The use of credit-based insurance scores in underwriting and rating is an actuarially sound practice that carries benefits and responsibilities for insurers and consumers alike, the American Insurance Association said at the National Association of Insurance Commissioners (NAIC) meeting.
“Credit history is a source of affordable, objective information readily available in the market that supplements the underwriting picture so more accurate and consistent decisions are made,” commented David F. Snyder, AIA assistant general counsel. “With the use of credit-based insurance scores, subjectivity is minimized, allowing for impartial underwriting and pricing decisions.”
Snyder joined the AIA’s industry partners and representatives from the financial services industry in testifying at the NAIC Market Conduct & Consumer Affairs (D) Committee’s public hearing on credit-based insurance scores. He discussed several issues related to insurance scores with the committee, most notably the question of causation – what causes an individual with a poor history of financial responsibility to be a higher insurance risk?
“While determining causation is not easy, it is not necessary, either,” Snyder said. “While we may not know or understand the exact causal relationship between credit history and loss ratios, the fact remains that there is a clear statistical relationship between the two.”
Snyder gave the example of an individual who has had a past conviction for drunk driving; the fact that the person has a prior conviction does not physically cause that person to drive under the influence again. Yet, actuarial data has shown that people with past drunk driving convictions are more likely to repeat that behavior in the future. This fact is reflected in that individual’s insurance premium.
The situation is similar with a consumer’s credit history, Snyder said. The fact that a person has a poor credit history does not physically cause that person to be higher-risk. Actuarial data, though, has shown that the relationship between insurance scores and loss ratios is statistically significant.
Snyder cited a 2000 study by James E. Monaghan that sought to answer the question “Why would an individual who has current or past difficulties meeting financial obligations be expected to have above-average costs to an auto insurer?” Some of the possibilities cited by Mr. Monaghan are: maintenance; moral hazard; claim consciousness; increased frequency and severity of fraud; and stress.
While insurance scores are irrefutably predictive, insurers still have a responsibility to use the tool fairly and wisely, Snyder said. For instance, he reassured commissioners that despite the predictiveness of insurance scores, insurers will still consider the extraordinary circumstances of individual consumers. “While insurance scores allow companies to objectively underwrite individual risks, companies can be asked to consider extenuating circumstances such as medical issues, terrorist attacks and identity theft when evaluating a risk.”
Education efforts on the issue must also continue for insurance agents, consumers, and policymakers, Snyder said.
The AIA and other industry partners have begun a campaign to educate insurance agents and consumers about the issue, developing brochures and other educational materials on the subject for distribution countrywide.