Credit risk scores could give insurers competitive advantage, and a development plan is the way to begin.
With little or no increase in personal lines premiums, carriers struggle to remain profitable in one of the most competitive markets in recent memory. Many carriers look at their internal processes and attempt to lower costs and improve efficiencies. Carriers also look to improve their rating plans, as competitive, profitable rating plans are essential in today’s market. One area of the rating plan getting a lot of attention is credit risk scores. Carriers, especially the personal passenger auto writers, are investing in improving the predictive contribution of credit risk scores.
There are generally two types of credit scores that are used in the insurance industry: generic and custom. Generic scores are built by the credit reporting company or a third-party scoring company. The score builders enlist the participation of a group of carriers who submit their policy and claim experience. Historical credit information is obtained and a score is created. A custom score uses the policy and claims data of a single carrier, and builds a score tuned to best predict the risk of that carrier’s applicants. The movement from generic scores to custom scores is a growing trend in today’s market.
ESSENTIAL DESIGN
Most carriers begin the process with a goal of building a score that improves pricing variations over the current generic score. As a result, the first considerations in building a custom score are usually technical.
Unfortunately, many carriers don’t consider the design of the score, which has a significant impact on its acceptance by three very important groups: agents, consumers and regulators. The design also can have a dramatic impact on the effectiveness of its use in the carrier’s business process. A poor design can increase the administrative costs of using it. The design may also influence the technical considerations.
Most regulators realize that when properly used, credit scores will contribute to rates that are fair. Many recognize scores will increase competition among carriers, resulting in increased choice for consumers.
Carriers should be prepared to fully disclose the new score to regulators. Regulators expect credit score users to be forthcoming about the content and expect the scores to be understandable to a non-insurance or non-credit expert. A well-designed score will be more readily accepted by regulators and will improve the rate filing process.
As a part of the overall score development plan, carriers should create a roll-out program and educational materials for their agents. Agents require the information necessary to speak to applicants and customers about credit scoring at a high level. They should have a general understanding of the data used in the score and how it impacts the rating plan, and know the discounts and surcharges that are used with the score. This will further enhance the agent’s position with applicants and make them more valuable to all policyholders.
One of the most important considerations in the actual design of the score is the data that will be used. Raw credit information must be summarized before it can be used in scores. These summaries are called attributes. Carriers can attempt to create their own attributes or obtain existing ones from the credit reporting company. Many existing attributes were built to predict financial outcomes. They tend to group credit data that has similar predictive value, for example, “presence of a lien, judgment or bankruptcy.”
Blended attributes can be confusing to consumers, and difficult to explain to regulators. Insurance companies should build or use attributes that are singular in nature. If a carrier is using the credit reporting company’s characteristics, it needs to ensure the characteristics were created specifically to predict insurance outcomes, and were designed to work within the insurance regulatory environment.
When building attributes, carriers should focus on information that requires consumers make a substantive change in their financial management for improvement. This leads to scores that are more stable over time.
FACTORING IN THE SCORE
All risk scores contain score factors. Score factors are descriptions that explain the underlying credit information that most impacted the score outcome. Older scores used general factors. Some were as simple as “recent delinquency,” but these factors created more questions than they answered, driving up administrative costs.
Carriers building custom scores should design score factors that are meaningful to consumers. The factors should communicate specifically what data was used, and describe what action by the consumer would improve the score and provide the optimal performance level for the attribute.
Michael Gaughan is VP of the insurance group for Chicago-based TransUnion.
To learn more about the credit score debate search “NAMIC Opposes Credit Score Ban” at www.insurancenetworking.com.
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