Credit-based insurance scoring keeps costs low
If some lawmakers have their way, their policies will hobble insurers and raise insurance premiums on Americans. That’s because recent pushes in state legislatures across the country—including Maryland, Washington State and Colorado—have taken aim at insurers’ practice of employing credit-based insurance scores in personalized rate calculations, which are used to predict the cost of insuring a customer. Proponents of banning this practice argue that it is unfairly discriminatory and harms certain groups of people. However, these critiques do not hold water.
While an inability to obtain homeowners or automobile insurance can inhibit a person’s ability to improve their circumstances, the use of credit in calculating insurance scores is not only fair and a proven indicator of future risk, but also allows for lower insurance rates for many.
When a prospective client is evaluated by an insurer for homeowners or automobile insurance, the insurer will take a variety of factors into account, including payment history, debt, geographic location and accident history, to determine the appropriate rate to charge that individual. Information gleaned from an individual’s credit history, such as length of credit history and the pursuit of new credit, is also often factored in. The resulting calculated insurance score is intended to be an evaluation of someone’s risk. Insurance companies use this perceived risk to individualize premiums for each policyholder. This results in higher rates for those deemed to be at higher risk of a claim and lower rates for those at lower risk.
Critics of this practice are concerned that the use of credit-based insurance scores provides companies with a proxy for race or socioeconomic status, but this concern has been preempted by existing regulations. Federal laws already prevent unfair discrimination, and the Federal Trade Commission has concluded that the use of credit-based scores is not discriminatory.
In order for a variable to be used by insurance companies to calculate scores, it must be a quantifiably accurate indicator of projected insurance claims. Additionally, in most cases, state insurance agencies must review insurance practices to ensure they are not problematic. Research has shown that information obtained from credit history is correlated with actual risk and projected insurance claims. According to the National Association of Insurance Commissioners, the credit information evaluated does not include racial or ethnic demographics, preventing companies from factoring race into the process, which would be illegal and unjust.
The insurance industry currently allows for a unique degree of price variability based on the potential risk of individual policyholders. If lawmakers limit the ability of insurance companies to consider credit as a variable in their risk assessment, costs would have to be redistributed, and premiums would increase for lower-risk policyholders—unfairly penalizing those with good credit-based insurance scores to protect those with poor scores. Policyholders shouldn’t be penalized by shortsighted attempts to address an inequity that doesn’t exist.