The credit score has been a pillar of how we work, spend and save since the 1990s, especially when it comes to determining auto insurance premiums. But recently, the legitimacy of the credit score is being challenged by Washington Insurance Commissioner Mike Kriedler and Root Insurance for not being as “unbiased” as it once seemed to be.
Telematics change the insurance rating equation
Historically, insurance companies have used credit-based insurance scores to set rates, stating that these scores accurately predicted risk and presented a correlation between credit and the chances of a customer filing an insurance claim. Being able to pull historical data and access information of drivers with bad credit can differentiate high-risk drivers from lower risk drivers, which helps insurance companies avoid risk.
But with the rise of telematics and usage-based technology being used to determine car insurance rates based on driving performance — including harsh braking, rapid acceleration, mileage, time of day driven and mobile device usage — the need for credit scores doesn't seem as accurate, definitive or informative as we once thought.
Currently, the use of credit scores in determining insurance rates differs state by state. Washington state announced in March 2021 a ban on the use of credit in setting insurance rates for new and renewed auto, homeowners and renters insurance policies, as of June 20, 2021. The APCIA initially challenged the commissioner’s request, stating that most consumers actually save money when credit scores are considered when determining insurance rates, as it may enable insurers to shift higher costs to the riskiest drivers. But by May, more than 50 insurers in the state complied with the commissioner’s order, impacting around 1.3 million policyholders’ rates. Some of these insurers include GEICO and Metromile. The state is now urging the NAIC to bar insurers from using credit-based insurance scores in premium calculations. Credit-based insurance scores consider other factors to help determine an individual’s score, including outstanding debt, credit history length, loans and more.
In addition, the Federal Reserve Bank of New York suggested credit scores may have become less reliable during the coronavirus pandemic. Not only did 2020 see an unemployment surge, the country’s largest forbearance options that allowed borrowers to delay payments for as long as 18 months and federal payment relief checks, meaning credit scores may not be as accurate as before the pandemic. According to New York Fed researchers, borrowers’ credit reports were treated as if they were making continued payments for credit-scoring purposes and account histories, when roughly 13% of borrowers were actually in forbearance at least once in the past year. According to researchers, “the concept of the credit score, a device to distinguish good borrowers from bad borrowers, may lose some of its power in signaling creditworthiness to lenders, at least for some time.”
More states restrict usage of credit as a rating factor
- California, Hawaii and Massachusetts don’t use credit scores to determine auto insurance premiums.
- New Jersey also passed a bill in February 2021 that bars insurance companies from using credit scores, education levels and a host of non-driving related metrics when setting auto premiums.
- Nevada temporarily banned the use of credit history during the pandemic.
- Colorado passed a bill banning insurers from directly or indirectly using any external consumer data and scoring model that “unfairly” discriminates against an individual based on membership in a protected class.
- Maryland, West Virginia, Illinois, Oklahoma and Louisiana have recently seen legislative activity around the same restrictions.
Alongside states making legislative moves, some carriers are actually evolving their business models to exclude credit scores from their underwriting processes altogether. Root, a usage-based insurance carrier, plans to remove the credit scoring model from its underwriting process by 2025, stating that using these scores is inherently biased. The insurtech states that its opt-in nature of the program in addition to the clear line between how driving behavior impacts a customer’s rate will increase the trust between the insurer and the insureds. The insurer states that it is working with regulators, partners and industry stakeholders to make this change and hope to inspire other companies to join in fighting discrimination, bias and systemic inequity in auto insurance. Loop, a B-Corp auto insurance MGA, also states that using credit scores, income and zip code is not a fair way to price people and instead plans to use AI-technology, big data and telematics to create more fairly priced insurance products.
With all these initiatives delegitimizing the concept of the credit score, it will be interesting to see if it causes a divide between companies or states that use it and those that don't in the car insurance industry. Today, credit scoring is allowed in 47 states, is used by the 15 largest auto insurers in the country, and is applied to over 90% of all U.S. auto insurers.