Nevada Consumers Puzzle over Using Credit History to Set Rates

July 5, 2007

As Ed Rathje sees it, his first foray into the Nevada Legislature as a citizen-activist ended in “total defeat” earlier this month when a bill he was pushing to limit the insurance industry’s use of credit histories to set rates was “incredibly watered-down.”

The insurers’ scoring models are “a credit electronic Ouija board,” Rathje, a Reno flight instructor, had told lawmakers, and should be banned until insurers agree to make their models more transparent.

Instead, the Nevada state Senate shot down a bill that would have banned insurers from considering the opening and closing of accounts when calculating “insurance scores,” and replaced it with a requirement that insurers provide more information when credit adversely affects insurance rates.

For consumer advocates around the country who share Rathje’s goal, that one-line change in law may be one of a very few successes in 2007.

“I was stunned that we couldn’t move that bill,” said Nevada Assemblywoman Debbie Smith, D-Sparks. “I was trying to hone in on one piece of (insurance scoring), that I thought was outrageous.”

Some type of scoring is used by most insurers, especially for homeowners’ and auto policies. Insurance scoring in its modern form has been used for more than a decade, but political resistance to it got charged up several years ago, when the practice became widespread.

Insurance scores are created when companies run a consumer’s credit history through a computer model that extracts certain criteria, such as when the first credit card was issued, or how many accounts were recently opened.

The results are used to estimate the risk that someone will file a claim and can dramatically change rates. Rathje’s rates more than doubled over a two-year period.

Exactly what the criteria are, and how they are weighted, is proprietary information that insurers are loathe to divulge.

Nevada regulators are moving in for a closer look at the industry’s arcane algorithms, reflecting continuing discomfort with the increasingly complex “insurance scoring” models, which consumer advocates have said leave people confused about how to improve their rates.

But a review of this year’s legislative action shows that insurance scoring has become at least entrenched, if not quite welcomed.

This year, lawmakers in more than 20 states introduced proposals to either ban or limit insurers’ use of credit information to set rates, calling the practice unfair, nonsensical, and possibly discriminatory.

Nearly all those proposals have died, or appear stalled in committees.

Last year, Oregon voters rejected an initiative, strongly opposed by insurance companies, to ban insurance scoring.

From Missouri and West Virginia, where legislatures let a dozen bills on the issue die in committee, to New York, where a lawmaker’s proposals to ban insurance scoring have failed every year since 2003, insurance companies flexed their considerable political muscles to protect a tool that has become an industry standard.

“The insurance industry is a very powerful interest in the state capitol,” said New York Rep. Jim Hayes, the bill’s sponsor. “They don’t seem to know why (insurance scoring) exists. But they certainly are willing to use it to charge higher premiums to customers.”

Insurance lobbyists say credit histories strongly correlate with a tendency to file more claims. Taking credit into consideration is fair, and lowers rates for most consumers, who have decent or better credit, they say.

“Over the last three or four years, this issue has kind of calmed down,” said Sam Sorich, a vice president with Property Casualty Insurers Association of America, an insurance industry trade group. “More and more consumers now understand that their credit will be considered. There’s a growing acceptance of it. Frankly, most people are helped by the fact an insurance company is using credit.”

Robert Hunter, who follows the insurance industry for the Consumer Federation of America, says the issue is far from dead. But he concedes it’s less widely debated today than a few years ago when more than 40 states were debating the issue every year.

That’s partly because about half of the states have adopted a 2003 model law proposed by the National Conference of Insurance Legislators, or NCOIL.

The model law prohibits companies from ‘”solely” using credit information to set rates. Proponents of stiffer legislation say the model law doesn’t do much because insurers prefer to also consider other, noncredit data anyway.

“I think the NCOIL model really snuffed out a lot of the activity,” Hunter said. “It gave the legislators a way to look like they were doing something without offending the insurance companies.”

Some states have gone further, adding restrictions, including Washington and most recently Delaware, where insurance companies can apply credit models to only new customers.

In 2002, Maryland became the first state to ban insurance scoring for homeowners’ premiums. Hawaii doesn’t allow scoring for homeowner’s insurance either, and regulators in California and Massachusetts don’t let companies consider credit when setting auto insurance rates.

Congress ordered the Federal Trade Commission to study the issue of credit-based scoring in 2003, and whether it discriminates against minorities. That study was due out last year but stalled. An FTC spokesman said it should be out this summer.

Insurers say that scoring models are not only race-blind, but income-blind, a provision that can throw customers like Rathje for a loop. Since they look at how you manage credit, even individuals who have high incomes but are sparing with credit sometimes don’t get the best ratings.

Early concerns that the models discriminate are giving way to a simpler question that consumers, regulators, and even many insurance companies find themselves in the dark about — how do the models work, and why?

Studies done by insurers and a few independent studies show a correlation between some credit information and a tendency to file more claims.

“The relationship is there, and the relationship has been verified,” Sorich said. “Why that exists, we’re not quite sure.”

Under federal law, insurers must give some explanation whenever they give a lower rate because of a customer’s credit.

Insurance companies find themselves caught between legal disclosure requirements and political pressure to tell their customers more about the systems, and wanting to protect the competitive advantage they believe they get from their model.

Smaller insurance companies often hire third-party vendors to provide them with insurance scoring models, and their agents don’t always have deep knowledge about how the systems work. Fair Isaac, the company that created the credit score, is a major vendor of insurance scoring models. Larger companies can afford to create their own models, which they believe give them an edge over competitors.

During hearings on the Nevada bill, a lobbyist for State Farm insurance told a panel of lawmakers that his client had spent millions of dollars on a credit-based insurance scoring system for one simple reason — it works.

That answer hasn’t been good enough for consumers like Rathje, who began his crusade against insurance scoring after his auto insurance company of more than 40 years raised his premiums dramatically.

That prompted the 64-year-old engineer to get his first-ever credit report, which he found riddled with errors. Among other things, the report stated he had a spouse named “Steve,” and that his Reno apartment was a military base. Rathje, who had divorced long ago, has a son named Steve, and has never been in the military.

He was able to repair his credit report, but not his insurance score. State regulators were alarmed that it took an extraordinary time and effort for a consumer as stubborn and well-educated as Rathje to understand his own insurance rates.

“He could explain it in a way that got everybody’s attention,” said Charles Knaus, lead actuary for the Nevada Division of Insurance. “You have a very intelligent man who could not sort through his record with his insurance company and see what was wrong.”

Knaus said state regulators are going to take a closer look at the scoring models, which are more complicated than the kinds of statistical analysis regulators typically use. He hopes the new Nevada law will allow regulators to end the sometimes vague explanations given to consumers about why they didn’t get better rates.

“It’s a matter of how far statistical correlation should go in determining things that may not have common sense appeal,” Knaus said.

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