‘The Juice’ on Credit Scoring

It may seem crazy to think it, but there are some strange parallels between baseball’s steroid crisis and the credit scoring and insurance issue that recently blew up in the Canadian media.

First, both issues are basically about cheating; as such, they raise questions surrounding what the rules should be governing the practice.

Second, and perhaps more importantly, both issues mask fundamental questions about the recent financial health of the industries involved, which should be of greater concern for all of the parties involved.

The alleged use of credit scoring for the purpose of underwriting auto insurance — contrary to prohibitions in Ontario — went mainstream in February 2009, when daily media started receiving consumer complaints.

Reacting to these reports, the Financial Services Commission of Ontario (FSCO) and the Registered Insurance Brokers of Ontario (RIBO), the province’s regulatory bodies for insurers and brokers, respectively, each issued bulletins reiterating that insurers in the province are prohibited from using a consumer’s credit information for the purpose of underwriting and quoting auto insurance premiums.

Predictably, just as in the steroids scandal down south, the media are shouting “off with their heads” and trying to expose alleged “cheaters” — i. e. insurance companies that have allegedly used credit scoring to pad their underwriting stats on the auto insurance side. And just as in the steroids scandal, rooting out and shaming the names of the cheaters is too narrow a focus.

If the credit scoring issue has legs, it’s because credit scoring involves a lot of complicated systemic issues. The practice raises a lot of legitimate questions. If, for example, credit scoring is allowed for the purpose of underwriting home insurance lines, then why should it be prohibited for use in auto lines? You would think the rationale for using credit scoring would be equally valid for either insurance line — i. e. a consumer’s credit score indicates how cautious a policyholder may be with their money, thus giving insurers an idea of what kind of risk he or she might represent either as a homeowner or as a driver.

The public policy concern is that insurers might decline to accept an auto risk based on a driver’s financial habits. This would practically amount to a de facto prohibition against low-income drivers with a poor or no credit rating. This is a problem when provinces have laws on the books requiring insurers to “take all comers” because insurance is a requirement for all drivers.

As in baseball’s steroids scenario, regulators in the insurance industry are reacting to media reports by promising to enforce the existing rules.

What they might consider doing instead is to lead the debate about whether the existing rules make sense and are in fact enforceable. Should credit scoring be banned entirely, or should it be allowed in all or some insurance lines? Is this properly an Insurance Act matter, or does it come under the jurisdiction of Canada’s privacy legislation?

The CCIR took this kind of initiative in a host of other debates, often employing a consultation paper to generate discussion. There’s no reason to think the same approach wouldn’t work here.

The sad part about watching third baseman Alex Rodriguez confess to using steroids way back in 2003 is that his team, the New York Yankees, just spent half a billion dollars to sign up three star players during the off-season. (What insurer couldn’t use US$500 million in capital right now?) This raises fundamental questions about baseball’s long-term financial viability. And yet, the steroids issue has thus far hijacked any such discussion.

In the Canadian insurance scene, at the same time the credit scoring issue is going public, shrinking capital test scores and ratings downgrades have raised questions about the declining financial fortunes of the industry as a whole.

Existing credit scoring rules do need to be enforced. But the current financial health of the insurance industry (particularly in these tough economic times) should probably be the focus of regulators and the public right now, and less so the credit scoring issue.