Texas study vindicates use of credit scoring

The second phase of the study on credit scoring engaged by the Texas Department of Insurance (TDI), has found the use of credit scores in underwriting “significantly improves pricing accuracy when combined with other rating variables in predicting risk”, according to insurance commissioner Jose Montemayor.Montemayor, who has been publicly skeptical of credit scoring, undertook the studies at the request of the state legislature in order to determine if credit scoring is an accurate predictor of risk and also whether it was biased against certain races or income groups.The first phase of the study did find some connection between certain racial groups and credit scores, although Montemayor notes that not all racial minorities had disproportionately low scores. In a letter to the state governor and legislators, he writes, “as Commissioner, I have the authority to end a practice that is either unfairly or intentionally discriminatory. However, I do not have a legal basis to ban a practice that has a disproportionate impact if it produces an actuarially supported result and is not unfairly or intentionally discriminatory.”He adds that to do away with credit scoring would mean doing away with almost all other forms of underwriting criteria as, by their very nature, they produce a disproportionate impact (i.e. they raise or lower rates). “Effectively, we would ban risk-based pricing and underwriting and revert to a pricing system where we homogenize the risk and essentially charge everyone the same price – regardless of risk. That would be a set-back to all Texans, of all races, especially those of moderate to lower income whose risk remains low.”Montemayor says despite his “initial suspicions” that credit scoring was a coincidental variable, with a superficial impact, the study reveals credit scoring is “justifiable actuarially and it adds value to the insurance transaction”. He adds that putting a “collar” on how much impact credit scoring can have (e.g. it can only produce a 5% change in rate either way) would have a similar impact to removing it as a rating criteria altogether prices would go up for a great many people. And, he concludes, “banning credit scoring overnight, by rule or law, creates pricing and availability disruptions in a market that has just stabilized and begun a rebound”.Insurers were not surprisingly pleased by the results of the study, with Property Casualty Insurers Association of America (PCI) president Ernst Csiszar noting, “the bottom line is that insurance scoring helps to lower insurance premiums for most consumers, which makes insurance coverage more available and affordable”.