Credit Scores for Insurance Applications

Now that FICO risk scores are being disclosed to borrowers to help them understand how the market assesses their creditworthiness, the next challenge appears to be convincing consumers and regulators that such scores are valid for insurance transactions. The use of credit scores by insurance underwriters is widespread but poorly understood by the general public. Consequently, it is fast becoming a regulatory and legislative issue.

Insurance companies have found a powerful statistical correlation between a person's credit history and the likelihood of filing a claim on their automobile or homeowner's insurance policy. The Fair Credit Reporting Act recognizes the evaluation of insurance applications and pricing as a permissible use of credit bureau data. Fair, Isaac and Co. began selling specialized scores for insurance purposes 10 years ago, but only in the past five years has the majority of property insurance companies adopted them as part of their underwriting procedures. The companies claim that premiums are reduced for about 70% of policyholders as a result. Fair Isaac encourages companies to tell such customers that they are getting a "financial responsibility" discount as a consequence of their good credit record.

Of course, some consumers must be paying more based on their poor credit history. Lamont Boyd, manager of insurance products for Fair, Isaac, told the American Banker that the use of credit data to predict insurance risk is "less intuitive" than using the data to predict creditworthiness. Yet, the statistical correlation is undeniable.

According to the Insurance Information Institute in New York, more than 20 state legislatures have considered restricting the use of credit bureau data for insurance purposes so far in 2002. Michigan became the latest example, when the attorney general in September petitioned the state for a formal hearing into the legality of using credit scores to set auto and homeowners insurance premiums. The National Association of Insurance Commissioners is considering whether to develop a voluntary standard for insurers to follow in using credit data.

Frank Fitzgerald, the Insurance Commissioner for the state of Michigan, told the American Banker that "from all the information we've received thus far, there does appear to be a correlation between a consumers' credit score and the odds that he or she will file a claim." He added, "The question is whether or not it's a fair correlation, although why there is a predictive link is not something that has to be answered to be legal."