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CAS: Insurers Should Consider Alternatives to Credit Scoring

Source: Casualty Actuarial Society


Posted on 14 Apr 2010

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Insurers will need to develop additional analysis techniques to help them assess risks if they can no longer use credit in the underwriting process, attendees of the Casualty Actuarial Society (CAS) Ratemaking and Product Management (RPM) Seminar were told.

Roosevelt Mosley, a principal with Pinnacle Actuarial Resources, Inc, said that credit scoring is a recurring topic and that insurers’ ability to use it continues to be under attack.

Mosley noted that this year, around 26 bills have been introduced in state legislatures around the country that targeted insurers’ use of credit. “This issue is not going to go away,” he said.

In addition, a number of studies and court cases as well as anecdotal evidence, public perception, and the credit crisis have brought the issue of credit scoring in underwriting into the spotlight again.

“In the last couple of years, the credit crisis and related economic troubles have served to reenergize the debate,” he said.

Mosley observed that there have been a number of recent state actions related to use of credit in insurance. For example, Idaho issued a credit crisis warning about a year ago related to insurers’ use of credit related information in a time of economic downturn and Michigan is awaiting a Supreme Court decision on whether insurers can use credit in personal lines.

Mosley cited Maryland which banned the use of credit in homeowners in 2002, as an example of what can happen when credit scoring is removed.

“The ban resulted in some rate inequities from a cost perspective and a little bit of a shake up in market share and industry loss ratios. However, the end result was that the market did not collapse. We did the best we could with the market that was there,” he explained.

Mosley said that when credit is removed, insurers need to recalibrate current factors and consider additional variables that may have been deemed insignificant when the credit score was included. “We should focus on the reasons that credit works,” he said.

Insurers should look at other variables that demonstrate the characteristics of responsibility, risk-taking behavior, and stability that go into the insurance scoring model. Payment history, accident and violation history, and number of years an individual has been insured and employed are some of the other variables to consider, Mosley said.

Eliade Micu, actuarial consultant, EagleEye Analytics, agreed that the use of credit scoring in underwriting is a controversial issue that is not going away any time soon. “The current economy and the political climate have brought this issue to the forefront again,” he said.

Micu observed that insurers have a range of options available to them regarding the use of credit and possible alternatives to credit. “Insurers can do nothing and take a wait and see approach, which effectively means wait until the legislature bans credit completely.

“Other companies have taken a more practical approach. They have a class plan that is generalized linear model (GLM) based, so they try to tweak their class plan to make up for the signal lost when you take credit away,” he said.

Micu noted that insurers taking this approach have a chance of making up some of what is lost when credit is taken away.

Another approach is to go outside of the class plan and use additional behavioral variables, such as payment history. “This has a better chance of working. You may find some useful variables that you should have had in the class plan,” he said.

According to Micu, insurers that look to go outside the class plan and find other predictors stand the best chance of making up what is lost by not using credit.

The Casualty Actuarial Society fulfills its mission to advance actuarial science through a focus on research and education. Among its 5,100 members are experts in property-casualty insurance, reinsurance, finance, risk management, and enterprise risk management.


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