Giving credit its due: Insurers, agents, legislators, regulators and consumers battle to define the role of insurance scoring. (Industry Strategies: Insurance Scoring).

Credit-based insurance scoring--the use of credit information to help set premiums and select risks--has become the hottest issue on the personal lines front. At least three states have enacted restrictive legislation, and dozens of others are considering regulatory or legislative curbs. Insurers maintain that credit-based insurance scores provide a valuable tool for their under-writing arsenal and can translate to lower premiums for credit-worthy policyholders. But consumer advocates have attacked the practice as discriminatory, and agent groups have argued that insurers too often apply this tool in an inflexible manner.

Speaking at the Winter National Meeting of the National Association of Insurance Commissioners in December, Robert Hunter, consumer advocate and a former Texas insurance commissioner, said the use of credit scores should be stopped. "If I have a poor credit score because I was laid off as a result of terrorism, what does that have to do with my ability to drive?" Hunter asked during a hearing on the subject.

To counter the growing movement by states to restrict the use of credit-based insurance scoring, trade organizations have stepped up their informational efforts at the state level and are urging member companies to reveal precisely how their use of insurance scoring benefits consumers. One of the toughest sells for insurers is convincing legislators and regulators of the strong correlation, corroborated by several studies, between a consumer's credit problems and the kind of risk-taking behavior that will lead to losses and the filing of claims.

"We have been extremely aggressive, both in lobbying individual legislators and state legislatures as a group, trying to educate them on this process," said Joseph Annotti, assistant vice president of public affairs for the National Association of Independent Insurers in Chicago, which represents about 700 property/casualty companies. "And we know it's a difficult job. Most people do not make an intuitive connection between someone's credit score and whether or not they're going to file an auto insurance claim. It takes some explaining and education to get them to see the connection there."

While no state has passed an all-out ban on insurance scores, industry groups say that three states-Utah, Washington and Idaho--have gone too far with their legislation. Utah lawmakers have approved a measure that prohibits insurers from using credit-based scoring as a criterion for canceling policies or denying their renewal. Washington's new law limits insurers to a 20% difference between the premiums charged to people with clean credit histories and those charged to people with poor insurance scores. And Idaho legislators have passed a bill prohibiting carriers from charging a higher premium or declining to insure a person based primarily on credit history.

In Missouri, where state legislators are considering a bill that would stop insurers from using credit scoring as a sole criterion, the insurance department said people without a credit history are paying as much as double the insurance premiums they might otherwise because of credit-scoring practices. The department estimates that as many as one in 10 people don't have sufficient credit history to qualify for a credit score, said spokesman Randy McConnell. Those most vulnerable to high premiums because of credit scoring include Hispanics, Muslims, farmers, senior citizens and people who have experienced catastrophic events, such as a serious illness that resulted in astronomical medical bills, he said.

The Alliance of American Insurers wants insurance companies to come forward with accounts of their own experience "to prove that the vast, vast majority of people have very good credit and can benefit from this," said Lynn Knauf, AAI policy manager of property/casualty. "There's much concern over how credit information is being used, and companies consider much of their credit-scoring methodology to be proprietary But in several states, insurance commissioners have been willing to meet individually with companies just to have a discussion as to how credit scoring is used." The AAI, based in Downers Grove, Ill., represents more than 325 property/casualty insurers.

Benefit to Consumers

As many as 70% of policyholders benefit from use of their credit-based scores, but most don't know this, Annotti said. When he receives his homeowners renewal, for example, he can readily see on the deck page that he's saving 5% because he has dead bolts on his doors and another 5% because he uses smoke alarms. "But when I get my auto insurance renewal, on my deck page it never says that because I manage my finances adequately, I'm getting a discount or qualifying for their lowest rate or their preferred program," he said.

Although the controversy over insurance scoring has intensified in the past two to three years, some insurers started incorporating this tool into their underwriting in the early 1990s. Credit scoring fills a need for auto insurers that motor vehicle records often can't, said David Snyder, assistant general counsel for the American Insurance Association. "It's provided some predictability in identifying better risks vs. worse risks, which is hard to do, considering that most motor vehicle records are really very inaccurate," he said, noting that drivers often have violations and convictions removed from their records. "[Credit-based scoring is] highly correlated with risk, as highly correlated as any factor that they've ever used before."

Annotti attributes the current ground swell of opposition to a recent upsurge in insurance-score usage. "We were once able to say if you didn't like the fact that the company you applied to uses your credit-score rating, you can go around the block and shop in other markets," he said. "But the number of companies that are not using credit scores is continuing to diminish, because most companies find that in order to be competitive, they have to use credit-based insurance scores."

Lamont Boyd, solutions manager for Fair, Isaac & Co., the San Rafael, Calif., company that has developed credit-scoring formulas and pioneered their use by the insurance industry, said one reason for the upsurge in score usage may be that some large carriers have built their own models in recent years.

State Farm, the nation's leading personal lines insurer, is a case in point. The company has worked with vendor ChoicePoint to develop its own scoring outcomes through what it calls its Auto Underwriting Model. This model, which uses State Farm's own data, "takes into account certain credit characteristics--ones that through our own exhaustive research we have found most predictive of future auto insurance claims," said Dick Luedke, company spokesman. "We use this in conjunction with prior loss-history data, which tells us the claims-filing history."

Credit and Claims

The Auto, Underwriting Model, which is used in most states and can vary slightly state by state, helps State Farm identify risks with favorable loss experience, Luedke said.

"It is significant that we are combining credit characteristics and prior claims history for these models and that we have developed the models using our own book of business," a company statement said. "We believe the use of these models will lessen the extent to which those who represent higher potential risk are subsidized by those who represent lower potential risk."

According to a 2001 Conning & Co. study, 92% of the companies that accounted for 43% of the personal auto premium volume in 1999 use credit data in underwriting or rating, and more than half have been doing so since 1998.

Misuse and Misunderstanding

Wes Bissett, vice president, state relations and state government affairs, for the Independent Insurance Agents of America, links the growing turmoil to the way certain insurers have used credit-related information. Some carriers have begun to nonrenew sizable portions of their books of business based solely on consumer credit scores, he said.

"There are insurers that would identify a particular credit or insurance score, and if your score was above that threshold, they kept you, and if you were below the threshold, they dropped you;' he said. "It was this kind of pervasive, inflexible and exclusive use of credit information that has brought this issue to the forefront. Reasonable use of this information has never been a problem."

The AAI's Knauf chalks up much of the current conflict to widespread misunderstanding. "Many times, if we explain how companies are actually using this or what can actually go into a credit report, it makes a difference," she said. "For example, we've had a lot of concerns about income levels being considered, but that's not in a credit score. If we can get out there early in the process and answer questions, that really helps quite a bit."

Opponents are concerned that insurance scoring will have a disparate impact on people with low incomes because, presumably, they tend to have the worst credit histories. Knauf and others in the industry say this is all wrong, pointing to research that shows how people manage their bills has nothing to do with their income levels. "It really has to do with how much you finance, how much you overextend yourself and how sloppy you are about paying your bills on time," Knauf said.

Boyd of Fair, Isaac & Co., said his company's scoring methodology doesn't incorporate income or demographics. "Our models don't care how much money somebody makes; our models don't care where somebody even lives or what religion they are or what race they are," he said. "Our models only care about the way in which that individual--whoever they are, wherever they are--manages their credit responsibilities."

Regulators and legislators seem to think that an applicant with a poor credit score is immediately put on the "don't-write list" by an insurer, Annotti said. But he knows of at least one member company that, upon receiving a good or excellent credit score, will not do any more extensive underwriting because it trusts in the accuracy of that score. On the other hand, an applicant's poor credit score will trigger additional underwriting to see how that person can be written, he said.

"Our members have told us unequivocally that using credit-based insurance scores allows them to write more business among all segments of the population, and it allows them to price the business more accurately, because credit scores have been proven over the last decade to be an incredibly accurate predictor of future claims behavior, future losses," Annotti said.

Michael Trevino, a spokesman for Allstate Corp., echoed that sentiment. Allstate's use of insurance scores helps the nation's No.2 personal lines insurer charge a fairer rate for policyholders and make insurance more available, he said. Allstate has been using information in credit reports since the early 1990s, but it began using insurance scores only in 1999. "It's a more sophisticated tool," Trevino said. "This is just another factor used in ultimately pricing insurance products. It hasn't been implemented in place of something else."

That's the philosophy that many parties on both sides of the aisle can accept, agreeing that credit scores alone should not determine an underwriting decision. Fair, Isaac, for one, does not recommend that insurers rely solely on its formulas. "We've always said that the reason we built this set of models and the reason we made them available to the industry--and as a former underwriter I really appreciate this--was to give an underwriter an additional tool, one more tool to help them make better decisions," Boyd said.

And members of the AIA have told legislators that they can accept that approach. "They think the credit is entirely justified but are willing to work with public officials if that's something that the officials feel that they need," Snyder said. The association represents 412 insurers that write more than $87 billion in premiums each year.

Frustrated Agents

Some of the most vocal participants in this heated debate have been agents who say they're losing loyal customers. Bissett said the industry's use of credit information is clearly a valuable tool, and the HAA recognizes that. But agents have been frustrated by seeing "weird, counterintuitive anomalies" arise because of the overemphasis of credit, he said. "Different companies use credit information in completely different ways-some use it in very reasonable, very balanced ways, but others are a problem."

Often, agents find that these anomalies arise at renewal times. For consumers who have never been late on premium payments and have never had an accident or any kind of loss, a nonrenewal or the doubling or tripling of the cost of insurance leaves the agent scratching his head about the true benefit of credit information, Bissett said. By the same token, consumers become puzzled when told that their credit-based score has led to a nonrenewal. "They're left thinking, 'What exactly does that mean? What does this mysterious number have to do with my ability to drive safely or not have a loss in my home?"' Bissett said.

The IIAA doesn't question the industry's view that there's a correlation between insurance scores and the filing of claims. But it wants to see this information used in a balanced way. "It should be a factor among others in the underwriting process, and consumers should know when their credit information is being utilized," Bissett said. "When adverse action is taken against them, they should have some understanding of what steps they can take to improve their situation."

Insurers need to change their business practices so they use credit information in a consumer-friendly way, he said. Otherwise, they're likely to lose the power to have that information, as some of the proposed state legislation would decree.

Although the AIA expected the credit-based insurance-score controversy to heat up this year, it was surprised by the negative reaction of independent agents, Snyder said. He thinks, however, that the trade group's effort to communicate with agents is paying off. "Agents are beginning to understand more and more the importance of this to them," Snyder said. "The companies that they write for are in a market and are able to expand because they've got a tool like this to predict risk. So I think we're seeing greater understanding from the agents. But I think, frankly, early on some of the issues were agent-based."

The agents' critical view of credit scoring has opened a lot of companies' eyes to the need for better communications with their agency force, whether captive or independent, Annotti said. They have learned that they need to inform agents about the way credit-based scores are used and the value they bring to the vast majority of consumers, he said. Agents also need to know how to answer questions from consumers about what happens if their rates go up because of their credit scores and what they can do to make sure they're accurate, Annotti said. "I think insurers now realize that they have to do a better job in communicating that kind of information to a very important constituency -- the agents."

Ban the Ban

The worst-case scenario would be legislative or regulatory overreaction in the form of total bans on credit scoring for insurance purposes, Snyder said. Ultimately, he said, that would hurt the very people that are intended to be helped, the consumers. A ban could increase the insurance costs of drivers with good credit histories, since they would no longer be distinguished from drivers with poor credit histories.

Credit-based insurance scoring has brought more capital to the market, given consumers more choices and provided for less subjective, more individually tailored, rating and underwriting, Snyder said. "We think it's been good for consumers directly as individuals, because it's enabled responsible risks to have a greater variety of companies to choose from and different sorts of rating tiers to select," he said. "Under the old system, it was sort of pass/fail -- you either qualified for the insurance company's three subsidiary companies or you didn't and you ended up in the assigned-risk plan."

So far, he noted that legislation has been proposed but hasn't moved for total bans in several states. "We're working hard on this; we're totally focused," he said. "We're hopeful that these things will work out one way or another."

Although many legislatures have adjourned without acting on insurance-scoring bills, the trade groups' efforts are far from over. Eighteen state legislatures considered insurance-scoring bills in 2001, and 26 weighed them in 2002, with three voting for restrictions on this practice, Annotti said. "I think it's very likely that those 23 that didn't enact legislation will come back with at least a bill for consideration next year," he said. "And I think there are several states out of session, most notably Texas, where it is almost certain to be an issue in 2003."

But now insurers have received a wake-up call and will do a better job in the future of communicating the benefits of credit-based scoring, he predicted. The industry also will come up "with language that we can introduce that seeks to regulate the use of credit scores fairly, to make sure that they're not the sole factor in underwriting, to make sure they're used in combination with other factors, to delineate how they're used between underwriting and rating, and new business and renewals," he said.

That would be all to the good, in Bissett's view. He thinks insurance companies need to step up to the plate if they want to preserve this valuable underwriting tool. "It's as simple as that: The fate of insurance scoring -- credit scoring-lies with the companies," Bissett said. "They're in the position to take the steps necessary to preserve its use in the future. But right now, policyholders and policymakers are extremely skeptical."

RELATED ARTICLES: Insurers Address Flurry of Insurance-Scoring Legislative Initiatives

The movement to limit insurers' use of credit-based insurance scores has spread to more than 40 states. In some cases, multiple proposals have sprung up, with recommended actions ranging from total bans on using credit history for insurance purposes to consumer notification if companies apply this method.

Against this backdrop, a working group of the National Association of Insurance Commissioners is gathering information and comments from interested parties as it considers whether a model act or regulation is needed to address insurers' use of credit information. The Credit Scoring Working Group held its first meeting in March during the NAIC's Spring National Meeting in Reno, Nev. If it decides a model is needed, it expects to have one ready for presentation to the NAIC's Winter National Meeting in San Diego in December.

Insurance agents have been recognized as the group that brought the issue to the attention of regulators. "Credit can be valuable for underwriting, but it can't be misused or overutilized," Wes Bissett of the Independent Insurance Agents of America told the working group.

Several independent studies have established an "undeniable correlation" between a person's credit score and the likelihood that he or she will file an auto or homeowners insurance claim, trade groups say. Members of the National Association of Independent Insurers report that using insurance scores enables them to charge lower premiums because of favorable scores, meaning those customers do not have to subsidize drivers who are likely to have more accidents.

Regulators say the impetus for states to seek restrictive legislation arises from the stories of consumers who have been harmed somehow, whether through denial, cancellation, nonrenewal or sudden and large price increases in their policies.

The NAIC working group also has been hearing from insurance advocates who want to make sure they are included in the process so they can provide information on why insurers see credit scores as a valuable tool.

"We're trying to deal with the informational and educational issues," said David Snyder, assistant general counsel of the American Insurance Association. "We're also working to see what the real problem areas are that we can work with the regulators and legislators to address."

The trade organizations saw this trend developing many months ago and have joined forces to speak to the concerns that legislators, regulators and agents have voiced, sald Lynn Knauf, policy manager of property/casualty for the Alliance of American Insurers.

So far, Snyder noted, the strategy has proven fairly successful on a state-by-state basis.

"We've given some ground in the process, and that seems to have resulted in some fairly effective compromises that address the greatest complaints that the com missioners are seeing," he said. "At the same time, this will preserve insurance scoring as the important pro-competitive and objective factor that it is for rating and underwriting purposes."

In 2001 and so far this year, several states have pursued a variety of approaches to control the use of insurance scoring for underwriting and rate setting:

* In Florida, a task force unanimously recommended in March that credit information should not be the only factor insurers use to determine coverage and rates. Florida Insurance Commissioner Tom Gallagher appointed the eight-member task force, which included legislators, consumer advocates, insurer and agent representatives and citizens. The task force also called for an investigation into the relationship between insurers' use of credit information and risk of loss.

* Earlier this year, Idaho legislators approved a bill stating that insurers may not base underwriting and pricing decisions "primarily" on credit-history information.

* Alaska, Indiana and Missouri have considered bills to limit or ban the use of credit-based insurance scoring as a sole criterion for deciding a premium rate.

* In New Hampshire, the state insurance department's new regulation for using credit-based insurance scores in underwriting will require insurers to file the credit-scoring model with the department for approval before they can use it, according to the NAII. The regulation also requires insurers to notify consumers when using insurance scoring--an unnecessary roadblock at a time when most states are trying to streamline regulation, Gerald L. Zimmerman, NAII senior counsel, said in a statement. But an earlier version of the rule required a written authorization from the consumer for an insurer to use an insurance score. That was removed, which "significantly" improved the regulation, the ALA said, especially in regard to insurance shopping conducted over the telephone.

* Virginia lawmakers were considering a bill, then decided not to move it so long as the industry did a better job of working with agents and helping them understand the issues so they could better communicate them to customers, Snyder said.

In fact, reaching out to agents about the use of insurance scoring is a top priority with the trade groups and individual insurance companies, he said.

Agents felt "they had a lack of information about what the companies were doing and why they were doing it," Snyder said. Now the question is whether these issues can be addressed by companies in the marketplace or if they will have to be dealt with through regulation or legislation. If it's the latter, Snyder asked, "how do you do that but at the same time not create a lot of unintended negative effects--the kinds of things that would happen if you were to remove a fairly accurate rating factor like credit?"

Insurance Scores Predict Potential for Loss

The people at Fair; Isaac & Co. are careful to point out that credit-risk scores and credit-based insurance scores are two different animals.

Credit-risk scores predict the likelihood of future delinquency on credit accounts, something that a mortgage lender, for example, would want to know

But credit-based insurance scores are generated from credit variables that aim for a different assessment. "They predict the potential for future loss-ratio relativities," said Lamont Boyd, solutions manager for Fair, Isaac, a leading developer of credit-scoring formulas, "So it's loss expectancy as opposed to credit-worthiness."

Insurance companies say several independent studies show a strong connection between an individual's insurance score and the likelihood of filing a claim. One theory for this is that people who are financially responsible also tend to act responsibly in other areas of their lives and have fewer accidents.

Insurance scores are based on information from consumer credit reports compiled by three major credit bureaus: Equifax, Experian (formerly TRW) and TransUnion. When an insurance company decides to use a Fair; Isaac model, it has to access it through one of those three major credit-reporting agencies, Boyd said.

Currently, about 375 insurers use the statistical models that Fair, Isaac began to market in 1993. When the company started to develop its mathematical formulas for the insurance industry, it looked at roughly 130 elements that were available on every credit report. But then, analysts narrowed down those elements to the 15 to 30 characteristics that the analysis revealed were really predictive of future loss ratio and incorporated only that number into the models, Boyd said. These characteristics include numbers of delinquencies and how recently they arose; the presence and numbers of collections, liens, foreclosures and bankruptcies; the types of credit accounts that an individual maintains; and the balances carried on those accounts relative to the limits available. The model also takes into account the number of consumer-initiated inquiries, an indication that the individual is seeking more credit.

"The score allows the insurance company to not have their agents and underwriters look at consumer credit reports," Boyd said. "From a privacy standpoint, we believe that consumer credit reports don't need to be in the hands of so many people."

Boyd said that Fair, Isaac already is witnessing the impact of the backlash against credit-based insurance scoring, with many insurers contacting the firm to ask how they can better use these models, given the new restrictions in some states.

"We help them try to understand what the state is trying to say," he said. "If necessary, we may have to revise the models for that particular state and then say these are the models that meet the needs of that state." The company already has made revisions in models used for policyholders in Indiana and Connecticut, where authorities have excluded use of certain variables from the formula.

Such changes can be difficult to make, Boyd acknowledged. "The real problem is that the vast majority of consumers benefit from the insurance industry's use of our models, because the vast majority of people manage their credit well, the vast majority of people then score well, and that means that the vast majority of people are getting preferred treatment by insurance companies," he said. "What happens when you create some problems for the models--meaning you have to eliminate variables that happen to be very, very good variables from a predictive standpoint--is you're diminishing the power or the ability of those models to help the majority of people."

Consumer-Friendly Approach

Amid the controversy over credit-based insurance scoring, a leading insurer has pledged to follow a new policy on the use of credit information in a move that has won the endorsement of a major agents' group.

Progressive Group, the largest writer of auto insurance through independent agents and the fourth-largest auto insurer in the United States, has implemented the following:

* a ban on using credit scoring to refuse, cancel or non-renew coverage;

* a ban on using disputed information in its credit formula;

* elimination of certain elements from its scoring formula, including nonconsumer-initiated inquiries;

* periodic reviews of consumer credit information and rewriting only when the benefit is to the consumer;

* sharing with consumers of specific information that explains how credit data adversely affected their underwriting;

* an exception process for consumers whose credit data is unduly influenced by extraordinary life events; and

* filing its credit-scoring model where required or encouraged by state regulators.

The company also has established a toll-free phone number for consumers and agents to assist them with concerns about the credit process.

"Using credit as an underwriting factor has allowed Progressive--and our agents--to offer more accurate and lower rates to more people," the company said in a statement. "Since Progressive began using credit, we have been able to offer standard and preferred-rate levels to many consumers who otherwise would have been eligible only for nonstandard rates."

Frequently, the company said, consumers unable to meet traditional underwriting guidelines are able to get a better rate because credit is a component of the underwriting process. "In fact, two out of every three Progressive customers countrywide have a lower rate than would be the case" if the company did not use credit, its statement said. "It is a powerful tool that allows Progressive independent agents to compete effectively with captive agents and direct writers."

Wes Bissett, vice president, state relations and state government affairs, for the Independent Insurance Agents of America, said his organization hopes more companies will follow Progressive's example. "They've really made it clear that they're going to use credit in very consumer-friendly ways, and they've come up with a list of principles that they're going to abide by."

While Progressive points out that the use of credit in underwriting and rating is expressly permitted under the Fair Credit Reporting Act, it says it is committed to working with state legislators and regulators "to find common ground that results in reasonable regulation of the use of credit."

On another front, a company that builds scoring models for the financial-services arena, including insurance companies, is providing online help for consumers who want to improve their credit scores. In March 2001, Fair, Isaac & Co. launched myfico.com, a Web site that gives consumers access to their Fair Isaac, or FICO, scores, based on its own mathematical formula. The service is provided in partnership with Equifax Inc., the Atlanta-based credit-reporting company.

For a fee, consumers who buy the basic service receive a copy of their Equifax credit report and Fair, Isaac's explanation of what the score means and how key variables are influencing it.

This spring, the company was scheduled to introduce a new feature--a simulator or online calculator--to allow consumers to explore, in a theoretical way, how changes in seven key variables might affect their FICO score. For example, the simulator would show any changes in score results if the consumer opened a new credit-card account or wanted to pay down credit-card balances Another new service will allow people to monitor their credit report and credit score for early indications of identity theft and fraud.

"The intention behind all this is obviously to help give people better guidance for improving the way they manage credit today, so that they will be able to do more things with credit in the futre. They'll be able to establish healthier credit relationships," said spokesman Craig Watts.

Fair, Isaac estimates that the market for these services would be from $500 million to $1 billion a year, for starters, Watts said.