The Texas Department of Insurance is the latest organization to enter the controversial arena of scrutinizing the use of credit scores by insurance companies. Many insurers use the scores to assess risk when underwriting auto and homeowners policies.In December, the department released its preliminary findings to the 79th Texas Legislature. And, because this study is the first of its kind to use actual policyholder data-as well as to undergo academic peer review-industry sources expect it may help to settle a contentious public policy debate.

"Previous (insurance scoring) studies have not gone to this level of detail," says Jim Hurley, spokesperson for the Texas Department of Insurance (TDI) in Austin. "They've only used ZIP code or Census data," he says.

TDI's study, however, is based on data on two million policyholders submitted to the state by six insurance organizations. Researchers have cross-matched their names and addresses or other identifying features with the Department of Public Service database to determine race and ethnicity. "That's never been done before," notes Hurley.

In addition, academicians at Texas A&M University and the University of Texas-Austin are reviewing the TDI research at all phases, including its methodology.

Previous studies criticized

That's important, sources say, because previous studies on credit-based insurance scoring, including one conducted last year by the Missouri Department of Insurance, have been criticized by industry trade groups for poor methodology.

Missouri's study found credit-based insurance scores have a disparate impact on low-income and minority populations. And, allegations of discrimination, as well as a spike in consumer complaints about adverse underwriting decisions by companies using the scoring practice, have caused policy makers to question it.

The majority of state legislatures have addressed the issue over the past two years, with many passing statutes that allow-but limit-the use of credit scores by insurers.

Industry representatives vehemently deny that credit-based insurance scores are used to discriminate against individuals based on race, ethnicity or income.

Insurance companies use credit scores to assess risk, they argue, because there's a proven association between low scores and losses.

"The ultimate issue is risk-based pricing," says Don Hanson, regional manager and counsel for the Southwest regional office of the Property Casualty Insurers Association (PCI), Des Plaines, Ill.

"If you're a believer in risk-based pricing, and if you're a believer in open competition and the American business model, you can't ignore the strength of that correlation."

In fact, TDI's preliminary findings do show a correlation between poor credit scores and increased claims activity. And a 2003 University of Texas study reached the same conclusion.

But TDI also found a relationship between race/ethnicity and credit scores. According to the research, blacks have an average score that is roughly 10% to 35% worse than the credit scores for whites, and Hispanics have an average credit score that is roughly 5% to 25% worse than for whites.

Too early to tell

Despite the urgency of this issue to the industry and consumers, it's not likely to be resolved this year.

The Federal Trade Commission, in conjunction with the Federal Reserve Board, is conducting research on credit scores-as mandated by the 2003 Fair and Accurate Credit Transactions Act (FACT).

The FTC won't release its report until late this year. And, at press time, the Texas Department of Insurance was planning to release additional findings from its research to the legislature at the end of January.

"It's too early to tell what Congress and state legislatures will do about the use of credit scores in insurance," says TDI's Hurley.

"But at least now, when we have public policy debates on this issue, we will have scientific data rather than rhetoric on which to make decisions."

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