Center for Legal & Responsible Commerce

Another Regulatory Failure

Most State Insurance Regulators Are Failing to Perform One of the Two Primary Functions

of an Insurance Regulator

The purpose behind creating departments of insurance in each state was twofold. The first was to ensure that insurance companies were adequately capitalized. The second was to ensure that insurers were not engaged in price discrimination. For this reason, departments of insurance were given the power to compel insurers to file their underwriting and rating criteria with the department. Depending on the state, the insurer even has to get permission to implement new rating and underwriting criteria.  

Discrimination in insurance takes many forms, but two of the most prevalent and most accepted forms of discrimination are in discounts for buying multiple insurance policies from the same insurer and use of credit scores for rating and underwriting.

Discrimination in insurance was originally defined as charging two people who pose the same risk a different rate. Despite this straightforward and widely accepted definition of discrimination, few if any insurers that advertise fail to advertise the fact that they offer multi-policy discounts, new customer discounts, discounts for switching insurers before the prior policy is set to expire, etc.... These discounts are discriminatory on their face and yet few if any regulators have banned these discounts. While it is understandable that no insurance regulator, some of whom are elected, wants to be blamed for discounts not being available in their state, allowing these discounts actually harms competition. By barring discounts that are not directly related the individual's or entity's risk, insurers would be forced to be more competitive on their base rates, and would not be in a position to disadvantage smaller insurers who do not offer multiple lines of insurance. Further, by allowing new customer discounts, insurers are capable of concealing the true cost of the policy, since many insurers do not itemize their discounts when courting new customers. Further, allowing discounts for having multiple policies allows for discrimination against those who do not own a home, boat, need life insurance, etc... This takes us to the second, and more insidious form of discrimination, credit score discrimination.

Credit scores correlate poorly with risk, but allow insurers to conceal discriminatory practices from regulators. Not only has the insurance industry refused to produce for public inspection the research that it claims supports the use of credit scores in underwriting and rating, but common sense proves that this is not likely. Credit scores are a poor indicator of how likely one is to pay a loan (the intended purpose of the credit score), and were created to give the facade of an objective and easy to understand indicator of risk. However, the use of credit scores is problematic for three major reasons. First, the same activity (e.g., closing an account not being used) can result in one's credit score going up or down. As a quick search of the Internet will prove, there are numerous strategies for gaming the system to inflate one's credit score. Second, since there are multiple credit reporting agencies and no consistent method for reporting to all three major agencies, there is a decent chance of inaccuracies appearing in one's report. Third, one's credit score is likely to reflect socioeconomic factors that are unrelated to one's insurance risk. One's home is not more likely to burn down because they have a low credit score. Based on what has been reported about credit score trends, credit scores are being used by insurers to engage in redlining without actually having to take out the map, or use race as an explicit criteria in their underwriting/rating formulas.

Until insurers are willing to share their research with the public, and allow their claims to be tested by researchers not being paid by the insurance industry, insurance regulators should bar the use of credit scores in underwriting and rating. However, given that many regulators seek jobs in the insurance industry after leaving their regulatory position, you may wish to contact your legislators and pressure them to enact legislation barring the use of credit scores for underwriting and rating. Until that happens, you can try to avoid doing business with insurers that use credit scores for rating and underwriting purposes by refusing to give your social security number when requesting quotes. This will not only hamper an insurer's ability to use your credit score, but should prevent them from obtaining your credit report. The later is important because the "hard inquiry" of an insurer will drive your credit score down. Finally, by withholding your social security number until the application is submitted, if the insurer comes back with a higher premium or refusal to insure, you will know that an adverse action was taken against you based on your credit score. Insurers often fail to comply with this requirement of federal law which requires notification and a free copy of the report(s) on which the insurer based its decisions.