U.S. PIRG Consumer Blog: Oops on credit scoring by Hartford Insurance

The Insurance Journal reports that under an agreement with Delaware Insurance Commissioner Matt Denn the Hartford insurance company has made refunds totaling $135,000 to 1,400 Delaware consumers it wrongly scored as bad insurance risks by miscalculating their credit scores. What does your credit score have to do with your insurance risk anyway?

Nothing, in the view of leading consumer groups. The state PIRGs, Consumers Union, Consumer Federation of America and the Center for Economic Justice have long campaigned for state bans on the use of credit scores for insurance ratemaking. Hawaii, Maryland and other states have adopted all or part of our proposals. The PIRG/Consumers Union model state Clean Credit and Identity Theft Reform Act includes a section banning credit scoring for insurance.

Unfortunately, the powerful insurance industry circulates an "industry-approved" model law of its own through the National Conference of Insurance Legislators or NCOIL, so some states have actually affirmed the practice of allowing insurance companies to raise consumer rates based on a score derived from their credit reports.

While this Delaware incident shows that credit scoring models can be flat-out incompetently designed, resulting in consumers with excellent credit paying higher rates, the use of credit scores in insurance ratemaking creates much more pernicious problems than simply rate mistakes.

The information in an insurance credit score is not derived from your driving habits (number of speeding tickets, number of accidents) or the number of homeowners' claims you've filed. It is derived from your credit report. The use of credit reports for insurance ratemaking brings up two fundamental problems.

First, no actuarial study has fully linked credit reporting to insurance risk. The industry claims a correlation, but cannot show statistical proof that meets actuarial tests.

Second, while the factors used in deriving a credit score may appear on face to represent good or bad credit and then that correlation that the industry claims, analysis by the Center for Economic Justice shows that some of the companies may instead be using credit scoring as a way to subvert civil rights laws and redline lower-income and minority Americans. As CEJ's Birny Birnbaum recently argued:

As you review the factors in these scoring models, two things become clear. First, your so-called “financial responsibility�? has little weight in the scoring model. And second, the models are systematically biased against consumers in low income and minority communities. The bias arises for two reasons. First, the credit scoring models are systematically biased against the credit characteristics of low income and minority consumers, such as type of credit used. Second, consumers in low income and minority communities are not served by the financial institutions that report to credit bureaus.
Even if a consumer was able to pay the massive interest rates for a check cashing, payday loan or rent to own, it would not help because these institutions do not report to credit bureaus. And so-called thin files – little credit information – yield bad scores. In short, insurance credit scoring is the 21st century tool for redlining. In the past, for example, insurers simply didn’t write homeowners insurance for homes older than a certain age or under a certain value. These underwriting guidelines eliminated coverage in older and low-income neighborhoods.

Fair housing groups challenged these practices and prevailed – these underwriting guidelines have largely been eliminated, although these characteristics are still used for determining premium. But today, insurers have a new tool – credit scoring – that accomplishes the same redlining as in the past. Insurers defend credit scoring as an “objective�? tool that doesn’t “consider�? race or income. Sound familiar? As if bias could not be built into a computer model.