Lansing Mulls Credit Scoring Ban

July 2, 2004
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LANSING — Michigan’s Office of Financial and Insurance Services is considering a proposed change to the state insurance code that would ban credit scoring in determining rates for homeowners’ and auto insurance.

In proposing the change, Gov. Jennifer Granholm said a ban on insurance credit scoring would cut base insurance rates.

But one industry official told legislators that base rates aren’t the same as insurance premiums, and that the net result of the proposal might be higher premiums.

According to OFIS, the base rate is the premium before discounts are figured in. Insurance credit score models were designed to predict future insurance losses by comparing actual policyholder loss performance data from insurance companies with corresponding credit bureau data of the policyholder.

OFIS argues that insurance companies increased base rates to recoup the cost of discounting premiums for consumers with good credit ratings. The new rule would eliminate credit scoring, which OFIS estimates would result in a base rate decrease of 10 to 45 percent.

The OFIS Buyers Guide to Auto Insurance report indicates that since 1999, average automobile insurance has risen 45 to 90 percent, depending on location.

Homeowner rates increased 86 to 152 percent over the same time period.  

Gov. Granholm claims the rise in rates has put homeowners and auto insurance out of reach for many Michigan residents, and that a better process would be to offer discounts based on actions consumers take to reduce insurance risk, such as installing a smoke detector or a car alarm.

Consumer advocates claim minorities and low-income people are being denied insurance or are being overcharged because of undisclosed scoring methods, some of which they say may be irrelevant.

Michigan’s Essential Insurance Act requires that discounts for insurance be applied uniformly throughout the state, and that rates be based “on a reasonable classification” under the code.

OFIS Commissioner Linda Watters said the use of credit scoring “does not meet the requirements of a valid discount” under the Essential Insurance Act.

“The unreliability of the data in credit reports alone violates the intention of the insurance code,” Watters said upon announcing the proposal. “Credit reports are fraught with errors, and consumer scores can vary from ‘high risk’ to ‘low risk’ depending on which credit reporting agency an insurer uses.”

Watters said there’s no industry-wide standard mathematical model for use in insurance credit scoring, which makes it impossible for consumers to know how a given insurance company will determine their credit score.

According to the American Insurance Association, having a good insurance score does not necessarily mean a person is a good driver or a more responsible homeowner.

However, AIA maintains that “research has shown that consumers with better insurance scores generally file fewer claims and have lower insurance losses.”

Bob Pierce, CEO of the Michigan Association of Insurance Agents (MAIA), said that all the research MAIA has seen shows a correlation between a person’s credit score and that person’s propensity to file insurance claims. He said states that have done studies have determined that credit scoring is a valid rating factor.

One concern is that consumers don’t know how insurance credit scores are derived and what they can do to improve their scores.

The MAIA, along with OFIS, has been working on legislation to standardize insurance scoring so that it’s more uniform from carrier to carrier. House Bill 5803, introduced in May, and Senate Bill 884, introduced earlier this year, are the results of those efforts.

The legislation would give a remedy to people who feel their insurance score is adverse. The measure also would require insurance companies to furnish consumers the four main “reason” codes that impact their credit scores, Pierce noted. 

Pierce said the MAIA is surprised OFIS has focused just on auto and homeowners’ insurance rather than some other financial services with a larger impact on consumers.

“If there are these issues with credit scoring, than that should cut across all financial services areas,” he said.

“We would think that the commissioner that also regulates banks and lending institutions would be focusing the same concern on all financial institutions.

“If you get a mortgage, they rely on your credit score to determine what rates you get. One might argue that the impact of an erroneous credit score on what you would pay on a mortgage would have a much greater financial impact on a consumer than what you might pay for your auto insurance.”

Pierce said banning credit scoring will raise premiums for some Michigan consumers.

“The insurance losses remain the same. Somebody’s going to pay less if you ban credit scoring, but inevitably someone else has to pay more. It would appear that the people who would pay more would be the people with good credit histories.”

Kent Shantz, an agent with Van Tol, Magennis & Lang Inc., said insurance credit scoring creates an additional work step for insurance agencies. So at first blush, he said, it might seem like doing away with insurance scoring is very appealing.

But Shantz — who is with the insurance company representing the Kent County Association of Insurance Agents — said a good share of the population receives a fairly substantial discount. So if insurance scoring ended, he said, there’s a good chance that the population that has fairly respectable credit scoring would see a rate increase.           

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