The National Council of Insurance Legislators offers sensible answers to using credit in calculating insurance premiums
Two weeks ago in the Maryland Legislature, the House Economic Matters Committee heard House Bills 690 and 436, two bills that contained the same language: if passed, they would prohibit insurance companies operating in Maryland from calculating consumers’ premiums using their credit information to assess risk of insurance loss.
Many heated questions were raised during the hearing, which implied—or even stated outright—that using credit information in calculating insurance rates is unnecessary or even discriminatory. After all, some legislators argued, insurance companies have other factors besides credit information they can use to calculate risk: why must they rely on credit-related information? Expert witnesses responded that credit information is profoundly associated with customers’ risk of insurance losses, but their protestations were largely drowned out by calls for protecting the poor across the state.
As with so much in policymaking, there is an effective gray area between the polar extremes of cutting off the use of credit information entirely and making it an unregulated, dominant factor in determining premium rates. To protect Maryland drivers from the results of either underuse or overuse of credit information, legislators should look to recommendations from insurance experts in the Model Act Regarding Use of Credit Information in Personal Insurance, which seeks to balance the interests of consumers and companies.
Why Credit Information Matters in Calculating Insurance Premiums
For insurance companies’ purposes, information related to credit—in simple terms, a person’s ability to pay back borrowed money—comprises more than a person’s credit score. In addition to payment history, credit-based insurance scores also consider the length of time the consumer has used credit, accounts opened or closed, and outstanding debt, among other factors.
According to expert witnesses who testified at the hearing, credit-based scores are one of approximately 75 factors used to evaluate an appropriate premium for customers. But while there are, as legislators insinuated, 74 other factors at play, credit-based insurance scores provide insurance companies with some of the most accurate calculations of risk. According to a 2004 study commissioned by the Texas Department of Insurance, the higher a credit-based insurance score, the lower the risk of loss borne by an insurance company—a finding that was backed up by the Federal Trade Commission (FTC) in 2007. In its conclusion, the FTC reported that because of this strong inverse relationship, the use of credit-based insurance scores allows the cost of premiums to better match the risk of losses. This conclusion makes logical sense. Credit is not a measure of income or any other factor except responsibility with finances, and fiscal responsibility is naturally reflective of responsibility in other areas, including driving.
Prohibiting the use of credit information would ultimately raise the price of insurance for customers across the board. If insurance companies cannot properly assess risk among customers, they must either absorb the losses themselves, which risks the integrity of their business, or allocate higher premiums for all customers, regardless of their risk, to cover the losses. Ultimately, without credit-based scoring, the insurance industry cannot employ specificity, making price hikes indiscriminate instead of based on an assessment of risk for each individual customer. Leadership at The Travelers Companies, a large insurance company based in Connecticut, warned of this consequence, explaining on the company’s Q3 earnings call that lower-risk drivers must subsidize the premiums of higher-risk drivers when laws prohibiting credit-based insurance scoring are enacted.
It is also true, though, that weighing credit information too heavily in the assessment can be unfair or punitive to customers. For instance, some unexpected life events can negatively impact credit, such as expensive medical bills or lengthy divorce proceedings. As a result, rather than banning the use of credit-based insurance scores outright, state legislators should look to expert advice from the National Council of Insurance Legislators (NCOIL) on the guardrails necessary to protect their effectiveness.
Model Act from NCOIL on Credit-Based Insurance Scoring
First, the model act reasserts, as is already the case, that factors such as income, ethnicity, zip code, marital status and others cannot be used to calculate insurance premiums, nor can low or nonexistent credit be the only factor considered in refusing to insure a customer. The act also puts guardrails around the timeline during which an insurer can take an action related to a customer’s credit score: the company can only decide to raise a premium within 90 days of the policy being issued or renewed, and credit-based insurance scores can only be recalculated every three years. This helps protect against many adverse life events: if a person has a difficult time paying off divorce proceedings, for instance, he or she can have time to chip away at the debt before the insurance company sees the potential impact to credit.
The model act also proposes prohibiting negative scoring impacts based on medical debt collection, home mortgages and car lending, and if a customer provides a written request asking their insurance company not to raise their premiums based on other catastrophic life events, insurance companies must consider providing an exception. If the insurer does raise a customer’s rate based on credit information, they must provide a written explanation with enough specificity to enable the customer to fix the potential issues in the future.
The suggestions from NCOIL strike a responsible, prudent balance between an overuse of credit information that might punish customers for adverse life events and an underuse that results in low-risk drivers subsidizing the premiums of high-risk drivers. While some Maryland legislators’ desire to protect customers from hikes in insurance premiums due to poor credit is understandable, the answer is not to prohibit its use altogether but rather to place effective guardrails around its use. The Model Act from NCOIL provides these guardrails, protecting the interests of both low-risk and high-risk drivers, and legislators in Maryland and across the country should look to implement them in their state policies.
Image credit: Jane