Section G Regulation of Insurance: Credit-Based Insurance Scores

Question 1

What constitutes a credit-based insurance score?

Answer 1

• Rankings assigned to an insurance risk based on that risk’s underlying characteristics
• Common purpose to produce useful information in underwriting and pricing insurance
• Provides a relative measure of the expected cost of the risk
• Uses items found in a typical individual’s credit report, such as number of inquiries into opening new accounts and accounts 30 days or more past due

Question 2

Describe how insurers use credit based insurance scores

Answer 2

• Some insurers use to determine whether to accept or reject a risk
• More commonly used to segment risks into homogenous groups for rating
• • May be used directly as a rating factor (risk classification factor)
• • May be used to assign risk to appropriate tier

Question 3

Briefly describe why credit scores are a statistically reliable tool for segmenting risks with different expected costs:

Answer 3

There is a strong correlation between insurance scores and expected costs associated with the risk

Question 4

Briefly describe two ways in which credit scores can be used to segment risks into homogenous groups for rating:

Answer 4

• May be used directly as a rating factor (a.k.a. risk classification factor)
• May be used to assign risk to the appropriate tier

Question 5

According to Kucera, what is the effect on premiums of not using credit-based insurance scores?

Answer 5

It will not lower overall insurance premium, but redistribute charges

• Risks with lower expected costs will pay more than actuarially fair
• Risks with greater expected costs will pay less than is actuarially fair

Question 6

What were the concerns about how the economic crisis would affect overall insurance costs and prices

Answer 6

Some regulators concerned that if insurance scores worsen, it will lead to unwarranted premium increases

Question 7

Explain why a distributional shift is likely to have a smaller effect on renewal business

Answer 7

Some states/ companies only allow use of scores for renewals if it reduces insured’s premium

Question 8

Argue for and against the use of credit- based insurance scores in personal lines insurance

Answer 8

Proponents

• Scores are predictive of an insured’s future claims experience
• Necessary tool for underwriting and/or rating

Critics

• Example of imposed discrimination against lower income individuals and protected classes of people
• Studies show use of scores disparately impacts certain classes of people

Question 9

Two classes of people adversely impacted by the use of credit scores in insurance:

Answer 9

• Lower income individuals
• Protected classes of people

Question 10

List four weaknesses in the credit reporting system

Answer 10

• 2000 study by Consumer Reports showed 50% of credit reports contained errors
• Identify theft leads to invalid information on reports
• Excessive access to credit as evidenced by the problems in the mortgage industry
• Credit reports disproportionately negatively affect certain parties

Question 11

List some parties disproportionately negatively affected in the credit scoring process

Answer 11

• Recent divorces
• Recently naturalized citizens
• Elderly
• Disabled
• Those with certain religious convictions
• Younger individuals who have not established credit histories

Question 12

Explain how a downturn in the economy could impact different segments of the population

Answer 12

It could potentially magnify differences in credit scores among vulnerable populations

Question 13

According to empirical data, is there a relationship between the credit score and frequency or severity of claims:

Answer 13

No significant difference in magnitude of claims, only frequency: Consumers with lower credit scores file more claims

Question 14

Provide a reason that the consumers with low credit scores file more claims:

Answer 14

Possible that frequency of insured loss events is the same across populations but that those with higher scores are less likely to file a claim

Question 15

The Florida Legislature limited use of credit based scores in 2003 for PPA and HO. List the four legal challenges that insurers used to oppose these limits

Answer 15

• FL Office of Reg didn’t have the authority to prevent use of credit scoring as underwriting/rating tool
• Office did not have authority to define term “unfairly discriminatory” as in statute
• Insurers didn’t have necessary data to demonstrate effect of credit scoring on protected classes
• Definition of “disproportionate impact” was too vague

Question 16

How did the judge respond to the four legal challenges that insurers used to oppose the limits imposed by the Florida legislature?

Answer 16

Judge ruled against all but the last. He did agree that “disproportionate impact” needs to be defined more comprehensively