In the Matter of Insurance Credit Scoring Practices—Update to Bulletin 2003-01-INS

Issued and entered this 13th day of May 2003 by Linda A. Watters Commissioner

Introduction

Insurance credit scoring is problematic at best. Perhaps no other widespread practice of insurers presents so many technical and social issues. Consider the following:

• Credit scores are grounded in credit histories that are compiled by credit reporting agencies. According to a study by Consumers Reports, there are serious errors in approximately 30 percent of those files.
  
• There are three main credit reporting agencies. They do not all receive information from the same sources. Due to this, according to a recent study, an individual’s insurance credit score may vary by as much as 40 points depending on the credit reporting agency from which an insurer obtains the score.
  
• Even where the credit history is the same, there may be substantial differences in an individual's insurance credit score depending upon which insurance credit scoring company is used.
  
• Insurers determine an individual’s discount by seeing where the credit score falls in its discount tiers. Some insurers have only two or three tiers. One has 46. Some insurers have maximum discounts of 10%. Three insurers have maximum discounts of 70% or more.
  
• The discounts drive up base rates. All policyholders are subject to these fundamental increases. This has the appearance of a surcharge on persons with low insurance credit scores, which is not allowed for automobile and home insurance sold on an individual basis.
  
• Discount plans on insurance sold to persons on an individual basis are only allowed where they reflect reasonably anticipated reductions in losses or expenses. Insurers have not demonstrated such reductions.
  
• The connection between a credit history and insurance losses is not understood. Consumers are justifiably wary of a system where a large amount of the premium they pay is determined by seemingly unrelated factors, such as whether they use department store credit cards.
  
• Some responsible credit management conduct, such as changing from a high interest credit card to a low interest credit card, may lead to lower insurance credit scores. This is because some systems treat frequent changes in accounts negatively.
  
• Despite the crucial importance of an insurance credit score to the determination of discounts, almost universally insurers do not disclose the credit score to an applicant or policyholder.
  
• Despite having access to key factors that led to a lower score, almost universally insurers do not disclose these factors to an applicant or policyholder.
  
• Many insurers fail to comply with requirements in federal law for giving applicants and policyholders notices of adverse actions based upon credit histories. As a result, consumers do not know why their premiums are high and that they may obtain a free copy of their credit reports so that they may find and correct errors.
  
• Some studies indicate that the use of insurance credit scoring has a disproportionate, negative impact on young, old, and low-income persons and minorities.

Such considerations led Governor Granholm to call for a ban on the use of insurance credit scoring altogether. In February, two bills were introduced that would ban the use of insurance credit scoring in the rating of automobile and home insurance. One would ban its use for insurance sold to persons on an individual basis. The other would ban its use for insurance sold to persons on either an individual or group basis.

If a ban cannot be achieved, at least significant reform legislation is imperative to protect the interests of consumers on such an important matter as the amount they pay for automobile and home insurance. This agency will be fully supportive of the Governor in these matters.

In the meantime, it is incumbent upon the Commissioner to make the most of current law in addressing the concerns above. Bulletin 2003-01-INS was designed to conform insurance credit scoring practices to Insurance Code requirements. A revision to the Bulletin and clarification as to the Fair Credit Reporting Act will advance the consumer protection objectives underlying the Bulletin.

Periodic Rescoring

The third directive in the Bulletin provides:

3. Companies using an insurance credit scoring discount must recalculate and then apply an insured's insurance credit score at least once annually.

This approach was taken to promote rate accuracy. As insurance credit scores age, they become less predictive of losses. Without periodic rescoring, rates may become unfairly discriminatory in violation of MCL 500.2109(1)(c). Periodic rescoring also brings about fairness in rates in another sense: policyholders whose scores have substantially improved will receive the higher discounts they deserve.

An improved, alternative approach is available to achieve the same consumer protection goals. Under this approach, rescoring is required only at the request of the policyholder. This avoids the expense of routinely rescoring individuals where little or no change has occurred. It lets a policyholder who has reason to believe his or her score has improved to seek a discount, if not yet receiving one, or a higher discount. It avoids subjecting policyholders to the potential loss of discounts each year.

In light of this, the third directive in the Bulletin is revised to read as follows:

3. At the request of an insured, a company using an insurance credit scoring discount must recalculate and then apply the insured's insurance credit score at least once annually.

This alternative will work well only if the policyholder has sufficient knowledge about his or her insurance credit score and discount tiers to make an informed decision. This underscores the importance of the seventh directive from the Bulletin:

7. Companies using insurance credit scoring must annually inform their automobile and homeowners policyholders or applicants of the credit score used to apply an insurance credit scoring discount, and the discount tier in which the insured or applicant is placed.

Most insurers rely on ChoicePoint or Fair, Isaac for insurance credit scores. These insurers receive or have access to factors that were the primary influences that adversely contributed to a given score.

Insurers are strongly encouraged to notify consumers of these factors in clear and specific language. This will place consumers in a better position to know whether to ask for rescoring. For example, under one system, a late payment is no longer taken into account after 24 months. This would be one factor to consider at renewal by a policyholder whose old, late payments are no longer being taken into account.

In the long run, consumers will also be able to achieve lower premiums by improving their credit management practices. This benefits companies as well as policyholders, for lower premiums promote policyholder retention.

Insurers will need to make changes to basic systems to put annual rescoring upon request into effect. This will include making changes to annual notices. Reportedly, many insurers will be able to make these changes within two months.

Accordingly, the Commissioner expects insurers to achieve compliance with the statutory authority underlying the third and seventh directives by July 1, 2003, or as soon thereafter as practicable.

Notices of Adverse Actions

While not a directive in the Bulletin, insurers were reminded of their responsibilities under the Fair Credit Reporting Act as follows:

To further compliance with the federal Fair Credit Reporting Act, under which states may bring enforcement actions, insurers are reminded that the Act requires them to inform applicants and policyholders of any “adverse action” stemming from the use of credit histories in the rating or underwriting of insurance. As interpreted by the Federal Trade Commission, an adverse action occurs where an applicant or policyholder is placed in any rating tier other than the one that would produce the lowest premium.

Information contained in credit histories is used by lenders in deciding to make loans, by employers in making hiring decisions, and by insurers in deciding to underwrite coverages and the price of those coverages. In light of the crucial importance of these decisions, Congress passed the Fair Credit Reporting Act to promote the accuracy of the information assembled by credit reporting agencies.

A key element of the Fair Credit Reporting Act is that users of credit histories, including insurers, must give notice to a person where an adverse decision is made based upon information in a credit report. The person is informed that he or she has the right to obtain a free copy of the credit report and may challenge and correct wrong information.

Based upon the reminder set forth above, some insurers were apparently concerned that OFIS would try to bring a compliance action against them under the Fair Credit Report Act. However, enforcement and interpretation of the Act rest largely with the Federal Trade Commission. Additionally, the chief law enforcement officer of each state is authorized to bring actions under the Act. In Michigan, that is the Attorney General.

Therefore, the Commissioner’s role will be to turn over accurate information respecting the lack of required notices to the state Attorney General or the Federal Trade Commission. Those officials will decide whether to bring enforcement actions.

Submitting this information will promote insurer compliance with the notice requirements of the Fair Credit Reporting Act. A given insured may be paying hundreds of dollars in premiums each year based upon incorrect information in his or her credit history. A notice of adverse action lets the policyholder know the cause of the high premium and gives the policyholder a chance to correct his or her credit history.

By reporting information to the state Attorney General or the FTC, OFIS could be instrumental in bringing the benefits of the Fair Credit Reporting Act to insurance consumers in Michigan.

Any questions regarding this bulletin should be directed to:

Office of Financial and Insurance Services
Division of Conduct Review and Securities
Product Review Unit
611 West Ottawa Street
P.O. Box 30220
Lansing, Michigan 48909-7720

Phone: (517) 373-4948
Toll Free: (877) 999-6442