly burdensome. Mostly, insurance prices are risk-based. This all works out okay but certainly has some costs.
Let’s start with the good parts. The economy is doing okay. All of the large casinos have been rebuilt better than ever. Jobs have come back and things look pretty prosperous. Republican state Sen. Billy Hewes, a likely candidate for mayor of Gulfport, tells me that city’s population (on a per-capita basis, more damaged than New Orleans) is now above where it was before Hurricane Katrina. So that’s all good. Nobody, it seems is suffering because of high insurance rates. Basically, from the economic standpoint, coastal Mississippi is a pretty good example of how market-based rates work.
On the other hand, a lot of potentially valuable oceanfront real estate still lies undeveloped and this is an obvious problem. Since much of it still has foundations on it—there’s no rubble that I’ve seen—it isn’t much good for wildlife habitat. And, in any case, “pocket” wetlands restoration is probably a minor environmental measure at best (and it’s expensive.) So is developing a lot of it into parks.
One of the best things to do would be to figure out more uses for land that are profitable but won’t be seriously impacted by a storm and thus either don’t need insurance or will have low insurance rates. A few—golf courses, shooting ranges—are pretty obvious, but others are harder to discern. And figuring out economically viable, profitable uses for this land, absent insurance price controls, is a big challenge for the future.
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Based on what I’m hearing, I find it unlikely—but not impossible—that North Carolina auto insurance reform will come during this year’s short session. It strikes me that it’s a lot more likely we’ll get real reform—meaningful reform—next year. I’ll wait and see.
