Parting Shots: Missing Perspective in Missouri

February 23, 2004

Property and casualty insurers’ use of credit information in underwriting and pricing automobile and homeowners insurance conforms with federal and state law and the fundamental principle of fairness that rates should correlate with risk.

Nothing in the recent Missouri Department of Insurance study demonstrates or even suggests otherwise, yet the governor has called for a ban on the use of credit. Because the study ignores the essence of underwriting and rating—differentiating risk and pegging premiums to expected losses—this is radical policymaking supported by incomplete analysis.

The Missouri study does not evaluate or even consider the actuarial benefits of credit scoring models. Yet it concludes that carriers’ use of credit information causes an unfair, “disproportionate impact based on the minority status of individuals and individual’s family income.” In fact, the study had no access to policyholders’ ethnicity. Rather, it assumes that a purported relationship between credit scores and ZIP code data should be assigned to ethnic status based on ZIP code demographics.

The study argues that its statistics “possess broad implications for important public policy issues” because “federal courts, as well as statutes in many states, restrict or prohibit the use of geographic area as a rating or underwriting factor in personal lines. … In fact, nonminorities have been recognized in both lending and insurance litigation as possessing an actionable claim if they are harmed by business practices with negative consequences associated with the racial composition in areas in which they reside.”

These legal assertions are misleading at best. Missouri law allows substantial use of territory as a rating factor. Territory is a nationally accepted rating tool; traffic and crime patterns around a consumer’s residence substantially affect the likelihood that she will file a claim.

Furthermore, to bolster its claim about the law governing “business practices” and “racial composition in areas in which [consumers] reside,” the Missouri study cites a 1994 U.S. Seventh Circuit case which turned to a previous decision of the same court, NAACP v. American Family Mutual, for rules to evaluate allegations of “redlining.” American Family, however, belies the study’s claims about the legal standards pertaining to geography.

The American Family court analyzed the case as if “the plaintiffs can establish that the defendant intentionally discriminates on account of race.” But no such allegation of intent is present in the Missouri study, nor could it be, since the state (and presumably the companies) did not know the ethnicity of individual consumers in the survey. American Family is particularly instructive because its premises about insurance, which stress the importance of properly evaluating risk, are absent from the Missouri study.

The court explained that “insurance works best when the risks in the pool have similar characteristics. … Auto insurance is more expensive in a city than in the countryside, because congestion in cities means more collisions. … Risk discrimination is not race discrimination. … [C]lassification of risks is important to insurance, and assigning higher rates to greater risks differs from assigning rates by race.” …

Editor’s note: To read the rest of this story, see the Feb. 23 issue of Insurance Journal Midwest, which covers Ohio, Michigan, Indiana, Wisconsin, Illinois, Missouri, Minnesota, Iowa, North Dakota, South Dakota, Nebraska and Kansas. Nathaniel Shapo is the former insurance director of Illinois and now a partner in the insurance regulatory group of the law firm Sonnenschein, Nath & Rosenthal.

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