Issued and entered this 13th day of May 2003 by Linda A. Watters Commissioner
Insurance credit scoring is problematic at best. Perhaps
no other widespread practice of insurers presents so many technical and
social issues. Consider the following:
- Credit scores are grounded in credit histories that are compiled
by credit reporting agencies. According to a study by Consumers Reports,
there are serious errors in approximately 30 percent of those files.
- There are three main credit reporting agencies. They do not all receive
information from the same sources. Due to this, according to a recent
study, an individual's insurance credit score may vary by as much
as 40 points depending on the credit reporting agency from which an
insurer obtains the score.
- Even where the credit history is the same, there may be substantial
differences in an individual's insurance credit score depending upon
which insurance credit scoring company is used.
- Insurers determine an individual's discount by seeing where
the credit score falls in its discount tiers. Some insurers have only
two or three tiers. One has 46. Some insurers have maximum discounts
of 10%. Three insurers have maximum discounts of 70% or more.
- The discounts drive up base rates. All policyholders are subject to
these fundamental increases. This has the appearance of a surcharge
on persons with low insurance credit scores, which is not allowed for
automobile and home insurance sold on an individual basis.
- Discount plans on insurance sold to persons on an individual basis
are only allowed where they reflect reasonably anticipated reductions
in losses or expenses. Insurers have not demonstrated such reductions.
- The connection between a credit history and insurance losses is not
understood. Consumers are justifiably wary of a system where a large
amount of the premium they pay is determined by seemingly unrelated
factors, such as whether they use department store credit cards.
- Some responsible credit management conduct, such as changing from
a high interest credit card to a low interest credit card, may lead
to lower insurance credit scores. This is because some systems treat
frequent changes in accounts negatively.
- Despite the crucial importance of an insurance credit score to the
determination of discounts, almost universally insurers do not disclose
the credit score to an applicant or policyholder.
- Despite having access to key factors that led to a lower score, almost
universally insurers do not disclose these factors to an applicant or
- Many insurers fail to comply with requirements in federal law for
giving applicants and policyholders notices of adverse actions based
upon credit histories. As a result, consumers do not know why their
premiums are high and that they may obtain a free copy of their credit
reports so that they may find and correct errors.
- Some studies indicate that the use of insurance credit scoring has
a disproportionate, negative impact on young, old, and low-income persons
Such considerations led Governor Granholm to call for a ban on the use
of insurance credit scoring altogether. In February, two bills were introduced
that would ban the use of insurance credit scoring in the rating of automobile
and home insurance. One would ban its use for insurance sold to persons
on an individual basis. The other would ban its use for insurance sold
to persons on either an individual or group basis.
If a ban cannot be achieved, at least significant reform legislation
is imperative to protect the interests of consumers on such an important
matter as the amount they pay for automobile and home insurance. This
agency will be fully supportive of the Governor in these matters.
In the meantime, it is incumbent upon the Commissioner to make the most
of current law in addressing the concerns above. Bulletin 2003-01-INS
was designed to conform insurance credit scoring practices to Insurance
Code requirements. A revision to the Bulletin and clarification as to
the Fair Credit Reporting Act will advance the consumer protection objectives
underlying the Bulletin.
The third directive in the Bulletin provides:
3. Companies using an insurance credit scoring discount must recalculate
and then apply an insured's insurance credit score at least once annually.
This approach was taken to promote rate accuracy. As insurance credit
scores age, they become less predictive of losses. Without periodic rescoring,
rates may become unfairly discriminatory in violation of MCL 500.2109(1)(c).
Periodic rescoring also brings about fairness in rates in another sense:
policyholders whose scores have substantially improved will receive the
higher discounts they deserve.
An improved, alternative approach is available to achieve the same consumer
protection goals. Under this approach, rescoring is required only at the
request of the policyholder. This avoids the expense of routinely rescoring
individuals where little or no change has occurred. It lets a policyholder
who has reason to believe his or her score has improved to seek a discount,
if not yet receiving one, or a higher discount. It avoids subjecting policyholders
to the potential loss of discounts each year.
In light of this, the third directive in the Bulletin is revised to read
3. At the request of an insured, a company using an insurance credit
scoring discount must recalculate and then apply the insured's insurance
credit score at least once annually.
This alternative will work well only if the policyholder has sufficient
knowledge about his or her insurance credit score and discount tiers to
make an informed decision. This underscores the importance of the seventh
directive from the Bulletin:
7. Companies using insurance credit scoring must annually inform their
automobile and homeowners policyholders or applicants of the credit
score used to apply an insurance credit scoring discount, and the discount
tier in which the insured or applicant is placed.
Most insurers rely on ChoicePoint or Fair, Isaac for insurance credit
scores. These insurers receive or have access to factors that were the
primary influences that adversely contributed to a given score.
Insurers are strongly encouraged to notify consumers of these factors
in clear and specific language. This will place consumers in a better
position to know whether to ask for rescoring. For example, under one
system, a late payment is no longer taken into account after 24 months.
This would be one factor to consider at renewal by a policyholder whose
old, late payments are no longer being taken into account.
In the long run, consumers will also be able to achieve lower premiums
by improving their credit management practices. This benefits companies
as well as policyholders, for lower premiums promote policyholder retention.
Insurers will need to make changes to basic systems to put annual rescoring
upon request into effect. This will include making changes to annual notices.
Reportedly, many insurers will be able to make these changes within two
Accordingly, the Commissioner expects insurers to achieve compliance
with the statutory authority underlying the third and seventh directives
by July 1, 2003, or as soon thereafter as practicable.
Notices of Adverse Actions
While not a directive in the Bulletin, insurers were reminded of their
responsibilities under the Fair Credit Reporting Act as follows:
To further compliance with the federal Fair Credit Reporting Act, under
which states may bring enforcement actions, insurers are reminded that
the Act requires them to inform applicants and policyholders of any
"adverse action" stemming from the use of credit histories
in the rating or underwriting of insurance. As interpreted by the Federal
Trade Commission, an adverse action occurs where an applicant or policyholder
is placed in any rating tier other than the one that would produce the
Information contained in credit histories is used by lenders in deciding
to make loans, by employers in making hiring decisions, and by insurers
in deciding to underwrite coverages and the price of those coverages.
In light of the crucial importance of these decisions, Congress passed
the Fair Credit Reporting Act to promote the accuracy of the information
assembled by credit reporting agencies.
A key element of the Fair Credit Reporting Act is that users of credit
histories, including insurers, must give notice to a person where an adverse
decision is made based upon information in a credit report. The person
is informed that he or she has the right to obtain a free copy of the
credit report and may challenge and correct wrong information.
Based upon the reminder set forth above, some insurers were apparently
concerned that OFIS would try to bring a compliance action against them
under the Fair Credit Report Act. However, enforcement and interpretation
of the Act rest largely with the Federal Trade Commission. Additionally,
the chief law enforcement officer of each state is authorized to bring
actions under the Act. In Michigan, that is the Attorney General.
Therefore, the Commissioner's role will be to turn over accurate
information respecting the lack of required notices to the state Attorney
General or the Federal Trade Commission. Those officials will decide whether
to bring enforcement actions.
Submitting this information will promote insurer compliance with the
notice requirements of the Fair Credit Reporting Act. A given insured
may be paying hundreds of dollars in premiums each year based upon incorrect
information in his or her credit history. A notice of adverse action lets
the policyholder know the cause of the high premium and gives the policyholder
a chance to correct his or her credit history.
By reporting information to the state Attorney General or the FTC, OFIS
could be instrumental in bringing the benefits of the Fair Credit Reporting
Act to insurance consumers in Michigan.
Any questions regarding this bulletin should be directed to:
Office of Financial and Insurance Services
Division of Conduct Review and Securities
Product Review Unit
611 West Ottawa Street
P.O. Box 30220
Lansing, Michigan 48909-7720
Phone: (517) 373-4948
Toll Free: (877) 999-6442