What is Credit Scoring or "Insurance Score"?

Insurance Credit Scoring is a relatively new theory in the insurance industry. The theory states that a person's personal credit history is a predictive indicator of two factors relating to insurance: Frequency and Severity.

Frequency refers to the number of claims an insured could be expected to report or turn in within a specified amount of time, or the "policy life" of an insurance customer.

Severity refers to the potential dollar amount of an indiviual claim an insurance company might reasonably expect to pay out during the "policy life" of an insurance customer.

The insurance industry maintains and supports the theory that a person's personal credit history (late payments, slow pays, charge-offs and bankruptcy) are indicative factors of predicting future losses. In short, the theory states that individuals with a "poor" credit history will expose the insurance carrier to far more claim (Frequency) and higher dollar settlements (Severity) in settling these claims.

Statistical studies have been done that show this theory to be true. One of the most famous studies was performed by the University of Texas Bureau of Business Research. You can download this sixteen page study here.

The use of Credit History as an underwriting factor is legal in Oregon. However, there are restrictions insurers must follow in practice:

1. Prohibitied Uses: Oregon law specifically addresses unfair discrimination by prohibiting use of income, gender, address, zip code, ethnic group, religion, marital status, or nationality. It prohibits insurers from using credit information as the sole basis for denying, canceling, or nonrenewing coverage, or for determining renewal rates. It prohibits adverse action solely because a consumer does not have a credit card, or if a credit report or an insurance score is calculated over 90 days from the date the policy is written or renewed. It establishes standards for allowing insurers to consider absence of credit or inability to calculate a credit score in the underwriting and rating process, and it requires insurers to recalculate the insurance score using an updated credit report no less than every 36 months following the last occasion on which the insurer obtained credit information on the insured. The model also prohibits insurers from using several discrete factors in insurance scoring methodology. These include credit inquiries not initiated by the consumer; inquiries relating to insurance coverage; collection accounts with a medical industry code; multiple lender inquiries from the home mortgage industry within 30 days of one another; and multiple lender inquiries from the automobile lending industry within 30 days of one another.

2. Dispute Resolution and Error Correction: If it is determined through dispute resolution (as set forth in Fair Credit Reporting Act) that credit information of a current insured was incorrect or incomplete and notice is provided to the insurer, the insurer must re-underwrite and re-rate that consumer within 30 days. The insurer must also make any adjustments necessary to comply with its underwriting and rating guidelines, and refund any overpayment to the insured.

3. Initial Notification: Insurers or their agents must disclose (either in writing or in the same medium as the application for insurance) on the insurance application or at the time the application is taken that credit information may be obtained in connection with the application. The model also provides example disclosure statements.

4. Adverse Actions: If an adverse action (defined to include denial, cancellation, increase in charge for or a reduction or other adverse change in the terms of coverage) is taken, the insurer shall provide notification (in accordance with requirements of the Fair Credit Reporting Act) to the consumer and explain the reasons behind such adverse action, including up to four factors that were the primary influences.

5. Filing Requirements: Oregon State law requires insurers that use insurance scores to underwrite or rate risks to file their scoring methodologies with the state department of insurance, which may include loss experience justifying the use of credit information. All such filings are to be considered trade secrets.

For more information regarding the use of credit scoring in general, this is an excellent study done the the Insurance Information Institute here.