The stories are disconcerting. A 32-year-old secretary who always pays her premiums on time receives a renewal notice from her insurer that her rates are being raised 46% due to her credit. She discovers that her ex-husband's bankruptcy is to blame.A 65-year-old Hispanic-American man who has filed only one insurance claim in 26 years is told by his agent that his premiums are increasing 25%. Convinced that his carrier has discriminated against him, he and several other clients of the same agency file a class-action lawsuit.

A 65-year year-old man refuses his insurance company's request to check his credit. He has never used a credit card, nor has he had an accident or traffic citation in 50 years. Shortly thereafter, he receives his renewal statement showing a 20% increase in premium because he did not qualify for a credit-score discount.

Such seemingly illogical underwriting and pricing decisions have been surfacing with more frequency in agents' offices and state insurance departments since 1998 when the use of credit-based insurance scores increased dramatically in the industry (see chart, page 26).

More than 50% of insurers responding to a 2001 survey by Conning & Co. indicated they began using credit data since 1998 for underwriting and risk classification. Today, 92 of the top 100 personal auto carriers surveyed by Hartford, Conn.-based Conning are using insurance scoring models.

But there's growing backlash from agents and consumers who have complained to state regulators and legislatures about the use of credit for insurance purposes and the lack of information about how the scores work. As a result, many states are now considering limitations or outright bans on the practice.

Many of the complaints are coming from consumers who have been adversely affected. A driving record makes sense when making an auto insurance underwriting or pricing decision, says J. Robert Hunter, director of insurance for the Consumer Federation of America, Washington, D.C., and former Insurance Commissioner of the State of Texas.

"If someone is having accidents and tickets, it's logical to expect they'll have future accidents. People understand that," he says. "People don't understand if they got laid off as a result of 9/11 that they suddenly are going to be a worse driver because they are having a little more trouble paying their bills. There's no logical connection."

Insurers cite benefits

Insurers insist that credit-based insurance scores are not illogical. In fact, they argue, insurance scoring is more objective and effective than the traditional methods underwriters use to determine risk.

"Insurance companies want to find very good performing risks and write them at a preferred rate very quickly-and that's what our models allow them to do," says Lamonte Boyd, a manager at Fair, Isaac and Co. Inc., the San Rafael, Calif.-based firm that pioneered the use of credit scores for both lending and insurance.

Fair, Isaac developed what are called "insurance bureau scores" and made them available to carriers about 10 years ago through the main credit bureaus-Trans Union, Equifax and Experian. The scores are produced using a statistical model that Fair, Isaac built after analyzing policyholder data from a cross-section of insurance companies, along with their credit data.

Using proprietary statistical software, Fair Isaac statisticians initially found that roughly 30 characteristics (out of about 130) on the credit reports correlated with policyholder losses-either positively or negatively. The company built its model based on these characteristics. Since then, many insurers obtain insurance bureau scores, while others, including Allstate, Progressive and State Farm, have developed their own statistical models, which are typically designed using their own policyholder data.

Allstate Insurance Co.'s "Insurance Financial Stability" score has enabled the company to develop a much more sophisticated and accurate risk classification system, says Mike Trevino, spokesperson for the Northbrook, Ill.-based carrier. "We're now able to put customers into a number of different tiers within a state," he says. "So instead of telling a customer we can't accept you-and the real reason is that we don't have a price for that risk-today we do have a price for the risk and we can place the business."

Insurers also say they are able to price their policies more equitably-charging higher rates for high-risk customers so that low-risk customers don't have to subsidize them. Several studies-from Fair, Isaac, insurance companies, the Virginia Bureau of Insurance and the Casualty Actuarial Society-have shown a strong correlation between credit history and the likelihood of future loss (see chart, page 24). Policyholders who take more risks with their finances are more likely to takes risks in other areas of their life, proponents of insurance scores argue.

Furthermore, insurers say, the majority of Americans with good credit are paying lower premiums as a result of insurance scores. For example, Progressive Insurance Co., Mayfield Village, Ohio, claims two out of three of its policyholders nationwide have a lower rate than they would if the company did not use credit in its decisions.

But critics dispute these reported benefits. According to the Consumer Federation's Hunter, there's no proof that most consumers are benefiting from insurance scoring or that there's a statistical correlation between credit and risk, because the industry won't share its data for independent analysis and public scrutiny.

"(Insurers) all say 60% (of policyholders) are getting a lower rate, but there's no proof of that," he says. "The average rate is going up fairly steeply. So where's the benefit? Why doesn't it show up in the averages?"

By and large, up until very recently, the insurance industry has not made an effort to educate the public about its use of insurance scoring. The Fair Credit Reporting Act does not require insurers to inform consumers whent they are checking their credit nor to tell them the specific reasons for their score. It does, however, require insurers to inform consumers if an adverse decision (rejection or a rate increase, for example) occurs because of their credit-and to provide consumers with information on how they can receive a copy of their credit report and dispute errors.

Secret black box

Despite the widespread use of insurance scoring, most consumers don't even know that insurers are using it, says Jeffrey Myers, spokesperson for the Independent Insurance Agents of America (IIAA). "It's only for those people where anomalies occur that the issues arise," he says.

In fact, consumers are rarely notified that credit history plays a role in the underwriting and rate-setting process, and they are often not aware when their credit history has affected them negatively, says W. Cloyce Anders, president-elect of Alexandria, Va.-based IIAA.

Agents also have been left in the dark. Insurance companies have been using credit to not renew policies or to raise premiums, without informing agents about how the scores work, why companies are using them, or why a particular client has been adversely affected by them, according to industry sources.

"Agents are on the front lines with consumers, and companies that are using credit information have failed to provide them with an adequate explanation as to why this is a useful tool," says Sam Sorich, senior vice president of the National Association of Independent Insurers, a Des Plaines, Ill. trade association that supports the use of insurance scoring.

The dearth of information on this relatively new underwriting and pricing practice has caused many agents and consumers to ask: If insurance scoring is so beneficial to consumers, then why haven't insurers publicized how it works or shared the specific reasons with agents and consumers for adverse decisions when they're made? Why won't companies such as Fair, Isaac, Allsate and State Farm share their models with the public? Some critics are even accusing insurers of using the scores to discriminate against minorities or low-income people (see article, page 22).

One reason why insurance companies have been reluctant to reveal how credit-based insurance scoring works is because they believe it gives them a competitive advantage.

In fact, the use of scores has grown so rapidly in the last few years because those companies that were not using them were "being adversely selected against," says Fair, Isaac's Boyd. In other words, consumers with low risk were receiving policies quickly from companies using the scores, while those with higher risk were being rejected and falling off to companies that did not use them.

Because of the competitive issue, Fair, Isaac, Allstate and State Farm say they will share their proprietary models with state regulators, but only with the promise of strict confidentiality. "We've spent a lot of time, energy, resources and money researching and developing the model," Allstate's Trevino says.

"To make it public would, in effect, allow a new player to come into the marketplace, copy the model and gain those same benefits without the expense of conducting research as we've done," he says.

Sole criteria issue

Regardless of the arguments about competitive advantage or the benefits to most consumers, the public outcry about using credit in underwriting and rating policies has been loud enough to capture the attention of state regulators and legislatures.

Minnesota's Department of Commerce, for example, receives about 40 calls per week about insurance scores, according to Jim Bernstein, the state's commerce commissioner, an advocate of banning their use.

This year, at least 20 states have considered bills that limit or prohibit credit-based insurance scoring. At press time, Washington and Idaho had just passed insurance scoring bills; Utah had a bill on the governor's desk. And bills were pending in Alaska, Arizona, California, Kentucky, Maryland, Minnesota, Missouri, New York, Ohio, Rhode Island, South Carolina, Tennessee, Vermont and Wisconsin.

One of the reasons insurance scoring is under fire is because a handful of companies have been very aggressive in using it as a sole underwriting determinant in states where they can do that, Boyd says. (About 10 states prohibit it.)

The statistical correlation between credit and risk is so convincing that companies are confident using insurance scores alone, he says. But Fair, Isaac "doesn't want, and never has wanted, an insurance company to use insurance scores as the only factor in making a negative or adverse decision," he adds.

A holistic approach

The "Big I" concurs. "Our position is that credit scoring should not be the sole determining factor in an underwriting decision. It should be a holistic approach that includes credit scoring as an element," IIAA's Myers says.

Insurance scoring is only one factor in the "Strategic Risk Management" (SRM) system Allstate launched in 1999 to classify risk more accurately, Trevino points out. "An example of another change we made is how we price the liability and medical portions of an auto premium using safety data for different vehicles," he says.

Before implementing SRM, the liability and medical portions of a premium were not influenced by this data, he explains. With SRM, they are. Therefore, a person driving an SUV is paying a higher liability portion-because an SUV is more likely to cause damage to other vehicles, while also paying a lower medical portion-because passengers in an SUV are less likely to be injured in an accident.

Using insurance scoring as a sole factor in underwriting and rating is one of many issues being discussed this year in state legislatures. Others include: canceling or not renewing policies due to credit data; using credit characteristics that do not necessarily suggest poor financial management, such as the absence of credit cards or the number of credit inquiries in a report; and penalizing people whose medical problems have affected their credit.

To quell the proliferation of legislation that has resulted from complaints people have about insurance scores, insurers need to reexamine their use of credit information and adopt balanced and reasonable business practices that consider the interests of consumers, IIAA's Anders says.

IIAA holds Progressive up as a model for other carriers to emulate for its positive actions in making insurance scoring more "consumer friendly." Among those actions:

* Progressive informs consumers that it uses credit information.

* It does not use credit scoring to refuse, cancel or not renew coverage.

* It has eliminated certain elements from its formula, such as inquiries that were not initiated by the consumer, which can have a negative impact on a credit report.

* It is developing a more tailored report to provide specific reasons why credit adversely affected a consumer.

* It is working on an exception process for people whose credit data is unduly influenced by extraordinary life events, such as job loss, identity theft or a serious illness.

* The company shares its insurance scoring model with state regulators when requested or encouraged to do so, even without the promise of trade-secret protection.

Indeed, when it comes to providing information about insurance scores, the industry is becoming aware that this issue is so controversial that an extensive education campaign needs to take place.

Breaking the silence

Allstate has taken a step-by posting information about its use of credit scoring on its Web site early this year. It addresses questions such as: Why is Allstate using credit information? What kind of credit information is it using? How is the company using credit information from credit reports? And what type of credit information is generally associated with the best scores?

In addition to developing insurance scoring training seminars, Fair, Isaac is using the Internet to get the word out about insurance scores, launching a "demystification" Web site this month at its InterACT conference in San Francisco. The password-protected site will provide Fair, Isaac customers with educational materials they can use on their own Web sites or in brochures or training programs for agents and consumers.

When asked why insurance companies haven't made this information available until recently, Fair, Isaac's Boyd replies, "I don't know why. But I do know that they are all very cognizant now that they need to be more aggressive in terms of education than they ever have been before."

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