Credit scoring

Broadly speaking, people who buy consumer goods and pay their bills on time tend to be the more desirable customers for providers of goods and services. That holds true for insurance as well, because these customers tend to have fewer insurance losses and claims.

The lengths to which marketers go to attract certain customers is fairly well known and accepted, but when insurance companies use an individual’s credit history and other so-called “lifestyle factors” with traditional underwriting tools to determine, first, whether they want that individual as a customer, and then, what products they’ll offer and at what price, it raises questions about fairness.

Some insurers consider credit scoring to be a powerful and effective underwriting tool because it identifies the desirable and undesirable market strata; however, it does so according to a purely mathematical formula. Even though the credit reporting agencies state that they don’t collect data on medical history, race, ethnicity, etc., people who don’t fit the formula are more likely to be in disadvantaged sectors such as young, low-income or elderly people, first-nations and immigrant groups, people in the midst of marital distress, and those who simply choose to deal on a cash basis and not rely on credit. In an insurance context, these people may find themselves unable to obtain coverage or unable to afford the premiums quoted to them.

Canadians are heavy users of credit, but are relatively naïve about it; in a 2003 MasterCard Canada survey more than one-quarter of Canadians indicated that they didn’t know what a credit rating is.

According to the Canadian Bankers Association, in 2006 there were 61 million Visa and MasterCard credit cards in circulation in Canada with a net volume of $243 billion charged to those cards. According to a study by the Public Interest Advocacy Centre in 2005, 17% of Canadians had checked their credit rating with the previous three years (in most cases while applying for more credit); of those 18% found inaccuracies on their credit report, and it took an average of four hours (half a day of work time) to correct the problem. Consumers usually only take steps to correct inaccuracies in their credit history if the inaccuracies are preventing them from obtaining a loan or mortgage. And they are generally reluctant to lodge complaints against financial institutions, taking the view that to do so is too time-consuming and futile.

While consumers are advised to regularly check their credit rating, this can actually be detrimental after a point because repeated credit queries can appear statistically as loan applications for which no loan is granted.

Because insurance credit scoring has potential for error and/or discrimination, and the potential to deprive consumers to access to affordable coverage for their assets, many U.S. states and some Canadian provinces have prohibited it, or placed stringent regulations on its practice. Canadian privacy legislation requires that consumers provide informed consent for the use of information beyond that required to fulfill specified purposes. But some financial institutions collect blanket consent to share information with their other operational divisions and for undisclosed purposes. And some insurers point out that they use credit scoring only to offer discounts to preferred customers, not to raise rates to other customers; however, because a certain amount of premium has to be collected to meet solvency requirements the customers who don’t get the discount still pay a higher rate.

Alberta’s superintendent of insurance in December 2008 issued a notice that insurers could be fined up to $25,000 for requiring a customer to consent to a credit report as a condition of obtaining a policy premium quote. The Financial Services Commission of Ontario has amended its regulations to prohibit underwriting or risk classification on the basis of credit history, residence history, occupation, employment status and level of income.

For information on the above: Trudy Lancelyn, IBABC, 604-606-8008, or click here.